Good day, everyone. Welcome to Western Alliance Bancorporation's Third Quarter 2023 Earnings Call. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorp.com. I'd now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.

Thank you. Welcome to Western Alliance Bank's third quarter 2023 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Tim Bruckner, our Chief Credit Officer, will join for Q&A. Before I hand the call over to Ken, please note that today's presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions, except as required by law, the company does not undertake any obligation to update any forward-looking statements. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company's SEC filings, including the Form 8-K filed yesterday, which are available on the company's website. Now for opening remarks, I'd like to turn the call all over to Ken Vecchione.

Thank you, Miles. Good morning, everyone. I'll make some brief comments about our third quarter 2023 results, and then I'll turn the call over to Dale. One year ago, on our Q3 2022 call, we discussed our plans to temper balance sheet growth to bolster capital and liquidity in order to reinforce our financial foundation and position the bank to navigate through a volatile rate environment. The events of the spring caused by duration mismatch at several regional banks validated the importance of our strategy and accelerated its implementation through surgical balance sheet repositioning. The recalibration of our business model to enhance overall liquidity and deposit granularity is designed to make the balance sheet unassailable in the event of another significant market disruption. As a result, our CET1 capital has grown from 8.7% a year ago to 10.6% today. Our HFI loan-to-deposit ratio has improved from 94% to 91%. To provide enhanced protection to depositors and cement the stability of our deposit base, insured and collateralized deposits have risen from 47% at year-end to 82%. In order to fortify our liquidity position, we have materially increased our cash and investment securities and now have $3.2 billion of high-quality liquid asset treasures. Having established strong capital, liquidity and deposit granularity, a sturdy foundation has been laid to deliver earnings improvement going forward. Over the last several quarters, we have prioritized stabilizing and growing deposits as well as optimizing the liability structure by paying down borrowings. This has led to net interest margin growing from our second quarter trough as we have sustained improvement in our funding structure, lowered our adjusted efficiency and produced above-peer return on average assets and return on average tangible common equity. Over the next one to two quarters, we will complete the optimization of our funding structure…

Thank you. [Operator Instructions] Our first question comes from Casey Haire of Jefferies. Casey, your line is open. Please go ahead.

Yes. Great. Thanks. Good morning. everyone. Maybe first question on the NIM. Can you just walk us through -- just walk us through, I guess, what the NIM guide presumes in the way of borrowings. Obviously, your deposit growth, very strong quarter-to-date. I think, Ken, you mentioned you do expect that to pay down. And so just -- that would bring the borrowings, which were up pretty significantly period end versus the average in 3Q. Just wondering where that would end up in the fourth quarter here.

Yes. So we have some seasonality within deposit categories that affect this number. But the direction of borrowings is going to continue to be down. So we paid off several of our more expensive funding sources that we achieved or acquired late in the first quarter. And there's a little bit left, I expect we're to pay down that amount as well. So we should continue to see kind of improvement there, where you see we are in terms of reasonably balanced on target for loan to deposit growth this quarter, I think you should see some kind of modest improvement in ending balances as well. And I think the average balances should improve somewhat as well, but not to the degree they did in the third quarter, I would expect.

Yes, Casey, as you've seen, we took down our short-term borrowings by $870 million. But any time we have any excess liquidity floating around, we use it to pay down borrowings. So average borrowings declined $6 billion in the quarter, and that helped bring down our lower funding rate.

Okay. Great. And just, Dale, I wanted to follow up on your comments on the fixed rate asset repricing benefit in the first three quarters of 2024. I think you said $2.4 billion per quarter. Can you give us a sense of where -- like what the blended yield is on that and what that can repriced to? Just trying to quantify what the repricing benefit could be.

So, in terms of what the repricing could be, these are coming off at something in the kind of around the higher seven and rates today have spreads of really not less than 300 basis points, 350 from there. And so maybe you don't have another rate increase in there, so I would take that on top of SOFR today. So something in the lower eight.

Okay. So over $7 billion of loans in the first three quarters with 100 bps left.

Approximately.

Okay. All right. Just last one for me on the expenses. Obviously, that was the one thing that kind of surprised negatively this quarter on the deposit cost. So if -- so I have -- the deposit with ECR. The DDA with ECR up 15%, but the deposit costs were up 40%. So I'm just trying -- like why the disconnect? What was the -- is there a different pricing dynamic today than there was historically? Just trying to understand that.

Well, we had higher balances and higher rates and I think the average balance was elevated. The average balance was up 28% during the quarter. So it wasn't -- let me approach it differently. In terms of the spreads that these clients receive, there's virtually no change.

Okay. So -- all right. So we don't have the average balances. It's just at period end was up 15%. The averages was up higher. And then just [indiscernible] as well.

28%, almost double that. Yes.

Okay. Great. Thank you.

Our next question comes from Steven Alexopoulos of JPMorgan. Steven, your line is open. Please go ahead.

Hi, everybody. I want to start, regarding getting back to the $500 million per quarter loan growth target at $2 billion deposit growth in 2024. Once you guys get to the mid-80% loan-to-deposit ratio target, what's more likely that you guys dial up the loan growth expectation at that point or that you dial down the deposit growth?

You'll see on the asset side, you'll see that, that will be the lever that will be used.

Okay. So you're thinking keep the $2 billion deposit target intact and then dial up expectations for asset growth?

Yes. This is Ken. I think so. I think some of the investments that we've made in a number of our deposits centric business lines will continue to propel deposits forward along the guide that we gave. And as we recalibrate to a mid-80s loan-to-deposit ratio, we'll then turn off the loan growth machine. We've proven here over time that we can generate sound, thoughtful, reasonable loan growth with very little asset quality problems.

Got it. Okay. And then going back to Casey's question on expenses. Excluding the ECR-related deposit costs, which flow through at those sites, how are you guys thinking about expense growth over the next year?

So running from Q3 to Q4, expenses absent the deposit cost will be relatively flat. And as we enter into 2024, there will be marginal expense growth and that marginal expense growth will be predicated on continuing to invest in new products, new services, new business lines, continuing to build out our risk management framework. The hallmark of Western Alliance has been this continuous investment through all cycles to kind of grow the business for future quarters and years. And so as long as the risk return and the investment returns are there, we'll continue to do that.

Got it. So from an efficiency ratio perspective, are you thinking that we'll have improvement through 2024 or that will keep about where you end in the fourth quarter?

Yes, I'd say about where we landed in the fourth quarter. Back to your first question, as we probably exit the second quarter and we achieve our loan-to-deposit ratio, we'll be able to step on the accelerator of loan growth, and that will generate higher interest income, which should provide the denominator of that equation to grow at a faster pace. But right now, if you're modeling, I would say, keep it consistent with Q4.

Right. But it sounds like revenue is set to accelerate here with the margin being more stable, like you said, more loan growth coming in next year, but we should think you're going to spend more of that, at least at this juncture, right? Because it seems like the setup is efficiency ratio improvement next year, where you're saying at least at this point, don't expect that.

Look, I think it is set up that way, but it's a little bit deferred in terms of when that takes place because of the reasons Ken is talking about that we're going to be sluggish on having the loan growth really kind of match 85% of the deposit growth as we continue to pull that number to the LDR number down for a couple of more quarters.

Got it. Okay. Thanks for taking my questions.

Thanks, Steve.

Our next question comes from Chris McGratty of KBW. Chris, your line is open. Please go ahead.

Great. Thanks. Dale and Ken, I want to go about that one a little bit different. The -- you're already at your -- you're going to be at your 11% target within a couple of quarters, if not one to two quarters. What do you -- I can't -- I'm not sure I'm prepared to ask this, but like wouldn't you be thinking about a share buyback at some point next year given the capital accumulation in your stock price?

Yes, I think that's a fair question to ask. I think there are a couple of things that will inform our decision. One, as we continue to grow and we continue to get closer and closer to the $100 billion threshold, we have to take into account the AOCI charge that will be applied against it. And so we want to continue to grow our CET1 ratio. Really 11% is the target. It's not the goal. And we expect to grow through that, all right? That's one. And number two, you'll see the CET1 ratio moderate in the back half of the year in terms of growth because we'll probably step on the accelerator for loan growth once we achieve our loan-to-deposit ratio.

And one of the reasons our ratio is planned so quickly is because we have really curtailed our risk-weighted asset increases, and that will pick up again as loan growth reaccelerates. I mean, we -- I just -- where the numbers saying, we've improved our CET1 ratio 190 basis points since we went on this risk-weighted assets dive and really paid a lot more attention to that, and we slowed our loan growth. And with our organic earnings, we're able to move that number rather quickly from a year ago, which was 8.7% to where we are now at 10.6%.

Okay. That makes sense. It feels like there's a combination of maybe both that could be considered in the back half of the year as the AOCI mark narrows and you get through your targets. It feels like a little bit of both.

Yes.

That's fair. And then maybe a bigger picture question -- keep going. Sorry.

I was going to say, even if we're higher for longer on rates, we will see that AOCI mark decline simply because the duration of the portfolio under five years, is going to continue to come down.

Chris, just on that, I'd say to you and the rest of the folks on the line, we're looking to build a very strong foundational balance sheet here, right, and not be sucked into any of the problems that you saw in the first quarter with the number of banks having their duration mismatched. And we just want to never go through that again. Or if we have to, have a minimal effect on us. And that's where our intent is, to continue to raise capital levels and also to build our liquidity.

Great. And maybe just one follow-up. I think you've talked about a mid-teens ROE through the cycle. I guess, updated thoughts on that given the higher for longer?

Well, I think there's -- so as our loan-to-deposit ratio continues to show kind of look -- kind of where we're headed, we are going to have more high-quality liquid assets. I think we can -- over time, our expense ratio can fall into the 40s on an adjusted basis. And so I think high teens works for us kind of intermediate to longer term.

Okay. Thanks.

Our next question comes from Bernard von-Gizycki of Deutsche Bank. Bernard, your line is open. Please go ahead.

So just on deposit costs, maybe I can ask it a little differently. But when you think of how your ECR-related deposit grow based on your guidance, expectations could go for 2024. If rates are steady from here throughout 2024 versus if we do see rate cuts in the second half of 2024, how would you think the deposit costs could migrate under those two different way paths?

Well, I think ECRs are going to have a very high beta. They have on the way up, and we expect them to have a high beta on the way down. And so if we get rate cuts, we'll be able to -- we'll be -- I think we'll be able to push those down kind of almost in lockstep. In addition, some of these are -- have ECRs that are effective Fed funds plus some number of basis points. And part of the reason why I think pressure really came on the industry overall on deposits is because of the competition from the bond market. So as people are comfortable that the FOMC is done with whatever rate increases they're going to contemplate, I do think that that's going to relax some of the pressure on deposit costs for the industry kind of at large. And I think that they give us an opportunity to tweak some of those adjustment figures that we might have on some of those ECRs.

Dale gave you the rate side, and I'd also add. For us, we expect another 25 basis points in Q4 with several cuts towards the back end of next year. So deposit costs will rise and fall along with those rate cuts. But if you're talking about total dollars, also keep in mind, if we exceed our guide, which we have in the last two quarters, you'll see the volume aspect take hold, and you'll see dollar-wise the ECRs rise. So it's going to be a little bit of a rate volume mix as we go forward. In addition, what Dale was alluding to earlier in terms of the deposit initiatives we have. We think that we have some of these will grow more quickly than what our warehouse deposits, which is kind of heavy ECR dependent have done, and that would give us a broader distribution and more diversification on our funding structure.

Great. And I appreciate that color. Maybe just on office CRE. I know your credit has been really good, but if I look at the 3Q exposure, I believe it increased from $2.3 billion in 2Q to $2.6 billion. Just wondering any color you can provide on the increase and if there's any loan sales.

Tim Bruckner here. I can take that. Any increase would have been in-flight balance increases, fund up of tenant improvements, it would be good news money with signed leases. We didn't increase new exposure in office.

Yes. I'll just say as long as you brought that up, remember, 89% of our office portfolio sits in suburban locations. Only 3% sits in central business districts, about 7% sits in Midtown. And our office book represents new construction or new vintage Class A in core submarkets. So again, we go with experienced sponsors, proven track records in adding value and repositioning. Our LTV there is about 60%.

Great. Thanks for taking my questions.

Our next question comes from Brandon King of Truist Securities. Brandon, your line is open. Please go ahead.

Hi. Good morning. So I wanted to follow up on the topic of ECR deposits. And just to confirm, are you expecting that composition of the DDA-based ECR deposits, are you expecting that to march higher over the course of next year?

Well, I think the acquisition of DDA funds in this elevated rate environment is quite challenging. So I mean, the DDA that we had increase in the third quarter was kind of overwhelmingly a mortgage warehouse. So -- and I think that straight, flat out DDA, we have had success with in the regions during the quarter as well to some degree. But yes, I think most of the deposits we're going to be in either interest-bearing checking or money market accounts.

Okay. Got it. Makes sense. And then I wanted to talk about the shift from the held-for-sale loans to held for investment, and particularly the lot banking loans. Could you walk us through the original thought process of designating those held for sale and then elaborate more on the decision of bringing those back as held for investment.

Yes. Let me take that. So this was a liquidity decision, right? So in Q2, we grew our total deposits by about $3.5 billion here. This quarter, we grew a little over $3.2 billion. I also want to emphasize, we paid down broker deposits by $441 million. So otherwise, we would have grown by $3.7 billion. And back from Q1, we put some loans into HFS in order to be ready to create additional pools of liquidity, which aren't needed. And so we moved these loans from HFS back into HFI. And regarding your lot banking question that you alluded to there. Generally, our lot banking programs are all on schedule with the builders. And really, the builders cannot afford to lose any of this inventory and lose control of their for-sale demand. So again, this is a segment of loans category that we like a great deal and has a very good risk/reward attribute to it. And we've never, since we've been doing it here at the bank, suffered a loss on that.

Got it. That’s all I had. Thanks for taking mu questions.

Thank you. Our next question is from Ebrahim Poonawala of Bank of America. Ebrahim, your line is open. Please go ahead.

Hi, good morning. Just maybe, Dale, when you think about the $2 billion per quarter deposit outlook for next year per quarter, just talk to us the source of that deposit growth, where that's coming at and what is your assumption around the rate at which these deposits are coming on? Is it meaningfully below so far? Just some color around how we should think about that and just how that's probably going to impact your NII, NIM outlook until rates get cut. Thanks.

So I'll take the first half of that and toss it over to Dale for the second half. But regarding where is the sort of the deposit strength coming from. Next year, I think you'll see -- first of all, you see it from some of our traditional lines. HOA will have -- is projected to have a good year next year. Warehouse lending/note financing, generally, is traditionally strong year-after-year. The critical item there is what happens in the mortgage industry that it could accelerate a little bit more, great pull back, and we'll see a little bit more deposit growth there. But into next year, we are looking for a number of our newer business lines to contribute in greater sums than they previously have, namely our settlement service business, our business escrow services business and our Corporate Trust business. Those three should have an above growth rate to prior year's history here and should really contribute. But I'll also say that the regions, this is the second quarter in a row the regions that have had very solid growth. And what we like most about the regions, it's a little more granular, okay? It's not big and chunky as some of the other parts of our business. And last but not least, we've had tremendous success with our consumer -- digital consumer platform. And that has really exceeded any of our wildest imaginations in terms of the numbers we initially forecasted for it. And that too will continue throughout 2024.

The large preponderance of the pricing that we're getting for new business ranges from the 3s, and that's really in the regions, to the 5s, and that includes some of the things we talked about, we're a mortgage warehouse and in some of these other channels. I think we're going to be kind of in the middle there. We weighted average something with -- in the quarters. And I think that's probably a good target for 2024.

Got it. That's helpful. And Maybe, Dale, sorry if I missed it, just in terms of your outlook, given the mortgage rates are 8%, how are you thinking about what origination gain on sale fees could look like in the absence of any rate release?

Yes. Thanks. I'll take that one. As we look forward, Q3 to Q4, mortgage servicing income should be sustained quarter-to-quarter, maybe even a slight growth as our MSR balances grow. In Q4, you generally have a seasonal fall with -- that happens. I think it may be a little more acute at the higher rates that we see here presently.

Go it. Thank you.

Thank you. Our next question comes from Matthew Clark of Piper Sandler. Matthew, your line is open. Please go ahead.

Thank you. Just a few questions around credit or maybe one or two here. Just the reduction in special mention nonaccruals, can you speak to how these credits were resolved? Did most of them mature? Or did you push them out of the bank? Just trying to get a sense for the workout process.

Sure. Tim Bruckner again. So I'm going to take the nonaccrual nonperforming first. About half of the improvement in that area is pay out or pay down, okay? The other half of the upgrade to performing categories. With regard to special mention, we base our credit culture on early elevation. And so we use that category very much as a transitional category. So as we signaled on the prior calls, we completed a deep portfolio review, we move assets into that category, and then we press for speedy resolution. So with respect to the movements in and out, those are dictated then by our strategy, which generally involves required remargin in this environment.

Okay. And then the other one for me around expenses. Can you speak to the investments you may still need to make to become or be considered $100-plus billion bank assuming you get treated like one beforehand by the regulators?

Yes. I think the second part of that question is right on, which is most banks in our size category will start to be treated like a $100 billion bank well before you get there, and you've got to build that framework in advance. And that framework is -- begins to look and feel a little more sophisticated around capital stress testing, around liquidity stress testing, and the framework that kind of evolves around that. As we get bigger, we'll have to make more investments into reporting that the larger banks over $100 billion will have to do. But we believe that starting it early and kind of building it into the run rate because then there's going to be costs that you're going to have to have to continue with the -- not only the development but the reporting and the management and the monitoring. We're trying to build it in now and kind of build out towards that.

Okay. Thanks, Ken.

Our next question comes from Gary Tenner of D.A. Davidson. Gary, your line is open. Please go ahead.

Thanks. Good morning. A couple of questions. In terms of the ECR deposits, can you give us the average for that in the quarter versus the 17.1 quarter end?

We'll get back to you on that one.

Okay. Thank you. And then in terms of your kind of 2024 expenses and kind of marginal growth, is that inclusive of the FDIC special assessment kicks in the first quarter? Or should we think about it as sitting on top core growth?

Especially with that, we're considering the special assessment, which it hasn't been defined yet in terms of exactly how it's going to come out. I mean I think that it could be revised. Yes, we're -- that excludes that. We think that's just really kind of below the line, and I think that's how the Street will treat it.

Okay. And then last question. In terms of -- Ken, when you're kind of rolling through the fourth quarter outlook, and you mentioned net charge-offs. If I heard you correctly, you kind of also suggested net charge-offs through the economic cycle in the 5 basis point to 15 basis point range beyond just the fourth quarter. Did I hear that correctly?

Yes. That's correct.

All right. Thank you.

Our next question comes from Andrew Terrell of Stephens. Andrew, your line is open. Please proceed.

Thanks. Good morning. Just one quick one for me. I wanted to ask on Page 11 of the presentation, the earnings at risk disclosure that you provide. In the down 100 scenario, the up 2.2% for earnings there, can you talk about just your comfortability with that level? Is that where you would like the company to holistically be at? Or any changes you'd like to make to that position? And then can you also talk about what the underlying mortgage assumptions are in the down 100 scenario from a gain on sale margin and volume perspective?

So they're not dramatically different. We do think margins would increase. I mean, look at kind of what happened during -- going into the pandemic where margins basically tripled during that period of time. We're comfortable with this in terms of kind of a decline and that we're a little bit better off, a little tighter on net interest income, but stronger in terms of expenses related to those ECR as well as AmeriHome revenue. A 100 basis point decline is not enough to jet up a meaningful refinance business. But we do think it would help on the purchase side in terms of what we'd be seeing on volume. And if we went down 200 basis points, we really think that that's going to open a window for a fair amount of refinancing that's been done over, let's say, the past year as well as have something close enough that you'll get more refinance activity on a cash out basis with somebody moving from 4% to a 6% rather than all the way up to something in the mid- to higher 7s.

Okay. Thanks for taking the question.

Thank you. Our next question comes from Timur Braziler of Wells Fargo. Timur, your line is open. Please go ahead.

Hi. Good morning. One more on ECR for me. I guess as you look at fourth quarter specifically, how much of that DDA growth is expected to stick around? And then should we see a commensurate reduction in ECR during the fourth quarter if DDA balances do go down?

Yes, you should -- I mean, the volatility in deposits in Q4 is around the mortgage warehouse business, which carries most of the ECR credits. And as that volume drops, you should see a corresponding decline in the ECRs in the operating expense line.

Okay. And I guess, just given the seasonality in the warehouse business, how likely is it that, that $1.3 billion of DDA growth that's on third quarter, how much of that actually rolls off with that seasonality next quarter?

I think there are two things going on. So the growth that we had in the third quarter was a baseline improvement, which I think that has life, the same power. The decline we're going to see in the fourth quarter is from taxes and insurance, escrow funds explicitly. So while that will come down in the fourth quarter, we expect to retain the higher deposit levels kind of moving forward into 2024. So we should see a more pronounced rebound coming into Q1 than the decline that we see in Q4.

Okay. Got it. And then last quarter -- okay. That's understood. And then last quarter, you had made a point to mention that the borrowings are being paid down are quite expensive. I think the number was SOFR plus 200. I'm just wondering with the remaining borrowings left, what's some of the higher cost borrowings that we should continue to see coming down over the next couple of quarters? How much of that expense of borrowings are still left on balance sheet?

Yes. As of quarter end, we still had $0.5 billion that is an [S+ 2] (ph). I expect that will be paid off this quarter. And there's also a little bit of an average balance benefit because not all of the payoffs that were done in the third quarter that were, I'll call it ratably, over the quarter. And so some of that benefit is not recognized in the third quarter.

Okay. And then lastly for me, just on the mention of HQLA and tying that back into the $100 billion threshold. I know you've been growing HQLA now for a couple of quarters. But is any of that build in relation to that $100 billion threshold? And I guess, what's the remixing of the bond book look like with additional HQLA purchases and how punitive might that be in this rate environment?

Well, I think it is all a bit related, and there is maybe a gentle slope in terms of HQLA looking for kind of the $100 billion number over time, which obviously we're not closed to. But I think that's part of it. I think part of it is as well, as we pull down the loan-to-deposit ratio, those funds are going to be invested in something with higher levels of liquidity like we've talked about. So it is -- I don't want it to appear -- that's not a big step variable here. It's going to be a gentle climb into higher levels of high-quality liquid assets over the next couple of years.

Great. Thank you for the questions.

Our next question comes from David Chiaverini of Wedbush Securities. David, your line is open. Please go ahead.

Hi. Thanks. I had a follow-up on the rate sensitivity. So in an environment where the Fed does pivot and we see 100 basis points of rate cuts, I see NII down 4%. But clearly, on the ECR side, we should see some cuts there as well or declines there. How should we think about the PPNR impact of 100 basis point cut in rates?

Well, if you go to PPNR, that's really going to be your earnings at risk. So you're going to see with lower levels of expenses like you'd identify, but you're also going to see higher levels of revenue from AmeriHome mortgage operation. And so on an EAR basis, this really is worth really talking about a kind of a PPNR kind of framework, and that would pick up.

Got it. And then shifting over to a follow-up on credit quality. You mentioned about the roughly $2.5 billion of quarterly CRE maturities next year. How -- can you talk about the health of your borrowers and their ability to withstand higher rates as these loans mature and reprice higher?

All right, sure. So first, I think that discussion was in the context of the investment.

Well, it was $2.4 billion, but it was total loans.

Yes, total loans, not just CRE. So our CRE is entirely floating rate, one, I think that's important. And is entirely for the not central business district. So when we underwrite an office, we underwrite suburban office. And so we've already dealt with the role, so to speak, because the interest rates have already come up, and we've already made the grading decisions, and then we've already executed our strategy. And at this point, over 75% of that portfolio, we've either affirmed the structure that exists or we restructured and remargin in the present environment.

Great. Thanks very much.

Our next question comes from David Smith of Autonomous. David, your line is open. Please proceed.

Thank you. So within the deposit outlook for the fourth quarter, can you give us some more details on what's embedded about the mortgage warehouse decline? If we take the regional deposit growth of $1.5 billion and $0.8 billion digital consumer this past quarter, that would imply something like a $2 billion reduction or so in mortgage warehouse. Does that sound reasonable?

Yes, that sounds very reasonable. So that's what's going to happen in the mortgage warehouse. And then you would have the digital consumer platform, the regions and some of the specialty lines picking up that flat to kind of get us back to even. Just so I'll say this as kind of a point. We made a strategic change with our warehouse lending business over the last year or so, where we used to have more P&I accounts, which saw a lot more volatility month-to-month. We moved more to tax and insurance accounts, right? Same clients, different liquidity deposits. And so you don't see the big swings month-to-month, but you do get them towards the middle of the year and towards the end of the year when they drop down and then have to built up. So as these balances build up, they'll build up starting on December 1 thereabouts this year, and they'll build up for the next six months going out into 2024. So this should have a little more stability. That's just a change that we made here.

And given how much of the ECR balances are in mortgage warehouse, is it possible that we could see deposit costs down quarter-on-quarter in the fourth quarter? Or is that going to happen too late in the quarter?

No. I think you can see it down in Q4. Absolutely.

And just thinking about the NIM guide of 3.6% to 3.7% against 3.67% in the third quarter, you've got the tailwinds of the fixed loan repricing. You've got some more borrowing pay down. It seems like more tailwinds. I just -- I wonder if you could break out some more of the headwinds you see there that going to stop it from elevating higher than 3.7%?

Yes. So you also saw that we had an increase in our cash position at quarter end relative to the last quarter and the average balance for the quarter. And so that is going to consume some of that otherwise opportunity to have a higher yield, higher spread.

And lastly, on capital. Are you saying you think CET1 ratio could decline in absolute terms as you step up loan growth in the second half next year? Or it'll just continue to grow more slowly?

We don't expect a decline. As I said, the target is 11%, and then we'll push through that target. We just expect it to grow at a slower pace once we cross over -- cross through 11%.

Are there any more inorganic levers you can pull here after like the CLN repayments? Or is it basically going to be a function of earnings and asset growth from here?

It's going to be a function of earnings and continuing to watch our risk-weighted assets and making sure we optimize that quarter-to-quarter.

All right. Thank you.

Thank you. Our next question is from Brody Preston of UBS. Brody, your line is open. Please go ahead.

Hi, everyone. How are you.

Good.

I want to just follow-up to make sure I was following the warehouse commentary correctly and just kind of piece it together from last quarter. So I think you were up $3 billion in July during the last conference call, and it looks like you ended up $1.6 billion for this quarter. And so it came down at the end of the quarter, and then we're expecting another $2 billion of potential runoff from there in the fourth quarter just on a seasonal and a low point. Am I following that math correctly, Dale?

So what Ken was alluding to earlier, what we have, there's the escrow funds from a mortgage warehouse client are bifurcated into two pieces. One is tax as an insurance, that's the one that we think is more attractive because it's a little more stable profile. And the other was principal and interest. Well, principal and interest is on a monthly cycle. But funds build up and then somewhere around the 20, 24th of the month, they get spun out to the government-sponsored enterprises. The other one is build up for six months, some even longer than that. And then they're paid to the taxing authority. So the preponderance of our portfolio comes from California. And so California taxes, I think, they're due in like November or something like this. And so you're going to see that come down. So what you saw earlier was really just normal cyclical behavior. And so in, say, in the middle of the month, you're going to have a higher number in principal and interest that then comes back out. So even though that number came down from where it was maybe in mid July to the end of September, the actual balance trend is actually still positive, growing during that particular time. We're just hitting a high point on the monthly sine wave that we get on P&I payments. So that trend looks strong because of the balance from quarter end to quarter end looks good. What we're saying is the balance from quarter end to quarter end for the fourth quarter is going to be down, not because of P&I, which looks good. but because of T&I and not because of client impairment, just simply because that's the cycle in terms of how those funds are distributed.

Got it. Okay. I appreciate the clarification. And then I wanted to just ask on the spot loan yields. I think if I remember in the slide correctly, it was 6.99% on the spot rate for the yield, which I guess I wanted to relate that to the residential portfolio to kind of get towards that spot yield. It implies that you have to get more expansion in that residential yield. And so how should we be thinking about residential loan yields going forward?

Well, I think residential loans are going to move much. I mean the CPRs on that stuff today are 5%, kind of about the lowest anyone's ever seen. And so that's just kind of generally bleeding off. That said, this is kind of the point on why we mentioned, hey, we have about 2.5 -- $2.4 billion of loans rolling off repricing every quarter. And so that could come up. Now a small piece of that is going to be residential, but the rest of it as well. So if you take the residential and those loans are -- again, are coming in, something that begins with an eight. I mean, they're basically -- it looks SOFR today at 3 to 3.5 of that. So those run off and are being replaced at kind of notably higher rates. And even the variable rate ones are being replaced at higher spreads because maybe uncertainty in the economy and the relative tightness. Did you hear Dale's answer, Brody?

Yes. It just cut out there for a minute. I guess, that makes sense. It's just that the loan yields jumped up a bit this quarter on the resi book, and that kind of caught me by surprise.

Well, we did some modest dispositions of residential loan.

Our final question today comes from Jon Arfstrom of RBC Capital Markets. Jon, your line is open. Please go ahead.

Thanks. We're going to get out of the weeds here for a second. Are you signaling flat EPS for the fourth quarter? Just when I look at the guidance on Slide 19, is that what you're signaling?

Yes. So we're signaling flat PPNR with some sensitivity to the gain on sale on the mortgage business, depending on the backup on rates that you're seeing here. That's what we're signaling.

Okay. Okay. So that's difficult for us to model, but you're saying PPNR, excluding that, it's going to be relatively stable.

Yes. I think that's a fair answer. Yes.

Yes. Okay. Okay. And then what's your level of confidence in loan growth returning in early 2024? Dale mentioned your organic loan growth has slowed, but what's your level of confidence in getting that greater than $500 million a quarter back in the run rate?

Yes. If you're talking about getting it back, say, starting in Q3 or towards the end of Q2, I'm confident about that, yes. We have enough channels, Jon, to bring in that loan growth. I will say subject to macroeconomic events, right, subject to the economy and what we see. So it's not loan growth for loan growth's sake. It's if we don't like the credit, we're not lending against it. But everything being equal, we have a high degree of confidence in this company to grow loans in excess of $500 million, and loan growth will follow the deposit growth that we've laid out.

Right. Okay. How about as you look to 2024? I mean it seems like you have a couple of quarters left, maybe one or two left, to do what you need to do on funding. I'm assuming that means that the margin starts -- especially if the Fed is done, I'm assuming that means the margin starts to lift in early 2024, which means PPNR also starts to lift in early 2024. Is that -- am I looking at that the right way?

So for us, we've got a rate increase in December, which will carry into the first two quarters of 2024. At the end of the second quarter, we have three rate decreases modeled in there to the back end of the year. So you've got to keep that in mind. But as we think about 2024, as I said, with deposits following the $2 billion guide and loans growing at a moderate pace, which is that $500 million, we see sort of the dexterity and agility of the national business line framework and the regional growth gives us confidence in that balance sheet construction going forward. So that's sort of what we're seeing along with stable asset quality as we go into 2024.

Yes, I'm just -- I'm looking at the $8 consensus number. And it feels to me like it's good. It puts you at 5 times earnings, but your stock is down 8%. And I'm just curious if I'm missing anything when I think through your kind of medium-term to longer-term outlook.

I'm also surprised that the stock was down 8%. We were very pleased with this quarter. And relative to other banks that have reported, I thought we did fairly well. And we're not ready to give full 2024 guidance, but I think you can take what we said directionally correct and model from there.

All right. Eight bucks from me, anyway. All right. Thank you. See you in November,

Okay. Thanks, Jon.

Ladies and gentlemen, this is all the time we have questions for. So I hand back over to Ken Vecchione of the team for any closing remarks.

Thank you all for your questions and your participation. And we look forward to the Q4 earnings call. Thanks again.

Ladies and gentlemen, this concludes today's call. Thanks for joining. You may now disconnect your line.