Wintrust Financial Corp
NASDAQ:WTFC
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Wintrust Financial Corp
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Welcome to Wintrust Financial Corporation’s Third Quarter and Year-to-Date 2020 Earnings Conference Call. Following a review of the results by Edward Wehmer, Founder and Chief Executive Officer; and David Dykstra, Vice Chairman and Chief Operating Officer, 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 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. Please go ahead.
Thank you very much. Welcome, everybody, to our third quarter earnings call.
With me, as always, are David Dykstra, our Chief Operating Officer; Dave Stoehr, CFO; Kate Boege, our General Counsel; Tim Crane, President; and Rich Murphy, our Credit Guru.
We have the same format as usual. I’m going to give some general comments regarding the results; going to turn it over to Dave for a more detailed analysis of other income, other expenses and taxes; back to me for summary; and then time for questions.
So, first of all, 2020 continues to be full of surprises and unpredictable. Weren’t for CECL, COVID and their effects on interest rates, I think we’d experience pretty much a gangbuster year. In that regard though, it’s nice to record earnings again.
Earnings were $107 million for the period or $1.67 a share. Year-to-date earnings of $191 million or $3.06 a share. Pretax, pre-provision pre-MSR, $165 million compared to $173 million in Q2. The net interest margin was down 17 basis points. I’ll go through that. ROA of 0.99%, ROTE of 13.43%.Our net overhead ratio at 0.87 -- 87 basis points. So, pretty good on all fronts from that regard.
Net interest income and the margin, first, net interest income was down approximately $7 million, primarily due to the reduction of PPP fee recognition of $8 million, resulting in slower-than-expected forgiveness estimates and the bank’s elevated liquidity numbers. Former was PPP amortization, the first part of 2021, the latter part will be the liquidity issue we discussed in the second. The NIM decreased 17 basis points to 2.57%. Earning asset yields decreases at 18 basis points were offset by 19 basis-point increase in -- decrease, I’m sorry, in paying liabilities. Free funds contribution decreased by 4 basis points due to the lower cost of funds. The remainder of decrease related to the format and correction of the PPP fee accrual was 14 basis points. The yield around 3.85%, given is our current number for PPP, yields going forward.
If you look at this in terms of the margin without PPP, and that’s taking out the PPP money, interest income and fees less cost of funds. Core net interest margin was relatively constant at $237 million. We believe that we can build off of this going forward. I think, this is the low point. We think that through investing and liquidity, our loan demand and the like that we -- at least 10 to 25 basis points gets you back to the 2.7% to 2.75%, we said we were bottom out at. We’re currently carrying over $3.8 billion over [indiscernible] money in negligible yields. The overall duration of our entire liquidity management portfolio is 1.44 years, down from 1.7 years in Q2 and 4.2 years at the previous year-end. To reference point, we usually try to keep it in a 4 to 5-year range. Redeploying these assets and the loans and other earning assets and shrinking our deposit base by reducing institutional funding behind the support of PPP loans and cash with a runoff will be helpful to the extent of 10 to 25 basis points over time.
So, as I said, it brings back in line with the 2.75% margin, plus or minus we previously told you the bottom number. It’s a very fluid situation. As you can imagine, the optimization will take a few quarters, depending on actual PPP runoff, et cetera. A little bit more on this later.
Credit quality, based on conventional metrics is remarkably good. You wouldn’t think that there was a pandemic going on. NPLs decreased by $15 million over Q2 to $173 million or 54 basis points compared to 60 basis points at the end of Q2. NPAs decreased $16 million to $182 million or 42 basis points as compared to 46 at the end of Q2.
COVID modifications fell to $413 million, $1.7 billion on June 30th, representing 1.4% of total loans net of PPP loans. Charge-offs net in the quarter totaled $9.3 million or 12 basis points. The charge-offs include $6.4 million of specific reserves on individual loans, which are in place since 6/30.
Provision for the quarter totaled $25 million as compared to $135 million in Q2. Majority of provision rates will move forward to the portfolio growth. The portfolio ratings remain relatively constant with prior quarters. Details of ratings migration included in the earnings release slide deck.
The allowance account stands at $389 million or 1.35% of loans, excluding PPP loans. Core ratio that is loans net of premium finance loans and PPP loans is at 1.88%. Hard to believe that credit is just good, given the environment, be assured we’re not to let our guard down here. We’re not naïve enough to think that there will not be bumps in the road going forward. But in any ways -- in any case, we’re actually reserved right now.
On the one-timer front for the quarter, net one-timers included $3.1 million to settle mortgage banking dispute related to 2008, believe it or not, a $6.3 million of contingent consideration related to a previous acquisition of -- and $132 million of acquisition expenses. $6.3 million of additional consideration we believe will cover the fourth quarter and the next year, the numbers get negligible in terms of the amount we would owe under that. So, we think we got to cover now that if we need more, it means the mortgage business is still on fire.
We also recorded a $3 million decrease in MSR valuations to the continuing falling mortgage rates. We now have close to $10 billion of service -- MSR service portfolio. So, any rise in rates is certainly going to be beach ball underwater. On the positive side, we also recorded a $9 million pretax settlement on an uncertain state tax position. So, other than the $3 million MSR valuation one-timers basically washed.
Quick and other income and other expense, Dave is going to cover in detail, but a couple of general comments. As you all know, the mortgage business was extremely strong. It appears this trend will continue at least for another quarter based on pipelines and hopefully longer, always dependent on interest rates. The mortgage business is an integral part of our overall strategy. When rates go down, the mortgage business kicks in and helps, while we readjust the balance sheet to optimize earnings in that regard. We retain a positive gap very much all times, and this is an offset to that. So, you cannot look at the mortgage business separately and try to break it out because when you think about it, it’s given us the time and the earnings to get the margin going again, and we’ll talk about that a little bit later. But, it is an integral part of the business, part of our strategy, part of our internal hedge to optimize earnings in any rate environment.
One of the reasons we maintain a positive gap is we know that this business can cover during any period of time of falling rates. So, to consider it outside as separate, this is an integral part, as I said, integral part of what we do and it’s an integral part of our strategic plan and how we manage the balance sheet, manage earnings. So, even when they fall off, we get another couple of quarters of really strong mortgages. They’re not going to fall off in total, but then, we believe that the margin will be back at 2.75% range as we grow. We are a growth company, we will grow through this. This is evidenced by growing almost $10 billion -- to over $10 billion in the last year alone. We have a great halo effect going, and we’ll talk about our deposit growth in a second.
On another note, wealth management revenue continued to track to be -- was back on track to $25 million. Assets under administration were $1.2 billion or 4.3% to $28.2 billion. Growth was in all three business areas, trust, the broker-dealer and asset management. The majority of the growth occurred in asset management as new institutional accounts accounted for $0.9 billion of that growth. That will be good revenue going forward. Again, the net overhead ratio of 85 or 87 basis points, well below our 1.5%, and that certainly helps mostly from a mortgage business. And that’s evidence that it makes up for the margin decline we hope to pick up going forward.
On the balance sheet front, we grew $200 million in total assets of $43.7 billion. Our earning assets were up $1 billion. Average earning assets from $39.8 billion from $38.7 billion. Our loans grew $700 million in a period of time when other people -- our competitors were not having loan growth. Our loan growth is very good, and we -- our pipelines are stronger than ever. We have a $500 million head-start given the average balance -- ending balance. And again, our loan pipelines are extremely strong. We expect very good core growth -- loan growth in the quarter.
On the positive front, we grew $192 million. That’s a little bit misleading, kind of the tail of -- let me go back a second, if I could. On the PPP loans, balance has actually increased in the quarter by $44 million to $3.38 billion, currently $1.25 billion and 4,000 loans are to forgiveness process. About a third of the portfolio is in the hopper for forgiveness. The deposit story, we said they grew $192 million quarter-over-quarter, but it’s a story within a story. As mentioned in the last earnings call, deposits assets as they -- as we -- when they had on the last earnings call, about $1 billion less in the quarter at the end of the second quarter, which means we were $1.2 billion in core low cost deposits as these deposits ran off or higher deposit costs. And the $1.2 billion is more core and a result of our business, the development, the halo effect on PPP and continued general growth throughout the franchise.
In Q4, we plan to return approximately $600 million of institutional deposits, we have brought on to fund PPP loans and for general liquidity end of Q1 when the world was getting pretty crazy. The core deposit growth rate remained strong. We do expect the core deposits will grow to offset that decrease, but again at lower costs.
Now, I’ll turn it over to Dave, who’s going to talk about other income and other expense.
Thank you, Ed. Ed touched on the wealth management revenue a bit. But, in the non-interest section, that wealth management revenue increased $2.3 million to $25.0 million in the third quarter compared to $22.6 million in the second quarter, and it was up 4% from the $24.0 million recorded in the year ago quarter. The revenue source has been positively impacted by higher equity valuations, which impact the pricing on a portion of our managed asset accounts and also due to a higher level of trading in our brokerage accounts from the depressed levels that we saw in the second quarter of this year.
On the mortgage banking revenue front, it increased by 6% or $6.2 million to $108.5 million in the third quarter from $102.3 million recorded in the prior quarter, and was up a strong 113% from the $50.9 million recorded in the third quarter of last year.
The Company originated $2.2 billion of mortgage loans for sale in the third quarter, essentially the same as the originations that we had in the prior quarter, and was up from the $1.4 billion of originations in the third quarter of last year. The increase in this category’s revenue from the prior quarter resulted primarily from an increase in mortgage servicing revenue, as a result of the larger servicing portfolio and a higher level of capitalization of MSRs and a smaller negative MSR valuation adjustment during the third quarter relative to the second quarter. The production revenue was relatively stable, but up slightly as the production margin on similar volume steady level with the prior quarter. These aforementioned increases in mortgage revenue were offset somewhat by an additional expense accrual of approximately $3.1 million in the third quarter for the settlement of a longstanding recourse obligation dispute. That puts that dispute to rest, it’s been out there related to loans that were basically a decade old, and we felt it was appropriate just to put that dispute about.
We currently expect originations in the fourth quarter of 2020 to be strong, although there may be some seasonality, we’ll see how it works out. The winter months tend to slow the purchase business a little bit, and there are holidays involved in November and December. But, the pipeline is very strong. We expect it to be a strong fourth quarter. Margins may come down a little bit, depending on that volume. We’ll see how it works out. But for the fourth quarter of the year, we expect it to be extraordinarily strong.
Table 16 of our earnings release provides the detail of all the mortgage banking revenue components, if you want to dig into that further.
Other non-interest income totaled $13.3 million in the third quarter, down approximately $1.4 million from the $14.7 million recorded in the prior quarter. The largest decline of revenue in this category related to lower swap fee income of approximately $1.7 million. There were a variety of other smaller positive and negative variances in this category that essentially offset each other.
Turning to the non-interest expense categories. Non-interest expense totaled $264.2 million in the third quarter, up approximately $4.9 million or 2% from the $259.4 million recorded in the prior quarter.
Turning to the more significant changes quarter-over-quarter. The sellers and employee benefit category increased approximately $9.9 million in the third quarter from the second quarter of this year. The biggest portions of that are the employee benefit expense, which accounted for about half of the total increase, and it was up approximately $4.8 million from the prior quarter. And that was due primarily to substantial increases in employee insurance claims as employees have begun to return to a more normal pattern of seeking health care, and they also were catching up on services such as discretionary doctors visits and surgeries, which have been deferred during the early stages of the coronavirus pandemic. Accordingly, the second quarter expense was unusually low, and the third quarter expense was unusually high. However, the average of the two quarters is generally in line with the prior quarter run rates and our expectations.
Additionally, salaries expense was up approximately $2.8 million from the second quarter. The primary cause of the increase was approximately $1.6 million of lower deferred salary costs relative to the prior quarter, which had higher deferred costs related to the PPP loan volumes that we had in 2Q. So less of salary deferrals in the third quarter, because we didn’t do the substantial amount of PPP loans in the third quarter. Additionally, the Company incurred a little bit more expense to support the significant mortgage volume being processed through the system.
Commissions and incentive comp expense increased approximately $2.3 million in the third quarter. That change was driven largely by additional commissions related to wealth management brokerage trading activity as well as higher incentive compensation expense recorded during the third quarter relative to the second quarter.
Data processing expense decreased approximately $4.7 million in the third quarter compared to the second quarter due primarily to approximately $4.5 million of conversion charges incurred related to the Countryside acquisition in the second quarter, and whereas the third quarter was void of any such acquisition-related conversion charges.
Professional fees declined by $1.2 million to $6.5 million in the third quarter compared to the $7.7 million recorded in the prior quarter. These professional fees can fluctuate on a quarterly basis, based upon the level of legal services related to acquisitions, litigation, problem loan workout, as well as consulting services. This category of expenses was down slightly from the prior quarter due to small declines in a variety of expense types, but nothing of any significance related to any particular category. The professional fees categories averaged about $7.3 million over the past five quarters. So, the current $6.5 million is a little less than that, but within what we think is a normal range.
Equipment expense totaled $17.3 million in the third quarter. It’s an increase of $1.4 million as compared to the second quarter. The increase is due to increased software licensing expenses, including some increases related to online -- increased online mortgage usage, PPP loan servicing enhancements, network upgrades to support our growth in digital enhancements and various other software upgrades. And we continue to invest in software and technology to enhance our customer delivery systems and products as well as investment systems to support our continued growth. Other than those expenses that I just discussed, all other expense categories were actually down on an aggregate basis by approximately $524,000 from the second quarter. Ed mentioned the net overhead ratio stood at 87 basis points, which was down 6 basis points from the 93 basis points recorded in the second quarter. And on a year-to-date basis, the net overhead ratio was 1.03%. The ratio continues to benefit from strong balance sheet growth and strong mortgage banking results.
Moving onto income tax expense. The effective tax rate in the third quarter of this year was approximately 21.8%, which is well below the 26% to 27% range that we would normally expect. The reason for the lower tax rate in the third quarter related to a $7.1 million net income tax benefit recorded during the third quarter related to the settlement of an uncertain tax position with taxing authorities. We’d anticipate the effective rate to return to the expected rate of 26% to 27% in the future quarters, barring any unanticipated events.
I’d also like to take a few seconds to address the preferred stock dividends. There seems to be some confusion out there, if I look at some of the analyst estimates on what the preferred stock dividend should be on a going-forward basis. So, the Company recorded $10.3 million of preferred stock dividends in the third quarter. However, on a going-forward basis, given the existing outstanding issuances and dividend rates and if declared by the Board of Directors, the amount of preferred dividends recorded should approximate $7.0 million. The reason for the higher amount in the third quarter was that the first dividend period was a five-month period. There was really a two-month stub period in May and June, and then the normal quarterly period for the third quarter. So, in the first period, the dividend declaration included five months, but in all subsequent periods, the dividend should be three months period. So slightly high in the second -- in the third quarter here at $10.3 million. But going forward, given the existing issuances, rates, et cetera, that amount should be $7.0 million. So I just wanted to clear that up as there seem to be some confusion about that.
And with that, I will turn my comments back over to Ed.
Thanks, Dave.
I got to say, we’re very pleased with the quarter. I couldn’t be prouder of the Wintrust team, the strategic agility they have displayed throughout these unusual times. Rich Murphy put it once, he said, this is a miracle. We’re able to operate from home and put up these numbers and grow like we are and keep credit where it is. It’s really hats off to the entire Wintrust team. Our approach going forward is really very simple. We need to grow through this part of the cycle by taking what the market gives us. Right now, that means organic growth.
Acquisition market is currently non-existent to the valuations. Uncertainty is to credit -- targets credit. We believe there’ll be opportunities as we get closer to the end of the pandemic, but as of now, there isn’t a lot going on.
We need to monitor balance sheet in order to optimize net interest income, the NIM, as PP -- and the NIM as PPP loans continue through the forgiveness pipeline. Given our asset sensitive position, we do have room for some fixed rate exposure, and we’re looking for opportunities in this area.
Although I’m not really excited about what happens to our mortgage backs, there are some opportunities and some things we’ll be doing in the future that will help earning asset yields and help the margin. Our pipelines are stronger than ever, and we’re ready for PPP too, if that occurs.
We continue to monitor credit very, very closely. As you know, there will be some cracks coming. All our reserves are robust. Our current metrics are off the charts good. We’re comfortable with current -- our current reserve levels are appropriate. Know that we will not change our conservative consistent underwriting parameters and policies for any reason whatsoever.
I’d like to go back to the core net interest margin concept I drew out before. The $237 million June through September, we believe that’s a low point, barring lower -- additional lowering of rates, overall rate environment going lower. Our pipeline is strong. If we believe that we can add $1 billion of loans this quarter and $0.5 million in investments and put the spreads out, that’s a $9 million to $10 million quarterly impact for us. That’s what we’re doing. We’ve got a lot of liquidity. We have the liquidity here -- we put a lot of liquidity out of the beginning of the period of really the second quarter was because of the unusual times [indiscernible] on their lines, they know they were going to continue at PPP loans. We’re letting some of that expensive liquidity run off. It’s being replaced by core deposits at cheaper rates. And so, that’s the plan going forward is to grow without that commensurate increase in expenses. And we’ve been able to do so, as indicated by this quarter, another $1.2 billion of regular deposit growth and $700 million worth of loans. We expect that to continue going forward. It’s going to take some time to work through this. The mortgage -- the PPP has found money as far as I’m concerned. And the mortgage business is going to continue to support us until such time as we can continue to build the earning asset base up, get a little bit more certainty in the market as to where we’re going.
But, our interest rate -- net interest rate sensitivity position right now is around -- our net GAAP is around 12% or 13%. As COVID runs off, that was about 18%, which is -- we like to keep it between 10% and 12%. We’ve got COVID -- not COVID, as the PPP loans run off, they’re on at a 2 or 2.5 -- two-year average life, I guess, in our GAAP calculations. So, we do have room there to add some fixed rate assets on both sides of the equation, still maintain a very positive GAAP.
Again, you have to look at Wintrust in total. You have to look at our margin. You have to look at our mortgage business. All of these are internal hedges to help in various interest rate times. So to pull one out and say, that’s not going to continue without giving credit to the other side of the equation, doesn’t make a lot of sense.
I know we’ll get a question on stock buybacks as you guys go forward, in the question-and-answer period. I’ll say we are considering it as we always do. Right now, we just ran the numbers that might make some sense to do it because it’s accretive to both earnings and tangible book value. But there aren’t any acquisition you could do. And we’re sitting at about $400 million to $500 million worth of cash right now that’s available. We’d like to keep a -- we like to keep cash at the holding company, but we do have that opportunity if the Board still wants to go that way.
So, with that, thank you for your support. We really appreciate it. Have faith in Wintrust. We’ve pulled through the Wintrust management team. We have your best interest at hearts because your interest is the same as ours.
So, with that, we’ll have to turn over to questions. Thank you.
[Operator Instructions] Our first question is from Jon Arfstrom with RBC Capital Markets. Please go ahead.
I thought it was a pretty good quarter, but obviously, people have questions about the outlook. And I guess, maybe I’ll talk about growth and the margin. But in terms of growth, it’s unusual to see the kind of growth that you saw and maybe you could touch on big picture, what you think is different and you think you can offset the PPP runoff and actually show stable to maybe higher loans?
Well, I think, based on the pipeline, the commercial, commercial real estate pipeline, yes. It’s higher than it’s been in a long time right now. Our pull-through rates are consistent. Our premium finance business continues. The life insurance business continues to grow nicely. And the commercial business continues to grow nicely. The average ticket size is relatively constant, around 38, 39 million bucks…
Thousand.
Thousand bucks. Sorry. I wish it was a $1 million, on the commercial side. So, we believe that we’ll continue to have really good core loan growth, at least for the foreseeable future on our terms, though. So, we’re not bending credit to get there. I’m telling you, this is -- a lot of it is the PPP halo effect pull-through. And we’re seeing an echo effect of that because the people who were pulling through are referring us to other people. These are good accounts, were taken from the larger banks in town. Nobody in particular, it’s everybody in total proportionately. But it seems like we’ve got very good momentum to carry good reputational momentum and our name is out there. So, we feel very good about our growth prospects. And that’s an integral part of what we have to do here is to grow through this.
That being said, if in fact we saw things turn, you couldn’t get paid for your risk, saw lots of exceptions coming through, wouldn’t be afraid to shut it down right it out like we did in the past and wait for the other shoe to fall. But we’re not seeing that now. Rich, you agree?
Yes. No, I’d say, Jon, you know our business model well. And one of the things that we always say is, we will take what the market gives us. And so, last year, CRE was a big contributor to growth, C&I, less so because of some of the things Ed talked about. We weren’t getting paid for the risk. And structure has got just a little bit crazy. So, one of the things that’s really encouraging so far this year is just the way that that growth is coming in. It’s really very balanced. CRE is still a contributor, but we’re seeing good C&I growth, as Ed pointed out, we’re seeing good growth out of the niches. We’re seeing good growth out of the premium finance area. So, one of the things that really keeps me confident is just that and all those engines are running pretty well right now. So if you took the first three quarters, I mean netted out margins held for sell and netted out PPP loans, we’re on an annualized track of about 8%. And that really requires everybody to kind of be getting their work done. And based on what we’re seeing in the pipelines for all of those, we’re continuing to feel pretty good about loan growth.
Well, the amazing thing to me is, and we’ll talk about this a lot is, a lot of the old time, really old names in Chicago, names you would recognize, are now doing business with us. They’ve had long-term relationships with the larger banks in town, and they’re getting kind of fed up. You’d be amazed that some of the names we’re dealing with, and they tell their friends and they tell their friends. So, a little bit of a pyramid effect going on here, which we’re very happy to be a recipient of.
Okay. All right. That’s good. And then, in terms of the margin, getting the margin back to that 270 plus type level, I understand the strategy. But, just talk a little bit about the cadence, how long do you think that will take to get back to those levels?
Well, PPP is going to run off and leave us with liquidity. If you think -- and we’ve got to be able to put that liquidity to work, plus we have to take the $3 billion we have of overnight money and put that to work. We’re currently at 80% loan-to-deposit on a core basis, 90% with the PPP loans included. We’ve got to run about 90%. And if you figure the growth that will be in here, returns of deposits put in, we think it will take 2 to 3 quarters, barring anything else. I would say around two quarters if everything stays where it is, we manage the funding properly. That’s about where we think we’ll -- it will take about two quarters to get there. But, it’s all a function of what’s going on in the markets. And if everything holds as it is right now, I would say, in two quarters, we do that. But, a lot of things can change. You get a lot more -- I mean, the deposit growth has been incredible for it, absolutely. Core deposit growth has been incredible. We’re not going to turn it down because these are really good clients, really good businesses that we’re going to get. That’s the raw material. I’ll take it all day if the prices we’re getting at now, as we bring in relationships with them, eventually those turn into larger relationships and lending relationships.
Just to give you an idea, Tim Crane is here. Tim, why don’t you talk about what’s going on in the treasury department right now, at least in the last quarter, what happened?
Sure, Ed. And Ed’s talked about the halo effect. This is the -- one of the follow-on pieces to both the PPP opportunity and any other credit opportunity is the treasury and services revenue that comes with. And so, we’ve had to add staff to handle the implementations that continue to come to us, and we’ll do that probably through at least the end of the year, with the treasury revenue really just starting to show up, probably in the beginning of the fourth quarter here. And, we think that will be relatively significant for us.
Picked up almost 140 accounts.
160, just already implemented with a number in the pipeline waiting to get set up.
Yes. And revenue on that could be over $2 million annualized. So, there is a lot of things going on there. And we got to go through this and keep our expenses under control. That’s got to be the secret here to get earnings back and be prepared for higher rates because the beach ball underwater we talked about 10 years ago, Jon, I think that one is deflated. We got to get another one down there, but it’s bigger than it’s ever been.
Our next question is from Chris McGratty with KBW. Please go ahead.
Hey, guys. Thanks for the question. Dave, on the mortgage business, you talked I think about the potential for margins to come in a bit. Maybe you could elaborate on how meaningful, given how much they’ve expanded year-on-year.
Well, a lot of it really just depends on where the pipelines are going. I mean, right now, they look pretty full, but if they decline and the margins generally decline as the pipeline comes down because people raise the margins as they’re trying to govern the amount of flow coming in. So, I think, you could be -- I think, you could potentially have a free handle on the margins next quarter. But, I said -- Chris, I said that last quarter, too. I said, volume would come in a little bit and margins would come down, and the application flow was just astounding to us that it stayed where it was. And the purchase activity really bumped up in the third quarter, and generally second quarter is bigger, so. And there’s still a lot of purchase activity going on out there in the marketplace. So, I could be surprised again. But, the foot quarter also has holidays where some people defer their actions or just don’t do it, and there are more holiday days in the quarter. So, that could impact it too. But I’m not going to give a specific number because I tried to give that guidance last quarter, and I was wrong. But, I think if it tails off a little bit in the winter months, they could come down to the 3s.
Got it. And just one more. With the prospects of taxes going up, can you remind me if anything is structurally different than when you guys got the benefit in ‘16 in terms of just sensitivity each point?
Yes. Well, we were liability -- a deferred tax liability at the time. So, there is some benefit. We still have a deferred tax liability. There are some tax planning strategies we could do. So, if there is a change in Congress and the administration, and it looks like there could be some increases in taxes. There are some elections we can take on depreciation and the timing of certain expenses that we think we can mitigate some of the increased cost of that tax law change. But, we are in a deferred tax liability. So, when we benefited last time when weights went down, it would be a negative to us. But, it could be -- if you look at our current deferred tax liability, like a $20 million number, but I think we can mitigate that substantially. So, there may be some impact, but I don’t expect it to be material.
Another gift from CECL. CECL raises the taxes and...
Our next question comes from David Long with Raymond James. Please go ahead.
Good afternoon, everyone.
Hi, David. How are you?
I’m doing well. I’m sure you guys are doing well after a great report, like you put up last night. With regard to the balance sheet and the size of the balance sheet, do you -- your clients seem pretty liquidate, you’ve seen nice deposit growth, do you expect deposit balances to come down at some point, and does that hinder your ability to invest some of the cash you have?
Well, we’re kind of floating there right now. And the reason -- one of the reasons we haven’t gone along yet is exactly that, is the money going to stay. We usually -- we don’t know how much of it is PPP -- it hasn’t been spent and will that go out if it does go out, where it will go, hopefully it will go into personal accounts and into Wintrust Wealth Management. But, we do believe that deposit growth and market share growth remained strong, just by virtue of the number of clients we’re picking up on the commercial side and on the retail side, as a result of the halo effect and the echo of the halo effect. So, I think, we’re okay in terms of deposits. I worry about that if it happens because by now everybody’s having too much.
Got it. Okay. And then, in your reserve today, what assumption are you using for future stimulus?
Yes. That’s a good question.
Yes. We don’t have anything substantial in there for guessing whether it’s going to be $3 billion -- or $1 trillion or $500 billion. So, if there’s more stimulus, we think that will help us. I think Moody’s assumes some continued stimulus. So, what Moody’s has in there is what our models would have because we used Moody’s economic scenarios. But, we aren’t putting any qualitative impacts into the assumption to say, boy, we think that there’s going to be a ton of stimulus. So, what Moody’s has got in for additional stimulus with what our models run with.
What scares me about as an ex PPP round, David, is if you do have a change in administrations, remember what happened to TARP when the administration changed the last time. They changed all the rules. And we’re going to have to offer it, but it’s going to -- may not be as simple as this really is right now or as the first PPP was. But, as I said before, the government is not the best counterparty they have. We do have to take care of our clients. There is a need out there. And I’m thinking -- it’s on our projections, what I’m thinking, if it did came -- come was reasonable, that going be $1 billion for us, a third of what we had before, to our existing customers. They had opened the lines for additional customers coming in. So, it will be a good thing, but I expect it to be kind of lumpier than this one.
Got it. And then, just the last thing, if I can. On the mortgage side of things, the Fannie Freddie, 50 basis-point charge expected to start here in December. Has that had any impact on volumes or spreads at this point, or do you expect it to?
Well, we built it in last time it came. We’ve got it built into our pricing models right now. So, we don’t expect that to -- the fact that they -- they had not delayed it. It probably -- it would have beaten our margins a little bit. But given the fact they delayed it, we’ve pretty much built that into our pricing schedules now.
Our next question comes from Brock Vandervliet with UBS. Please go ahead.
We talk about funding costs. It would seem like you may have some room to continue to move those down, particularly on the CD side. What should we be thinking about there?
Mr. Crane, do you want to answer that?
Yes. Brock, as you guys saw, the interest-bearing deposit costs went from 81% to 61%. And you’re correct. We believe we continue to have some room about -- well, more than half of the CD book will reprice in the next year. That’s moving from the 170 to about 60 basis points, 65 basis points. And so, you are correct, I think, you’ll see continued progress in moving our funding costs down in the next couple of quarters. That was a low point, if you took the low for each category, you get into the mid-30s. So, I think an early look now would get us 40ish or slightly below, given what we see in terms of a normal run rate on CD repricing. So, over time, I think 35 basis points was the low we had, the last time we had one of these rate environments. And we would expect to get there probably mid next year. Somewhere around there.
And most competitors are flat-by-flat in terms of loan growth. I hear you in terms of talking about picking up new clients. Clearly, that’s driving some of it. What was your loan utilization in the quarter? I believe it was 49% last quarter. Has that picked up?
It’s about 50%.
Yes.
Normal is around 50%, and that’s where -- went up to 56% or 57% beginning of the crisis, I think it might back down to 50%.
Yes. It seems to be normal. So, the growth really wasn’t increase in line utilization. It stayed relatively flat.
Okay, it’s new clients. Okay, got it. Thank you.
Our next question is from Terry McEvoy with Stephens. Please go ahead.
Ed, you mentioned a couple of times in your prepared remarks, you’re starting to see some cracks, and there are some losses coming I think was the expression. I was wondering if you could expand on that. Is that the hotel portfolio, which still has higher deferrals, or there are some other kind of segments within the portfolio that was behind that statement?
No. It wasn’t a specific statement. We don’t see them now, but we’re on a look out for them. We’ve always seen our first loss is our best loss, and we got an issue, we’ll take care of it right out of the box. But, my point was we’re not naïve enough to think that we’ll get through this unscathed. I can’t tell you where or how, but something is going to hit. And somewhere, somehow, the -- surprisingly, the franchise portfolio is doing pretty well. And our hotel exposure is basically nothing.
Rich, do you want to talk about that?
Yes. No, I think you answered the question exactly right. I mean, we look at all the material classified assets all the time. If something is really problematic, we’re going to market accordingly and move on. But things, generally speaking, are holding together pretty well. As Ed said, the high-risk portfolios that we laid out for the last couple of quarters have performed amazingly well. The franchise portfolio is largely made up of QSRs. And I asked the question to that group this morning about are we back to pre-pandemic levels in that space and pretty much at or above because they have modified their business model so much. Again, hotels are -- I can count our hotel deals on one hand. There’s just not that many. Energy, again, we’re not a big energy lender. So, I don’t know where we’re going to see some of these things pop. As we’ve talked about in prior quarters, you have some COVID-related industries that we have borrowers in those that are really highly affected, things that are in the tourism, things that are in more of the restaurants that is maybe non-franchise. I mean, it’s hard to say exactly where. But, if this pandemic continues throughout better part of next year, I mean, there’s going to be real challenges on those types of credits. But, for right now, we’re feeling okay.
And I think it’s -- it’s all been accounted for in the buildup of the reserve that we have right now. So, I just go back to central page saying, just because they’re not after us doesn’t mean you shouldn’t look over your shoulder. We’ve got to be very vigilant and stay on this if anybody gets complacent. But we don’t see it right now. As I said at the beginning of my comments, you wouldn’t think there was a pandemic or any crisis going on looking at our credit book right now.
And then, just as a follow-up, maybe for Dave. I was hoping to get your initial thoughts on expenses in 2021. It looks like maybe advertising and marketing are down $5 million year-over-year. So, that’s going to normalize, we hope. So, that’s about a $20 million increase. But, what else -- anything else stands out as you think about next year?
No. We’re going to, obviously, always have a little bit of salary increase for merit pay, but we’re going to try to hold the line as much as we can on the on the staffing front. If you look at what we did on the -- we had some one-timers as even in this quarter. I mean, we had $6 million of contingent consideration on the earnout this quarter and had $7 million last quarter, so there’s $13 million. We had the settlement of some of these recourse obligations that have been going on for years that there’s probably a few million dollars there difference from what you would have that we think we put behind us acquisitions and acquisition costs were in there. Last quarter, we just had $4.5 million of loan just on the conversion charges. So, I mean, I think there are some numbers in there that just aren’t going to happen again next year. But, we would hope that we could -- as Ed said, try to grow the deposit on the loan side of the equation and hold the line on expenses, there will be some increase, like you saw this quarter, just on the technology and software sides as we build out our digital platform and in customer-facing systems. But, hopefully, that helps on efficiencies in other areas of the businesses as far as the branches and the people we have, et cetera, that there’s offsets out there. So, I don’t have a specific number for you, Terry, but trying to hold the line on expense growth.
Yes. We are going through and looking at our branch network. We’re looking at the number of people who -- we have not laid anybody off or furloughed anyone during this period of time. We’ve been able to repurpose them in the PPP and what have you. But, I think that we have developed some efficiencies through this process can be carried through, and just so through normal attrition, we should be able to bring our headcount relatively speaking, down a bit because of this. Once we get to the PPP forgiveness, which is becoming somewhat laborsome and we’re growing at the same time. So, a lot of the -- we had to repurpose people to do that. So, I think, we’re going to be okay in that regard. We’ll see, though. Who knows what next year is going to bring in terms of opportunities and in terms of growth, so.
Thank you. [Operator Instructions] Our next question is from Nathan Race with Piper Sandler. Please go ahead.
I was hoping to just follow up on your comments just now around office location and so forth. We’ve seen some -- we’ve seen from some competitors in Chicago that they’ve closed some locations, just given that branch. Traffic has slowed considerably with economies closing down and so forth. Just curious, what you’re seeing in terms of the magnitude of opportunities if you guys do go down branch consolidation path like you were just talking to?
Go ahead, Tim.
Yes. As we mentioned in the last call, number one, we’re seeing the change, the increase in the use of electronic services that the other banks are, and that’s encouraging to us. And we’re also seeing obviously a different pattern in terms of how clients use our facilities. We’re nearing the end of analysis that I would guess will result in the closure of some number of branches. I don’t think, it will be trajectory changing, but it will be roughly comparable to what you’re seeing with some others. The important piece though I think, is that we still think there are markets we’d like to be. And so, whether those are underserved markets or there are markets that we find particularly attractive, we will also continue to selectively add some locations. But both, to Ed’s point about how efficiently we can run the locations that are open. And then ultimately, the number of locations we need, we think there will be opportunities.
Okay. That’s very helpful. I’m just changing gears a little bit, thinking about the commercial real estate growth in the quarter. I think, one item that stood out to me in some of the tables, I think in table one in particular was a growth out-of-state and other parts of the country that you guys don’t outline specifically within that table. So, I guess, is that just a function of you guys following some existing developers and clients to other parts of the country, or is it just like you guys alluded to earlier, just new client adds that are occurring in geographies that are a little more attractive from an underlying perspective than what’s happening in Illinois and other surrounding states?
Rich, do you want to handle that?
Sure. Yes. So, I think you anticipated my answer to that question. We have a really good client base that we’ve dealt with for a long time that as we’ve become -- gained expertise over the years and started looking at really expanding our Wintrust presence in the commercial real estate area, we’ve built up a very nice stable of good sponsors. As time has gone on, they’ve asked us to follow them out to some of the opportunities they’ve seen in different markets from Texas to Colorado to out on the East Coast, Florida. And we’re generally happy to follow them on those. And we don’t do them all, but generally speaking, we like the professionals, and we’re doing business with and lending money to. And so, we try to understand those markets, and we get a good handle on it. But, it really is a function of following the people that we’ve been for a long time.
General rule around here is our core portfolio has been Chicago nexus. Our niche portfolio can go anywhere in the country, leasing for premium financing alike, but the core portfolio has to have a nexus to Chicago, Milwaukee, our market area.
That makes sense. I appreciate you guys taking the questions multicolored.
Welcome.
Thank you. Our next question is from David Chiaverini with Wedbush Securities. Please go ahead.
Hi, thanks. A couple of questions for you, starting with mortgage banking. Clearly, this year, it’s a blowout year, double the revenue of the prior year. And I was curious, if we were to go back, we look out to 2021, and of course, 2021 is probably going to be a strong year also. But hypothetically, if mortgage banking revenue were to go back to 2019’s level, how much of an expense reduction would come with that? So, if we were to take 2020 and kind of divide that revenue in half, looking out to either next year or the following year, how much of an expense reduction would be related to that?
Pretty much the same percentage. We’re using a lot of contracted labor now. Our ability to contract our expense basis, the market contracts, you might lose a month there. But, basically on a run rate basis, you should be -- we’ve designed it so you’re going quoting it down fairly quickly. Murph, do you want to…
No. That’s exactly right. I mean, we have become much more nimble in terms of our ability to step up and correspondingly step down as volume dictates. It won’t be, I’d say, exactly one for one at any given point in time, but it’ll be close.
Yes. Generally, the efficiency ratio in that business has been around 80% or so. One of the reasons our efficiency ratio is higher than our peers is we have higher percent of our revenues in the mortgage banking area. So, there’s a substantial amount of expenses that would come out of that equation.
I think, the difference between the 2019 and 2021 will be one that use our use of contract labor; and two, our use of the front end is working wonderfully. Now, the old days, the front end was manual. It’s all now mechanic -- it’s all digitalized, taking costs out of business. The third is, a lot of the work that doesn’t touch the customer is being done offshore, on a per deal basis. So, those will fall off also. So, I think compared to -- I think, we talked about this in ‘19, those were our initiatives. And now they’re in full swing right now. And so, I think that the costs are more per unit, and they were fixed before.
I can tell you that every time he talks with our senior leadership team in the mortgage department, he says, congratulations on a great month, how are you going to get your cost down when the revenue goes up. So, it’s definitely a focus.
I’m becoming predictable. I don’t like that.
Great. Thanks for that color. And then, shifting to the provision outlook, $25 million this quarter is clearly down substantially from the second quarter. How should we think about the go-forward provision? I know, it’s a very uncertain environment, but is 25 kind of a good baseline going forward?
Well, I mean, theoretically, David, if you think about CECL, it’s a life of loan concept. So, if the portfolio didn’t grow, and the credit quality stays the same, and the economic outlook was the same, you have zero. Right? So, the drivers for that are going to be if we have growth, we’ll have to provide for that growth. If the portfolio would deteriorate, or get better, it would go up or down. And really depends on the economic scenarios, which prices graduate quite a bit. So, I think, you kind of look at this and have to just think about where you think the quality -- credit quality and growth is going to go in the portfolio. And then, if they add stimulus and the economy gets better, I mean theoretically, you could say, banks could start releasing reserves. And I don’t think we’re in that position yet, because we’re not -- you’re not seeing the economic scenario change dramatically. But, I think what’s going to drive our provision going forward, right now, as I look at it would just be is the portfolio going to grow. And that was -- this quarter you could see that we had some growth in the portfolio that helped drive that number up a little bit. And credit quality is knock on wood, holding in there right now. So, CECL is awfully complicated from that perspective. But, I think, the issue really is growth here, so.
That makes sense. And last one for me is, where you just left off there on loan growth. You mentioned about how pipelines are stronger than ever. What type of borrowers are you seeing the most demand from, in terms of loan growth? And I guess, related question to that, are distressed investors swooping in and purchasing CRE at this time?
I can handle the first part, and then I’ll get into the second part. So, where we’re seeing activity is really, in Chicago, into Chicago market, the pie, I don’t think is growing all that much. We just continue to grow our share of that pie. So, we’ve talked for the last couple of quarters and on this call about the halo effect of PPP in it. It is very real. I mean, not a -- one of our credit approval meetings goes by where we’re not seeing a deal come out of pick your big bank. Because, they’re just frustrated with the way that they handled PPP, the way they have sort of evolved, which is a much less banker focused model, more call center oriented. And as a result, you were just getting looks more often. Every time there’s a deal that comes to market, we’re sort of the guys sitting at the table. So, it really has, I mean, as I said earlier in the call that our visibility in the market is I think dramatically different than if you go back a couple of years, and even if you go back to this time last year, we sit in a different position. The quality of the borrower being where they’re coming from, it’s just -- it’s a good place to be right now.
As it relates to the distressed assets, and we are seeing every day in my inbox, there’s probably another 10 people sending notes saying, hey, we’re interested in buying your hospitality portfolio, we’re interested in buying your CRE portfolio. And I think it’s just, they send it out to everybody, because they’re just trying to find as many assets out there as possible. So, there are a lot of people out there looking for distressed assets.
Great. Thanks very much.
Thank you. Our next question is from Michael Young with Truist Securities. Please go ahead.
Hey. Thanks for the question. Maybe just wanted to ask kind of big picture, if there was going to be some KPIs or more high level articulation of financial targets, kind of on the heels of some of this disruption. I know, you guys did some of the management reorganization to free up some bandwidth to kind of evaluate strategy. So, I just didn’t know if there was anything that had come off that or that we should expect in the future from that.
No. I don’t think we’re going -- I don’t think we’re going to give any sort of different guidance out there right now. I mean, the overall strategies, what we’re looking at and some of those I said. This is a very diversified business model here that if you set some of those goals and the mortgage market is stronger than sort of the interest rate environment has been recently or vice versa, if rates go up and the margin expands, and mortgages go down. Some of those, some of those KPIs would change dramatically. So, we’re trying to manage the overall business and the diversified nature of it. And I think, if we start to provide you with very granular KPIs out there, we’re going to be explaining why they’re changing all the time, because the business is somewhat fluid.
And so, we take what the market gives us. We try to stay diversified. We try to take advantage of the revenue streams where they’re at. And that you have to be able to adapt over time and not corner yourselves into certain KPIs and so it is we have to meet those, because you’ll give up on some other aspect of the business. But, rest assured as Ed that said earlier, we are big shareholders of this relative to our net worth, and we manage this like shareholders and we manage it for the long-term and not for quarterly returns. And so, we’ll continue to do that, but I’m not so certain that we’re going to put out more KPIs.
Okay. That’s fair. And then just on kind of back on the growth question, I guess. You kind of mentioned on your own credit, things are good, but you’re worried something might pop up. And I’m just curious how you shifted maybe underwriting in terms of structure on new loans that you’re pursuing to make sure that there’s an appropriate margin of error, safety on new loan originations, whether it be CRE or C&I, that would be helpful.
We don’t change our loan policy, basically. This business hasn’t changed since in the peak season in [indiscernible]. So we don’t try to follow the herd any way, shape or form, but we have very conservative underwriting standards. As our history will tell you, we don’t change a lot of them. Go ahead, Murph.
Yes. Ed is right. I mean, I think, we have been pretty consistent in the way that we underwrite credit and the way we structure deals. I’d say, to your point, though, C&I, I wouldn’t say, we’re doing a whole lot of overlays there from an underwriting perspective. I’d say, in the CRE space, we’re trying to be very mindful of what potential vacancy rates could look like, in different segments, you could do an off -- we’re not doing a whole lot of office deals right now. But, we’re certainly -- we talk a lot about, what’s the pro forma vacancy rates that you get applied to those - retail, we are not doing anything really right now, but certainly, when we’re doing reviews on those, we kind of put those -- stress them out to a higher level of vacancy. But in the deals -- the new deals that we are doing, we are trying to be very mindful of the things that we are concerned about. I would say like in Illinois, we are looking at real estate taxes, and thinking about, okay, here’s where they’re at, how much stress in those real estate tax expenses can we absorb here.
So, I’d say, if anything, that’s probably the area of most focus right now is on that those CRE deals and kind of viewing what scenarios are to really understand them. But, again, I think the biggest thing that we really do focus on and one of the things that we’re -- as we look through our existing portfolio is, your sponsor selection is really critical. I mean, if you went in to the last six months with weaker deals and weaker sponsors, you’re going to have a rough ride. But, we have seen in a number of instances where we’ve seen sponsors step up and resize the deal and support deals where appropriately and that’s -- ultimately that’s your protection.
Okay. Thanks.
Thanks you. And our last question is from Brock Vandervliet with UBS. Please go ahead.
Brock, you’re coming for a rebound.
I just can’t get enough. I wondered if you could just briefly walk through the PPP dynamics on the NIM. Was that change related change in the term from, say, two years to five, or driven by an update on the level of forgiveness that you’re seeing?
Well, it’s really driven on the timing of the forgiveness that we’re seeing. Based upon the customer surveys and the customer responses that we did, we thought the forgiveness would happen quicker. So, we thought the cash flows would come in quicker. Then, as there is always talk about, maybe Congress will pass a law that gives a one page form for everything under 150,000. And some people talked about -- or -- yes 150,000. Some people talked about even higher numbers. So, we have a lot of accountants and lawyers advising our clients that hey, why don’t you just sit back? No reason for you to fill out this lengthy forgiveness application, if a simpler, easier one’s going to come through. And so, a lot of people have sort of held off. With that being said, about a third of our portfolio has got applications in now. Some of them have gone all the way through the process, and we’ve got the cash. Others are actually waiting for the final process. So, we have them in different stages. It’s just that flow backed up on us a little bit because of the anticipation that Congress or the SBA may give a more simplified streamlined approach to the borrowers, and so they don’t have to make a payment, they just sat back.
So, where we thought we’d have more flow in the third and the fourth quarters, we’ve sort of pushed that back more towards the end of the fourth quarter into the first quarter. And so, it’s really you just recalculate what you think your level of yield is going to be and how fast the accretion is going to come in. Does that make sense?
Yes. Got it. Okay. Thanks, Dave.
Thank you.
Thank you. And this concludes our Q&A session. I would like to turn the call back to Ed Wehmer for his closing comments.
Thank you very much for listening. If you have other questions, feel free to call Dave, me, Tim, Kate, Murph, anybody on the call. Thanks. We’ll talk to you later. Have a great holiday season. Talk to you soon. Thanks.
Thank you. Ladies and gentlemen, this concludes today’s conference call. Thank you for participating and you may now disconnect.