Wintrust Financial - Earnings Call - Q1 2018
April 17, 2018
Transcript
Speaker 0
Welcome to the WinTrust Financial Corporation's First Quarter twenty eighteen Earnings Conference Call. At this time, all participants are in a listen only mode. Following a review of the results by Edward Wehmer, Chief Executive Officer and President and David Dykstra, Senior Executive Vice President and Chief Operating Officer, there will be a formal question and answer session. During the course of today's call, Windstream's management may make statements that constitute projections, expectations, beliefs or similar forward looking statements. Actual results could differ materially from the results anticipated or projected in any such forward looking statements.
The company's forward looking assumptions that could cause the actual results to differ materially from the information discussed during this call are detailed in the first quarter twenty eighteen earnings press release and in the company's most recent Form 10 ks and any subsequent filings on file with the SEC. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Edward Wehmer.
Speaker 1
Thank you. Welcome, everybody, to our first quarter earnings call. With me, as always, are Dave Dykstra, Kate Bogey, our Legal Counsel and Dave Starr, our Chief Financial Officer. We'll have the same format as usual. I'll give some general comments regarding our results, turn it over to Dave Dykstra for more detailed analysis of other income, other expenses and taxes, back to me for some summary comments and thoughts about the future, then on to questions.
We're pleased to report on the earnings front that we recorded record earnings for the ninth consecutive quarter in a row. David Long, if you're out there, you should know that Papa George would be very proud of us. Net income totaled $82,000,000 up 19% over 2017 and 40% over the 2017. Earnings per share were $1.4 compared to $1 the 2017, 1.17, 40% up over last year, almost 20% up over the fourth quarter. Just to note, pretax income was $108,000,000 which is almost 13% over the fourth quarter and 23% over the first quarter of last year.
So even without taxes, we had good operating results. Our return on assets was 120,000,000 compared to 1 percent at the end of the fourth quarter of last year. Return on equity was 11.3 and return on tangible equity was 14%. As is readily apparent, our operating trends remain consistently positive. On the net interest margin front and net interest income front, the net interest margin increased nine basis points over the 2017 and eighteen basis points over the 2017 to 3.54%.
Net interest income grew $6,000,000 over the 2017 despite two days two less days quarter versus quarter. Both increases were driven by the higher rate environment and a larger earning asset base. The average earning asset base grew $586,000,000 in the quarter. Earning asset yields increased 13 basis points versus the fourth quarter, while interest expense increased eight basis points over 2017. Our loan to deposit ratio of the quarter rose to 95.2%, obviously higher than our desired range of 85 to 90%.
Some of this was caused by our back end loading of loans in the quarter, that is, ending loans exceeded our average loans by $365,000,000 This bodes well for as a head start for Q2 earnings of this year. Our deposit marketing is just kicking in, so we'd expect December to begin receding towards our targeted ratio. Accordingly, we expect our deposit rates to increase going forward. Our historical beta to date has been in the 20%, low 20% range. We expect December to be in the 40% range going forward.
As we are still very asset sensitive, additional rate increases, including the one announced in mid March, should still add materially to our bottom line despite this increased deposit beta. Every quarter point increase in Fed funds should continue to add north of $20,000,000 net interest income on an annual basis. You might note that this number has not changed from past discussions due to the increasing size of our balance sheet. In other words, we expect our rates to increase our deposit rates to increase a little bit faster, but our balance sheet is growing and that should cover that. We've been in no rush to build our balance sheet definitely as the yield curve as long as the yield curve is yet to move in concert with the short end, thereby for storing the liquidity stalling the liquidity play we've discussed in the past.
This initiative is still in the cards for us. I expect our loan to deposit ratio to stay in the low 90s until such time the spread for the long end gets better. More on this later. As such, with future rate increases, we anticipate our net interest margin to continue to grow. Remember that it takes a full year for these increases to work their way through our balance sheet.
So some of the benefits of some of the past increases are still being realized. On the credit front, credit remains historically great. Both NPAs and NPLs were down from the already low numbers, a $3,500,000 decrease in total. OREO balances were down $10,300,000 as we continued to push out old assets. Valuation charges were up as we reduced the number of older properties.
The fire sale values is just to get them out of here. Times are good, let's clear the deck, I think is the idea. So we really reduced the number to really liquidation value as we had some lowball offers. But why not push them out now? NPLs were down a touch versus Q4, but you'll see there's a change in the mix of the NPL portfolio.
Commercial premium finance loan non performers increased by 4,500,000 in the quarter, while all other categories decreased by a like amount. This increase was due to three unrelated yet one time events. These events also resulted in net charge offs in this category increasing $2,600,000 from Q4 and rising to 68 basis points, which was our normal historical rate, which resides in the mid-one 120 basis point range. The first of these was an agency fraud of about $1,500,000 We get one of these about every ten years. This one we usually get four or five a year.
We catch them early. This one was not caught during human error, but we expect minimal recovery. As you know, this is one of the risks of the business. We've been very diligent in this area, but this is one that was not caught as early as it should have been. Full review of the portfolio ensured our discovery of this incident with no indication of similar occurrences.
Control has been modified accordingly. The two other onetime events related to the bankruptcies of two small casualty insurance companies. We expect to recover majority of these funds through liquidation process, but these can take time, and I mean time and years. Refunds confirmed to date are carried in NPLs. Others were charged off, so we'll look out on recovery.
As said, we consider the timing of these events to be anomalies. Core business remains a very good one for us. We expect net charge offs in the normal range going forward. So in summary, credit remains very good. NPAs as a percent of assets decreased to 0.44% from 0.47% on net charge offs.
Reserves as a percent of NPLs was at 1.56, 156%, up from 153% at year end. Net charge offs as a percentage of loans increased five basis points to 12 basis points for the quarter. We continue to cull our portfolio for cracks, and we'll expeditiously move assets out when said crack any said cracks are found. We will also aggressively work our OREO portfolio to clear the decks. The other income and expense side, Dave is going to go through these in detail momentarily, but just some general comments.
On the mortgage front, our acquisition of Veterans First, which is going according to plan, provided a little noise in our expense numbers as we experienced a full quarter of overhead expenses with only one month of revenue. As part of the deal, they got to keep and close the loans that were in their pipelines as
Speaker 2
of
Speaker 1
the closing date. Dave will explain this a little further. Our wealth management operation continues to improve with revenues increasing to almost $23,000,000 for the quarter. Our net overhead ratio for the quarter was 1.58%, above our target of one point percent, but better than 11 basis points better than the 2017. Some of this was a little balance sheet driven as we are delaying our initiative delaying pulling the trigger on our liquidity initiative.
Other factors included the Veterans First acquisition, historically low slow first quarter in the mortgage area, our aggressive approach and our aggressive approach to clearing out some old OREO expenses and some other expenses that Dave will discuss. And that overhead ratio of 1.5% or better remains our goal for the year, but we believe it to be attainable. On the balance sheet front, assets totaled $28,457,000,000 up 7.6% from the fourth quarter and 10% from the 2017. Loans demand was very good, up across the board with $22,470,000,000 in loans, up $519,000,000 from the first quarter or the fourth quarter and $2,200,000,000 from the fourth quarter. Deposits were a little bit slow coming in.
I'll talk about that in a second. But as I mentioned, we start the quarter three fifty million dollars ahead of the game in terms of average versus ending balances going forward. Loan growth is projected in the high as we projected was in the high middle the high single digits and growth was across the board. Loan pipelines are consistently strong and actually increased this quarter. Deposit growth was negligible as some of our year end some year end large account balances were moved out.
It should be noted that we started our marketing at the beginning of this year and as such, we opened over 3,000 new checking accounts in the first quarter. We intend to continue our marketing here and also begin cross selling new relationships to our new customers. As mentioned, the loan to deposit ratio is higher than we want. The liquidity initiative we discussed is to have deposits growth outpace loan growth over time. The excess liquidity generated would be invested in a laddered securities portfolio.
This would have the effect of increasing earnings and ROA, lowering our net over add ratio and marginally decreasing our net interest margin and lessening our positive interest rate sensitivity, which makes sense as rates increase, we'll be bringing that down. With the curve flattening, have yet to pull the trigger here. Our marketing plans are kicking off. We expect to begin taking some headway on this initiative throughout the rest of the year. I'm going to turn it over to Dave for his discussion of other income, other expenses and taxes.
Speaker 3
Thanks, Ed. As normal, I'll touch on the noninterest income sections and the noninterest expense sections as well as a brief review of the taxes. In the noninterest income section, our wealth management revenue totaled $23,000,000 for the 2018, which was up 5% from the $21,900,000 recorded in the prior quarter and was also up from the $20,100,000 recorded in the year ago quarter. The trust and asset management component of this revenue category increased to $17,000,000 in the fourth quarter from $15,800,000 in the prior quarter due to market appreciation at the beginning of the quarter. The brokerage revenue component remained relatively steady at $6,000,000 in the first quarter, down by only $36,000 from the prior quarter.
Overall, the 2018 exhibited strength in revenue generation and represented a record quarter for our wealth management fee income. Mortgage banking revenue increased 13% or $3,500,000 to $31,000,000 in the first quarter from the $27,400,000 recorded in the prior quarter and was up substantially from the $21,900,000 recorded in the first quarter of last year. The increase in this category's revenue from the prior quarter resulted primarily from additional revenue of approximately $5,900,000 related to the Veterans First acquisition and a $4,100,000 positive fair value adjustment related to the mortgage servicing rights asset. That $4,100,000 fair value adjustment on MSRs compared to just $46,000 fair value adjustment in the fourth quarter of last year. This was partially offset by lower origination volume due to typical seasonality during the winter months in our primary market area.
The company originated and sold approximately $779,000,000 of mortgage loans in the first quarter, including approximately $112,500,000 related to the Veterans First acquisition. This compares to $879,000,000 originations in the prior quarter and $722,000,000 of mortgage loans originated in the first quarter of last year. Also, the mix of loan volume related to purchased home activity was approximately 73% compared to 67 in the prior quarter. Given existing pipelines of full quarter production for our Veterans First product line and the spring buying season, we expect originations to increase nicely in the 2018. As you know, the acquisition of Veterans First happened in January and began to contribute to mortgage revenue as we build out our pipelines began to close on those loans primarily in the latter half of the first quarter.
As a reminder, the loans locked in the pipeline when we closed on that acquisition accrued to the seller, so WinTrust needed to begin to build the pipeline early in the quarter, and that pipeline resulted in the majority of the revenue being realized late in the quarter. We expect to realize the full impact of the acquisition beginning in the second quarter with further increases in loan originations and revenue and corresponding increases in associated variable costs. Operating lease income increased in the current quarter compared to the 2017, primarily as a result of an approximate $1,100,000 gain realized from the sale of certain equipment held on operating leases. Other noninterest income totaled $11,800,000 in the first quarter, down approximately $728,000 from the $12,600,000 recorded in the fourth quarter of last year. There was a variety of reasons for the decline in this category of revenue, including not having any FDIC accretion related to loss share arrangements as we exited all those loss share arrangements in the fourth quarter of last year.
We had slightly higher losses related to foreign exchange valuation adjustments associated with the U. S.-Canadian dollar exchange rate, a lower level of loan syndication fees and a slightly higher valuation charge on certain assets held at fair value due to rises in interest rates. Turning to the noninterest expense categories. Noninterest expense totaled $194,300,000 in the first quarter, decreasing approximately $2,200,000 from the prior quarter. The decrease was generally related to approximately $8,800,000 of less commissions and incentive compensation, dollars 2,200,000.0 of lower professional fees primarily related to a reduced level of consulting expenses, offset by an increase in advertising and marketing of $1,400,000 and an increase in OREO losses and valuation adjustments of approximately $2,300,000 The prior quarter also had a pension valuation charge of approximately $1,200,000 that did not reoccur in the current quarter.
Also, total non interest expenses were impacted by approximately $5,900,000 of aggregate expense related to the Veterans First acquisition. So if we were exclude those expenses, overall non interest expenses would have declined approximately $8,100,000 on a same store sales type of approach. I'll talk about the more significant fluctuations from the fourth quarter. Salaries and employee benefit expenses were the main drivers of the decline in noninterest expense during the quarter. This category of expenses decreased $5,600,000 in the first quarter compared to the fourth quarter of last year.
As for the components of the salary and employee benefit expense, the annual and long term incentive compensation expense decreased approximately $6,800,000 from the prior quarter. Similar to what we communicated to you during the prior earnings call, we incurred additional annual bonus and long term incentive performance program accruals during the fourth quarter of last year due to higher forecasted net income for future years due to rate hikes balance sheet growth and recently enacted tax expense. The 2018 returned to more normalized levels. Commission expense was also lower in the 2018 by approximately $2,000,000 compared to the prior quarter, primarily due to lower mortgage loan originations. The base salary component increased approximately $3,700,000 in the first quarter over the fourth quarter of last year.
The first quarter included the impact of annual base salary increases that generally took effect on February 1 and were generally in the 3% range. It also included the increase in our minimum wage to $15 per hour for eligible noncommissioned employees, which took effect in early March. The $2,400,000 impact of the Veterans First acquisition also contributed to the growth in that number, and we also had normal growth in our employee base as the company continues to expand. Employee benefits expense was down approximately $546,000 in the first quarter compared to the prior quarter. The lower level employee benefit expense is related to two primary causes.
The first was the 2017 charge of $1,200,000 related to pension obligations that we inherited through two prior acquisitions that did not similarly impact the current quarter. And the second reason was a slight decrease in our health insurance costs. These decreases were offset somewhat by an increase in payroll taxes, which tend to be higher in the first quarter of the year. Turning to marketing expenses. These expenses increased by approximately $1,400,000 from the 2017 to $8,800,000 As we focus on building the franchise, we expended a bit more money on sponsorships and mass media advertising, including mass media branding campaigns tied to the Winter Olympics to generate brand awareness and additionally, some costs for the deposit promotions that Ed spoke about.
We believe the results of such advertising efforts have been effective and look forward to the benefits of those in the future quarters. Professional fees decreased to $6,600,000 in the first quarter compared to $8,900,000 in the fourth quarter of last year. Professional fees can fluctuate on a quarterly basis based on the level of legal services related to acquisitions, litigation, private loan workout activity as well as the use of any consulting services. This category of expenses came down substantially from the prior quarter, which included relatively substantial costs related to consulting engagements associated with investments in enhancing our digital customer experience and product distribution enhancements using technology and certain other IT initiatives. The first quarter was not similarly impacted with as much of these consulting costs.
OREO expenses were elevated, as Ed mentioned, in the first quarter as the company is making a concerted effort to sell or position ourselves to reduce the level of OREO properties held. Accordingly, during the 2018, the company recorded approximately $2,400,000 of realized losses on the sale of OREO properties and negative valuation adjustments to value certain properties at levels that will hopefully produce quicker sales. Although we have relatively low amount of OREO properties, we simply would like to reduce the inventory further, especially those properties that have been slow to exit the portfolio. All of the other expense categories, other than the ones I just discussed, were up approximately $1,800,000 on an aggregate basis in the 2018 compared to the 2017. This increase can be attributed to the expenses related to the Veterans First acquisition.
Without the Veterans First acquisition, these other expense categories would have actually decreased by approximately $700,000 Turning to taxes. The impact of the recently enacted tax reform, which reduced the federal income tax rate for corporations from 35% to 21% effective January 1 aided our net income during the quarter. Our effective tax rate for the quarter was 24.14%, but without the impact of the $2,600,000 of excess tax benefits associated with share based compensation, the effective tax rate would have been approximately 26.5%. If we were to compare these rates to the 2017, the company's effective tax rate was 33.67% and was approximately 37.5% excluding the impact of the excess tax benefits associated with the share based payments. So the net year to year effective tax rate was down approximately 11%.
At this time, we continue to expect our effective income tax rate for the full year of 2018 to be approximately 26% to 27% if you exclude the impact of the excess tax benefits associated with share based compensation. So with that, I'll conclude my comments and throw it back over to Ed.
Speaker 1
Thank you, Dave. So in summary, all in all, quarter for WinTrust on all fronts. Momentum continues across the board. Reduced taxes and higher interest rates have been beneficial to us, but core earnings growth and balance sheet growth bode well for future earnings growth and growth in franchise value. We are pushing our organic growth agenda as acquisitions in general become relatively expensive.
In that regard, we have a number of new branches and neighborhoods in our designated market area where we are not currently present. We have these planned. Our retail small business marketing programs, which we embarked on and earnest at the beginning of the year, are working and pulling in new accounts and relationships. However, that doesn't mean that we're not investing in potential business combinations in all areas of our business. As mentioned in previous calls, gestation periods have become a lot longer pretty much on all fields, but we are very busy in that regard.
We remain well positioned for higher interest rates. Credit is as good as it's going to get. We continue to review the portfolio for any early morning sides. Our exiting deals expeditiously and cracks are apparent. Loan growth has been good and pipeline has remained strong.
We continue to look at opportunities to further diversify our portfolio. We still believe the portfolio will grow in the mid to high single digit range for the year. We are embarking on our liquidity initiative, which should have the desired strategic results, which I talked about earlier. So in summary, we're very well positioned, and we like where we sit. That being said, it's a time like this where you get kind of worried.
When things are this good, you start looking around the corner, there's a boogeyman or the monster under the bed. We continue to evaluate where these risks could possibly be and making plans accordingly. But we're not sitting in our laurels. I've been in this business too long. I can say that now that I'm an old man.
They're out too long seeing these movies, hope for the best plan for the worst, as my father always used to say. With that, we are going to be assured of our best efforts to ensure the long term growth and franchise value of your company. Now that being said, times are pretty good right now. We continue to want to make hay while the sun is shining, yet buy some umbrellas just in case. So with that, I'm going to leave it open for some questions.
Speaker 0
Our first question comes from the line of Jon Arfstrom of RBC Capital Markets. Your line is open.
Speaker 1
Thanks. Good afternoon. Hi, Jon.
Speaker 4
Hi. A couple of things here. The liquidity strategy or deposit marketing is, I guess, what you referenced earlier in the call. I think we understand why you're doing it, but just give us a little more detail in terms of what you're doing and what you're targeting there.
Speaker 1
Well, we I don't like running at 95% loan to deposit. We've been running 85% to 90% for a long time. And we've let this move a little bit just because we're comfortable that we have altered sources in the event that we had a liquidity issue. Have more liquidity available to us than we would need. But with the long end, where it is right now and those spreads are not there, why break it in and not make any
Speaker 3
money on
Speaker 1
it? So we expect the long end or we have the long end to continue to grow with inflation up, and we see wage inflation starting to occur. I think the biggest issue our customers tell us, and you probably hear it from a lot of people, is finding good people and having to pay up for them. So we expect this to occur. We expect the long end, there was some separation in the long end of the curve.
And as such, we're going to grow deposits faster than loans, get back to our desired range over a period of time of 85% to 90% and ladder bring a ladder security portfolio in, which should hopefully after tax make you a little over 1% is our goal, like to make 1.25% if we could, and go from there. So, it's just a play a little bit of a play on interest rates right now. If you were to bring that number back to 87.5% right now, it's close to $2,000,000,000 in deposits. So we have our work done out for us. But running those numbers, you can see how beneficial that would be to the bottom line.
It would hurt our margin a little bit, and our net overhead ratio would drop precipitously. And also, as rates move up, which we expect them to continue to do as everybody does, we're well positioned for those higher rates. Those rates continue to move up. We think that we should start cutting back on our GAAP, our overall interest rate sensitivity position to protect the downside. This will help us do that also.
So it just seems like the right thing to do. We don't think there's any rush right now. But we as rates continue to move up, it you can see all the elements, the strategic elements that, that brings to the table for us. Does that make Yes,
Speaker 4
it does. So the message on the higher deposit betas, part of it is just about naturally rising deposit costs, another part of it is reducing the loan to deposit ratio. It's just two parts really.
Speaker 1
Yes. Yes. And we anticipated that in our budgeting and our planning process that our beta could we have such a retail based deposit structure that we've been able to lag probably more than others. But now that you can't lag as much as we have been, we need to bring those numbers up to be competitive in the markets. So and we built that in.
Hence, why another zero two five point rise in rate is only $23,000,000 and $23,000,000 two years ago when we started reporting that number. But we've a much larger balance sheet. You can kind of see that we built in the a little bit more deposit cost than you would imagine.
Speaker 4
Yes. Okay. That makes sense. Good. Maybe, Dave Dykstra, for you on mortgage banking.
If you set aside the Veterans First originations, what does the pipeline kind of look like throughout the quarter?
Speaker 3
That actually looks pretty good. Veterans First, on average, we probably think we have like half a quarter of revenue production, so we'd expect that to double next quarter. On the legacy portfolio, we actually think that could be up substantially. You took out Veterans First, if you look to give a little bit more detail in the press release, places time on our mortgage banking revenue and detailed it out so you can see all the components. We also broke out the Veterans First origination and our other sort of legacy, so to speak, originations, which was a pay of $660 some million.
I would expect that to that might be up 50% in the second quarter simply because
Speaker 1
of
Speaker 3
seasonality of the buying season. So maybe that goes up a few $100,000,000 plus the Veterans First is probably about $100,000,000 So the pipelines have to develop and it's early in the quarter, but our thoughts are that, that number could be getting up closer to $1,000,000,000 of production in the second quarter, plus or minus.
Speaker 1
Okay, good, good. That's what
Speaker 4
I was getting at. And then I guess the last one on that topic, the production margin was up. Is that mix? Is that Veterans First driven? Or is there something else going on?
Speaker 3
Yes. The production margin on our core business was relatively stable. I think it was down just a few basis points. Veterans First loans, those VA loans have a much higher margin to them. So that's what brought the overall production margin up.
Speaker 4
Okay. Good. All right. Thank you.
Speaker 0
Thank you. Our next question is from David Long of Raymond James. Your line is open.
Speaker 5
Hey guys. As you indicated in your opening comments, yes, Nick, Papa Giorgio and the rest of Griswold family, I'm sure are very proud.
Speaker 1
With that said, So Of I think that's the
Speaker 5
course. Of course. Vegas Vacation, a good movie, one of Chevy Chase's, but I prefer Fletch when it comes to Chevy Chase. That said, thinking about the expense base for the rest of the year and you guys seem like the expense to asset target of 150,000,000 is still in your on your radar screen for this year. I'm assuming that, that includes de novos and branch openings that you have.
But can you maybe walk me through how you think the expenses could progress as we go through the year and still stay at that 150,000,000 level?
Speaker 1
Well, I'll take a little of it and then Dave will jump in. The OREO expenses are included in there, and we're going to continue to push those down. We believe asset growth is going to stay strong, it's as a percent of assets. And also, January is a slow month for mortgages in general, but then the Veterans First picking up those extra expenses. If you were to back those things out, you're pretty close to the number right then and there.
So we're not that far off from an operating basis of what we look at. So we think even with the with our planned organic expansion, numbers should be in pretty good shape. Dave?
Speaker 3
Yes. I'd probably echo that. I mean, you backed out the $2,700,000 change in the OR goal, your net over address should be down around the 154 range. And then as Ed talked about, big piece of the net overhead ratio is the denominator, which is your average assets. So if this deposit initiative that we have kicks in a little bit, that pretty much gets you there.
And then as Ed mentioned, mortgages are increased mortgage activity is beneficial to the net overhead ratio. So as we get into the second and third quarters when mortgage activity is typically higher for us. That should help also. So I think if you look at a better mortgage business and a bigger balance sheet and just typical cost controls and back out this OREO charge we took this quarter, you can easily draw a road map that would get you there. But the big thing would be just the asset growth is a big driver of that.
Speaker 5
Okay. Got it. And then on the loan growth side, I think you mentioned mid- high single digit expectations for the year. Is that coming from an increase in your lines of use or utilization rates? Or is it are you still bringing in new customers to the bank?
Speaker 1
Interestingly, it still is bringing in new customers and growing the franchise through new relationships. An interesting phenomena that I something I usage still is around 52%, 53% on our lines. But what we've seen is lines increasing. We've seen a lot our clients coming in and increasing their overall lines by 10% or 20% because of increased business and they want to keep dry powder. So that number is a little bit misleading because we're at 52% of a higher base right now.
So in other words, I think you can say that there is some real economic expansion finally taking place. Does that make sense?
Speaker 5
Yes. Thanks for the color. That's all I had. Thank you, guys.
Speaker 0
Thank you. Our next question is from Brad Milsaps of Sandler O'Neill. Your line is open.
Speaker 1
Hey, good afternoon, guys. Hi, Dave, just to follow-up on John's mortgage question. The $5,900,000 in revenue related to the Veterans acquisition, is that all origination revenue? Or is that a mix of servicing as well?
Speaker 3
Origination and servicing.
Speaker 1
Okay. Got it. Got it. I'll follow-up. I'm just trying to get a sense of really what their gain on loan sale margin was because it did seem to be quite a bit higher than yours.
Speaker 3
Yes. It's between it's close it's 4.5% to 5% margins right now, so quite a bit higher than
Speaker 1
we are. Perfect. Oh, great. That's very helpful. Then Brad, that's why we that's why we partnered with them.
That and their higher margin still gives us a better mix of distribution, but also their expense model is different than the historical expense model in terms of not having to pay out 55% of the commission. So it's a good profitable business for us, a nice blend into what we were doing. So strategically, that acquisition worked great. We're excited to have them with us.
Speaker 3
Yes. And maybe a little bit more color for those people out there that try to model this out. If you increase the revenue out there, although we had a full quarter of expenses, there are variable costs that will go up. So they do pay commissions. As part of a consumer direct model, they also buy leads out there that helps drive the business.
So I would say for every dollar in the second quarter of revenue that goes up, there still may be an incremental 35% or so of expenses that come along with that with commissions and the lead generation and just the variable costs that go along with it. So if you're trying to model growth into the second quarter, even though we had a full quarter of expenses this time, those expenses will probably go up in the second quarter because of commissions, additional some additional lead generation and just some variable costs that go along with closing a loan. So, it was it was close to breakeven this quarter simply because we had to build the pipeline before we could close it, but it should certainly be profitable for us in the second quarter.
Speaker 1
That makes sense. And would you expect that business to be you kind of talked about it doubling in the next quarter, but would you expect it to be about 20% of your overall mortgage business going forward? Or do you think you can make it a bigger part of sort of the overall One Trust mortgage pie, so to speak?
Speaker 3
Yes. It's probably close to 20% is what we'd expect right now. That's probably a good range. I mean, we'll have to see how interest rates play out and how the mix plays out. But right now, I think high teens or 20% is probably not a bad range.
Speaker 1
Okay. And then just kind of switching gears to a piece of the balance sheet. Which is kind of small relative to the overall picture, but I did notice that borrowings, FHLB borrowings were up quite a bit linked quarter, but the rate was down. Just kind of curious, is that something that's kind of temporary that will reverse out? Is that in lieu of kind of some of the deposit movement you had this quarter?
Can you kind of give us a sense of kind of what the thinking was there? Is that preparing for something else as you kind of implement this deposit strategy? Well, that's always been our they call it around here as equilibrium, where you take mortgage held for sale plus the assets in our mortgage warehouse lending, a perfect world we finance that with Federal Home Loan Bank overnight money. Great spread there. It's variable.
You don't have to worry about the you can give it back if those numbers go up or down, and we can manage our liquidity that way. In the past, we've always had excess deposits that cover that, so we were never really at edge equilibrium. So right now, you're there. I would imagine if we do raise we're successful in continuing our organic growth, that, that number would come down. But if we weren't, that number would stay pretty much even.
It's a perfect match for us, both from a duration standpoint and a rate spread standpoint. Then we have excess deposits like we did throughout the years. We didn't bother grossing up the balance sheet at that point in time. Does that make sense? Yes.
That's a perfect explanation. Thanks for that. I appreciate it.
Speaker 0
Thank you. Our next question is from Chris McGarrity of KBW. Your line is open.
Speaker 6
Hey, good afternoon. Dave, maybe a question for you. Just want to make sure on the leverage strategy. Is it about the absolute level of long rates? Or is it the shape of the curve?
I guess what should we be looking at specifically to see when you guys might pick up the pace of securities purchase?
Speaker 3
No, it would be the shape of the curve. You want to get a spread between what you're going to raise the deposits at and what you invest in, and we would probably invest some of that, ladder it out. But a good portion of that would probably be Ginnies and Fannie's. So if you were sort of looking at where the deposit rates could come in and where you could lay them off in Ginnies and Fannie's, possibly some munis something like that. But it's the spread that we're looking at.
So with a relatively flat yield curve now, that doesn't work out to the numbers that Ed was talking about. So we need some steepening of the curve. So it's not the absolute rate, it's the spread.
Speaker 1
Okay.
Speaker 6
Thanks for that. On the loan yields, the nice improvement sequentially. Part of that, I would imagine, is the big LIBOR portion. Was there anything unusual in terms of loan fees, accretion, non accruals? Or is about this level of improvement per rate hike about what we should be expecting?
Speaker 3
Yes. And there was nothing unusual of the types that you talked about there. So this was really just the portfolio reacting to the rate environment.
Speaker 1
Remember, it takes a full year, like on the life insurance loans that are based on one year LIBOR. It takes a full year for those debt to reset for those portfolios. So we're still in the process of, what, absorbing three rate increases in that portfolio, notwithstanding future rate increases going forward. So it literally takes a full year for us to be in a position to get that $20,000,000 $23,000,000 we were talking about every quarter point. So we would expect that to continue even if we don't get another quarter point of rise in rates in the next month or two.
You know what I mean?
Speaker 6
Got it. Understood. That's great. And then maybe one last one, just to make sure I heard you guys right on the loan growth. I think you've talked about in the past high single digit.
And I think in your prepared remarks, you said mid to high. Is that just a wordsmithing? Is that you tweaking the guidance a little bit softer?
Speaker 1
No. I think it's the same. It's you know, what's high single digits? Eight or nine? I'm thinking seven to nine, somewhere in there.
Got it. Okay. I don't know what it's all semantics, I guess.
Speaker 3
Yes. So I think the short answer is we're not changing our tone.
Speaker 6
Okay, great. Thank you.
Speaker 0
Thank you. Our next question is from Nathan Race of Piper Jaffray. Your line is open.
Speaker 7
Hey, guys. Good afternoon.
Speaker 1
How are you?
Speaker 7
Just going back to the I'm good, thanks. Just going back to the loan growth discussion, Ed, just curious to get your updated thoughts on the commercial real estate market in Chicago, specifically multifamily. It looks like you guys had pretty good growth in commercial real estate during the first quarter and look like Illinois comprised a large chunk of that. So just curious on your updated thoughts on that asset class.
Speaker 1
Well, it's you really have to dive down, look at asset class. You're interested in the multi apartment buildings. We're really not interested in doing those right now.
Speaker 8
Retail The
Speaker 3
is something we're backing off of to a little bit, those two asset classes.
Speaker 1
Yes. What we've got is a number on the commercial real estate side, we have a number of larger construction projects. McDonald's headquarters that we led we co led that deal. They're moving into the next two months. Wrigley Field, McDonald or the new hotel, the development around Wrigley Field, those are all kind of working their way through.
So industrial real estate is still strong. Office real estate is still strong around the city. And in the suburbs now. We're comfortable with those. But again, these are not one off deals.
These are relationship deals. This isn't like in the past where we were beasts of burden where we we would just take a hunk of a deal and with the borrower who really didn't know that well. We we have to have full relationships with them. Sponsorships have to be good. We're not we're not getting out over our skis on this stuff right now.
We're being very cautious on the real estate side, as you would imagine. So a lot of it also has to do with the middle market business we're picking up to continue to pick up, where there's a building component that comes with it.
Speaker 0
Our next question is from Terry McVoy of Stephens Inc.
Speaker 1
Hi, Kerry. Hi. Just a follow-up on, I think it was Brad's question. The Veterans First expenses of $5,900,000 just $2.4 that was salaries. And I just want to make sure I understand correctly that $3,500,000 or call it $14,000,000 annualized you described as paying up for leads, etcetera.
Is that it sounds like that run rate is going to increase going forward? And then where within the expense lines will that will those expenses show up?
Speaker 3
Yes. So of the 5,900,000.0 you're right, dollars 2,400,000.0 was the salaries line. So then we do have commissions that would show up in the commissions line, various other expenses, occupancy, employee benefits and the like. But the big piece where you get a little bit of offset from our legacy business is lead generation. That shows really up in other noninterest expenses.
That's just loan expenses in our mind. That's just the cost of acquiring a loan out there. So it would show up in other noninterest expenses.
Speaker 1
Okay. And then just a separate question. The, call it, 11% annualized decline in noninterest bearing deposits, anything there beyond what you, I think, called out as seasonal in the press release?
Speaker 3
Yes. I think that's right. There's a lot of inflows in at the end of the fourth quarter and just some of those naturally came out in the first quarter. So we don't see anything systemic there, just sort of natural ebb and flow with seasonality in year end.
Speaker 1
That's it. Then my list. Thank you.
Speaker 3
Thank you.
Speaker 0
Thank you. Our next question is from Kevin Reevey of D. A. Davidson. Your line is open.
Speaker 1
Good afternoon, Hi, Kevin.
Speaker 2
So first question is on your the branch that you just recently opened in Wrigleysville. What's your anticipated timing as far as when you think that branch will breakeven then for the other four to five branches that you anticipate opening this year?
Speaker 7
Well, they usually breakeven
Speaker 1
in about eight months to a year. I think that's a fair number.
Speaker 2
Okay.
Speaker 3
But it's it's it's it's not a huge branch. It's a relatively small branch, and so, I think I think Ed's estimate is right.
Speaker 1
Show up on your account yet, Kevin? You gotta get your your Cubs debit card. That's right.
Speaker 3
And you put in all your deposits, Kevin, we'll we'll shrink that down to six or seven months.
Speaker 2
Okay. No deal. And then we're hearing from a lot of the other Indiana banks that they're seeing some some growth from a lot of migration from Illinois given the state's woes in into Indiana. Are you guys feeling any of that? Any of your customers feeling any of the, you you know, outward migration or any of fiscal woes at the state level?
Speaker 1
Well, I think everybody everybody, you know, worries about that. The, know, we're we're up in we're up in Wisconsin, across the border in Wisconsin. We have a heavy presence. So we we don't really lose any of that business. Indiana, we still service Northwest Indiana.
We have one branch there now. We'll continue to build. Most people don't have so much sunk cost in Illinois, they're not picking up and moving in total. They might expand there. They don't change their banking relationship out of expansion.
I'd be interested to hear who you're talking to that says they're taking all of Illinois' business because we're still right here. You think about Chicago, Northwest Indiana and Milwaukee, Megapolis, I think it's the fourteenth biggest economy in the world. So, there's still plenty of business to go around. I don't worry about it as much as others do, right now because there's still good building going on there. There's still, I think Chicago was the number one city in the country for branch reload or for headquarter relocations last year.
There's still a lot of good things going on here in spite of the of the the maelstrom around the the economic situation in the state. So I think we're hopefully, we'll work through that. But all in all, there's still a lot of business we had here in Chicago and in our market area. So I'm not, I don't think we're gonna see, Chicago turning into Detroit anytime soon or the old Detroit anytime soon.
Speaker 2
And then lastly, credit, as you say, is as good as it's going to get. How should we think about modeling the provisioning going forward for the rest of the year, given the credit is as good as it's going to get?
Speaker 3
Well, if you look at our 60 to 89, those near term delinquencies were down from last quarter. There's a little blip in '30 to 59, but most of that was administrative. We've actually had about $50,000,000 of that already cleared off just because it was administrative. So we're really not seeing any trend where the credit metrics look like they're getting worse. So until you start to unless you change the mix of the business where you're putting more loans on with higher reserve levels, which our mix has been pretty steady and the reserve the loans level has been pretty steady for quite a while now.
So unless you started to see a crack in credit quality, increase in delinquencies and the like, then I think you can think our provisioning level would be similar and unless you had a large announced sized growth quarter where it might increase it. But it really would depend on asset quality and growth. We see asset quality okay, and we've talked about the growth aspects. Kevin, it's so low right now that
Speaker 1
you can have one commercial deal go bad and blow your numbers up. Mean, materially or relatively speaking, go from where we are with a couple of basis points, 12 basis points up to 25 or 30, which is still remarkably good. We're calling the portfolio, trying to push things out constantly if we see any crack to avoid that. But eventually, something's going to happen. I mean, and the numbers are so low that a 5 or $6,000,000 charge off on one deal is your you know, is gonna be, would would would stick out.
So, you know, it's hard to I know that I I can empathize with you how hard it is to model. But if I was doing the modeling, I'd probably just add 30% or so to what we have in our provisioning and look good after the fact. But something eventually will will happen. I mean, we we're not that good or that lucky, but we're trying to stay ahead of the game. And again, on a material on a relative basis, you have one pop through, which would change our provisioning levels accordingly.
We don't see it. We don't anticipate it. We're fighting against it. But eventually, something's going to happen.
Speaker 0
Our next question is from Michael Young of SunTrust. Your line is open.
Speaker 9
Hey, good afternoon.
Speaker 3
Hi, Michael. Hi, Michael.
Speaker 8
I wanted to get a
Speaker 9
little color maybe just again on customer activity and what you're seeing as some of these loans come for renewal or repricing after extended duration at lower rates. And now with a significant step up we've had in both one month and twelve month LIBOR here recently, are you seeing any give on the absolute credit spread even though the base rates increase?
Speaker 1
We're seeing that start to happen in the market. Again, we have our profitability models and our loan policy, we don't vary from them. So we adjusted our profitability models to do on an after tax basis and raised all those. Don't want to give away the benefits of the taxes because as you well know what Washington give it, Washington can take it away very quickly. You really don't want to you still got to get paid for your risk notwithstanding taxes.
So I would say there's always been pressure on spreads. They were they had worked their way down on the commercial side, low enough that they really can't go much lower on a commercial middle market lending. They were low already. So we're not seeing a lot of that. On real estate side, you see a little bit of it, but we'll just pass on it.
If it doesn't cut our pricing, we don't take it. We haven't seen them given away. We haven't seen a mass effort by the part of the bigger banks through our competition to give away the benefits that they've gotten from higher rates or the tax increase as of yet. I would imagine that will come throughout the course of the year. There'll be more pressure.
But we will stick to our guns.
Speaker 9
Okay, great. And just as we look at the deposit portfolio and the efforts to kind of improve the loan to deposit ratio, and I guess I'm kind of marrying that with the comments that you think that the loan to pick up. Taking those together, do you plan to extend the duration of the deposit book and term out some funding at this point?
Speaker 1
Well, I think that we'll be offering up to three and five years TVs out there. People want to jump in. They don't seem remember, customers always want what you don't want to give them. Their customers aren't wanting to extend right now. But we have such a big interest rate sensitive position right now.
As rates continue to move up, we're gonna wanna we're gonna wanna lessen that. So we'll we'll let a little bit more long and borrow short and ought to do that. So we don't if we see an opportunity to extend on a rate basis, we certainly will, but sometimes the rates are almost too high right now to wanna extend on the positive side. Not the deposit side, I mean. So I don't mind going short lending long because, as I said, as rates go up, we're going to want to shrink our gap anyhow.
That makes sense?
Speaker 9
Yes, that makes sense. Thanks.
Speaker 0
Thank you. Our next question is from David Scheverini of Wedbush Securities. Your line is open.
Speaker 8
Hi, thanks. A couple of follow ups. The first on mortgage banking. You mentioned that for each dollar of revenue that you're going get in the second quarter to expect $0.35 of incremental expense. I was wondering and I'm not sure if you're willing to specify, but can you provide what the efficiency ratio was for the mortgage banking business in 2017 and then what you expect it to be for 2018?
Speaker 3
Yes. Let me clarify. When I was talking about that, every one point dollars 3 I was just really talking about the relationship on the Veterans First piece because it's kind of goofy that we only had half a quarter of revenue and then we had a fuller quarter of expenses. So I was trying to just give a little guidance on that, And that didn't relate to the entire portfolio. That was just trying to help on the Veterans First side of the equation.
But the mortgage business has generally been in 80%, 85% efficiency ratio business. It's a high efficiency ratio business. It doesn't use much capital. We'd obviously expect that to be a little bit less with the consumer direct channel, but we haven't given any guidance on that.
Speaker 8
Got it. Got it. And then the other follow-up I had related to the leverage strategy. You mentioned about how you're still going to benefit WinTrust will still benefit from higher rates with NIM expansion, but at the same time, with the leverage strategy, it could hurt the NIM. So should we expect that in the quarters in which you deploy the strategy that the NIM should net out to being flat?
Speaker 1
No, I don't think that'd be the case. I think it will be negative. But if you phase into this over the next two years, certainly, we'll have a marginally negative effect on the NIM, but not one that's going to knock out our continued growth of the NIM.
Speaker 3
And then although with as Ed mentioned earlier, although with the NIM, it it it has a corresponding benefit to the net overhead ratio and and positive to to earnings. So you would take a little bit of pressure on that NIM to get higher EPS, but we just don't want to lock into too small of a spread. So that's why we're waiting for the yield curve to get to a point where it makes sense to jump in.
Speaker 8
Got it. No, that makes perfect sense. And then the last question I had, going back to the loan growth outlook, how you somewhat tweaked the guidance of saying mid to high as opposed to high. Is this related to the strategy of bringing your loan to deposit ratio back down to the 85 to 90, Adam?
Speaker 1
No. No. I I probably missed I mean, my mind was it was just some headaches. It's we haven't changed. It's high single digits, which means, you know, eight or nine 7% to 9% is what we're thinking.
So I guess that would be high single digits. So, we're not we're not we're not changing our thoughts at all. I just probably misspoke.
Speaker 3
We will we will generate all the good loans that we can, and we will find a way to fund those. So the way you bring the loan to deposit ratio back in the line is with the deposit side of the equation. We're not going to turn away good loans.
Speaker 8
Great. Thanks very much.
Speaker 0
Thank you. Our next question is from Brock Vanderbilt of UBS. Your line is open.
Speaker 10
Hey, thanks for taking the question. So Dave, a question for you on housekeeping. I think there was a question on this earlier. The Federal Home Loan Bank advances, the rate has really moved around the last five quarters. I would think that would be linked to some you know, thirty day, sixty day kind of base rate and have been moving up pretty consistently.
Why is that not doing that?
Speaker 3
Well, because there's two pieces on that Federal Home Loan Bank funding side. We have a portion of that is longer term fixed rate funding. And so if you've got very little overnight, that rate is going to be high. If you've got more overnight at the lower rates, that's going to bring that yield down considerably. And so if you probably the way to look at it is if you go look at our K or our Q, we schedule out in the footnote what the longer term fixed rate funding is.
That's going to be there regardless. But then when you bring on a lot of overnight funding at very low rates, it's going to bring that yield down. If you back off on that overnight funding during the course of the quarter, the rate is going to gradually go back up to what that longer term funding that you have in place that's there all the time. So it moves around based upon how much overnight funding you have throughout the quarter.
Speaker 10
Got it. Okay. And at this point, is there any reason to expect it to be closer to 170 than $2.60?
Speaker 3
No, I don't think we put that much more on, especially Okay. If the deposits start coming
Speaker 10
And I apologize, I missed the first couple of minutes of the call. What's driving the focus or the renewed focus on driving down that loan to deposit ratio? Is it the shape of the curve or something else?
Speaker 3
No, I mean, generally our philosophy has been as we're sort of old time banker, you've got interest rate risk, you've got credit risk and you've got liquidity risk. And we've always thought operating that sort of 85% to 90% loan to deposit ratio provided us with the appropriate level of liquidity. And so as Ed mentioned earlier, we think we have enough liquidity sources that we're not worried about it. But just as one of our basic tenants is to maintain sufficient liquidity out there where you can sleep well at night and it's just the right thing to do. And we think that range is sort of 85% to 90% loan to deposit.
But that being said, right now, with the shape of the curve, we've got plenty of liquidity sources, but we'd rather operate closer to 90%.
Speaker 1
And it's a positive. I mean, all it does is add to the bottom line. If you figure you can make you can do pretty well with that.
Speaker 3
And and, you know, the the the leverage that we're doing, like it like we said, it it put might put some pressure on the NIM, but it's gonna increase your your net income. But you wanna protect yourself from a rising rate too, so you gotta get a sufficient spread on that leverage in order to jump into it. But it doesn't take much capital either. So if you get if you invest in the Ginnie's or the Fanny's, those are very low capital instruments. And so it wouldn't take much capital to do that.
So it would increase your earnings, put a little pressure on your margin, help your net overhead ratio and not eat much capital. So we think it's a net positive, but you don't want to do it at such a tight spread that for HRISE, you're not doing well in the future.
Speaker 5
All right. Okay. Thank you.
Speaker 1
Great. I'd like to just make sure I clarify something. When we talked about deposit betas earlier, we talked about moving to a marginal deposit beta closer to 40 basis points. What we believe up from the 24%, 25% we've experienced. What we believe is we're still going to have margin expansion.
Just it's not the beach ball underwater, it's, I don't know, a tennis ball, a number of tennis balls underwater with every 0.25 increase. We still make 20,000,000 to $23,000,000 every zero two five point increase on an annualized basis. And that includes increasing our deposit beta our deposit rates accordingly. We're not going to be able to maintain this 25% beta marginally going forward. We're still very asset sensitive.
We still expect the rates that increases that have occurred to date are still working their way through the system. That's very positive. Four more rate increases would be very positive. We expect the margin to go up every time, every quarter, every month now going forward as we absorb those rate increases that have occurred already and future increases will help us too. So I know everybody think we're going to jump from 24 to 40 overnight and have our margin go down.
That's not the case at all. Rate increases are very good for us. We're well positioned as rate is. And anybody think that this is going to hurt our margin or our net interest income going forward, it's still a very positive outlook for us in that regard, just we're not going be able to maintain on future increases a 25% beta. That beta will be higher as rates go on.
We built that into our plans, and that's included in the quarterly earnings or the annual earnings increase we talked about on quarterly increases. So I wanted to get that point across. Maybe I was unclear on that, but we expect margin expansion throughout the rest of the year. We expect good asset growth. We expect even with our liquidity play, as we phase into that over the next two years, it's not going to happen overnight, that will be very positive for us also.
So we think the outlook for us is very bright for future record earnings quarters to keep Mr. Papa Giorgio very happy. So if you have any questions about that, I didn't mean to confuse you about that, but maybe I did as I was thinking about it as the call went on. So did I miss anything there, Dave? Dear?
No,
Speaker 3
think it's time to end the call.
Speaker 1
Anyhow, with no more questions, thanks, everybody, for calling in. Call if you have any questions.