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Wintrust Financial Corp
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Welcome to Wintrust Financial Corporation's Third Quarter and Year-to-Date 2021 Earnings Conference Call. A review of the results will be made by Edward Wehmer, Former Founder and Chief Executive Officer; Tim Crane, President; David Dykstra, Vice Chairman and Chief Operating Officer; and Richard Murphy, Vice Chairman and Chief Lending Officer. As part of their reviews, the presenters may make references to both the earnings press release and earnings release review presentation.
Following their presentations, there will be a formal question-and-answer session. During the course of today's call, Wintrust management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Actual results could differ materially from the results anticipated or projected in any such forward-looking statements. The company's forward-looking assumptions that could cause the actual results to differ materially from the information discussed during this call are detailed in our earnings press release and in the company's most recent Form 10-K and any subsequent filings on file with the SEC. Also, our remarks may reference certain non-GAAP financial measures. Our earnings press release and earnings release presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded.
I would now like to turn the conference call over to Edward Wehmer.
Thank you very much. Welcome, everybody, to our third quarter earnings call. As mentioned with me are Dave Dykstra, Dave Stoehr, Kate Boege, Tim Crane and Rich Murphy. We have the same format as we instituted earlier this year. I'm going to give some general comments regarding our results, forward to Tim Crane for more detail on the balance sheet, then to Dave Dykstra for other infill and other expense. And Rich Murphy will discuss credit, back to me for some summary comments and thoughts on the future and then time for questions.
On the overview, all in all, a very successful quarter. I can almost give the same comments made at the end of Q2. At the end of last April, the start of the pandemic, the government's massive response to it, indicated Wintrust is supposed be -- it was going to attempt to grow through it. Then we've accomplished this goal and as such, third quarter shows the strategy is working. All our growth to date has been organic. Second quarter was another all around $1 billion quarter. Assets, deposits, core loans, out of PPP loans, all grew by over $1 billion. Both prospects remain very good. On particular note, core loan growth resulted in an overall increase in total loans for the quarter even after PPP runoff. We're able to achieve another $1 billion loan quarter in Q4 which we believe is more than a reasonable assumption given our pipelines which, by the way, are 13 month high at quarter end. We will fully replace all the PPP balances. This was our intent before we embarked on this strategy.
The income for the quarter was $109 million or $1.77 per diluted common share. Year-to-date, we stood $367.4 million or $6 per share. Important, Net interest margin decreased 4 basis points, to 2.59%, primarily due to excess liquidity. Net interest income was up $19.7 million from quarter two. If you back out the PPP loan income. In total, net interest income is up almost $8 million over quarter two. Period-end loans exceeded average loans of the quarter by $607 million which bodes well for Q4. Our liquidity portfolio is up $1.563 billion on average versus this portfolio means very short -- remains very short, over $5.2 billion overhead money at the Fed. Investing this money as rates rise is a lever we can pull when the time is right.
Strong growth, as I say, it was excellent in all areas of our business as our current pipelines. Line usage remains low, a little over 39% is up around 1% from the end of quarter two. Hopefully hit bottom on this end and line uses start to increase. Normal average is closer to 50% return and run would add another $1 billion in outstanding loans. Credit quality is even better, charge-offs totaling like net 0. We had some charge-offs but we have recoveries which shows -- should indicate to you our consider to this ready things often a good on recovery. NPLs and NPAs were constant versus Q2 NPLs was $2.5 million to $90 million or 27 basis points for NPAs shrunk $2.5 million, same 22 basis points. This plus improved portfolio quality and Moody's sunnier view of the overall economy so a reserve release of $7.9 million. Mortgage increased -- experienced some growth in the quarter. Dave will discuss in detail. Wealth Management considered steady improvement fees up $1 million for quarter-over-quarter, up $18 million year-to-date.
I'll turn the call over to Tim which will provide some detail on the balance sheet. Tim?
Good. Thanks, Ed. I'd like to briefly highlight a few balance sheet items as well as cover two topics that appear to be of interest. First, with respect to the balance sheet, total assets increased to just under $48 billion as we continue to experience strong growth.
As Ed mentioned, loans excluding PPP grew $1.2 billion during the quarter, essentially mirroring last quarter's growth. The growth was spread across virtually all loan categories, as Rich will discuss in a few minutes. On a percentage basis, this is the second straight quarter where annualized loan growth, again, excluding PPP, was approximately 15%. With respect to PPP loans, we saw a reduction of approximately $800 million during the quarter. At this point, almost all of the PPP loans originated in 2020 have been forgiven and approximately half of the loans from 2021 either have been or in the process of being forgiven. By year-end, we project the remaining PPP balances will be down materially and the remaining income impact to be relatively small. For the remainder of the year, we are comfortable with our loan growth target of mid- to high single digits on a percentage basis. Again, Rich will provide some additional color on loan pipelines and the factors that would drive potential upside to that number.
Deposit growth for the quarter was also strong, $1.1 billion, almost all of it either DDA or low-cost deposits. This is an annualized growth rate of approximately 12%. Despite the high levels of PPP forgiveness, we are not seeing unusual volatility in customer deposits. This quarter, the interest-bearing deposit costs fell another 9 basis points to 29 basis points. This is largely a function of CD repricing. Deposit costs will continue to decline but at a slower pace in coming quarters. As we've noted in prior periods, we continue to monitor the deposit growth carefully given the high levels of liquidity in the market. However, we've used stable, low-cost deposits as a strength of the company and we'll continue to pursue deposits related to client relationships. On the investment front, we remain very liquid. During the quarter, our securities balances were up slightly as we replaced investments maturing but generally have not yet moved to deploy the large amounts of excess liquidity as we remain wary of locking in low long-term yields.
As the market continues to trend up, we will evaluate our position and view appropriate deployment of this liquidity as an opportunity in future periods to improve the margin and income. Our capital levels remain appropriate given the conservative risk profile of the bank, you will note that during the quarter, we repurchased approximately $9.5 million worth of stock at just over $71 per share. Given where we believe volumes and yields will land, we continue to expect that despite lower PPP accretion, net interest income will increase as it has for four consecutive quarters. And that excluding PPP, the margin will remain roughly stable. I have two other brief comments that relate to new slides in the earnings release presentation.
The first has to do with Digital adoption. You'll see on Page 9 of the presentation that our high-touch community banking model also has a high-tech component and that we are seeing the same increases in digital adoption and usage that some larger banks have reported. We continue to upgrade our digital capabilities to give clients options on how they would like to be served. These capabilities position us to compete successfully and in some cases, to differentiate ourselves versus our competitors. Currently, you'll see that a full 2/3 of our checking clients regularly use our digital services.
Page 10 of the presentation document is also a new slide, relates to the customer satisfaction of our commercial clients. Illustrates with source of Greenwich data, that as you can see Wintrust is top ranked across the important categories. To scale this for you with 97% overall satisfaction score Wintrust achieved, compares challenge of scores in the 60s and 70s of many of our competitors. The service we provide increase the depth of our relationship and it's a foundation for a strong momentum in the Illinois and Wisconsin markets as well internationally in many of our niche businesses.
With that I'll turn it over to Dave.
Great, Thanks. As Ed mentioned I'll cover the income statement category. Starting with net interest income, for the third quarter of 2021 net interest income totaled $287.5 million, that was an increase of $7.9 million compared to the second quarter and an increase of $31.5 million as compared to the third quarter of last year. The $7.9 million increase in net interest income compared to the second quarter was primarily due to average earning asset growth which was up on an annualized basis by 12.5% over the prior quarter and one additional day in the third quarter which was offset somewhat by compressed net interest margin.
Net interest margin decline in 4 basis points to 2.59%, the beneficial decline of 8 basis points for the rates paid on liabilities was offset by 10 basis points decline on the yield on our average earning asset and a two basis point decline in the net free funds contribution which was also then -- slight decline in the net interest margin. The decline in the earning assets in the third quarter as compared to the current quarter which primarily due to the impact of building short-term liquid assets. The decrease on the rate paid on interest-bearing liabilities as compared to the prior quarter was primarily due the 9 basis points decrease in the rate paid on interest-bearing deposits due to the repricing of time deposits. I think it's important to know that the net interest income expanded despite $11.4 million of less interest income associated with the PPP on portfolio in the third quarter which included $7.8 million of lower PPP loan fee accretion. and net interest margin excluding the PPP portfolio was relatively stable as a decline by only one basis point.
Turning to the provision for credit losses. Like many other banks have done this quarter, Wintrust again recorded a negative provision for credit losses of $7.9 million compared to a directionally similar negative provision of $15.3 million in the prior quarter and a $25 million provision expense recorded in the year ago quarter. The negative provision was driven by a reduction in the allowance for credit losses primarily due to improvements the loan portfolio characteristics during the quarter, including decreases in net charge-offs and COVID-related loan modifications and improving loan risk rating migration. Rich will cover credit quality and additional detail in just a few minutes.
I will now talk about the non-interest income and non-interest expense and income tax sections. In the non-interest income section, our Wealth Management revenue increased $841,000 to another record level of $31.5 million in the third quarter compared to $30.7 million in the second quarter and that revenue was up 26% from the $25 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.
Mortgage banking revenue saw a reasonable solid loan origination volume during the third quarter with origination activity fairly consistent with the second quarter of this year. To that end, the company originated $1.6 billion of loan -- mortgage loans for sale in the third quarter of 2021 down from the approximately $1.7 billion that we originated in the prior quarter. As we forecasted on our last call, mortgage banking revenue increased to $55.8 million for the third quarter of '21 as compared to $50.6 million in the second quarter. Revenue was higher in the current quarter, primarily due to a less material unfavorable fair value adjustments on our mortgage servicing right portfolio. The company recorded a $5.5 million negative valuation adjustment in the second quarter as compared to a smaller decrease of $888,000 in the current quarter.
Looking forward based on market condition and expected seasonality of home purchasing activity, we anticipate mortgage origination for sale on the fourth quarter 2021 to be down 20% to 30% from origination values we experienced in the third quarter and mortgage revenue excluding the MSR valuation adjustments to be down similarly. Also, as you saw in the first three quarters of this year the wildcard related to mortgage banking. As it relates to mortgage banking revenue is the mortgage servicing rights valuation which is tied closely to mortgage interest rate movements. And I'm not going to speculate on where those rates are going to move to. But our previous forecast of a reduction of 20% to 30% excludes any change in the MSR valuation.
Other non-interest income totaled $23.4 million in the third quarter of '21, up approximately $3.0 million from the $20.4 million recorded in the prior quarter. The primary reasons for the higher revenue in this category include $2 million of higher swap fee revenue, $2.2 million of higher income from investments in partnerships which are primarily related to CRA purposes, a positive swing of $859,000 in foreign exchange valuation adjustments associated with the U.S.-Canadian dollar exchange rate, $812,000 of higher BOLI income and offsetting those increases was the fact that the prior quarter included a $4 million gain on the sale of a few branch locations in southwestern Wisconsin and there were no such similar gains in the current quarter.
Turning to non-interest expense; non-interest expenses totaled $282.1 million in the third quarter, up approximately $2 million from the $280.1 million recorded in the prior quarter. There are a handful of categories that I'll address that comprise the majority of that net increase. Salaries and employee benefits expenses actually declined by $1.9 million in the third quarter as compared to the second quarter of this year. The $1.9 million decline is primarily related to $6.3 million of lower compensation expense associated with the mortgage banking operation offset somewhat by higher incentive compensation expenses for annual bonus and long-term incentive compensation plans.
Advertising and marketing expense totaled $13.4 million in the third quarter an increase of $2.1 million compared to the second quarter of 2021. The increase in the third quarter relates primarily to increased sponsorship activity for the summer months, including our major/minority baseball sponsorships and more community events occurring. We would expect this expense level to decline in the fourth quarter as many of the sponsorships are geared towards the summer months. Software and equipment expense totaled $22.0 million in the third quarter, an increase of $1.2 million as compared to the second quarter a total of $20.9 million. The increase is due to increased expenses associated with upgrading our data centers for increased capacity, scalability and reliability. Other network upgrades to support our growth and ongoing digital enhancements and various other software upgrades.
As we've done over the last few years, we've continued to invest in software and technology to enhance our customer experience and delivery systems and products as well as to invest in systems to support our growth. And as Tim mentioned, our customer satisfaction results are great. And so I think the investment in those systems is paying dividends. OREO expenses were actually negative by approximately $1.5 million in the third quarter as the company recorded gains of approximately $1.9 million on the sale of OREO properties. These gains were an amount that exceeded the aggregate cost of OREO expenses and valuation charges on other OREO properties.
The miscellaneous expense category totaled $23.4 million in the third quarter compared to $21.3 million in the second quarter of this year at an increase of $2.2 million. Increase was primarily impacted by approximately $1.7 million of more travel and entertainment expenses and a variety of other smaller fluctuations. The increase in the travel and entertainment expense category was due to increased costs associated with in-person client relationship meetings and conferences as well as some additional expense associated with an all-employee event to celebrate Wintrust's 30th anniversary and to thank our employees for performing so well during the pandemic. Although this expense category is higher in recent quarters, they're still lower than the general run rate we had in prior periods before the bank pandemic began and we're encouraged to see our team returning to more normal in-person events to build and maintain solid customer relationships. This activity is important to maintaining the strong loan growth we've been achieving in recent quarters. So, other than those expense categories I just discussed, all other expense categories in the aggregate were up by less than $1 million compared to the second quarter and nothing of significance to discuss there.
The net overhead ratio, a measure of our operational efficiency improved in the third quarter relative to the prior quarter. The net overhead ratio stood at 1.22% which is down 10 basis points from the 1.32% recorded in the second quarter. The ratio continues to benefit from strong balance sheet growth and good mortgage banking results. Our current target assuming a relatively normal mortgage activities for the net overhead ratio to stay below 1.35% due to the strong balance sheet growth and the focus on expense control relative revenue growth. I should note that the efficiency ratio also improved in the third quarter relative to the prior quarter. Efficiency ratio stood at 66.13% in the third quarter, a decline of 253 basis points from the prior quarter. Moving on to the income tax expense. The effective tax rate was relatively stable at approximately 27% which is in range that we would consider normal.
In summary, core fundamentals were strong with robust loan and deposit growth, increased net interest income despite significant PPP loan reductions Record wealth management revenues, strong more mortgage revenues, improved net overhead and efficiency ratios, strong pipelines and very good credit quality.
So with that summary, I'll conclude my comments and turn it over to Rich.
Thanks, Dave. As noted earlier, credit performance for the second quarter was very solid from a number of perspectives.
As detailed on Slide 4 of the deck, loan growth for the quarter, net of PPP and was $1.2 billion or 15% annualized, well above our guidance. Equally as important was the nature of this growth which was spread across our loan portfolio. Specifically, C&I loans were up $543 million, CRE loans which were up $207 million, Wintrust Life which was up $296 million and First Insurance Funding which was $95 million. Throughout the pandemic, we have seen solid and consistent loan growth. If you look at Q3 '20 compared to Q3 '21, we have seen total loans net of PPP grow by $3.4 billion or 12%.
On our last earnings call, we expressed confidence in our ability to continue to meet or exceed our loan growth guidance because of the strength of our core loan pipeline. We believe this momentum is attributable to a number of factors. The PPP halo effect which is really taking hold on the level of commercial loans. We have seen substantial expansion in the numbers and amounts of treasury management relationships over the past several quarters but it takes time to move the entirety of the credit relationship out of the incumbent bank. We are now seeing those effects resulting in outstandings. Market disruption has been pronounced throughout this year and throughout the pandemic and we have seen customers and bankers look to Wintrust as a consistent and preferred banking partner in Chicago and southern Wisconsin. As a result, pipelines continue to look very strong and at the highest levels we've seen in several years.
Finally, as detailed on Slide 17, after five quarters of decrease C&I Line utilization, the trend is beginning to reverse. As noted in earlier calls, this utilization has been historically close to 50%. We saw this level bottom out in Q2 of 38.4% and we ended Q3 at 39.3%. We believe this trend of increased usage will continue in the fourth quarter. As discussed in prior quarters, one of the keys to the performance and growth of our credit portfolio has been diversification across a number of product lines. This quarter was another great example of that strategy. Our niche products, particularly premium finance and leasing grew substantially during the pandemic. Now we are beginning to see very strong growth coming from our core banking customers. In addition, Slide 15 details the geographic diversification in our portfolio. As we have stated before, Wintrust and the Chicago, Milwaukee networks. However, as this slide illustrates, our various business lines provide us with meaningful amount of credit opportunities outside of these primary markets.
From a credit quality perspective, as detailed on Slide 16 and we continue to see solid credit performance across the portfolio as the economy stabilizes. This can be seen in a number of metrics. Non-performing loans remained flat and ended approximately $90 million or 27 basis points. NPLs continue to be at record low levels and roughly half of where those were at this time this time last year. Charge-offs for the quarter were essentially 0, an amazing result, especially when looking at total charge-offs of approximately $2 million for the past two quarters combined. And as noted in the bottom right quadrant, Page 16, credit risk rates continue to show meaningful positive migration and as our customers continue to recover from the pandemic.
That concludes my comments on credit and I'll turn it back to Ed to wrap up.
Thanks, Rich. Those of you who examined transcripts of our earnings call, there was a lot of similarities between this quarter and the last, both in expense and consistency. As I mentioned at the beginning of the call, our strategy has been to grow the balance sheet during this period of low rates, use our structural hedges like mortgages to both of loss and NII until such time as balance sheet growth can offset the income loss due to lower rates. PPP expected benefit to add on to this strategy. All of the above which should be accomplished by enhancing our assets on steady position and participation of higher -- eventual higher interest rates. Excellent balance sheet growth asset deposit growth of $4.1 billion year-to-date and loan growth of $3.4 billion, excluding loans held for sale and PPP, we have experienced, as Tim laid out, has been done totally in on an organic basis. The acquisition market remains somewhat consistent with quarter two based on the amount of inbound calls we continue to receive.
Sellers still have very high expectations, so we'll see where this ends up. Loan pipelines remain strong in all major categories and I said at the beginning, at a 13-month high. This is aided by not only our reputation but also market disruption and our diversified portfolio. Our asset sensitive position is right where we want it. And it appears that the folly that inflation is transitories come to an end and rate increases are inevitable. The underwater beach ball will rise and hopefully soon. We continue to in new investments with our excess liquidity, take advantage of market flips where now is total invested is locking allows you to the long-term rates doesn't make a lot of sense to us. Credit is remarkably good, thanks to our consistently conservative underwriting standards and diversified loan portfolio, work on both our lending line and credit folks NPAs and NPLs are lower than they were before the start of the pandemic. Wealth Management area is delivering strong results with assets under administration continuing to grow. So, to date, the plan is working. We need to continue to grow in order to bring this plan to fulfillment. Organic wealth should remain strong with taking advantage of the opening of the acquisition market to makes sense.
I'm sure like where we stand. As mentioned or we referred to in December, we will celebrate our 30th anniversary in close to a $50 billion bank with $35 billion in assets under administration and our Wealth Management group is beyond any thought of where we'd be at this point in time. So, I was a couple of guys in here at that original table. And I think you could pinch us if you knew we were about where we are and what our prospects are going forward for the next 30 years. You can be assured of our best efforts going forward. We appreciate your continued support.
Now, we have time for some questions. So, thank you very much. Well, time for questions.
[Operator Instructions] Our first question comes from the line of Jon Arfstrom from RBC Capital Markets. Your question please.
Thanks, good morning, everyone or afternoon, everyone. Good morning, I guess.
How are you Jon?
Yes, I'm good. I'm good little confused but on the time. But anyway, I want to talk about loan growth, I know that you guys -- but the -- just the loan growth numbers. I appreciate the guidance for the fourth quarter but to Murph's comments on the PPP halo market disruption line utilization. I think, I would throw in premium finance bull market in there as well. But what slows this down? And what would cause you to pull back on saying you can put up this, kind of, growth into 2022?
I think if you see rationale, if rates stay low, then rationality kicks in and we're trying to see that the bigger banks going to just given it away, because the dearth of earning assets out there that could cause us to back off a little bit, because as you know our policy and our profitability model are inviolate and we're not going to be changing those trailing. But right now we don't see it. We see people coming from other banks, who appreciate our long-term approach. Appreciate our approach to doing business. I'd like to say that, you know, a lot of them just they just thought there have a good time where the bank and before. As Tim mentioned, we spent a lot of money and we do a better job of telling you how much money we spend on our technology going into the fourth quarter, that's why we will give you a real detail how much of our expenses relates to our technology build and winning the -- those Greenwich Awards is really heartening to us, because the numbers we're seeing it 95% in the like of people would recommend us and that builds on itself, so I don't think you can see the premium finance market change that much.
In turn, I think it's really a harder even next year. The market continues to get harder, people who are thinking maybe 20%, 30% increase there, additional increase in premiums on the commercial side, on the life side we see some pricing risk but we stay away from those. And with what's going on with the tax laws and like it's going to make life insurance a reasonable way to plan your state and not have to pay the exorbitant state taxes that are being proposed. On the commercial side, Murph, I don't know.
Yes. No, you hit the nail on the head. I think that generally speaking we like where we sit and we think that our positioning in the marketplace is very good and as we alluded to, we're seeing not only customers but also bankers look at us as a real attractive alternative. So, really good core momentum there. I think, to your question, what wrinkles are out there, as Ed said the challenges that you look at every one of our competitors and they are also they have a lot of cash to deploy. So, you are seeing pricing being very aggressive and you're seeing, you know, structure is also pretty aggressive. So, right now we don't anticipate any type of open over or anything like that. But it's something that we are very aware of. The other thing is on the life side, it is because rates were so low, it really was a great opportunity for people to use that product and if rates were to go up dramatically here that's probably going to have an impact on that. But for right now, we see ourselves being -- as we go into budget season, we're pretty optimistic about where…
Both our leasings [ph].
Leasing is good, you know, leasing's had a really good time during the pandemic, anything where leasing tends to be a little bit more of a transactional business and so people are very focused on structure and pricing and so we are very mindful of that. So, we're not going to go out there and chase deals. But as you've seen, Jon over the course of the last three years and the way we've grown that portfolio we're pretty optimistic of where it's at. But it's probably the one area where we're really focused on pricing, because we're -- if we're going to lean in on pricing, it's going to be for complete relationship where you get the full share of wallet.
Yes. Okay, good color on that. Thank you. And then I guess just one on the margin. I appreciate the comments Tim on the margins being relatively stable. You alluded to the beach ball we've heard that for a long time but any threats to the margin. Yes, no I've heard it a lot 20-years ago but we're waiting, we're still waiting. But what can make your margin lift? And you've alluded to maybe getting a little bit more aggressive on liquidity deployment but still being careful but as we look forward to the margin, it feels like it's bottomed out here? And maybe the only way to go is up from here. But talk a little bit about the plan and can the margin lift?
Well, additional liquidity would cause the margin to have additional pressure. But in terms of net interest income, I think, you're going to see that growing nicely throughout the rest of the year. Tim you want to comment on the...
Sure, Wehmer. Yes, I mean, we're kind of watching pricing pretty carefully, deposit costs will continue to help a little bit, not as much as they have in the prior quarters. And if we get rising rates here the 10-years up to $165 million, we watch that closely and we deploy some more liquidity will help both our margin or income. We're patient there, so I hesitate to forecast when that might happen but we feel pretty good. We remain very interest sensitive and feel like that's still an important part of the equation.
Okay, thanks guys.
Dave, you got some of other?
No. I just -- $5 billion of that liquidity and then deposits peak coming in, so that's a good lever but I was then also say that both new loans are sort of coming on at the existing portfolio pricing right now. So, if you see a little bit of compression from some older loans paying off at higher rates. But the new loans are coming on, so I think we've stabilized on the lower side substantially and so ex PPP it should have like you said, should have roughly bottomed out and we have the upside from the deployment. So, we're optimistic on that front.
Okay, all right. Thank you.
Thank you. Our next question comes from the line of Michael Young from Truist Securities. Your question please.
Hey, thanks for taking the question. Wanted to do a quick follow-up on just the excess liquidity that $5 billion or so. And just kind of cash basically on the balance sheet. It seems like it current rates you can deploy that maybe for 150 basis point, kind of, pickup up over cash yields. So, by my math that's maybe $0.75 or so of earnings to $1 of earnings. Is that kind of the right way to think about it? But then maybe if you could deploy that into loans instead, maybe it's $1.50 or so?
Well, yes, I think right now -- I think the concept is right, I mean, as you said you're earning roughly 15 basis points on mortgage backs or plus or minus 2% right now. So, there is your spread differential for investing at the -- just question if you want to invest long-term at that rate or do you want to wait for it to go up but it's pretty simple math, it's 15 basis points and beside what asset class you want to invest it in and what rates, so the loan probably be closer to 3%, so... we think that we were a slowly showing solid growth in NII by the growth that we're having. I think that for kids and ourselves and we believe we're not at the start or in the -- even in the first quarter of an inflationary cycle. The wages are rising, I sit on a couple of boards and we talk to them and price increases are flying through but not going to go backwards, supply chain disruption plus lack of labor is going to cause this cycle to start once it starts and get some momentum, it's hard to stop, it's stopped by higher rates. The government has to take eventually in which case, because of our deposit base at a higher rate -- is the lower rates you're playing like in the red zone. The higher rates you're going to get normal spreads anyhow. So, to lock in long-term at 2% although it could make us money now but there is down the road.
So, we look at -- we take a long-term view and there is also the possibility at the end of the year. People said moving money out. There is so much money out there, they move it out there -- hopefully, they'll keep it in the bank, we never know where it's going to go. We have to keep a little bit excess liquidity, because of that I think. So, these are really unprecedented times in terms of the liquidity side of the equation. But they're not unprecedented in terms of the inflationary cycle. We're starting to see start and this -- you can't fight the economics of it all, can try to stay still economics where you're going to do but we're old school guys and we believe that at rather lock-in at 5% or 6% and the way up, then the 2% percent right now, because of our deposit base being very retail and well, just retail nature of the deposit base and all could have cut basically 90%-odd is all core of deposits. We can lag on the way up, then we can make a lot more money than. So, we take it a long-term measured approach on this that we could drop it in and make another bucket share -- a couple of bucks a share over time but we don't think that's prudent to do given that we think down the road. I think a lot more money to the company and for the shareholders.
Okay, thanks for all that color. And just, kind of, my follow-up question you segued it nicely and to just inflation, it's been a long time since we've seen material inflation and just curious kind of your high level thoughts maybe on inflation? And then how that could affect the expense base and kind of growth there?
Well, I think the government wants inflation, I got all the money that borrowing we want get back and cheaper dollars. So, we've seen the movie you kind of think it's not going to have a different ending I think it's going to be there for a period of time. I think the cycle has started, it's hard to stop the cycle without raising rates and slowing things down of it, kind of, a conundrum because of the -- are not out of the pandemic, yet, supply chain issues are causing some of those. I don't think there'll be over by at the end of next year, according to some of the boards and the manufacturing I'm talking to. Doing those in force majeure anything else going on, it's tough out there for our clients and labor is tough. So, to pay a lot more money to get people in the house. Transportation stuff out there right now, it could be a truck there, making a 150 grand a year. Some of the offerings that are out there now. So, I think inflation is here and it's going to stay and we have to be ready for it. And in inflation we have to make more money they did before just to stay even right. So, that's what -- that's our plan, that's what we're doing, we sticking through it. And I just think I've seen the movie answer how it's going to any differently.
And Dave, maybe any thoughts on your expense base specifically and how that will affect kind of our outlook for 2022 or 2023, kind of, expense growth?
I think, I'd look at it, Michael, is if the inflation really kicks into the expense base and rates rise of the increase in the margins going to more than more than offset the expenses and our efficiency ratio will get better and our net overhead ratio, etc. We'll actually probably to get better because of the growth in the assets and the growth in the margin. So, yes, our biggest cost is labor cost, so we're just -- if you see increases in labor costs and will have half of that go up but the rest of that we should be able to control reasonably well. But I just think the margin will expand dramatically more than the expenses, if inflation does kick in.
Okay, thanks.
Thank you. Our next question comes from the line of Terry McEvoy from Stephens. Your question please.
Hi, thanks, good afternoon.
How are you, Terry?
Good, thank you. Maybe I'll start with Table 8 your interest rate sensitivity. I'm just wondering how your underlying deposit betas maybe have changed this cycle versus the past? And when I look at the 83% loan to deposit ratio and that includes PPP? How much are you assuming you can lag on deposit rates when rates rise?
Well, I mean, we're pleased that a third of deposits or DDA and obviously the bulk of -- the rest of it is very low rate at this point. I think we will lag as rates move up hard to predict what will happen, kind of, with the PPP money again from my comments earlier, we've not seen anything unusual with respect to deposit volatility. I think, it will continue to help us. I think for the next couple of quarters, you'll see deposit costs go down almost, in spite, of what happens to rates and we should be in good shape.
Yes. And I think, Terry, my recollection is right. The last time we have rising rates from the near zero environment. The first 25 really there wasn't much of a rise in deposit costs and the second 25 basis point increase was same and they only started to see increases with the third increase. And I would think that it would be similar to that, if not even a longer lag, because of the way more liquidity in the system right now and people aren't as anxious to bring deposits. So, I think if history repeats itself you'd have a waste 50 basis point increase before -- in too much movement by the industry. And my personal opinion is, because of all the liquidity in the system that might go up beyond that before you see much of an increase in the positive cost.
Yes and Terry if it helps virtually none of our deposits are linked to an index, so...
That's helpful. Thank you. And then as a follow-up. We all know there is a large acquisition about to close later this year in your market and a new name about to enter your market. So, I guess my question is, how quickly did you start to see the disruption from the last deal MBFI [ph] and how long did that window remain open for a bank like Wintrust to capitalize on any opportunities?
What we're starting to see a little of it. The window stays open for a long time. I mean, we will give you the year to see this is going to work or not. We're relentless on our pursuit of these guys. On a previously announced deal it took what four or five years before, we started seeing an outflow. So, in guess which one that is, we know you cannot really get anybody on the old place and now we're getting people and assets that we never thought we'd get there were very loyal to the old place. So, we'll be relentless side and we'll see. Murph any thought?
No I think that's right. It's really kind of the tone that gets set by the acquiring institution and we've seen it run the gamut from the day that the deal gets announced and they come in and they immediately change, you know, the credit culture and just the overall tone of the organization. But as Ed pointed out, we've seen the other side where it takes a while but eventually things change and people cut both customers and bankers, you know, bankers sense that change and look to find something a little more in keeping with the way they like to be treated. So, I don't think there's one set answer to the question but it is inevitable.
Word of mouth has been great for us. I mean, these awards that we're getting from Greenwich are very, very helpful, plus we walk the walk. We don't just talk the talk. People come over and they see our technology and what we have, I'll put up against the big banks for the most part. We are better than them because of the personal service we give on top of it and I get nothing but complementary letters about how happy people are when they get over here. So, I'd like to say, I just thought they are having a good time before but now they really are having a good time. So, word of mouth is happening a lot too, plus I think our advertising is paying off in Chicago's bank and Wisconsin's bank. They have great momentum there but we got to back it up, we have been backing it up. And the people, we are seeing people from all the acquired organizations asking us well what our plans are, what we're going to do and great interest on their part.
Another thing is with remote working, it's helped us like on the IT side, we were able to pick up a number of people just because of our reputation. We picked up a couple out in New York who heard -- who just heard how good we were to our clients and our people and they came with us. So, the talent is out there, I think our reputation helps and I think our momentum is very good and we don't see anything that will stop it right now.
Thanks, again. Appreciate it.
Thank you. Our next question comes from the line of David Long from Raymond James. Your question please.
Hey, everyone. Thanks for taking my questions.
How are you doing David?
Good. Hey, appreciate all the color on the loan growth and the margin expectations. The question I wanted to ask you about now is more about, you're hitting $50 billion in assets here very soon. How does that change your operating strategies and does that change how you're thinking about regulations and the ability to continue to acquire?
Not really, because we do the smaller deals which aren't going to -- so we've certainly done smaller deals which don't really get the attention of the big guys in DC. When we do -- as of now, who knows what will happen if the new counselor comes in and maybe we'll have to speak Russian or something then but right now we have a great relationship with the regulators. Our CRA is, I mean almost what, 14 of the 15 banks are outstanding, the other one is about hopefully really close and we always said that the regulators make the rules, got to play by the rules, you can yell at the ref, only I can bump the ref but we'll play it by year but I think we have a good reputation with them. And the second thing we do just because of how we're structured, we still are small, I mean we might be $50 billion in the aggregate but our average bank is what $2 billion, $3 billion and the branches combined they have their own -- I mean everybody is an owner here, we're able to really be close to the customer with our decisions. I think that model can keep going for a long time and we -- any comments on that?
No, I don't think there's anything magical about the $50 billion mark per se. I mean our infrastructure is that we can have considerable growth. And we just continue to build the infrastructure and the team to handle that. So, I don't see anything significant. You hear in the marketplace that the bigger deals are a little bit slow to get regulatory approval right now but as Ed said we typically have done the smaller tuck-in deals and those seem to be moving at a quicker pace. So, I don't see anything significant, David.
Got it. And then, you mentioned the infrastructure to become a larger bank. At what point do you have to upgrade it? Is it core deposit system couldn't handle a doubling of your size at this point or is there at some point that you would need to make any additional investments?
No, we -- I think our investments and -- we have -- done a very good job of telling you how much we spent on this but we have lots of room to grow here. We have really upgraded every system in the joint and made it, not just upgraded but very flexible in terms of being able to work off the base systems that we have and add things on and take them off and Tim you want to comment on that?
Yes, we are fine from a whole system standpoint and the enhancements and new introduction of services on the digital side is really starting to pay dividends. And so I think in terms of getting to the point where we're comfortable at $50 billion, we've been working that for years. And so I don't see any immediate issues at all in that front and we're well positioned to continue to grow.
Got it. Thanks for the color and keep up the good work. Thanks.
Thanks, David.
Thank you. Our next question comes from the line of Chris McGratty from KBW. Your question please.
Hey guys, maybe a question on M&A just to further explore. I mean you've got so much momentum organically right now and we've seen some of the reactions for deals in the buyer stocks. I guess, why do you even need to consider a deal at this point? Is there something that -- these are business you need to build out or a market you need to develop a bit more?
So, we've always been opportunistic about it and it's got to make sense on the pricing side and strategically. We haven't done anything in a couple of years, because we have found one that did and we've always been very, very prudent in how we approach it. So, I said before, 1,000 times we are not going to give up a lot of tangible book value to grow, give up five years of earnings to grow $0.20 a share. It doesn't make a lot of sense. We take what the market gives us right now, it's giving us organic growth, pricing on deals, big or small, big deals are a pain in the neck, not to say that we wouldn't consider it but if I want to philosophize that, every big deal we've seen starts with taking care of management before they take care of shareholders, that drives be absolutely crazy, absolutely nuts. And guys who come in and you start with that and the conversation about what about us, what about our shareholders, doesn't work. Management is the last, you cut your deal, live with it. So, that we haven't had -- we have every investment bank in the world calling on us about this deal or that deal or big deals and how big we could be and that's unimportant to us.
What's important to us is continuing to grow like we grow, the market gives us right now this organic growth is awesome, smaller deal is still our bread and butter, up to $1 billion is good and it has to make sense, it has to make sense strategically, it has to make sense economically and bigger deal, it would just be -- it just doesn't make a lot of sense right now for a lot of reasons but you never know, till we have one that does make sense but I'd say it drives me nuts when management says what about me and know a little about my shareholders. I hate those conversations and they are a turn off right out of the box for me. I agree with you, the market is giving us great growth, why differentiate -- deviate from that and there'll be a time when the acquisitions become more affordable and makes more sense and we'll jump in then.
Dave, you got anything on that?
No, I think that's right. We understand the concept you laid out Chris, that we can walk in and at the same time if there's a deal that comes that makes economic and cultural sense. But as I've said, we're not going to overpay or do a deal just to do a deal. So, we're enjoying the organic growth now and pipelines are good and we'll keep marching to that -- to them for the time being [ph].
Great answer, thank you.
Thank you. Our next question comes from the line of Nathan Race from Piper Sandler. Your question please.
Yes. Hi guys, afternoon. Going back to Terry's question on some of the loan growth drivers and within the context of the M&A disruption that's ongoing, curious in terms of the commercial real estate, C&I growth that we saw in the quarter, obviously, on the C&I side of things, you guys benefit from an uptick in line utilization but just curious how much of that growth you're seeing in footprint on the commercial side of things is being driven by share gains. And I'm curious within that context, what inning we're in, in terms of Wintrust benefiting from all the M&A related disruption that's occurred in Chicago within last few years?
Rich?
I would say we're in pretty early innings at this point, I mean we, as we talked about a couple of questions ago, this disruption has really been pretty recent phenomenon, over the last four, five years. So, we think that the goodwill that got established during the pandemic through PPP and we basically told all of our lenders when the pandemic hit, this is when you really start to differentiate yourself as being a banker that you can count on and customers appreciated the fact that we were out of the box, reaching out and seeing what they needed, doing the things that make us different. I had lunch with one of our bankers that we hired from one of our competitors recently and he said it was the exact opposite at the bank he was at, that they were curtailing lines and they were bumping rates and doing things that in the short term it could enhance the overall return but in the long run, you're just going to really just anger your customers. So, I think there is a long way to go here. I mean, our market share is still relatively small in Chicago and Milwaukee relative to the competitors. So, I think there is a real strong opportunity here over the next couple of years to be able to grow that core business.
Got it, that's great color. And maybe just changing gears, a question, Dave, on mortgage, curious if you could remind us in terms of the gain on sale margin expansion that we saw this quarter is a little more pronounced than we saw from some others. So, just curious if you could remind us in terms of the VA ARM, what that secondary market premium tends to look like in terms of -- or at least on a relative basis to be kind of conventional 30-year product generally speaking.
Well, I am trying to figure out how to answer that. You are wondering about the directionality of the gain on sale margins?
Yes and just, you need to -- Wintrust obviously you guys have the VA ARM that contributes somewhere around quarter volumes each quarter. So, just curious in terms of what that gain on sale margin benefit from having that production arm in the fold relative to just the typical 30-year venture product?
Well, certainly it's higher. But as far as the blend of the gain on sale margin, that's pretty much been a quarter of our business for the last, over a year. So, I don't think it's going to change the directionality of the overall margin. It may be a little bit higher in the fourth quarter as the purchase business goes down in the Chicago area because veterans first does business all over the country and a lot in the southern states but I don't think it would change dramatic dramatically. We actually think as far as our margin goes, it increased a little bit this quarter as secondary marketing gains and losses were a little bit better this quarter as far as that hedging activity that we do goes in and a little bit of product mix change where Veterans First was 26% of the volume versus 23% last time. So, those two factors helped increase the margin a little bit. Our thoughts for the fourth quarter right now and again will depend on mix of business and some other secondary marketing volatility that could or may not happen but we would expect a gain on sale margins to be relatively flat in the fourth quarter relative to the third quarter.
Okay, great, that's really helpful, I appreciate all the color. Thanks, guys. Nice quarter.
Thank you.
Thank you. Our next question comes from the line of Richard [ph] from DA Davidson. Your question please.
Hey, good afternoon guys. Just one big picture question for me at this point and it relates to Slide 15 of your deck that highlights the geographic and loan portfolio diversification. They are clearly paying dividends with the growth you guys are putting up, I'm just curious, are there any geographies you are not in that you'd like to be or loan products or niche lending verticals that would fill out this map further?
We're always looking for new niches. Problem is right now, if there is one out there, they want a lot of money for if you want to buy it and kind of wait till it dies down and starting from scratch and paying big though and have a big CBV dilution. Rich, you want to comment on the other side?
Yes, I think that's right. I mean we are always looking at opportunities. I think the leasing example is a good one. We started that three years ago and have built that out because of exactly what you're talking about, it gives us a much more geographic spread to the loan portfolio. But if we had bought something of comparable size, we would have paid substantial premium on it. So, we like to be building these things but we're, right now I think it's not so much about markets that we're not necessarily in but really trying to expand the markets. I mean I think that certainly adjacent to the footprint, we would like a bigger presence in Indiana, we'd like to expand our presence in Wisconsin and looking around the Midwest, you can kind of see some of the other markets that I think would really appreciate kind of what we do and how we run our business because it really isn't a Wintrust type alternative in some of the meaningful cities around the Midwest. And then we're also looking at opportunities. We've been able to, through following our CRE sponsors to other markets, we've seen some real good opportunities and we've been able to build the Wintrust brand in some markets that historically we haven't had many and haven't had a presence and we're looking at, does it make sense to step out a little bit maybe open up LPOs or see how that would fair but it's definitely something that is, that's why we put this slide in here. It's front and center for us to make sure that while we love Chicago and Wisconsin, we want to make sure that we're just -- we're having good diversification within the portfolio.
Concentration skill. I always say that and say if you can diversify between product type and geography, that's a very good thing.
Thank you, guys. That was it for me. I appreciate your thoughts.
Thank you. Our final question for today comes from the line of Brock Vandervliet from UBS. Your question please.
Thanks. Dave, just following up on the mortgage banking, I just wanted to clarify, so we should look for 20% to 30% origination drop and similar rev drop in Q4. Correct?
Yes, that's right. Now, those applications in October have been very similar to September so far, a little less than July and August. But just based upon seasonality, that what we're thinking and I think it's fairly in line with the MBA forecast too.
Okay. So, that's -- you just hit on it. That's more seasonality than any rate move that's already percolated through your pipeline. That's just what you're expecting for things to kind of fall off?
Yes. Hopefully it's a little bit better than that but that's what our expectations are right now. I don't think we generally are too much different than the overall market on origination trends.
Okay. And shifting over to PPP, I apologize if I missed this already but you've got about $25 million left I believe, what's kind of the cadence of that recognition do you think?
It's probably -- from a fee standpoint, maybe another 30% to 40% of that comes in the fourth quarter and then it tails off from there depending on kind of what we see in terms of customer seeking forgiveness. But as we talked about, we think the loans will drop off quite a bit and the fees follow.
Got it, okay. All right, thank you.
Thank you. This does conclude the question-and-answer session of today's program. I would like to hand the program back to Edward Wehmer for any further remarks.
Thanks, everybody for listening in. Good quarter, you can be assured of our best efforts going forward. If you have any other questions that come up after you continue reading our 1,000 page press release, please call Dave, Murph, Tim or I and we'll be happy to discuss it with you. Thank you and we'll talk to you in next quarter. Take care. Thanks.
Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.