Wintrust Financial Corporation (WTFC) Q4 2012 Earnings Report, Transcript and Summary

Welcome to Wintrust Financial Corporation’s 2012 Fourth Quarter Earnings Conference Call. Following the 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. The Company’s forward-looking assumptions are detailed in the fourth quarter’s earnings press release and in the Company’s most recent Form 10-Q and Form 10-K on file with the SEC. I would now like to turn the conference call over to Mr. Edward Wehmer.

Thanks very much. Welcome everybody and thank you very much for dialing in. With me as always are Dave Dykstra, our Chief Operating Officer; Dave Stoehr, our Chief Financial Officer; and Lisa Pattis, our General Counsel. Lisa has now resorted to putting a shock collar on me so I don’t say anything out of line, so it will probably be a pretty boring conference call. Keeping up with our usual protocol, I’m going to make a number of general comments about the quarter and the year. David Dykstra will follow with more detailed review of other income and other expense line items. I’ll be back for some summary comments and then we’ll have plenty of time for questions. The fourth quarter was pretty much a solid quarter in all aspects of, really not a lot of noise for Wintrust. The only noise was a loss on the extinguishment of some long-term repo debt that was offset by securities gains from sales of securities related to that repo, $2.6 million with the pre-tax gains and $2.2 million with the losses. Other than that, the quarter was pretty clean. The quarter was highlighted by net income of $30.1 million, or $0.61 a share, annualized loan growth of 12% and deposit growth of 17%. Demand deposits for checking accounts now comprise 17% of our deposit base. It wasn’t too long ago and for most of our history, we were stuck at 9% of that base, may not be bottom line valuable now, but it will be when rates eventually rise. It also evidences the success of our commercial initiative, which we started about 2.5 years ago. The margins did decline 10 basis points, but the net interest income actually improved 6 basis points of the drop related to a buildup of additional liquidity…

Now thanks, Ed. I’ll briefly touch on the other non-interest income and non-interest expense sections. Ed covered them in global sense, I’ll get into the details a little bit more. Starting with the non-interest income sections, wealth management revenue improved slightly to $13.6 million in the fourth quarter compared to the prior quarter of $13.3 million and increased slightly from a year-ago level of approximately $11.7 million. The increase in the wealth management revenues from the prior year quarter came primarily from the trust and asset management business, which increased $1.5 million. The new business development efforts as well as the acquisition of the Trust Department from a local community bank at the end of the first quarter were the primary reasons for the increase over the prior year quarter. Our mortgage banking revenues improved again to $34.7 million in the fourth quarter of 2012 from the $31.1 million recorded in third quarter of this year and was nearly twice as much as the $18 million recorded in the fourth quarter of last year. The company originated and sold $1.2 billion of mortgage loans in the fourth quarter compared to $1.1 billion of mortgage loans originated in the prior quarter and $883 million in the year-ago quarter. The mortgage banking revenues improved as a result of the favorable rate environment, relatively strong volume related to purchased home activity again and continued good pricing metrics in the market. The current quarter was also benefited slightly from a higher valuation in the fair market value of our mortgage servicing rights, and the value of that portfolio increased to 67 basis points from 63 basis points in the prior quarter and was approximately $474,000 higher than the value at September 30, 2012. Obviously, future mortgage origination volumes and servicing rights will be impacted…

Thank you, Dave. 2012 was a record year for Wintrust, and it’s the third record year out of 4 years. Net income increased 43%, assets grew 10.3%. Loans grew almost 11%, deposits grew 17%, tangible book value per share grew 11.5%, credit quality improved, the number of branches increased 12% to 111 outlets in our market area. We acquired 3 FDIC-assisted banks. We did one assisted bank deal. We did one branch acquisition. We bought the Trust Department and we bought the Canadian premium finance company. Needless to say, we’re very pleased with these results. We’re really out of the results of continuation of strategy, which we adopted in 2006. In our release, we included a number of graphs that indicates the quarterly how Wintrust has done through the 5-year credit cycle. In short, compound annual growth rates of $13.3% in total assets, almost 12% in total loans, 14% in total deposits, 9% intangible book value per share, 15% net income and almost 22% in pre-tax pre-provision income. I can’t tell you that, but not many other banks can probably exhibits statistics like this over the last 5 years. We exemplify our commitment to creating long-term shareholder value, no matter what the environment is, that is our goal and that’s the goal we wanted to continue to work off of as we go forward. So what does it mean for 2013? Well, it’s no news to you folks that the prolonged 0-rate environment is going to have margins under pressure. The secret to 2013 for Wintrust will be good growth at somewhat lower margins without commensurate growth in operating expenses. This is our goal for 2013. There is a great deal of operating leverage still in our platform when we plan to take advantage of this in 2013. You can…

[Operator Instructions] Our first question comes from the line of Steve Scinicariello with UBS.

Just a couple of quick ones for you. So as you look at the dislocated asset pipeline for 2013, the best gauge that you have, how much do you think is going to be tilted towards kind of these organic growth and how much tilted towards bolting on more of these platforms or business lines?

That’s a good question. I think that was asked yesterday by a good friend Jon Arfstrom. I think you can look at the historical, our historical numbers as it relates to them. We are back to the -- our pre-2006 kind of growth metrics. But we expect every bank, every bank charter to grow $70 million, $75 million a year, which brings us to about a $1 billion worth of organic growth in the system right now, maybe a little more and maybe a little bit less all tempered by our ability to generate earnings assets. I would expect that everything on top of that would come through opportunities on the acquisition side either FDIC or unassisted. Again, they’re lined up like planes over O'Hare again. And so we think that organic growth will be anywhere between $900 million and $1.2 billion, and that everything else would be through acquisition. So on the niche side of things, we continue to look at earning asset platforms to diversify the balance sheet. We found a couple of nice loans that related to the retail orient, just to say how the regulations affect us, we shied away from them. We figured that in any retail oriented niche program, well, you can make any money, it’s only a matter of time before the CFTB comes down and tells you, you can’t do it, and we are not -- we don’t want to take that risk. So we are looking more on the commercial side of things and we will continue to do that throughout the course of the year, because it’s really all going to boil down to the generation of earning assets. As indicated by this quarter, you can build a lot of liquidity and not make any money on it in this rate environment. So you have to be able to be asset driven and generate earning assets, and we will be very active in trying to diversify that platform, but continuing to grow throughout our franchise. We got great -- as I mentioned we got great momentum on the core loan side of the business. Our commercial guys are really hit the cover off the ball and have succeeded beyond my wildest dreams when we embarked on this 2.5 years ago. The Wintrust name for not being known in Chicago 3 years ago by design is now -- as my kids say, "Welcome to the 90s Mr Banks," in everybody's Rolodex, so at the top of everybody's Rolodex. I guess I should say on their contacts right now, but we have a great reputation in the market. We’ve got great momentum in the market, we’ve great people, we’ve got a great plan to execute. And so earning asset is still -- being asset driven is critical to everything that we do here, and we will continue to do that in a diversified fashion. I hope I answered your question.

Wow, definitely, it’s a great color. And then the only other one I had for you is, just given the massive amount of build into liquidity management assets like you said, just kind of climbing the ladder, but with these things approaching 16%, 17% of total assets, what’s kind of the right level. And assuming it’s a little bit below that, as you look ahead, I mean into this kind of repricing environment, do you kind of see kind of that core, kind of 10ish or less basis points or just repricing headwind that you then have to grow through as we look kind of going forward -- just kind of trying to gauge, kind of what you are up against in terms of like margin headwind? :p id="224081" name="Edward Wehmer" type="E" /> Well, margin headwinds are going to be there. And it’s so exacerbated by the rate environment that we are in. I feel like we’re playing the football game constantly in the red zone, we don’t have a lot of field to play with here. But as I mentioned what I ran through that quick example, it’s going to be hard for the margin to go up without giving some niche assets through some FDIC related assets. But net interest income, we think we’ll flourish this year and without the commensurate increase in expenses. So we believe that we can actually -- we actually can help our metrics materially, but the margin will be down doing it. So you can focus on the margin or you can focus on absolute dollars and employing the leverage that we have both into the system. Everyone of our operating subsidiary heads has an objective this year to keep their expense flow on a same store approach and notwithstanding acquisitions and the like, less than 1%, 1% or less. That’s the goal this year. Everybody has got it, that’s built into their budget, so we can do that. Yes, we might have -- the margin is like everybody else is going to be under pressure, but the net interest income itself will drive and improve our metrics, so that and improved credit quality, should bode well for us this year. We are also working very hard. Dave mentioned, we’ve been putting on series on a interest rate caps like laddering them in going forward to continue to prepare the balance sheet for higher rates. I can’t fight nature here, it is what it is, the market is what it is. But we can prepare, we can make more money this year, we expect it, but we can’t prepare ourselves when rates go up and get the beach ball underwater effect. So can’t fight City Hall, but we can certainly work around it and make more money.

Our next question comes from the line of Jon Arfstrom with RBC Capital Markets.

Hey, the number of wehmer-isms on this call at an all-time high. So I’m going to throw one back at you on expenses. I believe you’ve used the term wring the chamois in the past on expenses, is it time to do that or is just kind of trying to trim back the rate of growth and you may get more aggressive later, I just want to understand where you are in your thought process on expenses?

We have to get more out of what we have, Jon, that’s the issue. We will be divesting our Second Federal in February, that will alleviate some expenses. We do have a number of the deals that we did last year that will be coming up for conversion in the subsequent quarters which allows us to cut expenses once that’s done. We’re not the type of guys that do massive risk. I mean, but we try when we do those things to make sure that through attrition we are able to place those people who would be displaced by when we do these conversions, we can take advantage of that. So we think there is lots of places that can cut expenses and we can be very careful. We think that our expense base can support a lot more growth than we have. So we just got to be very careful. Last year, we did a number of programs to maintain, to control and to reduce expenses. I think our expense ratios are pretty damn good right now at each of the operating companies, but there is a lot of leverage to build then. So I don’t know if I answered your question. Dave, you want to comment on that?

I think what Ed said is correct. We do have 2 conversions with First United, coming up in May and Hyde Park coming up in February, once we are through that, but that will help us integrate those a little bit better and reduce some cost. There is also leverage if you look in the premium finance side of the equation -- and for a little over a year and now the market every month is harden from a premium perspective, where rates are higher than they were in the prior year month. And if we can take our average ticket size and increase it 10% or 20% and we come off the all-time lows since the market started to harden. But our average ticket size is around $22,000 is, bottomed out around $20,000. But and the last hard market was up around $40,000. So we can just go up 10% or 20% and get those numbers up to $27,000 or $28,000, which is sort of the long-term average for us. We can do all of that with no additional overhead and can put on $300,000, $400,000, $500,000 -- million dollars of additional of loans. And so there is a lot of leverage built in the premium finance side, but we have to wait for that market just hardens a little bit. And then on our bank side as Ed says, we're there. Our efficiency ratio as we’ve talked before, tend to be a little bit higher in periods of large mortgage originations, because that business is a much higher efficiency ratio of business than the banking business in general. And also in our wealth management operation, we have a fairly large wealth brokerage operation relative to other companies our size, and that tends to operate at a higher efficiency ratio also. But we will continue to grow into this infrastructure and there is plenty growth opportunities as Ed said. Our plate has never been fuller with people wanting to talk to us right now.

Two things right down there, we invest money before we go into something. In our SBA program, we’ve got 16 people in our SBA department right now, but we just put into place, 13 months ago, 14 months ago. They’ve moved up to be I think one or 2 in the state in terms of their production in SBA, will make an higher push there. But that’s the type of leverage these investments that we’ve made. Investments that we’ve made in downtown office where we’ve got 50 plus commercial officers and all the support people, they are operating at about 50% capacity right now as they build this portfolio. So there is a lot of -- that’s what I mean about capacity. We’ve made investments on the earning asset side and growing the business, where we have a lot of capacity, but we can grow without commensurate increases in expense and we’ll have some expense cuts coming from the -- let me convert and do those other things that we can use also. So it is driven home to every CEO, pretty much every time they talk about which is, you can understand how pleasant they find that, so…

All right. That’s the pudding in the plumbing quote I believe building for future growth, I understand. Just a statement, that’s kind of the holy grill and that’s the one thing that I know that you know frustrates investors is the expense base so I'm happy to hear that, because people want to see those returns come up. Then I guess that brings the second question is just on the credit cost, couple of quarters ago, you talked about a light at the end of the tunnel and you said you hope it’s not a train, it doesn’t seem like that’s the case. Are you seeing anything out there on credit that upsets you or do you think that this is finally the time where the credit costs are going to start to come down?

Well we would hope for the latter, Jon, and that’s what we think is going to happen. We’ve been very aggressive and we’ve not kicked the can down the road in anyway shape or form. You haven’t -- not that there’s anything wrong with this, but you haven’t seen us have to resort to a loan sale where we have to sell a bunch of loans at 50% of cost. We haven’t had to do that. We’ve dealt with our issues, we’ve identified them quickly, we’ve kicked them out. We haven’t played any games, not saying anybody else is, all I’m saying is that we take them one at a time, we identify and we push them out. At this point in time, I mean our non-performers are 1% and you could see if you could take a barometer, you would say, boy, you released a lot of reserves, which means a lot of that stuff was pushed out. So we are very hopeful that we think that there is $40 million pre-tax built in when we return to our normalized levels of charge-offs and credit cost. So the sooner we get there, the better, I think you have seen good progress was year over year over year and hopefully this would be a very, very good year in that regard. We don’t see anything -- but I think you never know. You never know what’s going to pop-up. And I don’t like to say it, because then people try to manage to it. And I don’t want people to manage to it, I want to create. But you’ve got a problem, bring it up, let’s get it out of here. We put a number out there, I'll find people trying to work around it, manage to it, and then we are going to have, we might have problems down the road, that’s a management style that has people kicking the can down the road, and that’s not what we do. We feel pretty good about where it’s going. We think we are in pretty good shape in that regard, but that’s an upside for us and we feel good about that upside. That’s what all I can say.

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

Dave or Ed, maybe I’ll approach the expense question a little differently. You had $489 million of kind of reported expenses this year. Given all your commentary, should we be thinking down expenses in 2013? I know the mortgage is variable, or should we think of the rate of growth being kind of low single-digit in this year?

Well, my crystal ball on mortgage rates is not clear. Clearly, we think it’s going to be strong in the first quarter and probably into the second quarter as the home buying season heats up. Beyond that, my crystal ball is not clear. I think we would think that it would ease off towards end of the year, and it that happen, certainly commissions and the variable pay go down there. And so, barring any other acquisitions, then I think you would think that you could, you keep the expense growth certainly into the single-digits, because you would lose some of that expenses, and as Ed said, we’re trying to maintain on same-store sales, 1% growth rate. And we do have a couple -- we have acquisitions in 2012 that occurred that will have a full year of 2013 and so you have to build those in. But yes, I would think that if you look at it that way, you could keep it certainly in the single-digits.

Okay, maybe on the growth perspective, in terms of the quarter, I would say, generally speaking, the commercial loan growth in the Midwest has been, I think, a surprise to most of us on the positive. Ed, can you comment on where the growth is coming from? Obviously, the economy is not growing, but can you maybe talk about sources of growth, whether it would be larger banks or peers?

The majority is coming from larger banks. I would say. In the middle, especially in the commercial middle market area, they dominate that and we’ve been able to pick up a lot from you name it probably. And I would say in proportion to their market share in Chicago is where they’re coming from. Smaller banks really don’t have a lot, you can take right now, so the commercial side that’s where it’s coming from. In Chicago, our market area is what, one of the biggest economies in the world when you think about it. And there is a ton of business out there and we think we’re just scraping the tip of the iceberg right now. And we’ve had, we brought in over a 1,100 new middle market commercial relationships in the 2.5 years that we’ve been at this. And over the next 3 or 4 years, that number could triple for us. And it’s just one at a time, our approach is different. We don’t just scatter things to the wind. Our guys downtown will every year, and they update it every quarter, will take a census of the middle market companies in our market area, and we’ll decide which ones we’re going to go after and then we are absolutely relentless until we get them. And so if you look at those numbers we think going forward, we will have good, continue to have good success in that regard. The rest of the business itself --with premium finance, we continue to grow on the property and casualty side, I think the number of units again was up almost double-digit, which it has been for the past 3 years. We’re finally seeing some increase in, as Dave said, in the average ticket sizes, which we think will continue…

Great. Last one, on the mortgage, obviously QM came out late in the year. Can you talk about what any impact that may have on your business with the IO issue?

You broke up there a little bit, the qualified mortgage issue?

Yes, and the interest-only, the amount of interest-only loans that either originated, or that are on your books and whether it could impact kind of your business in the mortgage going forward?

We don’t do much in the way of interest-only at all. I mean you may do a few of those in the banks for a well-known customer that has unique business model, where he doesn’t fit into the nice square box that’s out there, but it’s not a big part of our business at all.

Our next question comes from the line of Stephen Geyen with Stifel Nicolaus.

Just curious about the, Ed, you mentioned the pricing in that you’ll step out of the markets, are those markets that where pricing is I guess outside of your range or outside the comfort zone? And maybe if you could talk a little bit about where if you’re seeing of that and where it’s a little more prevalent versus others and where the pricing is still more favorable?

In our market area, you’re talking about or just in general by class?

By class.

Yes. Probably there is pricing, it’s most competitive for the larger middle market companies that have a lot of cash balance, wealth management, and treasury management services, those guys are golden and people really compete for those deals. If you’re out doing smaller commercial real estate deals or smaller business loans, those deals are still holding up fairly well. But the $10 million, $15 million, $20 million middle market, commercial loan where people are very, very competitive on those loans right now.

Can you give us a sense of pricing, what the pricing looks like now, or the spread now versus where they were maybe 12 months ago?

It depends on the deal. 12 months ago, I don’t think they moved. I mean there is some deals if they get hot; the spreads are going down to 1.75, maybe 1.5 or lower on really hot deals. But there are some institutions in town that are trying to buy some business and will do that. But we’ve been able to keep our spreads pretty good. Relatively speaking, and again our profitability model is pretty simple and it falls outside the profitability model, we won’t do the deal, there’s got to be the future business. Well, we’ll get all this future business. We got to look at that pretty hard. But I would say that they really have not moved that much in the last 12 months. That would might be my guess. Just 12 months like this.

Sure. Next question, you gave some nice information on the pipeline and just thoughts on the outlook over the next 3 to 6 months or so, on loan growth. In the press release, you talked about a lot of the growth coming near the end of the quarter, and maybe if you could provide just a little bit more color on that, do you think it’s related to the election or some other factors and kind of any thoughts on how it's progressed heading into the first quarter?

Well, there’s still some pent-up demand from the first quarter that rolled over, although I think lot it did depend on the election. The last 2 weeks of the year, we were very busy in closing loans. And some of that did spill over into the first part of the year. As to why, a lot of it was the -- I think it was the election. I think some it was the fiscal cliff, it’s the $10 million gift thing was an issue for some folks. I mean a lot of people and lot of attorneys were busy on that, lot of people were very busy on that. So things just kind of get pushed off towards till the end of the quarter for whatever reason. Usually, the last 2 weeks of the quarter kind of slowdown a bit, but it was frantic around here getting deals pushed through and get deals done, but it did carryover. And first quarter, I am glad to have the carryover, because in the first quarter we should have some good momentum build up, but then it slows down just a little bit, February is a throwaway month, as people are waiting to get calendar year-end guys with their audits are done or their financials come in, and you wait for that to do approvals and get things done. So -- and then it picks back up March, April and May and picks up very hard. But I think you can anticipate the same sort of growth that we’ve had on those line items this quarter or this in 2013 as we had in 2012. So the pipelines really have not deviated much quarter-to-quarter and our pull through rates are still basically dropped a little bit, but not enough to be concerning.

Okay. And last question, really just a question about the margin, just curious where the pressure might come from, if it’s going to be both on the loan side and security side? I guess the liquidity management assets were down about, the yield was down about 8 basis points quarter to quarter. And I guess you have a portion or I look at it is a portion that are very short-term in order to fund near-term loan growth and then a piece maybe longer term, companies, and then just kind of curious about that longer-term piece. As those reprice, is there still likely some pressure on that piece that’s a little bit longer-term?

I think that the decrease in the liquidity management assets is mostly a mix issue. We just had a lot more that was short. We didn’t put more into a longer-term bucket. So I think it was a mix issue that drove that number down a little bit. That’s where you see the overall liquidity effect on the margin. We’re not excited about putting things out long-term. Our long-term thought is that rates are going to go up and I don’t want to be in a position to have all sorts of offsets against my capital because I went long with $500 million, $600 million. It could help me today, when the long-term is going to turnaround and whack my capital pretty hard and I don’t want to be there, all right. I think we played this for the longer-term. I think the fixation on the margin just kind of makes me laugh. I fixate on making money and we always have. And so I’m fixated on net interest income, and if the margin does go down a bit, but I make a lot more net interest income and position myself forward to eventual rise in rates, I think we at Wintrust are doing the right thing by our shareholders. So I wouldn’t expect to see us to make a major investment going long right now. It’s just not going to happen and if we do build up more liquidity, we will have to cut our rates and we will try to manage our cost to funds to keep that liquidity down. But it’s a juggling game. I remember the first 2 quarters of last year, we were climbing the other side of the ladder, trying to find liquidity, so is this kind of manage everyday and going forward. But I don’t see us going long and if we end up as we are growing and we don’t have the assets we put them into, we’re going to have to temper our growth because if we just throw it in liquidity, you’re going to see liquidity asset go down even more, the rate on those and it will hurt your margin even more. So we got to keep climbing the ladder and we got to take it a rung at a time.

I think I would add to that, Stephen, as you asked about the pressure on. As you know, as we’ve talked about in our remarks, we do this covered call program where we add to the yield on the securities. And 3 months ended December 31, our liquidity management assets interest is $9.8 million. And we also had a little over $2 million of call option income that we sort of look at those 2 together. But because we run that program, a lot of our longer-term agencies have been called away and we’ve reinvest in a lower rates and so that’s one of the reasons you see that our short-term investment portfolio, our investment portfolio in total, is a little less than our peers is because we’ve had that pressure down on it, because with security has already been called away. So most of our longer-term agencies are near today’s rates because they’ve recently been called away, but you have to remember the offset to that as we’ve been making $2 million of quarter, roughly on covered call income, which is supplemented the return on that portfolio.

Our next question comes from the line of Brad Milsaps with Sandler O’Neill.

I just want to follow-up on the net interest income comments. I know you mentioned, you thought net interest income could flourish this year, despite margin compression. You’re up about -- I guess about 13% in 2012 and your loans are up about a $1.3 billion. I know there is some acquisitions in there. So gets a little muddled, but you thought you could grow about $900 million to $1.2 billion in 2013. How we’d be entering the year with a lower margin in 2013 versus 2012, your margin in 2012 was about 7 basis points. Do you feel like you need to grow even faster than that $1 billion or $1.2 billion to even maintain the NII or is it also going to be a function of getting some deals there as well, and that’s a bunch of questions in one, but just kind of trying to square some of this comments up?

Well, no, I think NII will go up. I mean we grow a $1 billion, our net interest income, it obviously going to go up, the margin maybe down a bit, but the quarrel of it is, we’ll continue to increase our interest rate sensitivity position to make sure that the rates go up, we get that beach fall underwater effect. The actual growth is going to depend on our ability to put it out into earning assets. If for some reason the market moved away from us, let’s say rates and terms really got goofy -- and we go back to 2005 and 2006 and 2007, our circuit breakers will kick in and our loan production will stop. I mean you know us well enough to know that we are pretty disciplined on that and we’re not going to move. If that’s the case, our growth could slow down a bit as it did when we went in the local lot before in 2006, 2007 and 2008, but we don’t see that happening right now. We actually believe that if we can grow organically at that $1.2 billion -- and let’s say if you put it out through this spread of 3% obviously your net interest income is going to go up, right? And if you can do less than 100 basis points in marginal expenses that go along with that and that will be pretty accretive to our metrics in terms of ROA and to our bottom line? And then if you prepare the balance sheet at the same time for raising rates on that bigger base, you’ll be better off when rates go up and I think they got to go up at some point in time, as a student of history as I said, when they go up, they’re going to go up pretty big I think. So 4% of raising rates, you can calculate the numbers based on what we give you give you, what that would do to our margin. So it’s a long-term play. That’s our play for this year. But we think that you can run the numbers and 3.25 spread on 1.2 billion growth, average it out, less than a 100 basis points in marginal expenses. That should be pretty good for us.

Our next question comes from the line of Peyton Green with Sterne Agee.

I guess my comment is, maybe it’s not what you decide to do with the portfolio that really matters in terms of the duration. But why have $850 million or so of it in a negative spread? I mean I guess in looking at the Federal Home Loan Bank advances and the notes payable and other borrowings, you’ve effectively got $815 million at 217 average cost against liquidity management assets at an average benefit of 133, and the simplest thing would be to get rid of that. That relationship has been true for 3 or 4 years now, just why not operate with a smaller, more profitable balance sheet?

We did some of that in this quarter by getting rid of the repo transactions. Part of the way you manage the balance sheet though, you’ve got to prepare yourself for any eventuality, and we have positioned our balance sheet for a rise in interest rates, and…

But it’s been that way for 3 or 4 years now. I mean why not work it through -- I mean if the loans are a good portion variable, I mean why not extend it? Why not use more derivatives instead of upside down bond trades or borrowings against the liquidity management asset portfolio? I mean I guess I just don’t understand why have that much of your balance sheet or equity losing money on a quarter-to-quarter basis year in year out?

All right, let’s go back. Year-in year-out, Peyton, in the first 2 quarters of last year, we were struggling to find liquidity our loan demand was strong. If we had done that, the opposite, if we had embarked on shrinking that we would have been really upside down on liquidity and growth. So just because we have little excess liquidity this time, because we put a bank out, we got to save $170 million to divest of Second Federal. Next quarter, if insurance rates harden, it turns the other way and then I got a liquidity issue. So you have to look at it -- and I understand what you’re saying, it looks like, "Boy, you can shrink the bank, you could blow those things out, take your loss on it, and then have no liquidity." Well, then I’m back in the same ball game, and I’ve got to go long anyhow to keep my interest rate sensitivity where it is. You bring up a good point. We discuss it a lot. But it fluctuates every quarter. I mean literally, we were scrambling at the end of the first 2 quarters of last year to get liquidity on our balance sheet. You can look at broker funds have popped up and so I see what you are saying, and we have done some of that this year and last year we’ll continue to look at that, but we’re managing the overall balance sheet, the overall interest rate sensitivity position and we’ll keep looking at it. But I appreciate your thoughts.

In terms of…?

And I know you’re consistent, at least you're consistent, Peyton.

Well I know, but I guess my question is this. I mean if you have $3 billion in liquidity management assets really under-earning, I mean let’s just take it as 20% of earning assets. I mean what does that number really have to be to be liquidity management, I guess is my question?

It’s around 20%. Depending on what the rest of the balance sheet looks like, but the regulators -- the regulators and us. We still think liquidity is important, who knows what’s going to happen. We’ve always run at 85% to 90% loan to deposit when other guys are at 110%, 120%, we actually -- we have to keep that liquidity and the regulators are looking at liquidity with the hard look. And that’s about the number we have to keep, Peyton. And it’s in fact our loan-to-deposit ratio were to fall to 70% and we were sitting on all of that, your argument has a lot more merit and it’s something we will consider, but now it’s managing the overall balance sheet, and I know it looks simple on the top, but we’ll continue looking at it and there is a cost of that to. I mean you may have a $20 million to $30 million loss to get out of the federal home loan bank and then if you do change your interest rate risk sensitivity in that regard, and nobody’s crystal ball is perfect there. You sell those things and take a $20 million and $30 million pre-tax loss and interest rates could change the next day and people would say that was pretty very stupid that you sold those. So we try to manage it in a holistic approach. We understand it, we look at it, we talk about it a lot. $400 million of federal home loan banks say, some of those will be maturing. We are letting other wholesale funds run-off. We did, as you saw, eliminate the long-term repos to this quarter. And so we do try to balance all this stuff out running the balance sheet from a holistic risk perspective, including forward-looking interest rate risk and liquidity risk.

It’s just a big bond swap when you look at it. We look that -- we look at those numbers every quarter and how they relate to GAAP and we run the bond swap numbers on exactly what you are talking about, how it relates to GAAP, how it relates to liquidity, and it’s something we do look at, Peyton, and we will continue to do so.

I guess the last only 2 other comments that I’d make is, I mean if earning assets are up roughly $1.2 billion year-over-year in the fourth quarter, liquidity management assets are actually down $100 million. So I mean you actually did leverage the liquidity a bit. I mean if you grow loans $1 billion, do you have to add to the liquidity management assets to keep your liquidity profile going forward? I guess that’s question one, and then how sticky do you think your non-interest bearing deposits are, because they grew about over 500 million over the prior year at about $2.3 billion, which is materially different than how you used to exist.

Oh, yes. Well, we think they’re very sticky, as a matter of fact, some of them is still filling out. Certainly, some of that stuff will go to work and that will lead to additional lending, so it’s kind of a win-win. When we put the cash to work, then the line usage is going to go up too. Then we would all be happy if that occurred. But the rate of growth that we have, it takes a good 4, 5 months to fill out the balances of our new clients as they come in. So we believe it’s very sticky, they are tied into treasury management, and we expect that number to continue to grow. I think it would be nice that, it’s grown consistently every quarter since we started this commercial initiative and we anticipate good success this year in the commercial initiative and continued increases. We would love to get that number to 19%, 20%, and when rates go up, that’s terrific for us. The first question, if we do grow or if we grow more than that and loans are higher. Yes, then we got to go back and look for liquidity. We have liquidity in our policies in the regulatory guidance, the regulators and everything is numeric these days. So they have their number as they relates to liquidity. We managed to our own thoughts of liquidity and to their numbers. So if your loan to deposit ratio were to go to 95%, you’re going to have to go out and get more deposits or find more liquidity. We keep a lot of capacity for broker funds. We don’t have a lot for a banker size. We only use them really for asset liability management purposes, up until the first 2 quarters last year we had to using for liquidity purposes. But we keep a lot of sources available for liquidity. So we can manage it on a quarter-by-quarter basis. But certainly if loan-to-deposit ratio went up, you’re going to have to sign more liquidity to keep everybody happy.

I guess -- and so we keep the liquidity management assets at let’s just say around 20% or can you push it down to 17% or 16% of the earning asset base going forward?

I think that 20% number is probably within 2 percentage points, one way and other. Depending on what’s going on, I think it’s probably I think 20% middle of the road. We’ve always said you can look at the balance sheet. We’re pretty plain vanilla Bank, 85% to 90% loan to deposit. We might go a little bit about that. But that’s how we’ve run the company since the beginning.

Okay, so it’s still a pretty good assumption. Okay, great.

Our next question comes from the line of Herman Chan with Wells Fargo Securities.

Wanted to ask a question on reserves, 91 bps of total loans to reserve ratio is pretty close to pre-crisis level, of let’s say 70, 80 basis points. Should we expect the reserve coverage to drift toward or even below pre-crisis levels, considering Wintrust now has a different loan composition with less commercial real estate, but more commercial and premium finance?

Well, the calculation is so mechanical these days. But if you go back to Page 28 of the press release, it’s all a function of almost what really very close to what they are proposing right now, the FASB is one of the methods the FASB had but now that they’re talking about more, which is not a loss given the thought, but historical losses. And if you look at our Page 28, where we break out the reserves by category, you can see that 131 basis points is basically the core portfolio and 29 basis points of niche portfolio. Take those numbers and go back a couple of pages and apply it to our historical loss ratios and you’ll see that they make a lot of sense. So to the extent that credit gets better and losses go down, it will take some time, but those historical losses will work their way through the system and we go back to our normal loss ratios on commercial, commercial real estate and the like, you will get back down to those numbers, it’s just the very mechanical calculation that we have to go through to get there, and it’s a bunch of historical charge-offs, apply that to the balances in that account, add your specific reserves and there you got it. So if losses get better, I would imagine that the reserve will go along with that.

Got it. And a question specifically on comp expense. After a pickup in comp in Q3, it was pretty flattish in Q4. Based on your comments on operating leverage, do we expect that $75 million, $76 million level as a base heading into the 2013, even assuming continued balance sheet growth?

Well, it’s a good question, but a lot of that comp is relates to the mortgage market being as hot as it is, basically, you’re paying out commissions of 40% to 50% on your volumes there. So that comp expense number, you have to take out the variable compensation as it relates to mortgages and the brokerage side of wealth management, because obviously that’s variable. But once you do that from an operating run rate, in the first quarter you get raises that come through when we average 2% to 2.5%. But you’re going to have those conversions are going to take place in the first quarter and the divestiture Second Federal, in February, which will alleviate costs from us. So I guess it’s a good enough start base, but you have really got to go backwards and all depends on what the variable comp.

It really does. We’ve got Hyde Park which will go on for a full quarter, but we have Second Fed coming off and the like. But mortgages will probably be less to share and we say that every year and we’ll see where rates go, but at the mortgage did come off, the variable comp will come down a little bit. But it’s a pretty decent range to hang in. We’re really trying to hold the line on sellers and grow on to the leverage. So depending on what we do from an acquisition perspective would be the only reason you’d see significant change from that.

Got it.

Other than the mortgages.

Okay, got it. And I did notice a pullback in Canadian commercial premium finance loans in the quarter. Can you point to anything specifically in terms of performance there?

No, well I think they’re doing fine. Their bigger months are in the middle part of the year and some of those payoffs, that the levels have trended down a little bit, but it’s not for lack of anything structurally happening there, it’s just when their larger months are, and so it’s a little bit of seasonality from that perspective.

Our next question comes from the line of John Moran with Macquarie Capital.

This is Mike Ka [ph] from John’s team, just got a quick question on mortgage banking. How quickly do you think you can ramp down sort of the mortgage banking variable cost in terms of -- as volumes sort of come down in the latter half of 2013?

Excellent question, the $64,000 I keep pounding our mortgage company with. The ability to accordion our expenses with volume has been, in our planning, has been at the top of the list, approximately 23% to 24% of our operating costs are outsourced right now. So we’ve got specific parameters where to keep our level of quality up, where how much we can throughput our own system. When we go over that, we go, we outsource it, so 23% of that business is outsourced. So that drops off right away once that volume drops off. If you consider that around 40% of our volume is on average is purchases. So -- and purchases should stay relatively constant with some seasonality to it, as this market picks up. So 60% of that is refi, if half of that business goes away that’s 30%, I get 23% I can drop off at that point in time, of course, we have plans to bring it down. So we are on this, we drill it, we test it, and it is certainly a major factor. And we got caught in this 1.5 years ago and it took us 3 months to get our ducks in line, so we gave back about a month’s worth of earnings, because we weren’t able to accordion fast enough. So we have the SWAT team on this that we will make sure that we can keep expenses in line with volumes going forward.

Okay. And just one more question. Can you just give us a sense of how much your OREO expense is related to sort of revaluation of properties and how much is carrying cost?

The majority of it was revaluation, carrying cost was maybe $1.5 million to $2 million or so.

Our final question is the follow-up from Peyton Green with Sterne, Agee.

On the expense side, I mean in thinking about the hypothetical that you gave, if you grew $1 billion you’d hope to keep the expenses to 1%. That would imply 2% growth in expenses year-over-year all else equal, which I know not all else is going to be equal. But historically, that’s not been really something the Street has seen you all do. I mean maybe you can talk a little bit just about, I mean are you going to limit yourself from taking advantage of opportunities going forward, and harvest the investments you’ve made over the past couple of years as you reentered the more stable and slightly growing economy? Or I guess just give a little bit of color on that.

Sure, well we qualified that statement by saying with same-store sales. In other words, if we get an opportunity to acquire a branch or acquire a bank, that certainly will add to our expense numbers. So what we’re saying is the current operations that we have right now, less than 1%. And we certainly have an opportunity comes up, we’re not going to be shy about taking advantage of that if it’s going to be accretive to us. But we have so much leverage built up, like in the SBA world and the commercial world, and a number of branches that we have that we can grow out of without doing that up, without adding expenses. We feel good about our ability to make that happen on a sort of same-store sales, same-store approach if you will. It certainly will not limit us from taking advantage of opportunities. We are serial builders, as you know, and we will continue to build the organization and not be afraid to put the plumbing in if we see an opportunity to go forward. But that’s the plan that relates to marginal business going forward, anything above that, if we were to buy something that would have hopefully be accretive right out of box to us, so an earning asset generator or another bank, that they would actually add to the bottom line. We don’t like doing unaccretive deals. We never have, we just don’t like that, so I had to qualify it that way.

No, I guess I was just I mean, because the 2 messages are slightly different. I mean, they’re both positive to operating leverage, but on the same-store sales it’s half the expense growth as the hypothetical, we grow $1 billion, I guess…

No.

I think I’m hearing you. I understand it better now.

Okay. Well, we need to end this conference call, because if I keep talking, the stock keeps going down. I think that we are not going to record earnings anymore if stock goes down, but I’m just kidding guys. Thank you very much for listening in and we’ll talk to you all later. Thank you.

Ladies and gentlemen, this does conclude your conference. You all may disconnect and have a good day.