Q2 2023 Wintrust Financial Corporation Earnings Call
Yeah.
Okay.
Welcome to win Trust financial corporations second quarter and year to date 2023 earnings conference call.
A review of the results will be made by Tim Crane, President and Chief Executive Officer, David Dykstra, Vice Chairman and Chief operating Officer and.
Richard Murphy, Vice Chairman and Chief lending Officer.
As part of the reviews the presenters may make reference to both the earnings press release and the earnings release presentation.
Following the presentation there'll be a formal question and answer session.
During the course of today's call when Trust management May make statements that constitute projections expectations beliefs or similar forward looking statements.
Actual results could differ materially from the results anticipated or projected in any such forward looking statements.
The company's forward looking assumptions that could cause the actual results to differ materially from the information discussed in this call are detailed in our earnings press release and in the company's most recent Form 10-K and any subsequent filings with the SEC.
Also our remarks may reference certain non-GAAP financial measures are.
Our earnings press release and earnings release presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure.
As a reminder, this conference call is being recorded.
I will now turn the conference call over to Mr. Tim Crane.
Yes.
Thank you and good morning, everybody. We appreciate you joining us for our second quarter earnings call.
In addition to Dave Dykstra, and Rich Murphy, who the operator introduced Dave.
Daystar, our Chief Financial Officer, and Kate Bogie, our General Counsel are with me in the room today.
In terms of an agenda I'll share some high level highlights Dave will speak to the financial results and rich will add some additional information and color on credit performance.
I'll wrap up with some summary thoughts and as we always do we will do our best to answer some questions.
On our last call in mid April we were still in a period of volatility and to a degree of uncertainty for the banks.
At the time, we talked about several objectives continuing to focus on our customers capitalizing on our strength and stability.
Once again being opportunistic when there is disruption in the market.
We talked about managing the balance sheet in a conservative fashion growing deposits to fund loan growth and continuing to enhance liquidity.
And we talked about continuing to take advantage of higher rates, specifically to demonstrate our ability despite rising deposit costs to stabilize the net interest margin.
We feel like our performance on these objectives has been very solid.
In addition to reporting record income for the first half of the year.
For the second quarter, we had strong and balanced loan and deposit growth, adding clients and building the franchise through the volatile period when others were distracted.
We improved liquidity, reducing federal home loan bank borrowings and as you will hear shortly have demonstrated through the sale of a portfolio of loans that occurred after the quarter and the flexibility to continue to manage our balance sheet effectively.
And while as expected deposit costs are up.
We are originating very high quality loans with attractive both yields and terms and continue to benefit from loan repricing, which we believe differentiates us from many of our peers.
Just to give you some detail you'll recall our margin was 383 for the first quarter and specifically $3 70 at the end of March.
Our margin for the second quarter. Despite the very good growth was $3 66, and importantly with stable throughout the quarter.
Lastly, our credit performance remains strong with no evidence of systemic issues.
Rich will discuss this in some detail, including proactive steps that illustrate our ability to address any softening that may occur.
Again I'll come back at the end, but with that I'll turn this over to Dave to provide some additional detail.
Okay. Thanks, Tim first of all with respect to the balance sheet growth. We're very pleased to see deposits for the quarter grew by $1 $3 billion or 12, 4% on annualized basis.
This deposit growth was aided by the popularity of our suite of <unk> products that provide enhanced FDIC coverage.
And we did not rely upon additional wholesale deposits during the quarter for that growth. This growth was also despite our wealth management deposits declining by just under $400 million owing in large part to less deposits from our 10 31 exchange business due to a slowdown in tax free commercial real estate exchanges in the marker.
Place.
And so the deposit attrition.
<unk>, we again saw some additional movement from noninterest bearing deposits to interest bearing accounts.
Noninterest bearing deposits at the end of the quarter represented 24% of our total deposits compared to 26% at the end of the first quarter.
These movements do not appear to be unique to us, but they obviously increase the cost of deposits for the quarter.
Although I would note that the mix shift out of noninterest bearing deposits seems to have subsided. Thus far this quarter is the percentages is relatively stable now than it was at the end of the second quarter.
This strong deposit growth helped fund similar strong loan growth of $1 $5 billion. During the second quarter. The growth was predominantly fueled by exceptionally strong production from our commercial premium finance operations and to a lesser extent from commercial real estate growth, including draws on previously existing credit lines rich.
Murphy, who will discuss the loan portfolio growth growth in more detail in just in just a bit.
The investment portfolio declined slightly as we only reinvested about a third of the $940 million of securities that were called away at the end of the prior quarter. The additional liquidity provided by not reinvesting the entire amount of those called Securities also helped to fund the quarters loan growth.
The company was able to reduce its non deposit funding primarily federal home loan bank advances during the quarter by $208 million.
The result of these balance sheet movements was a growth in total assets of approximately $1 4 billion are slightly elevated.
The loan to deposit ratio of 93, 2%.
And relatively stable capital ratios all in all it was a very successful quarter in growing our franchise, our differentiated business model of exceptional service and unique position in the Chicago and Milwaukee markets continue to serve us well.
As Tim mentioned, the exceptionally strong growth in our commercial premium finance portfolio in the out in the outlook for continued loan growth provided us with an opportunity to structure a loan sale transaction of approximately $500 million of our U S commercial premium finance portfolio risk.
This loan sale occurred earlier this week and provided multiple benefits to us including that it demonstrates that our premium finance portfolio is a strong source of additional liquidity if needed actually provided us with liquidity this quarter to eight and funding anticipated loan growth reduces our loan to deposit ratio to a desired operating level that is closer.
90%.
Reduces some of the concentration on the premium finance space as we've had strong growth over the last quarter and quite frankly over the last year and would provide a small gain in the third quarter from the sale of those loans. As you know these loans are very short term loans that make monthly payments and they'll likely be replaced substantially by new volume by the end of the year.
Next I'll cover noteworthy income statement categories, starting with the net interest income for the second quarter of 2023 net interest income totaled $447 5 million and was a decrease of $10 $5 million as compared to the prior quarter and an increase of $109 $7 million compared to the same quarter of 2020.
Two the.
The decrease in net interest income as compared to the prior quarter was primarily due to compression in the net interest margin influenced by the higher funding cost.
The net interest margin was 366% in the second quarter, which was just slightly less than the three 7% margin that we discussed on our first quarter earnings call and which was the approximate run rate at the end of March.
However, the margin was 17 basis points less than the prior quarter level of 383%.
Importantly, the net interest margin was stable for each of the months in the second quarter and as I'll discuss later, we expect the margin to continue to remain relatively stable for the remainder of 2023.
And so the details of the component changes impacting the margin in the second quarter.
Relative to the first quarter the company saw a beneficial increase of 42 basis points on the yield on earning assets, excluding the impact of our interest rate swap positions, a 15 basis point increase in the net free funds contribution.
Offsetting that was increase of 66 basis points.
Of an increase in the rate paid on liabilities.
And it's important to note that roughly half of the margin decline during the quarter was associated with an additional eight basis points of margin drag from a full quarter impact of the interest rate swap positions that we have in place.
Those swaps were generally put on in the first quarter in the first quarter only had a portion of the impact. So this quarter was fully baked in was accounted for about half of the margin decline.
We continue to believe that our balance sheet structure can provide for margin stability is our premium finance portfolios, which comprise roughly a third of our loan portfolio should continue to reprice upward over the course of this year and that should substantially mitigate the rise in deposit pricing.
Accordingly based on the current interest rate environment, which includes an expected 25 basis point increase by the fed later this month, we expect our margin to remain relatively steady in the $3 six out of $3 seven O range during the remainder of 2023.
Turning to the provision for credit losses.
Company recorded a provision for credit losses of $28 $5 million in the second quarter this compared to a provision of $23 million in the prior quarter and $20 4 million.
The dollars of provision expense recorded in the year ago quarter.
Higher provision expense in the second quarter relative to the prior quarter was primarily a result of a higher loan growth change.
Changes in macroeconomic outlooks, including projected credit spreads and projected commercial real estate price index and slightly higher net charge offs again, rich Murphy, who will talk about credit and the loan portfolio characteristics in just a bit.
As other noninterest income another noninterest expense total noninterest income totaled $113 million in the second quarter.
And it was up approximately $5 2 million compared to the prior quarter of total of $107 $8 million.
The primary reason for the increase were due to an $11 million increase in mortgage banking revenue the mortgage banking operation saw a slight increase in volume of loans originated during the.
Second quarter with relatively stable.
Margin.
Production margins.
Roughly 84% of the application volume is still related to purchased home activity won't have kidney application activity continues to be subdued due to the lack of housing inventory and higher rates, but we would expect right now similar to slightly elevated production, but nothing dramatic in the third quarter.
Wealth management revenues improved by $3 9 million in the second quarter relative to the first quarter and this was bolstered by revenue from the acquisition that we closed at the beginning of the quarter and offset somewhat by continued headwinds relative to the slowdown in the commercial real estate transactions and the resulting impact on the 10 31 exchange business revenue.
However, these increases were offset by $1 $4 million reduction on gains and losses related to the company's securities portfolio. The company recorded a $1 $4 million gain in the first quarter on security sales and really nothing in the second quarter of this year.
$7 $8 million decrease in covered call options also impacted this revenue category as I discussed earlier.
We did not reinvest much of our securities that were called in this.
Created less opportunity to write covered call transactions during the quarter.
Turning to noninterest expense categories, the noninterest expenses totaled $320 million.
$326 million in the second quarter and were up approximately $21 $4 million when compared to the prior year quarter total of $299 2 million. The primary reasons for the increase was related to a few general areas.
First the acquisition of the wealth management companies at the beginning of the quarter added roughly $4 million of additional expense sprinkled throughout the various expense categories, but excluding that impact salaries and employee benefits expense increased by approximately $8 $1 million in the second quarter of 2022 compared to the first quarter and relative.
Prior quarter.
There was $4 $7 million increase largely related to higher mortgage commissions and to a lesser extent incentive compensation accruals.
So.
Yeah.
Most of that was commissions related to the increased mortgage operation. So this category fluctuates, depending upon the mortgage volume.
Category also saw approximately $4 1 million of higher employee benefit expenses due to an increased level of health insurance claims during the quarter health insurance claims can fluctuate on a monthly basis is worse, we're self insured the first quarter was a little low in the second quarter was a little high can fluctuate but.
The change between quarters is really more of a probably a timing of when the employees took advantage of our health insurance program.
Next advertising and marketing expenses increased by $5 $8 million in the second quarter when compared to the prior quarter as we've discussed on previous calls this category of expense tends to be higher in the second and third quarters of the year due to expenditures related to various major and minor League baseball sponsorships other summertime.
Sponsorship events that we hold in the communities that we serve and marketing of our brand and deposit products.
Also in the second quarter lending expenses increased approximately $4 $8 million due to the strong and higher overall loan origination activity in the second quarter.
And other than that the expense categories, just discuss them other than the expense categories just discussed above.
All the other expense categories were relatively consistent.
The efficiency ratio increased to 57% for the second quarter from 53% in the first quarter of the year and this was primarily due to the impact of lower net interest margins and a reduced level of covered call income and a slightly elevated expenses.
Fred ratio was 158% in the second quarter, an increase from $1, 49% in the prior quarter.
Due to the slightly higher expenses in summary, we think this is a very solid quarter, we had strong loan and deposit growth and improved liquidity position stabilized net interest margin with a steady outlook net revenues at worst than 1% of the prior quarter's record level despite funding cost pressures.
Low levels of nonperforming assets and our second highest quarterly net income result in our company's history we.
We feel like we've managed through a turbulent first half of 2023, delivering net income that was a record for the first half of any fiscal year in the company's history, and we have a positive outlook for continued growth in assets revenues and earnings.
So with that I will conclude my comments and turn it over to rich Murphy to discuss credit. Thanks.
Thanks, Dave as noted earlier credit performance continue to be very solid in the second quarter from a number of perspectives as detailed on slide six of the deck loan growth for the quarter was $1 5 billion. The loan growth was largely attributable to over $1 billion of growth in the commercial premium finance category. This growth is due to a number of factors the second quarter.
There is historically when we see our highest funding volume and as we have noted in past several quarters, we have seen significantly harder market for insurance premiums, particularly for commercial properties. As a result, we have seen the average loan size increase.
Finally, we continue to see new opportunities as a result of consolidation within the premium finance industry.
We also saw good growth in commercial real estate, largely resulting from draws on existing commercial construction loans and portfolio residential real estate loans.
This rate of growth loan growth is significantly higher than the first quarter and well above our guidance of mid to high single digits. We believe that loan growth for the second half of the year will be more in line with our guidance as we anticipate the premium finance loan growth will moderate and be more in line with historic norms. We also anticipate that higher borrowing costs will continue to affect borrowers to reconsider the.
<unk> of new projects business expansion and equipment purchases.
We continue to see solid momentum in our core C&I and CRE pipelines disruptions in the banking landscape continue to work to our benefit and we have seen numerous quality opportunities from other regional banks.
In summary, we continue to be optimistic about loan growth for the balance of 2023, and we believe that our diversified portfolio and position within the competitive landscape will allow us to grow within our guidance of mid to high single digits and maintained our credit discipline.
From a credit quality perspective as detailed on slide 14, we continue to see strong credit performance across the portfolio. This can be seen in a number of metrics nonperforming loans remained stable at 26 basis points or $109 million up slightly from what we saw in the first quarter.
Overall npls continue to be at historically low levels and we are still confident about the solid credit performance of the portfolio.
Charge offs for the quarter were $17 million or 17 basis points, which was up from the prior quarter, but still at a relatively low level.
This higher level was primarily attributable to a charge of $8 million, which resulted from the sale of a portfolio to co working office loans totaling $17 million.
As we have noted in previous calls we are constantly looking for signs of stress in our portfolios and are very focused on our non owner occupied office portfolio.
The common denominator of the loans, we sold was the co working nature of the tenants. We believe that this sub segment of the market will continue to experience significant stress from weak tenant demand and rising cost of debt and we took this opportunity to meaningfully reduce our exposure. This sale made up close to half of our exposure into the subcategories.
We have always looked at strategic options to reduce exposures to areas of concern within our portfolio and we will continue to do so.
Finally, as detailed on slide 14, we saw stable levels in our special mention and substandard loans with no meaningful signs of additional economic stress at the customer level.
As noted in our last earnings call. We continue to be highly focused on our exposure to commercial real estate loans, which compose roughly one quarter of our total loan portfolio.
Higher borrowing costs and pressure on occupancy and lease rates are cause for concern, particularly in the office category.
On page 18, we've updated a number of important characteristics of our office portfolio.
Currently this portfolio remained steady at $1 4 billion or 13, 2% of our total CRE portfolio and only three 4% of our total loan portfolio.
Of the $1 4 billion of office exposure over 40% as medical office or owner occupied.
The average size of alone in the office portfolio is only $1 3 million.
We only have five loans above $20 million. There has been significant concern about office properties located within the central business district, or CBD exposure is limited to $350 million or approximately one quarter of the office portfolio happened. This is in Chicago and happens in other cities. The bulk of the portfolio is located in suburban areas and areas outside CBD.
And portfolio performance to date has been very good with no loans currently over 90 days past due.
We continue to perform portfolio reviews regularly on this portfolio when we stay very engaged with our borrowers we are not immune from the macro effects that challenges product type, but we believe that our portfolio is well constructed very granular and should perform well moving forward.
As noted earlier higher higher borrowing cost and pressure on lease renewals are cause for concern across the CRE space to better understand how these issues could impact our portfolio. Our CRE team updated their deep dive analysis on every loan over $2 5 million, which will be renewing between now through the first quarter of 2020 for this analysis, which covered 79% of <unk>.
All CRE loans maturing during this period resulted in the following.
More than 52% of the loans will clearly qualify for a renewal at the prevailing rates roughly 32% of these loans are anticipated to be paid off or will require a short term extension at prevailing rates and approximately 16% of the loans will require some additional attention which could include a pay down a pledge of additional collateral.
We have tentative agreement on renewal terms with many of the borrowers in this final group.
Again, our overall CRE portfolio was not immune from the effects of rising rates or the market forces behind lease rates, but we have been diligently identifying weaknesses in the portfolio and working with our borrowers to identify the best possible outcomes and we believe that our portfolio is in reasonably good shape and situated to weather the challenges ahead.
That concludes my comments on credit and I'll turn it back to Tim.
Thanks Rich.
To wrap up for the last several months, we've had the opportunity and in some cases I would say the responsibility to explain to our customers why wind trust continues to be a better alternative than the larger.
Too big to fail banks.
Not only have we've successfully done that with almost no attrition, but we continue to win business and as you can see grow deposits and build our franchise.
We continue to think we're uniquely positioned to take advantage of the current environment with our diverse businesses that limit the potential impacts of economic softness in any individual area and.
And we remain positioned to benefit from higher rates.
As Dave noted and we noted in the press release, we expect that our margin will be relatively stable for the remainder of the year and our net interest.
Income will increase in the coming quarters.
I would say that the current market is a little bit choppy and we remain incredibly focused to pursue opportunities that we see and we will do that aggressively in the coming months at this point I'll pause and we can take some questions Elizabeth back to you.
As a reminder to ask a question. Please press star one one on your telephone and wait for your name to be announced to withdraw your question. Please press star one again.
Yes.
Our first question comes from the line of John Armstrong with RBC capital markets.
Good morning.
Hi, Chad.
Okay.
I'm going to start off.
First question I guess.
You used the word choppy, Tim and you guys talked about a little bit slower loan growth in the second half of the year, but.
You put up a pretty good quarter and I guess.
My question is what are the pipelines look like what the quality of what Youre seeing in very early Tim you alluded to like pricing and structure being better, but touch a little bit on that in terms of how that may have changed.
Yes.
Take the first part and rich can add to that.
With respect to choppy.
Companies are obviously reacting to higher rates.
Real estate projects in some cases are on hold and there's folks still wrestling with labor issues, which we think are generally better but not universally better.
And then obviously there are some competitors that are pulling back in terms of credit and their participation in the market.
So.
We're seeing opportunities I think a lot of people are seeing opportunities and we just have to be selective and disciplined and I think our team is doing a nice job in that regard, which is driving both higher yields and.
Better terms in some cases more equity and real estate deal. So thats why im pleased to add to that yes, no I think you said it well.
Every week that goes by we see new opportunities really across the portfolio in terms of customers, who arent getting.
Yeah.
There are existing banks to work with them in a productive way and we're also seeing the tremendous amount of opportunities.
Capital market type opportunities, where there is multiple banks involved and there's almost more than you could possibly want frankly, because there's just so much that's out there right now.
So it does give us the opportunity to pick and choose price accordingly structure accordingly.
We've always had a history of being pretty disciplined in this space.
It's not going to change but.
It is it's a great opportunity for US disruption always has worked to our benefit post pandemic post PPP. We saw very similar kind of environment, where a lot of banks were kind of struggling getting their footing.
We're seeing that right now as well and so.
We're pretty optimistic but most importantly, we just want to stay disciplined.
Okay fair enough.
The premium finance size limits on your balance sheet.
We expect to see more of these sales and I'm. Just curious if you guys continue to service that I know Theres short very short term in nature, but help us understand the outlook for that in terms of on your balance sheet.
So the 500, we sold as an off balance sheet transactions that will come off the books in the third quarter and John as you know and probably most people on this call know is that those loans make monthly payments on average on that have an average life of nine to 10 months. So by the end of the year, though substantially have been paid off anyway.
We if you recall, we did a securitization of premium finance loans, a decade ago or so.
As about a 300 or $600 million facility that we did.
For a few years and so it's not a new transaction for us, but we thought it was important to get the plumbing in place we had $1 billion quarter.
Great growth quarter, the market's still hard the disruptions helped us.
The outlook is good there and so without getting the plumbing in place sort.
Sort of testing it out having another source of liquidity was a good thing to do we have the opportunity to do it in the future, but right now we don't have any plans to do another loan sale, but if we were to have outside loan growth going forward, we might be able to pull the trigger into it and do it quickly and now that we've demonstrated that.
We can do it again and.
And John Yes, we continue to service those loans I think was part of your question yes.
Okay. Just last one mortgage obviously was a decent quarter for you.
You said slightly elevated production in the third quarter is that it.
Is that what you mean and just give us an idea of what youre seeing there.
30 million dollar type quarter.
I mean, we're just a few weeks into the third quarter, but application volumes have ticked up just slightly so I would expect it to be up a little bit but.
As part of it depends on what happens to the valuation of your MSR is two but from a production perspective, I would expect it to be.
Just.
A little bit and we'll just have to see how the production flow through but nothing nothing substantial.
If it's up.
Couple of million dollars that might be in the right neighborhood.
We will have to just see how it plays through okay.
Okay, Alright fair enough. Thanks, a lot guys I appreciate it yes. Thanks John .
Our next question comes from the line of David Long with Raymond James.
Okay.
Good morning, David.
Good morning, Dave.
Just kind of blinked out there I didn't I didn't hear if that was my name or not quite good morning, everyone. Thanks for taking my question.
A couple of things on the funding side you seem to still have good growth obviously, you've got a vehicle now where you can.
Reduced.
Or securitize or sell some of those loans, but.
And the funding side going forward.
Are you thinking about incremental <unk> advances versus deposits, whether it's Cds or brokered Cds.
Most attractive source.
Funding side right now and.
How did it costs.
Compare right now.
Sure David I mean, generally we'd like to grow deposits to match any loan growth and we think deposits are the core of our franchise.
Lee the Max Safe product suite was very helpful to us in the quarter.
Clients didn't have to go elsewhere, even at competitors, where they are reciprocal products. We don't have to pay the additional fee that might be involved with that so.
That worked out very very well.
The Max Safe product in general is in total a little less than 4% in terms of the deposit cost and we're putting loans on at seven five to eight at this point so the spreads good.
We continue to add business everybody is asking for deposits.
So our focus so.
We're going to try to grow deposits before we use other liquidity sources.
Got it thanks, Tim and then.
Four.
Are the competitive dynamics for deposits right now are you seeing more pressure from the larger regional banks are you seeing more pressure from the community banks, whereas the.
Competition more intense.
Deposit side.
Well all over would be my blanket answer, but certainly the regional banks and rich mentioned that.
Some companies are finding it more difficult to get what I would call transactional type.
Work done and.
For folks that just don't have a relationship with their bank relationship can be either uncertain are strained at this point.
We're very focused on having relationships and taking good care of our clients and so.
One that hasn't been difficult for us for our existing base and two it's created an opportunity.
<unk>.
Certain places can see new clients that frankly, we're very happy to be doing business with.
Alright, Thanks, Tim I appreciate it.
You bet.
Our next question comes from the line of Terry Mcevoy with Stephens.
Okay.
Hi, good morning, everyone. Good morning.
Maybe a question on expenses some other banks are facing some NII pressure and prospects of rising credit costs could you just talk about maybe expense management plans and your thoughts on expenses over the next two to four quarters.
Sure I mean, we're always looking out for expenses.
Our approach is.
Has generally been to grow the balance sheet and try to grow the revenues a quicker pace than the expenses.
Like we've talked.
Pretty optimistic about the balance sheet growth and pretty optimistic about maintaining.
Maintaining the margin, which would translate into increased NII so from that perspective.
We're very optimistic on the expense side this quarter had as I said, a few increases seasonal marketing.
The addition of the <unk>.
<unk> expenses from the acquisitions.
And slightly elevated.
Lending expenses due to them.
Double digit loan growth and increased mortgage production so.
Those were the primary reasons for the increase this quarter, but we're always looking at expenses. We are very focused on them right now to keep them in check and trying to keep them less than the revenue growth going forward, but we don't want to cut to the bone here and not take advantage of the growth opportunities in the marketplace.
<unk> always done that we've always taken advantage of the disruption and we think we're in great position to do that again.
Yes.
Thanks, David and then as a follow up it sounds like next week, we're going to get updated regulation for banks over $100 billion of assets.
What's the risk of that kind of dribbles down into banks, maybe $50 billion and above and how are you thinking about any changes changes in regulation for a bank thats, what $54 $55 billion of assets today.
Well I guess, we'll watch with great interest to what they come out with but I think youre right I think most of its focused at $100 billion, where we're really not there yet I think most of the focus will be.
Interest rate risk and liquidity management at the supervisory level right now.
And making.
Making sure that our risk management in place there. We think we do a great job with that so we're not that concerned about it but we'll watch with interest what they come up with but we don't have any plans of hitting $100 million.
<unk>.
Here. So here. So I think we have some time to plan for it.
Okay.
Definitely thanks for taking my questions. Thanks Terry.
Our next question comes from the line of Ben Garlinger with Ft Group.
Alright good.
Hey, guys.
Good morning.
Curious if we could talk through deposit pricing, just a little bit I know you've touched on a couple of different ways, but first I wanted to confirm that the guidance of three six to $3 seven on margin incorporates any sort of mix shifts that might happen.
Yes.
Got you, Okay, just confirming that one so when you think about that.
Incremental dollar at this point.
Without giving away too much of your playbook. How are you guys approaching the new the next dollar or are you looking for relationships that automatically have to bring over deposits from day. One on the new loans are you looking for any different niche avenues of deposit pricing.
Deposit gathering at a lower price and then kind of juxtaposed against that Howard that flows or mix shift changed over the last call. It 60 days.
Well, we're always looking to gather deposits at lower costs and with the commercial relationships, we win come the treasury businesses and the operating accounts that.
Generally at the most favorable price.
The Max safe product for us is mostly interest bearing theres several flavors of it some that are for municipalities. For example, and some that are for our corporate customers.
At the margin.
At 4% and then we've been.
Offering some promotional type CD activity that we really used to kind of balance the remainder of the activity. So we've got a lot of levers to pull.
We were certainly asking for deposits win with our customers, but frankly, that's not anything new for us I mean, we want the relationships and we want the operating accounts from these companies.
So we.
We think we can gather deposits at an appropriate level that allow us to operate as we have now.
Talked about the loan yields and structures being attractive to us and so.
We don't think at the moment, we're giving up a lot in terms of spread.
And we also this is David we also think we have a great position in the Chicago market, We've got the fourth largest deposit market share behind.
Three big guys Chase Bank of America, and BMO, and then it really falls off.
At least for banks headquartered in <unk>.
Chicago, and Illinois, we actually have the largest market share and we're less than 10% and in Chicago and in Illinois quite frankly.
The big banks really as we talked earlier arent the ones, putting the pressure on some of the regional banks that have presence here are offering higher rates in the community banks are pretty disciplined so if someone wants to do business with with a large a larger bank.
That's located in Illinois, and a worst sort of.
The go to bank and we give great service. So we think we're uniquely positioned to take advantage of this.
Offer good products give good service and cement and the customer relationships. So we're kind of excited about the opportunities there.
Yes.
Got you that's helpful. And then if we could switch gears, a little bit towards credit and on the guidance here was a little bit softer loan growth on the back half of the year to get more in line with previous guidance.
When you think about the provision I know you sold a large component and frankly, the first half of this year's feels like the first half of a decade.
So that's a bit unknown economically speaking, but how do you guys think about the provision going forward if loan growth slows a little do you think the provision could come down from here or how do you guys approach it.
Seasonal is it.
As.
A life of loan concept as far as.
Forecasting out what the losses are in your existing portfolio. So, yes, theres a loan growth.
That's higher or lower that's going to impact and obviously there is a mix issue. If we grow a lot in our life or commercial premium finance portfolios those are less.
Provision then a CRE loan our commercial loan, but but generally speaking if you have higher growth here will have a higher provision.
But the things that impacted provision substantially or some of the economic factors. So.
If the forecast from the economists that are that are out there.
Yet the last recession focused and more soft landing or mild recession focused than I think some of those economic forecast factors will get better and that would have a positive impact on the provision but.
I'm not an economist I don't make economic predictions, but.
We filed Moody's we follow some other economic forecast as we model out our seasonal so.
I would suspect unless theres, a big change in the economic forecast that growth would be the item that would impact the provision.
Got it Okay. That's helpful. I appreciate the color guys.
Yeah. Thanks Pat.
Our next question comes from the line of Chris Mcgratty with K B W.
Great Good morning.
Dave just a question on the.
A nuance on the capital.
Covered call strategy.
How do we think about I guess.
Broadly reinvesting.
Reinvesting going forward that line item and obviously will play into the size of the overall, earning asset base.
Well our securities.
We'd like to run in the roughly 90% loan to deposit ratio and then.
The remaining liquidity is either overnight money or securities in our securities have generally been 12% to 13% of the.
Of the asset base, so we would expect to sort of keep it in there.
That range and use our liquidity to fund what we expect to be good good loan growth. So the reinvestment of the of this cash flows off the securities. We would we would put back into.
Some sort of asset class and we've generally done Ginnie mae's and if you do genies or manage it can write covered calls against them.
What were you generally get higher covered causes when rates go down and the security to get called away and then you reinvest those securities.
And then you're right calls against them again.
So in our or in a flat rate environment, where you can continue to write calls on them quarter after quarter, but.
Would suspect that given given the.
Demand, we have for loan and given that we're sort of at a.
A decent spot we could invest.
Investment portfolio go up another.
500, or $1 billion or something over time, as we grow here, probably but that's not going to create tremendous amount of covered cost.
So I would probably say in this environment if youre thinking.
$2 million to $5 million of covered calls maybe a normal range given the interest rate environment, our investments right now that probably not a bad way to look at it.
Okay. That's helpful and then just.
Two small ones.
Maybe a comment on gain on sale margins.
For mortgage and then I want to make sure I heard you the $8 million loss on the was that a $17 million to help with roughly little under 50% loss rate on the office loans.
Sure.
That's correct okay.
And then the gain on sale gain on sales for us it's been around two holding around 2%. The last couple of quarters, so pretty pretty stable.
Alright. Thanks.
Okay.
Our next question comes from the line of Brody Preston with UBS.
Hey, good morning, good morning, everyone. How are you.
Great.
I just wanted to ask on the fixed rate loan portfolio.
It's about 17 five.
Billion I, just wanted to make sure that.
The.
The 787879 that mentioned that re prices or matures over the next year or so do you happen to know what the what the existing yield is on that portfolio and then what.
What new origination rates look like right now.
Well if you look at that seven 8 billion 6.6 of it is fixed fixed great.
Commercial premium finance loans, the vast majority of that is the.
Commercial premium finance portfolio, which.
109th of that basically turns over every every month.
So those loans generally are pricing it just net net sort of prime plus one range.
Plus or minus depending on the mix of large loans versus small loans. So.
That portfolio will be returning over and you can go back and look we put in our press release, we sort of show what the indices or you can go back and look at what Prime was nine months ago and what it is now and that should be roughly the pickup you'd get in the yield on those.
Got it thank you very much.
And then I did want to ask just within the available for sale portfolio.
You did you gave the effective duration.
Six and a half I wanted to ask you. If you knew what the conditional prepayment rate youre, assuming within that duration calculations.
I don't have it handy right now the majority of those are Ginnie maes.
But I would have.
No what I don't have it handy with me right now we can we can get back to you on that Brody.
Okay great.
And then just wanted to ask just on the on the CRE deep dive.
You talked about.
Well I think it was 32%.
And I need some service type of a short term extension, 16%, a little additional attention, 50% and 52% qualifying for.
Renewal.
Is that the way it works down you kind of look at you said you qualify you might need a short term extension.
You probably need some more equity I guess like what drives the delineation between just needing a short term extension and maybe needing to bring more accurately the table and then if you could just on the ones that need a short term extension like what happens after they get the short term extension like how long is the extension for and do that.
Loans.
Move off the balance sheet and go somewhere else. So just trying to understand the moving parts there.
Yes. The one that's for short term extensions generally are we're transitioning out to and financing thats, probably going to be off our balance sheet and that's.
That's pretty typical or the history of.
Payoffs is.
Pretty substantial.
Substantial in terms of what we see every quarter just rolling off. So there is a lot of construction financing that we do that where we're not going to be the best scenario for them in the long term. So that's kind of how that works and we still see lots of liquidity out in that end market.
As it relates to the other part of the question, which is what are you. What are we looking for typically what triggers that conversation is really going to be performance of the underlying property, which is really our primary focus.
Have.
At least.
Income that you're matching up against your expenses and your debt service and if there's a mismatch there we're going to have a conversation.
Generally speaking.
I think most of our borrowers will still tell you that they believe strongly in their project and property and they want to support it I mean generally those conversations at this point or are still very productive.
We do have situations where.
This loan sale, where we had conversations and you could see that probably was not going to get better and at that point in time, we have to make a decision as to do we because of there's so much liquidity is still in the market. This was an opportune time to just say the situation is probably not going to get any better and we need to.
We think about some alternatives.
Got it okay. That's helpful.
You for that and you mentioned you did mentioned that there you're still seeing a lot of liquidity in that in that end market is that for a wide range of projects or is it more I guess more tailored to specific asset classes other than construction, where there's available liquidity.
Yes.
That's a good point.
If if it's multifamily or it is industrial.
There's a lot of appetite still out there for that type of product obviously in some of these more.
Distressed areas like CRE and retail that's a different story altogether, but we don't do a lot of the construction financing in those segments.
So generally speaking, where we're looking to transition loans out too.
And financing those.
We've been really focused heavily on more multifamily and industrial over the past three or four years.
Got it and I know it was small it was a smaller amount of loans.
Everything that was a relatively small charge.
Did I hear you right and regret I guess under the 8 million to $8 million charge that you took against $17 million of co working office loans.
Was that where it was in <unk>.
$8 million charge, almost $17 million loan portfolio.
That's correct.
Small group of properties.
No one market in particular, but.
They were all as I said the common denominator is that co working space, which we think is probably going to be the last piece to recover in office and probably the hardest to kind of re tenant at this point so.
We're as we have said in the past we try to be really strategic in terms of taking advantage of the liquidity and albeit there's probably less liquidity for this type of product out there and thats why the discount but.
It's better off just to get the runway clear because we're not sure what's coming down the road, but we want to be prepared.
Yes.
I understand that and so you don't think that that level of charges indicative of what you might see it.
If you are other banks, maybe you had to sell what I would call a more regular way kind of normal office no no not at all I mean again, the co working space, which we have.
Very little of.
This was almost half of that total that we have.
Yes. It is.
A much more distressed subsegment of this.
Office category.
So we think that you are probably going to see a little more stress in that subcategory.
But in.
In general have now we are still pretty confident about where valuations are.
Got it and then just one last one for me just on the on the loan sale within the commercial finance premium finance portfolio.
Who are the end buyers of these.
Our name obvious thing, but just like a tight is it private equity like who are the end buyer.
This loan on this type of loan portfolio and I think you mentioned that this kind of gives you the opportunity to explore.
Are there types of these transactions down the road.
What would drive you to kind of look to lean into selling more of these loans versus keeping them on balance sheet.
Yes, so if we sold it in a special purpose vehicle that then sells it out.
Asset condo et cetera, invest investing so yes.
We're not going to give the name right now is we have an NDA, but it's your standard.
Financial institution.
Underweight financing so.
We didn't even have to do it if we didn't sell it off to some of these firms that are buying distressed assets. Obviously this is not a distressed portfolio. We have no reason to do that this was more testing and the plumbing and getting us setup to provide a lever to pull for liquidity, if we need it so.
Think the reason you would do it again is if you if you're if loan growth was was were very very strong and you needed to fund it and deposit growth wasn't as quick again as Tim says, we much prefer to grow our franchise, we've always done that to grow the franchise through deposits, which is which is the core business that we that we love.
Love, but to the.
Stent that the asset growth without strip the strip the deposit growth.
Any given quarter, we could we could pull pull the lever on this either as a distinct sale like we did this this time or you could also set up a similar transaction where it's revolving.
Securitization facility, where you could just continue defeated into were not as favorable as studied that.
Because generally you would want to set it up for two or three year time period at least Anne.
Crystal ball isn't always so clear is how how strong loan demand will be three years out. So we would rather do it discreetly in kind of this book.
Poke sort of.
Transactions.
As is needed.
But.
Right now, we don't anticipate doing it again in the future, but if we did it again it'd probably be a good thing because that means we're having really really good loan growth.
Got it.
And I think I heard you right that you're going to continue to service. These loans borrowers, but they are short term. So is there much in the way of servicing income that will come from from that.
No. It saves our very short term in the servicing costs are pretty low in this portfolio.
Got it. Thank you very much for taking my questions that are on I. Appreciate it you bet.
<unk>.
Our next question comes from the line of Nathan race with Piper Sandler.
Yes, hi, guys good morning.
Good morning Nate.
Question on just the increase in the substandard loans in the world looks like they're up 60% versus the first quarter any specific drivers there.
Of note.
To what extent if any the impact.
Provision in the quarter.
No I don't think there's necessarily any color that I could give you on that.
The levels are still very subdued in terms of overall.
But in terms of driving changes in.
Okay.
Cecil I don't know if it really had a whole lot of.
So I'm just going to take a look at it yes.
We're at 1% still so I mean as it relates to.
Overall levels I think we're still in pretty good shape.
Kind of looking at my list of additions to it.
I mean that a lot of common denominators here, we tried to be incredibly proactive and our portfolio reviews of identifying any type of loan that might be.
The CRE sub segment for instance, where you have a decline in debt service coverage that gets a little bit closer to one to one four at one to one that's going to be something so we see so I can see some of that there's also.
Our commercial customers.
Pressed a little bit on cash flow, we might make that a sub standard and typically we're going to anticipate that thats going to turnaround. So there's no one thing I can point to but just.
Certainly higher borrowing cost probably would be the primary driver of that.
Sure.
Is it puts a little more strain on cash flow both in the C&I and CRE segment.
But as it relates to seasonal I mean net net net.
I think as David pointed out earlier I think the bigger drivers on seasonal is really going to be in some of these economic factors.
Yes, I think it's more a function of just a very proactive approach to reviewing these credits and making sure we understand where everything is.
Then rich they remain at very low level.
Got it that's helpful.
Just going back to Terry's question around expenses I think last quarter, Dave you were talking about kind of a high single.
Visit outlook for this year is that still kind of hold.
I think it does I mean, you got if you factor out the impact of the acquisitions. We've always said that it's excluding acquisitions, but yes, I think thats still holds.
This quarter I've talked about the reasons for this quarter, but yes, I think we still look at that as being appropriate.
And just one last housekeeping question with the sale of some MSR in the quarter does that impact.
Mortgage revenue in any way materially in <unk>.
No we took an opportunity I mean, you always mark the MSR to market.
We had.
The market value.
Them.
At the end of last quarter. When we started to look at this transaction when we actually sold in this quarter were roughly the same so there wasn't a big impact that was really just.
Reducing risk again, MSR as I've run up nicely in all in.
Take a little bit of that.
Asset off of our books at sort of the top of the MSR evaluation as we as we look at it seem to be prudent in the.
The long the servicing rights that we sold were generally those loans that were outside of the Chicago Milwaukee market area. So they werent are.
Banking customers they were loans that we've made in other regions of the United States.
Got it.
If I ask one more on capital totaled.
Total risk based it down to 11 nine I know you guys kind of want to stay above 11% I imagine with the.
I'm sorry, the insurance premium finance securitization, that's upcoming and just given perhaps higher for longer interest rate environment.
That.
As have plenty of capital to just kind of continue to support the growth opportunities that.
That exists organically in front of you today.
Yes.
Yes, we think so Nate I mean, obviously this was a big growth quarter in the sale occurred after the quarter end so.
We feel comfortable in.
Loan growth normalizes into the range rich discussed, we should be adding capital and the other thing that happened in the other capital ratios stayed relatively flat total risk base was down a little bit because as you know we had a sub debt offering out there that.
Sub debt you lose 20% of it each year as it is a matured in the last 20% of that sub debt capital ran off on June 30, so that impacted the total risk based capital just a little bit, but clearly we expect capital ratios to grow going forward based upon our projected earnings and balance sheet.
Both.
Got it and it sounds like the priorities for excess capital deployment is still organic growth first.
Perhaps buybacks or lower down on the spectrum, just given the organic growth opportunities at today, Yes, I think thats I think Thats fair Nate I mean, obviously, we look at all the alternatives but.
Again, we anticipate good growth, we like where we are in the market.
Okay great.
I appreciate all the color and taking the questions.
You bet. Thank you have a good day.
Our next question comes from the line of Jeff <unk> with D. A Davidson.
Thanks, Good morning.
Good morning, Jeff just wanted to check back in on the.
On the hedging strategy on margin appreciate the guidance at $3 $63 72 to the.
In the back half of the year.
I guess, what's the duration of those hedges I think.
Early parts of the year, you talked about maybe taking the top end office.
Percent, plus but also protecting much below $3 50.
I guess does that extend into 2024, basically what you're what you've hedged in and I guess, how does that range get affected further out kind of with another hike no <unk>.
Or kind of a cut I'm just trying to think of that.
Duration of those hedges is that get into 'twenty, four or any early expectations of how margin behaves.
Into 'twenty four.
Yes, no yes, when we did those hedges they were generally longer term transactions. So on slide 22 of our earnings deck are you can look in our last 10-Q that we had the maturity dates range from.
September 25, all the way out into.
<unk> 2028, so theyre longer term hedges and if you look at that slide it's Scott.
Swap rates in them, which are generally.
From the mid threes into the low 4% range as far as for them.
Swap rates are at so.
The market given the slope of the curve just hasnt been that favorable from our perspective dinner tomorrow. So we haven't we didn't enter into any in the second quarter, we'll still look at that but.
They are there for downside protection and quite frankly as I said in my comments had it not had it not been for this portfolio our margin.
If we didn't put the swaps and our margin would be 15 basis points higher overall, because thats the impact this quarter last quarter. The impact was seven so the differential this quarter was was eight first quarter. The impact was <unk>. This quarter was 15, so the differential was eight.
But we think Thats a fair price to pay if we can keep the margin relatively stable like we think it is to protect from from the downside risk of substantial rate reduction so.
Just the risk mitigation again.
Yes.
There are longer term alright.
Alright.
Sort of extend that that guidance range in the 'twenty four but you feel pretty good about kind of maintaining that level even beyond.
Into next year.
Well it depends I mean.
Everybody is used different if you take the higher for longer than I think that bodes well for us if you look at the curve and rates dropped precipitously.
And then we probably would have some pressure on our margin, but thats why we have these hedges in places to help mitigate some of that impact.
That's helpful just to see where you.
Lean into that.
Last one would be.
Just checking in on wealth management.
I think the acquisitions sort of juice that number a bit but looking forward to the outlook.
Would you expect that growth to level off linked quarter was strong, but maybe acquisition driven.
Yes.
That was acquisition driven so we would expect to continue to grow it but it would just be slow steady growth and that some of that is obviously dependent on the market. Because you are in your feeds based on.
The underlying asset value. So if the market continues to rally then that would be beneficial for us.
Okay. Thank you.
Okay.
Listen if we can do one more if you want.
We have a question from the line of Brody Preston with UBS.
Hey, guys.
Rob I just wanted to clarify something on the co working space.
Is that like is that like a we work I just wanted to make sure I totally understood with the property was.
Yes.
Work light.
It's just where I think there was a move for a while there were people thought they could get a significantly higher lease rate by going short term on their leases.
That works when the market is hot but it doesn't.
It's called.
You haven't raised earlier.
Great. Thank you very much guys I appreciate it.
That concludes today's question and answer session I would like to turn the call back to Tim Crane for closing remarks.
Thanks, Elizabeth and for everybody is still on the phone. Thank you for your interest and support I think you can tell we remain optimistic about <unk>.
Our position and the opportunities we're seeing in the market.
If you purchase didn't get your question answered please feel free to call any of us and as we've always said, we'll work hard thanks very much.
This.
Today's conference call.
You for participating you may now disconnect.
Okay.
[music].
Okay.
Good.
Yes.