Wintrust Financial - Earnings Call - Q2 2018

Transcript

Speaker 0

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, Wind Trust 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 second 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 will now turn the conference call over to Mr. Edward Wehmer.

Speaker 1

Thank you. Welcome, everybody, to our second quarter earnings call, and happy summer to you all. With me as usual are Dave Dykstra, our Chief Operating Officer Kate Bogie, our General Counsel and David Starr, our Chief Financial Officer. We will conduct a call under the same format as usual. I will give some general comments regarding our results, then turn it over to Dave Dykstra for more detailed analysis of other income, other expense and taxes, back to me for some summary comments and thoughts about the future, then there's always time for questions.

We're very pleased to report record earnings for the tenth consecutive quarter in a row. David Long, Nick Papa Giorgio is still on our roll here. Net income of $89,600,000 was a 9.25 increase over the $82,000,000 in the first quarter and 38% over the $65,000,000 recorded in the same period last year. Year to date year over year, we're up 28%, about 171,600,000 to $123,300,000 On earnings per share basis, 1.53 compared to 1.4 in the first quarter, 1.11 last year, dollars 2.93 year to date and 2.11 for compared to 2.11 for last year, up twenty eight percent thirty seven versus 38% almost over last year's quarter to quarter. Just to put in perspective also about pretax earnings.

Pretax earnings in the first quarter in the second quarter were 121,600,000 over $108,000,000 up 12.6% and up 1919.3% over the $102,000,000 we were in the 2017. For the year, pretax earnings were $230,700,000 up over 180,000,000 above $190,000,000 or 17%. So good results across the board. Our margin increased, as you all know, by seven basis points from the first quarter. And for year to date, we're up 20 basis points over last year.

ROA of 126 compared to 120 in the first quarter. Year to date, we're 123 compared to 97 basis points Last year, the return on equity and tangible equity numbers are in the release. As readily apparent, our operating trends continue remain consistently positive. The net interest margin, net interest income, the NIM increased seven basis points over the first quarter and 20 basis points over 2017 to 3.54%. Net interest income grew $13,100,000 over the first quarter due to one more day, good earning asset growth, including good loan growth and the rising rate environment.

So really, both increases were driven to the higher rate environment and a larger level of earning asset base. Our average earning asset base grew seven zero six million dollars in the quarter. Earning asset yields increased 19 basis points by cost of paying liabilities increased 17 basis points. The free funds ratio or the amount of the 28% of demand deposits we had made up the difference as it relates to our margin. We'll talk about betas a little bit later.

It's funny to me that number a year ago or two years ago, it was pretax, pre provision earnings was the buzzword. Now it's deposit betas. Our average loan to deposit ratio for the quarter rose slightly to 95.5%, obviously higher than our desired range of 85% to 90%. Some of this was caused by our back end loading of the loans in the quarter. Ending loans exceeded average loans by $326,000,000 which bodes very well for Q3 earnings.

At period end, our loan to deposit ratio stood at 92.8% due to good deposit growth. Speaking of deposits, Q2 was a great quarter for core growth. Our deposit marketing coupled with successful opening of five new branches contributed $1,100,000,000 in growth. Our deposit marketing is just kicking in, so we'd expect this number to begin receding loan to deposit ratio receding towards our targeted ratio. Accordingly, as we expect, our deposit rates increased in this quarter more than prior quarters.

Our historical beta if you look at betas, it's for cycle to date, which includes six increases rate increases, does not include the June increase, where our interest bearing deposits were about 0.31%. Quarter two was 68%. If you recall, last quarter, we said over time, we expect to be in the 40% to 45% range in this as we catch up plus with our turns towards more organic growth than acquisitive growth. That would be consistent. It's not going to happen overnight, but I think that that's going to be I think we'll still stay well below the 60 basis points, which I heard is the industry average these days.

But we expect our margin to continue to, as I said last quarter, not be a beach ball underwater, but more like ping pong balls underwater. But going forward, we'll have good increases. It takes a full year for a deposit or for a rate increase to work its way through our system. Our models still show every quarter point adds about 22,000,000 to $23,000,000 in pretax earnings to us. So it just comes in over time ratably.

And but we expect our margin to continue to increase, maybe some comparatively bigger betas, but ending out, we think, with three or four more interest rates in the 40 to 45 basis point range percent range in that regard. I know we'll get questions on that, so I'll save any other comments to later on that. We are still very asset sensitive. Additional rate increases should continue to add, excluding the one happened in June, we'll add $22,000,000 to our net interest income on an annualized basis. It hasn't changed from our previous discussions to the ever increasing size of our balance sheet as we work to as rates continue to move up, we will continue to we will begin bringing our interest rate gap down.

It actually went up a little bit at the end of the quarter. We're still waiting for the long end to move, but we'll talk about that in a second. Like right now, now as long end of the curve is yet to move and constant with the short end, we wait for the bank debt liquidity play we have discussed in the past. This initiative is still in the cards and expect our loan to deposit ratio to stay in the low 90s and until such times as spreads on the long term on the long end get better. More on the again, a little bit more on this later.

As such, the future rate increase, we expect our net interest margin to continue to grow slowly but surely. On the credit side, credit remains historically great. Both NPAs and NPLs were down from their already low numbers. We had a $7,500,000 decrease in total NPAs. NPLs were down nonperforming loans were down $6,400,000 Our oil balances were down 1,100,000 So we continue to push out old assets.

Valuation charges were down modestly. We continue to actively work to dispose of older properties. Net charge offs totaled $1,100,000 Charge offs of $6,900,000 were offset by recoveries of $5,800,000 falling through on our basic operating tenet of being conservative on charge offs and looking good on recovery. As is evident in the NPA and charge offs numbers, the little hiccup we had in the commercial premium finance book is behind us and recoveries are starting to materialize. So in summary, credit remains very good.

NPAs as a percent of total assets decreased to 0.4% from 44 basis points. Reserves as a percent of NPLs was at 172%, up from 150% at the end of quarter one, and net charge offs decreased 10 bps to two basis points in the quarter. We continue to call our portfolio for cracks and we'll expeditiously move assets out when said cracks are found. We'll also continue to aggressively work our OREO portfolio to clear the decks. On the other income and other expense side, Dave is going to go into these in detail momentarily, just some general comments.

On the mortgage front, revenues and volumes were up from quarter one. However, overall profitability decreased due to decreasing execution spreads without a commensurate decrease in cost of processing. That's more of a supply and demand function. It's got a little bit of a provider inflation here with lots of people out there going after fewer and fewer deals. That being said, I like where we stood on our volume numbers.

But to that end, on the cost side, we're diligently working to reduce our cost to produce a loan. As you know, these are up over 3.5 times due to Dodd Frank and the like from the good old days, if you will. So to that end, we our Zoom Mortgage product, it's our version of Rocket Mortgage, went live on a test basis this quarter and soon be fully implemented the quarter three. Early results show a decrease of cost a decrease of almost two days in processing time through the use of this front end system. And we all know time is money.

We're also looking at any other number of cost initiatives in that area. We 're not going to comment on them now, but they're in all aspects of the business, and we expect them to be fully implemented by the end of this year. Dave will be explaining our quarterly results in the mortgage area in detail in a moment. And as you all know, of importance we know this is important to all of you. So please note that we are committed to this business for the long term.

Our wealth management operations continue to improve. Assets under administration grew $300,000,000 to $24,600,000,000 from $24,300,000,000 at the end of quarter one. Revenues for the quarter fell slightly due to less trading from our broker dealer and the overall market in general in the second quarter. Our net overhead ratio was 1.57%, down one basis point from quarter one, but a little bit above our 1.5% or better. Some of this is balance sheet driven as we're delaying pulling the trigger on the liquidity initiative we previously announced.

Other factors include the comparative low mortgage revenue as a percent of volume without a commensurate decrease in expenses. Our full quarter of Veterans First expense, seasonably higher marketing expenses, additional incentive comp accruals due to better results and we opened five new branches in accordance with our organic growth initiative. Again, Dave will discuss in detail. Our net overhead ratio of 1.5% or better still remains our goal, and we'll continue to work on it. On the balance sheet front, assets grew $1,000,000,000 with no acquisitions included to $29,465,000,000 Loans grew $548,000,000 in the quarter.

That's a 9.7% growth, again, single digits as we anticipated. If you average loans grew $572,000,000 So we're in pretty good shape on the loan side. Deposits we talked about up 1.1 or 18% over the previous quarter on an annualized basis. So we look the balance sheet grew nicely. I'll talk about the acquisition market in my final comments.

Loan growth as projected was in high single digits as in most categories with the exception being commercial real estate where payoffs and our wariness about the current competitive market negated growth there. We'll be very choosy about the deals we're going forward, making sure they meet our standards and our pricing and profit our pricing standards and our underwriting standards. Loan pipelines though are consistently strong and increased this quarter, the second highest level we've had in about two years. So momentum is good. A lot of that is due to our reputation, some due to changes in the marketplace, and we think that's just the start of that.

Deposit growth was we're heartened by our growth and our success there. We flipped the switch as bank pricing has moved away from us. We're at that inflection point where organic growth, as many of you have known us in the past, we made our bones on organic growth and we've been very good at it. It's nice to be able to flip the switch and see that we still have it. But five new branches came on during the quarter, and we have a number of more branches planned for the rest of the year.

That's not to say we're not interested in acquisitions, however, pricing is relatively high right now. We continue to look, but we will continue to take what the market gives us and stay disciplined in our approach to deals. In any event, I'm going to turn it over to Dave now to talk about other income and other expense.

Speaker 2

All right. Thank you, Ed. As normal, I'll just touch briefly on the noninterest income and noninterest expense sections and those areas that had the most significant changes. In the noninterest income section, our wealth management revenue held fairly steady in the second quarter, totaling $22,600,000 compared to $23,000,000 recorded in the prior quarter and up from the $19,900,000 recorded in the year ago quarter. A modest reduction in the brokerage revenue component due to a reduced amount of customer trading was the primary reason for the slight decline in the combined wealth management revenue.

Overall, the 2018 was another solid quarter in revenue generation. Mortgage banking revenue, as Ed alluded to, increased approximately 29% or $8,900,000 to $39,800,000 in the second quarter from $31,000,000 recorded in the prior quarter and was also up from the $35,900,000 recorded in the second quarter of last year. The increase in this category's revenue from the prior quarter resulted primarily from higher loan origination volumes. The company originated approximately $1,100,000,000 of mortgage loans in the 2018. This compares to $779,000,000 of originations in the prior quarter and a similar $1,100,000,000 of mortgage loans originated in the second quarter of last year.

Increase in origination volume was attributable to $229,000,000 increase from our retail origination channel, a $92,000,000 increase from the Veterans First consumer direct origination channel as we had our first full quarter of production since the acquisition, and this was offset slightly by a $3,000,000 decline in our correspondent originations. The mix of loan volume related to purchased home activity was approximately 80% in the second quarter compared to 73% in the first quarter of this year. Page 23 of our second quarter earnings release provides a detailed compilation of the components of the mortgage banking revenue, including production revenue, MSR capitalizations and net of payoffs and paydowns, MSR fair value adjustments and servicing income. Given the existing pipelines, we currently expect originations to soften slightly in the third quarter to approximately $1,000,000,000 but obviously, this estimate could ultimately be more or less depending on the market conditions during the remainder of the quarter. Operating lease income decreased approximately $945,000 in the current quarter compared to the first quarter of this year.

This was primarily as a result of a $1,100,000 gain realized from the sale of certain equipment on operating leases in the prior quarter of the year. Other non interest income totaled $14,100,000 in the 2018. This was up approximately $2,200,000 from the $11,800,000 in the first quarter of this year. There are a variety of reasons for the increase in this category revenue, including the higher level of interest rate swap fees, higher level of loan syndication fees, an increase of $521,000 on gains from early payoffs of capital leases and a $600,000 settlement on a BOLI policy. Turning to noninterest expense categories.

Noninterest expenses totaled $206,800,000 in the 2018, increasing approximately $12,400,000 from the prior quarter. The increase was primarily attributable approximately $9,200,000 of higher salary and employee benefit expenses and $3,000,000 of higher advertising and marketing expense. Of these were related to the growth of the revenue and the balance sheet. I'll talk about the more significant changes in detail as well as comment on a few other items of interest. The base salary expense increased approximately $5,000,000 in the second quarter over the first quarter of this year.

Slightly more than $3,100,000 of the increase is related to a full quarter impact of the annual base salary increases that generally took effect on February 1, a full quarter of the increase in our minimum wage to $15 per hour for eligible non commissioned employees, which took effect in early March and normal growth as the company continues to expand its staffing for the five new branches and other growth at the company. And slightly more than $1,800,000 of the remaining portion of the increase was related to the impact of bringing Veterans First team fully under our payroll in the second quarter. Veterans First retained some of their employees to handle the runoff of the volume that they maintained, and those employees fully came on to our payroll in the second quarter. So the second quarter's run rate for them is fully staffed up now. Commissions and incentive compensation expense increased approximately $4,000,000 to $35,900,000 from $31,900,000 in the prior quarter.

The company experienced an increase of approximately $2,400,000 in commission expense tied to the higher mortgage origination volumes, with the remaining increase associated with higher long term and annual incentive compensation accruals due to the higher earnings experienced by the company. Marketing expenses increased by approximately $3,000,000 from the first quarter to $11,800,000 As we've discussed on previous calls, this category of expenses increased as our corporate sponsorships tend to be higher in the second and the third quarter of the year due primarily to our marketing efforts with the Chicago Cubs

Speaker 1

and the Chicago White Sox as well

Speaker 2

as increased spending related to our deposit generation activities and brand awareness to grow our loan and deposit portfolios. And we clearly believe these marketing efforts are effective in enhancing the franchise value of the company. Other than the salaries and employee benefits and the marketing expense categories that I just discussed, all the other expense categories were up on an aggregate basis by only $223,000 from the prior quarter. A $1,900,000 reduction in OREO expenses was offset by slightly higher levels of expenses in a variety of other expense categories such as equipment expense, data processing expense, postage expense, FDIC insurance and other miscellaneous expense categories. And as Ed mentioned, the company's net overhead ratio decreased by one basis point to 1.57% and the company's efficiency ratio on a fully tax equivalent basis declined to 61.8% in the second quarter from 62.2% in the first quarter.

So those are the highlights of the other income and other expenses. And with that, I will turn it back over to Ed. Thank you, Dave.

Speaker 1

So summary, all in all, a pretty good quarter for WinTrust on all fronts. Momentum continues throughout the organization. Reduced taxes and higher interest rates have been very beneficial to us to our core earnings growth, and our balance sheet growth has been good, that all bodes well for future earnings growth and future growth in franchise value. We are pushing our organic growth agenda as acquisitions in general become relatively expensive. In that regard, we saw the number of new branches planned over the next eighteen months in neighborhoods in our designated market area where we currently are not present.

Our retail and small business marketing programs, which we embarked on in earnest at the beginning of this year, are working well and pulling in new accounts and relationships both in the new branches and in the underutilized branches we had picked up during the great acquisition spree that resulted during and immediately after the Great Recession. We this doesn't mean that we're not investigating future business combinations in all areas of our business. But as we mentioned in previous calls and today, pricing has become unrealistic in some respects in our opinion. And when you do get something going, the gestation periods become very long. We remain well positioned for higher interest rates and are prepared to protect our downside as rates rise by gradually decreasing overall rate sensitivity.

Credit is as good as it's going to get. We continue to review our portfolio for an early warning signs and are exiting deals expeditionary when cracks are apparent. As noted in some of your reports, thirty and sixty day past dues, many of which are for the most part organizational and not credit cracks have decreased as we continue to make to push our people and staff to make sure that we can turn things around much quicker and not have past dues due to our inability to get things done on time. Loan growth is good and pipelines remain very strong. Our niche businesses continue to work very well with us.

We continue to look for other niche businesses to diversify our portfolio because as we said in the past and as you all know, concentrations kill. We are prepared to embark on our liquidity initiative should we have the desired we should have the desired strategic results. And I keep looking at the short interest in the treasuries and the treasury market. And if those guys are right, maybe we'll get a little pop here in the long end at some point in time, which would be very good for us. So in summary, we're well positioned.

We like where we sit. The disruption that's occurring in the market is good for us, very good for us as a matter of fact, as we target customers who may want to be refugees from big banks. That's what made our bones in the past. That's how I'll continue to do it in the future. So we like where we sit right now.

We think we feel good about it. But that being said, as I said last quarter, we keep looking under the table for the boogeyman. We continue to prepare and maintain a fortress type balance sheet, keeping our credit clear, clean, not reaching for to do new loans. I'm heartened by the fact that we had such good loan growth, and our critical exception number continues to come down in these deals. So we're not chasing deals.

And our profitability models are still holding strong and we're getting pricing for relationships we're bringing in to meet those profitability goals. But that being said, we keep looking around and making sure that we are prepared in the event of any number of things, and we bring this I let you know all this just to know that we're not standing on our laurels assuming this is the new normal. We're all many of us have seasoned enough to know that just when you think you got it, something comes up and bites you. We want to be prepared when that happens. And I think the way we've built this organization with core funding, good diversification in the balance sheet, we're in very good shape to handle whatever they throw whatever gets thrown at us.

So that being said, you can be assured of our best efforts to ensure the long term growth of the franchise value of your company through both by maintaining that fortress balance sheet, maintaining double digit earnings rates, earnings increases, good asset growth and protecting net book value per share of the company. So that being so right now, we feel pretty good, but who knows. But now we have time for questions, and let's

Speaker 0

Our first question comes from the line of Jon Armstrong with RBC Capital Markets. Your line is now open.

Speaker 3

Thanks. Good morning, guys.

Speaker 1

Hi, Jon.

Speaker 3

Hey. Just start with big picture, Ed, you touched on it towards the end of your prepared comments, but just the lending environment, I think what you're saying is everything seems pretty healthy, but you are a little bit more cautious on commercial real estate, maybe a little bit more bullish on C and I. But give us your best guess as where you see the best opportunities and where things are a bit irrational for you.

Speaker 1

Well, commercial real estate is you're just seeing some irrational pricing coming in from some of the smaller banks, some doing five and ten year fixed rate deals in the 4s. You're seeing development kind of popping up a bit. Were having a number of payoffs in the development of those loans we did do early on in the cycle. Those are all done with really good sponsors. That's not to say we won't look at those, but it's just we just have to slow down in that area as it's not meeting our loan policy criteria pardon me, nor our pricing criteria.

But the commercial loan pipeline is very strong. The niche businesses also are doing very well. Our leasing business, our franchise business, commercial premium finance all grew nicely. And the life premium insurance continues its steady growth. Again, haven't had a loss in that portfolio.

So we continue as I said, we continue to look for other types of businesses. But the market here is in a bit of turmoil with the recent acquisitions, both of our two smaller than us, the largest competitor local competitors in the market. Are seeing opportunities there. We also are spending money up in Wisconsin, where we have a beautiful franchise up there, where we're hitting the market hard on middle market lending up there, Something we hadn't really done, we concentrated on Chicago here and that's running like a top. Now we're taking that same model up to Wisconsin, where there's a lot of big bank competition, but nobody really does it our way.

So we're seeing good results up there already, looking at deals that these guys never thought they'd never get a shot at. So our reputation is good. The momentum is good across the board. We worry a bit about commercial real estate. But again, pipelines are as strong as they've been across the board.

So knock on wood, we'll get deals done on our terms and our pricing. So we feel pretty good about that low single digit number for the rest of the year.

Speaker 3

High single digit, right?

Speaker 1

Yes, sorry. Single

Speaker 3

We're digit number for the rest not at rope a dope yet.

Speaker 1

No. That's kind of interesting. You talk about rope a dope. I was using a double negative. I meant to say hi.

I'm like the President. But you hear a lot about we were always big proponents of the inverted yield curve and what that meant. And I'm hearing a lot of pundits on TV talk about the yield curve flattening and how that means a recession is coming soon. We looked at this very closely and did a lot of research. We had our quant slope and we had we verified it.

We read Goldman's work and the like. It's a little bit different this time. The yield curve flattening is somewhat technical. And that with the Volcker Rule, the big banks have taken their alternative investments down from 10% or 11%, and the big banks are a lot of those, the top five or six banks, they have from 11% to 4% or 5%, which means they're out buying anything long any Ginnys or any treasuries that come out that are long term to get that yield because the Fed is sitting if the Fed were to go faster and get rid of the $4,500,000,000,000 that they're sitting on, that's worth about one point to the yield curve right now. Our guys did it interestingly enough, Goldman came out with something on it too.

So I'm not that concerned about that asset. We don't see our clients are all doing very well. The only issue they're having right now is with labor and some when we really good clients are having trouble getting labor and that's an issue. But other than that, they're doing they're all doing really well. So I don't see problems I don't see storm clouds yet on the horizon.

So we're not thinking about rope a dope. We're thinking just about dopes in the real estate area, guess. No rope, no dope.

Speaker 3

Okay. Okay. Just one more on deposit the deposit cost step up. My sense is you want to address it, but it's a little bigger than I thought it would be. I understand it.

But just maybe give us an idea of where you feel like you need to defend yourself? And is this something that can maybe flatten out later in the year in terms of the cost increase? Thanks.

Speaker 1

We lagged more than most for a long time, and it does catch up with you. With our growth this quarter and the like, it popped a little. But in a quarter rise, if you take that quarter rise, it wasn't as high. At the end of the if you take the rate increase, it took effect June 15, it was as much as you think. We look at this over time and we are at 31 basis points for the cycle, 31% for the cycle.

We were 68% for and this is just on interest bearing deposits for this quarter. But that only brought us to 31% for the cycle. If you look at total, including demand deposits, we're at 22 basis points for the cycle and 52 basis points for the quarter. We expect those numbers to get up the total cycle after two or three more rates, that 31 is going to go to 40. To get that, it's going to you're going to have a little bit higher end of quarters going forward.

However, you're still catching up on two and now three rate increases that are working their way through the system. So it's balanced. We look at this very closely. And a lot of it's the lag that we had in the past, but we will catch up. And then by the end of this year with February, we'll probably be at that 40 basis point number for the cycle up from 31 or 40 or 45.

So you will see it, but earning assets should continue to increase greater than that. Does that make sense?

Speaker 3

Yes, makes sense.

Speaker 1

Thank you. I'm going to catch up, but we're giving you where we're going be at the end of the deal.

Speaker 3

Yes. Okay. That makes sense. Thanks.

Speaker 0

Our next question comes from the line of David Long with Raymond James. Your line is now open.

Speaker 4

Good morning,

Speaker 1

gentlemen. David, how are you?

Speaker 4

Good. How are you guys doing?

Speaker 1

Living the dream every day. Good.

Speaker 4

Good. Thinking about the deposit growth and the pace of the liquidity build, where in your mind, where are you today on the liquidity build? And between now and, call it, to the end of next year, where do you think that you will be with that? And then how much does the failure of the yield curve to fully cooperate impact that pace or ultimate size?

Speaker 1

Well, we'd like to get back to 90% loan to deposit at a max. So that should tell you what the type of growth we would like to achieve by the end of the year to get to that number, which the rest of it takes is we love to run-in the middle of the 90. So we love to be at 87.5%. We're not going to rush to 87%. If we're 91% too, that's fine.

But we're not going to rush to 87.5 unless we can get something on it. Does that make sense? So it's kind of a variable answer. If the rates we want to get the 90% loan to deposit, the high end of our range by the end of this year. That's what we're trying to do.

If rates were to if the long end were to move, we'd like to get to 87.5% long term, right in the middle of our desired range. I still think liquidity is important. I have not I don't sleep well knowing that we're at 94, 95 but that's the plan. Dave, do you want to comment on that?

Speaker 2

No, I think that's right. I mean we brought it down a little this quarter with our branch openings and our targeted marketing, and we'll continue to plug away with that. I think we had hoped that the long end of the curve would have been up, that we could have been a little bit more aggressive with those deposits and put them to work with longer investments, but that hasn't happened. So as that says, if the curve would pop up, which there's no indication that that's going to happen, it could happen quicker. Otherwise, we'll just we'll plug away at it and increase it gradually and get down to that 90% range.

And if the long end pops up, we'll probably get below 90%. But it'll be a gradual thing. We won't just go out and get another 1,000,000,000 or $1,500,000,000 of deposits and put it to work like we would if there was steepness to the yield curve.

Speaker 4

Got it. And with the liquidity building that you're doing today, what are you investing in? What types of securities and what types of yields are you looking at right now?

Speaker 2

Well, we just increased a little bit with Ginnies and Fanny's, but we haven't gone dramatically into that. So the liquidity is either sitting in cash and we've been lagging in slightly with ginny's and panties, but not dramatically yet.

Speaker 1

In a perfect world, we would love to see muni rates move up a little bit more to kind of hedge against we've never had a large muni portfolio. If they were to move up closer to 80% of the number, the long end number, the taxable number inside 80% or 85% of that number, it'd be a great move for us to hedge against a different administration coming in down the road and raising taxes. So it might be a good time to think about that. And we watch that very closely, too. We've never really had a large municipal portfolio, which has served us well, but now might be the time to get in there and hedge a little bit.

So that could be an area for growth, too. We watch those rates very carefully, watch the overall environment very carefully. If it appears that things are slowing and rates may go backwards, you may see us move faster into that. Because one of the things we're doing, we expect to go long on the liquidity side to bring our gap down and probably not write calls on a lot of it as we have in the past. As rates get higher, we don't want to have that huge gap and have that downside vulnerability.

So we're looking at a lot of different strategies. We have a lot of quantitative mathematicians and economists left over from the stress test days. The four of these, they're still doing stress tests, but they have a little extra time on their hands. So we have them running lots of these. So we're all over this thing.

We'll watch it very carefully.

Speaker 2

Just one other thing, David, is if you look at our investments at the end of the quarter, they were up just slightly. We used some of those deposits really to fund the loan portfolio. And you'll see that our Federal Home Loan Bank advances actually came down from the first quarter a little bit. So rather than borrowing the Federal Home Loan Banks as much to fund the mortgage portfolio, we just used those deposits since we had them. Part of it was to just borrow less in the first quarter.

So we're still waiting for that long end to move before we invest heavily in securities.

Speaker 4

Got it. And the last thing I wanted to ask just quickly was the deposits at period end were much higher, about $1,000,000,000 ahead of the average. So am I right in assuming that a lot of the deposit growth in the quarter came at the end of the quarter?

Speaker 1

Yes. Yes. Okay. Well, we opened two very successful branches right in right around the June. One was in Evanston, an area we've never been in, which is a fairly large parochial suburb of Chicago with First Bag Evanston selling to Byline that opened up an opportunity for us to come take that positioning.

And the branch at Wrigley, we opened right at the beginning of middle of May, and that's off to a great start, too. So many of the branches opened in the latter part of the quarter, and they really did well taken off. So it's nice to see when we open it, people still want to come.

Speaker 4

Got it. Thanks a lot, guys. Appreciate it.

Speaker 5

Our

Speaker 0

next question comes from the line of Chris McGratty with KBW. Your line is now open.

Speaker 5

Hey, good morning. Thanks for the question.

Speaker 1

Hey, Chris.

Speaker 5

Ed or Dave, obviously the guidance on the overhead has been 150,000,000 over time. I guess given what you're doing with the balance sheet is how should we be thinking about whether a point in time or maybe not a full year basis, but what's a realistic time to get there? Could you get there by the end of next year, early next? Or is it kind of a longer aspirational target?

Speaker 1

Well, we put the if we put $2,000,000,000 on it, Ross, to the 87.5% loan to deposit, we'd be there right now, the ultimate goal. So a lot of it has to do with the balance sheet not being where we are and the yield curve. Some of it this quarter, as you said, was due to the mortgage profits and the expenses being too high. But we investing in organic growth and that's putting your costs of growth through the income statement as opposed to buying for a big number and not having the cost go through the income statement, taking it through your tangible book value per share. General argument we used to have when we were really doing organic growth before we got into the whole splurge of acquisitions.

But it is aspirational. We think we can get we'd be there now. If you had any slope to the yield curve, we'd probably be there now. But we continue to work at it. You're going to bounce, I think, between that 150,000,000 and 160,000,000 number every quarter until really you see us get the liquidity play underway.

Speaker 5

Great. And maybe if I could follow it up. Some of your peers look at just the spread between revenue growth and expense operating leverage, which for you guys is kind of in the 300 to 400 basis point range for recent years. Is that about a fair way to look at the company given the investments you're making and the revenue growth, the double digit revenue growth is kind of a three hundred four hundred basis point operating leverage kind of still realistic given where we are?

Speaker 2

Chris, I really haven't run the numbers the way you're talking about them. But clearly, operating leverage is something we think we have as we grow up these small banks. So I don't want to talk off the top of my head without running the numbers, and we don't look at it that way. We look sort of at the net overhead ratio because there's lots of moving parts. Like some people said in their reports so far that expenses were a surprise this quarter, but the expenses were really up because the revenue generation was up.

The mortgages were up and the advertising was up to generate the deposits and the sponsorships we had, it was a lot of it is to generate the deposits and the loans is the end game, obviously. And so you spend the money to make the money. And so we really look at that relationship as far as are leveraging that well from a net overhead ratio. But I'd have to go back and study the numbers you're looking at because we just don't present it that way.

Speaker 5

Okay, fair enough. Thanks a lot Dave. Thanks Ed.

Speaker 0

Our next question comes from Brock Vandervliet with UBS. Your line is now open.

Speaker 6

Thanks for taking the question. So I guess on the mortgage business or businesses, could you review what product verticals you now have? And are you kind of where you want to be in mortgage generally? Or are there more plug ins that you find attractive?

Speaker 1

Well, we have you want to talk about the verticals, and I can talk about where we're going.

Speaker 2

Well, I mean, the three that we show is we just have our standard retail And obviously, if we can bring on more originators there, that would be fine as long as we can make the offices profitable. The Veterans First is a consumer direct channel. And as soon as we get that fully under our belt and comfortable with it, we could expand that consumer direct channel to other product lines besides just the VA type of loans. As Ed mentioned early on, we put in what we call our Zoom product, which is more of a consumer direct type of product, although we haven't used it that way yet.

We're just using it to be more efficient on our own processing right now. But we could expand that out. We'd certainly like to expand the government loans a little bit more as the pricing on those tends to be better than the others. But other than maybe moving more towards a more of our product line towards a consumer direct channel, I think we have really what we want for the short term here right now.

Speaker 1

We are really not looking right now other than organic growth of producers at any equity. We've done a number of mortgage acquisitions in the past. They've all been done on earn out basis, which is leaves us without a lot of stress on these deals as to working out or not. But we're going to concentrate now, at least for the rest of this year, on getting efficiencies out of our process. And we have a number of interests that I'm not going to talk in detail about, but a number of interesting concepts and proven concepts that we are big enough now that we can take advantage of that will hopefully drop our costs of processing in total in about half of processing.

Now commissions are a whole different story. The commission structure in Veterans First is different than the retail commissions. There has to be, Doug Frank kind of screwed that thing up, but you cannot pay, you pay commissions on volume and not profitability. When the profits go down, you're still paying commissions. Got to find a way to figure that out.

So everybody is on the same team here. But we think we can cut our costs of actual backroom processing in half. We're going be working on that very hard over the next three to six months. Hope them all implemented by that point in time. The commission structure is the biggest cost you have, something we're not going to tamper with now.

But there are ideas coming. I think the whole industry has to deal with that issue in general. If rates stay down, if the spreads stay down where they are, people without our volumes smaller than us can have a hell of a time dealing with that issue on the cost side.

Speaker 6

Okay, great. And just a housekeeping note, Dave. Were any of those deposits that came in toward quarter end considered wholesale?

Speaker 2

No. Our brokerage deposits were relatively flat. They changed just marginally. I mean, some ran off and we did bring some on to replace them, but the wholesale broker deposit number was relatively flat.

Speaker 6

Okay, great. Thank you.

Speaker 0

Our next question comes from the line of Kevin Reevey with D. A. Davidson. Your line is now open.

Speaker 1

Good morning, Hello, Kevin.

Speaker 7

How are you?

Speaker 1

Long time no see.

Speaker 7

Yes. Yes. Congrats on a great quarter.

Speaker 1

Thank you.

Speaker 7

So my first question is line utilization. It was around 52% or 53% when we talked last quarter. Has it

Speaker 1

moved up?

Speaker 7

Or has it stayed pretty much the same?

Speaker 1

Phenomenal is still the same. Dave's got the number here, but

Speaker 2

Yes, it is trending pretty much the same as we have in the last few months. So utilization rates are about the same.

Speaker 1

But people are taking bigger lines. They still have there's still anticipatory line increases going on. So borrowing is up, but the lines are increasing proportionally.

Speaker 7

That's a good thing. Absolutely.

Speaker 1

We think so.

Speaker 7

Yes. And then Ed, at the end of your prepared remarks, you talked about that you continue to look for other niche businesses. Can you kind of give us some color on what those businesses are?

Speaker 1

If I knew, I'd be doing them. A lot of things we run across are things we haven't things we never thought of before. Different interesting little businesses where that we think we can go to scale. We like to think that our any one of these niche businesses should be able to go to $400 to $500,000,000 Many of them we've never heard of before. We read about them, we look at them.

We're not big at buying them because they're pretty expensive right now when we run into them. But we were pretty big on starting from scratch like we did leasing. Our leasing portfolio is 1,000,000,000 point dollars started two point five years ago. We see good growth there. Interestingly, the moves that have been made in Chicago banking are opening up some opportunities on the leasing front too.

So we believe that within some of the niches, can get some additional diversification by adding additional products that we haven't had in existing leases or in existing businesses. So a lot of it is stuff we never heard of, different concepts or ideas and we're not afraid to go nationally with our niche businesses either. So if you hear of any, let me know.

Speaker 7

Will do. And then with the recent disruption in Chicagoland, earlier you talked about opportunities as far as gaining customers. Are you seeing any opportunities as far as talent acquisition?

Speaker 1

Yes, just to leave it at that. Yes, we are. You can imagine that some of the deals that were announced involve cost cuts that puts uncertainty in all areas of the business. And so when we open a position on the operational side in deposit ops or in the BSA or compliance, we are seeing a number of opportunities of very seasoned people wanting to come be here. We were always in the position because our compliance numbers and our CRA numbers are so darn good are being poached.

Now it's the other way around. So we like that. On the lending side, you do see I'm not going to comment in particular, but disruption that is taking place and has taken place a year ago has been is good to us and will continue to be good to us as we add to our staff. So lots of dislocations going on in assets and people, and we intend to just be disciplined in taking advantage of them.

Speaker 7

Great. Thank you.

Speaker 0

Our next question comes from the line of Terry McEvoy with Stephens. Your line is now open.

Speaker 2

Thanks. Good morning.

Speaker 1

Hi, Terry.

Speaker 8

Hi. So how are you thinking about the third quarter margin in terms of getting the benefit of the June rate hike along with the higher deposit betas that we've talked about as well as some of the balance sheet actions that you've discussed on the call?

Speaker 2

Well, as Ed mentioned, we still think we have upward potential in the margin. Deposit betas are up over prior quarters, but we are very asset sensitive. So our loan pipelines are repricing. Some of those more significant niches that we have like the premium finance niche, it takes nine months for the commercial premium finance portfolio to turn over and the life portfolio reprices once a year. So some of those loans that are repricing now are taking advantage of a couple of prior reprices too.

So we still expect our asset yields to outpace our deposit costs slightly. And so we would expect that margins could continue to trend upward.

Speaker 8

Okay. And then the $900,000,000 call it, 50,000,000 of franchise loans, could you just discuss the underlying health of that portfolio? And are you becoming any more selective at all within that business?

Speaker 1

We've always been selective in that business. The health of the portfolio is very good, grew nicely last quarter. We again look for diversification inside the brands that are in there. McDonald's is still the largest exposure that we have. But it doesn't make up that much of I don't have it in front of me here.

Next time, I'll bring the report in with me. But no, we don't have a lot of stress and any stress really in that portfolio other than every now and then you get a guy and you want to stay with the brands and where they support the franchisee and the goodwill of their business and not let them go under if they have an issue. So the portfolio is very healthy, where you have no issues with it. Look forward to good growth in it.

Speaker 8

And then just one last question. Will the advertising and marketing expenses remain seasonal? Will there be a decline later this year? Or do you think because of the market disruption, you'll be a little bit more proactive on the advertising and marketing side?

Speaker 2

No. As I indicated in my comments, I think the third quarter will stay elevated. And a lot of that's, again, due to the sponsorships that we do. A lot of them happen in the summertime. Clearly, our Chicago Cubs and Chicago White Sox sponsorships are heavier during the baseball season, which is generally in the second and third quarter.

Speaker 1

We're hoping a bit of the fourth quarter is heavy sponsorships, which means the Cubs will be in the playoffs World Series again.

Speaker 2

But then we would expect it to trail off a bit again in the fourth quarter and then the first quarter and then pop back up again. So there is seasonality to that in the middle quarters of the year.

Speaker 1

Yes. It should grow the overall basic marketing expense. What we've done is pivoted from brand marketing more to product marketing. And so there it's just a pivot of expense. The core expense should grow commensurate with the overall organization with these little blips in the summer for our baseball sponsorships.

Speaker 6

Great. Thank you both.

Speaker 1

Thank you.

Speaker 0

Our next question comes from Nathan Race with Piper Jaffray. Your line is now open.

Speaker 9

Hi, guys. Just going back to Terry's first question Just curious if there are any prepayment fees that may have impacted loan yields this quarter. I understand, obviously, you got the full benefit of the last few rate hikes that came through loan yields. But I guess the increase in loan yields that we saw this quarter was a little higher than we saw in previous quarters following an increase in the by the Fed.

Speaker 1

Nothing unusual. But most of it comes through the leasing business and we didn't really have anything out of the ordinary there. Prepayments usually on a lease that prepays or we had nothing out of the ordinary. And by the way, we're still you said the last two rate hikes, those won't be fully implemented for another two quarters. So we started experiencing the growth of those.

It's kind of a snowball rolling down the hill for us.

Speaker 2

And we did see a little bit of elevation in payoffs on the commercial real estate side, but those were more end of term, maturity term for those and some of those went outside to insurance companies or the like, but as planned.

Speaker 1

It's not like the McDonald's deal. We led McDonald's new headquarters in Chicago. We were the lead on that. Co lead with Bank of America, there was a big constructional. We see those coming to maturity, and those are rolling off into permanent financing outside the banking system.

Speaker 2

But those generally don't come with prepayment penalties because they're at maturity. So nothing unusual in the quarter.

Speaker 9

Got you. And then kind of changing gears and perhaps a broader question on deposit growth. I guess, the kind of core deposit growth that we saw this quarter sustainable, just given the rate increases that you guys implemented across a number of products during the quarter? Or do you guys have your or do you guys see yourself having to spend more on both marketing and so forth and continue to raise rates across a number of products to continue to deliver this magnitude of deposit growth over the back half of this year?

Speaker 1

Well, on the advertising side, think we answered that question kind of more of a pivot from advertising. Brand advertising to product advertising, and that should grow proportionally with our number of branches and with the size of the organization kind of that core pricing. And at the same time, we are growing new branches. This is there's growth is coming across the board. So a lot of it is growth coming in without higher because of how we're structured, we don't have to raise rates everywhere.

Not like a big bank that's a mono brand that has to they raise it. They have to raise it across the board. I can go to one bank and raise rates where I want that's inefficient and want to grow there to get those efficiency with no commensurate cost increase in expenses or to a new bank where I want to come out. At the same time, I'm growing at existing banks at not elevated rates. So I think you have to look at the aggregate, what our aggregate plan is, is over the next if they have two more raises, our overall beta will be in the 40% range.

So that's kind of hefty. You will gather that and know that we're saying we believe our earning assets will surpass that and we will have ping pong ball increases in the margins. Ping pong ball underwater, not beach ball underwater, increases in the margins as rates continue to go up. And that will always be on a larger earning asset base, which should materially help net interest income.

Speaker 9

Got it. I appreciate the color, guys. Thank you.

Speaker 0

Our next question comes from Michael Young with SunTrust. Your line is now open.

Speaker 5

Hey, thanks for the question. Ed, I wanted to go back to some of your comments earlier in the call about maybe potential for the long end of the curve to move higher. If you start to see that taking place or things move in that direction, would you look to term out the CD book while rates are kind of lower now? Or are you asset sensitive enough that just doesn't make sense?

Speaker 1

We look at both sides of the balance sheet as it relates to rates going up and as rates continue to move up, reducing our interest rate sensitivity. So we would look at both sides of the balance sheet of doing that. Yes, we want to lock in longer rates when they're there. We're doing that now to some extent. But we also would look at the asset side, say, we're probably more at the asset side than the liability side.

But yes, we want to we would certainly, we'd like to lock in the asset side before the liability side if you're trying to reduce your gap going forward.

Speaker 5

Okay. And maybe more just a broad comment on credit spreads. Obviously, base rates continue to move up. But how much of that is kind of being given back in just absolute credit spreads and pricing on new production at this point?

Speaker 1

That's a good question. We're seeing the market do that, smaller banks in particular, some large banks in some specific areas are doing it. But fortunately, as I've said in previous calls, it really has been the history for our how we operate here throughout our life is we don't change our loan policy or pricing model for anything. If it doesn't work, we won't do it. So we're we the market is moving a little bit.

We are seeing it. But fortunately, we've been able to get our business on our terms. And we beat the guys left and right. We're not going to chase the market. We're not going to chase the down rates.

We'll let deals go, hence the commercial real estate runoff that we've had. Some of it has been contractual runoff for projects that are completed going into the secondary market. So it's been good, solid commercial real estate that is going to another bank a price that doesn't make sense to us, we don't chase it. We're seeing a little we're seeing it there. On the commercial side, it's as low as it's going to go.

I mean the commercial side has been as low as it can be. So the middle market commercial side has been as low as it can be for the last three years. We don't see that occurring that much. In the private equity portfolio, we are seeing our sponsors sell or to buy, which should tell you something, but we're holding steady in that portfolio. We are seeing non banks come into that area, like the Ares and Antares of the world with rates that we would not be comfortable with on the deals.

Still, they look pretty good at 400 over four I think 4 hundred and five hundred over, but air balls that are way out of control. So and those aren't our sponsors doing. Our sponsors aren't playing. Our sponsors are selling. And that means something to us.

So we are seeing some irrationality in the market on the commercial real estate side, on the private equity side, the private equity side being mostly non banks throwing money at deals that don't make sense to us.

Speaker 2

Thanks. In other words, I think spreads are holding in there for us.

Speaker 1

Yes. Thanks,

Speaker 0

Our next question comes from the line of David Ciaverini with Wedbush Securities. Your line is now open.

Speaker 10

Hi, thanks. So I wanted to follow-up on the discussion about loan growth, has been very good. And high single digit guidance was maintained despite the caution on commercial real estate. So I was curious, are you seeing enough demand or an acceleration in demand on the C and I side and in premium finance to generate and continue that type of growth?

Speaker 1

Yes. On the commercial side, well, we're just taking business from people. As Dave said, our utilization rates are still in the low 50s and lines we're bringing in. But with the disruption in the market, with our reputation continuing to grow and our abilities, we're continuing to be recognized in this area. We're getting looks and feels from other banks because of our good looks and also because of the disruption in the market that's taken place.

On the premium finance side, Dave, you want to talk

Speaker 2

about that? The premium finance business is pretty strong. I mean, we continue to market and get new clients. SunTrust sold recently, which was disruption in the marketplace. They sold to one of our larger competitors.

And so that is helpful to us. And we do give great service and a good product. So we get our foots in the door and we continue to build the business, our feet in the door. We continue to build the business there. So we keep blocking and tackling.

There was some regulatory relief that we hope down the road may pop in that would help us compete with the non regulated entities. Hopeful that that's going to come shortly, which would be another tailwind to us. And we've lost some business because of regulations that apply to banks that don't apply to non banks or insurance companies, but we're hopeful that that's going to be resolved soon. So that might be a tailwind for us going forward. But as we mentioned on the front end, our pipelines are working their way back up and at a relatively high levels compared to recent history.

So the business is there and we think we can sustain it.

Speaker 10

Thanks for that. And in terms of benefiting from the disruption, are you able to benefit without hiring from these other organizations? Or is hiring a prerequisite to benefit from the disruption?

Speaker 1

The former. We benefit out of the box. Hiring is just we're very selective in that regard, and that's just additive. But for the most part, you really don't need to hire. We have the capacity to take on additional business across the board, but hiring doesn't hurt.

Speaker 10

Thanks very much.

Speaker 2

Thank you.

Speaker 0

I'm not showing any further questions in queue at this time. I'd like to turn the call back to Mr. Wehmer for closing remarks.

Speaker 1

Thanks very much, everybody. Have a great rest of the summer, and hopefully, we'll be back with our eleventh consecutive quarter of earnings when we talk in October. So we'll talk to you soon. Thank you.

Speaker 0

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.