Wintrust Financial Corp Q2 FY2021 Earnings Call

Welcome to Wintrust Financial Corporation's Second Quarter and year-to-date 2021 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 reviews, the presenters may make reference to both the earnings press release and the earnings release presentation. Following their presentation, there'll be a formal question-and-answer session.

Good morning everybody and welcome to our second quarter earnings call. As mentioned, with me are Dave Dykstra, our Chief Operating Officer; Dave Stoehr, CFO; Kate Boege, our General Counsel; Tim Crane, President; and Rich Murphy, Vice Chairman of Credit. We'll stick with the format we started in the first quarter where I'll lead but as much as you can listen to Dave. David Dykstra will give us detailed analysis of the income statement. Tim Crane will talk about the balance sheet. Rich Murphy will provide an overview of credit, and back to me for some summary comments where I'll talk about the future. Of course there will be time for questions. Last April we started the pandemic and the government made a massive response to the economy and to the general interest rate environment. I indicated Wintrust's support would be steady; we'll try to go through it. Today we have capital, so far so good. The second quarter shows that the strategy is working. The growth has been — all of our growth today has been organic since that period of time. The second quarter was our million-dollar quarter I'd like to say. Assets surpassed the core loans. PPP loans grew by approximately $1 billion, plus or minus. Our growth prospects remain very good. The income for the quarter totaled $105 million or $1.70 per common share. Year-to-date income was $258.3 million or $4.34 per common share. Our reported net interest margin grew nine basis points to 2.63% and our net interest income was up $17.7 million versus Q1. Our backup PPP loan income — the NIM grew three basis points to 2.49% after backing out PPP loan income. Core loan growth and investment activity at the end of the quarter grew for the quarter three. Period-end loans exceeded average loans in the quarter by over $800 million. So we started Q3 with a nice position in our back pocket. Loan growth was excellent and our pipelines in our businesses remain very good. Utilization is an important metric; it is at an all-time low, about 38%–39%, and our normal average is closer to 50%. We'll go back there; we've got $1 billion of growth built in there.

I'll turn to Dave for a review of the income statement. I'll review the balance sheet maybe just for a second and then turn it over to Dave. As Ed mentioned, in the quarter assets grew $1.1 billion to $46.7 billion. A couple of items worth highlighting here: first, we experienced very strong core loan growth. Loans excluding PPP were up $1.2 billion in the quarter. Growth was spread nicely across loan categories, commercial real estate and our niche businesses. Rich will share a little more detail in a few minutes. On a percentage basis this $1.2 billion equates to 15% annualized growth and on a year-to-date basis our loan growth excluding PPP is just over 11% annualized. As Ed mentioned, we believe these growth numbers were solid. During the quarter we continued to see a decline in utilization, a trend that in the coming quarters we hope will reverse and will help rather than hurt our loan growth activity. In addition, the pipelines remain strong as we see evidence of accelerating economic activity in our markets. With respect to PPP loans, we saw a reduction of $1.4 billion as the forgiveness activity accelerated materially during the quarter. Total PPP loans at the end of the quarter were $1.9 billion, down from a peak of $3.3 billion at the end of the first quarter. For the remainder of the year, we remain comfortable with our loan growth target of mid- to high-single digits on a percentage basis. We could have upside with either improved line-of-credit utilization or continued strong market conditions. Deposit growth for the quarter was $932 million. The majority of the growth was in non-interest-bearing DDA; this represents annualized growth of nearly 10%. Deposit costs continue to fall as we primarily repriced term deposits. For the quarter, the cost of interest-bearing deposits fell an additional seven basis points to 38 basis points, a trend we expect to continue in the coming quarters. Notably, the non-interest-bearing DDA deposits now comprise a third of our total deposits.

Thanks Tim. As Ed indicated, I'll cover the noteworthy income statement categories starting first with net interest income. For the second quarter of 2021, net interest income totaled $279.6 million, which was an increase of $17.7 million as compared to the first quarter of 2021 and an increase of $16.5 million as compared to the second quarter of last year. The $17.7 million increase in net interest income compared to the first quarter was primarily due to earning asset growth, which is up 9% over the prior quarter, net interest margin expansion and one additional day in the second quarter. For your reference, one additional day approximates $3 million of net interest income for Wintrust. The net interest margin improved nine basis points from the prior quarter to 2.63% as the rate on interest-bearing liabilities declined seven basis points in the second quarter as compared to the prior quarter. A four-basis-point increase from the yield on earning assets was partially offset by a two-basis-point decline in our net refund contribution. The four-basis-point improvement in the yield on earning assets was comprised of a three-basis-point increase on the yield on loans and a 13-basis-point increase in the yield on liquidity management assets through the deployment of a portion of our liquidity into investment securities late in the first quarter.

Thanks, Dave. As noted earlier, credit performance for the quarter was very solid from a number of perspectives. Loan growth net of PPP was $1.2 billion and this growth was across the portfolio, but a couple of areas really stood out. First, insurance funding, where we finance commercial insurance premiums, grew by $563 million, an outstanding quarter, which was the result of a number of new larger relationships, a hardening market, which took our average premium up to $39,000 from $34,000 in the first quarter, and the continued popularity of financing insurance premiums due to lower interest rates. Wintrust Life Finance grew by $248 million or 16% annualized. As we have seen, this product has grown by over a billion dollars over the past year as more people are looking at life insurance as a key part of their estate plan, and the market allows them to finance the product at historically low rates. From a core loan perspective, commercial loans excluding PPP grew by $148 million, or 6.3% annualized, most of which closed at the very end of the quarter, and commercial real estate loans grew by $134 million, or 6.3% annualized as well. A couple of additional notes on loan growth: pipeline levels continue to look very strong. The total core pipeline is approximately $1.3 billion, consistent with what we saw in Q1. As Tim pointed out, while we are pleased with the overall level of core loan growth, we think that the number is impacted by the level of line utilization, which fell to 38% in Q2 compared to pre-pandemic levels in the upper 40% range. This lower utilization resulted in funded balances being reduced by approximately $1 billion. I'd also like to point out the granularity within the portfolio. As we have talked about in prior quarters, one of the keys to our credit portfolio has been diversification across a number of product lines. This quarter was a great example of that strategy: while we continue to have good, consistent growth from our core portfolio, our niche products have allowed us to grow the overall portfolio well ahead of projections. In addition, slide 12 details the geographic diversification in our portfolio. As we have stated before, Wintrust will always have a Chicago–Milwaukee nexus. However, as this slide illustrates, our various product lines provide us with a meaningful amount of credit opportunities outside of our primary markets. From a credit quality perspective, as detailed on slide 13, we continued to see meaningful improvement in credit performance across the portfolio as the economy continues to recover from the pandemic. This can be seen in a number of metrics. Non-performing loans reduced from $99 million at the end of Q1 to $88 million at the end of the second quarter. This is roughly half the level of NPLs we saw at the end of the third quarter of 2020. We recorded $2 million of net charge-offs during the quarter, which was down from $13 million in the previous quarter. This is a very good quarter from a charge-off perspective and was helped by a number of recoveries, primarily out of the insurance funding portfolio. We also saw a reduction of over 40% in COVID-19 modified loans from $254 million to $146 million during the quarter, as outlined on slide 19. The majority of these remaining modified loans are primarily in our select high-risk impact industries and credit ratings continue to show a meaningful, positive migration as our customers continue to recover. Finally, on PPP, as outlined on slide 14, we funded $4.9 million to more than 44.9 billion to more than 15,000 different businesses through the PPP program. We cannot be happier with the results from this program and the positive effects on our customers and community; it was an enormous team effort. We are so proud of the employees of Wintrust who made it possible. We are now focused on working with our customers to process their applications for forgiveness. This is proceeding very well as we have now processed forgiveness applications for over 90% of our 2020 PPP loans and over 85% of those loans have received their final forgiveness decision. That includes my comments and I'll turn it back to Ed to wrap up.

Thanks Rich. As I mentioned earlier, the core strategy throughout this has been to grow the business even in a pretty low-rate environment. These are structural hedges, like mortgages, to buffer the loss of net interest income until such time as balance sheet growth can offset the income loss. Due to the lower rates and PPP volumes, we adjusted our expected benefit and added onto this strategy. All of the above was accomplished by enhancing our asset sensitivity position in anticipation of essentially higher rates and to achieve growth. For the year, we asked for the $1.7 billion core loan growth; the core loan was $1.7 billion, swing loans held for sale and PPP. We've experienced all this, as Tim laid out, and it has been done on a totally organic basis. The acquisition market, which has been sleeping, today appears to be picking up based upon the amount of inbound calls we've received lately. So we're still having a high expectation; we'll see where all this ends up. As Rich said, the pipeline was extremely strong across all our major categories. I have said since the beginning that if the position is where we want it, we could take advantage of it. We continue to ladder into our investments and our excess liquidity takes advantage of market flips. There's no rush to be totally invested and lock into low long-term rates. It doesn't make a lot of sense. Plus, credit is remarkably good thanks to our consistently conservative credit standards. I wish our loan portfolio both with our lending line and credit folks and NPLs are lower than they were before the start of the pandemic. This area is delivering strong results and our administration continues to grow. So to date, the plan is working. We need to continue to execute in order to bring this plan to full realization. Organic growth should remain strong. We'll take advantage of the opening of the acquisition market if it actually makes some sense, as well as this core wealth that would offset any reduction in PPP loans. And we seem to be doing that. I think that at the end of the day, if we get another $1 billion loan-growth quarter by the end of the year, we should have made up the PPP loans and that should actually help our margin and our net interest income. Overall, we feel very good about where we are right now. The plan is achieving what we set out to achieve and I'm going to continue to take what the market gives us. With that, I turn it over to questions. Thank you.

Now, first question, coming from the lineup, John Austin with RBC Capital Markets is open.

Thanks. A couple of questions on some of the expectations here on mortgage and NII and expenses. I did want to ask on the loan growth: Tim, you talked about accelerating economic activity, and Rich, you talked about a little bit higher commercial at the end of the quarter. I'm curious what you guys are seeing outside of the premium finance businesses in terms of some of the growth potential there — is it starting to broaden out — and then just the sustainability of the premium finance growth as well?

Yeah, I'll take the core question first. I think we are seeing our customers feeling much better about the prospects going into the back half of the year. Confidence has really improved dramatically. There are obviously some headwinds that are making people nervous — labor availability is an issue, and the uptick in COVID cases has people a little anxious — but overall we are feeling pretty good about where our customers are. I think you will see line utilization increase as we go into the back half of the year. As we've talked about in the past, the concept of becoming Chicago's bank has really started to happen. We really feel like at this point in time we are a go-to bank in terms of new opportunities; the pipelines are very good and I think we'll continue to bring more customers on as a result of the disruption that's been in the market. The most recent announcement related to First Midwest helps us as well. So we're pretty confident about where core loan growth might be going into the back half of the year. As it relates to first insurance, I think the hard market is not going away anytime soon. The team on that side has done a very good job of bringing in new relationships, and with the hard market there is a lot of strong momentum there. On the life side, similarly we had anticipated that things were going to begin slowing down in the back half of the year, but in talking with that team as recently as yesterday, they're also feeling very good about where the back half of the year could go. So we're not changing our guidance, but we're feeling comfortable that momentum will continue at least through year end.

Okay. Talking about estate planning and estate taxes in that regard — so they're doing something right for us.

That's good. Question for you, Dave: this is a more difficult question, but when you think about the mortgage line — and I know there's a lot that goes into it — the business really took off when the pandemic hit. When you look at some of the numbers prior to the pandemic, it was in this $50 million-a-quarter range, and I'm just wondering if there's anything materially different about your business today than where it was pre-pandemic other than rates. I'm trying to get at longer-term expectations of the business. Anything you can do to help us out on that, I'd appreciate it. Well, I think the mix between Veterans First and the retail business has been fairly stable. Refi volume has obviously dropped off a little bit, although with the recent rate movement it looks like that may be picking up a little bit as people come back. Longer term, I think we have better technology and better tools to reach people than we did before, and those tools help our originators to serve their customers better and do more deals. So I think our technology is better, but at the end of the day it's still good old-fashioned service with improved technology. I don't see anything substantially different between that mix of business or our ability to serve customers. As we continue to expand our footprint into different areas of our market, we can hopefully pick up additional customers, but I wouldn't say it's dramatically different — it's improved product and service model.

Your next question coming from the line of David Long with Raymond James. Your line is open.

Just as it relates to deposits, you've had some very good deposit growth and a lot of liquidity has been created. Is your sense that these deposits are sticky? Are these new relationships that are going to remain on your balance sheet for quite some time or, as things improve and customers start to spend again, do you see a drop off in those deposits?

Well, judging by the activity in our tertiary areas, these are all new relationships for the most part. A lot of it is leftover from the PPP loans; we picked up close to 500 new customers as we brought them in. Those are pretty sticky. They are full relationships. Tim, your thoughts?

Yeah David, we're watching it carefully, but we feel pretty good. We're continuing to add households. We don't disclose specific numbers here, but we see the digital lift that everybody else is reporting. Folks have good tools. We've added a couple of branches, which will continue to bring a few more customers online between now and the end of the year. So again, we'll watch it carefully, but so far it's been pretty sticky.

Got it. And then on the lending side — the commercial side, your core C&I stuff — as far as the competitive backdrop, we talked a little bit about that, but internally are you guys doing anything differently? Are you able to loosen anything in your underwriting, or how have you changed internally your willingness to lend on the commercial side over the last few quarters?

Well David, I say this often: we do not change our loan policy or our pricing decisions lightly. Those are sacrosanct. We're not seeing any more exceptions or deviations from our profitability models. So to say we would do anything differently, I would say no — we're not changing our credit stance at all. We never do that lightly. Murphy, your thoughts?

Yeah, I would agree with that. It's something we talk about on a regular basis in our credit meetings because the market is very competitive. Pricing competition is very hot and structural competition is pretty aggressive. So we're very mindful of that topic and we have to know where the lines are. We have really good communication between the lines and our credit people to make sure we're all on the same page, and I think we've done a pretty good job so far in that regard. One note: as we continue to grow, we look at different niches all the time and want to broaden out our product suite. That would probably be the only thing we might look to do as we grow forward — different areas like parts of our leasing group or aviation finance, and we've talked about our money services group. Those are things we want to continue to evolve as opportunities present themselves.

And then just a final follow-up with the PPP and the additional relationships that you talked about — maybe you're seeing it on the deposit side — are you seeing that in your loan numbers today? Are your former PPP customers borrowing yet? Are you seeing any loan growth attributed to these new relationships yet?

Yeah, David, there's two sides to that. It's been a substitution in some cases and part of the reason you're seeing utilization down, but we've also added new relationships. We track the larger ones: there's over $0.5 billion in commitments already on the books with more to come and utilization there is better than our utilization overall. So we still feel good about that. We've got more activity and we're probably half to three quarters of the way through the PPP prospect pipeline.

Yeah, unfortunately it just takes longer to bring the lending side of the relationship over. There's a lot of work that needs to get done in terms of getting the loan structure, getting it approved, getting it documented and working through payoffs. But it's definitely coming. We see it on a weekly basis; we see new opportunities that are coming as a result of our work with PPP.

Market disruption has been very helpful. There's still some hangover from that which has benefited us. Private deals, same thing — now we're starting to see more of that. We're seeing opportunities that we never saw before. And obviously First Midwest's move is something to watch. Any sort of market disruption is good for us because it creates decision points; we want to be at the table if people are going to change. We've been very successful at that.

Our next question, coming from the line of Terry McEvoy with Stephens.

Hi. Good morning everyone. Maybe Dave, a question for you on your mortgage outlook: what type of production margins are you thinking about over the near term? That top-left graph on page 10 shows a pretty steep decline down to 2.2% last quarter.

Yeah, it's impacted a little by the way we presented it because of declining pipeline and some inventory changes. We also had a bit of volatility in the secondary market: last quarter we had gains, this quarter we had some small losses. I think we're thinking about mortgage production margins more in the 3% plus or minus range next quarter, excluding any major changes in the pipeline.

Thanks. And then as a follow-up question, I'm not sure if you're just being cautious or maybe trying to tell us something, but the last two press releases' final quote has been the exact same: something along the lines of evaluating expenses on an ongoing basis to enhance profitability. Should we read into that — is there some expense plan coming or is it more that you are consciously always aware of expenses?

We are always looking at expenses and working them through. We still are a growth company and we're going to invest in the company. We have a number of branches opening up in markets where we haven't been yet; those will cost money to get up and running. Contrary to what somebody might believe, we watch our expenses very closely. We had a net overhead ratio in the mid-130s this quarter. That's about where we think we'll normalize, but it could be up or down depending on other activities. Mortgages skew things quarter to quarter because there are many moving parts: sometimes we record the income in one quarter and the expenses in the next, so they can look uneven. All in all, with the mid-130s overhead ratio, our goal is to be in that area on a normalized basis and we're comfortable, but that doesn't mean we don't always look at expenses and try to manage them down.

Next question coming from the line of Brock Vandervliet with UBS.

David, I just wanted to follow up on your mortgage commentary. Was there anything to call out regarding Veterans First — that volume dropped by about a third or so and it seemed to drop harder than the rest of the business?

Yeah, I think their business is more heavily weighted toward refinance activity, and that part of the market got hit harder. In our footprint, customers walking into the bank with an existing relationship are more likely to do purchase activity, which has held up better. So it's really driven by mix differences between purchase and refinance.

Okay. And just kind of combining securities growth and what you may retain on the balance sheet for the mortgage bank: I think you've given guidance around 10% of production you'll retain on balance sheet. How should we look at that versus how you may grow the investment securities book in this environment? It sounds like you're pretty cautious about growing the securities book given the rate environment.

Yeah. Our thought was to keep a lot of the jumbo mortgage production on our books — historically around $100 million — and then we also generally keep maybe another $100 million or so of other products we originate in the bank, some non-standard or variable-rate products. So probably a couple of hundred million in total that we would add to the balance sheet per quarter would be a rough number. On the liquidity side, you're right: we were essentially flat quarter-end to quarter-end because mortgage-backed rates backed off a bit. We're being cautious about investing that liquidity. Taking 1.75% or 1.80% for long-term instruments doesn't seem appealing right now, so we're going to be patient and hope to grow the loan portfolio and deplete some of that liquidity. We view that as an opportunity; it may suppress earnings in the quarter a little by not investing at long-term low rates, but we look at it as an opportunity to grow NII and improve the margin, so we're being patient rather than locking into low rates.

Got it. Thank you.

Our next question, coming from the line of Nathan Race with Piper Sandler.

Good morning. A couple of questions on capital: the stock came in a little bit along with the rest of the group. Just curious to get some updated thoughts on returning to buybacks?

We've got money left under our prior authorization, so if the time is right we will utilize that and go from there. We look at it all the time vis-à-vis where to deploy capital — where to invest, whether to buy back stock or pursue acquisitions. We have about $33 million, plus or minus, available under the prior authorization. If market conditions are right, we can look at buybacks; we evaluate it constantly.

Got it. And along those lines on acquisitions: I think in the past you've spoken to an appetite to do a larger acquisition. I'm curious how that appetite stands today given your organic growth and the currency where it's at. How large a deal would you potentially want to do and does the current organic growth trajectory make M&A less of a focus?

I would say it depends on what the market gives us. For years the market gave us deals under a billion dollars at reasonable prices. There are deals in the market anywhere from under $1 billion to $2–3 billion, but we aren't going to do anything that destroys shareholder value. We won't give up years' worth of earnings just to grow. We still have attractive organic growth, so we'll stick with that unless a deal comes along that makes strategic sense. As to size, the market is kind of limited in our geography. We will look at anything that makes shareholder and franchise sense. Inbound calls have picked up a lot, but price expectations on many of the deals we've reviewed don't fit our criteria. If a local bank sells to somebody else, that could be beneficial for us. Disruption tends to open opportunities. It's getting harder for banks of $2–3 billion to stay competitive because of the technology and regulatory costs. So we need to be disciplined. If a good deal comes along at the right price, we would consider it, but right now organic growth is very attractive.

Yeah, that makes sense. Given the organic growth runway in front of you, that's probably less of a focus, but obviously you remain open if something strategic appears. Thanks and congrats on the quarter.

Yeah. I'll add briefly: we'll be 30 years old in December. We have a good chance of hitting $50 billion just through organic growth over the next several years. People always ask how big we want to be; I don't know exactly where we'll be five or ten years from now. We'll take what the market gives us if it makes sense. We'll continue to grow profitably and preserve shareholder returns; we operate on growth, profitability and growth in tangible book value. Anything that advances those objectives is of interest.

Our next question, coming from the line of Julien Brush with Truist Securities.

Hey, this is Michael Young on for Truist Securities. Thanks. As loan growth broadens out beyond some of the premium finance categories, would you expect those loan yields to be accretive to the overall loan yield? What's the pricing environment telling you that would cause that to happen or not?

Yeah, we have a very strict pricing model and we're not going to do things that aren't accretive to where we want to be. We monitor pricing closely and we won't compromise our pricing model just to win business. So overall, we remain disciplined and focused on returns.

Okay. And maybe a follow-up on the expense commentary related to mortgage: you guys are seeing quite strong loan production so I would assume there's some natural inflation to the expense run rate, but with the offset of that $8 million potential reduction depending on production levels, is that the right way to think about it — those two pieces?

I'm not sure I follow entirely, but the way I would frame it is that we think about roughly an $8 million net improvement in profit assuming the revenue level is in line with the prior quarter. If production revenues go up materially — say additional millions — I would expect expenses to go up a little bit as well. But you should be able to maintain that delta of roughly $8 million profit improvement on the mortgage business, assuming similar revenue levels quarter to quarter.

Okay, perfect. Thanks.

Your next question coming from the line of Chris McGratty with KBW. Your line is open.

On asset quality: you guys have historically been quick to work out problem assets and it has served you well over cycles. Given the amount of bids for assets across the industry, are there any portfolios that you guys are effectively looking to reduce exposure to given prices are high today?

Chris, we've done asset sales in the past and we're always going through the portfolio to find where potential weak spots exist and to test the market. We're open to that concept. We've done well getting maximum value on assets we've worked through. In the past when pricing discounts were too large we weren't willing to accept them, but if that gap narrows we might take a look at portfolios where we see some distress. Generally speaking, we take it deal by deal and work through it. No specific plans at this point.

I'm showing no further questions at this time. I would now like to turn the conference call back over to Mr. Edward Wehmer for closing remarks.

Thanks everybody for listening in. Our goal is to continue to increase all the important things in the right way and avoid decreases. With that, thanks very much and we'll talk to you again in three months. If you have any further follow-up questions, please feel free to call anybody who was on the call. Thank you.