Western Alliance Bancorp (WAL) Q2 2019 Earnings Call Transcript

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Western Alliance Bancorp (NYSE: WAL)
Q2 2019 Earnings Call
Jul 19, 2019, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the Second Quarter 2019. Our speakers 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 o'clock PM Eastern July 19th, 2019 through August 19th, 2019 at 9 AM Eastern Time by dialing 1 (877) 344-7529 with the passcode 10132284.

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 performances and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to different significantly from historical results and those expressed in forward-looking statements.

Some factors that could cause actual results to differ materially from historical or expected results, includes 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 now like to turn the call over to Ken Vecchione. Please go ahead.

Kenneth A. Vecchione -- Chief Executive Officer

Thank you. Good afternoon and welcome to Western Alliance second quarter earnings call. Joining me on the call today are Dale Gibbons and Robert Sarver. I will provide an overview of quarterly results and then Dale will walk you through the bank's financial performance in greater detail. Afterwards, we will open the line and Robert, Dale and I will take your questions.

Western Alliance delivered another exceptional quarter with strong deposit growth, primarily in non-interest bearing accounts, which funded high quality balanced loan growth. We maintain top tier financial performance while positioning our balance sheet to be resilient in front of potential slower economic growth and lower rates. As you'll see throughout our remarks, our results advanced our key strategic objectives, which include leveraging our branch lite business model to drive both discipline and thoughtful loan and deposit growth, carefully managing our balance sheet with regards to asset sensitivity, accretive capital allocation policies and de-risking our loan composition all while maintaining strong efficiency and profitability across all interest rate environments.

The strategy delivered outstanding results. Net income during the second quarter rose to a record $122.9 million or $1.19 per share compared to $120.8 million and $1.16 per share for Q1. Balance sheet growth was exceptional, with the Company reaching a new milestone of $25 billion in total assets. Year-over-year net income rose 17.4% and EPS grew 20.2%.

Total loans were $19.3 billion, an increase of 25% on a linked quarter annualized basis compared to $18.1 billion during Q1 2019. On a year-over-year basis, loans rose by 19.3%, assisted by $1 billion of residential growth, a part of our strategic de-risking plan as we view residential loans as a thoughtful, responsible alternative to manage loan growth. During the quarter, we also reduced our construction and land and development loans by $73 million, reducing their representation in our portfolio to 11.5% compared to 12.6% in Q1.

Deposits remained a bright spot for us during the second quarter as we grew over $1.2 billion from quarter end, supported by $998 million rise in non-interest bearing deposits. Total deposits grew on a linked quarter annualized basis by 24.4%. This bears repeating, 83% of our deposit growth was DDA, and non-interest bearing deposits now comprise over 40% of all deposits. This is the second consecutive quarter during which we grew deposits by over $1 billion. Over the last two quarters, loan growth of $1.5 billion has been fully funded by deposit growth of $2.3 billion. The loan to deposit ratio increased to 89.8% from 89.6% in Q1.

Continued balance sheet growth more than offset NIM reduction to 4.59% as we increased net interest income for the quarter by $7.3 million. Total operating revenues grew $7.4 million for the quarter compared to an expense increase of only $2 million and drove a 40 basis point improvement in our efficiency ratio to 42% from Q1. We are confident in our ability to remain one of the industry's most profitable banks while also prudently investing in growth initiatives even in a declining rate environment.

Return on assets was 2.05%, return on average tangible common equity -- equity was 19.7%, as we continue to post industry-leading performance -- our financial results for our Company by strong asset quality. Charge offs for the quarter were $1.6 million, representing only 3 basis points of average loans. Non-performing assets were $70 million, up $8 million from the prior quarter, but will remain at near historical low levels. Non-accrual loans and OREO to total assets was 27 basis points in line with the past four quarters.

Turning now to capital management, last month we announced the initiation of a dollar annual cash dividend. We also continue to opportunistically repurchase shares. During the quarter, we purchased 793,000 shares at $42.82, which when combined with last quarter share repurchase of 1.7 million shares, combined for a total cost of $41.45 year-to-date. Overall, the share count has been reduced by 2.5% through repurchases since the initiation of the stock buyback program in mid-Q4 2018.

On display this quarter was our ability to thoughtfully manage capital allocation between share repurchases and loan growth. Tangible common equity ratio absorbed significant balance sheet growth and opportunistic share repurchases and was 10.2% at quarter end, down 10 basis points from prior quarter. But up 30 basis points from prior year. The common equity Tier 1 ratio was 10.6% , relatively flat to the prior quarter. Tangible book value per share grew $6.03 [Phonetic] -- sorry 6.3% or $1.45 from the prior quarter to $24.65. Over the past five years, we have grown tangible book value per share by 213% compared to average peer growth of 67% over the same period, which includes adding back peer dividends.

Lastly, I want to reflect on Western Alliance surpassing $25 billion in assets. We've come a long way since our public company in 2000 [Phonetic] -- since becoming a public company in 2005, having increased our assets by 10.5 times over the $2 billion that we started with. Back then, we outlined the core principles of our strategy, strength of our management team, our conservative credit culture, the attractive growth characteristics of the markets where we operate, and the ability to attract seasoned bankers with long standing relationships in their community -- communities.

I'm proud that we stay true to those ideologies and cultural values, as we've grown. And as these precise qualities that continue to set Western Alliance apart. The people of Western Alliance drive our bank success and I would like to take a moment to recognize all of the people who have helped us achieve this exciting milestone.

Dale will now take you through our financial performance.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Thanks, Ken. Overall, our strong ongoing balance sheet growth resulted in record earnings despite headwinds from a flattening yield curve preceding an anticipated Fed rate cut. Net interest income rose $7.3 million or 12% annualized from the first quarter to $255 million, driven by a $968 million increase in average earning assets, which outweighed reduced loan yields and higher rates on deposits. From the corresponding period last year, net interest income was up 13.6%. The provision for credit losses was $7 million for the quarter, an increase of $3.5 million from the prior quarter due to strong loan growth of $1.1 billion.

Non-interest income was down slightly, up $1.2 million from the first quarter to $14.2 million as warrant income and fair value gains on securities decreased $1.1 million and $1.3 million respectively. Non-interest expense was up a modest $1.3 million, as professional fees and deposit costs increased by $3.6 million and $1.9 million, partially offset by $2.8 million decrease in compensation costs. The increase in professional fees relates to consulting projects aimed at the implementation of CECL, as well as other technology initiatives that will allow us to continue to grow in future periods.

Share repurchases to date pull down the diluted share count to $103.5 million, resulting in diluted EPS of $1.19. Of the approved $250 million authorization, we've now used $107.5 million, with $142.5 million remaining. Coming now to our net interest drivers. During the quarter, despite a flattening yield curve, net interest income grew 12% annualized to $254 million. Investment yield decreased 13 basis points from the prior quarter to 3.34% due to a flattening yield curve and lower reinvestment rates, but overall yield remains up 10 basis points over the past year.

Loan yields rose 15 basis points over the past year to 5.98% in the most recent period. On a linked quarter basis, loan yields decreased 4 basis points due to lower yields on C&I and construction loans, supporting the decline in yields was our intentional shift toward residential loans, the de-risking of our construction portfolio as well as the decline in LIBOR.

We expect these -- this mix shift to continue. Interest bearing deposit cost increased by 12 basis points in the second quarter as a result of acquiring relatively more expensive term deposits prior to the downward shift in short-term rates. This increased funding costs by 4 basis points when all of the Company's funding sources are considered, including non-interest bearing deposits and borrowings. We think this will be temporary since during Q3, we anticipate approximately $980 million of higher cost short duration CDs will roll off or reprice at current lower market rates. Improving deposit funding.

As stated, net interest income rose $7.3 million during the quarter or 12% annualized -- it's our strategic shift in our loan mix away from construction and the reduction in market rates weighed on the margin, but was more than offset with improved revenue from our strong balance sheet growth. Given no change in the economic outlook, this will be the theme of our ongoing performance. Volume growth will outweigh a declining net interest margin for the remainder of the year. 41% of our loan book is tied to LIBOR, 20% is tied to prime and another 12% are fixed rate term loans that mature and therefore will reprice within the next 12 months. As market sentiment shifted from a rising to a falling rate environment, one month LIBOR declined 11 basis points and three month LIBOR fell 29 basis points during the quarter, reducing our margin by 6 basis points.

As you saw in the second quarter, our net interest income increased at a 12% annualized rate despite a reduced net interest margin. Based on our earning asset growth at quarter end that was not reflected in the second quarter average balances, we already have a 4% linked quarter unannualized balance sheet growth baked into the third quarter. With market-driven rates anticipating a July Fed rate reduction, deposit pricing has lagged the loan repricing, which began in earnest mid-quarter as LIBOR fell and the yield curve inverted.

Net interest margin decreased 12 basis points to 4.59% during the quarter as the earning asset yields decreased 9 basis points coupled with a 4 basis point increase in funding costs. We anticipate reductions in deposit costs to be rapid in a declining rate environment as we expect to promptly adjust rates in response to Fed actions and that deposit betas will accelerate in the near term assuming that Fed cuts rates in July, September, December and next June, as we have modeled. We have over $4 billion in money market and NOW accounts that have received exception pricing that could see rate reductions.

Regarding loan acquisitions, accretion on acquired loans increased from $2.8 million in the first quarter to $4.6 million in the second. Our remaining acquired loans were $869 million and the remaining marks at quarter end are 15.7 [Phonetic]. Going forward, accretion will fall to $1.3 million each quarter for the remainder of 2019, if all discounted acquired loans paid just their contractual principal commitments as the acquired loan portfolio is replaced with organic growth.

With regards to our asset sensitivity, while the convention is to immediately shock interest rates, we believe a more revelistic scenario include either a 12 month ramp down scenario with four quarterly 25 basis point reductions, which would reduce net interest income by 2.4% or a steepening scenario where short end rates declined 100 basis points and the long end remains flat reducing net interest income by 2%. Additionally, these sensitivities assume our static to -- second quarter position as of June 30th.

However, as Ken mentioned, management has already begun advancing strategic actions to diversify our mix shift to residential loans and further mitigate margin volatility. Turning now to operating efficiency. On a linked quarter basis, the ratio was down -- improved 40 basis points to 42% as revenue growth outpaced expense growth. From the second quarter of 2018, the ratio decreased 10 basis points. On a taxable equivalent basis, operating revenue increased $29.4 million to $273 million in the second quarter of '19 compared to a year ago. Over the same term, operating expense increased $12.4 million to $115 million and generated positive operating leverage of 2.4 times.

Our provision -- our pre-provision net revenue ROA of 2.54% and RO [Phonetic] -- and return on assets of 2.05%, these metrics continue to be in the top decile compared to the peer group. Our strong balance sheet momentum continued during the quarter, as loans increased $1.1 billion to $19.3 billion and deposit growth of $1.2 billion brought our deposit balance to $21.4 billion a quarter end. Our loan to deposit ratio increased in the current quarter to 89.8% from 89.2% a year ago. Our strong liquidity position continues to provide us a balance sheet flexibility to pursue attractive risk adjusted lending opportunities. Notably, our ending balance at June 30th was $836 million greater than the average balance for the second quarter, and ending deposits were $1.1 billion greater than the average balance for the second quarter, which when taken together is equivalent to an incremental quarter of loan and deposit growth over what we had on average balance in -- at for the second quarter.

Tangible book value per share increased to $1.45 over the prior quarter and 47 [Phonetic] or 24.6% over the prior year. Despite having repurchased 2.5% of our outstanding shares over the past three quarters. Our industry-leading finance performance is a direct result of the powerful combination of commercial banking relationships within our regional footprint and our national business lines across the country.

Our loan growth of $1.1 billion was driven by increases in C&I loans of $730 million, non-owner occupied commercial real estate of $382 million and residential loans of $119 million. Construction loans declined by $73 million and made up 11.5% of our total loans in the second quarter versus 12.6% when compared to the first quarter. This intentional decrease advances our strategy of reducing construction loans to 10% of the total loans by the end of next year. $500 million of the $1.1 billion of quarterly growth was in sectors that have had cumulative losses of only $400,000 since 2010, including public finance, mortgage warehouse, non-profit, resort lending, equity fund resources, and homeowners associations.

Turning to deposit growth and further demonstrating the strength of our deposit franchise, deposits grew $1.2 billion, mainly driven by an increase in non-interest bearing DDA of nearly $1 billion. Over the past year, deposits grew across all types with the largest increase in savings in money market of $1.4 billion and non-interest bearing DDA of $729 million. Over the past two quarters, loans were up $1.5 billion and deposits were up $2.3 billion. Over the past year of loan growth of $3.1 billion was fully funded by deposit growth of $3.4 billion. We believe our ability to profitably grow deposits is both a key differentiator and a core value driver to our platforms' long term growth.

Total adversely graded assets increased $41 million during the quarter to $399 million,as special mention credits increased $64 million. The increase in special mention credits for the quarter was primarily driven by three credits that have had modest changes in their credit profile but are well secured with no elevated risk of loss. We do not see this increase as indicative of a trend or area of concern. From the prior year, total adversely graded assets have increased just $31 million versus a $3 billion increase in loans.

Adversely graded assets increased as a result of an increase in special mention credits, partially offset by a decrease in classified accruing loans to non-performing loans and other real estate. Non-performing assets comprised of loans on non-accrual and repossessed real estate increased to $70 million or 0.27% to total assets compared to 0.26% in the prior quarter and have decreased from 0.29% in the prior year. Total adversely graded assets declined to 1.64% in total assets from 1.83% a year ago.

Gross credit losses of $2.6 million during the quarter were partially offset by $1 million in recoveries, resulting in net credit losses of $1.6 million or 3 basis points of total loans annualized. The credit loss provision of $7 million doubled from the prior quarter supporting our strong loan growth, provisioning related to our loan growth was also increased the allowance for loan and lease losses to $160.4 million, up $13 million from a year ago. This reserve was 87 basis points of non-acquired loans at June 30, as acquired loans are booked at a discount to the unpaid principal balance and hence have no reserve at acquisition.

For acquired loans, credit discounts totaled $10.6 million at quarter end, which were 1.22% of the $869 million purchase loan portfolio which is primarily from the Bridge Bank and Hotel Franchise Finance transactions. Relative to our peer group, our special mention loans, classified loans, non-performing assets and net charge offs are all lower for us yet our allowance is higher than that of the peers, confirming the conservative nature of our reserve methodology.

Finally, we continue to generate significant capital and maintain strong regulatory capital ratios with tangible common equity to total assets of 10.2%, which is 130 basis points higher than the peers and common equity Tier 1 of 10.6%. Tangible book value per share growth rose $1.45 in the quarter to $24.65 and is up 24.6% in the past year. Notably, our production of tangible book value has been more than 3 times that of the peer group over the past five years. Given capital requirements the banks operate under, we believe that consistent capital accretion is fundamental to value creation.

This concludes my review and I'll turn the call back to Ken.

Kenneth A. Vecchione -- Chief Executive Officer

Thanks, Dale. As you are aware in June, we announced that the Board of Directors authorized the initiation of regular quarterly dividends beginning in the third quarter of 2019 of $0.25 per share. Given the continued success of our strategic approach to our business, the Company consistently creates more capital than needed to support our strong growth and is building a sound financial capital base, which allows us to remain flexible and nimble, coupled with our opportunistic share repurchase program we endeavor to provide superior total shareholder return compared to peers without curtailing growth capital and will reward investors with recurring cash flow for stock ownership.

Just want to like add a few words on the outlook. The strength of our product lines and geographic diversity, combined with an experience in credit oriented management team, generates above trend loan volume in a prudent, predictable manner. Our diversified model, which is the centerpiece of our ability to prudently manage credit risk and allocate capital while maintaining a growth trajectory is found in other -- is not found at other similarly sized institutions. This business approach delivers a level of sophistication that offers unique value enhancing business expansion opportunities. Our record of growth has capitalized on our competitive advantages to drive industry-leading growth.

We believe our business model helps diversify risk and protects against undue risk taking. Within our market today, we have observed little change in business activity as our loan and deposit pipelines remain strong. We expect loan and deposit growth to continue a pace at the same level as our prior guidance of $600 million in loan growth per quarter fully funded by core deposit growth. We do not expect any give back from our strong performance year to date as none of our growth was pulled forward from future periods.

We will continue to execute our plan of improving our risk profile by decreasing our allocation to construction loans, which we expect will comprise 10% of the portfolio by end of next year. This de-risking process will be complemented by continuing to shift our loan mix into relatively low LTV residential real estate first mortgages as we will strive to more than double the proportion of our loans in this sector from 8% to 16%. As we enter a lower rate environment, we expect our deposit funding mix to remain fairly stable. We expect net interest income to continue to rise throughout the year as volume increases from residential purchases, higher earning assets and our strong loan pipeline will outpace de-risking activities, repositioning of our asset sensitivity and projected Fed rate actions.

In quarters where target Fed fund rates are stable, our margin should be fairly stable and lead to net interest income growth tracking our growth and earning assets. Further, we expect our efficiency ratio to increase modestly as we continue to invest in new business initiatives and value enhancing technology solutions. Our commitment to top level efficiency is advanced by our strategy of providing select business lines that have few -- advanced by our strategy of providing select business lines that have fewer competitors, lower losses and high operating leverage delivered through a branch lite business model. Despite economic uncertainty, particularly related to trade and the slope of the yield curve, we have not seen this effect, the behavior of our borrowers in terms of loan demand or potential credit stress. Given the mature stage of the economic cycle, we continue to emphasize underwriting discipline and the majority of our loan growth we have this quarter was in areas with little or no historical credit losses.

So to summarize, we grew loans while reducing our risk, had exceptional deposit growth while improving our mix, grew net interest income 12% annualized despite a 3% or 12 basis point decline in net interest margin, maintain stable asset quality at historically low levels continue to opportunistically repurchase shares and announce an initiation of quarterly dividends, grew year-over-year net income by 17%, EPS by 20% and position the Company to carry forward its momentum through the second half of the year. This should enable us to have ongoing EPS growth even in a declining rate scenario, and we remain comfortable with street consensus estimates for the remainder of this year and next.

At this time, Robert, Dale and I will be happy to answer your questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Casey Haire with Jefferies. Please go ahead.

Casey Haire -- Jefferies -- Analyst

Yeah,thanks good morning, guys.

Kenneth A. Vecchione -- Chief Executive Officer

Good morning.

Casey Haire -- Jefferies -- Analyst

I wanted to touch I guess on the loan growth mix going forward and sort of the NIM outlook. You know, obviously, commercial was a very big contributor this quarter and resi was not. But it sounds like that will change going forward. How so -- and I'm assuming that's some -- a lower yield product versus your 590 [Phonetic] book. So how does NIM stay stable if that's going to be driving the bus on loan growth going forward?

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Yeah, so we're really focused on -- on net interest income and as we talked about, as I mentioned just a minute ago, we've got 4% growth in the third quarter already in terms of average balances just holding the June 30th balances relative to what our average was in the second quarter. Plus, we expect to grow again, $600 million per quarter in loans and deposits in the third quarter. When -- we were talking about when rates were rising, our NIM would rise approximately 5 basis points, per 25 basis points to the Federal Reserve action. Although we have -- been moving into residential, we put on $1 billion in the past year, that relationship still holds. So I would expect about a 5 basis point margin decline when the Fed cuts rates 25 basis points. I expect the margin to fall more than that though, because, you know, if you look at our ending balance because of the strong deposit growth, we had particularly at quarter end, which is still with us, by the way, those dollars are really sitting in the Federal Reserve account.

So we have -- it's a good problem to have, but we have. We're sitting on a lot of cash, yielding only 2.35%. Yet -- well, that's dilutive to the margin, it's accretive to net interest income and earnings per share. So yes -- so we're going to be having a declining margin, but our margin declined very similar to the second quarter, we expect to be able to earn through to have growing EPS.

Casey Haire -- Jefferies -- Analyst

Okay, I understood. And the operating leverage dynamics and the language has changed a little bit there. Is that -- I mean, it sounds like you guys are baking in a bunch of cuts. Dale, I think you said four cuts. So is that -- so the -- the top decile of the peer group, you guys are way above that at 2.5 times revenue to expenses. Are you coming off of that 2.5 times revenue expenses just because of the Fed cuts or, just trying to get understanding of what seems to be a change in that language?

Kenneth A. Vecchione -- Chief Executive Officer

Yeah, the Fed cuts definitely have an impact. But what we're gonna be continue to be focused. Operating leverage is the way we make our money here, it's one of the ways and we feel that we can continue to invest in technologies to bring on new customers and also continue to have a very strong positive operating leverage. But that 2.5 times, which is what we used to do with the rates scenario four cuts, is going to be more difficult.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Yeah. We're not going to be able to sustain the 2.5 to 1 [Phonetic]. But with that, and with strong expense control, we can still move our operating leverage, it'll still be in the top decile. It may increase from the 42% it's at today, but we're comfortable with that we can sustain again this pre-tax income growth, efficiency and ongoing EPS growth.

Casey Haire -- Jefferies -- Analyst

Understood. Thank you.

Operator

Our next question comes from Michael Young with SunTrust. Please go ahead.

Michael Young -- SunTrust -- Analyst

Hey, good morning.

Kenneth A. Vecchione -- Chief Executive Officer

Good morning.

Michael Young -- SunTrust -- Analyst

I appreciate all the color that you provided in the guidance and the outlook. But I was wanting to just dig into the loan growth a little more this quarter, obviously with a strong C&I growth. Can you give a little more color on, was a lot of that pickup in utilization from clients or any sentiment change that you're seeing? And also, if you could just tell us how much was mortgage warehouse related?

Kenneth A. Vecchione -- Chief Executive Officer

Yeah, our loan growth was spread through our regions and through our product lines. So to answer your specific question, warehouse grew $224 million. But we also saw a lot of growth for example, in our equity fund resources group, that would be capital call and subscription lines that went up nearly $70 million, tech and finance, which previous to this quarter had a lot of commitments signed, but no loans outstanding grew this quarter by $144 million. Our muni and non-profit book grew about $60-ish million, so it was spread throughout the product lines and also through the regions.

Michael Young -- SunTrust -- Analyst

Okay, were there any loan purchases during the quarter?

Kenneth A. Vecchione -- Chief Executive Officer

Yeah, there were, and that totaled $140 million.

Michael Young -- SunTrust -- Analyst

Okay, and then maybe just switching to capital, as you move forward, you've got the dividend coming in place in the third quarter, obviously, very strong loan growth this quarter and it looks like that's going to continue for some time. Are you kind of looking to back off of the share repurchase authorization for a time or do you still feel like you can move forward with that?

Robert G. Sarver -- Executive Chairman

Yeah, it's Robert. No, I don't think not necessarily, we'll continue to be opportunistic in terms of share buybacks. You know, we evaluate it every month and we still have some excess capital that we're growing even given the dividend.

Michael Young -- SunTrust -- Analyst

Okay, so it's more a function of stock price than growth at this point?

Robert G. Sarver -- Executive Chairman

Correct.

Michael Young -- SunTrust -- Analyst

Okay, thank you.

Robert G. Sarver -- Executive Chairman

Thank you.

Operator

The next question today comes from Timur Braziler with Wells Fargo. Please go ahead.

Timur Braziler -- Wells Fargo -- Analyst

Hi, good morning, impressive quarter.

Kenneth A. Vecchione -- Chief Executive Officer

Thank you.

Timur Braziler -- Wells Fargo -- Analyst

Maybe just looking -- looking at the Arizona deposit growth this quarter, quite impressive. Anything specific that drove that? And I guess, what's the outlook, if there's any kind of promotions or anything else going on that helps fuel that growth?

Kenneth A. Vecchione -- Chief Executive Officer

Yeah, I mean, a lot of the growth came from title companies, we're not doing strong promotions. I would say the entire Company since the beginning of the year has been very focused on the deposit growth and particularly focused on non-interest bearing deposit growth. So nothing different there. You know, what you can see from time to time in the regions contrasted to each other is depending on which customer, which new customer comes in. What customer has a big project they need to pull cash out of, it's kind of hard to kind of predict what's going to happen by region. But all the regions are focused on growing their deposits.

Timur Braziler -- Wells Fargo -- Analyst

Okay, that's helpful. And then maybe switching to margin, given the strong DDA inflow in Q2 coupled with nearly $1 billion of CDs, either rolling off or repricing. Can we see funding costs actually get lower in the third quarter on a quarter-to-quarter basis and if that's the case is the margin compression kind of ex-any Fed cuts solely going to be driven by the asset side, or is there some other dynamic that I'm missing that could see some lag and additional funding costs as well?

Kenneth A. Vecchione -- Chief Executive Officer

So, yeah, no, I think we can see the funding costs come down a bit. I mean, with regard to the margin, as I mentioned today -- so we had $1.1 billion in cash at June 30th in large measure related to the significant increase we had in deposits in the second quarter. That -- those funds are predominately still with us today. So we had cash of more than double really what we need and while we want to deploy that into loans, that is basically sitting at the Federal Reserve, yielding 2.35%. So that decreases our net interest margin, even though it helps us with net interest income. So I do think there's pressure on the margin without regard to necessarily just kind of what our funding costs are, although I do think our funding costs are going to be declining in the third quarter.

Timur Braziler -- Wells Fargo -- Analyst

Okay, that's helpful. And then just on the time deposits that are either repricing or rolling off, do you have a gauge as to what's actually going off balance sheet and what you expect to keep on at lower rates?

Kenneth A. Vecchione -- Chief Executive Officer

I don't, we don't have a gauge of that at this time, but we're negotiating with these depositors, frankly, from a position of strength. We've had such strong funding growth that we've already told hundreds of millions of these depositors and saying, look, the Fed is going to move on July 31 and just so you know, we're going to move -- what we're paying you in lockstep was whatever the Fed does, it's going to be a 100% beta on a lot of those deposits. And they say, yeah, we get that. And so far, I think we've got about 100% that we expect to retain on those. But we're going to lose some. And -- and we've got the strength and the funding resources and network and levers we can pull that we can deal with that.

Operator

The next question today comes from Brad Milsaps with Sandler O'Neill. Please go ahead.

Brad Milsaps -- Sandler O'Neill -- Analyst

Hey, good morning, guys.

Kenneth A. Vecchione -- Chief Executive Officer

Good morning.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Good morning.

Brad Milsaps -- Sandler O'Neill -- Analyst

Dale, just a -- you just addressed this to some extent, but it does sound like you have a lot of confidence in being able to pass along Fed rate cuts to depositors. Do you think, you know, sort of as you look at your deposit cost today of around at least the interest bearing of around 135 basis points, do you think you can get those back to where they were in the first or second quarter of 2018? You know, assuming we do get the four cuts that you guys are looking for or do you think there's going be more lag than that?

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Yeah, I think we have a lot of control and a lot of strength in order to be able to not have a lag. And -- and so, I expect that in general, you're going to see kind of a mirror image of betas as they rose kind of coming in, let's say we get four cuts here, that we're going to see those betas be fairly sharp in the beginning and then as we get to lower rates, I think they're going to become a bit more muted. So but out of the gate, I think our betas are going to be fairly high.

Brad Milsaps -- Sandler O'Neill -- Analyst

Okay. And then just a follow up for Ken, with the $1 billion of DDA growth this quarter, how much of that would you say was maybe driven by, you know, some of the deposit initiatives you've talked about over the last year versus just, you know, maybe hard to delineate between the two just from your regular business? Just curious if there's still a lot on the comp from some of those initiatives you've been talking about.

Kenneth A. Vecchione -- Chief Executive Officer

There is a lot on the comp. So what we define as the deposit initiative Number 1, grew $60 million this quarter and deposit initiative two, which is not even up and running yet, grew $26 million. And I want to say about both of these initiatives, we are pacing ourselves on this. We're not rushing. We want to make sure the customer service aspect and be able to deliver what we say, we're going to deliver is very important to us. And so with the other parts of the business really kicking tail here, we are pacing ourselves not to push out and get ahead of our skis, but we are pleased that deposit initiative 1 brought in $60 million.

And by the way, deposit Initiative two really doesn't go live until into Q4. So we're a little ahead of ourselves, but we're able to bring in some dollars this quarter.

Brad Milsaps -- Sandler O'Neill -- Analyst

That's great. Thanks for the call. Great quarter.

Operator

The next question comes from Chris McGratty with KBW. Please go ahead.

Chris McGratty -- KBW -- Analyst

Great, thanks. Dale, maybe a question on the balance sheet. The $600 million loan growth, appreciating the remix that's going on between construction and resi, how should we be thinking about the proportion that comes from resi over the next call it six quarters. Is it 50%? Is it more than that? Any help would be great.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

I think it's going to be 40% and it could be even a little bit higher. I mean, frankly, the second quarter we thought was going to come in a little stronger than it did. We had about double the $130 million we had it in net growth in origination behavior. But as others experienced, when rates fell sharply, the refi business really picked up and that pulled that in. And I think that refi business while still strong, isn't quite as hot as it was then. And so -- so we think the -- that proportion is going to be climbing here.

Kenneth A. Vecchione -- Chief Executive Officer

Let me just add a little something. I've been on the road a little bit visiting our partners here. We hope on a gross basis to kind of drive about $200 million to what we call the flow side of the business. We'll lose some of the existing book because rates are dropping and then we'll also be opportunistic in terms of buying portfolios. So that's sort of the way to think about it at the moment. And that's against the $600 million overall loan growth target that we have.

Chris McGratty -- KBW -- Analyst

Got it. Thanks for that. The $1 billion -- follow-up on the non-interest bearing deposits, the $1 billion. Can you speak to the granularity of that deposit setting, I think a couple of quarters ago, you pushed a couple out. So Number 1, speaking of the granularity and Number 2, kind of early trends in the third quarter whether you've retained those or any those were seasonal? Thanks.

Kenneth A. Vecchione -- Chief Executive Officer

All right, back to the quarter you're referencing, which is Q4. We let one customer go for credit reasons, not pushing out for deposits. That's one. Number 2, some of the investments that we made in technology really showed up this quarter in our warehouse lending group, where our warehouse lending deposits rose $550 million and almost a 100% of that found its way into DDA. So we did pick up one or two major customers, one in warehouse lending and then one or two in the regions.

So I think that's what helped drive some of the growth. And -- and looks like we're holding onto everything, that's what I would say for -- for Q3.

Chris McGratty -- KBW -- Analyst

Okay, so the flat balances that you had talked about in the past, probably upside to that number, OK. Maybe last one, Dale, on the tax rate. How should we think about it? It was a little late this quarter?

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Yeah, we had some -- some kind of modest, non-recurring gains I would say in the 18% is where we guided at the end of the first quarter and I would continue that going forward.

Chris McGratty -- KBW -- Analyst

Great. Thank you.

Operator

The next question comes from Jon Arfstrom with RBC. Please go ahead.

Jon Arfstrom -- RBC -- Analyst

Thanks. Good morning, guys.

Kenneth A. Vecchione -- Chief Executive Officer

Good morning.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Good morning.

Jon Arfstrom -- RBC -- Analyst

A question on construction and development. I think we all understand the mix change that you're going through. But anything new to report, positive or negative in terms of trends that you're seeing in the health of the book.

Kenneth A. Vecchione -- Chief Executive Officer

So we're going through a change here. We just went through a change of Chief Credit Officer. So our outgoing Chief Credit Officer, has now become the Chair of our Senior Loan Committee, and he has less day to day responsibility, but more responsibility to go out, visit customers and ensure that he feels comfortable with the credit that's coming in, especially part of the launch credits. Our new Chief Credit Officer, the first thing I asked him to do, new -- when I say new, new to the role, but had been in -- has been in the Company for over three years. I asked him to tear apart the construction land and development book and give me his own independent viewpoint on that. And as late as this morning, he still feels very comfortable with the book. And so what you see in us driving down the percentage by taking down the numerator and also growing the denominator is really just to make I think investors feel more comfortable that we don't have any outsized risk sitting on our balance sheet. But he went through it and he feels very comfortable where we are today.

Jon Arfstrom -- RBC -- Analyst

Okay. I would guess, you're seeing some terrific opportunities in Phoenix and Vegas, in new relationships, potentially. I mean, I think, we understand the reason, the concentration issues, but my guess is there has to be a lot of activity that you can pick from?

Kenneth A. Vecchione -- Chief Executive Officer

Well, remember too now, as we are bringing down the percentage, one of the ways to do that is we're increasing the price. So we're going to be far more selective in who we bring in as we bring down the overall level of representation to total loans.

Jon Arfstrom -- RBC -- Analyst

Okay. Good.

Kenneth A. Vecchione -- Chief Executive Officer

But yeah, I will say, Nevada is very busy, Vegas is very busy, Reno is busy, Phoenix is very busy in terms of building, absolutely.

Jon Arfstrom -- RBC -- Analyst

Okay.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

But the busier it gets -- the busier it gets, the more you have to focus on your credit underwriting. And so that's how we kind of monitor the flow, as Ken said, based on price, but also based on equity and debt coverage ratios. So in a stronger environment, you're going to want to have more cushion in debt coverage and you're -- want to require more equity.

Jon Arfstrom -- RBC -- Analyst

That makes sense. That kind of dovetails in the next question. I think it's more philosophical, but four rate cuts, it's pretty aggressive relative to what your peers are saying. But just curious if that comes true, does it change the way you think about risk or growth potential for your Company? Because on one hand, you're saying, your economy is rock solid. But if we do get four rate cuts, it seems like you're going to have quite a bit of growth. And I'm just curious if you feel blending gets riskier and non-bank competitors come back in and all the stuff we've dealt with before.

Kenneth A. Vecchione -- Chief Executive Officer

So we actually believe there's going be just two rate cuts, but we're setting the Company up to be prepared for four rate cuts. And that way as everyone looks forward, they have to think through what their operating expenses are going to be, how we're going to grow, that's one. Number 2 since 18 to 24 months ago, we've been lending as if we are in the very last inning of this expansion. So if we have a couple more rate cuts, I don't think we're going to actually change our philosophy in granting credit because we've been tightening up and we've been concerned -- sorry, we've been always worried that we're, that the expansion may stop. So we've been very conservative in how we are pushing dollars out the door.

Third, as it relates to earnings and what we plan to do, if we have four rate cuts, we may just very well have a somewhat slower loan growth, but we'll still have EPS rise year-over-year.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

So, Jon, if I'm like you and I'm sitting there, I am saying to myself. Okay, you guys are defensive and you're concerned about credit quality, you focus on risk. But how do you keep growing every quarter and how do you kind of put those two together? And what I would say is just from a high level perspective, let's talk about credit. I've had a chance to meet, with a lot of other banks out there in the market, our size, a little smaller, a little bigger. And at the end of the day, on the credit side, we just have a much more robust and sophisticated model than most of the banks our size. It's based on a broader loan product array, more geographic options, and a more sophisticated credit allocation model.

And so what all that translates to is it allows us to have stronger growth than our peers and also at the same time be generating better risk adjusted yields than our peers. We just have a lot more buckets and those more buckets, along with our credit allocation model, allows us to be much more forward thinking and be able to modify and adjust to different markets based on product and geography. And that's how we get better growth without taking on more risk. The deposit side is a little bit different, the deposit side, the Company also has a lot more deposit products and I don't mean like a checking account product or a loan product. What I mean is a product that specifically fits a niche of customers.

So on the deposit side, while we were able to continually grow faster than peers with quality core deposits is, we are in a lot of different markets that are -- require products too sophisticated for community banks. But the deposit market isn't big enough for big banks to really focus on. We're able to bring in a lot of business from that standpoint, and so at the end of the day, what I think a lot of people lose sight of is we're not just a large $25 billion community bank. You know, a lot of banks our size have gotten where they've gotten by doing the same thing over the last 20, 30, 40 years. They've just gotten bigger. We're not so much -- we're bigger, but we're actually different. And the difference in our model is what allows us to, keep putting out these growth results that are superior to peers, but at the same time, manage our risk.

Jon Arfstrom -- RBC -- Analyst

Okay. That all makes sense. Thanks.

Operator

The next question comes from Gary Tenner with DA Davidson. Please go ahead.

Gary Tenner -- DA Davidson -- Analyst

Hi, good morning. It's Gary Tenner.

Kenneth A. Vecchione -- Chief Executive Officer

Hi, Gary.

Gary Tenner -- DA Davidson -- Analyst

Hi. Just couple of follow ups, in terms of the deposit growth, noticed a big chunk came from tech and innovation space. Was that -- is that to be thought of as some money on deposit from capital raise rounds or is it venture capital related deposits. What's the genesis of that?

Kenneth A. Vecchione -- Chief Executive Officer

Actually, it's both. Northern California has been seeing a great deal of capital raising and that has generated from the technology and finance side about $449 million of incremental deposits for us. But also as we move a little bit deeper into equity funding, which is the capital call and subscription lines, for example, this quarter, our deposits equaled almost dollar for dollar, what we put out in loans. So we're generating from that perspective, which is to say, those are existing customers that have cash that we're able to bring onto our balance sheet.

Gary Tenner -- DA Davidson -- Analyst

Okay, so it's both the VC fundraising and having their balances as well as the -- the portfolio company balances

Kenneth A. Vecchione -- Chief Executive Officer

Yeah, correct. Yeah.

Gary Tenner -- DA Davidson -- Analyst

Great. Sorry. And then just in terms of just the buyback, the rest of my questions have been answered. I know, you kind of talk about being opportunistic. The last couple of quarters, you've been buying anywhere from the high 30s to low 40s, now we're back in the high 40s. So how should we think about your relative appetite at this level versus $42?

Dale Gibbons -- Vice Chairman and Chief Financial Officer

I think we again, look at the market and on dips, I think, you know, you could see us buy some stock, but I'm not going to tell you exactly what price we buy it or not.

Gary Tenner -- DA Davidson -- Analyst

All right, fair enough. Thank you.

Operator

The next question comes from Brock Vandervliet with UBS. Please go ahead.

Brock Vandervliet -- UBS -- Analyst

Hi, good morning,

Kenneth A. Vecchione -- Chief Executive Officer

Good morning, Brock.

Brock Vandervliet -- UBS -- Analyst

On the -- on those warehouse deposits, how on the mortgage warehouse deposits, how seasonal are those? Are those pretty sticky or do those kind of ebb and flow with -- with the mortgage activity behind it.

Kenneth A. Vecchione -- Chief Executive Officer

So they're a little more seasonal on Q4, they do have an ebb and flow. They actually build up during the course of a quarter and then they dip as the payments are made and then they begin to build up again. So you've got that ebb and flow just naturally inherent in that business.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

But there is -- tax payments are due usually in November, and that did contribute to our seasonality that we had in the fourth quarter of last year.

Brock Vandervliet -- UBS -- Analyst

Got it. And on the rate sensitivity, the shock analysis that you show that down 6.6% or so, that hasn't changed much from the Q1 shock that you showed in the Q, is -- as you look at the prospect of four cuts. Do you feel like you are positioned, the way you want to be or are there other levers that you would pull beyond just adding more resi mortgages as we go forward?

Kenneth A. Vecchione -- Chief Executive Officer

Well, we've looked at other elements, like swaps and whatever else, I think swaps can be fairly efficient. But, with the pricing they are at today, we can't get there from here. But -- but we would consider doing something synthetic like that. We have other loan -- other categories as well. So we've been extending some securities -- some securities durations, we've got some public finance types of things that we're doing that are longer term fixed rate. The residential piece is just happens to be the largest.

No, I mean, yeah, we've been -- we've been doing this. And yet over the -- not just the last quarter, as you know, over the past year, you know, our shock scenarios really haven't moved much. I believe that that will change and we're going to start making bigger dents there as we do more in terms of the residential piece and as we pull down construction, which is a 100% basically tied to either LIBOR or prime. So I think, we're going to be pulling down some things that are highly sensitive, moving into things that are less sensitive.

And I think, you're going to see that number move a bit. But you're right, I mean, that's why my guidance was a year ago, it was like, hey, we're going to expand our margin 5 basis points for 25 basis point. And it's still that same ratio. We're going to drop 5 basis point for 25 basis point on the way down.

Brock Vandervliet -- UBS -- Analyst

Got it. OK, appreciate it.

Operator

The next question comes from David Chiaverini with Wedbush Securities. Please go ahead.

David Chiaverini -- Wedbush Securities -- Analyst

Hey, thanks. Couple of questions for you. So starting with the efficiency ratio, you mentioned how it could, increase modestly from the 42%. Can you provide a sense of magnitude of how much it could increase?

Dale Gibbons -- Vice Chairman and Chief Financial Officer

You know, it will drift up modestly as we go through the year, and that will be somewhat dependent on how many rate cuts come at us. It also helps again one of the advantages that we have here that helps the efficiency ratio is that we've basically got another quarter of loan growth in this quarter and that gave us such a high average balance. So that should generate more revenues, which should help our efficiency ratio.

David Chiaverini -- Wedbush Securities -- Analyst

Okay. And related to that, you mentioned how you're investing in technologies and you gave the example of the benefits seen in the warehouse lending group. Can you provide other examples of where you're investing in technology?

Kenneth A. Vecchione -- Chief Executive Officer

Well, those two deposit initiatives are all generated by technology in the back office to provide the appropriate customer service. So those are two places. I would tell you that there's the things that aren't sexy in this Company, CECL, making sure we have the right BSA system. So what I would say the guts of what makes a bank a bank, we continue to invest in. Fortunately, we're not a consumer bank. So we don't have to go against the big money center banks. But we do have to continue to invest to make sure our infrastructure can not only support where we are today, but we're trying to build it out for where we're going.

Dale Gibbons -- Vice Chairman and Chief Financial Officer

There's ongoing enhancements required to be. Just to be consistent and to be competitive on treasury management services. Those are -- those are getting better all the time. More mobile app applications, more functionality.

David Chiaverini -- Wedbush Securities -- Analyst

Great. And then shifting gears to credit quality, with the increase in special mention loans, you mentioned how there's no trend developing. But I was curious, you know, if you're able to disclose what areas or loan categories those were in?

Kenneth A. Vecchione -- Chief Executive Officer

So let me just take you through maybe three or four of them real quick and you can get a sense. We have a property that's being built, a spec home in California. The property is completed, the construction ran a little longer. The builder funded all the costs out of pocket. It sits there at a 44% LTV. I've walked the property, it's beautiful. And quite frankly, we put it in there because the builder went longer than projected, but no risk of loss and we're in good shape. We have a assisted living memory care facility in Arizona. Well again, the LTV there is 66%, they were lagging behind in terms of their residency. They switched managers, we don't see there is any problem there. And the borrow has put up money to not only cover the next six months of interest, but also any operating deficit.

We have a hotel with one of our really good sponsors that saw a little more supply in the area than they expected, their RevPAR was a little below, but we're sitting there with an LTV of 58% and that sponsor has put the hotel up for sale and they have enough cash on their balance sheet to carry it for another 17 months. And then we had a few smaller deals, which were all in tech and innovation, where we're just waiting for the infusion of equity capital to come in, but the remaining months of liquidity are now drop below six. So when something drops below six, it's our standard practice to put that on special mention.

So Dale kind of quoted in his prepared remarks, there's nothing that's across the Company that's giving us concern, but we watch all those things. And when it goes on special mention, it gets more attention, actually gets attention even before it gets there. But these are the things that we've put on special mention this quarter.

David Chiaverini -- Wedbush Securities -- Analyst

That's good color. Thanks very much.

Operator

The next question comes from Aaron Saganovich [Phonetic] with Citi. Please go ahead.

Aaron Saganovich -- Citi -- Analyst

Thanks. I was just curious if you could talk about the deposit growth. How much came from new customers versus existing?

Dale Gibbons -- Vice Chairman and Chief Financial Officer

It was about 40% from new customers with the largest customer, just coincidentally, as Ken was alluding to, was approximately the same size as the one that we walked away from in the fourth quarter.

Aaron Saganovich -- Citi -- Analyst

Okay. All right. Thank you.

Operator

This concludes our question-and-answer session, I would like to turn the --

Kenneth A. Vecchione -- Chief Executive Officer

Operator?

Operator

Yes.

Kenneth A. Vecchione -- Chief Executive Officer

Thank you. I was going to say, just turn it over to me. Just before we go, one question that wasn't asked that hugely is asked is what does the M&A landscape look like? So let me throw that out to Robert and have him give a few comments on it.

Robert G. Sarver -- Executive Chairman

Yeah, sure. I mean, we have always preferred organic growth to acquired growth. And as we said before, any deal we would do would have to be both financially and strategically accretive. But at this point, looking out at the landscape, and looking where we're at, we're really more focused internally. We think our organic growth, our operating leverage and share buybacks provide enough levers for really strong EPS growth and tangible book value growth. And that's where our focus is today.

Kenneth A. Vecchione -- Chief Executive Officer

Thank you all for attending the call. And we look forward to talking to you about our Q3 results. Have a great day, everyone.

Operator

[Operator Closing Remarks]

Duration: 61 minutes

Call participants:

Kenneth A. Vecchione -- Chief Executive Officer

Dale Gibbons -- Vice Chairman and Chief Financial Officer

Robert G. Sarver -- Executive Chairman

Casey Haire -- Jefferies -- Analyst

Michael Young -- SunTrust -- Analyst

Timur Braziler -- Wells Fargo -- Analyst

Brad Milsaps -- Sandler O'Neill -- Analyst

Chris McGratty -- KBW -- Analyst

Jon Arfstrom -- RBC -- Analyst

Gary Tenner -- DA Davidson -- Analyst

Brock Vandervliet -- UBS -- Analyst

David Chiaverini -- Wedbush Securities -- Analyst

Aaron Saganovich -- Citi -- Analyst

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