Columbia Banking System Inc
NASDAQ:COLB
Earnings Call Analysis
Q4-2023 Analysis
Columbia Banking System Inc
The company's balance sheet reveals a proactive approach to managing its investment portfolio, translating into a more stable and higher earnings stream. The unrealized loss from market valuation has decreased, leaving over half of the portfolio holding an unrealized gain, which speaks to the company's adaptability and sound financial management. The total deposits have remained largely unchanged, suggesting a steady customer base despite the usual fluctuations in small business balances and public deposits, a positive sign of resilience. Moreover, a stable book yield of 3.59% and an effective duration of 5.4 showcase the company's prudent investment strategy.
The loan portfolio composition remains diversified, indicating a robust commercial book and a well-performing office portfolio. A noteworthy credit reserve bolstered by an additional 21 basis points of loss-absorbing capacity signals a cushion against potential credit losses. The $55 million provision expense, although primarily driven by a modestly negative economic outlook, might suggest a trend towards normalization in credit quality after an exceptionally high-quality phase. Overall, credit performance persists as positive, suggesting a solid risk management framework in place.
The granularity of the deposit base highlights the strategic focus on maintaining a diversified and stable funding source. The initiative to grow public deposits has proven to be successful, counterbalancing other declines and representing a strategic victory for the bank. Interestingly, the bank has leveraged predictive analytics to increase fee income, suggesting a forward-looking approach to revenue generation and customer relationship management. This has materialized in $11 million in additional revenue since 2020, indicating a significant win from investing in technology and relationship building.
With the anticipation of interest rate cuts, the bank's Net Interest Margin (NIM) trajectory is a significant point of discussion. Conservative estimates with deposit betas in low to mid-30s in a declining rate environment hint at possible margin protection strategies. The bank is preparing to take proactive measures to influence the market, potentially allowing it to either lead or follow market trends, which will determine its competitive position in a changing rate environment. Moreover, the impacts of inflation on small businesses shed light on near-term deposit activity trends, indicating attentiveness to the challenges clients face and the potential influence on deposit levels.
Inflation appears to be a pressing issue for small businesses, potentially influencing their deposit activity with the bank. Although plans to deal with interest rate cuts are underway, the broader economic impacts of inflation call for vigilant monitoring and strategic response to sustain deposit growth and overall financial health in the uncertain economic climate ahead.
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Welcome to the Columbia Banking System Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised that today's call is being recorded.
At this time, I'd like to introduce Jacque Bohlen, Investor Relations Director, to begin the call. Please go ahead.
Thank you, Valerie. Good afternoon, everyone. Thank you for joining us as we review our fourth quarter 2023 results, which we released shortly after the market closed today. The earnings release and corresponding presentation, which we will refer to during our remarks this afternoon, are available on our website at columbiabankingsystem.com.
With me this afternoon are Clint Stein, President and CEO of Columbia Banking System; Chris Merrywell and Tory Nixon, the Presidents of Umpqua Bank; Ron Farnsworth, Chief Financial Officer; and Frank Namdar, Chief Credit Officer. After our prepared remarks, we will take your questions.
During today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the safe harbor provisions of federal securities law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Slide 2 of our earnings presentation as well as the disclosures contained within our SEC filings.
We will also reference non-GAAP financial measures alongside our discussion of GAAP results. We encourage you to review the GAAP to non-GAAP reconciliations provided in our earnings release and throughout the earnings presentation.
I will now turn the call over to Clint.
Thank you, Jacque. Good afternoon, everyone.
2023 was a tremendous year for Columbia. We closed and integrated our transformational merger with Umpqua Bank, expanding our footprint to encompass 8 Western states and creating one of the largest banks headquartered in the West.
We achieved targeted net cost savings ahead of schedule and 6% above our original projections, even after taking franchise reinvestment into account.
With the integration behind us, our priorities in 2024 and beyond have shifted to focus more fully on optimizing performance and driving shareholder value.
The fourth quarter was noisy and our results reflect that. The FDIC special assessment and other elevated expense items brought our quarterly expense run rate above prior guidance.
Our cost of funds reflects the rate environment and the associated impacts of repricing CDs and higher priced funding sources like public deposits and brokered funds. While these items mask the quality of our core deposit base, they do not dilute it.
Relationship banking drives our franchise value and it's the value proposition we bring to new and existing customers. Our fourth quarter results do not reflect this value, and we are focused on improving controllable variables to offset macro-driven headwinds.
Looking to the year ahead, the competitive environment for deposits and the impact of higher rates is likely to persist, and the macro credit environment will likely normalize at minimum.
We are well situated to benefit during times of distress should they emerge. Our talented associates, scaled franchise and offerings, and customer-focused business model provide us with the resources to win business and, long term, drive consistent, repeatable performance.
I'll now turn the call over to Ron.
Okay. Thank you, Clint. And for those on the call who want to follow along, I will be referring to certain page numbers from our earnings presentation.
Slide 4 lays out our Q4 performance ratios, noting the decline in the quarter was driven primarily by the decline in noninterest-bearing demand deposits as customers continue to utilize cash; higher provision for credit loss based on slightly worsening economic forecast; and higher expense, including the FDIC special assessment. These are 5-quarter views. And recall, we closed the combination at the end of February.
Slide 5 shows our summary balance sheet, noting that our deposits in total were flat from Q3, even seasonal inflows, primarily on public deposits, mostly offset customers' use of cash. Our tangible book value is up 13% as our accumulated other comprehensive loss was halved during the quarter as bond markets rallied.
Now on Slide 6, we highlight the income statement trends. GAAP earnings were $0.45 per share impacted by declining merger expense as we completed the integration, along with fair value changes due to market yield changes. On an operating basis, we earned $0.44 per share in Q4, lower than expectations, again, given noninterest-bearing deposit flows, higher costs on interest-bearing deposits and an increased provision with slightly worsened economic forecast and higher expense driven primarily by the FDIC special assessment which, at $33 million, reduced GAAP and operating EPS by $0.12 per share.
Turning to Slide 7, we break out Q4 GAAP earnings to help investors understand the nonoperating and merger-related impacts on results. The first column represents our Q4 GAAP results with net income of $94 million or $0.45 per diluted share and return on tangible common equity of 12%. The second column includes our nonoperating designation for income statement changes mostly related to fair value swings, along with merger and exit and disposal costs included in noninterest expense, which are detailed out in the appendix.
These net to $2 million of income in Q4 earnings, resulting in a third column for operating income. Again, our operating income for Q4 was $91 million or $0.44 per share, and results were impacted by the FDIC special assessment and reserve build given, again, slightly worsening economic forecast. The appendix shows trending on each of these columns.
And the fourth column includes discount accretion and CDI amortization, noting that discount accretion will be a steady and reliable source of interest income over time as the majority is driven by rate, not credit, providing us with a steady build of capital over time. And recall that CDI amortization does not impact tangible book value, so the $0.13 per share net from merger accounting was the equivalent of $0.25 per share added to tangible book value in Q4. We'll continue to highlight and trend it here to aid investors in valuing all our earnings streams. Our tangible book value, excluding AOCI, increased $0.27 during the quarter to $17.75 per share.
Moving to the next section on Slide 9, we highlight net interest income and margin. Our NIM declined to 3.78% for the quarter driven primarily by a higher cost of interest-bearing deposits more than offsetting increased loan yields and lower costs from term debt.
Slide 10 breaks out the repricing and maturity characteristics of the loan portfolio, noting 41% is fixed, 30% is floating and 29% are adjustable.
Now Slide 11 provides an updated view of our interest rate sensitivity under both ramp and shock scenarios. We've taken proactive measures to reduce the balance sheet sensitivity to a future declining rate environment. You can see here the trending over the past year where our rates down risk has been reduced significantly. And noted below, we calculate our cycle-to-date funding betas, which are calculated on a combined company basis over the periods presented for comparability.
As of the fourth quarter, our interest-bearing deposit portfolio has priced in 47% as the Fed funds rate increases. Notable here is the cost of interest-bearing deposits, which was 2.54% for Q4 and 2.71% for the month of December.
The lift this quarter was influenced by several factors. The decision in Q3 to replace maturing better home loan bank advances with broker deposits was essentially neutral to the cost of interest-bearing liabilities, but it drove nearly 30% of the increase in interest-bearing deposit costs between Q3 and Q4. Approximately 15% of the quarter's increase relates to an increase in the average balance and rate paid on public deposits and approximately $900 million in customer CDs with largely 12 and 13 month terms matured during the quarter, with many repricing upwards of 200 basis points higher.
The cost of interest-bearing liabilities normalizes for balance sheet management decisions and the quarter's 30 basis point increase was significantly lower than the increase in interesting-bearing deposit costs. Cost of interest-bearing liabilities was 3.02% in Q4 compared to 3.15% for the month of December and 3.19% as of December 31.
Slide 12 breaks out noninterest income items, noting the largest changes in Q4 relate to interest rate-driven line items. The changes in loans held at fair value at the bottom was a direct result of decreasing long-term yields this quarter.
Next up on Slide 13, we note we achieved the $143 million in cost synergies guided last quarter, exceeding our original target of $135 million by 6%. This amount is net of reinvestments made in various areas. While we will continue to target efficiency improvements, with the integration now largely complete, we no longer consider future cost-saving opportunities to be merger-related.
Q4 expense was above our previously guided range due to several elevated expense items. Noted on the right side is the waterfall from the prior quarter with increases driven by higher repairs and maintenance, equipment purchases, a branding campaign and most notably the $33 million FDIC special assessment.
On Slide 14, we introduce our outlook for 2024 on several key financial statement items. Our net interest margin remains sensitive to customer deposit balances, with growth driving margin stability and perhaps expansion as we replace wholesale funding and outflows driving contraction.
Our interest rate outlook, which incorporates 3 rate cuts in the back half of the year, does not meaningfully impact prepayment assumptions related to purchase accounting.
Our expense outlook incorporates a low single-digit level of growth from Q4's adjusted run rate. We see areas for efficiency improvement to offset the costs associated with franchise reinvestment and inflation. To that end, we consolidated 5 branches this month.
Moving ahead to the next section on the balance sheet. On Slide 16, we detail out the investment portfolio. The table takes you from current par to amortized cost to fair value, noting the difference between current par and amortized cost is a combined net discount, which will be accretive to interest income over time. The increase in market value this quarter, of course, resulted from lower market yields given the bond market rally, again, with the unrealized loss halving. Just over half of the portfolio is now sitting with an unrealized gain at year-end, which gives us significant flexibility to manage the balance sheet moving forward. As you can tell, I'm excited about this portfolio, as it gives us a significantly higher and stable earnings stream with greater optionality.
The overall book yield was 3.59% with an effective duration of 5.4 at quarter end.
Slide 17 covers our liquidity, including deposit flows, during the quarter. Total deposits were essentially flat in the fourth quarter. Seasonal and targeted increases in public deposits nearly offset contraction in small business balances as other categories were relatively unchanged.
The upper right table details our off-balance sheet liquidity with $11.7 billion available as of quarter end. Below that, we add cash and excess bond collateral not pledged for lines to arrive at total available liquidity of $18.7 billion.
Slide 18 provides the driver of 3% annualized loan growth in Q4.
Turning now to Slide 19, we present the remaining balance of discount marks as compared to the prior quarter and at closing. For the AFS portfolio, the acquired discount was reduced to $21 million via accretion to interest income. In our earnings release detail, we include this $21 million along with $16 million of higher bond interest income on the portfolio restructure we completed post close to arrive at the $37 million of total accretion for bonds.
On the loan side, we had $27 million of rate accretion, $5.4 million for credit. The total marks declined $69 million in Q4 through accretion to interest income.
And finally, in the back, on Slide 26, we highlight our regulatory capital position, noting our risk-based capital ratios increased 20 basis points as expected in Q4. We do expect to quickly approach our long-term capital target of 12% on total risk-based capital, which we'll provide for enhanced flexibility to return excess capital to shareholders.
With that, I will now turn the call over to Frank.
Thank you, Ron. Slides 20 through 22 provide select characteristics of our loan portfolio, including composition of our commercial book and an overview of our office portfolio, which continues to perform well.
Moving on, Slide 23 highlights our reserve coverage by loan category. Also, the remaining credit discount on loans provides for an additional 21 basis points of loss-absorbing capacity. The $55 million provision expense recorded in the quarter was primarily driven by a slight worsening in the economic forecast used in the credit models, along with credit migration. Delinquency and nonperforming loan movements over the past 2 quarters suggest a move toward a more standard credit environment following a phase of exceptional high quality.
Slide 24 provides an overview of our consolidated credit trends. In general, our credit performance is and has remained positive, excluding the anticipated trend in FinPac. Impact charge-offs remain elevated during the fourth quarter, still centered in the trucking portion of the portfolio. We continue to expect a slow recovery time line over multiple quarters for this portfolio. Excluding FinPac, charge-off activity at the bank remains at a low level.
I will now turn the call over to Tory.
Thank you, Frank.
Turning to deposits. Slide 25 highlights the quality of our granular deposit base. As Ron noted, small businesses' use of cash drove a reduction in customer deposits during the fourth quarter as other commercial balances and consumer accounts were relatively stable in aggregate.
The fourth quarter included normal course of business, use of cash like distributions, dividends and year-end tax payments, while public balances experienced a related increase.
Public deposits were positively impacted by targeted efforts by our teams to grow public relationships in local communities as we work to reduce wholesale funding balances.
Our teams remain focused on driving balanced growth in deposits, loans and core fee income as they work to expand existing relationships throughout the bank, bringing new prospects into the bank.
We see tremendous opportunity with our existing customer base to grow fee income. We launched Smart Leads in 2020 as a way to capture additional business with our existing customer base through predictive analytics. We generated an additional $11 million in revenue since 2020 with $5 million generated in 2023 alone, highlighting increased traction with our teams and the benefits of our scaled organization. We will continue to selectively invest in talent, technology and locations that enable us to profitably expand our businesses as the efficiency opportunities Ron noted maintain our dedication to growing in a cost-effective manner.
And lastly, our loan, deposit and core fee income pipelines remain robust.
I will now turn the call back over to Clint.
Thanks, Tory. Our regulatory capital position is outlined on Slide 26. And as Ron discussed, we expect capital to continue to accrete quickly in the coming quarters, providing us with ample flexibility for future shareholder return.
This concludes our prepared comments, and our team is available to answer your questions. Valerie, please open the call for Q&A.
[Operator Instructions] Our first question comes from the line of David Feaster, Raymond James.
I appreciate all the guidance. And maybe just talking about -- starting on the margin and digging into some of the impacts of rate cuts, I'm curious how you think about the NIM trajectory. Obviously, you guys include 3 cuts in your forecast. How do you think about the impacts of cuts? You guys have done a great job managing the downside in the rate sensitivity scenarios. I'm just curious how you think about the trajectory of the margin and how quickly you'll be able to reprice some of those core deposits on the way down.
Yes, David, this is Ron, great question. As I look into '24, I mean, if that were to come true and we see 3 rate cuts in the back half of the year or x number of rate changes as the market is predicting, really, key with that is going to be what happens to the deposit betas. And in those rates down scenarios, I think we're pretty conservative in these numbers, with betas in the low to mid-30% range. Whereas on rates upside, we were now at 47% and we modeled 53%, 54% on rates up. So something tells me you're going to see most banks probably be north of their model results on the rates down side just given nature and the fact that deposits moved up so quickly. So with that, it would suggest that there could be potential upside on it. But again, under all of it is going to be what's going on with underlying customer deposit flows, right? So that's still the main driver versus betas, I would suggest.
David, this is Chris. I'll add to the rate part of that discussion that between Tory and myself and our teams, we're already looking at a competitive market. We're looking at where rates are trending. I think you'll start to see us start moving potentially ahead of any sort of rate cut scenario and putting in place the long-term kind of more plan of if we get a rate cut and pick your month, what are we planning to do. So all of that's being laid out right now, and we should be launching that relatively soon here. But yes, just trying to get ahead of that aspect of it. And I think you see the market is already kind of moving in that direction, so it will just be a matter of, historically, can we follow or can we lead as we've done in the past, and that would be the ideal situation.
Okay. That's helpful. And maybe kind of just a follow-up to some of this, just staying on the deposit side. In the prepared remarks it was alluded to, some of the declines being attributed to small business declines. I'm curious, maybe what are some of the drivers of that from your standpoint? Obviously, there's some seasonality. But how much of it's activating deposits versus paying down debt, using cash to fund growth or just less profitability at this point for some of the small businesses? And just curious, I mean it's early in the first quarter, just curious, are you seeing things stabilize? And how do you think about core deposit growth going forward?
Yes. You got a lot in there, David. I would say the uses that you mentioned, absolutely, you're seeing that completely across the board. You are seeing some small businesses that good operators have the ability to increase their prices and things of that nature. But for many of them, inflation is certainly taking a big impact, and that goes across all items from products to service to the employment inputs and things of that nature. We moved into really kind of more of a seasonality type of situation in the first quarter as well. I would say we're in contact with the small business customers through our local presence, mainly through the branches. People are positive, but they're also, let's say, looking down the road for when something is going to take place that's going to provide them some relief. We haven't seen that quite yet.
And Tory can speak to a little bit more onto the commercial side there.
Yes. David, this is Tory. On the commercial side, it's pretty kind of typical with the end of the year and Q4. The one difference is you saw people that they take excess cash that they have in their operating accounts and want to reposition that into some interest-bearing account, just it's kind of a good course of business on from their standpoint. But it's a typical use of cash of dividends, distributions, tax payments, those types of things, investments, some customers making investments and doing it with cash instead of borrowing for it, so kind of some typical stuff that we've seen in the last year or so.
Yes. And David, I'd say, Tory and I talk quite a bit about the momentum that's building and our teams getting excited about being out in the market, integrations behind them, and we're seeing new business start to come on with some of the other things that are going on out there. Now it's coming on at a higher cost than we've seen in the past, but we're driving those operating accounts, we're getting the full relationships with the focus. And I'd say Tory and myself see stories almost every day about somebody somewhere in the footprint, bringing in a new name into the bank.
That's great. That's great. And I guess to that point, I'm curious, on the C&I growth, curious where are you having success driving growth? How much of it is from client acquisition versus increased utilization or deeper relationships or even the new hires that you've made? And just curious, your appetite for growth and whether you'd expect C&I to be the key driver of loan growth going forward.
Yes. David, it's Tory again. Definitely see C&I growth as the place that we will grow the lending side of the house with full relationship banking, so like we said, I think, very consistently. We're in 8 Western states, great markets. We've got great people. They have very strong pipelines. We saw C&I growth kind of a mixture between new client acquisition, as Chris was talking about, plus lending to existing customers doing their normal course of business. So it was spread throughout the footprint. So there's not one place where I can say we got most of our growth, it was kind of spread throughout our footprint. And as Chris said, I mean, we feel very good about the pipelines and the activity that's occurring out in the field.
Our next question comes from the line of Timur Braziler of Wells Fargo.
Following up on the net interest income, net interest margin commentary. Just with the expectation for deposits and funding to remain a source of pressure here in the near term and then the expectation for rate cuts in the back end of the year, is there an outcome where NII inflects and grows in '24? Or is that more likely a 2025 event?
Tim, this is Ron, good question. And again, it's going to be really a function of the cost of that deposit growth. I could definitely see a scenario where you see a little on the lower end and the front end, if we do continue to see pressure on noninterest-bearing demand specifically, within that guide range. But then once they start moving, again, I talked about earlier that deposit beta, I think that's pretty conservative and I would suggest probably most of the regional banks think their model betas on the rates down side, they're going to be closer to what they were on the upside. So you could see that scenario exactly where you get some pickup in the second half.
Okay. And then I guess, looking at the deposit costs and some of the December 31 spot rates, is that a good ceiling here? Is that kind of where we expect the funding base to stall out? Or is there going to be some more mix shift in the first half of the year to some of these higher cost categories, which could keep that lag around and costs for a little bit longer?
Yes. Obviously, it's an estimate, but we'd expect the lag to continue there. And that's probably why we showed the 47% beta to date, but we model the 53% on the rates upside, so you got that additional piece. We also have -- in the past quarter, we had about $900 million of CDs repricing that were in that 12- to 13-month tenors. So they have been sitting there for a year, and those all repriced up close to 200 basis points. In the first quarter, I want to say it's around $650 million to $700 million of CDs maturing, which will reprice, but it will be less than 200, just given the timing of those compared to when the Fed was raising rates earlier in '23.
Okay. And I guess what's the thought process or the rationale for maintaining all of those balances rather than being more aggressive with rates here and letting some of that money walk?
Just overall liquidity levels where we feel comfortable sitting with cash on the balance sheet, just bringing cash into Fed. And keep in mind, too, I mean, we've got an incredible amount of optionality, again, compared to the average regional bank, with a little over half of our bond portfolio sitting on an unrealized gain. But then again, too, the goal will be to accrete that remaining discount up to par, over the life of that book, because that's all government rate from that standpoint. So we've taken the approach of maintaining that flexibility, so we earn back that discount, which reduced capital a year back, at the culmination of closing. And by utilizing that, we utilize overnight our wholesale funding in that 2- to 4-month tenor to maintain that overall level of liquidity. We have reduced the overall level of on-balance sheet liquidity. Where we were sitting up closer to $3 billion early mid-'23 of interest-bearing cash, we've now taken that down into the, call it, $1.5 billion to $2 billion range. I can see that probably dropping a little bit more into '25, but probably not too much more.
Our next question comes from the line of Brandon King at Truist.
So I wanted to talk about the leaning into those public deposits. Could you just elaborate on the thought process behind that and if you're able to achieve that just based off of rate or primarily relationships? Just give us the puts and takes there.
Brandon, this is Tory. So we have a lot of existing customers in the bank that are municipalities spread throughout the footprint. Most of them are smaller rural communities and we have strong relationships with them and just made a very significant effort to go out and call on that group and ask for more deposits in the bank. And it says a lot about the capability of the teams, both in the branches and in commercial banking, to have those relationships and to call on them to further deepen and strengthen those relationships. And that was the effort. It's that time of year as tax payments come in, so they have more money. And distributing it to us, we thought, was a really good idea.
And Brandon, I'll add to that, that, as Tory mentioned, that local presence and working together, it's not just existing customers and then maybe getting a little bit of a price up on some of the reserve money. That can lead you into -- we're talking about full relationships. We're talking to them about their operating accounts. That sales cycle takes a little longer, but we're already seeing positive momentum into new names that came onboard, a money market type of account that are "I want to investigate my operating account with you." That's when that relationship really gets cemented. And as Tory said, that's due to people. They live. They work in the communities. They know the individuals that are at the public entities and they're building relationships and they're asking for the business. And with our capabilities, with the new TM capabilities that came onboard for a lot of our footprint as well, we're getting looks. And we're going to win that business, and that momentum is building.
And it's a great funding alternative to not on the operating, we get the operating account, but then with their surplus liquidity, we provide an alternative to the local government pools. And it's a way of bringing in deposit balances without cannibalizing our core deposit base or repricing the whole sector of our deposit base. And so it's kind of a different lever that we can pull. Now it creates noise. And in my prepared remarks, I made a reference to the results of the quarter don't necessarily reflect the quality of our deposit base. But that's what I was really getting at, is that this is just a lever we can pull. And recall, when tax proceeds are coming in for municipalities, it's a great time to pull that lever.
Got it. Got it. And just my follow-up would be, do you care to quantify the level or the amount of public funds deposits you have? And would you consider these deposits higher beta relative to maybe some of your more core deposits?
I think you have to bifurcate it because we do have the operating relationship with virtually all of these public entities. And so that's going to behave more like a traditional part of our portfolio. And then you have what I referenced as an alternative to the local government pools. And so I think Ron has got the detail you're looking for.
Yes. And again, we do highlight that in those trends on Page 17 of the earnings presentation, but in total, $2.9 billion of total public deposits. And that was up roughly $0.5 billion, a little under $0.5 billion, for the quarter. And of that, you're going to be probably in the -- 10%, 15% range would be the core operating accounts; 20%, probably tops, but a good stable base.
Okay. Okay. And just lastly, Ron, I know you're working to kind of reduce asset sensitivity just given the forward rate curve and the potential for rates to come down. Are there any actions that you're considering or looking at that would make sense at this point to achieve that?
Yes, great question. It's really difficult on the derivative side just given pricing and expectations, but we took that shot and we did that. And you can see the trending there, too, on Page 11 of the presentation with how we repositioned the portion of the bond portfolio in that first week post close back in Q1 and then also utilization of shorter-term wholesale funding, be it the broker deposits or home loan bank advances, to help offset the deposit flows during the year. Those two items, in and of themselves, basically act like a swap to benefit you in rate down because you've locked out cash flows on the portfolio and you'll have fully floating down cash flows on the right side of the balance sheet. So that was really the majority of the change from a year back to now where in the past year back, we had a more traditional asset-sensitive profile and today, we're relatively neutral.
Our next question comes from the line of Chris McGratty of KBW.
Ron, maybe on your expense guide for a minute. The $1 billion to $1.1 billion, I'm interested in your comments on what the revenue environment would be at different points of that guide.
Good question, Chris. Generally, historically, the movement on the expense side directly tied to revenue would have had to do with home lending back in a different much lower rate environment, right? You see seasonality over the course of the year which would drive higher revenue in the second and third quarter, lower seasonal in first and fourth. And you have corresponding expense trends along the lines. I'd say our outlook here is not for significant rates downward to where home lending is picking up significantly in volume. So it's going to be really range-bound within that NIM. It's going to be the driver of the revenue side. And I think over the course of the year, ex any legacy home lending seasonality, you're generally going to see higher payroll tax type items in the first 2 quarters of the year and then those would tail off in the second 2 quarters of the year. You'll also generally see annual merit cycles, which basically approximates inflation rates at the start of the second quarter. So you'll see a little bit of a lift and then stabilization over the course of the year.
Okay. That's helpful. And Clint, maybe on capital. You noted in the release, CET1 of 9.6% is above your 9% target and your total is within 20 basis points. Could you help us on when the buyback would be more of a discussion or an announcement? Is it when you hit 12%, you have to build a buffer to 12%? How are you thinking about the buyback given the outlook?
Yes. I think 12% is kind of like the Fed trying to stick the landing on the economy. It's difficult to just get to 12% and keep it there. And so I think that we'd want a little bit of a buffer before we implement the buyback; probably not a huge buffer but enough that we could do a meaningful buyback and still be above 12% after you took that into account. So I know I'm not giving you like a hard and fast time line or number, but we do see, and you can see the trend over the last 3 quarters, of how capital builds. There are some things, the rate environment, we do get 3 cuts. I think that, that gives us some additional optionality even over and above what we already have on our balance sheet, some flexibility that can put us in a position to do a buyback sooner than later. But we're probably really talking, is it 1 quarter or 2 quarters before, we would do it just naturally through steady state with the 20, 25 bps of capital increase in each quarter.
Okay. That's helpful. And then just a follow-up, would that be the top use of capital beyond growing your business that you've talked about? Or is there an alternative use? I know you have the dividend that's pretty competitive, but inorganic growth at all on the table?
Yes. The regular dividend, obviously, is something that we have talked about that we want to be consistent and provide that. And for some of our investors, that's a very important component of their investment in our company. The organic growth component of it, Tory mentioned in his prepared remarks, the pipelines. And I've had the opportunity to meet with some of our market leaders over the past 30 days. And when they talk about what their pipelines look like and the opportunities they have in front of them from a business perspective, many of you have seen Ron in person when he talks about the bond portfolio and he just gets giddy, that's the same type of reaction that our bankers have with the opportunities that they're currently in the middle of pursuing. But even with that said, I think the capital generation is so strong that any level of reasonable organic growth, I don't think it outstrips the building of those ratios between the regular dividend, organic growth. And so that does leave us with buyback options. Potentially, depending on if buybacks didn't make sense, then we could always look at whether a special dividend makes sense. And then to your question, inorganic growth, it feels like we're in a time period like we were in mid-2020 where the M&A markets are kind of frozen. The math is very hard right now. I know there's been a few things announced, but those aren't healthy, thriving franchises that would be of interest to us. We don't feel like that it'd be additive to our long-term value, but that will change with the passage of time. And so I do think that there's going to be some opportunities to at least look at things. But as we've said before, the size company we are, the 8 states that we're in, there's not a plethora of opportunities that move the needle for us. So we'd be very selective and disciplined about looking at any type of inorganic opportunities.
Our next question comes from the line of Jeff Rulis of D.A. Davidson.
I wanted to clarify, is it safe to assume a loan growth expectation would mirror your balance sheet growth expectation of no growth to 3% or possibly outstrip that?
Jeff, this is Ron, good question. Yes, I mean, ideally, over time, you want the deposit growth to match the loan growth. And that's our goal here over the course of 2024.
Okay. So loan growth at maybe no growth. I just want to kind of pair that up, Clint, with kind of the field and getting us out there, is there a point where you're kind of tamping down your kind of loan officers on, hey, we got to true it up with deposit growth? I'm just trying to get the assumptions underlying of a pretty limited growth and kind of mete that with kind of the team. And you're going on the anniversary of the merger close, I just want to kind of get the sense for feet under those folks and starting to produce pretty significant net growth.
Yes, it's a great question. It gets back to the response I had on inorganic growth. We've talked for the last couple of quarters about being relationship-centric. And in a QT-type environment, where we're holding back and being very restrained is on transactional real estate type things. Our C&I teams, small business bankers, I mean they've got a green light and the ability to go out. But I don't think there's a single banker in this company that doesn't understand, and I use the term banker purposely, we don't have lenders, we have bankers, and that they need to go get the full relationship, needs to come with deposits. And they're not going to fund dollar for dollar. I mean that's not the nature of it. But that's why we have our robust 300-strong retail network to help with the funding. But that's where I think the optimism is. The integration is behind us. We've shut down the integration management office, and they're ready, they're on their front foot and ready to go play offense.
And Tory, I don't know if you have anything to add?
Yes. Jeff, it's Tory. I would just maybe reiterate a little bit of Clint's comments around just the sales force and the bankers in the footprint, there strong desire to grow market share, really to manage what we have and keep what we have and continue to expand with what we have, but to grow market share. And that sometimes is a relationship that includes a loan and sometimes it's a relationship where there's no lending activity. A deposit only or a deposit and core fee income relationship is very valuable and supports this local presence that Chris always talks about and this ability to grow their book of business. And our focus is definitely on the C&I side of the house. And as you can see in the growth in real estate, it's flat and on purpose, and we're pushing on the C&I front. And so we've got a lot of great bankers and great markets that are out pounding the pavement and looking to bring in new names into the bank.
Appreciate it. I wanted to maybe hop over to the credit side of things and really kind of looking at that kind of the crosshairs going in FinPac. Thinking about I think mid last year, we were kind of pointing to maybe it was hopeful or some signs forming that those trucking losses would ebb lower. It looks like we're bouncing back up. And I guess kind of over the course of '24, if you think about losses and its impact, is it safe to assume we could still be in that 5% to 6% for the full year? Or do you see any trend that we could kind of come off a cliff with that?
Jeff, yes, I do not expect that this trend goes all through '24. I mean if we look at the loss curves and really the vintages that have caused this pain, the vintages were really the last half of '21 and all of 2022. From a loss curve perspective, we're through all of '21, and we're about halfway through '22. So I believe we will see at the end of the second quarter those losses start to tail off at a more rapid way than they have historically. And don't forget, I mean, the fourth quarter is a tough barometer for collecting because of all the holidays that are during that quarter. And in this space, I mean, remember, FinPac may be a subsidiary of the bank and provides a valuable product set for the bank, but at its core, it's still a finance company. And in a finance company, this type of activity and what we're seeing currently is not abnormal. And if you go out there and survey our competitors, they're experiencing the exact same thing, even at a worse clip than we are. What is encouraging is that it is isolated to the trucking portfolio, and we do see the light through the data that we have, that there is an end in sight, and I do believe it will be halfway through this year.
Got it. Just to kind of get into that vintage, and I appreciate the color there, the thought that as we moved into the back half of '23 and hopeful of a decline, was it that you got into some of those '22 vintages that were like, wow, this is all so troublesome. Is that why sort of you extended?
Yes. We were coming out of '21, and we did see that '22 was also displaying some of the elevated loss characteristics, and so we kind of had a feeling that it would be a long drag-out process for getting back to that 3.5% clip. But we do see it. And the early returns, I will tell you, for the '23 vintage, they're very positive, so that is encouraging. The tweaks that we've made to the model and the criteria really in the portfolio as a whole, but in particular, the trucking portfolio, really seems to be paying off in the '23 vintage.
Great. And then one last one. Ron, I'll take another crack. I didn't really hear a response on the margin trajectory. I know it resides with deposit success. But I guess, to put it more clearly, do you expect more compression in the first half of '24 versus the second half when you layer on potential rate cuts, your 3 basis points of cuts?
That's correct, just given the fact that we've got that conservative estimate in there for the deposit betas. And that will really be a driver of, if we do see a rates down environment, I expect we'll outperform. I expect our betas will be above the 30% on the down. I mean they're closer to, like I said earlier, the 50% on the up. Overriding all of that, of course, would be what's going on with just basic customer deposit flows. And you've heard enough conversation on that point to date. So we'll see how it plays out.
If we're talking [ $350 million, $360 million ] for the full year, you may shoot to that midyear and then kind of thumbing up is sort of how you would trend on that?
If in that view over the course of the year, you saw a couple of rate cuts in the second half of the year, and we, like most banks, expect that, that will perform on our deposit betas to the rates down side, then yes, that's a true statement.
Our next question comes from the line of Brody Preston of UBS.
Ron, I just wanted to ask a few questions on NII. The $4.3 billion of loans that you have above floors, do you happen to know where those floor rates are?
They're sitting more than the 3 cuts down. We'll have that detail into the next quarter's release, but they're definitely more than 3 cuts down.
All right. Would they be more than the 4 curve down, the 5 or maybe 6 depending on the day?
I don't have that in front of my hands. But again, recall, going back over the last 1.5 years, 2 years, as rates were increasing, it was easily more than, what, 6 cuts would be 125, 150 bps. It's easily more than 150 bps ago that we started to slow down, talking about loans going above their floors.
Yes. Okay. I noticed that you shifted some of the borrowing base to BTFP this quarter. I think it was maybe $200 million of utilization. But you still got a lot of FHLB lines. And if I'm remembering correctly, those are pretty short from a duration perspective. I think it's like an 80-something basis point gap between the cost of your borrowings right now and what BTFP is. Would you consider shifting the rest of the borrowings to BTFP to help with the margin? And if so, is that contemplated in your guidance at all?
We are looking at that. It's not the full amount of the home loan bank advances just given the capacity at the BTFP, but we are looking at that here over the course of the first quarter.
Okay. Great. So if I look at the NII sensitivity slide that you all provide, it looks like in either up 100 and 200 down, 100 and 200 kind of scenario, it's negative for NII and all but a couple of them as of December 31. And then I don't think you have a lot in fixed asset repricing. So if we got no cuts, maybe that kind of incremental deposit beta creep and lag that you've talked about would continue. So I guess I'm just struggling a little bit, Ron, to think about holistically, like what's the best rate environment that you could proceed just kind of looking at those pieces of the puzzle.
Yes, I mean an interesting question. I would suggest this that in anyone's interest rate risk modeling, if they're looking at the difference between 0.7% and 1.1%, and saying there's exact precision in that, they're not being truthful with you, right? There's so many assumptions that go into that over the course of the year, inclusive of customer deposit flows, betas, timing, lags. So I kind of look at all those as relatively neutral if they're within a point or 2 of each other just because I know that's generally the grenade range you're going to be facing over the course of the year.
Got it. And what is the NIB mix that's contemplated within your NII guidance? I'm sorry if I missed that.
Within the traditional NII guidance or interest rate sensitivity analysis, which is what this is, you generally assume a static balance sheet and then things repricing into themselves. So again, that's where I got to earlier, talking about within the range of the guide, if we're better on the deposit side, then we're going to be on the upper end. If we're not, we're going to be on the lower end.
Okay. And then last one for me, just if I take the pieces of your guidance, $48.5 billion of average earning assets, 3.55% on the margin, and then factor in the expenses, if I do something just like last 3 quarters' average fee income, assume the run rate, annualize it and grow it by low to mid-single digit, it kind of implies like mid-780s on PPNR. Am I far off the mark there?
Brody, I don't have the calculator out in front of me to run through that math with you. I'd just ask, we're not providing inputs in the guidance on EPS. We're not giving an EPS guide. But if there's other maybe specific questions that might help you on the modeling side, I highly suggest contacting Jacque. She's great, and she'll set you straight.
Our next question comes from the line of Matthew Clark of Piper Sandler.
And Brody, 780, that's kind of where I am right now. First question just on expenses relative to the balance sheet size, if we end up at the low end of that average earning asset range, the $48 billion, I believe, is it fair to assume that noninterest expenses will be at the low end as well, $1 billion versus $1.1 billion?
There's potential for that. Obviously, we have efficiency improvements that we're working through as well. But there's also just enough uncertainty when you look into the year, inclusive of inflation rates, to say our target is going to be somewhere relatively in the middle of that. And there is downside, there's upside, and we'll see which way it plays over the year. But we wanted to just make sure we recognize that there is some level of uncertainty to timing and flow over the course of the year. So not giving a specific guide on that by quarter or the trajectory.
I'm just trying to be consistent with the balance sheet size relative to expenses, should we be consistent or not?
There is a little bit of movement with the balance sheet size. But again, you also have changes in, say, for example, deferred loan costs, which are influenced by the balance sheet size; or we get leverage within deposits per branch, which doesn't necessarily have an impact on expenses other than incentives. So it's just difficult to say with precision at this point.
Understood. Okay. And then just the step-up in other noninterest expense, I think it went from, excluding merger charges, so call it, I don't know, $45 million and change, $45 million, $46 million, up from $38 million last quarter. Anything unusual in there that we should strip out going forward? I'm just trying to get a sense for them, if you could remember.
Yes, no, good question. I take a look at Slide 13. Again, Jacque did a great job showing the movement in the bridge and a good chunk of those items inclusive of the FDIC special assessment, but a good chunk of those items are elevated and not expected to continue at those levels.
Yes, I know the FDIC, that's obvious. But I'm talking about in the merger. We're stripping all that out, I'm just talking about anything else beyond FDIC and merger charges?
Yes. I mean you look through, again, on that bridge on Slide 13, you'll see some items were in to small equipment repairs and maintenance, so it's more in the occupancy and equipment area. But then you've got legal title and other, those are in the other area. So we tried to call those out on the bridge.
Okay. Got it. Okay. Fair enough. And then back on the deposit beta outlook for kind of the remainder of the cycle, did I hear you correctly that you're expecting the cumulative interest-bearing deposit beta to get to 53% at the peak? Is that what I heard?
That is what our models would suggest, but then again, recognize that those are models.
Understood. Okay. Just want to make sure I heard that. And then just on the provision, I mean, obviously a moving target in any given quarter, but it looks like a decent step-up in reserve build here. And I understand classified increased a little bit but not meaningfully. I think most macro models actually improved this quarter. So I'm a little surprised in the step-up in reserve build relative to the migration in the macro. But how should we think about provisioning going forward? Is this somewhat outsized, do you think, or not? Are going to assume higher charge-offs just with normalization? But I'm trying to get a sense for kind of reserve coverage and whether or not this provision might be a little elevated.
Yes, I mean, good question. I guess in terms of the models and the slightly worsened economic forecast, I mean, there are dozens of variables that go into CECL models and not simply just GDP or CPI rates. You also have things along the lines of vacancy rates or rent changes within various markets that we operate in which factor into those. So I would characterize it as just in total, across, again, those dozens of variables, they were just a little bit worse. But that just means they were a little bit better a quarter ago. And they're all a guess, right, they're all projections which we factor in the models from that standpoint. So underlying trends, though, I'd refer back to Frank's comments earlier, right? We do expect we'll see some abatement on the FinPac side, and then the rest is going to be what's going on with the overall economy 2 or 3 quarters from now and then, more interestingly, have those forecasts looking ahead over the life of the portfolio, at those points in time. So I don't have more specifics for you in that but that's what we're dealing with.
Our next question comes from the line of Jon Arfstrom of RBC Capital Markets.
Just most of my questions have been asked and answered, but on Slide 9, the red bar, in deposit pricing, just kind of looking at that over the last couple of quarters, Ron, what do you think that bar looks like in the first and second quarter? I know there's a lot that goes into it, but I guess it's this rate of change in deposit pricing. And just if you could take a stab at what you think that looks like over the next couple of quarters, that might help.
Yes. Jon, good question. I'd refer back to we do disclose in here the spot rates as of year-end, so use that as your starting point for when you look into Q1. But I also say that this 36 bps change that's been noted in the walk on Page 9, a good chunk of that was related to the decision we made back in late in Q3, where we brought on broker deposits to help reduce home loan bank advances, which are in the borrowings category, right? So I wouldn't expect as big of a move. But again, that depends on what we do with those balances over the course of the year. But that was really a good chunk of the driver there, of that 36 bps in Q4. Now that's specific to interest-bearing deposits. I talked about though, in interest-bearing liabilities, it wasn't as big of a change, and that's just because of a shift from a little bit higher cost of borrowings into similar costs in broker deposits.
Yes. Okay. Okay. Yes, that was kind of my next question. I wanted to ask about funding cost peaking. And I think you may be saying you're reasonably close on that. Is that fair?
Yes. I mean, again, models, right, but just also assume generally a 2-quarter lag on the back end of that.
Yes, Jon, this is Chris. As I mentioned earlier in the call, we're starting to see the market pull back a little bit. Are we at the peak? We can't tell you that. We don't know. It appears that we're somewhere there. I would expect it to start slowing down from what we experienced in the previous quarters. And some of the things that are coming due on the CD side, there's not as big of a lift between their current rate and where we project we might be in a month or 2. So all that being said, I think the pace is going to certainly slow down. And we'll see what everybody does out there. It's a fluid market as well, but pace should slow down.
Okay. Okay. Ron, one more crack at the most annoying question on the call, but the margin trajectory, is it safe to assume, the way it sits right now with your guide, U-shape, J-shape type margin for '24, with kind of a mid-year trough? Is that fair?
I think, again, assumptions around that are going to be around timing and number of cuts and where the betas are, but underlying all of it is going to be where core customer deposit flows. So just not prepared to give a guide in terms of what that looks like by quarter. We're giving you an estimate of what we feel it could be for the full year from our target standpoint.
I'm showing no further questions at this time. I'll turn the call back over to Jacque Bohlen for any closing remarks.
Thank you, Valerie. Thank you for joining this afternoon's call. Please contact me if you would like clarification on any of the items discussed today are provided in our earnings material. Thank you.
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.