Western Alliance Bancorp (WAL) 2018 Q2 法說會逐字稿

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the second quarter of 2018. Our speakers today are Ken Vecchione, Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Robert Sarver, Executive Chairman. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com.

The call will be recorded and made available for replay after 2:00 p.m. Eastern Time on July 20, 2018, through August 20, 2018, at 9:00 a.m. Eastern Time by dialing 1 (877) 344-7529 and then entering passcode 10121936.

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 facts. 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 statement.

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. I would now like to turn the call over to Ken Vecchione. Please go ahead.

Good afternoon, everyone. Welcome to Western Alliance second quarter earnings call. This quarter represents our 32nd consecutive quarter of record net income. Joining me on the call today are Dale Gibbons and Robert Sarver.

This quarter, we produced net income and earnings per share of $104.7 million and $0.99, respectively. Both net income and EPS grew 30% from the same period last year. These results were achieved in conjunction with accelerating economic growth, rising hourly wages, increasing consumer confidence and higher personal spending. Unemployment continues its decline and more people are returning to the workforce. The recent tax bill legislation and the administration's softening approach to regulation continue to provide support and momentum to the economy.

Our business model, which focuses on National Business Lines in conjunction with a regional presence in the southwest, produced strong loan growth and even better deposit growth. For the quarter, total loans were $16.1 billion, up $578 million from prior quarter and up $1 billion for the first half of this year. Year-over-year, loans grew $2.1 billion or 15.4%.

Deposits expanded $733 million to nearly $18.1 billion from Q1. Year-over-year deposits rose $2.1 billion or 13% and year-to-date deposits was -- were $1.1 billion. This performance moved the loan-to-deposit ratio from 89.7% as of the end of last quarter to 89.2%.

Net interest margin improved this quarter as our asset-sensitive balance sheet and high level of non-interest-bearing deposits moved the NIM to 4.7% compared to 4.6% in the prior quarter. Our growth this quarter has been entirely organic, providing us the optionality not to chase pricey M&A targets and wait for opportunistic deals that will be more attractively priced.

Asset quality continues to remain stable with special mention loans declining $35 million while classified accruing loans rose by a like amount. Positive operating leverage assisted in the reduction of the company's efficiency ratio by 60 basis points to 42.1%. Embedded inside the efficiency ratio are several new organic loan and deposit initiatives that continue to show promise and progress.

Going forward, depending on testing, performance and product rollout, we may, and I emphasize may, bring forward some of these development costs from 2019 into this year, which could put temporary pressure on our 3:2 revenue to expense growth rate target.

Quarterly earnings added nearly $100 million to equity, increasing the tangible common equity ratio to 9.9% as total assets rose $607 million, providing the company the ability to continue to support its organic growth objectives.

Finally, compared to prior quarter, tangible book value per share increased 19.5% annualized to $19.78, which is the byproduct of the 2.02% ROA and a return on tangible common equity that was above 20% for the second consecutive quarter. And now, I'll turn it over to Dale.

Thanks, Ken. Net interest income rose $9.9 million from the first quarter to $224 million, driven by a $541 million increase in average loans as well as the 10 basis point margin increase. Net interest income rose 16% from the year-ago period.

Operating noninterest income was up $1.4 million from the first quarter to $14.1 million, largely due to more income from technology financing, resulting in total revenue up $11.3 million to $238.2 million, which was nearly 20% annualized growth from the first quarter.

Operating expense rose $3.4 million or 13.5% annualized growth from the first quarter to $102.7 million. Consistent with our expectations, the revenue growth rate of near 20% was about 50% faster than the 13.5% expense growth rate even as the company earned through $1.2 million in higher noninterest deposit expense incurred to support interest-bearing deposit growth. On a dollar basis, the $34.8 million increase in revenue from the second quarter of last year was more than double the $14.5 million increase in expense over the same period.

The provision for credit losses was $5 million for the quarter as asset quality remained steady. Securities losses, net of OREO gains, was $0.5 million. The effective tax rate climbed to 19.5% from 17.1% last quarter but which included a benefit from restricted share awards of Western Alliance stock vesting at a higher share price than when the equity grant was awarded as our stock price has climbed. The diluted share count held essentially flat at 105.5 million resulting in EPS of $0.99.

For the next 3 pages, an orange line has been added to the 2017 period to show what these ratios would've been without the reduction in tax-exempt benefits due to the Tax Cuts and Jobs Act passed late last year. While the numbers in green are the actual reported performance, the numbers in orange provide continuity to the quarters in 2018 had the tax change been in effect in the prior year.

Investment yields rose 16 basis points during the quarter to 3.23% and has consistently climbed from the 2.87% adjusted yield in the second quarter of 2017. Similarly, loan yields have climbed over the past year after adjusting for the effect of the Tax Act rising 32 basis points from 5.49% in the second quarter of last year to 5.81% in the most recent period.

As the percentage increased of the target Fed funds rate over the past year of 75 basis points, the adjusted trailing 4-quarter loan beta was 43%. On a linked-quarter basis, loan yields rose 22 basis points, resulting in a loan beta of 88%.

Interest-bearing deposit cost rose 22 basis points in Q2, also at 88% beta from the first quarter as the company responded to competitive pricing pressure with sufficient strength to continue its healthy organic growth and sustain its core deposit funding profile. From the second quarter of 2017, interest-bearing deposit cost rose 40 basis points, resulting in a 53% beta. However, this measure does not consider our relatively high level of non-interest-bearing deposits, which grew $446 million in the past quarter and $1.1 billion over the past year.

When all the company's funding sources are considered, including non-interest-bearing as well as borrowings, total funding cost climbed 15 basis points for the quarter and 26 basis points over the past year to 0.61%, resulting in a linked-quarter funding cost beta of 60% and a 1-year trailing funding cost beta of 34%. Over both last quarter and last year, the bank's loan beta has exceeded its funding cost beta.

The company believes this metric provides a more complete picture of WAL's funding price sensitivity to rising rates and betas that only comprise a portion of the bank's funding structure while also acknowledging the bank's 44% proportion of non-interest-bearing deposits.

Interest margin climbed 10 basis points during the quarter to 4.70%, primarily driven by the benefit of higher rates on our asset-sensitive balance sheet. From a year earlier and after adjusting the prior margin by the effective lower taxable-equivalent benefit, the second quarter margin climbed 21 basis points from 4.49%, which was a 28% participation rate in the 75 basis point increase in target Fed funds during the past year. This is slightly better than the guidance we have provided of a 5 to 6 basis point improvement in the margin for each 25 basis points increase in the target Fed funds rate by the FOMC.

Accretion on acquired loans slipped to $5.1 million from $5.7 million in the first quarter. Forecasted accretion will fall to $2 million in future periods if all discounted acquired loans paid just their contractual principal commitments. However, because of loan prepayment activity, actual accretion will likely exceed this estimate.

The efficiency ratio decreased to 42.1% from 42.7% on a linked-quarter basis and is essentially flat from the 42.3% a year ago after adjusting for the tax change. The $3.4 million increase in operating expense from the first quarter was driven by higher professional expenses and increased deposit cost as compensation charges held flat and compares favorably to the rise in revenue of $11.3 million for a 3:1 revenue to expense increase in dollars. Similarly, year-over-year revenue growth of $34.8 million was 2.4x the $14.5 million increase in operating costs.

Our pre-provision net revenue was 2.61% and return on assets exceeded 2% for the first time in company history. These metrics have consistently been in the top decile relative to peers. Strong first quarter loan and deposit growth grew total assets to $21.4 billion at period end. Our consistent balance sheet momentum continued during the quarter as the 15% annualized loan growth of $578 million was very close to the 16% annual growth we reported in loans for the past 3 years.

Similarly, annualized second quarter deposit growth of nearly 17% from the $733 million increase closely compares to the 3-year compounded deposit growth rate of 16%, which is the same as we had in loans. Deposit growth of $733 million exceeded loan growth of $578 million by $150 million and enabled us to reduce our Federal Home Loan Bank borrowings to only $75 million at June 30.

Our loan growth of $578 million was driven by C&I of $334 million and residential real estate loans up $131 million. All of the loan categories declined modestly as a percentage of total loans. Our line of business, the growth was broad-based with every geographic region and NBL increasing from the first quarter.

Deposit growth of $733 million was particularly strong in the Arizona and Nevada regions and the tech and innovation business line. 60% of the deposit growth was non-interest-bearing while other categories increased moderately.

Total adversely graded assets declined by $10 million during the quarter to $369 million as an increase in classified accruing loans was largely offset by a decrease in special mention credits. Nonperforming assets, comprised of loans on nonaccrual and repossessed real estate, decreased to $62 million or only 29 basis points of total assets.

Gross credit losses of $3.9 million during the quarter were partially offset by $1.3 million in recoveries, resulting in net losses of $2.6 million or 7 basis points of total loans annualized. The credit loss provision of $5 million compared to $6 million in the prior quarter as the required reserve to support strong loan growth was partially offset by a reduction in specific compared credit allocations and increased the allowance for loan and lease losses to $147 million, up $15 million from a year ago. This reserve was 99 basis points of organic loans as of June 30 as acquired loans are booked at a discount to the NPA principal balance and hence, have no reserve at acquisition.

For acquired loans, credit discounts totaled $20 million at quarter end, which was 101.5% to the $1.3 billion purchase loan portfolio, primarily from the Bridge Bank and Hotel Franchise Finance transactions.

Our strong capital growth for the quarter exceeded our balance sheet growth and drove each capital ratio higher from the first quarter. Tangible book value per share was $0.92 during the quarter to $19.78 and is up 18% in the past year, and 9.9% are tangible common equity is at the top quartile of the peer group while return on tangible equity again exceeded 20%. I'll turn the call back to Ken.

Okay, thanks, Dale. Our business model, regional presence in the southwest combined with National Business Lines positions us for continued success in the back half of the year. The loan pipeline looks strong as our regions and National Business Lines provide us the flexibility to move capital to better price and better structure transactions.

The National Business Lines carry with them less competition, more stable pricing, good asset quality and positive operating leverage. Deposit growth will continue to challenge the industry, and despite our outstanding growth this quarter, continues to get management's full attention. We take nothing for granted while we expect our deposit growth to continue to fund loan demand.

Our tech and innovation, life science, HOA and warehouse lending National Business Lines continue to be an active source of deposits for us, and our approach to requesting deposits when providing loans is of the optimism we can continue to grow deposits alongside loans.

Our NIM, supported by a high percentage of non-interest-bearing deposits and loan yields that have performed well but remain under pressure, should have an upward bias for the remainder of the year and dependent on additional rate increases by the Fed. We expect interest-bearing deposit betas will modestly decline from here to year-end as we still target approximately 50% beta to the rate cycle with any future fed action supporting a higher NIM.

Year-to-date, operating leverage has benefited from a nearly 3:1 revenue to expense performance as revenues have risen $72.5 million and expenses $25.5 million year-over-year. This performance metric depicts the underlying leverage more clearly when comparing revenue growth percentages to expense growth percentages.

Asset quality remains stable and we work hard not to trade away deal structure for growth. We remain vigilant when conducting asset quality reviews and move expeditiously when borrowers show early signs of credit stress.

Overall, our culture at Western Alliance combines an entrepreneurial approach with prudent credit and risk management practices. Management will continue to focus on both aspects of our business as we move into the second half of the year. At this time, Robert, Dale and I will be happy to take your questions.

(Operator Instructions) Our first question comes from Timur Braziler of Wells Fargo Securities.

First one for Ken. The loan to deposit initiatives that you referred to, any additional color you can provide there? And I guess, what's going to be the deciding factor whether or not some of those expenses do get accelerated into 2018?

Okay. As I said on the last call, we're not going to give any clear line of sight as to exactly what we're doing. What I can say is loan to deposit initiatives is organically grown, meaning we saw an opportunity inside of our book of business today to expand a particular area. We have a couple of those people already on or in the company, and we do need to acquire a few more as we begin to push forward and grow those deposits. The second deposit initiative, we just hired the leader of that group at the middle to tail end of June. And right after this, I'm going to sit down and review his operating plan and depending on how fast he can get that business up and running will depend on how quickly we hire the people. That's probably about as much as I can offer at this time.

Okay, that's helpful. And then just maybe looking at the broader deposit base. Is there any bifurcation in betas maybe in Arizona, Nevada markets versus some of your other markets and other National Business Lines? Any difference in competitive landscape?

It's Robert speaking. Historically, the California market has carried lower-cost deposits than Arizona and Nevada. But I think the biggest thing for our company is, and a lot of this has been done to our strategy, is by far, the majority of our customers are pretty DDA-rich and that's really the value in our deposit franchise is our DDA. So if you go -- if you look back, the balance sheet focus during the recession was capital. And then as the economy started getting better, it shifted to loan growth and now, it's deposits. And for the last 10 years, we've been just building, as Ken alluded to, some of these business niches that have paid off pretty handsomely that we've organically grown like municipal finance or homeowner association. So we have very few borrowing segments we have that aren't DDA-rich. And so while our non-interest-bearing money could go up, we still continue to add significant amounts of DDA and that's really going to be the key to our deposit growth in our margin.

Great. And just one last one for me. Looking at the other National Business Lines, the loan growth this quarter, how much of that came from the warehouse business, and what's that balance at the end of the quarter?

Yes. So overall, National Business Lines produced $424 million of incremental growth quarter-to-quarter. $200 million of that came from warehouse lending. But when you look at all of our National Business Lines and all of our regions, every single business contributed to quarter-over-quarter growth. So we're very pleased that our business activities are very broad-based in terms of pushing up total loan growth this quarter.

Our next question comes from Casey Haire of Jefferies.

Wanted to touch on the loan growth specifically -- or the outlook rather, specifically the mix. CRE obviously is very competitive. You guys did manage some growth. You were also pretty -- the resi growth was very strong this quarter, one of the strongest you've had in some time. Is that sort of -- is that how we should look at loan growth going forward? Is CRE a little bit tougher? And how much more are you willing to take up the resi, which has not obviously been a big piece of the portfolio for you?

Yes, so let me give you a macro answer first and I'll get to the micro. What we do every week is because we have so many business lines and regions, we're able to allocate out our capital to the best risk/reward opportunities we have. And therefore, that puts less pressure on our pricing throughout the business. So if we see opportunities in one particular segment and we like the risk/reward, we'll push more there if those opportunities are coming in. That's number one. Number two, residential loans did grow by about $127 million. It still only represents 3.4% of our total loans. And here, we've entered into some forward flow arrangements with some of our warehouse lenders at attractive rates without the origination, distribution and compliance expense, which provides attractive operating leverage for us. However, we do not underwrite -- I'm sorry. I want to say, however, we do underwrite all these loans ourselves. And last but not least on structure because I always -- you have to put that alongside of pricing. We just don't compromise on structure, all right? And we are fortunate that in the markets that we play in, we're not competing a lot against the large money center banks, which tend to sometimes, in our viewpoint, give up structure. So we haven't had as much structure pressure on us as maybe some of the other banks that have reported. However, there are a lot more nonfinancial banks coming into the market as they see opportunities here, and it wouldn't surprise me that we'll see more structure pressure. But we just don't give up on structure.

Understood. And just switching to sort of, I guess, capital management. The -- can you give us some updated thoughts on what the M&A environment is like? I know bank pricing -- bank deal pricing has not been to your liking. But what about loan portfolio opportunities, which appear to be decent opportunities in today's environment?

Yes, I mean, first thing I'll say is there's a lot for sale and more and more for sale. So the number of banks that are interested in selling is growing. And I think as that continues to increase, there'll probably be some better opportunities. As we've alluded to before, we're primarily an organic grower. And being able to compound out a 20% return year after year and grow our book value by a like amount makes the hurdle a little bit higher on these acquisitions. We have found some very good opportunities to add value to the company over the last 10 years with what I'd call nonbank acquisitions. We continue to look at a lot of those. We think there's quite a bit of value there because we have the ability, unique ability to really grow our deposit base. A number of the companies are a little more deposit constrained, and so that gives us an opportunity in today's environment to look at some of these lending niche opportunities like you said. And like we did with the purchase from GE Capital and a couple other purchases we've done. So we're open to continue to look at bank deals. As you said, a lot of the pricing has -- stuff's been fully priced. And I think a number of these niche opportunities, whether it's a good acquisition or organically, is a pretty strong focus of ours.

Okay, great. So it seems like it's a decent opportunity. What is holding you back from successfully landing on one? Is it pricing or is it just the risk profile?

No, I think the part of it is the risk profile and part of it is pricing, too. But a lot of it has to do with culture. We're not a big consumer lender so we're focused more on stuff in the commercial space. And we've got a few organic initiatives on these lines, which we think have a lot of opportunity. And organically, for us, has been a better way to add value. It maybe doesn't hit the P&L as much upfront, but down the road obviously, there isn't any dilution, and so it tends to be more accretive for our shareholders over the long term. But we continue to look at a lot of opportunities. I would say we probably get shown half a dozen deals every week, different sizes, different shapes and it's increasing. So we're -- but we have a high hurdle rate. When you're returning 20% of equity, we got to make sure if we do a deal, we're going to get that kind of return. So I guess, it's a high-class problem to have but we're pretty disciplined in that regard.

Understood. And just lastly, I know you guys have talked about potentially rightsizing capital ratios if you don't find one of these deals. But given that it does seem like a good opportunity -- a good environment for deals and you have some organic initiatives in the works, does this mean that you're going to forego rightsizing capital ratios in '19 if they continue to build and you're just happy to let them grow from here?

Yes, I don't know if we can talk about '19 right now, but I think that is an issue. I mean, our capital ratios are growing and that's something we'll continue to look at. It's something the board addresses every quarter, but right now, we have no plans to rightsize capital. And I do believe with the pressure on deposits that we've alluded to that's in the market that, that will provide more opportunities for companies like us whose business model is, as I'd say, DDA deposit-rich. There'll be some opportunities. So I'm not concerned with opportunities quarter-to-quarter as I am finding the right opportunities and going after those.

Our next question comes from Arren Cyganovich of Citi.

Just thinking about the competitive environment on lending, clearly, there's credit spread compression on CRE. What are you seeing within your National Business Lines? And what provides that ability to keep those credit spreads from tightening too much?

So in the National Business Lines, we have seen pressure in warehouse lending and we've seen some pressure in our hotel group. And so -- and we have dropped our pricing, no doubt about that. But we still continue to get a premium to what the market pricing is. And every company says the same thing, which is it's because of service and responsiveness and that's how we get the money. That's how we get the spreads. So yesterday, 2 deals came across my desk and it was, if we can say yes to these dynamics, these financial terms in the next 48 hours, the deal was ours, all right? And we pushed on it and we looked at it, we did our review. I would have liked to have seen more pricing but we were still getting a 50 basis point premium to what the market was and we took the deal. And we got the deal, even more important. So we are seeing some pressure there. And we've grudgingly, as I said, bring our rates down.

I think one of the differences for us compared to some of the companies that I know you're alluding to is we have so many different business lines and so many different credit opportunities that we are able to balance where we are maybe slowing down and where we are speeding up based on market. And a number of the areas that we're in have much fewer competitors in place rather than just say CRE lending or construction real estate lending.

Right, okay. And then are you able to put any kind of magnitude on when you're talking about the potential expenses you'd pull forward from 2019? Is it material or is it just relatively small? And I'm just trying to gauge what you're referring to there.

So the answer is no. I don't have that in front of me and the reason is we're still trying to understand how big the opportunity is. And depending on how big the opportunity is and how fast we can bring it to market will determine how much we pull forward. So on one of the initiatives, I said we just hired our senior leader. Yes, he's going to need a couple more people to start getting this thing moving. That will be a few more people. On the other deposit initiative, we have a few people already in-house that were on our payroll. We probably need to bring in a couple of more. So what we're trying to do is balance it in the constraints of our operating leverage as well.

Okay, great. And then just last quick question on models. The tax rate seems a little bit lower than what I was expecting. What's your expectation for tax rate going forward?

Yes. There wasn't anything in the second quarter of tax that I would call nonrecurring. So in that sense, I call it a core number of about 19.5%. That said, our taxable income is growing at a faster rate than our tax-exempt income, which has been a little bit challenged since the Tax Act went into effect that reduced the benefit for withholding tax-exempt assets. And so as a result, I would guide more toward 20% but 19.5% was a core number for Q2.

Let me come back to your other question because you asked about these new business initiatives. But if you were thinking about what does it mean to our total expenses, then for Q3, we will see -- we could see an upward drift on expenses by maybe $2 million to $3 million more, in that vicinity, just as we begin to roll in new projects and continue to try to hire producers. So that maybe will give you some sense of guidance as to what's coming forward, coming ahead.

Our next question comes from Chris McGratty of KBW.

On credit, it obviously looks very good. I think in the past, you talked about some caution growing the hotel portfolio. But as you stand in the midpoint of the year, maybe Robert or Ken, how are you thinking about portfolios? Do you prune, given this strong appetite for assets in the industry?

I'm sorry. How do we think about what?

Just pruning the portfolio. Is there any credits that...

Pruning, you said?

Pruning, correct.

Yes, we're not pruning. We still see good opportunities. First, in the hotel, we try to have a model that says let's be in the top MSAs and within there, let's be in primary and secondary locations. And then let's make sure we have operators that have more than 10 hotels that have done this for a number of years and have good sponsorship and liquidity behind them. What we do look at is a lot of the demand-supply dynamics. And sometimes, we'll say no to funding a hotel because we think too much supply is coming online and that in itself could lead to a problem down the road. But we're not pruning. We see continued opportunities in the hotel space and actually -- and just about most of all the National Business Lines.

I think one of the things that is helping the market is the amount of institutional equity coming into a lot of projects. So like in the hotel space, we're not competing on the onesies deals that the community banks and the local regional banks are doing. We're doing more portfolio deals. I will say one of the risks in real estate right now is the cost in construction. A lot of projects are showing significant cost overruns, especially at some of the bigger markets. And so where we are, if you want to say the word pruning, is being cautious on the amount of equity we have available and on the construction side where the sponsors have the liquidity and the resources committed to get projects done. And so we're a little more pickier in terms of our sponsorship, but there's still plenty of business out there so the portfolio itself doesn't have to shrink.

Just broadly, maybe think of another answer to this, too, and one of the things we're doing is a lot of people ask, what keeps me up at night? And one of the things that keeps me up at night is trying to find something that keeps me up at night, all right? Because things look pretty good these days. So what we've tried to do especially in the hotel group, which could have volatility, we've set the covenant levels at a higher level. So we're hoping -- if anything happens, our borrower trips at a higher covenant level, which allows us to get there earlier, helps us remargin the property, have additional liquidity put in there while the property is still really cash flowing and doing nicely. So that floated away. I won't say we're pruning but we have put a higher level of covenants in there. And then do we lose a deal or 2 because of that? Yes. But I feel good that if something trips in any one of our deals, we get there first and then we can work it out. So I'd rather see our special mention jump up for a quarter or 2 and then have that loan go right back up to pass rather than to find its way in to sub or in to a loss. So not exactly pruning but we have set a level of expectation in terms of deal structuring at a higher level.

We have a full suite of service available in commercial real estate. And so -- and as you know, we're -- that's an area we're pretty savvy and pretty forward thinking in itself. In some of the areas that you would look to and say, well, maybe some of these prices are getting a little high or terms or whatever, we've also shifted to the debt market where we're helping finance people that are lending in those areas. So if we think we don't want as much exposure, we're worried about valuations and cap rates and stuff, we may finance other lenders that do that business. And so therefore, we cut our exposure by 50%. So yes, instead of making a 70% loan-to-value on a certain asset class, we may advance 50% to an institutional entity that's also making a 70% or 75% loan. So there's a lot of different ways to do it. But the way we look at the real estate, we look at it geographically, we look at it by product type and then we'll look at it on a macro basis to try to manage our risk.

If I could ask one more, Dale, on the securities portfolio. Certainly, the size will be dictated by your flows in deposits. But anything -- any color on reinvestment rates, what you're buying, [GSEs], any change quarter-on-quarter?

Yes. So we're -- I mean, we're replacing the portfolio at probably slightly higher than where we are today, primarily buying GSE paper 3.5- to 4.5-year kind of target duration. The balance came down a little bit in Q2. I'm not looking to shrink the portfolio. I think it's going to be fairly flat for the rest of '18.

Chris, I got a question for you. How has the productivity of your interns been this summer?

Excellent. A lot of good training going on.

Our next question comes from Brett Rabatin of Piper Jaffray.

Wanted to ask, I guess, first, just going back to the commentary around deposit betas moderating. Can you maybe give a little more color around is that a function of kind of the betas have increased and so from here, they're less meaningful? Or are you expecting a mix shift change to maybe help the beta? Can you maybe just give a little more color on the moderation question or commentary?

Sure. So we were defensive kind of early on this year in terms of moving deposits, being responsive to kind of customer complaints. And we tried to get in front of it a little bit and you saw that in the second quarter. I think we've effectively done that for the kind of rate situation we sit at presently. And so consequently, I think our deposit betas are going to ease off from the kind of pronounced rate they were at in 2Q. That said, we've long been expecting that the deposit betas through this cycle are going to be no different than what they are in prior cycles. I know some people thought because we started out so slow, so sluggish coming off of basically a zero-rate environment that they were going to stay low. I never thought that was going to be the case. And so that's about a 50% beta overall. We're still lower than that on a cumulative basis as the rate cycle began. But I'm looking for about a 50% kind of out from here.

Okay. And then on the margin with the June rate hike, I guess, I'm just curious, Dale, when the yield curve looks to be flattening and that's kind of made you a little bit nervous about the forward margin, can you maybe just put all those things into context about your thoughts on the margin from here?

Sure. So our guidance has been about 5 or 6 bps for 25 from the FOMC. We think that's basically intact. What perhaps could work against that is what you're alluding to, Brett, and that is what about -- what can we reprice in kind of the middle of the curve if the CRE book prices off of the swap curve essentially. And that really hasn't moved that much since the beginning of 2018. I think that's correct that it's a proportion of the kind of the total effect on the loan yield and the NIM, it's going to be fairly muted. We have -- 25% of our loans are tied to prime, 30% are 30-day LIBOR, 5% are 90-day LIBOR, so that's a total of 60%. And then the rest that you see, that reprices only reprice as it matures and most of our CRE loans have a duration of about 4 years or so. So you're not repricing near as many dollars kind of in that space. But yes, so 60% of our loans are basically floating rate. That should move the margin up. But yes, if we don't see the yield curve kind of move in a parallel shift, it can be a little more muted than the 5 to 6 that we're indicating.

Our next question comes from Brad Milsaps of Sandler O'Neill.

It looks like maybe you hired about 60 people during the quarter. That's maybe a little heavier than normal. I'm just kind of curious if you can break those down maybe between revenue producers versus more back office infrastructure type folks. And I think you kind of alluded to it, Ken, that maybe a lot of that is in the run rate and with the kind of OpEx guidance you gave a few minutes ago on the call.

Yes. So we went up a little over 60 people quarter-to-quarter. Our hiring in Q1 happened to be light. But I would break down those 60 people as follows: 40% are revenue producing or people that support the revenue producers. About 25% of that happen to be interns. And then the remainder, about 1/3 happens to be the infrastructure folks that help make the company tick in the back office.

Got it, okay. And then just to follow up on loan growth, Dale. Was warehouse -- I was just kind of curious what the type of contribution it had to the kind of the period-end loan growth for the quarter.

Yes. So $88 million mortgage warehouse loans.

Okay, so not a big number. Okay, all right. Great.

Our next question comes from Jon Arfstrom of RBC Capital Markets.

Just to follow up on Brad's question. Commercial, you had a strong commercial loan growth quarter, and like last quarter, period-end is also significantly higher than the average. So 2-part question, maybe talk a little bit about the key drivers of commercial during the quarter. And how are you feeling about the outlook there? It seems a bit stronger.

Yes. On the commercial side, we're constructive. We like what we see and the flow of opportunities has been consistent for the first half of this year. Nothing unusual there.

I mean, it really was broad-based. Tech was up. Each of the regions were up so we feel pretty strongly that it's got momentum to it. I would point out that our loans, we call it -- we have a telephone situation, telephone line situation here where they tend to peak at the last day of the quarter, there are some things that close and stuff like that. And then they ease off a little bit. So we do have a significant variance between our average balance and our ending balance. That's a little more pronounced in the second quarter than usual. So I think that, that may change. But we do look for -- I would look for our average balance to increase significantly. But when you can't necessarily draw a linear line from 6/30 million to what you think we're going to be at 9/30, given kind of the guidance we're giving in, call that, the average. It's going to be a little lower than that.

Okay. Okay, good. That helps. And then a bigger picture question back on M&A. But you're over $20 billion and a lot of banks with that $50 billion, $50 billion threshold talked about want to get to $30 billion or $35 billion that they started to get treated like a bigger bank. I'm just curious, from your perspective, maybe Ken or Robert, lifting that $50 billion cap, does that make you think differently strategically about the company longer term?

Yes, a little bit. But I think the key in terms of risk management is trying to be ahead of yourself. And I look at it more as an evolving process. Listen, there's a lot of what you need to do or what you used to have to do or maybe you still have to do at $50 billion that we do now just because we think it's a prudent way to run the company. So to me, it's just an evolving process. The risk management piece, I just don't look at the absolute dollar amounts kind of regardless of the regulation. So just what's best to manage the company.

Our next question comes from Michael Young of SunTrust.

Maybe starting with just a bigger picture question either for Robert or Ken. Just given where we're at in the economic cycle and the spread dependency of the business, is there anything that you all are doing or thinking about at some point to be more defensive either by adding kind of nonspread-driven businesses or extending duration, et cetera, in the loan book? And what would maybe trigger that?

So the things that we're doing defensively are what I already comment on, which is trying to raise the covenant levels. So if things do go wrong, we're there first in front of the borrower to help reconcile that -- rectify that, I should say. That's pretty much where we're headed. You mentioned that the economy is a little bit long in its recovery but the southwest economy is humming. And we see economic growth having a positive impact on all sectors of real estate. We see that CRE continues to be an attractive investment alternative. We see a large inventory of renters that want to fuel new home purchases and multifamily development. Unemployment is dropping in this area. Particularly in Arizona, we see more companies looking to relocate here for a variety of reasons, mostly cost and talent level. So I think we're doing the right things at this time and I'm somewhat optimistic about where the economy is going in the future.

We're certainly watchful about emerging signs and there's been a lot of talk about some of the macroeconomic elements, trade disputes and things like that. So far, I think, they haven't had an effect here. But we're watching them and if we thought things were turning, I think that does affect kind of what we're looking at and perhaps, we would -- while we're not going to bet on interest rates, we might shift our asset-sensitive profile to be a little more neutral.

All our credit people and our management people have been through the last 2 recessions. And so I think while we're optimistic about where the economy is, we're also conducting our business in a way that if we hit a recession, starting tomorrow, we've got ourselves protected. And we do that primarily through our collateral position, advance rates and our sponsor capacity, financial capacity. I remember as a young banker, they talked about the 5 Cs of lending. And when I went through the first recession, I learned that there's really only 3 Cs of lending and that is collateral creates character. And so we're very collateral focused.

Okay. And switching gears completely. Just to the deposit portfolio that's related to kind of Bridge Bank. Can you give us a sense of the size of the DDA balances from that? And have you seen any incremental pressure in that book of business to kind of migrate into interest-bearing accounts?

So the DDAs there probably sit about $1.3 billion. And generally, the tech business runs almost 2x deposits to loans. Life science runs even higher than that. And then of course, just HOA is off the charts in terms of deposits to loans. So that's what helps push this for our non-interest-bearing DDA to the level that it was.

Yes. I mean, the tech group, and this is similar to other players in the space. I mean, the proportion of their deposits that are non-interest-bearing significantly beats that of any other areas of the company.

But not seeing any new or renewed pressure in any of those books specifically?

No. That isn't where the competitive pressure lies with those types of credits. It's more to do with structure and getting comfortable with -- for an entity that maybe has revenue but is losing money and how do you lend against that safely, whether that's asset-based lending or something like that.

Our next question comes from Gary Tenner of D.A. Davidson.

My questions have largely been answered. Just wanted to ask on the expense side. A couple of items with some sequentially higher numbers, some of it related to some of the repossessed asset-related expenses. But particularly, legal and professional up about $2 million sequentially. Is that a number with some kind of artificial noise or volatility in it? Or is there -- is that $8 million a number we should be thinking about going forward?

Well, it might be a little elevated in Q2 but the noise or volatility really was more in Q1, which was a little bit low for various maybe seasonal reasons. So Q2 is a better run rate number but it does bounce around. I mean, those are specific contracts, there are projects that are being undertaken. And so it's not a constant expense stream like the compensation element would be.

But Q1 was seasonally a little bit lower, right?

Yes.

Our next question comes from Brock Vandervliet of UBS.

Just following up on one of the earlier questions on tech and life sciences. I mean, how does that -- when you speak of the risk/reward across the niche businesses, how does the risk/reward here scale out versus the others right now versus, say, a year or 2 ago?

So tech and innovation, life sciences, they have some of the highest yields in the company. And so the return is appropriate for the risk that we take. What we also try to do is ensure that we don't give up on structure and we've seen there -- if there's one place in the book that we see more competitive pressure in terms of relapsing structure is in tech and innovation. We haven't followed that but that's where we see some of the relaxation from some of our competitors. So in terms of the risk/reward, these credits -- what's a little bit different about these credits, they've got to be actively monitored. We have businesses that are producing revenue but generally aren't producing net income yet. And if there is something that goes amiss, the key there is getting there quickly, early and working with the sponsors. And that gives us comfort to the revenue side of getting the higher yields that we're getting in that business.

Is that an area that you continue to parachute people into or do you feel like you've got the troops on the ground that you need at this point?

So we've got really well-qualified people to do this at Bridge. There is a little bit more of a war for talent up in the Bay Area. And so we're always looking to get people there, but the price of those people have escalated a little bit. And so we're always on the lookout for folks there. But we like our team that's there now very much so.

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

Thank you all for joining us today, and we look forward to coming back to you with our third quarter results. Enjoy your day. Thanks.

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