Independent Bank Group - Q1 2023

Transcript

Operator (participant)

Good morning, and welcome to the Independent Bank Group First Quarter 2023 Earnings Call. We appreciate you joining us. The related earnings press release and investor presentation can be accessed on our website at ir.ifinancial.com. I would like to remind you that remarks made today may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and expected results to differ. We intend such statements to be covered by safe harbor provisions for forward-looking statements. Please see page five of the text in the release or page two of the slide presentation for our safe harbor statement. All comments made during today's call are subject to that statement. Please note that if we give guidance about future results, that guidance is a statement of management's beliefs at the time the statement is made, and we assume no obligation to publicly update guidance.

In this call, we will discuss several financial measures considered to be non-GAAP under the SEC's rules. Reconciliations of these financial measures to the most directly comparable GAAP financial measures are included in our release. I'm joined this morning by our Chairman and Chief Executive Officer, David Brooks, our Vice Chairman, Dan Brooks, and our Chief Financial Officer, Paul Langdale. At the end of their remarks, David will open the call to questions. With that, I will turn it over to David.

David Brooks (Chairman and CEO)

Thank you, Ankita. Good morning, everyone, and thanks for joining the call today. For the first quarter, we reported a GAAP net loss of $37.5 million or $0.91 per diluted share, which includes the impact of the $100 million legal settlement expense that was previously disclosed on February 27th. This one-time payment settles litigation ongoing since 2009 involving Stanford International Bank and related entities that was inherited in connection with our 2014 acquisition of Bank of Houston. This settlement will resolve all current and potential future claims related to the Stanford entities, and we believe this settlement to be in our shareholders' best interest as it enables us to avoid the cost, risk, and distraction of protracted litigation.

Excluding this one-time legal expense, adjusted net income for the quarter was $44.1 million or $1.07 per diluted share. Our core operating business continues to maintain a healthy level of profitability despite the challenges presented by the volatile macroeconomic and interest rate environment. Our underlying business is buoyed by a strong balance sheet and a resilient asset quality with non-performing assets of just 32 basis points of total assets and net charge-offs of just 4 basis points annualized. We continue to maintain robust capital levels with an estimated total capital ratio of 11.85% and a TCE ratio of 7.31%. Sharper than anticipated funding cost pressures for the first quarter compressed our net interest margin by 32 basis points to 3.17, we remain encouraged by the continued repricing of our maturing loans in the mid-7s.

This repricing should be a consistent tailwind to our adjusted loan yields, which expanded by 32 basis points in the first quarter to 5.33%. While accumulating the benefit of higher loan yields will be more gradual, our pursuit of incremental expense discipline is far more immediate. Adjusted non-interest expense for the quarter was $84.9 million, down three and a half million dollars from the linked quarter due to the continued realization of benefits from our expense management initiatives. With that overview, I'll turn the call over to Paul to give more details on the financials.

Paul Langdale (CFO)

Thank you, David. Good morning, everyone. Starting with the balance sheet this morning, total assets increased by $540 million from the linked quarter to $18.8 billion, which was primarily driven by excess liquidity held on balance sheet funded by short-term FHLB advances. On balance sheet, cash increased to $1.05 billion at quarter-end. The company decided to strategically increase our liquidity position out of an abundance of caution and in response to the macroeconomic environment, which is consistent with our philosophy of conservatism in gearing the balance sheet. On the liability side, non-interest-bearing deposit balances decreased steadily throughout the quarter as depositors sought higher-yielding alternatives for their cash balances. Quarter-end non-interest-bearing balances were $4.15 billion, down from $4.74 billion at year-end 2022.

Average non-interest-bearing balances during the first quarter were $4.40 billion. Most of the non-interest-bearing deposit attrition occurred prior to the end of February as depositors sought higher rates. A portion of these deposits were moved off balance sheet to our wholly owned subsidiary, Private Capital Management. During the quarter, approximately $184 million of deposits flowed to Private Capital Management to be deployed in market-based liquidity management strategies. Overall AUM at Private Capital Management increased by $235 million, their largest quarter on record. Since these deposits remain in our ecosystem, we expect to have the opportunity to recapture some of these funds on balance sheet in the future. Slide 20 shows the deposit funding vertical trends.

Interest-bearing branch deposits were down 3% or $217 million for the linked quarter or for the quarter, which was mostly a result of seasonality and yield-seeking behavior early in the year. From February 28 through quarter end, interest-bearing branch deposits reversed this trend and increased. The increase of $197 million in brokered CDs was opportunistically executed in February when market rates fell below 5%. The weighted average rate for brokered CDs added in the first quarter was 4.73%. The onset of broader industry events in mid-March meaningfully impacted the pricing and availability of both brokered and non-brokered specialty liquidity. During this time, we opted to instead utilize less expensive short-term FHLB advances to supplement funding. This included the replacement of $556 million of non-brokered specialty treasury deposits.

Public funds balances increased by $101 million from year-end. As anticipated, the cost of brokered funds has dropped meaningfully following quarter end, and we have begun to strategically replace maturing FHLB advances with brokered funds as appropriate. Far in the second quarter, we have added $162 million brokered funds at an average rate of 4.9% in three, six, and nine-month tenors. Due to this, FHLB utilization has begun to decline during the second quarter. As noted on slide 19, adjusted uninsured deposits, which excludes fully collateralized public funds deposits, totaled $5.26 billion or 37.4% of deposits at March 31st, 2023. As of quarter end, we have $5.5 billion of immediate borrowing capacity between the FHLB, the Fed, and Fed funds lines, enough to cover all uninsured deposits.

We also maintain access to multiple contingent sources of deposit funding with more than $7 billion of additional capacity, which brings total contingent funding capacity to over $12 billion. Other borrowings increased by $70.5 million during the quarter as a result of the company drawing $100 million on our holding company line of credit to facilitate the repayment of the $30 million tranche of subordinated debt redeemed at quarter end that had moved to floating, as well as to facilitate the payment of the legal settlement expense discussed in David's remarks. Since quarter end, we have repaid $32.5 million on the holding company line of credit, and we expect to retire the remainder of this balance by the end of the third quarter.

Regulatory capital levels remain healthy and well in excess of well-capitalized minimums with a Common Equity Tier 1 ratio of 9.67%, a Tier 1 ratio of 10.03%, and a total capital ratio of 11.85% at quarter end. Additionally, the TCE ratio remains strong at 7.31%. Moving on to the income statement. Net interest income decreased by $13.9 million from the linked quarter and $3.2 million from the first quarter of 2022. NII was impacted by slower loan growth and increased funding costs during the quarter. While net growth was impacted by first quarter seasonality, yields continue to benefit from gross production and adjustments in pricing.

The average loan yield net of acquired loan accretion and PPP income was 5.33% for the quarter, up 32 basis points from the linked quarter. Funding costs, as discussed, were impacted by the remixing of non-interest-bearing to interest-bearing balances during the quarter, as well as higher liquidity levels held on balance sheet. Non-interest income increased by $1.5 million compared to the linked quarter, which included the recognition of a $318,000 benefit claim related to the BOLI portfolio. Adjusted non-interest expense was $84.9 million, a decrease of $3.5 million versus the linked quarter. The primary drivers of the reduction in non-interest expense were lower salaries and benefits expense, as well as lower professional fees. Looking ahead, we will continue to maintain expense discipline and explore additional targeted opportunities to strategically reduce non-interest expense through initiatives.

These are all the comments I have today. With that, I'll turn the call over to Dan.

Dan Brooks (Vice Chairman)

Thanks, Paul. Loans held for investment were $13.6 billion in the first quarter. Loan growth, excluding mortgage warehouse and PPP loans totaled $8.5 million or 0.2% annualized for the quarter. New production during the quarter was subdued due to seasonal slowness in the first quarter, as well as lower demand across our markets. Despite the lower growth, during the quarter, we originated $599 million of new commitments and $315 million of which funded during the quarter. We continue to see opportunities in the pipeline, and we continue to underwrite with the same discipline that has guided us through past economic cycles. Average mortgage warehouse purchase loans remain stable at $298 million versus the linked quarter. Our expectation is for this business to continue to remain flat at the current levels.

Credit quality metrics continued to strengthen during the quarter. Total non-performing assets decreased to $60.1 million or 0.32% of total assets at quarter end. Other real estate owned decreased to $22.7 million due to an impairment of the $1.2 million recognized during the quarter. Net charge-offs totaled just four basis points annualized for the first quarter. We continue to see the loan portfolio exhibit resilience in the face of volatile macroeconomic conditions. We remain confident in the strength of our credit quality as we enter the second quarter. These are all the comments I have related to the loan portfolio this morning. With that, I'll turn it back over to David.

Paul Langdale (CFO)

Thanks, Dan. Looking ahead, we remain focused on optimizing our franchise to navigate a complex macroeconomic and banking landscape. We remain encouraged by the continued gross loan production and the repricing of our fixed rate loans. We will continue to focus on opportunities to strategically play both defense and offense on the deposit base. While loan production was seasonally lower in Q1, we are seeing solid opportunities in the pipeline and still expect to grow loans at 4%-5% annualized rate for the remainder of the year. In the second quarter, we will continue to optimize our expense base for the current environment. We expect to achieve targeted expense reduction opportunities that will allow us to incrementally manage the run rate down over the course of 2023. Thank you for taking the time to join us today. I will now open the line to questions. Operator?

Operator (participant)

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Brad Milsaps (Managing Director)

Hey, good morning.

Paul Langdale (CFO)

Hey, good morning, Brad.

Operator (participant)

Good morning.

Brad Milsaps (Managing Director)

Thanks for taking my questions. I was just curious, Paul, a lot of movement, you know, with the balance sheet at the end of the quarter. I'd be curious if you'd be able to provide us sort of, you know, spot deposit rates and maybe even spot loan rates, and maybe how that, you know, might inform, you know, your margin outlook as you think about sort of all the moving parts, you know, as we kind of move through the next couple quarters?

Paul Langdale (CFO)

Sure, Brad. Happy to provide some color on that. On the earning asset side, our loan yields are coming on in the mid 7s. We've reliably seen that for the last couple of months, and we expect that pace to continue based on what we see in the pipeline. On the deposit side, the marginal funding that we're adding to our balance sheet is just under 5%. We've tried to manage that rate relative to the liquidity available in the market and relative to our strategy. That's our expectation to hold funding at that level, depending on the trajectory, of course, of monetary policy.

Brad Milsaps (Managing Director)

Okay. Maybe just drilling down a little bit further. I mean, you had total deposit cost of, I think, around 170 basis points. Interest-bearing costs were a little over 2.4%. If you thought about where those numbers kind of move to, you know, at the end of the quarter, given all the moving parts, you know, are you seeing the pace of the beta slow down? Or would you expect, you know, something, you know, similar to what you saw in the first quarter?

Paul Langdale (CFO)

The betas in the first quarter, Brad, were driven significantly by the non-interest bearing remixing trends that we saw into interest-bearing, so adding those interest-bearing funds. We didn't expect the magnitude of non-interest bearing mix shift in the first quarter. It was really driven by accelerated yield-seeking behavior that coming out of the fourth quarter really accelerated into January and February. Most of the NIM pressure, I think, has happened in the first quarter. Following quarter end, we've seen a stabilization in funding costs, which leads us to anticipate that NIM will bottom out in Q2 and start expanding in Q3 and beyond as earning asset yields begin to climb. It's hard to give an exact range given the dynamism in the environment, but we certainly don't anticipate the kind of betas and NIM compression in Q2 that we saw in Q1.

Brad Milsaps (Managing Director)

Paul, just the kind of final follow-up. I think you had a loan beta around 38% in the quarter. Obviously, you've been talking about, you know, the repricing characteristics of your loan book for a while. Do you expect that, you know, to continue to step up? Is it, you know, more heavily weighted in, you know, one quarter, you know, versus another? Is it just gonna kind of be this, you know, sort of gradual, you know, climb as we move through the year?

Paul Langdale (CFO)

It's weighted heavier in the back half of the year in 2023 than in the front half of the year. We have seasonal slowness usually, especially in the first quarter. The amount of bulk repricing that we get in the first quarter is reliably less than in the back half of the year when we expect to see the most growth. I will say that we certainly do expect, given our loan growth guide, to see those earning assets, especially loan yields, pick up. The more production we have and the more net growth we have, the more that will impact the yield.

Brad Milsaps (Managing Director)

Okay, great. Thank you, guys. I'll hop back in queue.

Paul Langdale (CFO)

Great. Thanks, Brad.

Operator (participant)

Thank you. Our next question comes in line of Brandon King with Truist Securities. Please proceed with your question.

Brandon King (Wholesale Payments and Treasury Sales Analyst)

Hey, good morning.

Paul Langdale (CFO)

Good morning, Brandon.

Brandon King (Wholesale Payments and Treasury Sales Analyst)

See, I had another question on deposits. I know before it was the goal to match deposits with loan growth. Wanted to get updated thoughts on your outlook for where you see deposits trending for the remainder of the year.

Paul Langdale (CFO)

You know, our focus, Brandon, really remains on growing the core deposit base. We believe that we've equipped our teams with the tools necessary to successfully compete both offensively and defensively against what we're seeing in the market. It's important to note also that relationship deposits do factor into our lending decisions, and we believe that our ability to produce loans also translates to an ability to produce deposits. We're going to be very focused on making sure that we can grow deposits and can fund loans with deposit growth. Obviously, the accelerated attrition that we saw in Q1, we don't expect a repeat in Q2 because we've seen some stabilization since quarter end. Given what we've tasked our teams with and given what we're seeing in the market, we think we're in a good position to grow deposits in Q2.

Brandon King (Wholesale Payments and Treasury Sales Analyst)

Okay. I know you've mentioned in the commentary as far as the deposits moving kind of off balance sheet but still within the bank. What do you think it would take for those deposits to come back, and kind of when do you anticipate that happening?

Paul Langdale (CFO)

I think it depends entirely on the trajectory of monetary policy and specifically the yield in the treasury market. Most of the liquidity management products out there are based on treasury yields and a ladder treasury strategy. As we see the Fed hit the terminal rate, especially if we have some economic storm clouds on the horizon, I think there'll be an opportunity for banks to be very competitive on rate versus the treasury market. It'll just depend, again, on the trajectory of inflation and monetary policy.

Brandon King (Wholesale Payments and Treasury Sales Analyst)

Okay. there's nothing, I guess, internally that you plan on doing to kinda encourage those deposits coming back sooner rather than later?

Paul Langdale (CFO)

I think it depends on the idiosyncratic beliefs and behavior of the customers and what they're specifically looking for. Obviously, we have opportunities to incentivize customers to return that cash on the balance sheet. As of right now, it's a relationship-driven strategy that we really focus on understanding the individual customer, their needs, and we really want to provide them with a total suite of solutions that fits what they're looking for.

Brandon King (Wholesale Payments and Treasury Sales Analyst)

Okay. I will hop back in the queue. Thank you for taking my questions.

Operator (participant)

Thank you. Our next question comes from the line of Brett Rabatin with Hovde Group. Please proceed with your question.

Brett Rabatin (Managing Director and Head of Equity Research)

Hey, good morning, gentlemen.

Paul Langdale (CFO)

Morning, Brett.

David Brooks (Chairman and CEO)

Morning, Brett.

Brett Rabatin (Managing Director and Head of Equity Research)

Wanted to, I guess, first start on expenses. You know, the expense levels are obviously something when you're focused on this year, and the numbers in 1Q on a core basis were a little better than I expected. Can you talk maybe, Paul or David, about what you think you'll achieve from here on the expense side and just a good way to think about maybe the efficiency ratio relative to what you're trying to get done on the revenue side? Thanks.

Paul Langdale (CFO)

Sure, Brett. I'm happy to talk to expenses. Obviously, we remain focused on notching incremental expense discipline. That is something that we have expressed a clear intent to continue to focus on over the last several calls. If you look at our expenses in Q1, they are seasonally a little bit lower than they typically are. I would expect the expense run rate to be around $88 million for the remainder of the year. Midway through the first quarter, we did have our merit increases, so that does impact the runway on a go-forward basis. The trajectory of expenses and the magnitude of savings that we can realize is gonna be dependent upon the opportunities that we see across our expense base. Obviously, we're looking under every rock and making sure that we're being mindful of gearing the organization for the current economic environment.

Brett Rabatin (Managing Director and Head of Equity Research)

Okay. That's helpful. On, on capital, I wanna make sure I understood that correctly. You repaid the $30 million of sub-debt post-quarter. Was that correct?

Paul Langdale (CFO)

No, we repaid that at quarter end, so it is-

Brett Rabatin (Managing Director and Head of Equity Research)

At quarter end? Okay.

Paul Langdale (CFO)

That was three-month LIBOR plus 283, so that was a little over 8% paper for modeling purposes.

Brett Rabatin (Managing Director and Head of Equity Research)

Would the plan be to replace that in the near term?

Paul Langdale (CFO)

We continue to accrete enough capital to be able to not replace that little $30 million tranche.

Brett Rabatin (Managing Director and Head of Equity Research)

Okay. Then any thoughts on capital generally? Just, you know, that I think some banks are thinking about running with excess capital just due to some uncertainty. You know, is there a specific capital ratio that you're focused on and maybe what capital level would you be trying to target, you know, maybe later this year or in the environment?

David Brooks (Chairman and CEO)

Yeah, Brett, let me, let me address it from a high level, just where I believe the board is and what our strategy is, how we're thinking about it. We have continued to approve our dividend at its current level that we came into the year with. We finished fourth quarter of 2022 and into 2023 with our dividend level. We expect to keep that constant for the foreseeable, you know, future, the next few quarters as we observe what's going on, you know, macroeconomically, as Paul has said. We have a, you know, a buyback in place, or, you know, approved, but we're not expecting to be active with it, you know, for the foreseeable future. Part of that is what you alluded, what you allude to, Brett.

That is, we're watching closely what's going on with the economy. You know, the markets seem to be pricing in now, you know, at least a moderate recession, and some, you know, rate declines in the back half of the year. We're, you know, we're not making any assumptions around that, but we're watching and preparing. We're going to allow capital to accrete, as Paul just said, here in the next few quarters and continue to strengthen that ratio. We're not expecting, as Paul said, to add any additional sub-debt or capital at this time. We feel really good about where we are.

As far as specific capital ratios, I don't know, Paul, you may have a thought on that, but I think, broadly we feel good where we are, Brett, and we expect those to accrete up over the next few quarters.

Paul Langdale (CFO)

The only thing I would add, Brett, is that we continue to target TCE ratio north of 7%. That's something I think you'll see continue to increase as we accrete capital over the remainder of the year.

David Brooks (Chairman and CEO)

Yeah, we like that.

Brett Rabatin (Managing Director and Head of Equity Research)

Okay.

David Brooks (Chairman and CEO)

from that standpoint, Brett. you know, particularly the fact that we have a small bond portfolio and a relatively insignificant AOCI charge at this time. you know, we think that puts us in a good spot from an overall capital standpoint.

Brett Rabatin (Managing Director and Head of Equity Research)

Okay. That's helpful. Thanks so much for the color.

David Brooks (Chairman and CEO)

Okay. Thanks, Brett.

Operator (participant)

Thank you. Our next question comes from the line of Michael Rose with Raymond James. Please proceed with your question.

Michael Rose (Managing Director and Equity Research)

Hey, good morning, everyone. Thanks for taking my question. Just wanted to go back to deposits. I think like every bank, you're seeing a mix shift into obviously higher cost deposits. Any sense from a modeling perspective where you think that mix shift kind of troughs? Like, where does DTA trough? If you can just kind of update us on beta expectations, you know, cumulative through the cycle. Thanks.

David Brooks (Chairman and CEO)

Thanks, Michael. Let Paul handle that. Good morning.

Paul Langdale (CFO)

Sure, Michael, thanks for the question. As I mentioned earlier, the pace of non-interest-bearing attrition was really accelerated through the first part of the first quarter due to yield-seeking behavior. Since quarter end, we've seen that pace slow down meaningfully and begin to stabilize. Based on what we know today, there could be some incremental pressures that hits the terminal rate, but all in, we don't expect to see the big move down in non-interest-bearing balances that we saw in Q1 repeat itself. If non-interest-bearing, you know, being a percentage of the deposit book it is today, I'd expect that ratio to gradually come down maybe another 1%-2% over the coming 12 months. Although, I wouldn't expect any significant non-interest-bearing runoff relative to what we've seen in Q1.

From a beta standpoint, as I mentioned earlier, betas will slow down given that we've already passed on a meaningful amount of deposit costs increases to our customers. It has been our stated strategy since the beginning of this rate hike cycle to play defense with our interest-bearing balances and make sure that we're taking care of our customers. If we pay rate to anyone, we would like it to be to our core customers. That's why you've seen us, you know, have a little bit sharper betas over the last couple of quarters relative to the interest-bearing branch book. I think given where we are in the cycle right now, you'll see those betas meaningfully slow.

Michael Rose (Managing Director and Equity Research)

Very helpful. Paul, I think you mentioned that you expected deposit balance growth in the second quarter. Appreciate that. I would expect that, you know, given commentary around maybe some of those deposits that kind of moved off balance sheet potentially coming back on, that we should expect continued growth through the year. You guys, I assume the expectation would be to keep that loan-to-deposit ratio sub 100%.

Paul Langdale (CFO)

Yes, absolutely. We do expect to keep the loan-to-deposit ratio under 100%, and we are employing an all-of-the-above strategy in the deposit book. We like to maintain a reasonable mix shift, especially among the broker deposits. Keep it relatively short duration, use a laddered strategy, use a number of different products. We really do believe that strategically achieving granularity across the deposit book, both in our core deposits and in our wholesale flavored deposits, is something that will benefit us long term and really dovetails well with our conservatism in gearing the balance sheet. That's something I think you should expect us to continue to do over the coming quarters.

Michael Rose (Managing Director and Equity Research)

Okay, great. Then maybe just finally for me, back to expenses. Appreciate the color on the kind of expense run rate. Maybe just holistically, if you can kind of balance for us, cost-saving efforts with investments, you know, as you continue to grow, you know, the franchise and just how you balance that maybe in the context of, you know, how do you think about the efficiency ratio kind of when we get into the intermediate term now that, you know, funding cost profiles have definitely changed? Just trying to get some holistic color on how you balance investments versus savings. Thanks.

David Brooks (Chairman and CEO)

Sure, Michael. It's obviously the same conundrum that, you know, every management team has across the country right now given the economic environment. We've made significant investments in our infrastructure over the last couple of years, as you know. We've spoken about it, you know, clearly in technology and practice improvement and risk enterprise risk management build-out, things like that that we continue to do and continue to invest in, and we're not going to, you know, back away from our commitments there and our strategy there. We're clearly, you know, as we think about the next few years, you know, assessing what, you know, what the highest priorities are and moving ahead on those projects.

At the same time, you know, looking at our organization in our org chart, you know, division by division and just understanding, you know, where we've invested and what that investment is, you know, is going toward in terms of our high-level objectives of our company. I just think it's a healthy process that we go through on a regular basis anyway of, you know, investing and then assessing, investing and then assessing, you know, how we're doing there. We're continuing to go through that process. As you know, we really started it last fall. Just, you know, we expected that it was gonna be a difficult environment in 23, and so it's playing out how we expected, and we'll just continue to be diligent around that.

We're not going to, you know, do anything from a cost-cutting standpoint that, you know, harms our franchise or our long-term value. We believe deeply in the markets we're in. We believe deeply in our team on the field who's, you know, who are day-to-day interacting with our customers. We've got, you know, terrific customer base in our markets. As you know, we don't have national business lines and things like that. As you know, our strategy is really focused on the four great markets we're in, dealing with our customers in those markets. Whatever, you know, we have to invest in to meet the needs, as Paul said earlier, to make sure we've got the product set and the technology and everything that our customers need.

At the same time, being mindful that, you know, we're running a business here and, you know, we need to run a high-performing business, and we're committed to doing that.

Paul Langdale (CFO)

Appreciate the call. Thanks everyone.

David Brooks (Chairman and CEO)

Thanks. Bye.

Operator (participant)

Thank you. Our next question comes from line of Brady Gailey with KBW. Please proceed with your question.

Brady Gailey (Managing Director)

Hey, thanks. Good morning, guys.

David Brooks (Chairman and CEO)

Good morning, Brady.

Brady Gailey (Managing Director)

I know we've talked about the components of the net interest margin, when you look overall at the net interest margin, how do you think that trends from here? I know in the past, we've talked about, you know, once the Fed pauses your CRE loan yield will catch up and you could actually see some NIM expansion. How do you think about the overall NIM from here?

Paul Langdale (CFO)

Brady, as I discussed a little bit earlier, we saw an accelerated NIM compression in the first quarter due to predominantly the mix shift as well as some funding cost pressures. We don't expect to see that repeat in the second quarter. We do expect to see NIM bottom in the second quarter, and the magnitude of the decline from Q1 to Q2 will be less than it was from Q4 to Q1. On the whole, it's hard to handicap exactly where the bottom is. From Q3, Q4 onward, we do expect to see NIM expansion because we do believe that we've hit close to the peak in terms of our funding costs with the Fed, assuming a Fed terminal rate of just above 5%.

Ultimately, the fixed rate loan repricing, those yields will continue to expand on loans, and that'll continue to drive our NIM upwards through cycle. It's a little bit different due to the short duration nature of our CRE book. We'll have that continued loan yield expansion over the next three-four years.

Brady Gailey (Managing Director)

All right. That's helpful. Paul, on your expense guidance of $88 million per quarter for the rest of the year, does that incorporate any further cost cutting, or is that just, you know, where you see it as of now? If you did decide to do further cost cuts, that would be of benefit to that number.

Paul Langdale (CFO)

There could be upside to that number, Brady, but it's going to be dependent on the opportunities we identify and our ability to really execute on them.

Brady Gailey (Managing Director)

Okay. Lastly for me, you know, I know Independent is a pretty big commercial real estate lender, the market seems to be concerned about, you know, CRE over the next couple of years. I mean, you guys have a great track record over a lot of cycles in commercial real estate. Maybe just your updated thought on CRE over the next couple of years.

Dan Brooks (Vice Chairman)

Good morning, Brady. This is Dan. I'll take that one. As you can imagine, we continue to scrub that portfolio and stress it, in particular the ones that are maturing in the next couple of years for higher rates, in an effort to identify any potential risks there. In short, you know, we're confident based on that we will continue to see it perform well in any slowdown. As you know, we've always employed a disciplined approach to growing our book. We've avoided holding outsized pieces of credits, which limits the impact to any individual credit that we have. We relied on cash equity, which stays in the deal versus appraised equity, which we have seen, time and again through downturns that makes a difference.

We've not used trended rents and underwriting, which I know some banks have been prone to do. We just think that sets you up for some issues when you have contraction in that. For the most part, we have secondary sources of repayment that are vetted, and as you know, we stay in the markets that we're in with our known borrowers, which those strongest markets in the country, as David mentioned, have seen strong NOI growth with material increase in rents and occupancy over the last five years. The coverages provide significant cushion in NOI and a strong debt service coverage. We have been stressing the book as most banks have been in particular for those that are maturing here in the next couple of years.

I would tell you those have average rates currently in the high 4s with that fixed rates. Our stressing of that all the way up to the high 7s indicates that that book is gonna perform really well in there. The few that will have some work with the customers have strong guarantor support with verified liquidity. Again, we feel very confident in that at this point.

Brady Gailey (Managing Director)

Thanks, Dan. That's helpful.

David Brooks (Chairman and CEO)

A couple add-ons I would have there, Brady. One is, I think what Dan is saying at, you know, at a granular level is playing out a little bit at the higher, more strategic level. We saw, for instance, in our loan growth, we generated right at about the amount of loans in the first quarter that we expected, but we had an unusual number of paydowns in the first quarter. That was driven by mostly asset sales that were driven by the cap rates continuing to be lower in our markets than what I think sellers maybe expected. For instance, you know, there are investment groups and wealthy families that are getting offers on properties that are at lower cap rates than what you would expect given our interest rate environment.

It speaks to the strength of the underlying markets, and that's the point I'm making with that, is we've seen these paydowns are coming from asset sales at really strong prices. And as Dan said, as we've seen these loans reset pricing and things, the NOIs have been very robust. The growth in the last 3 or 5 years since we made the loan or since that last price reset to where it is today. We're not seeing, you know, pressure there. The final comment I'll make about the CRE portfolio, just to emphasize again what Dan said, is that, you know, our loan sizes, our loan holds are just different than what a lot of banks that have a big CRE concentration or a large CRE concentration have. Our average hold sizes are much smaller.

We have many more loans against many different properties. You know, diversification of risk by not only asset class, but within the asset classes. Again, and I understand, right now we're facing a potential, you know, as Paul said earlier, storm clouds on the horizon that people are concerned about it, and we get it. To some extent, you know, it's gonna have to play out, right? That investors and folks can see exactly how different banks' asset quality holds up. We continue to be very confident in how ours will hold up and, you know, but we'll just have to, you know, play it out the next few quarters and see how the economy does. We remain confident in not seeing any difficulties on the horizon at this point. That's good color. Thanks, guys. Thanks, Brady.

Operator (participant)

Thank you. Ladies and gentlemen, as a reminder, if you'd like to join the question queue, please press star one on your telephone keypad. Our next question comes from the line of Matt Olney with Stephens Inc. Please proceed with your question.

Matt Olney (Research Analyst)

Hey, thanks. Good morning, everybody.

David Brooks (Chairman and CEO)

Morning, Matt.

Matt Olney (Research Analyst)

Paul, thanks for all the commentary on the deposit cost and the margin. I'll take a swing at a topic too. if I assume a deposit beta that moderates in 2Q from what we saw in 1Q, and if I assume that the NIB outflow, the pressure there kind of eases up quite a bit in the second quarter as well, I'm still getting a margin that drops below 3% in the third quarter. and that would still be kind of, you know, less than that margin pressure that you talked about in the first quarter. I just wanna make sure I'm thinking about this right as far as kind of where that margin could ultimately cross. Thanks.

Paul Langdale (CFO)

The core NIM excretion is gonna depend upon a variety of factors, Matt. Obviously, we have a few offsets relative to our costs redeeming that tranche of sub-debt. As I noted, we did repay part of the borrowings that we had at the end of last quarter as well. While we do still expect some incremental NIM compression, we do believe it should hold in a reasonable area around 3%. That's our expectation going into Q2.

Matt Olney (Research Analyst)

Okay. Thanks for that, Paul. You mentioned you paid down a part of that FHLB more recently. Any color on kind of what that balance is currently?

Paul Langdale (CFO)

I don't have the updated balance right in front of me, but we continue to use short-term advances on the FHLB front. What we did, Matt, in the back half of March, is we really focused on using short duration FHLB advances so that we could replace those funds selectively with brokered and core deposits as we pursued our growth initiatives in that category. The funding markets were very dislocated in the last two weeks of March. The cost for both broker deposits and specialty deposits were significantly higher than where they are today. We waited for those rates to come down at quarter end and started adding those funds back after quarter end.

Matt Olney (Research Analyst)

Paul, on that note, how favorable is that trade as you move back into some of those specialty products over the last few weeks relative to FHLB? Any context for, you know, how much more favorable that is versus the FHLB?

Paul Langdale (CFO)

It's not meaningfully favorable over FHLB. It's probably a spread of about 15 basis points today. It was very favorable related to versus the brokered market in mid-March.

Matt Olney (Research Analyst)

Got it. Okay. That's helpful, Paul. Thanks for that. Other questions have been addressed. I guess just lastly on the mortgage warehouse, I think Dan mentioned expecting stability there. Just any color on stability versus end of period or average, quite the delta we saw in the first quarter. Thanks.

Dan Brooks (Vice Chairman)

Yeah. Matt, this is Dan. Good morning. I think we indicated in there that we averaged right around almost $300 million for the quarter. We actually saw a significant increase in March and ended the quarter above $400 million. We've continued to be at that level here in April. As we have indicated in the past, we expect it to be fairly flat for the year, and following the rest of the market. We did see some increase as you will see there.

Matt Olney (Research Analyst)

Okay. All right. Thank you guys.

David Brooks (Chairman and CEO)

Thanks, Matt.

Paul Langdale (CFO)

Thanks, Matt.

Operator (participant)

Thank you. Ladies and gentlemen, that concludes our question and answer session, and I'll turn the floor back to Mr. Brooks for any final comments.

David Brooks (Chairman and CEO)

Thank you. I appreciate everyone joining this morning. We remain encouraged about the position of our company relative to being nimble for whatever comes our way for the balance of the year. We expect that we'll continue to see good growth and we're confident in our team and confident in our ability to execute in this environment. Looking forward to what the next few quarters brings. I appreciate everyone's interest. Always happy to be available if you need us for anything, feel free to reach out. Hope everyone has a great day.