Wintrust Financial Corp (WTFC) 2018 Q2 法說會逐字稿

Good morning, and welcome to the Wintrust Financial Corporation Second Quarter 2018 Earnings Conference Call.

(Operator Instructions) Following a review of the results by Edward Wehmer, Chief Executive Officer and President; and David Dykstra, Senior Executive Vice President and Chief Operating Officer, there will be a formal question-and-answer session.

During the course of today's call, Wintrust management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements.

Actual results could differ materially from the results anticipated or projected in any such forward-looking statements.

The company's forward-looking assumptions that could cause the actual results to differ materially from the information discussed during this call are detailed in the second quarter 2018 earnings press release and in the company's most recent Form 10-K and any subsequent filings on file with the SEC.

As a reminder, this conference call is being recorded.

I would now turn the conference call over to Mr. Edward Wehmer.

Thank you.

Welcome, everybody, to our second quarter earnings call and a happy summer to you all.

With me, as usual, are Dave Dykstra, our Chief Operating Officer; Kate Boege, our General Counsel; and Dave Stoehr, our Chief Financial Officer.

We will conduct the call in the same format as usual.

I will give some general comments regarding our results then turn it over to Dave Dykstra for a more detailed analysis of other income, other expense and taxes, back to me for some summary, comments and thoughts about the future and then as always, time for questions.

We're very pleased to report record earnings for the 10th consecutive quarter in a row.

David Long, Nick Papagiorgio is still [on a roll] here.

Net income of $89.6 million or was a 9.25% increase over the $82 million in the first quarter and 38% over the $65 million recorded in the same period last year.

Year-to-date, year-over-year we're up 28% or about $171.6 million to $123.3 million.

On an earnings per share basis, $1.53 compared to $1.40 in the first quarter, $1.11 last year, $2.93 year-to-date and $2.11 for -- compared to $2.11 for last year or up 28%, 37 -- 38% almost over last year's quarter-to-quarter.

Just to put it in perspective also about pretax earnings.

Pretax earnings in the first quarter -- in the second quarter were $121.6 million over $108 million, up 12.6% and up 19.2 -- 19.3% over the $102 million in the second quarter of 2017.

For the year, pretax earnings of 230.7 million, up over 180, above $190 million or 17%.

So good results across the board.

Our margin increased, as you all know, by 7 basis points from the first quarter and for year-to-date were up 20 basis points over last year.

ROA of 1.26% compared to 1.20% in the first quarter.

Year-to-date were 1.23% compared to 97 basis points last year and return on equity and intangible equity numbers are in the release.

As is readily apparent, our operating trends remain consistently positive.

The net interest margin, net interest income.

The NIM increased 7 basis points over the first quarter and 20 basis points over 2017 to 3.54%.

Net interest income grew $13.1 million over the first quarter due to 1 more day, good earning asset growth, including good loan growth and the rising rate environment.

So really both increases were driven to the higher rate environment and larger level of earning asset base.

Our average earning asset base grew $706 million in the quarter.

Earning asset yields increased 19 basis points by cost of paying liabilities increased 17 basis points.

The free funds ratio are the amount of the 28% of demand deposits we had made up the differences of related store margin.

We'll talk about betas a little bit later.

It's funny to me I remember, a year ago or 2 years ago, it was pretax, pre-provision earnings was the buzzword, now it's deposit betas.

Our average loan-to-deposit ratio for the quarter rose slightly to 95.5%.

Obviously, higher than our desired range of 85% to 90%.

Some of this was caused by our back-end loading of loans in the quarter.

Ending loans exceeded average loans by $326 million, which bodes very well for Q3 earnings.

At period end, loan-to-deposit ratio stood at 92.8% due to the good deposit growth.

Speaking of deposit, Q2 was a great quarter for core growth.

Our deposit marketing, coupled with successful opening of 5 new branches, contributed to $1.1 billion in growth.

Our deposit marketing is just kicking in, so we'd expect this number to begin receding -- loan-to-deposit ratio receding towards our targeted ratio.

Accordingly, as we expected, our deposit rates increased in this quarter more than prior quarters.

Our historical data -- if you look at betas, it's for cycle to date, which includes 6 increases, rate increases, does not include the June increase, where our interest-bearing deposits were about 0.31%.

Quarter 2 was 68%.

If you recall, last quarter, we said, over time, we expect to be in the 40% to 45% range in this as we catch up, plus with our turns towards more organic growth than acquisitive growth.

That would be consistent.

It's not going to happen overnight.

But I think that it's going to be -- I think we'll still stay below well the 60 basis points, which I heard is the industry average these days.

But we expect our margin to continue to, as I said last quarter, not be a beach ball underwater, but more like ping-pong balls underwater.

But going forward, we'll have good increases.

It takes a full year for a deposit in -- or for a rate increase to work its way through our system.

Our models still show every quarter point adds about $22 million to $23 million in pretax earnings to us.

So it just comes in over time ratably and -- but we expect our margin to continue to increase maybe some comparatively bigger betas, but ending out, we think, with 3 or 4 more interest rates in the 40 to 45 basis point range -- percent range in that regard.

I know we'll get questions on that, so I'll save any other comments to later on that.

We still are very asset sensitive.

So additional rate increases should continue to add, excluding the one that happened in June, we'll add $22 million to our net interest income on an annualized basis.

It hasn't changed from our previous discussions to the ever-increasing size of our balance sheet as we work to -- as rates continue to move up, we will continue to -- we will begin bringing our interest rate gap down.

It actually went up a little bit at the end of the quarter.

We're still waiting for the long end to move.

We will talk about that in a second, like right now.

The long end of the curve is yet to move in concert with the short end, we await for the break that liquidity play we have discussed in the past.

This initiative is still in the cards and expect our loan-to-deposit ratio to stay in the low 90s until such time as spreads on long term -- on the long end get better.

Again, a little bit more on this later.

As such, the future rate increases we expect on net interest margin to continue to grow slowly but surely.

On the credit side, credit remains historically great with NPAs and NPLs were down from their already low numbers.

We had a $7.5 million decrease in total NPAs.

NPLs were down -- nonperforming loans were down $6.4 million.

However, balances were down $1.1 million, so we continue to push out old assets.

Valuation charges are down modestly.

We continue to actively work to dispose of older properties.

Net charge-offs totaled $1.1 million.

Charge-offs of 6.9 were offset by recoveries of $5.8 million, following through on our basic operating tenant of being conservative on charge-offs and looking good on recovery.

As is evident in the NPA and charge-offs numbers, that little hiccup we had in the commercial premium and finance book is behind us and recoveries are starting to materialize.

So in summary, credit remains very good.

NPAs as a percent of total assets decreased to 0.40% from 44 basis points.

Reserves as a percent of NPLs was at 172%, up from 150% at the end of quarter 1. And net charge-offs decreased 10 bps to 2 basis points in the quarter.

We continue to cull our portfolio for cracks and will expeditiously move assets out when said cracks are found.

We'll also continue to aggressively work our OREO portfolio to clear the decks.

On the other income and other expense side, Dave is going to go into these in detail momentarily, just some general comments.

On the mortgage front, revenues and volumes were up from quarter 1. However, overall profitability decreased due to decreasing execution spreads without a commensurate decrease in cost of processing.

That's more of a supply and demand function.

It's got a little bit of a provider inflation here with lots of people out there going after fewer and fewer deals.

That being said, I like where we stood on our volume numbers.

But to that end, on the cost side, we're diligently working to reduce our cost to produce a loan.

As you know these are up over 3.5x due to Dodd-Frank and the like from the good old days, if you will.

So to that end, we -- our ZOOM mortgage product, it's our version of Rocket mortgage, went live on a test basis this quarter and will soon be fully implemented at quarter 3. Early results show a decrease of almost 2 days in processing time through the use of this front-end system.

And we all know time is money.

We're also looking at any other number of cost initiatives in that area.

We -- well, we're not going to comment on them know, but they're in all aspects of the business and we expect them to be fully implemented by the end of this year.

Dave will be explaining our quarterly results in the mortgage area in detail in a moment.

And as you all know, of importance -- we know this is important to all of you, so please know that we are committed to this business for the long term.

The wealth management operations continue to improve.

Assets under administration grew $300 million to $24.6 billion from $24.3 billion at the end of quarter 1. Revenues for the quarter fell slightly due to less trading from our broker-dealer and the overall market in general in the second quarter.

Our net overhead ratio was 1.57%, down 1 basis point from quarter 1, but a little bit above our 1.5% or better.

Some of this is balance sheet driven as we're delaying pulling the trigger on the liquidity initiative we previously announced.

Other factors include the comparatively low mortgage revenues as a percent of volume that should decrease in expenses.

Our 4 quarter Veterans First expense, seasonably higher marketing expenses, additional incentive comp accruals due to better results, and we opened 5 new branches in the quarter -- in accordance with our organic growth initiative.

Again, Dave will discuss in detail.

Net overhead ratio of 1.5% or better still remains our goal and we'll continue to work on it.

On the balance sheet front, assets grew $1.8 billion with no acquisitions included to $29.465 billion.

Loans grew $548 million in the quarter.

That's a 9.7% growth.

Again, high single digits as we anticipated.

If you -- average loans grew $572 million.

So we're in pretty good shape on the loan side.

And deposits, we talked about up $1.1 billion or 18% over the previous quarter on an annualized basis.

So we look -- the balance sheet grew nicely.

I'll talk about the acquisition market in my final comments.

Loan growth, as projected, was in high single digits and is in most categories with the exception being commercial real estate where payouts and our wariness about the current competitive market negated good growth there.

We'll be very choosy about the deals we're going forward, making sure they meet our standards and our pricing and profit -- our pricing standards and our underwriting standards.

Loan pipelines, though, are consistently strong.

It increased this quarter to the second highest level we've had in about 2 years.

So our momentum is good.

A lot of that is due to our reputation.

Some due to changes in the marketplace, and we think that's just the start of that.

Deposit growth was -- were heartened by our growth and our success there.

We flipped the switch as back pricing has moved away from us.

We're at that inflection point where organic growth, as many of you noticed in the past, we made our bones on organic growth, and we've been very good at it.

It's nice people have flipped the switch and see that we still have it.

But 5 new branches came on during the quarter, and we have a number of more branches planned for the rest of the year.

That's not to say we're not interested in acquisitions, however, expected pricing is relatively high right now.

We continue to look, but we will continue to take what the market gives us and stay disciplined in our approach to deals.

In any event, I'm going to turn it over to Dave now to talk about other income and other expense.

Thank you, Ed.

As normal, I'll just touch briefly on the noninterest income and noninterest expense sections and those areas that had the most significant changes.

In the noninterest income section, our wealth management revenue held fairly steady in the second quarter, totaling $22.6 million compared to $23 million recorded in the prior quarter and up from the $19.9 million recorded in the year ago quarter.

A modest reduction in the brokerage revenue component due to reduced amount of customer trading was the primary reason for the slight decline in the combined wealth management revenue.

Overall, the second quarter of 2018 was another solid quarter in revenue generation.

Mortgage banking revenue, as Ed alluded to, increased approximately 29% or $8.9 million to $39.8 million in the second quarter from $31 million recorded in the prior quarter and was also up from the $35.9 million recorded in the second quarter of last year.

The increase in this category's revenue from the prior quarter resulted primarily from higher loan origination volumes.

The company originated approximately $1.1 billion in mortgage loans in the second quarter of 2018.

This compares to $779 million of originations in the prior quarter and a similar $1.1 billion of mortgage loans originated in the second quarter of last year.

The $318 million increase in origination volume was attributable to the $229 million increase from our retail origination channel, a $92 million increase from the Veterans First consumer direct origination channel as we had our first full quarter of production since the acquisition.

And this was offset slightly by a $3 million decline in our correspondent originations.

The mix of loan volume-related purchased home activity was approximately 80% in the second quarter compared to 73% in the first quarter of this year.

Page 23 of our second quarter earnings release provides a detailed compilation of the components of the mortgage banking revenue, including production revenue, MSR capitalizations net of payoffs and paydowns, MSR fair value adjustments and servicing income.

Given the existing pipelines, we currently expect originations to soften slightly in the third quarter to approximately $1 billion.

But obviously, this estimate could ultimately be more or less, depending on market conditions during the remainder of the quarter.

Operating lease income decreased approximately $945,000 in the current quarter compared to the first quarter of this year.

This was primarily as a result of a $1.1 million gain realized from the sale of certain equipment on operating leases in the prior quarter of the year.

Other noninterest income totaled $14.1 million in the second quarter of 2018.

This was up approximately $2.3 million from the $11.8 million from the first quarter of this year.

There are a variety of reasons for the increase in this category of revenue, including a higher level of interest rate swap fees and higher level of loan syndication fees, an increase of $521,000 on gains from early payoffs of capital leases and a $600,000 settlement on a BOLI policy.

Turning to noninterest expense categories.

Noninterest expenses totaled $206.8 million in the second quarter of 2018, increasing approximately $12.4 million from the prior quarter.

The increase was primarily attributable to approximately $9.2 million of higher salary and employee benefit expenses and $3 million of higher advertising and marketing expenses.

Both of these were related to the growth of the revenue on the balance sheet.

I'll talk about the more significant changes and details as well as comment on a few other items of interest.

The base salary expense increased approximately $5.0 million in the second quarter over the first quarter of this year.

Slightly more than $3.1 million of the increase is related to a full quarter impact of the annual base salary increases that generally took effect on February 1, a full quarter of the increase on our minimum wage to $15 per hour for eligible noncommissioned employees, which took effect in early March; and normal growth as the company continues to expand its staffing for the 5 new branches and other growth at the company.

And slightly more than $1.8 million of the remaining portion of the increase was related to the impact of bringing Veterans First team fully onto our payroll in the second quarter.

Veterans First retained some of their employees to handle the runoff of the volume that they maintained, and those employees fully came on to our payroll in the second quarter.

So the second quarter's run rate for them is fully staffed up now.

Commissions and incentive compensation expense increased approximately $4 million to $35.9 million from $31.9 million in the prior quarter.

The company experienced an increase of approximately $2.4 million in commission expense tied to the higher mortgage origination volumes with the remaining increase associated with higher long-term and annual incentive compensation accruals due to the higher earnings experienced by the company.

Marketing expenses increased by approximately $3 million from the first quarter to $11.8 million.

As we've discussed on previous calls, this category of expenses increased as our corporate sponsorships tend to be higher in the second and the third quarter the year due primarily to our marketing efforts with the Chicago Cubs and the Chicago White Sox, as well as increased spending related to our deposit-generation activities and brand awareness to grow our loan and deposit portfolios.

And we clearly believe these marketing efforts are effective and enhancing the franchise value of the company.

Other than the salary and employee benefits and the marketing expense categories that I just discussed, all the other expense categories were up on an aggregate basis by only $223,000 from the prior quarter.

A $1.9 million reduction in OREO expenses was offset by slightly higher levels of expenses on a variety of other expense categories such as equipment expense, data processing expense, postage expense, FDIC insurance and other miscellaneous expense categories.

And as Ed mentioned, the company's net overhead ratio decreased by 1 basis point to 1.57% and the company's efficiency ratio on a fully tax equivalent basis declined to 61.8% in the second quarter from 62.2% in the first quarter.

So those are the highlights of the other income and other expenses.

And with that, I will turn it back over to Ed.

Thank you, Dave.

So in summary, all in all, a pretty good quarter for Wintrust on all fronts.

Momentum continues throughout the organization.

Reduced taxes and higher interest rates have been very beneficial to us to our core earnings growth.

And our core -- our balance sheet growth has been good, and that all bodes well for future earnings growth and future growth and franchise value.

We are pushing on our organic growth agenda as acquisitions in general become relatively expensive.

In that regard, we saw the number of new branches planned over the next 18 months in neighborhoods in our designated market area where we currently are not present.

The retail and small business marketing programs, which we embarked on in earnest at the beginning of this year are working well, employing new accounts and relationships both in the new branches and in the underutilized branches we had picked up during the great acquisitions spree that resulted during and immediately after the Great Recession.

We -- this doesn't mean that we're not investigating future business combinations in all areas of our business, but as we've mentioned in previous calls and today, pricing has become unrealistic in some respects, in our opinion.

And when you do get something going, the gestation periods become very long.

We remain well positioned for higher interest rates and are prepared to protect our downside as rates rise by gradually decreasing our overall rate sensitivity.

Credit is as good as it's going to get.

We continue to review our portfolio for any early warning signs and are exiting deals expeditiously when cracks are apparent.

As noted in some of your reports our 30- and 60-day past dues, many of which are, for the most part, organizational and not credit cracks, have decreased as we continue to make to push our people and staff to make sure that we can turn things around much quicker and not have past dues due to our inability to get things done on time.

Loan growth is good.

Pipelines remain very strong.

Our niche businesses continue to work very well with us.

We continue to look for other niche businesses to diversify our portfolio because as we said in the past and as you all know, concentrations kill.

We are prepared to embark on our liquidity initiative, should we have the desired -- we should have the desired strategic results.

And I keep looking at in the short interest in the treasuries in the treasury market and if those guys are right, maybe we'll get a little pop here in the long end at some point in time, which would be very good for us.

So in summary, we're well positioned.

We like where we sit.

The disruption that's occurring in the market is good for us, very good for us, as a matter of fact, as we target customers who may want to be refugees from big banks, that's where we made our bones in the past.

That's how we'll continue to do it in the future.

So we like where we sit right now.

We think we feel good about it.

But that being said, as I said last quarter, we keep looking under the table for the bogeyman.

We continue to prepare and maintain a fortress-tight balance sheet, keeping our credit clear -- clean, not reaching for to do new loans, heartened by the fact that we had such good loan growth, and our critical exception number continues to come down in these deals.

So we're not chasing deals.

And our profitability models are still holding strong, and we're getting pricing for relationships we're bringing in that meet those profitability goals.

But that being said, we'll keep looking around and making sure that we are prepared in the event of any number of things and we bring this.

I'll let you know all this just to know that we're not standing on our laurels assuming this is in the new normal.

We're all -- many of us are seasoned enough to know that just when you think you got it, something comes up and bites you.

We want to be prepared when that happens.

And I think the way we built this organization with core funding, good diversification in the balance sheet, we're in very good shape to handle whatever they throw -- whatever gets thrown at us.

So that being said, you can be assured of our best efforts to ensure the long-term growth of the franchise value of your company through both -- by maintaining that fortress balance sheet, maintaining double-digit earnings rates, earnings increases, good asset growth and protecting net book value per share of the company.

So that being -- so right now, we feel pretty good, but who knows?

But now we have time for questions and let's go.

(Operator Instructions) Our first question comes from the line of Jon Arfstrom with RBC Capital Markets.

Just to start with big picture.

Ed, you touched on it towards the end of your prepared comments.

But just the lending environment, I think what you're saying is everything seems to be pretty healthy, but you are a little bit more cautious on commercial real estate.

Maybe a little bit more bullish on C&I.

But give us your best guess as where you see the best opportunities and where things are a bit irrational for you.

Well, commercial real estate is, you're just seeing some irrational pricing coming in from some of the smaller banks in 5- to 10-year fixed-rate deals at 4 -- in the 4s.

You're seeing development kind of popping up a bit.

We're having a number of payoffs in the development loans we did do early on in the cycle.

Those are all done with really good sponsors.

That's not to say we won't look at those, but it's just -- we just have to slow down in that area as -- it's not meeting our loan policy criteria, probably nor our pricing criteria.

But the commercial loan pipeline is very strong.

The niche business is also -- are doing very well.

Our leasing business, our franchise business, commercial premium, finance all grew nicely.

And the life and premium insurance continues its steady growth.

Again, haven't had a loss to date in that portfolio.

So we continue, as I said, we continue to look for other types of businesses.

But the market here is in a bit of turmoil with the recent acquisitions both of -- our 2 small -- largest competitors -- local competitors in the market.

We are seeing opportunities there.

We also are spending money up in Wisconsin, where we have a beautiful franchise up there, where we're hitting the market hard on middle market lending up there.

Something we hadn't really done.

We concentrated on Chicago here and that's running like a top.

Now we're taking that same model up to Wisconsin where there's a lot of big bank competition, but nobody really does it our way.

So we're seeing good results up there already looking at deals that these guys never thought they would ever get a shot at.

So we have -- our reputation is good.

The momentum is good across the board.

We worry a bit about commercial real estate.

But again, pipelines are strong as they've been across the board.

So knock on wood.

So we're getting deals done on our terms and our pricing.

So we feel pretty good about that low single-digit number for the rest of the year.

High single-digit, right?

Yes, sorry.

High single-digit number for the rest of the year.

We're not rope -- we're not at rope-a-dope yet.

No, that's kind of interesting.

You talked about rope-a-dope.

I was using a double negative, I meant to say high, I'm like the President.

But you hear a lot about -- we were always big proponents of the inverted yield curve and what that meant.

And I'm hearing a lot of pundits on TV talk about the yield curve flattening and how that means a recession is coming soon.

We looked at this very closely and did a lot of research.

We had our clients looped in.

We had -- and we verified it.

We read Goldman's work and the like.

It's a little bit different this time.

The yield curve flattening is somewhat technical.

And that with the Volcker Rule, the big banks have taken their alternative investments down from 10% or 11% and the big banks, or a lot of those, the top 5 or 6 banks, have from 11% to under 4% or 5%, which means they are out buying anything long -- any Ginnies or any treasuries that come out that are long term to get that yield because the Fed is -- if the Fed were to go faster and get rid of the $4.5 trillion that they're sitting on, that's worth about a point to the yield curve right now.

Our guys did it and interestingly enough, Goldman came out with something out at 2. So -- I'm not that concerned about that asset.

We don't see -- our clients are all doing very well.

The only issue they're having right now is with labor and some -- we -- really good clients having trouble getting labor.

That's an issue.

But other than that they're all doing really well.

So I don't see the problems -- I don't see storm clouds yet on the horizon, so we're not thinking about rope-a-dope.

We're thinking just about dopes in the real estate area, I guess.

Okay, okay.

Just one more on deposit -- the deposit cost step-up.

My sense is you want to address it.

But it's a little bigger than I thought it would be.

I understand it.

But just maybe give us an idea of where you feel like you need to defend yourself?

And is this something that can maybe flatten out later in the year in terms of the cost increase?

Well, we lagged more than most for the long time and it does catch up with you with our growth this quarter and the like.

It did pop a little.

But again, the quarter rise -- if you take that quarter rise, it wasn't as high at the end of the -- if you take the rate increase that effect June 15, it wasn't as much as you think.

We look at this over time, and we are at 31 basis points for the cycle, 31% for the cycle.

We were 68% for -- this is just on interest-bearing deposits for this quarter.

But that only brought us to 31% for the cycle.

If you look at total, including demand deposits, we're at 22 basis points for the cycle and 52 basis points for the quarter.

We expect those numbers to get up -- the total cycle after 2 or 3 more rates, that 31 is going to go to 40.

To get that, it's -- you're going to have a little bit higher in the quarters going forward.

However, we're still catching up on 2 and now 3 rate increases that are working their way through the system.

So it's balanced.

We look at this very closely and a lot of it is the lag that we had in the past.

But we will catch up and by the end of this year, or the first quarter of next year, we'll probably be at that 40 basis point number for the cycle up from 31 or 40 or 45.

So you will see it, our earnings asset should continue to increase greater than that.

Does that make sense?

Yes, makes sense.

We're going to catch up, but I believe we're giving you where we're going to be at the end of the deal.

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

Thinking about the deposit growth and the pace of the liquidity build, where -- in your mind, where are you today on the liquidity build and between now and, call, it to the end of next year, where do you think that you will be with that?

And then, how much it does of the failure of the yield curve to fully cooperate impact that pace or ultimate size?

Well, we'd like to get back to 90% loan to deposit at the max.

So that should tell you what the type of growth we would like to achieve by the end of the year to get to that number which -- the rest of it we'd love to run in the middle of the 90s.

So we'd love to be at 87.5.

We're not going to rush to 87.

If we're 91 too, that's fine.

But we're not going to rush to 87.5 unless we can get something out of it.

Does that make sense?

So it's kind of a variable answer that the rates -- we want to get to 90% loan to deposit, the high end of our range, by the end of this year.

That's what we're trying to do.

If rates were to -- if the long end were to move, we'd like to get to 87.5 long term right at the middle of our desired range.

I still think liquidity is important.

I've not -- I don't sleep well knowing that we're at 94 or 95.

But that's the plan.

Dave, do you want to comment on that?

No, I think that's right.

I mean, we brought it down a little this quarter with our branch openings and our targeted marketing and we'll continue to plug away with that.

I think we had hoped that the long end of the curve would have been up, that we could have been a little bit more aggressive with those deposits and put them to work with longer investments, but that hasn't happened.

So as Ed says, if the curve would pop up, which there's no indication that, that's going to happen, it could happen quicker.

Otherwise, we'll just -- we'll plug away at it and increase it gradually and get down to that 90% range.

And if the long end pops up, we'll probably get it below 90%.

But it'll be a gradual thing.

We won't just go out and add another $1 billion or $1.5 billion of deposits and put it to work like we would if there was steepness to the yield curve.

Got it.

And with the liquidity building that you're doing today, what are you investing in?

What types of securities and what types of yields are you looking at right now?

Well, we just increased a little bit with Ginnies and Fannies but we haven't gone dramatically into that.

So the liquidity's either sitting in cash and we've been legging in slightly with Ginnies and Fannies, but not dramatically yet.

In a perfect world, we would love to see muni rates move up a little bit more to kind of hedge against the -- we've never had a large muni portfolio.

If they were to move up closer to 80%, the number, the long end number, the taxable number inside 80% or 85% of that number, it'd be a great move for us to hedge against a different administration coming in down in the road and raising taxes.

So it might be a good time to think about that, and we'll watch that very closely, too.

We've never really had a large municipal portfolio, which has served us well.

But now might be the time to get in there and hedge a little bit.

So that could be an area for growth, too.

We watch those rates very carefully, watch the overall environment very carefully.

If it appears that things are slowing and rates may go backwards, you may see us move faster into that.

Because one of the things we're doing, we expect to go long on the liquidity side to bring our gap down and probably not write calls on a lot of it, as we have in the past.

As rates get higher, we don't want to have that huge gap and have that downside vulnerability.

So we're looking at a lot of different strategies.

We have a lot of quantitative mathematicians and economists left over from the stress test days.

The 4 of these, they're still doing stress tests, but they have a little extra time in their hands.

So we have them running lots of these, so we're all over this thing.

We'll watch it very carefully.

But just one other thing, David, is if you look at our investments at the end of the quarter, they're up just slightly.

We use some of those deposits really to fund the long portfolio.

And you'll see that our Federal Home Loan Bank advances actually came down from the first quarter a little bit.

So rather than borrowing within our Home loan Bank to fund the mortgage portfolio we just use those deposits since we have them.

So part of it was to just borrow less in the first quarter, so we're still waiting for that long end to move before we invest heavily in securities.

Got it.

And the last one thing I wanted to ask just quickly was the deposits at period end were much higher, about $1 billion ahead of the average.

So am I right in assuming that a lot of the deposit growth in the quarter came at the end of the quarter?

Yes.

Yes.

Well, we opened 2 very successful branches right in -- right around the first part of June.

One was in Evanston, an area we've never been in, which is a fairly large parochial suburb in Chicago with First Bank Evanston selling to...

Byline.

Byline.

That opened up an opportunity for us to come take that positioning and the branch at Wrigley we opened right at the beginning -- middle of May and that's off to a great start, too.

So many of the branches opened in the last part of the quarter.

And they really did well taking off.

So it's nice to see when we open and people still want to come.

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

Ed or Dave, obviously, the guide on the overhead has been 1.50 over time.

I guess, given what you're doing with the balance sheet, is -- how should we be thinking about whether a point in time or maybe not on a full year basis, but what's the realistic time to get there?

Could you get there by the end of next year or early next?

Or is it kind of a longer aspirational target?

Well, if we put $2 billion out of [gross of these], that 87.5% loan-to-deposit, we'd be there right now, the ultimate goal.

So a lot of it has to do with the balance sheet not being where we are in the yield curve.

Some of it this quarter, as we said, was due to the mortgage profits and the expenses being too high.

But we are investing in organic growth, and that's putting your cost of growth to the income statement as opposed to buying for a big number and not having the cost go through the income statement but taking it to the tangible book value per share.

It's an old argument we used to have when we were really doing organic growth before.

We got into the whole splurge of acquisitions.

But it is aspirational.

We think we can get -- we'd be there now -- if you have any slope to the yield curve, we'd probably be there now.

But we'll continue to work at it.

You're going to bounce, I think, between that 1.50 and 1.60 number every quarter until you really see us get the liquidity play underway.

Great.

And maybe if I could follow it up.

Some of your peers look at just -- this is probably between revenue growth and expenses and operating leverage, which for you guys is kind of in the 300 to 400 basis point range for recent years.

Is that about a fair way to look at the company given the investments you're making and the revenue growth -- the double-digit revenue growth is kind of the 300 to 400 basis point operating leverage kind of still realistic given where we are?

Yes, Chris, I really haven't run the numbers the way you're talking about them.

But clearly, operating leverage is something we think we have as we grow up these small banks.

So I don't want to talk off the top of my head without running the numbers.

We don't look at it that way.

We look sort of it at the net overhead ratio because there's lots of moving parts.

Some people said in their report so far that expenses were a surprise this quarter.

But the expenses were really up because the revenue generation was up.

The mortgages were up.

And the advertising was up to generate the deposits and the sponsorships we had.

But it was -- a lot of it is to generate the deposits and the loans, the end game, obviously.

And so you spend the money to make the money.

And so we really look at the relationship as far as are we leveraging that well from a net overhead ratio.

But I'd have to go back and study the numbers you're looking at because we just don't present it that way.

Our next question comes from Brock Vandervliet with UBS.

So I guess, on the mortgage business or businesses, could you review what product verticals you now have?

And are you kind of where you want to be in mortgage generally?

Or are there more plug-ins that you find attractive?

Well, we have -- you want to talk about the verticals and I can talk about where we're going.

Well, I mean, the 3 that we show is we just have our standard retail origination channel.

And obviously, if we can bring on more originators there, that would be fine as long as we can make the office as profitable.

The Veterans First is a consumer direct channel.

And as soon as we get that fully under our belt and comfortable with it, we could expand that consumer direct channel to other product lines besides just the VA type of loans.

As Ed mentioned early on, we've put in on what we call our ZOOM product, which is more of a consumer direct type of product.

Although we haven't used it that way yet, we're just using it to be more efficient on our own processing right now.

But we couldn't expand that out.

We'd certainly like to expand the government loans a little bit more as the pricing on those tends to be better than the others.

But other than maybe moving more towards a -- more of our product line towards a consumer direct channel, I think we have really what we want for the short term here right now.

We're really -- we're not looking right now other than organic growth of producers.

And we've done a number of mortgage acquisitions in the past.

They've all been done on earn-out basis, which leaves us without a lot of stress on these deals as to working out or not.

But we're going to concentrate now, at least for the rest of this year, on getting efficiencies out of our processing.

We have a number of interests we're not going to talk in detail about, but a number of interesting concepts and -- proven concepts that we are big enough now that we can take advantage of that will hopefully drop our cost of processing in total into -- in about half, processing.

Now commissions are a whole different story.

The commission structure in Veterans First is different than the retail commissions.

There has to be Dodd-Frank kind of screwed that thing up but you cannot take -- you take commissions on volume but not profitability.

When the profits go down, you're still paying commissions.

Got to find a way to figure that out, so everybody is on the same team here.

But we think we can cut our costs of actual backroom processing in half.

We're going to be working on that, very hard over the next 3 to 6 months.

I hope they're all implemented by that point in time.

The commission structure is the biggest cost we have, something we're not going to tamper with now, but they are ideas.

I think the whole industry has a deal with that issue in general if rates stay down.

If the spreads stay down where they are, people without our volumes, smaller than us, are going to have a hell of a time dealing with that issue on the cost side.

Okay, great.

And just a housekeeping now, Dave, were any of those deposits that came in toward the quarter end considered wholesale?

No, our brokerage deposits were relatively flat.

They changed just marginally.

I mean, some ran off and we did bring some on to replace them.

But the wholesale broker deposit number was relatively flat.

Your next question comes from line of Kevin Reevey with D.A. Davidson.

So my first question is line utilization.

It was around 52% or 53% when we talked the last quarter.

Has it moved up or has it stayed pretty much the same?

For now, it's still the same.

Dave has got the number here but...

Yes, it is trending pretty much the same as we have the last few months.

So utilization rates are about the same.

But people are taking bigger lines.

They still have anticipatory line increases going on.

So borrowing is up, but the lines are increasing proportionately.

That's a good thing, absolutely.

We think so.

Yes.

And then, Ed, at the end of your prepared remarks, you talked about that you'll continue to look for other niche businesses.

Can you kind of give us some color on what those businesses are?

If I knew, I'd be doing them.

A lot of things we run across are things we haven't -- things we had never thought of before, different interesting little businesses where -- that we think we can go to scale.

We like to think that our -- any one of these niche businesses should be able to go to $400 million to $500 million.

Many of them we've never heard of before.

We read about them, we look at them.

We're not big at buying them because they're pretty expensive right now when we run into them.

But we're pretty big on starting from scratch like we did leasing.

Our leasing portfolio is $1.1 billion.

It started 2.5 years ago.

We see good growth there.

It's interestingly, the moves that have been made in Chicago banking are opening up some opportunities on the leasing front, too.

So we believe that within some of the niches we can get some additional diversification by adding additional products that we haven't had in existing leases or in existing businesses.

So a lot of it is stuff we never heard of, different concepts or ideas and we're not afraid to go nationally with our niche businesses, either.

So if you hear anything, let me know.

Will do.

And then with the recent disruption in Chicagoland.

Earlier, you talked about opportunities as far as gaining customers.

Are you seeing any opportunities as far as talent acquisition?

Yes.

Let's leave it at that.

Yes, we are.

You can imagine that some of the deals that were announced involve cost cuts that will put uncertainty in all areas of the business.

So when we open a position on the operational side, in deposit ops or in the BSA or compliance, we are seeing a number of opportunities of very seasoned people wanting to come, be here.

We were always in a position because our compliance numbers and our CRA numbers are so darn good, of being poached, now it's the other way around.

So we like that.

On the lending side, you do see -- I'm not going to comment in particular.

But disruption that is taking place, that has taken place a year ago has been -- is good to us and will continue to be good to us as we add to our staff.

So lots of dislocations going on in assets and people, and we intend to just be disciplined in taking advantage of them.

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

So how are you thinking about the third quarter margin in terms of getting the benefit of the June rate hike along with the higher deposit betas that we've talked about as well as some of the balance sheet actions that you've discussed on the call?

Well, as Ed mentioned, we still think we have upward potential in the margin.

Deposit betas are up over prior quarters, but we're very asset sensitive, so our loan pipelines are repricing.

And some of those more significant niches that we have, like the premium finance niche, it takes 9 months for the commercial premium finance portfolio to turn over and the life portfolio reprices once a year.

So some of those loans that are repricing now are taking advantage of a couple of prior reprices, too.

So we still expect our asset yields to outpace our deposit costs slightly.

And so we would expect that margins could continue to trend upward.

Okay.

And then the, call it, $950 million of franchise loans, could you just discuss the underlying health of that portfolio?

And are you becoming any more selective at all within that business?

Well, we've always been selective in that business.

The health of the portfolio is very good, grew nicely last quarter.

We again look for diversification inside the brands that are in there.

McDonald's is still the largest exposure that we have, but it doesn't make it that much -- I don't have it in front of me here.

Next time, I'll bring them report in with me.

But no, we don't have a lot of stress, any stress, really, in that portfolio other than every now and then, you get a guy and you want to just stay with the brands where they support the franchisee and the goodwill of their business and not let them go under if they have an issue.

So the portfolio is very healthy where you have no issues with it.

Look forward to good growth in it.

And then just one last question, will the advertising and marketing expenses remain seasonal?

Will there be a decline later this year?

Or do you think because of the market disruption, you'll be a little bit more proactive on the advertising and marketing side?

No, as I indicated in my comments, I think the third quarter will stay elevated, and a lot of that's, again, due to the sponsorships that we do and a lot of them happen in the summertime and clearly our Chicago Cubs and Chicago White Sox sponsorships are heavier during the baseball season, which is generally the second and the third quarter.

So we're hoping a bit in the fourth quarter as heavy sponsorships means the Cubs will be in the playoffs and World Series again.

But again, we would expect it to trail off a bit again in the fourth quarter and then the first quarter and then pop back up again.

So there is seasonality to that in the middle quarters of the year.

Yes, it should grow -- the overall basic marketing expense.

What we've done is pivoted from brand marketing, more to product marketing.

And so it's just a pivot of expense.

The core expense should grow commensurate with the overall organization with these little blips in the summer for us for our baseball sponsorships.

Our next question comes from Nathan Race with Piper Jaffray.

Just going back to Terry's first question on loan yields and pricing.

Just curious if there are any prepayment fees that may have impacted loan yields this quarter?

I understand, obviously, you got the full benefit of the last few rate hikes that came through loan yields.

But I guess, the increase in loan yields that we saw this quarter was a little higher than we saw in previous quarters, following an increase in the -- by the Fed.

No, nothing unusual, but most of it comes through the leasing business that we didn't really have anything out of the ordinary there.

Our prepayments are usually on lease and prepays.

We had nothing out of the ordinary.

And by the way, we're still -- you said the last the 2 rate hikes, those won't be fully implemented for the another 2 quarters.

So we still are experiencing the growth of those.

It's kind of a snowball rolling down the hill for us.

And we did see a little bit of elevation and payoffs on commercial real estate side.

But those are more end of term, maturity term for those and some of those went outside to insurance companies or the like, but as planned.

It's like with the McDonald's deal.

We let -- McDonald's new headquarters in Chicago was the lead on -- co-lead with Bank of America that was a big construction loan.

We see those come into maturity and those are rolling off into permanent financing outside the banking system so...

But those generally don't come with prepayment penalties because they're at maturity.

So nothing unusual in the quarter.

Got you.

And then kind of changing gears and perhaps a barter question on deposit growth.

I guess, is the kind of core deposit growth that we saw this quarter sustainable just given the rate increases that you guys implemented across a number of products during the quarter?

Or do you guys see yourself having to spend more on both marketing and so forth and continue to raise rates across a number of products to continue to deliver this magnitude of deposit growth in the back half of this year?

Well, on the advertising side, I think we answered that question, kind more of a pivot from advertising.

We -- brand advertising to product advertising.

And that should grow proportionally with our number of branches and with the size of the organization, kind of that core pricing.

And at the same time, we are growing new branches, this is -- there's growth that's coming across the board.

So a lot of it is growth coming in without higher -- because of how we're structured, we don't have to raise rates every year.

We're not like a big bank that has a model brand so has to raise it.

They have to raise it across the board.

I can go to one bank and raise rates where I want -- it's inefficient and want to grow there to get those efficiencies with no commensurate cost increase in expenses or to a new bank where I want to come out of it.

At the same time, I'm growing in existing banks and not elevated rates.

So I think you have to look at the -- what our aggregate plan is over the next -- if they have 2 more raises, our overall beta will be in the 40% range.

So that's kind of hefty we will gather that and know that we're saying we believe earning assets will surpassed that and we will have ping-pong ball increases in the margins.

Ping-pong ball in the water, not beach-ball underwater increases in the margins as rates continue to go up.

And that will always be on the larger earning asset base, which should materially help that interest income.

Our next question comes from Michael Young with SunTrust.

Ed, I wanted to go back to some of your comments earlier in the call about maybe a potential for the long end of the curve to move higher.

If you start to see that taking place or if things move in that direction, would you look to term out the CD book while rates are kind of lower now?

Or are you asset sensitive enough that that just doesn't make sense?

We look at both sides of the balance sheet as it relates to rates going up and we -- as rates continue to move up, reducing our interest rate sensitivity.

So we would look at both sides of the balance sheet in doing that.

Yes, we want to lock in longer rates when they're there.

We're doing that now to some extent.

But we also would look at the asset side.

We'd probably have more of the asset side than the liabilities side.

But yes, we wanted -- certainly, we would like to lock in the asset side before the liabilities side if you're trying to reduce your gap going forward.

And maybe more just a broad comment on credit spreads.

Obviously, base rates continue to move up.

But how much of that is kind of being given back in just absolute credit spreads and pricing on new production at this point?

That's a good question.

We're seeing the market do that, smaller banks in particular.

Some large banks in some specific areas are doing it.

But fortunately, as I've said in previous calls, it really has been the history for how we operate here throughout our life is we don't -- we don't change our loan policy, our pricing model for anything.

If it doesn't work, we won't do it.

So we're -- we -- the market is moving a little bit.

We are seeing it.

But fortunately, we've been able to get our business on our terms, and we beat the guys left and right.

We're not going to chase the market.

We're not going to chase the down rates.

We'll let deals go, hence, the commercial real estate runoff that we've had.

Some of it has been contractual runoff for projects that are completed and going into the secondary market.

So it's been good, good, solid commercial real estate is going to another bank.

For a price that doesn't make sense to us, we don't chase it.

And we're seeing it there.

On the commercial side, it's as low as it's going to go.

I mean, the commercial side has been as low as it can be.

So the middle market commercial side has been as low as it can be for the last 3 years.

We don't see that occurring that much.

In the private equity portfolio, we are seeing our sponsors sell or buy, which should tell you something.

But we're holding steady in that portfolio.

We are seeing nonbanks come into that area, like the Ares and Antares of the world with rates that we would not be comfortable with on the deals.

Still, they look pretty good at 400 over, between 400 and 500 over, but air balls that are way out of control.

So -- and those aren't our sponsors doing it, our sponsors are playing.

Our sponsors are selling, and that means something to us.

So we are seeing some irrationality in the market on the commercial real estate side, on the private equity side, but the private equity side being mostly nonbanks, throwing money at deals that don't make sense to us.

So...

In other words, I think spreads are holding in there for us.

Yes.

Thanks, Dave.

(Operator Instructions) Our next question comes from line of David Chiaverini with Wedbush Securities.

So I wanted to follow up on the discussion about loan growth, which has been very good and high single-digit guidance was maintained despite the caution on commercial real estate.

So I was curious, are you seeing enough demand or an acceleration in demand on the C&I side and in premium finance to generate and continue that type of growth?

Yes.

On the commercial side, well, we're just taking business from people.

As Dave said, our utilization rates are still in the low 50s on lines we're bringing in.

But with the disruption in the market, with our reputation continuing to grow and our abilities continuing to be recognized in this area, we're getting looks at deals from other banks because of our good looks and also because of the disruption in the market that's taking place.

On the premium finance side, Dave, do you want to talk about that?

The premium finance business is pretty strong.

I mean, we continue to market and get new clients.

SunTrust sold recently, which is disruption in the marketplace, and they sold to one of our larger competitors, and so that is helpful to us.

And we do give great service and a good product.

So we get our foots in the door, and we continue to build the business.

Our feet in the door, we continue to build the business there.

So we keep blocking and tackling.

There was some regulatory relief that we hope down the road may pop in that would help us compete with the nonregulated entities.

We're hopeful that, that's going to come shortly, which would be another tailwind for us.

We've lost some business because of regulations that apply to banks that don't apply to nonbanks or insurance companies, but we're hopeful that, that's going to be resolved soon.

So that might be a tailwind for us going forward.

But as we mentioned on the front end, our pipelines are working their way back up and at relatively high levels compared to recent history.

So the business is there, and we think we can sustain it.

And in terms of benefiting from the disruption, are you able to benefit without hiring from these other organizations?

Or is hiring a prerequisite to benefit from the disruption?

The former.

We benefit out of the box.

Hiring is just -- we're very selective in that regard, and that's just additive.

But for the most part, you really don't need to hire.

We have the capacity that take on additional business across the board, but hiring doesn't hurt.

And I'm not showing any further questions in queue at this time.

I'd like to turn the call back to Mr. Wehmer for closing remarks.

Thanks very much, everybody.

Have a great rest of summer.

And hopefully, we'll be back with our 11th consecutive quarter of earnings when we talk in October.

So everybody, talk to you soon.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the program, and you may now disconnect.

Everyone, have a great day.