TCF Financial Corp (NYSE:TCB)
Q3 2016 Earnings Conference Call
October 21, 2016 10:00 AM ET
Justin Horstman - TCF Investor Relations Manager
Craig Dahl - Chief Executive Officer
Tom Jasper - Chief Operating Officer
Brian Maass - Chief Financial Officer
Mike Jones - Executive Vice President Consumer Banking
Bill Henak - Executive Vice President Wholesale Banking
Jon Arfstrom - RBC Capital Markets
Bob Ramsey - FBR
Steven Alexopoulos - JPMorgan
Chris McGratty - KBW
Jared Shaw - Wells Fargo
Oliver Brassard - BMO Capital Markets
Good morning everyone and welcome to TCF's 2016 Third Quarter Earnings Call. My name is Jamie and I will be your conference operator today. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer period. [Operator Instructions] Please note the conference call is being recorded.
At this time, I'd like to introduce Mr. Justin Horstman, TCF Investor Relations Manager to begin the conference call.
Good morning. Mr. Craig Dahl, Chief Executive Officer, will host this conference. Joining Mr. Dahl will be Mr. Tom Jasper, Chief Operating Officer; Mr. Brian Maass, Chief Financial Officer; Mr. Mike Jones, Executive Vice President Consumer Banking; and Mr. Bill Henak, Executive Vice President Wholesale Banking.
During this presentation, we may make projections and other forward-looking statements regarding future events or the future financial performance of the Company. We caution that such statements are predictions and that actual events or results may differ materially.
Please see the forward-looking statement disclosure in our 2016 third quarter earnings release for more information about risks and uncertainties which may affect us. The information we will provide today is accurate as of September 30, 2016, and we undertake no duty to update the information. During our remarks today, we will be referencing a slide presentation that is available on the investor relations section of TCF's website, ir.tcfbank.com.
On today's call Mr. Dahl will begin with a discussion of third quarter observations and highlights, revenue, loans and leases and credit. Mr. Maass will discuss expenses, deposits, interest rates and capital. Mr. Dahl will then provide closing comments, and open it up for questions.
I will now turn the conference call over to TCF Chief Executive Officer, Craig Dahl.
Thank you, Justin. This morning TCF reported another good quarter of financial results, largely attributable to the enterprise-wide focus we have on our four strategic pillars of diversification, profitable growth, operating leverage and core funding. All of which remained top of line across the organization every day.
Looking at Slide 3, we believe successfully achieving profitability growth will be based on increasingly overall profitability of the portfolio, not the absolute size of the portfolio. We've a strong improvement loan and lease origination strategy that provides flexibility in terms of revenue generation, capital management and credit risk. In fact, the stability of our credit matrix such as net charge-offs and delinquencies continued in the third quarter while our non performing assets continued to decline.
While we did see an increase in add-on delinquencies and net charge-offs, they were offset by similar reduction in other portfolio. This continues to demonstrate the value of our diversification strategy. All areas of TCF are focused on doing their part to improve operating leverage. We’re seeing results as revenue growth again outpaced expense growth on a year-over-year basis.
As we continue to identify efficiencies across the business, we’re also actively reinvesting in our businesses to enhance our ability to better meet the evolving needs of our customers. I’m encouraged by the enterprise-wide commitment our team has shown towards serving our customers every day in a way that meets our core TCF values. We’re focused on continuing to create superior and sustainable financial performance.
Slide 4 includes all review of why we feel we’re well positioned versus our peers. Our model provides for more diverse revenue sources and higher profitability compared to our peers. We’re also unique and our ability to maintain consistent loan and lease yield performance. Our strong execution on pricing and unique blend of lending business, allow us to do this without expanding our credit box.
We’ve been able to consistently generate organic originations while maintaining discipline on price, structure and credit quality. 94% our deposits are insured compared to our peers at 62%. This is a competitive advantage for us in our price and balance prospective. In addition, we have a preferred deposit composition primarily made up of low balance retail deposits which have a highest liquidity value. Our net charge-offs remain in line with our peers. Our wholesale portfolio with just 10 basis points of net charge-offs in the third quarter of 2016, it’s having more of a positive influence on our consolidated credit story as our first mortgage portfolio continues to run off.
Slide 5 shows key year-over-year financial highlights for the third quarter with trends remaining very positive in these areas. Loan and lease originations increased 8.7% year-over-year while average deposits were up 7.3%. We also saw nice increases on revenue and book value for common share. ROA of 1.12% increased 2 basis points, while return on average common equity declined 17 basis points. From a credit stand point, non-accruals declined 7.8% year-over-year. While we did see an increase in provision, we remained comfortable with our current reserved levels.
As you turn to Slide 6, we continue to demonstrate the revenue capabilities of our franchise as total revenue increased 4.5% year-over-year. A quarter-over-quarter increase in non-interest income was largely due to increase in gains on sales of loans, offsetting a reduction in leasing revenue. Meanwhile, our net interest margin moved lower by only 1 basis point, as loan and lease yields and deposit costs remained consistent quarter-over-quarter.
We would expect to see some margin pressure moving forward due to the continuing current rate environment competition and mix changes within our portfolio. Finally, on the right side of the slide, you can see the level of diversification we have from both the interest income and non-interest income perspective. Diversification remains an important part of our strategy in terms of both the balance sheet and income statement.
Turning to Slide 7, you can see the consistent and superior diversification within our loan and lease portfolio. Year-over-year loan and lease growth was 1.1% as we continue to focus on increasing the overall profitability of the portfolio. Had we not sold any loans in the third quarter, we would have experienced an annualized growth rate of 22%. This demonstrates the flexibility our model provides as we manage the business moving forward. In addition, we remained comfortable with the 55/45 split between wholesale and consumer.
Slide 8 highlights our ability to continuously generate strong loan and lease originations. These originations are a key aspect of our diversification and profitable growth strategies. We have multiple origination channels that create flexibility while allowing us to maintain our discipline on price, structure and credit quality. Third quarter originations increased 8.7% from the third quarter of 2015.
Slide 9 provides an overview of our loan sales which have been a core competency for nearly five years. The third quarter totals include another auto loan securitization. Total loan sales have now increased each of the last fourth quarters, which does have an impact on our balance sheet growth. We continue to evaluate and optimize our hold versus sell strategy on a quarterly basis based on various factors including concentration management, capital liquidity and revenue generation.
On Slide 10, you can see that our service for others portfolio continues to grow, now with an average balance for the second quarter of $5.1 billion. Our loan, sale and servicing strategy contributes revenue through both gains on sales of loans and servicing fee income. Our servicing revenue continues to increase as we sell and service these loans, totaling 10.4 million in the second quarter of '16, up 29% from a year ago.
Slide 11 highlights the consistency of our yield performance despite a low rate environment. We have been able to achieve this through a combination of loan and lease diversification and disciplined pricing. We saw a typical seasonal increase in inventory finance yields in the third quarter while auto yields declined primarily due increased loan sales of higher yielding loans. Meanwhile, peer bank loan lease yields have trended downward. Our diversification strategy has allowed us to keep a significant yield advantage over our peers while remaining our discipline.
Turning to Slide 12, you can see that after several years of improvement, overall credit quality is within our expected range. Our 60 day delinquencies remain very low at 11 basis points. We continue to be comfortable with our provision and reserve levels and our non-performing asset levels continue to decline and now are at the lowest levels since the third quarter of 2008.
Taking a more detailed look at our net charge-offs on Slide 13, you'll see the continued strong performance of our wholesale portfolio at just 10 basis points. Consumer net charge-offs increased two basis points year-over-year to 47 basis points as an increase in auto net charge-off was offset by a reduction in consumer real estate. Year-to-date, net charge-offs in auto are at 78 basis points, which is within our expected range. In total, our net charge-offs continue to perform in the low end of our expected range.
And with that, I’ll turn the call over to our Chief Financial Officer, Brian Maass.
Thank you, Craig. Turning to Slide 14, non-interest expense increased 3% year-over-year, while revenue increased 4.5%. This demonstrates our continued focus on creating operating leverage. Compensation expense remained relative flat year-over-year despite a 9.3% increase in our average assets and our average service for others portfolio. In total, we’re encouraged to see the efficiency ratio decline over 100 basis points year-over-year.
Slide 15 shows our deposit mix, which is the primary funding source for our loan and lease growth. Average deposit balances have increased 7.3% year-over-year, including checking account balances up 5% as attrition continues to decrease. In addition, the average interest cost on our deposits was unchanged from the second quarter of 2016 at 37 basis points.
Slide 16 demonstrates how we're well prepared for changing interest rates given our mix of short term and variable rate loans. The shorter duration of our assets also allows for optionality in a changing interest rate environment. Absent another interest rate hike, we may see some pressure on our margin moving forward related to portfolio mix changes, growth and competition.
In addition, 57% of our loans on these balances are expected to reprise, amortize or prepay within the next twelve months. Meanwhile, 62% of our deposits are low or no interest cost with an average balance of 10.6 million at an average cost of 2 basis points for the third quarter of 2016.
Turning to Slide 17, all of our capital ratios continue to grow through earnings accumulation. We declared a common stock dividend of $0.075 per common share earlier this week.
With that, I will turn the call back over to Craig Dahl.
Thank you, Brian. Slide 18 provides a summary of our strategic pillars. We continue to generate strong loan and lease originations that provide, portfolio diversification and revenue growth, all while maintaining credit quality discipline. We have diverse revenue sources that our flexible as we balance our hold versus sell strategy.
We’re making strides from an operating leverage prospective, while also continuing to invest in our business. Finally, we continue to maintain our deposit base that supports our loan and lease growth. We do all of this with a strong enterprise risk management and credit culture.
And with that, I'll open it up for questions.
[Operator Instructions] Our first question today comes from Jon Arfstrom from RBC Capital Markets. Please go ahead with your question.
I guess it’s all about cards and credit, at least initially. The overall credit numbers are good, but people that I’ve heard from this morning are concerned about the increase in the 60 day delinquencies on auto and also the charge-offs. And just help us understand what's going on there. Is there anything you need as just a trend you expect to hit higher? I know you said it was within your range, Craig, but just help us understand a little bit more of what's going on there?
Yes, I'm going to turn over to Mike Jones, Jon, in just a second, but I mean, there is a number of factors that affect our performance. There is the seasoning of our portfolio, the seasonality of it. There is some enhanced regulatory requirements, and there is industry performance trends. I don't think that were unique and what's happened. So, with that I'll turn it over to Mike.
Yes, Jon, just to provide you a kind of a little bit more detail, I mean our portfolio as you know we purchased -- again, we went back in November of 2011 and have been building that book kind of overtime. So, the time on book is increased over on a year-over-year basis, which is having an impact on the credit performance of the portfolio, as that gets aged and kind of moves out that lost curve. I would say secondly on the industry trends, if you look at kind of delinquency and charge-offs on a year-over-year basis, and this is kind of looking August-to-August data because that's what's kind of publicly available to us. It's up -- delinquency is up about 7%, and loss is up about 10% on a year-over-year basis. So, the overall -- we're not immune to kind of what's happening in the industry. And then, I would say finally on a seasonality basis, if you kind of look at kind of delinquency and losses, really kind of that's -- April, May and June is kind of our dip point, if you look at below the average; and September and December are typically above that average. So, as you look at kind of an annual basis and I think that's what Craig focused in on, was within acceptable range, but you have kind of the peaks and valleys as you go through the year.
So, the message is, you don't -- you're not seeing anything here that alarms you or maybe it's outside of your expectation?
No, I don't think anything here is outside of our expectation.
Okay, and it doesn't -- this doesn't cause you to back off your growth aspirations in the business at all?
Well, I've talked about previously and I threaded some comments on here as well, Jon, that we're concerned with the profitability of the portfolio, not absolute growth of the portfolio. So, we're going to continue through managing our originations in our loan sale process, making those decisions strategically quarter-to-quarter. And so, I wouldn't say that we have a grow-at-all-cost strategy right now.
And then maybe Brian, or Mike or Tom, just on efficiency, you're talking about efficiency ratio improvement goals, what's the overall message on expenses? Is it modest growth or are there other initiatives that you have in place too, to really limit the growth or maybe bring expenses down?
What I would say on that? This is Brian. As similar to what I said in the previous quarters, it's not necessarily about outright expense reductions; it's been insuring that we're growing revenue faster than we're growing expense. So, year-to-date revenue is up 4.9% and expenses are up 1.8%. However, we've been saying all year long that we expected expense growth to be this year. We didn't expect year-over-year, and we thought it would be in the 1% to 2% range, and I still think will be within that range at year end.
Our next question comes from Bob Ramsey from FBR. Please go ahead with your question.
I think, in your prepared remarks, you mentioned that there could be some pressure on margin from here. Just curious, if you could talk about the trajectory for net interest income which was down a little bit quarter-over-quarter, do you think that hold steady, can grow it even with the margin pressure, just sort of thought there?
This is Brian. I'll give you a couple of comments there. I think you've asked first about net interest margin. We would still expect margin to decline in the fourth quarter. For us, a lot of it is driven on the mix of the portfolio and the yields on different aspects of the portfolio. So, in third quarter, market didn't go down as much as we have expected, and part of that was due to inventory finance when you look at the yields there. Some of the timeline book for some of that portfolio was longer, and we get higher yields over time. That kind of starts to reverse itself in the first quarter as we have growth coming onto book it'll be at slightly lower rates. So, we do expect margin to go down in the fourth quarter, as a result of that. From a net interest income prospective, I don’t expect dramatically different origination levels kind of heading into the fourth quarter. So it will really just be a function of where we expect loan sales to be, which I say as somewhere within the range as that you've seen over the last five quarter.
Okay. And I guess on that line, obviously, this is a really strong quarter for your loan sales of auto and mortgage. Could you maybe elaborate a little bit on the pipeline for those two businesses for sales going into the fourth quarter?
Yes, this is Mike Jones. I think, the team has done, I believe a great job of establishing a stable investor base where we’re starting to see a lot more consistency in that investor base, and then wanting loans on a more regular basis and a consistent basis. I think, the demand for our loans in the market place has been strong and continues to be kind of a core competency of our business model.
Okay, so, I guess, I think going into the fourth quarter, you think there will be similar to this quarter, you think seasonally it will be a little bit, little bit less, based on where the pipelines are today?
It will be somewhat depended on the market place. As you get into the fourth quarter, if you look at kind of quarter-to-quarter and execution out into the different market place on loan sales, asset back securitization in that type of thing. Volume tends to be a little bit slower. But it will be depended on market demand.
Okay. And I guess, we're taking a little bit higher level view. I mean your commentary around demand for your loans probably bodes well in that we can expect volume in 2017 to be at least what it was in 2016?
I'd say overall, I think we kind of see the booking over the last five quarters and what I would expect on a quarterly basis.
Our next question comes from Steven Alexopoulos from JPMorgan. Please go ahead with your question.
I want to follow up first on the commentary around the increase in the auto delinquencies. Could you guys give us color on the trends -- I know you don't have this in the release -- on the 30-to-60 day delinquency transfer auto. How did that change in the quarter?
We don't disclose 30 to 60 day.
Okay. Could you at least provide -- are you seeing more pressure there than what we're seeing in the 60-day delinquency trend?
I don't think there we're seeing more pressure. I think, it's kind of consistent on what you've seen kind of on a 60 day.
Okay, got you. And then when you look at the auto loans that you guys have sold that you are servicing, do you see this very similar credit pressure on those? Or is it any different than what you're holding on the balance sheet?
Yes, I mean, those different factors that come into play, I mean, we still have -- there's still the industry trends, right, that impact the managed book. There is also the seasonality that kind of impacted as well as kind of the time on book. I would say that the time on book on that portfolio is pretty consistent with our own. So, yes, I would say that it's probably consistent with those three items that I alluded to earlier. I would also add with that said, I mean with those type of deals and those, their whole-loan transactions, as well as private placement securitizations, we can provide those institutions kind of visibility into kind of the loss curves associated with those. And those have been tracking along those loss curves from an expectation standpoint. So, those investors are getting kind of what we articulated to them around the loss curve.
Got you, that's helpful. Thank you. Maybe -- could I shift to the deposit side for a minute? Can you first remind us where you're comfortable allowing the loan to deposit ratio to move? I know it's been higher than this, but what range are you comfortable with?
We don't necessarily manage to our loan-to-deposit ratio. I mean, you've seen it come down a lot, but I'd say over the last five years, it's probably down 20 points. And I think, we're close to 101 right now. It's a number that we wouldn't necessarily -- that can go up 5% from here. We're right -- I think, we'd be comfortable with that. For us, it's really the composition of our liabilities and the composition of our deposits that we care about. And for us, it's -- we've a lot of insured deposits that our retail and that type of things.
Got you. So how should we think about that moving forward? Should we think of more focus on deposit growth, or potentially more loan sales to manage that mix?
I'd say, generally, as we've said in the past, we'll continue to focus on growing deposits primarily to fund our loan growth. We do obviously have wholesale funding sources that are available to us. In fact, they can be cheaper often than what the deposits are, but we like the liquidity value. We like rolling the deposit base over time.
Okay. And then finally -- not to monopolize the call, but do you feel you have enough deposit growth capacity within the existing retail footprint to fund the loan growth? Or do you need to consider maybe M&A to expand that capacity a bit?
I do feel that we've got still capacity within the network of the footprint that we have. I mean, if you look back since 2012, we've raised 5 billion of deposits just leveraging our existing branch network. And I would say even with that, we aren't necessarily getting still our fair share. So, I think there's capacity. Some capacity is still within our network and within our footprint to continue to grow that in the near term.
Our next question comes from Chris McGratty from KBW. Please go ahead with your question.
Craig, your capital levels continued to build a little bit. Interested in whether a buyback is at all being considered today as we kind of near the end of the year, and whether there's any clarity on the NORA Letter. Thanks.
I talked a lot in the past nine months regarding our governance process, regarding capital and talked about the four options that we discussed with our Board. We just came out of the Board meeting this week. Dividend increases and buybacks were actively discussed and continue to be actively discussed. But I wanted to -- we also talked about organic growth and corporate development, and many of our lending businesses are going active and evaluating acquisition opportunities, whether they are strategic, which would include incremental origination teams; or are simply tactical, which mean our portfolio of acquisition. And all of these are being evaluated as sort of our strategic pillars. But as we continue to stress, we're interested in profitable growth, not just absolute growth. And we either have not been willing to pay when others will pay; or we’ve not going to be comfortable with the credit box for cultural fit of the management. But we do have a history of successful corporate development at the business line level, and we’re going to remain active in the evaluation process.
If I could just add: the portfolio acquisition you're talking about -- was that more on the asset side? And if it was, how would you think about funding? Or was it more on the deposit side?
No, if they would have been on the asset side, and we're -- as Brian mentioned, we have a lots of wholesale funding capacity at an interim basis if necessary. And we also have our loan sale opportunities to which, again, we manage where our capital liquidity around that as well.
Okay, great. And maybe just a comment on any changes in the status of the NORA Letter?
No, there really is no update, we continue in discussions within -- there is no established time table or there is no notable deliverable at this point in time.
Our next question comes from Jared Shaw from Wells Fargo. Please go ahead with your question.
A follow-up just a little bit on the auto, this is the third quarter where we've seen originations slow. Is that more a function of trying to manage the size in what you're keeping on the balance sheet? Or is that more a function of just the dealer network and flow coming through, through the dealer network?
This is Mike Jones. I would say there is a couple of things there as far as the dealer network, I think it’s established on where we would like it to be. I think, we have the sales teams in place that we believe we need to be successful. And now, it’s really about getting operating leverage out of that business and efficiency out of that sales force. So, how can we take origination team and increase the amount of sales that they can generate for that team and reduce the app that we are looking, but not booking. So, that factor is called, what we called the current look-to-book and how can we drive that percentage higher and get more efficient with our teams. I would say that, as that kind of balances out, and I think it goes back to what Craig mentioned; we're in search of profitable growth, not just growth. And we're going to make sure that the originations that we're originating are within our box and kind of meet our price parameters and structure parameters that we've kind of laid out for that team.
Okay, thanks. And then just my final question is looking at the compensation costs over the last few quarters, we have seen it continue to come down. Is this a level to assume growth from now? Or is there still going to be a little bit of squeeze coming out of comp costs?
I would say comp expenses are pretty close to where they were last year. They're down a little bit from Q2. In general, I'd say, we should expect comp to continue this range to grow a little bit. Again, we're not necessarily out to decrease the expense line there. We will see some efficiencies or some reduction from the headcount coming down with the branch closures that we had in the first half of the year. But in general, you'll see that line continue to go up a little bit as assuming that we continue to have revenue growth right on ongoing basis.
[Operator Instructions] And our next question comes from Oliver Brassard from BMO Capital Markets. Please go ahead with your question.
First question: I don't know if you have given it in the past, but do you guys have an expected normalized net charge-off range for the auto book?
Yes, this is Mike Jones. I mean, we don't -- we haven't really kind of focused in on providing that data to you. I think, we've got -- if you look at kind of the performance over last 12 months; and as Craig said, the charge-off ratio being at 78 basis points on a year-to-date basis is acceptable to us.
Okay. And then switching to deposit pricing, you guys had less -- you know, stable deposit pricing for the first time in a while. Is that sustainable? Or do you think you're going to have to maybe start inching up pricing to gather deposits from here?
This is Brian. What I'd say is, it's a function of several factors which you've talked about in the past, right. It's about how much growth and deposits do we need. It's about what's happening in the rates market, and then what's happening from a competitive perspective. I mean, a couple of those things have been in our favor this year, right. So, you've had the rates markets. In general, rates are lower today. I'd say promotional rates, and they were at the beginning of the year when everybody expected rates to be going higher. So, depending upon what happens in the rates market will have some impact on where deposits price, as well as it's about how much growth that we need. As we have slightly less balance sheet growth, we're managing kind of the liability side of the balance sheet from a promotional perspective, and that's where you're seeing kind of the stability coming from. But if that was to grow faster, I wouldn't still expect to see that cost to incrementally go up like you've seen in the past.
And ladies and gentlemen, at this time, we would like to thank you for your questions today. Should any investors have further questions, Jason Korstange, Director of Investor Relations, will be available for the remainder of the day; the phone number listed on the earnings release. I would now like to turn the conference call back over to Mr. Craig Dahl for any closing remarks.
Well, thank you for joining us today. I remain excited about leading this Company and working with all of our great team members. When I look at the fundamentals of our business model, I see a strong revenue growth, outpacing year-over-year, approving and consistent loan origination platform and a desire to serve the needs of our customers every day. These will be the drivers as we continue to work towards meeting our organizational goals. Thank you very much and have a great day.
Ladies and gentlemen that does conclude today's conference call. We do thank you for joining. You may now disconnect your lines.
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