Wintrust Financial Corporation (WTFC) Q4 2016 Earnings Report, Transcript and Summary

Welcome to Wintrust Financial Corporation's 2016 Fourth Quarter and Year-to-date Earnings Conference Call. At this time all participants are in listen-only mode. [Operator Instructions] Following a review of the results by Edward Wehmer, Chief Executive Officer and President; and David Dykstra, Senior Executive Vice President and Chief Operating Officer, there will be a formal question-and-answer session. During the course of today's call, Wintrust’s 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 fourth quarter and year-to-date 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 will now turn the conference call over to Mr. Edward Wehmer.

Thank you and good afternoon everybody. Happy New Year and welcome to our fourth quarter earnings call. With me as always is David Dykstra, our Chief Operating Officer, Kate Boege, our General Counsel and Dave Stoehr, our Chief Financial Officer. Our call will follow the usual format. I will kick it off with some general comments about the fourth quarter and full year results. Dave Dykstra will then provide more detailed analysis of other income and other expense categories for the quarter, then back to me for some summary comments on thoughts regarding the future and then as we had mentioned, time for questions. In December, Wintrust celebrated a milestone. December 27th marked the 25th anniversary of the opening of our first bank, Lake Forest Bank & Trust. I remember that day like it was yesterday. 11 people and 1,100 square foot store front, hoping and praying that when we opened the doors at 7 o'clock there might be a customer or two who would wander in. Surprisingly to me, there was a line of people at the door when we opened and since then we really haven't looked back. We had no delusions of the grandeur on that day, just an idea to bring back old time community banking to our community. Little did we know that 25 years later we would be a $25 billion plus asset bank with an almost equal amount in wealth management assets. We would be the second biggest commercial bank headquartered in Illinois, making over $200 million in net income. In fact, I just wanted to get the $100 million in assets and that was going to be a challenge. So it's been heck of a run and we are still not looking back as we think the future remains extremely promising for our organization. Thanks for affording me the opportunity to take a little stroll down the memory lane and down to our results. Our earnings for the quarter totaled $54.6 million or $0.94 a share, up 54% and 47% respectively. And income for the year totaled almost $207 million or $3.66 a share, up 32% and 25% respectively. For the quarter net interest income was up $6.1 million versus the third quarter due mostly to the asset growth as the margin stayed relatively constant, really constant at 3.21%. Loan yields were up 5 basis points and paying liability cost remained constant at 50 basis points. Liquidity management yields were above 33 basis points as we deliberately shortened up our portfolio duration in the second half of the year. First half it was 5.5 year duration that was on all liquidity management, second half we were down to 3.75 years in total duration as we thought rates were just too low to expand at that point in time. As the rate environment increases, hopefully, during the course of this year, we intend to ladder back into our long-term securities to achieve a duration more consistent with our past history. We maintain we are well positioned for higher rates in the first quarter of 2017 to benefit from the late quarter rate increase that we saw in December. Our net overhead ratio for the quarter was up 4 basis points to 1.48%, again below our target of 1.5%, and totaled 1.47% for the year. As I mentioned, Dave will go into detail on other income and other expenses, but I will note that expenses were a bit elevated in the fourth quarter due to multiple 25th anniversary celebrations and lots of entertainment related to our Chicago Cubs winning the world series. So any of you guys who work with work with your models you might want to note year 2041, which will be our 50th anniversary, we plan to party pretty at that point in time and may be by then the Cubs will win again and that would be quite a good trend because if took 108 years to win it the last time, so maybe 50 years that would be a 50% improvement. Extraordinary items, as we view them, basically washed in the quarter. $1.2 million MSR was offset by $1 million in acquisition related costs and a little over $700,000 loss on the early extinguishment of $262 million in Federal Home Loan Bank advances. That ladder should provide some income for us going forward in 2017. Mortgage and wealth management revenue remained constant quarter versus quarter. Our provision was down $2 million versus quarter three. Coincidentally, covered calls were down about the same amount, basically [indiscernible]. But the provision was down due to the fact that net charge-offs for the fourth quarter were down $3 million to only $2.7 million or 6 basis points. Non-performing loans remained constant at 44 basis points and our reserve coverage ratio to NPLs is 140%. OREO balances did increase $5 million during the period but contributing to this increase was a $7.2 million addition from acquisition of First Community which we completed in the fourth quarter and a transfer of $4.2 million from our covered loan portfolio as the loss share expired on one of our FDIC assisted deals. I think it's fair to say that credit was much better. That being said, we will always be carefully culling the portfolio for potential problem loans in order to rectify or clear them before they become real problem loans. Our effective tax rates were relatively the same as we pretty much pay the maximum statutory rate, we are on pins and needles anxiously, awaiting the new administration's tax plan. Reductions of rate could have a material effect on us going forward. From the balance sheet standpoint, total assets grew $347 million for the quarter and $2.76 billion for the year, increases of 5.5% and 12% respectively to the total of $25.7 billion at year-end. As mentioned, we retired $276 million of Federal Home Loan term advances and then added $185 million of assets in the First Community acquisition in the quarter both of which affected our year-end growth levels, asset levels. Total loans, excluding loans held for sale and covered loans were $602 million for the quarter and approximately $2.6 billion for the year. That’s 13% and 15% respectively and we ended the year at $19.7 billion of loans. Quarter loan growth included $79 million from the First Community acquisition. We experienced good growth in all of our major loan categories. Our loan pipelines remain consistently strong and we are experiencing consistent pull-through from these pipelines. Undrawn commitments remain relatively the same across the board and they were pretty much relatively the same all year. I would add that the franchise portfolio we acquired in the third quarter is performing as anticipated and the portfolio actually has experienced some reasonable growth, $97 million in the quarter and we are up to $863 million on a little over [$1 billion] [ph] of commitments in that area. So good growth there in a new diversified asset class for us. And the overall portfolio of course remained well diversified as you would expect from us. Deposits grew $511 million for the quarter and $3 billion for the year, 10% and 16% respectively, to a year-end balance of $21.7 billion. And demand deposits make up 27% of the total deposits and that’s consistent with prior periods. In summary, a good growth year, good earnings year for Wintrust. Now I will turn it over to Dave for a detailed look at other income and other expenses.

Thanks, Ed. As I normally do, I will just briefly touch on the non-interest income and non-interest expense sections. In the non-interest income section, our wealth management revenue totaled $19.5 million for the fourth quarter, which was up from $19.3 million recorded in the prior quarter and was also up from the $18.6 million recorded in the year ago quarter. The trust and asset management component of this revenue category increased to $13.1 million from $12.6 million in the prior quarter, whereas the brokerage revenue component declined slightly to approximately $6.4 million in the fourth quarter compared to $6.75 million in the third quarter of 2016. Overall, the fourth quarter of 2016 represented the highest wealth management fee level in our company's history. Mortgage banking revenue increased $777,000 or 2%, that’s $35.5 million in the fourth quarter of 2016, from $34.7 million recorded in the prior quarter and was 52% higher than the $23.3 million recorded in the fourth quarter of last year. The increase in this category's revenue from the third quarter was partially impacted by a $1.2 million positive fair value adjustment related to our mortgage servicing rights, resulting primarily from lower projected prepayment speeds compared to a $2.5 billion negative fair value adjustment in the prior quarter. The company originated and sold approximately $1.2 billion of mortgage loans in the fourth quarter compared to $1.3 billion in the third quarter and $809 million of mortgage loans originated in the fourth quarter of last year. Also the mix of the loan volume related to purchased home activity was approximately 52% in the fourth quarter compared to 57% in the prior quarter. Given the recent rise in interest rates from the typical seasonal slowdown in mortgage production in the first quarters, we expect to see originations decline in the first quarter of 2017. However, we continue to look for opportunities to further enhance the mortgage banking business, both organically and through acquisitions. Fees from covered calls were $1.5 million in the fourth quarter of 2016 compared to $3.6 million in both the previous quarter and the fourth quarter of last year. Revenues from selling covered call options tend to decline in periods of rising rates, however we expect improvement in net interest income to offset such declines as this activity is designed to provide a hedge to the margin pressures caused during periods of low interest rates. The revenue in the fourth quarter of 2016 for operating leases totaled $5.2 million compared to $4.5 million of the prior quarter, increasing 16% during the quarter. The increase in this revenue item compared to the prior quarter is primarily related to an increase in the outstanding balances of operating leases to $129.4 million at the end of year. These amounts relate to operating leases only as capital leases are carried in the loans section of our balance sheet. Other non-interest income totaled $13 million in the fourth quarter, down from $13.6 million in the prior quarter of this year. The primary reason for the decrease in this category of revenue is related to $717,000 loss in the extinguishment of debt as a result of the prepayment of the $262 million of Federal Home Loan Bank advances that Ed referenced. Turning to the non-interest expense categories. Total non-interest expenses were $180.4 million in the fourth quarter of 2016, increasing approximately $30.8 million compared to $176.6 million recorded in the prior quarter. I will now talk about the most significant changes in more detail as well as comments on a few other notable fluctuations from the third quarter. Salaries and employee benefit expense increased approximately 1% or $1 million in the fourth quarter compared to the third quarter of 2016. The increase was comprised primarily of $329,000 of acquisition related severance charges, $492,000 of charges related to pension obligations related to plans inherited through prior acquisitions and an increase in commissions and incentive compensation expense from the prior quarter related to both long-term and short term incentive plans due to increased net earnings. As I discussed in regard to the operating leases in the non-interest income section, the company experienced a corresponding increase in depreciation expense related to operating leases due to the growth in that portfolio. Again, we would expect this category of expense to grow at a similar rate to the revenue side as the portfolio of operating leases continues to expand. Occupancy expenses increased by $1.5 million during the quarter compared to the third quarter due primarily to increased rent expensed on leased property, higher maintenance and repair costs including snow removal charges in December, as well as slightly higher real estate tax accruals. Our data processing expense increased by $255,000 in the fourth quarter compared to the prior quarter. The increase was principally due to $155,000 of acquisition related conversion charges with the remainder of the increase due to general growth of our loans and deposits. Our marketing expense declined by $674,000 from the third quarter to $6.7 million, as we have discussed on previous calls, this category of expense tends to be higher in the second and the third quarters of the fiscal years as our marketing spend on our corporate sponsorship costs, particularly the Cubs and the White Sox are higher in those quarters. Now FDIC insurance expense increased by $1 million in the fourth quarter of 2016 to $4.7 million. The increase is a result of changes to the FDIC, assessment rate and the methodology of that assessment. If you combine all the other categories of non-interest expense other than the ones just discussed, they were essentially flat on an aggregate basis and were up only $17,000 in the fourth quarter compared to the third quarter. In summary, the fourth quarter represented the fourth consecutive quarter of the company's net overhead ratio being below our net overhead total of 1.54%. We will continue to work hard to effectively leverage our expense base and we will keep you posted on our efforts. So with that, I will throw it back over to Ed.

Thanks, Dave. I just got a note from one of our investors that, kind of like on TV we are up against one of the great other CEOs in the country, our pal John Allison down at Home BancShares. So thank you for listening to us and not Johnny. I appreciate your loyalty. In summary, I would like to just, 2016 was a really solid year for Wintrust. I had the opportunity before the holidays to meet with a potential investor in Wintrust. This fellow had definitely done its homework and he mentioned that he had read our transcript from the fourth quarter 2015 earnings call. He made me happy when he warmed the cockles of my heart when he said, well, it appears the company has done everything you said you were going to do and then some. You have grown, you have become more efficient as evidenced by your sub 1.5% overhead ratio. You have added asset classes, you have kept credit quality pristine. You have acquired banks and you look like you will make your $200 million a robust number. I love it when a plan comes together but you credit all those to the hardworking staff, to the directors of our organization, to the team effort, and the team came through again. So I am very proud of that and thank all of our team for making this a really good record year for us and as we continue on our journey to be Chicago's bank and Milwaukee's bank. But I got to tell you, every New Year's eve at midnight, the back of my mind I hear that rock rolling down the hill and know that like Sisyphus, who by the way is our corporate mascot, how many other banks have a Greek mythological guy as their corporate mascot. But I know that next morning we are going to have to start pushing that rock back up the hill. The slope is going to be steeper and the rock is going to be bigger. But in words of Hyman Roth when he talked to Michael Corleone in the Godfather, this is the business we have chosen. So this is the business we have chosen and we are going to continue to make great headway, as I mentioned earlier, in 2017. I would expect more of the same in 2017. This is a real possibility of some favoring winds in the form of regulatory relief, tax relief and hopefully higher interest rates. Each of these will have a positive effect and the latter of the two, if they do occur, may result in materially positive effects depending on the scope and the extent of the rate increases and tax decreases. We have got great momentum moving into 2017. Credit is good. Loan pipelines are consistently strong. We have room to becoming a more efficient although in that again we are not going to be afraid to make investments when those opportunities present themselves. They are logical investments and present long-term profit opportunities. Our acquisition pipelines are active in all lines of business and the Wintrust brand continues to be well received in our markets. In short, we are very excited about our prospects for 2017. That being said, we are not going to get ahead of ourselves. Our credit policy and procedures will not chase the market. We will continue to take what the market gives us and be good stewards of capital. Thanks for listening and for your interest and now we have time for questions.

[Operator Instructions] Our first question is from Jon Arfstrom with RBC Capital Markets. You may begin.

Congrats on 25 years. I will let David Long congratulate you on the Cubs, I am sure he is in the queue. But the mortgage banking line, it's obviously held up well this quarter and you are talking it down a little bit. Can you help us out, help us kind of think through the puts and takes on that in terms of how -- what the magnitude of that might be? And then also maybe touch on -- you are talking about opportunities to further enhance that line, what do you mean by that?

Jon, this is Dave. The further enhancements are -- you know when rates go up, typically the pipelines of producers do down and they are generally a little bit more willing to join us then because they are not leaving a pipeline behind. So we actively are talking to the producers in the market at all time. And likewise, we are talking to few other firms about the potentially acquiring their assets and their people and their locations. So we are actively looking on both of those fronts. As far as the production goes, I think you generally can look at what the industry is predicting. I think I am seeing some things that I have talked about 35% to 40% declines in volume on that. We don’t have a good crystal ball yet because we don’t have applications in that are really affecting the end of February and early March completely. But we do we expect refinances to fall off a little bit. There was kind of a rush at the end of the year with a lot of those people anticipating higher rates coming in. Although they have fallen off some in first quarter, it looks like it's not down to zero. Our pipeline, I think, held up a little bit better than some others because we don’t do a lot of wholesale and generally the retail market holds up a little bit better. Some of the wholesale providers have a higher cost of funds and just aren't able to be quite as competitive on the pricing and so some of that business moves through our retail section a little bit better than the wholesale and we just don’t do any wholesale. And it wasn’t a lot but our correspondent line improved a little bit and did decline during the quarter and we are just getting a little bit better traction with some of our correspondents that we do business with. And it's a small piece of it but it helped to prevent further decline. So I think the fact that we do retail assisted us a little bit more in the quarter than folks that do retail and wholesale.

Jon, this is Ed. The mortgage business is going to continue to be strategic for us and we understand the volumes grow up in that, especially seasonality in overall markets, but everybody is still going to need a mortgage and it's incumbent on us to do a couple of things in that area. One is to continue to reduce the cost of producing a mortgage. They have gone up, [traded] [ph] in the like 2.5, 3 times. We are working very hard to streamline our own rocket mortgage, if you will. Lot of shelf population in the application process. But we also think under the guise of picking what the market gives us, as rates rise a number of these firms will, independent firms who are out there, even waiting for this to happen, they are going to want to give up the ghost because the business had gotten a lot harder. But they didn’t want to give it up while the getting was good which it has been over the last year. So we think there will be opportunities for us to squeeze the costs, overhead costs out in there. Squeeze down the cost of production and add to a national platform, we think this is a good deal. Because we don’t really, if you look at our historical deals, we do buy assets. Most of them are done and almost all of them, everyone I think, has been done on an earn out basis. So you don’t put a lot of capital at risk and we do add to our platform. And again it's then just incumbent on us to knock the cost down and make sure we can accordion them with the market. I mean accordion the cost as the market moves back and forth. I think we have got good predictors to that and I think our system works pretty well. But, again, when you think about the overall balance sheet hedge, when rates go up we make more on the margin and the mortgages will drop down a little bit. So it's a nice internal hedge to have. It's why we like the business. We think everybody is always in the need of mortgage and we think the bigger we get, more cost effective we can be and the more profitable it could be for us.

Okay. Good. That helps. Just one, just on that topic. The loan yield is up a bit, 5 basis points in the quarter. Anything unique or specific there or are you just actually starting to see lift in loan yields?

Little bit of lift in loan yields, Jon, but also LIBOR has been moving on throughout the course of the fourth quarter. Even before the rate [wise] [ph] increase. So, like our life portfolio, one-twelfth of it, every month reprices. So you are just starting to see the effect of LIBOR increasing, then prime increased for the 15 days or whatever in the quarter. So it's a little bit of both there. But that’s why I said I think in the first quarter you will see more of that occur. As portfolio continues to reprice.

Thank you. Our next question is from David Long with Raymond James. You may begin.

I will follow up on Jon's comments and say congrats to us on the Cubs win, and hopefully you guys got some positive feedback from the national exposure.

Well, of course we did.

We are taking all the credit for it. I mean you can't ignore the correlation of our sponsorship and their winning.

Absolutely. Just a couple things. On the expense line, you talked a little bit about how there was some, maybe one timers or nonrecurring items in the quarter. When we are looking at the first quarter versus the fourth quarter, is there anything that you can point to that may not be recurring or is there a number you can put behind that?

Well, you know the big items in the quarter, we had the pension adjustment and the severance cost was about $800,000. We don’t expect to see a lot of volatility in that line item. A little bit [indiscernible] would be impacted from the declines in the mortgage banking business, if it declines. So you would have the commissions expense come down there. The FDIC insurance popped up because of the methodology so that probably is going to stay elevated at that level. Marketing probably will come down a little bit, as I said it's usually higher in the second and the third quarters. Fourth quarter generally would have come down a little bit more but it did do some more marketing around our 25th anniversary in association with our Cubs sponsorship, so it kept that elevated a little bit. But other than those items, as I said, most of the other categories were relatively flat. So I won't expect to see much significant change in those categories. And salary is always going to pop in the first quarter because we go through our year-end salary adjustments and I think we held those around 2%, is the number we use for raises and the likes on the aggregate basis. So we expect them to pop a little bit and other than that I think it covers it, right.

Yes. Shouldn’t be anything unusual.

Okay. And then as a follow up, looking at the net interest income number and thinking about, you talked about the benefits from a higher rate environment and maybe you hinted a little bit with the premium finance portfolio that you can get some of that each month. But how quickly can we see that net interest margin expand here and we had a 3 basis point expansion in the first quarter of last year, are you looking at something similar to that this time around?

Well, if you followed my drift, David, if we had not cut back on the duration of the portfolio, we probably would have been up three or four basis points this quarter. But how quick we will see it, I don’t know. Dave, you want to comment on that?

You know, I think it's going to be somewhat gradual. A lot of it will depend on what's happening with positive rates in the marketplace. That’s, actually the competition has been pretty rational and we really haven't seen much move there. So I would expect it would be a few basis points next quarter, all else being equal.

Thank you. Our next question comes from Kevin Reevey with D.A. Davidson. You may begin.

Congratulations on your anniversary and I hope to join you in 2040. My question is related to -- it looks like your total capital or risk-weighted assets is around, came down to about 11.9%. How comfortable do you feel with it around that level and at what point would you think about either maybe scaling back the growth and/or raising capital to get your capital--?

Sure. We expect good earnings this year obviously and of course we got to wait to see it happen. But we would also expect mortgages held for sale and the like to drop off in the first quarter between that and what we earn. We think we can be pretty much self-sufficient as growth exceeds. If we always hang around 12%, we will have a 9% to 12%, it's not that much. If you think about our normal growth pattern and what we think our earnings are going to be, we should be hanging around that number. I think we have always been good stewards of capital. We would always if we are going to need it. We don’t overload, we don’t under load, we take what we need. And if it turns out the growth is more extensive then we anticipate for any number of our pipeline, acquisition pipeline opportunities come along, we would not be afraid to avail ourselves of the market at that point in time. But on a status quo basis, we are kind of comfortable where we are right now. Sure enough, David.

Yes. I think so. I mean if you think about the earnings of $50 million plus a quarter that supports a fair amount of growth, so it's really just going to depend where the growth is at and where the acquisitions are, as Ed said. And on top of the mortgages held for sale probably our mortgage warehouse lines will come down a little bit because our borrowers are probably going to see a similar decrease. So that gives us a little bit of capacity on other loan sides to increase without dramatically impacting the capital ratio. So we will monitor. We will see how growth and acquisitions go and that will tell us whether we need capital.

And then as far as, can you refresh my memory as far as the percent of your loan book that is variable rate versus fixed rate and how much is tied to prime versus LIBOR?

Yes. I don’t have that report in front of me right now. I am going to get it from Mr. Stoehr here. We gave those percentages in the last quarter. I don’t have it here with me, Kevin. We gave those percentages last quarter on the call and they haven't changed dramatically since that time. The two things that I would mention there that if you look at the premium finance portfolio, they are fixed rate loans but on property and casualty side of the equation those are on average 9 to 10 months full payout loans where they pay down every month. So about one-ninth or one-tenth of that portfolio was repriced in every month. And on the life side, they are generally repricing once a year. So theoretically, if you put them on throughout the year, ratably about one-twelfth of that’s repricing. So that’s a big chunk of what we would be deemed fixed rate on our portfolio but they are awfully quick repricing scenarios.

Thank you. Our next question comes from Brad Milsaps with Sandler O'Neill. You may begin.

Ed or Dave, I appreciate the commentary around the liquidity management assets. Just curious, if you could give any more color on how quickly you might put that money back to work? I mean it's encouraging to see the loan yields tick up a bit but really the big headwind was the securities book on the margin. So just curious how quickly you put that back out into some higher yielding instruments?

Can you tell me when, [how well] [ph] rates are going to do?

You won't see me in 2040.

Can you [indiscernible]. It's going to be function of where rates are. We are sitting on a lot more liquidity than we like and we will ladder it in over time. And the time will be a function of where rates go and, anyhow, our goal is -- the goal like we have would be to have it all employed ratably over the next year. Could be as soon as six months depending on where rates are. So our goal is to get back to that five-year, 5.5 year overall liquidity duration, and that makes a lot of sense. So it could be anywhere between six months and a year. But when mortgages back with 190s, why they want to go along on that when the thought is that this economy is -- our belief is this economy is about to really roar, right. And there is demographic data that would tell you that it's going happen. There is new administration and business friendliness that’s going to tell you it's going to happen. It's the fact that every time we have had a major Keynesian event, there has been a period of time where we have had growth, had great inflation and higher rates. This time we haven't had it. I think it's a function of the regulism that we have had to deal with. And if you add those two together, I think the economy is going to be very strong and I think rates are going to go little bit faster than anybody anticipates them. So we are willing to play it for the long-term. Our earnings are good and we will take our time on this because you don’t want to lock in too early and a lot will be dependent on growth too.

Yes. But none of it specifically marched for -- you are not planning to take the loans to earning asset ratio higher. I'm just trying to get a sense of how you are thinking about deploying it.

Well, we would deploy it in investment securities, mortgage backed to what have you, that would take you up to that 5.5 -- the overall portfolio back to a 5.5 year duration as opposed to 3.75, I think I said it was, duration that we experienced at year-end. And quite frankly, we started deploying in December, our duration was down about three, about three years in November. So October and November were on three years. We did employ some of it and we are just going to take our time as rates move. So we are not going to change our loan to deposit ratio. Our goal is still 85 to 90. Sometimes you get over that a little, 91 or whatever, but that’s still our goal. We are not going to run the loan and deposit ratio higher.

Okay. Great. That’s helpful. And then just on the insurance lending side, you guys have had great growth on the life side this year and last year as well. The commercial side maybe has slowed a little bit. I know you are top five in the country in that business. Is that mostly a function of just the insurance market being softer? Just kind of curious how many customers you have added versus if there is more inertia there than you may see in the numbers?

We don’t have the data here, I don’t think, on the number of contracts we have processed. But I can tell you that the average ticket size used to be $27,000 in the normal market. When the market was really soft, it got down to $18,000. It worked its way back to about $22,500. Now it's back down to around $20,000 a ticket size. So we still increased the number of tickets and the market share. But there is a lot of liquidity in the insurance market these days and not even a good disaster, I don’t think anybody is hoping for one, but not even a good disaster at this day would raise the -- when you listen to the insurance guy, would increase the premiums because there is so much money waiting to go to work in that business. So we believe they will be subject to a softer market. I think all the industry periodicals are talking about that. So if we can hold at around 20 this year, we will be happy. We would love to see it get to 22 and 23, or back to 27, which for years had been kind of the normal premium rate going in.

That's helpful. And just one final housekeeping question. I think maybe it's early in the second quarter, some of the preferred equity can convert to common. Do you anticipate that happening? I know it was subject to certain circumstances but I'm just curious if you expect that piece to convert?

Hey, Brad. I think it's convertible in April this year and the board will meet the next week but we clearly are well above the threshold where we are allowed to convert it. And my expectation would be that the board would authorize such conversion.

Right. And that's already in the diluted count, right? It would just show up as common.

Yes, right.

Thank you. Our next question comes from Casey Haire with Jefferies. You may begin.

I wanted to follow up a little bit on the mortgage banking. What is the mortgage servicing component within that $35.5 million?

Well, the change in the valuation was on the portfolio that we had was $1.2 million. You can look in our press release we breakout what the value of the mortgage servicing rights are at the end of the year. And they increase because we added more loans to the servicing portfolio. But we would have had...

I guess on a net servicing basis is what I'm getting after. Because if I take out that $35.5 million, strip out the gain on sale of $28.8 million, that leaves a decent amount even with the MSR markup. I'm just trying to get to what that missing $5 million or so is.

Yes. I mean we have capitalized about $3.5 million on new assets. We had servicing fees of about a $1 million and then there is some amortization that those plus the recourse obligation. So the other thing that we don’t include in the production is if we have any recourse obligations on the loans that we have sold. That’s generally a pretty small number. But the big missing piece was really the gain on the capitalized MSRs which is about $3.5 million and not $1 million of actual servicing fees.

Okay. All right. And then switching gears, the C&I was, after a pretty strong year, I was a little surprised to see the growth taper a little bit in the fourth quarter here. I would have thought that we had some relief post election. Just some color there on what was dragging on the C&I growth this quarter and what's the outlook going forward?

You know, just a little bit seasonality there. We had made a good loan growth across the board and the fact that we are starting the quarter with $400 million more in average loans is going to be very good for us. This seasonality, our pipelines are very -- you know we have a very diverse portfolio and our pipelines are consistent across the board. So I would chalk it up to seasonality and nothing more than that. We still are making good headway on the C&I side. So I don’t see any in the draws. The draw levels have remained constant really for the last year. We feel that the overall portfolio, the overall including home equity loans, more construction loan, C&I lines and the credit and the line, we have been at 28% undrawn all year. So we haven't seen any additional usage coming out. But just seasonal on that, we see no issue there.

Okay, understood. Just lastly, could you give us some updated thoughts on your M&A appetite. And then specifically, we have heard from other banks that regulators are going to be cracking down on consolidators and limiting banks to one deal per year. If that is the case, are you feeling that pressure and if so would you target larger banks?

We always said we will take what the market gives us and we are not going to overpay for banks. The probability of a larger bank acquisition is probably the same as it always been. Depends on the price and even paying over two times book for something they would see [indiscernible] to an asset to make 10% on equity, we do that. And second, it's kind of hard, so that will force us to probably continue to be the zero to $1 billion banks. Not to say we wouldn’t do when they are really strategic and make a lot of sense but probably wise I would see it still playing the game we have always played. We have in the past year spaced them out a little more. Washington, our understanding is that Washington likes to get involved if we are doing bulk of big deals and that closes everything down. So we have been rationing ourselves in that regard. But that doesn’t mean that we haven't heard anything about cracking down on consolidators. And hopefully this brave new world, we are going to get out of the got you mode and get into a more collaborative mode with regulators. But it's hard to turn that chip right now but we don’t see much change. We are always pretty disciplined on what we do.

Thank you. Our next question comes from Kevin Fitzsimmons with Hovde Group. You may begin.

Ed, just dovetailing off that last topic on M&A. I'm just curious with the run in bank stock prices that we have seen post election, how do you see that changing the dynamics of M&A? On one hand, buyers have stronger currencies. On the other hand, the sellers have gone up as well or maybe they are pricing expectations have as well. And maybe some sellers that were ready to throw in the towel see this looming environment that you're talking about, a better growth environment, and they might stay in the game. So do you see it changing at all one way or the other?

I think sellers expectations always get higher, basically. Our stock goes up so they think they are worth more and it doesn’t make a lot of sense to me but that’s the logic that people employ. And even our friends, the investment bankers, those who are listening, know who you are, say, well your stock is up you could pay more. What would I pay more, you know. The target is worth what the target is worth. And you just got to run the numbers and make sure it's accretive to you and it's always number one to us. Really dilution is a four letter word to us and although we may accept some someday if it's really strategic, we have been able to avoid that for the most part. And we then will continue to grow our tangible book value. So there is that expectation that’s always out there when bank prices go up but it's kind of a relative zero sum game because pricing expectations do go up and we end up around the same place. But we look at it as your value is your value. Because I am up doesn’t mean you can reach in my pocket for something tell me that you are worth more.

Great. One quick follow up just on the optimism that seems to be out there and the potential for the economy to improve. Just meeting with your customers, have you sensed whether this optimism is still just talk right now or is it beginning to translate into actual activities? Specifically, are borrowers looking at expanding actual operations as opposed to, it seems like loan growth for a long time has been just taking market share away from other banks for everyone. But are you seeing actual positive progress on that front in activity? Thanks.

Good question. Yes. I think everybody is in a wait and see mode. I think the biggest, for a lot, most of the customers issue is taxed. If they come up with a tax stand, and I think you will see a little bit more optimism because I think that’s really going to heat up the environment. And I think they are waiting to see what the trade issues are going to be in that tax. Are they really going to follow through on the tax, no tax of imports, exports, parts and that sort of thing. So I think everybody is still in a wait and see attitude. I think people are being optimistic, but in part I think it's show me. So, yes, we will know after tomorrow. I will say on the retail and the residential side, it's kind of interesting. If you look at the numbers, the millennials have been six years to maybe even a little bit over six years delayed in starting household formation. But we are starting to see that happen. And when that happens, they are not going to [indiscernible] in that 800 square foot spending four or five bucks a foot, they are going to want some green space. They are going to want to put their kids in some place. And data says we are 6 million to 7 million housing starts behind that actually occurs. So I think you are going to see that kind of kick into the equation to as people start investing and these guys actually buy cars and buy houses. That doesn’t bode well for the apartment boom, we have said that for a number of years. Here in Chicago lots of apartments going up, who is going to be taking those 800,000 square foot apartments and pay on those numbers. So we have kind of laid off that market for a period of time. So we think that’s the policies and the demographics have a real chance to push this going forward. But most of our customers are still wait and see.

Thank you. Our next question is from Nathan Rice with Piper Jaffray. You may begin.

Ed, just following up on your last point in terms of the commercial real estate and high end apartment condo market in Chicago. It looks like a lot of your commercial real estate growth in the fourth quarter came in Illinois. Just curious on your updated thoughts on where you are seeing the greatest opportunities in that asset class and in what areas?

Well, there is some commercial going on, commercial real estate. Like we and Bank of America were the lead banks on the new McDonald's headquarters that’s going up the United Center on Oprah Winfrey's old lot there. We are getting -- hard to believe that we would be needing a McDonald's headquarter, it's another thing I am going to laugh at. 25 years ago I would be going to McDonald's top get a Big Mac and now we are financing them and we are the fifth largest lender to their franchise system. But we are seeing some deals across the board. We are staying away from large apartments. We are doing some. It really depends on the sponsor. We are getting very low advance rates on those things. Usually 50% to equity loan. The equity with really good sponsor. What we are seeing the commercial real estate is kind of in tail end of some of the buildings from middle market businesses we have brought over. Those tend to take a little bit longer to close then move over to us. Something their spot fees are swapped in place that need to be run out, that sort of thing. So we are not, we are kind of seeing it across the board. We are shying away from a lot of larger apartments. We have not changed our [right] [ph] size appetite. You know $25 million to $30 million maybe on the big deals. So it's across the board but we are shying away from multifamily right now.

Okay, that's helpful. And then in terms of deposit price and expectations in 2017, can you guys give us your updated thoughts to get to rate hikes this year? And what your expectations are in terms of inability to lag pricing relative to competitors?

Well, again, as I mentioned before, I think a lot of it is going to depend on the competition. The rate rise we had at the end of 2015, we sort of thought if rates went up 25, our deposit costs might go up 10 and of course you can see that didn’t happen. And so had the same viewpoint on this so maybe a 40% data would, I think is the pretty common view out there. But rates have been holding and we have been holding our rates. So we are going to hold as long as we can and truly going to be dependent upon what the competition does in the marketplace. But I think internally we sort of have been expecting if rates go up 25 basis points, we might expect ours to go ten on the deposit side. But we haven't seen that yet and I am not sure whether that will transpire but that was our thought. But as long as the competition holds, we are going to hold too because we are certainly getting compressed on the way down. As asset rates comes down, we are just going to lower the deposit rates anymore. So we think it's fair to be able to sort of decompress and like those rates a little bit longer. So low cost, ten right away, but it will work its way up.

Okay, got it. And then just the last one. Dave, do you have the amount of premium amortization that may have impacted the securities portfolio yield? I think it was just under $2 million last quarter.

I don’t have that number handy with me. Rates went up and they started to slow. We expect that to be substantially lower than the first quarter. It was a smaller number this quarter, I just don’t have it with me, so I apologize.

Thank you. Our next question comes from Michael Young with SunTrust Robinson Humphrey. You may begin.

Wanted to see if I could get your updated thoughts on just sort of your credit outlook for 2017. Non-performers have been fairly stable here for some time and net charge-offs dropped down to 6 basis points. Do we have to necessarily see provisions moving higher throughout the year as maybe those trends remain stable or go the other way?

Well, the provision is a mechanical functions now that’s based on calculations that if you put them all together they look like the Chicago phone book. So lot of calculations we go into creating. It's not the thing that would come up in the air like we used to as it relates to the provision and decide which way the wind is going or what you want to do. We get a little of that in terms of overlays but the fact is we don’t see any cracks in the environment right now. Again, we maintain our underwriting parameters all the way through, we are not cycle the last pick, if you will. We stick to -- we are consistent all the time. So I could tell you it's as good as it gets. It's a function of, could you have a big hit come, yes, you could and would it be a one-off, yes. We don’t see anything right now that’s industry specific or trend specific to make it think there is anything in the future that’s bad for us. I am knocking on wood as I say that but we are in risk business and sometimes as Forrest Gump says, it happens. But I think we probably would stay in the level we are right now in terms of the overall 62-70 basis point range. If the -- like if premium trends would slow down and instead of that portfolio you know being our niche portfolio -- our niche portfolio being a third of everything we do down to 20%, you would obviously see our provision go up because we don’t have losses in that business and that’s helpful to us. But right now we see nothing trending. We see no systemic trends. We are always anticipating one-offs but then again, we try, still the market is very receptive for us to push loans we identify as having a slight hairline fracture, we will push them out the door and there is probably three bids waiting for them on the way out, probably most of them better than what we been offered anyhow. So still very competitive here in Chicago.

Yes. And on the charge-off side, if you look at the last few quarters, they have between $6 million to $7 million. This quarter actually had a couple of million dollars more of recoveries which was helpful to the equation to.

But no expectation for those to continue the commercial side recoveries?

Well, we always get some but we just were fortunate that we had a few hit this quarter. So generally like the commercial real estate we have been more in the $300,000 to $400,000 per quarter and we were closer to $1.9 million. So we will see. We are hopeful we can get those but I think my crystal ball is not that good.

Okay, great. And then just on the net overhead ratio improvement from here, maybe ex mortgage, what's sort of the biggest catalyst other than just scaling up and growing the revenue side? Are there any levers to pull on the expense side still at this point?

Well, the biggest catalyst was last year. We acquisition a $1.1 billion worth of assets and basically we were driving out 80% of the cost of that banks and that was about on an annualized basis, $44 million on the half year since we have bought them, $22 million. We paid a reasonable premium on those and we had to drive those costs out. So we took our dilution to the income statement is probably what I am saying and we drove those costs out of the combined duplicate branches and what have you and basically we were able to pick up a $1.1 billion worth of assets at around 20% of the normalized cost of those, the operating cost of those asset. So it took us six months to push those costs out and then first part of the year, you can see we took a drastic jump in the first part of the year because we have pushed them all out. Now we still believe that we have the infrastructure available to absorb more growth with a commensurate increase in expenses. Everything doesn’t touch a customer except one department which we will be converting this year has been consolidated. So when you think of us as a multi-charter holding company, we really are going to think of us more as just a multi-branded holding company because we have squeezed out a lot of the cost and it's running the operations -- the operations are running pretty much like it would if it was a standalone bank. One charter as opposed to 15. So we continue to look for that but you will really get it out of the infrastructure that we have and that infrastructure's ability to handle more assets.

Thank you. Our next question comes from John Rodis with FIG Partners. You may begin

Congratulations, I guess to the Cubs. That's hard to say coming from St. Louis. Hopefully we can do better than 17 games out this year. Just one question for you guys, most of my questions asked and answered, but just on the tax rate. If we do see something out of Washington, if we do see a lower federal rate, if we see a 5 percentage point reduction or 10 percentage point or whatever, how much of that do you think flows through for you guys? Is it the vast majority or how are you looking at that?

We are paying the statutory rate. So he goes, think about it, he goes from 35% to 20% and say pre-taxes $4 million. You know so about $60 million, that’s over $1 a share. That’s if it [indiscernible] there is some talk, are you going to be able to deduct interest and even then with the bank not being able to deduct interest doesn’t make sense me, but even if they did that, that would be at a 15 -- we have to do it at a 15% tax rate. Anyway you look at it, we pay maximum. So it's almost dollar for dollar depending on what the other provisions of the tax act would be, would flow to the bottom line. So we are anxiously awaiting the plan.

And would you anticipate taking any one-time charges or impairment to the DTA or anything like that?

No. There's nothing significant there.

They would. I mean you could do it on DTA but you would have to take charge but it would be far offset by whatever the -- our DTA isn't that big. So it would be offset head and shoulders by the tax deduction.

Thank you. Our next question comes from Chris McGratty with KBW. You may begin.

The securities portfolio, I just want to make sure I'm interpreting the guide appropriately. Is the expectation for it to grow in terms of dollar amounts and to maintain the similar proportion of the balance sheet? Is that the right way to think about the $3.9 billion-ish liquidity position?

Well, we just invest some of it [indiscernible]. Right now we have pulled a lot of it in short in decreasing our overall liquidity management duration. They are just 3.5, 3.7 years down from 5.5 years. So we would just be taking some of it going a little bit longer.

Okay. So it's just extension not necessarily levering up and getting larger in terms of dollars?

No, we are still going to run hopefully to 85% to 90% loan to deposit. We have been at the high end of that for the last two years. So that would leave x amount in the liquidity management portfolio and we usually barbell that. I mean it's usually really short more on mortgage backs. Now the barbell is weighted on one side right now, more short than longer term. So we will probably have to even that out as rates move over the [topic]. Rates are so damn low, it just didn’t make any sense to us to lock in forever a variable loan rate. So we pulled back and it hurts you at the short-term but helps in the long term.

Understood, thanks for that. And just one on competition and dislocation. There's obviously a fairly notable transaction in your market. Any opportunities for clients or for talent given what may or may not happen in Chicago?

Disruption is always good in the market. It usually leads to dislocations of customers and assets and people. And we like to stand under the tree and we have somebody shaking it and then with our blanket we catch whatever falls out. So we are always looking, taking advantage of dislocations and we will continue to do that. But who knows if that deal is going to happen. You guys probably know more than we do but God bless if it does or doesn’t but it's still full steam ahead for us and we will look very hard to take advantage of any dislocation that occurs in the market.

Thank you. This concludes the Q&A session. I would now like to turn the conference back over to Edward Wehmer for closing remarks.

Thanks, everybody for listening in. We look forward to talking to you again in April and have some good news. And if you have to listen Johnny's taped call after this, God bless you. We do appreciate you listening in with us and call if we missed anything and we can answer that for you. Have a great day. Thank you.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.