Wintrust Financial Corporation (WTFC) Q2 2017 Earnings Report, Transcript and Summary

Welcome to Wintrust Financial Corporation's second quarter and year-to-date 2017 Earnings Conference Call. At this time, all participants are in a 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 second quarter and year-to-date 20017 earnings press release in and 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 like to turn the call over to Mr. Edward Wehmer.

Thank you and good morning everybody. Welcome to our second quarter earnings call. With as usual are David Dykstra; David Stoehr, our Chief Financial Officer and Kate Boege, our General Counsel. We'll conduct this meeting in our usual format, I'm going to give some general comments regarding our results for the quarter and year-to-date. David Dykstra will dive into the detail of other income and other expense, then back to me for some summary comments and thoughts about the future, then we'll have time for questions. Starting to feel like [indiscernible]. Now I am going to leave that out there for anybody who are trivia guys, but another quarter, another record, another quarter, another record. We're very pleased with our results today with earnings of $64.9 million, up 30%, $1.11 per diluted share. Year-to-date earnings of $123.3 million are up 24% and represent $2.11 per diluted share as compared to a $1.80 last year. A net interest margin, a net fee basis increased to 3.43% in the quarter, up from 3.39% in the first quarter, to 3.27% for the second quarter of last year. Majority of this increase was due to the rising rate environment. The increase was somewhat muted by the flattening of the yield curve and non-parallel movement of the three-month one-year LIBOR rates. We expect continued increases in our margins are a maybe a little bit muted, and we'll talk about that a little bit later, in the coming months as the existing of future rate rises take hold. These could be accelerated by steeping of the yield curve. In the interim, we are happy that our internal hedge, that being our mortgage business is delivering results as anticipated in this rate environment. Net interest income was up $11.8 million, over the first quarter. Our earning asset yield is up 9 basis points for the first quarter and 21 basis points over the second quarter of 2016, while our cost of funds are 5 basis points over the prior quarter and 7 over the period last year. We expect both sides of this equation to increase in the coming quarters, as we rely more on organic growth, more to come on this strategy later. Our provision increased $3.7 million over Q1 to approximately $9 million. The provision increased covered the increase in portfolio balances and charge-offs of $5.3 million up from $1.6 million in Q1 or 10 basis points versus 3 basis points, still pretty darn good. Overall credit quality which remains pristine will be discussed in a second. Dave will take you through other income and other expense, but first some general comments. Our overhead ratio declined to 1.4% to 1.6% in Q1 is below our goal of 1.5%. to the year, the ratio is around 1.52%, just around the goal. That overhead ratio is computed using average assets. Given the fact that quarter only [ph] growth was again back-end loaded, that is ending assets for $900 million over average assets, that overhead ratio is even lower if the ending asset number was used. This will become more relevant to you when I talk about our growth strategy in my summary comments. In the aggregate, wealth management fees continue to steady climb as assets under administration increase 15% to $23.28 billion and mortgages, obviously have a strong quarter. Expenses are online with our expectations. On the balance sheet side, we grew $1.2 billion in the quarter to almost $27 billion in total assets. Loans excluding mortgages held for sale and covered loans grew $812 million in the quarter to $20.7 billion. Loan growth was consistent among all of our categories of loans. Year-to-date paid loan growth -- year-to-date loan growth of a little over $1 billion equated to 11% growth rate, as compared to 2016, loans were up 14%. Because of the previously mentioned back-end loaning, I think loans exceeded quarterly average loans by $478 million. This coupled with our continued strong pipelines in all of our loan categories bodes well for the third quarter and beyond. Total deposits grew $875 million in the quarter and $947 million year-to-date to $22.6 billion. Demand deposits comprised 28% of our total deposits. This is a flatter yield curve. We have not laddered our investments as anticipate in the rising rate environment, accordingly the overall duration of our liquidity management portfolio has stayed relatively dancing [ph] around the 4.5-year range. Credit quality was pretty pristine, again, can't get much better, but we're going to keep and try and get it better. As mentioned, quarterly charge-offs were around 10 basis points. Non-performing loans decreased $10 million to $69 million or 33 basis points down from 40 basis points at March 31st and 48 basis points at the end of last year. Total non-performing assets were also down from $10 million from Q1 to 40 basis points now from 46 basis points at the end of March and 52 basis points at the end of last year. Reserve coverage our non-performing loans at a high watermark at 188% of reserve as a percent of total loans stayed relatively constant. Be advised that although credit looks really good now, we are not resting on our laurels, we continually report through our entire loan portfolio looking for weak credits and cracks and exiting those relationships. The overall competitive market changed to welcome our regions. Now over to Dave, to talk about other income and other expense.

Thanks Ed. As normal, I'll briefly touch on the other non-interest and other non-interest expense sections. Turning first to the income area. Our wealth management revenue totaled $19.9 million in the second quarter of 2017, which was down just slightly from the $20.19 recorded in the prior quarter, but was up nicely from $18.9 million recorded in the year ago quarter. The trust and asset management component of this revenue category increased to $14.5 million in the second quarter from $13.9 million in the prior quarter, whereas the brokerage revenue component declined to approximately $5.4 million compared to $6.2 million in the first quarter of 2017. The decline in the brokerage revenue is partially due to conversion of accounts to manage money and a slight low in activity as brokers were focused on the implementation of the new fiduciary rule during the quarter. Overall, the second quarter of 2017 represented another strong quarter for wealth management revenue. Mortgage banking revenue increased approximately 64% or $14 million to $35.9 million in the second quarter from $21.9 million recorded in the prior quarter, but was slightly lower than the $36.8 million recorded in the second quarter of last year. The increase in this category's revenue from the first quarter was due to high origination volumes as a result of typical lower seasonality in the first quarter and a favorable interest rate environment. The company originated and sold approximately $1.1 billion of mortgage loans in the second quarter compared to $722 million of originations in the prior quarter and $1.2 billion of mortgage loans originated in the second quarter of last year. Also, the mix of loan volume related to purchased home activity was approximately 84% compared to 66% in the prior quarter. Given the existing pipelines and interest rate environments, we would expect originations to remain strong during the third quarter of this year, but could be down slightly from the first quarter which had a stronger seasonal home purchasing activity. The mortgage servicing asset increased by approximately $5.7 million, primarily due to retaining servicing on approximately $331 million more of mortgage loans net of paydowns and pay offs. The estimated fair value adjustment was not being material during the quarter. Additional we continually look for further opportunities to enhance this business both organically and through acquisitions. The revenue in the second quarter of 2017 for operating leases totaled $6.8 million compared to $5.8 million in the prior quarter, increasing approximately 18% during the quarter. The increase in this revenue item compared to the prior quarter is primarily related to the growth in operating lease portfolio during the second quarter to 191 million from 155 million at the end of the first quarter. These amounts relate to operating leases only as capital leases are carried in the loan section of the balance sheet. Other non-interest income totaled $18.1 million in the second quarter up approximately $5.9 million from the $12.2 million recorded in the first quarter of this year. The primary reason for the increase in this category of revenue was related to a reduction of approximately $4.9 million of the estimated liability related to claw back revisions within certain loss sharing agreements associated with past FDIC assisted acquisitions and approximately $788,000 of additional interest rate swap fees and this was partially offset by lower gains on early payoffs of operating leases. Turning to the non-interest expense category, total non-interest expenses were $183.5 million in the second quarter, increasing approximately $15.4 million or 9% compared to $168.1 million recorded in the prior quarter. I'll talk about the more significant changes in more detail now as well comment on a few other notable fluctuations from the first quarter. Salaries and employee benefits expense increased approximately $7.2 million in the second quarter compared to the first quarter. As to the components of this expense category, the base salary expense component was up just slightly by approximately $207,000, less than 1% from the prior quarter. Offsetting this slightly increase in base salaries were employee benefits, which were down approximately $428,000 in the current quarter compared to the prior quarter and this was primarily due to lower payroll tax expense, which is approximately $886,000 lower in the second quarter compared to the first quarter, and as you are aware, payroll taxes tend to be higher in the first quarter of each fiscal year. Accordingly, the primary reason for the increase in the expense category relates to commissions and incentive compensation expense, which increased approximately $7.4 million to $34.1 million from the $26.1 million in the prior quarter. The company experienced an increase in commission expense related to higher mortgage revenue along with an increase in a prudent incentive compensation from the first quarter levels as a result of our higher earnings level. As they were discussing regard to operating leases in the non-interest income section, the company experienced a corresponding increase in depreciation expense related to these operating leases due to their growth in the portfolio. again, we would expect this category of expenses to grow at a rate similar to the revenue side as the portfolio of the operating leases continues to expand. Marketing expenses increased by approximately $3.6 million from the first quarter to $8.7 million in total. As we discussed on our previous calls, an increase in this category was expected to occur as the first quarter of the year tends to be our lowest quarter of marketing spending. This category of expenses increased as our corporate sponsorships tend to be higher in the second and third quarters of the year, to our marketing app first with the Chicago Cubs and the Chicago White Sox as well as increased spending related to deposit and branding, marketing to grow our deposit base to support the growth of the loan portfolio and to enhance the franchise value of the company. Professional fees increased to $7.5 million in the second quarter of 2017 compared to $4.7 million in the prior quarter. Professional fees can fluctuate on quarterly basis based on the level of legal services related to acquisition, litigation, probably loan workout activity as well as the use of consulting services. And this category of expenses was somewhat elevated this quarter as we had a confluence of consulting engagements related to things such as the implementation of [indiscernible] customers experienced and product distribution enhancements using technology and certain other IT initiatives. We would expect this level of spending to subside a bit in future quarters. The miscellaneous line item of overall non-interest expense category increased by approximately $1.2 million in the second quarter to $16 million. The primary reason for the higher level of expenses due to greater amount of travel and entertainment expense of approximately $1.1 million. Again, as we discussed last quarter, we anticipated that this expense category would increase in the second quarter with the foreseen seasonally higher travel and entertainment and expenses. All the other expense categories other than the ones I just discussed were down on an aggregate basis by approximately $387,000 in the second quarter compared to the prior quarter with no significant items that are particularly noteworthy on an individual basis. As Ed mentioned, the company's net overhead ratio declined to 1.44% in the second quarter when its below our goal of 1.50%. additionally, the company's efficiency ratio improved to 62.0% in the second quarter from 63.9% in the first quarter of the year and we will continue to be diligent in our efforts to continue to improve upon these ratios as the year progresses. So, with that, I will turn it back over to Ed.

Thanks Dave. A little summary and some thoughts about the future. The second quarter is obviously a very strong quarter for us in all areas of our business. We expect this momentum to carry forward in the immediate future and hopefully beyond. We start Q3 with a head start on loan and overall earning asset growth, given the backend balance sheet loading which we experienced in the second quarter. Loan pipelines as I mentioned in all areas of our business remain consistently strong, we will be benefiting from the recent rate rises over the next few quarters as these increases work their way through the balance sheet. We remain well positioned for future rate increases and hopefully the steepening of the yield curve will be very helpful also. Our mortgage business is vibrant and will be subject to a rate environment and seasonality going forward. Our wealth management business should continue a steady climb. Credit is good, is as good as it's going to get. We'll continue to monitor and comb [ph] the portfolio for potential problems. Acquisition pipelines remain strong in all areas of our business. However, pricing expectations and gestation periods are lot longer than our recent past. Those of you who have followed us for some time, know of our disciplined approach to these opportunities. Notwithstanding above, our financial institutions now as opposed to the last few years that we're looking at do not have the excess liquidity that previous acquisition opportunities afforded us. To refresh everyone's memories over the past few years, we have grown to an equal mix of organic growth and acquisitions. Most of the acquisitions we did came at a reasonable price and provided excellent liquidity to fund our loan growth sticking with our approach of taking what the market gives us. As a result of this, we have talked about the inherent leverage in our operating structure, that is we have a number of locations that are not optimized and there was really no rush to bringing on excess liquidity and grow those locations in the zero-rate environment, why bring on excess liquidity you can't make any money on. But now with acquisitions slowing down a bit, we're turning more to organic growth to fund us and to optimize existing brand system. I think you see the idea, we want to grow without that commensurate increase and expenses. For example, new marginal growth, let's just make this a hypothetical example, new marginal growth comes on and maybe 25 basis point overhead ratio and maybe you have to pay up 25 basis point premium on deposits to attract people in our bundle packages that we sell. Let's assume that this initiative provides about half of our required organic growth. Our structure allows for this with a multiple charters and multiple brands we sell, we can target different areas where we are underutilized and not have to cannibalize the whole organization. So, we assume half of that comes from organic growth and half of it comes from our new initiatives. You're growing at about 37.5 basis points as opposed to 150 basis points that we're operating now. So, by optimizing our branch structure and by growing and growing the franchise value which we consider the right-hand side of our balance sheet to franchise value, our growth comes a lot cheaper and very profitable for us. We also have a number of de novo branches on the drawing board over the next few years, which saw the number of neighborhoods in our stated market area where we need the presence. These will be brought on on the time schedule that fits our financial goals. We still are looking actively at deals de novo [ph] we're not doing that, but we are as I said going to be really pushing the organic side of the equation to keep up with our loan growth. We've always been an asset driven company. The extent we're able to put assets on the books, we can go out and gain more households and more businesses and the like to fund those and that really builds our franchise. But we think the combination of the three approaches outlined above will serve us very well. So, in summary, I really like where we stand right now, we're pleased with quarter two and a lot of momentum going in to the rest of the year. Our credit metrics are good, our goals remain double digit earnings growth on increasing tangible book value. We will accomplish these using our usual discipline. So, thanks for listening and now we have some time for questions.

Thank you. [Operator Instructions]. And our first question comes from John Arfstrom from RBC Capital Markets. Your line is open.

Thanks. Good morning.

Hey John.

Question for you, you just commented on some of the new growth and funding the loan growth. You've got a pretty broad network of branches and charges, can you talk about what you're thinking about deposit pricing, sounds like maybe you're willing to pay up a little bit if the growth comes in, but give us an idea if whether or not you're seeing any pressures and what kind of expectations you have for the next couple of quarters.

Well as I said, I think not withstanding any acquisitions, notwithstanding any acquisitions half of our global will come through our momentum and the other half will come through these, this is just what we're thinking right now, we're obviously can be very flexible on this, but the half comes through our normal momentum of just building the business and the other half will come through the special promotions we would do with our least efficient branches. You've been around long enough to know the old days, we were one or two in market share, both in deposits and households on the retail side in every market we were in. Through the last eight or nine years since the crisis, we have added a lot to our branch network, but we have not gone out and tried to enhance that to get those lost the market share goals, because we have no place to put the money. We actually funding ourselves with the acquisitions. So, what we're going to do is in those specific locations we're underutilized, we will be going back and offering our bundled packages and we're always very good at organic growth, where we're kind of rekindling a lot of that and pushing that out. That will, as you're going to have to offer [indiscernible] account down some things, and the example I used they said 25 basis points maybe overall is what the premium you have to pay to bring these deposits in, but you're going to bring it in with really no overhead cost. So, the numbers actually work very well. So that's the plan. We want to stay 85% to 90% loan-to-deposits. We've been running a little bit higher than that right now which I like to be 85% to 90% has been our goal since for 26 years since we started this thing. So, we'll run a little higher now so we've got to go out and fund ourselves, but [indiscernible] the franchise value and we've been planning for this, we knew that eventually we'll be at an inflection point where growth through acquisitions would not be because of pricing and other issues might not be tolerable to us. We don't like dilution. We would rather grow profitable and I think if we can use the little infrastructure that we have and grow in that 25 basis points and maybe pay 25 more, you're making an extra 1 point on that business. So theoretically I think we enhance the value, we keep shareholder value, so we enhance earnings, we enhance our intangible book value, we're not overpaying on deals that might give you immediate benefits but would take years to catch up on. This has always been, we've always climbed the ladder if you will. We take what the market give us, it gives us inexpensive acquisitions, we'll find ourselves that way if those move away, we'll build ourselves out. So that's the plan, I hope that made sense.

Yes, made sense. Okay. And what is the [indiscernible] big picture thinking on the margin? Is there still more room to come on the margin or do you eventually hit some kind of a peak margin that's just kind of tethered by spreads or do you think there is more room to run here?

Well, it takes a while for the rates to work their way through on the asset side, the repricing of our portfolio. Also, with the one-year LIBOR that we have, I don't know how much Mr. Stoehr on one-year LIBOR?

$6.5 billion.

$6.5 billion.

$3.5 billion.

$3.5 billion in one-year LIBOR, which really has not moved and we will back down the chain. You get the three months and six months and one year in between three months and one year, it's not been a parallel shift in the curve, the long end will be down does not help us in that regard. So, a lot of it will depend on rates and the asset side, but we expect earning assets to continue to move up during the course of the year, could be accelerated if the long end were to move up. On the other side, we expect our deposits also to move up but we expect notwithstanding wide swings and either of those our margins to creep along and hopefully get better. That's the plan. It really is a function of the overall yield curve in the rate environment right now. Hope that answers that question.

Yes, that does. Okay, thank you.

Thank you. Our next question comes from Chris McGratty from KBW. Your line is open.

Hey good morning. Thanks for the question. Ed on the overhead ratio, obviously you guys have boogied [ph] yourself to 150 historically. Given your comments in the outlook, is kind of revising this target kind of a consideration maybe 140, is that a reasonable assumption based on what you're seeing or would you kind of still caution the 150?

Well our goal is 150, anything below that is gravy. Fully optimized, if you look at numbers and using this leverage we have on the system, notwithstanding transactions and other things that were going on, you can get -- in one scenario you get to the 130, but it really depends on, there is a lot of moving parts that's not linear. We're going to keep 150 as a goal knowing that if we're very successful in our organic growth as we were in the first quarter, we should be able to drive that number down considerably.

Great. Just a question on the mortgage numbers, maybe you can reconcile the total $36 million relative to the origination of $28 million. Can you explain that $78 million what it was, because I think that spread last quarter was closer to $4 million [ph], you mentioned there was no MSR mark, just wondering what that delta is.

We retained our additional servicing assets and so, as you retain those assets you capitalize those servicing rights and so, as said on the call, the majority of that income, almost all of that increase was additional servicing rights that we capitalized and those servicing rights are going on at higher rates now and then you had pay offs and paydowns that were coming off that lower rates. So, it's just pretty much a combination of servicing revenue plus what we capitalized for the period, which are going on much higher rates that the loans that are paying down and paying off now.

Okay, that's great. Maybe if I can sneak one, one last one in on capital, obviously given the strong outlook on growth and your stock price strength in recent months. How are you thinking about potentially capital need over the next two quarters?

Well I think you saw our growth, this is first part of a slow growth, second quarter was good growth, we kind of caught up, but we actually self-funded our ratios, didn't move much at all, our ratios are in pretty good shape. If we have huge growth and I really think our earnings should be able to keep up with it notwithstanding acquisitions or opportunities, but if we have bigger organic growth than anticipated, we may be in a position where we'd have to bolster that. But right now, it looks like we can be self-sufficient notwithstanding any sort of extraordinary external event like an acquisition.

Great. Thank you.

Thank you. Our next question comes from Michael Young from SunTrust. Your line is open.

Ed wanted to start on just the M&A commentary, I think last quarter you were pretty bullish on the prospects there and obviously is switching tone at least on the whole bank side, but maybe the fee income side any updates there, you're still seeing a lot of appetite?

Well I think I gave the message as the last quarter related to bank acquisitions regarding price expectations and gestation period. I think I had been somewhat consistent on that and then I think you can see that this quarter the other growth was all organic, so we've kind of turned that switch already. So, I think I've been consistent in that regard in terms of the messaging I've given you. But we are active in all aspects of our business and as you know we have a very diverse business here between specially finance companies, wealth management, mortgage and banks. So, we see opportunities across the board, I don't think there is a week goes by where somebody doesn't throw a flier by us and in any one of those businesses. But again, the pricing and expectations are very high. We continue to look. Lot of times, cultures, we start with culture right out of the box. The culture doesn't work, we're not even interested, I don't care what the price is, the size or the price, culture drives everything. I think I've given the muted approach to this that we see opportunities, but it's just getting over the finish line, it terms reasonable to us, it's getting [indiscernible].

Okay. And then on the liquidity management, as I understand, not laddering out yet, but what are you looking for kind of maybe what's the decision tree or the rate that you would want before you started ladder back into that on a longer duration basis.

Well, with our growth we generate more and more liquidity, it is easy [ph], it will drive that down, we're not taking that liquidity and taking it out long. We thought as rates moved up, we would move ourselves from a 4.5 duration in our total liquidity management portfolio close to between 5.5 and 6 and that would be the ladder we would work with. So, you need the long end to kind of move in parallel with the moves the fed has made to get us interested again.

Okay, thanks.

Thank you. Our next question comes from Nathan Rice from Piper Jaffray. Your line is open.

Hey guys. Good morning.

Good morning.

Question on the C&I in the quarter, obviously a very strong growth here in 2Q. was that more so a function of just increased optimism across your C&I base or some -- are you guys starting to benefit somewhat from recent M&A in and around Chicago and do you kind of expect this growth to carry forward within C&I going forward?

Really our draw rates have remained the same. We don't see additional -- we don't see things moving higher than, I think it was 40 something percent is the draw rate number that we have and it really hasn't moved much over the last number of years. this is more really momentum. We're still picking up just new business, pirating business from the larger business. The recent acquisition that you're referring where activity has taken place in the market, whether [indiscernible] or private or whatever, we haven't seen much of that yet, but who knows what else happened there. I'm sure that they are all very aggressive about maintaining their businesses. But this is pretty, the market we serve around here and basically our commercial real estate loans have to have a nexus too, should call to our market one way or another. This is the 14th largest economy in the world. Now we're seeing how screwed up the state government is. It's still is a very diverse and large economy with lots of business out there. We're still feeding off the momentum we've got from our branding, from us winning the J.D. Power award, from the relationships that we have and quite frankly our competitors stumbling on service and that sort of thing. We pride ourselves in our service and we actually walk the walk and not just talk the talk. So, lot of this is just momentum and growing businesses, we continue grow our franchise. So, we have not targeted any particular acquisition that takes place, but we were happy to stand under the tree with our blanket, when it shakes and see if we can catch when it falls down. And you question about continuing, our pipelines, although we do disclose that, those are just our commercial and commercial real estate pipeline, throughout the little bit quarter-over-quarter, but that's expected. We have such a large closing June, that's just happened because of that, but our pipelines that are consistently strong, our pull through rate have remained relatively constant, but those doesn't include our premium finance business which also shouldered growth this quarter, our leasing business which showed good growth, our franchise business showed good growth. So, we had good growth in all of our businesses this quarter. So, across the board we feel very good about where we are in terms of being able to maintain that growth and now its climbing the ladder and get the funding to [indiscernible] you need loans, you need deposits, you need loans, you need deposits. So, we're on the deposit side of things, so as I explained earlier.

Yes, understood. Thanks. And Dave, can you help us with the tax rate going forward, particularly in light of the Illinois corporate tax rate and higher?

Yes, as the rate recently went up, you do get a considerable benefit for that. So maybe a 1% increase going forward, it wasn't retroactive. We're still getting some benefits through the stock option and equities change that we referenced in the first quarter, although the first quarter is the largest quarter, it's a little bit more muted this quarter. But, we'll be up slightly on the state taxes because of the income tax rate, but it's just a going forward basis. There is no retroactive to the beginning of the year aspect of that.

Yes, the state taxes, the document for federal purposes that we --

Right. So, you got to take the federal benefit off of it and assuming federal benefit stays at 35%, you can reduce that by roughly a third of the state increase by roughly a third.

Yes, I appreciate all the color.

Thanks.

Our next question comes from Kevin Reevey from D.A. Davidson. Your line is open.

So, Ed I know last quarter you had given us a dollar figure for the CRE and C&I pipeline at the end of March. Do you happen to have that number, what it was at the end of June?

Yes, we had in the press release again Kevin.

Okay, I'll lean [ph] for that.

Yes, we can look here as you're going through your next question and I'll pull it out.

And then related to the recent general obligation bond downgrade by Moody's and S&P, you're seeing any negative impact on your customers and if so, was that going -- you think that will impact you in any way?

You mean in Illinois?

Yes.

Well, they a budget now, I think the lack of a budget probably and that that problem was more concerning to people because they were going to stop [indiscernible] stop a lot of things going on in the state. So, they had a budget. Now they have one and they can keep going. Now you could then talk about what the budget did which was just add taxes and do nothing for reform, which still has people very, very frustrated here in the state. But there as I said earlier, there is so much invested capital in Chicago in our market or Chicago and Milwaukee in North West Indiana, that people are kind of dealing with this issue, you still have the attributes in our market area of transporting as a logistics hub, you've got seven major highways that run through here, you've got O'Hare, you've got every rail line runs through here, you've got the second biggest, next to Boston, educational hub in the country, I never realized that so, I heard that a couple of months ago, not that I'm not into education, but I wasn't when I was in school, that's for sure. But, there is still a lot of benefits here and there is still corporations moving here, a lot of tech moving here. So, the feeling is somewhat mix, everybody is unhappy that the structural changes were made and I don't think that press will be off but compared to California, New York and other places, we're still okay, or maybe not that okay. So, our moves into Northwest Indiana and the southern Wisconsin were defensive also, but we want to grow those areas too to catch all the refugees running and those are going to move or expand in that area. So, I think in general people are pretty much disgusted with how it came about and no reforms came with it, but are happy that the budget's in place and life is continuing.

No, that's great color. Then my last question is, last quarter you talked about despite the bump up in interest rates, you didn't see a slowdown in your life insurance premium finance business. Is that still the case going in to the third quarter and for the remainder of the year?

Well there's always competition in that area and they're all based on one-year LIBOR. So, one-year LIBOR hasn't moved as much at least recently, so that bump up, we don't see the bump up in that area, so it doesn't affect our volume. We actually affect the volume growth throughout the year, and again, we're the 900-pound gorilla in that space. We actually can provide value added to these people. Lot of people pulse in and out of this business, lot of banks take it easy, tax is very complicated, they go, well, we can do it, then anybody can do it, but we have the experts in the business and add a lot of value and we get paid for our value too. So, we have not seen any declination in volume, although we would love to see the one-year LIBOR move little bit, that would be very helpful to our margin.

And Kevin, just for your reference, on page 12 of our press release, in our commercial and commercial real estate loan pipelines, we had $1.2 billion at the end of the quarter, it was down from $1.5 billion last quarter, but as I had mentioned, we had a lot of closings this time and then on a probability up close we set about $797 million versus $934 million last time, but that pipeline level's still in our range. We generally range 1.1, 1.2 up to 1.5, 1.6 [ph], and so, we consider that to still be strong pipelines for us and down a little bit just simply because of the strong pull through rate that we had in the second quarter.

Great. Thanks guys. This is helpful.

Thank you. [Operator Instructions]. And our next question comes from Terry McEvoy from Stephens. Your line is open.

Your rate sensitivity, if I look at the press release went up again this quarter, and I'm just trying to dig in, is it some changes in assumption or is it just a mix shift that occurred in the quarter within the assets and the liabilities of the balance sheet?

Yes, no its more of a mix shift. We extended out on some of our deposits and some of our liabilities. The adjustability rate loans with the pickup in mortgages out for sale and some of our other asset classes, it's just sort of mix, plus we also had $1.5 billion of increase in non-interest-bearing accounts. So, it's really a mix of the business.

And then just sticking with the deposit side, do you expect any impact of the most recent June rate hike on deposit pricing in your markets? Have you seen any impact so far?

Well deposit pricing is starting to creep up. You would expect it, we actually held out longer than -- the industry itself has held out longer than I would have anticipated with number of rate increase we have, but you're starting to see pressure on these rates and they're going to start moving up, we're going to put five basis points this quarter and I think certainly we want to keep that data to be about the same whether earning assets go to 9 or 10 and other cost going up 5, that would be fine with me, that 5, 6 basis of margin every quarter, that would be just fine. But you're starting to see that occur and I think we've held after a long time, but the demand is now, we're holding on we need to buy some, so we're going to start paying up a little bit as they referenced and try to do it on a spot basis. Again, a lot of people question our structure but our structure does allow us to go into individual banks and individual neighborhoods and target, least efficient branches to grow them with specials we don't have to do that across the system. So, the cannibalization stays down. So, we expect assets to increase more than our cost of funds were able to move up.

And then just lastly, Ed, you talked about your rejects are finding new homes in terms of pushing out lending relationships, is there any common theme among those borrowers that are you're pushing aside?

Well it depends on, we're in so many different businesses, on the C&I side, you start seeing some cracks and with our pipeline's being as good as they are, somebody might have a bad quarter or might have -- we pushing the edge of the envelope on their advance rates and with their business slowing, although they're still profitable, you look at those and you say, we don't like having customers, especially in good times, who's legs are already up against the wall. We like to keep some rule where I tell clients when we allowed our prospects that you're looking for us to push the edge of the envelope and give you your best deal, where you're most aggressive, we're not your bank. We like to leave room so that when things do turn bad, we can be there for you and so if you get somebody whose legs are up against the wall and doesn't appear that they've got a plan to get out of it, we will move them. So, that sort of be, we get then to do lot of triage on this stuff and we work with any customer we possibly can who will work with us, but if they don't want to work with you or they say, what you're talking about, that sometimes you're just not a good fit, we'll move them on and its people, there is such an appetite for loans and somebody who, people like to take business from us. They'll go their way. On commercial real estate side, same sort of thing, where we like to, where we're not in hospitality per se, so we don't have that issue but on retail we see if there is some retail, smaller retail type, strip centers and the like, start showing some vacancy with the way retail's going, we're a little bit squeamish at that, it moves out and there's always a home front someplace.

Thanks, and I did take the bait and looked up late [indiscernible] from the movie Vegas Vacation is what I quickly found.

That's correct, Valery [ph] said, put in a quarter, win a car, put in a quarter, win a car. So, another quarter, another record, that's the way I looked at it.

That sounds good. Thanks Ed, thanks Dave.

Thank you. Our next question from David [indiscernible] from Wedbush Securities, your line is open.

Hi, thanks, few questions. Wanted to start with the FDIC indemnification liability reduction of $4.9 million. Is that one time or permanent reduction going forward?

Well, for an income statement impact it was, the change in an estimate. We were somewhat conservative on some of our assumptions and as we've been working through this process, we've had some clarity on some provisions of loss share agreements that were unclear and so we took a conservative approach, but we have since gotten more clarity and work through the provisions with the FDIC and some others. And it was sort of a change in estimate, so the liability would be down permanently, but the impact of the income statement is more of a one-time effect.

Okay, thanks. And then on mortgage banking, so I was pleasantly surprised to see it as strong as it was, given others in the industry have spoken about pressure on gain on sale margins, did volume make up for it or was it the servicing revenue that made up for it, with you guys?

No, it's pretty much volume. Our volume in the first quarter was $722 million and volume in the second quarter $1.11 billion. Our gain on sale margins stayed relatively flat. As I said on the call, we still see the pipeline's strong now. We would expect them to be down maybe slightly from the $1.1 million in the second quarter or $1.1 billion in the second quarter simply because the second quarter tends to have a higher seasonality for home purchasing. But we expect the pipelines are still pretty strong. So, the main reason for the increase was the increase in origination volumes.

Got it. And I wanted to follow up on the discussion about the state of Illinois. Are you able to quantify your direct or indirect exposure to the state government of Illinois or businesses that rely on income from the state, if there were some more extreme budget cuts at the future.

Well, we don't have a lot of exposure of any of state of Illinois as a bank per se on our balance sheet. Now we tell our customers, certainly there are customers who are doing business with the state. I don't think we have quantified that any way, shape or form, but most of them are vital services such as medical, hospital, construction, so if you get a delay, there might be a delay, but we do look at that when we underwrite the deals.

Yes, certainly when we're underwriting deals, if somebody had a large proportion of the revenue from the state of Illinois, that would be a negative underwriting on that loan and if that was a high proportion of receipts. And so, our lenders are aware of those clients that are getting revenue and they're monitoring them, but we have aggregated and disclosed it, but we don't think it's a significant concern for us that we don't have any direct obligations from the state. We don't hold direct state bonds or the like or have any loans to the state of Illinois directly, but we do monitor our customers and we do look at that when we're underwriting the loans.

Thanks very much.

Thank you. We do have a follow-up from Michael Young from SunTrust. Your line is open.

Hey just wanted to follow-up on the MSR. Do you plan to continue to hold as much servicing as you did this quarter? I know it will be dependent on volume and paydowns, but do you expect that to be a continued part of the strategy to hold a higher level of servicing going forward?

We hold servicing our loans, we do in our footprint. Our mortgage businesses are national footprint and we maintain and hold servicing on the local ones. I got tired of turning over to people having them sell my customers, I rather do that myself. So, we do that at capacity and we'll continue to build -- I would expect that the mortgage servicing will continue to build based on how we do in our footprint in terms of generating loans. Again, as based I think the spring season, the second quarter is always the strongest because of the purchase market and third quarter's always pretty good fourth quarter seems to slow down, but I remember last year we had a little rise in rates and that kind of lowering of rates and that pushed the market pretty high. So, I think it was real commensurate with our organization, I don't think it's going to be major point, it's just strategic move for us and should grow kind of parallel with the overall organization.

Okay, so no change in the strategy. And then just, going back to the branch, new de novos, can you talk any more about maybe the timing and then are those going to be net increases or will you be culling some branches in some other areas?

Pretty much all net increases areas that we want to get in to and again the timing over the next 24 months, we have a number of planned, maybe 36 months actually. So, we'll bring them on, some are more convenience locations that are added on to markets we're already in, others are new markets. So, the newer markets will actually be a little bit more expensive. But again -- say okay, is there community bank there already that we can buy and for the last eight years, we have relied on them, we get them at reasonable prices. There is none there. We have to go and do the novo and as an inflection point between the cost you have to pay, the amount of goodwill you generate versus actually investing, losing money for a year and half or two before you make money on that branch, but it's a lot less the premium you have to pay, so we basically our dilution through our income statement. But again, we're going to time that so that it does not get in the way of our ultimate goal of continuing to grow tangible book value and earnings and during our earnings in the double-digit rate. So, that's how we're going to time it in and that's our plan and we're sticking to it.

All right. Thanks very much.

Thank you. And I'm showing no further questions from our phone line. I would now like to turn the conference back over to Edward Wehmer for any closing remarks.

Thank you everybody for listening in. Have a great summer, what's left of it. It seems like you hit 4th of July and it seems like it's over, but there's still lot of summer left and we'll be sure of our best efforts going forward. Please call Dave or me if any additional questions come to mind. So, have a great summer. Thanks for listening.

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