Wintrust Financial Corp
NASDAQ:WTFC
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Wintrust Financial Corp
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Welcome to Wintrust Financial Corporation's Second Quarter and Year-To-Date 2023 Earnings Conference Call. A review of the results will be made by Tim Crane, President and Chief Executive Officer; David Dykstra, Vice Chairman and Chief Operating Officer; and Richard Murphy, Vice Chairman and Chief Lending Officer. As part of their reviews, the presenters may make reference to both the earnings press release and the earnings release presentation. Following their presentations, there will be a formal question-and-answer session.
During the course of today's call, Wintrust 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 our earnings press release and in the Company's most recent Form 10-K and any subsequent filings with the SEC.
Also, our remarks may reference certain non-GAAP financial measures. Our earnings press release and earnings release presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded.
I will now turn the conference call over to Mr. Tim Crane.
Thank you, and good morning, everybody. We appreciate you joining us for our second quarter earnings call. In addition to Dave Dykstra and Rich Murphy, who the operator introduced, Dave Stoehr, our Chief Financial Officer; and Kate Boege, our General Counsel, are with me in the room today.
In terms of an agenda, I'll share some high-level highlights. Dave will speak to the financial results, and Rich will add some additional information and color on credit performance. I'll wrap up with some summary thoughts, and as we always do, we will do our best to answer some questions.
On our last call in mid-April, we were still in a period of volatility and to a degree, uncertainty for the banks. At the time, we talked about several objectives: continuing to focus on our customers, capitalizing on our strength and stability, once again being opportunistic when there is disruption in the market.
We talked about managing the balance sheet in a conservative fashion, growing deposits to fund loan growth and continuing to enhance liquidity. And we talked about continuing to take advantage of higher rates, specifically to demonstrate our ability despite rising deposit costs to stabilize the net interest margin. We feel like our performance on these objectives has been very solid.
In addition to reporting record income for the first half of the year, for the second quarter, we had strong and balanced loan and deposit growth, adding clients and building the franchise through the volatile period when others were distracted. We improved liquidity, reducing federal home loan bank borrowings and as you will hear shortly, have demonstrated through the sale of a portfolio of loans that occurred after the quarter end, the flexibility to continue to manage our balance sheet effectively.
And while as expected, deposit costs are up, we are originating very high-quality loans with attractive both yields and terms and continue to benefit from loan repricing, which we believe differentiates us from many of our peers.
Just to give you some detail, you will recall our margin was 3.83% for the first quarter and specifically 3.70% at the end of March. Our margin for the second quarter, despite the very good growth was 3.66% and importantly, was stable throughout the quarter. Lastly, our credit performance remains strong with no evidence of systemic issues. Rich will discuss this in some detail, including proactive steps that illustrate our ability to address any softening that may occur. Again, I'll come back at the end.
But with that, I'll turn this over to Dave to provide some additional detail.
Okay. Thanks, Tim. First, with respect to the balance sheet growth. We are very pleased to see deposits for the quarter grow by $1.3 billion or 12.4% on an annualized basis. This deposit growth was aided by the popularity of our suite of MaxSafe products that provide enhanced FDIC coverage and we did not rely upon additional wholesale deposits during the quarter for that growth.
This growth was also despite our wealth management deposits declining by just under $400 million owing in large part to less deposits from our 1031 exchange business due to a slowdown in tax-free commercial real estate exchanges in the marketplace.
As to the deposit composition, we again saw some additional movement from non-interest-bearing deposits to interest-bearing accounts. The non-interest-bearing deposits at the end of the quarter represented 24% of our total deposits compared to 26% at the end of the first quarter. These movements do not appear to be unique to us, but they obviously increased the cost of deposits for the quarter.
Although I would note that the mix shift out of non-interest-bearing deposits seems to have subsided thus far this quarter as the percentage is relatively stable now that it was at the end of the second quarter. This strong deposit growth helped to fund similarly strong loan growth of $1.5 billion during the second quarter. The growth was predominantly fueled by exceptionally strong production from our commercial premium finance operations and to a lesser extent, from commercial real estate growth, including draws on previously existing credit lines. Rich Murphy will discuss the loan portfolio growth in more detail in just a bit.
The investment portfolio declined slightly as we only reinvested about a third of the $940 million of securities that were called away at the end of the prior quarter. The additional liquidity provided by not reinvesting the entire amount of those called securities also helped to fund the quarter's loan growth. The company was able to reduce its non-deposit funding, primarily Federal Home Loan Bank advances during the quarter by $208 million.
The result of these balance sheet movements was growth in total assets of approximately $1.4 billion, a slightly elevated ending loan-to-deposit ratio of 93.2% and relatively stable capital ratios.
All in all, it was a very successful quarter in growing our franchise. Our differentiated business model, exceptional service and unique position in the Chicago and Milwaukee markets continue to serve us well.
As Tim mentioned, the exceptionally strong growth in our commercial premium finance portfolio and the outlook for continued loan growth provided us with an opportunity to structure a loan sale transaction of approximately $500 million of our U.S. commercial premium finance portfolio. This loan sale occurred earlier this week and provided multiple benefits to us, including that it demonstrates that our premium finance portfolio is a strong source of additional liquidity, if needed.
Actually provided us with liquidity this quarter to aid in funding anticipated loan growth, reduces our loan-to-deposit ratio to a desired operating level that is closer to 90%, reduces some of the concentration in the premium finance base as we've had strong growth over the last quarter and quite frankly, over the last year and would provide a small gain in the third quarter from the sale of those loans.
As you know, these loans are very short-term loans that make monthly payments and they will likely be replaced substantially by new volume by the end of the year. Next, I'll cover noteworthy income statement categories, starting with the net interest income for the second quarter of 2023.
Net interest income totaled $447.5 million. That was a decrease of $10.5 million as compared to the prior quarter and an increase of $109.7 million compared to the same quarter of 2022. The decrease in net interest income as compared to the prior quarter was primarily due to a compression in the net interest margin influenced by the higher funding cost.
The net interest margin was 3.66% in the second quarter, which was just slightly less than the 3.7% margin that we discussed on our first quarter earnings call and which was the approximate run rate at the end of March. However, the margin was 17 basis points less than the prior quarter level of 3.83%. Importantly, the net interest margin was stable for each of the months in the second quarter. And as I'll discuss later, we expect the margin to continue to remain relatively stable for the remainder of 2023.
As to the details of the component changes impacting the margin in the second quarter relative to the first quarter, the company saw a beneficial increase of 42 basis points on the yield on earning assets, excluding the impact of our interest rate swap positions, a 15 basis point increase in the net free funds contribution. And offsetting that was an increase of 66 basis points of an increase in the rate paid on liabilities. And it's important to note that roughly half of the margin decline during the quarter was associated with an additional 8 basis points of margin drag from a full quarter impact of the interest rate swap positions that we have in place.
Those swaps were generally put on in the first quarter and the first quarter only had a portion of the impact. So this quarter was fully baked and was accounted for about half of the margin decline. We continue to believe that our balance sheet structure can provide margin stability as our premium finance portfolio, which comprise roughly a third of our loan portfolio should continue to reprice upward over the course of this year and that should substantially mitigate the rise in deposit pricing.
Accordingly, based on the current interest rate environment, which includes an expected 25 basis point increase by the Fed later this month, we expect our margin to remain relatively steady in the 3.60% to 3.70% range during the remainder of 2023.
Turning to the provision for credit losses. The company recorded a provision for credit losses of $28.5 million in the second quarter. This compared to a provision of $23 million in the prior quarter and $20.4 million of provision expense recorded in the year ago quarter. The higher provision expense in the second quarter relative to the prior quarter was primarily a result of a higher loan growth, changes in macroeconomic outlooks, including projected credit spreads and projected commercial real estate price index and slightly higher net charge-offs.
Again, Rich Murphy will talk about credit and the loan portfolio characteristics in just a bit. As other non-interest income and other non-interest expense, total non-interest income totaled $113 million in the second quarter and was up approximately $5.2 million compared to the prior quarter of total of $107.8 million.
The primary reason for the increase was due to an $11 million increase in mortgage banking revenue. The mortgage banking operation saw a slight increase in volume of loans originated during the second quarter with relatively stable margin – production margins. Roughly 84% of the application volume is still related to purchased home activity. Application activity continues to be subdued due to lack of housing inventory and higher rates, but we would expect right now, similar to slightly elevated production, but nothing dramatic in the third quarter.
Wealth Management revenues improved by $3.9 million in the second quarter relative to the first quarter, and this was bolstered by revenue from the acquisition that we closed at the beginning of the quarter and offset somewhat by continued headwinds relative to the slowdown in the commercial real estate transactions and the resulting impact on the 1031 exchange business revenue.
However, these increases were offset by a $1.4 million reduction in gains and losses related to the company's securities portfolio. The company recorded a $1.4 million gain in the first quarter on security sales and really nothing in the second quarter of this year. A $7.8 million decrease in covered call options also impacted this revenue category. As I discussed earlier, we did not reinvest much of our securities that were called and this created less opportunity to write covered call transactions during the quarter.
Turning to non-interest expense categories. The non-interest expenses totaled $320.6 million in the second quarter and were up approximately $21.4 million when compared to the prior quarter total of $299.2 million. The primary reasons for the increase is related to a few general areas.
First, the acquisition of the wealth management companies at the beginning of the quarter added roughly $4 million of additional expense sprinkled throughout the various expense categories. But excluding that impact, salaries and employee benefits expense increased by approximately $8.1 million in the second quarter of 2022 compared to the first quarter. And relative to the prior quarter, there was $4.7 million increase largely related to higher mortgage commissions and to a lesser extent, incentive compensation accruals. So most of that was commissions related to the increased mortgage operations. So this category fluctuates depending upon the mortgage volume.
The category also saw approximately $4.1 million of higher employee benefit expenses due to an increased level of health insurance claims during the quarter. Health insurance claims can fluctuate on a monthly basis as we are self-insured. The first quarter was a little low. The second quarter is a little high can fluctuate. But the change between quarters was really more probably a timing of when employees took advantage of our health insurance program.
Next, advertising and marketing expenses increased by $5.8 million in the second quarter when compared to the prior quarter. As we have discussed on previous calls, this category of expense tends to be higher in the second and third quarters of the year due to expenditures related to various major and minor league baseball sponsorships. Other summertime sponsorship events that we hold in the communities that we serve and marketing of our brand and deposit products.
Also, in the second quarter, lending expenses increased approximately $4.8 million due to the strong and higher overall loan origination activity in the second quarter. And other than that – other than the expense categories just discussed above, all the other expense categories were relatively consistent. The efficiency ratio increased to 57% for the second quarter from 53% in the first quarter of the year and this was primarily due to the impact of lower net interest margins, the reduced level of covered call income and the slightly elevated expenses. Net overhead ratio was 1.58% in the second quarter and increased from 1.49% in the prior quarter due to the slightly higher expenses.
In summary, we think this was a very solid quarter. We had strong loan and deposit growth, improved liquidity position, stabilized net interest margin with a steady outlook. Net revenues at more than 1% of the prior quarter's record level despite funding cost pressures, continued low levels of non-performing assets and the second highest quarterly net income result in the company's history. We feel like we've managed through a turbulent first half of 2023 delivering net income that was a record for the first half of any fiscal year in the company's history and we have a positive outlook for continued growth in assets, revenues and earnings.
So with that, I will conclude my comments and turn it over to Rich Murphy to discuss credit.
Thanks, Dave. As noted earlier, credit performance continued to be very solid in the second quarter from a number of perspectives. As detailed on Slide 6 of the deck, loan growth for the quarter was $1.5 billion. The loan growth was largely attributable to over $1 billion of growth in the commercial premium finance category. This growth is due to a number of factors.
The second quarter is historically when we see our highest funding volume. And as we have noted in the past several quarters, we have seen a significantly harder market for insurance premiums, particularly for commercial properties. As a result, we have seen the average loan size increase. Finally, we continue to see new opportunities as a result of consolidation within the premium finance industry.
We also saw good growth in commercial real estate, largely resulting from draws on existing construction loans and portfolio residential real estate loans. This rate of loan growth is significantly higher than the first quarter and well above our guidance of mid- to high single digits. We believe that loan growth for the second half of the year will be more in line with our guidance as we anticipate the premium finance loan growth will moderate and be more in line with historic norms. We also anticipate that higher borrowing costs will continue to affect borrowers to reconsider the economics of new projects, business expansion and equipment purchases.
However, we continue to see solid momentum in our core C&I and CRE pipelines. Disruptions in the banking landscape continue to work to our benefit, and we have seen numerous quality opportunities from other regional banks. In summary, we continue to be optimistic about loan growth for the balance of 2023, and we believe that our diversified portfolio and position within the competitive landscape will allow us to grow within our guidance of mid- to high single digits and maintain our credit discipline. From a credit quality perspective, as detailed on Slide 14, we continue to see strong credit performance across the portfolio. This can be seen in a number of metrics.
Non-performing loans remained stable at 26 basis points or $109 million, up slightly from what we saw in the first quarter. Overall, NPLs continue to be at historically low levels, and we are still confident about the solid credit performance of the portfolio. Charge-offs for the quarter were $17 million or 17 basis points, which was up from the prior quarter, but still at a relatively low level. This higher level was primarily attributable to a charge of $8 million, which resulted from the sale of a portfolio to co-working office loans totaling $17 million.
As we have noted in previous calls, we are constantly looking for signs of stress in our portfolios and are very focused on our non-owner-occupied office portfolio. The common denominator of the loans we sold was the co-working nature of the tenants. We believe that this sub-segment of the market will continue to experience significant stress from weak tenant demand and rising cost of debt, and we took this opportunity to meaningfully reduce our exposure. This sale made up close to half of our exposure into the subcategory. We have always looked at strategic options to reduce exposures to areas of concern within our portfolio, and we will continue to do so.
Finally, as detailed on Slide 14, we saw stable levels in our special mention and substandard loans with no meaningful signs of additional economic stress at the customer level.
As noted in our last earnings call, we continue to be highly focused on our exposure to commercial real estate loans, which composed roughly one quarter of our total loan portfolio. Higher borrowing costs and pressure on occupancy and lease rates are cause for concern, particularly in the office category. On Page 18, we've updated a number of important characteristics of our office portfolio.
Currently, this portfolio remains steady at $1.4 billion or 13.2% of our total CRE portfolio and only 3.4% of our total loan portfolio. Of the $1.4 billion of office exposure, over 40% is medical office or owner occupied. The average size of the loan in the office portfolio is only $1.3 million. We only have five loans above $20 million. There has been significant concern about office properties located within central business districts.
Our CBD exposure is limited to $350 million or approximately one quarter of the office portfolio. Half of this is in Chicago and half is in other cities. The bulk of the portfolio is located in suburban areas and areas outside CBDs. And portfolio performance to date has been very good with no loans currently over 90 days past due.
We continue to perform portfolio reviews regularly on this portfolio, and we stay very engaged with our borrowers. We are not immune for the macro effects that challenges product type, but we believe that our portfolio is well constructed very granular and should perform well moving forward.
As noted earlier, higher borrowing costs and pressure on lease renewals are caused for concern across the CRE space. To better understand how these issues could impact our portfolio, our CRE team updated their deep dive analysis on every loan over $2.5 million, which will be renewing between now and through the first quarter of 2024.
This analysis, which covered 79% of all CRE loans maturing during this period, resulted in the following: more than 52% of the loans will clearly qualify for renewal at the prevailing rates. Roughly 32% of these loans are anticipated to be paid to offer will require a short-term extension at prevailing rates and approximately 16% of the loans will require some additional attention, which could include a paydown or pledge of additional collateral. We have tentative agreement on renewal terms with many of the borrowers in this final group.
Again, our overall CRE portfolio is not immune from the effects of rising rates or the market forces behind lease rates, but we have been diligently identifying weaknesses in the portfolio and working with our borrowers to identify the best possible outcomes, and we believe that our portfolio is in reasonably good shape and situated to weather the challenges ahead.
That concludes my comments on credit, and I'll turn it back to Tim.
Thanks, Rich. To wrap up, for the last several months, we've had the opportunity and in some cases, I would say, the responsibility to explain to our customers why Wintrust continues to be a better alternative than the larger too big to fail banks. Not only have we successfully done that with almost no attrition, but we continue to win business and as you can see, grow deposits and build our franchise.
We continue to think we are uniquely positioned to take advantage of the current environment with our diverse businesses that limit the potential impact of economic softness in any individual area and we remain positioned to benefit from higher rates. As Dave noted and we noted in the press release, we expect that our margin will be relatively stable for the remainder of the year, and our net interest income will increase in the coming quarters.
I would say that the current market is a little bit choppy, and we remain incredibly focused to pursue opportunities that we see, and we'll do that aggressively in the coming months.
At this point, I'll pause and we can take some questions. Elizabeth, back to you.
[Operator Instructions] Our first question comes from the line of Jon Arfstrom with RBC Capital Markets.
Good morning.
Hi, Jon.
Hey, I’m going to start – the first question, I guess, you used the word choppy, Tim, and you guys talked about a little bit slower loan growth in the second half of the year, but you put up a pretty good quarter. And I guess my question is, what do the pipelines look like? What's the quality of what you're seeing? And very early, Tim, you alluded to like pricing and structure being better, but touch a little bit on that in terms of how that may have changed?
Yes. I'll take the first part and Rich can add to that. With respect to choppy, companies are obviously reacting to higher rates and certainly real estate projects, in some cases, are on hold. And there's folks still wrestling with labor issues, which we think are generally better, but not universally better. And then obviously, there are some competitors that are pulling back in terms of credit and their participation in the market. And so we're seeing opportunities. I think a lot of people are seeing opportunities, and we just have to be selective and disciplined. And I think our team is doing a nice job in that regard, which is driving both higher yields and better terms, in some cases, more equity in real estate deals. So Rich, why don't you please add to that?
Yes. No, I think you said it well. Every week that goes by, we see new opportunities really across the portfolio in terms of customers who aren't getting their existing banks to work with them in a productive way. And we're also seeing a tremendous amount of opportunities, large capital market type opportunities where there's multiple banks involved. And there's almost more than you could possibly want, frankly, because there's just so much that's out there right now. So it does give us the opportunity to pick and choose price accordingly, structure accordingly. We've always had a history of being pretty disciplined in this space, and that's not going to change. But it's a great opportunity for us.
Disruption always has worked to our benefit. Post-pandemic, post PPP, we saw a very similar kind of environment where a lot of banks were kind of struggling getting their footing we're seeing that right now as well. And so we're pretty optimistic, but most importantly, we just want to stay disciplined.
Okay. Fair enough. The premium finance size limits on your balance sheet, we expect to see more of these sales. And I'm just curious if you guys continue to service it. I know they're very short-term in nature, but help us understand the outlook for that in terms of on your balance sheet?
Yes. So the $500 million we sold is an off-balance sheet transaction that will come off out the books in the third quarter. And Jon, as you know and probably most of the people on this call know is that those loans make monthly payments and have an average life of nine to 10 months. So by the end of the year, they will substantially have been paid off anyway. So we – if you recall, we did a securitization of premium finance loans a decade ago or so, I think is about a $300 – or $600 million facility that we did for a few years. And so it's not a new transaction for us. But we thought it was important to get the plumbing in place. We had a $1 billion quarter, a great growth quarter. The market is still hard. The disruptions helped us, the outlook is good there.
And so without getting the plumbing in place, sort of testing it out and having another source of liquidity was a good thing to do.We have the opportunity to do it in the future. But right now, we don't have any plans to do another loan sale. But if we were to have outside loan growth going forward, we might be able to pull the trigger and do it quickly. And now that we've demonstrated that we can do it again.
And Jon, yes, we continue to service those loans, I think was part of your question.
Yes, yes. Just last one. Mortgage obviously, was a decent quarter for you. Dave, you said slightly elevated production in the third quarter. Is that what you mean? And just give us an idea of what you're seeing there. $30 million type quarter.
Yes. I mean we're just a few weeks into the third quarter, but application volumes have ticked up just slightly. So I would expect it to be up a little bit, but as part of it depends on what happens to the valuations of your MSRs too. But from a production perspective, I would expect it to be up just a little bit. We'll just have to see how the production flows through, but nothing substantial. I mean if it's up a couple of million dollars, that might be at the right neighborhood, but we'll have to just see how it plays through.
Okay. All right. Fair enough. Thanks a lot, guys. Appreciate it.
Yes. Thanks, Jon.
Our next question comes from the line of David Long with Raymond James.
Good morning, David.
Good morning. I was kind of blanked out or I didn't hear if that was my name or not, but good morning, everyone. Thanks for taking my questions. A couple of things. On the funding side, you seem to still have good growth. Obviously, you've got a vehicle now where you can reduce or securitize or sell some of those loans. But on the funding side going forward, how are you thinking about incremental FHLB advances versus deposits, whether it's CDs or brokered CDs, with the most attractive source on the funding side right now, and how do the costs compare right now?
Sure, David. I mean, generally, we'd like to grow deposits to match any loan growth, and we think deposits are the core of our franchise. Obviously, the MaxSafe product suite was very helpful to us in the quarter. Clients didn't have to go elsewhere, even at competitors where they're reciprocal products, we don't have to pay the additional fee that might be involved with that. So that worked out very, very well. The MaxSafe product, in general, is in total a little less than 4% in terms of the deposit cost, and we're putting loans on at 7.5% to 8% at this point. So the spread is good. We continue to add business. Everybody is asking for deposits. It's a focus. So we're going to try to grow deposits before we use other liquidity sources.
Got it. Thanks, Tim. And then for the competitive dynamics for deposits right now, are you seeing more pressure from the larger regional banks? Are you seeing more pressure from the community banks? Where is the competition more intense on the deposit side?
Well, all over would be my blanket answer, but certainly, the regional banks, and Rich mentioned that some companies are finding it more difficult to get what I would call transactional type work done. And for folks that just don't have a relationship with their bank, the relationship can be either uncertain or strained at this point. And we're very focused on having relationships and taking good care of our clients. And so one, it hasn't been difficult for us for our existing base; and two, it's created an opportunity in certain places and see new clients that, frankly, we're very happy to be doing business with.
Great. Thanks, Tim. Appreciate it.
You bet.
Our next question comes from the line of Terry McEvoy with Stephens.
Hi, Terry.
Hi, good morning. Maybe a question on expenses. Some other banks are facing some NII pressure and prospects of rising credit costs. Could you just talk about maybe expense management plans and your thoughts on expenses over the next two to four quarters?
Sure. I mean we're always looking out for expenses. Our approach has generally been to grow the balance sheet and try to grow the revenues at a quicker pace than the expenses. And like we've talked, we're pretty optimistic about balance sheet growth and pretty optimistic about maintaining the margin, which would translate into increased NII. So from that perspective, we're very optimistic.
On the expense side, this quarter had, as I said, a few increases, the seasonal marketing, the addition of expenses from the acquisitions and slightly elevated lending expenses due to the double-digit loan growth and increased mortgage production. So those were the primary reasons for the increase this quarter. But we are always looking at expenses. We're very focused on them right now to keep them in check and try to keep them less than the revenue growth going forward. But we don't want to cut to the bone here and not take advantage of the growth opportunities in the marketplace. We've always done that. We've always taken advantage of the disruption, and we think we're in a great position to do that again.
Thanks, Dave. And then as a follow-up, it sounds like next week, we're going to get updated regulation for banks over $100 billion of assets. What's the risk of that kind of dribbles down into banks maybe $50 billion and above? And how are you thinking about any changes in regulation for a bank that's, what, $54 billion, $55 billion of assets today?
Well, I guess we'll watch with great interest what they come out with. But I think you're right. I think most of it is focused at $100 billion. We're really not there yet. I think most of the focus will be on interest rate risk and liquidity management at the supervisory level right now. And making sure that the risk management in place there, we think we do a great job at that. So we're not that concerned about it. But we'll watch with interest what they come up with. But we don't have any plans of hitting $100 billion in the next year or so here. So I think we have some time to plan for it.
Definitely. Thanks for taking my questions.
Thanks, Terry.
Our next question comes from the line of Ben Gerlinger with Hovde Group.
Hi. Good morning, guys.
Good morning.
I was curious if we could talk through deposit pricing just a little bit. I know we touched on it in a couple of different ways, but first, I wanted to confirm that the guidance of 3.6% to 3.7% on margin incorporates any sort of mix shift that might happen?
Yes.
Got it. Okay. Just confirming that one. So when you think about the incremental dollar at this point, without giving away too much of your playbook, how are you guys approaching the new – the next dollar? Are you looking for relationships that automatically have to bring over deposits from day one on the new loan? You’re looking for any different niche avenues of deposit pricing or deposit gathering at a lower price and then kind of juxtapose against that. How is the flows or mix shift changed over the last, call it, 60 days?
Well, we’re always looking to gather deposits at lower costs. And with the commercial relationships we win from the treasury businesses and the operating accounts that are generally at the most favorable price. The MaxSafe product for us is mostly interest bearing. There’s several flavors of it, some that are for municipalities, for example, and some that are for our corporate customers. At the margin that’s, call it, 4%. And then we’ve been offering some promotional type CD activity that we really use to kind of balance the remainder of the activity.
So we’ve got a lot of levers to pull. We’re certainly asking for deposits with our customers, but frankly, that’s not anything new for us. I mean we want the relationships and we want the operating accounts from these companies. So we think we can gather deposits at an appropriate level that allow us to operate as we have. We talked about the loan yields and structures being attractive to us. And so we don’t think at the moment we’re giving up a lot in terms of spread.
Yes. And we also – this is Dave. We also think we have a great position in the Chicago market. We’ve got the fourth largest deposit market share behind three big guys: Chase, Bank of America and BMO. And then it really falls off for at least for banks headquartered in Chicago and Illinois. We actually have the largest market share and we’re less than 10% in Chicago and in Illinois, quite frankly.
And the big banks really, as we talked earlier, aren’t the ones putting the pressure on some of the regional banks that have presence here are offering higher rates and the community banks are pretty disciplined. So if someone wants to do business with a larger bank that’s located in Illinois, we’re sort of the go to bank. And we give great service.
So we think we’re uniquely positioned to take advantage of this, offer good products, give good service and cement in the customer relationships. So we’re kind of excited about the opportunities there.
Got it. That’s helpful. And then if we could switch gears a little bit towards credit. I know the guidance here was a little bit softer loan growth in the back half of the year to get more in line with previous guidance. When you think about the provision, I know that CECL is a large component, and, frankly, the first half of this year feels like the first half of the decade. So that’s a bit unknown economically speaking. But how do you guys think about the provision going forward? If loan growth slows a little, do you think the provision could come down from here? Or how do you guys approach it?
Well, CECL is a life of loan concept as far as forecasting out what the losses are in your existing portfolio. So yes, if there’s a loan growth, that’s higher or lower that’s going to impact. And obviously, there’s a mix issue if we grow a lot in the life or commercial premium finance portfolios, those are less provision than a CRE loan or a commercial loan. But generally speaking, if you have higher growth, you’ll have a higher provision.
But the things that impact the provision substantially are some of the economic factors. So if the forecast from the economists that are out there get less recession focused and more soft landing or mild recession focused, then I think some of those economic forecast factors will get better and that would have a positive impact on the provision. But I’m not an economist. I don’t make economic predictions, but we follow Moody’s, we follow some other economic forecasts as we model out our CECL. So I would suspect unless there’s a big change in the economic forecast that growth would be the item that would impact the provision.
Got it. Okay. That’s helpful. Appreciate the color, guys.
Yes. Thanks, Ben.
Our next question comes from the line of Chris McGratty with KBW.
Great. Good morning. Dave, just a question on the kind of a nuance on the capital the covered call strategy. How do we think about I guess broadly reinvesting going forward like that line item and obviously it will play into the size of the overall earning asset base?
Well, our securities, I mean, generally, we like to run-in the roughly 90% loan to deposit ratio and then the remaining liquidity is either overnight money or securities and our securities have generally been 12%, 13% of the asset base. So we would expect to sort of keep it in that range and use our liquidity to fund what we expect to be good loan growth. So the reinvestment of the cash flows up, the securities we would put back into some sort of asset class and we’ve generally done Ginnie Mae’s. And if you do Ginnie’s or Fannie’s, you can write covered calls against them.
So where you generally get higher covered calls is when rates go down and the securities get called away and then you reinvest those securities and then you write calls against them again. So in a – or in a flat rate environment, where you can continue to write calls on them quarter after quarter.
But I would suspect that given the demand we have for a loan and given that we are sort of at a decent spot who could – investment portfolio go up another $500 million or $1 billion or something over time as we grow here probably, but that’s not going to create tremendous amount of covered calls.
So I would probably say in this environment if you’re thinking $2 million to $5 million of covered calls maybe a normal range given the interest rate environment and our investments right now that’s probably not a bad way to look at it.
Okay. That’s helpful. And then just two small ones. The – maybe a comment on gain on sale margins for mortgage. And then I just want to make sure I heard you. The $8 million loss on the – was that a $17 million sales or roughly little under 50% loss rate on the office loans? Is that what I heard?
That’s correct.
Okay.
And then the gain on sales, Dave?
The gain on sales, for us, it’s been around holding around 2% the last couple of quarters, so pretty stable.
Great. Thanks, Dave.
Our next question comes from the line of Brody Preston with UBS.
Hey, good morning, everyone. How are you?
Great.
Hey, I just wanted to ask on the fixed rate loan portfolio. Excuse me. It’s about $17.5 billion. I just wanted to make sure that the $7.8 billion to $7.9 billion that mentioned that reprices or matures over the next year or so. Do you happen to know what the existing yield is on that portfolio? And then what the like what new origination rates look like right now?
Well, if you look at that $7.8 billion, $6.6 billion of it is fixed rate commercial premium finance loans. So the vast majority of that is the commercial premium finance portfolio, which 1/9 of that basically turns over every month. So those loans generally are pricing at just net-net sort of prime plus 1 range, plus or minus depending on the mix of large loans versus small loans.
So that portfolio will be turning over. And you can go back and look, we put in our press release, we sort of show what the indices are. You can go back and look at what prime was nine months ago and what it is now and that should be roughly the pickup you’d get in the yield on those.
Got it. Thank you very much. And then I did want to ask just within the available-for-sale portfolio. You give the effective duration of 6.5. I wanted to ask you if you knew what the conditional prepayment rate you’re assuming within that duration calculation is?
I don’t have it handy right now. The majority of those are Ginnie Mae’s, but I’d have – I don’t know what. I don’t have it handy with me right now. We can get back to you on that, Brody.
Okay, great. I just want to ask just on the CRE deep dive that you talked about where I think it was 32% would need some service type of short-term extension, 16%, a little additional attention, 50% or 52% qualifying for a renewal. I guess, is that the way it works down? You kind of look at you say you qualify. You might need a short-term extension. You probably need some more equity.
I guess like what drives the delineation between just needing a short-term extension and maybe needing to bring more equity to the table? And then if you could just on the ones that need a short-term extension, like what happens after they get the short-term extension? Like how long is the extension for? And do those loans move off the balance sheet and go somewhere else? Just trying to understand the moving parts there.
Yes. The ones for short-term extensions generally are we’re transitioning out to end financing that’s probably going to be off our balance sheet. And that’s pretty typical. The history of payoffs is pretty substantial in terms of what we see every quarter just rolling off. So there’s a lot of construction financing that we do that we’re not going to be the best scenario for them in the long-term. So that’s kind of how that works and we still see lots of liquidity out in that end market.
As it relates to the other part of the question, which is what are we looking for typically what triggers that conversation is really going to be performance of the underlying property, which is really our primary focus. You have lease income that you’re matching up against your expenses and your debt service. And if there’s a mismatch there, we’re going to have a conversation.
And generally speaking, I think most of our borrowers will still tell you that they believe strongly in their project and property and they want to support it. I mean generally, those conversations at this point are still very productive and that we do have situations where in this loan sale where we had conversations and you could see that probably was not going to get better. And at that point in time, we have to make a decision as to do we because of there’s so much liquidity still in the market, this was an opportune time to just say the situation is probably not going to get any better and we need to probably think about some alternatives.
Got it. Okay. That’s helpful. Thank you for that. And you mentioned – you did mention that there you’re still seeing a lot of liquidity in that end market? Is that for a wide range of projects? Or is it more, I guess, more tailored to specific asset classes within construction where there’s available liquidity?
Yes. That’s a good point. If it’s multifamily, if it’s industrial, there’s just – there’s a lot of appetite still out there for that type of product. Obviously, in some of these more distressed areas like CRE and Retail, that’s a different story altogether. But we don’t do a lot of the construction financing in those segments.
So generally speaking, where we’re looking to transition loans out to for end financing, those – we’ve been really focused heavily on more multifamily and industrial over the past three, four years.
Got it. And I know it was a small – it was a smaller amount of loans and it was [indiscernible] team of things that was a relatively small charge. But am I – did I hear you right then and read right, I guess, that the $8 million charge that you took against $17 million of co-working office loans. Was that – was it an $8 million charge on a $17 million loan portfolio?
That’s correct. It was a small group of properties no one market in particular, but they were all, as I said, the common denominator is that co-working space, which we think is probably going to be the last piece to recover in office and probably the hardest to kind of re-tenant at this point.
So where as we have said in the past, we try to be really strategic in terms of taking advantage of the liquidity and albeit there’s probably less liquidity for this type of product out there and that’s why the discount, but it’s better off just to get the runway clear because we’re not sure what’s coming down the road, but we want to be prepared.
Yes. No, I understand that. And so you don’t think that that level of charge is indicative of what you might see if you or other banks maybe had to sell what I would call a more regular way kind of normal office property?
No, no, not at all. I mean, again, in the co-working space which we have very little of and this was almost half of that total that we have. It’s a much more distressed sub-segment of this office category. So we think that you’re probably going to see a little more stress in that subcategory. But in general, no, we’re still pretty confident about where valuations are.
Got it. And then just one last one for me. Just on the loan sale within the commercial finance – premium finance portfolio. Who are the end buyers of these? You don’t even give a name, obviously, but just like a type. Is it private equity? Like, who are the end buyers of this loan – of this type of loan portfolio? And I think you mentioned that this kind of gives you the opportunity to explore other types of these transactions down the road. What would drive you to kind of look to lean into selling more of these loans versus keeping them on balance sheet?
Yes. So if we sold it in a special purpose vehicle that then sells it out asset conduits that are investing. So yes, we’re not going to give the name right now as we have an NDA. But it’s your standard financial institution conduit financing. So again, we didn’t have to do it. We didn’t sell it off to some of these firms that are buying distressed assets. Obviously, this is not a distressed portfolio. We have no reason to do that.
This was more testing the plumbing and getting us set up to provide a lever to pull for liquidity if we need it. So I think the reason you would do it again is if you – if loan growth was very, very strong and you needed to fund it and deposit growth wasn’t quick, again, as Tim says, we must prefer to grow our franchise. We’ve always done that to grow the franchise through deposits, which is the core business that we love.
But to the extent that the asset growth would outstrip deposit growth, in any given quarter, we could pull a lever on this either as a distinct sale like we did this time or you could also set up a similar transaction where it’s a revolving securitization facility where you could just continue to feed into.
We’re not as favorable as setting that because generally you’d want to set it a two or three-year time period at least. And your crystal ball isn’t always so clear as how strong loan demand will be three years out. So we’d rather do it discreetly in kind of bespoke sort of transactions as needed. But right now, we don’t anticipate doing it again in the future. But if we did it again, it probably a good thing because that means we’re having really, really good loan growth.
Got it. And I think I heard you right that you’re going to continue to service these loans for those borrowers, but they are pretty short-term. So is there much in the way of servicing income that will come from that?
No, no. It’s a very short-term and the servicing costs are pretty low in this portfolio.
Got it. Thank you very much for taking my questions, everyone. I appreciate it.
You bet.
Our next question comes from the line of Nathan Race with Piper Sandler.
Yes. Hi, guys, good morning.
Good morning, Nathan.
Of course, not just the increase in the substandard loans in the quarter. It looks like they’re up 16% versus the first quarter. Any specific drivers there of note? And to what extent if any did that impact the provision in the quarter?
No, I don’t think there’s necessarily any color that I could give you on that. I mean, it’s – the levels are still very subdued in terms of overall. But in terms of driving changes in the CECL, I don’t know if it really had a whole lot of – yes. So I’m just going to take look at it.
Yes. We’re at 1% still. So I mean as it relates to overall levels, I think we’re still in pretty good shape, kind of looking at my list of additions to it. Not a lot of common denominators here. We try to be incredibly proactive in our portfolio reviews of identifying any type of loan that might be in the CRE sub-segment, for instance, where you have a decline in debt service coverage that gets a little bit closer to 1:1 or at 1:1, that’s going to be something.
So we see some – so I see some of that. There’s also as a commercial customer is – compressed a little bit on cash flow. We might make that a substandard and typically we’re going to anticipate that that’s going to turn around. So there’s no one thing I can point to, but just certainly higher borrowing cost probably would be the primary driver of that as it puts a little more strain on cash flow both in the C&I and CRE segment. But as it relates to CECL, I mean, not a whole I think as Dave pointed out earlier, I think the bigger drivers on CECL is really going to be some of these economic factors.
Yes. I think it’s more a function of just our very proactive approach to reviewing these credits and making sure we understand where everything is. Again, Rich, they remain at very low level.
Got it. That’s helpful. And just going back to Terry’s question around expenses. I think last quarter, Dave, we were talking about kind of a high single-digit outlook for this year. Is that still kind of hold?
I think it does. I mean, you got to – if you pack out the impact of the acquisitions, we’ve always said that it’s excluding acquisitions. But yes, I think that still holds. This quarter, I talked about the reasons for this quarter. But yes, I think we still look at that as being appropriate.
Gotcha. And just one last housekeeping question. With the sale of some MSRs in the quarter, does that impact mortgage revenue in any way materially in 2Q?
No. We took an opportunity. We always mark the MSRs to market and we had the market value of them at the end of last quarter when we started to look at this transaction when we actually sold them this quarter were roughly the same. So there wasn’t a big impact. That was really just reducing risk again. MSRs have run up nicely and to take a little bit of that asset off of our book at sort of the top of the MSR valuation as we look at it seem to be prudent and the loan – the servicing rights that we sold were generally those loans that were outside of the Chicago, Milwaukee market area, so they weren’t our banking customers. That were loans that we’ve made in other regions of the United States.
That makes sense. If I could just pass one more on capital. Total risk based took down to 11.9. I know you guys tend to want to stay above the 11.5%. But imagine what the – I’m sorry, the insurance premium finance securitization that’s upcoming and just given perhaps higher for longer interest rate environment, that you guys have plenty of capital to just kind of continue to support the growth opportunities that exist organically in front of you today, that the right way to stand out?
Yes, we think so, Nate. I mean, obviously, this was a big growth quarter and the sale occurred after the quarter-end. So we feel comfortable. And if loan growth normalizes into the range Rich discussed, we should be adding capital.
Yes. And the other thing that happened, the other capital ratio stayed relatively flat. Total risk based was down a little bit because as you know, we had a sub debt offering out there that sub debt you lose 20% of it each year as it matured and the last 20% of that sub debt capital ran off on June 30. So that impacted the total risk-based capital just a little bit, but clearly, we expect the capital ratios to grow going forward based upon our projected earnings and balance sheet growth.
Got it. And it sounds like the priorities for excess capital deployment are still organic growth first. Perhaps buybacks are lower down on the spectrum, just given the organic growth opportunities today?
Yes. I think that’s fair, Nate. I mean, obviously, we look at all the alternatives, but again, we anticipate good growth. We like where we are in the market.
Okay, great. I appreciate all the color and taking the questions.
You bet. Thank you. Have a good day.
Our next question comes from the line of Jeff Rulis with D.A. Davidson.
Thanks. Good morning.
Good morning, Jeff.
Just wanted to check back in on the hedging strategy on margin, appreciate the guidance of 3.60%, 3.70% for the back half of the year. I guess what’s the duration of those hedges? I think in early parts of the year you talked about maybe taking the top end off of 4% plus, but also protecting much below 3.50%.
I guess does that extend into 2024 basically what you’ve hedged? And I guess, how does that range get affected further out kind of with another hike, no hikes or kind of a cut? I’m just trying to think if that duration of those hedges, does that get into 2024 or any early expectations of how margin behaves into 2024?
Yes. No, yes. When we did those hedges, they were general longer-term transaction. So on Slide 22 of our earnings deck or you can look in the last 10-Q that we had, the maturity dates range from September of 2025 all the way out into 2028. So they’re longer-term hedges. And if you look at that slide, it’s got the swap rates in them, which are generally from the mid-3s into the low-4% range as far as where the swap rates are at.
So the market, given the slope of the curve, just hasn’t been that favorable from our perspective to enter into more. So we haven’t – we didn’t enter into any in the second quarter. We’ll still look at that. But they’re there for downside protection and quite frankly, as I said in my comments, had it not been for this portfolio, our margin.
If we didn’t put the swaps in, our margin would be 15 basis points higher overall because that’s the impact this quarter. Last quarter the impact was 7. So the differential this quarter was 8. In the first quarter, the impact was 7, this quarter was 15. So the differential was 8. But we think that’s a fair price to pay if we can keep the margin relatively stable like we think it is to protect from the downside risk of substantial rate reduction. So just a risk mitigation again in our longer-term.
All right. So that sort of extend that guidance range into 2024, but you feel pretty good about kind of maintaining that level even beyond into next year?
Well, it depends. I mean, everybody’s used different. If you take the higher for longer, than I think that bodes well for us. If you look at the curve and rates drop precipitously, then we probably would have pressure on our margin, but that’s why we have these hedges in places to help mitigate some of that impact.
That’s helpful. Just to see where you lean into that. Just the last one would be just checking in on wealth management. I think the acquisition sort of juiced that number a bit. But looking forward to the outlook, would you expect that growth to level off, linked quarter was strong, but maybe acquisition driven the outlook?
That was acquisition-driven. So we would expect to continue to grow it. But it would just be slow, steady growth. And some of that is obviously dependent on the market because you earn your fees based on the underlying asset value. So if the market continues to rally, then that would be beneficial for us, so.
Okay. Thank you.
Elizabeth, we can do one more if you want.
We have a question from the line of Brody Preston with UBS.
Hey guys. Sorry about that. I just wanted to clarify something on the co-working space. Is that like a wework? I just wanted to make sure I totally understood what the property was.
Yes, kind of we work light. It’s just where I think there was a move for a while there where people thought they could get a significantly higher lease rate by going short-term on their leases that works when the market is hot, but doesn’t feel like it’s cold.
Yes, you had a race already. Yes, go ahead.
Great. Thank you very much, guys. I appreciate it.
That concludes today’s question-and-answer session. I’d like to turn the call back to Tim Crane for closing remarks.
Thanks, Elizabeth, and for everybody still on the phone, thank you for your interest and support. I think you can tell we remain optimistic about our position and the opportunities we’re seeing in the market. If you perchance didn’t get your question answered, please feel free to call any of us, and as we’ve always said, we’ll work hard. Thanks very much.
This concludes today’s conference call. Thank you for participating. You may now disconnect.