Earnings Call Transcript - WTFC Q4 2022

Operator, Operator

Welcome to Wintrust Financial Corporation’s Fourth Quarter and Full Year 2022 Earnings Conference Call. A review of the results will be made by Edward Wehmer, Founder and Chief Executive Officer; Tim Crane, President; David Dykstra, Vice Chairman and Chief Operating Officer; and Richard Murphy, Vice Chairman and Chief Lending Officer. As part of their review, the presenters may make reference to both the earnings press release and the earnings release presentation. Following their presentations, there will be a formal question-and-answer session. During the course of today’s call, Wintrust management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Actual results could differ materially from the results anticipated or projected in any such forward-looking statements. The company’s forward-looking assumptions could cause the actual results to differ materially from the information discussed during this call as detailed in our earnings press release and in the company’s most recent Form 10-K and any subsequent filings with the SEC. Also, our remarks may reference certain non-GAAP financial measures. Our earnings press release and earnings release presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded. I will now turn the call over to Mr. Edward Wehmer.

Edward Wehmer, CEO

Thank you very much. Welcome, everybody, to our fourth quarter year-to-date 2022 earnings call. With me always are David Dykstra, our Chief Operating Officer; Dave Stoehr, our CFO; Tim Crane, the President; Rich Murphy, our Head of Credit; and Kate Boege, our General Counsel. Now the same format as we have been doing in the past, I am going to give some general comments regarding results for both the quarter and the year in total, then turn it over to Tim Crane for more detail on the balance sheet and then to David Dykstra to discuss the income statement in detail. Rich Murphy is going to talk about credit and back to me for some summary comments about the future. We will have some time for questions. We finished the year very well. It’s a great year for us. The earnings for the year are $509 million, almost $510 million, up almost 10% from the previous year. Grew earnings per share of fourth quarter $144 million, $145 million, compared to $142 million, $143 million in the third quarter and about $99 million in the fourth quarter of 2021. Earnings per share $2.23 for the quarter, $8.02 for the year, compared to $7.58 for the previous year. Our pre-tax pre-provision income was a record for us, $2.43 versus $2.06 for the year of 780 versus 579. The prospects for growth are good as the margin finished at 3.73%, 3.17% for the year, up from 3.35% in the third quarter. We expect to approach 4% coming this next quarter. Return on assets around 1% for the year, 1.10% for the quarter, current equity of 12.72% up 41 basis points for the year. Tangible book value rose to $61 a share, compared to $59.64 fourth quarter 2021. Again, it was a very good year for us. If you look at the balance sheet to some extent, assets grew nicely for the year. The loan growth about $1 billion with about $700 million over average, so we will be able to work that going forward. Credit is remarkably good. Rich Murphy will talk about that, but we will point out that, if you look at the real numbers, the quarter was actually down for the quarter because of about $17 million of fiscal life loans that got hung up waiting for the money to come back. Only the fiscal portfolio has $17 million past due that has been confirmed is going to be returned. So credit was actually better than it was before and we feel very good about that. I will now turn over to Tim to talk about the balance sheet.

Tim Crane, President

That’s good. Thanks, Ed. I’d like to highlight a few balance sheet items. I will offer a comment on several items likely to be of interest, including the continued impact of rising rates on margin expectations. The approximately $1 billion of growth for the fourth quarter was 11% loan growth on an annualized basis, which continues to be spread nicely across all major loan categories. As noted in the release, period-end loan balances were $630 million higher than the quarter average, which will help our first quarter 2023 results. Going forward, while we remain encouraged by stable loan pipelines, we believe there is some evidence of a modest slowdown in market loan demand; loan growth in the mid-to-high single digits on an annualized basis remains a reasonable expectation given the current economic uncertainty. Rich will speak to loans in more detail in just a few minutes, but a couple of notes on the provision and our allowance. Of the $48 million in provision, approximately two-thirds is related to a modest deterioration in CECL macroeconomic factors and only one-third is related to our growth and portfolio changes that occurred during the quarter. To be clear, we are not signaling a change in our credit performance. With respect to our allowance of 91 basis points of total loans, it’s important to note that excluding our historically low loss niche loans, primarily the premium finance loans, our allowance is 142 basis points of total core loans. Deposit growth for the quarter was approximately $105 million. The continued rise in rates is clearly making deposit gathering more challenging. The cost of deposits are rising and nominal changes in deposit mix are occurring. Interest-bearing deposit costs of 130 basis points for the fourth quarter were up 66 basis points. We anticipate continued increases in both the Fed funds rate and the rates associated with our loan and deposit activity. Currently, the beta on our interest-bearing deposits is approximately 25%. We anticipate an interest-bearing deposit beta of approximately 40% to 45% over the full cycle of interest rate changes. Our securities book was up $1.5 billion in the quarter. At year-end, liquidity remained strong with approximately $2.5 billion of cash on the balance sheet. Our securities book is split almost equally between available-for-sale and held-to-maturity, while the AFS valuation swings during the year were significant. As Ed pointed out, the bank’s tangible book value was up for both the fourth quarter and the year to $61 a share. We believe each 25 basis point increase in the Fed funds rate will result in approximately $30 million in pre-tax net interest income on an annualized basis and an improvement in the margin of 5 to 8 basis points. To be more specific on the margin, as Ed mentioned, it was 3.73% in the fourth quarter, an improvement of 38 basis points. Our margin will approach 4% at some point during the first quarter and has not yet peaked. Conversely, we benefit from rising rates, as discussed on our last call, the bank entered into several interest rate collars in the third quarter of 2022. Further, early in this quarter, we entered into additional derivative contracts with the intent of reducing the variability of the margin in a lower interest rate environment. So our approach has been to leg into these contracts. With that, I will turn it over to Dave.

David Dykstra, CFO

Great. Thanks, Tim. As usual, I will cover some of the noteworthy income statement categories, starting with net interest income. For the fourth quarter of 2022, net interest income totaled $456.8 million. That was an increase of $55.4 million as compared to the third quarter and an increase of $160.8 million as compared to the fourth quarter of last year. The increase in net interest income was due to an improvement in the margin and loan growth. For the fourth quarter, the margin was 3.73% in the fourth quarter, a beneficial increase of 84 basis points on the yield on earning assets and a 22-basis-point increase in the net free funds contribution, combined with the negative impact of a 68 basis-point increase on the rate paid on liabilities resulted in that improved net interest margin. The increase in yield on earning assets in the fourth quarter was primarily due to an 87-basis-point improvement on loan yields. Wintrust recorded a provision for credit losses of $47.6 million in the fourth quarter, compared to a provision of $6.4 million in the prior quarter. The higher provision expense in the fourth quarter was primarily a result of less favorable macroeconomic conditions including wider projected credit spreads. Stronger loan growth also contributed to provision expense for the quarter. Rich will talk about credit in more detail, but current quarter’s net charge-offs, classified loans and delinquency data all remained relatively stable. Turning to other non-interest income and non-interest expense. In the non-interest income section, our wealth management revenue was down $2.4 million from the prior quarter. Consistent with overall industry trends and the impact of relatively higher home mortgage rates, our mortgage banking operation experienced a revenue decline of $9.8 million from the third quarter due to lower loan origination volumes and lower production margins. We expect mortgage origination volumes to continue to be low in the first quarter due to the rate environment and the seasonal purchasing trends, but it’s still an important part of our business. The company recorded net losses on investment securities of approximately $6.7 million during the fourth quarter. Non-interest expenses totaled $307.8 million in the fourth quarter and we are up a little over $11 million compared to the prior quarter total. The primary reason for the increase was due to higher compensation-related expenses. Our efficiency ratio declined to 55% for the fourth quarter from 58% in the third quarter. And with that, I will turn it over to Rich to cover credit.

Richard Murphy, Chief Lending Officer

Thanks, Dave. As noted earlier, credit performance for the fourth quarter was very solid from a number of perspectives. Loan growth for the quarter was $1 billion or 11% annualized, an outstanding result. We continue to see loan growth across the portfolio. Specifically, commercial real estate grew by $373 million. Commercial loans grew by $290 million. Our total loan growth was $5 billion or 15% year-over-year, a very productive 2022. We anticipate this momentum will continue into 2023. While we are optimistic about loan growth for this year, we would anticipate that the pace of growth may trend closer to the middle of our guidance. From a credit quality perspective, we continue to see strong credit performance across the portfolio. Non-performing loans remained stable at 26 basis points or $101 million, compared to $98 million in the third quarter. Charge-offs for the quarter were $5.1 million or 5 basis points. Overall, non-performing loans continue to be at very low levels, and we are still confident about the solid metrics in the portfolio. I will turn it to Ed to wrap up.

Edward Wehmer, CEO

Thanks, Murph. Year end is always a good time to review the entire body of work over a longer period of time versus our stated goals that the company has had. If you go back 30 years, results versus peers will be about the same. Increasing tangible book value is extremely important. Our tangible book value has increased every year since we went public, with an eight-year CAGR of 8%. Even last year, we were still positive. Earnings growth at 16% on a 10-year CAGR, asset growth at 12%, dividends paid at 22%, stock price only at 9%. During the past 10 years under review, we saw a bit of everything, high rates, low rates, pandemics, you name it. Interest has thrived during all of these. Lower rates helped our mortgage company pick up the slack. We employ people who work at Wintrust. When rates were low, our mortgage company helped with the net interest margin compression. This is an orchestra here; we all sort of play different parts at times. Mortgage is an important offering, but it’s not everything. Based on the above and many more points, one has to wonder why we consistently trade at a discount to our peers. Our margin should continue to increase, and we remain committed to our objectives. With that, I think we can ensure our best efforts moving forward. It’s time for questions.

Operator, Operator

Thank you. Our first question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead with your question.

Jon Arfstrom, Analyst

You guys hear me, all right?

Edward Wehmer, CEO

Yeah. How are you, Jon?

Jon Arfstrom, Analyst

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

David Dykstra, CFO

Well, I think, Jon, the CECL, as you know, is sort of a life-of-loan concept. If we have loan growth, the provision will go up. But if the economic scenario stays the same, you would have no additional provision in the next quarter per se. It really depends on the economy's trajectory. If the forecast gets better next quarter, you could expect the provision to come down; if it gets worse, it would likely stay elevated. But, as Tim and Rich pointed out, there’s nothing specific here that we are pointing to that signifies a current problem in the portfolio. This is just how credit forecasts have changed moderately, rather than an indication of deterioration in our credit. So it's really a function of the CECL modeling.

Jon Arfstrom, Analyst

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

Edward Wehmer, CEO

Yeah.

David Dykstra, CFO

Yes. Yeah.

Edward Wehmer, CEO

Yeah. Someone is reaching.

Jon Arfstrom, Analyst

The other question I have was on the margin. I think I understand what you guys are saying, but if the Fed bumps a couple more times and then holds it for a while. What could happen to your margin? Are you guys were talking about a 4% level, but then, Ed, you alluded to floating a little bit higher above 4%. What do you think about the margin outlook in that scenario where the Fed is not cutting?

Edward Wehmer, CEO

Well, they are raising where it should be, as Tim said, $30 million on an annual basis per quarter. Eventually, we have been lagging on the private side, we have been lagging on the deposits. Much is going to catch up with that overall beta. But we still have a lot of assets that are repricing right now, particularly in the premium finance business, which reprices over the course of the year. We're monitoring this carefully as we transition into these derivatives to help maintain the margin. It’s hard to say where it’s going to be; it depends on some of these derivatives. But I think that depending on how rates go, margins will continue to go up. A projection of 3.75% to 4% long-term, depending on where rates are, would be a good thing, but it’s going to take a lot more derivatives to do that.

Tim Crane, President

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

David Dykstra, CFO

This is Dave. I think what we have said here is that we expect the margin to approach 4%, and if the Fed raises some more, it may pop a little over 4%. Given existing competitive pressures and yield curve, if they stop raising, we can hold it there, because, as Ed said, we have a lot of asset beta left too. The life insurance premium finance portfolio resets once a year, and those rates are significantly higher now. So, there’s a lot of repricing that happens there. We feel confident we can hold the margin if rates increase and stabilize.

Jon Arfstrom, Analyst

Okay. All right. That’s all very helpful, guys. Appreciate it. Thank you.

Edward Wehmer, CEO

You are welcome.

Operator, Operator

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

David Long, Analyst

Good morning, everyone.

Edward Wehmer, CEO

How are you doing, David?

David Long, Analyst

Good. Good. You guys are bucking the trend here on the deposit side showing deposit growth; a lot of the banks continue to have outflows. What are your expectations on the deposit flows? And regarding mix shift, do you see much shifting coming in the next couple of quarters?

Tim Crane, President

Yeah, David. It’s Tim. The deposit activity has been lumpy, both in and out. We’ve been pretty disciplined with our pricing and cautious about getting ahead of the market. We are responding to promotional activity to retain our clients and we think we operate in good markets with deposit potential. We typically outperform our peers in terms of growth, even in markets where we have a small deposit share. We will hold our own.

David Long, Analyst

Good. Thanks, Tim. And then, my follow-up relates to the amount of cash you have versus deposits. Your cash is down to just under 6% of deposits; I guess you monitor that, right? Is there a target you want to keep above a certain cash level just in case you do get some deposit runoff?

Tim Crane, President

Yeah. I think we are comfortable with where the cash is now. We had a billion extra cash from prior borrowings that we invested. We like where we are at right now for the mix of cash, securities, and loans.

Edward Wehmer, CEO

Liquidity has always been critical to us, and we expect our deposit costs to go up. We are monitoring it carefully; liquidity is extremely important.

David Long, Analyst

That’s right. Thanks for the color, guys. Appreciate it.

Operator, Operator

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

Chris McGratty, Analyst

Hey. Good morning. Thanks.

Edward Wehmer, CEO

Hi, Chris.

Chris McGratty, Analyst

How are you doing? Dave, the 4% margin roughly that you are talking about, I guess, what does that map to in terms of loan yields? Is it kind of somewhere like in the mid-6s?

David Dykstra, CFO

It's probably mid-6s to approaching 7 right now. If rates keep going up and the mix of business changes, that’s a variable, but that’s the right range.

Chris McGratty, Analyst

Okay. And then there was a comment in the press release that talked about additional improvements in efficiency. Could you provide more color around that? You are obviously in a good spot exiting the year in the mid-50s. But how would you think about that ratio playing out, appreciating that mortgages are in recessionary levels?

David Dykstra, CFO

Yeah. We will have some additional expenses in 2023, and generally, you are probably looking at slightly above mid-single-digit growth in expenses. First quarter is less, but as we add in the acquisition that will add to it.

Edward Wehmer, CEO

We continue to look at cutting costs in different areas, particularly in the mortgage space. We need to grow and invest to grow the bank. While efficiency ratio matters, more critical is getting our net overhead ratio below 1.5. We are working very hard to do that.

David Dykstra, CFO

The covered calls, as you know, are used to protect against down-rate environments and add to the return on those securities. Depending on volatility, we may expect those numbers to vary. It’s hard to predict too much in advance, but we can operate within a reasonable range.

Operator, Operator

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

Terry McEvoy, Analyst

Hi. Thanks. Good morning. Maybe first off, Dave, thanks for reminding me of the repricing opportunities of your loan portfolio in 2023; I appreciate that. And maybe for a question circling back, I think, it was Jon’s question on protecting the margin. Is that 3.75% to 4% a floor that this strategy can produce? If rates go down 100 basis points or all the way back to zero, I just think that’s an important kind of comment there.

Tim Crane, President

Yeah. We entered into a combination of collars and received fixed swaps. The impact of those instruments depends on the interest rate scenario. We are trying to improve margin and also hedge against lower rate environments.

David Dykstra, CFO

So, that would sort of be our goal, but we will not do all of the derivatives at once. We’ll leg into this as far as contract lengths and amounts. Our crystal ball isn’t perfect. We hope to maintain 3% to 4%, but it’s going to depend on market movements and how we execute our strategies.

Terry McEvoy, Analyst

Appreciate all that. And then maybe just to follow-up, could you expand on market disruption? You are benefiting from that; where are you seeing that specifically? Do you factor in some hiring from the disruption?

Tim Crane, President

We are benefiting from disruption as relationship managers look for homes at firms that can take care of them. We will pursue those opportunities as they arise, but not in a large team.

David Dykstra, CFO

We always take advantage of market disruption. It’s part of Wintrust's DNA. We will continue to do this.

Edward Wehmer, CEO

We have great products, as indicated by several awards we have received. We think these opportunities will allow us to take advantage when bigger banks are having troubles.

Operator, Operator

Thank you. Our next question comes from the line of Ben Gerlinger of Hovde Group. Your line is open, Ben.

Ben Gerlinger, Analyst

Thanks, guys. Most of the questions around the margin have been answered, but I wanted to highlight your strategy of protecting the downside. If there is a Black Swan event, is there anything in terms of non-interest expense that you can cut abruptly?

David Dykstra, CFO

Well, we are a growth company, so we don’t plan to cut. The mortgage business can shift to contribute significantly even in a lower rate environment. That’s how we approach it strategically.

Ben Gerlinger, Analyst

Got you. Okay. That’s helpful on the strategy. Some of your larger competitors are involved with M&A, which gives you guys the opportunity to take their clients. Is there anything you are targeting specifically there for 2023?

Richard Murphy, Chief Lending Officer

We continually seek opportunities as larger banks change their strategies. Our objective is to maintain a consistent approach in how we underwrite and price. We believe steady performance attracts business.

Edward Wehmer, CEO

We have seen these large banks step back from some services, which creates opportunities for us. We aim to offer alternative services. We think that will be beneficial.

Ben Gerlinger, Analyst

Got you. Appreciate the color, guys. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Brandon King of Truist. Your line is open, Brandon.

Brandon King, Analyst

Hey. Good morning.

Edward Wehmer, CEO

Good morning.

David Dykstra, CFO

Good morning.

Brandon King, Analyst

I had a question on mortgage. What was the production margin in the fourth quarter and has that bottomed in your view and outlook?

David Dykstra, CFO

The production margin was around 1% in the fourth quarter. We expect the first quarter to be slightly higher. The majority of our revenue in the mortgage business now comes from servicing income.

Edward Wehmer, CEO

It's been gravy for us with the higher rate environment; it’s still an essential part of our offerings.

Brandon King, Analyst

And then on the deposit strategy, could you provide details on your CD strategy as far as what prices you booked demand in the fourth quarter? What are your terms?

Tim Crane, President

Most clients are still not willing to lock into term products. We are seeing terms from nine months through two years, mostly around a year.

David Dykstra, CFO

You can see the CD rates by maturity on table two of our earnings release. The promotional rates are trending up, and we are focused on protecting our customer mix.

Brandon King, Analyst

Okay. And then for 2023, how confident are you in your ability to generate operating deposits and DDAs for this year?

Tim Crane, President

We are working hard to continue to add clients and deposits. Our treasury management business is performing well, and we plan to continue to grow.

Brandon King, Analyst

Okay. That’s all I had. Thank you.

Edward Wehmer, CEO

Thank you.

David Dykstra, CFO

Thank you.

Operator, Operator

Thank you. Our next question comes from Jeff Rulis of D.A. Davidson. Your question please, Jeff.

Jeff Rulis, Analyst

Thanks. Good morning. I have some housekeeping items. On the expense side, you alluded to a mid-single-digit expectation for the full year. What was the expectation again for 2023?

David Dykstra, CFO

I was saying probably mid-to-high single digits for the full year, particularly with the pending acquisition, which will affect the latter half of the year’s expenses.

Jeff Rulis, Analyst

Just to catch up on the margin again, did you have a December average for the month?

David Dykstra, CFO

We haven’t disclosed that; we think we will be around 3.70% for the fourth quarter.

Jeff Rulis, Analyst

Fair enough. And then just on the tax rate, any expectation that that’s going to change anywhere off of 27%?

David Dykstra, CFO

26.5% to 27% is a reasonable assumption for 2023.

Jeff Rulis, Analyst

Got it. Thank you.

David Dykstra, CFO

Thank you.

Operator, Operator

Thank you. At this time, I’d like to turn the call back over to Edward Wehmer for closing remarks. Sir?

Edward Wehmer, CEO

Thanks everybody for listening in. We have a big rock to push back up this year, but we are committed to making it happen. If you have any other questions, please contact any of the speakers today, and we will talk to you again soon. Thank you.

Operator, Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.