Wintrust Financial Corporation (NASDAQ:WTFC) Q4 2023 Earnings Call Transcript

Wintrust Financial Corporation (NASDAQ:WTFC) Q4 2023 Earnings Call Transcript January 18, 2024

Wintrust Financial Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to Wintrust Financial Corporation’s Fourth Quarter and Full Year 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 over to Mr. Tim Crane.

Tim Crane: Good morning, and thank you for joining us for the fourth quarter and full year call. For those we haven’t spoken to recently, Happy New Year. In addition to Dave Dykstra and Rich Murphy who the host introduced, Dave Stoehr, our Chief Financial Officer; and Kate Boege, our General Counsel are with me. In terms of an agenda, I’ll share some high level highlights. Dave Dykstra 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 on 2024, and as always, we’ll do our best to answer some questions. For the year, we reported record net income of just over $622 million, up 22% over 2023. The results reflect our conservative approach to managing and growing our franchise.

Specifically, we target steady growth in both loans and deposits, sound and conservative liquidity and risk management, and an unwavering commitment to taking care of our clients. In our materials, as we do at every year end, we have also included a series of 10 year historical charts that show solid progress on key metrics, evidence that our approach not only works but differentiates us from many of our peers. While this is not new information, we think these charts are meaningful evidence of our strong and consistent performance and if you haven’t already, I would encourage you to look at and review these materials. For the fourth quarter, net income was just over $123 million, a solid result given the recognition of a $34.4 million extraordinary expense related to the replenishment of the FDIC Fund following the March bank failures, and an approximately $10 million expense related to the write-down of certain mortgage related assets due to the falling interest rates during the quarter.

We reported record net interest income of $470 million, up approximately $8 million from the third quarter as a result of both an increase in the net interest margin of 2 basis points to 3.64% and continued good loan growth. Deposits were also up in the quarter. Non-interest bearing deposits increased slightly and were steady as a percentage of total deposits. While we continue to expect credit performance to normalize from the very low levels experienced over the last few years, our losses and NPLs remain low. Despite these low credit losses, we’ve continued to build the allowance. And as you’ll hear from Rich, we continue to proactively address challenged credits in our portfolio. I would highlight that our allowance coverage for core loans, excluding primarily our low loss insurance finance portfolio, is at a healthy 1.55%.

This detail is in Table 12 of our press release. The market rate decreases during the quarter that caused the adjustment to the value of the mortgage assets also led to a material improvement in AOCI, driving up our book value and capital levels. The tangible book value increased by $385 million to over $70 a share during the quarter. You’ll see in one of the charts that I mentioned, that our book value has increased every year during the 10 year period shown. And in fact, if you were to go further back, our tangible book value has increased every year since the Company went public in 1996. Our liquidity position remains strong. Overall, a solid quarter, which we believe will compare well and may differentiate us relative to many of our competitors.

With that, I’ll turn this over to Dave and Rich. And as I mentioned, I’ll come back and wrap up with some thoughts on the 2024 outlook.

David Dykstra: Great. Thanks, Tim. First, with respect to the balance sheet growth, we were again pleased to see loans for the quarter grow by approximately $686 million or 7% on an annualized basis, consistent with our prior guidance of mid to high-single digit loan growth. The increase in loans was across many of the loan categories, but was primarily related to commercial real estate and commercial premium finance portfolio growth. And Rich Murphy will talk about that in just a little bit. The company also recorded deposit growth of $404 million during the quarter, which is a 4% increase over the prior quarter on an annualized basis. And as to deposit composition, non-interest bearing deposits at end of the third quarter and fourth quarter both represented 23% of total deposits, evidencing the stabilization of the non-interest bearing balances during the latter half of 2023.

Other balance sheet results were that, total assets grew by approximately $705 million. We had slightly increased ending loan-to-deposit ratio and our capital ratios were relatively stable, with most of those ratios increasing slightly. Overall, a very successful quarter for the growth of the franchise. Our differentiated business model, exceptional team and service, and the unique position in Chicago and Milwaukee markets continues to serve us very well in that regard. Turning to the income statement categories, starting with net interest income. For the fourth quarter of 2023, net interest income totaled $470 million, an increase of $7.6 million as compared to the prior quarter and an increase of $13.2 million as compared to the fourth quarter of 2022.

I should note that the fourth quarter net interest income represents the highest quarterly amount ever recorded by the company. The increase in net interest income as compared to the prior quarter was primarily due to an increase in average earning assets of approximately $509 million. An increase in the company’s net interest margin also contributed to the increase in net interest income. The net interest margin was 3.64% in the fourth quarter, which was 2 basis points higher than the prior quarter level. Accordingly, as we discussed on prior calls, our balance sheet composition, structure, and repricing characteristics provided for a relatively stable net interest margin during the quarter. And based on the current interest rate environment, we believe we can maintain our net interest margin within a narrow range around the current levels during the first quarter of 2024 and beyond, in 2024, assuming the rates stay at roughly the same.

I’d also like to note that total loans as of December 31st were $770 million higher than the average total loans in the fourth quarter, which obviously provides us with some momentum into the first quarter of 2024. The combination of the expected balance sheet growth and relatively stable net interest margin should allow for further growth of our net interest income in the first quarter of this year. Turning to the provision for credit losses. Wintrust recorded a provision for credit losses of $42.9 million in the fourth quarter. This is up from a provision of $19.9 million in the prior quarter, but actually down from the $47.6 million of provision recorded in the year ago quarter. The higher provision expense in the fourth quarter relative to the third quarter was primarily the result of higher net loan growth during the quarter, a slightly higher level of net charge-offs, and some deterioration in the forecasted macroeconomic conditions, primarily wider forecasted BAA credit spreads and forecasted depreciation in the commercial real estate price index.

Rich will talk about the credit and loan characteristics in just a bit. Regarding the other non-interest income and non-interest expense. Total non-interest income totaled $100.8 million in the fourth quarter, which was down approximately $11.6 million when compared to the prior quarter. The primary reason for the decline was related to $20 million less of mortgage banking revenue. Relative to the third quarter, mortgage revenue had a $9.7 million unfavorable change in net valuation adjustments from our mortgage servicing rights assets and certain other mortgage-related assets that we hold at fair value. Those declines were really due to a decline late in the fourth quarter in the mortgage rates and accelerated prepayment speeds. We also experienced $7 million decline in production revenue due to seasonally lower volume and compressed gain on sale margins.

But I think it’s interesting to note that although our production revenue was lower than the prior quarter, it’s actually higher than the fourth quarter the prior year, which is encouraging for us. We are also encouraged that with a lower rate environment, that our application volume is ticking up early in 2024 thus far. Albeit still at low levels, we are seeing increases over our application volumes that we were receiving in January of last year, and application volumes that are slightly up from December of ’23. There’s a variety of relatively smaller changes to other non-interest income categories as shown in the tables in the earnings release, but those changes were not unusual and in the aggregate, resulted in an increase in the non-mortgage-related categories of approximately $8.3 million from the prior quarter.

Turning to non-interest expenses. Non-interest expenses totaled $362.7 million in the fourth quarter and were up approximately $32.6 million from the prior quarter. The primary reason for the increase was the negative impact of the $34.4 million special assessment by the FDIC to pay for the two of the bank failures that occurred earlier in 2023. The remaining variances in non-interest expense both positive and negative, offset to a relatively small reduction in non-interest expenses from the prior quarter of just under $2 million. In summary, it was a very good solid quarter in our view, with good loan and deposit growth, a stable net interest margin with a steady outlook, a record level of net interest income, and a continued level of — low level of non-performing assets.

We feel like we’ve managed well through a somewhat turbulent period in 2023 delivering net income that was a record for any full fiscal year in the company’s history, and we have a positive outlook for continued growth in assets, revenue, and earnings. And although it’s easy to get caught up in looking at the quarterly results, I think it’s also instructive to occasionally look back over time. As Tim referred to, we included some 10-year charts in the earnings release that I think provide some impressive evidence that our approach to running the business has provided for a consistent growth in loans, deposits, earnings, and tangible book value per share over an extended period of time, all while managing credit risk very well. We’ll work hard to continue those trends in 2024 and beyond and increase shareholder returns.

So with that, I’ll conclude my comments and turn it over to Rich Murphy to discuss credit.

Richard Murphy: Thanks, Dave. As Tim and Dave noted earlier, credit performance continued to be very solid in the fourth quarter from a number of perspectives. As detailed on Slide 7 of the deck, loan growth for the quarter was $686 million, and similar to the third quarter, this growth was driven by a number of factors. We continue to see a harder market for insurance premiums, particularly for commercial properties, resulting in higher average loan sizes in our commercial premium finance portfolio, and consolidation within the premium finance industry has provided us with a number of new opportunities. We saw a good growth in the commercial real estate portfolio, resulting largely from draws on existing construction loans.

And finally, our leasing group had another very solid quarter. Total loan growth for all of 2023 was $2.9 billion or 7%. We believe that loan growth for 2024 will continue to be within our guidance for the following reasons. The commercial premium finance team should continue to show solid growth as premiums continue to be elevated. Our various pipelines have stayed very solid and our leasing team continue to see significant demand in the market. And as we’ve noted in prior calls, we continue to benefit from disruptions in the banking landscape and we’ve seen numerous quality opportunities in our core C&I and CRE business. In addition, we continue to look at a number of lending teams and niche lending opportunities that come from dislocations at other regional banks.

Offsetting this growth will be continued pressure on C&I line utilization which dropped from 37% to 34% year-over-year, as higher borrowing costs have negatively affected usage. We anticipate that higher borrowing costs will continue to cause borrowers to reconsider the economics of new projects, business expansion, and equipment purchases. In summary, we continue to be optimistic about our ability to grow loans in 2024, and 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 14, we continue to see strong credit performance across the portfolio. This can be seen in a number of metrics.

Non-performing loans increased by $6 million during the quarter from 32 basis points to 33 basis points. While NPLs have increased from 26 basis points to 33 basis points during 2023, they continue to be at historically low levels and we are confident about the solid credit performance of the portfolio. Charge-offs for the quarter were $14.9 million or 14 basis points, up from $8.1 million or 8 basis points in Q3. 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 few earnings calls, we continue to be highly focused on our exposure to commercial real estate loans, which comprises roughly one-quarter of our total portfolio.

Higher borrowing costs and pressure on occupancy and lease rates are cause for concern, particularly in the office category as we’ve noted before. On our second quarter call, earlier this year, we noted that we are very focused on a subset of office loans, which are secured by co-working properties. At that time, we had sold a portfolio of approximately $17 million, which reduced our total co-working exposure in half. During the fourth quarter, we saw an increase in CRE NPLs of $17.4 million, which was largely due to a downgrade of a single co-working loan to non-performing. It is important to note that the underlying loan is current and has been previously identified as a potential non-accrual due to cash flow issues. We continue to work with the borrower to determine the most cost effective strategy going forward.

On Slide 18, we have updated a number of important characteristics of our office portfolio. Currently, this portfolio remained steady at $1.4 billion or 12.8% of our total CRE portfolio and only 3.4% of our total loan portfolio. Of the $1.4 billion of office exposure, 42% is medical office or owner occupied. The average size of the portfolio loan in the office portfolio is only 1.4 million, and we continue to have only five loans above $20 million in this category. We continue to perform reviews regularly on this portfolio, and we stay very engaged with our borrowers. As mentioned on prior calls, our CRE credit team regularly updates their dive analysis of every loan over 2.5 million, which will be renewing between now and the end of the third quarter of 2024.

This analysis, which covered 82% of all CRE loans maturing during this period resulted in the following, approximately one half of these loans will clearly follow by for a renewal at prevailing rates. Roughly 35% of these loans are anticipated to be paid off or will require short-term extension at prevailing rates. The remaining 14% of these loans will require some additional attention, which could include a paydown or a pledge of additional collateral. It’s important to note that the previously mentioned loans secured by co-working space had been identified during our prior deep dive analysis. We have back checked the results of these tests conducted during prior quarters and have found that the projected outcomes versus actual outcomes were very tightly correlated and generally speaking, borrowers of loans deem to require additional attention, continue to support their loans by providing enhancements, including principal reductions.

Again, our portfolio is not immune from the effects of rising rates or the market forces behind lease rates, but we continue to proactively identify weaknesses in the portfolio and work with our borrowers to identify the best possible outcomes. 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.

Tim Crane: Great. Thanks, Rich. To wrap up our prepared remarks, we continue to believe that we are well positioned, perhaps uniquely well positioned to take advantage of the current environment with our diverse businesses. Over the last several quarters, we’ve taken steps to achieve an interest sensitivity position much closer to neutral. You can see some specific data on Table 8 in our press release. While we don’t believe that rapid rate cuts are warranted at this point, we are assuming that there will be 325 basis point rate cuts in 2024. With that assumption, as Dave mentioned, our net interest margin will be reasonably stable in a narrow range around the current level for the near term. More interest rate cuts above and beyond the three we’ve assumed would slightly pressure the margin but would also likely result in more favorable economic activity as an offset.

For example, improvements in our mortgage business and growth in commercial line utilization, which Rich mentioned is at currently very low levels. So to reiterate our prior comments, our target is to continue to grow loans in the mid to high-single digit range in terms of our percentage and to fund the loan growth through deposit increases at like levels. Our pipelines remain solid. And as Dave mentioned, we experienced strong growth at the end of the fourth quarter, which represents good momentum going into the first quarter of 2024. Overall, we’re pleased with the 2023 results, and we’re encouraged about where we start 2024. I know there’ll be some questions. So at this point, I’ll pause and we can turn it back to the host.

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Q&A Session

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

Jon Arfstrom: Thanks. Good morning, everyone.

Tim Crane: Good morning, Jon.

Jon Arfstrom: Hi. Maybe Tim or Dave just wanted to ask about some of the last comments you made, Tim, on your expectations for the margin to remain in the current range. Can you talk about what you guys are doing to protect the margin around these levels? I think about your loan growth guidance and the net interest income growth potential. It seems a little better than peers, particularly your loan growth, but just talk about how you’re protecting the margin and your confidence that we can maintain the current range absent greater than three cuts.

Tim Crane: Yeah. Thanks, Jon, and Dave can add to this. We’ve talked about the fact that we’ve got an asset sensitive loan book that continues to reprice and at this point, the repricing in our loan book is closely correlated to what we’re seeing in terms of the increase in deposit costs. We expect that for at least a short period going forward here that, that will continue to be the case and that the spread between our loan and deposits will be roughly stable. I would characterize stable as plus or minus some number of basis points, around 3.6. So we feel pretty good about that and we’ve baked in the three cuts starting in June. If those cuts are either deeper or more than I think we’ve got probably some pressure on the margin, but an offset in other parts of our business.

David Dykstra: Yeah. Another thing to focus, I think that’s true, the structure of the balance sheet also helps too. The premium finance book, which is a third of our portfolio, sort of lagged on the way up, but if rates go down, it also lags on the way down. So there’s benefit to us there. As you know, and as we’ve disclosed in the materials, we’ve got over $6 billion worth of interest rate derivatives that will also assist us if rates fall down. So, we were patient when rates went up to allow the margin to expand and we hit the upper threes, we felt like we should reduce that asset sensitivity and lock in the rates through balance sheet management and derivatives and we’ve tried to become relatively neutral on that rate, now, just by using both the structure and the derivatives to be somewhat neutral, here. So….

Tim Crane: The competition is out there. So we’ll depend on what the competition does with loan and deposit pricing if rates move. But right now, the way we look at the world, we think we can hold it pretty tight.

Jon Arfstrom: Okay. That’s helpful. Just one more revenue question just on mortgage. You touched on it, but obviously a tougher revenue quarter for mortgage, and I get it but, I think what you’re saying is originations look good, spreads were depressed and if we don’t have the same headwinds on the MSR maybe we can repeat the kind of quarter that we saw in the first quarter of ’23, is that fair Dave, maybe even potentially a little better.

David Dykstra: Yeah. I think that’s pretty accurate, Jon. I mean, our production revenue was down about $7 million — to about $7 million of production revenue. But that was higher than about $3 million of production revenue in 2022 and we had $8 million to $9 million of production revenue in ’23, so what we’re seeing is right now at least through the first part of January applications are ticking up, again, not wildly. But they are up from December and November and clearly they’re up from where we were in January of ’23. So, I would expect that, that revenue would sort of get back to those levels based on what we know right now. Again, it’s not going to be a spike up, but I do think we’re going to sort of return to where we’ve been in the previous few quarters.

And then hopefully that if the spring buying season hits, that mortgage rates are down a little bit. And hence one of the reasons some of the MSR values declined a little bit. But hopefully that decline in rate spurs a little bit of additional home buying activity come March and April.

Jon Arfstrom: Yeah. It will be interesting to watch. Just a little rebound would be good though. I agree on that. Okay. Thanks a lot guys. I appreciate it.

Tim Crane: Thank you, Jon.

Operator: Thank you. Please standby for our next question. Our next question comes from the line of Chris McGratty of KBW.

Chris McGratty: Hey. Good morning.

Tim Crane: Hi, Chris.

David Dykstra: Hi, Chris.

Chris McGratty: Maybe a question for Rich. I mean you guys have in the past fourth quarters I would say proactively built the reserve, when things are still good. Given where your reserves sit today, I guess, can you just speak to the potential need or desire to build reserves additionally in early 2024 or is this just kind of a, get ahead of it and build it while you can?

Richard Murphy: CECL doesn’t necessarily work that way. I mean, yeah, so, I mean, I — if you are asking me how the provisioning should work, it wouldn’t not necessarily result in the same things that we’re getting out of the CECL models. Because as Dave pointed out, I mean, we — the BAA spreads that, the way they reacted, definitely affected what we had to do in the fourth quarter. There is just — the loan growth affected it, and not necessarily what Rich Murphy thinks about the quality of the portfolio. I do think that what we’ve done, as you point out, at the end of last year, this year, was pretty material. And I think we have put ourselves in a very good position going forward. And if CECL works like it’s supposed to work, we’re actually pre-funding the losses that should accumulate down the road. So, I actually — I feel really good as to where the allowance is given the shape of our portfolio right now.