Earnings Call Transcript - WTFC Q3 2021

Operator, Operator

Welcome to Wintrust Financial Corporation's Third Quarter and Year-to-Date 2021 Earnings Conference Call. A review of the results will be made by Edward Wehmer, Founder and Former 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 references to both the earnings press release and earnings release review 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 on file 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 would now like to turn the conference call over to Edward Wehmer.

Edward Wehmer, Founder and Former Chief Executive Officer

Thank you very much. Welcome, everybody, to our third quarter earnings call. As mentioned, with me are Dave Dykstra, Dave Stoehr, Kate Boege, Tim Crane and Rich Murphy. We have the same format as we instituted earlier this year. I'm going to give some general comments regarding our results, forward to Tim Crane for more detail on the balance sheet, then to Dave Dykstra for other income and other expense. And Rich Murphy will discuss credit, back to me for some summary comments and thoughts on the future and then time for questions. On the overview, all in all, a very successful quarter. I can almost give the same comments made at the end of Q2. At the end of last April, the start of the pandemic, the government's massive response to it indicated Wintrust was supposed to be — it was going to attempt to grow through it. Then we've accomplished this goal and as such, third quarter shows the strategy is working. All our growth to date has been organic. Second quarter was another all around $1 billion quarter. Assets, deposits, core loans, PPP loans all grew by over $1 billion. Both prospects remain very good. Of particular note, core loan growth resulted in an overall increase in total loans for the quarter even after PPP runoff. We're able to achieve another $1 billion loan quarter in Q4 which we believe is more than a reasonable assumption given our pipelines which, by the way, are at a 13-month high at quarter end. We will fully replace all the PPP balances. This was our intent before we embarked on this strategy. The income for the quarter was $109 million or $1.77 per diluted common share. Year-to-date, we were $367.4 million or $6 per share. Important, net interest margin decreased 4 basis points to 2.59%, primarily due to excess liquidity. Net interest income was up $19.7 million from quarter two. If you back out the PPP loan income, in total, net interest income is up almost $8 million over quarter two. Period-end loans exceeded average loans of the quarter by $607 million which bodes well for Q4. Our liquidity portfolio is up $1.563 billion on average — this portfolio remains very short; over $5.2 billion overnight money at the Fed. Investing this money as rates rise is a lever we can pull when the time is right. Growth, as I say, was excellent in all areas of our business and our current pipelines. Line usage remains low, a little over 39%, up around 1% from the end of quarter two. Hopefully we hit bottom on this and line usage will start to increase. Normal average is closer to 50%; a return to that would add another $1 billion in outstanding loans. Credit quality is even better, charge-offs totaling near net zero. We had some charge-offs but we have recoveries, which should indicate to you our recoveries often are good. NPLs and NPAs were constant versus Q2. NPLs were $90 million or 27 basis points. NPAs shrunk by $2.5 million to the same 22 basis points. This, plus improved portfolio quality and Moody's sunnier view of the overall economy, resulted in a reserve release of $7.9 million. Mortgage experienced some growth in the quarter. Dave will discuss in detail. Wealth Management continues steady improvement; fees up $1 million quarter-over-quarter, up $18 million year-to-date. I'll turn the call over to Tim who will provide some detail on the balance sheet. Tim?

Timothy Crane, President

Good. Thanks, Ed. I'd like to briefly highlight a few balance sheet items as well as cover two topics that appear to be of interest. First, with respect to the balance sheet, total assets increased to just under $48 billion as we continue to experience strong growth. As Ed mentioned, loans excluding PPP grew $1.2 billion during the quarter, essentially mirroring last quarter's growth. The growth was spread across virtually all loan categories, as Rich will discuss in a few minutes. On a percentage basis, this is the second straight quarter where annualized loan growth, again excluding PPP, was approximately 15%. With respect to PPP loans, we saw a reduction of approximately $800 million during the quarter. At this point, almost all of the PPP loans originated in 2020 have been forgiven and approximately half of the loans from 2021 either have been or are in the process of being forgiven. By year-end, we project the remaining PPP balances will be down materially and the remaining income impact to be relatively small. For the remainder of the year, we are comfortable with our loan growth target of mid- to high-single digits on a percentage basis. Again, Rich will provide some additional color on loan pipelines and the factors that would drive potential upside to that number. Deposit growth for the quarter was also strong, $1.1 billion, almost all of it either DDA or low-cost deposits. This is an annualized growth rate of approximately 12%. Despite the high levels of PPP forgiveness, we are not seeing unusual volatility in customer deposits. This quarter, the interest-bearing deposit costs fell another 9 basis points to 29 basis points. This is largely a function of CD repricing. Deposit costs will continue to decline but at a slower pace in coming quarters. As we've noted in prior periods, we continue to monitor the deposit growth carefully given the high levels of liquidity in the market. However, we've used stable, low-cost deposits as a strength of the company and we'll continue to pursue deposits related to client relationships. On the investment front, we remain very liquid. During the quarter, our securities balances were up slightly as we replaced investments maturing but generally have not yet moved to deploy the large amounts of excess liquidity as we remain wary of locking in low long-term yields. As the market continues to trend up, we will evaluate our position and view appropriate deployment of this liquidity as an opportunity in future periods to improve the margin and income. Our capital levels remain appropriate given the conservative risk profile of the bank. You will note that during the quarter, we repurchased approximately $9.5 million worth of stock at just over $71 per share. Given where we believe volumes and yields will land, we continue to expect that despite lower PPP accretion, net interest income will increase as it has for four consecutive quarters. And that excluding PPP, the margin will remain roughly stable. I have two other brief comments that relate to new slides in the earnings release presentation. The first has to do with digital adoption. You'll see on Page 9 of the presentation that our high-touch community banking model also has a high-tech component and that we are seeing the same increases in digital adoption and usage that some larger banks have reported. We continue to upgrade our digital capabilities to give clients options on how they would like to be served. These capabilities position us to compete successfully and in some cases to differentiate ourselves versus our competitors. Currently, you'll see that a full two-thirds of our checking clients regularly use our digital services. Page 10 of the presentation document is also a new slide, relates to the customer satisfaction of our commercial clients. In this case the source is Greenwich data, and as you can see Wintrust is top ranked across a host of important categories. To scale this for you, the 97% overall satisfaction score Wintrust achieved compares favorably to scores in the 60s and 70s for many of our competitors. The service we provide increases the depth of our relationships and is the foundation for strong momentum in the Illinois and Wisconsin markets as well nationally in many of our niche businesses. With that I'll turn it over to Dave.

David Dykstra, Vice Chairman and Chief Operating Officer

Great, thanks. As Ed mentioned I'll cover the income statement categories. Starting with net interest income, for the third quarter of 2021 net interest income totaled $287.5 million; that was an increase of $7.9 million compared to the second quarter and an increase of $31.5 million as compared to the third quarter of last year. The $7.9 million increase in net interest income compared to the second quarter was primarily due to average earning asset growth which was up on an annualized basis by 12.5% over the prior quarter and one additional day in the third quarter which was offset somewhat by compressed net interest margin. Net interest margin declined 4 basis points to 2.59%. The beneficial decline of 8 basis points for the rates paid on liabilities was offset by a 10 basis point decline in the yield on our average earning assets and a two basis point decline in the net free funds contribution, which then resulted in the slight decline in net interest margin. The decline in the yield on earning assets in the third quarter as compared to the prior quarter was primarily due to the impact of building short-term liquid assets. The decrease in the rate paid on interest-bearing liabilities as compared to the prior quarter was primarily due to the 9 basis point decrease in the rate paid on interest-bearing deposits due to the repricing of time deposits. I think it's important to know that net interest income expanded despite $11.4 million of less interest income associated with the PPP portfolio in the third quarter which included $7.8 million of lower PPP loan fee accretion. Net interest margin excluding the PPP portfolio was relatively stable as it declined by only one basis point. Turning to the provision for credit losses. Like many other banks this quarter, Wintrust again recorded a negative provision for credit losses of $7.9 million compared to a directionally similar negative provision of $15.3 million in the prior quarter and a $25 million provision expense recorded in the year-ago quarter. The negative provision was driven by a reduction in the allowance for credit losses primarily due to improvements in the loan portfolio characteristics during the quarter, including decreases in net charge-offs and COVID-related loan modifications and improving loan risk rating migration. Rich will cover credit quality in additional detail in just a few minutes. I will now talk about the non-interest income and non-interest expense and income tax sections. In the non-interest income section, our Wealth Management revenue increased $841,000 to another record level of $31.5 million in the third quarter compared to $30.7 million in the second quarter and that revenue was up 26% from the $25 million recorded in the year-ago quarter. The revenue source has been positively impacted by higher equity valuations which impact the pricing on a portion of our managed asset accounts. Mortgage banking revenue saw reasonably solid loan origination volume during the third quarter with origination activity fairly consistent with the second quarter of this year. To that end, the company originated $1.6 billion of mortgage loans for sale in the third quarter of 2021 down from the approximately $1.7 billion that we originated in the prior quarter. As we forecasted on our last call, mortgage banking revenue increased to $55.8 million for the third quarter of '21 as compared to $50.6 million in the second quarter. Revenue was higher in the current quarter, primarily due to a less material unfavorable fair value adjustment on our mortgage servicing right portfolio. The company recorded a $5.5 million negative valuation adjustment in the second quarter as compared to a smaller decrease of $888,000 in the current quarter. Looking forward based on market conditions and expected seasonality of home purchasing activity, we anticipate mortgage origination for sale in the fourth quarter 2021 to be down 20% to 30% from origination values we experienced in the third quarter and mortgage revenue excluding the MSR valuation adjustments to be down similarly. Also, as you saw in the first three quarters of this year the wildcard related to mortgage banking revenue is the mortgage servicing rights valuation which is tied closely to mortgage interest rate movements. And I'm not going to speculate on where those rates are going to move to. But our previous forecast of a reduction of 20% to 30% excludes any change in the MSR valuation. Other non-interest income totaled $23.4 million in the third quarter of '21, up approximately $3.0 million from the $20.4 million recorded in the prior quarter. The primary reasons for the higher revenue in this category include $2 million of higher swap fee revenue, $2.2 million of higher income from investments in partnerships which are primarily related to CRA purposes, a positive swing of $859,000 in foreign exchange valuation adjustments associated with the U.S.-Canadian dollar exchange rate, $812,000 of higher BOLI income and offsetting those increases was the fact that the prior quarter included a $4 million gain on the sale of a few branch locations in southwestern Wisconsin and there were no such similar gains in the current quarter. Turning to non-interest expense; non-interest expenses totaled $282.1 million in the third quarter, up approximately $2 million from the $280.1 million recorded in the prior quarter. There are a handful of categories that I'll address that comprise the majority of that net increase. Salaries and employee benefits expense actually declined by $1.9 million in the third quarter as compared to the second quarter of this year. The $1.9 million decline is primarily related to $6.3 million of lower compensation expense associated with the mortgage banking operation offset somewhat by higher incentive compensation expenses for annual bonus and long-term incentive compensation plans. Advertising and marketing expense totaled $13.4 million in the third quarter, an increase of $2.1 million compared to the second quarter of 2021. The increase in the third quarter relates primarily to increased sponsorship activity for the summer months, including our major/minor league baseball sponsorships and more community events occurring. We would expect this expense level to decline in the fourth quarter as many of the sponsorships are geared towards the summer months. Software and equipment expense totaled $22.0 million in the third quarter, an increase of $1.2 million as compared to the second quarter total of $20.9 million. The increase is due to increased expenses associated with upgrading our data centers for increased capacity, scalability and reliability; other network upgrades to support our growth and ongoing digital enhancements; and various other software upgrades. As we've done over the last few years, we've continued to invest in software and technology to enhance our customer experience and delivery systems and products as well as to invest in systems to support our growth. And as Tim mentioned, our customer satisfaction results are great, and so I think the investment in those systems is paying dividends. OREO expenses were actually negative by approximately $1.5 million in the third quarter as the company recorded gains of approximately $1.9 million on the sale of OREO properties. These gains exceeded the aggregate cost of OREO expenses and valuation charges on other OREO properties. The miscellaneous expense category totaled $23.4 million in the third quarter compared to $21.3 million in the second quarter of this year, an increase of $2.2 million. The increase was primarily impacted by approximately $1.7 million of more travel and entertainment expenses and a variety of other smaller fluctuations. The increase in the travel and entertainment expense category was due to increased costs associated with in-person client relationship meetings and conferences as well as some additional expense associated with an all-employee event to celebrate Wintrust's 30th anniversary and to thank our employees for performing so well during the pandemic. Although this expense category is higher in recent quarters, it's still lower than the general run rate we had in prior periods before the pandemic began and we're encouraged to see our team returning to more normal in-person events to build and maintain solid customer relationships. This activity is important to maintaining the strong loan growth we've been achieving in recent quarters. Other than those expense categories I just discussed, all other expense categories in the aggregate were up by less than $1 million compared to the second quarter and nothing of significance to discuss there. The net overhead ratio, a measure of our operational efficiency, improved in the third quarter relative to the prior quarter. The net overhead ratio stood at 1.22% which is down 10 basis points from the 1.32% recorded in the second quarter. The ratio continues to benefit from strong balance sheet growth and good mortgage banking results. Our current target, assuming a relatively normal mortgage activity, is for the net overhead ratio to stay below 1.35% due to the strong balance sheet growth and the focus on expense control relative to revenue growth. I should note that the efficiency ratio also improved in the third quarter relative to the prior quarter. The efficiency ratio stood at 66.13% in the third quarter, a decline of 253 basis points from the prior quarter. Moving on to the income tax expense, the effective tax rate was relatively stable at approximately 27% which is in a range that we would consider normal. In summary, core fundamentals were strong with robust loan and deposit growth, increased net interest income despite significant PPP loan reductions, record wealth management revenues, stronger mortgage revenues, improved net overhead and efficiency ratios, strong pipelines and very good credit quality. So with that summary, I'll conclude my comments and turn it over to Rich.

Richard Murphy, Vice Chairman and Chief Lending Officer

Thanks, Dave. As noted earlier, credit performance for the third quarter was very solid from a number of perspectives. As detailed on Slide 4 of the deck, loan growth for the quarter, net of PPP, was $1.2 billion or 15% annualized, well above our guidance. Equally as important was the nature of this growth which was spread across our loan portfolio. Specifically, C&I loans were up $543 million, CRE loans were up $207 million, Wintrust Life was up $296 million and First Insurance Funding was $95 million. Throughout the pandemic, we have seen solid and consistent loan growth. If you look at Q3 2020 compared to Q3 2021, we have seen total loans net of PPP grow by $3.4 billion or 12%. On our last earnings call, we expressed confidence in our ability to continue to meet or exceed our loan growth guidance because of the strength of our core loan pipeline. We believe this momentum is attributable to a number of factors: the PPP halo effect which is really taking hold on the level of commercial loans; we have seen substantial expansion in the numbers and amounts of treasury management relationships over the past several quarters but it takes time to move the entirety of the credit relationship out of the incumbent bank; we are now seeing those effects resulting in outstanding balances. Market disruption has been pronounced throughout this year and throughout the pandemic and we have seen customers and bankers look to Wintrust as a consistent and preferred banking partner in Chicago and southern Wisconsin. As a result, pipelines continue to look very strong and at the highest levels we've seen in several years. Finally, as detailed on Slide 17, after five quarters of decrease in C&I line utilization, the trend is beginning to reverse. As noted in earlier calls, this utilization has historically been close to 50%. We saw this level bottom out in Q2 at 38.4% and we ended Q3 at 39.3%. We believe this trend of increased usage will continue in the fourth quarter. As discussed in prior quarters, one of the keys to the performance and growth of our credit portfolio has been diversification across a number of product lines. This quarter was another great example of that strategy. Our niche products, particularly premium finance and leasing, grew substantially during the pandemic. Now we are beginning to see very strong growth coming from our core banking customers. In addition, Slide 15 details the geographic diversification in our portfolio. As we have stated before, Wintrust and the Chicago, Milwaukee networks are central; however, as this slide illustrates, our various business lines provide us with meaningful amounts of credit opportunities outside of these primary markets. From a credit quality perspective, as detailed on Slide 16 we continue to see solid credit performance across the portfolio as the economy stabilizes. This can be seen in a number of metrics. Non-performing loans remained flat and ended at approximately $90 million or 27 basis points. NPLs continue to be at record low levels and roughly half of where those were at this time last year. Charge-offs for the quarter were essentially zero, an amazing result, especially when looking at total charge-offs of approximately $2 million for the past two quarters combined. And as noted in the bottom right quadrant of Page 16, credit risk rates continue to show meaningful positive migration as our customers continue to recover from the pandemic. That concludes my comments on credit and I'll turn it back to Ed to wrap up.

Edward Wehmer, Founder and Former Chief Executive Officer

Thanks, Rich. Those of you who examined transcripts of our earnings calls, there was a lot of similarity between this quarter and the last, both in expense and consistency. As I mentioned at the beginning of the call, our strategy has been to grow the balance sheet during this period of low rates, use our structural hedges like mortgages to both offset loss and support NII until such time as balance sheet growth can offset the income loss due to lower rates. PPP provided an expected benefit to add on to this strategy. All of the above should be accomplished by enhancing our assets and positioning for eventual higher interest rates. Excellent balance sheet growth: asset and deposit growth of $4.1 billion year-to-date and loan growth of $3.4 billion, excluding loans held for sale and PPP. This growth, as Tim laid out, has been done totally on an organic basis. The acquisition market remains somewhat consistent with quarter two based on the amount of inbound calls we continue to receive. Sellers still have very high expectations, so we'll see where this ends up. Loan pipelines remain strong in all major categories and, as I said at the beginning, are at a 13-month high. This is aided by not only our reputation but also market disruption and our diversified portfolio. Our asset sensitive position is right where we want it. It appears that the theory that inflation is transitory may be coming to an end and rate increases are inevitable. The underwater beach ball will rise and hopefully soon. We continue to be prudent in new investments with our excess liquidity; taking advantage of market flips where locking into long-term rates doesn't make a lot of sense to us. Credit is remarkably good, thanks to our consistently conservative underwriting standards and diversified loan portfolio; our NPAs and NPLs are lower than they were before the start of the pandemic. Wealth Management is delivering strong results with assets under administration continuing to grow. So, to date, the plan is working. We need to continue to grow in order to bring this plan to fulfillment. Organic wealth should remain strong while taking advantage of the acquisition market when it makes sense. As mentioned, we will soon celebrate our 30th anniversary as we approach a $50 billion bank with $35 billion in assets under administration. Our Wealth Management group is beyond any thought of where we'd be at this point in time. So, I was a couple of guys in here at that original table. And I think you could pinch us if you knew where we are and what our prospects are going forward for the next 30 years. You can be assured of our best efforts going forward. We appreciate your continued support. Now, we have time for some questions. So, thank you very much. Time for questions.

Operator, Operator

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

Jon Arfstrom, Analyst, RBC Capital Markets

Thanks, good morning, everyone or afternoon, everyone. Good morning, I guess.

Edward Wehmer, Founder and Former Chief Executive Officer

How are you Jon?

Jon Arfstrom, Analyst, RBC Capital Markets

Yes, I'm good. I'm a little confused about the time. But anyway, I want to talk about loan growth. I know that you guys — just the loan growth numbers. I appreciate the guidance for the fourth quarter but to Murph's comments on the PPP halo, market disruption, line utilization. I think I would throw in premium finance and the bull market there as well. But what slows this down? And what would cause you to pull back on saying you can put up this kind of growth into 2022?

Edward Wehmer, Founder and Former Chief Executive Officer

I think if you see — if rates stay low, then irrational pricing kicks in and we're starting to see the bigger banks go to give it away, because of the dearth of earning assets out there that could cause us to back off a little bit, because as you know our policy and our profitability model are inviolate and we're not going to be changing those. But right now we don't see it. We see people coming from other banks, who appreciate our long-term approach and our approach to doing business. I'd like to say that a lot of them just thought they had a good time where they banked before. As Tim mentioned, we spent a lot of money and we do a better job of telling you how much money we spend on our technology. Going into the fourth quarter, we will give you real detail on how much of our expenses relate to our technology build, and winning the Greenwich awards is really heartening to us, because the numbers we're seeing — 95% or so say they would recommend us — and that builds on itself. So, I don't think you can see the premium finance market change that much. In turn, I think it's going to get harder even next year. The market continues to get harder; people who are thinking maybe 20% to 30% increase there, additional increase in premiums on the commercial side, on the life side we see some pricing irrationality but we stay away from those. And with what's going on with tax laws, life insurance remains a reasonable way to plan your estate and not have to pay exorbitant state taxes that are being proposed. On the commercial side, Murph, I don't know.

Richard Murphy, Vice Chairman and Chief Lending Officer

Yes. No, you hit the nail on the head. I think that generally speaking we like where we sit and we think that our positioning in the marketplace is very good and as we alluded to, we're seeing not only customers but also bankers look at us as a real attractive alternative. So, really good core momentum there. I think, to your question, what wrinkles are out there — as Ed said the challenges that you look at every one of our competitors, and they also have a lot of cash to deploy. So, you are seeing pricing being very aggressive and you're seeing structures also pretty aggressive. So, right now we don't anticipate any type of collapse or anything like that. But it's something that we are very aware of. The other thing is on the life side, because rates were so low, it really was a great opportunity for people to use that product and if rates were to go up dramatically here that's probably going to have an impact on that. But for right now, we see ourselves being — as we go into budget season, we're pretty optimistic about where…

Edward Wehmer, Founder and Former Chief Executive Officer

Talk about leasing, Rich.

Richard Murphy, Vice Chairman and Chief Lending Officer

Leasing is good. Leasing's had a really good time during the pandemic. Anything where leasing tends to be a little bit more of a transactional business and so people are very focused on structure and pricing and so we are very mindful of that. So, we're not going to go out there and chase deals. But as you've seen, Jon, over the course of the last three years and the way we've grown that portfolio, we're pretty optimistic of where it's at. But it's probably the one area where we're really focused on pricing, because if we're going to lean in on pricing, it's going to be for complete relationships where you get the full share of wallet.

Jon Arfstrom, Analyst, RBC Capital Markets

Okay, good color on that. Thank you. And then I guess just one on the margin. I appreciate the comments Tim on the margins being relatively stable. You alluded to the beach ball we've heard that for a long time but what can make your margin lift? And you've alluded to maybe getting a little bit more aggressive on liquidity deployment but still being careful. As we look forward to the margin, it feels like it's bottomed out here and maybe the only way to go is up from here. Talk a little bit about the plan and can the margin lift?

Edward Wehmer, Founder and Former Chief Executive Officer

Well, additional liquidity would cause the margin to have additional pressure. But in terms of net interest income, I think you're going to see that growing nicely throughout the rest of the year. Tim, you want to comment on the...

Timothy Crane, President

Sure. Yes, I mean, we're kind of watching pricing pretty carefully. Deposit costs will continue to help a little bit, not as much as they have in the prior quarters. And if we get rising rates here, the 10-years up to $165 million — we watch that closely and if we deploy some more liquidity it will help both our margin and income. We're patient there, so I hesitate to forecast when that might happen but we feel pretty good. We remain very interest sensitive and feel like that's still an important part of the equation.

Jon Arfstrom, Analyst, RBC Capital Markets

Okay, thanks guys.

David Dykstra, Vice Chairman and Chief Operating Officer

No. I just was going to say $5 billion of that liquidity and then deposits keep coming in, so that's a good lever. But I was going to also say that those new loans are sort of coming on at the existing portfolio pricing right now. So, if you see a little bit of compression from some older loans paying off at higher rates but the new loans are coming on, I think we've stabilized on the lower side substantially and so ex-PPP it should have roughly bottomed out and we have the upside from deployment. So, we're optimistic on that front.

Jon Arfstrom, Analyst, RBC Capital Markets

Okay, all right. Thank you.

Operator, Operator

Our next question comes from the line of Michael Young from Truist Securities. Your question please.

Michael Young, Analyst, Truist Securities

Hey, thanks for taking the question. Wanted to do a quick follow-up on just the excess liquidity, that $5 billion or so, just kind of cash basically on the balance sheet. It seems like at current rates you can deploy that maybe for 150 basis points kind of pickup over cash yields. So, by my math that's maybe $0.75 or so of earnings to $1 of earnings. Is that kind of the right way to think about it? But then maybe if you could deploy that into loans instead, maybe it's $1.50 or so?

Edward Wehmer, Founder and Former Chief Executive Officer

Well, yes, I think right now the concept is right. As you said you're earning roughly 15 basis points on mortgage-backed securities or plus or minus 2% right now. So, there is your spread differential for investing at that rate. The question is if you want to invest long-term at that rate or do you want to wait for it to go up. But it's pretty simple math; it's 15 basis points and besides what asset class you want to invest it in and what rates — so the loan probably be closer to 3%, so we think that we are slowly showing solid growth in NII by the growth that we're having. For us, and we believe we're not at the start or even in the first quarter of an inflationary cycle. Wages are rising; I sit on a couple of boards and we talk to them and price increases are flying through. Supply chain disruption plus lack of labor is going to cause this cycle to start and once it starts and gets some momentum, it's hard to stop; it's stopped by higher rates. The government has to act eventually, in which case because of our deposit base at higher rates — in the lower-rate environment you're playing in the red zone. At higher rates you're going to get normal spreads. So, to lock in long-term at 2%, although it could make us money now, there is a question down the road. We take a long-term view and there's also the possibility at the end of the year people move money out. There is so much money out there; we never know where it's going to go. We have to keep a little bit of excess liquidity because of that. These are really unprecedented times in terms of the liquidity side of the equation. But they're not unprecedented in terms of the inflationary cycle. We're starting to see it start and you can't fight the economics of it all. We're old-school guys and we believe that rather than lock-in at low rates now, we may lag on the way up, and then we can make a lot more money. So, we take a long-term measured approach on this; we could deploy and make another couple of dollars a share over time but we don't think that's prudent given that we think down the road there will be more money to the company and for shareholders.

Michael Young, Analyst, Truist Securities

Okay, thanks for all that color. And just, kind of, my follow-up question — you segued it nicely into inflation. It's been a long time since we've seen material inflation and just curious your high level thoughts on inflation and then how that could affect the expense base and kind of growth there?

Edward Wehmer, Founder and Former Chief Executive Officer

Well, I think the government wants inflation; they got all the money that they're borrowing and they want to get it back in cheaper dollars. So, we've seen the movie; you kind of think it's not going to have a different ending — I think it's going to be there for a period of time. I think the cycle has started, it's hard to stop the cycle without raising rates and slowing things down. It's a conundrum because we're not out of the pandemic yet; supply chain issues are causing some of those pressures. I don't think it'll be over by the end of next year, according to some of the boards and the manufacturers I'm talking to. It's tough out there for our clients and labor is tough. So, to hire people you have to pay a lot more money. Transportation costs are high and some of the offerings are very costly. So, I think inflation is here and it's going to stay for a while and we have to be ready for it. In inflation we have to make more money than before just to stay even. So that's our plan and what we're doing; we're sticking with it. And I just think I've seen this movie and I don't think it's going to end too differently.

Michael Young, Analyst, Truist Securities

And Dave, maybe any thoughts on your expense base specifically and how that will affect kind of our outlook for 2022 or 2023, kind of expense growth?

David Dykstra, Vice Chairman and Chief Operating Officer

I think I'd look at it, Michael, is if the inflation really kicks into the expense base and rates rise, the increase in the margins is going to more than offset the expenses and our efficiency ratio will get better and our net overhead ratio will get better because of the growth in the assets and the growth in the margin. So yes, our biggest cost is labor cost, so if you see increases in labor costs we will have some of that go up but the rest we should be able to control reasonably well. I just think the margin will expand dramatically more than the expenses, if inflation does kick in.

Michael Young, Analyst, Truist Securities

Okay, thanks.

Operator, Operator

Our next question comes from the line of Terry McEvoy from Stephens. Your question please.

Terry McEvoy, Analyst, Stephens

Hi, thanks, good afternoon.

Edward Wehmer, Founder and Former Chief Executive Officer

How are you, Terry?

Terry McEvoy, Analyst, Stephens

Good, thank you. Maybe I'll start with Table 8, your interest rate sensitivity. I'm just wondering how your underlying deposit betas maybe have changed this cycle versus the past? And when I look at the 83% loan to deposit ratio and that includes PPP, how much are you assuming you can lag on deposit rates when rates rise?

Timothy Crane, President

Well, I mean, we're pleased that a third of deposits are DDA and obviously the bulk of the rest of it is very low rate at this point. I think we will lag as rates move up — hard to predict what will happen with PPP money. Again from my comments earlier, we've not seen anything unusual with respect to deposit volatility. I think it will continue to help us. I think for the next couple of quarters, you'll see deposit costs go down almost in spite of what happens to rates and we should be in good shape.

David Dykstra, Vice Chairman and Chief Operating Officer

And Terry, my recollection is the last time we had rising rates from the near zero environment, the first 25 basis points really there wasn't much of a rise in deposit costs and the second 25 basis point increase was the same, and they only started to see increases with the third increase. I would think it would be similar to that, if not an even longer lag, because of the way more liquidity in the system right now and people aren't as anxious to move deposits. So, if history repeats itself you'd have a 50 basis point increase before too much movement across the industry. And my personal opinion is, because of all the liquidity in the system, you might go beyond that before you see much of an increase in deposit cost.

Timothy Crane, President

Yes, and Terry if it helps, virtually none of our deposits are linked to an index.

Terry McEvoy, Analyst, Stephens

That's helpful. Thank you. And then as a follow-up. We all know there is a large acquisition about to close later this year in your market and a new name about to enter your market. How quickly did you start to see the disruption from the last deal MBFI and how long did that window remain open for a bank like Wintrust to capitalize on any opportunities?

Edward Wehmer, Founder and Former Chief Executive Officer

What we're starting to see a little of it. The window stays open for a long time. I mean, we will give you the year to see if this is going to work or not. We're relentless in our pursuit of these customers. On a previously announced deal it took four or five years before we started seeing an outflow. So, we know you cannot really get anybody on the old place and now we're getting people and assets that we never thought we'd get; they were very loyal to the old place. So, we'll be relentless and we'll see. Murph any thought?

Richard Murphy, Vice Chairman and Chief Lending Officer

No I think that's right. It's really kind of the tone that gets set by the acquiring institution and we've seen it run the gamut from the day that the deal gets announced and they immediately change the credit culture and the overall tone of the organization. But we've also seen the other side where it takes a while but eventually things change and people and bankers look to find something a little more in keeping with the way they like to be treated. So, I don't think there's one set answer to the question but it is inevitable.

Edward Wehmer, Founder and Former Chief Executive Officer

Word of mouth has been great for us. These Greenwich awards are very helpful, plus we walk the walk. People come over and they see our technology and what we have; I'll put up against the big banks for the most part. We are better than them in many cases because of the personal service we give on top of it. We get nothing but complimentary letters about how happy people are when they get over here. So, word of mouth is happening a lot too. Plus our advertising is paying off in Chicago and Wisconsin. They have great momentum there but we got to back it up and we have been backing it up. People from acquired organizations are asking us what our plans are and what we're going to do and there is great interest on their part. Remote working has helped us; on the IT side we were able to pick up a number of people just because of our reputation. We picked up a couple out in New York who heard how good we were to our clients and our people and they came with us. So, the talent is out there, our reputation helps and our momentum is very good and we don't see anything that will stop it right now.

Terry McEvoy, Analyst, Stephens

Thanks, again. Appreciate it.

Operator, Operator

Our next question comes from the line of David Long from Raymond James. Your question please.

David Long, Analyst, Raymond James

Hey, everyone. Thanks for taking my questions.

Edward Wehmer, Founder and Former Chief Executive Officer

How are you doing David?

David Long, Analyst, Raymond James

Good. Appreciate all the color on the loan growth and the margin expectations. The question I wanted to ask you about now is more about, you're hitting $50 billion in assets here very soon. How does that change your operating strategies and does that change how you're thinking about regulations and the ability to continue to acquire?

Edward Wehmer, Founder and Former Chief Executive Officer

Not really, because we do the smaller deals which aren't going to trigger the same attention. We've certainly done smaller deals which don't really get the attention of the big guys in DC. We have a great relationship with the regulators. Our CRA ratings are very strong. The regulators make the rules, you've got to play by the rules; you can complain but we'll play by them. I think we have a good reputation with them. And because of how we're structured, we still operate in smaller community bank units — our average bank is roughly $2 billion to $3 billion — and the branches combined have their own local decision-making. Everybody is an owner here; we're able to really be close to the customer with our decisions. I think that model can keep going for a long time and we continue to build the infrastructure and the team to handle growth. So no immediate issues on that front.

Richard Murphy, Vice Chairman and Chief Lending Officer

I don't see anything significant. You hear in the marketplace that the bigger deals are a little bit slow to get regulatory approval right now but as Ed said we typically have done the smaller tuck-in deals and those seem to be moving at a quicker pace. So, I don't see anything significant, David.

David Long, Analyst, Raymond James

Got it. And then you mentioned the infrastructure to become a larger bank. At what point do you have to upgrade it? Is it core deposit system couldn't handle a doubling of your size at this point or is there at some point that you would need to make any additional investments?

Edward Wehmer, Founder and Former Chief Executive Officer

No, we've done a very good job of investing. We have lots of room to grow. We have really upgraded every system and made them flexible to work off base systems and add capabilities. Tim?

Timothy Crane, President

Yes, we are fine from a systems standpoint and the enhancements and new services on the digital side are starting to pay dividends. In terms of getting to the point where we're comfortable at $50 billion, we've been working toward that for years. So, I don't see any immediate issues at all on that front and we're well positioned to continue to grow.

David Long, Analyst, Raymond James

Got it. Thanks for the color and keep up the good work. Thanks.

Operator, Operator

Our next question comes from the line of Chris McGratty from KBW. Your question please.

Chris McGratty, Analyst, KBW

Hey guys, maybe a question on M&A just to further explore. I mean you've got so much momentum organically right now and we've seen some of the reactions for deals in the buyer stocks. I guess, why do you even need to consider a deal at this point? Is there something that you need to build out or a market you need to develop a bit more?

Edward Wehmer, Founder and Former Chief Executive Officer

So, we've always been opportunistic about it and it's got to make sense on the pricing side and strategically. We haven't done anything in a couple of years because we haven't found one that did. We're very, very prudent in how we approach it. We're not going to give up a lot of tangible book value to grow, or give up five years of earnings to grow $0.20 a share. It doesn't make a lot of sense. We take what the market gives us. Right now the market is giving us organic growth; pricing on deals is such that big deals are a pain. Not to say we wouldn't consider it but every big deal we've seen starts with taking care of management before they take care of shareholders, and that drives me absolutely crazy. Management-first deals are a turn-off. We're enjoying the organic growth now and pipelines are good and we'll keep marching to them for the time being.

David Stoehr, Executive Vice President

No, I think that's right. We understand the concept you laid out Chris. If there's a deal that makes economic and cultural sense, we'll consider it. But we're not going to overpay or do a deal just to do a deal. So we're enjoying the organic growth now and we'll keep focusing on that for the time being.

Chris McGratty, Analyst, KBW

Great answer, thank you.

Operator, Operator

Our next question comes from the line of Nathan Race from Piper Sandler. Your question please.

Nathan Race, Analyst, Piper Sandler

Yes. Hi guys, afternoon. Going back to Terry's question on some of the loan growth drivers and within the context of the M&A disruption that's ongoing, curious in terms of the commercial real estate and C&I growth that we saw in the quarter, obviously on the C&I side you guys benefit from an uptick in line utilization but just curious how much of that growth you're seeing in footprint on the commercial side of things is being driven by share gains. And I'm curious within that context, what inning we're in, in terms of Wintrust benefiting from all the M&A related disruption that's occurred in Chicago within last few years?

Edward Wehmer, Founder and Former Chief Executive Officer

Rich?

Richard Murphy, Vice Chairman and Chief Lending Officer

I would say we're in pretty early innings at this point. This disruption has really been a relatively recent phenomenon over the last four to five years. The goodwill that got established during the pandemic through PPP differentiated us; we were out early reaching out and doing things that made us different. I had lunch with one of our bankers that we hired from a competitor recently and he said it was the exact opposite at the bank he was at — they were curtailing lines and bumping rates and doing things that in the short term might enhance return, but in the long run you're going to anger customers. So, I think there is a long way to go here. Our market share is still relatively small in Chicago and Milwaukee relative to competitors. So, I think there is a real strong opportunity over the next couple of years to grow that core business.

Nathan Race, Analyst, Piper Sandler

Got it, that's great color. And maybe just changing gears, a question Dave on mortgage: curious if you could remind us in terms of the gain on sale margin expansion that we saw this quarter. It was a little more pronounced than some others. So, just curious if you could remind us in terms of the VA ARM, what that secondary market premium tends to look like in relative terms to the conventional 30-year product generally speaking?

Richard Murphy, Vice Chairman and Chief Lending Officer

I'm trying to figure out how to answer that. You're wondering about the directionality of the gain on sale margins? Certainly it's higher for the VA ARM. But as far as the blend of the gain on sale margin, Veterans First has been a consistent portion of our production for the last year. So, I don't think it's going to change the directionality of the overall margin dramatically. It may be a little bit higher in the fourth quarter as the purchase business goes down in the Chicago area because Veterans First does business all over the country and a lot in the southern states, but we would expect gain on sale margins to be relatively flat in the fourth quarter relative to the third quarter, all else equal.

Nathan Race, Analyst, Piper Sandler

Okay, great, that's really helpful, I appreciate all the color. Thanks, guys. Nice quarter.

Operator, Operator

Our next question comes from the line of an analyst from DA Davidson. Your question please.

Unidentified Analyst, Analyst, DA Davidson

Hey, good afternoon guys. Just one big picture question for me at this point and it relates to Slide 15 of your deck that highlights the geographic and loan portfolio diversification. They are clearly paying dividends with the growth you guys are putting up; I'm just curious, are there any geographies you are not in that you'd like to be or loan products or niche lending verticals that would fill out this map further?

Edward Wehmer, Founder and Former Chief Executive Officer

We're always looking for new niches. Problem is right now, if there is one out there, sellers want a lot of money. So, kind of wait till it dies down and start from scratch rather than pay big premiums and suffer book value dilution. Rich, you want to comment?

Richard Murphy, Vice Chairman and Chief Lending Officer

I think that's right. We are always looking at opportunities. The leasing example is a good one. We started that three years ago and have built that out because it gives us a much more geographic spread to the loan portfolio. But if we had bought something of comparable size, we would have paid a substantial premium. So, we like to be building these things internally but right now it's not so much about markets we're not in but really trying to expand our existing markets. We would like a bigger presence in Indiana; we'd like to expand our presence in Wisconsin and other Midwest markets that would appreciate our model. We've also been able to follow CRE sponsors to other markets, build the Wintrust brand in markets where we historically haven't had a presence, and we might consider opening LPOs or stepping out a bit, but it's front and center for us to ensure we have good diversification within the portfolio.

Unidentified Analyst, Analyst, DA Davidson

Thank you, guys. That was it for me. I appreciate your thoughts.

Operator, Operator

Our final question for today comes from the line of Brock Vandervliet from UBS. Your question please.

Brock Vandervliet, Analyst, UBS

Thanks. Dave, just following up on the mortgage banking, I just wanted to clarify, so we should look for 20% to 30% origination drop and similar revenue drop in Q4. Correct?

David Dykstra, Vice Chairman and Chief Operating Officer

Yes, that's right. Now, applications in October have been very similar to September so far, a little less than July and August. But just based upon seasonality, that's what we're thinking and I think it's fairly in line with the MBA forecast too.

Brock Vandervliet, Analyst, UBS

Okay. So, that's more seasonality than any rate move that's already percolated through your pipeline. That's just what you're expecting for things to kind of fall off?

David Dykstra, Vice Chairman and Chief Operating Officer

Yes. Hopefully it's a little bit better than that but that's what our expectations are right now. I don't think we are generally too much different than the overall market on origination trends.

Brock Vandervliet, Analyst, UBS

Okay. And shifting over to PPP, I apologize if I missed this already but you've got about $25 million left I believe, what's kind of the cadence of that recognition do you think?

Richard Murphy, Vice Chairman and Chief Lending Officer

It's probably — from a fee standpoint — maybe another 30% to 40% of that comes in the fourth quarter and then it tails off from there depending on what we see in terms of customers seeking forgiveness. But as we talked about, we think the loans will drop off quite a bit and the fees follow.

Brock Vandervliet, Analyst, UBS

Got it, okay. All right, thank you.

Operator, Operator

This does conclude the question-and-answer session of today's program. I would like to hand the program back to Edward Wehmer for any further remarks.

Edward Wehmer, Founder and Former Chief Executive Officer

Thanks, everybody for listening in. Good quarter, you can be assured of our best efforts going forward. If you have any other questions that come up after you continue reading our 1,000-page press release, please call Dave, Murph, Tim or me and we'll be happy to discuss it with you. Thank you and we'll talk to you next quarter. Take care. Thanks.

Operator, Operator

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.