Wintrust Financial Corp (WTFC) 2014 Q1 法說會逐字稿

Welcome to the Wintrust Financial Corporation's 2014 first-quarter earnings conference call. At this time, all participants are in a listen-only mode. (Operator Instructions). As a reminder, this conference call is being recorded.

Following the review of the results by Edward Wehmer, Chief Executive Officer and President, and Dave Dykstra, Senior Executive Vice President and Chief Operating Officer, there will be a formal question and answer session. The Company's forward-looking assumptions are detailed in the first quarter's press release earnings and in the Company's most recent Form 10-K on file with the SEC.

I will now turn the conference over to Mr. Ed Wehmer. Please go ahead.

Thank you very much. Good morning, everybody. Happy spring and welcome to our first-quarter earnings call. With me, as always, are Mr. Dykstra; Dave Stoehr, our Chief Financial Officer; and Lisa Pattis, our General Counsel. We will follow the usual protocol for the meeting. I will provide some general comments about the quarter. Dave Dykstra will gone on through other income and other expense [capitals] in detail, and then back to me for some summary comments and thoughts about the future.

All-in-all, it is a pretty good start to 2014 for Wintrust. Earnings of $34.5 million or $0.68 a share are 8% above the first quarter of 2013. Our margin increase stayed basis points for 3.61% versus the fourth quarter of 2013. Earning asset yields were up 6 basis points and liability costs down 2 basis points due to a better funding mix. We talked about the margin before in terms of a range of between 10 basis points, plus or minus off of 3.5% or a little bit about that now, higher loans at a positive ratio helped. It is an increase in liquidity itself and in that regard.

Other income in total was down really due to the mortgage environment. Our wealth management fees are holding up very nicely at $2 million year over year. A lot of that has to do with the market, but a lot more has to do with our growth in assets under administration. We have a lot of momentum in this area. Our proprietary products are doing very well, and we have great emphasis on this going forward as we think all the pieces are in place now. I sound like Dave Wannstedt when he was coaching the Bears. I hope that is not an omen. But all the pieces are in place, and there is great momentum. Great cross-selling going on between our customers and our wealth management operation now that we have all the pieces in place and can confidently put them in front of our customers. And on the institutional side, we are seeing good growth there, too.

So wealth management is a sleeper for us, but it is doing very, very well going forward.

On the mortgage side, the market in general fell off a cliff in January, and this was exacerbated by the Arctic weather experienced, not just in Chicago, but the country in general. January and February were not good months at all as we struggled with lower volumes. I think we had $170 million of volume in both of those months, and we accordioned our expenses, and we are going through the process of doing that, but really not too much because March rebounded nicely with $230 million in volume and good profitability. Our current forecasts show about the same March level, if you look at our locks and our applications and the like. We are looking at 2 to 3 months of $230 million or above in terms of volumes, but it will be what it will be, but -- and you never know. But, it appears it is rebounding nicely. We couldn't cut all the expenses because we saw this rebound coming and rather than fire and build it back up. So we had to take it in the chin for a little while in our expenses in those first couple of months.

The first quarter is always a noisy one on the other expense side and hard for modelers to use as a basis for their projections. I am sure Dave will give you enough detail to make it pretty much as clear as mud going forward. However, in general, when you explain away some of the quarter's oddities, I think you will see that overall expense control is actually pretty good. Obviously, the mortgage market declined, and the time it takes to right-size the expenses didn't help matters much. This plus some of the first-quarter oddities resulted in a higher efficiency ratio of that plus the fact that we have two less days in the month always hurts our efficiency ratio, but we believe this to be an anomaly, and Dave will get into this in much more detail.

On the balance sheet, total assets grew to $18.2 billion, up $130 million from the end of the year and up $1.15 billion over March 31 of 2013. Total loans, excluding loans held for sale and covered loans, grew $237 million, close to the $250 million we look for every quarter. Commercial loans really led the charge this quarter, increasing 23% on an annualized basis from 12/31/13. (inaudible) premium finance division showed growth as did commercial real estate. Home equity loans, consumer loans, and residential real estate fell, so all-in-all a pretty good core portfolio growth here and in line with our expectations.

Lending environment continues to loosen, but, as you would expect and as always been our history, we are not going to follow the herd if it continues to go that way. We continue to book business on our terms, using our steadfast and ever-changing loan policies and pricing models. So we are going to still hold the course, and we are still seeing enough business that we can book on our terms. However, we're still just taking a bigger piece of the pie as utilization rates have not really risen over the past year or more. The covered loans continue to increase as we work through the portfolios acquired in the failed transactions, the failed bank transactions that we participated in. We continue to have very good results there. We are constantly managing pushing these things out, and we are doing a very good job of it to make sure that the railroad tracks come together, that is that the indemnification asset is gone when the loss share period runs out. And I think we are doing pretty well in that regard.

And, obviously, on the loan segment mortgages held for sale this quarter, over $110 million versus the end of the year. Pipelines remain consistently strong with $1.2 billion gross and -- in the pipeline, and if you weight that, the probability of close, and this is kind of a three-month look forward. $750 million on a weighted basis. So consistently consistent in that regard.

Our capital positions remain very strong, assuming the conversion of our preferred stock -- convertible preferreds. Our PCE ratios will get close to 9%. Our capital stack has capacity as we have no straight, preferred, or sub debt currently on the books. So we have lots of options there. The days of just in time capital are over when we used to -- when run it down and run our capital ratios down and then bring them back up. And banks like us, or organizations like us are in acquisition mode, like to have the capital in place before hand to keep the regulators happy and allow us to consistently and efficiently move through the process when we identified opportunities.

On the credit side, good progress here, continued good progress here. All our credit metrics are now pretty much back to pre-cycle levels. Nonperforming assets fell 2.79% of assets to nonperforming loans -- 2.69% of loans. Reduction of $10 million in the quarter of nonperforming assets. These numbers are still too high to my liking, and we think we will continue to make good progress bringing these numbers down. We will continue to identify and expedite the clearing of any problem assets that do show up.

Nonaccrual infos were low this quarter, $5.6 million, a low watermark in the last five years. As much as the covered loan portfolio is tracking better than anticipated, we had two big bad loans paid off in full. Did I mention the solution credit standards in the market? Plus, a number of other positive events occurred during the quarter. As such, we actually recorded a negative provision on the covered loan portfolio in the quarter, taking the negative provision out. Our core portfolio provision was about $3.3 million. Net charge-offs totaled $7.8 million, the majority of which were related to two credits that have been well reserved in previous quarters.

The allowance for credit losses stands at 70 basis points. For all of you out there who are new to us, I will refer you to page 25 of the press release where we break out the components of the reserve by loan type. It shows that over a third of the portfolio, our mixed asset portfolio, with premium finance go forward as being the biggest of those, and no losses. Really, basically no losses over the past years. And, therefore, they only carry a term by 19 basis points. When we back that out, the core portfolio is reserved at 1.02%, which makes a lot of sense and, again, I will refer you to page 25. But it does make a lot of sense considered that in our core portfolio we have always operated at two-thirds or less of the peer group as relates to these types of loans. This is a credit to our policies and our underwriting and our conservative approach to lending. We always get this question, so we always provide as much detail as possible, as to the calculation of our reserves, and we realize a lot of our reserves are appropriate. And, again, that reserve level is back to the levels of that prior to the cycle starting out.

Our reserve coverage on NPLs is as high as it's been since 2001. OREO charges for the quarter were approximately $4 million, up from $2.7 million in the fourth quarter of 2013, and recovery of $1.6 million in the first quarter of 2013. $2.8 million of these costs related to valuation charges with $2 million of that related to two assets. One was a golf course that we had a buyer for. Can you imagine a $1.5 million purchase price at a golf course that has a 30,000 square plus foot clubhouse, a swimming pool, and a golf course where they played qualifiers for the U.S. Open? So if you ever come out, we can take you out to our golf course, and we would love to have you there. Hopefully, it won't be ours at the time that it comes out. But this shows you golf course lending isn't very good.

All-in-all, we feel good about where we are in credit, but you never know. We are always prepared to move forward. It is what it is, but we're going to continue to knock that number down.

On the expansion front, a prominent bank in Chicago I was having dinner with last week or two weeks ago, and he asked me if I was going through withdrawal. And I said, withdrawal? And he said, yes, you haven't done a deal in the quarter. Well, no withdrawal here because we announced two deals last week. One branch acquisition in Milwaukee, Wisconsin. It had about $95 million in assets. There is a great Muskie Lake, for you fishermen, in Milwaukee. And we did another 11-branch acquisition in southern Wisconsin, deposits only, $360 million from Talmer, with the former First Banking System, which Talmer picked up when that bank failed. It added 50% to our Wisconsin franchise deposit base with plenty of opportunity to grow. You notice, we are just taking deposits here, but the -- all the loan officers are coming over with us. Talmer is retaining the loans, and I would imagine that, from a loan strategy standpoint, with Talmer not having presence there, that our loan officers should be able to bring a lot of those good assets back onto the books of the bank. They also have an expertise in ag lending, something we are looking into very seriously as a niche for us going forward. We are not in that business now. We can pick up that extra piece in Illinois, Wisconsin, the big ag states, and something that we can -- that we think we can build on strategically over the next four or five years. So that is kind of exciting for us. Both of these deals coming in Wisconsin really fills in our franchise. We put a map in the press release to show you how it really fills in between, we had run from Milwaukee straight west to Madison. This fills in that gap between the Illinois border and up to that where our banks are. So we are excited about these opportunities and filling in the franchise and, as we always say, I have never had a bad time in Wisconsin, so we are always happy to be there and committed to that market.

It also recently became public, we are acquiring a small branch in Chicago from Urban Partnership Bank. That's another fill in branch as we continue to expand -- continue to expand our footprint in Chicago. We also -- we have not abandoned de nevo. We opened two de novo area branches in the quarter, Evergreen Park and Prospect Heights, to continue our fill-in of the Chicago market area.

We are maintaining a balanced approach to expansion, filling out our franchise with planned, profitable growth. Acquisition opportunity pipelines remain strong, but we find that gestation periods of deals are becoming much, much longer; higher-priced expectations; plus involvement of investment bankers and lawyers and the like has slowed this process from where it had been in the past, but we will be diligent and persistent, and we will continue to strategically grow, planned profitable growth both through de novo and through acquisitions.

Now I will turn it over to Dave to discuss our income and other expense in detail.

Thanks, Ed. As Ed mentioned, I will just briefly touch on the major changes in the noninterest income and non-interest expense sections. Turning to noninterest income, our wealth management revenue increased slightly to $16.8 million for the first quarter of this year from $16.3 million in the prior quarter and improved by $2 million when compared to the year ago quarter of $14.8 million. Brokerage revenue was down slightly this quarter, but relatively stable at $7.1 million compared to the prior quarter, while our trust and asset management revenue showed an increase in revenue to $9.7 million from $9.1 million in the prior quarter. And that increase was primarily attributable to growth in the assets under management due to the new customer acquisitions, as well as market appreciation for the assets.

Mortgage banking revenues, as Ed mentioned, declined 15% to $16.4 million in the first quarter from $19.3 million recorded in the prior quarter and was also down from the $30.1 million recorded in the first quarter of last year. The Company originated $527 million of mortgage loans in the first quarter compared to $742 million of mortgage loans originated in the fourth quarter of last year and $974 million in the year ago quarter. Although the volume declined in the quarter, a gain on sale margins increased over the fourth quarter, primarily due to the shift in the mix of business originating from our retail and correspondent channels. The first quarter had a lower revenue component from the correspondent net worth, which was a lower margin business than our retail business.

Also, the first quarter showed a relatively strong mix of volume related to the purchased home activity, which represented about 69% of our first-quarter volume, and this was very similar to the percentage attributable to purchased activities in the fourth and the third quarter of last year. Mortgage servicing rights portfolio declined to $8.7 million as of the end of the first quarter compared to $8.9 million in the prior quarters. That is the valuation of the portfolio, and we currently have it valued at 92 basis points, and it was valued at 93 basis points in the prior quarter.

Turning to other items, fees from covered call options remained relatively consistent and totaled $1.5 million in the first quarter of 2014 compared to $1.9 million in the previous quarter and $1.6 million reported in the first quarter of last year. As we have said before, we have consistently utilized fees from our covered call options to supplement the total return on our treasury and agencies [sold in] our portfolio in an effort to hedge -- provide a hedge against margin pressures caused during a period of declining interest rates.

Trading losses were relatively small this quarter at $652,000 compared to $278,000 in the prior quarter and a loss of $435,000 a year ago quarter. And, as we have said before, the trading losses in the current and prior quarters were primarily the result of fair value adjustments related to interest rate contracts that we do not designate as hedges. And these are primarily an interest rate cap position that the Company uses to manage interest rate risks associated with rising rates.

It is interesting to note that the net impact of the trading gains and losses over the past five quarters has in the aggregate been slightly positive at a net $240,000 trading gain. The level of other non-interest income categories recorded for the quarter was fairly consistent with the levels recorded in the prior four quarters other than we did see a decline in fee income generated from transactions related to customer-based interest rate swap contracts, as the market conditions for these products is not quite as attractive to our customers today as it was in the prior quarters. The Company recognized only $951,000 in interest rate swap revenue in the first quarter of 2014 compared to $1.5 million and $2.3 million in the prior year ago quarters, respectively.

So nothing else unusual on the noninterest income side that I will address. Turning to the noninterest expense categories, total noninterest expense was $131 million in the first quarter of 2014, increasing approximately $4.3 million compared to the prior quarter. The categories which exhibited increases over the prior quarter were salaries and benefits, equipment and occupancy, and OREO expenses. Now, all other major categories actually showed expense reductions from the prior quarter, indicating decent overall expense control excluding for those categories that I mentioned.

Salaries and employee benefits increased $5.9 million in the first quarter compared to the fourth quarter of 2013. Employee benefits were approximately $2.5 million higher in the first quarter compared to the fourth quarter of 2013, and this was predominantly due to higher payroll taxes. Now payroll taxes are always higher in the first quarter of the year as Social Security tax limits that are reset at the beginning of the year. The increase in this salary and employee benefits category also reflected an additional $5.2 million of performance-based pay accrual, primarily related to the Company's long-term incentive plan. And this was partially offset by $1.7 million of reduced commission expenses, which is primarily related to the diminished levels of mortgage banking revenue. And, finally for this category, the base salary expense is relatively flat with the prior quarter, despite the fact that the first quarter included the impact of annual-based salary increases for employees, which were generally in the 2% to 3% range.

Turning to occupancy expenses, they jumped $1 million in the first quarter of 2014 to $11 million compared to the last quarter. The increase in the current quarter was impacted by higher utility costs and snow removal costs associated with the unusually cold and snowy winter experienced in our market areas this winter, as well as a slight increase related to the increased number of facilities that we now own.

Professional fees totaled $3.5 million in the first quarter, representing a reduction of $678,000 from the prior quarter and a slight increase of $233,000 from the year ago quarter. And we are pleased with the reduction in this category in the current quarter, and we are optimistic that this expense category will trend down over time as we continue to see the reduction in the nonperforming assets and the related legal costs associated with collection measures.

The first quarter saw an increase of $1.3 million in net OREO expenses compared to the prior quarter, resulting in net OREO expense of $4.0 million compared to $2.7 million in the prior quarter. That was $4.0 million of OREO expense in the current quarter, approximately $1.5 million related to operating expenses.

Page 36 of our earnings release provides additional detail on the activity in and the composition of our OREO portfolio, which increased to $54.1 million at March 31, 2014, from $50.5 million at the end of the prior quarter.

The other categories of noninterest expense declined by $2.4 million, and that brought the level to $13.9 million from $16.3 million in the prior quarter and $14.8 million in the first quarter of 2013. The expense in this category is at its lowest level since September of 2011 and is reflective of reduced costs associated with a variety of expense categories, including loan expenses, both on our core and our covered loan portfolios, travel and entertainment expenses, operating losses, postage, supplies, and other miscellaneous expenses. So in a broader range of categories, we had good expense control there and had really nothing out of the ordinary included in those categories this year.

And, as Ed noted, and as we noted in the press release, our efficiency ratio was elevated in the first quarter, primarily due to the time lag between the decline of mortgage revenues and the related decrease in the mortgage-related expenses, as well as our decision to limit the staffing reduction, as Ed mentioned, in order to remain properly staffed for the higher volumes that we anticipate in the second quarter. That, combined with the OREO valuation charges and the seasonal payroll taxes, contributed to the elevated efficiency ratio. If you exclude those items, the Company's efficiency ratio would have been more in line with the prior periods and, as I just mentioned, the other expense categories were well-controlled.

So I think that is the highlights for other income, other expense, and I will turn it back over to Ed.

Thanks, Dave. So to summarize, it is a put a good start to the year. Going forward, we expect continued good loan growth. As I mentioned, our pipelines are consistently strong. We have good traction in the wealth management business. We feel good about that. We certainly expect a better mortgage environment, at least for the near-term, going forward. Happy to be free of the first-quarter anomalies and other expenses. We will continue to manage liquidity levels to maintain our margin, but this could be a little bit bumpy with the acquisitions we are doing. Remember, it is the net interest margin range that I've explained to you, but remember it is really the net interest income that counts. So we will continue to try to manage that to stay as efficient as possible, but these acquisitions come in and bring us extra liquidity, it might take a quarter or so to lend those out or to get the loan volume to cover that. So we would expect to continue be within that range in our net interest margin if, in fact, rates don't rise. If they rise, then all bets are off, and we feel very good about our interest rate sensitivity position, which we continue to become more sensitive every day.

Hard to believe that I am trying to become more sensitive, isn't it?

Rates will go up, and every day we do get closer to rates going up. So we look forward to not just the effect overall of rising rates, but the decompression of costs on deposits that will accompany that move. Remember, we are 94%, 95% core funded with basic products and demand savings now, and as rates go up, spreads will get wider on those, also, as we lag and when they hit their historical kind of caps that go on those products. So we are anxiously awaiting that day for the beach ball underwater to finally pop up.

We're going to continue to look for expansion opportunities in a balanced way. This consolidation process, in our opinion, I think I have said previously, is going to be a five-year sort of thing as banks continue to get healthier and in a position to sell. Most of these banks will be community banks under $1 billion that fit our culture and will allow us to continue to expand our footprint. We are the right cultural acquirer for those banks where we see they all will be seeking a safe haven from our brave new world of banking. I really like how the Company is positioned right now. We have got good momentum and good opportunities looking us in the face. We just have to execute properly and stay within -- don't get out over our skis and continue to work to raise shareholder value in every way possible.

So thank you very much all for listening, and now we have some time for questions.

(Operator Instructions). Jon Arfstrom, RBC Capital Markets.

Just a question for you on expenses. The revenue environment looks pretty good. We have heard some grumbling on the expense trends. And, Ed, I put your clear as mud guidance into my earnings model and I get an error. So I have to get some more detail on this.

The question is, are there more mortgage banking expenses to come out, and is there anything else out there in terms of expense pressures that are coming other than the acquisition?

Well, really, I would say not. There is a lot of anomalies in the first quarter, as we mentioned, that take place. The mortgage expenses, we did consciously -- we didn't cut back all the way because we saw levels returning to the $250 million sort of volume on a monthly basis. So rather than let everybody go and then have to hire everybody back and suffer the inefficiencies of that, we just bit the bullet, and in March we had a very, very good month, and it looks like it should be good going forward. At least for the foreseeable future, we are prepared to what we see as a long-term downturn in overall volumes to make those moves. But, we still carry -- what Dave said, if you look at all other aspects of our expenses, they were down or up negligibly.

So we still carry a lot of operating leverage in the system. Right now, what the market is giving us is acquisitions that are profitable to us. Good growth opportunities that are profitable to us. We partner up with these banks that are 50% liquid. We are able at our loan volume to lend them up relatively quickly and make them very, very profitable deals, but right now the organic growth aspect of what we are doing is not what you have experienced in the past.

When rates rise, that is going to happen. We have a number of branches that are in towns that we really want to be in that are underutilized right now. It is just hard to attract organic growth in the way we had in the past until rates move up. So we do have a lot of, what I call, kinetic leverage out there that we will be able to use when rates move up and we shift back to organic growth.

Our theory, Jon, is that as rates move up, banks are going to become more expensive, and it is really hard to pay old-time multiples for these banks because they take have taken trust preferred out of the equation. All goodwill has to be backed with really common equity or expensive preferreds. We think that the pricing models are going to move away from us, but that -- when that happens it is going to open up the opportunity to leverage the system and take advantage of leverage we have built in through organic growth.

So we are carrying a little bit more. We are not as efficient as we should be in a number of the banks, but this is -- we play this for the long-term. And we like the way we are positioned there. So, overall, expenses, I think you will see come back in the line in the second quarter, and we will go from there.

Dave, do you want to add anything?

No, I think that is a good summary.

Okay. Great. The other part is just on the sustainability in the NIM. You had a nice jump, and maybe, Dave, if you could touch on the liquidity management yields. And I think you touched on it earlier, Ed, but is this type of NIM sustainable?

Well, I will start and say, again, it is all dependent on the amount of liquidity we have on the balance sheet, John. We are operating right at the top of where we are comfortable at 90%, 91%. And that is -- so we have got a very efficient balance sheet as relates to the net interest margin. If we pick up -- we go to 86%, 88%, that is going to affect the margin. And, as we said, as long as we are able to stay optimized, we should be at these numbers that we are at right now. However, you bring in some excess liquidity, and I can't manage it quarter for quarter with some of these deals that is going to come in a little lumpy that will affect that. But, right now, we are optimized, and I will let Dave talk about the liquidity management deals.

Yes. So I think Ed is right there on the liquidity side and --

Thanks, Dave.

He is very sensitive, too, I have noticed. As the management, I think that makes sense. We also have been seeing that our loan yields on new loans have been fairly stable portfolio-wide, and the funding costs have hedged down. So we don't see the compression on the core portfolio, so it is really just the amount of liquidity.

As far as the yield on liquidity management assets, we did get some extra positive -- and you will also notice, also, on the deposit table that we have some off management deposits. So we have one wealth management client that we obtained some additional deposits for, and we used that to lever the balance sheet a little bit. Those are longer terms as far as maturity deposits floating with the low rates, which we used one of our interest rate caps to lock in that rate, and then we went and we used some of that liquidity to buy some Fannie Maes, some agencies, and some municipals.

So we extended out a little bit with some higher rate securities using those funds that we locked in with our interest rate cap. And so that has caused liquidity management assets to go up. But, you know, on balance, we still maintain a fair amount of cash on the balance sheet of 25 basis points, and so we feel good from a liquidity perspective. But, with that additional funding coming in, we thought it was a good opportunity to put some of that money to work.

Yes, we basically took $300 million and extended it out, but locked the spread for three years. And if rates go up in that three-year time period, then we will be making a lot more money, hopefully, knock on wood. But we are positioned to do that, so this seemed like it would be a good play right now where we could lock in a spread for three years. And if rates don't move, we will be fine. If rates go up, we will be making a lot more money. So, Peyton Green, wherever you are, we probably should have done it a little bit earlier.

Brad Milsaps, Sandler O'Neill.

Just to follow up on John's question, Dave, I was going to see if you could maybe break down sort of how -- any change in liquidity management assets. Just curious the composition. How much actual cash or federal funds makes up the $2.6 billion, on average? I see the period-end numbers, but on average for the quarter versus December 31.

So at the end of the fourth quarter, we had about $2.6 billion of liquidity asset managements, and about $1.85 billion on average was in all of our securities, and the rest of that was really overnight money. And, at the end of the first quarter, we again had a little over $2.6 billion, and the securities made up $2.1 billion. So we are up about $250 million on the securities side and down about that on the cash side.

Okay. And so that essentially represents that $300 million or so that you just discussed.

Right.

Okay. And then, just to follow up on expenses, the $5 million-some-odd number you talked about in long-term incentive accrual, is that a bit of a catchup, or is that something that will stay on a run rate, or you expect that to maybe dissipate even more in the second quarter?

You know, those numbers bounce around a little bit because there is three years worth of plans, and they each have different target percentages. Some of that was a little bit of a catchup for prior years as when we made the final determination for the payouts in early 2014 on the first go around. But there is a lot of moving parts in the first quarter with payroll taxes, the bonus accrual, and the (inaudible) accrual, and the commissions, and the like. And so I think maybe the easy way to do this is, if you look at our total salaries and benefits expenses and back off the commission line that we disclosed because those really fluctuate based upon the mortgage volume --

And the wealth management volume.

And the wealth management volume. But they fluctuate much more dramatically with increases and decreases than with the mortgage business. So if you took our total salaries and employee benefits and exclude the commission line, we think sort of our run rate in this area is probably in the $66 million to $57 million range.

So if you take that number, excluding any acquisitions that we do or our expansion plans that we do in the future, so if you take that number and then if you -- you can all make your guesses on where you think the mortgage market is going to go and where that commission line is going to go, and that is probably the best guidance I can give you on the salaries without going through line by line and talking about it. But, probably a little extra in the LTIP, but if we do better, some of that may stick around next quarter, and so I am hesitant to make a line by line projection going through that section. But, I think that is probably the best way to look at it, if you boil it down to the two components -- commissions and everything else.

Peyton Green, Sterne, Agee.

Just a question, maybe, Ed, for you is on the loan-loss reserve, I know the credit quality, the charge-off rate certainly are coming down, and I would think you all would expect them to come down to a more normal level going forward. What is the right way to think about just the loan-loss reserve that you had kind of allocated at the end of the first quarter? I mean, do you feel like you are at a level that you would kind of keep it at that level, or is there still some ability to take it -- I mean, is a 1%-ish number the right level for the portfolio, ex- niche businesses, or how should we be thinking about that?

Well, we are back, Peyton, and I hope you appreciated the shoutout I gave you, Peyton.

Yes.

We are back to the level we were at pre-crisis, right around 70 basis points -- 69, 68, 70 basis points, right on that level. And, as I mentioned in previous calls, the calculation of the reserve has become this massive mechanical exercise that looks at note by note by note, by risk rating, by collateral code, and it is really a voluminous process we go through here to get these numbers. So, as the losses go down, you could see -- if historical losses were down and time goes forward, you could see it drop on a little bit more. There is not a lot of room there, Peyton, because I think this is a level that we are comfortable at, but a couple basis points here or there.

What could screw it up, Peyton, is, when you buy a bank, you do not bring the loan-loss reserve over. And if we were to do an acquisition of size or a couple of -- $200 million, $300 million deals when you bring the loan portfolios over, they come without a reserve. So the number gets a little funky. And that is why we pointed out on page 25 exactly how we have allocated this reserve to the various elements of the portfolio. So that is the long answer.

The short answer is, we think they are appropriate right now. About 1% is a good number. You can see, if you look at page 25, residential construction, we keep a 2.2% reserve. Land, that is almost a 3% reserve. We are not doing a lot of that stuff. As those portfolios run off, you will see that the numbers could come down a little bit more.

But there will be hiccups. We are not perfect there. There will be issues here and there that will make this thing move. But you really have to study the chart on page 25. But, right now, I would say we are probably in a comfort range, but it could go lower or higher by 5 or 10 basis points, I guess would be the way to put it.

Okay. I guess where I am really coming from is modeling out the future -- and I guess we all have charge-off rates that are probably higher than the pre-cycle levels that you all -- on the high end were 25 basis points before you really got into the premium finance business, and they dropped down to 10 basis points or below on an annualized basis once you did get into the premium finance business. I mean, how do you view normalized charge-offs for the economy as you would expect it to exist over the next two or three years?

Peyton, this is Dave. As Ed mentioned, I think things can get a little lumpy here and there, but I think when we look at it, we sort of think that charge-offs are, for what we do and how the portfolio is, ex any acquisitions, because of, as Ed said, you don't bring the reserve over, and your initial charges on those would go against your credit reserves if you set up against those purchase portfolios. But we sort of think of ourselves as originating loans probably in the 25 to 35 basis point charge-off range. We hope we do better than that, but we are prepared for that kind of a charge.

All right. Great. No. That helps very much. Ed, how did you see the competitive conditions change over the course of this quarter? I know it -- I guess it has been two quarters now where you have commented that competitive conditions have gotten a bit more intense than maybe -- like they were in 2006. How would you characterize it this quarter?

You know, there is a bit of a feeding frenzy going on for earning assets, as you would expect. It is not too dissimilar to after 9/11 when rates were kept probably low longer than they should have been and people have -- you can't get anything in your securities portfolio. So people are -- bankers have amnesia, and they are very good at generating convenient logic when they want to book a deal.

We have seen the rates out there -- competitive rates that basically they bottomed out two, three, quarters ago. But now you are just seeing some funky things going on. Unmatchable things, as I like to refer to them, where -- and a lot of it is a result of an overheated market in the private equity side and people buying businesses. People are buying businesses for huge multiples right now, and that creates big air balls. And we see people extending air balls being the unsecured portion of a transaction where we are comfortable, depending on the business, two, three, four years, something like that. We are seeing seven, eight years out there. And that is something we just won't play in. You are seeing guarantees go by the wayside, and you are just seeing a loosening of terms out there. As I said, rates have bottomed out two, three quarters ago. But you are seeing loosening in terms, and the specific examples that I gave you -- or general examples, specific to us -- where the two loans that we had in our covered asset portfolio was, we had huge discounts associated with what were taken out in total during the quarter.

Now, we don't get that income on those discounts right now. That goes back into the pool and is amortized over the life of the loan, but one was close to a $13 million deal that we thought only underwrote at $4 million or $5 million at the max, and it was taken out in total by a large bank competitor here. We had another one, the same sort of thing, where it is we couldn't understand how lending or (inaudible) was done, but you just start to see maybe people are thinking they can ride this wave and get away with some of the stuff, but that is not how we play the game. So you are seeing -- again, I think that the Fed is keeping rates too low, too long, and it is forcing people to use this convenient logic to go out and do some dumb things.

Again, we won't do that. As you know us from the past and you look at our history, we don't play that game. But, fortunately, there is enough business out there that we can book on our terms without having to do that, that we still feel comfortable and not ready to call (inaudible) yet. I would say we will or we won't, but there still seems to be enough business that is keeping our pipelines full.

Okay. And then just on capital and I will quit asking questions, I mean, what do you think is the right all-in kind of TC ratio for the environment? I mean, how much dry powder do you want to keep?

Well, I think we are certainly comfortable where it is at. We actually think it could go down a little bit. As Ed said, if you put in a conversion, we are approaching 9% in the upper 8s, you can probably bring that down a percentage point if you had to do that. And before the Fed, I think we will start to get a little nervous as far as acquisition applications and the like. And we have had a good relationship there, so we have never had a hiccup in the road. But I think it is because we have kept good capital levels.

So we are comfortable where we are at. We think they could go a little skinnier, but if they went down by more than (multiple speakers) or 125 basis points and somewhere in that range, we probably would start to think about something.

Steve Scinicariello, UBS.

Just looking to get some color on the deal pipeline that is out there. It is good to see you do those couple of branch deals and just kind of curious what the rest of the pipeline might look like from here.

Well, we are still very active in talking to potential partners in really all areas of our business. As we have said in the past, Steve, most of the bank that is consolidated -- we think the consolidation in our market area would be banks $1 billion and below as they work their way out, and they are all starting to get a little bit better in working out their problems, and they don't want to play in this brave new world of -- brave new regulatory and capital world and earning asset world, which is really where they are having trouble, is trying to generate earning assets. There will be a steady stream coming to us.

Our pipelines are good, but, as I mentioned, seller expectations have moved up a bit, and it is hard to explain that some of these fellas, the folks that are you are not going to see those old multiples anymore. It is just not going to happen because dollar for dollar you have got to put comment equity up against goodwill, it's just not going to work. If you look in the past, we always financed our goodwill with trust preferreds. It was almost equal, so we were able to get leverage out of that. Now you can't do that. So there has got to be a little reconciliation in the minds of the buyers. There are sellers that it is not going to be like it was in the old days. And then, again, it is all relative, too. It depends where your stock price, multiples move up, everything will move up.

But, we see activity across the board. The gestation periods have become longer than we would be able to sit down and in a month cut a deal and move forward. That is where we end the four or five month sort of cycles. Investment bankers are -- they are looking to make some fees, too, and they are out calling out on everybody, and you think you can have a handshake deal on something, and they will come in and go, whoa, we can do better, and the boards for their fiduciary responsibility are, okay, we will look at it differently or attorneys who say they have to do that.

So it is a little bit different now in terms of the gestation period, but, again, it is going to be, all-in-all, a five-year consolidation, in our opinion, and we are probably just finishing up year two of that. So we think there will be a good three years. There is many banks out here in Chicago in that range or in our market area in that range, and we have identified the ones that fill us in nicely, and we will just take them one at a time.

We have the capacity, because of our structure, to do more than most. I mean, 15 charters, we could do five or six deals that nine or 10 of the charters are just cruising ahead, and the others are working on the acquisitions. So we are structured properly to take on a number of these small ones -- smaller deals, per se, and we are going to continue to make hay while the sun shines and find these good groups.

We are also on the wealth management and the specialty asset side. We are seeing some opportunities, especially the asset side, what we see today, our prices are through the roof as people are trying to find earning assets. And we haven't found really anything that made sense for us yet, but we continue to poke around across the board, and you saw this quarter, too, that we did a couple de novo branches. With the consolidation that is taking place and a lot of the failures, there are some good bank branches that show up as people are consolidating that we are able to move into a market with a pretty good location.

So trying to be very nimble in our approach. We don't see the pipeline slowing down for the next couple of years, but we expect it just to take longer to get from Point A to Point B.

No. That makes perfect sense. And then, I am just curious, for these mostly deposit acquisitions that you do, about how long does it take you to loan these things up to get them to their more full run rate that -- where you would want them to be?

Well, we target core growth around $250 million a quarter. We do pick up some loans in most of the deals that we do. So you could imagine that it could take -- and we are not seeing a lot of -- we are seeing some organic growth, but not what you have seen in the past. So it could take a couple of quarters to loan them up and keep us at this optimized level. That's why I say the margin may be a little lumpy. We maybe run a little more liquidity every now and then, but that is okay. Again, we will concentrate on the interest income that will come from it and the overall earnings that we were able to come from. And it just adds to our ability of, once rates move up and we can get some -- the ability to go out and entice people to move over, it's hard to get the family in the car and say, we will pay you 1% on a CD, and they don't all jump in the station wagon and come over to change all their banking accounts.

But, the way we are going forward, when rates are higher, we can actually put our packages out there and our tried and true marketing out there to entice people to come over.

So short answer, we want to stay optimized, but it could be a little lumpy. We could be growing it a little more liquidity than we would like in quarters three and four, but you might find a earning asset that we pick up, too.

And the other thing, Stephen, is really dependent on the deals, the Milwaukee branch sale, for example, where we are getting $50 million more on loans than deposits. So in that deal, it is loaned up right away, plus. So they are all sort of unique.

Emlen Harmon, Jefferies.

Just a quick follow-up on that last line of discussion on acquisitions and what the pipeline looks like. A lot of what you guys have done, obviously, is kind of in the $200 million, $300 million, $400 million area in terms of balance sheets. Are you -- as far as your pipeline specifically is concerned, do you see kind of a lot of opportunity in that $500 million to $1 billion space, or do you think, in terms of the deals you guys are focused on, do you think you kind of stay with the smaller several branch type acquisitions?

Well, there's not too many banks over $1 billion in Chicago. There are four or five of them that are kind of independent out there. But there is a lot more of the smaller $100 million to $1 billion branches or banks. So it really depends on the footprint that these banks have. Some of them are footprints we are already in and really don't make a lot of sense for us. They are just too small to be an add-on or providing a big strategic to us for the prices that they want. But I would imagine that if you built a curve, it would be mostly in that $0 to $500 million range of opportunities. That is where you would have most of your opportunity, $500 million to $1 billion would be the second, and then over $1 billion would be the third. So probably on a three-two-one sort of basis if you looked at it that way.

But we certainly are not adverse to the $500 million to $1 billion. I mean, we like those a lot. It is a nice size for us. It can easily accommodate the integration into the Company. They haven't been the ones that have been knocking on the door as prevalently as guys that are in the low $500 million range.

Yes. Perfect. That is what I was kind of hoping to get at there. And then, could you give us a sense what the term origination levels have been out of surety, and are they basically seeing a lot of declines in origination volumes that are kind of in line with what you are seeing from the broader industry? And I know last quarter you had said that maybe revenues were not quite there yet, but were you kind of at a full run rate for the surety mortgage originations yet?

Yes. The first quarter was a pretty full quarter for surety. I think the market in California has been a little bit more competitive on the (inaudible) side and the like, but they certainly are contributing and they are fully up to speed. It is probably somewhere in the 20% of our volume area. Before we bought them, they were maybe more 25% of our volume. There is a couple of programs out there that they did, but they had joint ventures that we didn't continue.

So we are happy with the production that they are doing out there. It is actually fairly competitive in California, but they are holding their own and fully integrated now.

Chris McGratty, KBW.

Ed, you had 20% commercial loan growth in the quarter, but your loan yields were actually pretty stable. Can you comment -- and I know it is maybe some other asset classes contributing to that. Can you comment on commercial load yield trends?

Well, yes. I think pricing, basically, has bottomed out and stabilized for the last three quarters. So from the commercial side of the equation, I think that we are right where we are going to be until rates move. Not much farther to go there. And, again, we look at the overall relationship of profitability, the overall relationship to wealth management, treasury management, and the like, when we bring these in. So I think that you should see relatively stable rates in that commercial area until such time as rates actually move.

And what were the absolute -- just so I have a sense of where they bought them that were kind of low trade, or can you give a little color there?

No, it has been pretty stable in the low 4 range, probably between 4 and 4.25, depending on the month, but low 4s, was at 90 closer to 4.25 than 4.25 now, but it has been pretty stable in that range.

Bigger deals in the middle market are commanding lower rates. We are looking at the LIBOR-plus 200 to 225, somewhere in there. But then you are able to get in the smaller business and the SPA and all the things that we -- the other businesses -- the small business lending and the like, you are able to get higher rates.

So we are seeing good growth across the board. Obviously, the middle market are bigger ticket sizes, but we have an internal hold limit, and we try to keep it as diversified as possible, and that is always the way we have done it.

Great. Just want to follow up on your decision of kind of expanding Wisconsin, is this telling you something more about Chicago, or is this telling you more -- telling us more that you are just looking to broaden the footprint?

No, we are focused on both, but we really put some additional emphasis in Wisconsin because we expected there to be more opportunities in Wisconsin during the cycle than there actually worth. We expected there to be more banks that actually went under than there actually were. So we went through three or four years, and that franchise was $1 billion in and of itself, plus about $900 million in and of itself. We had expected opportunities to come up. The ones that did come up were really -- we priced foolishly, in our opinion. We weren't willing to pay that much.

So we really didn't want to abandon that market. We kind of felt a little bit like our foster child up there. We wanted to spend some time and really work that market hard to continue to increase our franchise. We did bid on that first banking center when it went under, and we obviously didn't -- we were not the winner, but we felt that that was just a beautiful fill-in for us between the Milwaukee-Madison corridor and the Illinois border.

So this really fills them out. It adds 50% and gives them enough to do for the next year or so, but we will continue to look up there. We think Wisconsin is a great market, and then we think that the consolidation will take place up there also. And if we can get some momentum in terms of culturally and people understanding who we are and how we work and how we do these deals and our desire to grow these franchises once we get them, it really differentiates us in that market.

So they got enough to do for the time being. It was a pointed move on our part to really work hard in Wisconsin to help build that franchise as we have. But there is nothing about Chicago. We are still very happy here and looking to continue to both de novo and through partnering up with some folks, continue to grow this footprint, also.

Stephen Geyen, D. A. Davidson.

The C&I growth, you mentioned that the growth came primarily from new customers. Just based on your discussions with existing customers, is there any increased optimism versus a year ago and I guess any movement toward line usage or new loans?

There is increased optimism. We -- I think I mentioned this once. We hosted a WBBM -- the NewsRadio station here in Chicago. Hosted a business lunch here and we had 200 of our customers were here, and they did a poll, who thinks it's going to be better? Everybody raised their hand. I was the only guy who didn't raise my hand, and I was sitting there. But I just didn't come out of a budget meeting. So the first (inaudible) in the budget meeting, so I was a little jaundiced on the subject.

But, I think people are feeling very good. There is still some trepidation in Illinois -- the Chicago/Illinois fiscal situation is not the best. And I think if we could get that squared away and the political situation, but we could get that squared away, I think people would feel much better about their expansion plans and the like. But our customers are all doing very, very well. They are all feeling very good about what they are doing. They rolled through the cycle very well. They have been able to pick up lines and other businesses or dislocations and make their businesses stronger. Many of them we like to see them have [fortress] balance sheet, and most of them do.

So they are all feeling a little bit better, but everybody is still -- we would love to see this state get its act together. That would be a big, big move. I hate driving into the city of Chicago and seeing signs from Indiana saying, are you Illinoyed? Come and bank here or come and bring your business here. And you have seen some move across the border to Hammond and the like, but we are moving to Northwest Indian also, and that will be helpful and some of our guys into Wisconsin where there are friendlier states as it relates to the tax environment and the fiscal environment.

But that is really the only thing hanging things up right now. I think people feel pretty good about where their businesses are. Feel pretty good about growth.

Is that kind of the same thing you are seeing for commercial real estate beyond multifamily? Any kind of spec building out there or additional building?

You know, there is. We are not partaking in a lot of it. There is apartment buildings going up left and right over the city. I mean, it is almost time to start counting the cranes again. I always say, when you count more than 10 cranes over the loop, it is time to hunker down, but we are not at that level yet.

So there is some spec real estate going on. A lot of apartment building is going on. Not a lot of condo stuff going on. So a lot of resi, and we are seeing some commercial growth here. Not a lot of -- the landmark and the housing market, there is still a lot of joy and a lot of farmland out there that needs to be developed before you see that. They are still kind of working out of that. But a lot of the bigger land companies or new house builders have swooped in and bought a lot of cheap land from banks that they took back in foreclosure. So there will be a lot of inventory there. That is not a market we're going to play in.

I think the housing industry is very cyclical, as you know. It is almost like the airline industry. I think if you put land developers together and you added up their profits and losses for the last 100 years, it would be an absolute breakeven. So we are going to stay out of that. We have played in it a little, and that is where we took most of our losses during the cycle. So we are not going to play that anymore. We will do the onesies, twosies with very strong developers, but we are not going to play the big game anymore. But, we are seeing good real estate opportunities for our own customers, too.

Okay. And on deposit growth, it is very strong. Just curious if it is mostly driven by commercial relationships or retail? And then, a follow-on, the average cost of the new deposits, is it roughly in line relative to the mix currently?

Very much in line. We have a number of smaller promotions going on. Remember, the old days, we would open a bank, and it would skew our cost of funds as we went out and bought out business, basically. But, now, like those two de novo branches that we opened, we will run founders ads that do have teaser rates on them, but it is so negligible given the size of the organization right now that you will never see it. The organic growth in our established branches is coming in at the same levels as, really, not a lot of teasers out there.

So coming in at the same levels we see recorded in our financials.

But, again, organic growth is kind of hard. CDs are running out the door. If you have seen our mix change a lot in the last year, the money -- people are putting CDs in the market. They can get a 1% or 2% dividend yield, they will play the market as opposed to keep the money in cash. Some of the online guys are taking it, but that money can come back if we ever need it when rates rise.

So we like the way our balance sheet is positioned right now. We believe that we will have plenty of opportunity to grow when we want to grow organically. But right now, given our desire to keep an optimized balance sheet, we are able to pick up pretty much all the liquidity we need in these deals we are doing.

So -- but, again, and I will add that when you said commercial (inaudible), our demand growth is a little smaller than it had been in previous quarters, but we continue, as you see that commercial portfolio grow, you will see more and more demand deposits coming on. We are getting close to 19%, and we would like to be in the 20s in terms of overall demand deposits as a percent of total deposits. We think that will happen if we continue to make great headway into the commercial side.

So broad-based approach, in terms of organic growth with commercial, basically leading the way, for the most part, and most of our acquisitions are bringing the real growth into the deposit side.

Okay. I think you might have answered my next question. As far as the origination of one-to-four family arms, is there any interest of holding those on the balance sheet?

Yes, there is. We used to do that all the time, and then when you hit the 2000s when you can get pretty much any deal done as a 30-year fixed, there was really no niche there. Now, with the new QRM rules and the like, there is an opportunity to build an on-balance sheet ARM portfolio. We think that we can build that over the next three or four years up to about $0.5 billion. It is starting to move. These are for the guys that can't qualify, but are certainly credit worthy. We can house them in there for a year or two, and then whatever the condition that made them unqualified goes away like self-employed or cosigning with a child, that sort of thing, who is buying a house, there are so many different ways that these come up.

When those conditions go away, we will be able to push them in the secondary market.

So we are pushing that product. It is going to be slow and steady to win that race, but we finally see there is an opportunity to -- there is a niche out there that we can fill, and that is what we are trying to do.

And last question, just curious, as far as the Talmer branches, any thoughts on any guidance you can provide us on the potential impact as far as costs, like one-time costs and maybe operating costs?

Yes. We haven't disclose anything of that, Stephen.

John Rodis, FIG Partners.

Dave, just a follow-up question for you on the salary and benefit line. You said a run rate, I think, of $66 million to $67 million. What did that include or not include?

As I said, it included everything but the commissions line.

Okay. So when you say commissions, does that include the bonus line or --?

No. Just the commissions on our mortgage and wealth management area.

Okay. And so what was that this quarter, Dave? It wasn't the full $21 million, right?

No. The commissions number this quarter was -- hold on -- about $11 million.

Okay. So the [60] -- so this quarter that number would have been the [44] plus the -- so the [58], so about $70 million, I guess, roughly?

If you -- this quarter commissions were about $11 million. If you use the base of $67 million for everything else, you would be at $78 million. Now, commissions go up next quarter because mortgage volume goes up or wealth management volume goes up, then $11 million is going to go up.

Yes. $67 million plus X, notwithstanding acquisitions and the like. I think that is what Dave saying. So whatever commissions at variable comp in terms of commissions. And the commissions of wealth management and mortgages -- whatever that number is plus $67 million is a reasonable run rate, notwithstanding acquisitions.

I am showing no further questions in the queue. I would like to turn the call back over to management for any closing remarks.

Thank you very much, everybody. It has been a longer call than I anticipated, but happy that you have interest in us. So everybody have a happy Passover, Easter, whatever, and we will talk to you again, when, hopefully, it is warm in July. Thank you.

Ladies and gentlemen, thanks for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.