Q3 2019 Earnings Call
Good day, everyone welcome to the earnings call for Western Alliance Bancorporation for the third quarter of 2019.
Our speakers today or Ken Vecchione, Chief Executive Officer, Dale Gibbons, Chief Financial Officer, and Robert Sarver Executive Chairman you May also be as a presentation today via webcast through the company's website at Www Dot Western Alliance Bancorporation dotcom.
The call will be recorded and made available for replay after two PM Eastern time October 18th 2019 through November 18th 2019.
Nine am eastern time by dialing 187734475 to nine passcode 10134684.
The discussion during this call may contain forward looking statements that relate to expectations beliefs projections future plans and strategies anticipated events or trends and similar expressions concerning matters that are not historical facts. The forward looking statements contained herein reflect our current views about the key.
Current events in financial performance and are subject to risks uncertainties assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results.
It was expressed and any forward looking statement.
Some factors that could cause actual results to differ materially from historical or expected results include those let's sit in the filings with the Securities and Exchange Commission.
Except as required by law the company does not undertake any obligation to update any forward looking statements.
Now for the opening remarks, I would now like turn the call over to Ken Vecchione. Please go ahead. Thank you operator, good afternoon and welcome to Western Alliance is third quarter earnings call. Joining me on the call today are Adele and Robert I will provide an overview of the quarterly results and Dale will walk you through the banks funny.
Actual performance in greater detail and then afterwards, we'll open up the line and Robert deal and I will take your questions. During the third quarter. We continued advancing our key strategic objectives, which include leveraging our branch like business model to drive disciplined and thoughtful loan and deposit growth carefully managing our balance sheet with regards to.
Asset sensitivity pursuing accretive capital allocation policies and de risking our loan composition, all while being unique in our ability to drive industry, leading growth and efficiency across changing market environments worsened alliance produced another record quarter with robust loan and deposit growth.
Which generated continued increases in net interest income in earnings per share our combination of regional banking and national business line lending drove loan growth of 19% on a linked quarter annualized basis, as we saw a wide ranging broad participation across our businesses.
We achieved annualized net interest income growth of 18% with total revenue growth of 22 plus percent as we produce positive operating leverage all why well de risking our balance sheet and improving asset sensitivity. This was achieved against the headwind of a challenging yield curve.
As discussed on our prior earnings calls, we expect ongoing loan origination volume offset net interest margin compression and produce continued increases in net interest income. So let me go through a few of the key highlights.
Net income during the quarter rose, 3.6% to a record $127.4 million or 14.6% year over year, our earnings per share grew 4.2% to $1.24 per share and 18.1% from the prior year.
When she growth continues to be exceptional and exceeded our guidance of $600 million per quarter for both loans and deposits total loans were $20.2 billion, an increase of $903 million were 18.8% on a linked quarter annualized basis and had risen by 2.4 billion over the last.
Three quarters on a year over year basis loans rose by 20.4% with $1 billion of growth coming from the residential program.
Part of our strategic de risking plan, we viewed review residential loans as a fourth pool responsible alternative to managing our loan growth, while deepening our warehouse lender relationships residential loans now comprised 9.3% of our portfolio during the quarter, we also reduced our construction and.
Land and development loans by $55 million lowering their proportion in our overall portfolio to 10.7 per cent compared to the 12.6% in quarter. One this puts us within striking distance of our 10% target for year end 2020 with opportunities to bounce future readout.
Actions, we had another stellar quarter in deposit growth, which really highlights the continuing strength of our diversified funding channels and overall deposit franchise. This quarter total deposits grew over $1 billion or 18.7% on a linked quarter annualized basis to $22.4 billion.
Which is the third consecutive quarter of more than $1 billion in organic deposit growth.
This growth was attributable to an increase in savings and money market accounts of 1.2 billion Boes, primarily driven by our tech in innovation business due to a healthy capital fundraising environment noninterest bearing demand deposits rose another $78 million to 8.8 billion and over 1.3 Bill.
One of our year to date deposit growth has been in D. ace.
D.A. as a percentage of total deposits declined slightly to 39% from 40% in Q2 overall the loan to deposit ratio remained consistent at 89.8% compared to the prior quarter continued balance sheet growth drove healthy net interest income expansion of $11.7 million in Q3.
Or 18.4% annualized well confronting yield curve headwinds, which resulted in an 18 basis point reduction in NIM to 4.41% NIM compression was driven by recent pressure on the yield curve increased deposit liquidity and continued de risking of our loan portfolio partially.
The offset by proactive steps taken to reduce our deposit rates all of which Dale will speak to in greater detail later in the call total operating revenues grew 15.2 million for the quarter compared to an expense increased 7.7 million producing a two times revenue to expense growth ratio and inefficient.
See ratio of 42.4%, we remain one of the most profitable banks in our industry and produce return on assets of 1.94% and return on tangible common equity of 19.4%, we believe our ability to simultaneously drive industry, leading growth and efficiency.
He differentiator our financial results were accompanied by continued stable asset quality as the markets. We operate in are experiencing some of the strong economic growth in the country.
Nonperforming assets were $66 million down 4 million from the prior quarter and remain at near historical low levels. During the quarter, we had net recoveries of $600000 and loan growth in low loss categories, such as residential which resulted in a provision expense of $4 million.
Turning to capital management on display this quarter was our ability to thoughtfully managed capital allocation between loan growth and share repurchases last quarter. We paid our initial quarterly dividend of 25 cents per share. We also continue to opportunistically repurchase shares during the quarter we purchase.
Just 1 million shares at 43 Dolphin 63 cents, bringing total program repurchases to 3.6 million shares at an average price of 41059 cents overall the share count has been reduced by 3.4% through repurchases since the initiation of the stock buyback.
Program in Q4, 2018, we anticipate using the remaining $99 million available under the current plan as opportunities present themselves given all these actions tangible common equity ratio absorbed the significant balance sheet growth and share repurchases and was 10.1% at quarter end.
Down only 10 basis points from prior quarter, but up 10 basis points from the prior year period tangible book value per share grew 3.9% or 95 cents from the prior quarter to $25.60 and now has grown by 225% over the past five years as.
We continue to scale our business.
Additionally, our asset sensitivity profile has improved as variable rate loan floors are increasing deposit costs are quickly being adjusted and our loan portfolio continues to shift into longer fixed rate residential loans.
Spec asset sensitivity will continue to improve with additional rate cuts as more loan floors are trigger.
Finally, lastly, I'd like to thank the 1800 people at Western Alliance that did a fantastic job to produce these financial results this quarter and now Dale will take you through the financial performance.
For managed balance sheet growth resulted in record earnings despite headwinds from a flattening yield curve preceding the anticipated fed rate cuts net interest income rose 11.7 million or 18.4% annualize the second quarter 266.4 million driven by a 1.8 billion increase in average, earning assets, which outweighed.
Reduce loan yields hurt for the corresponding period last year net interest income was up 13.8%.
The provision for credit losses was 4 million for the quarter, a decrease of 3 million from the second quarter due to net loan recoveries during that period in the mix shift to high quality residential loans.
Noninterest income increased 5.2 million for the COVID-19 point Fourmillion its equity investment income from our check and innovation segment and gain on sales of investment Securities increased 2.9 million in 3.2, respectively.
Non interest expense was up 11.7 million, it's compensation cost and deposit cost increased by 5.2 million at 3.9 million, partially offset by 2.9 million decrease in professional fees.
Compensation costs were affected by increase accruals for annual performance incentive plan.
Deposit cost were elevated by 2.2, and a half million due to a single client to maintain higher than anticipated balances throughout the quarter, but is ending balances were zero, we do not expect a repeat of this activity in Q4.
We also experienced a 3.4 million dollar loss on sale in Oreo property, which was essentially offset by the securities gains.
Share repurchases to date reduce the diluted share count to 102, and a half a million shares resulting in diluted EPS of $1.24.
As Ken mentioned, a bit 250 million authorization, we repurchased a total of 151 with 99 million remaining.
Turning now to our deposit drivers net interest income rose 11.7 million during the quarter to a record 266.4 million.
Investment security yield decreased 26 basis points from the prior quarter to frio, eight due to a flattening yield curve and lower reinvestment rates.
Lower long term rates increased mortgage prepayment speeds in the resulting accelerated amortization of premium was responsible for lowering the overall quarterly portfolio yield by 16 basis points.
On a linked quarter basis loan yields decreased 19 basis points due to reduction in interest rates in spreads.
Further impacting that lining yield was our intentional mix shift toward residential loans in the decline in LIBOR, which preceded cut from the fed funds rate right.
Interest bearing deposit cost decreased by five basis points in Q3 to 1.3% as result of proactive steps taken to reduce our deposit rate immediately after the fed rate cut.
During the quarter, we lowered our rates on approximately $6.2 billion of exception price deposits with a weighted average reduction of 23 basis points.
Additionally, after the fed announcements, we reduced our stated rates on a 5.2 billion of interest bearing non maturity deposits by an average of 29 basis points.
This decrease funding cost by six basis points when all of the company's funding sources are considered including non interest bearing deposits and borrowings.
However, due to our decision to time rate reduction coincident with fed rate announcement. The full effect of these actions are not reflected in the third quarter results. We expect that the effective cost of reliability finding was down to 80 basis point at the end of Q3 compared to the 87 basis point average.
The strategic shift in our loan mix away from construction and the reduction in market rates weighed on the margin, but was more than offset with improved revenue from our consistent balance sheet spansion driving a net interest income increase of 11.7 million for the quarter.
Given no change in the economic outlet this will be the theme for ongoing performance that we can continue to earn through NIM compression.
Net interest margin decreased 18 basis points to 4.41% during the quarter, it's our earning asset yield fell 24 basis points, partially offset by six basis points of funding costs decreased.
The largest component of the margin decline this were from the sharp change in the relationship between LIBOR and fed funds during the quarter as the outlook shifted from a rising to declining rate.
With nearly half of the bank loans tied to LIBOR or loan yields began declining in the second quarter, however deposit costs could not be reduced until after the whimsy.
The target fed funds rate at the end of July compression between these two rate indexes reduce the margin by nine to be 18 basis point total decline.
The increase in our on balance sheet liquidity drove another seven basis points of the margin contraction as our strong balance sheet deposit growth resulted in 550 million increase in average cash balances during the quarter.
Finally, two basis points of the reduction was due to de risking our portfolio from the ongoing shift into residential loans and lower construction loans.
Looking ahead margin volatility in the fourth quarter should be much lower as the basis risk issue from a change in direction of rate behind this excess liquidity a deployment should continue even with additional cuts to the federal funds target as expected.
With regard to or asset sensitivity our rate risk profile has declined notably as our mixed shift primarily to fixed rate residential loans has reduced our net interest income variability due to the changes in the rate environment.
Meanwhile, 2 billion of our variable rate loans are now behaving as fixed since the rate wars are now active after the first two rate cuts we've already had.
This is reduced our interest rate risk in the 100 basis point parallel shock lower to 4.8% at September Thirtyth from 6.6% at June Thirtyth.
As we stated last quarter, we believe a ramp down is a much more probable rate reductions scenario, which would further reduce our rate risk profile by another 60%.
We believe a 1.8% reduction in net interest income in this situation. It's something we can quite reasonably managed through with continued balance sheet growth earnings through margin compression like we did in the second and third quarters of this year.
Of our $14 billion variable rate loans 9.3 billion EUR, 66% have floors with 2 billion in the mining.
With each additional 25 basis point rate cut another 1 billion of loans with floors will be triggered which reduced the sensitivity in the shock scenario by another 50 basis points further mitigating our recent margin compression.
Turning now to operating efficiency in Q3, we produced another strong quarter of operating leverage while continuing to invest in new product and business initiatives to drive ongoing growth.
On a linked quarter basis, our efficiency ratio increased 40 basis points to 42.4%.
As I mentioned earlier, a significant portion of the deposit costs and or re expense are onetime in nature and not likely to be repeated in the fourth quarter.
On a taxable equivalent basis operating revenue increased 15.4 million to 288.9 million in the third quarter 2019, compared to an operating expense increase of 7.7 million to 122.6 million generating operating leverage of two times.
As a core component of our strategy in irrespective of the rate environment. We continue.
Continue continued disciplined expense management and credit underwriting to maintain industry, leading operating leverage and profitability.
Our pre provision net revenue return on assets was 2.44% and our away was 1.94%. These metrics continue to be in the top decile compared to peers.
Our balance sheet momentum continued during the quarter as loans increased 903 million to 20.2 billion in deposit growth of 1 billion brought our deposit balance 22.4 billion at quarter end.
Our loan deposit ratio remained essentially flat at just under 90% are ample liquidity position continues to provide us with balance sheet flexibility to pursue attractive risk adjusted lending opportunities.
Tangible book value per share increased 95 cents over the prior quarter in $4, a 90 cents or 23.7% over the prior year.
Our industry, leading financial performance is a direct result of the powerful combination of commercial banking relationships within our regional footprint and our national business lines.
Total loans were 20.2 billion, an increase of nine 903 million driven by increases in non owner occupied commercial real estate 346 residential loans. The 282 in Cnine loans were 275.
Residential loans now comprised 9.3% of our loan portfolio, while construction loans have decreased by another 55 million and make up 10.7% of total loans versus 11.5% at the end of the second quarter.
Regarding deposit growth and further demonstrating the strength of our franchise deposits grew 1 billion in a third quarter driven by an increase in savings in money market accounts of 1.2 billion.
This growth was partially offset by a net decline in mainly higher cost Cvs of 221 million. This is the third consecutive quarter of more than $1 billion in organic deposit growth.
Over the past year deposits grew across all categories with the largest increase in savings in money market of 2 billion and non interest bearing DDA sub 141 million.
Year to date deposit growth has been $3.3 billion, which nearly 40% has been nvidia.
Over the past year loan growth of 3.4 billion with fully funded by deposit growth of three Uh huh.
We believe our ability to profitably grow deposits is both a key differentiator and a core value driver to our platforms long term success.
Overall asset quality continues to remain stable total adversely graded assets increased $40 million during the quarter to 439 million Especial mentioned credits increased 36 million to 88 basis points of total assets.
From the prior year total adversely graded assets have increased just 81 million or two basis points to 1.72% or total assets versus a 3.4 billion rise in loans.
Nonperforming assets comprised of loans on non accrual and repossess real estate increased marginally to 66 million or 25 basis points. The total assets and continue to hold steady as of a portion of the balance sheet.
Regarding the increase in special mention credits looking back over five year period loan bit of migrated to special mention has less than a 1% risk of loss as it is an early potential stress indicator that had little correlation to loans, becoming nonperforming.
Overall, we see nothing in our portfolio that raises concerns or indicates a change in credit outlook as we expect asset quality ratios to remain at historically low levels relative to do overall size of the balance sheet.
Gross credit losses of 2.1 million during the quarter were more than offset by 2.7 million in recoveries, resulting in net recovery of 600000 or one basis point with total loans annualize.
The credit loss provision of 4 million decreased from the prior quarter due to this net recovery position in the change in the loan origination mix.
Servicing related to our loan growth increase the allowance for loan lease losses to 165 million.
15 million from year ago, resulting in a reserve of 85 basis points of non acquired loans at September Thirtyth.
For acquired loans credit discounts totaled seven and a half million at quarter end, which was 95 basis points of the remaining 788 million to purchase loans, primarily from the bridge Bank and hotel franchise finance transactions.
Finally, we continue to generate significant capital and maintain strong regulatory capital ratios with tangible common equity a total assets of 10.1% and it's the ratio of 10.3.
Despite the payment of our first quarterly dividend of 25 cents per share in the buyback of 1 million shares our tangible book value per share rose 95 cents in the quarter and it's up 23% in the past year.
Notably our production rate of tangible book value is in more than three times better the peer group over the past five years given capital requirements. The banks operate under we believe that consistent capital creation is fundamental value creation.
Turn it back to Ken.
Thanks, Phil.
On display this quarter was the advantages our diversified business model that provide us the flexibility to actively adapt our business and capital allocation strategy in response to the changing external environment without sacrificing credit quality the combination of our regional banking and national business line lending provided powerful growth.
The net interest income loans and deposits our business model generates positive operating leverage growth in high quality loans industry, leading aro way or are we and meaningful tangible book value per share growth.
Within our market today, we have observed little change in business activity as our loan and deposit pipelines remained strong we expect loan and deposit growth on average to continue at the same level as our prior guidance of $600 million in loan growth per quarter fully funded by core deposit growth.
Despite a challenging interest rate environment, we expect net interest income to continue to rise as volume increases from residential purchases higher earning assets and our growing loan pipeline will overcome potential net interest margin compression.
The repositioning upside I should say net interest margin compression and the repositioning of our asset sensitivity and projected rate actions. So to summarize we continue to generate robust loan growth, while reducing risk had exceptional deposit growth of over $1 billion for the third consecutive quarter grew net interest income 18% annualized.
Continue to maintain stable asset quality at historical low levels grew year over year net income by nearly 15% and EPS by 18% positioned the company to carry forward its momentum through the fourth quarter and into next year, and we reduced asset sensitivity and further insulated ourselves in a down rate environment.
So operator at this time, if you would open the line and Robert down I would be happy to take your questions.
Thank you we will now begin the question and answer session to ask your question you May Press Star then one on your telephone keypad.
Our using a speakerphone please pick up their hands that before passing the keys to withdraw. Your question. Please press Star then to at this time, we will pause momentarily to assemble our roster.
The first question today comes from Michael Young with Suntrust. Please go ahead.
Hey, good morning, good afternoon or two thank you.
We ended the last call with unsolicited comment on M&A submitted all started this call with.
Solicited comment on M&A, where do you feel the appetite is for acquisitions at this point or should we take the activity on the share buyback is just seeing embedded value in buying your own stock at this point.
Yes, it's Robert I would say probably more the ladder.
I mean, we're continually evaluating the best use of our capital on a daily basis looking at a lot of deals but.
As of now we've chosen to.
Invest in our own Brandon organic growth and to repurchase our own shares so I would say probably more the ladder.
Okay, and then just on the one to four family purchase strategy Im curious if you could just talk about.
It sounds like you have a pretty strong appetite to continue that as a de risking measure but.
Any anything changed relative to the drop in 10 year rates and the yields you're able to get on that paper and just seasonal impact capital.
Allocation to that or anything like that any any changes in strategy there.
And no change in strategy, we still think it's a very effective method, which do extend the duration of our assets and do so with something that should perform quite well should an economic downturn.
Presents health at sometime in the future so rates are lower than what we're getting initially going into the program, but we're still getting into the into the lower fours in terms of yield.
These are really good quality.
Underwriting that 60, 768% loan to value 760 FICO.
Mid thirtys on debt to income and were able to do this because we're buying things that maybe don't quite fit in the box from our mortgage warehouse originators that would be qualified so so some of these are loans that have an io period in the beginning some of these are loans that are not necessarily primary residences.
But by well heeled borrowers so we're continuing to execute on that and and we think it's we think it's really helping in terms of our interest rate risk management.
Theres one other thing to add to that which is it puts us closer to all warehouse lender. So we now have another product to offer them. In addition to warehouse lines MSR lines.
No financing getting deeper with the deposits and now picking up some of their volume on a forward flow basis.
Gives us an opportunity that remain close to that.
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The next question today comes from Tim Your Brazil, or with Wells Fargo Securities.
Hi, good morning.
Thank you.
First of all for me Dale you had mentioned a couple of times that there was a large deposit on the books for the quarter that that has now exited just wondering what's the size of that deposit.
That was a little over 500 million average balance for the quarter. It's we still have a relationship with the client, but that but those deposit dollars were zero at quarter end.
Okay, and then maybe sticking with deposits.
Certainly quite encouraging to see the drop in funding costs. This quarter I know from prior conversations you guys had been proactive in addressing the deposit rates kind of right. After the fed has caught.
I know the full impact of what's been done already will be reflected in the fourth quarter results, but going forward that proactive approach does that reduce ability to lower deposit costs. Further on additional rate cuts or are you expecting to see similar magnitudes for each incremental we see well I don't know how how.
Great low rates are going to go I mean, if we got to the zero band I mean, eventually you're going to get some compression in terms of ability to cut but this is where the floors becomes so effective because as as rates get lower a greater proportion of our loan portfolio becomes a effectively fixed rate. So it's an asymmetric kind of a return in that.
If and when rates ever go up again, we should actually have increased sensitivity on the other side. So so yes, I mean, if rates continue to drop substantially at other.
A number of.
Cuts from here you are going to see some compression, but but the floors will be stronger hey, we've moved pretty quickly immediately after the two rate cuts and what we noticed as many of our competitors did not so I think as they catch up to US next quarter on the next cut then there will be less opportunities for our clients to go else.
Aware and don't see the same action among many more banks.
Okay. That's good color and then just.
If I could one more looking longer term and this rate drop environment are you guys still think and I wanted to have to one kind of revenue to expense level is still achievable.
In 2020 or is that really dependent on how how many additional rate cuts are going to be.
Look going forward, we expect to continue industry, leading and peer group operating leverage.
As part of our strategic growth management programs, we have a core discipline of expense management.
Then the company I do not expect that to change and will bounce that.
Against the delivery.
On platform expenses in services and also new product expenses that we may spend so we'll do what's right for the company as we go forward.
Understood. Thank you.
The next question today comes from Brad Milsaps lets Sandler O'neil. Please go ahead.
Hey, good morning, guys morning afternoon.
Hey, maybe kind of a three part question around credit you guys have excellent asset quality numbers, but just kind of curious kind of bigger picture you know kind of what you're seeing in the credit environment in terms of pricing underwriting and then just any additional color on what drove the increase in the adversely rated credits understood that's coming off a low base.
But just kind of any color there and then Dale.
Just any color around Cecil might also be helpful. Okay.
Okay. So I'll take parts, a and B and we'll give dale potency. So a general quality a general statement asset quality remained stable our portfolio looks fine we see no economic stress from the economy.
As I always say, we see more self inflicted wounds, whether it be partner dispute. So our company's expanding to quickly or ill time will poorly executed acquisitions or poor coal cost controls those drives some of the stresses in the companies that we're dealing with as a general statement, though I'll say.
Say that we believe we're at the top end of the expansion. So therefore, we are lending as if the expansion is coming to an end even though this is not our opinion. So we're trying to grow safely thoughtfully.
Very.
Conservative managed way as it relates to some of the activity this quarter I.
I think what's important to know is our credit process and philosophy. So our credit process is based on early identification and resolution. So we like to identify early elevate early and that creates more resolution options and it also creates them sooner for us. It also go.
Honors early executive level attention. So many people are on any loans that you. The fall into this special mention category or fall into substandard and so in reality, we cycle loans in we cycled amount I'm really talking about special mention here.
That do drive a little bit more special mentioned in terms of dollars, but the real reiterate what Dale said only 1%. The ball special mentioned loans are charged off as we look at that over the last five years. So I'd end by saying there really has no trend in our special mention composition, it's all back to self inflicted.
Owns or or companies that are beginning to show some weakness that we want to make sure we attend to right away.
Regarding Cecil Brad as you know this is something that's going to be done on the first of next year independent upon economic conditions at that time.
But we expect a charge of about 20 basis points of our of our capital position.
At adoption based upon current situation and that would cover both the reserve build as well as reflecting what we need to do for unfunded commitments.
That's helpful. Thanks, I know, it's early but would you expect kind of provisioning to sort of track to keep the reserve. It at that result at level.
Yes, it could be so if thats, a 20, 30% increase in.
In the in the reserve that provisioning given the same economic outlook, we probably have a comparable rate of increase.
Great. Thank you guys really appreciate it.
Your next question today comes from Casey Haire with Jefferies. Please go ahead.
Great. Thanks.
Good morning, So a question on the loan deposit growth guidance.
It just feels a little bit conservative given the performance year to date, especially on the deposit side, which is.
Averaging about 1 billion or our quarter and Ken to your point it sounds like business activity is still pretty good. So just trying to get a feel for.
Why or why the conservatism in the guidance.
So.
We say it averages $600 million certainly on the deposit side Q4, seasonally a slow quarter for us in deposits all right. So I keep that in mind and sometimes you know whether it be on the loans or deposits its hard to control when deals get completed. So for example in Q1 on loan growth was only 400 mill.
The involved so these things have an ebb and flow to it and so what we like people think is on average it should be 600 million some quarters it will be far more and occasionally we will be less.
Okay.
Fair enough.
And then just on the liquidity side.
What is.
What is the or how optimistic are you that you can can work down the.
The the excess liquidity and is there just given the deposit momentum is there any thought to getting a little bit more aggressive with this with the securities book.
Especially with I mean, the deposit initiatives that you have on MACOM.
Could potentially build this your deposit momentum could it could accelerate so I'm just trying to get a sense.
Ill liquidity drag could be here to stay for a decent while if the if these trends continue.
Yes, it could contain it could continue to look at a drag I don't expect it to increase from where we are as you know kind of how we got here for the third quarter is we had a substantial run up in deposits going into the end of the second quarter and that was elevated throughout the third quarter, and then came down a bit as of the last day. So so I would.
Expect and we did purchase some securities I'm sure you saw that too we are fully opens up it was up a bit in Q3.
You know given the seasonal outlook that Ken just mentioned in terms of the fourth quarter I think we're going to burn off some of that liquidity drag and we'll look at this on an ongoing basis.
Rather than loading up and securities and buying RAIT residential mortgage backed which is mostly what people purchase I rather deployed into our residential purchase program.
So certainly a better return for us and so we'll see how that plays out, but but I think liquidity drag is likely to have a little bit at least.
Gotcha and just last last one from me that the hotel franchise finance.
That is.
That has been growing last year. So is it I thought the plan was just sort of to maintain that or is.
Just just wondering what's what's behind the apathy increased appetite to grow that that portfolio.
Well, we like that product and we're growing it and what we think is a prudent way so.
With low loan to value loan to cost numbers.
With sponsors that are well capitalized and only working with operators as well that have maybe a dozen or more hotels with top brands.
In top and essay.
Areas and primary and primary secondary locations in those top emmis phase. So when we have some opportunities and we have deals that meet that entire criteria, we put our money into the hotel group.
We don't expected to increase proportionately to the to the loan portfolio from here, though I mean, we had an increase in that in the third quarter on some of that's going to be sold down at some other things going on so I think this is or proportionately kind of high watermark.
Great. Thank you.
The next question today comes from Arren Cyganovich with Citi. Please go ahead.
Thanks, Yeah, I think the thing that stands out from for me is is you have the strong organic growth and we agree in terms of our model that you can outgrow the NIM. The the skeptic in me, though is a little bit worried about the the level of growth in the potential.
Credit quality associated with that.
Good history in the past several years of delivering on credit could you can you give any kind of examples of maybe some of that conservatism that you're taking in terms of this growth. So that we give give folks a little bit more comfort in terms of that credit outlook.
Yes, let me start with that.
I think our business models, a little bit unique in that we have a lot up.
Different products in a lot of different markets that we lend money too.
And because we have so many different channels and types of businesses were lending too.
We can look for better risk adjusted returns as opposed to the typical bank our size that may be does commercial lending commercial real estate in consumer.
So we're in so many different niches.
That we're able to reallocate capital on a current basis to niches that provide us protection into down economy, and that's what we've been doing for probably the last three or four years. So if you look at where the growth is coming from.
And then you look even further within that growth at the underwriting standards I think you'd be pretty.
Pretty comfortable.
We have a number of things we're not doing as much of that we used to do.
And so we're just really able to kind of change where we allocate the funds.
And we use that to kind of mitigate our risk and as I said look for the best risk adjusted returns.
Yes, just to add a few things that.
To what Robert said this quarter store over 100 million dollar increase in capital call lines to Robert's point, very very low to no losses in that business product resort finance went up again, we've never had a loss there and the team that's running that has never had a loss in over 30 years resi.
Dental portfolio that Dale mentioned, very strong and asset quality as well so thats. The some some numbers maybe or examples behind the model that Robert mentioned.
Yes, Mike as an example, some of the things we don't do as much of today, because we think that the market hasn't price the risk properly or maybe it's the risk levels aren't there would be restaurant franchise finance some of the corporate syndicated credits a corporate finance group. These are areas. We've we've cut.
Back on.
Because we think the market is maybe a little too aggressive on.
Yes.
I'd throw solar lending in there too.
Yeah good point.
Thanks, that's helpful. I appreciate that the.
Second question I had was just on kind of the re get recent weakness in some of the valuations of.
Technology Unicorns et cetera are you seeing any anything from here.
Northern California, or your technology and innovation.
Businesses that would be impacted by these lower valuations.
So what we're seeing is first they're having a very very strong capital raising activities and a lot of our deposit growth. This quarter came from there.
We're seeing loans churn at a little bit faster rate generally are the average maturity of our loans is three and a half years for our entire portfolio, but it's much much less than that.
In the tech and innovation.
We're seeing.
We're seeing some aggressiveness on pricing and structure from.
Newly established competitors.
But we're not following that because we think theres enough activity for us to pick and choose what it is that we like.
And.
Also in that in tech and innovation, we're putting a little bit more capital allocation to our capital call lines strategy.
Okay, but nothing from a from a valuation standpoint.
Cause any negative impact to your balance sheet.
No okay. Thank you.
The next question today comes from Chris Macquarie of KBW. Please go ahead.
Great. Thanks.
Maybe deal for you in any given your prepared remarks, you said given the strategies with the floors in the deposit pricing.
The pressure on NIM.
Maybe a little bit less severe kind going forward, maybe you could.
I'll make some initial comments in terms of severity, especially with the comments on liquidity coming down a little bit for Q4.
Sure so so.
These floors, we have two from our efforts to rate cuts. We've got 2 billion into money. The next one I will put another $1 billion in the money. The one after that goes to about 1 billion too and then 1 billion for so we're gradually becoming kind of one dimensionally kind of fixed rate on our loan portfolio should rates kind of continue to fall and.
And then.
Meanwhile, we continue to have expectations that we're going to be able to respond quickly based upon Fedex that we've got to another alco meetings that for October thirtyth right. After they meet if they move we're going to move and I think that helped us in the third quarter and now that that now that the shift in kind of the basis is behind us where LIBOR is.
No longer anticipating fed rate increases I think that that is will mitigate the risks that we have in terms of kind of further rate thats from here.
Okay, and with a focus on I mean, if we get a cut in October .
We should still given the balance sheet momentum you still see commensurate growth of Eni that we saw maybe this quarter that is that reasonable well I think I think the net eni growth will be slower in the fourth quarter. So in the third quarter that was the inflection point for the margin change at 18 basis points.
I think the fourth quarter is going to be the inflection point for the change in terms of net interest income. So I'm looking for while the margin drop should be substantially less I'm looking for a lower growth in terms of net interest income we're going to get the the effective potentially as many for rate cuts that are going to have an influence on fourth quarter net interest.
Net income the one the one in July the one in September the one in October which we believe is going to happen then maybe it's a little bit if we get the fourth one in December versus only two rate thats affected the third quarter number.
Okay, but even under that scenario it sequentially I'll be hires what you're saying.
Yeah, we yeah, we believe we'll be able to exceed where we were in Q3.
And maybe just one more.
The expense line the deposit costs, you talked about this quarter being kind of just one off.
But if we look over the last couple years, obviously that numbers, it's grown considerably as rates have risen how do we think about that expense line into 2020 with rate cuts is that these are correlation that number should come down or is it kind of setting that 70 million Bucks a quarter. Yeah I think in the fourth quarter I think we're going to look a lot more like we did in the second quarter than the third.
If we get additional rate cuts hobbies that that will release pressure on that number and it should otherwise at lower except that to the degree we're continuing to move our deposit liabilities that will be a countervailing effect. So I'm not sure exactly how that necessarily going to sort out, but but I would look for the third quarter number is being.
Essentially a blip that will the will largely reverse.
Great. Thank you.
The next question today comes from Tyler Stafford with Stephens. Please go ahead.
Hey, good morning last quarter I wanted to start on I guess first on expenses the salaries increased due to the estimated corporate bonus payout that you mentioned in the deck I.
I know for 20 tenure achieved 130% incentive pay out. So I was just hoping you could give us delson details about.
How much of accrued so so far in 2019, and what incentive reduction Tailwinds you might see just given a tougher in Sri backdrop. If you do just achieve that I guess hundred percent baseline going forward.
Yeah. So so we're north of 40 million here in terms of estimated accrual for for bonuses in 2019.
And.
That number yes, I mean.
That number it could be variable the pace, depending on kind of what we're going to be doing in terms of performance against the against the budget when approved in the beginning of 2020. So I mean, the big driver for US in terms of the change from where we were estimated where we were at 630 versus now is really in demand deposits. We we've got an okay.
Goal in there you can see it in the proxy in terms of what that number was four four core.
Core demand and we now believe that we're going to achieve that in where we were somewhat uncertain about that earlier in that kind of move the needle for us. So I can't speak to what the specific goals are going to be like for 2020, but but we have the expectation as we've stated that that we're going to continue to be able to earn through kind of.
Where we are in terms of margin compression and and I think something that would set up that would enable that to be a variable item should we fall short.
Okay, Yes, no doubt the fundamental results you guys put up this year warrant that higher incentive comp I until I get that can you tell us what that 40 million is I guess relative just to a baseline number for 2019.
So the baseline number would be about about 30 by 10 million higher okay perfect.
And then just last from me just on on the mortgage warehouse could you tell us what those average balances were for the third quarter.
The average balance for the for the for the mortgage warehouse balances.
Don't have that number in front of me I'm gonna have to we'd have to get with the afterwards.
Okay, all right. Thanks, guys.
Thanks.
Justin Today comes from Matthew Clark of Piper Jaffray. Please go ahead.
Hi, good morning.
Good morning, Chip that do you happen to have the spot rate on interest bearing deposits at the end of September .
Well, so I said 80 basis points, which was a blended number including DTA. So if you back that back out you're going to be.
Basically divided by about 0.6 or something like that so.
Got it.
Yes, I missed that.
When filing.
Okay.
And then just on.
The buyback I guess any sense for.
Any change in appetite going forward when I'd like to slow that down to some degree or.
Vice versa.
Okay.
He said, we've got about $100 million left in the authorization.
I think.
Looking at levels of under two times book in under 10 times current earnings to us seem fairly attractive so.
I'm not going to tell you exactly what will buy and how much but the program is going to continue.
Okay, and then Dale I think last quarter, you talk to you know forever.
Fed rate cut five basis point impact to NIM.
If you add back to liquidity down seven I know the timing of the fed cut was the two cuts were.
I wanted to started the quarter either but.
With these floors come into play I mean, how do you think about that guide.
Ted to cuts kind of integrate premier here going forward.
Yeah, I think that I think the two cuts than the and that five bips per cut it was basically borne out and what I'm, what I'm labeling. The you know the basis risk that we happened in the in the third quarter I think I don't think that includes liquidity. Obviously I think we're basically on track with that and as such we're looking for emerging from price.
Can substantially less in the in the fourth quarter relative to the third it was brought up earlier that we do have a kind of a countervailing element that is if you get a lot lower rates from here.
We're going to run into compression on the liability side repricing, which I think offsets what we're doing on the on the on the loans and then the fours related to that so I would say the relevant range is that still a fairly decent kind of metric five bips per quarter for.
For up to two or 3.2 or three additional cuts.
Okay, great. Thank you.
The next question today comes from Jon Arfstrom with RBC capital markets. Please go ahead.
Thanks, Good morning.
Morning.
Hey.
Ken can give us an update on the deposit initiative progress I think we ask you that every quarter and it seems to get a little better but give us the latest.
Yes.
This both moving along.
The deposit initiatives number one is active brought in.
Balances last quarter it held those balances this quarter and.
We continue to move and slow, but steady pace, ensuring that we have the right customer service and technology to satisfy our customers Tech now.
Product initiatives number two just went live this quarter. We just had our first sales meeting the other day planning out how we're going to grow that so really not much to add there, although they have gotten some balances and.
Which surprised us all.
Okay. Good.
And then a question on on the floors.
You made a comment about getting ahead of the competition I'm just curious are.
These forward that were already in place or you went out and ask for them or you're doing it on renewal.
Help us understand that process.
Well, there's been an integral part of our credit underwriting process for years through this whole way Stoke.
It's all its only lately Ben a topic of discussion.
Broader sense.
Okay.
Difficult conversations at all with clients, if you're saying your peers aren't doing this at all.
Maybe but you know.
Thats offset by the reliability and convenience that we give them and.
You know, we're able to get them.
I think maybe more banks use floors than you think John .
Okay, Yeah, it's a brand new topic for us and obviously.
Can you made a comment.
But your acting as if you are coming to the end of the expansion, even though it's not your opinion.
For conversation leads me to believe were action is if you are acting as if rates are going much much lower even though you may not believe that that is that a fair statement.
That's right, but it doesn't hurt to have these floors.
Okay alright, thank you.
The next question today comes from Brock Vandervliet with you BS. Please go ahead.
Oh thanks.
I figure you're not going to use the floor here to talk about 2020 guidance are you already would've done so but just directionally.
As you think about margins and and I.
Now assuming two or three more cuts I wouldn't I would expect at some point youre now the the asset yields reset more quickly.
And then you get a catch up on the funding side, causing a longer term lift as we kind of pure around the corner and a in NIM.
Is that fair.
Analysis.
In terms of your balance sheet.
Well I think Directionally. That's that's that's right I mean, we're focused on the net interest income so as we head into next year.
We set a few times.
We expect to overcome many NIM compression. We also expect asset quality remained flat and for us to manage our expenses are appropriately.
I think it could play out that way Brock I mean, we're dialing in three more rate cuts I think we have some skepticism whether it will be that many particularly if maybe maybe Brexit gets done in a little more better results in competence coming out of Europe , which I think it's been a factor in terms of whats affected the rate environment here, but but I think you paint a scenario that has.
Some reasonable probability of playing out.
Okay and.
As a follow up.
Year to date, roughly how much of the deposit growth is coming from tech and innovation.
Give me a second on then I'll give you an answer.
And I guess is there any aspect of those deposits that you would you would flag in terms of being.
Yes, more volatile on and perhaps tying back to what looks like a very conservative guide on deposit growth.
So I answer your first question.
Our technology group generate over $700 million.
For this year.
You would then look at the now.
Life Science added a little bit, but an equity resources add a little bit but most of that comes out of the tech and technology sector I'm sorry, what was the second question.
Second question is is it just is there a inherent.
Volatility to those deposit flows that you would you would call out the perhaps ties back to your you know seemingly pretty conservative guide on on deposit growth overall.
Yes, I think thats a good observation.
You can see that happened they raise money for a reason.
You can see.
Some of our companies being taken out.
And purchase which then you'll see flow through our fee income line through equity in warrant income and therefore, our loans may soften a little bit and then that's incoming and outgoing.
Would be our customers using their cash to buy other companies.
And hopefully we tie into loans that they need for that but they will use their equity and cash before they pull down on our loans. The deposit growth. We've had in that sector has exceeded that of the bank. Overall, it's also very low cost very attractive to us, but yes. It is a bit lumpier and it does have a greater volatility and in summary.
Specs, a little little more difficult in terms of forecasting than some of the other elements of our funding sources, but historically if you look at it bridge bank over the last in excess of 15 years.
Including multiple cycles of money coming into money going out they've grown their deposits every year.
Got it okay. Thanks to the color.
The next question today comes from Dana CIMB Verine of Wedbush Securities. Please go ahead.
Hi, Thanks, a couple of questions first on the mortgage warehouse business, how much of the deposit growth was related to mortgage warehouse in the quarter.
So it's kind of it.
Mortgage warehouse, probably grew this quarter, a little bit less than it normally does.
So our under under 10%.
Oh, sorry.
They grew about sorry about 40 million of the $1 billion in deposits.
Okay. That's good in a in respective seasonality heading into the fourth quarter and then do you. Similarly on mortgage warehouse do you happen to have.
The period and balance of loans outstanding you mentioned you didn't have the average balance.
But did you happen to have the period end.
Yeah.
It is one just on the 1.8 billion.
Great.
And then shifting back to the floor conversation. So the typical average life you mentioned for the overall portfolios three and a half years is that the same for the loans that have floors that the average life is three and a half years.
I mean to four loans tend to be probably tend to be a little bit shorter.
I mean, the commercial real estate tends to be a little more fixed rate.
And so and so it's going to be it's going to be on the shorter side of that two and a half to three years I would say.
But it's an exception to not have a floor in a floating rate loans.
And each time these loans are renewed I imagine you know if the interest rate environment is coming down at the floors would come down as well when a new floors put in upon origination is that correct me for the most for the most part floors are either at or.
Moderately below 25 to 50 basis points below the current below the current rate using using the metric, though what the index to off of prime or LIBOR.
Lately, that's not the case, we put on a number of loans in the third quarter and into the fourth quarter, whereby the loan the fixed the fixed rate portion of the alone is active I.E. that rate is higher than what the index plus the spread would be on a floating rate base. The floors hit before we did the loan yeah, that's simple way of saying.
Got it Okay. That's helpful. And then final one from me going back to.
Credit.
With the increase in special mention loans 36 million I know you said there is less than 1% risk of loss on those loans, but curious as to either what industry or loan category kind of made up the the increased this quarter.
Yes, there is there's nothing in terms of a concentration it's spread out.
Through our entire book and.
I'll just leave it there I think the simplest answer.
Got it thanks very much.
The next question today comes from Gary Tenner of D.A. Davidson. Please go ahead.
Thanks, Good morning.
Just wanted to us.
Another kind of question regarding credit you made the comment that even though you don't necessarily think the expansions coming to an end. Your your lending is though it is can you square that with the 18% your day growth rate I mean, we've got a lot of banks that are.
Loan growth is being pulled back.
Coming back on growth are they just being that much more conservative or what how do you have you square that.
I would add a couple things that are wed square. It is one we have residential loans that are a big forward flow and purchase activity and that was.
Over $300 million, a $300 million this quarter against 900 million of total loan growth. So that helps us and also I come back to the lines of business or rent so capital call had $100 million of growth.
A lot of banks are not in that resort financing had about 35 to 40 million lot of banks are not in that so Robert said earlier in the conversation here, it's because of how we're able to allocate our capital among a variety of different products.
Models products are not being carried by competitors remember the characteristics of our national business line very few competitors, we get pricing stability occasionally pricing power very very good asset quality and high operating leverage.
Yes fewer competitors allow the banks that are in the field to have better underwriting.
Stronger credit.
If you're just out making generic business loans see an eye loan you're competing with every community Bank midsized bank and large bank.
You're gonna have more stress on rates and pricing and on credit structure.
If you're doing a lot of the niches were in you're going to be able to get much better credit structure.
Behind the deals you're doing.
Okay. Thank you.
This concludes our question and answer session to I would like to turn the conference back over to Ken Vecchione for any closing remarks.
Oh, we thank you all for participating and we look forward to talking to you.
For our fourth quarter call. Thanks again, everyone.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.