WAL (2025 - Q1)

Good day, everyone. Welcome to Western Alliance Bancorporation's First Quarter 2025 Earnings Call. You may also view the presentation today via webcast through the company's website at 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 Po

Thank you. Welcome to Western Alliance Bank's first quarter 2025 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. 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 our 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.

Thanks, Miles, and good afternoon, everyone. I'll make some brief comments about our first quarter earnings before handing the call over to Dale to review our financial performance and drivers in more detail. And then, I'll close with some prepared remarks regarding our 2025 outlook, and our Chief Banking Officer for Regional Banking, Tim Bruckner, will then join us for Q&A. Before turning to our financial results, I want to thank the people of Western Alliance as well as our customers and investors for the many kind notes and well wishes received during my leave of absence. I also want to express my appreciation to the other members of the executive leadership team for managing the company during my absence. I'm feeling great and excited to be back at work. We often refer to Western Alliance as a bank for all seasons, that is always ready to serve our commercial clients' needs, irrespective of the macro environment. This is because our extensive sector expertise enables us to evaluate and structure business around perceived risks. The significant diversification of our business lines means we are able to consistently support profitability and risk-adjusted earnings while compounding tangible book value. In other words, we produced growth through all seasons. Different pistons in our growth engine fire at different times during the economic cycle, but the net result is consistent, safe and sound loan and deposit growth even during times of uncertainty like the present. Over the past two years, Western Alliance has significantly increased its capital and liquidity to fortify our balance sheet against potential market fluctuations, ensuring we are all well prepared for any changes in the U.S. economy, including from tariffs. We have preliminarily evaluated our borrowers and do not see a meaningful number of them with significant transaction volume with China, Canada and Mexico, since Western Alliance serves U.S. companies dependent on largely domestic supply chains with limited international exposure. Looking back on the first quarter, we are pleased with our execution that delivered financial results in line with expectations as we continue to prudently grow the balance sheet and maintain asset quality. Western Alliance's balance sheet growth supported solid pre-provision net revenue of $278 million, which equates to a $31 million or 12% year-over-year increase. Driving this increase was net interest income, which grew $52 million year-over-year or 9%. Net interest income, inclusive of deposit costs, also grew $52 million year-over-year as ECR costs reverted to the prior year's first quarter level. Net interest margin held steady at 3.47%, declining only 1 basis point from the prior quarter, while adjusted NIM, inclusive of deposit costs, expanded 17 basis points to 2.75% as a result of our accelerated ECR cost reduction efforts. Asset quality was stable. Net charge-offs declined 5 basis points in the quarter to 20 basis points, which aligns with our full year view. Provisioning for the quarter was $31 million, which was significantly below Q4 levels of $60 million. While classified assets rose $186 million, non-accrual loans declined by $25 million quarter-over-quarter to $451 million and moved 7 basis points lower as a percentage of funded HFI loans to 82 basis points. I know collateral values are affirmed by recent appraisals above loan values. Dale will now take you through the rest of the results in more detail.

Thank you, Ken. Looking closer at the income statement. Net interest income grew 9% year-over-year to $651 million and declined $16 million quarter-over-quarter, almost entirely from two fewer days in Q1. Our back-loaded loan growth places us in a good position to drive continued net interest income growth with ending held for investment balances $1.1 billion higher quarter-over-quarter versus a quarterly average increase of only $57 million. This loan growth is indicative of the improving profitability of our balance sheet and points to expanded NII going forward. As Ken mentioned, net interest income inclusive of deposit costs increased $52 million from the prior year and $22 million quarter-over-quarter. Noninterest income was relatively stable year-over-year at $127 million. Mortgage loan production volume increased 25% annually, and the gain on sale margin was 19 basis points. This quarterly decline in mortgage banking revenue was primarily related to lower gain on sale due to a decline in secondary trading gains. The smaller quarterly decline in net servicing revenue stemmed from a lower MSR fair value change, net of hedging. The result -- the reduction in income from equity investments was driven by an approximately $8 million charge on investment due to change in timing of income recognition, which we expect to fully recover over time. Noninterest expense was reduced $19 million to $500 million from the prior quarter as deposit costs declined $38 million to $137 million. Provision expense of $31 million replenished $26 million of net charge-offs as well as provided an incremental benefit to the reserve for commercial real estate, which we saw -- see as prudent given the current macro volatility. As a reminder, we focus on mitigating future losses by requiring low advance rates at the time of underwriting. This standard is validated by recent appraisals that show collateral values exceed loan values. Turning to our net interest drivers. Continued improvement in interest-bearing deposit costs and overall liability funding outpaced lower loan and securities yields. In Q1, the yield on total securities compressed 4 basis points to 4.63%. Held for investment loan yields decreased 14 basis points to 6.20%, which reflected a full quarter's impact of rate cuts made during Q4 on our variable rate loan book. Our cost of interest-bearing deposits declined 23 basis points as a function of our active management of deposit rates even without additional FOMC rate cuts since Q4. We continue to sustain momentum in lowering the bank's cost of funding as demonstrated by the interest-bearing deposit cost spot rate by adding 29 basis points below the average rate for the quarter. As discussed earlier, net interest income declined $16 million from Q4 to approximately $651 million, almost entirely due to the smaller day count. Net interest margin remained relatively stable from Q4 at 3.47%. The impact of reduced HFI loan yields was mostly mitigated by a comparable decrease in interest cost of funding average earning assets. Noninterest expenses declined $19 million quarter-over-quarter as deposit cost fell $38 million from both lower rates and smaller average balances. This decline offset normal seasonal increases in compensation and other expenses. Salaries and benefit expenses were higher from an annual incentive compensation plan bonuses earned from the achievement of various performance goals as well as higher payroll taxes. Our adjusted efficiency ratio of 56% compares favorably to the 57% ratio reported in the first quarter of 2024. While we remain asset sensitive on a net interest income basis, we are essentially interest rate neutral on an earnings-at-risk basis in a ramp scenario. This offset is supported by a material projected ECR-related deposit cost decline this year and an increase in mortgage banking revenue. Our updated rate forecast calls for two 25 basis point rate cuts before the end of 2025. The balance sheet expanded $2.1 billion from year-end to $83 billion in total assets, which reflected HFI loan and deposit growth of $1.1 billion and $3 billion, respectively. The seasonal rebound of mortgage warehouse deposits also allowed us to reduce borrowings by $1.4 billion. Total equity increased $508 million, inclusive of $293 million in proceeds from the issuance of REIT preferred equity. Finally, tangible book value per share climbed 14% year-over-year, aided by sustained organic profitability and some rate-driven relief for a negative AOCI position. HFI loan growth of $1.1 billion demonstrated gathering momentum toward the end of the quarter. C&I drove most of the growth, supported by smaller contributions from commercial real estate and construction. Residential loans decreased $63 million. C&I loans now account for 44% of the HFI loan portfolio compared to 39% a year ago, while residential loans are now 26% of the portfolio compared to 29%. These results exemplify the deep sector expertise and strong client relationships the company has fostered. I'd also like to add, this expertise is concentrated in areas with inherently low embedded risk of loss, which we view as increasingly valuable amidst the changing macro backdrop. Regional Banking produced over $900 million of loan growth, led by contributions from homebuilder finance and end market relationship banking. National Business Lines provided the remainder, with lender finance, the main driver of its growth with -- but with smaller diversified increases from other areas. Our growth in lender finance has continued to gain traction from our relationships with private credit clients. Deposits grew $3 billion in Q1, mostly in noninterest-bearing and were complemented by growth in savings and money market balances. Seasonal strength in mortgage warehouse was augmented by a solid result in HOA and our specialty escrow services. HOA solidified its market-leading position by posting a $900 million increase in quarterly growth during a seasonally strong quarter and surpassed $10 billion in deposits for the first time. Among specialty escrow services, Corporate Trust was a standout with nearly $300 million of growth in business escrow services generating approximately $100 million. Corporate Trust momentum could continue to benefit from the positive rating actions Western Alliance received in February. Turning to asset quality. Criticized assets rose $254 million from increases of $68 million in special mention loans and $186 million in classified assets. These loans have been reserved or charged down to current as is market values and are revalued on an ongoing basis. Nonperforming assets as a percent of total assets eased 5 basis points from year-end to 0.6%. Quarterly net charge-offs were $26 million or 20 basis points of average loans. Provision expense of $31 million added reserves to cover charge-offs that augmented our CRE reserves. Our ACL for funded loans increased $15 million from the prior quarter to $389 million. The total loan ACL to funded loans was unchanged from the prior quarter at 77 basis points. Our ACL ratio is conservatively weighted to economic scenarios more pessimistic than economists are forecasting, which include a weighted peak of unemployment rate above 6%, continued reductions in CRE valuations with greater than 50% peak-to-trough contraction in office values and several quarters of negative GDP growth. The ACL walk we regularly provide to add more context behind our allowance methodology moved for ACL from 77 basis points to 1.35%. This incorporates the effect of credit-linked notes as well as low-to-no loss loan categories like equity fund resources, our low LTV and high FICO residential portfolio and mortgage warehouse. Additionally, we applied another method to compare our loan portfolio to peers since loan mix matters when establishing loss reserves from differences in embedded loss content across various portfolios. Relative to peers, Western Alliance's loan portfolio is much more weighted to categories with very limited risk of loss. We have over $8 billion of mortgage warehouse loans, which were advances on mortgage properties while being escrowed for the GSEs with an average duration of about two weeks. We know of no bank that has incurred loan losses in this category. Our $8 billion total compares to the peer median of just $69 million with several having no exposure at all, which suppresses our relative reserve level. Our $14 billion in residential portfolio is larger than the peer median of $9.4 billion and also carries a high proportion of loans in high FICO, low LTV residential mortgages that we believe is not the case for the typical peer. Credit-linked notes ensure $8.5 billion of this portfolio where we already have the funds to cover any losses that might emerge. Conversely, Western Alliance has de minimis consumer loans compared to a peer median of $3 billion. These loans require substantially higher reserve levels as they are generally supported by a single source of repayment and more easily disrupted by adverse life events. If you apply the peer median loan mix to our portfolio, the comparable allowance would be over 1%. Turning to another look at capital levels, we believe reserves should be considered in the context of adjusted capital. Our CET1 capital ranks around the median of the peers. However, if you add to that our lower adverse AOCI mark and the ACL to address that some peers may have capital trapped in their reserve, you can see our adjusted capital is 11%, which is flat since year-end and ranks above the peer median for asset cohort. This supports our confidence that our capacity to absorb any losses in contract with steady loan growth remains strong. Our CET1 ratio decreased approximately 13 basis points to 11.1% during the quarter as a result of strong loan growth. Our tangible common equity to total assets ratio remained 7.2%. In late March, we received proceeds of $293 million from the sale of preferred equity at our REIT subsidiary. We issued out of the REIT in order to generate ongoing material after-tax dividend cost savings instead of issuing at the holding company. This issuance lifts our Tier 1 leverage ratio from 8.1% at year-end to 8.6%. Emblematic of a balance sheet with a lower risk profile, our risk-weighted assets to tangible assets ratio is among the lowest of peers at 70%. Tangible book value per share increased $1.83 from year-end to $54.10 as a function of organic earnings combined with $56 million reduction in negative AOCI position from a lower rate environment. Consistent upward growth in tangible book value per share remains a hallmark of Western Alliance as it exceeded peers by six times over the past decade. I'll now turn the call back to Ken.

Okay. Thanks, Dale. Our updated 2025 guidance is as follows: while we remain attentive to economic and macro developments, our balance sheet guidance remains unchanged at $5 billion of loan growth and $8 billion of deposit growth for the full year as pipelines remain healthy with strong client engagement. Turning to capital, our CET1 ratio should remain above 11%, a level we have been above for a year as we produce solid risk-weighted loan growth. Net interest income should ascend sequentially throughout the year and is still expected to increase 6% to 8% for 2025, largely as a result of sustained loan growth and expanding net interest margin that approximates 2024's level on a full-year basis. Noninterest income will follow net interest income's trajectory of 6% to 8% growth due to the ongoing traction in cultivating deeper client relationships with commercial banking fee opportunities. Noninterest expense, assisted by declining ECR costs from two rate cuts expected before December, should land between 0% growth and 5% decline. We expect ECR costs in Q2 of $140 million to $150 million. Our revised full year ECR cost outlook of $485 million to $535 million incorporates our current rate assumptions and typical seasonal outflows of mortgage warehouse deposits in Q4. Asset quality should remain stable, with full year net charge-offs hovering around 20 basis points. And lastly, we now expect the effective tax rate for 2025 to be approximately 20%. At this time, Dale, Tim and I will take your questions.

[Operator Instructions] Our first question is from Casey Haire with Autonomous. Your line is now open.

Thanks. Good morning, guys. Dale...

Good morning, Casey.

I appreciate all the color you gave -- good morning, guys. Dale, I appreciate all the color you gave on the ACL and certainly it does seem like it's predicated on some very conservative macro assumptions, but it's just -- obviously, it's a major overhang on the stock for investors to see the ACL that low. Just wondering, is there any thought to use some qualitative reserves to just get that into a more tolerable level for the market?

Well, I mean I think we've shown that our reserve is adequate, both in composition and when you add it with the [convenience] (ph) of capital. What I don't want to have happen is I don't want people to think, oh my gosh, they have a reserve level that's lower than somebody else. Is there -- after I've become an owner of Western Alliance, is there a charge coming that's going to take the reserve to a higher level? We do not see that. We continue to have a very rigorous methodology for determining our allowance and supporting that by what's taking place. We actually had a scenario this last quarter where we would have had a release of reserves in the CRE, but we instead put that into additional overlay on CRE and, again, gets us to the higher levels we have now with a more conservative view using the S4 scenario from Moody's to be able to put on our commercial real estate office.

Fair enough. And then, just switching to the guide for '25, everything seems to be tracking pretty well with the exception of fees. It sounds like that's coming from just more traction with your commercial clients. Just wondering if it's down year-over-year and you've got a healthy high-single-digit expectation, is there any help coming from mortgage or just the cadence of what looks to be a pretty steep fee ramp in the remaining quarters here?

Yeah. We see fee income rising in the second half of the year, buttressed from the seasonal increase in mortgage income. We expect mortgage income to remain flat year-over-year to prior year. Although I will say we are mindful that the recent rate volatility could impact consumer behavior, but all in, we expect noninterest income at this point to follow the net interest income trajectory.

Our next question is from Jared Shaw with Barclays Capital. Your line is now open.

Hey, good morning, everybody. Ken, it's great to have you back on the call. Looking forward to hearing more as we go through the summer. Maybe just the first, can you give a little color on some of the C&I growth dynamics where you're seeing strength and what was driving that this quarter?

Yeah. So, let me just talk about the balance sheet, I think in its entirety to begin. But there's strong momentum on both sides of the balance sheet. For loans, the client pipelines are active and full. And at this point, we expect Q2 loan growth to actually top Q1. Our national homebuilder group, warehouse lending group, note finance, lender finance will all fuel the growth for the following quarters, all right? And then for -- with that, we see our deposits also tracking to our full year guide to support the loan growth that we're bringing in.

Okay. Thanks for that color. And then, I guess looking at the capital raise, that was an interesting structure. Was the primary goal for that to raise Tier 1 leverage? And are you happy with where that is now? Or could we expect to see some other maybe unique capital moves going forward?

Yeah. It was to raise the Tier 1 leverage ratio, and we are happy with our level in kind of the mid-8% range. Again, if you juxtapose our Tier 1 leverage ratio compared to peers, which maybe is a little below the median, but a much higher than median level of risk-weighted assets to total assets, we think that gives you a good balance, and also shows you really confirmed by where we stand on a CET1 ratio of north of 11%. I might also note that we have a subordinated debt transaction that becomes callable this quarter. And we expect to call at least part of that in the near-term, which will mitigate to some degree the cost of the preferred. So, we did a preferred deal with the REIT. A lot of banks don't have this option because they don't have a REIT to be able to do that. The rate on that preferred less that those dividends are tax deductible. If we pay dividends out of the holding company, they're not tax deductible, they are just like common share dividends. But out of the REIT, they are tax deductible. And so, the net to us is a lower-cost after taxes than what it would have been if we had issued out of the parent.

Great. Thanks for that detail. Appreciate it.

Our next question is from Bernard von-Gizycki with Deutsche Bank. Your line is now open.

Hey, guys. Good morning. Just on insurance costs and deposit service charges, so I know you engage your larger depositors about passing over the deposit insurance costs over to them if they want to maintain the level of insurance. I know it just was over about $1 million for the quarter, but service charges increased over $5 million. So, I'm just wondering, is this mostly due to the larger depositors maintaining their insurance in accounts and you're benefiting from higher service charges, or was that the increase due to the change in pricing that you previously noticed from Jan 1?

This is Ken. I also think the answer here is that we've put a full court press on improving our treasury management services and outreach to our clients. And I think what you're seeing is that increase is showing up in the service charges for this quarter. And if you really look at it year-over-year, it's really up significantly for us. And so, Tim Bruckner, who's sitting to my right, he's kind of led that charge to bring in more fee income. And we've been focusing on that for the last 18 months to two years, rolling out products, improving our products and service capabilities and delivery, and we're pleased to see that type of improvement.

Okay. And then, my follow-up, just on the expenses for ECR-related deposit costs, I know the 2Q $140 million to $150 million is a small uptick versus 1Q. And I think you just raised the guide on that for full year. Could you just break down? Like, is that higher expected ECR-related deposits, higher rate? What's driving that change?

It's a really higher average balance. So, Q4 was -- it came down. It builds back up in the first quarter. So, as you go from Q1 to Q2, we expect a higher average balance in ECR-related deposits, and that's what's kicking that up. We do not see spreads on ECRs climbing from here.

Okay, great. Thanks for taking my questions.

Our next question is from Ebrahim Poonawala with Bank of America. Your line is now open.

Hey, good morning. Thank you. I guess maybe, Dale, just following up on the NII and the margin trajectory. One, remind us whether rate cuts, including of ECR costs are helpful or neutral to the NII outlook? And when we think about the sequential improvement, is this more back-half weighted? Is it a big step up in the fourth quarter when you think about just how NII and the margin trajectory are going to play out for the remaining three quarters?

Yeah, this is Ken. So, on net interest income, we kind of see the net interest income sequentially growing quarter-to-quarter, certainly for Q2 and Q3. We do have two rate cuts in there, one in June, and I think the other in September is our forecast. And so, what you'll see from us is net interest margin increasing gradually through the year, but I think you'll see more of an increase in the adjusted net interest margin as ECR costs kind of rise a little bit in Q2 and then flatten to decline in the -- in Q3 and really in Q4 as volume also leaves us, right, for the warehouse seasonal mortgage exit. So, you'll see the adjusted net interest margin grow, and that's going to bring the net interest income to that sequential pattern of growth, plus the loan growth itself is going to help us. And so, to the extent that we could accelerate our loan growth and increase it at a faster pace, that will give an increase to our average earning assets, which will give more support to the net interest income. And that's how we get to our full year guide.

Got it. And, Ken, welcome back. I guess, another question back to -- I heard Dale's response on the reserves, but I think when you think about -- and I know you spend a lot of time, when you think about the stock performance, it's trading at 7 times earnings. Like what do you think you can do to improve shareholder returns? I'm not sure if I heard any sort of discussion around buybacks. But how do you get the stock to re-rate? How do you improve shareholder returns? Like, what do you think needs to happen for the stock to react differently as we move forward?

I think we need to do a better job kind of really promoting what we're doing and the strength of our diversified business model. We talked about that a little bit about being able to pivot from one sector or one business to another, depending on what's in favor, what might be at risk kind of going forward. And we were talking about this earlier. We've seen how some companies brought up the Southeast, what they're doing there. Well, we have $14 billion in loans and $14 billion in deposits in the Southeast. And I don't know that, that gets enough attention. We have offices there. We've got people there. We've got people in some 40 states. But we haven't put a flag in some of those, so they don't -- so it doesn't show up necessarily on an FDIC scan. But we're there, we're active and we're successful.

And would you consider some sort of -- like, we've talked about bank M&A and maybe the regulatory environment improving, like, would some sort of a strategic partnership that better sort of extract franchise value? Is that something that you would consider? Like, how would you think about that?

No, I don't think so. I mean, look, it's hard to find another bank in our peer group that can grow the way we can grow on the balance sheet side, and improve earnings the way we generally have improved earnings and improved really tangible book value over the last 10 years. So, I don't think we're going to consider anything along those lines.

Got it. Thank you.

Thank you.

Our next question is from Gary Tenner with D.A. Davidson. Your line is now open.

Thanks. Good morning. And, Ken, welcome back. A bit of a follow-up to that last question. Just in terms of if M&A is not on the docket, the stock is trading at 120% of tangible book and below your out tangible book and you don't have a big dividend payout ratio. So, any more openness to using some capital for a buyback at this level?

So, right now, in times of uncertainty, you want to have excess capital and liquidity to either defend the bank against market or economic disruptions or be well positioned to take advantage of these disruptions. We've said since 2023 that we want to have a 11% CET1 floor. We are there. We think that position the best -- the bank's best in terms of taking advantage of growth. Go back to my opening statements, where a bank that tends to grow through all different types of economic cycles. I understand that there are many of our peers are buying back their stock, but that is more of a temporarily improving EPS through those stock repurchase programs. For us, we look to have that capital. We can deploy that capital into sound, safe and thoughtful loan growth. We believe we can deliver a return on average tangible common equity, in Q1, was 13%, but we see that rising as we go forward into the mid-teens percentage. And we think over time, that is the best use of our capital. Additionally, we compete against very strong and against the top 10 banks in the country with our national business lines. And when we go in to talk to clients, we need to kind of look like they do in terms of their CET1 ratios and liquidity profile. And having a larger CET1 or a higher CET1 ratio is very helpful on us being awarded business. So, we do use it as a competitive strength in terms of growing the balance sheet, where at this point, we're still not inclined to use it to buy back stock. We think the best longer-term value is doing what we're doing, and it's growing the company.

Fair enough. Appreciate the thoughts there. And then, as it relates to the positive second quarter loan growth commentary, I know it's still a bit early in the quarter, but any visibility as to kind of how that may layer in over the course of the quarter, given the commentary about the first quarter loan growth being pretty late quarter?

Yeah. I mean, to be honest, that's the hardest thing for us to forecast. My viewpoint is it always should come in early, and it always should come in on the first day of a quarter. It just never works out that way, unfortunately. You've always got deals to be done and completed by our clients. You've got lawyers in the way, and it's always a little later than we think. We're confident about our loan growth for the second quarter. My guess, it comes more towards the middle of the second quarter to the back half of the second quarter. But we make a very concerted effort here to push it up as quickly as we can into a quarter, but that is a hard task for us to accomplish every quarter.

Thank you.

Our next question is from Ben Gerlinger with Citi. Your line is now open.

Hey. Good morning. Welcome back, Ken. Just a quick question. I know it follows up a little bit on the past couple. I hate to beat a dead horse here, but if you look at -- as you said, interest-bearing deposit costs, spot rates down 29 bps. So, it gets you below 3 to end or to start April. Why is the margin only going up gradually considering loan growth is pretty healthy in the month of March? I'm thinking it's a little bit more than gradual when you look at just the pace of which NII should increase. Am I missing something here?

I do think that we're going to be more -- a little more stable on noninterest-bearing from here. I mean that has a strong recovery with primarily ECR-related deposits going into the second quarter. I would say as well that there is a little bit of issue with pricing pressure. So, we are seeing our loan growth, which we're confident about achieving. It is going to have a lower average spread relative to kind of the current -- what's currently on the balance sheet. And so, that's going to be modestly dilutive to the margin over time. Again, we're really focused on PPNR and what we can do to drive that more than we are about managing the margin per se. And so, we look -- and so PPNR obviously also includes the ECR costs that are in noninterest expense.

Right. No, that makes sense. It seems like PPNR is going to go higher seemingly every quarter for the next year or two here, but obviously, rate dependence is hard to see six or seven quarters out. But when you think about just the investment spend associated with PPNR, i.e., non-ECR-related deposits, is there anything incremental to a non-run rate perspective on investment, i.e., to get over the $100 billion that you still need to do? Or if the rules were changed and $100 billion was more like $50 billion or something like that, would you be ready today?

So, embedded in our forecast and certainly in our PPNR guide is the fact that we continue to build out our LFI readiness. And we assume on a natural growth curve that somewhere at the end of '26, early '27 will be over $100 billion, and we are preparing to do that. And embedded in our expense base is about $30 million to do that, okay? Now, if your question is, if new rules or regulations come out, and kind of push that out a little bit, and we don't have to be ready to cross over $100 billion, then, yeah, there would be some expense savings as we would push out the development for that. But I'll tell you, just on -- as much as this is a heavy lift for us inside of the company, and I don't think it really gets appreciated that or what type of heavy lift we're doing inside the company and simultaneously being able to grow the company the way we're growing it. The preparation for the LFI or Category 4 levels actually helps us make better decisions. It provides a better disc cost around the table with better data. And so, we are seeing some benefits from it immediately as we prepare to cross over that level in the future.

Got you. That's helpful. Thank you.

Our next question is from Timur Braziler with Wells Fargo. Your line is now open.

Hi. Good morning. Going back to the loan yield conversation, just the C&I loans that were put on back end of the quarter. I'm just wondering given rate activity, could you actually see those loan yields increase in 2Q or just some of the pricing pressures that you're talking through the loan production was below the kind of average balance for the first quarter?

Yeah. I would [indiscernible] you're going to see those loan yields increase over in Q2. Again, we have a rate decrease occurring in the second quarter, so that will put some pressure on the loan yields. Dale mentioned this in his comments that we are seeing some pricing pressure in the market. So, we're still winning deals, but there are a number of banks that are out there really searching and groping for loan growth. And sometimes they come in with pricing that for us doesn't make any sense, and we'll walk away from those deals. But there is some gradual downward pressure on loan yields.

As Ken mentioned, we have two rate cuts expected. The first of those is at the June FOMC meeting, which is in the middle of the month. And so, assuming it's a 25 basis point cut, that will move the preponderance of our loan book, lower by 25 bps as well. Again, it's only for one-sixth of the quarter, but you're going to get a haircut of a few basis points from that too.

Okay. Great. And then, my follow-up, just on credit. Maybe can you talk through the increase in C&I classified this quarter? And then, as you look at the office portfolio, just the reappraisal rates, when I'm looking at Page 22 of the deck, just over the last couple of quarters, that's grown from 7% over 80% LTV in 3Q, that's over 25% of the portfolio today, granted much of that did occur last quarter. I'm just wondering how granular was some of those reappraisals that are now over 80%. And just with 40% of the office book maturing in '25, 75% maturing through '26, does the current uncertainty in the macro change the way you potentially think about the risk profile of these upcoming maturities?

Sure. Yeah, I'll take that. So, first, with the substandard in our methodology and our risk rating, we are quick to move into substandard. We use special mention very sparingly. And we do that because we have built our culture around elevation and then timely resolution. So, that moves those loans into a very direct remediation strategy. So, the movements in substandard role are all fully secured, fully appraised and real estate backed, not -- unlike the discussion we've had on past calls. So, when we look at the appraisal rates, everything that we underwrite. Let's talk about office. Everything that we underwrite in office, we go in at 55% or below on the appraised value. And then, we have any additional fundings that would move on from there as we call it, good news money with signed leases and close support from the sponsorship. So, through this cycle, we've been rigorous to make sure that we have that support dynamic, and that if we don't have that dynamic, we take very timely moves to sort of control over the asset. So, as you see, those move up, you also see the basis of appraisal move from a fair market value to a very conservative as is value, giving effect to current market conditions. So, when you see those appraisal movements, the number is a small part of the story. The bigger part is the basis of the appraisal.

Great. Thank you.

Our next question is from Chris McGratty with KBW. Your line is now open.

Great. Thanks. Welcome back, Ken. If I'm looking at Slide 18, the guide, is there any reason why you would steer us away from the midpoint across PPNR? Are you leaning in any direction for any of the NII fees or expenses?

Sorry, Chris, your question again is what? I think...

Sure. If I'm looking at your near future guidance, is there any reason for us to not assume the midpoint of the various ranges? Or are you leaning to the high or low end in any one of the three components of pre-provision earnings?

I think the midpoint is appropriate. If I had my druthers in terms of what would happen by the end of 2025, we would have pushed a little harder on deposit growth and a little harder on loan growth based upon from the guidance we have here, and that would be kind of the primary driver of improved performance. But again, we want to be very attentive to changes in economic conditions, which, of course, have been rather frequent of late.

Okay. And on that point, Dale, if the revenue, either mortgage or the growth doesn't come through, but can you speak to the degree to flex the expenses a little harder?

I think if there's any flex that's really going to drive PPNR upward will be higher loan growth and higher average earning assets that would drive the PPNR higher. I think the flex on the expenses is pretty much what we've guided to at this point, and I would not change that guide or change that in your model.

Okay. Thank you.

We have a question from Jon Arfstrom with RBC. Your line is now open.

Hey, thanks. Hello, everyone.

Hey, Jon.

Hey. A question for you guys on the mortgage banking outlook. I think, Ken, you mentioned earlier, flat mortgage revenues year-over-year. Can you talk a little bit about your rate assumptions around those expectations? And is there a 10-year level where the volumes start to increase and maybe there's upside to that outlook?

Yeah. I mean, in terms of mortgage rates and what we saw last year, the pickup in volume begins somewhere when the mortgage yield for the 30-year is 6.25% or lower. That's when we saw it to really see a pickup in volume. If you talk to the mortgage folks at AmeriHome, they'll tell you anything that crack 6% would really be a race for the roses in terms of a much, much higher volume. So, we're assuming that rates kind of stay where they are to getting a little bit better throughout the year, and that's sort of what gives us this projection to keep mortgage income flat year-over-year. I will tell you that we are watching consumer behavior, and we're mindful that the recent rate and market volatility could impact future consumer behavior, and we'll wait to see how unfolds. But right now, we're sticking with the full year guide. It may come a little bit later in second quarter and then into the third quarter. I think April was a little choppy for consumers for the obvious reasons.

And we've heard this persistent cry, refis are coming, refis are coming, and yet they seem to be going to perpetually put off. And there's two pieces -- as Ken was mentioning, there's two pieces to that rate spread issue that we have. One of them is overall rates higher and then the other is the volatility in the premium price above like, say, the 10-year treasury for the mortgage refinance. And that's because, in part, some are concerned, buyers are concern, well, if I buy this mortgage now, but yet we see the volatility crush or we see rates decline for whatever reason that could happen, maybe a pullback in terms of tariff action, maybe action from the FOMC, we could see both of those collapse. And so, if you're going to be buying -- financing mortgages, you're going to be in a refi business kind of out of the gate. And so, I think just more stability might mute the ball and the rates for what we have in a 30-year mortgage property relative to market -- independent market rates anyway.

Yeah. Okay. That makes sense. Any thoughts on the gain on sale outlook. Would you -- do you think 19 basis points is unusually low? Or any thoughts on that outlook?

I don't -- I can't say whether it's going to expand. I would say that 19 basis points is unusually low.

Okay. Thanks, guys.

Thanks, Jon.

We have a question from Andrew Terrell with Stephens. Your line is now open.

Hey, good morning. And, Ken, welcome back. If I could ask on just, Dale, you mentioned in the prepared remarks the Moody's rating change back in February. I was hoping you could maybe just discuss a bit more any incremental traction you're gaining in the Corporate Trust business following that news? I know it's been a point you guys have talked about for a couple of years now.

Well, I think primarily what it does is, it again, reinforces confidence in terms of the strength and stability of the company. It was also upgraded by Fitch at that same time line. And so, a lot of those are based upon kind of deposit ratings as opposed to debt ratings, which already were an A-rated situation. So, we think that's helpful. But again, it kind of gets back in terms of kind of closer to where we've been historically. And we think, overall, it just promotes confidence, not just in Corporate Trust, but with our business escrow services, with our digital account products as well.

I'll just add to that, I'm very proud of the Corporate Trust folks this quarter. They grew deposits of $270 million. Our Corporate Trust business is now over $800 million in deposits. Our business escrow services is just about touching $1 billion. And so, we've got six different digital -- or six different deposit platforms that are going gangbusters, led by, of course, HOA, which we now think we are the market share leader. And as Dale mentioned earlier, grew $900 million. So, yeah, I think the upgrade in investment-grade rating is going to help. I just think these deals take time. We've got to be awarded deals and then they've got to fund the deals and then we get those deposits. But we're encouraged by what's happening in all of our deposit channels, and I think it's supported by that upgrade by Moody's and by Fitch.

Great. I appreciate the color. If I can go back to just some of the commentary on loan yields, I don't know if you guys have it, but could you share the weighted average yield on the new production for the first quarter? I'm just trying to get a sense of -- I hear you on the competitive front. Just trying to get a sense for how different new loans being put on are from the, call it, 6.20% or so book yield today? Thanks.

Right now, it's coming in at 3 basis points lower, but our deposit costs are coming in 29 basis points lower. So, we're seeing a slight decline in yields -- loan yields, but we're picking it back up in deposits.

Okay. Thanks for taking the questions.

Thank you, Andrew.

Our next question is from Matthew Clark with Piper Sandler. Your line is now open.

Hey, thanks. Good morning. And welcome back, Ken. Just on the kind of round out the discussion on margin in NII, it looks like you've got some pretty good visibility going into 2Q with the end-of-period loan growth, call it, 6.17% and the drop in the spot rate. You would argue for a margin over 3.60% on a reported basis, but any sense for kind of where that margin ended at the end of the quarter, if you normalize it for any unusual fees?

Well, we don't track what the margin is at -- sorry, at the end of the month or -- sorry.

Yeah, end of the month. End of the month, yeah.

Yes. So, end of the month, right. I'll just say -- let me try to kind of give you disguise. I think when you think about the net interest margin, we kind of see it staying rather kind of moving slightly upwards in Q2, a little bit more in Q3, and then plateauing Q4 to Q3. That's the net interest margin. The adjusted net interest margin, inclusive of the ECR costs, we kind of see second quarter and first quarter kind of being about the same and then we kind of see it growing net interest margin improving -- adjusted net interest margin improving stronger in Q3 and then again in Q4. That's probably the best guidance I can give you on that.

Yeah, you're definitely going to see more leverage over the adjusted margin than just a reported margin. That's really -- that's closer to what we're focused on. It's more direct relationship to PPNR. What we don't want to do is we don't want to not underwrite -- we have liquidity, a reasonable credit opportunity that has strong credit metrics just because it might be decremental to the loan yields under the margin.

Okay. Fair enough. And then just on the criticized increase this quarter, any thoughts on the outlook and migration in general, whether or not we might see some improvement, or is this kind of environment makes a little more skeptical?

Our migration, as I mentioned, is really focused on real estate related, particularly office secured loans. So, when we look at those, those have been in view now for a couple of years, and we've been working our strategies on that. So, when we look forward, we see the path to resolution as well as the necessary steps and we know the assets by name. Again, this is a floating rate portfolio. We're not waiting for balloons or maturities here. So, we've developed these assets early. So, where I see it is flat in the coming quarter. We see it begin to move downward in the later part of the year.

Great. Thank you.

We have a question from Anthony Elian with JPMorgan. Your line is now open.

Ken, good to hear you're feeling much better, and welcome back. I want to start on loan growth. I know you mentioned that second quarter should top -- I know you mentioned that second quarter loan growth should top first quarter growth, but can you just share with us anecdotally anything you've heard since Liberation Day on what you've heard from your customers in terms of business investment, CapEx they may be thinking about, but that's on pause now, and if they're making any adjustments now given the elevated uncertainty from tariffs?

Yeah. So, our clients are certainly mindful and cautious of what's going on. I would say the longer the tariff discussion stays in limbo, the more uncertainty and angst will be added to their outlook. But we're seeing a lot of our growth in Q2 come from longer-dated capital expenditure programs, i.e., national homebuilder finance, which we do a lot financing, and then we do the vertical construction on that. Those folks make a longer-term investment decisions, and we're funding them as such. And so, those folks are, of course, mindful, but not immediately impacting their business mostly because there's somewhat of a housing shortage in the U.S. On the C&I side, lender finance seems to continue to push forward. We're actually seeing some improvements in tech and innovation. Although overall, that sector has slowed a little bit, certainly in deposit generation and liquidity events. But we seem to be winning more than our fair share of market deals that are out there or taking market share. And so that's giving us some confidence as well.

Thank you. And then, my follow-up on credit. If I think back to the early days of COVID, you guys were early in terms of proactiveness, diving deeper into potential problem portfolios. Ken, it sounds like you did that again based on your prepared remarks and you don't see a significant number of borrowers or meaningful exposures to China or Canada. But are there any segments now within national business lines that you're just paying a little bit more attention to given the outsized uncertainty? Thank you.

We really look at our -- as Ken [introed] (ph) with, our diversified business model as the strategy for any type of economy, and it plays out in this type of economy. So, we're constantly at the table, dialing some of our businesses up a little bit, and we're seeing great results and we're dialing other businesses down. So, we're a bank going into this period with virtually no retailer energy exposure, no consumer exposure outside of our mortgage business. And all of our borrowers, for the most part, are domestic companies doing business in the U.S. That doesn't take the risk away, but it gives us a very manageable model with our diversified strategy where we can -- we think, manage through this better than most.

Thank you.

There are no further questions at this time. So, I'll pass it back to Ken Vecchione for any closing remarks.

Yeah. Thank you all for joining us, and thank you for -- again, for all your well wishes and look forward to seeing you on the road at conferences and then picking up again with you on our next earnings call. Thanks again.

That concludes today's call. Thank you all for your participation. You may now disconnect your lines.