Wintrust Financial Corporation

Welcome to Wintrust Financial Corporation's third quarter and year-to-date 2020 earnings conference call. Following a review of the results by Edward Wehner, Founder and Chief Executive Officer, and David Dykstra, Vice Chairman and Chief Operating Officer, there will be a formal question and answer session. During the course of today's call, Wintrust management may make estimates 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. 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 slide presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded. I will now turn the conference call over to Mr. Edward Weiner. Please go ahead.

Thank you very much. Welcome, everybody, to our third quarter earnings call. With me, as always, are Dave Dykstra, our Chief Operating Officer, Dave Starr, CFO, Kate Bogey, our General Counsel, Tim Crane, President, and Rich Murphy, our Credit Guru. We have the same format as usual. I'm going to give some general comments regarding the results. I'm going to turn it over to Dave for more detailed analysis of other income, other expenses, and taxes. Back to me for a summary, and then time for questions. First of all, 2020 continues to be full of surprises and unpredictable. If it weren't for Cecil, COVID, and their effects on interest rates, I think we'd be experiencing pretty much a gangbuster year. In that regard, though, it's nice to record record earnings again. Earnings were $107 million for the period, or $1.67 a share. Due to date earnings of $191 million to $3.06 a share. Pre-tax, pre-provision, pre-MSR. 165 million compared to 173 in Q2. The net interest margin was down 17 basis points. I'll go through that. ROA at 0.99. ROT of 13.43%. Our net overhead ratio at 0.87, 87 basis points. So pretty good on all fronts in that regard. Net interest income in the margin first. Net interest income was down approximately $7 million, primarily due to the reduction of PPP fee recognition of $8 million, resulting in slower-than-expected forgiveness estimates and the bank's elevated liquidity numbers. Former low-push PPP amortization, the first part of 2021, the latter part will be the liquidity issue, be discussed in a second. The NEM decreased 17 basis points to 257. Earning asset yields decreases of 18 basis points were offset by 19 basis points increase in decrease, I'm sorry, in paying liabilities. Free funds contribution decreased by four basis points due to the lower cost of funds. The remainder of the decrease related to the aforementioned correction of the PPP fee in Google was 14 basis points. The yield around 385 given is our current number for PPP. yields going forward. If you look at this in terms of the margin without PPP, then that's taking out the PPP money, interest income and fees, less cost of funds. Our coordinate interest margin was relatively constant at $237 million. We believe that we can build off of this going forward. I think this is the low point. We think that through investing and liquidity, our loan demand and the like, that we at least 10 to 25 basis points get you back to the 2.7 to 2.75% we said we were bottom out at. We're currently carrying over $3.8 billion of overnight money in negligible yields. The overall duration of our entire liquidity management portfolio is 1.44 years, down to 1.7 years. in Q2 and 4.2 years at the previous year end. As a reference point, we usually try to keep it at the four- to five-year range. The redeployment of these assets and the loans and other earning assets and shrinking our deposit base by reducing institutional funding brought on to support PPB loans in concert with a runoff will be helpful to the extent of 10 to 25 basis points over time. As I said, it will bring us back in line with the 275 margin, plus or minus we previously told you would be our bottom number. It's a very fluid situation in times like this. You can imagine the optimization will take a few quarters, depend on actual PPP runoff, et cetera. A little bit more on this later. Credit quality, based on conventional metrics, is remarkably good. You wouldn't think that there was a pandemic going on. NPLs decreased by 15 million over Q2, 273 million or 54 basis points, compared to 60 basis points at the end of Q2. NPAs decreased $16 million to $182 million, or 42 basis points, as compared to $46 million at the end of Q2. COVID modifications fell to $413 million, $1.7 billion on June 30th, revenue of 1.4 percent of total loans, net of PPP loans. Charge-offs net in the quarter totaled $9.3 million, or 12 basis points. The charge-offs include $6.4 million of specific reserves on individual loans, which were in place at 630. Provision for the quarter totaled 25 million as compared to 135 million in Q2. Majority of provision rates to the portfolio growth. The portfolio ratings remained relatively constant for the prior quarters. Details of ratings migration include in the earnings release slide deck. The allowance to outstanding is 389 million or 1.35 percent of loans excluding PPP loans. Core ratio, that is loans, net of premium finance loans and PPP loans, is at 1.88%. Hard to believe that credit is this good given the environment. Be assured we're not going to let our guard down here. We're not naive enough to think that there will not be bumps in the road going forward. But in any case, we're actually reserved right now. On the one-timer front for the quarter, negative one-timers include $3.1 million to settle a mortgage banking dispute related to 2008, believe it or not. $6.3 million of contingent consideration related to previous acquisition and $132 million of acquisition expenses. $6.3 million of additional consideration. We believe we'll cover the fourth quarter, and then next year the numbers get negligible in terms of the amount we would owe under that. So we think we've got it covered now, but if we need more, it means the mortgage business is still on fire. We also record $3 million decrease in MSR valuations. to the continuing falling mortgage rates. We now have close to $10 billion of MSR service portfolio. So any rise in rates is certainly going to be the beach ball underwater. On the profit side, we also recorded a $9 million pre-tax settlement of an uncertain state tax position. So other than the $3 million MSR valuation, one-timer is basically washed. Quick on other income, other expense. Dave's going to cover in detail, but a couple of general comments. As you all know, the mortgage business was extremely strong. It appears that this trend will continue at least for another quarter based on pipelines and hopefully longer, always dependent on interest rates. You know, the mortgage business is an integral part of our overall strategy. When rates go down, the mortgage business kicks in and helps while we readjust the balance sheet to optimize earnings in that regard. You know we retain a positive gap at pretty much all times, and this is an offset to that. So you cannot look at the mortgage business separately and try to break it out because when you think about it, it's given us the time and the earnings to get the margin going again, and we'll talk about that a little bit later. But it is an integral part of the business, part of our strategy, part of an internal hedge to optimize earnings in any rate environment. One of the reasons we maintain a positive gap is we know that this business can cover for any period of time a falling rate. So to consider it outside as separate, this is an integral part, as I said, an integral part of what we do, and it's an integral part of our strategic plan and how we manage the balance sheet, manage earnings. So even when they fall off, we get another couple quarters of really strong mortgages. They're not going to fall off in total. By then, we believe that... The margin will be back at 275 range as we grow. We are a growth company. We will grow through this. This is evidenced by growing almost $10 billion, over $10 billion in the last year alone. We have a great halo effect going, and we'll talk about our deposit growth in a second. On another note, wealth management revenue continued to track to be, was back on track to $25 million. Assets under administration were $1.2 billion, or 4.3% to 28.2%. Growth was in all three business areas, trust, the broker-dealer, and asset management. The majority of the growth occurred in asset management. There's new institutional accounts accounted for $0.9 billion of that growth. That would be good revenue going forward. Again, in that overhead ratio, 87 basis points, low below 1.5%, and that certainly helps mostly from the mortgage business, and that's evidence that it makes up for the margin decline we hope to pick up going forward. On a balance sheet front, we grew $200 million in total assets to $43.7 billion. Our earning assets were up a billion dollars. Average earning assets from 39.8 to 38.7. Our loans grew $700 million in a period of time when other people, our competitors, are not having loan growth. Our loan growth is very good, and our pipelines are stronger than ever. We have a $500 million head start, given the average balance, standing balance. And again, our loan pipelines are extremely strong. We expect very good core growth, low growth in the quarter. On the positive front, we grew $192 million. That's a little bit misleading, kind of the tale of... Let me go back a second, if I could. On the PPP loans, the balance has actually increased in the corridor by $44 million to $3.38 billion. Currently, $1.25 billion in 4,000 loans under the forgiveness process. About a third of the portfolio is in the hopper for forgiveness. The deposit story, we said they grew $192 million quarter over quarter, but it's a story within a story. As mentioned in the last earnings call, deposit says that they – when they had the last earnings call, about a billion dollars less than a quarter at the end of the second quarter, which means we've got $1.2 billion in core lower-cost deposits as these deposits ran off or higher deposit costs. And the $1.2 billion is more core and a result of our business development, the halo effect on PPP. and continued general growth throughout the franchise. Pardon me. In Q4, we've arranged for the return of approximately $600 million of institutional deposits. We have brought on to fund PPP loans and for general liquidity at the end of Q1 when the world was getting pretty crazy. Over the quarter deposit growth rate remains strong, so we do expect the quarter deposits will grow to offset that decrease, but again at lower cost. Now I'll turn it over to Dave, who's going to talk about lower income, lower expense.

All right. Thank you, Ed. Ed touched on the wealth management revenue a bit, but in the non-interest section, that wealth management revenue increased $2.3 million to $25.0 million in the third quarter, compared to $22.6 million in the second quarter. And it was up 4% from the $24.0 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, and also due to a higher level of trading in our brokerage accounts from the depressed levels that we saw in the second quarter of this year. On the mortgage banking revenue front, it increased by 6% or $6.2 million to $108.5 million in the third quarter. From $102.3 million recorded in the prior quarter, and was up a strong 113% from the $50.9 million recorded in the third quarter of last year. The company originated $2.2 billion of mortgage loans for sale in the third quarter, essentially the same as the originations that we had in the prior quarter, and it was up from the $1.4 billion of originations in the third quarter of last year. The increase in this category's revenue from the prior quarter resulted primarily from an increase in mortgage servicing revenue as a result of the larger servicing portfolio and a higher level of capitalization of MSRs and a smaller negative MSR valuation adjustment during the third quarter relative to the second quarter. The production revenue was relatively stable but up slightly as a production margin on a similar volume state level with the prior quarter. These aforementioned increases in mortgage revenue were offset somewhat by an additional expense accrual of approximately $3.1 million in the third quarter for the settlement of a longstanding recourse obligation dispute. That puts that dispute to rest. It had been out there related to loans that were basically a decade old, and we felt it was appropriate just to put that dispute to bed. We currently expect originations in the fourth quarter of 2020 to be strong, although there may be some seasonality. We'll see how it works out. The winter months tend to slow the purchase business a little bit, and there are holidays involved in November and December. But the pipeline is very strong. We expect it to be a strong fourth quarter. Margins may come down a little bit depending on that volume. We'll see how it works out. For our fourth quarter of the year, we expect it to be extraordinarily strong. Table 16 of our earnings release provides the detail of all the mortgage banking revenue components if you want to dig into that further. Other non-interest income totaled $13.3 million in the third quarter, down approximately $1.4 million from the $14.7 million recorded in the prior quarter. The largest decline of revenue in this category related to lower SWAT fee income of approximately $1.7 million. There were a variety of other smaller positive and negative variances in this category that essentially offset each other. Turning to the non-interest expense categories, non-interest expense totaled $264.2 million in the third quarter, up approximately $4.9 million or 2 percent from the $259.4 million recorded in the prior quarter. Turning to the more significant changes quarter over quarter, the salaries and employee benefit category increased approximately $9.9 million in the third quarter from the second quarter of this year. The biggest portions of that are the employee benefit expense, which accounted for about half of the total increase and was up approximately $4.8 million from the prior quarter. And that was due primarily to substantial increases in employee insurance claims as employees have begun to return to a more normal pattern of seeking health care. And they also were catching up on services such as discretionary doctor's visits and surgeries, which have been deferred during the early stages of the coronavirus pandemic. Accordingly, the second quarter expense was unusually low and the third quarter expense was unusually high. However, the average of the two quarters is generally in line with the prior quarter run rates and our expectations. Additionally, salaries expense was up approximately $2.8 million from the second quarter. The primary cause of the increase was approximately $1.6 million of lower deferred salary costs. relative to the prior quarter, which had higher deferred costs related to the PPP loan volumes that we had in 2Q, so less of salary deferrals in the third quarter because we didn't do the substantial amount of PPP loans in the third quarter. Additionally, the company incurred a little bit more expense to support the significant mortgage volume being processed through the system. Commissions on the set of the comp expense increased approximately 2.3% $3 million in the third quarter. That change was driven largely by additional commissions related to wealth management brokerage trading activity as well as higher incentive compensation expense recorded during the third quarter relative to the second quarter. Data processing expense decreased roughly $4.7 million in the third quarter compared to the second quarter due primarily to approximately $4.5 million of conversion charges incurred related to the countryside acquisition in the second quarter, whereas the third quarter was void of any such acquisition-related conversion charges. Professional fees declined by $1.2 million to $6.5 million in the third quarter, compared to the $7.7 million recorded in the prior quarter. These professional fees can fluctuate on a quarterly basis based upon the level of legal services, related acquisitions, litigation, loan workouts, as well as consulting services. This category of expenses was down slightly from the prior quarter due to small declines in a variety of expense types, but nothing of any significance related to any particular category. The professional fees categories averaged about $7.3 million over the past five quarters, so the current $6.5 million is a little less than that, but within what we think is a normal range. Equipment expense totaled $17.3 million in the third quarter. It's an increase of $1.4 million as compared to the second quarter. The increase is due to increased software licensing expenses, including some increases related to online, increased online mortgage usage, PPP loan servicing enhancements, network upgrades to support our growth and digital enhancements. and various other software upgrades. And we continue to invest in software and technology to enhance our customer delivery systems and products, as well as investment systems to support our continued growth. Other than those expenses that I just discussed, all other expense categories were actually down on an aggregate basis by approximately $524,000 from the second quarter. Ed mentioned that that overhead ratio stood at 87 basis points, which is down six basis points from the 93 basis points recorded in the second quarter, and on a year-to-date basis, the net overhead ratio was 1.03 percent. The ratio continues to benefit from strong balance sheet growth and strong mortgage banking results. Moving on to income tax expense, the effective tax rate in the third quarter of this year was approximately 21.8 percent, which is well below the 26 to 27 percent range that we would normally expect. The reasons for the lower tax rate in the third quarter related to a $7.1 million net income tax benefit recorded during the third quarter related to the settlement of an uncertain tax position with taxing authorities. We'd anticipate the effective rate to return to the expected rate of 26 to 27 percent in the future quarters barring any unanticipated events. I'd also like to take a few seconds to address the preferred stock dividends. There seems to be some confusion out there if I look at some of the analyst estimates on what the preferred stock dividends should be on a going forward basis. So the company recorded $10.3 million of preferred stock dividends in the third quarter. However, on a going forward basis, given the existing outstanding issuances and dividend rates, and if declared by the Board of Directors, the amount of preferred dividends recorded should approximate $7.0 million. The reason for the higher amount in the third quarter was that the first dividend period was a five-month period. There was really a two-month stub period in May and June, and then the normal quarterly period for the third quarter. So in the first period, the dividend declaration included five months, but in all subsequent periods, the dividend should be a three-month period. slightly high in the third quarter here at $10.3 million, but going forward, given the existing issuances, rates, et cetera, that amount should be $7.0 million. So just wanted to clear that up, as there seemed to be some confusion about that. And with that, I will turn my comments back over to Ed. Thanks, Dave.