Western Alliance Bancorporation (NYSE:WAL) Q3 2022 Earnings Conference Call October 21, 2022 12:00 PM ET
Company Participants
Miles Pondelik – Director of IR and Corporate Development
Ken Vecchione – President and CEO
Dale Gibbons – CFO
Conference Call Participants
Casey Haire – Jefferies
Ebrahim Poonawala – Bank of America
Steven Alexopoulos – JPMorgan
Brad Milsaps – Piper Sandler
Tim Braziler – Wells Fargo
Chris McGratty – KBW
Andrew Terrell – Stephens Inc.
Brandon King – Truist Security
Jon Arfstrom – RBC Capital Markets
Operator
Good day, everyone. Welcome to the Western Alliance Bancorporation Third Quarter 2022 Earnings Call. You may also view the presentation today via webcast through the company’s website at www.westernalliancebancorporation.com.
I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.
Miles Pondelik
Thank you and welcome to Western Alliance Banks third quarter 2022 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer.
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 take 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 over to Ken Vecchione.
Ken Vecchione
Thanks, Miles.
This quarter, the company continued its strong financial performance as our diversified national commercial bank again delivered record net interest income, PPNR and earnings, complemented by strong deposit and loan growth, supporting higher net interest margin with stable asset quality.
For the third quarter, Western Alliance generated record total net revenues of $664 million, net income of $264 million and EPS of $2.42. Earnings were propelled by accelerating net interest income quarterly growth of $77 million or 15% from the prior quarter to $602 million as the rising rate environment expanded our net interest margin 24 basis points to 3.78%.
We made industry-leading performance with return on average assets and return on average tangible common equity of 1.53% and 24.9%, respectively, which will continue to support building capital levels in the quarters to come.
Sound balance sheet expansion continued with quarterly loan growth of $3.6 billion or 7.5% quarter-over-quarter and deposits rose by $1.9 billion or 3.5% quarterly, mostly from noninterest-bearing DDA accounts. Loan demand remained healthy with 27% of growth coming from our regional banking divisions and 50% from national business lines.
Deposit growth of $1.9 billion trailed strong loan growth this quarter. In Q3, our regional banking divisions contributed 32% of deposit growth, and our specialized deposit franchises added 63%.
We are proud that one of our new deposit business lines, business escrow services is gaining meaningful traction and contributed $424 million this quarter. We expect business escrow services, settlement services and other deposit initiatives to meaningfully contribute to growth and continue to enhance our funding profile in 2023.
Mortgage banking-related income declined $35 million as the origination market continues to face major market disruption. The speed and level to which rates have climbed have greatly reduced refinance activity and restrained affordability of the purchase market. Provision revenue was negatively impacted by a $22 million MSR hedge loss driven by volatility that spiked towards the back end of the quarter.
We have positioned AmeriHome to properly operate in a lower origination market focused on becoming the industry leading low-cost operator and have implemented a strategy to prioritize profitability against volume market share. Finally, asset quality continues to remain in great shape, and we do not see issues on the horizon. For the quarter, Wells recorded net loan recoveries of $1.9 billion or negative 2 basis points. And year-to-date, we are in a net recovery position.
At this point, Dale will take you through our financial performance.
Dale Gibbons
For the quarter, Western Alliance generated net income of $264 million, EPS $2.42 and PPNR of $358 million. Excluding the $2.8 million mark-to-market loss on preferred securities and a $4 million charge related to severance and other compensation charges primarily at AmeriHome, our EPS was $2.47 and 13% higher on a linked quarter annualized basis.
Additionally, loan growth of $1.3 billion in excess of consensus added approximately $10 million in incremental provisions, which is front-loaded due to CECL. Total provision expense of $28.5 million also captures our somewhat softer outlook on the economy.
Total net revenue of $664 million was an increase of $44 million during the quarter and $115 million or 21% year-over-year. Net interest income increased by 15% from Q2 to $602 million which was driven by loan growth and further NIM expansion. Overall, noninterest income declined $33 million to $62 million from the prior quarter due to lower mortgage banking-related income, which fell $35 million to $37.5 million.
Gain on sale revenue was $14.5 million due to lower purchase volumes, while servicing fell to $23 million as volatility rose, which led to an MSR hedge loss late in the quarter. While the mortgage industry has made strides in rightsizing overcapacity to adjust to lower volumes in a higher rate environment, this process is ongoing and normalized margins have not yet returned.
Noninterest expense increased 13.7% or $37 million, resulting in an efficiency ratio of 45.5%, primarily due to higher deposit costs related to earnings credit. If the efficiency ratio was adjusted to reclassify deposit costs as interest expense, it would be 40.5% as remaining operating expenses were flat.
Turning now to net interest drivers. Our growing asset-sensitive balance sheet benefited from the rising rate environment. Investment yields increased 72 basis points from the prior quarter to $3.66 is variable rate securities repriced. On a linked quarter basis, loan yields increased 65 basis points with an end-of-quarter spot rate of 5.43%. Loans held for sale benefited from rising mortgage rates to increased 88 basis points to 4.87%.
Total funding costs, including borrowings and deposits increased 50 basis points to 88 basis points with this broad rate of 1.12% as the average rates and balances for deposits rose. Short-term borrowings and credit linked notes also climb.
Long-term debt expense increased $13.5 million this quarter due to $940 million in total CLNs we have issued program to date, which has preserved nearly $400 million in equity capital and minimized stock issuance. The higher interest expense and a little capital issuance also provides credit protection on 24% of our loan book.
As mentioned earlier, net interest income growth of $77 million or 15% linked quarter benefited from average interest-earning asset growth of $3.8 billion and NIM expansion of 24 basis points to 3.78%. Interest income grew 32% more quarter-over-quarter than our total funding costs, inclusive of ECR expenses as we remain asset sensitive.
Our rate shock analysis shows with a 100-basis point rise for 12 months and on a static balance sheet, net interest income is expected to lift 6%. Using the same scenario on our growth balance sheet, we expect net interest income to grow over 15%. Reviewing the effect of a 200-basis point shock on a growth balance sheet, net interest income is expected to rise over 25% over the 12 months from the current run rate.
Our efficiency ratio increased 270 basis points to 45.5%. after reclassifying deposit cost and interest expense, it improved from 41.1% in the second quarter to 40.5% in the third, demonstrating the high operating leverage of the company.
Deposit costs increased $38 million from the prior quarter due to higher earnings credit rates on deposits of $15.9 billion, of which, $11.3 billion is in noninterest-bearing DDA. Pre-provision net revenue rose to a record $358 million during the quarter, a 14% increase from the same period last year and an increase of $7 million or 2% from the prior quarter.
This resulted in PPNR ROA of 208, a decline of 11 basis points compared to 219 last quarter. While leading organic capital generation produces approximately 45 basis points in CET1 capital on a static balance sheet per quarter and provide significant financial flexibility to fund balance sheet growth or build capital ratios.
Balance sheet momentum continued during the quarter as loans held for investment increased $3.6 billion to $52.2 billion and deposit growth of $1.9 billion or balances to $55.6 billion at quarter end. Mortgage servicing rights balances increased $218 million during the quarter to $1 billion, in part from declining prepayment fees.
Total borrowings increased $1.1 billion over the prior quarter to $7.2 billion, primarily due to an increase in short-term borrowings to fund loan growth in excess of deposit expansion. Tangible book value per share increased $0.49 or 1.3% over the prior quarter to $37.16, primarily due to strong organic earnings that offset unrealized marks on available for sale securities recorded in AOCI. Tangible book value increased 7.2% over the prior year.
This quarter, we generated sound organic growth for our national business lines and regional banking divisions. Loans held for investment grew $3.6 billion, driven by $1.6 billion in C&I loans, $893 million in sponsor backed commercial real estate and $766 million in resi real estate. C&I growth was driven by $534 million in tech and innovation, $392 million in warehouse lending and $350 million in capital call lending. 43% of our loan growth this quarter came from our core very low to no loss national business lines.
Turning to deposits. We continue to experience growth across our diversified funding channels. This quarter, our regional banking divisions generated approximately 32% of our net deposit growth, while specialty positive NBLs drove the remainder.
In total, deposits grew $1.9 billion or 13.9% annualized in the third quarter with noninterest-bearing DDA up $1.2 billion, CDs $533 million, and savings and money market $176 million. Noninterest-bearing DDAs now comprise 45% of our total deposit mix of which 55% or $13.6 billion have no associated earnings credit rate.
Our diversified deposit franchise continues to provide ample opportunities to generate attractive funding to support loan growth with warehouse lending up $1.2 billion, regional banking divisions up $604 million and business escrow services up $424 million. Business escrow services has continued to establish new relationships with large corporate acquirers, attorneys and private investment firms that support the growth ramp this quarter.
Going forward, we expect our scalable national deposit businesses such as HOA, settlement services and business escrow to continue to generate attractive deposits to fund ongoing balance sheet growth and temper the impact of elevated rates on our overall funding costs.
Our asset quality remains stable and strong as classified and nonperforming assets as a percentage of total assets are still lower than pre-pandemic levels. Total classified assets increased $39 million in Q3 to $385 million or 56 basis points of total assets. Subsequent to quarter end, approximately half of this increase in classified has been resolved and we see nothing to demonstrate a trend. Total nonperforming assets to total assets remained stable at 15 basis points, and we realized net recoveries of $1.9 million.
Special mention loans decreased $5 million during the quarter to 60 basis points of funded loans, which represents a further decline from already historical lows last quarter. As the prospects for additional economic volatility continue to evolve, we believe our underwriting discipline borne out through that our national business line strategies has prepared us for any credit stress that may accompany additional macro headwinds.
However, we have not observed any preliminary signs to credit migration or client pressure. We believe our safe and sound asset quality decisions will dictate our thoughtful, diversified loan growth trajectory and enable us to navigate through heightened economic uncertainty.
Approximately 55% of our loans are now in low to no loss categories and 24% of the portfolio is credit protected through government guarantees, CLM first loss, or is cash secured. Quarterly net recoveries were $1.9 million, 2 basis points of average loans, which brought us through a net recovery position on a year-to-date basis. Our total loan ACL increased $29 million from the prior quarter to $356 million and is now greater than our pandemic high watermark that was set in 2020.
Year-to-date, our ACL has increased by $66 million. Total loan ACL to funded loans remained flat quarter-over-quarter at 68 basis points, while our ACL to nonperforming loans rose from 385% in the prior quarter to 396% this quarter. Adjusting for the $10.8 billion of loans covered by credit linked notes, where ample first loss coverage is assumed by a third party.
These coverage ratio rises to 86 basis points. We believe these superior asset quality trends are sustainable throughout economic cycles due to Western Alliance’s deliberate post-GFC business transformation strategy to become a national commercial bank, focused on deep underwriting specialization and greater business diversification. While national reach and deep segment expertise enables selective relationships with the strongest counterparties on the go to attractive projects with superior company risk management.
During the global financial crisis, 67% of West Alliance’s losses came from loan categories comprising 44% of the 2009 loan portfolio, which today makes up less than 6% of total loans. Western Alliance has spent the last decade working to minimize these risks and diversify the business.
We view a primary impediment to a higher stock valuation as misplaced concern about the credit risk heading into elected recession. Cumulative net charge-offs for the past decade have totaled only $27 million against $356 million current reserves. 55% of our loan book is in to low to no loss categories.
Lastly, the intended consequence of the credit-linked notes issuance has 24% of the whole portfolio credit protected. We know of no other bank that can make this fight. Excellent asset quality has been a hallmark of the new wall, rapid improvement drove ratios due to the top quartile where they have essentially held even through the height of the pandemic.
Classified and nonaccrual loans continue to hold below peers, while charge-offs have been minimal with the net recovery recognized year-to-date. Nonaccruals and net charge-offs have consistently ranked as one among the best in the industry and the classified loans in the top quartile even during the pandemic.
Our credit risk mitigation expertise shined during 2020 and 2021 and will be critical if the economy weakens further. A hallmark of Wells business model is that greater diversification leads to sustained superior earnings growth with reduced volatility.
Similar to a traditional sharp ratio for stock returns, our risk-adjusted net income growth has been excellent relative to other large peers, among the 33 domestic publicly held – publicly traded banks in the U.S. with assets between $25 billion and $150 billion, Wells has produced the highest risk adjusted average net income growth. While they weren’t the leader in earnings growth or the lowest in earnings volatility separately, our combined strong and steady growth has produced the top risk-adjusted return.
Given our industry-leading returns on equity and assets, we continue to generate significant capital to fund organic growth and maintain well-capitalized regulatory ratios. Our tangible common equity with total assets of 5.9% and common equity Tier 1 ratio of 8.7% were both slightly lower than quarter-over-quarter. With AOCI dynamics impacting tangible book value ratios across the industry, we utilized our ATM to strengthen capital in addition to solid earnings. We do not anticipate any share issuance will be needed as CET1 builds throughout next year.
Finally, inclusive of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased $0.49 or 1.3% quarter-over-quarter to $37.16, which is slightly above our Q1 level. Notably, our tangible book value has grown 19.4% annually since 2013, 3.5x the rate of the peer group.
I’ll now hand the call back to Ken for closing comments.
Ken Vecchione
Thanks, Dale.
I was pleased with the management team’s ability to adapt to the changing interest rate and economic environment to produce record operating results. Thoughtful balance sheet growth in conjunction with operating and executional focus position the bank to capitalize on net interest income sensitivity while simultaneously growing both sides of the balance sheet with industry-leading performance. Our superior operating leverage offset the decline in mortgage banking income. Asset quality remains stable and solid with no signs of elevated stress. Organic earnings should grow capital as we reposition the company for slower growth ahead of a potential slowdown.
So let me tell you what you could expect going forward here. Given the uncertain future economic and operating environment, we believe it’s prudent to prioritize more measured but still double-digit loan growth, targeting up to $1.5 billion per quarter. We plan to surgically reduce loan growth through increased pricing and tighter credit criteria while deemphasizing loan growth not accompanied by high-quality deposits. Deposits are expected to grow at approximately $2 billion a quarter. This will lower our loan-to-deposit ratio over time, which currently stands at 94%.
Our goal over the next year is to bolster key capital ratios back to pre-AmeriHome levels, including 10% CET1. Our bank industry-leading return on average tangible common equity produces significant organic capital of approximately 45 basis points of CET1 net of dividends per quarter, which provides us with significant flexibility to grow capital ratios and fund the balance sheet growth. We expect to achieve our 10% CET target by mid-2023, aided by restrained balance sheet growth and risk-weighted asset optimization programs.
Net interest margin is expected to continue to expand in Q4 at a similar pace to Q3, given the anticipated rising rate environment, we expect to continued – we expect continued quarterly expansion of NIM and growth in net interest income throughout 2023, even after the Fed pauses rate increases as fixed rate securities and loans reprice and balance sheet growth continues.
Total revenue should continue to decline due to strong net interest income with the drag from mortgage banking likely to moderate, assuming muted volatility. Our expense ratio, excluding the impact of deposit costs should remain in the low 40s given inherent operating leverage of our business.
Asset quality remains well positioned and ranks among the industry’s best. The technical recession, we believe we have entered may move some key ratios slightly higher, but we do not anticipate any material deterioration that would change our above peer standing. In conclusion, we continue to see an EPS of $9.80 for 2022 as a launching pad for which 2023 EPS can ascend.
At this time, while we’re happy to take your questions, and I should have also said that Tim Bruckner, our Chief Credit Officer, is with us here today as well.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question is from Casey Haire from Jefferies. Please go ahead.
Casey Haire
Yes, thanks good. Morning, guys. So I want to get some color on the comments about NIM expanding through next year. Obviously, if you – it sounds like you’re going to be a little bit more selective on the loan growth front, which could help on the yield side. But it does obviously seem a little bit tougher on the deposit betas and the funding pressure there. So what kind of – and I know you guys don’t manage the deposit betas, but what kind of deposit beta is in your forecast that is still allowing you to just drive NIM expansion through next year?
Ken Vecchione
Okay. So we’ll tag team this. Let me start off and then I’ll throw it over to Dale. I just want to make sure we’re clear that for Q4 and through 2023, we are projecting a growing and vibrant net interest income using the consensus FOMC forecast. So net interest income and NIM will continue to grow into 2023 even after the FOMC concludes raising rates.
And we feel comfortable with this forecast for several reasons. Number one, the increase or excess liquidity that we’re going to get from having deposits grow faster than loan growth will drive federal home loan bank borrowings downward, lowering funding costs.
Second, current and future loan growth is being priced at higher levels as we’ve seen liquidity withdrawn from the banking system. Third item is $1.5 billion of loans repriced every quarter with about 50% rolling over at higher spreads, and our fixed rate securities and loans totaling $800 million also repriced quarterly, which we see – we think we can get some benefit from.
The other thing I would say is, since my return to the company, taking over as CEO, we focused on net interest income rather than net interest margin rate. And then focusing on net interest income allows us to also produce the EPS results that we have achieved.
And so in our mind, what we have done is, going forward, we have priced 100% deposit beta with 100% loan beta. And we kind of see the spreads, which have been materially increasing for us, certainly since the beginning of Q3, but even before that, to carry us for the rest of the year. Dale, do you want to add anything to that?
Dale Gibbons
Sure. Yes, Casey, so we have lower levels of interest-bearing deposits and other funding sources, borrowings and CLNs than we do in terms of interest asset earning loans and securities. And that’s primarily because of our DDA that has no ECR to mention that is $13.6 billion.
And so we’re okay bringing on high beta funding so long as it’s going into 100% beta assets, and we’re going to continue to see that. I think some of the other institutions have been challenged because they’ve actually held back on their deposit raising the deposit cost.
They have consumer or something else, and they believe that it’s going to withstand that and then they’ve been surprised. And so now they have betas in excess of 100, at least for some accounts, we haven’t been there.
We know what our funding looks like. We haven’t relied that we can kind of sneak things by. And so we have been – our pricing is right there in terms of where it needs to be. And what we’re seeing in terms of our spot rates, it kind of confirms this. So for example, on our loan yield, our spot rate at the end of the second quarter was 4.51%.
At the end of the third quarter was 5.43%, up 92 basis points. Meanwhile, for our funding costs, our deposits, living costs was up from 63 to 112, so up 51 basis points. And again, what we had during the second and third quarter is, we had loan yields tempered because we were floors were still active. That’s not the case anymore. And so we see that picking up, and then we’re going to have more dollars rolling over in terms of maturities.
And right now, those fixed rate loans are about 300 basis points below the current offer rate that we would do today, that is going to reprice more than what we’re going to see on liabilities because liability repricing for us hasn’t lag.
Ken Vecchione
Case, I’m going to give you a quick story. I think everyone on the phone will like. And then I’m going to ask you for a pop quiz here, okay? We turned down 31 loans in our senior loan committee. Those alone is $25 million or greater, not because of credit.
We like the credit a great deal. But we turned them down because of pricing. Either the initial price wasn’t high enough or the step downs were coming down too quickly or we didn’t like the floors, and we decided to move the floors up. And so here’s your pop quiz. How did we do against 31 loans, we went back to the borrowers and asked them if they would accept the higher pricing level?
Casey Haire
Not very well.
Ken Vecchione
You’re wrong. We went 100 for 100, 31 for 31, right, which…
Casey Haire
They all took the higher price.
Ken Vecchione
A little bit – 31 people came back and said, yes to the higher price, you’re right. And that told us a few things. One, it makes us almost feel like you put your house on the market on day one and you sell it. First thing you say, oh my God, I – he sold it too cheaply. So what we really determined from that – and that was over a couple of week period when we went back and looked at the 31 loans, but what we really determined was liquidity is leaving the system, right? And one of the things that’s natural for us and what’s different for our bank versus others is that we try to be a bank for all seasons, and we try to remain open for all seasons.
Now that may mean that we tightened credit criteria, which we have. It may mean that we have some more equity in the deals which we have. And it may mean that we’re asking for higher pricing. But we remain open. And one of the things – one of the reasons you see the volume of loan volume continue to come in above what our previous guide has been is because we’ve developed this loyalty and people come to us because they know they can get a deal done and the incremental short-term costs or higher cost of funding doesn’t compare to the longer-term value that they’re getting. So I just wanted to – you asked a simple question, and we decided to give you a long answer.
Casey Haire
Yes. No, no, I appreciate it. Okay. Just on the 10% CET1 target by midyear, is – so that’s – is there anything that you’re going to do that organically, right, just moderating the loan growth? Or is there – and without the ATM, is there any like bond book runoff? Is that part of it or anything else that help you there on that in short order?
Ken Vecchione
Well, there are two things that we’re doing. Certainly, just repositioning our loan growth to up to $1.5 billion is going to help us probably grow net or 14 basis points per quarter. We generally do 45 basis points of organic growth, subtract out for the $1.5 billion. And that’s how you get to 12-or-so basis points, quarter-by-quarter. The other thing is Tim Bruckner’s sitting here with us, but he’s led this reoptimization or optimization of our risk-weighted assets, specifically around unfunded commitments, and we expect that to grow as well. There may be a CLN note that you’ll see, a deal happened, maybe this quarter or maybe in quarters one or two.
And it’s the combination of those things and a bunch of other smaller activities I just don’t think are worthwhile going through at this time, that drive us to a 10% level. Q2, we think late is Q3. And it’s all without – you ask a very specific question. It’s all without hitting the ATM.
Casey Haire
Okay. Very good, thanks, I’ll step-back. Thanks guys.
Operator
Your next question comes from Ethan Kariwala from Bank of America. Please go ahead.
Ebrahim Poonawala
Okay. Ebrahim here. I guess just maybe going back to comments around $2 billion plus in the growth, some perspective around your comfort around there. Obviously, there’s a lot of concern around the industry, around deposit pricing, deposit growth. So like your conviction level in meeting those deposit growth numbers, and then how should we think about its impact on deposit costs and mix shift as we think through 2023?
Ken Vecchione
We’re going to split this one off and tag team it as well. I’ll take the volume side. Dale will take the cost side. And so if I heard you clearly enough, and correct me if I’m wrong here, you really want to know what gives us the confidence around the $2 billion, right? Well, we’ve been running that and then some on that if you go back looking at our history. But we’ve got several deposit franchises that are very strong. We have our HOA business, okay? That’s strong. Settlement services is something we started to build in 2018.
We rolled out in 2019. It now has $3 billion of deposits. And so going back a couple of years, when everyone – when I say everyone, the other banks that, gee, we don’t want any more deposits. We always said, no, deposit franchises will really determine what our market capitalization will be in the future and how well we perform. So we rolled out settlement services. We rolled out business escrow services. We also have a tech business that produces $3 of deposits for every $1 in loans. Warehouse lending has also been a very strong provider of deposit growth.
And I want to bring you back to AmeriHome for a moment. This is very important. When we bought AmeriHome, we said, we bought it because we saw an emerging regional bank. In the 7 quarters that we’ve owned AmeriHome, we’ve taken AmeriHomes deposits from a standing start of zero to $7 billion, $7 billion in 7 quarters, right? I would tell you not to extrapolate that going forward.
But it goes to show you that, that $7 billion really sat – it really sits on the bank side of the of the company and has been generating that incremental interest income from us. So those are the growth channels. You want to take the cost side, Dale?
Dale Gibbons
Yes. So on the cost side, I’ll note, we talked about that we brought in $420 million of – in deposits from business escrow services. Well, $300 million of that is in non-ECR DDA. So that should help us on the cost side, and we’re getting traction there. I got to tell you, we’ve got an application pending with the OCC to commence a corporate trust operation.
We think that, that is likely to kick off this particular time. We hired a team from Wells Fargo after they sold their operation, and we think that’s going to be a source of funding for us also kind of going forward. And then in terms of deposits.
So again, we’re there that we’re not trying to necessarily wrestle that everything has to come in at super cheap, standard rates or not market rates. But we have the ability and we’ve demonstrated this to bring in funds consistently. I would say our pipelines going forward are at least as good as what they’ve been in the past couple of quarters. And it has been a little harder than we thought. We did exceed loan growth versus deposit growth. We’re rightsizing that from Q4 forward.
Ken Vecchione
Let me just tie it back to a question that Casey asked as well and tie it back to net interest income. If you don’t have loan growth, it’s harder to bring in deposit growth because that deposit growth is coming in at a very high incremental cost to it. We have the ability to grow loans in excess of $1.5 billion, and you’ve seen that, right? And so the fact that we can match off deposit growth at a marginal rate compared – with 100% beta to it, compared to 100% beta on the loan side allows us to make the spread. And as we’ve said, we’ve increased those spreads. So that’s what kind of gives us the benefits.
And again, I’ll point you right back to – and I don’t think we get enough credit for this, and I’m going to start hopping on it, that our business model is different than almost every other bank’s business model, and this is what our model allows us to do.
Ebrahim Poonawala
Got it. As far as there’s no pulp, this is I’m fine with that. And I guess just another follow-up question. Dale, you talked about credit costs. When you look at the ACL 86 basis points, what should that – what is that embedding in terms of the macro, understanding your portfolio is very different if the economy is headed into a recession like where do you see that reserved building because that’s the other piece of downside EPS risk as we think about the next few quarters?
Dale Gibbons
Yes. So we use the Moody’s model like I think most do. We take weights but the preponderance is on the kind of consensus. And then we have a much heavier weight on S4 versus S1. And so as those numbers have become kind of more impaired as they did in third quarter over second, it did pull up a little bit more in terms of what an appropriate ACL would be. I would say, we’re not expecting charge-offs to occur. And so long as we are right side up on LTV. And we’re a low LTV lender across the board.
Our residential book is – was underwritten at 65% but is now probably under 60% in terms of LTV. Our commercial real estate is done anywhere from 45% to about 65%. And so we feel strongly that – and the Moody’s model showed this that unless there’s something really severe happening, we’re going to be able to do well on that. And if I go forward back to the pandemic, we saw the hotel book and hotels clearly took a direct hit from travel during 2020 and 2021. And people were throwing numbers back at me in terms of what we’re looking at in terms of losses.
We didn’t lose a dime in hotels, the entire time. Because we had good sponsorship, low loan to value, and we’re – and the type of loans we’re doing. We weren’t doing central business, big boxes, where people weren’t coming anymore and that have very brittle cost structures in terms of not a lot of flexibility. These are like select service deals like residence in and then the hotels they close every other floor to hold their cost down and that worked, and it worked for us.
Ebrahim Poonawala
Got it. And just to make sure that I heard you correctly. I think you mentioned full year EPS $9.80 into about $2.78 EPS run rate for fourth quarter. Do you believe you can grow earnings off of that in anything?
Dale Gibbons
I’m sorry, I didn’t hear the – here clearly. Yes.
Ken Vecchione
If I heard you correctly, Ebrahim, I mean, yes, we think that the $9.80 is a period from – that we can – that’s the fourth quarter number implicitly obviously. And that from there, given what we expect to happen in terms of continued loan growth, a little bit more tempered than maybe what the Street is have us at. But margin expansion, which is the opposite of what the Street had us at that we can continue to sustain that throughout 2023. Again, this is the backdrop of what the FOMC actions are going to be as predicted in the futures curve.
Ebrahim Poonawala
Sir. understood. Thanks for taking my questions.
Ken Vecchione
Thanks.
Operator
Your next question is from Steven Alexopoulos from JPMorgan. Please go ahead.
Steven Alexopoulos
Hi everybody. I wanted to start on the deposit cost side. If I include the cost of…
Ken Vecchione
Steve, you got to talk up. Steve, we can’t really hear you. Can you pick up the receiver or get closer to the phone. We’re just not hearing you clearly.
Steven Alexopoulos
Is that any better?
Ken Vecchione
Much better.
Steven Alexopoulos
Okay. On the deposit cost side, if I include the cost of the earnings credit related deposits and the cost of total, we calculate these change by about 61 basis points quarter-over-quarter. Earning assets are up 71 basis points. So from a spread view, it’s up about 10. Looking at it through that lens, how do you see that spread trending over the next few quarters?
Dale Gibbons
Probably, most likely, parallel. I mean I think we have a little bit of momentum in the loan side because of – kind of they were held back because of floors. But yes, we’re comfortable with the parallel shift there. Also, we’re getting better pricing on the loan side. And I don’t think that we – there’s much more to go on funding cost increases.
Steven Alexopoulos
Okay. On the ECR deposits, how much of the $2 billion per quarter growth do you assume will come from that? And how should we think about that cost moving forward?
Dale Gibbons
We’re not expecting that our deposit structure on the liability side is going to be improving at all. And so what we’ve dialed in is growth predominantly in either interest-bearing or in ECR related. I do think that we’ve got opportunities to bring some other stuff in, as I mentioned, with business escrow services and some of these others but that is not a major factor in terms of moving that needle. I think we’re going to be paying for deposits.
Steven Alexopoulos
Got it. Okay. And then finally, in terms of pulling back the lending a bit, which categories are you planning to deemphasize here?
Ken Vecchione
Yes. Good question there, Steve. And so as I said, we’ve tried to do this in a very surgical way. So we’re going to pull back our resi loan growth, this quarter, it was $750 million. I would expect that to drop to under $250 million in Q4 and then drop to under $100 million going forward.
But just to refresh memory for those on the phone, it wasn’t too long ago that we had $6 billion sitting in liquidity at 10 basis points. And so building up a residential book seems to be the appropriate thing to do back then. We’re not going to be emphasizing it now going forward. The other places you’ll see us be more circumspect on is in the capital call subscription line space. We really haven’t seen the cross-lending portfolio company opportunities that we had hope to have materialized, they did not.
And so we’re going to pull back there. That business eats up a lot of our unfunded lines, our unfunded commitments. That’s why Tim Bruckner is working on that in terms of the optimization. And I said – I guess I would say, the other thing is, we continue to stay close to all our clients, and no loan gets approved, certainly at the most senior level in this company, without a significant deposit relationship coming over. And we made that a big focus as well.
And therefore, if you’re not bringing over deposits, then some of our loan growth will slow naturally. But quite frankly, as an entrepreneurial bank that has always outperformed on the loan growth side, this is a challenge for us and to a certain extent, to be more surgical on where we’re going to grow.
We think we can do that, and we think we could keep the loan growth to under $1.5 billion and that kind of connects back to the CET1 ratio on why we’re trying to also move it up to 10%. We’re not getting credit for the loan growth, Steve, and people are saying, well, you’re probably lending into a recession. We just will pull back, and we’ll look for higher yields on all that.
Steven Alexopoulos
Got it. Okay. Thanks for taking my questions.
Operator
Your next question comes from Brad Milsaps from Piper Sandler. Please go ahead.
Brad Milsaps
Hi, good afternoon.
Ken Vecchione
Good afternoon, Brad.
Brad Milsaps
Ken, I think I heard you mention that you thought the efficiency ratio would stay in the low 40s sort of ex the impact of ECR deposit costs. I want to make sure I heard that correctly. So there was some severance – small severance costs in the quarter and wondering if – what the benefit from those might be going forward? And then finally, because you’re pulling back on growth, does that mean we should maybe think of pulling back on the expense growth as well? I’m just trying to get a sense of kind of the expenses ex the ECR?
Ken Vecchione
Yes. So you did hear me correctly that ex deposit costs, the efficiency ratio should stay in the low 40s. Brad, if we don’t keep it there. I mean, look, we can take it down, but we’re not going to do that for several reasons. And I think I’ve been clear about this on previous calls. Number one, we’re preparing for the day that we grow over the $100 billion threshold. And we always need to continue to invest in risk management and technology, which we’re doing. We also are continuing to invest in new products and new services and new rollouts.
And Dale mentioned 1, it actually got a little ahead of – what I was going to say about that on the corporate trust, I was going to wait until we brought in some deposits. But we’ve built that into our expense base next year as well, which is a new product, our new business line. So it’s important for us to continue to build up these new business lines, and that’s why we’re going to keep it in the low 40s. That will help us or that will not deter our growth in total EPS as we roll into 2023. There are a couple of components to your question. Do I answer all of them?
Brad Milsaps
Yes. And then maybe as my follow-up question to Dale, just on the ECR deposits again. Do you see a change in the pace of that beta or that rate in which those costs are going up? Do you see that accelerating? I’m sure it’s not decelerating, but just kind of curious your thought around just kind of the pace of that change going forward.
Dale Gibbons
I don’t. I mean out of the gate, we had some that were a little more sluggish than others, but this has been the most widely telegraphed rate rise scenario, I think, in history. And no one is not aware of it, not a Western Alliance anyway. And so yes, so they’re fully participating. They’re basically moving in lockstep with FOMC or effective Fed funds.
Brad Milsaps
Okay. Great. Thank you.
Dale Gibbons
Thanks Brad.
Operator
Your next question comes from Tim Braziler from Wells Fargo. Please go ahead.
Tim Braziler
Hi. good morning. Maybe looking at the MSR hedge loss this quarter, can you just help us kind of frame our thoughts around that? Is that kind of going to continue in the fourth quarter, just given the pace of rates? Was that a little bit more idiosyncratic with just the shift in volume? And any color on kind of broader direction for AmeriHome kind of gain on sale revenue would be greatly appreciated?
Ken Vecchione
Yes. Let me give you the broader direction and tell you what we are planning for in 2023. So we are using the Q3 total mortgage servicing revenues of $37 million as our base going forward throughout 2023. We hope to do much better than that. But for our planning purposes, 23 – I’m sorry, $37 million is the base as we go forward.
So that’s, I think, the first thing. Regarding the $22 million ball hit that we had. Our models when we model things, we model out the life of the loan for 30 years, all the cash flows and then we discounted back. And we hedged that in our model, but we hedge it out to 18 months.
After that, there’s not enough liquidity in some of the hedging instruments. And so we took a little bit of a hit in the volatility going out above 18 months. Now what I should say, and we should have said in the opening statements here, we pulled back half of that in the MSR valuations. We have outside firms, look at the MSR valuations. And so while we took a $22 million back about $10 million of that.
So the net impact was $12 million. But we’re also doing something different in the business. We continue to rightsize that business. We’re probably down about 29% in total people count there. So we’re trying to make sure we are the low-cost operator in that space.
And we’re not trying to win share for share purposes only. We’re trying to win profitable share. So the volume of correspondent moments that we purchased will be less. But we are pushing and hopefully, the market will see this and also follow that the margins will increase. And so far, early results in early Q4 is that strategy is beginning to work.
Tim Braziler
Okay. That’s great color. I appreciate that. And then maybe just going back to one of Dale’s comments when talking on asset quality. You mentioned the provisions kind of capture, a softer view of the economy. I know you’re pulling back on some lending verticals but that doesn’t seem credit related. I guess as you look out across your landscape, what are those softer areas that you’re kind of focusing on here?
Ken Vecchione
You mean softer or the more opportunistic areas. Actually, I’ll let Tim answer.
Timothy Bruckner
Yes, I can take that. I think we signaled that we saw some headwinds in the economy where have we pulled back or where will we respond, is that correct?
Tim Braziler
Yes, that’s, right.
Timothy Bruckner
Okay. Great. So a year ago, we started adding a real heavy stress to everything, development, construction-related and commercial real estate. Okay? So that’s one. So we had tempered our underwriting. We’ve maintained that. We’ve become more conservative in advance and underwritten with a significantly heavier interest rate stress, I think that’s positioned us well in that segment.
On the investor dependence side, starting in November – October/November of last year, we significantly stressed our enterprise valuation methodology. So those two areas are areas that given our portfolio weighting would receive more stress, and we adjust it early.
Ken Vecchione
We’re also bringing our portfolio to this. We did this coming out of last year into four major categories. The insurable portfolio, which Dale referenced, which is about 24% of our portfolio is credit protected insured or how the government guarantee to it. We have economic, resilient economic resistant and then we have economic sensitive. And we’ve been deemphasizing the economic sensitive loan categories and staying with the other 3, actually basically the insurable category and the economic resistant categories, we’ve been spending more of our time in terms of our lending pursuits.
Tim Braziler
Got it. And then just as a follow-up, you guys have certainly outpaced the market when it comes to warehouse lending. And I know a good component of that is just kind of tapping into the AmeriHome network. I guess, how big of an opportunity is left there? And maybe just broader thoughts around warehouse would be appreciated?
Ken Vecchione
Yes. So when we say warehouse lending, we’ve got a couple of components to that. One is the traditional warehouse lending, but also embedded in rounding is our node financing opportunity. That’s note-on-note financing, where we’ll see LTVs of about maybe 40% or lower, and we’ll be in a first position. No financing business is really very strong at this point. And so it’s helping lift the warehouse lending side a little bit. But to be honest with you, we’re still seeing a lot of good growth coming in warehouse lending.
And there, I would say is that we’re taking some market share as other people are pulling back. And as other people are struggling to deliver the type of service we deliver. We’re also seeing MSR lending is embedded in that group, too. And that has a lot of interest from borrowers, and we have some comfort level that we can grow that throughout 2023.
Tim Braziler
Great. Thank you for the color. I appreciate it.
Operator
Your next question comes from Chris McGratty from KBW. Please go ahead.
Chris McGratty
Great, thanks. Dale, I want to go back to the loan and deposit repricing, if I could, and moving a little slow today. Can you just repeat kind of the comments about incremental betas on both sides of the balance sheet? I’m just trying to make sure I get what the messaging is on repricing of assets and liabilities.
Dale Gibbons
So if I look at our spot rates, we have a greater momentum coming from Q2 to – and then Q3, that isn’t captured in the average rates on the loan side more significantly than it is on the funding side. And I think that’s because, in part, the loans were held back because of floor has been – nothing is close to a four today.
And so I think that carries us in terms of what that looks like going forward. And so it so long as we have a loan beta from here that is no lower than the loan to the deposit beta, and we’re anticipating deposit betas to be very high. We’re going to continue to do well, and especially if we can reprice things higher, as Ken mentioned, with these 31 returns that we had from our senior loan committee, all of which came back with, yes, we’ll take the underwriting even at a higher cost. So we think, we’re well situated to carry that.
Now for the fourth quarter, I mean, I think we’re dialing in 75 and then 50 and then we don’t have anything in 2023, I think maybe there’s going to be a little bit of a tail. But with that kind of a profile and with really, the repricing we’re doing on our loan book that isn’t – I don’t see that in our funding book because our funding book is already really fully moving in lockstep.
Now we do have some benefit opportunities like we had in 3Q, where $300 million of our DDA was not ECR related. I think some of those things are going to kick in, but we don’t have to do that. So long as we – all we have to do is have our loan betas be no lower than our deposit betas, the loan book and with the securities book, which has demonstrated a variable rate as well, largely, we’re going to be able to continue to have expansion of net interest margin and then couple that with a more modest expansion of the balance sheet.
Chris McGratty
That’s help. But you said a very high deposit. Did you put a number on that for kind of future betas?
Dale Gibbons
No, no. I mean really, as Ken mentioned, that’s not our management thing. We’re not trying to optimize betas. We’re trying to optimize net interest income and DDR.
Chris McGratty
Okay. Last one, just to make sure I understand the $9.80 that you reiterated, is that – just remind me, is that full year net income earnings per share? Or is that fourth quarter annualized? Just trying to get the right starting off point.
Dale Gibbons
Yes, that’s the full year of kind of what an operating income would be, correct.
Chris McGratty
Okay. Thanks.
Operator
Your next question comes from Andrew Terrell from Stephens Inc. Please go ahead.
Andrew Terrell
Hi, good morning. Most of might have been asked and addressed already. But Dale, can you remind us just expectation for the size of the average loans held for sale portfolio? And then do you have the spot rate on that book at the end of the quarter?
Dale Gibbons
Yes, the spot rate on that book was $5.29. And we think that balance is going to be modestly lower than where we ended at $9.30.
Andrew Terrell
Okay perfect, thank you.
Operator
Your next question comes from Brandon King from Truist Security. Please go ahead.
Brandon King
Hi. Just one question from me. I understand and I see benefits when rates are rising. But I’m curious, what are the actions you’ve taken in the event that we have a recession and theoretically rates will fall, just curious if there have been any actions that you’ve taken place to kind of protect against that in the future?
Dale Gibbons
Yes. So one thing that really helped us during the pandemic is we are active and basically mandate anything that isn’t a syndicated situation led by somebody else that we get loans on. And so we did that, and that held up our loan yields much better than some others and kind of improved our net interest income. We’re still doing that. They’re really, I would say, largely ineffective at this point in time because you put a floor in, maybe that floor is 100 basis points lower than the current rate based upon the variable rate instrument there.
And then if it’s going up another 150 in the next 90 days, I mean, it’s going to be way out of the money. But if we hold at higher rates per se, like a year, we’ll be able to reprice a lot of those floors much closer to the current rate, which will give us a lot of insulation in terms of what that would be like. The other thing I would say is, my gosh, I mean, in a lower rate environment, I think the mortgage market is – it’s going to get jump started, and we’re certainly ready for that also.
Brandon King
Okay. And no other, I guess, hedges or interest rate collars being put on the balance sheet, has that been contemplated as well?
Dale Gibbons
We always debate that. We put some term kind of hedges on. We – some fixed swaps back when rates were in the low double-digit basis points. So we’ll evaluate that at that time. But again, that’s just to mitigate kind of the downturn.
Brandon King
Okay, thanks for taking my question.
Operator
Your next question is from Jon Arfstrom from RBC Capital Markets. Please go ahead.
Jon Arfstrom
Hi thanks, how are you guys doing?
Ken Vecchione
Good Jon.
Jon Arfstrom
Good. Just a few cleanup questions. One on Chris McGratty’s question on the run rate deal. I know it’s kind of nitpicky, but if you take the annualized $9.80, you get to $2.45 for the fourth quarter, I think you’re saying that’s too low, but we kind of have to stretch to get to $9.80, just clarify that for us on the $9.80 number, what do you mean by that?
Dale Gibbons
So the $9.80 is the full year operating EPS. So you have to be above I – maybe I misunderstood Chris’ question a little bit. You have to be above that. That’s going to take you to kind of the $2.70 range or somewhere in there to be able to do that.
Jon Arfstrom
Yes, for the fourth quarter. And you’re saying that’s the jumping off point for ’23?
Dale Gibbons
Yes.
Jon Arfstrom
Yes. Okay. I’ve had a couple of questions. I think people know I’m the last guy on the call maybe, but can you talk about the ECR expenses and talk about the efficiency ratio with ECR and how you want us to think about that expense in the model?
Dale Gibbons
Well, we’re showing it both ways. I mean to me, if it looks actions and smells like something, maybe that’s what you should call it. I think it really acts like interest expense. That’s not really how the gap maps it geographically. So here we are. So we can look at it both ways. I do think that taking it out and considering it as interest expense gives one a much better view in terms of, one, is the bank asset sensitive or not, how is revenue rising and interest income relative to expense? And we’re still higher, not as much higher as that we keep it in expense. And then you look at your operating kind of architecture, and we’re in the low 40s if you just eliminate it completely. And I think those are kind of both appropriate.
As Ken said, I think our efficiency ratio going forward, roughly the same position of the low 40s is appropriate. And again, we’re looking for continued improvement on net interest income grows relative to interest expense, including deposit costs.
Ken Vecchione
Jon, I’d add only one thing to that is just, you’ll see deposit costs rise in Q4 again, near maybe the same level as Q3. But as we begin to enter into 2023, that rise will be tempered, and it won’t be as noticeable as we go through 2023 based on the FOMC projected rate increases.
Jon Arfstrom
Yes. Okay. Okay. I just have two more if I can. Just kind of on that topic, when do you think the margin starts to top out kind of winter where? Because I look back in my models, and I know your business is a little different, but you were approaching the high 4s in the last hiking cycle. And I’m just curious if that’s just out of the question and just the timing on when you think this all might peak?
Ken Vecchione
So again, everything is predicated at least right now for us on what the FOMC is going to do, which, for us is 75 bps in a couple of weeks, followed by 50. That’s in our – that’s what’s in our forecast. We actually don’t have anything in there at all in the upward actions in 2023. But we see in terms of the NIM, the rate, we see that continuing to rise quarter-to-quarter. It may flat a little bit out towards the very end of the year.
But right now, we even still have that kind of rising as a nice slope throughout the year in excess of what we see in consensus. Yes, but certainly lower than the historical highs that you alluded to.
Jon Arfstrom
Yes, yes. Okay. All right. And then the last one I have, I like what you guys are doing, but I have to ask this. When you go 31 for 31 on the higher pricing, I mean, I understand that’s a positive, but you could take it the other way as well. It could cause you to question pricing and the competitive environment as well. But what are – what is that – what do you really learn from that, that 31 for 31? What does that say about the competitive environment? And maybe what did you learn from that?
Ken Vecchione
Yes. Thanks, Jon. On the competitive side, it’s telling us that other banks, other competitors have pulled back probably for several reasons. First and foremost, we think it’s because they don’t have that deposit base that we have or that fresh liquidity coming into their bank, number one. Number two, they may be more regionalized in their lending, or they may be just more product niche focused.
We have the ability to deploy liquidity and capital to at least 17 different national business lines that we have inside the bank. So it gives us an opportunity to really flex our business models and capability. The third may be a different perception on the economy. Now we are expecting a recession, and we are modeling that, and we are doing our underwriting as if a recession is going to occur. And of course, we stress test everything for much higher rates and lower vacancies and lower rents and all the other things you would expect us to do. But we feel comfortable with our underwriting and the quality of borrower that we’re getting in.
And the reason why I think we feel comfortable. One of the reasons is, back to being a bank for all seasons. We remain open. And as I’ve said this to every client, we’ll always remain open to try to help you, but given the economic either uncertainty or environment, we’re going to just change around credit criteria equity we’re going to acquire in the deal and pricing. But you should be able to get a loan from us assuming that the deal pencils out and we’re dealing with a good borrower.
And while borrowers always grows a little bit about higher interest rates. They come back and pay them because they realize the short-term cost of that interest rate is nothing compared to the longer-term benefits they’re going to get. And so this comes back to the service side, dependability, the ability to close when we say we’re going to close, we close and once we shake hands, we don’t re-trade. And that has a lot of positive force to having our clients continue to return to us.
Dale Gibbons
We have provide a commodity service, I mean, so even in normal times, our pricing is almost always higher than others. But because of what Ken said, in terms of our ability to kind of to deliver on time and the consistent structure as promised, that’s worth something to our clients and they’re willing to pay for it.
Jon Arfstrom
Okay all right, thank you very much.
Ken Vecchione
Thanks Jon.
Operator
There are no further questions at this time. Please proceed.
Ken Vecchione
Okay. Thank you all for attending the call. Good questions. We liked the quarter that we had and we’re positive about what we can do going forward, and we look forward to speaking to you on our next call in January. For those that I don’t talk to, I know it’s early, but have a good holiday. Thanks, everyone.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
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