Western Alliance Bancorp (WAL) 2016 Q4 法說會逐字稿

Good day everyone. Welcome to the earnings call for Western Alliance Bancorporation fourth quarter 2016. Our speakers today are Robert Sarver, Chairman and CEO; and Dale Gibbons, Chief Financial Officer.

You may also view the presentation today via webcast through the Company's website at www.WesternAllianceBancorporation.com. The call will be reported recorded and made available for replay after 2:00 PM Eastern time January 27, 2017, through Monday, February 27, 2017, at 9:00 AM Eastern time, by dialing 1-877-344-7529, passcode 10099229.

The discussion during this call may contain forward-looking statements that relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical fact. The forward-looking statements contained herein reflect our current views about future events and financial performance, and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause our actual results to differ significantly from historical results, and those expressed in any forward-looking statements. Some factors that could cause actual results to differ materially from historical or expected results include those listed in the filings with the Securities and Exchange Commission. Except as required by law, the Company does not undertake any obligation to update any forward- looking statements.

Now, for the opening remarks, I would like to turn the call over to Robert Sarver. Please go ahead.

Thank you. Welcome to Western Alliance's fourth-quarter earnings call. I would like to start off by wishing everybody a happy, healthy, and prosperous new year for 2017. 2016 for us was really a great year on all fronts, and we're happy to share the news with you. Dale and I are going to through some of these slides in the deck that is posted on the website, and then we will open up the lines for your questions.

We closed out 2016 with another record year. Our net income was $69.8 million, or $0.67 a share for the quarter, excluding $0.03 in nonrecurring merger charge from our systems conversion. Diluted EPS was $0.70, up 23% from the $0.57 number in the fourth quarter of 2015. On a linked-quarter basis, our net interest margin rose 2 basis points to 4.57%, which benefited our efficiency ratio as well, as it improved to 42.4%. Driven by C&I, loans grew $175 million during the quarter to $13.2 billion, and deposits were up $107 million to $14.5 billion. Nonperforming assets to total assets were flat from the third quarter at 0.5% of total assets, and are down over 20% from 65 basis points a year ago. In the fourth quarter we had net credit recoveries of $800,000 and net loan losses were only 2 basis points for the whole year of 2016. Our tangible common equity ratio rose to 9.4% at year end, and our tangible book value increased to $15.17.

For the full year, our net income climbed 33% to $260 million, and our earnings per share rose 23% to $2.50. Our return on assets and return on equity were both amongst the best in the industry at 1.61% and 17.7% respectively. Net interest income for the fourth quarter increased $2.8 million or 1.6% from the second quarter to $175.3 million, and is up $32 million or 22% from the prior year. Operating non-interest income fell slightly to $10.5 million, as warrant revenues slipped. Operating expense essentially was held flat at $82.7 million, as an increase in some consulting costs were largely offset by other savings and expenses. Operating pre-provision net revenue rose 2.3% during the quarter to $103 million. Our credit loss provision fell to $1 million as we had another net recovery quarter.

Acquisition and restructuring costs were $6 million, reflecting the completion of our conversion of our core banking platforms for both Bridge Bank and the GE hotel franchise transaction. In addition, we incurred some charges from the consolidation of two offices in the Nevada market. Income taxes decreased $2.8 million to $26.4 million, truing up our average tax rate for the year, which resulted in diluted EPS of $0.67, and operating EPS of $0.70, if you add back one-time costs. For the year, total revenue rose 34% to just under $700 million, while operating expenses rose 26% to $319 million. This improvement in operating leverage, which is a hallmark of how we try to operate our organization, has taken our efficiency ratio down from 45.8% in 2015 to 43.4% in 2016. While the credit loss provision more than doubled to $8 million, it reflected our high credit quality, as net loan losses were only $2.4 million or 2 basis points of average loans for the year.

Although the ending balance in the securities portfolio was flat at $2.8 billion for the quarter, average loan balance increased over $300 million, reflecting the full effect of purchases made in the third quarter. Lower yields on the third-quarter purchases drove down the yield 9 basis points to 281. Loans slipped slightly, 3 basis points as improving average in note yields was more than offset by lower accretion on purchased credits. Interest-bearing deposits costs were held flat, as some pressure from rising rates was offset by selective deposit pricing reductions in premium accounts. Higher loan yields drove the reported margin up 2 basis points to 4.57%. Excluding $7 million of accretion from purchased accounting entries, the core margin rose 7 basis points to 4.40%. The graph on the right shows that we expect stable accretion from purchase accounting margin throughout this year. [Axle] accretion is likely to be higher than what is shown here, due to loan prepayment activity.

Revenue growth, a bit above the rate of expense increased, took our efficiency ratio down to 42.4%, down about 3 points as I discussed earlier, from the last year. Our branch light commercial banking-focused model contributes to our low efficiency ratio, and results and compensation costs continued to climb faster than total expenses, rising from 56% in the fourth quarter of 2015 to 60% last quarter. The consistency of our performance shows up on our PPNR ROA of 2.4%, and our 1.60% ROA, both measures in the top decile performance compared to peers.

Let me talk a minute for the balance sheet. The balance sheet was stable during the quarter, as increase in loans was partially offset by a reduction in cash. 1% increase in total assets was funded by higher deposits, as well as an increase in short-term borrowings, which remain at very low levels of less than 0.5% of total assets. For the year 2016, assets grew 20%, while our tangible book value per share grew 21%.

Loan growth for the quarter was modest at $175 million for the quarter. And contributing to that was really three things: One, we were under-growing our system conversion during the quarter, which had a little bit of distraction. We had a number of people focused on that. Second thing is, we were digesting the $2.1 billion growth for the year, which included the GE purchase. And then thirdly, to some degree, credit conditions across our industry and competitive pressures in our industry, based on competition, have had us to be a little more cautious in certain areas, given where we are in the cycle, and given some of the frothy asset valuations. We are going to continue to focus on good solid loan growth, but also going to be very prudent in looking at generating the best risk-adjusted returns for our loan portfolio.

We remain well within the 100% and 300% regulatory capital guidelines for construction and investor commercial real estate loans at 70% and 244. Our deposits increased $170 million during the quarter, mainly money market accounts. For the year, we had outstanding deposit growth, $2.5 billion of organic deposit growth, with non-interest-bearing DDA increasing $1.5 billion of that.

Dale, do you want to step in a talk about the loan portfolio and capital?

Sure. Diversely graded assets remained strong, with only NPAs of $98 million, 51 basis points of total assets. On a dollar basis, other adversely graded loans rose modestly during the quarter to $255 million, but are still lower than they were a year ago. Total adversely graded assets as a percentage of the balance sheet fell 19% to 2.07% during 2016. These figures are net of $28 million of purchase accounting discounts to unpaid principal balance on notes acquired.

Gross credit losses of $1.4 million during the quarter were more than offset by $2.2 million of recoveries of prior charge-offs. Net loan losses covered nearly 2 basis points, hovering near zero for the entire year. The loan loss reserve rose to $125 million at year end, and is enough to cover eight years of gross loan losses at our 2016 run rate. Eight-year reserve coverage is double the four-year duration of our loan book. In addition to the $125 million in reserve, our acquired loan portfolio is held at a $47 million credit discount to the unpaid principal balance of these borrowers. As a number of these loans may pay off as agreed, at least a portion of this discount may also be used to cover credit charges. Together, it results in a reserve ratio of 1.3% of total loans.

Each of the four major capital ratios rose during the quarter, as our 17%-plus return on tangible common equity exceeded our balance sheet growth. All have also climbed from a year ago, particularly our total capital ratio, which was up 1% to 13.2, as it was also augmented by our subordinated debt issuance last summer. While our return on tangible common equity remained above 17%, tangible book value per share rose 21% last year, despite more sluggish growth in the fourth quarter from the revaluation of our available for-sale securities, in light of rising rates near the end of 2016. In our view, the market value reduction in the investment portfolio that is included on the balance sheet as a component of equity, was easily dwarfed by the value increase on our core deposit base. As you know mark to market valuations to deposits remain off balance sheet, and do not affect other comprehensive income.

Looking forward to this year, 2017. Western Alliance remains asset sensitive. We expect yields on our investment and loan portfolios to climb in the first quarter of 2017, as the prime rate increase in mid-December is reflected by the full quarter. However, as we usually warn, this increase will be tempered by a 2% reduction of income earning days during the quarter from 92 to 90. Our days-adjusted margin should rise in the first quarter, as increase in costs on non-maturity deposit accounts have been muted relative to prime rate increases. Given our asset sensitive balance sheet, rising rate environment bodes well for net revenue increases, while a distribution-light delivery model helps contain expense growth. This should lead to continued improvement in operating efficiency over time. However, during the first quarter, revenues crimped by the reduction in days, while almost all expenses were driven on a monthly basis. This will likely defer any efficiency benefit until the second quarter.

In terms of asset quality, asset quality remained very strong during 2016, with an improving economic backdrop. We don't currently foresee changes that would increase non-performing assets or gross charge-offs substantially. However, our long-running tail of recoveries is beginning to fade, and will result in modestly rising net loan losses this year. In terms of our balance sheet, we're budgeting a 12% organic growth for loans and deposits for this year, so we have pretty good pipelines, and will continue to be able to have good positive operating leverage in 2017 on an organic basis. Our capital accounts will continue to rise a little bit, as our return on equity will exceed that 12%, and that will put us in a good position to be not only defensive in terms of if the economy were to change with strong capital and liquidity, but also to be opportunistic in terms of evaluating potential loan and bank acquisitions for 2017.

With that, I would like to open it up for any questions that you have for Dale or I.

(Operator Instructions)

Casey Haire, Jefferies.

Rob, wanted to start on the loan growth outlook. If I grow the loan book 12%, that implies a decent acceleration in loan volume this year, roughly $1.6 billion or so if my math is right, versus $800 million organically in 2016. Given your comments that it's getting more competitive out there, what categories are driving this growth?

We have to manage our business holistically. And so if you look at last year, we had a large acquisition, $1.3 billion portfolio acquisition. We have to factor that in, into how we manage the bank. And so I think you can't really just look at the organic by itself.

Had we not done the GE acquisition our organic loan growth would have been larger. We have some limits as to how fast we can grow this business. We are focused on strong risk management, asset quality, loan oversight, capital planning, forecasting, whatever.

For us, the $2.5 billion growth in loans and deposits for 2016 is what we were comfortable with. So I wouldn't read too much into the organic growth for the year. I think you've got to take into the account the acquired growth with it.

Okay, so it's holistic, it's also factoring in potential M&A.

The 12% I gave you isn't factoring M&A, but if we were to do -- acquire another loan book, then it's very likely that our organic growth would back off a little bit too.

Understood. Just maybe switching topics to the M&A front. What is the update there? Are loan portfolio opportunities still -- are you still coming across them? And what about on the whole bank front M&A?

I think for us for this quarter, and finishing out the year, it was very important to really make sure we had the GE portfolio fully digest, had our arms around all the credits, the relationships, the people, the integration and then the computer conversion. I think we've done that, and feel pretty good about that.

Then in terms of our system conversion as it relates to our main systems converting onto the system Bridge was on, that was a big undertaking for us. We are in the process of finishing to digest all of that, as well as enhancing some of the other areas within the Company. That will put us in a good position to have a fresh plate and start looking at opportunities, and we will see where we go from there.

There is definitely more sellers today than there was a year ago, as prices have gone up. But as you know, we are pretty selective at looking at transactions that really make money for our shareholders. So we have a history of not wanting to get big to get big, and in our investor presentation we got a great slide this shows loan and deposits as they've grown over time, divided by shares outstanding.

That's one of the differentiators in why our stock does so well, is our growth tends to inure to our shareholders, rather than just bigger balance sheet numbers and higher compensation numbers for the President. We are looking at a bunch of those opportunities, and I think 2017 will be interesting. I think there will be some opportunities, but I can't tell you when or what.

Understood. Lastly, some housekeeping items. The tax rate, Dale, what can we expect going forward? And the FHLB special dividend, sorry if I missed it, but what was that amount benefiting the quarter?

About $400,000 additional. In terms of the tax rate, we are looking for about a 28% average for 2017. That's pretty close to where we were in 2016. As I recall, in the last earnings discussion that we had, I mentioned that with our high water mark in about five years, and that was driven by the significant increase we had in fully taxable income from the GE transaction.

We have since put in place some elements that will push that rate back down, and you saw part of that certainly in the fourth quarter. We are looking for 28% in 2017, and that will be skewed lower in Q1. It will be a bit -- a couple points lower in the first quarter, but averaging for the year.

Great. We will see what we get from Washington tax reform, but assuming all else equal, is that 28% hold into 2018?

Yes. I think that's a reasonable number for 2018. This doesn't include anything regarding tax rate changes or anything like that.

Thank you.

Timur Braziler, Wells Fargo.

Just following up on the loan transfer the quarter. Was there any elevated levels of payoff activity this quarter, with the sharp rise in rates? And subsequent to that, what was the level of prepayment penalty fees or loan fees that were incurred during the quarter?

We did have an increase in repayment activity during Q4. It was about $500 million, which maybe reflect some of the things you're talking about, but in terms of our loan yields for new credit, they were right on top of our average yield for our portfolio, so we didn't really see much change there.

Great. Just looking at the outlook for 2017, how much of that 12% organic loan growth is expected to come from the national businesses versus the regional bank?

Probably about half and half. About two-thirds of our national business is done within our core markets. You can look at it in a couple different ways.

That's helpful. The commentary surrounding tougher credit and competitive pressures in some of your markets, is that still primarily reflecting commercial real estate in northern California? And just more broadly on commercial real estate, given your aptitude or your ability to put out additional growth, without really reaching that 300% level, are you seeing any opportunities from others maybe stepping back in that space, or is that still ultra competitive?

That's a good question. To a certain degree, there are some of that are stepping back a little bit. A number of the community banks are above that, those numbers, so their business models are getting whacked right now, and are out of the market. So we are seen a little bit of an impact from that.

But for us it's mainly looking across, let's say we got 20 different products that we have to offer, and at different times, some of those products become a little more competitive from other banks, so the pricing gets bad. Or perhaps there's a little deterioration in some of the terms, and so we make adjustments.

And so one of my main jobs, along with our Chief Credit Officer, is to figure out where we should be more conservative and more aggressive in terms of how we're underwriting credit. That doesn't necessarily mean we say we will do more of this or less of this, by saying we are not doing things. It means we adjust our underwriting.

And so as a comes to commercial real estate would be a good example, the type of transactions we're looking at more today require, evolve around institutional type equity, where the loan-to-cost numbers have come down. So the type of commercial real estate we're doing now is at a lower loan-to-cost than it was three or four years ago.

Commercial real estate would be one example where you have asset values that are at pretty high levels. When we underwrite that real estate, we look more at construction costs, and want to be cautious in terms of the advanced rate. That's an example. We've got other areas throughout the Company where we find opportunities to do more, and opportunities to do less.

Right now, some of the municipal stuff, is opportunity to do more. That market is a little disruptive, people aren't sure on rates, and there's a few uncertainties in the market. We're picking up some good near investment or investment grade credits that ordinarily would go into the public markets.

Then there's other areas throughout the Company, where maybe our competition is a little stiff in some areas, like on $2 million and under owner-occupied commercial real estate. Seen spreads in there 250 and under, we are not doing that. It changes from time to time.

But I think part of our secret sauce is to make sure we can book good risk-adjusted returns, and are not just stuck doing traditional commercial real estate and C&I loans, like most community banks. So that diversification allows us to continue with good growth, and also continue with a pretty good loan yield.

Great. Thanks for the color.

Brad Milsaps, Sandler O'Neill.

Robert, I was curious if you have the number of new lending hires you made in the fourth quarter, and maybe in total for 2016, and if you would expect a similar number in 2017?

I think we hired seven in the fourth quarter. I don't know the number for the year. Obviously that would include about eight from the GE hotel acquisition.

Yes, I see that continuing. And if anything, maybe picking up a little bit. Given a little uncertainty in a few areas in California with some competitors, and some of the landscape changes.

Sure. Any new niches or anything, or any additional color there?

Nothing new on the board right now in terms of new niches, but always looking.

Okay. I know fee income is a pretty small number, we've talked about it a lot. I know you're not interested in trusts or anything like that. But is it more just building on some of the FX products you have, and things like that, in terms of fees?

We actually increase for our budget for our bonus goals for 2017 for all our staff. We tweaked that number up a little bit on the fee income. We're putting a little more effort on that. We've got a goal to grow our fee income by over $4 million this year, and so that's point of emphasis.

And that's core free income, so it excludes things like bank-owned life insurance. That's a double digit growth rate.

Got it. Thank you.

Brett Rabatin, Piper Jaffray.

I want to ask on the deposit side, thinking about 2017 and deposit growth, if you look at Q4, DDA was flat from the end of the period, but the averages were up nicely. Can you point to any seasonality in Q4, and what you're doing to guard deposits in 2017, in terms of business lines?

I don't know if it's so much seasonality as it is a little volatility in terms of some of our deposit relationships that are sizable, or in areas where especially, like in technology and stuff, and fund services, where money is coming in and out. I wouldn't necessarily call it seasonal. But our deposit pipelines are good. We've been telling you what we've been saying for several years, in terms of roughly around that $300 million to $400 million a quarter organic growth rate.

The other thing, I know at one point, when you thought rates weren't going to go up, you were reducing your asset sensitivity increases. Was just curious about your thoughts on rates this year and if you're doing anything or planning anything to increase your asset sensitivity?

We think rates are -- we have dialed in two increases in 2017. I think maybe if anything happens, it might even be more than two. Based upon relative strength in the economy, not just in our markets.

This is where we've got to put one of those disclosures on that people say. Economic assumptions and forecasts are our views, and not necessarily the views of the corporate governance committee of Western Alliance Bancorporation.

As our C&I book has climbed at a faster rate than CRE, that tends to make us more asset sensitive. In 2016, as you know, we had a significant growth in our DDA, that would also tend to put us with a more asset-sensitive bias, which we still retain. We're looking for some new expansion base to fund the rate environment.

We won't bet heavily one way or the other. So we did a little bit of an extension in the securities book, we're not really doing that now. We are poised for higher rates.

Thanks for the color.

John Moran, Macquarie.

Maybe just a quick follow-up on that. Dale, if you could help maybe dimension that for us, maybe either dollars or basis points per 25 movement? And do the two increases in 2017 that you're looking for, does that include the one that we already got?

The one we got was in 2016, and I agree, the effects of that are in 2017. I'm looking for two changes from the FOMC in calendar year 2017. In terms of, our rule of thumb, if you just take per 25 basis points, everything else being equal, that would add about 20% of that number, or $0.05 to our margin.

Okay.

Did you major in economics? What was your major?

Psychology.

You're both qualified to opine on where rates are going, although he's pretty smart, so he may be right.

Okay. The other one I had was just on the OpEx run rate. I think last quarter, we talked about normalizing mid-single digit, in terms of growth, and I'm wondering if there was anything else that dropped out from the system conversion, and how we ought to be thinking about that into 1Q here?

Let me just say in general, we are going to get some economies of scale on the system side. I think that's just where life is right now, when it comes to technology, no matter what you're talking about in technology. Things are cheaper, things are running now.

It's also up to us, in areas throughout the bank, to use technology as a way to become more efficient at doing certain things. On the flip side, we need some more higher-level smart people to help us manage this Company, as we become bigger and more sophisticated. You're see some expense added in that, you're going to see some efficiencies in technology, but most of all you will see a growth in net interest income, that's going to more than offset all of that.

And that's probably one of the key differentiators with us with a lot of our peers, and it's our ability to consistently grow revenue with quality assets. So all of these efficiency improvements that we make don't actually reduce expenses on a dollar basis.

But as I mentioned, the guidance that you cited from before, mid single digits in terms of the expense growth, we think is probably reasonable. That would be matched with a stronger performance, in terms of net interest income given, the balance sheet growth metrics that Robert outlined earlier. We are looking for efficiency to continue to gradually improve, but expenses to continue to climb.

Understood. With positive operating leverage and continued improvement in the efficiency ratio. Okay. The only other one I had, Robert, you're saying, focusing obviously on where you see best risk-adjusted returns, in the national business lines you referenced municipal finance as a place with some uncertainty and opportunity there. If there's other areas in NBL that you would feel relatively more excited about today? And if you could give us a quick rundown on what you're seeing in the regional banks by geographies?

Holy smokes. The state of the union? In terms of our specialty groups I will point out a few broad examples, high level or just in other areas.

In terms of medical and healthcare, a lot of opportunities, a lot of growth. In terms of technology and our business in technology, a lot of growth opportunities in terms of those industries; however I think you're going to see the banking industry probably have to look at that market a little more cautiously, looking at some of the regulatory guidance coming down the line.

In terms of our hotel finance loans, our book is about where we want it to be, given this stage of cycle in the hotel business. So we are underwriting deals more cautiously, because next year, you're probably going to see a little bit of a flip in terms of absorption -- in terms of new rooms outpacing absorption, so we are a little more cautious there. We are looking at 40% down payments on a lot of deals. So that book is probably going to just stay about the same, and we will be replacing things.

In terms of our mortgage warehouse business, you will see us probably do a little more mortgage servicing financing. We've got opportunities with large customers with strong balance sheets, but you may see the overall volume in the mortgage warehouse business flat to down a little bit, with rates going up. So it just varies from place to place, but that's my high-level view on some of our specialty units, and where I think some of that is going.

In terms of our core business, we're fortunate now in that really all the markets we are in are pretty healthy. And they also haven't had recoveries of that have been super strong, so I think there are some legs to it.

I continue to be bullish on Phoenix, San Diego, obviously Los Angeles, but we are pretty small there. The Bay Area on the commercial side is very strong, but we are not a big player in CRE in the Bay Area. It's more steady as she goes in the different geographic regions, and in our specialty units, it's adjusting to the economy, our risk management appetite, and regulatory guidance. Nevada looks good as well, Southern Nevada and you can triangulate on that by listening to some of the large gaming enterprises there, and how they look at what happened to tourism and everything, which is looking pretty strong.

Great. I appreciate it. Thanks.

Gary Tenner, D.A. Davidson.

Just wanted to follow up on John's question regarding the regional segments, particularly Southern California. I think that was the one segment among the regions that had loan runoff and your growth in the others. Could you talk about the competitive dynamics and credit conditions, maybe were that particular market differed from the others?

I don't know that it differed too much. We got one competitor in that market that's pretty big that's not in the other markets, that's Union. There are some products they're that are pretty aggressive in, in terms of pricing owner-occupied commercial real estate, that's been a struggle for us in Southern California.

We haven't really made the inroads we need to in the Los Angeles market. I think there some opportunity. And quite frankly, we are little disappointed in some of the loan growth there in San Diego, which I think we can do better on this year. But overall, I think the opportunities are pretty much about the same. We just didn't maybe execute as well last year.

So as you look at new lenders or hires, is that particularly a market you would focus on?

It is. Yes. And our biggest opportunity is to really figure out that LA market, in a way that we can have a meaningful impact with the right people, and so that's towards the top of the strategic planning agenda.

Thanks for that. Dale, when you were just commenting earlier on FHLB specialty, you broke up a little bit. I didn't catch the number.

I believe we were up $400,000.

$400,000. Okay. Thanks.

Brian Klock, Keefe, Bruyette & Woods.

Dale, can you tell us what, remind us what the size of the mortgage warehouse book is, and what was the decline was like in the fourth quarter?

It was about -- let's see here. $800 million, and it was up about $70 million during the quarter. And my point on that, Brian was, I think there was a fair amount of business that got done in the fourth quarter, rates started going up and people got off the dime to do things. But I think looking into the first half of this year, you're going to see probably a slowdown in terms of the refinance business, which is obviously one component.

Got it. That makes sense. Dale, just wanted to follow up. When you talk about the impact from the 25 basis point hike, you mentioned $0.05, so are you actually saying earnings-per-share, or you're trying to say that the NIM impact is 5 basis points?

It's both actually. Five basis points on the NIM, given our earning assets, and then you take that after-tax and you get $0.05 as well.

Got you. Robert, if I can follow up, you talked about some of the different things in thinking about the HFF portfolio. It's about where you want it to be. And you continue to as you grow capital, you are seeing that concentration go down.

Is there any reason you're thinking about maybe taking that down lower from what was 280%, now 260%, to 240% now. Is there any point where you think you would turn around and start growing again, or is it more just a risk of adjusted growth return you are focused on?

What did you mean about the 240?

The 240%, the concentration of your commercial loans?

For one, we are going to stay within our policy and our guidance, and Fed regulatory expectations. That's just a fact. Now, below that, it depends on what the market gives us, in terms of how we view underwriting. We have ways, based on different products in different markets, and looking at debt yields, looking at loan to cost of construction, and looking at what future products are coming online, what absorption is, and we're going to be sticking to our credit quality criteria. And if that credit quality criteria brings us in credit that takes that number to 260% or takes that down to 220% so be it, that's what it will be.

We just don't see the policy limits here as really being restrictive at all, in terms of what we're going to be doing. For example, let's say our capital grows $75 million per quarter, roughly based upon earnings. Of course we have 100% retention of that. That's $300 million a year. Multiply that by 3, the 300% test, that means --

Quarter, quarter.

$3 million for the year. $75 times then -- If we make $75 million a quarter, the 300%, that's $225 million per quarter, or $900 million a year. And today only 38% of our loan book is actually in the 300% bucket. So if we just stay proportional to where we are, 38% of the 12% number that Robert mentioned on loans is significantly lower than what just our internal capital generation would allow us to provide. We just don't see any type of ceiling there, as really being relevant or restrictive.

Makes sense. There's a lot of capacity to add with your earnings power.

The capacity is not going to be -- I don't want to be redundant here, but the capacity is not going to be driven by how close we can get to those numbers without going over. It will be driven by the market and what we think are prudent underwriting standards, and where we think we should be lending money.

Got it. Last question, if you think about that from origination of your own new credits, if you're looking at targets, is that any deterrent, if there's a potential target out there that may have maybe too much commercial real estate?

Yes. In two ways. One, what is the absolute dollar that the target has? And two, how well underwritten is the portfolio, compared to where we are in the cycle? So both.

Thanks for taking the time. Appreciate it.

Jon Arfstrom, RBC.

Most of my questions have been asked, in fact I think John Moran actually majored in clairvoyance. He took every single one of my questions. I've got a couple though, I want to follow up on. The higher note yields you talked about Robert, is that just a function of higher rates, or are you actually seeing spreads widen in certain areas of the loan portfolio?

In some areas we are seeing it widen, and some we're seeing it shrink.

Can you give a little more detail?

Yes. CRE is widening. Some of the more commodity based products, that are cookie-cutter and easy to do, continue to be narrowing.

Okay. But you are expecting loan yields to generally rise in Q1? I know you talked about the day count and everything, but loan yields are generally going up?

LIBOR rose throughout the fourth quarter so you don't necessarily see a lot more there, although I think the expectation is again, a rising rate environment, so that should continue to climb. We've got north of $3 billion of LIBOR tied pricing.

The prime rate didn't increase until mid-December. That's even a larger number in terms of repricing effect, for tied to prime loans. You are absolutely going to see that number in Q1.

Plus we do a lot of five, three, five, and seven-year fixed rate loans, and those spreads rose 40, 50 BPs, too.

Seen any pressure at all in deposit pricing, so far?

Selective. We have not changed our posted deposit rates, but there have been some one-off types of things that we have done. We elevated our pricing, and you can see that when we got the GE deal, and eased it off in the third and fourth quarter. We are, overall for the most part, the increase that we saw in the prime rate is not going to be spent on interest expense.

The majority of our deposits come from Arizona, California, and Nevada. We do have now about $2 billion in our community association bank, homeowners association bank, of which may be $1.3 billion of which maybe $1.3 billion or $1.4 billion is outside of those three states.

But aside from that, most of our deposit generation really comes from these few states. The beauty about most of those markets we are in, like San Diego, Phoenix, Tucson, Vegas, Reno, is that 80% of the deposit share in those markets is from three or four large national banks. Our cost of funding is pretty closely related to how quick BofA, Wells and Chase raise their interest rates on deposits.

Good. Thank you. Last question. On the provision, I think the message is, is really nothing changing or going on in credit, but the provisions are likely to rise modestly, and that's just the function of less recoveries. Is that fair, or is there anything going on in credit?

That's what it will be. We are going to have less recoveries, so depending on what the charge-offs are, that will depend on the recoveries. If you want to figure about 1% for loan growth and the rest for charge-offs.

Okay. Thanks for the time.

This concludes our question and answer session. I would like to turn the conference back over to Robert Sarver for any closing remarks.

Nothing other than thanks for joining us. We will be back in touch in 90 days to update you on the first quarter.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.