Q2 2019 Earnings Call
<unk> Public school good day, everyone welcome to the earnings call for Western Alliance Bancorporation for the second quarter 2019, [laughter]. Our speakers are Ken Vecchione, Chief Executive Officer, Dale Gibbons, Chief Financial Officer, and Robert Sarver Executive Chairman.
You May also view the presentation today via webcast through the Companys website at Www Dot Western Alliance Bancorporation Dotcom.
The call will be recorded and made available for replay after two o'clock PM Eastern July 19th 2019 through August 19th 2019 at nine am eastern time by dialing 1877344.
Seven five Tonight with the passcode 10132284.
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 future events and financial performances and are subject to risks uncertainties assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in forward looking statements.
Some factors that could cause actual results to differ materially from historical or expected results include those listed 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 to turn the call over to Ken Vecchione. Please go ahead.
Thank you.
Good afternoon, welcome to Western Alliance second quarter earnings call. Joining me on the call today are Dale Gibbons and Robert Sarver, I will provide an overview of quarterly results and then Dale will walk you through the bank's financial performance in greater detail after which we will open the line and Robert down I will take your questions. What's the winds delivered another exceptional quarter with strong deposit growth primarily in noninterest bearing accounts, which funded high quality balanced loan growth, we maintain top tier financial performance, while positioning our balance sheet to be resilient in front of potential slower economic growth and lower rates.
As you will see throughout our remarks, our results advanced our key strategic objectives, which include leveraging all branch life business model to drive both disciplined and thoughtful loan and deposit growth carefully managing our balance sheet with regards to asset sensitivity accretive capital allocation policies and de risking our loan composition, all while maintaining strong efficiency and profitability across all interest rate environments. The strategy delivered outstanding results net income during the second quarter rose to a record $122.9 million or $1.19 per share compared to 120.8 million and a $1.16 per share for Q1 balance sheet growth was exceptional with the company, reaching a new milestone of 25 billion in total assets year over year net income rose, 17.4% and EPS grew 20.2% total loans were 19.3 billion an increase of 25%.
Rent on a linked quarter annualized basis compared to 18.1 billion. During Q1 2019 on a year over year basis loans rose by 19.3% assisted by $1 billion of residential growth.
A part of our strategic de risking plan as we view residential loans as a thoughtful responsible alternative to manage loan growth.
During the quarter, we also reduced our construction and land and development loans by $73 million, reducing their representation in our portfolio to 11.5% compared to 12.6% in Q1.
Deposits remained a bright spot for us during the second quarter as we grew over $1.2 billion from quarter end supported by $998 million rise in non interest bearing deposits total deposits grew on a linked quarter annualized basis by 24.4%.
This bears repeating 83% of our deposit growth was DTA and noninterest bearing deposits now comprise over 40% of all deposits. This is the second consecutive quarter during which we grew deposits by over $1 billion over the last two quarters loan growth of one and a half billion dollar has been fully funded by deposit growth of 2.3 billion the loan to deposit ratio increased to 89.8% from 89.6% in Q1.
Continued balance sheet growth more than offset NIM reduction to 4.59% as we increased net interest income for the quarter by $7.3 million total operating revenues grew 7.4 million for the quarter compared to an expense increase of only $2 million and drove a 40 basis point improvement in our efficiency ratio to 42% from Q1, we are confident in our ability to remain one of the industry's most profitable banks, while also prudently investing in growth initiatives, even in a declining rate environment return on assets was 2.05% return on average tangible common equity equity was 19.7% as we continue to post industry, leading performance. Our financial results were accompanied by strong asset quality charge offs for the quarter were $1.6 million, representing only three basis points of average loans nonperforming assets were $70 million up 8 million from the prior quarter.
Peter will remain at near historical low levels nonaccrual loans and Oreo to total assets was 27 basis points in line with the past four quarters.
Turning now to capital management last month, we announced the initiation of a dollar annual cash dividends. We also continue to opportunistically repurchase shares during the quarter, we purchased 793000 shares at $42.82, which when combined with last quarter share repurchase or up 1.7 million shares.
Combined for a total cost of $41.45 year to date.
Overall, the share count has been reduced by 2.5% through repurchases since the initiation of the stock buyback program in mid Q4 2018.
On display this quarter was our ability to thoughtfully manage capital allocation between share repurchases and loan growth tangible common equity ratio absorbed significant balance sheet growth and opportunistic share repurchases and was 10.2% at quarter end down 10 basis points from prior quarter, but up 30 basis points from prior year.
Common equity tier one ratio was 10.6% relatively flat to the prior quarter.
Tangible book value per share grew 6.3 cents, six sorry, 6.3% or $1.45 from the prior quarter to $24.65 over the past five years, we have grown tangible book value per share by 213% compared to average peer growth of 67% over the same period, which includes adding back peer dividends lastly, I want to reflect on Western alliance, surpassing $25 billion and assets, we've come a long way since our public company.
In 2006, since becoming a public company in 2005, having increased our assets by 10.5 times over the $2 billion that we started with.
Back then we outline the core principles of our strategy strength of our management team are conservative Conservative credit culture, the attractive growth characteristics of the markets, where we operate and the ability to attract seasoned bankers with long standing relationships in their community.
Communities I'm proud that we stay true to those ideologies and cultural values as we've grown and as these precise qualities that continue to set Western alliance apart the people of Western Alliance drive our banks success and I would like to take a moment to recognize all the people who have helped us achieve this exciting milestone.
I will now take you through our financial performance.
Thanks, Ken overall, our strong ongoing balance sheet growth resulted in record earnings despite headwinds from a flattening yield curve proceeding and anticipated fed rate net interest income rose $7.3 million or 12% annualized from the first quarter $255 million.
Driven by a 968 million an increase in average, earning assets, which outweighed reduced loan yields and higher rates on deposits from the corresponding period last year net interest income was up 13.6%.
The provision for credit losses was $7 million for the quarter, an increase of $3.5 million in the prior quarter due to strong loan growth of $1.1 billion.
Noninterest income was down slightly up $1.2 million from the first quarter to 14.2 as warrant income at fair value gains on securities decreased 1.1 million and $1.3 million respectively.
Non interest expense was up a modest $1.3 million as professional fees and deposit costs increased by $3.6 million and $1.9 million, partially offset by 2.8 million decrease in compensation costs.
The increase in professional fees related to consulting projects aimed at implementation of seasonal as well as other technology initiatives that will allow us to continue to grow in future periods.
Share repurchases to date pull down the diluted share count to $103.5 million, resulting in diluted EPS of $1.19 of the approved $250 million authorization. We've now used 107, and a half with 142 and a half remaining.
Turning now to our net interest drivers during the quarter. Despite a flattening yield curve net interest income grew 12% annualized to $254 million.
Invesco field decreased 13 basis points from the prior quarter to 334 due to a flattening yield curve and lower reinvestment rates, but overall yield remains up 10 basis points over the past year.
Loan yields rose 15 basis points over the past year to 5.98% in the most recent period.
On a linked quarter basis loan yields decreased four basis points due to lower yields on cnine construction loans.
Supporting the decline in yields was our intentional shift towards residential loans the de risking of our construction portfolio as well as the decline in LIBOR.
We expect these this mix shift to continue.
Interest bearing deposit cost increased by 12 basis points in the second quarter as a result of acquiring relatively more expensive term deposits prior to the downward shift in short term rates.
This increased funding this increased funding cost by four basis points when all of the company's funding sources are considered including non interest bearing deposits and borrowings. We think this will be temporary since during Q3, we anticipate approximately $980 million of higher cost short duration Cds will roll off or repriced at current lower market rates improving deposit funding.
As stated net interest income rose $7.3 million during the quarter or 12% annualized as our strategic shift in our loan mix away from construction in the reduction in market rates on weight on the margin, but was more than offset with improved revenue from our strong balance sheet growth.
Given no change in the economic outlook. This will be the theme of our ongoing performance volume growth will outweigh declining net interest margin for the remainder of the year.
41% of our loan book is tied to LIBOR or 20% tied to prime and another 12% or fixed rate term loans that mature and therefore will reprice within the next 12 months.
As market sentiment shifted from a rising to a falling rate environment. One month LIBOR declined 11 basis points to three month LIBOR fell 29 during the quarter, reducing our margin by six basis points.
As you saw in the second quarter, our net interest income increased at a 12% annualized rate. Despite a reduced net interest margin based on our earning asset growth at quarter end that was not reflected in the second quarter average balances, we already have a 4% linked quarter on annualized to balance sheet growth baked into the third quarter.
With market driven rates anticipating a July fed rate reduction deposit pricing has lagged the loan repricing, which began in earnest mid quarter as LIBOR fell in the yield curve inverted.
Net interest margin decreased 12 basis points to Fourfifty nine during the quarter as the earning asset yields decreased nine basis points, coupled with a four basis point increase in funding costs.
We anticipate reductions in deposit cost to be rapid in a declining rate environment as we expected promptly adjust rates in response to fed actions in that deposit betas will accelerate in the near term assuming the fed cuts rates in July September December and next June as we have modeled.
We have over $4 billion in money market and now accounts that have received exception pricing that could see rate reductions.
Regarding loan acquisitions accretion on acquired loans increased from $2.8 million in the first quarter to $4.6 million in the second.
Our remaining acquired loans were $869 million in the remaining marks at quarter end or 15.7.
Going forward accretion will fall to 1.3 million each quarter. The remainder of 2019 evolve discounted acquired loans paid just their contractual principal commitments as the acquired loan portfolio is replaced with organic growth.
With regards to our asset sensitivity, while the convention is to immediately shock interest rates. We believe a more realistic scenario include either a 12 month ramp down scenario with four quarterly 25 basis point reduction, which would reduce net interest income by 2.4%.
Or a steepening scenario, we're short end rates declined 100 basis points in the long end remains flat, reducing net interest income by 2%.
Additionally, these sensitivities assume our static to second quarter position as of June Thirtyth.
However, as Ken mentioned management is already begun advancing strategic actions to diversify our mix shift.
Residential loans further mitigate margin volatility.
Turning now to operating efficiency on a linked quarter basis. The ratio was down improved 40 basis points to 42% as revenue growth outpaced expense growth.
From the second quarter of 2018, the ratio decreased 10 basis points on a taxable equivalent basis operating revenue increased 29.4 million to 273 in the second quarter of 19 compared to a year ago over the same term operating expense increased 12.4 million to $115 million in generated positive operating leverage of 2.4 times.
Our provision our pre provision net revenue, our ROA of 2.54% and Aro and return on assets of two 2.05%. These metrics continue to be in the top decile compared to the peer group.
Our strong balance sheet momentum continued during the quarter as loans increased $1.1 billion to 19.3 in deposit growth of $1.2 billion brought our deposit balance to 21.4 billion at quarter end.
Our loan to deposit ratio increased in the current quarter to 89.8% from 89.2 a year ago.
Our strong liquidity position continues to provide us with balance sheet flexibility to pursue attractive risk adjusted lending opportunities.
Notably our ending balance at June Thirtyth was 860 $36 million greater than the average balance for the second quarter and ending deposits were $1.1 billion greater than the average balance for the second quarter, which when taken together is equivalent to an incremental quarter of loan and deposit growth over what we had on average balance in Ed Tech.
For the third for the second quarter.
Tangible book value per share increased $1.45 over the prior quarter, and 47 or 24.6% over the prior year.
Despite having repurchased 2.5% of our outstanding shares over the past three quarters.
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 across the country.
Our loan growth of $1.1 billion was driven by increases in cnine loans of $730 million.
Non owner occupied commercial real estate of $382 million in residential loans 119.
Construction loans declined by $73 million and made up 11.5% of our total loans in the second quarter versus 12.6, when compared to the first quarter.
This intentional decrease advances our strategy of reducing construction loans to 10% of the total loans by the end of next year.
$500 million of the $1.1 billion of quarterly growth was in sectors that have had a cumulative losses of only $400000 since 2010, including public finance mortgage warehouse nonprofit resort lending equity fund resources in homeowners associations.
Turning to deposit growth and further demonstrating the strength of our deposit franchise deposits grew 1.2 billion, mainly driven by an increase in non interest bearing VVA of nearly $1 billion.
Over the past year deposits grew across all types with the largest increase in savings and money market of $1.4 billion in non interest bearing DDA of $729 million.
Over the past two quarters loans were up $1.5 billion in deposits were up $2.3 billion.
Over the past year loan growth of $3.1 billion was fully funded by deposit growth of 3.4.
We believe our ability to.
Profitably grow deposits as both a key differentiator and a core value driver to our platforms long term growth.
Total adversely graded assets increased to $41 million during the quarter to $399 million as special mention credits increased $64 million.
The increase in special mention credits for the quarter was primarily driven by three credits that have had modest changes in their credit profile, but are well secured with no elevated risk of loss. We do not see this increase is indicative of a trend or area of concern.
From the prior year total adversely graded assets have increased just $31 million versus a 3 billion increase in loans.
Adversely graded assets increase is the result of an increase in special mention credits, partially offset by a decrease in classified accruing loans nonperforming loans and other real estate.
Nonperforming assets comprised of loans on non accrual and repossessed real estate increased to $70 million or.
0.27% of total assets compared to 0.26% in the prior quarter and a decrease from 2.29% in the prior year.
Total adversely graded assets declined to 1.64% of total assets from 1.83% a year ago.
Gross credit losses of $2.6 million during the quarter were partially offset by $1 million in recoveries, resulting in net credit losses of $1.6 million or three basis points of total loans annualized.
The credit loss provision of 7 million doubled from the prior quarter supporting our strong loan growth provisioning related to our loan growth was also also increased the allowance for loan and lease losses to $160.4 million up $13 million from a year ago.
This reserve was 87 basis points of non acquired loans at June Thirtyth as acquired loans are booked at a discount to the unpaid principal balance and hence have no reserve acquisition.
For acquired loans credit discounts totaled 10.6 million at quarter end, which were 1.22% of the $869 million purchase loan portfolio, which is primarily from the bridge Bank and hotel franchise finance transactions.
Relative to our peer group, our special mentioned loans classified loans nonperforming assets and net charge offs are all lowered our all lower for us it our allowance is higher than that of the peers confirming the conservative nature of our reserve methodology.
Finally, we continue to generate.
Significant capital and maintain strong regulatory capital ratios with tangible common equity to total assets of 10.2%, which is 130 basis points higher than the peers in common equity tier one of 10.6%.
Tangible book value per share growth rose $1.45 in the quarter to 20, 465 and is up 24.6% in the past year.
Notably our production of tangible book value has been more than three times that of the peer group over the past five years.
Given capital requirements events operate under we believe that consistent capital accretion is fundamental value creation.
This concludes my review and I will turn the call back to Ken.
Thanks, Dale as you are aware in June we announced that the board of directors authorized the initiation of regular quarterly dividends beginning in the third quarter of 2019 of 25 cents per share given the continued success of our strategic approach to our business. The company consistently creates more capital than needed to support our strong growth and is building a sound financial capital base, which allows us to remain flexible and nimble coupled with our opportunistic share repurchase program. We endeavor to provide superior total shareholder return compared to peers without curtailing growth capital and will reward investors with recurring cash flow for stock ownership.
Just want to add a few words on the outlook.
The strength of our product lines and geographic diversity combined with an experiencing credit oriented management team.
Generates above trend loan volume in a prudent predictable manner.
Our diversified model, which is the centerpiece of our ability to prudently manage credit risk and allocate capital while maintaining a growth trajectory is found at other is not found at other similarly sized institutions. The business approach to this business approach delivers a level of sophistication that offers unique value enhancing business expansion opportunities our record of growth has capitalized on our competitive advantages to drive industry leading growth.
We believe our business model helps diversify risk and protect against undue risk taking.
Within our market today, we have observed a little change in business activity as our loan and deposit pipelines remain strong we expect loan and deposit growth to continue a pace at the same level as our prior guidance of $600 million in loan growth per quarter fully funded by core deposit growth. We do not expect any give back from our strong performance year to date as none of our growth was pulled forward from future periods. We will continue to execute our plan of improving our risk profile by decreasing our allocation to construction loans, which we expect will comprise 10% of the portfolio by end of next year. This de risking process will be complemented by continuing to shift our loan mix into relatively low LTV residential real estate first mortgages as we will strive to more than double the proportion of our loans in this sector from 8% to 16%.
As we enter a low rate environment, we expect our deposit funding mix remained fairly stable. We expect net interest income to continue to rise throughout the year as volume increases from residential purchases higher earning assets and our strong loan loan pipeline will outpace de risking activities repositioning of our asset sensitivity and projected fed rate actions in quarters, where target fed fund rates are stable our margin should be fairly stable and lead to net interest income growth.
Tracking our growth in earning assets further we expect our efficiency ratio to increase modestly as we continue to invest in new business initiatives and value enhancing technology solutions, our commitment to top level efficiencies advanced by our strategy of providing select business lines that have few excuse me.
Vance by our strategy of providing select business lines that have fewer competitors lower losses and high operating leverage delivered through a branch lite business model.
Despite economic uncertainty, particularly related to trade in the slope of the yield curve, we have not seen this effect the behavior of our borrowers in terms of loan demand or potential credit stress given the mature stage of the economic cycle. We continue to emphasize underwriting discipline and the majority of our loan growth. We had this quarter was in areas with little or no historical credit losses. So to summarize we grew loans, while reducing our risk had exceptional deposit growth while improving our mix grew net interest income, 12% annualized despite a 3% or 12 basis point decline in net interest margin maintained stable asset quality at historically low levels continued to opportunistically repurchase shares and announced and initiation of quarterly dividends grew year over year net income by 17% EPS by 20% and positioned the company to carry forward as momentum through the second half of the year. This should enable us to have ongoing EPS.
Growth even in a declining rate scenario and we remain comfortable with street consensus estimates for the remainder of this year and next.
At this time.
Robert Dale and I will be happy to answer your questions.
We will now begin the question and answer session.
You ask a question you May press Star then one on your Touchtone phone.
If you are using a speakerphone. Please pick up your handset before pressing the keys to drive your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Our first question today comes from Casey Haire with Jefferies. Please go ahead.
Yes, thanks, good morning, guys.
Good morning.
I wanted to touch I guess on the loan growth mix going forward and sort of the NIM outlook.
Obviously it comes to commercial was very big contributor this quarter resi was was not but it sounds like that will change going forward.
How so and I'm, assuming that's a lower yield product versus your Fivenine Inc. book. So how does how does NIM stays stable, if thats going to be driving the bus on loan growth going forward.
Yes. So so we're really focused on on net interest income and as we talked about as I mentioned.
Just a minute ago.
We've got 4% growth in that in the third quarter already in terms of average balances just holding the June thirtyth balances relative to what our average was in the second quarter, plus we expect to grow again 600 million per quarter in loans and deposits in the in the third quarter, we were talking about win rates were rising.
Our NIM was rise approximately five basis points per 25 basis points to the federal reserve action.
Although we have been moving into residential we put on a $1 billion in the past year that relationship still holds so I would expect about a five basis point margin decline.
When the fed cuts rates 25 basis points.
I expect the margin to fall more than that though because if you look at our ending balance because of the strong deposit growth, we had particularly at quarter end, which is still with us by the way.
Those dollars are really sitting in the federal reserve accounts. So we have it's a good problem to have but we have we're sitting on a lot of cash yielding only 2.35%.
Yes, well thats dilutive to the margin, it's accretive to net interest income and earnings per share. So yes. So no. We're not we're going to be having a declining margin, but but our margin decline very similar to the second quarter, we expect to be able to earn through to have growing EPS.
Okay, I understood and.
The operating leverage dynamics.
The language has changed a little bit there is that.
I mean, it sounds like you guys are beginning in a bunch of cuts.
I think you said for cuts so.
Is that what I mean, so the the top decile of the peer group you guys are way above that two and a half times revenue expenses are you.
And are you coming off of that two and a half times revenue expenses, just because of the fed cuts or.
Just trying to get understanding on what seems to be a change in that language.
Yes, the fed cuts definitely have an impact, but what we're going to be continue to be focus operating leverages. The way, we make our money here. It's one of the ways and we feel that we can continue to invest in technologies.
To bring on new customers and also continue to have a very strong positive operating leverage but that 2.5 times, which is what we used to do.
With the rates scenario for cuts is going to be more difficult.
Yes, we're not going to be able to sustain the two and a half to one but with that and with.
Strong expense control, we can still move our operating leverage will still be in the top decile. It may increase from the 42% it's at today, but but we're comfortable with that we can that we can sustain again this pre tax income growth efficiency and ongoing EPS growth.
Understood. Thank you.
Our next question comes from Michael Young with Suntrust. Please go ahead.
Hey, good morning.
Morning.
I appreciate all the color that you provided in the guidance and the outlook, but I was wanting to just dig into the loan growth a little more this quarter, obviously with the strong cnine growth can you give a little more color on was a lot of that pickup in utilization.
From clients or any sentiment change that you're seeing and.
Also if you could just tell us how much was mortgage warehouse related.
Yes.
Our loan growth was spread through our regions and through our product lines.
So to answer your specific question warehouse grew $224 million, but we also saw a lot of growth for example in our equity fund resources group that would be capital call and subscription lines that went up nearly $70 million.
Tech in finance, which what which would which previous to this quarter had a lot of commitments signed but no no loans outstanding grew this quarter by $144 million, our Muni and nonprofit book grew about 60 ish million dollars. So it was spread throughout.
The product lines and also through the regions.
Okay were there any loan purchases during the quarter.
Yes, there were and that totaled $140 million.
Okay.
And then maybe just switching to capital as you move forward you got the dividend coming in place in the third quarter, obviously very strong loan growth this quarter and it looks like Thats going to continue for some time are you kind of looking at back off of the share repurchase authorization.
For a time or do you still feel like you can move forward with that.
Thanks, Robert No I don't think not necessarily will continue to be opportunistic in terms of.
In terms of share buybacks.
We evaluated every month and.
We still have some excess capital that we're growing even given the dividend.
Okay. So it's more a function of stock price than than growth.
Correct.
Okay. Thank you.
Good.
The next question today comes from Tim Mira portfolio with Wells Fargo. Please go ahead.
Hi, good morning impressive quarter.
Maybe just looking.
Looking at the Arizona deposit growth this quarter.
Quite impressive.
Anything specific that drove that.
And I guess.
What's the outlook.
Theres any kind of promotions or anything else going on that help fuel that growth.
Yes, I mean, a lot of the growth came from title companies, we're not doing strong promotions.
I would say the entire company.
Since the beginning of the year has been very focused on.
Deposit growth and particularly focused on noninterest bearing deposit growth so nothing different there.
What you can see from time to time in the region contrasted to each other is depending on which customer which new customer comes in what customer has a big project that need to pull cash out of its kind of hard to kind of predict what's going to happen by region, but all the regions are focused on growing their deposits.
Okay. That's helpful and then maybe switching to margins.
Given the strong DTA inflow in Q2, coupled with nearly $1 billion of seed easy. They are rolling off are repricing can we see funding costs actually get lower in the third quarter on a quarter to quarter basis.
And if thats the case as the margin compression kind of ex any fed cuts solely going to be driven by the asset side or is there. Some other dynamic that I'm missing that could see some lag in additional funding costs as well.
So yes, no I think we can see the the funding costs have come down a bit I mean with regard to the margin.
As I mentioned you know today, so we had $1.1 billion in cash as at June Thirtyth.
In large measure related to the the significant increase we had in deposits in the second quarter.
That those funds are predominantly still with us today. So we had cash of more than double really what we need and while we want to deploy that into loans that is basically sitting at the federal reserve is yielding 2.35%. So so thats that decreases our net interest margin, even though it helps us with net interest income.
So I do think there is pressure on the margin without regard to necessarily just kind of what our funding mix what our funding costs are although I do think our funding costs are going to be declining in the in the third quarter.
Okay. That's helpful. And then just on the time deposits that are either repricing or rolling off do you have a gauge as to what's actually going off balance sheet and what you expect to keep on at lower rates.
I don't we don't have a gauge of that at this time, but we were negotiating with these depositors' frankly from a position of strength. We've had such strong funding growth that we've already told one hundreds of millions of these depositors and saying look if the fed is going to move on July 30, Onest and just so you know.
We're going to move what we're paying you in lock step with whatever the fed does it's going to be 100% beta on a lot of those deposits and they say yeah, we get that and so far I think we've got about a 100% that we expect to retain on those but we're going to lose some and and we've got the strength in the funding resources and network and levers we can pull that we can deal with that.
The next question today comes from Brad Milsaps with Sandler O'neill. Please go ahead.
Hey, good morning, guys.
Good morning.
Hi, Darryl just a you just addresses to to some extent, but it does sound like you have a lot of confidence in being able to.
Pass long fed rate cuts to depositors do you think you know sort of as you look at your deposit cost today of around at least interest bearing of around 100 and.
35 basis points do you think you can get those back to where they were in the first or second quarter of.
2018.
Assuming we do get the four cuts that you guys are looking for or do you think.
You know there is going to be more lagged in that.
Yes, I think we have a lot of control in a lot of strength in order to be able to not have a lag and and so I expect that in general you're going to see youre going to see kind of a mirror image of betas as they rose kind of coming in the say, we get four cats here, we're going to see those betas be fairly sharp in the beginning and then as we get to lower rates I think they're going to become a bit more muted so but out of the gate I think our betas are are going to be fairly high.
Okay, and then just a follow up for Ken but the billion dollars of DTA growth this quarter.
How much of that would you say was maybe driven by some of the deposit initiative you've talked about over the last year versus just you know.
Maybe hard to.
Delineate between the two just from your regular business just curious if there's still a lot on the come from some of those initiatives you've been talking about.
There is a lot on the comp so what we define as the positive initiatives number one grew $60 million this quarter.
And deposit initiative to which is not even up and running yet grew $26 million and I want to say about both of these initiatives. We are pacing ourselves on this we're not rushing we need we want to make sure the customer service aspect and be able to deliver what we say we're going to deliver is very important to us and so would the other parts of the business really kicking tail here.
We are pacing ourselves not to push out and get ahead of our skis, but we are pleased that the positive deposit initiative, one brought in $60 million.
And by the way deposit initiative to really doesn't go live until into Q4. So we're a little ahead of ourselves, but we were able to bring in some dollars this quarter.
That's great. Thanks for the color great quarter.
The next question comes from Chris Mcgratty with KBW. Please go ahead.
Great. Thanks.
Steve maybe a question on the balance sheet.
The $600 million loan growth appreciating the remix thats going on between construction and ready.
How should we be thinking about the proportion that comes from rising over the next call. It six quarters is it 50% is it more than that any help would be great.
I think it's going to be I think it's going to be 40% and could be even a little bit higher I mean, frankly, the second quarter. We thought it was going to come in a little stronger than it did.
We had to about double the 130 million, we had in that growth.
And origination behavior, but as others experienced when rates fell sharply the refi business really picked up and that and that pulled that and I think that re fi business, while still strong.
Isn't isn't quite as quite as hot as it was then and so so we think the depth that proportion is going to be climbing here.
Let me just add a little something I've been on the road a little bit visiting our partners here, we hope on a gross basis to kind of drive about $200 million prove what we call the flow side of the business I will lose some of the existing book because rates are dropping and then we'll also be opportunistic in terms of buying portfolios. So that's sort of the way to think about it at the moment and that's against the $600 million overall loan growth target that we have.
Got it thanks for that the the billion dollars, who follow up on the non interest bearing deposits the billion dollars can you speak.
To the granularity of that deposits I think a couple of quarters ago, you pushed a couple out.
So number one speaking of the granularity into kind of early trends in the third quarter, whether you've retained those are any of those were seasonal thanks.
Alright.
Back to the quarter Youre referencing which is Q4, we let one customer go for credit reasons, not pushing out for deposits.
That's one number two.
Some of the investments that we made in technology.
Really showed up this quarter.
In our warehouse lending group, where our warehouse lending deposits rose $550 million and almost 100% of that found its way into DTA. So we did pick up one or two major customers one in.
Hi, warehouse lending and then one or two in the regions.
So.
I think thats, what helped drive some of the growth and.
It looks like we're holding on to everything there is what I would say for for Q3.
Okay, so that sort of flat balances that you had talked about in the past.
Good probably upside to that number okay.
Maybe last Monday on the tax rate, how should we think about it was a little light this quarter.
Yes, yes, we had some some kind of modest nonrecurring gains I would I would say in the 18% is where we guided at the end of the first quarter and I would continue that going forward.
Great. Thank you.
The next question comes from Jon Arfstrom with RBC. Please go ahead.
Thanks, Good morning, guys.
Hi, good morning.
Okay.
Question on construction and development.
I think we all understand that.
Mix change that you're going through but anything new to report positive or negative in terms of trends that you're seeing in the health of the book.
So.
We're going through a change or we just went through a change of.
Chief Credit officer, so our.
Our outgoing Chief Credit Officer has now become the chair of our senior loan Committee and he has less day to day responsibility, but more responsibility to go out visit customers and ensure.
That.
He feels comfortable with the credit that's coming in specialty part of the launch credits, our new Chief Credit Officer. The first thing I ask them to do.
New when I say, new new to the role but had been.
As it has been in the company for over three years I asked him to tear tear apart the construction land and development book and give me his own independent viewpoint on that and as early as late as this morning, he still feels very comfortable with the book.
And.
So what you see in us driving down the percentage by taking down the numerator and also growing the denominator is really just to make I think investors feel more comfortable that we don't have any outsized risk sitting on our balance sheet.
But he went through it and he feels very comfortable where we are today.
Okay. Okay, I would guess you are seeing.
Some terrific opportunities in Phoenix and Vegas.
In new relationships potentially I think we understand the reason the concentration issues, but my guess is there has to be a lot of activity that you can pick from.
Well remember too now as we are bringing down the percentage one of the ways to do that as we're increasing the price. So we're going to be we're going to be far more selective in who we bring in as we bring down the overall level representation to total loans.
Okay. Good yes ill say, Nevada is very busy Vegas very busy renos busy Phoenix is very busy.
In terms of building absolutely correct, okay, but the business to get the busier gets the more you have to focus on your credit underwriting and so.
You know that that's how we kind of monitor the flow as Ken said based on price, but also based on equity and debt coverage ratios. So in a in a stronger environment, you're going to want to have more cushion and debt coverage or your want to require more equity.
That makes sense because it kind of dovetails on my next question I guess, it's more philosophical but.
For rate cuts, it's pretty aggressive relative to what your peers are saying, but just curious if that comes true.
Does it change the way you think about.
Risk.
Or growth potential for your company because on one hand, you're saying your economy is rock solid, but if we do get for rate cuts it seems like.
You're going to have quite a bit of growth and I'm. Just curious if youre running blending gets riskier non bank competitors come back in and all the stuff we dealt with before.
So.
We actually believe theres going to be just two rate cuts, but we're setting the company up to be prepared for rate cuts and that way as everyone looks forward. They have to think through what their operating expenses are going to be how we're going to grow.
That's one number two.
Since 18 to 24 months ago.
We've been lending.
As if we are in the very last inning.
Of this expansion so.
If we have a couple more rate cuts I don't think were going to actually change the way our philosophy in granting credit because we've been tightening up and we've been concerned well sorry, we've been always worried that were that the expansion may stop so we've been very conservative.
In how we are pushing dollars out the door.
Third as it relates to earnings and what we plan to do you know if we have for rate cuts. We may just very well have a somewhat slower loan growth, but we will still have excess rise year over year.
No John if I, if I'm like you and I am sitting there and saying to myself.
Okay, you guys are defensive.
And you're concerned about credit quality or focus on risk, but how do you keep growing every quarter.
And how do you kind of put those two together and what I would say is.
Just from a high level perspective.
Talk about credit.
I've had a chance to meet.
With a lot of other banks out there in the market our size a little smaller little bigger.
And at the end of the day on the credit side.
We just have a much more robust than sophisticated model than most of the banks our size, it's based on a broader loan product to ray.
More geographic options in a more sophisticated credit allocation model.
And so what all that translates to is that allows us to have stronger growth than our peers and also at the same time be generating better risk adjusted yields than our peers.
We just have a lot more buckets in those more buckets, along with our credit allocation model allows us to be much more forward thinking and be able to modify and adjust to different markets based on product and geography, and that's how we get better growth without taking on more risk the deposit side is a little bit different.
The deposit side. The company also has a lot more deposit products and I don't mean like a checking account product or loan product. What I mean is a product that specifically fits a niche of customers. So on the deposit side, why we're able to continually grow faster than peers.
With quality core deposits is.
We are in a lot of different markets.
That are required products too sophisticated for community banks, but the deposit market is big enough for big banks to really focus on it we're able to bring in a lot of business from that standpoint, and so at the end of the day, what I think a lot of people lose sight of is we're not just a large $25 billion community bank a lot of banks, our size have gotten where they've gotten by doing the same thing over the last 2030 40 years, they've just gotten bigger.
We're not so much we're bigger but were actually different in the difference in our model is what allows us to.
Keep putting out these growth results that are superior to peers, but at the same time manage our risk.
Okay that all makes sense. Thanks.
The next question comes from Jerry Tenner with da Davidson. Please go ahead.
Hi, Good morning, it's Gary Tenner.
I'm here.
Okay, just a couple of follow ups.
In terms of the deposit growth noticed a big chunk came from second second innovation space was that.
Is that three thought of as a.
Somebody on deposit from capital raises.
Rounds or is that venture capital related deposits or what's the.
What's the Genesis of that.
Actually it's both.
Northern California has been seeing a great deal of capital raising and that has generated from the technology and finance side about $449 million of incremental deposits for us, but also as we move a little bit deeper into equity funding, which is the capital call and subscription lines. For example, this quarter.
Our deposits.
Equaled almost dollar for dollar what we put out in loans.
So we're generating from that perspective, which is to say those are existing customers that have cash that we're able to bring onto our balance sheet.
Okay. So it's both the VC fund raising and having their balances as well as the B portfolio company balances.
Correct, yes.
Right.
Sure and then just in terms of just the buyback the rest of my questions have been answered I know you've kind of talked about being opportunistic.
The last couple of quarters, you've been buying anywhere from the high Thirtys to low Fortys now we're back in the high Fortys. So how how should we think about your relative appetite at this level versus 42 Bucks.
I think we.
You know again look at the market and on dips I think you could see us buy some stock, but I'm not going to tell you exactly what price, we buy or not.
All right fair enough. Thank you.
The next question comes from Brock Vandervliet would you be US. Please go ahead.
Hi, good morning.
Turning Brock.
On the.
On those warehouse deposits.
How on the mortgage warehouse balances, how seasonal or those those are pretty sticky or do those kind of ebb and flow with the mortgage activity behind it.
So they're a little more seasonal in Q4.
They do have an ebb and flow they actually build up during the course of a of a quarter and then a dip as payments are made and then they begin to build up again, so you've got that ebb and flow.
Just naturally inherent in that business.
But there is no tax payments are due usually in November and and that did contribute to our seasonality that we had in the fourth quarter of last year.
Got it.
And on.
The rate sensitivity the the shock analysis that you show that down 6.6, or so that hasn't changed much from the Q1 shock that you showed in the Q is.
As you look at the prospect of four cuts.
Do you feel like you're you're positioned the way you want to be or are there other level of leverage that you would pull beyond just adding.
Yeah, more resi mortgages as we go forward.
Well, we've looked at we've looked at other elements like swaps and whatever else I think swaps can be fairly efficient, but with the pricing they are at today.
We can't get there from here, but but we would consider doing something synthetic life that we have other loan cat other categories as well. So we've been we've been expense extending some securities.
Some securities durations, we've got some public finance types of things that were doing that are longer term fixed rate.
Is the where the residential piece is just happens to be the largest no I mean, yeah. We've been we've been doing this and yet over the not just the last quarter as you know over the past year, you know our shock scenarios really haven't moved much.
I believe that.
That that will change and we're going to start making bigger dense there as we do more in terms of the residential piece and as we pull down construction, which is 100% basically tied to either LIBOR or prime. So I still work, we're going to be pulling down some things that are highly sensitive moving into things that are less sensitive and I think you're going to see that number move a bit but you're right I mean thats why my guidance was.
A year ago. It was like Hey, we're going to expand our margin five basis points for 25, and its still that same ratio, we're going to drop five per 25 on the way down.
Got it okay I appreciate it.
The next question comes from David Sherbini with Wedbush Securities. Please go ahead.
Hi, Thanks.
Couple of questions for you so starting with the.
Efficiency ratio you mentioned, how it could increase modestly.
From the 42% can you provide a sense of magnitude of how much you could increase.
It will it will drift up modestly as we go through the year and that will be somewhat dependent on how many rate cuts.
Come at Us.
It also helps you know again.
One of the advantages that we have here that helps the efficiency ratio is that we've basically got another quarter of loan growth in this quarter and that gave us such a high average balance so that should generate more revenues, which should help our efficiency ratio.
Okay and related to that you mentioned, how you're investing in technologies and.
You gave the example of the benefit seen in the warehouse lending group can you provide other examples of where you are investing in technology.
Well those two deposit initiatives are all generated by technology and the back office too.
Provide the appropriate customer service. So those are those are two places I would tell you that there is the things that arent sexy in this company Cecil.
Making sure we have the right DSD system, So what I would say the guts of what makes a bank a bank.
We continue to invest in Fortunately, we're not a consumer bank. So we don't have to go against the Big money Center banks, but we do have to continue to invest to make sure our infrastructure to not only support where we are today, what we're trying to build it out for where we're going is ongoing enhancements required to be just to be consistent and to be competitive on on Treasury management services. Those are those are getting better all the time more mobile app applications more functionality.
Great and then shifting gears to credit quality with the increase in special mention loans, you mentioned, how there's no trend developing but I was curious if you're able to disclose what areas or loan categories. Those were in.
So let me just take you through maybe three or four of them real quick and you can get a sense.
We have a property that's being built.
A spec home in.
In California, the properties completed the construction ran a little longer the builder funded all the costs out of pocket. It sits there at a 44% LTV I've walked a property it's beautiful.
And quite frankly.
We put it in there because of the the builder went longer than projected but no risk of loss and we're in good shape, we have a.
Assisted living memory care facility in Arizona or again, the LTV there, 66% they were lagging behind in terms of their residency they switched managers.
We don't see there is any problem there and the borrower has put up money not only cover the next six months of interest, but also any operating deficit.
We have a hotel.
With one of our really good sponsors that saw a little more supply in the area than they expected their revpar was a little below but were sitting there with an LTV of 58% and that sponsor is put the hotel up for sale and they have enough cash on their balance sheet to carry it for another 17 months and then we had a few smaller deals which are all in tech.
And innovation, where we're just waiting for the infusion of equity capital to come in but the remaining months look liquidity RMS now dropped below six so when something drops below six is our standard practice to put that on special mention so Dale kind of quoted in his prepared remarks, there's nothing that's across the company, that's giving us concern, but we watch all of those things and when it goes on special mentioned it gets.
More attention actually gets attention even before it gets there.
But these are the things that we've put on special mention this quarter.
That's good color thanks very much.
The next question comes from Arren Cyganovich with Citi. Please go ahead.
Thanks, I was just curious if you could talk about the deposit growth how much came from new customers versus existing.
It was about 40% from new customers.
The the largest customer just coincidentally as Ken was alluding to was approximately the same size as the as the one that.
That we walked away from in the fourth quarter.
Okay all right. Thank you.
This concludes our question and answer session I would like to Brian Yes. Thank you.
I was going to say just turn it over to me.
Just before we go one question that wasn't asked a hugely event is what does the M&A landscape look like so let me throw that out to Robert and have them give a few.
Comments on it yes, sure I mean, we have always preferred organic growth.
Two acquired growth.
And as we said before any deal we would do would have to be both financially and strategically accretive.
But at this point looking out at the landscape in to look at where we're at we're really more focused internally.
We think our organic growth, our operating leverage and share buybacks provide.
Enough levers for really strong EPS growth and tangible book value growth and that's where our focus is today.
Okay.
Thank you all for attending the call and we look forward to talking to you about our Q3 results have a great day everyone.
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