Wintrust Financial Corporation (NASDAQ:WTFC) Q2 2023 Earnings Call Transcript

Wintrust Financial Corporation (NASDAQ:WTFC) Q2 2023 Earnings Call Transcript July 20, 2023

Operator: Welcome to Wintrust Financial Corporation’s Second Quarter and Year-To-Date 2023 Earnings Conference Call. A review of the results will be made by Tim Crane, President and Chief Executive Officer; David Dykstra, Vice Chairman and Chief Operating Officer; and Richard Murphy, Vice Chairman and Chief Lending Officer. As part of their reviews, the presenters may make reference to both the earnings press release and the earnings release presentation. Following their presentations, there will be a formal question-and-answer session. During the course of today’s call, Wintrust management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Actual results could differ materially from the results anticipated or projected in any such forward-looking statements.

The Company’s forward-looking assumptions that could cause the actual results to differ materially from the information discussed during this call are detailed in our earnings press release and in the Company’s most recent Form 10-K and any subsequent filings with the SEC. Also, our remarks may reference certain non-GAAP financial measures. Our earnings press release and earnings release presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded. I will now turn the conference call over to Mr. Tim Crane.

Timothy Crane: Thank you, and good morning, everybody. We appreciate you joining us for our second quarter earnings call. In addition to Dave Dykstra and Rich Murphy, who the operator introduced, Dave Stoehr, our Chief Financial Officer; and Kate Boege, our General Counsel, are with me in the room today. In terms of an agenda, I’ll share some high-level highlights. Dave will speak to the financial results, and Rich will add some additional information and color on credit performance. I’ll wrap up with some summary thoughts, and as we always do, we will do our best to answer some questions. On our last call in mid-April, we were still in a period of volatility and to a degree, uncertainty for the banks. At the time, we talked about several objectives: continuing to focus on our customers, capitalizing on our strength and stability, once again being opportunistic when there is disruption in the market.

We talked about managing the balance sheet in a conservative fashion, growing deposits to fund loan growth and continuing to enhance liquidity. And we talked about continuing to take advantage of higher rates, specifically to demonstrate our ability despite rising deposit costs to stabilize the net interest margin. We feel like our performance on these objectives has been very solid. In addition to reporting record income for the first half of the year, for the second quarter, we had strong and balanced loan and deposit growth, adding clients and building the franchise through the volatile period when others were distracted. We improved liquidity, reducing federal home loan bank borrowings and as you will hear shortly, have demonstrated through the sale of a portfolio of loans that occurred after the quarter end, the flexibility to continue to manage our balance sheet effectively.

And while as expected, deposit costs are up, we are originating very high-quality loans with attractive both yields and terms and continue to benefit from loan repricing, which we believe differentiates us from many of our peers. Just to give you some detail, you will recall our margin was 3.83% for the first quarter and specifically 3.70% at the end of March. Our margin for the second quarter, despite the very good growth was 3.66% and importantly, was stable throughout the quarter. Lastly, our credit performance remains strong with no evidence of systemic issues. Rich will discuss this in some detail, including proactive steps that illustrate our ability to address any softening that may occur. Again, I’ll come back at the end. But with that, I’ll turn this over to Dave to provide some additional detail.

David Alan Dykstra: Okay. Thanks, Tim. First, with respect to the balance sheet growth. We are very pleased to see deposits for the quarter grow by $1.3 billion or 12.4% on an annualized basis. This deposit growth was aided by the popularity of our suite of MaxSafe products that provide enhanced FDIC coverage and we did not rely upon additional wholesale deposits during the quarter for that growth. This growth was also despite our wealth management deposits declining by just under $400 million owing in large part to less deposits from our 1031 exchange business due to a slowdown in tax-free commercial real estate exchanges in the marketplace. As to the deposit composition, we again saw some additional movement from non-interest-bearing deposits to interest-bearing accounts.

The non-interest-bearing deposits at the end of the quarter represented 24% of our total deposits compared to 26% at the end of the first quarter. These movements do not appear to be unique to us, but they obviously increased the cost of deposits for the quarter. Although I would note that the mix shift out of non-interest-bearing deposits seems to have subsided thus far this quarter as the percentage is relatively stable now that it was at the end of the second quarter. This strong deposit growth helped to fund similarly strong loan growth of $1.5 billion during the second quarter. The growth was predominantly fueled by exceptionally strong production from our commercial premium finance operations and to a lesser extent, from commercial real estate growth, including draws on previously existing credit lines.

Rich Murphy will discuss the loan portfolio growth in more detail in just a bit. The investment portfolio declined slightly as we only reinvested about a third of the $940 million of securities that were called away at the end of the prior quarter. The additional liquidity provided by not reinvesting the entire amount of those called securities also helped to fund the quarter’s loan growth. The company was able to reduce its non-deposit funding, primarily Federal Home Loan Bank advances during the quarter by $208 million. The result of these balance sheet movements was growth in total assets of approximately $1.4 billion, a slightly elevated ending loan-to-deposit ratio of 93.2% and relatively stable capital ratios. All in all, it was a very successful quarter in growing our franchise.

Our differentiated business model, exceptional service and unique position in the Chicago and Milwaukee markets continue to serve us well. As Tim mentioned, the exceptionally strong growth in our commercial premium finance portfolio and the outlook for continued loan growth provided us with an opportunity to structure a loan sale transaction of approximately $500 million of our U.S. commercial premium finance portfolio. This loan sale occurred earlier this week and provided multiple benefits to us, including that it demonstrates that our premium finance portfolio is a strong source of additional liquidity, if needed. Actually provided us with liquidity this quarter to aid in funding anticipated loan growth, reduces our loan-to-deposit ratio to a desired operating level that is closer to 90%, reduces some of the concentration in the premium finance base as we’ve had strong growth over the last quarter and quite frankly, over the last year and would provide a small gain in the third quarter from the sale of those loans.

As you know, these loans are very short-term loans that make monthly payments and they will likely be replaced substantially by new volume by the end of the year. Next, I’ll cover noteworthy income statement categories, starting with the net interest income for the second quarter of 2023. Net interest income totaled $447.5 million. That was a decrease of $10.5 million as compared to the prior quarter and an increase of $109.7 million compared to the same quarter of 2022. The decrease in net interest income as compared to the prior quarter was primarily due to a compression in the net interest margin influenced by the higher funding cost. The net interest margin was 3.66% in the second quarter, which was just slightly less than the 3.7% margin that we discussed on our first quarter earnings call and which was the approximate run rate at the end of March.

However, the margin was 17 basis points less than the prior quarter level of 3.83%. Importantly, the net interest margin was stable for each of the months in the second quarter. And as I’ll discuss later, we expect the margin to continue to remain relatively stable for the remainder of 2023. As to the details of the component changes impacting the margin in the second quarter relative to the first quarter, the company saw a beneficial increase of 42 basis points on the yield on earning assets, excluding the impact of our interest rate swap positions, a 15 basis point increase in the net free funds contribution. And offsetting that was an increase of 66 basis points of an increase in the rate paid on liabilities. And it’s important to note that roughly half of the margin decline during the quarter was associated with an additional 8 basis points of margin drag from a full quarter impact of the interest rate swap positions that we have in place.

Photo by Mark OFlynn on Unsplash

Those swaps were generally put on in the first quarter and the first quarter only had a portion of the impact. So this quarter was fully baked and was accounted for about half of the margin decline. We continue to believe that our balance sheet structure can provide margin stability as our premium finance portfolio, which comprise roughly a third of our loan portfolio should continue to reprice upward over the course of this year and that should substantially mitigate the rise in deposit pricing. Accordingly, based on the current interest rate environment, which includes an expected 25 basis point increase by the Fed later this month, we expect our margin to remain relatively steady in the 3.60% to 3.70% range during the remainder of 2023. Turning to the provision for credit losses.

The company recorded a provision for credit losses of $28.5 million in the second quarter. This compared to a provision of $23 million in the prior quarter and $20.4 million of provision expense recorded in the year ago quarter. The higher provision expense in the second quarter relative to the prior quarter was primarily a result of a higher loan growth, changes in macroeconomic outlooks, including projected credit spreads and projected commercial real estate price index and slightly higher net charge-offs. Again, Rich Murphy will talk about credit and the loan portfolio characteristics in just a bit. As other non-interest income and other non-interest expense, total non-interest income totaled $113 million in the second quarter and was up approximately $5.2 million compared to the prior quarter of total of $107.8 million.

The primary reason for the increase was due to an $11 million increase in mortgage banking revenue. The mortgage banking operation saw a slight increase in volume of loans originated during the second quarter with relatively stable margin – production margins. Roughly 84% of the application volume is still related to purchased home activity. Application activity continues to be subdued due to lack of housing inventory and higher rates, but we would expect right now, similar to slightly elevated production, but nothing dramatic in the third quarter. Wealth Management revenues improved by $3.9 million in the second quarter relative to the first quarter, and this was bolstered by revenue from the acquisition that we closed at the beginning of the quarter and offset somewhat by continued headwinds relative to the slowdown in the commercial real estate transactions and the resulting impact on the 1031 exchange business revenue.

However, these increases were offset by a $1.4 million reduction in gains and losses related to the company’s securities portfolio. The company recorded a $1.4 million gain in the first quarter on security sales and really nothing in the second quarter of this year. A $7.8 million decrease in covered call options also impacted this revenue category. As I discussed earlier, we did not reinvest much of our securities that were called and this created less opportunity to write covered call transactions during the quarter. Turning to non-interest expense categories. The non-interest expenses totaled $320.6 million in the second quarter and were up approximately $21.4 million when compared to the prior quarter total of $299.2 million. The primary reasons for the increase is related to a few general areas.

First, the acquisition of the wealth management companies at the beginning of the quarter added roughly $4 million of additional expense sprinkled throughout the various expense categories. But excluding that impact, salaries and employee benefits expense increased by approximately $8.1 million in the second quarter of 2022 compared to the first quarter. And relative to the prior quarter, there was $4.7 million increase largely related to higher mortgage commissions and to a lesser extent, incentive compensation accruals. So most of that was commissions related to the increased mortgage operations. So this category fluctuates depending upon the mortgage volume. The category also saw approximately $4.1 million of higher employee benefit expenses due to an increased level of health insurance claims during the quarter.

Health insurance claims can fluctuate on a monthly basis as we are self-insured. The first quarter was a little low. The second quarter is a little high can fluctuate. But the change between quarters was really more probably a timing of when employees took advantage of our health insurance program. Next, advertising and marketing expenses increased by $5.8 million in the second quarter when compared to the prior quarter. As we have discussed on previous calls, this category of expense tends to be higher in the second and third quarters of the year due to expenditures related to various major and minor league baseball sponsorships. Other summertime sponsorship events that we hold in the communities that we serve and marketing of our brand and deposit products.

Also, in the second quarter, lending expenses increased approximately $4.8 million due to the strong and higher overall loan origination activity in the second quarter. And other than that – other than the expense categories just discussed above, all the other expense categories were relatively consistent. The efficiency ratio increased to 57% for the second quarter from 53% in the first quarter of the year and this was primarily due to the impact of lower net interest margins, the reduced level of covered call income and the slightly elevated expenses. Net overhead ratio was 1.58% in the second quarter and increased from 1.49% in the prior quarter due to the slightly higher expenses. In summary, we think this was a very solid quarter. We had strong loan and deposit growth, improved liquidity position, stabilized net interest margin with a steady outlook.

Net revenues at more than 1% of the prior quarter’s record level despite funding cost pressures, continued low levels of non-performing assets and the second highest quarterly net income result in the company’s history. We feel like we’ve managed through a turbulent first half of 2023 delivering net income that was a record for the first half of any fiscal year in the company’s history and we have a positive outlook for continued growth in assets, revenues and earnings. So with that, I will conclude my comments and turn it over to Rich Murphy to discuss credit.

Richard Murphy: Thanks, Dave. As noted earlier, credit performance continued to be very solid in the second quarter from a number of perspectives. As detailed on Slide 6 of the deck, loan growth for the quarter was $1.5 billion. The loan growth was largely attributable to over $1 billion of growth in the commercial premium finance category. This growth is due to a number of factors. The second quarter is historically when we see our highest funding volume. And as we have noted in the past several quarters, we have seen a significantly harder market for insurance premiums, particularly for commercial properties. As a result, we have seen the average loan size increase. Finally, we continue to see new opportunities as a result of consolidation within the premium finance industry.

We also saw good growth in commercial real estate, largely resulting from draws on existing construction loans and portfolio residential real estate loans. This rate of loan growth is significantly higher than the first quarter and well above our guidance of mid- to high single digits. We believe that loan growth for the second half of the year will be more in line with our guidance as we anticipate the premium finance loan growth will moderate and be more in line with historic norms. We also anticipate that higher borrowing costs will continue to affect borrowers to reconsider the economics of new projects, business expansion and equipment purchases. However, we continue to see solid momentum in our core C&I and CRE pipelines. Disruptions in the banking landscape continue to work to our benefit, and we have seen numerous quality opportunities from other regional banks.

In summary, we continue to be optimistic about loan growth for the balance of 2023, and we believe that our diversified portfolio and position within the competitive landscape will allow us to grow within our guidance of mid- to high single digits and maintain our credit discipline. From a credit quality perspective, as detailed on Slide 14, we continue to see strong credit performance across the portfolio. This can be seen in a number of metrics. Non-performing loans remained stable at 26 basis points or $109 million, up slightly from what we saw in the first quarter. Overall, NPLs continue to be at historically low levels, and we are still confident about the solid credit performance of the portfolio. Charge-offs for the quarter were $17 million or 17 basis points, which was up from the prior quarter, but still at a relatively low level.

This higher level was primarily attributable to a charge of $8 million, which resulted from the sale of a portfolio to co-working office loans totaling $17 million. As we have noted in previous calls, we are constantly looking for signs of stress in our portfolios and are very focused on our non-owner-occupied office portfolio. The common denominator of the loans we sold was the co-working nature of the tenants. We believe that this sub-segment of the market will continue to experience significant stress from weak tenant demand and rising cost of debt, and we took this opportunity to meaningfully reduce our exposure. This sale made up close to half of our exposure into the subcategory. We have always looked at strategic options to reduce exposures to areas of concern within our portfolio, and we will continue to do so.

Finally, as detailed on Slide 14, we saw stable levels in our special mention and substandard loans with no meaningful signs of additional economic stress at the customer level. As noted in our last earnings call, we continue to be highly focused on our exposure to commercial real estate loans, which composed roughly one quarter of our total loan portfolio. Higher borrowing costs and pressure on occupancy and lease rates are cause for concern, particularly in the office category. On Page 18, we’ve updated a number of important characteristics of our office portfolio. Currently, this portfolio remains steady at $1.4 billion or 13.2% of our total CRE portfolio and only 3.4% of our total loan portfolio. Of the $1.4 billion of office exposure, over 40% is medical office or owner occupied.

The average size of the loan in the office portfolio is only $1.3 million. We only have five loans above $20 million. There has been significant concern about office properties located within central business districts. Our CBD exposure is limited to $350 million or approximately one quarter of the office portfolio. Half of this is in Chicago and half is in other cities. The bulk of the portfolio is located in suburban areas and areas outside CBDs. And portfolio performance to date has been very good with no loans currently over 90 days past due. We continue to perform portfolio reviews regularly on this portfolio, and we stay very engaged with our borrowers. We are not immune for the macro effects that challenges product type, but we believe that our portfolio is well constructed very granular and should perform well moving forward.

As noted earlier, higher borrowing costs and pressure on lease renewals are caused for concern across the CRE space. To better understand how these issues could impact our portfolio, our CRE team updated their deep dive analysis on every loan over $2.5 million, which will be renewing between now and through the first quarter of 2024. This analysis, which covered 79% of all CRE loans maturing during this period, resulted in the following: more than 52% of the loans will clearly qualify for renewal at the prevailing rates. Roughly 32% of these loans are anticipated to be paid to offer will require a short-term extension at prevailing rates and approximately 16% of the loans will require some additional attention, which could include a paydown or pledge of additional collateral.

We have tentative agreement on renewal terms with many of the borrowers in this final group. Again, our overall CRE portfolio is not immune from the effects of rising rates or the market forces behind lease rates, but we have been diligently identifying weaknesses in the portfolio and working with our borrowers to identify the best possible outcomes, and we believe that our portfolio is in reasonably good shape and situated to weather the challenges ahead. That concludes my comments on credit, and I’ll turn it back to Tim.

Timothy Crane: Thanks, Rich. To wrap up, for the last several months, we’ve had the opportunity and in some cases, I would say, the responsibility to explain to our customers why Wintrust continues to be a better alternative than the larger too big to fail banks. Not only have we successfully done that with almost no attrition, but we continue to win business and as you can see, grow deposits and build our franchise. We continue to think we are uniquely positioned to take advantage of the current environment with our diverse businesses that limit the potential impact of economic softness in any individual area and we remain positioned to benefit from higher rates. As Dave noted and we noted in the press release, we expect that our margin will be relatively stable for the remainder of the year, and our net interest income will increase in the coming quarters.

I would say that the current market is a little bit choppy, and we remain incredibly focused to pursue opportunities that we see, and we’ll do that aggressively in the coming months. At this point, I’ll pause and we can take some questions. Elizabeth, back to you.

See also 20 Countries With Highest Rate Of Down Syndrome and 25 Poorest States in America.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Jon Arfstrom with RBC Capital Markets.

Jon Arfstrom: Good morning.

Timothy Crane: Hi, Jon.

Jon Arfstrom: Hey, I’m going to start – the first question, I guess, you used the word choppy, Tim, and you guys talked about a little bit slower loan growth in the second half of the year, but you put up a pretty good quarter. And I guess my question is, what do the pipelines look like? What’s the quality of what you’re seeing? And very early, Tim, you alluded to like pricing and structure being better, but touch a little bit on that in terms of how that may have changed?

Timothy Crane: Yes. I’ll take the first part and Rich can add to that. With respect to choppy, companies are obviously reacting to higher rates and certainly real estate projects, in some cases, are on hold. And there’s folks still wrestling with labor issues, which we think are generally better, but not universally better. And then obviously, there are some competitors that are pulling back in terms of credit and their participation in the market. And so we’re seeing opportunities. I think a lot of people are seeing opportunities, and we just have to be selective and disciplined. And I think our team is doing a nice job in that regard, which is driving both higher yields and better terms, in some cases, more equity in real estate deals. So Rich, why don’t you please add to that?

Richard Murphy: Yes. No, I think you said it well. Every week that goes by, we see new opportunities really across the portfolio in terms of customers who aren’t getting their existing banks to work with them in a productive way. And we’re also seeing a tremendous amount of opportunities, large capital market type opportunities where there’s multiple banks involved. And there’s almost more than you could possibly want, frankly, because there’s just so much that’s out there right now. So it does give us the opportunity to pick and choose price accordingly, structure accordingly. We’ve always had a history of being pretty disciplined in this space, and that’s not going to change. But it’s a great opportunity for us. Disruption always has worked to our benefit.

Post-pandemic, post PPP, we saw a very similar kind of environment where a lot of banks were kind of struggling getting their footing we’re seeing that right now as well. And so we’re pretty optimistic, but most importantly, we just want to stay disciplined.

Jon Arfstrom: Okay. Fair enough. The premium finance size limits on your balance sheet, we expect to see more of these sales. And I’m just curious if you guys continue to service it. I know they’re very short-term in nature, but help us understand the outlook for that in terms of on your balance sheet?

Timothy Crane: Yes. So the $500 million we sold is an off-balance sheet transaction that will come off out the books in the third quarter. And Jon, as you know and probably most of the people on this call know is that those loans make monthly payments and have an average life of nine to 10 months. So by the end of the year, they will substantially have been paid off anyway. So we – if you recall, we did a securitization of premium finance loans a decade ago or so, I think is about a $300 – or $600 million facility that we did for a few years. And so it’s not a new transaction for us. But we thought it was important to get the plumbing in place. We had a $1 billion quarter, a great growth quarter. The market is still hard.