Wintrust Financial Corporation (NASDAQ:WTFC) Q4 2022 Earnings Call Transcript

Wintrust Financial Corporation (NASDAQ:WTFC) Q4 2022 Earnings Call Transcript January 19, 2023

Operator: Welcome to Wintrust Financial Corporation’s Fourth Quarter and Full Year 2022 Earnings Conference Call. A review of the results will be made by Edward Wehmer, 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 review, 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 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 call over to Mr. Edward Wehmer.

Edward Wehmer: Thank you very much. Welcome, everybody, to our fourth quarter year-to-date 2022 earnings call. With me always are David Dykstra, our Chief Operation Officer; Dave Stoehr, where are you, Dave, our CFO; Tim Crane, the President; Rich Murphy, our Head of Credit Guru; and Kate Boege, our General Counsel. Now the same format as we have been doing in the past, I am going to give some general comments regarding results for both the quarter and the year in total, turn it over to Tim Crane for more detail on the balance sheet and then to David Dykstra is going to discuss the income statement in detail. Rich Murphy is going to talk about credit and back to me for some summary comments about the future. We will have some time for questions.

We finished the year very well. It’s a great year for us. Beach ball jumped up. It’s selling its way up, earnings for the year $509 million, almost $510 million, up almost 10% from the previous year. Grew earnings per share of fourth quarter $144 million, $145 million, compared to $142 million, $143 million in the third quarter and about $99 million in the fourth quarter of 2021, earnings per share $2.23 for the quarter, $8.02 for the year, compared to $7.58 for the previous year. And our pre-tax pre-provision income, it was a record for us, I think, $2.43 versus $2.06 for the year of 780 versus 579. And the prospects for growth were good for this to continue our way up as the margin finished at 3.73%, 3.17% for the year, up from 3.35% in the third quarter or 38 basis points and 59 basis points year-to-date to 3.17%.

And then we expect to approach 4% coming this next quarter. Tim will talk about all that. Return on the assets around 1% for the year, 1.10% for the quarter, current equity of 12.72% up 41 basis points for the year. Tangible book value rose to $61 a share, compared to $59.64 fourth quarter 2021. Again it was a very good year for us. If you look at the balance sheet to some extent, assets grow nicely for the year. The loan growth about $1 billion with about almost $700 million over average, so we will be able to work that going forward. The margin, as Tim will discuss — Tim and Dave will discuss trying to hedge it a little bit to maintain our downside risk. It makes sense as rates go up. Their next move will be down at some point and we are adjusting the balance sheet for that.

Tim will talk about that. Credit side, credits are remarkably good. Rich Murphy will talk about that, but we will point out that if you look at the real numbers, the quarter was actually down for the quarter, because of about $17 million of fiscal Life loans that got hung up in waiting for the money to come back. Only the fiscal portfolio you have to understand it all that money that’s out there that we show is past due, has been confirmed is going to be returned. So credit was actually better than it was before and we feel very good about that. I will now turn over to Tim

Tim Crane: All right.

Edward Wehmer: about the balance sheet.

Tim Crane: That’s good. Thanks, Ed. I’d like to highlight a few balance sheet items. I will offer a comment on several items likely to be of interest, including the continued impact of rising rates on the margin expectations. The approximately $1 billion of growth for the fourth quarter was 11% loan growth on an annualized basis, which continues to be spread nicely across all major loan categories. As noted in the release, period-end loan balances were $630 million higher than the quarter average, which will help our first quarter 2023 results. Going forward, while we remain encouraged by stable loan pipelines, we believe there is some evidence of a modest slowdown in market loan demand, loan growth in the mid-to-high single digits on an annualized basis remains a reasonable expectation given the current economic uncertainty.

Rich will speak to loans in more detail in just a few minutes, but a couple of notes on the provision and on our allowance. Of the $48 million in provision, approximately two-thirds is related to a modest deterioration in the CECL macroeconomic factors and only one-third is related to our growth and portfolio changes that occurred during the quarter. To be clear, we are not signaling a change in our credit performance. With respect to our allowance of 91 basis points of total loans, it’s important to note that excluding our historically low loss niche loans, primarily the premium finance loans, our allowance is 142 basis points of total core loans. You can see that on table 12 of the press release where we provide some detail. Deposit growth for the quarter was approximately $105 million.

The continued rise in rates is clearly making deposit gathering more challenging. The cost of deposits are rising and nominal changes in deposit mix are occurring. Interest-bearing deposit costs of 130 basis points for the fourth quarter were up 66 basis points. We anticipate continued increases in both the Fed funds rate and the rates associated with the bank’s loan and deposit activity. Increases in loan yields, however, at this point in the cycle continue to exceed the change in deposit costs given our asset sensitive position. Our deposit betas and the increase in deposit costs to-date are in line with our expectations. Currently, the beta on our interest-bearing deposits is approximately 25%. We anticipate an interest-bearing deposit beta of approximately 40% to 45% over the full cycle of interest rate changes.

Our securities book was up $1.5 billion in the quarter as we believe yields are becoming more attractive and represent the opportunity for reasonable longer term returns. At year-end liquidity remained strong with approximately $2.5 billion of cash on the balance sheet. As discussed last quarter, our securities book is split almost equally between available-for-sale and held-to-maturity, while the AFS valuation swings during the year were significant. As Ed pointed out, the bank’s tangible book value was up for both the fourth quarter and the year to $61 a share. Those of you who follow us know that the tangible book value per share is an important metric for us. It has increased every year since going public in 1996. With respect to rate sensitivity in the margin, although our GAAP position is trending down, we remain asset sensitive and well positioned to continue to benefit from rising interest rates.

We believe each 25 basis point increase in the Fed funds rate at this point in the cycle will result in approximately $30 million in pre-tax net interest income on an annualized basis and an improvement in the margin of 5 basis points to 8 basis points. Note, this is down slightly from our prior positioning. To be more specific on the margin, as Ed mentioned, it was 3.73% in the fourth quarter, an improvement of 38 basis points. With rates rising, we continue to achieve, and in some cases, exceed the margin improvement discussed or projected on our prior calls. At this point, depending on the impact of competition for deposits and the pace of additional Fed increases, we believe our margin will approach 4% at some point during the first quarter and has not yet peaked.

Conversely, while we clearly benefit from rising rates, as discussed on our last call, the bank entered into several interest rate collars in the third quarter of 2022. Further, early in this quarter, first quarter of 2023, the bank entered into additional derivative contracts with the intent of reducing the variability of the margin in a lower interest rate environment. Our approach has been to leg into these contracts and we anticipate that additional activity on this front is likely. You can see table eight in the press release for more information on our GAAP position. As you know, we also view our mortgage business as a natural hedge as it has proven to perform well in lower rate environments when margins tend to be pressured. For the fourth quarter, capital ratios were stable to up slightly and remain appropriate given our risk profile and with the higher net interest margin and currently forecasted loan growth, the company’s earnings are projected to result in organic improvement to our capital levels in the coming quarters.

With that, I will turn it over to Dave.

David Dykstra: Great. Thanks, Tim. As usual, I will cover some of the noteworthy income statement categories, starting with net interest income. Tim and Ed referenced some of these numbers, but we will just go through it in detail. For the fourth quarter of 2022, net interest income totaled $456.8 million. That was an increase of $55.4 million as compared to the third quarter of $22 million and an increase of $160.8 million as compared to the fourth quarter of last year. The $55.4 million increase in net interest income as compared to the prior quarter was due to an increase in the net interest margin and loan growth. As a 38-basis-point improvement in the margin brought it to 3.73% in the fourth quarter, a beneficial increase of 84 basis points on the yield on earning assets and a 22-basis-point increase in the net free funds contribution, combined with the negative impact of a 68 basis point increase on the rate paid on liabilities resulted in that improved net interest margin.

The increase in yield on earning assets in the fourth quarter as compared to the prior quarter was primarily due to an 87-basis-point improvement on loan yields and higher liquidity management asset yields as the company earned higher short-term yields on its interest-bearing deposits held at banks and its investment securities portfolio. The increase in the rate paid on interest-bearing liabilities in the fourth quarter as compared to the prior quarter was driven by a 66-basis-point increase in the rates paid on the interest-bearing deposits. Tim already went through the deposit beta, so I will let you refer to his comments on that. Turning to the provision for credit losses, Wintrust recorded a provision for credit losses of $47.6 million in the fourth quarter, compared to a provision of $6.4 million in the prior quarter and a $9.3 million provision expense recorded in the year ago quarter.

The higher provision expense in the fourth quarter was primarily a result of less favorable macroeconomic environment conditions including wider projected credit spreads and less favorable commercial real estate price index data included in the economic forecast that we use. Stronger loan growth also contributed to provision expense for the quarter. Rich will talk about credit in more detail, but I should know that the current quarter’s net charge-offs, the mix of classified loans and the delinquency data all remained relatively stable or better and really pretty good. So those factors really did not have a significant impact on the level of the fourth quarter’s provision for credit losses expense. And as Tim said, this is not the larger expense level, it’s not a signaling of any specific issues, it’s really a function of the macroeconomic forecast that we use in our CECL models.

Turning to other non-interest income and non-interest expense. In the non-interest income section, our wealth management revenue was down $2.4 million from the prior quarter and was at the level of $30.7 million for the quarter, decline in revenues for this quarter were primarily related to less fees associated with our tax deferred like kind exchange business, which had been very strong in the prior quarters and slowed just a bit in the fourth quarter. Consistent with overall industry trends and the impact of relatively higher home mortgage rates, our mortgage banking operation experienced a revenue decline of $9.8 million from the third quarter due to lower loan origination volumes and lower production margins during the quarter. We expect mortgage origination volumes to continue to be low in the first quarter due to the rate environment and the seasonal purchasing trends, but it’s still an important part of our business, and we expect it to pick up some volume in the spring buying season starts in the second quarter.

The company recorded net losses on investment securities of approximately $6.7 million during the fourth quarter, compared to a $3.1 million net loss in the prior quarter as market conditions and equity valuations continue to affect a portion of our securities portfolio. Other non-interest income totaled $19.3 million in the fourth quarter, which was up $3.5 million from the amount recorded in the prior quarter. The contributing reason for the increase in this category is that the company recorded approximately $1.1 million of higher BOLI income, which was primarily related to higher earnings on BOLI investments that support certain deferred compensation plan benefits. And so I should note that, that $1.1 million increase in the BOLI income has a similar offsetting increase in compensation expense during the quarter.

So they have sort of net — as far as net income goes, but there is an increase in both those categories for the quarter. Additionally, the prior quarter had a negative valuation adjustment of approximately $2 million on our early buyout loans — certain early buyout loans, whereas the prior quarter had a $2 million negative valuation on the early buyout loans, whereas the current quarter had an insignificant adjustment. Turning to non-interest expenses. Non-interest expenses totaled $307.8 million in the fourth quarter and we are up a little over $11 million when compared to the prior quarter total of $296.5 million. The primary reason for the increase was due to higher compensation related expenses and a variety of other less significant contributing factors.

Salaries and employee benefits expense increased by approximately $4.2 million in the fourth quarter as compared to the prior quarter of the year. Relative to the prior quarter, the increase of $2.8 million of higher salaries expenses and $2.3 million of higher employee benefits expense were the primary causes. As to the higher salaries expenses, so it’s caused by $1.8 million of increased deferred compensation costs. As I mentioned, partially related to the underlying BOLI investments where we recorded the income on the other non-interest income part of the income statement and on the employee benefits side, those are almost exclusively related to higher health insurance claims during the quarter, so elevated in the fourth quarter generally as people try to use up some of their health benefits before the deductibles recept.

Also although a smaller change from the quarter, commissions and incentive compensation was slightly lower as mortgage banking commissions were reduced, although we did have some higher bonus and long-term incentive compensation accruals for the quarter related to the higher earnings level, but then that was a reduction in that category. Advertising and marketing expenses decreased by $2.3 million in the fourth quarter compared to the prior quarter. As we have discussed on previous calls, this category of expenses tends to be lower in the fourth and first quarters of the year due to less marketing and sponsorship expenditures related to various major and minor league baseball sponsorships and less summertime sponsorship events that we obviously don’t do in the winter time.

Professional fees increased by approximately $1.7 million in the fourth quarter. These fluctuations were primarily related to some consulting services that we utilized in conjunction with the implementation of various new financial and customer related processing systems. Other miscellaneous expense increased by $4.8 million during the quarter, which included a $1.1 million additional charitable contributions and a variety of other normal operational fluctuations, none of which I think are worth noting for this call. Our efficiency ratio declined to 55% for the fourth quarter from 58% in the third quarter as our expenses did not increase at a rate commensurate with the increase in revenue. And with that, I will turn it over Rick — to Rich to cover credit.

Richard Murphy: Thanks, Dave. As noted earlier, credit performance for the fourth quarter was very solid from a number of perspectives. As detailed on slide eight of the deck, loan growth for the quarter was $1 billion or 11% annualized, an outstanding result. And similar to the past few quarters, we continue to see loan growth across the portfolio. Specifically, commercial real estate grew by $373 million. Commercial loans bolstered by a strong quarter and leasing grew by $290 million. Commercial premium finance had another solid quarter, up $136 million and residential real estate loans were up $137 million. Year-over-year, we saw total loan growth of $5 billion or 15% net of PPP loans, a very productive 2022. As noted on our prior earnings calls, we continue to see very solid momentum in our core C&I and CRE portfolios.

Pipelines have been very strong throughout the year and we saw that materialize into increased outstandings over the past several quarters. In addition, ongoing disruptions within the competitive banking landscape continue to work to our benefit. Also, commercial premium finance had a very strong 2022 with increased outstandings of close to $1 billion year-over-year. We anticipate this momentum will continue into 2023. While we are optimistic about loan growth for this year, we would anticipate that the pace of growth may trend closer to the middle of our guidance of mid-to-high single digits for a number of reasons. While Wintrust Life Finance grew by $1.1 billion during 2022, the rapid increases in rates during the past year have affected that pace of growth.

This portfolio grew $86 million in the fourth quarter versus $396 million in the third quarter. We would anticipate the slower rate of growth will continue in this higher rate environment. Also increases in commercial line utilization, excluding leases and mortgage warehouse lines as detailed on slide 17 have flattened during the fourth quarter, possibly reflecting a more cautious business sentiment. As a result, while we continue to be diligent about the possibility of a business recession, we believe 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 16, we continue to see strong credit performance across the portfolio.

This can be seen in a number of ways. Non-performing loans remained stable at 26 basis points or $101 million, compared to $98 million in the third quarter. And as Ed noted earlier, of this total, $17 million was related to Wintrust Life loans, which went 90 days past maturity. Roughly half of these loans have since been paid off, the balance of which are fully secured and we would anticipate full repayment from the carrier shortly. Overall, NPLs continue to be at very low levels, and we are still confident about the solid metrics in the portfolio. Charge-offs for the quarter were $5.1 million or 5 basis points, up slightly from the previous quarter. Charge-offs for 2022 totaled $20.3 million or 5 basis points. Finally, as detailed on slide 16, we saw stable levels in our special mention and substandard loans with no meaningful signs of additional economic stress at the customer level.

That concludes my comments on credit and I will turn it to Ed to wrap up.

Edward Wehmer: Thanks, Murph. Year end is always a good time to review, not just the fourth quarter and the year-to-date, but whether we view the entire body work over a longer period of time versus our stated goals that the company has had. Let’s go back 10 years. Now if you go back 30 years results versus peers will be about the same. Increasing tangible book value, we think is extremely important. One of the goals we always look at, as Tim noted earlier, we have increased it every year since we went public eight-year CAGR of 8% is pretty good. Even last year, it had been kind of tough, but we still were up above — we were positive. Earnings growth 16% at 10-year CAGR, asset growth 12%, dividends paid 22%, stock price only 9%, go figure.

During 10 years under review, we saw a bit of everything, high rates, low rates, pandemics, you name it. Interest has thrived during all of these. It’s a testament to our business model. We employ in the people who work at Wintrust. When rates were low, our mortgage company helped pick up the slack and net interest margin compression — of the net interest margin compression that occurred. Lower rates what we more increase our positive gap where the risen mortgages has died down. I say this because I am often asked, well, you are a mortgage bank. No, we are not. It’s just is part of what we do. This is an orchestra here now at a combo. This is a big orchestra. We all sort different parts at times, they all kick in. Times say, they don’t kick in.

Mortgage is an extremely important thing of important offering that we have, but it — it’s not doing well now, but it will do well as rates come back down. Now about our — the margin up, we are embarking on, as Tim mentioned, locking in this increased margin for a longer period of time. All the above is going to accomplish by maintaining our exceptional credit statistics. High metro concentrations kill has also served us well both in deposit and the asset side, extremely well diversified and there’s something that always works when something isn’t working. Where growth come take what the market gives us, acquisitions organic growth or have both worked very well for us. Based all the above and many more points, one has to wonder why we consistently trade at a discount to our peers.

I have to put that in there, I am sorry. As the future you can spend more of the same. Our margin should continue to increase as the remainder of asset portfolio reprices and liability costs increased at a lesser rate. Marginal force is in our future. We will be locking at a higher margin. As we mentioned in today’s comments, is already underway. Loan pipeline is still strong, but a bit lower than historically, as Murph pointed out, and we keep our guidance the same, but are focusing on the lower side of that. Credit stats are solid, but we are prepared for additional humeral attack by the folks at Moody’s, which we had on this quarter. I was just thinking still being evaluated in all aspects of our business. Pricing is still an issue, especially given our stock price.

Now as the acquisition of Rothschild American business on track for a first quarter or second quarter closing. In short, we like where we stand. With all that, I think, you can sure our best efforts going forward. We will be consistently good. We are all the major owners of this. Our networks are tied up in this company. Not going to do anything stupid. In fact, we hope to thrive no matter what the economic cycle is and where we are at in it to ensure our best efforts in this. And time for some questions, please.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Jon Arfstrom of RBC Capital Markets. Your question please.

Jon Arfstrom: You guys hear me all right?

Edward Wehmer: Yeah. How are you, Jon?

Jon Arfstrom: Hey. Good. Jon Arfstrom from RBC.

Edward Wehmer: Okay.

Jon Arfstrom: You guys — the numbers look good here, the one that surprised me a little bit was the provision and it seems like you have touched on it and alluded to it, but what do you want the message for us to be going forward? It feels like it’s going to pull back. It feels like it pulls back with a little bit slower loan growth as well, but you guys view this as more of a onetime step up and we go back to a normal pace or how should we think about that?

David Dykstra: Well, I think, Jon, the CECL, as you know is sort of a life of long concept and if we have loan growth, the provision will go up. But if the economic scenario stayed exactly the same, you would have no additional provision in the next quarter per se for that. So it really depends if the economists obviously changed our forecast frequently. But if that forecast gets better next quarter, you could expect the provision to come down, I think, gets worse, it would probably stay elevated. So it’s really a function of where the economy is going. But as Tim and Rich and Ed and I have all said, there’s nothing specific here that we are pointing to that we think is a current problem in the portfolio. This is just how commercial real estate price index forecast and how credit spreads and GDP on all those forecasts got moderately worse in the forecast that we — economic forecast we use.

So it really is a function of the CECL modeling and not a function of us seeing a deterioration in our credit. So if you can tell me where that crystal ball is next quarter as far as economic forecasts, you could know which way our provision is probably going to go.

Jon Arfstrom: Okay. Okay. So it really wasn’t any heavier weighting by you. It was just more of the output from that?

Edward Wehmer: Yeah.

David Dykstra: Yes. Yeah.

Edward Wehmer: Yeah. Someone is reaching.

Jon Arfstrom: Okay. Sure that will be in the transcript, Ed.

Edward Wehmer: Yeah.

Jon Arfstrom: The — yeah, yeah, yeah. The other question I have was on the margin. I think I understand what you guys are saying, but if the Fed, it feels like you are trying to predict — protect downside, but does the Fed bumps a couple more times and then hold it for a while. What could happen to your margin, are you guys were talking about a 4% level, but then, Ed, you kind of alluded to floating a little bit higher above 4%. What do you think about the margin outlook in that kind of a scenario where the Fed is not cutting?

Edward Wehmer: Well, they are raising where it should be, as Tim said, $30 million on an annual basis per quarter. Eventually, the — we have been lagging on the private, we have been lagging on the deposits. Much is going to catch up to that overall beta. But we still have a lot of assets that are repricing right now, if you think about premium finance business, every prices over the course of the year. The other assets do the same. We are monitoring this very carefully as we leg into these derivatives to help maintain the margin. So it’s hard to say where it’s going to be, it depend on some of derivatives, we give up some upside to protect the downside. But I think that depending on how rates go, margin will continue to go up.

If we can predict something in the 3.75% to 4% range long-term, depending on where rates are, that would be a good thing, but it’s going to take a lot more derivatives to do that and we are not really good at market timing. So we will — when that happens, the mortgages will kick in and life will be good in that regard. So we kind of had some internal hedges, too. But Tim, do you want to talk about that?

Tim Crane: Yeah, Ed. I think, Jon, in general, we would expect the margin to sort of top out after the Fed stops raising rates and so whether that’s a quarter or two or whether we moderate that with some thoughtful decisions around the derivatives, that’s kind of what we are thinking.

David Dykstra: Yeah. This is Dave. I think what we have said here is that we expect the margin to approach for and if the Fed raises some more, it may pop a little over for, but it’s — but then we think given existing competitive pressures and the existing yield curve that if they stop raising that we can kind of hold it there if all else being stable, because as Ed said, we have a lot of asset beta left too, everyone talks about the deposit betas. But if you look at our life insurance premium finance portfolio, as you know, that those reset once a year. And if you go back a year, they are based generally off of a 12-month LIBOR or 12-month treasury rate and those rates were 58 basis points a year ago, if you look at the page 25 of our earnings release.

Those rates are up over 400 basis points. So there’s a lot of repricing that happens there. The property and casualty premium finance loans are fixed rate loans and so they reprice over the course of the year. So that’s a third of our portfolio that has pretty good deposit — our asset beta changes left that we think will substantially offset the deposit betas. So we feel like we can kind of hold the margin if they go higher and then plateau.

Jon Arfstrom: Okay. All right. That’s all very helpful guys. Appreciate it. Thank you.

Edward Wehmer: You are welcome.

Operator: Thank you. Our next question comes from the line of David Long of Raymond James. Your question please, David.

David Long: Good morning, everyone.

Edward Wehmer: How are you doing, David?