Wintrust Financial - Earnings Call - Q4 2018

Transcript

Speaker 0

Welcome to One Trust Financial Corporation's Fourth 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, One 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 fourth quarter twenty eighteen earnings press release and in the company's most recent Form 10 ks and of 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

Good morning, everybody. Welcome to snowy wintery mix Chicago for our fourth quarter earnings call. With me as always are Dave Dykstra Kate Bogey, our Legal Counsel and Dave Starr, our CFO. We will conduct a call under the same format as usual. We'll give some general comments regarding our results.

I'll turn it over to Dave Dykstra for more detailed analysis of other income and other expenses and taxes. Back to me for some summary comments and thoughts about the future, then we'll have time for some questions. On the earnings front, income was $79,657,000 for the quarter, down from the previous quarter, but up from last year is almost $69,000,000 So up 16% about 16% from last year, down 13% from the year before. On a year to date basis, we're at $343,000,000 our eighth consecutive year of record earnings, up from $258,000,000 up 33%. Earnings per share were $1.35 in the quarter, down from 1.57 but up from $1.17 the previous year and $5.86 for the year, up from $4.4 or again 33%.

On an apples to apples basis, which way we like to look at it, pretax income for the quarter was up close to 12%, dollars 108,000,000 versus $96,000,000 for the year was up 18%. So notwithstanding, we hadn't had a tax break, which will be reporting record year end numbers. Well, it wasn't for the last few weeks of December, we have been able to report our twelfth consecutive record quarter of earnings. Market volatility took a toll on our results for the quarter, notwithstanding these events. Our core business performed extremely well and we were very well positioned for 2019.

As indicated in the press release, our fourth quarter results were negatively affected by on a pretax basis by $8,500,000 charge at mortgage servicing rights, an unrealized loss on equity securities of $2,600,000 $1,100,000 loss on Canadian foreign exchange, dollars 1.6 of acquisition expenses, so approximately $14,000,000 of negative adjustments pretax affected the earnings. This coupled with other factors in the mortgage business, including seasonal reductions in volumes and market driven margin issues account for the majority of the reduction fourth quarter income versus third quarter income. Dave will talk to you all about this in detail. When you look at the income statement, you'll see the most of the difference in the quarter took place in the other income section. This had negative effect on our net overhead ratio for the quarter.

As you can imagine, taking it to an unacceptable 1.79%. Backing out the quarter's extraordinary items brings it closer to our goals. The positive front, our FTE margin increased two basis points in the quarter to 3.63%, which coupled with an increase in average earning assets of $581,000,000 resulted in net interest income increasing $6,500,000 during the quarter. A little more on the margin, earning asset yields were up 13 basis points to 4.58%, while net cost of funds including the free funds contribution was up 11 basis points. It should be noted that our acquisition of CDEC, Chicago Deferred Exchange Corporation had minimal effect on fourth quarter margin.

CDEC was acquired in mid month December. By year end, we had transferred $1,100,000,000 of CDEC low cost deposits onto the balance sheet. With those deposits, we paid close to $700,000,000 of much higher priced institutional money, 75,000,000 of much higher priced brokered deposits and $200,000,000 of Federal Home Loan Bank advances. As mentioned, this had minimal effect in Q4, but can be expected to help our cost of funds in a meaningful way in the future. The CDEC business and related deposits, which we believe we can grow in the future, coupled with mid December's rate increases other than the notorious ten year rate and our continued loan growth bodes well for increasing margins in the immediate future.

It should be noted that the period end loans exceeded fourth quarter averages by over $650,000,000 It gives us a nice head start and boding its head start for 2019 and bodes well for the net interest margin and net interest income. Prior to the ten year collapsing, we were able to make a bit of headway on our laddering program. We've talked about our laddering program earlier. That's the program where we'll be extending our investment portfolio to start a balanced way to lower our interest rate sensitivity. The effects of these minor gains is hidden to some extent by our growth.

However, we did invest close to $400,000,000 in the longer end of the market. Continue to work in the future to reduce our interest rate sensitivity by the previous mentioned laddering program and by other means. We'll continue to monitor the rate environment and to continue our investment duration laddering program. Wealth management continues its slow and steady growth, happy with our results year over year. Other expenses are pretty well in line and we discussed in detail by Dave.

On the annual earnings front, 2018 was a record year for us, eighth in a row as I mentioned. Net income and EPS were 33% and the pretax was up 18%. Our margin increased 17 basis points to 3.61. The overhead ratio was 162 for the year, up from 156. We have been closer to the 2017 number as the fourth quarter not turned out like it did.

ROA increased 20 basis points to 1.18%. ROE and ROTE for 2018 were eleven point two six percent and thirteen point nine five up from 9.26% to 11.63% the previous year. All in all, it's a great year, which we're very proud in spite of the unlucky fourth quarter. On the credit side, credit metrics remained very strong. Non performing assets decreased $18,000,000 in the quarter or 0.44% of assets down from 0.52% at the end of the Q3 and 0.47% at the end of 2017.

Net charge offs for the fourth quarter were $7,100,000 or 12 basis points. The year net charge offs totaled almost $20,000,000 or nine basis points, up from seven basis points a year ago. Reserve coverage stood at 134%, up from the 118 we recorded in the third quarter, but down from the 153% experienced a year earlier. Three large loans, which went on non accrual are being resolved as anticipated, with one being cleared totally, one expected to clear in late Q1 or Q2, and one on its way to becoming a performing loan. All in all, remains extremely good.

On the balance sheet front, ending assets grew $1,100,000,000 in the quarter and $3,300,000,000 for the year to $31,240,000,000 These are increases of 1411% respectively. The acquisition of American Enterprise Bank in early December contributed $164,000,000 to these totals. American Enterprise Bank is an interesting transaction for us as we did not acquire any branches in the deal, given the proximity of their branches to the WinTrust branches. We acquired certain assets and assumed certain liabilities of the bank with basically no operating expenses. So pretty much a total cost out deal, which will profitable transaction for us going forward.

Total loans, net of loans held for sale were up approximately $700,000,000 quarter versus quarter and $2,200,000,000 year over year or 11.79.2% respectively. American Enterprise Bank contributed $119,000,000 of this growth. As mentioned, most of the growth occurred in December. We start quarter one twenty nineteen with a great head start of over $650,000,000 Deposits grew $1,180,000,000 in the quarter and $2,910,000,000 for the year, translates into deposit growth of 18% to 11% growth. American Enterprise contributed $151,000,000 to this growth.

We are excited about our prospects of growing our deferred exchange business with our CDEC transaction as these provide a diverse and steady flow of very low cost deposits. At the year end, CDEC managed $2,400,000,000 of deposits for customers. 1,100,000,000.0 of that was on our balance sheet, the remainder placed at other third party banks for a fee. These deposits by nature are short term in duration as the customer needs to get their funds reinvested in three to six months. As such, there can be volatility in aggregate balances.

We'll always be conservative in our reliance on these core deposits. And as I said earlier, we do think we can grow this business nicely. Our loan to deposit ratio returned closer to desired range of 85% to 90%, 90% closing 2018 at a little over 91%. Our goal is still to get in with that desired range. Now I'm to turn the call over to Dave to take you through other income, other expense and taxes.

Speaker 2

Thanks, Ed. As Ed noted, fourth quarter had some unusual volatility with the majority of the impact flowing through the noninterest income section. So I'll focus on those areas and then provide a bit of background on the noninterest expense category that experienced an overall decline in total expenses relative to the 2018. Turning to the non interest income section, our wealth management revenue held relatively steady at $22,700,000 in the fourth quarter compared to $22,600,000 in the third quarter of last year and up 4% from the $21,900,000 recorded in the year ago quarter. Brokerage revenue was down approximately $582,000 while our trust and asset management revenue offset that decline by increasing 674,000 Overall, as Ed indicated, we believe the 2018 was another solid quarter for our wealth management segment despite the volatility experienced in the equity markets late in the fourth quarter.

Mortgage banking revenue decreased approximately 42% or $17,800,000 to $24,200,000 in the fourth quarter from $42,000,000 recorded in the prior quarter and was also down slightly from the $27,400,000 recorded in the fourth quarter of last year. The decrease in this category's revenue from the prior quarter resulted primarily from lower levels of loans originated and sold during the quarter. And correspondingly, we also had lower production margin on those volumes. The company originated approximately $928,000,000 of mortgage loans in the fourth quarter. This compares to $1,200,000 of originations in the prior quarter $1,000,000,000 of originations in the prior quarter and $879,000,000 of mortgage loans originated in the fourth quarter of last year.

The mix of the loan volume that we originated during the quarter was approximately 71% related to home purchase activity compared to 76% in the prior quarter. So purchased home activity continues to be the majority of the new origination activity. On Page 22 of our earnings release, we provide a detail compiling the components of the origination volumes by delivery channel and also the mortgage banking revenue, including production revenue, MSR capitalization, MSR fair value and other adjustments and also the servicing income. So you can look there for further detail on the mortgage banking segment. Given the existing pipelines, we currently expect originations in the 2019 to be similar to the 2018.

The company recorded losses on investment securities of approximately $2,600,000 during the fourth quarter, primarily related to unrealized losses associated with a large cap equity fund that the holding company has an investment in, which was used for seed money for a proprietary mutual fund. As you know, many large cap stocks experienced significant drops in value near the end of the year and our holdings, which were required to record at market value were similarly impacted. Thus far in 2019, the funds recouped some of its value as the stock market has rebounded a bit in early twenty nineteen. The revenue in the 2018 for operating leases totaled $10,900,000 compared to $9,100,000 in the prior quarter, increasing 19% during the quarter. The increase in this revenue item compared to the prior quarter is primarily related to growth in the operating lease portfolio as the period end balances of operating leases increased to $233,200,000 at December 3138 from $199,200,000 at the end of the third quarter.

These amounts relate only to operating leases as capital leases are carried in the loan section of the balance sheet. Other non interest income totaled $10,600,000 in the fourth quarter, down approximately $5,500,000 from the $16,200,000 recorded in the third quarter of last year. There were two primary reasons for the decline in this category of revenue, including a negative swing of $1,500,000 of foreign exchange valuation adjustments associated with the U. S.-Canadian dollar exchange rate. The current quarter had a negative valuation adjustment of approximately $1,150,000 whereas the 2018 had a positive adjustment of approximately $350,000 so a swing of $1,500,000 The currency rate volatility was abnormally high during the fourth quarter.

We usually don't see that much of a change. And again, thus far in 2019, that exchange rate has recovered a bit, but we'll have to see where it ends the quarter up at. Next, BOLI income was down $3,700,000 from the third quarter, primarily as a result of a $2,200,000 death benefit recognized in the third quarter with no similar benefit recognized in the fourth quarter and a $1,100,000 loss on BOLI investments that support deferred compensation plan benefits that were impacted by equity market returns. I should note that this $1,100,000 BOLI loss resulted in a similar reduction in compensation expense during the quarter. In summary, the volatile market conditions near the end of the quarter influenced mortgage servicing rights valuation, equity, security valuations and foreign exchange rates that all negatively impacted our non interest income revenue amounts.

Interestingly, each of these items, which are mark to market each quarter had positive adjustments in the third quarter, but to a much smaller magnitude. We believe these categories have experienced some recovery in value thus far in the first quarter, but we'll have to see whether recovery continues and where they end up at the end of the first quarter. But typically, the swings in value were much smaller. Turning

Speaker 1

to the

Speaker 2

non interest expense categories. Non interest expense totaled $211,300,000 in the fourth quarter, down approximately 2,300,000 from the prior quarter. I should note that the current quarter included approximately $1,600,000 of acquisition related expense items compared to a total of $2,600,000 in the prior quarter. I'll talk about a few of the categories with the most significant changes now. The base salaries and employee benefit expense category decreased approximately $1,700,000 in the fourth quarter from the third quarter of last year.

The decline was due to a variety of factors, including lower commissions related to the mortgage banking production, a higher amount of salary deferrals related to loan origination costs, which reduced the seller expense and a reduction in costs related to deferred compensation plans impacted by the market returns on the BOLI plans, which I just discussed earlier in the noninterest income discussion. These declines are partially offset by additional expense related to normal staffing growth as the company continues to expand and an increase in payroll taxes associated with incentive compensation awards paid during the quarter. Marketing expenses decreased by approximately $1,700,000 from the 2018 to $9,400,000 As we've discussed on prior calls, this category expenses tends to be lower in the fourth and the first quarters of the year as our corporate sponsorship spending is more heavily geared towards the middle two quarters of the year. As I discussed in regard to the operating leases in the non interest income section, the company experienced a corresponding increase in depreciation expense related to operating leases due to the growth in that portfolio. This category of expenses increased $1,100,000 in the fourth quarter compared to the prior quarter.

Again, expect this category expense to grow at a similar rate to the revenue side of the portfolio of operating leases the portfolio of operating leases continues to expand. This is actually a category you're happy to see grow the expenses because it reflects it, or having increased revenue associated with that. If we group all the other expense categories together other than the three that I just discussed, the remaining non interest expenses were essentially flat on an aggregate basis being up approximately $54,000 in the fourth quarter compared to the prior quarter. So I won't spend much time on those since the pluses and the minuses offset and nothing real significant to discuss there. So with that, I'll conclude my comments and throw it back over to Ed.

Speaker 1

Thanks, Dave. As usual, clear as mud. Thank you.

Speaker 2

Always try to help the cause.

Speaker 1

Thank you. Despite the fourth quarter hiccup, 2018 was an extremely good year for Wind Trust as evidenced by another record year of earnings, EPS and balance sheet growth. Although aided by reduced taxes, remind you again the pretax income for the year was up in and of itself 18%. For those of you who've been following us for a long period of time, you should know what our goals are. Double digit earnings growth, exemplary credit metrics and a fortress balance sheet are tops on that list of goals.

To that end, year end is kind of a nice place to take a look back over the last five years and see how we have delivered. For the last five years net income growth five year CAGR is 20%, asset growth five year CAGR 12%, loan growth five year CAGR 13%, deposit growth five year CAGR 12%. NPAs as a percent of assets, the five year average is 0.52%, net charge offs for the five year average is 12 basis points a year. Based on the above, the hard press to say we're not achieving our goals, not just this year, but over a much longer period of time. Hopefully, this buys us some credibility in the market.

But history is just that history. That's why we at WinTrust, we have a mascot. It's a Greek god Sisyphus. Those of you who aren't familiar in your Greek mythology, Sisyphus was condemned by the gods to put your rock up a hill every day. At the end of the day, the rock would fall down the hill and have to push it back up again.

Just like him every December 31, that rock rolls back down the hill and we're fated with having to push it back up again. And the rock is always bigger and the slope is always steeper. But we take that chance, we relish that challenge. We're looking forward to 2019 with a great deal of confidence so we can again deliver on our goals. We're well positioned for the first quarter in particular and beyond.

The CDEC acquisition should aid in keeping our interest cost of funds intact. Q1 twenty nineteen will be the first full quarterly effects of these low cost deposits on earnings and we're embarking on growing that business. The AEP acquisition should be accretive in year one, should be accretive in the first quarter. We started the year at $650,000,000 head start on loans, Xenic balances exceeded quarterly averages by that amount. Loan pipelines remain consistently strong.

We're booking loans on our terms. Although non bank competition is becoming more and more aggressive, our brand and market disruption is helping us to continue to gain market share. The situation warrants however, that is our circuit breakers, our pricing policies and loan policies trip. We'll not be afraid to stop the borders we have in the past. As of now, we see no reason to do this.

Exceptions in our portfolio, which we monitor monthly, I remain consistent for the last three years, both on new deals and in the overall portfolio. And our pricing is holding up as well as can be expected. We expect the margin to grow modestly in 2019, assuming a consistent rate environment, but nicely. Credit metrics remain strong, although we'll continue to call the portfolio for any and all cracks and negative relationships where said cracks are found. We always remember the old adage, your first loss is your best loss.

Let's not try to kick the can down the road. It takes a full year for short term interest rates to work their way through our asset base. December increases is really yet to be seen in our numbers and other increases in 2018 that we experienced in 2018, but still working their way through the system. This bodes well for the margin. Wealth management should continue to slow and steady climb.

In 2018, we opened 10 branches and we have the same number on tap for 2019. Pretty much all of the 2018 branches are performing ahead of plan. We expect the same for the ones opening this year. While the ones we're opening this year will be in Naples, Florida, believe it or not. That is going to open in the February as a small convenience branch.

But when you look at the numbers of Illinois refugees in Florida now and our name recognition, We're not expecting much out of this, but I think it's going be a lot better than we anticipated. We completed two bank acquisitions in 2018 as well as CDAC. It looks to us like pricing for banks and our asset in our desired asset range are becoming more reasonable. As such, our landing patterns has remained full, but gestation periods remain slow. You can be assured of our consistent conservative approach to deals.

The lower 10 rate, although hurtful in Q4, should help volumes in the upcoming spring buying season in the mortgage business. Business. We continue with our cost cutting and efficiency moves in this business, many of which will be operational by mid year. As a community bank, we remain committed to the mortgage business. We are committed to achieving a net overhead ratio of 1.5 or better.

However, as we are mandated to prepare our platform to become a $50,000,000,000 asset bank, you can all wonder who you don't have to wonder who that mandate came from. Achieving that number at year end maybe hard, number in the mid-150s is our short term goal. In short, we're probably build over the last twenty seven years and approach 2019 with a great deal of confidence. As always, you can mature to our best efforts and we appreciate your support. Now we can turn it over for some questions.

Speaker 0

Thank Our first question comes from Jon Arfstrom with RBC Capital Markets. Your line is open.

Speaker 3

Thanks. Good morning. Good morning, John. Couple of questions here. The CDEC deposits, you talked about $1,000,000,000 on your balance sheet and maybe I think $1.3 or $1.4 off the balance sheet.

What's the plan with the off balance sheet piece of that?

Speaker 1

Well, we a nice fee on that that will run through fee income. We don't want to get overly reliant on this. You'll probably see what we're going to do is look at the twelve month rolling averages because it does go up and down somewhat seasonal for people to get things done in calendar years or quarters. We'll probably maintain the one year, either the max that they have on their books or the one year rolling average. And the rest we will place with other banks and receive the fee on it.

Does that make sense?

Speaker 3

Yes, that makes sense. And the general message on loan yields, it sounds like based on your very last comments, your expectation is loan yields can continue to rise modestly?

Speaker 1

Well, because of the structure of the balance sheet, yes. And the rate rises continue to work their way through. So we would expect that to occur. We would hope that it's kind of a weird environment now, but we would hope to be able to mute our deposit costs, our core deposit costs, notwithstanding the effect of CDEC's replacement of higher cost funds, but to maintain those relatively low. So we'll see, that's the plan at least.

Speaker 3

Okay. And then just on mortgage, know this is tougher, maybe it's for you, Dave. But you talked about pipelines being consistent, maybe margins being down last quarter. You're also talking about some seasonality. And I guess we didn't touch on efficiency opportunities.

So just kind of can you unpack mortgage for us a little bit in terms of how we should be thinking about Q1 and then headed into Q2 on mortgage?

Speaker 2

Well, heading into 2Q, we would expect it to increase as the seasonality factors go away. We certainly don't have those pipelines in place yet because we from an application to closing is generally in the forty day or less range. So we're not getting applications yet for the second quarter, but we would expect that to be the pickup in strength. First quarter, we would expect that the Veterans First consumer direct platform would say relatively stable. They don't have quite as much seasonality because they're not focused in Midwest like our retail channel is.

So we would expect there to continue to be a little bit of pressure on retail channel in the first quarter. And so that would be relatively stable, maybe down a little bit. Correspondent business would be relatively stable and Veterans First would be relatively stable. So that would be our thoughts. Our Veterans First tends to have a little bit higher gain on sale margin because it's government products than the other two channels.

But when volumes go down, margins tend to get compressed because you have so many people competing for a much smaller pie. And so that's where the compression is coming, just the competition out there right now.

Speaker 1

Interestingly enough, John, on the competition side, we're seeing a great deal of stress in our competition. We believe that the long awaited consolidation will be taking place. We know some firms are merging, some are going out of business, some in the markets now, which should bode well for us both in terms of recruitment and less competition in the area. On the efficiency front, we're doing a number of things. One of which could be pretty interesting by mid year, while it goes to plan.

Our Zoom mortgage, which is our rocket mortgage platform we should be able to start marketing that online. So people can kind of like Rocket Mortgage, you still will have a person available to work with you. But through that distribution, we can cut commissions probably by in half or more if they come in if applications come in that way. That's the secret to this. We're still going to rely on that personal service.

We still rely on the mortgage reps. We'd like to tilt the balance to be more consumer direct and we're in the process of proving out that concept. Focus groups have told us that our product is better than some of the major competition out there. Time will tell, hopefully by mid year we can get that sometime in the middle of year, we'll get that up and running and start marketing that, which could Zoom also will cut it is cutting a couple of days off the front end. We're doing a number of other efficiency moves and that we're going to talk about now that should bring down our cost and our time to get loans done.

So I know some people say, why should you be in mortgage? We're a community bank, we got to be in mortgage. Mortgage notwithstanding even including the fourth quarter was profitable for us for the year in a nice way. And it's something we believe that you got to take the good with the bad, ride it out. Interestingly enough, we were having discussions about hedging our mortgage service pipeline in the fourth quarter.

Greedy Ed thought rates for long end was going continue to go up and schedule it for the first quarter. So that one's on me. I screwed that one up. Hard to believe I screwed something up, right, Dave?

Speaker 2

Very hard to believe that.

Speaker 1

Yes, thank you, Dave. But we are looking at that. But we're refining this business and we think it's going to be a good steady business for us going forward. We'd like to take the volatility out, but we'll work to do that when the time is right. Obviously, it was right and I screwed it up, but other than that, we're okay.

Speaker 3

Okay. All right. Thanks for the help guys.

Speaker 0

Thank you. Our next question comes from Brad Milsaps with Sandler O'Neill. Your line is open.

Speaker 4

Hey, good morning guys.

Speaker 1

Hi, Brad.

Speaker 4

Hey, I just wanted to follow-up on the NIM discussion and maybe the size of the balance sheet as it relates to the CDEC deposits. I guess maybe initially I thought that you would use that funding to sort of grow the overall size of the balance sheet, but smartly so you guys opted to pay off some higher cost deposits. As you think about funding your $2,000,000,000 ish of loan growth this year, I assume you want to do that with core. Do you bring back some of the more wholesale sources to lever up into the bond book if rates behave the way you want them to? Just kind of want to get a sense of kind of what you're thinking in terms of size of balance sheet and how best to deploy that liquidity going forward?

Speaker 1

Well, our prospects for loan growth are consistent with prior years. So we need to be able to bring deposits in to do that. We worked very hard to develop a diverse deposit base, but for the most part core. We only use the brokerage stuff when we have to or to control our asset liability management. So our interest rate sensitivity.

The $700,000,000 that we paid off was brought on, was longer term deposits. When we took on about approximately the same amount of franchise loans when we bought those from GE. We had to fund that right away. Now we consider these, see that to be core and we really don't want to have a lot of reliance on institutional funds. Now it's nice to have them there.

We basically have brought those numbers down significantly to hardly to almost 3% or 4% or toll deposits, but we have that available should the market so warrant. So it's nice having that capacity available to grow if rates get goofier, we find it hard to for some reason to grow organically. If you look at Lindt Trust over the years, we grew organically for a long period of time, we got into acquisitions and now we're back to filling out the franchise and growing organically. Most of the growth this year was organic. And we feel pretty good about our ability to do that.

Our branches are performing better than we experienced. But we think that the deposit side of our balance sheet is really our franchise value, those core deposits and we're going to stick to trying to grow those, not lever up, unless there's some situation where we can plan arbitrage someplace and make us a lot of money. We don't see that happening with the flat yield curve, but it's nice to have that in our back pocket in the event it were to occur. So in short, we like core deposits. We're going to continue to grow core deposits, continue to fill out the franchise where we can grow without the commensurate increase in expenses and be very, very flexible.

That's it's hard to believe I like being flexible, I wish I could be personally, but we will certainly be in on a business side.

Speaker 4

So in summary, basically adding the excess $1,000,000,000 above the $2,000,000,000 that you need for loan growth is you just want to be flexible, it's really going to depend on kind of what the yield curve gives you?

Speaker 1

Yes. And we want to be conservative. We make we obviously don't make as much as we make in the margin and taking all the CDEC money in, but you don't want to rely on it too much. And then you find yourself get whipsawed and what do you do. So we're going be conservative and we make good money.

It was a great deal for us, they're wonderful people. They have a great market presence, that we think we can enhance. So we're excited about those prospects and we just don't we want to get to know the business better before we get out over our skis and have a funding issue that we have to deal with later.

Speaker 4

And Dave, I don't know if you can look at it this way, but I know you mentioned there was a huge impact to the CDEC money in the fourth quarter, but would the December margin be appreciably higher than, say, the October margin?

Speaker 2

Yes. The December margin was higher than the October margin. It was actually higher than our ending margin. That's why we believe that the margin will increase in the first quarter and we gave that guidance.

Speaker 4

Got it. Okay, great. Thank you very much.

Speaker 0

Thank you. Our next question comes from Kevin Reevey with D. A. Davidson. Your line is open.

Speaker 3

Morning.

Speaker 1

Hello, Kevin.

Speaker 3

Are you?

Speaker 1

Living the dream every day, my friend, every day. Forward to your pictures and pictures reporting.

Speaker 2

Yes. So my question relates to core operating expenses. I'm coming up for the fourth quarter roughly with a number around $210,000,000 Is that kind of a good number to use going forward, assuming a modest rate of inflation? And obviously, you've got some other things going on. Is that kind of a good start?

Kevin, we never really give guidance on the expense side because it moves around quite a bit depending on what happens with the mortgage business. And as I mentioned, the marketing and advertising costs spike up a little bit in the second and third quarters. But the things that that could impact that again would be the commissions on the mortgages. We tend to give salary increases in the first quarter starting in February. So roughly 3% is a plus or minus number that you could use on average starting in February.

So that generally kicks in. The rest of it, operating lease depreciation, again, you could see on that category, it went up $1,100,000 this quarter, but that's good because we had a more corresponding revenue come on with those balances. So we because of all the moving parts, we really haven't given a ton of guidance on that. But if you can look at the $1,600,000 of acquisition related expenses we had for the quarter, those were unusual. But the rest was sort of standard as far as variability goes.

Okay. And then how should we think about the GAAP and the FTE tax rate for 2019? Well, I think you what we the guidance we gave before, I think, sort of the 26.5% plus or minus would be sort of where we would think it would fall other than the credit you get for when you have stock equity award grants. And you sometimes get credits for that with the stock prices higher than what the award price was. And so we give those numbers in the press release and in our Qs as to what they were in the year.

So you can look at that and make an estimate, I guess, depending on where you think the stock price is going to be. But it will be somewhat lower than that with those equity award credits that come through. But barring that, I would still think it would be in sort of the 26.5% range.

Speaker 3

That's helpful. Thank you.

Speaker 0

Thank you. Our next question comes from Chris McGratty with KBW. Your line is open.

Speaker 5

Good morning. Thanks for the question. Dave, on the margin, just want to come back to it for a minute. The first quarter, it seems like a setup pretty good setup from the deal and kind of the back ended loan growth in the quarter. If the Fed doesn't move anymore, can you speak to the kind of the trajectory of the margin?

Your comments on moderating deposit betas was interesting. But it's interesting, once we get that lift in Q1, what's the outlook if the Fed doesn't move anymore?

Speaker 2

Well, I mean, we show what our variable and fixed rate loans are in the press release. You can kind of look at that, but there are some tailwinds with the life portfolio that we have, the premium finance life portfolio we have, there's approximately $4,500,000,000 of those loans that are tied to twelve month generally tied to the twelve month LIBOR rate and those reprice once a year. So theoretically, about onetwelve of those reprice a year. So if the twelve month LIBOR doesn't change, then we've got some tailwinds in that regard. And we put a graph on Page 20 of our press release that sort of shows where that rate was a year ago and where it is now.

So you get some benefit from that. Similarly, our $2,500,000,000 of property and casualty premium finance loans are fixed rate and generally have a nine month life. So about one ninth of that portfolio is repricing as they come due at a higher rate.

Speaker 1

So those two things have a

Speaker 2

little bit of tailwind. Deposit pricing, you'll still get a little bit of CD repricing out there as upward pressure. But if rates don't move, then as Ed said, we think we can sort of hold the increases on the deposits elsewhere pretty well. And then the mix change with the CDAC versus some of the wholesale funding should help. But what we've sort of seen in the marketplace is, and I think it's probably perception that people now believe that maybe the Fed may not raise.

And so you're seeing people get less aggressive on deposit pricing than you're actually seeing no longer in wholesale brokered fund pricing back off a little bit. So it just seems like the marketplace is sort of taking a pause here waiting to see what's going to happen and we'll certainly pause along with it on the deposit side.

Speaker 5

Great. If I could sneak one more in on capital. You guys have historically been pretty shareholder friendly. Given the movement of stock in the group, can you speak to thoughts on a buyback, whether it be standalone or kind of funded with some sort of alternative instrument? Thanks.

Speaker 1

Well, we always look at that, but we are a growth company. We've got to concentrate on our TCE ratios and the like. But it's something we review all the time and depending on where the market goes, we'll see where we end up. If we saw a period of rope a dope two coming on board, we'd probably go out and raise a bunch of capital and buy and wait to buy some stock back, I would imagine. But right now, we're still experiencing good growth and the acquisition market is strong.

So it doesn't seem to make a lot of sense now, but something we always look at and we'll continue to look at. Dave? Yes. Well, and

Speaker 2

the other thing is, I mean, you look at our total capital ratio, which tends to be our limiting one, we're 11.6% at the end of the quarter. And that fell really because of the acquisitions and the associated goodwill that goes along with that. But generally, our earnings are supporting our growth. But we generally wouldn't want to fall into the low 11s or high 10s. And so we don't have that much excess capital.

So to the extent that we thought that we wanted to enter into a stock buyback, we would probably have to raise sub debt or preferred or something like that in order to accommodate the repurchase of it, just because we generally don't like our total capital ratio to fall much lower than that.

Speaker 5

Got it. Thanks a lot.

Speaker 0

Thank you. Our next question comes from Terry McEvoy with Stephens. Your line is open.

Speaker 2

Good morning.

Speaker 1

Hi, Terry.

Speaker 6

Ed, your closing remarks, you finished with Wind Trust crossing $50,000,000,000 and making some comments about the expenses this year reflecting crossing that threshold, which caught me a little bit off guard given your $31,000,000,000 today. That's a 50%, 60% increase from where we are. So maybe could you just expand a little bit on why twenty nineteen you expect to start building up those expenses? Do you have any thoughts organically with the deal pipeline when that actually will happen? And just help us gauge the buildup of those specific expenses and put some sort of time frame around it as well.

Speaker 1

Sure. Well, this expectation was put on probably a year and a half ago. And we've added 110 people in IT for God's sake. We're a growth company. And I'd like to say we're kind of like in puberty right now, Corey.

And we have to grow into our into the overhead we put on. There's still some more coming. Regulators are pushing us because of it. They say you got to be ready and we like it to have $50,000,000,000 platform. We don't you say what if the expenses are coming?

We've experienced probably more of them than we'd like already and some more coming. We don't I can't tell you we're going to hit 50. I'm just telling you what the expectations are. We have to have this platform ready. The referees, the regulators are the referees and only I'm allowed to bump the ref.

The other guys can yell at them only I can bump them, but we want to have good relationships with them. All in all, we're making investments in the business that allow us to get there. So we need to grow into our close. We intend to grow consistently like we have in previous years. We don't intend to look at very large acquisitions.

We never know what comes along. It's business as usual for us, which would get us there, feel good that way and nothing would have changed, we'll get you there in five years probably. But that's what's expected of us and we need to grow into it from to get that overhead ratio where we want it. So I was just being open with you that the 150 is kind of hard to reach when we have to go to a committee on committees now to figure out what else is going on. But we put the infrastructure in place, we're very happy with it.

Everybody is happy with it and there'll be some more additions we want to bring we'll need to bring on over the next year and a half or two years to make everybody happy with it, if you follow my drift.

Speaker 6

Great. I appreciate that. And then just as a follow-up, premium finance commercial business was up 8% last year, the life side was up 13%. Is that a reasonable growth outlook, kind of 8% to 10% for 2019 for those two specific lines of business?

Speaker 2

Yes. I mean, generally, we think of our loan portfolio growing in the high single digits. And generally, we like those to sort of grow in concert with the total balance sheet. P and C could get a little bit better boost. I mean, the market is hardening just slightly in certain areas, but the fact that some there was some regulatory relief on collecting tax ID numbers and certain sort of know your customer rules out there for the premium finance business that were implemented late last year.

We lost a fair amount of business over the last couple of years because we had to collect those TIN numbers where some of our competitors didn't. We hope to gain some of that back and we already are starting to gain some of that back, but it takes time because these customers buy annual policies and they only come up once a year. So there could be a little bit of tailwind in that regard. And of course, we'll always want to grow it. But I would think that those would be reasonable expectations.

Maybe the P and C could be a little bit higher depending on the market hardening aspects that may occur during the year and how well we do on regaining some of that lost business we have because of the unleveled regulatory playing field.

Speaker 1

On the life side, I think the law of large numbers will catch up with us eventually. So you might, if I had to guess probability wise, it's probably more probable that the P and C business will be up more on a percentage basis than the like business. Great. Thank you both. Thank you.

Speaker 0

Thank you. Our next question comes from David Long with Raymond James. Your line is open.

Speaker 7

Good morning,

Speaker 1

Hello, David. How did you like our double doink then the quarter? I can't be

Speaker 4

double I

Speaker 8

was hoping for another Vegas vacation comment, which did not happen. So maybe we'll go back to that next quarter.

Speaker 2

The double doink, for those of

Speaker 1

you who don't know, was our Bears kicker hitting the upright on the crossbar to lose the game. It's known as double doink in Chicago. We're calling the fourth quarter, our double doink.

Speaker 8

Yes. I prefer to get back to another quarter, another record. That said, following up on Terry's comments about the premium finance business. My sense has always been that those there are more repricings happen early in the year on both the life and the commercial side. Is that the right way to think about it?

Speaker 2

No. The business fluctuates a little bit as far as volumes go because a lot of people have policies that renew in December and generally the loans flow through in January. So January tends to be a large month and July does because the other high quarter end month is June. So quarter ends tend to be a little bit higher, but not so dramatically that it would change the landscape as far as the rate environment too much.

Speaker 8

Got it. And then you talked a little bit about deposit competition maybe easing to some extent. And I have not seen as many teaser rates, if you will, or the 2.5%, 3% rates on deposits and some of the mailers going out. Where do you guys stand on some of these promotional deposit yields that you have previously

Speaker 3

focused on?

Speaker 1

Well, when we opened a new branch, we still use them. We opened 10 last year, we'll open 10 scheduled open 10 this year. We will be using them at those locations. But again, then we take those taper off when the as time goes by and most half the ones we did last year all tapered already. So I would expect there to be some hiccup there or increase there, but as a percentage of our total deposits, it becomes less and less.

But we agree with you. We don't there's not as many silly things going on in the market right now. I think people are taking a breath. We had great loan growth because of our diversification in the quarter. I don't think you've seen that in the smaller banks and other places right now.

And if they've got off in the fund, they're not going to pay that kind of money. So yes, I believe the competitive environment for deposits is taking a breather as Dave said.

Speaker 8

Got it. That's all I had. Thanks

Speaker 1

guys. Thanks.

Speaker 0

Thank you. And now our next question comes from Nathan Race with Piper Jaffray. Your line is open.

Speaker 9

Hey guys, good morning.

Speaker 1

Good morning, Nathan.

Speaker 9

Going back to the discussion around CDAC, Dave, just wondering if you could paint a little more color around what the specific fee income and noninterest expense impact we should expect in 1Q as you guys get the full quarter impact of that deal?

Speaker 2

Yes. We haven't disclosed that yet. I and it sort of depends on the volume of deposits and that's so they can go up and down. So I think we'll take a pass on giving you that information until we let first quarter go.

Speaker 9

Okay. Sounds good. And then just maybe a broader question for Ed. There's been a lot of M and A in Chicago, not only in the last year, but in the last few years. So just curious as you kind of sit here today, how you kind of if you're more or less optimistic on loan and deposit growth opportunities into 2019 than maybe you would have thought twelve months ago?

Speaker 1

On the acquisition front, I think I said in my comments that it's actually pricing expectations are coming down a bit. Think especially in the under $1,000,000,000 banks, which is what we focus on. I think they're all getting a little worried that they want to get out now before the next wave hits. We don't see that next wave yet, but there always is one. And their expectations have come back a little bit.

So we believe that with the acquisition front could be very interesting this year. On an organic loan and deposit growth, we talked a little bit about premium finance where we think that's gone. But again, our loan pipelines are as strong as they've ever been and our ability to book these loans on our terms is holding up. As I mentioned, our critical exceptions is both a percent of new deals and in the portfolio just exceptions in general. And the portfolio in total has been relatively consistent and a little bit trending down over the last two quarters.

So we are able to get deals on our terms. And again, we've always been an asset driven company. If the assets dry up, we're not going to go out and raise a bunch of deposits. We'll hunker down and wait for everything to hit the fan and hopefully clean up again. So things there's some disruption in the market with our neighbor over here expecting to close pretty soon that always is good for us.

So we like where we sit right now, but at the end of the first quarter, I might not like where I sit. We'll see where it goes. Most of the competition is not coming from banks, it's coming from non banks, at least the pricing and the leverage and term side. And it's getting a little bit goofy out there. But that being said, our reputation plus the turmoil in the market is okay right now.

It's really our pipelines remain strong. So we feel pretty good about where we are.

Speaker 9

Got it. That's great color. I appreciate you guys taking the questions.

Speaker 0

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

Speaker 7

Hey, good morning guys. Could we just go back to the mortgage business? Ed, it sounded like you made the call not to hedge the pipeline going forward. Is that going to be hedged? Is the pipeline going to be hedged as a matter of course?

Or are you going to reevaluate every quarter?

Speaker 1

We'll reevaluate every quarter.

Speaker 2

Yes. It's the servicing portfolio, not we do hedge sort of most of our pipeline. So it's just the servicing portfolio that we're referring to as a hedge.

Speaker 7

Okay. Well, was my next question, whether you hedge the MSR and your MSR capitalized values basically doubled more than doubled in the last year. That that's not hedged at the moment?

Speaker 1

That's what I was referring to was that we our pipeline we do have and that works fine for us. But I as we need to call that something we would do in the first quarter. If you recall, the ten year got up very nicely during the fourth quarter before it tumbled. And it appeared that was going to be consistent. And my call is to say, as someone were to look at it the first quarter and started lagging into it, then fell off again.

So now we're reevaluating. Does that make sense?

Speaker 7

Yes, does. I know MSR marks have bitten many banks over time. I'm just a little surprised with it growing, you're not just going to hedge out that exposure or large portion of it?

Speaker 1

Well, it is growing over time and we are looking at it. So it was something that was a nice run up for us. It was my fault. I should have looked at it and been more conservative, but it's something we're looking at now and we'll get back down. But I'll fall on the grenade for that one.

But I think I've been on the other stuff, I think.

Speaker 2

Yes. In reality, Brock, if you look at it, the MSR valuations were almost flat for the year. I mean we had gains in the first three quarters and it gave it all back at the end. So on an annual basis, it was somewhat flat. But if your viewpoint is that you think rates are going to rise a little bit, you could ride up that value and then hedge it in and we just felt that the long end would not tumble like it did.

So and it's come back a little bit since the end of the year. So you could see some pickup in those MSRs. Now we're not even near the end of the quarter yet. And with the volatility we saw in the fourth quarter, who knows? But we have a hedging strategy in place and we'll evaluate it.

It's just the timing of when you implement it.

Speaker 7

Okay. Fair enough. And just as a quick follow-up, what would be your general sense of can you give us any sense of twenty nineteen volumes assuming, say, no further hikes in your mortgage business? Is that kind of flat or up small or?

Speaker 1

I would say flat.

Speaker 2

No, I'd say generally flat.

Speaker 7

Flat assuming no hikes. Okay. Thank you.

Speaker 0

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

Speaker 10

Hey, good morning. Just wanted to touch really quickly on the loan to deposit ratio. You guys have done a nice job of bringing that down from kind of 95% at the beginning of 2018. We're almost to kind of the high end of the range here headed into 2019 of 85,000,000 to 90,000,000 that you guys are targeting. Any color on kind of where you feel like that will trend or what you're watching in terms of being able to bring that lower throughout the year?

Speaker 2

Yes. Well, our goal is still the 85,000,000 to 90,000,000 And you could we could have easily been there had we not getting rid of the brokered funds here in the fourth quarter when we brought CDAC on, so we could have just grown that. But with the long end coming down, there really was no place to put those funds. So we elected to use those funds to get rid of some of the higher priced wholesale brokered and Federal Home Loan Bank funding that we had. So we still have the goal to just gradually bring that down.

And if the market if the long end would go up, Ed said, you could potentially lever and get there right away. But in the interim, we hope to just gradually continue to bring that down into the 90%, so 85% to 90% range in 2019. But we'll just have to see what happens to the yield curve and how fast you do that. Don't want to resolve the deposits and have no place to go with them. So we'll monitor the curve and go from there.

Speaker 10

And just wanted to follow-up on the comments that you guys started to kind of ladder back out sometime this quarter and kind of last quarter. Any chance that the covered call income is going to tick up here in 2019? Or is that still likely going to be steady at kind of this lower run rate?

Speaker 2

Yes. We write them on some of the securities. So generally, you get more covered call when rates are going down because people will pay you more for those. With the thought that the rates may be relatively flat to at this point on the long end to going up, you don't get that much. And you can see that we had some of our securities called away when we reinvest those and but that's sort of typical.

So I wouldn't expect too much difference in that. It just really sort of depends on what the market perception is, where rates are going, what the volatility is at the beginning of quarter when we write those, but probably not dramatically different.

Speaker 8

Okay. Thanks.

Speaker 0

Thank you. I'm showing no further questions at this time. I'd to turn the call back over to Ed Weimer for closing remarks.

Speaker 1

Thanks everybody for dialing in. Put the double dyke quarter behind us and we're going to look forward to a very good first quarter hopefully knock on wood and talk to you again in April. If you have any additional questions or follow ups, feel free to call Dave Starr, Dave Dykstra and myself, happy to talk to you. Talk to you later when pitchers and catchers are in. Thanks.

Bye.