Welcome to the Wintrust Financial Corporation's first quarter 2018 earnings conference call. At this time, all participants are in a listen only mode. If anyone should require operator assistance, please press star then the zero key on your telephone keypad. Following a review of the results by Edward Wehmer, President and Chief Executive Officer, 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 first 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 like to turn the conference over to Mr. Edward Wehmer.
Thank you. Welcome everybody to our first quarter earnings call. With me as always are Dave Dykstra, Kate Boege, our legal counsel, and Dave Stoehr, our Chief Financial Officer. We'll have the same format as usual. I'll give some general comments regarding our results, turn it over to Dave Dykstra for more detailed analysis of other income, other expenses, and taxes. Back to me for some summary comments and thoughts about the future. On to questions. We're pleased to report on the earnings front that we recorded record earnings for the ninth consecutive quarter in a row. David Long, if you're out there, you should know that Papa George would be very proud of us. Net income totaled $82 million, up 19% over fourth quarter of 2017, and 40% over the first quarter of 2017.
Earnings per share were $1.40 compared to $1 the first quarter of 2017, and $1.17, 40% up over last year, almost 20% up over the fourth quarter. Just to note, pre-tax income was $108 million, which is almost 13% over the fourth quarter and 23% over the first quarter of last year. Even without taxes, we had good operating results. Our return on assets was at 1.20% compared to 1% at the end of the fourth quarter of last year. The return on equity was 11.3% and the return on tangible equity was 14%. As is readily apparent, our operating trends remain consistently positive. On the net interest margin front, and net interest income front, the net interest margin increased nine basis points over the fourth quarter of 2017 and 18 basis points over the first quarter of 2017 to 3.54%.
Net interest income grew $6 million over the fourth quarter of 2017, despite two less days quarter-over-quarter. Both increases were driven by the higher rate environment and a large earning asset base. The average earning asset base grew $586 million in the quarter. Earning asset yields increased 13 basis points versus the fourth quarter, while interest expense increased eight basis points over the fourth quarter of 2017. Our loan-to-deposit ratio of the quarter rose to 95.2%, obviously higher than our desired range of 85%-90%. Some of this was caused by our back-end loading of loans in the quarter. That is, ending loans exceeded our average loans by $365 million. It was both well as a headstart for [inaudible] of this year. Our deposit marketing is just kicking in, we'd expect this number to begin receding towards our targeted ratio.
Accordingly, we expect our deposit rates to increase going forward. Our historical beta to date has been in the low 20 range. We expect this number to be in the 40% range going forward. As we are still very asset sensitive, additional rate increases, including the one announced in mid-March, should still add materially to our bottom line despite this increased deposit beta. Every quarter point increase in Fed funds should continue to add north of $20 million in net interest income on an annual basis. You might note that this number has not changed from past discussions due to the increasing size of our balance sheet. In other words, we expect our deposit rates to increase a little bit faster, our balance sheet is growing and that should cover that.
We've been in no rush to build our balance sheet definitely as the long end of the yield curve is yet to move in concert with the short end, thereby forestalling the liquidity play we've discussed in the past. This initiative is still in the cards for us. I expect our loan-to-deposit ratio to stay in the low 90s until such time the spread for the long end gets better. More on this later. As such, with future rate increases, we anticipate our net interest margin to continue to grow. Remember that it takes a full year for these increases to work their way through our balance sheet. Some of the benefits of some of the past increases are still being realized. On the credit front, credit remains historically great. Both NPAs and NPLs were down from the already low numbers, a $3.5 million decrease in total.
Loan balances were down $10.3 million as we continue to push out old assets. Valuation charges were up as we reduced the number of older properties to fire sale values just to get them out of here. Times are good, let's clear the deck, I think is the idea. We really reduced the number to really liquidation value as we had some lowball offers. Why not push them out now? NPLs were down a touch versus Q4. You'll see there's a change in the mix of that NPL portfolio. Commercial premium finance loan non-performance increased by $4.5 million in the quarter, while all other categories decreased by a like amount. This increase was due to three unrelated, yet one-time events.
These events also result in net charge-offs in this category, increasing $2.6 million from Q4 and rising to 68 basis points, which is our normal historical rate, which resides in the mid-20 basis point range. The first of these was an agency fraud of about $1.5 million. We get one of these about every 10 years. We usually get four or five a year. We catch them early. This one was not caught due to human error. We expect minimal recovery. As you know, this is one of the risks of the business. We are very diligent in this area, but this is one that was not caught as early as it should've been. A full review of the portfolio ensued our discovery of this incident, with no indication of similar occurrences. Controls have been modified accordingly.
The two other one-time events relate to the bankruptcies of two small casualty insurance companies. We expect to recover the majority of these funds through the liquidation process, but these can take time. I mean time in years. Refunds confirmed to date are carried in NPLs, while others were charged off, we'll look at on recovery. As said, we consider the timing of these events to be anomalies. The core business remains a very good one for us. We expect net charge-offs in the normal range going forward. In summary, credit remains very good. NPAs as a percent of assets decreased to 0.44% from 0.47% on net charge-offs. Reserves as a percent of NPLs was at 1.56%, up from 1.53% at year-end. Net charge-offs as a percentage of loans increased five basis points to 12 basis points for the quarter.
We continue to cull our portfolio for cracks and will expeditiously move assets out when any said cracks are found. We will also aggressively work our OREO portfolio to clear the decks. The other income and expense side, Dave is going to go through these in detail momentarily, but just some general comments. On the mortgage front, our acquisition of Veterans First, which is going according to plan, provided a little noise in our expense numbers as we experienced a full quarter of overhead expenses with only one month of revenue. As part of the deal, they got to keep and close the loans that were in their pipelines as of the closing date. Dave will explain this a little further. Our wealth management operation continues to improve, with revenues increasing to almost $23 million for the quarter.
Our net overhead ratio for the quarter was 1.58%, above our target of 1.5%, 11 basis points better than the fourth quarter of 2017. Some of this was balance sheet driven as we are delaying pulling the trigger on our liquidity initiative. Other factors included the Veterans First acquisition, historically slow first quarter in the mortgage area, and our aggressive approach to clearing out some old OREO expenses, and some other expenses that Dave will discuss. A net overhead ratio of 1.5% or better remains our goal for the year, that we believe to be attainable. On the balance sheet front, assets total $28.457 billion, up 7.6% from the fourth quarter and 10% from the first quarter of 2017. Loans demand was very good across the board, with $22.47 billion in loans, up $519 million from the fourth quarter, and $2.2 billion from the first quarter.
Deposits were a little bit slow coming in. I'll talk about that in a second. As I mentioned, we start the quarter $350 million ahead of the game in terms of average versus ending balances going forward. Loan growth, as we projected, was in the high single digits and growth was across the board. Loan pipelines are consistently strong and actually increased this quarter. Deposit growth was negligible as some year-end large account balances were moved out. It should be noted that we started our marketing at the beginning of this year, and as such, we opened over 3,000 new checking accounts in the first quarter. We intend to continue our marketing here and also begin cross-selling new relationships to our new customers. As mentioned, the loan-to-deposit ratio is higher than we want. The liquidity initiative we discussed is to have deposits growth outpace loan growth over time.
The excess liquidity generated would be invested in a laddered securities portfolio. This would have the effect of increasing earnings and ROA, lowering our net overhead ratio, and marginally decreasing our net interest margin and lessening our positive interest rate sensitivity, which makes sense as rates increase, we'll be bringing that down. With the curve flattening, we've yet to pull the trigger here. Our marketing plans are kicking off. We expect to begin making some headway on this initiative throughout the rest of the year. I'm going to turn it over to Dave for his discussion of other income, other expenses, and taxes.
Thanks, Ed. As normal, I'll touch on the non-interest income sections and the non-interest expense sections, as well as a brief review of the taxes. The non-interest income section, our wealth management revenue totaled $23 million for the first quarter of 2018, which is up 5% from the $21.9 million recorded in the prior quarter and was also up from the $20.1 million recorded in the year-ago quarter. The trust and asset management component of this revenue category increased to $17 million in the fourth quarter from $15.8 million in the prior quarter due to market appreciation at the beginning of the quarter. The brokerage revenue component remained relatively steady at $6 million in the first quarter, down by only $36,000 from the prior quarter. Overall, the first quarter of 2018 exhibited strength in revenue generation and represented a record quarter for our wealth management fee income.
Mortgage banking revenue increased 13%, or $3.5 million, to $31 million in the first quarter from the $27.4 million recorded in the prior quarter and was up substantially from the $21.9 million recorded in the first quarter of last year. The increase in this category's revenue from the prior quarter resulted primarily from additional revenue of approximately $5.9 million related to the Veterans First acquisition and a $4.1 million positive fair value adjustment related to the mortgage servicing rights asset. That $4.1 million fair value adjustment on MSRs compared to just $46,000 fair value adjustment in the fourth quarter of last year. This was partially offset by lower origination volume due to typical seasonality during the winter months in our primary market area. The company originated and sold approximately $779 million of mortgage loans in the first quarter, including approximately $112.5 million related to the Veterans First acquisition.
This compares to $879 million of originations in the prior quarter and $722 million of mortgage loans originated in the first quarter of last year. Also, the mix of loan volume related to purchased home activity was approximately 73% compared to 67% in the prior quarter. Given existing pipelines, the full quarter production for our Veterans First product line and the spring buying season, we expect originations to increase nicely in the second quarter of 2018. As you know, the acquisition of Veterans First happened in January of this year and began to contribute to mortgage revenue as we built out our pipelines and began to close on those loans primarily in the latter half of the first quarter. As a reminder, the loans locked in the pipeline when we closed on that acquisition accrued to the seller.
Wintrust needed to begin to build the pipeline early in the quarter, and that pipeline resulted in the majority of the revenue being realized late in the quarter. We expect to realize the full impact of the acquisition beginning in the second quarter with further increases in loan originations and revenue and corresponding increases in associated variable costs. Operating lease income increased in the current quarter compared to the fourth quarter of 2017, primarily as a result of an approximate $1.1 million gain realized from the sale of certain equipment held on operating leases. Other non-interest income totaled $11.8 million in the first quarter, down approximately $728,000 from the $12.6 million recorded in the fourth quarter of last year.
There was a variety of reasons for the decline in this category of revenue, including not having any FDIC accretion related to loss share arrangements as we exited all those loss share arrangements in the fourth quarter of last year. We had slightly higher losses related to foreign exchange valuation adjustments associated with the U.S. Canadian dollar exchange rate, a lower level of loan syndication fees, and a slightly higher valuation charge on certain assets held at fair value due to rises in interest rates. Turning to the non-interest expense categories. Non-interest expense totaled $194.3 million in the first quarter, decreasing approximately $2.2 million from the prior quarter.
The decrease was generally related to approximately $8.8 million of less commissions and incentive compensation, $2.2 million of lower professional fees primarily related to a reduced level of consulting expenses, offset by an increase in advertising and marketing of $1.4 million and an increase in OREO losses and valuation adjustments of approximately $2.3 million. The prior quarter also had a pension valuation charge of approximately $1.2 million that did not reoccur in the current quarter. Also, total non-interest expenses were impacted by approximately $5.9 million of aggregate expense related to the Veterans First acquisition. If we were to exclude those expenses, overall non-interest expenses would have declined approximately $8.1 million on a same-store sales type of approach. I'll talk about the more significant fluctuations from the fourth quarter. Salaries and employee benefit expenses were the main drivers of the decline in non-interest expense during the quarter.
This category of expenses decreased $5.6 million in the first quarter compared to the fourth quarter of last year. As to the components of the salary and employee benefit expense, the annual and long-term incentive compensation expense decreased approximately $6.8 million from the prior quarter. Similar to what we communicated to you during the prior earnings call, we incurred additional annual bonus and long-term incentive performance program accruals during the fourth quarter of last year due to higher forecasts of net income for future years due to rate hikes, balance sheet growth, and recently enacted tax cuts. The first quarter of 2018 returned to more normalized levels. Commission expense was also lower in the first quarter of 2018 by approximately $2 million compared to the prior quarter, primarily due to lower mortgage loan originations.
The base salary component increased approximately $3.7 million in the first quarter over the fourth quarter of last year. The first quarter included the impact of annual base salary increases that generally took effect on February 1st and were generally in the 3% range. It also included the increase in our minimum wage to $15 per hour for eligible non-commission employees, which took effect in early March. The $2.4 million impact of the Veterans First acquisition also contributed to the growth in that number, and we also had normal growth in our employee base as the company continues to expand. Employee benefits expense was down approximately $546,000 in the first quarter compared to the prior quarter. The lower level employee benefit expense is related to two primary causes.
The first was a fourth quarter of 2017 charge of $1.2 million related to the pension obligations that we inherited through two prior acquisitions that did not similarly impact the current quarter, and the second reason was a slight decrease in our health insurance cost. These decreases were offset somewhat by an increase in payroll taxes, which tend to be higher in the first quarter of the year. Turning to marketing expenses. These expenses increased by approximately $1.4 million from the fourth quarter of 2017 to $8.8 million. As we focus on building the franchise, we expended a bit more money on sponsorships and mass media advertising, including mass media branding campaigns tied to the Winter Olympics to generate brand awareness, and additionally, some cost for the deposit promotions that Ed spoke about.
We believe the results of such advertising efforts have been effective and look forward to the benefits of those in the future quarters. Professional fees decreased to $6.6 million in the first quarter, compared to $8.9 million in the fourth quarter of last year. Professional fees can fluctuate on a quarterly basis based on the level of legal services related to acquisitions, litigation, problem workout activity, as well as the use of any consulting services. This category of expenses came down substantially from the prior quarter, which included relatively substantial costs related to consulting engagements associated with investments in enhancing our digital customer experience and product distribution enhancements using technology and certain other IT initiatives. The first quarter was not similarly impacted with as much of these consulting costs.
OREO expenses were elevated, as Ed mentioned in the first quarter, as the company's making a concerted effort to sell or position ourselves to reduce the level of OREO properties held. Accordingly, during the first quarter of 2018, the company recorded approximately $2.4 million of realized losses on the sale of OREO properties and negative valuation adjustments to value certain properties at levels that will hopefully produce quicker sales. Although we have a relatively low amount of OREO properties, we simply would like to reduce the inventory further, especially those properties that have been slow to exit the portfolio. All the other expense categories other than the ones I just discussed were up approximately $1.8 million on an aggregate basis in the first quarter of 2018 compared to the fourth quarter of 2017. This increase can be attributed to the expenses related to the Veterans First acquisition.
Without the Veterans First acquisition, these other expense categories would have actually decreased by approximately $700,000. Turning to taxes. The impact of the recently enacted tax reform, which reduced the federal income tax rate for corporations from 35% to 21% effective January 1st of this year, aided our net income during the quarter. Our effective tax rate for the quarter was 24.14%, but without the impact of the $2.6 million of excess tax benefits associated with share-based compensation, the effective tax rate would have been approximately 26.5%. If we were to compare these rates to the first quarter of 2017, the company's effective tax rate was 33.67%, and was approximately 37.5% excluding the impact of the excess tax benefits associated with the share-based payments. The net year-to-year effective tax rate was down approximately 11%.
At this time, we continue to expect our effective income tax rate for the full year of 2018 to be approximately 26% to 27% if you exclude the impact of the excess tax benefits associated with share-based compensation. With that, I'll conclude my comments and throw it back over to Ed.
Thank you, Dave. In summary, all in all, good quarter for Wintrust on all fronts. Momentum continues across the board. Reduced taxes and higher interest rates have been beneficial to us, but core earnings growth and balance sheet growth bode well for future earnings growth and growth in franchise value. We are pushing our organic growth agenda as acquisitions in general become relatively expensive. In that regard, we have a number of new branches and neighborhoods in our designated market area where we are not currently present. We have these planned. Our retail and small business marketing programs, which we embarked on in earnest at the beginning of the year, are working and pulling in new accounts and relationships. However, that doesn't mean that we're not investigating potential business combinations in all areas of our business.
As mentioned in previous calls, gestation periods become a lot longer, pretty much on all deals. We are very busy in that regard. We remain well positioned for higher interest rates. Credit is as good as it's going to get. We continue to review the portfolio for any early warning signs. Our (rezoning) deals expeditiously and cracks are apparent. Loan growth has been good and pipelines remain strong. We continue to look at opportunities to further diversify our portfolio. We still believe the portfolio will grow in the mid to high single-digit range for the year. We are embarking our liquidity initiative, which should have the desired strategic results, which I talked about earlier. In summary, we're very well positioned, and we like where we sit. That being said, it's a time like this where you get kind of worried that things are this good.
You start looking around the corner for the boogeyman there, the monster under the bed. We continue to evaluate where these risks could possibly be and making plans accordingly. We're not sitting on our laurels. I've been in this business too long. I can say that now that I'm an old man and been around too long seeing these movies. Hope for the best, plan for the worst, as my father always used to say. With that, you can be assured our best efforts to ensure the long-term growth and franchise value of your company. All that being said, times are pretty good right now. We continue to want to make hay while the sun is shining, yet buy some umbrellas just in case. With that, I'm going to leave it open for some questions.
Ladies and gentlemen, if you have a question at this time, please press star, then the number 1 key on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, to ask a question, that's star one. Our first question comes from the line of Jon Arfstrom of RBC Capital Markets. Your line is open.
Thanks. Good afternoon.
Hi, Jon.
A couple things here. The liquidity strategy or deposit marketing is, I guess, what you referenced earlier in the call. I think we understand why you're doing it, just give us a little more detail in terms of what you're doing and what you're targeting there.
Well, I don't like running at 95% loans to deposit. We've been running 85%-90% for a long time. We'd let this move a little bit just because we're comfortable that we have alternate sources in the event that we had a liquidity issue. We have more liquidity available to us than we would need. With the long end, where it is right now and those spreads are not there, why bring it in and not make any money at it? We expect the long end to continue to grow with inflation up, and we see wage inflation starting to occur. I think the biggest issue our customers tell us, and you probably hear it from a lot of people, is finding good people and having to pay up for them. We expect this to occur.
We expect there is some separation in the long end of the curve. As such, we're going to grow deposits faster than loans, get back to our desired range over a period of time of 85%-90%, and bring a laddered security portfolio in, which should hopefully after tax make you a little over 1%, is our goal. Like to make one and a quarter if we could, and go from there. It's just a little bit of a play on interest rates right now. If you were to bring that number back to 87.5% right now, it's close to $2 billion in deposits. We have our work cut out for us. Running those numbers, you can see how beneficial that would be to the bottom line. It would hurt our margin a little bit. Our net overhead ratio would drop precipitously.
It also, as rates move up, which we expect them to continue to do, as everybody does, we're well positioned for those higher rates. Those rates continue to move up. We figure we should start cutting back on our gap, our overall interest rate sensitivity position to protect the downside. This will help us do that also. It just seems like the right thing to do. We don't think there's any rush right now. As rates continue to move up, you can see all the elements, the strategic elements that brings to the table for us. Does that make sense?
Yeah, it does. The message on the higher deposit betas, part of it is just about naturally rising deposit costs. Another part of it is reducing the loan-to-deposit ratio. It's just two parts, really.
Yeah.
That's fair.
We anticipated that in our budgeting and our planning process that We have such a retail-based deposit structure that we've been able to lag probably more than others. Now that you can't lag as much as we have been, we need to bring those numbers up to be competitive in the markets. We built that in, hence why another quarter point rise in rate is only $23 million. It was $23 million two years ago when we started reporting that number. We're on a much larger balance sheet. You can kind of see that we built in a little bit more deposit cost than you would imagine.
Yeah. Okay. That makes sense. Good. Maybe Dave Dykstra, for you on mortgage banking. If you set aside the Veterans First originations, what does the pipeline look like throughout the quarter?
It actually looks pretty good. Veterans First, on average, we think we had half of a quarter of revenue production. We'd expect that to double next quarter. On the legacy portfolio, we actually think that could be up substantially. If you took out Veterans First, if you looked, we gave a little bit more detail in the press release this time on our mortgage banking revenue and detailed it out so you can see all the components. We also broke out the Veterans First origination in our other sort of legacy, so to speak, originations, which was maybe about $667 million. I would expect that might be up 50% in the second quarter, just simply because the seasonality of the buying season. Maybe that goes up a few hundred million dollars, plus the Veterans First is probably up about $100 million.
The pipelines have to develop, and it's early in the quarter, but our thoughts are that number could be closer to $1 billion of production in the second quarter, plus or minus.
Okay. Good. That's what I was getting at. I guess the last one on that topic, the production margin was up. Is that mix Veterans First driven, or is there something else going on?
Yeah. The production margin on our core business was relatively stable.
Yeah.
I think it was down just a few basis points. Veterans First loans, those VA loans have a much higher margin to them. That's what brought the overall production margin up.
Okay. Good. All right. Thank you.
Thank you. Our next question is from David Long of Raymond James. Your line is open.
Hey, guys. As you indicated in your opening comments, yes, Nick Papagiorgio and the rest of Griswold family, I'm sure, are very proud.
You know who that was.
Of course. Vegas Vacation, a good movie, one of Chevy Chase's, but I prefer Fletch when it comes to Chevy Chase, so. That said, thinking about the expense base for the rest of the year, you guys seem like the expense to asset target of 150 is still on your radar screen for this year. I'm assuming that includes the de novos and branch openings that you have. Can you maybe walk me through how you think the expenses could progress as we go through the year and still stay at that 150 level?
Well, I'll take a little of it, then Dave will jump in. The OREO expenses are included in there, we're going to continue to push those down. We believe asset growth is going to stay strong and it's a % of assets. Also, January's a slow month for mortgages in general, then the Veterans First picking up those extra expenses. If you were to back those things out, you're pretty close to the number right then and there. We're not that far off from an operating basis of what we look at. We think even with our planned organic expansion, numbers should be in pretty good shape. Dave?
I'd probably echo that. If you backed out the $2.7 million change in the OREO, your net overhead ratio would be down around the 154 range. As Ed talked about, the big piece of the net overhead ratio is the denominator, which is your average assets. If this deposit initiative that we have kicks in a little bit, that pretty much gets you there. As Ed mentioned, increased mortgage activity is beneficial to the net overhead ratio. As we get into the second and third quarters when mortgage activity is typically higher for us, that should help also. I think if you look at the better mortgage business and a bigger balance sheet and just typical cost controls and back out the OREO charge we took this quarter, you can easily draw a road map that would get you there.
The big thing would be just the asset growth is a big driver of that.
Got it. On the loan growth side, I think you mentioned mid to high single-digit expectations for the year. Is that coming from an increase in your lines of use or utilization rates, or are you still bringing in new customers to the bank?
Interestingly, it still is bringing in new customers and growing the franchise through new relationships. An interesting phenomena, usage still is around 52%-53% on our lines. What we've seen is lines increasing. We've seen a lot of our clients coming in and increasing their overall lines by 10% or 20% because of increased business and they want to keep dry powder. That number's a little bit misleading because we're 52% of a higher base right now. In other words, I think you can say that there is some real economic expansion finally taking place. Does that make sense?
Yep. Thanks for the color. That's all I had. Thank you, guys.
Thank you. Our next question is from Brad Milsaps of Sandler O'Neill. Your line is open.
Hey, good afternoon, guys.
Hi, Brad.
Brad.
Dave, just to follow up on Jon's mortgage question, the $5.9 million in revenue related to Veterans acquisition, is that all origination revenue, or is that a mix of servicing as well?
Origination and servicing.
Okay. Got it. I'll follow up. Just kind of trying to get a sense of really what their gain on loan sale margin was because it did seem to be quite a bit higher than yours.
Yeah. It's close. It's 4.5%-5% margins right now. Quite a bit higher than.
Okay
our existing business.
Perfect. Oh, great. That's very helpful.
Brad, that's why we partnered with them. That and their higher margins, it gives us a better mix of distribution, but also their expense model is different than the historical expense model in terms of not having to pay out 55% of the commission. It's a good profitable business for us, a nice blend into what we were doing. Strategically, that acquisition worked great. We're excited to have them with us.
Yeah. Maybe a little more color for those people out there that try to model this out. If you increase the revenue out there, although we had a full quarter of expenses, there are variable costs that will go up. They do pay commissions. As part of a consumer direct model, they also buy leads out there that helps drive the business. I would say, for every dollar in the second quarter of revenue that goes up, there still may be an incremental 35% or so of expenses that come along with that, with commissions and the lead generation and just the variable costs that go along with it.
If you're trying to model growth into the second quarter, even though we had a full quarter of expenses this time, those expenses will probably go up in the second quarter because of commissions, some additional lead generation, and just the variable costs that go along with closing a loan. It was close to breakeven this quarter simply because we had to build the pipeline before we could close it, but it should certainly be profitable for us in the second quarter.
That makes sense. Would you expect that business to be you kind of talked about it doubling in the next quarter, but would you expect it to be about 20% of your overall mortgage business going forward? Or do you think you can make it a bigger part of sort of the overall Wintrust mortgage pie, so to speak?
It's probably close to 20%, is what we'd expect right now. That's probably a good range. Obviously, we'll have to see how interest rates play out and how the mix plays out. Right now, I think high teens or 20% is probably not a bad range.
Just kind of switching gears to a piece of the balance sheet. This is kind of small relative to the overall picture, but I did notice that borrowings, FHLB bonds are up quite a bit linked quarter, but the rate was down. Just kind of curious, is that something that's kind of temporary that will reverse out? In lieu of kind of some of the deposit movement you had this quarter, can you kind of give us a sense of kind of what the thinking was there? Is that preparing for something else as you kind of implement this deposit strategy?
They call it around here Ed's equilibrium, where when you take mortgage held for sale, plus the assets in our mortgage warehouse lending, a perfect world, we finance that with Federal Home Loan Bank overnight money. Great spread there. It's variable. You can give it back if those numbers go up or down, and we can manage our liquidity that way. In the past, we've always had excess deposits that cover that, so we were never really at Ed's equilibrium. Right now, you're there. I would imagine if we're successful in continuing our organic growth, that that number would come down. If we weren't, that number would stay pretty much even. It's a perfect match for us, both from a duration standpoint and a rate spread standpoint.
The day we have excess deposits like we did throughout the years, we didn't bother grossing up the balance sheet at that point in time. Does that make sense?
Yeah. No, that's perfect explanation. Thanks for that. I appreciate it.
Thank you. Our next question is from Christopher McGratty of KBW. Your line is open.
Hey, good afternoon. Dave, maybe a question for you. I just want to make sure on the leverage strategy. Is it about the absolute level of long rates, or is it the shape of the curve? I guess, what should we be looking at specifically to see when you guys might pick up the pace of securities purchase?
It would be the shape of the curve. You want to get a spread between what you're going to raise the deposits at and what you invest in, and we would probably invest some of that, ladder it out. A good portion of that would probably be Ginnies and Fannies. If we're sort of looking at where the deposit rates could come in and where you could lay them off in Ginnies and Fannies, possibly some munis or something like that. It's the spread that we're looking at. With a relatively flat yield curve now, that doesn't work out to the numbers that Ed was talking about. We need some steepening of the curve. It's not the absolute rate, it's the spread.
Okay. Thanks for that. On the loan yields, nice improvement sequentially. Part of that, I would imagine, is the big LIBOR portion. Was there anything unusual in terms of loan fees, accretion, non-accruals, or is about this level of improvement per rate hike about what we should be expecting?
Yeah. There was nothing unusual of the types that you talked about there. This was really just the portfolio reacting to the rate environment.
Remember, it takes a full year, like on the life insurance loans that are based on one-year LIBOR. It takes a full year for that to reset for those portfolios. We're still in the process of what, absorbing three rate increases in that portfolio, notwithstanding future rate increases going forward. It literally takes a full year for us to be in a position to get that $20 million, $23 million we were talking about for every quarter point. We would expect that to continue, even if we don't get another quarter point rise in rates in the next month or two. You know what I mean?
Got it. Understood. That's great. Then maybe one last one, just to make sure I heard you guys right on the loan growth. I think you've talked about in the past high single digit, and I think in your prepared remarks, you said mid to high. Is that just a word-smithing or are you tweaking the guidance a little bit softer?
No, I think it's the same. What's high single digits? Eight or nine? I'm thinking seven to nine, somewhere in there.
Got it. Okay.
Mid to high, I don't know what. It's all semantics, I guess.
Yeah. I think the short answer is we're not changing our tone.
Okay, great. Thank you.
Thank you. Our next question is from Nathan Race of Piper Jaffray. Your line is open.
Hey, guys. Good afternoon.
How are you?
I'm good, thanks. Just going back to the loan growth discussion. Just curious to get your updated thoughts on the commercial real estate market in Chicago, specifically multifamily. Looks like you guys had pretty good growth in commercial real estate during the first quarter and looked like Illinois comprised a large chunk of that. Just curious on your updated thoughts on that asset class.
Well, you really have to diagnose what kind of asset class you're interested in. The multi apartment buildings, we're really not interested in doing those right now.
Retail.
Pardon me.
Retail is something we're backing off of too, a little bit. Those two asset classes.
Yeah. What we've got is on the commercial real estate side, we have a number of larger construction projects. The McDonald's Corporation headquarters, we co-led that deal. They're moving in the next two months. Wrigley Field, the new hotel, the development around Wrigley Field. Those are all kind of working their way through. Industrial real estate is still strong. Office real estate is still strong around the city. In the suburbs now, we're comfortable with those. Again, these are not one-off deals. These are relationship deals. This isn't like in the past where we were beasts of burden, where we would just take a hunk of a deal and with a borrower we really didn't know that well. We have to have full relationships with them. Sponsorships have to be good. We're not getting out over our skis on this stuff right now.
We're being very cautious on the real estate side, as you would imagine. A lot of it also has to do with the middle market business we're picking up, to continue to pick up, where there's a building component that comes with it.
Got it. That's helpful. All my other questions have been answered. Thanks, guys.
Thank you.
Thank you. Our next question is from Terry McEvoy of Stephens Inc. Your line is open.
Hi, good afternoon.
Hi, Terry.
Hi. Just to follow up on, I think it was Brad's question. The Veterans First expenses of $5.9 million, just $2.4 million of that was salaries. I just want to make sure I understand correctly, that $3.5 million or call it $14 million annualized you described as paying up for leads, et cetera. It sounds like that run rate is going to increase going forward. Where within the expense lines will those expenses show up?
Yeah. Of the $5.9 million, you're right, $2.4 million was the salaries line. We do have commissions that would show up in the commissions line. Various other expenses, occupancy, employee benefits and the like. The big piece where you get a little bit of offset from our legacy business is the lead generation. That shows really up in other non-interest expenses. That's just loan expenses on our money. That's just the cost of acquiring a loan out there. It would show up in other non-interest expenses.
Okay. Just a separate question. The call 11% annualized decline in non-interest-bearing deposits. Anything there beyond what you, I think, called out as seasonal in the press release?
Yeah. I think that, Brad. There was a lot of inflows in at the end of the fourth quarter and just some of those naturally came out in the first quarter. We don't see anything systemic there, just sort of natural ebb and flow with seasonality in year-end.
Okay. (That's an MSRs). Thank you.
Thank you.
Thank you. Our next question is from Kevin Reevey of D.A. Davidson. Your line is open.
Good afternoon, gentlemen.
Hi, Kevin.
First question is on the branch that you just recently opened in Wrigleyville. What's your anticipated timing as far as when you think that branch will break even, then for the other four to five branches that you anticipate opening this year?
Well, they usually break even in about eight months to a year. I think that's a fair number.
It's not a huge branch. It's a relatively small branch. I think Ed's estimate is right.
Did you open your account yet, Kevin? You got to get your Cubs debit card.
That's right.
You put in all your deposits, Kevin, we'll shrink that down to six or seven months.
Okay. Deal. We're hearing from a lot of the other Indiana banks that they're seeing some growth from a lot of migration from Illinois, given the state's woes into Indiana. Are you guys feeling any of that? Any of your customers feeling any of the outward migration or any of fiscal woes at the state level?
Well, I think everybody worries about that. We're up right across the border in Wisconsin, we have a heavy presence. We don't really lose any of that business. Indiana, we still service Northwest Indiana. We have one branch there now. We'll continue to build. Most people, though, have so much sunk cost in Illinois, they're not picking up and moving in total. They might expand there, and they don't change their banking relationship out of expansion. Be interested to hear who you're talking to that says they're taking all of Illinois' business because, we're still right here. If you think about Chicago, Northwest Indiana, and Milwaukee megapolis, I think it's the 14th biggest economy in the world. There's still plenty of business to go around. I don't worry about it as much as others do right now because there's still good building going on there.
I think Chicago was the number one city in the country for headquarter relocations last year. There's still a lot of good things going on here in spite of the maelstrom around the economic situation in the state. Hopefully we'll work through that. All in all, there's still a lot of business we have here in Chicago and in our market area. I don't think we're going to see Chicago turning into Detroit anytime soon, or the old Detroit anytime soon.
Lastly, credit, as you say, is as good as it's going to get. How should we think about modeling the provisioning going forward for the rest of the year, given the credit is as good as it's going to get?
Well.
Well, if you look at our 60 to 89s, those near-term delinquencies were down from last quarter. There's a little blip in the 30 to 59s, but most of that was administrative. We've actually had about $50 million of that already cleared off just because it was administrative. We're really not seeing any trend where the credit metrics look like they're getting worse. Unless you change the mix of the business where you're putting more loans on with higher reserve levels. Our mix has been pretty steady and the reserved loans level has been pretty steady for quite a while now. Unless you started to see a crack in credit quality, increase in delinquencies, and the like, then I think you can think our provisioning level would be similar unless you had a large, outsized growth quarter where it might increase it.
It really would depend on asset quality and growth. We see asset quality okay, and we've talked about the growth aspects.
Kevin, it's so low right now that you could have one commercial deal go bad and blow your numbers up. I mean, materially or relatively speaking, go from where we are with 12 basis points up to 25 or 30, which is still remarkably good. We're culling the portfolio, trying to push things out constantly if we see any crack to avoid that. Eventually something's going to happen. I mean, if the numbers are so low that a $5 million or $6 million charge off on one deal would stick out. I can empathize with you how hard it is to model. If I was doing the modeling, I'd probably just add 30% or so to what we have in our provisioning and look good after the fact. Something eventually will happen.
I mean, we're not that good or that lucky, we're trying to stay ahead of the game. Again, on a relative basis, you could have one pop through, which would change our provisioning levels accordingly. We don't see it. We don't anticipate it. We're fighting against it. Eventually, something's going to happen.
Great. Thanks for the color.
Thank you. Our next question is from Michael Young of SunTrust. Your line is open.
Hey, good afternoon.
Michael.
Hi, Michael.
I wanted to get a little color maybe just again on customer activity and what you're seeing as some of these loans come for renewal or repricing after extended duration at lower rates and now with a significant step-up we've had in both one month and 12-month LIBOR here recently. Are you seeing any give on the absolute credit spread even though the base rates increase?
We're seeing that start to happen in the market. We have our profitability models and our loan policy. We don't vary from them. We adjusted our profitability models to do on an after-tax basis and raised all those where we don't want to give away the benefits of the taxes because, as you well know, what Washington giveth, Washington can taketh away very quickly. You still got to get paid for your risk, notwithstanding taxes. I would say there's always been pressure on spreads. They had worked their way down on the commercial side low enough that they really can't go much lower on a commercial middle market lending. They were low already. We're not seeing a lot of that. On the real estate side, you see a little bit of it, but we'll just pass on it. It doesn't cut our pricing.
We don't take it. We haven't seen a mass effort by the part of the bigger banks who are our competition to give away the benefits that they've gotten from higher rates or the tax increase as of yet. I would imagine that will come throughout the course of the year. There'll be more pressure. We'll stick to our guns.
Okay, great. Just as we look at the deposit portfolio and the efforts to kind of improve the loan-to-deposit ratio, and I guess I'm kind of marrying that with the comments that you think that the taking those together, do you plan to extend the duration of the deposit book and term out some funding at this point?
Well, I think that we'll be offering up the three and five-year CDs out there. If people want to jump in. Remember, customers always want what you don't want to give them. The customers aren't wanting to extend right now. We have such a big interest rate sensitive position right now. As rates continue to move up, we're going to want to lessen that. We'll lend a little bit more long and borrow short, and that ought to do that. If we see an opportunity to extend on a rate basis, we certainly will, but sometimes the rates are almost too high right now to want to extend on the positive side. On the deposit side, I mean. I don't mind going short and lending long because, as I said, as rates go up, we're going to want to shrink our gap anyhow. That make sense?
Yeah, that makes sense. Thanks.
Thank you. Our next question is from David Chiaverini of Wedbush Securities. Your line is open.
Hi. Thanks. Couple follow-ups. The first on mortgage banking. You mentioned that for each $1 of revenue that you're going to get in the second quarter to expect $0.35 of incremental expense. I was wondering, and I'm not sure if you're willing to specify, but can you provide what the efficiency ratio was for the mortgage banking business in 2017 and then what you expect it to be for 2018?
Let me clarify. When I was talking about that every $1.35, I was just really talking about the relationship on the Veterans First piece because it's kind of goofy that we only had half a quarter of revenue, then we had a fuller quarter of expenses. I was trying to just give a little guidance on that. That didn't relate to the entire portfolio. That was just to try to help on the Veterans First side of the equation. But the mortgage business has generally been in 80%-85% efficiency ratio business. It's a high efficiency ratio business. Doesn't use much capital. We'd obviously expect that to be a little bit less with the consumer direct channel, but we haven't given any guidance on that.
Got it. The other follow-up I had related to the leverage strategy. You mentioned about how Wintrust will still benefit from higher rates with NIM expansion, but at the same time, with the leverage strategy, it could hurt the NIM. Should we expect that in the quarters in which you deploy the strategy that the NIM should net out to being flat?
I don't think that'd be the case. I think it would be negative. If you phase into this over the next 2 years, certainly will have a marginally negative effect on the NIM, but not one that's going to knock out our continued growth of the NIM.
As Ed mentioned earlier, although it , it has a corresponding benefit to the net overhead ratio and positive to earnings. You take a little bit of pressure on that NIM to get higher EPS, we just don't want to lock into too small of a spread. That's why we're waiting for the yield curve to get to a point where it makes sense to jump in.
Got it. No, that makes perfect sense. The last question I had, going back to the loan growth outlook, how you somewhat tweaked the guidance of saying mid to high as opposed to high.
No, I probably misspoke. It was just semantics. We haven't changed. It's high single digits. Which means, eight or nine, 7%-9% is what we're thinking. I guess that would be high single digits. We're not changing our thoughts at all. I just probably misspoke.
We will generate all the good loans that we can, and we will find a way to fund those. The way you bring the loan to deposit ratio back into line is with the deposit side of the equation. We're not going to turn away good loans.
Great. Thanks very much.
Thank you. Our next question is from Brock Vandervliet of UBS. Your line is open.
Oh, hey. Thanks for taking the question. Dave, just a question for you on housekeeping. I think there was a question on this earlier. The Federal Home Loan Bank advances, the rate has really moved around the last five quarters. I would think that would be linked to some 30 day, 60 day kind of base rate, have been moving up pretty consistently. Why is that not doing that?
Well, because there's two pieces on that Federal Home Loan Bank funding side. We have a portion of that as longer term fixed rate funding. If you've got very little overnight, that rate's going to be high. If you've got more overnight at the lower rates, that's going to bring that yield down considerably. Probably the way to look at it is if you go look at our K or our Q, we schedule out in a footnote what the longer term fixed rate funding is. That's going to be there regardless. When you bring on a lot of overnight funding at very low rates, it's going to bring that yield down.
If you back off on that overnight funding during the course of the quarter, the rate's going to gradually go back up to what that longer term funding that you have in place that's there all the time. It moves around based upon how much overnight funding you have throughout the quarter.
Got it. Okay. At this point, is there any reason to expect it to be closer to $170 than $260?
No, I don't think we'd put that much more on, especially if the deposits start coming in.
Okay. I apologize, I missed the first couple minutes of the call. What's driving the renewed focus on driving down that loan to deposit ratio? Is it the shape of the curve or something else?
No, generally, our philosophy has been is we're sort of old-time bankers. You've got interest rate risk, you've got credit risk, and you've got liquidity risk. We've always thought operating that sort of 85%-90% loan to deposit ratio provided us with the appropriate level of liquidity. As Ed mentioned earlier, we think we have enough liquidity sources that we're not worried about it. Just as one of our basic tenets is to maintain sufficient liquidity out there where you can sleep well at night and it's just the right thing to do. We think that range is sort of 85%-90% loan to deposit. With that being said, right now with the shape of the curve, we've got plenty of liquidity sources, we'd rather operate closer to 90%.
It's a positive. All it does is add to the bottom line. If you figure you can do pretty well with that.
The leverage that we're doing, like we said, it might put some pressure on the NIM, it's going to increase your net income. You want to protect yourself from a rising rate too, so you got to get a sufficient spread on that leverage in order to jump into it. It doesn't take much capital either. If you invest in the Ginnies or the Fannies, those are very low capital instruments. It wouldn't take much capital to do that. It would increase your earnings, put a little pressure on your margin, help your net overhead ratio, and not eat much capital. We think it's a net positive, but you don't want to do it at such a tight spread that for each rise, you're not doing well in the future.
Right. Okay. Thank you.
Great. I'd like to just make sure I clarify something. When we talked about deposit betas earlier, we talked about moving to a marginal deposit beta closer to 40 basis points up from the 24, 25 we've experienced. What we believe is we're still going to have margin expansion. Just it's not the beach ball underwater I don't know, a tennis ball, a number of tennis balls underwater with every quarter point increase. We still make $20 million-$23 million every quarter point increase on an annualized basis. That includes increasing our deposit rates accordingly. We're not going to be able to maintain this 25% beta marginally going forward. We're still very asset sensitive. We still expect the rates that increases that have occurred to date are still working their way through the system. That's very positive. Four more rate increases would be very positive.
We expect the margin to go up every time, every quarter, and every month now going forward, as we absorb those rate increases that have occurred already, and future increases will help us too. I know everybody thinks we're going to jump from 24 to 40 overnight and have our margin go down. That's not the case at all. Rate increases are very good for us. We're well positioned. Anybody think that this is going to hurt our margin or our net interest income going forward, it's still a very positive outlook for us in that regard. Just we're not going to be able to maintain on future increases a 25% beta. That beta will be higher as rates go on. We built that into our plans, and that's included in the quarterly earnings or the annual earnings increase we talked about on quarterly increases.
I wanted to get that point across. Maybe I was unclear on that, but we expect margin expansion throughout the rest of the year. We expect good asset growth. We expect, even with our liquidity play, as we phase into that over the next two years, it's not going to happen overnight. That'll be very positive for us also. We think the outlook for us is very bright for future record earnings quarters to keep Mr. Papageorgiou very happy. If you have any questions about that, I didn't mean to confuse you about that, but maybe I did as I was thinking about it as the call went on. Did I miss anything there, Dave?
Dear?
Dear. Did I miss anything, dear?
No, I think it's time to end the call, man.
Anyhow, with no more questions, thanks everybody for calling in. Call if you have any questions