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Wintrust Financial Corp
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Welcome to Wintrust Financial Corporation's Third Quarter and Year-to-Date 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] 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, Wintrust's management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Actual results could differ materially from the results anticipated or projected in any such forward-looking statements. The Company's forward-looking assumptions that could cause the actual results to differ materially from the information discussed during this call are detailed in our earnings press release and in the Company's most recent Form 10-K and any subsequent filings on file with the SEC.
Also, our remarks may reference certain non-GAAP financial measures. Our earnings press release and slide 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. Edward Wehmer.
Thank you. Good afternoon, everybody. Welcome to our third quarter earnings call. With me, as always, are Dave Dykstra, our Chief Operating Officer; Kate Boege, our General Counsel; and Dave Stoehr, our CFO. What we do, we'll have the same format as usual; I'll give some general comments regarding our results, turn over to Dave for a more detailed analysis of other income, other expenses and taxes, back to me for some summary comments and thoughts about the future and then have some time for questions on the financial results for the quarter and year-to-date.
In general, the quarter can be summarized as follows: Record quarterly earnings, nice to be able to say that again; very strong organic balance sheet growth; margin and net interest income pressures due to rate environment, effectively offset by strong mortgage results and balance sheet growth; credit metrics returned to historically low numbers; one-timers being the MSR valuation adjustment, the FDIC refund of $4 million each that basically offset each other; and we had about $1.3 million pre-tax and acquisition-related expenses.
Net income was $99.1 million for the quarter up to -- close to $270 million for the year, that's up 2%; same could be said for the earnings per share on a year-to-date basis, $4.60 compared to $4.50 and $1.69 compared to $1.38 for the quarter, we have 22% from last quarter, but then last quarter generally included some extra charges on the credit side.
Looking at that income pre-MSR valuation adjustments, in the quarter we're up 21% and the year we're up 9%; same for earnings per share. So close to the double-digit earnings growth that we project and that we always look for.
Return on assets was up about 1.16%. Return on equity 11.42%. Return on tangible equity of 14.36%. Now net overhead ratio dropped to 1.40% due to a balance sheet growth and fee income on the mortgage side. That 24 basis point drop basically offset the drop in the net interest margin. All-in-all, pretty good quarter considering the rate environment and the headwinds that we had.
The NIM has been frequently pointed out today, fell 25 basis points as earning asset yields fell 21 basis points. Interest expense was 2 basis points. And the net free funds ratio was positive with a margin of 1 basis point. Loan yields fell 14 basis points. Loans held for sale only fell 79 basis points, while liquidity management yields fell 30 basis points.
The drop in liquidity management yields was due to the $812 million increase in average liquidity management assets during the quarter. This increase at the end of the quarter had yet to be invested into longer-term securities, as evidenced by the drop in the liquidity management portfolio duration from 4.1 years to 3.4 years. Investing these assets in the longer-term securities will assist this part of the margin contribution going forward; we're well underway doing that as we speak.
Our goal is to maintain our approximate six-year duration in liquidity management assets, so we have some opportunity there. It's also resulted in our loan to deposit ratio falling into our desired 85% to 90% range, but just barely at 89.6%, down from 92% in the prior quarter.
On the interest expense front deposit expense increased 6 basis points in the quarter, but flat from our month of June run rate. As you know, it takes time to decrease deposit rates. We're actively and aggressively working to do this and decrease the cost of funds on our deposit base. So there's a lot of opportunity here also.
Consumers don't know what LIBOR is. LIBOR can fall, but until you get moves in prime, it's hard to move your deposit rates in this competitive environment, but we feel pretty good about where we are. Overall cost of funds, interest-bearing liabilities was up 5 basis points. Deposit increased, plus a full quarter of our $300 million in sub-debt, which was 2 basis points, was offset by lower funding and other funding cost decreases.
On the net interest income front, the quarter decrease of only $1.3 million. I was telling somebody today, I can't eat net interest margin, I can eat net interest income and by $1.3 million we believe that’s usually made up through the investments that we made in liquidity management. And as we lower the cost of -- lower our cost of funds, we feel very good about and continue to grow, by the way, we feel very good about where we are right now.
Going forward, depending on the rate environment, further rate cuts would not be appreciated, by the way. We expect the margin to be under decreased pressure due to our ability to deploy liquidity management assets, the higher yielding securities, aggressive deposit, cost cutting where we can.
We're closing STC deal and the Countryside Bank deals, which will add approximately $800 million of total assets and additional organic loan growth, more on this later. Net interest income should grow as a result of the above additional organic franchise growth.
The other income and other expense side, Dave will be reviewing these areas in detail a bit later; I'd like to provide some high level remarks. Obviously, the quarter was greatly influenced by mortgage banking results. If you know our business model, you know that we have a very diversified model with internal hedges in the businesses that we have.
When rates fall our mortgages take off and cover, while we get the margin squared away and go from there. And it's working in that regard. I know a lot of people think that mortgages -- the mortgage business is too volatile to be considered core. But this is an integral part of what we do and a part of our overall management and it's working as we anticipated.
We expect strong growth and strong results in the fourth quarter and hopefully in the first quarter rates remain where they are. Being very aggressive on the mortgage side, our new product, a person can apply for a mortgage and basically a little over an hour online, we then have it in and we were able to turn around relatively quickly. So we are advertising and we believe that this is -- it's a good thing for us and is working just as we anticipated.
Other expenses were in line and consistent with prior quarter, when one considers increased commissions on the increased mortgage business. Other than that, I think, we're pretty good shape. The net overhead ratio fell to 1.40%, the 25 basis point increase basically offset, as I said earlier, the drop in the margin. This coupled with return to historical norms in credit cost resulted in the record quarter we experienced.
Onetimers included offsetting MSR valuation adjustments and FDI insurance refunds, as well as $1.3 million acquisition-related expenses. If one were to add back the after-tax of those -- net of those onetimers, we were to experience our first quarter where we exceeded $100 million. We look forward to achieving that milestone very, very soon. If one were to omit the negative MSR valuation adjustments for the year, as I said earlier, we'll be close to achieving our double-digit earnings growth objective, despite the second quarter credit blip that we had.
On the balance sheet side, we continued our strong balance sheet growth in the quarter. Assets were up $1.2 billion to almost $35 billion. Average earning assets were 31 from 29, up $1.7 billion. Loans were up $405 million with $364 million head start in the fourth -- for the fourth quarter, due to the average in ending issues that we always -- we always seem to book things at the end of the quarter, but we start with a great -- a good head start going forward.
Deposits were up almost $1.2 billion. That's after returning over $500 million and expense in brokered funds that occurred during the quarter that will help us also in our overall cost of funds. So on average, our deposits were up $1.8 billion. Loan deposit ratio at 89.6%, as I said. And I talked about the liquidity management yield and the investment of those. They were down 30 basis points, but we expect to pick some of that up through the investments we're making and have made already this quarter.
On loan side, loan growth is good across the board. Pipelines, real estate loans and commercial, residential grew $257 million. Insurance premium finance $240 million. And basically, C&I, our commercial portfolio is relatively flat, down a little bit. We still have good pipelines. We're booking a lot of deals, but we're seeing companies sell. We only lost maybe $89 million, $90 million going out to other institutions last quarter that's consistent with every quarter we've had.
In the past three or four quarters, most of them go to Finco companies where we retain the deposit relationship, but we're seeing a lot of recaps and dividend recaps people taking money out and more highly leveraged transactions that we don't – don't fit into our credit appetite.
So, all the numbers, if you look at the paydowns of what we've had, the numbers are consistent over the last four quarters. We start the fourth quarter close to $350 million head start on the loan front as growth again this quarter was back-end loaded. Our pipelines remain consistently strong. We expect to continue growing loans in the single-digit area – single-digit percentage wise, consistent with our prior statements in that regard.
On credit side, as mentioned, credit metrics return to historical norms. NPLs decreased in total sort of 0.38% of outstandings. This is as low as it's been at any time in the recent past. Same thing, we said for non-performing assets, which stood 44 basis points of total assets; again, as low as they've been in recent past.
The charge-offs of $9 million, included $4 million of charges that was related to the three credits we discussed last quarter. They had been reserved for. So in that previous quarter and provided for, so there are behind us now. I declare the issue closed on these particular bad assets and good returns to them all. Charge-offs for the quarter in the year were 15 basis points of average total loans. We expect that we have a number of going forward that we're comfortable with.
We continue to pull the portfolio looking for problem credits, before they become problems and get them on expeditious basis as there is still a number of mighty's out there who will use anything. So, we – when we ask somebody to leave they can find a new home relatively quickly.
With that, I'm going to turn it over to Dave to talk about other income, and other expense and taxes.
All right. Thank you, Ed. As normal, I'll briefly touch on the non-interest income and expense sections that had significant variations and just in general. So, turning first to the non-interest income, our wealth management revenue stayed relatively steady at $24 million in the third quarter compared to $24.1 million in the second quarter of this year, and was up 6% from the $22.6 million recorded in the year-ago quarter. Overall, we believe the third quarter of this year was another solid period for us in our wealth management segment.
Mortgage banking revenue increased by 36% or $13.5 million, to $50.9 million in the third quarter from $37.4 million recorded in the prior quarter, and was also up 21% from the $42 million recorded in the third quarter of last year. The increase in this category's revenue from the prior quarter resulted primarily from higher levels of loans originated and sold during the quarter. A mix of originations weighted more heavily to the higher margin business versus the prior quarter aided the higher average production margins. We basically have wound down the corresponded channel of our mortgage business during the quarter.
The Company originated approximately $1.42 billion of mortgage loans for sale in the third quarter. This compares to $1.15 billion of originations in each of the second quarter of this year and the third quarter of last year. The mix of loan volume originated for sale that was related to purchase home activity was approximately 48% compared to 63% in the prior quarter.
So, refinance volumes increased substantially during the quarter and then was relatively equal weighted with the purchased home activity. We continue to see an elevated level of refinance volume going into the fourth quarter relative to the prior quarters.
Now table 16 of our third quarter earnings release provides a detailed compilation of the components of origination volumes by delivery channel, and also the mortgage banking revenue, including production revenue, MSR capitalization, MSR fair value and other adjustments and servicing income. Given the pipelines we have and the increase in refinance business, we expect the fourth quarter to again be another strong quarter for the mortgage operation.
Other non-interest income totaled $17.6 million in the third quarter of 2019, up approximately $3.4 million from the $14.1 million recorded in the second quarter of this year. The primary reasons for the increased revenue in this category include $1.6 million of higher interest rate swap fee revenue and $1.7 million of income from investments in partnerships.
Turning to the non-interest expense categories, our non-interest expenses totaled $234.6 million in the third quarter, up approximately $4.9 million or 2.2% from the prior quarter. Commissions associated with the significant increase in the mortgage production and acquisition related charges of approximately $1.3 million were the primary drivers of the increase.
Turning to the more significant categories, the salaries and employee benefits expense category increased approximately $7.3 million in the third quarter from the second quarter of this year. Commissions and incentive compensation expense accounted for approximately $3.8 million of that increase relative to the prior quarter and that was due to the higher commission expense tied to the accretionally greater mortgage origination production.
Salaries expense accounted for slightly more than $2.7 million of the increase, resulting from a full quarter of the staffing cost related to the Oak Bank acquisition completed in late May of 2019. Approximately $1.1 million of severance accrual, partially related to the recent acquisitions and normal growth as the company continues to expand, including staffing for the seven new branch banking locations that we opened this year.
Additionally, employee benefits expense was approximately $782,000 higher in the current quarter than the prior quarter, due primarily to the impact of higher health insurance claims during the quarter.
Turning to equipment expense, it totaled $13.3 million in the third quarter of 2019, an increase of $555,000 as compared to the second quarter of 2019. The increase in the current quarter relates primarily to increased software depreciation and licensing.
Professional fees increased to $8 million in the third quarter compared to $6.2 million in the prior quarter. These fees can fluctuate on a quarterly basis based on the level of legal services related to acquisitions, litigation, term loan workouts, as well as any consulting services. Although up slightly from the prior quarter, this category of expenses remains close to the mid-range of the last five quarters expense totals. The slight increase in this categories expense was due primarily to acquisition related legal fees, an increase in consulting fees, which is related primarily to some work that we're having done relative to the CECL projects and the LIBOR replacement projects. And then, also a small increase in legal fees for loan documentation and collections.
The FDIC insurance expense was down $4 million in the third quarter compared to the prior quarter. As you may know, the FDIC insurance assessment regulations provided that after the reserve ratio reached 1.38%, the FDIC would apply small bank credits to reduce small banks regular deposit insurance assessments, up to the full amount of the assessments or the full amount of the credit whichever is less. The reserve ratio reached 1.40% on June 30 of 2019. Therefore, credits were first supplied on our September 2019 invoice.
Since each of our subsidiary banks are less than $10 billion in assets, each of them qualified for the credits. We believe we have up to $3 million of additional assessment credits that could be applied in the future, if the insurance reserve ratio remains above the required threshold.
Other than the expense categories that I just discussed, all of the other expense categories were down in the aggregate by a little over $700,000 from the prior quarter with no particular items to know.
As Ed mentioned, the Company's net overhead ratio for the third quarter improved to 1.40% from 1.64% in the prior quarter, and improved to 1.58% for the nine months ended September 30, 2019. This 24 basis point decline in net overhead ratio essentially offset the net interest margin compression for the quarter, and was primarily driven by growth in total assets and strong mortgage origination quarter.
We expect balance sheet growth and the continuing strong mortgage market will result in the company have another good net overhead ratio in the fourth quarter and should cause our annual net overhead ratio to be less than our previously discussed target of 1.55% for the year.
So with that, I will conclude my comments and turn it back over to Ed.
Thanks Dave. It's nice to be back in the record earnings and a record quarterly earnings train. That's 12 over the last 15 quarters that we've had record earnings and we expect to -- it's our goal to continue that trend going forward.
Although the rate environment provides a plethora of challenges, we believe that we will be able to navigate to the storm. Overall growth both organic and acquisition, we've talked in previous quarters about the ability to add organic growth without a commensurate increase in expenses.
If in fact we grow faster the loans again that's okay. I think we can make a net 1% after tax or higher on the investments that we make as we ladder out our portfolio. We want to make sure the numbers are -- the deposits are sticky enough they stay here so we don't end upside down on anything like that but we feel that that plus adding $800 million in assets from the two acquisitions will be important.
Decrease our cost of funds is a priority. Again we are actively doing that as we speak with the last drop in prime where customers understand the rate environment is going down and we're able to execute these. Loan pipeline still remain very strong. We're deploying liquidity management assets. We have every expectation of a continued strong mortgage market.
Credit there is always the big question looks pretty good right now but you never know. We were not ones to kick the can down the road as you all know when it comes to credit. We're going to continue to grow and will be the key. We also have closed this STC transaction already and expect to close Countryside this quarter. That's $800 million in total assets as I said earlier.
We expect significant cost-outs from these deals, but it will take a few quarters to achieve these efficiencies. We have to get them converted and takes a couple of quarters to do that but STC is close to 80% cost-out for us by estimate and the Countryside deal is closer to the 35% of the 40% cost-out. So those should be very accretive to us once we get that done.
We're not a loss for future acquisition opportunities and as our pipelines remain full, we’re consistently setting the value in these opportunities in all areas of our business. As always we can be assured of our best efforts. We appreciate your support and look forward to future record quarters going forward. Now it's time for questions.
Thank you. [Operator Instructions] Our first question comes from Jon Arfstrom with RBC Capital Markets. Your line is now open.
Hey thanks. Good afternoon.
Hi, Jon. How are you?
I am good. How are you?
Living the dream everyday
Good.
Certainly put our record earnings and the stock gets clobbered, but maybe we should go the other way
This is your opportunity. I want to ask about just margin in mortgage, but on deposits what was different? What drove that quarter? There was a big deposit growth number and you, kind of, alluded to it but if that continues and you have the acquired deposits come on; it kind of feels like next quarter it looks a lot like this quarter with some NIM pressure, but maybe some growth in net interest income but just maybe touch on what drove it and what you guys are thinking for how this might look in Q4?
Well, if you look at the last few quarters pull it up here, deposits have grown in December $2.6 billion; in March $1.9 billion; this month $1.2 billion, it should be closer to $1.7 billion if you add the brokered we paid back. So this is consistent -- this is just consistent growth for us some.
Our marketing is paying off. We've opened new branches. The acquisitions. We started marketing heavily into those markets. The smaller banks never really had the capital to go out and market. So a lot of it is -- this is consistent with everything we've done in the past. So I don't think anything is different, it's just the same old, same old for us.
Okay. And I guess in terms of thinking about the outlook for the margin, you talked about the plan to put some of that liquidity to work. And I guess curious how quickly you think you can do that and what I kind of go through some assumptions maybe we get to flat to maybe a little bit down on the margin. But we don't have the insight that you have in terms of how you put some of liquidity to work. So maybe give us some help there.
The margin could -- might go down a couple of basis points, but again we're at a point in time where the margin -- you got to look at net interest income more than the margin. I think everybody gets hung up on the margin I said, I can't eat the margin I can eat net -- I can eat off net interest income. That's real money.
If we have to -- if the loan to deposit ratio comes down if we grow -- again if loans grow slower than deposits, which seems to be the case right now, we'll bring those investments that will give us a great after-tax return, great return on capital no overhead associated with it and still make hopefully 120 on assets, which is accretive to where we've been right now after tax.
So I think you got to change your focus off the margin to net interest income, which we think we -- yeah we'd love to see the margin go up where we’re working like crazy to hold it steady. But it's hell like a barometer. The net interest income is where we’re most concerned with and that will flow right through the bottom line and that's earnings per share and that's what we get paid for. So probably a little bit of pressure on the margin but we believe net interest income should be up nicely this coming quarter. That makes sense?
It makes sense. I understand that I guess unfortunately people do look at that number but I understand what you're saying.
I know, they look at it because that's how they model. But we've been able in the past to manage and maneuver through times like this and put up record good quarters. The margin itself -- sure as I said we'd love it to go up, we're working like crazy to go up, but if your loan to deposit ratio does come down, which we expect it to come down a little bit more to back in the 85% to 90% range, your margins are going to get hurt a little bit but your net interest income to be just fine.
So we love to have loans keep up with it but we're not going to do anything stupid right now and we continue -- our loan portfolio is growing nicely. For the year it's up over those single -- high single-digits that we talked about, it's up 11.18% just deposits up a little bit more. So we hope to be able to control the margin and really grow net interest income. That's our plan.
Yeah. No I've got it and plus the acquired loans I understand that that's coming on. So Dave just a quick one for you we ask about it every quarter, but mortgage banking typically see a bit of a tail off in Q4 but it sounds like maybe a little more optimistic. Is that fair and any thoughts on volumes?
I think we're seeing a higher percentage of our applications recently been in the refinance area. So, I do think you’ll see some seasonality like we typically do on the purchase side, we're hoping that to offset on the refinance side right now. So maybe down just a tad but I wouldn't expect it to be down dramatically.
And it could hold in there. We're just going to have to see how the refi volumes. They've been fairly strong recently. So we expect it to be a strong quarter certainly probably more than what we had in the second quarter, but maybe just a tad off from the third quarter but crystal ball there, Jon as you know as we close these things now in a fairly short period of time, so until you start November and see what those applications are you don't really have visibility for the full quarter. But right now it looks like another really pretty consistently strong.
We're advertising a lot Jon. I mean, now that we've been able to get that application time closer a little bit over an hour if you do it online. We were able to -- our front-end has tested better than rocket mortgages front-end and we believe that we -- if we advertise properly, we can bring in a lot of new customers because it is easy to work with them and we are local and the local aspect of it is that if you do have an issue, a guy jumps on and it can walk you through and take care of you locally. So we hope to be we -- my goal is to beat up the seasonality aspect of this in the fourth and the first quarters; we'll see how good we are at it.
Okay. All right. Thank you.
Thank you. Our next question comes from David Long with Raymond James. Your line is now open.
Good afternoon guys.
Hi David.
On the deposit costs when you look at the total deposit costs in the quarter, we were up about -- you guys were up about five basis points and you talked about needing prime to change. We've gotten that now. As we're looking at just the deposit side of the equation here what can we see in the fourth quarter into early 2020 on the total cost there?
Give that to Mr. Dykstra.
Well, some of this depends on mix and we've had the specials and CDs and the money market areas and so it just -- a lot of it will depend on where the money comes in. I mean if you look at our CD portfolio, the cost of that in the third quarter was 2.18. The new money coming on rates paid the last month was closer to sort of more like to 1.14 [ph] range. So, we put in the repricing of the CDs in the press release.
So, if all things stay equal that portfolio over time should be repricing now down nicely and we'll just have to see whether people placing their money there or in money markets et cetera. But we haven't given a specific number, but we certainly are working on hard to get those numbers down.
There was a lot of specials that we ran when we are opening branch in the early quarters that kind of carried through the second quarter and early part of the third quarter. So, as you climb up that ramp, you have to come down the same amount to sort of offset it and we're starting to bring that down. So, we're optimistic that the rates are going to come down. I'm hesitant to give you exact basis point number.
David interestingly in the last 15 months we've opened 15 branches, almost $850 million in new deposits, new customers those come in I'd say probably 70% -- 60% to 70% of that money comes in the first six months subject to teasers and then the teasers run off.
So, we're seeing that happen is the rates that reprice we bring them down. But that's not bad for 15 months and we still think the right hand side of the balance sheets it's a franchise and we get these people in and we got to give a reason to come over. They come over -- our retention rates are extremely good on that.
But now as those teaser running off under repricing you have to slowly bring a value on a given the bends. So, we bring them down. And so we're doing that. And there are a number of customers that had specials.
In other words, a guy with a big deposit who has sold this business or whatever comes and he gave 2%. We're bringing those down to 1.5% and 1.25% on almost every cases, but it is going to take a year to -- not a year probably three four months to get all that done.
And the core rates come down right when it happens where we can't come down 25 basis points we're only paying 15 or 20 on something that a little bit. So, it's hard to give you that number because I don't really know how -- I know that through the specials that we can cut those by 75% -- 75 basis points. That will be very helpful.
So, all in all, it should be very positive for us in that regard. And then the flip side is investing those assets which we've done. So, we're already pretty much done with that. So, I think we'll be okay.
And I think there's a little -- just a little -- I think if you think of this holistically, as Ed said early on, we have a fairly diversified business model here. So, as rates have come down, the mortgage market reacts better, we've gotten good growth and growing the franchise and taken advantage of this market disruption. It's great to bring in those deposits and garner those households.
We will put that -- those funds to work on those down the road. We've worked in a low interest flat environment for a number of years over the last decade. And so we know how to deal with it. There is just a little lag here because we were really ramping up and giving good deposit growth to fund the good loan growth and the market turn quickly. So, just a little bit of a lag here.
But the pieces are working together, as Ed said, on the front end of the call and the deposit pricing maybe lagged a little bit because of the specials we're running and the growth we were having, but it'll catch up here and we're working hard there, it's not rocket scientists that when rates come down, you got to low year deposit rates and we're doing that now.
Got it. No, I appreciate the color. I know that's sort of the core Tier franchise value is the deposit side of the equation here. So, the other question that I had it relates to the liquidity management assets and I think you said it was up $812 million in the quarter.
Do you expect that to be up to the same extent here in the fourth quarter or do you see that number coming down and did you disclose what maybe that impact was on the margin just having that $812 million that you pointed out?
Well, I think the excess liquidity cost was probably seven, eight basis points. So, we put that at the work probably seven, eight basis points at least. And then some of the cash that we did invest short-term probably was another three basis points. So, I'll probably seven to 10 basis points for keeping it short.
And replacing it what 2.5% to 3% investment securities. So, again, six years is -- a little over six years is our standard duration, but we're down to four years because of all this liquidity piling up. And so now that we know that it's good it's sturdy liquidity, we even returned $0.5 billion of brokered funds as a result which should help to deposit costs and then we'll get the deposits in from these two acquisitions which are good sticky low-cost consumer basis which is going to be helpful and we're not running as many new branch specialist going forward.
So, this will flow through the system and the rates will come down and we'll put the liquidity to work and in the meantime the mortgage business is our internal hedge to that and it worked fine. I mean we've had record earnings this quarter. It worked fine. We expect it to work in the future. Life's not linear but we have a plan and we will be -- we are lowering rates and we expect to generate good net interest income as Ed said.
Got it, cool. Thanks guys. Appreciate it.
Thank you.
Thank you. And our next question comes from Kevin Reevey with D.A. Davidson. Your line is now open.
Good afternoon.
Hello Kevin.
So, I'm going to ask about the left side of the balance sheet. To what extent are you using floor as a way to protect your loan yields? And if you can give us some color on how you're structuring them?
Our new deals we try to get a floor all the time, but it's just it's competitively hard to do. So, we're living with that right now. On the life insurance funding, we usually get floors. Property and casualty is nine-month full payout, so who cares.
Leasing is usually fixed rate. Mortgages are what they are. And the commercial side is what's left and we did floors where we can, but none of our competitors are doing it. So, we live with that risk for the most part.
Okay. And then as far as what we're seeing and what we're hearing manufacturing, are your clients feeling the negative impact given what's happening from a geopolitical standpoint?
While line usage is down about 1.5, so you can see a little bit of it taken place. It's interesting though if you think about the geopolitical side of things trade -- total trade, if you take total exports and imports is actually up. You add-on both together, it's pretty interesting. China might be down 30% or 25%, but Vietnam is up 30%, and India is up 10%, and Taiwan is up like 20%. Trade is still doing -- is going okay. So, we -- our manufacturers are doing pretty well. What we're seeing though is people -- everybody thinks if there is going to be recession. I find it hard to believe unless we talk ourselves into it that there will be one.
I don't think recessions and full employment go so together very well, but you never know I'm not an economist, but our clients that we have are pretty well fortress balance sheets, we are lowering, as I said, we've got out of about $100 million of exit loans that ones we want it out this quarter, mostly in the HLT side of things. We are doing that and we're trying to keep our customers, our clients in -- and I say, we lost about 100, 90 at -- it's between $90 million and $100 million ton of other companies usually Fincos, who allow much higher leverage.
So we don't see that as the problem with our commercial C&I loans being flat. It's not the business side of things maybe 1.5 [ph] in terms of the draws. But all-in-all our clients are doing pretty well.
And then Ed you mentioned HLT that's an area you're showing shying away from. Are there any other areas in lending given where we are in the cycle that you're deemphasizing and then staying away from?
Private equity firms where we don't have a general relationship with the PE guys. That's where we got in trouble last quarter; learned our lesson there. We're getting out of those as many of those as we can, but that being said, we had a lot of businesses sold out. The good PE guys are harvesting right now. They're not buying their harvesting.
So staying away from those and participations in those and HLTs are bring them down a little bit. We never had them may to begin with, but your lenders go out there, they are like seek the level of least resistance. They'll bring in HLT and we really don't want to do that.
So we're trying to shy away from those in general. But really, we got out of retail commercial real estate over the last two years. We're basically have brought that almost down by 60%, but that's been a two-year project, but still commercial real estate is doing very well here with great sponsors and our growth there has been really nice. So -- but just in these sectors where great sponsors, great equity, great and that sort of things.
So we're diverse enough that if something is not work and something else is. So we feel good about where we're going with our loan portfolio.
Great. Thank you.
Thank you. Our next question comes from Brad Milsaps with Sandler O'Neill. Your line is now open.
Hi Brad.
Hey, guys. How are you?
Great.
Just wanted to follow-up on the loan yield discussion. Loan yields down 14 basis points linked quarter, do you think that will be pretty consistent with subsequent reduction in Fed funds and LIBOR or anything else going on this quarter that may be made that compression better or worse than you thought it should have been?
And then secondly just kind of curious the new loans that you brought on this quarter kind of what types of rates are you seeing on those, as they come on the books compared to the back book?
Well, I think part of the issue Brad was -- I mean if you look at one month LIBOR and we disclosed in our press release how much is tied to one month LIBOR and we've got about $8.4 billion of our variable rate loans tied to that.
So we got $25.7 billion of total loans and $8.4 billion tied to one month LIBOR, but one month LIBOR during the quarter dropped quite a bit. I mean it ended June up at 2.40% and ended up at 2.02%. So it's down 38 basis points. So that's one of the reason you saw the decline in the loan yields is a variable piece of that.
And one year LIBOR was down 15 basis and second and third quarter was down 53 basis points in the prior quarter. So it's dropped a lot in our life portfolio is tied to that a little about only about one-twelfth of that portfolio reprices every month. So we're starting to see a little bit of that impact on the repricing. So really the one month LIBOR just dropped much more precipitously than other rates and that caused a little bit of pressure.
So if you can tell me where one month LIBOR is going to go the rest of this quarter, I can probably give you a better view point on that, but I think people can look at the math on that and look at where LIBOR rates are going and make some conclusions on their own. I would be broke up if I bet on interest rate. So we care not to.
On the -- what's going on the books, our premium -- commercial premium finance business is going very well. We've been able to hold our yields up there in the 5s. I think they may have been down four, what five, six, seven basis points something like that over the last two quarters, but the interesting there is that the average ticket size from year goes up from $22,000 almost of $30,000 again. So we're seeing pretty good growth there without the commensurate increase in expenses. Thank God for hard markets.
On the life side, the spreads have remained relatively consistent. The spreads have -- but again, it's off a one year LIBOR. So it's always been a competitive market. We have big banks pulls in and pulls out of that market and they come and try to buy, some and then they figure out that they don't know what they're doing and then they get out. So we have to maintain our business there, but the spreads have been relatively consistent there like to over one year or something like that on average.
The other things -- the commercial real estate is holding up well and we put close to $100 million of residential mortgages on the books, $50 million of those were variable rate waiting for conditions to clear. It's our hybrid product where if somebody had just went into business for themselves, we got a loan, we can't sell that loan, put him in a variable rate product. It's in the 4s. And then we book $50 million of fixed rate stuff to kind of help us to bring the gap down.
I think you'll probably see that going forward on the real estate side, on the residential real estate side. Probably $50 million net of new growth on the hybrid product and $50 million coming over on the longer-term product that help us with our GAAP position and it's nice to have, you do $1.04 billion upon $50 million out of good stuff is okay, good rates. And our GAAP position jumped up a little bit because of our liquidity we had.
We still want to maintain a positive gap just because as rates go down the propensity for them to go up is higher than it is to go down further, but we want to mitigate that to some extent by bringing the -- bring it down from the 11%. It is now down to -- down back to where it was 6% -- 5%, 6%. So, it makes sense on that?
Yeah. I think so. And then Dave just one follow-up on the mortgage business. I was writing quickly, but I think I heard you say, you hope to hang on to the gain on loan sale margin. I think I also heard you say that you had basically discontinued sort of your correspondent network. Just kind of curious the difference between kind of what you make on a loan sold out of the corresponding network versus out of your retail channel, which obviously is more profitable?
Yeah. Well, the correspondent channel is probably 20 basis point, 30 basis point margin. So, you can -- and in the past maybe we did a $100 million, 150 million, $200 million of that and supplemented it. And there were reasons to do that, but we just decided, we don't do wholesale. And now we'd decided not to -- we would just get out of the correspondent business based on those margins.
So part of the reason for the aggregate increase in our gross margins was because we reduced the amount of correspondents. So next quarter it should be next to zero. There might be just be a tab that carried over from some relationship that grew -- that we have, but not much at all. It should be very close to zero. So, the margins on the Veterans First stuff is high 3s to 4% depending on the products that they do. And then the retail is generally in the upper 2s or so.
Great. Thank you very much.
Thank you. Our next question comes from Chris McGratty with KBW. Your line is now open.
Great. Thanks. Dave or Ed, given the success you guys have been having with deposit growth in particular last couple of quarters, how are you thinking about the kind of the debt that's on the balance sheet? You got about $1 billion of higher cost debt. I was wondering if there is any thought to point one of those levers to support earnings of the margin this environment given the momentum on the deposits?
Well, not sure if I understand your question whether we would with…
Just pay off some of the borrowings or reduce the borrowing given the high rate?
Well, the borrowings are at the holding company level Chris. So to pay those off I'd have to dividend up a bunch of money from the banks or issue new debt. It is not debt at the bank level, it's at the holding company level. So I don't have...
That's just cheap capital is what it is for us it's cheap – if we are making 12% on ROE and 14% ROTE they have 5% debt, the after tax that's 3.5%, 3.70% something. It's just cheap capital for us. So no unless – as we make a ton of money we're going to keep using cheaper capital and we make a ton of money I'd rather buy stock back as you pointed out to you many times.
I know some people issue that debt at the bank level I understand the question but this at the holding company level. So, I don't have that much dividend capacity for the banks the $0.5 billion plus that we look at it as cheaper capital than doing common or whatever.
Got it. That's a great clarity. Thanks. Given the top line pressures that the group is facing, given lower rates, can you speak about protecting profitability through kind of expenses? I know you guys have been opening branches, you've obviously made the mortgage business more efficient but just any steps Dave, you kind of enter budget season that you might be looking at to kind of reduce the rate of growth and expenses?
I think one of the things we've tried to point out in the release is even when the margin came down 25, and as we said, we think there is certainly not going to decrease at that same rate because of this lag effect that we're going to be able to hopefully get on investing of the liquidity and reducing the deposits but the net overhead ratio came down by almost the same amount.
So if you can get the growth and get the operational efficiencies out of it, that's one way to offset lower margins is to grow into your close a little bit more and just grow and invest that money as Ed talked about.
So, could you sit down and start slowing the boat down and not invest in the company and cut expenses you could but there's a lot of opportunities in Chicago right now and a lot of the disruption and we'd like to take advantage of that market disruption and take advantage of the growth. And so we think that, as Ed has said a number of times, we can grow through this and build the franchise at the same time. We'd rather grow into it and absorb that operational capacity versus start to cut and not grow. So...
Got it.
The acquisitions we're doing, they should have relatively great cost outs, which will help our overhead ratio and as you go on the budget season things you could probably levers, you could pull your marketing lever back a little bit nothing that would move the dial that much. But we are telling everybody to try to get by what they've got for a year. We'll see how that goes through the budget process but I said, you are going to add somebody they got – it either got to be a critical piece or somebody is going to make me money.
We'll see the budget processes are ongoing and they are always are arm wrestling but our goal was always is to give you double-digit earnings growth and we’ll pull every lever we can to get there. At the same time, it just seems you've got a growth through this thing right now and we stop the boat. And then we start it again it costs a lot more. So...
Got it. Okay And just one clarifying comment. The NII comment for Q4, I think you said is going be up nicely, does that assume we get a cut later this month from the Fed or kind of what are your rate expectations built into that?
We got to cut later this month. It will be – it won't be as good as we'd like it to be.
I think from my perspective, we are not predicting whether it's going to be October or December, or even if they're going to be one sort of as we stand right now, because we don't know whether they could fix China and the one-month LIBOR for whatever reason pops a little bit. Well that would be helpful too.
So we just don't know again what's going to happen with that one-month LIBOR rate but they kept 25 that would add – that would be a little bit more problematic because – but it all depends really on what – the question there Chris is really how does LIBOR react to that?
If LIBOR stays flat, I got $8.5 million that doesn't do anything even a prime comes down 25. If they reduce prime and LIBOR goes down another 25 well that's problematic. But I think the market is kind of a head of prime. So we're not expecting that LIBOR to go down.
So around about way to say, I'm not sure what the market dynamics are going to be between that relationship with LIBOR and prime. But I think the market is already kind of priced in the downward expectations for rate in the one-month LIBOR already.
Okay. I appreciate it. Thank you.
Thank you. Our next question comes from Terry McEvoy with Stephens. Your line is now open.
Hi, good afternoon. First question. Hey, Dave you mentioned earlier you're spending money or you spent money on CECL preparation, what's your updated thoughts around CECL at the end of the year and the day one impact?
We aren't in a position where we think we should disclose that number yet. We're well along in the process. We've got the dry runs and the parallel runs and all that kind of stuff going on but we just – we want to. We're well along in the process. We want to just get a little bit further and be a little bit firmer with it before we disclose it. But – so I think the answer is, well along in the process we think we're in good shape on that but not ready to disclose a number yet.
Okay. And then just as a follow-up, are the retail deposit promotions a function of the market disruption today that you're seeing given, particularly the acquisition that occurred earlier in this year or is it more of a bigger picture kind of over-strategy to build out the branches and just having to pay up for deposits to support those branches and the expenses. And I hear you loud and clear, you can eat the margin, but the investors eat on the stock performance. And I just don't know how the margin sensitivity is going to go away anytime soon. So I think it's important to understand why we saw a five basis point increase in deposits when these larger banks all week have been reporting lower deposits and what is the core strategy around the deposit growth in the impact on the margin?
Well, we have opened 15 new branches and we do put teaser accounts out there to get people in the door. They are bundled packages, so they open a checking and savings account maybe at safe deposit. So, we got to move our entire relationship. That's pretty cheap when you think about it. But these -- and you kind of wean them down off of that over a period of years. So, that takes time and that's about it brought in a couple of $1 billion of that money to build out these branches. So that's the strategy. That plus if it's the market disruption -- the branches are doing well because of market disruption because we have great reputation in town and we won the JD Power Award during the last few years for customer service. We won a lot of Greenwich awards for commercials service. We've got great momentum. We got to take advantage of that.
And the disruption on the commercial side has caused us to get new clients in the door from other banks in town and they may come with lot of liquidity and we might pay a little bit up on that. Those are the specials. They are about $1 billion of that that we're talking about and going from the 2%s down to 1.5%, 1.25% et cetera. So, it is about growth. It is about pacing people to join us and that's how we -- I've been doing that since 1991 when we open the first bank, got to get people reason to leave, got them happy, they get in, they love the service and you get them for life. That's what we do.
So, we believe our cost of funds notwithstanding another rate cut that we talked about earlier our cost of funds should come down nicely this quarter and continue to kind of bottom out after that. So, it's just -- as I said for the retail, they don't know LIBOR. It takes time where you can have an excuse to bring it out, so everybody -- it's all hands on deck for that and that's what we're doing. So -- and I think by the way investors should be more concerned about net interest income than they should about one number the margin isn't it. You and I can have that discussion offline, but I think you want to make more money, don't you.
I'm not going to push back on that. Thanks for the insight Ed.
Thank you. Our next question comes from Nathan Race with Piper Jaffray. Your line is now open.
Hi guys. Good afternoon.
Hi Nathan.
Just going back to deposit cost questions, I'm just curious what the timing was in terms of the run-off of the brokered CDs in the quarter and if there is any other opportunities to further optimize the deposit base just given what you're seeing in terms of core deposit growth recently?
Most of that was earlier in the quarter. So, probably the first month of the quarter that some of that went away. On the margin, there is some other brokered funds that are out there that we're looking to see if we can replace, but some of it is term and you're committed to it. So -- but all in all, our brokered rates are pretty low Nathan. We don't rely upon the brokered funding that much. We're certainly down under the 4% -- probably 4% or 5% range on brokered funds. So that's not a lot there to play with anymore.
Okay understood. And then just changing gears a bit; the C&I growth was fairly soft this quarter for the first time in a while. So I'm just curious if that was partially related to some of the work outs that you had with some non-performers or if it's a seasonal or just maybe perhaps less of an appetite to put on floating-rate assets today?
Well, if you look at the amount of payoffs as we had spud $74 million payoff, actually $87 million paid off by going to do another financial institution. That's about consistent with what we've done every quarter. We had about $100 million of exit strategies. That's about double the normal and we had about another $100 million with the businesses were sold and line usage was down 1.5%. So, we still brought in a good deal of business, but we're getting offset with those types of pay downs so.
So I think Nathan second quarter was really a strong quarter for us, but the third quarter was new loans was fairly consistent with the first quarter and quarters prior to that. So the issue really is what had talked about is just an elevated level of pay-downs and payoffs.
Understood. I appreciate it.
Pipelines are still very good. So you can always know when the customer is going to close the loan and the third quarter tends to be we call it sort of the doldrums around here at times because borrowers are on vacation and lenders are on vacation and sometimes things just get pushed back. So, we would expect a pretty decent fourth quarter based upon our pipelines.
Understood. Thank you.
Thank you.
Thank you. Our next question comes from Brock Vandervliet with UBS. Your line is now open.
Thanks. I'm still kind of spun around about NII. I mean, it seems from what you're saying and when I look at let's say one-month LIBOR average quarter-to-date one month is down say 30 basis points versus where it was in the third quarter. I know you don't want to talk about NIM, but it seems like NII could be flat to down modestly again in Q4.
It just depends on what happens with the LIBOR rate over the quarter. We wouldn't have been down nearly this much if LIBOR gone down 38 basis points in the third quarter and as if you can tell me what's going to happen then we can do that. I think the point…
It's down 30 -- it's down 30 right now in the fourth quarter -- the average and so it just stops right here, we're down 30 at the end of the year.
The point -- then you're going to have pressure on the asset yields and we're going to have worked hard on the funding side to get that cost down and then we're going to try to grow through it. We're going to have $800 million of growth come on through the acquisitions or we will have other strong growth. We believe through the lending side of the equation and continue deposit side and -- we'll try to grow through it as Ed said and get the NII. And eventually rates are going to stabilize at some point and you manage through the process.
So we're going to have the short blips up and down in the LIBOR rates, but we're going to grow through it. And we will get it stabilized versus a little bit of lag on the funding side.
Okay. Is deposit pricing set centrally or is that set through the subsidiaries or mix -- mix of both?
It's approved centrally many of it is set centrally. Specials are obviously are dependent upon -- one of the beauties we've is we've got a branch of bank of Wintrust Bank let's say, we just opened and back of the yards in Uptown or Wrigleyville. We can price the deposit there on a special but not cannibalize our whole organization.
So one of the beauties of our multiple -- charter multiple brand approach is that we can eliminate - limit cannibalization on our deposit base and really target our marketing there.
So basically set centrally, approved centrally, but competitively they've got -- some guys might have a guy in the market who is coming after, we have to be flexible there. So but generally it's all approved centrally and usually set centrally for the most part.
Got it, okay. I appreciate the color, guys.
But can different by charter.
Thank you. Our next question comes from Peter Ruiz with Sandler O'Neill. Your line is now open.
Peter?
Peter, if your line is muted, please unmute?
We go onto the next call. It's for the David
And our next question comes from David Chiaverini with Wedbush Securities. Your line is now open.
Hey, thanks. A couple of questions for you. I wanted to follow up on the NII discussion. I guess in this question might be a bit specific, but what LIBOR level are you assuming for NII to be up in the fourth quarter versus the third quarter?
We're just assuming sort of the current state right now and adding in the growth.
Got it. And then, if -- with that as a backdrop looking out to 2020, do you think in, I guess, looking at the Fed funds futures, if we do assume 25 basis point cut at some point in the fourth quarter here and an additional 25 cut in the first quarter of next year, do you think NII could be up in 2020, despite the NIM headwind?
Yes, it really depends on growth, and we've -- if you build in the $1.5 billion to $2 billion growth we've had every quarter organically, plus the occasional acquisition, I think that it can be okay. We never know, as Dave said, you know, it's -- who knows. I mean, a lot of it is relationships of the loans and of the rates themselves, the shape of the curve, what's working, what isn't working around here. That's the plan and we're working very hard on that.
And so I can say, but theoretically you could have something to make it go down and you have other things you may go up a lot. So where we want it to go up and where we want to have double-digit earnings growth without MSR valuations and one-timers that's what our goal is and I know better when we get through the budget cycle at the end of the -- in the next couple of -- six or seven weeks and go from there. But it's kind of hard to run all these different scenarios.
If Charlie Evans come out and say, he doesn't see a need for another rate drop this year. So he is head of the Chicago Fed. What scares me is, if rates keep going down is, it forms bubbles and then bubbles don't help the economy, and then all bets are off if rates go down for a lot of different reasons, people say, would you go into opened up again, well not now.
But if rates keep going down and the market gets stupid again, we very well could, which then all bets are off. But to say with any certainty where you would be, that's our goal. That's what we're shooting for. In the current rate environment, we think we can do it if rates move, then it's going to be harder, but we've got through the last one okay; we'll go through this one okay.
Yeah. I really
But it's just hard to -- there is so many -- you got political issues for god sakes. Those are huge. It's just there is so many variables right now, all we can do is control, we can control do -- we can do as the market turns against this, we could very well going into opened up, but we don't see it now. We're still getting deals on our terms. We know we have to cut costs. We know that the beta going down is the same as a beta going up.
We've got to get more demand deposits and here we've been very fortunate to get the CDEC deposits that are back up to over sort of $1.2 billion or $1.3 billion got $800 million on our books. So those are relatively cheap cost for funds for us and continue to grow that.
So a lot of levers to pull, but there are so many variables out there, it's just hard to say where you are going to end up. But we feel good as the rates stay where they are right now, we have taken out a little bit. We think we can pull this off. So that's why we get the big bucks.
That's helpful. I can definitely appreciate all the variables involved. Shifting gears back to loan growth, you mentioned about consistently strong pipelines. And I think in your prepared comments, you mentioned single digit loan growth. Are we still looking for mid to high single-digit?
Yes I don't think we haven't changed our -- we didn't put the qualifier up, but we still have that same cast.
Yeah. You know, 11% this year -- which is, we didn't expect that to be single digit -- mid single-digit growth rate should be very good for us. We'd be happy to have -- mid to half, sorry,
I just want to make sure we're clear.
Sorry. It's been a long call.
Great, thanks very much.
Thank you.
Thank you. This concludes today's question-and-answer session. I would now like to turn the call back over to Ed Wehmer for any further remarks.
Thanks, everybody. We hope to talk to you again in January, if not before. If you have any other questions on the quarter or what we are doing and where we are going, feel free to call me or Dave. Thanks a lot.
Ladies and gentlemen this concludes today’s conference call. Thank you for participating. You may now disconnect.