TCF Financial Corporation's CEO Discusses Q2 2012 Results - Earnings Call Transcript

| About: TCF Financial (TCB)

TCF Financial Corporation (NYSE:TCB)

Q2 2012 Earnings Call

July 19, 2012 11:00 AM ET

Executives

Jason Korstange – Director, Corporate Communications

William Cooper – Chairman and CEO

Mike Jones – EVP and CFO

Craig Dahl – Vice Chairman and EVP, Lending

Earl Stratton – EVP and CFO

Tom Jasper – Vice Chairman and EVP, Funding, Operations and Finance

Neil Brown – Chief Risk Officer

Analysts

Jon Arfstrom – RBC Capital Markets

Erika Penala – Bank of America/Merrill Lynch

Paul Miller – FBR Capital Markets

Matt O’Connor – Deutsche Bank

Craig Siegenthaler – Credit Suisse

Steven Alexopoulos – JP Morgan

Scott Siefers – Sandler O’Neill

Emlen Harmon – Jefferies

Dan Werner – Morningstar Equity

Chris McGratty – KBW

Terry McEvoy – Oppenheimer

Andrew Marquardt – Evercore Partners

Stephen Geyen – Stifel Nicolaus

Peyton Green – Sterne Agee

Tom Alonso – Macquarie Securities

Operator

Good morning and welcome to TCF’s 2012 second quarter earnings call. My name is Christy, 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 will be a question-and-answer period. (Operator Instructions)

At this time, I would like to introduce Mr. Jason Korstange, Director of TCF Corporate Communications, to begin the conference.

Jason Korstange

Good morning. Mr. William Cooper, Chairman and CEO, will host this conference. Joining Mr. Cooper will be Mr. Barry Winslow, Vice Chairman of Corporate Development; Mr. Neil Brown, Chief Risk Officer; Mr. Tom Jasper, Vice Chairman of Funding, Operations and Finance; Mr. Craig Dahl, Vice Chairman of Lending; Mr. Mike Jones, Chief Financial Officer; Mr. Earl Stratton, Chief Operations Officer; and Mr. Mark Nyquist, Chief Credit Officer.

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 you that such statements are predictions and that actual events or results may differ materially.

Please see the forward-looking statement disclosure contained in our 2012 second quarter earnings release for more information about risks and uncertainties which may affect us. The information we will provide today is accurate as of June 30, 2012, and we undertake no duty to update that information.

I will now turn the conference call over to TCF Chairman and CEO William Cooper.

William Cooper

Thank you, Jason. TCF today reported net income of some $31.5 million, that’s $0.20 a share, and that compares to the Street projection of about $0.18 a share in the second quarter. Return on assets was 0.76%; return on equity, 8.13%. The net interest margin reflecting the benefits of the restructuring that we did in the first quarter was 4.86% versus 4.02% last year. I believe that 4.86% is probably one of the highest net interest margins in the banking business, certainly among our peers.

Our pre-provision pre-tax profit was $108 million in the quarter, up 53% from the first quarter and 14% from a year ago, again demonstrating the strong core operating potential of the Bank and the improvement in core earnings as a result of restructuring and the improvement in our core operations.

Loans grew to $15.2 billion, up from $14.6 billion a year ago. Delinquencies continue to decline, signifying reduced credit cost in future periods. TCF has changed its strategy and returned to its roots with our reintroduction of Free Checking. Early returns show increased originations and decreased attrition as a result of those changes.

Total core revenues totaled $298 million in the quarter, up 10.8% from the first quarter, again demonstrating the power of the growth in our balance sheet. Fee income was up 12.4% and margin was up 10%. Retail banking fees were up 15% from the first quarter, part of that at least was seasonal. We did have a gain on the sale that included the sale of our Visa Class B stock, the gain of some $13 million. Most of that gain was offset by one-time accounting or provision charges eating up that gain.

We sold some $144 million in auto loans at a gain of $5.5 million for the quarter. These were mostly the lower FICO-score auto loans, and that’s a core-earning provision for us as we expect to continue to sell auto loans on a quarterly basis. Even after that sale, auto loans on the balance sheet now total $262 million, up from $139 million in the first quarter. Those loans yielded 6.98% in the second quarter. Originations remain strong and we expect, in fact, them to improve. The quarter-to-quarter decrease in inventory finance loans was seasonal, as was predicted.

Charge-offs remain below peak levels, and leading indicators are positive. Provisions included several one-time items totaling some $10 million. Deposit growth remains strong, we’re now at over $13 billion and that included an $800 million deposit acquisition that we completed.

Interest expense on deposits was only about $10 million for the quarter versus interest income of $219 million. Borrowing only cost $10 million, down from $48 million a year ago, again demonstrating the power of the restructuring that we did. Interest expense in our margin at TCF is only 9% of interest income, one of the lowest rates in the banking business, one of the big contributors to our strong net interest margin.

Core expenses are up due to the growth of our emerging businesses. For instance, we added some 50 people in the auto origination business. And even with that additional people, the auto business, which is a new business started for us at the beginning of the year, was profitable in the quarter. We expect to lever the operating expenses that we’ve added into our core businesses, business expansions, as we grow the balance sheet around those businesses, and that is indeed happening.

TCF remains strongly capitalized. We raised both the preferred and sub-debt during the quarter and we announced the call of our $115 million of 10.75% trust preferreds, and I think that’s callable at the end of this month.

The first half of the year, saw significant changes at TCF. We did the restructuring, the management reorganization. We got Gateway auto up and running. We acquired the BRP outstanding, some $650 million. We’ve gone back to our roots on our pricing, reintroducing Free Checking and changing our pricing among most of our product structure in the retail banking side.

We did the preferred and the sub-debt and we called our trust preferreds along with a number of other things. So it was a very active first half of the year. Second half of the year, we expect to get down to it and benefit from some of those changes, all of those changes, that we worked on so hard in the first half. We are now in a much better position to capitalize on these efforts in the second half of 2012 and going into 2013.

With that I will open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Jon Arfstrom of RBC Capital Markets.

Jon Arfstrom – RBC Capital Markets

Hey, thanks. Good morning, guys.

William Cooper

Hi Jon.

Jon Arfstrom – RBC Capital Markets

Just a couple of questions. Bill, I’m wondering if you could expand a little bit on your comment about the gain that you took being offset by some one-time provision charges, or being eaten up by one-time provision charges. Can you walk through what would be considered unusual in the provision this quarter versus what a provision run rate might look like?

William Cooper

All right. Mike, you want to handle it?

Mike Jones

Yes, we had probably about three things within the quarter that were one-time in nature that you wouldn’t see on a run rate going forward. The first one is related to trial modifications. There has been a lot of press as well as a lot of guidance coming out from the regulators and the SEC around how we account for trial modifications and when do you deem those to be TDRs. In the quarter we made that change and basically all trial modifications effective in the quarter were deemed to be TDRs and thus reserves established on those.

Additionally, related to those from a TDR status, a lot of clarity around the level of reserves that you maintain on modifications, even when those modifications come back and return to their full payment in contractual terms, or original contractual terms, prior to the modification. So that amounts or resulted in an increase in reserves associated with TDRs that would not happen on an ongoing basis.

Also, I think you identified in the press release, we talked about one large leasing exposure that resulted in the quarter. This is a business that typically doesn’t have these type of charge-offs and reserves associated with them. So we posted about a $4 million reserve in the quarter associated with that credit.

William Cooper

All of that, Jon, adds up to about $10 million.

Jon Arfstrom – RBC Capital Markets

$10 million, okay. Are you seeing anything in terms of the consumer charge-off trends, I know it’s jumped around historically, and it hasn’t been predictable, but is there anything happening there that’s different?

William Cooper

Actually it has been fairly predictable. Craig, you want to speak to that?

Craig Dahl

Yes, it has been I think fairly stable, and we are seeing declines in delinquency as well. So the trends are headed right now the right way.

William Cooper

We had the lowest charge-off on consumer in June that we’ve had in two years. Whether that’s a trend or not remains to be seen.

Jon Arfstrom – RBC Capital Markets

Okay. All right. Thank you.

Operator

Your next question comes from the line of Erika Penala of Bank of America/Merrill Lynch.

Erika Penala – Bank of America/Merrill Lynch

Good morning. Your deposit service charges had a nice boost this quarter to $48 million. I’m wondering as we look forward, and you mentioned, Bill, that you’re going back to your roots in terms of offering Free Checking. What we can expect for that line item in terms of the quarterly run rate, taking into account less seasonality going forward as well as going back to Free Checking.

Earl Stratton

This is Earl Stratton. Actually as we make those changes there are some numbers in the mix that are going to change. Obviously we’re giving up monthly fee revenue, but we’re also giving up high-value premiums that we pay to acquire accounts and investing some of that in marketing. So overall we believe it’s a good exchange of punts, but it will take a while for the numbers to settle in. We have an investment to make in getting the Free Checking understood by the consumer and understood by our customers. Tom, did you have a comment?

Tom Jasper

Yes, Erika, it’s Tom Jasper. When you look at the 15% increase, there is always seasonality in the numbers that we have within that line item. And I would say, of that 15% increase, about 10% is related to seasonality. The other potion of the increase is related to the changes in the product lineup that we made and we talked about in the last call late in the first quarter and the impact of those changes throughout the second quarter.

Now when we make those changes, there are trends. It does take a long time for some of those changes to work through, because as customers attrite or we have some of those trends that take 60 days sometimes past when those changes went into effect for us to see the full impact. So we expect to see more of a normalized run rate in third quarter versus second quarter because we still have some spillover from fourth quarter activity in first quarter results. Does that make sense?

Erika Penala – Bank of America/Merrill Lynch

Got it. And just my second question, and then I’ll step out of the queue, is on capital. I was wondering if you could give us a sense of what your Tier 1 common would look like under Basel III? And given that you have really done a good job in terms of executing your strategy with regards to diversifying away from just servicing the consumer, I’m wondering if any adjustments or having the NPR out inhibits you from growing at the pace in terms of portfolio acquisitions or et cetera?

William Cooper

Mike, can you handle it?

Mike Jones

Sure, Erika, this is Mike Jones. In our review of the notice of the proposed rulemaking, I’ll just give you a rundown of how we look out at the two different rulings – rulemakings that came out. We don’t expect a significant change to the numerator in our capital calculation. As you might remember and the people on the call might remember with the balance sheet repositioning, we reduced our exposure to securities available for sale and we expect to have a lower risk profile on the issue of capital volatility due to mark-to-market risk. So really no significant changes to the numerator based on the notice of proposed rulemaking.

As it relates to our Tier 1 common, we estimate the reduction to be approximately about 150 basis points driven by risk-weighting changes, mainly in our consumer resi portfolio. This adjusted level puts us above the fully phased-in level of 7% by 2019, so we’re comfortable with that. In addition, I would add that the phase-in period gives us enough time to react, and as you mentioned the consumer, and we’re repositioning the portfolio more away from the first-lien consumer resi portfolio on a go-forward basis.

Erika Penala – Bank of America/Merrill Lynch

Got it. Thank you.

William Cooper

You’re welcome.

Operator

Your next question comes from the line of Paul Miller of FBR Capital Markets.

Paul Miller – FBR Capital Markets

Hey, thank you very much. Hey, a follow-up on Erika’s questions on the run rate of the fees and service charges. You said that it’s not fully – I mean, going back to Free Checking, you’re not getting the full impact this quarter. So can we look for another, outside of seasonality, another 10%, 20% increase in that line item? How should we look at it going forward, especially going into the third quarter?

Tom Jasper

This is Tom Jasper. I’m not going to put any numbers on that. But we made the move going back to Free Checking to get an increase in fee income. We’re going to be spending less as it relates to those deposits, the premiums in order to open accounts. But the onset here, we’re really relying on a strong marketing campaign and a strong Tell-A-Friend program.

So getting Free Checking out to our customers late in June, we’re waiting to see the reaction to that. Customers are giving their first statement with that pre-notice, we converted the entire base over. We expect to see an increase beyond the seasonality, typical seasonality increases in that line going forward. But I’m not going to hazard a guess right now as to what that level will be.

Paul Miller – FBR Capital Markets

Okay. Yes, that’s fine. And then moving down to the – you might have said this earlier, but I have been jumping around today with all these releases, the gain on sale of auto loans. Is that a – I know that’s also got some seasonality behind it. But can that number go up as you ramp that up, or is that going to be – that $5.5 million a good run rate going forward?

William Cooper

See, my judgment, this is Bill Cooper speaking, it is now a core operating profit for us, and it will be a function of origination and our appetite for what we want to keep versus what we want to sell. And I would hesitate to predict what it would be quarter-by-quarter, but it over time should continue to be a contributor in terms of our core operating income. Craig, would you agree with that?

Craig Dahl

Yes, I’d agree with that.

Paul Miller – FBR Capital Markets

Okay. Hey, guys. Thank you very much.

William Cooper

You’re welcome.

Operator

Your next question comes from the line of Matt O’Connor of Deutsche Bank.

Matt O’Connor – Deutsche Bank

Hi, guys.

William Cooper

Hi.

Matt O’Connor – Deutsche Bank

Clearly part of the rational for bringing back the Free Checking is to increase deposit levels as well over time and to fund some of the loan growth. Can you just talk a bit about what the loan growth might look like the next several quarters from here?

William Cooper

(Inaudible).

Mike Jones

Well, I think it’ll be a continuation of the pattern you’ve seen, our especially financed businesses, primarily auto finance, will lead the second-half increase, but we’ve also seen some excellent growth in the commercial portfolio as well. One of the sort of wildcards in predicting the consumer book though is the speed and level of pre-payments, so we’re monitoring that as well. But we’re looking for a continuation of the second quarter trends through the third and fourth quarter.

Matt O’Connor – Deutsche Bank

And as we think about the net interest margin, came in a little bit higher than what you had expected this quarter. I would imagine a NIM this high is a little bit hard to maintain, not only in this rate environment but also as you grow the loan book. How should we think about the NIM trending? I think you’ve talked about above 4.60% over time, does that still hold? How quickly do we get there?

William Cooper

If you look at the – in the press release, we have a schedule in there that shows the yields on our loans and our cost of funds. And as I mentioned in my presentation, our interest expense today in the first quarter was only $20 million against interest income of $220 million. And that $20 million, $10 million of it was deposits on $13 billion of deposits and $10 million of it was on borrowings.

One of the stories about that, there isn’t much to go there. I mean it’s pretty difficult to reduce that number in a significant – it’s not a big significant number as it stands.

When you look at the comparison this year to a year ago, we had kind of a race in the balance sheet. We reduced the lower yielding assets of mortgage-backed securities by the restructuring in that sale, some of the lower – some of the higher-yielding assets have refinanced and come in at lower rates and our more standard businesses, the yields on those businesses, came down somewhat. The consumer, the commercial, et cetera. But while at the same time, the yield on some of our new businesses, which are growing businesses, the inventory, finance and the auto businesses, which carry higher yields, offset that.

And so it’s interesting when you look year-to-year, we kept pretty much the same yield on our assets, I think it was 5.34%, speaking from memory. And I think that was an excellent job doing that, but it is going to be difficult to continue that for the balance of the year. And with rates low and even lower, we’ll probably see some reduction in that very high net interest margin over the pull and somewhere around 4.60%, 4.65% is probably a better run rate on that level than it was in this quarter.

Matt O’Connor – Deutsche Bank

Okay. And how long does it take to get to that 460, 465? Is that by the end of the year or at some point next year?

Mike Jones

I would think, this is Mike Jones. I would think it would rebalance over a 12- to 18-month period as we look out.

Matt O’Connor – Deutsche Bank

Okay. Thank you very much.

William Cooper

One point I’ll make by the way, this isn’t an encouraging note, but it’s important to note, that with TCF’s balance sheet, TCF’s margin and net interest margin income will increase at higher rates. We’re inherently a more profitable Bank because of our large zero and near zero funding deposit base, which doesn’t go up much, if at all, in rising rates. And with when rates do rise, which doesn’t look like it’s going to happen anytime soon, but when they do, that margin rate can improve going forward.

Operator

Your next question comes from the line of Craig Siegenthaler of Credit Suisse.

Craig Siegenthaler – Credit Suisse

Thanks, guys. Good morning.

William Cooper

Good morning.

Craig Siegenthaler – Credit Suisse

First, just looking at the auto finance portfolio, I’m wondering do you have a target on how large this portfolio could get, either as a percentage of total loans or on a dollar basis over the next few years.

William Cooper

Neil, you want to handle that?

Neil Brown

Inventory or auto?

William Cooper

Did you say auto?

Neil Brown

Auto.

Craig Siegenthaler – Credit Suisse

Yes. Auto finance.

Neil Brown

Well, this is Neil Brown. We have plans as it relates to that auto finance portfolio. As you know, we’re a relatively small player within the industry, so we have plenty of room to grow, but it is a business that we’re going to move with forward cautiously and diligently. And I think over the near-term, you’re going to see growth rates consistent with what you’ve seen this quarter.

Craig Siegenthaler – Credit Suisse

On a dollar basis?

Neil Brown

Yes.

William Cooper

Yes.

Craig Siegenthaler – Credit Suisse

Okay. And then just looking at the size of your securities portfolio now, after all the changes you made over the last three months, I’m wondering how should we expect this portfolio to either grow or shrink, given where rates are where they are now?

Neil Brown

Well. As it refis, the mortgage-backed security – and our mortgage-backed security portfolio is pretty vanilla. I mean...

Craig Siegenthaler – Credit Suisse

Yes.

Neil Brown

They are standard. It refis, we buy some to kind of keep it where it’s at and that will tend to slowly tick the rate down, as is happening in the portfolio as a whole. I would not expect to see it grow in its dollar amount for where it currently is. Is that fair to say?

Tom Jasper

Yes. This is Tom Jasper. Everything that we’re doing on growing deposits is centered around funding our loan and lease growth. And so we’re not taking any actions, specific action, to try to increase the size of the securities portfolio. It’s more of a fall out of all the actions and seasonality and balances, et cetera.

William Cooper

I’ll just point out by the way on that question, TCF’s loans are almost – are about 85% of its assets. That compares to our peers that are about 65%, is that right, Neil? It’s about right there. So TCF is a loan-funded bank and that is one of the things that – and we consider ourselves to be, in connection with the banking business, in the lending business, not in the investment business. We keep investments to maintain a satisfactory level of liquidity and to manage our interest rate risk in various ways.

And so we don’t really look at that as a profit center and we consider it to be – those banks that carry a significant portion of long-term marketable securities, as is apparent in this new Basel rule, there could be a very significant mark-to-market with rising interest rates that’s a risk that I don’t think is commonly perceived in the banking industry. It was one of the things that we significantly mitigated in connection with our restructuring, is reducing that risk of a significant mark-to-market when rates rise.

Craig Siegenthaler – Credit Suisse

Great. Thanks for taking my questions.

William Cooper

You’re welcome.

Operator

Your next question comes from the line of Steven Alexopoulos of JP Morgan.

Steven Alexopoulos – JP Morgan

Hey, good morning everyone.

William Cooper

Hi.

Steven Alexopoulos – JP Morgan

I wanted to start, regarding the $4 million provision on the one leased loan, was this lease from one of your new businesses you’ve gone into recently? And can you talk about the size of the total loan?

William Cooper

No, it was not one of our new businesses. It’s one of our mature businesses, very unusual transaction. It was a customer that frankly has been in the newspaper, has become a surprise problem. Our exposure in the loan is $6 million. We’ve reserved it up $4 million, which is our estimate of what our collectable balance is. We do have a – what we call discounted a significant portion of this exposure. The accounting leaves it on the balance sheet. So it’s in the nonperforming category, but we do not have any risk exposure on it because it had been discounted. So our real exposure is $6 million and we’ve reserved $4 million.

Steven Alexopoulos – JP Morgan

Got you. Bill, I wanted to follow-up, given the pro forma Tier 1 common ratio, I guess around 7.8%, and, like you just said a few minutes ago, now you’re loan funded or loan growing, how do we think about the need for additional capital going forward to support this growth?

William Cooper

One of the things, the – in terms of this Basel thing, remember it is a proposal at this point, and it’s a proposal going into I think 2018 or something?

Earl Stratton

2018.

William Cooper

2018. And that gives us a fair amount of time to restructure things to fit within those risk categories, because that’s really the only practical import it has for us is in effect a denominator in connection with the calculation of those capital ratios. And the denominator gets bigger in some cases, because of the structure of your loans or other assets. And that we’re going to have an opportunity to address some of those things over time.

Over the pull, from a reality perspective, your retained earnings is what finances loan growth. And you can fill up some of the other buckets in terms of some of these other capital ratios with subordinated debt, et cetera, to meet those capital requirements.

Steven Alexopoulos – JP Morgan

Okay. And just one follow-up question. I think I asked last quarter on customer attrition, I think you said it was too early to tell. Now that we’re a quarter later, are you able to tell on customer attrition trends and has it turned with the reintroduction of Free Checking? Thanks.

William Cooper

I’ll put it this way, the exit polls are positive. Okay? The election results aren’t out, but the exit polls are positive. We’ve seen preliminary good data on origination and attrition. Is that fair to say, Earl?

Earl Stratton

That’s fair to say.

Steven Alexopoulos – JP Morgan

Thanks for all the color.

Operator

Your next question comes from the line of Scott Siefers of Sandler O’Neill.

Scott Siefers – Sandler O’Neill

Good morning, guys.

William Cooper

Hi.

Scott Siefers – Sandler O’Neill

Just wanted to revisit this overall credit quality issue. You’ve’ given some color in response to previous questions, which I appreciate. But just looking for example at the provision, even if you pull out that $10 million, it’s still a kind of elevated level. And I think one of the frustrations has been the stickiness of your non-performer base as well. I know in the past, you’ve talked about a much more meaningful improvement in credit in the second half of the year. Is that something you’re still comfortable with or is kind of stalling out? What are your expectations there?

William Cooper

The big number in our provision is still our consumer loans, and there are positive indicators in that area. As I mentioned, June was the best charge-off month that we’ve had in several years and our delinquency levels are low, that’s the leading indicator of problems in that portfolio. Our especially finance businesses are all doing very well. We had this one bubble up that we just talked about that, but that’s a one-time event and that will happen every couple of years.

The commercial, where it’s still the onesies and twosies. One of the things I’ll mention, and when you look at our non-accruals in the commercial, 80% of the non-accrual loans in our commercial portfolio are current, and most of them have never been delinquent. Now we’ve got some more provisions and some more charge-offs to come in that area, but I think I personally can be relatively optimistic in most of our areas that we’re going to see good credit parameters. There could be a couple more, in this environment in particular, a couple more relatively larger one-time charges in that commercial portfolio. And Craig, would you have anything to add on it?

Craig Dahl

No.

Scott Siefers – Sandler O’Neill

Okay. Thank you.

William Cooper

Yes.

Operator

Your next question comes from the line of Emlen Harmon of Jefferies.

Emlen Harmon – Jefferies

Good morning. Just a couple of quick questions on the asset growth side of things, are you guys had announced the independent boat inventory finance deal last night. I was just hoping you can give us a size of – or sense of the size of that opportunity in terms of assets and when you’d expect that business to start to come on to the books?

Craig Dahl

Yes. This is Craig Dahl. The IBBI is a marine purchasing co-op and they have 22 boat builder members. We signed an agreement with them which now gives us the opportunity to provide inventory finance to them. We do not have any programs signed with those 22 boat builders at this time, but that was the first step in the new program acquisition process.

William Cooper

The answer to that is, we don’t know.

Emlen Harmon – Jefferies

Okay. Got it. And then I heard your comments earlier on auto, and you don’t expect to add a whole lot more to the balance sheet, but just from an origination perspective, you guys were around I think $300 million this quarter when you add up what was sold and what was added to the balance sheet? Are you at capacity in terms of where that organization is today? How much could those grow going forward?

William Cooper

We are not at capacity and we do plan on adding balance sheet. We plan on continuing to originate and sell as we’ve done over the last couple of quarters, and we do plan on growing the balance sheet and probably at an accelerated rate. And we are not at capacity in that business. That is a huge business, the auto business, and we’re just a drop in the rain bucket in terms of that business. We’ve significantly expanded our dealer basis and we’ve significantly expanded the origination capacity staff. That’s why we added the 50 people in auto and so forth. And so we are not where we’re going to be in that thing by a long shot. Again is that fair to say?

Earl Stratton

Right on, Bill.

William Cooper

All right.

Emlen Harmon – Jefferies

Right. So if we say like $300 million in originations in total this quarter and then, of the staff that you have today, what’s the capacity that that group has?

Earl Stratton

Well, I guess we wouldn’t really talk about it in that basis, but we would look to increase originations in the third quarter from the fourth quarter with the existing staff.

Emlen Harmon – Jefferies

Okay. Thanks. I appreciate the time.

William Cooper

All right.

Operator

Your next question comes from the line of Dan Werner of Morningstar Equity.

Dan Werner – Morningstar Equity

Good morning. With regard to the Prudential deposit acquisition, could you give me or could you provide an average cost of those deposits? And then, in terms of runoff going forward, what are your thoughts there?

Mike Jones

This is Mike Jones here. We don’t really – we haven’t talked about the average cost of those deposits to us. What we have disclosed is that we feel that those are at market. If you want to look at that portfolio, we believe that the majority of it, probably 85% of it, is very sticky in nature and is a good source of funding for the organization and will be with the organization for an extended period of time. The other 15% we would envision, those are basically brokerage CDs, would runoff over their duration and that’s how we’ve modeled it.

Dan Werner – Morningstar Equity

Okay. And then a second question. With regard to the auto loan servicing portfolio, with that business, generally what kind of servicing fee do you generate? Is it a 10-basis-points, 25, 50? I’m not familiar with that and where would I find that in the fee income statement?

Mike Jones

We haven’t disclosed that before on that specific line item. What we believe is that we’re getting the market rate for that servicing, and that is on that total managed portfolio that we’ve sold and continue to service.

Dan Werner – Morningstar Equity

Okay. All right. Thank you.

Operator

Your next question comes from the line Chris McGratty of KBW.

Chris McGratty – KBW

Sure, good morning guys.

William Cooper

Hi.

Chris McGratty – KBW

I had a couple of questions on the expense line. Saw the pickup in the advertising and marketing, I assume that’s the return to the Free Checking. If you could elaborate if that’s an elevated number that will continue for few quarters or is it going to gravitate lower towards then?

Tom Jasper

Hey, Chris, it’s Tom Jasper. Really what I would look at is, look at the deposit account premiums in the advertising and marketing on a combined basis. And that’s a little bit over $7 million in the quarter, and it was elevated due to all the front-end development work that went into our Free Checking campaign. I’d expect that a run rate in future quarters is going to be about a 25% reduction from that number on a combined basis between the two lines as we settle in. And to the extent that we have any increase, I’d view that as a good thing, as really what we’re relying on in the premium line is our Tell-A-Friend campaign, which is a really good way for us to increase our customer base within the checking group. So that’s how I would look at it on a go-forward basis.

Chris McGratty – KBW

Okay. And another one on the expense. The FDIC insurance is up a couple of million bucks. Can you just maybe give us a little help on the outlook there?

Mike Jones

Yes, this is Mike Jones. I mean there are a couple of things. The asset growth drives that a little bit within the quarter and will continue to drive some of that in that percentage as we go forward in the future. Additionally, the insurance rates increased for us due to – as anticipated by us due to the net loss associated with the balance sheet repositioning. And that’s a four-quarter look at your profitability and where it puts you on the grid from an insurance rate standpoint. So we would have that continue throughout the rest of this year and then fall off into 2013.

Chris McGratty – KBW

Okay. Last one, on the Basel III question before, the guidance is helpful. Can you just remind us your comfort level in terms of absolute ratios? I know it’s a long way away, but where is that level of Tier 1 common likely to be managed to longer-term?

William Cooper

I don’t really think we are prepared to – but that Basel thing is just brand-new. It’s proposed, there’s still a lot of ambiguities in it and it’s open for comment and I don’t think we’re prepared at this point to give a lot of comfort in terms of where our numbers will fall in there. Is that fair to say, Mike?

Mike Jones

That’s fair.

Chris McGratty – KBW

Thanks.

Operator

Your next question comes from the line of Terry McEvoy of Oppenheimer.

Terry McEvoy – Oppenheimer

Thanks, good morning.

William Cooper

Good morning.

Terry McEvoy – Oppenheimer

First question, the full impact of the staffing build-out, do we see that in the second quarter particularly as it relates to the comp and benefit line?

William Cooper

Which build-out did he say?

Terry McEvoy – Oppenheimer

Just the staffing build-out in some of the specialty lending businesses?

William Cooper

I think we’ve done most of that. In the expansion businesses, both the inventory finance, the auto business, that that staffing increase – now it did slide in through the whole quarter. So you are going to get an elevated level from that, but we are pretty much done with that.

Just let me give you a little more color on that, where that really goes with us. First of all, absent that, our expense control on comp and so forth has been very strong and is down. We’ve actually cut expenses in lots of parts of the bank that weren’t producing these kinds of revenues. But the key again is, you put 50 people on and you add $100 million of outstandings, that isn’t a good exchange of punts. But you put people o n and you add a $1 billion of outstandings, that’s a real good exchange of punts. And that’s where we’re heading with those expense additions. You put the people on and then you put the people on later – the business on later.

Terry McEvoy – Oppenheimer

And then just my second question, back on the fee income. I just want to make sure I understand correctly, monthly fees are going away and I was wondering, has TCF ever disclosed the size of those fees and how meaningful have those fees been in recent quarters as I look at the fees and service charge line?

William Cooper

We haven’t disclosed them, and frankly I can’t remember what they are. But I’ll tell you this, what was happening is they were going away anyway. People were changing their behavior. There is a very concerted consumer unhappiness with that monthly fee. And one of the reasons that we made the change we made is, we went and talked to our customers and asked them what it is they wanted and how they wanted to do their banking. And that is the one fee that they really strongly objected to.

I’ll just say this about it in terms of looking at the strategy, we’re back to a situation where our biggest competitors in this world are the huge mega banks, all of which have significantly increased their fees. This is where we stood back in 1986 when we introduced this product. We had it for ourselves for 10 or 15 years. Everybody copied the product and it became pretty banal.

We’re back to a situation in most of our markets where we are going to have a significant competitive pricing advantage in connection with that product, and we’re not big enough in connection as a competitor with these mega banks for them to change their strategy to compete with us. And that’s where we were a long time ago and that’s where we are today. That strategy worked well back then and hopefully it will work as well this time.

Terry McEvoy – Oppenheimer

Great. I appreciate it. Thank you.

Operator

Your next question comes from the line of Andrew Marquardt of Evercore Partners.

Andrew Marquardt – Evercore Partners

Good morning, guys. Thanks. Just back on the deposit service fees. So there is some seasonality this quarter which will go away, and then the Free Checking. So in terms of net new product rollout, how should we think about the loss revenue there mitigated by the net new checking accounts? Should we roll into the mid-40s, low 40s, in the back-half of this year, and obviously there’s going to be some offset in the expenses as you mentioned?

Tom Jasper

Andrew, its Tom Jasper. So at the end of the day the reason that we went back to free is to try to leverage up the branches by getting more customers into the stores, and we’re literally 30 days into that coming off the announcement of launching that campaign. Our success on the fee line on a go-forward basis is going to be directly tied to the number of customers that are banking in our stores. So I’m very confident around our sales team and their ability to sell the product. I think we have a very good marketing position with where we’re at within the competitive set. But as we look at it going forward, we’re going to have to grow the checking base in order to get – in terms of number of accounts, in order to achieve those results.

That’s how I would think about it on a go-forward basis and literally less than 30 days into the campaign, it’s tough for us to give you any type of perspective guidance related to that line item.

Andrew Marquardt – Evercore Partners

Got it. And do you have a goal in terms of when you think you’ll have -you’ll move over the blip in terms of going to net growth in checking accounts versus attrition, is it by year-end or how should we think about that?

Tom Jasper

It’s right now, it’s this quarter.

Andrew Marquardt – Evercore Partners

2Q or 3Q?

Tom Jasper

3Q.

Andrew Marquardt – Evercore Partners

3Q? Great. Okay. And then if you could tack on credit quality and cost, I just want to make sure I understood. So it sounds like $10 million of costs in the quarter, that won’t repeat. So should we think about the base run rate should be in the $44 million range and then it’s going to be lumpy from there? Is that fair, did I understand that correctly?

Mike Jones

Well, I think – this is Mike Jones. I think you can think of it in that way, it’s just the wildcard is what happens with commercial, and because of the lumpiness nature of those credits and the ones that we have to work through. And I think Bill said it before and we’ve talked about it before, I think all of those credits are known. We’ve got them fencepost in. Now it’s just working them out and which direction that they ultimately fall and go.

William Cooper

Let me mention one other thing about that in terms of the commercial, I don’t think we have a criticized asset that we’ve made since 2010. And these were older problems that originated because of the depreciation and values associated with – the collateral associated with these ventures and they are clicking down. I mean we’re working them through and over time they’ll go away.

Andrew Marquardt – Evercore Partners

All right. Thank you.

Operator

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

Stephen Geyen – Stifel Nicolaus

Hey, good morning. Just one question on the season decline in the inventory finance. I was just curious maybe how quickly it could build and maybe if there is some other offsetting seasonal business lines or relationships that could help out there?

Craig Dahl

This is Craig Dahl. As we disclosed at the end of first quarter call, the March timeframe is our seasonal peak because of the carryover of winter product and the introduction of the spring product. So nothing that happened in the quarter was a surprise to us and we should see it close to the first quarter number by the end of the year.

Stephen Geyen – Stifel Nicolaus

Okay. Thank you.

Operator

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

Peyton Green – Sterne Agee

Yes. A couple of unrelated questions. First on the indirect business, the dealer growth was about 29% or so in the first quarter and it was very strong again in the second quarter. Where do you see saturation in terms of number of dealers that you would expect to penetrate? And then how much of the volume that you originated in second quarter was a result of volume or of the dealers that you added in the first quarter?

William Cooper

Okay. The second question, I don’t have the answer for that. Dealers added in the first quarter, I can get that but I don’t have that with me. As it relates to the pace of dealers, we would expect to go beyond 10,000 dealers when this gets to our mature state. And so as we hire the new sales teams, they’re in new markets and so their initial business development activities are signing up new dealers. And so that’s what is driving the dealer increase.

Peyton Green – Sterne Agee

Okay. Is it fair to say that the bulk of the growth in the second quarter is really just a function of giving Gateway capacity versus their standalone?

William Cooper

Yes. I would say it’s the expansion of the product set with our cost of funds and their origination model.

Peyton Green – Sterne Agee

Okay. So really too early to see a huge slip from the dealer growth in the first and second quarter until probably sometime later this year or next year.

William Cooper

Yes, but you have to keep in mind that our model is really only about two to three transactions per dealer, so it’s – per month, excuse me. So it’s not a sign up a dealer and try to do 70% of it as used volume. So it’s a diversification strategy across geographies and across the number of dealers.

Peyton Green – Sterne Agee

Okay. And then, unrelated, you all mentioned you’re more optimistic about credit on the consumer real estate book, and the 60 day past-dues have improved fairly modestly or slightly. What makes you more optimistic as you sit here on July 20 compared to say year ago or even in January?

William Cooper

We do a lot of modeling in connection with that business and it is very subject to modeling. There is a whole bunch of loans there and there is a lot of parameters that go into that thing and the modeling as a whole is what makes us a little more optimistic going forward. Mark, is that fair to say.

Mike Jones

Yes.

Peyton Green – Sterne Agee

Okay. And I guess maybe to ask it another way, where are you seeing changes geographically, Illinois versus Minnesota versus Michigan I guess?

William Cooper

Illinois and Michigan are our poorest market, and I would say Illinois is the poorest market and the political situation in Illinois as it relates to foreclosures and so forth is not good, in terms of how they handle that stuff. It’s an economy that hasn’t come back like other places have. In the housing, prices haven’t rebounded. A lot of things they have done to forestall foreclosure, they were also done to reduce recovery, in my opinion at least. Minnesota is improved considerably as is Denver and even Michigan and Wisconsin. So the tough part for us is Chicago and a very significant portion of our problem assets are in the Chicago market.

Peyton Green – Sterne Agee

And just in general, how much of your consumer real estate is in Illinois, or Chicago?

William Cooper

38%.

Peyton Green – Sterne Agee

Okay. All right, thank you.

William Cooper

38% and shrinking.

Peyton Green – Sterne Agee

Okay. All right, and then one follow-up on the TDR. So I mean the bulk of the increase was simply moving the modified but non-TDR piece into TDRs. So now...

William Cooper

Yes.

Peyton Green – Sterne Agee

So going forward, if we see a decline in TDRs, there is not likely to be another reclassification, I guess is a better way to say it.

William Cooper

No.

Peyton Green – Sterne Agee

How much was the reserve that was established on the piece that goes into performing?

William Cooper

$1.6 million, was it?

Mike Jones

No. That was approximately around $2 million.

Peyton Green – Sterne Agee

$2 million?

William Cooper

This whole TDR accounting thing just continues to evolve from an accounting perspective, and a lot of this stuff, what it simply does is accelerate what was going to happen in subsequent quarters, and so it piles into these quarters and that’s kind of the way this is all worked.

I would like to mention something about consumer TDRs, again I mention this each quarter. These things don’t go away. Once a consumer TDR is identified as a TDR, it pretty much stays there forever until it pays off. Now one of the things I’ll say about our TDR, $450 million or whatever that is, almost 80% of those are pass. Is that the right percentage? And what that means is that they haven’t missed a payment in over six months. They are not classified. And it is as easy to overestimate, what – and we sit there with a 14% whatever reserve on it, on those credits. And it’s easy though because it’s been given a particular classification that never goes away to look at them as an emerging problem, and I think those that have gone into a payment status in our pass credits, we can look at differently than the balance of them.

Mike Jones

Yes. Those numbers are 72% and the definition of those are loans that are current and have not been delinquent for at least six months.

William Cooper

And that’s not your everyday TDR in the banking business. This is not your sub-prime bad customer, et cetera. It’s a different kind of – TCF never engaged in that kind of business and these are people, these are good people trying to work out of a difficult problem when a bad thing happen to a good person.

Operator

(Operator Instructions) Your next question comes from the line of Tom Alonso with Macquarie Securities.

Tom Alonso – Macquarie Securities

Thanks, guys. As you might imagine at this point most of my questions have been answered. Just one on the Prudential CDs, just looking at the change in the cost on a linked quarter basis, it seems like it jumped up. I’m assuming that’s from what you acquired. I assume over time that 85% that you keep, there is potential to bring that down?

Tom Jasper

Yes, this is Thomas Jasper. There is really two things though that happened in the quarter. We did have the acquisition. We also did run some CD campaigns in the quarter and that impacted the overall volume. In total, during the quarter we added about $450 million in CDs through the non-Prudential acquisition, outside of that Prudential acquisition. And of that, about 84% of that was pure incremental growth through the organization. And so the pricing on that, we ran various specials between 11 months and up to I think 23 months in the quarter at around 1%.

Mike Jones

Tom, this is Mike Jones, and I would just add that we do have the flexibility around those deposits to re-price those and we will balance those based on market and maintaining a good deposit base, in our organization.

Tom Alonso – Macquarie Securities

Okay. Fair enough. Thanks guys.

William Cooper

Thank you.

Operator

There are no further questions at this time.

William Cooper

Thank you very much. You all have a good day.

Operator

This concludes today’s conference call. You may now disconnect.

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