Webster Financial - Q3 2024

Transcript

Operator (participant)

Good morning. Welcome to the Webster Financial Third Quarter 2024 Earnings Call. Please note, this event is being recorded. I would now like to introduce Webster's Director of Investor Relations, Emlen Harmon, to introduce the call. Mr. Harmon, please go ahead.

Emlen Harmon (Director of Investor Relations)

Good morning. Before we begin our remarks, I want to remind you that the comments made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of nineteen ninety-five, and are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in today's press release and presentation for more information about risks and uncertainties which may affect us. The presentation accompanying management's remarks can be found on the company's investor relations site at investors.websterbank.com. For the Q&A portion of the call, we ask that each participant ask just one question and one follow-up prior to before returning to the queue. I'll now turn it over to Webster Financial CEO and Chairman, John Ciulla.

John Ciulla (CEO)

Thanks, Emlen. Good morning, and welcome to Webster Financial Corporation's third quarter twenty twenty-four earnings call. We appreciate you joining us this morning. I'm very pleased to welcome Neal Holland as he is joining his first earnings call as Webster's CFO. As we anticipated, Neal has hit the ground running since he officially stepped into the role in mid-August, and you can already see the impact of some of the steps his team has taken to optimize the positioning of our balance sheet and grow interest income this quarter. Luis Massiani, Webster's President and Chief Operating Officer, is also joining us for the Q&A portion of the call today. I'll provide remarks on our high-level results and operations before turning it over to Neal to cover our financial results in greater detail. We're really pleased with our strategic and tactical accomplishments in the quarter.

I'll hit the highlights, and Neal will provide more details. We grew deposits 3.6% in the quarter, including growth in DDA, overall commercial deposits, and HSA. We grew loans 0.7% in the quarter, consistent with our full-year growth expectations. Excluding a $300 million securitization we performed to reduce our CRE concentration, our growth was 1.3% in the quarter, with accelerating growth in C&I categories. We further reduced our CRE concentration through payoffs and reclassification of certain healthcare-related loans. As a result, our CRE outstandings as a percentage of Tier 1 capital and reserves declined from 285% to approximately 265% at the end of Q3. Our net interest income grew quarter over quarter and increased over last year's comparable period, in line with our full-year expectations.

We benefited from asset growth and a balance sheet repositioning. We continued to mitigate our asset sensitivity, positioning us well as rates continue to come down. Our capital levels remain strong, with our CET1 now in excess of our current operating target of 11%, resulting from earnings and capital optimization activities, providing us capital flexibility in 4Q and beyond. Our expenses remained well managed, resulting in a third quarter efficiency ratio of 45%, still in an industry-leading position. I'll now turn to our financial performance for the quarter, beginning on slide two. On an adjusted basis for the quarter, we generated a return on average assets of 1.22% and a return on tangible common equity of 17.3%. Our adjusted EPS was $1.34. Our profitability and return metrics remained favorable to peers again this quarter.

At this point, most of you are familiar with slide three, which illustrates our diverse and versatile deposit base. As I mentioned upfront, our robust growth this period came from a breadth of the segments on this slide, including lower-cost channels in our commercial bank, HSA Bank, and Ametros. We executed on the $400 million deposit opportunity for HSA Bank we discussed last quarter, which provided a nice boost to deposits there. Strong execution within the commercial bank added to lower cost funding growth as well. Our ability to generate low-cost funding across a number of business segments continues to be a tremendous advantage in growing our balance sheet efficiently and profitably. Moving to slide four, I will review our commercial real estate portfolio, as that has been a continued focus of investors.

The segment of the CRE portfolio on which we have been most focused continues to be traditional office. The portfolio balance continues to shrink, with $917 million in outstandings at quarter end, down roughly 45% from the first half of 2022. We did see some continued negative migration this quarter, with non-accrual loans decreasing to 14% from 9% last quarter, largely as a result of two larger credits. We continue to be proactive in identifying and managing problem credits and prudently managing reserves in the sector. While it has been an investor focus, there have been no significant changes in the quality of our rent-regulated multifamily portfolio, where credit performance has held up consistently well.

On credit more generally, we continued to see negative risk rating migration in the quarter as we keep a close eye on credit at a later stage in the cycle. We did see our non-accrual loans increase by $50 million this quarter, primarily driven by the aforementioned office portfolio migration. Outside of CRE office, negative migration was generally credit specific across the portfolio and not driven by one industry, sector, or asset class, although healthcare-related portfolios continue to show some weakness. While we have seen continued migration and will continue to be proactive in our risk reviews, our realization of loan losses remains in the range we have observed in recent quarters and importantly, is consistent with through the cycle and pre-pandemic commercial annualized charge-off rates. With that, I'll turn it over to Neal to cover our financials in more detail.

Neal Holland (CFO)

Thanks, John, and good morning, everyone. I'll start on slide five with our GAAP and adjusted earnings for the quarter. On an adjusted basis, we reported net income to common shareholders of $230 million and diluted EPS of $1.34. Adjustments consisted of a pre-tax $20 million securities repositioning charge, a $16 million impact from the exit of non-core factoring operations, and $22 million of strategic restructuring costs. Turning to slide six, total assets were $79 billion at period end, up $2.6 billion from the second quarter, mirrored by robust deposit growth of $2.2 billion. Deposit growth was aided by a seasonal surge in public funds of $1.1 billion. As a result of the substantial deposit growth, we are holding higher cash balances than we have historically.

We also exhibited solid loan growth of 1.3%, excluding the securitization. The loan-to-deposit ratio was 80.5%. Tangible book value increased to $33.26 per common share, with the increase from the prior quarter driven by retained earnings and positive movement in AOCI due to the low rate environment. Capital levels improved significantly. The common equity tier one ratio was 11.23%, up 64 basis points linked quarter, and our tangible common equity ratio was 7.48%. In addition to internal capital generation, the TCE ratio benefited from the improvement in AOCI. The common equity tier one ratio also benefited from several actions we undertook to optimize asset risk weightings, as well as the securitization. In total, these actions added 44 basis points to our common equity tier one ratio.

Loan trends are highlighted on slide seven. In total, loans were up $374 million, or 0.7% linked quarter. Excluding CRE, other loan categories grew by 3.2% this quarter. Commercial real estate balances were down $570 million as we experienced some natural attrition in addition to the securitization. This accelerates our path to our target of 250% of capital plus reserves. The securitization frees capacity and adds and allows us to add commercial real estate relationships with attractive risk-reward characteristics. The yield on the portfolio is flat, given the mix of new loan originations and repricing of floating-rate loans on the September Fed move. We provide additional detail on deposits on slide eight. We grew total deposits by $2.2 billion, with diverse growth across categories.

The pace was accelerated this quarter due to seasonal inflows of public deposits and a discrete opportunity with an HSA bank that added $400 million of low-cost deposits. DDA balances increased by over $700 million this quarter, with the majority of the increase coming from seasonal effects. However, it is still encouraging to see normalization in the DDA balances after several quarters of declines. Moving to slide nine, net interest income was up $18 million from the prior quarter, driven by balance sheet growth and higher earning asset yields. Adjusted non-interest income was up $1 million. Adjusted expenses were up $2 million, and the provision decreased by $5 million. Excluding adjustments, our tax rate was 22.2%. Overall, adjusted net income was up $14 million relative to the prior quarter. Our efficiency ratio was 45%.

On slide ten, we highlight net interest income, which increased $18 million or 3.1% linked quarter, driven by balance sheet growth and the increased earning asset yield. The net interest margin was up four basis points to 3.36. Our yield on earning assets increased four basis points over the prior quarter, with loan yields flat and the securities portfolio up twenty-four basis points. In the third quarter, we incrementally sold securities with a book value of $304 million and reinvested with an approximate four hundred basis point improvement in yields with minimal impact to capital ratios. We anticipate an earn back of less than two years. On net, we were able to maintain our total deposit costs effectively flat for the quarter.

Slide 11 illustrates the progress Webster has made in mitigating its asset sensitivity over the past three years by increasing the duration of our assets and reducing the duration of our liabilities. On Slide 12 is non-interest income, which was up $1 million versus prior quarter on an adjusted basis. Adjusted income included both a $3.8 million negative CVA and $4.4 million gain on the securitization. We continue to experience pressure on core fee growth. Year over year, fees are up $3 million, including the impact of the Ametros acquisition, offset by year-over-year changes in CVA. Non-interest expense is on Slide 13. We reported adjusted expenses of $328 million, up $2 million from the prior quarter, driven by modest increases in technology, human capital, and occupancy costs.

Slide 14 details components of our allowance for credit losses, which was up $19 million relative to the prior quarter. After booking $35 million in net charge-offs, we recorded $54 million provision, primarily due to credit factors. As a result, our allowance coverage to loans increased to 132 basis points from 130 basis points last quarter. Slide 15 highlights our key asset quality metrics. As you can see on the four charts, we saw continued migration in the quarter. Net charge-offs came in at $36 million, versus $33 million in the prior quarter. On Slide 16, we enhanced our already strong capital levels. As we noted previously, we took several actions to improve our capital ratios in the quarter, including reviewing the risk weighting of our multifamily, lender finance, and public sector portfolios, as well as the securitization of multifamily loans.

These actions, in combination with organic capital generation and lower AOCI losses, led to a significant increase in our capital ratios this quarter. I will wrap up my comments on slide seventeen with our outlook for the fourth quarter. We expect loans to grow by 1%-1.5%, with growth across the diverse categories, including the potential for some modest growth in commercial real estate. We are anticipating deposits will decline by around 1%, as seasonality in the public funds business leads to outflows. We expect net interest income in the range of $590 million-$600 million on a non-FTE basis. This is within the guidance range we provided on the second quarter earnings call. Our net interest income outlook assumes 50 basis points of cuts in the fourth quarter, with 25 basis points each in November and December.

Adjusted non-interest income will be $85 million-$90 million. We anticipate adjusted expenses will be in the range of $335 million, with an efficiency ratio in the mid-40s. Our near-term Common Equity Tier 1 ratio remains 11%. With that, I'll turn it back to John for closing remarks.

John Ciulla (CEO)

Thanks, Neal. I'm anticipating we'll receive questions on our priorities for capital allocation, given the sharp increase in our capital ratios in the quarter. While we continue to prioritize funding organic balance sheet growth and complementary tuck-in acquisitions, our capacity to return capital to shareholders has increased since the second quarter, and we will be prudent and proactive managers of capital. We are well positioned to maintain our profitability profile. As Neal detailed, we have proactively managed our balance sheet over the past year to ensure stable net interest income in a declining interest rate environment, both in terms of managing our funding costs and tweaking the profile of our earning assets. We have capacity and capability to grow our balance sheet via a diversified mix of loan and deposit categories, while at the same time maintaining flexibility on capital allocation.

Our efficiency ratio remains among the best of our peers. We have retained superior profitability, even as we invest in people, processes, and technology. On the latter, over the last twenty-four months, we have made significant investments to strengthen our technology foundation, including the modernization of our core banking platform, building advanced BSA AML competencies, and heightening our cybersecurity and cloud capabilities. Finally, I'd like to thank our colleagues for their continued effort. Their hard work is reflected in our performance this quarter, particularly in our strong deposit growth in favorable categories. Thank you again for joining us today. Operator, we will open the line to questions.

Operator (participant)

Thank you. If you would like to ask a question, please press star one on your telephone keypad. If you would like to withdraw your question, simply press star one again. We ask that you please limit yourself to one question and one follow-up, then rejoin the queue if needed. Please ensure your line is not on mute when called upon. Your first question comes from the line of Chris McGratty with KBW. Your line is open.

Chris McGratty (Head of U.S. Bank Research and Managing Director)

Hey, good morning.

John Ciulla (CEO)

Morning, Chris.

Chris McGratty (Head of U.S. Bank Research and Managing Director)

Maybe John or Neal, the actions you took with the balance sheet, you know, obviously set up for a better, more, neutrally positioned balance sheet going into 2025. How do we think about, I guess, trough NII? Is Q4 the trough? How are you thinking about it, given you freed up a little bit of space on the balance sheet? Yeah, maybe I'll leave it there.

Neal Holland (CFO)

Yeah. So, you know, we came in at 3.36 for the quarter. Kind of as you look at how we exited Q3, we're going to be holding a little bit more cash on the balance sheet, which in Q4 will have a slight drag to NIM. So we're kind of in the Q4, we're going to be in, you know, 3.32 range and having that exit velocity into next year, and then kind of staying right in that level into 2025 is how we think about NIM. So, we think we're at a stable NIM. We may be ±3 basis points as we move forward, but that's the range we're looking at going forward into 2025.

Chris McGratty (Head of U.S. Bank Research and Managing Director)

Okay, perfect. And then my follow-up, John, you alluded to the capital return flexibility. Could you maybe just rank order and, and also the timing of which you think you might be able to return more capital?

John Ciulla (CEO)

Yeah, I mean, I think you know, we always talk about kind of prioritizing for organic balance sheet growth, thinking about doing things like we've done with Ametros and Interlink and Bend. And then obviously, if there's no other productive use of capital, I do think, given where we are and the fact that we do think with interest rates coming down, that we should see an inflection point in credit as we get into this quarter, in the first half of 2025, that we're more likely to begin repurchases again, absent other organic opportunities to deploy that capital, Chris. So I think we're there. We feel really good about our capital levels now, and we have some more flexibility.

So we're more likely than we were before in the next quarter or two to begin share repurchases, absent other uses of organic deployment.

Chris McGratty (Head of U.S. Bank Research and Managing Director)

Perfect. Thank you.

Operator (participant)

Your next question comes from the line of Jared Shaw with Barclays. Your line is open.

Jared Shaw (Senior Equity Research Analyst)

Hey, good morning, guys.

John Ciulla (CEO)

Hey, Jared.

Jared Shaw (Senior Equity Research Analyst)

You know, looking at maybe loan growth, as we exit 2024, going into 2025, how much additional attrition or headwind should we expect from CRE? It sort of sounds like maybe not that much, but you know, and should we expect or anticipate that maybe the overall loan growth rate starts to accelerate as we exit the year going into 2025?

John Ciulla (CEO)

Yeah, I mean, it's a great question, right? Loan growth has clearly been muted for the industry in the last couple of quarters. We did have a really good quarter in many core C&I categories, and I will say that sort of pull-through has continued early on in this quarter. Although we know that the fourth quarter is also subject to significant prepayments, and there's a lot of activity, particularly on transactional sponsor and specialty deals. So that's why we didn't really change our guidance for the fourth quarter. You know, I think you've heard me say, and you know, for 10 years or so, we've been able to kind of grow commercial categories in the high single digits to around 10%.

I think right now, our view of 2025, Jared, is that, you know, we see there's continued, kind of modest loan demand. So I think right now, we think about next year as a 5% kind of loan growth. You know, we're going to give formal 2025 guidance when we get into the January call. Could we outperform that? Sure. I think I've always said, I think we can kind of perform at or better than whatever the market allows. But I, you know, I think if you read what others are saying and we look kind of at activity, I think 2025, you know, may not be a blowout year, but be more modest and similar to this year with respect to loan growth.

With respect to your question about mix and commercial real estate, you know, obviously, we're really pleased this quarter, and I think there's a bit of a template there for us. We had significant organic prepayments, which I know many others in the industry have reported over the last couple of quarters in CRE. And then we did this securitization, which actually was economically beneficial to us in terms of the gain on the transaction. And we look at that not as just trying to drive down CRE balances as much as we can, but it gives us capacity to support our really good clients in full relationships. We're really good at it, and so, you know, you will see some level of origination there.

And then at the end of the day, as we grow our capital base and we grow our other C&I classes, you know, you'll see either flat to modest growth overall in CRE with our ability to maybe exit non-strategic CRE, CRE relationships. But I think we showed this quarter, we can still grow loans at market while not relying on outsized CRE growth.

Jared Shaw (Senior Equity Research Analyst)

That's a great color. Thanks. And then maybe for my follow-up on the deposit side, you know, really good, good trends there. You know, as we're entering the enrollment season, what are your thoughts on maybe HS-

Luis Massiani (President and COO)

Yeah. Hey, Jared, it's Luis. We feel good.

Jared Shaw (Senior Equity Research Analyst)

Do you think that, you know, there could be some pressures or opportunity?

Luis Massiani (President and COO)

Oh, hello. Hey, Jared, it's Luis. So we do see, you know, we've seen pretty good early indicators that the enrollment season is going to be, you know, as good as we've seen, you know, in the recent, you know, couple of years. So, you know, we've made a fair amount of investments in, you know, a bunch of client-facing technology. We launched a new investment management platform that you may have seen, we rolled out earlier this year. And so we feel very good about the investments and how we positioned the and continue to position the HSA business. And we think that you're going to see similar to slightly, you know, more, you know, faster deposit growth in 2025 relative to what we saw this year. So we feel, we feel good about where HSA is today.

John Ciulla (CEO)

And Jared, as we usually do in January, we'll be able to give you a kind of a first look at new business and what we anticipate. And then obviously, at the end of the first quarter, we kind of can final tally what's come in. I agree with Luis. I think it was a good selling season for HSA.

Jared Shaw (Senior Equity Research Analyst)

Great. Thanks a lot.

John Ciulla (CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Mark Fitzgibbon with Piper Sandler. Your line is open.

Mark Fitzgibbon (Managing Director and Head of FSG Research)

Hey, guys. Good morning.

John Ciulla (CEO)

Hey, Mark.

Mark Fitzgibbon (Managing Director and Head of FSG Research)

John, The Real Deal published an article late last week suggesting that you guys have two large office loans in New Jersey that are in default, to the tune of about $140 million. I guess I'm wondering, are these on nonaccrual in the third quarter? And do you have any, you know, specific reserves against them?

John Ciulla (CEO)

Thanks for the question, Mark. Yeah, so both of those loans, and let me make a couple of comments. You know, obviously, with a $52 billion loan book, we don't generally comment on specific relationships, single-point exposures, litigation, and so on and so forth, but obviously, this has become a bit public. So what I will tell you is, you know, the headline numbers there are significantly overstate Webster's exposure. Those were two loans originated pre-merger. One has a Webster exposure under $45 million, the other one is Webster exposure under $25 million. Both of those loans are on nonaccrual at the end of the third quarter. Both of those loans have obviously been reviewed, and there have been the appropriate charge-offs and specific reserves put against those loans.

As I mentioned in my early comments, two office loans drove the increase in nonperformers in the quarter. Those were the two loans, and, you know, we took charge-offs that contributed to the overall $36 million charge in the quarter. So, you know, that's what I'll tell you. You know, office charge-offs were 55% of the charge-offs in our quarter, so you can kind of triangulate from there. But, you know, we're pretty good about making sure that we are proactively managing things, that things go nonperforming when they're supposed to go, and taking charges that we're supposed to take. And so, you know, the good thing about being a company our size right now is we've got significant earnings power.

We've got, you know, a very high loan loss reserve compared to our peer median. And so this quarter, it really didn't have an impact on our overall financial performance, and we feel pretty good that we've got, you know, enough reserves in not only those two loans but in our overall CRE portfolio that we continue to work down to not have there be a material financial impact as we move forward.

Mark Fitzgibbon (Managing Director and Head of FSG Research)

Okay, that's great. And then just as a follow-up, John, you guys have done a great job shrinking the office book. I guess I wondered if you could share with us what the reserve on the office portfolio is right now?

John Ciulla (CEO)

Yeah, I think it's up 6%. Mark, you know, I'll give you—again, I'll repeat what I said. Jason had talked to me when the portfolio was $1 billion a quarter or so ago. You know, we talked about there being about a third of that, which is kind of hand-to-hand combat that we're working through. These two credits that I just referenced and that you asked about were obviously in that, you know, kind of third of difficult working through. We've got about a third of the portfolio that we don't worry about, that's highly leased, that has, you know, long dated maturities.

And then the stuff in the middle, you know, we continue to kind of just actively manage, and we think we've got enough secondary and tertiary support as well as, you know, in-place leases to kind of work through. So when you think about 6% on the overall $917 million that's left, remember there are some specific reserves as well. When you think about the reserving, we feel comfortable about it because it's really against that one-third of the portfolio that's most problematic for us.

Mark Fitzgibbon (Managing Director and Head of FSG Research)

Thank you.

John Ciulla (CEO)

Thank you, Mark.

Operator (participant)

Your next question comes from the line of Matthew Breese with Stephens. Your line is open.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

Hey, good morning, everybody.

Neal Holland (CFO)

Hey, Matt.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

I was hoping you could talk a little bit about expectations around loan and deposit betas, you know, over the next year or so. Whether or not you've had any early success tweaking and lowering deposit costs? If so, where? And then the other side of the coin is just given, you know, over the quarters, you've reduced asset sensitivity, whether or not you think full cycle loan beta will match what we've seen during the hiking cycle, which was kind of in the low 50% range.

Neal Holland (CFO)

Yeah. I'll jump in there. You know, I think, obviously, we had our first cut in the cycle, 50 basis points, and we took pretty quick action on the deposit portfolio. And we repriced down $27 billion-$28 billion of that portfolio at about of our deposit portfolio at about a 60% beta. So, it's kind of, you know, $16 billion at a 100% beta, or if you look at our total book, about 25% beta so far. It's our Interlink deposits, basically a 100%, almost immediate beta, and those are over $7 billion. We saw some nice pricing down in our commercial deposit portfolio. Now 60% beta so far on our online portfolio with Brio, and then a bunch of different moves on our consumer portfolio through the first cut.

So, so we're feeling pretty good there. And, you know, as you take a step back and look at our overall portfolio, within the next year, we expect approximately $30 billion of our loans and securities and cash to reprice. You know, that's $28 billion in loans and $1 billion in securities. So, our securities book is fixed and long, with less than $1 billion out of our $17 billion portfolio, they are variable. So we kind of look at that as the repricing side on the loans. And then if you flip to the deposit side, you know, in the first five quarters of the upcycle, we saw 34% beta, and we're anticipating approximately 30% beta in the first five quarters down.

And if you think about a 30% beta on a $65 billion portfolio, you do the quick math there, that's about $19 billion-$20 billion at a 100% beta. We have short borrowings, $3 billion out or $4 billion will mature this quarter or next. We've got a $5 billion hedge portfolio that helps support our current positioning. And then there's another large factor for us, is that we have approximately $5 billion of fixed rate securities that mature and turn annually, and those are anticipated to roll off at about 4% and roll back on with new originations in the 6% range. So the 200 basis points or so up.

So when you kind of put all that together, we have a pretty well-balanced position going into next year. And as you can see in our modeled results, a very neutral positioning, despite us having a fairly large portion of variable rate loans. So a long answer there, but I know it's an important topic, and I think that the team has done a really good job positioning us for this down rate environment.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

I appreciate all that. Thank you. And the follow-up is just on expenses. Expectations around expense growth, you know, over the next year or so, specifically as it relates to preparation for a hundred billion. Should we expect any acceleration in the coming quarters or year in expense growth as you get ready for this? And what areas do you expect to address as you kind of beef out infrastructure? Thank you.

John Ciulla (CEO)

Yeah, Matt, thank you for the question, and this may leave you a little wanting for more. But as we said, you know, we're finishing up right now with PwC, our gap analysis and our plan for our march to Category Four. I always remind you that we're three to four years away from an organic growth perspective in hitting the $100 billion category. And as we mentioned before, there will be additional expense for us to get there in terms of hiring people and building out reporting capabilities and technology, and obviously, the expense of TLAC.

We're going through right now, kind of a cadence of running that through, and our plan is, as I mentioned last quarter, that in January, when we give our 2025 guidance, that will include kind of our fully loaded assumptions about what that means for expenses. I also remind you that we have the three to four years to spread those expenses out, and you heard Neal mention earlier, for example, that we took some charges on severance and a lot of those moves in terms of exiting non-core businesses and looking at our organization will free up dollars to invest. As we move forward, you're going to get the answer to the question in January in our 2025 guidance. We think that that will put additional pressure on our expenses, but it won't be material.

We still feel very confident in our ability to deliver outsized returns as we go through this process. And so, you know, Neal, I don't know if you want to put a little bit of more flavor around that, but [crosstalk]

Neal Holland (CFO)

Yeah, I think you said that well, John. And, you know, one of my initial concerns coming into the organization was, hey, we're running at a 45% efficiency ratio. Are there really opportunities to find more efficiency? And as John mentioned, the team has done a nice job putting together a small program. And with the restructuring charges we took this quarter, we expect our expense run rate next year to drop $17 million, which won't flow all to the bottom line. We'll use some of those dollars to reinvest and prepare for Category IV. So I think it's an example of how we can continue to find efficiencies to pave our way to that kind of the requirements.

As John mentioned, we'll talk about specific numbers in Q1, but, you know, if you take a step back, we have an expense base that's just over $1.3 billion. So 1% of that is $13 million. If you add 1% to our expense growth rate over the next four years, you know, that probably hits a good chunk of what we need to build. I'm not saying that that's what's going to happen, but just kind of highlighting that it should be some incremental around the edges on the expense side versus a kind of a big pop-up of one-time expenses is the current view. But as John mentioned, we're not fully through the analysis on preparation, and we're making good progress there, and we'll give more details on Q1.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

I appreciate all that. Thank you. That's all I had.

John Ciulla (CEO)

Thank you, Matt.

Operator (participant)

Your next question comes from the line of Daniel Tamayo with Raymond James. Your line is open.

Daniel Tamayo (Analyst)

Thank you. Good morning, everyone.

John Ciulla (CEO)

Good morning.

Daniel Tamayo (Analyst)

I guess first, just a follow-up on the credit side. John, I think you mentioned an inflection in credit could lead to, you know, the possibility for increased repurchases going forward, but how should we think about that? Do you think that nonaccruals are at or nearing a peak here? Obviously, there's some uncertainty with how the whole office loan environment plays out, but just curious how, you know, we should be thinking about those nonaccrual and kind of early stage credit levels and how that plays into your thinking on net charge-offs as well.

John Ciulla (CEO)

Yeah, it's a terrific question, and one that I loathe answering just because it is difficult to predict. You know, we mentioned last quarter that this quarter would be, you know, less worse, and it was- we were marginally less worse. We've been through the entire portfolio. We are getting to a point where I think we've identified, obviously, all proactively, all the real issues in the portfolio that we go through. And, you know, I, again, remind everybody that if you look at our absolute statistics, they're kind of still in line with pre-pandemic statistics. So I know a lot of CEOs are saying, we're trying to remind everybody that this hasn't been a cratering of credit. It's been sort of a return to normalcy on credit.

You know, our hope right now and what we're looking at is we've got, you know, interest rates coming down. We have already seen an increase in commercial real estate refinancing activity based on the behavior of the five-year and the forward curve. And so as interest rates come down, if the Fed navigates this soft landing, you know, I do think that, you know, we should see running through bank PNLs and bank balance sheets an inflection point in credit, certainly in the first half of 2025. It's tough to call a particular quarter. We have seen some negative risk rating migration. We've been pleased that that migration has not continued to result in higher levels of annualized charge-offs.

And so it would be difficult for me to say, "Hey, we think Q4 is the bottom." But I do think all the macro factors and our understanding of our portfolio, that the first half of 2025, we should start to see kind of absolute improvement in the balance sheet. And obviously, we have a forward look based on where we're trading. If you're asking the question with respect to capital allocation and return of capital, you know, we've got lots of earnings, we've got really good reserves. So, you know, we'll put that all into the box and decide whether or not in the fourth quarter we start buybacks or whether or not that's a first half of 2025 activity.

Daniel Tamayo (Analyst)

Okay, terrific. Thanks for all that color. And then changing gears here, just looking at loan growth, the loan growth side. You talked about how the fourth quarter could be impacted by some slower, perhaps C&I and sponsor with the headwinds you mentioned specifically prepayments. But just curious, you know, the pace of growth in the third quarter, what you saw there, if that picked up near the end of the quarter, if it was relatively steady. And then just also curious on the residential side, expectations for, you know, how much you're going to be adding to the portfolio relative to the other sides of the house. Thanks.

John Ciulla (CEO)

Yeah. Our, you know, our primary focus is continuing to grow a myriad of C&I categories. I would say that the loan behaviors in the third quarter, you know, interestingly, that 1.3% growth, if you take out the securitization, it was sort of more back-ended, if you will, in the quarter, which gives us some momentum on NII as we go into Q4. And as I said, we've continued to see pull-through in the early in the fourth quarter. The reason we didn't up the guidance is because we know there's a lot of activity, both on origination and prepayments in the quarter, and we don't really have full visibility yet. I think, you know, we still have pressure on our sponsor and specialty business from the proliferation of private credit.

We're going to have our asset manager program hopefully up and running in the first quarter, which should give us some additional momentum there. Our middle market performed well. Our public sector finance performed well. You know, we've got other levers to pull in asset-based lending and in equipment finance. So I, you know, think with our portfolio, we'll continue to be able to grow C&I categories. You'll probably see some level, as Neal mentioned, of modest growth in commercial real estate, because right now, if you're good at it and you can get really nice risk reward because there are fewer players in the market. And then I think we'll sort of fill in with our mortgage originations, obviously serving our customers in our market, and then some level of correspondent mortgage origination.

So I would say it's balanced, and on balance, you know, we still think that kind of 5%-ish annualized loan growth is the right number.

Daniel Tamayo (Analyst)

Okay, great. Thanks for all that color.

Operator (participant)

Your next question comes from the line of Bernard Von Gizycki with Deutsche Bank. Your line is open.

Bernard Gizycki (Equity Analyst)

Hey, guys. Good morning, so on page six of the deck, you know, you noted that you've identified and documented certain loans eligible to optimize RWA treatment, and I know you've been talking about this on the call, but just to elaborate a bit more on these actions, and if you could, you know, size how big this was to the capital improvement during the quarter?

Luis Massiani (President and COO)

Yeah. So I think all of our actions in total were about 44 basis points to the quarter. We really went in and did deep dives into our multifamily lender finance and public sector portfolios and looked at the risk weighting. I'll give you an example. Kind of in the public sector, we had a lot of loans sitting at 100% risk weighting, and, you know, general obligation bonds can be at 20% and revenue pledge at 50%. So we did a lot of work to pull additional data and really optimize our risk weighting there. That's one example across the category.

Hopefully, that and then, as we mentioned, the securitization also helped drive increased capital levels, and that was about 6 basis points included in that 44 that I just mentioned.

Bernard Gizycki (Equity Analyst)

Okay, great. That's helpful.

Luis Massiani (President and COO)

Great.

Bernard Gizycki (Equity Analyst)

And then on expenses, you know, obviously, with technology, you know, you basically highlighted, you've been making significant investments in the tech stack, you know, modernizing the core banking platform, the BSA/AML, cybersecurity cloud capabilities. You know, during the quarter, you know, you also highlighted the tech spend increase sequentially, professional services and occupancy costs. Could you just provide some color on those for the quarter on the tech professional and occupancy?

Luis Massiani (President and COO)

You know, specifically, what's, Bernard, your question being, like, specific expenses related to those initiatives for the quarter?

Bernard Gizycki (Equity Analyst)

Yeah.

Luis Massiani (President and COO)

Because that's. Yeah.

Bernard Gizycki (Equity Analyst)

Yeah.

Luis Massiani (President and COO)

We don't really think about it that way. I think that this is ... You know, we, you know, every year we look at a rolling three-year technology roadmap and investment initiatives, and everything that you highlighted there and that we've highlighted in the, you know, the, the specific items that you were talking about are part of no long-term strategies that we've been, that we've been deploying. So there is nothing really new there that we would isolate as something that's going to be recurring long term in nature. You know, Neal alluded to what we expect expenses are going to be and, you know, kind of what the progression of those are going to be into 2025.

You know, all you know, that estimate and projection includes everything that we think is going to be required to continue to modernize the tech stack, build out the tech stack, invest in the various business lines, invest in risk management platforms. You know, all you know, it's all inclusive when we provide that guidance for 2025, and we don't envision that there's going to be any outsized you know, tech spend in 2025 relative to what you've seen this year. We feel, again, pretty good about what our tech you know, long-term technology roadmap is, and we have a clear path to making the investments in specific areas to support client experience, while at the same time building out risk and operating platforms.

Bernard Gizycki (Equity Analyst)

Okay, great. Thanks for taking my questions.

Luis Massiani (President and COO)

Thanks, Bernard.

Operator (participant)

Your next question comes from the line of Laurie Hunsicker with Seaport. Your line is open.

Laurie Hunsicker (Analyst)

Yeah. Hi, good morning, gentlemen, and Neal, welcome.

John Ciulla (CEO)

Thank you.

Laurie Hunsicker (Analyst)

Just to go back to office, here, and certainly appreciate office is only 2% of your book, and you've been very proactive and transparent, but on your $54 million of loan loss provisions that you took this quarter, how much of that was office? And then of the two loans that are new and non-performing, that $45 million and $25 million, can you help us think a little bit about, you know, what is the occupancy, what's the new debt service there? And then specific reserves on those two loans, you know, certainly under the backdrop that you gave Mark, office reserves are 6% or $55 million. Basically, of your $55 million, what are the specific reserves on those two loans?

And then just sort of final question here on office, on specifically that $45 million exposure that Bankwell just filed, they're a part of it. And you guys, it looks like were the lead, i.e., Sterling was the lead. Can you just help us think about, you know, again, this is just per the Bankwell filing, that there was a refreshed property appraisal done in April at $105 million, and then five months later, that property is now worth $36 million. So if you could just help us think through any parts of that, that would be really helpful. Thanks.

John Ciulla (CEO)

Yeah, Laurie, I don't think. First of all, I don't have all of that information, and I don't think I can give you very good answers there. I mean, I'll tell you, with respect to CECL and the provisioning for the quarter, there are so many ins and outs, right? That you can't identify the amount of the provision related to a specific credit or even to a specific portfolio because what you're doing is refreshing and updating your risk ratings along with your qualitative factors, and you're coming up with a refreshed life of loan losses for a $52 billion portfolio. So, you know, certainly, the amount of charge-offs impacts what you provide, but it doesn't necessarily immediately correlate with where the charge-offs came from.

So I don't think I can draw a connection to those two loans to our provision. I gave you the fact that the charge-offs in the quarter, about 55% of the charge-offs were related to office loans. Those loans we mentioned being the largest drivers. We actually had net recoveries in consumer, which offset our overall charge-offs a little bit. So again, it's tough to draw those conclusions. I certainly don't have the in-place debt service coverage and LTVs on those two specific loans now. You know, what I can tell you from the CEO seat is that if they're on nonaccrual, it means that there's a question as to whether or not the underlying cash flows can repay the loan as agreed.

So, we might be able to get you some of that offline with Emlyn and Jason, but I can't give you the specifics on those two transactions. We were the lead lender. You're correct, it was, I think, a two thousand and nineteen or two thousand and eighteen origination, significantly pre-merger. So, I can tell you that we were the agent on those two credits, and I think that's the information that I have available to me here, Laurie.

Laurie Hunsicker (Analyst)

Okay. Okay, and then my follow-up question, just switching gears, when in the quarter did the securities restructuring occur? And then finally, do you have a September spot margin?

Neal Holland (CFO)

Yeah.

Laurie Hunsicker (Analyst)

Thanks for taking my question.

Neal Holland (CFO)

I'll jump in with the September spot margin. You know, so, September was a little bit lower. We were about 3.31%. Loans came down eight basis points and deposits, two basis points. You know, I'll caveat that by saying, monthly NIM is a little bit more variable than quarterly NIM. I'll also say that, September NIM really represents our repricing dynamics. SOFR started moving down well before the Fed cuts, and there was obviously some lag, there with our deposits repricing later with the cut coming in the middle of the month. You know, we also started holding higher levels of cash in September.

So since mid-September, as I mentioned before, we've taken significant action on our deposit costs, that 25% beta already, and we are confident, you know, that our Q4 NIM will come in above our September spot number. Yes, I think that's it. And then the, the transaction there was kind of, it happened throughout the quarter, but probably weighted average more to the middle of the quarter.

John Ciulla (CEO)

Thank you, Laurie.

Operator (participant)

Your next question comes from the line of Samuel Varga with UBS. Your line is open.

Samuel Varga (Equity Research Analyst)

Hey, good morning. Just wanted to go back to the securities book, and you commented on the roll-on yields being around 6% expected on the sort of the $5 billion of annual cash flows on that. Obviously, this quarter's was 584. So can you just comment on why this quarter was lower, why you expect it to move higher over the next 12 months?

Neal Holland (CFO)

Yeah. So, on my comment of that 6%, that was more a mix of loans and securities, so kind of full fixed-rate repricing. To your point, in this quarter, we added $1 billion at 5.84%. I think we're modeling 5.40% average for Q4, and our most recent purchase was kind of in between that 5.84% and 5.40%. So, feeling good about our numbers there, but just to clarify that, that 6% or that plus 200 basis points was the repricing of our fixed securities and loans. So that's why the numbers are a little bit higher there.

Samuel Varga (Equity Research Analyst)

Got it. Thanks for the clarification on that. And then on the Brio deposit base, you said the 60% beta. Just to clarify as well, is that on the new production for this quarter, or is that the overall book, given the short duration of it, that's already realized 60%?

Neal Holland (CFO)

Yeah, the 60% is on the overall portfolio.

Samuel Varga (Equity Research Analyst)

Okay. And then, so in terms of new production, have you been able to get to near 100% or potentially over 100%?

Neal Holland (CFO)

Yeah. So, I think before the cut, and to where we're priced now, we're down thirty basis points, fifty basis points for the cut, and we're actively monitoring for potential additional moves. I think the team has done a really nice job of balancing liquidity versus earnings, and we've been very prudent in our moves, and you'll see more downward moves from us in the future, as we've seen pretty good client reaction so far through the first cut that we've made.

Samuel Varga (Equity Research Analyst)

Great.

John Ciulla (CEO)

There's no real difference. Jim, actually, the portfolio is one rate on the portfolio. So new dollars versus the existing portfolio. It's not like there's diverse, you know, product pricing in there. So the way to think about it is one overall beta for the portfolio, which is existing deposits, plus new deposits, are all getting originated at their, you know, essentially the same, the exact same yield. So the beta on both new and existing would be roughly the same.

Samuel Varga (Equity Research Analyst)

Got it. Thank you.

John Ciulla (CEO)

Thank you, Sam.

Operator (participant)

This concludes the question and answer session. I'll turn the call to John Ciulla for closing remarks.

John Ciulla (CEO)

Thank you very much. We appreciate everyone joining today and your continued interest in the company. Have a great day.

Operator (participant)

This concludes today's conference. We thank you for joining. You may now disconnect your lines.