TCF Financial Corporation
Q1 2017 Earnings Call Transcript

Published: 24 Apr 2017

[Operator:]

Good morning, everyone, and welcome to TCF’s 2016 second 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 will be a question-and-answer period. [Operator Instructions] Please also note today’s event is being recorded. At this time, I’d like to introduce Mr. Jason Korstange, TCF Director of Investor Relations, to begin the conference call.

[Jason Korstange:]

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; Mr. Bill Henak, Executive Vice President, Wholesale Banking; and Mr. Jim Costa, our Chief Risk Officer and Chief Credit Officer. During this presentation, we may make projections and other forward-looking statements regarding the future events or future financial performance of the company. We caution that such statements are predictions, that actual events or results may differ materially. Please see the forward-looking statements disclosed in our 2017 first quarter earnings release for more information about risks and uncertainties, which may affect us. The information we provide today is accurate as of March 31, 2017 and we undertake no duty to update the information. During the remarks today, we will be referencing a slide presentation that is available on the Investor Relations section of TCS’ website ir.tcfbank.com. On today's call, Mr. Dahl will begin his first quarter observations and update on our auto finance strategy. He will then discuss revenue, loans, leases and credit. Mr. Maass will discuss expenses and deposits, interest rates and capital. Mr. Dahl will then provide closing comments and opening up for questions. I will now turn the conference call over to TCF Chief Executive Officer, Craig Dahl.

[Craig Dahl:]

Thank you, Jason. Good morning. As we begin 2017, we’re going to continue to operate with a focus on our four strategic dollars. We reported net income for $46.3 million, which is down 3.7% year-over-year. Last quarter, we indicated we will be conducting a strategic reassessment of our auto finance business. This was completed during the first quarter and we began implementing changes. We’ll provide more details on this in just a minute. We also lowered our risk profile through a $49.4 million consumer real estate non-accrual loan sale during the quarter, which resulted in an $8.7 million recovery. We are seeing the benefit of higher interest rates through margin expansion on both a dollar and percentage basis. In addition to a one-time charge related to changes on auto, strategic investments in technology drove additional expenses during the quarter. Also, we have strong growth in our wholesale lending and checking and savings deposits on the balance sheet. And similar to other banks, we have a lower tax rate related to new stock compensation accounting guidance. Turning to slide four, the auto finance strategy background, we conducted a detailed reassessment of the auto finance business over the past few months. Our initial strategy in auto have been successful as they have generated asset and revenue growth and increased our portfolio diversification and helped fund the expansion of the business. However, based on the reassessment and changing market conditions, we have decided to make changes to the strategy that will allow us to increase the profitability, reduced earnings volatility, and reduced capital, liquidity and operational risks related to the gain on sale model moving forward. Turning to slide five to the auto finance strategic shift. We are in the process of implementing several key strategic changes within the business. Many of these changes have already been made, but it will take some time to see the full impact. We’re going to significantly reduce overall originations in auto by 30% to 40% and we’re going to transition from reliance on gain on sale revenue to an originate-to-hold model. These actions will result in increased earnings predictability. In response to market conditions, we have tightened credit underwriting standards within each loan credit grade. And corresponding to the origination decrease, we are optimizing expenses across all functions of the auto business, including sales and servicing. Our expected full year reduction in headcount of approximately 200 employees in 2017. Now, the impact on the first quarter is going to be – we’ve created a one-time pretax charge of $5.4 million and we have a year-over-year reduction in gain on sale of $9.1 million. The full year 2017 impact looks like this. We’re going to have a significant reduction in gain-on-sale revenue. However, we expect to see growth of risk-adjusted margin by the fourth quarter. We expect an estimated EPS reduction of $0.07 to $0.08 from the auto business in 2017, including that one-time charge in the first quarter. However, for 2018, we see a full run rate of risk-adjusted margin. We see a reduction of our overall expenses and we expect an improved return in the auto business compared to 2016. We expect the payback period to be less than two years, including the one-time charge. Our strategy shift is prudent based on our strategic pillars of optimizing profitable growth and improving operating leverage. We have confidence in the management team to execute on the new strategy and we look forward to our strategic change having a positive impact on the organization moving forward. Now, in addition, based on the new business model in auto, we have reduced and deferred other expense initiatives across the entire organization. Brian Maass will have further comments on this later in the presentation. Turning to slide six, our revenue summary. We’re beginning to see the shift from non-interest income to net interest income in the quarter, and we look for this shift to continue as we move forward. We have strong seasonal increase in our margin, driven by higher inventory finance balances as well as the recent rate hikes. We are encouraged by the 9 basis point expansion in net interest margin year-over-year, demonstrating the true asset sensitivity of our business model that we’ve been talking about. And our net interest income increased nearly $11 million year-over-year, more than offsetting the $9 million decline in gains on sales of auto loans. Turning to slide seven, the loan and lease portfolio. We continue to see strong growth in the wholesale business, which now makes up 59% of the portfolio. We continue to be comfortable with this mix, but our diversification philosophy gives us flexibility to continue to optimize the mix as we move forward. The reduction in consumer real estate is related to the continued run-off of our first mortgage core sales of Junior League mortgages and the completion of a $49 million consumer real estate non-accrual sale. Turning now to slide eight, diverse loan and lease origination capabilities. This chart shows a five-year review of the first 400 originations to remove the seasonality factor. We began to see the impact of the auto strategy shift as our origination declined during the quarter. However, only a 6% declined year-over-year as the changes were implemented later in the period. As I indicated, we would expect auto originations to decline 30% to 40% when the strategy is fully implemented. Our originations in the other businesses remained strong and consistent with our expectations. Turning to slide nine, loan and lease sales and revenue, we had a lower gain on sale as a result in the shift in our auto finance strategy towards originate-to-hold model. We did not complete an auto securitization during the fourth quarter, but we did complete a whole loan sale of $248.5 million [indiscernible]. While we will be reducing our reliance on gain-on-sale revenue going forward, we will look for opportunities to achieve acceptable returns, while working with our strategic partners. Our consumer real estate loan sale model continues to consistently meet our expectations. Turning to slide ten, loan and lease yields. The increase in short-term rates is beginning to show up in our yields. Yields across all of our portfolios, except our run-off first mortgages, are up year-over-year. Leasing and auto yields are now similar to those that are – of the loans that are paying off. This is another strong example of the revenue power of our diversified portfolio. Turning to slide 11, credit quality trends, overall credit trends remain very positive. Provision and net charge-offs were impacted by the $49 million sale of consumer real estate non-accrual loans and the corresponding $8.7 million recovery. As expected, we had a nice decline in 60-day delinquencies, including a quarter-over-quarter reduction in auto from 23 basis points to 13 basis points. This is important because delinquencies are a leading indicator for auto charge-offs. Turning to slide 12, the net charge-off ratio. Excluding the non-accrual loan sale, net charge-offs were up 4 bps year-over-year to 31 basis points. After historically lower charge-off levels in commercials, we experienced an increase in the quarter as a result of two credits in different segments in different markets. We are currently working through those credits. We have no additional concerns regarding the quality of the commercial portfolio as a whole as we have had an extremely clean commercial credit book for an extended period. Excluding the non-accrual sale, consumer net charge-offs declined 3 basis points year-over-year despite the increase in auto net charge-offs. Continued improvements in the consumer portfolio more than offset the increase in auto, which increased by only $380,000 from the fourth quarter of 2016. We continue to see the value of our diversification strategy in our credit performance. And with that, I'll turn it over to Brian Maass.

[Brian Maass:]

Thanks, Craig. Turning to slide 13, non-interest expense, compensation expense experienced a seasonal increase on a linked-quarter basis, but remained flat year-over-year. Other expense, impacted by the one-time charge in auto and strategic investments in technology capabilities. The technology investments are related to enhancements in our digital channel and other initiatives to create operating leverage and efficiencies. In addition to the auto reassessment, we also reviewed the enterprise as a whole. As a result, we have taken certain actions to reduce spend in some areas, while reinvesting in others. Going forward, we would expect to see a shift in our non-interest expense, with Q2 to Q4 2017 compensation and benefits remaining relatively flat to slightly down versus the respective quarters in 2016. We would other expense to increase around 2% to 3% for the remainder of the year compared to those same quarters in 2016. Overall, we expect revenue growth to exceed expense growth for the remainder of 2017. Turning to slide 14, deposit generation. What makes us unique is that 89% of our deposits are retail. We are excited as the relative value of these retail deposits is beginning to show with the rise in interest rates. In addition, average checking balances increased 5.7% year-over-year. We had a decrease in average cost of deposits as money market and CD balances were a smaller percentage of our overall deposit mix in the quarter. Turning to slide 15, the pie chart in the upper right hand highlights the low-cost granularity of our deposit base as 63% of our deposits are low or no interest cost, with an average cost of one basis point. Rising interest rates are also having a positive impact on our assets as 40% of our assets are variable or adjustable rate. We added a chart at the bottom of the slide to highlight the year-over-year impact on the margin, which increased 9 basis points. It is better to look at our margin on a year-over-year basis, given the seasonality related to the inventory finance balances, which peak in the first quarter. With a second hike now being announced in March, we are optimistic that the slope of our margin in 2017 will be more flat than it was in 2016, with the potential for better performance if there are additional rate hikes. Turning to slide 16, our capital ratios remain strong and generating organic growth remains our capital priority. I will now turn the call back over to Craig Dahl.

[Craig Dahl:]

I’ll take you to slide 17, which shows our strategic pillar summary. Diversification continues to give us growth flexibility and we continue to benefit there from a credit quality standpoint. We expect a change in auto to help us achieve consistent, profitable growth, while reducing earnings volatility, capital liquidity and operational risks. Our expenses are being impacted by seasonality in the first quarter, the auto strategy shift and investments in technology, but the latter will help us improve our operating leverage in the near future. Our deposit base remains a strength of the company and the value it’s demonstrated becomes more clear in the rising rate environment we're seeing today. We’re confident about the changes we are implementing and the positive impact they’re going to have on our organization moving forward. And with that, I’ll open it up to questions.

[Operator:]

[Operator Instructions] And our first question today comes from Jon Arfstrom from RBC Capital Markets. Please go ahead with your question.

[Jon Arfstrom:]

Hey. Thanks. Good morning. Brian, just a quick question for you. Can you go over the expense guidance again? I just want to make sure I understand what you're saying, particularly on comp.

[Brian Maass:]

We’ve kind got a shift that’s going on from what you see in the past, so first I’ll go through comp. As you’re looking at – trying to give guidance towards Q2, Q3 and Q4 for 2017, the best way to look at it is look at what those quarters were for last year. And basically, my guidance is that it’s going to be flat to slightly down versus last year on the comp side.

[Jon Arfstrom:]

Okay.

[Brian Maass:]

Offsetting that, on the other expense line, if you’re looking at page 13, kind of the same ideas. Look at the other expense for second quarter to fourth quarter, which is the 99 – the 102 and the 99. The guidance there is that those quarters versus the respective quarters are going to be up roughly 2% to 3%.

[Jon Arfstrom:]

Okay. And so, you’re basically saying, without being too tied on this, about $230 million run rate, plus or minus, and then in total. Is that what you’re talking about?

[Brian Maass:]

I didn’t give any comment relative to operating lease depreciation, which is, obviously, just going to be dependent on the amount of operating leases that we have.

[Jon Arfstrom:]

Yeah, okay. So, [indiscernible] there’s likely a step down, I guess is…

[Brian Maass:]

Yeah, there is a step down coming, obviously. And Q1 here, you’ve got the one-time charge for auto. That’s going to be coming out. We do expect to have other expense, the other slightly higher level. But offsetting that is – we’re going to be able to see comps staying flat to going down slightly in the coming quarters.

[Jon Arfstrom:]

Okay. Okay, good. That helps. Craig, where are we at? What inning are we in in terms of the auto restructuring? I can’t tell if we’re in the third inning or the sixth in terms of where you feel you’re at.

[Craig Dahl:]

That’s a good question. That’s a good way to put it. I would say we’re in the sixth or seventh inning. The bulk of the changes have already been implemented. A significant amount of staffing reductions have already taken place. And we’re working towards reducing the origination capability as we move forward as well. So, I would say, probably the seventh inning.

[Jon Arfstrom:]

Okay. The last question here, the gain on sale line, I understand and appreciate – if you take out some of the volatility, will there still be a gain on sale line in auto and will it – and if so, will it accrue each quarter?

[Craig Dahl:]

I would answer it yes. There could continue to be a gain on sale, but, no, it's not likely to occur in every quarter.

[Jon Arfstrom:]

Okay. Okay, good. All right, thank you.

[Operator:]

And our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead with your question.

[Ken Zerbe:]

Great. Thanks. Good morning. Given you’re shifting more to that originate-to-hold in auto, I guess the question is, is your credit quality characteristic – I’m trying to think – like, in terms of what you're going to hold on your balance sheet, has that changed in any way? Because last I recall – and you did talk about some of the risk-adjusted returns, which presumably, my guess, implies little more of the less prime kind of auto lending to get better risk-adjusted returns. Can you just talk about the types of loans and how that’s changing that you want put on?

[Craig Dahl:]

Yeah. I’ll have Mike Jones cover that and I’ll have a couple of concluding comments.

[Michael Jones:]

Yeah. Ken, I think you’re actually spot on. As we kind of move this forward, there will be a little bit kind of that near prime paper that's held on balance sheet. So, there is a kind of a little bit change in mix. I would say that it’s not significant, but there will be a slight change in mix that will help from a profitability standpoint and drive a higher risk-adjusted yield for that business.

[Craig Dahl:]

Ken, the only thing I was going to add is, what I talked at meeting you were in were really taking that really super prime off the table. Okay, that’s still going to happen. So, they’re still going to get an improvement in what we hold on our balance sheet even on the higher credit tiers. But the key here is that we’re going to originate 30% or 40% less of it and take a lot of risk off the table beginning of each quarter.

[Michael Jones:]

The only thing that I would add to that, Ken, is that that’s a key point. I don't think you can decouple that and it’s very linked. The reduction of originations to the elimination of the originate-to-sell model, right? So, it's reducing that to the size that we want to place on our balance sheet.

[Ken Zerbe:]

Got it. Understood. And you guys are still targeting – are you changing the 15% concentration in auto?

[Craig Dahl:]

Well, that' wasn’t – that was actually where the portfolio ended at the quarter and I think that's still a good measurement, although there could be a little bit of a change, a slight increase as we transition to these lower sales volumes and the historical portfolio amortizes.

[Ken Zerbe:]

Got it. Okay. And then just one last question, just in terms of the $0.07 to $0.08 that you – I think it was slide five in terms of full year impact on EPS, is that mostly in expense, like driven lower EPS, or did that also – is that split any one – versus another, versus like lower expenses versus the lower gain on sale.

[Brian Maass:]

This is Brian. I’ll make some comments on it, then maybe have Mike add anything. It’s twofold. It’s change on the revenue side, as well as there is expense – as well as there is expense take-up.

[Ken Zerbe:]

Okay. All right, thank you.

[Operator:]

Our next question comes from Ebrahim Poonawala from Bank of America. Please go ahead with your question.

[Ebrahim Poonawala:]

Good morning, guys. I was just wondering if you could first touch upon – I think, Craig, you mentioned in your opening comments around – you’ve pushed out certain expense initiatives that you had previously planned. If we can just talk about what those investments were and how you’re thinking about levers, I think those may be later in the year or next year.

[Craig Dahl:]

I’ll have Brian come in and I’ll just have some confirming comment here.

[Brian Maass:]

So, just in general, we still have a focus on operating leverage. So, in the first quarter, obviously, you see, with the one-time charge, expenses are up more than revenue. Or really focused on it. And as the year goes on that you're going to see the growth in revenue exceeding the growth in expense as the rest of the year goes on, whereby we’re hopeful that we can get kind of back to, I’d say, where our efficiency ratio was for last year, even including the charges that took place. In regards to specific expense items, we’re focused. Obviously, there’s a lot of things that are taking place. We have the additional charges in auto. We’re being cognizant of what initiatives we’re taking on, what expense rates are. So, I’d say it’s a little bit of belt tightening, I’d say, just around the organization. As we know, we’re making some investments in some technology initiatives. So, I’d say it’s general belt tightening and trying to manage the expense line in proportion to where revenue is going for the organization.

[Ebrahim Poonawala:]

Understood. And just switching to auto on the credit side, you mentioned delinquencies fell quarter-over-quarter. What’s your sort of best guess or expectation in terms of auto charge-off, looking into the second quarter and for the rest of the year?

[Michael Jones:]

Yeah. This is Mike Jones. I won’t give you a specific guidance around the charge-off numbers. But as you saw, delinquencies came down on a 60-day basis. Directionally, we don’t report the 30-day number, but directionally that similarly has come down in the same direction. So, we would anticipate that the second quarter, as in prior years, the charge-offs would come down based on those delinquency numbers.

[Ebrahim Poonawala:]

Got it. And I guess just tied to that, if you could talk about sort of the overall level of provisioning. I guess, if you add back the $8.7 million, which was the charge-off reversal for this quarter, are you seeing like $20 million in provisioning or should that number be higher as you retain more loans on the balance sheet?

[Brian Maass:]

In general, I’d say we will see slightly higher levels over the course of the year. We did have those couple of commercial credits, which we don’t expect to necessarily be recurring. The level of charge-offs that we’ve seen, I think as we’ve said, continues to be probably towards the bottom end of the range at this point.

[Ebrahim Poonawala:]

So, you do expect overall level of charge-off maybe slightly, but tending higher and the adjusted provisioning also being flat to slightly higher for the rest of the year?

[Brian Maass:]

Correct.

[Ebrahim Poonawala:]

Okay. Thank you for taking my questions.

[Operator:]

Our next question comes from Chris McGratty from KBW. Please go ahead with your question.

[Chris McGratty:]

Hey, good morning. Thanks for taking the question. Craig, in the release, you talk about the 30 basis point – 31 basis point provisioning rate or the charge-off rate adjusted for the sale, but that it was at the lower end of your kind of normalized. Given where we are in the cycle and kind of the shift in the strategy, maybe not by portfolio, but consolidated, how are you conceptually thinking about where the charge-off rate should trend over the next couple of years?

[Craig Dahl:]

Over the next couple of years? We haven't seen, I would say, significant headwinds in credit in any of our segments at this point. And so, we’ve been operating in the 20 – if you look at the five quarters, 27%, 23%, 26%, 27%, 31%, those are all numbers that are underneath our business models. And right now, we don't see a significant ramp-up in any of those and have no leading indicators that have us. We’re always conservative on our underwriting and conservative through our diversification policy. And that’s really where we’re going to stick over the next couple of years.

[Michael Jones:]

Chris, this is Mike Jones. I think you really saw the benefit of the diversification strategy in the quarter where year-over-year you’ve got an increase in auto and you’ve been following that industry and the impact that that’s had on our portfolio. And we’re not immune to that. But that's being offset by the decline in the residential mortgage. So, on a consumer on a year-over-year basis, pretty flat to down.

[Chris McGratty:]

Okay. Mike, if you have on the consumer book, it was down around a little over $400 million. Part of it was the sale. Obviously, that portfolio is still on run down, but I think the decline was a little bit more than we have been modeling. Help us with kind of the trajectory of that, call it little under $5 billion portfolio.

[Michael Jones:]

Yeah. I would say two things. I think that portfolio will continue to decline. The things we've been discussing internally is, how best do we service our customers within our footprint? We’re servicing them currently today through a correspondent relationship. Are there some of those customers that we would like to see on our balance sheet and have a stronger relationship with them? So, we’re revaluating that as interest rates increase on whether or not we want to look to balance sheet some of those on our balance sheet versus going through the correspondent relationship. Do I think that will be significant? No. But I think there is a portion of those customers that are very good and very strong credit-wise that we may look to put on our balance sheet.

[Craig Dahl:]

And the only thing I would add, Chris, is the timing of our consumer loan sales has an impact to when it occurs within the quarter as well, so…

[Chris McGratty:]

Okay, great. If I could [indiscernible] one more in for Brian, the margin was quite a bit better than I think most of us had been expecting. And just looking for a little bit of color. Number one, was there anything in the margin this quarter that might've been, you would call out as, maybe a little bit one-time either or an interest recovery? And then, for the balance of the year, I understand the year-over-year comps with inventory, but should we be expecting the margin comes in a little bit from these pretty strong levels, given betas probably are moving up a little bit in deposits?

[Brian Maass:]

Yeah. I’d just like to make a couple of comments on that. It was off, I’d say, little bit more than we had expected in the first quarter. And a couple of reasons for that. No kind of real one-time items, but just in general we have slightly better growth, I’d say, in inventory finance as well as in the commercial book and all of that is variable rates. We just one couple percentage more variable rate assets than we were kind of projecting, as well as we just had a lower mix of promotional deposits in Q1. So that helped out as well. And we continue to see very rational retail deposit, so that gave us benefit in Q1. As time goes on and depending upon the amount of deposits we need, how competitive the environment gets, we will see deposit pricing. If you look right now, what we I guess weren’t expecting is interest expense on a year-over-year basis is actually down, right? I don’t necessarily expect that to continue. We will see a little bit of pressure on that, but I’m very optimistic and excited about kind of where our net interest margin is. The seasonality in Q1 does lift it up higher than in some of the subsequent quarters, but being that we did get a rate hike in March, I’m also optimistic that we’re going to start to see our net interest margin start to flatten out potentially here in 2017. So, it’s a very positive story. I’m excited about where it’s at. It’s been a long time since we’ve had been talk about kind of increasing net interest income and increasing net interest margins. So…

[Chris McGratty:]

Great. Thanks for the color.

[Operator:]

Our next question comes from Steven Alexopoulos from J.P. Morgan. Please go ahead with your questions.

[Steven Alexopoulos:]

Hey, good morning, everybody. On auto strategy, it seems a little late in the cycle to be switching to an originate and hold model. Can you help us think about the provision expense for auto going forward with a little bit more near prime in the mix?

[Michael Jones:]

Steve, this is Mike Jones. I think how you have to think about it right is that higher risk-adjusted yield, right? So, we believe – if you look at that, I think we bottomed out kind of in the fourth quarter at 3.03%. If you take kind of that three-month annualized charge-off rate less that yield that’s on the balance sheet, we would look for that to improve over the period. And that’s coming from multiple sources, Steve. It’s not just kind of having a little bit more of that near prime on the balance sheet, but it's also reducing the cost to originate. We’re very focused on how can we get more efficient, how can we better improve our cost, on how much it costs to originate each of those individual loans. The second thing I would say is, even though we will hold a little bit more that near prime on the balance sheet, we also, in January and February, enacted quite a few changes in our underwriting, which we believe is going to drive better results within each of the different credit grades as we move forward into reaction of what's going on in the marketplace, in the used car market and some of the recovery rates.

[Steven Alexopoulos:]

Okay. Thank you, that’s helpful. On the new auto originations, it looks like the guidance is around $550 million a quarter. How much of that should be near prime? What's the percentage we should be thinking?

[Michael Jones:]

I think how you should think about it, somewhere between that 10% to 15% range there. But it’s all going to be dependent on how it performs from a credit standpoint and then market conditions and we’ll push on it downwards if we’re not like what we see from a risk-adjusted yield perspective.

[Craig Dahl:]

I would remind you too that, we have a history of originating and servicing these loans and we also have an understanding of how they are expected to perform, and that's a key part of it. This is not a new. We’re not dropping down to the near subprime or the subprime. And I wanted to point that out as well.

[Steven Alexopoulos:]

Okay. And then – so if you hold more auto in portfolio, should we expect stronger overall loan growth or do you expect these loans to replace loans in other categories?

[Michael Jones:]

I think how you have to think about it, Steve, is kind of that 15% to 16% of the balance sheet in the makeup of the mix within our portfolio. And as Craig and Brian mentioned, that may be a little bit higher in the near-term as we get to these lower origination rates. We’ve been very methodical and intentional on how we get to those rates. We want to make sure that we’re taking care of our dealer network and making sure that we have the value proposition for them out in the marketplace. So, we’ve been guiding those down from that standpoint. But I don’t think you're going to see us try to ramp up auto as a concentration within the balance sheet.

[Steven Alexopoulos:]

Thanks. And if I could ask one separate question on the commentary around a higher tax spend going forward, what is the annual tax spend rate now?

[Brian Maass:]

It’s not certainly a number that we disclose separately. So, I’m probably not going to give you that. But the spend is coming in a couple of different areas. Like we said, part of it is, like we’ve talked about in the past, right, as we’re closing branches, we’re making investments back into our digital, our digital platform. We find the best what our customers want from a customer experience perspective, as well as as we shift ultimately some more activity from being in a branch to being mobile. That’s also going to help lower our operating costs, as well as we’re making investments in this core platforms to better operating leverage out of our business as we continue to grow.

[Steven Alexopoulos:]

Okay, fair enough. Thanks for all the color.

[Operator:]

Our next question comes from Dave Rochester from Deutsche Bank. Please go ahead with your question.

[Dave Rochester:]

Hey, good morning, guys. Just back on the NIM, give your color that there is nothing really one-time in that this quarter. And correct me if I’m wrong, but it doesn’t sound like you’re really seeing any incremental deposit pricing pressure from the March hike at this point. Do you think you’re being a little conservative [indiscernible] NIM flattening out here? It seems like you could have some more expansion in 2Q.

[Brian Maass:]

As you know, it's a little bit hard to predict. We do have the seasonality of the inventory finance book that goes through there, as well as portfolio mix changes can have an impact on the net interest margin. But, in general, you’re right. From a deposit perspective and you go back to the fact that we’ve got 89% of our deposits are retail, we’re starting to see the benefits of that, right? It’s been eight or ten years that everyone has had deposits. We haven’t been really able to differentiate. What we’re seeing now is the differentiation and we’re seeing that we’re picking up on the deposits items. We’re seeing good price now. We’ll change over time potentially, right, depending upon how much growth we need out of the portfolio, what happens with competition, what happens with additional rate hikes. But I feel really good with where we’re at, now that we’re three rate hikes in. There continues to be a very rational pricing in the retail market. So, I expect that to continue, but we could see that change if there’s additional rate hikes later this year. As you kind of get to the fourth or fifth rate cycle, there’s going to start to be a little bit more pressure on retail, but I think we’re still going to be in a good position.

[Dave Rochester:]

Got you. Thanks for the color there. Just looking at credit on the auto charge-offs this quarter, sorry if I missed this, but is that a function of higher rate of frequency or rate of severity or both?

[Michael Jones:]

Yeah, this is Mike Jones. I would say that more of it came from greater severity that you're saying kind of in the used car prices. There was a slight uptick in incidences, but I would say the majority of it was greater severity. I think the benefit that we have is the reduction in delinquency as you saw that come down pretty significantly in the quarters. So, as we roll into 2Q, that bodes well for us.

[Dave Rochester:]

Great. And then just going back to these questions from earlier, can you just give us maybe a new range for either earning asset growth or loan growth for the year, now that you're growing auto again?

[Brian Maass:]

I don’t have that much of a different expectation. This is Brian. And probably what I had said at the beginning of the year from a mid-single-digits perspective. Again, I wouldn’t necessary say that we’re growing auto. I think we expect that it’s going to in this 15% to 16% range that it has been. I think the commentary that was made at that in the near term as we’re adjusting to new origination levels and adjusting with reduced sales, you could see it higher in the near-term. But generally speaking, you’re still going to see auto being in this 15%, 16%.

[Dave Rochester:]

Okay, great. Thanks, guys.

[Operator:]

Our next question comes from Scott Siefers from Sandler O’Neill Partners. Please go ahead with your question.

[Scott Siefers:]

Good morning, guys. I think maybe just a follow-up question on sort of what the overall loan growth rate and even auto ends up looking like. I guess I’m wondering why over time it doesn’t go down, auto as a percent of the total portfolio. So, you’ve got I think about $3 billion right now, just under NIM. I think maybe you’ve been originating about a $4 billion annual rate. And if that comes down 30% to 40%, over time, shouldn’t the other portfolio come down? And I guess separate, but related question on that is, what would be the amount of the time that the existing auto portfolio takes to roll off if you originated nothing else. Is it three-year average life, so maybe a little longer than that for the total portfolio. How would that dynamic work?

[Brian Maass:]

I’ll make a couple of comments. Just in general, I’d say the average life of the auto books probably pretty close to two years is what I would say. From the overall growth perspective, obviously, it’s a function – we’re saying 15%, 16%, it’s kind of a function of what else is happening on the balance sheet. So, it’s hard to be too precise on that. But in the first quarter, we continue to see really good growth out of our wholesale businesses right now. Leasing and equipment finance were up 6.7%, inventory finance was up 7%, and our commercial was up 8.4%, right? So, there’s a lot of origination that’s happening there. Being offset by the runoff in the consumer real estate book, as we’ve mentioned in the past. But generally we still feel comfortable with that mid-single-digit rate.

[Craig Dahl:]

And the other thing – this is Craig. The other thing I would add is we’ve been originating more like 3.5 billion than 4 billion. So, I think your reduced volume might be a little off on that.

[Scott Siefers:]

Okay. Sounds good. And then, one other question, just on the yield of the book, the auto book specifically, you’ve got a nice bump up of 11 basis points fourth quarter to first quarter, but you’re still flat year-over-year. What are sort of the underlying yield trends? Why wouldn’t that be up more since we’ve had Fed rate hikes, first quarter 2016 to first quarter 2017? What’s sort of the underlying trend there as you see it?

[Michael Jones:]

This is Mike Jones. I think there’s a couple of things that are going on there. I think, one is kind of the, while it’s short in nature, it’s kind of that middle trend there. So, you haven’t seen a significantly higher increase kind of in that tied to kind of that two to three-year type rate. Secondly – or not as much increased. And then, I think, secondly, it’s been a very competitive market throughout 2016. And those are the assets that are on the balance sheet. I would say prospectively, we’re going to – what you will see in this book as we drive to kind of higher risk-adjusted yield is the yields getting more in line kind of the yield levels of the rest of the book that we have out there from a comparability standpoint.

[Scott Siefers:]

Okay. All right. That’s helpful. Thanks. And then maybe just one question, now that you’ve completed the strategy review in auto, I guess it looks like 90 days, it’s obviously very clear something very substantial had happened in you guys’ auto business, but I don’t think anyone really left last quarter with a great sense for exactly what it was. Was it just the credit profile of what you guys were, trying to sell into the secondary market or was it the – maybe the size of you guys’ loan sales? What was it that caused such an abrupt change with the benefit of the strategic review now in the rear-view mirror?

[Craig Dahl:]

Well, this is Craig. Well, the gain on sale margins and process, we had successfully executed during the first nine months, we went into the fourth quarter with an expectation, while it continues to be a process that we would be able to execute on it. When it happened so late in the quarter, we really needed to test whether or not it was a one-time event or whether we thought it was going to be a systemic event. And the second part is, we really can’t announce staff reductions until we’ve talked to the staff themselves, so I couldn't lead with that even though those had already started to occur until after the quarter had ended. And I think those are the two key things.

[Michael Jones:]

This is Mike Jones. Just to add to that, if you look at kind of what's transpired over 2016 and as we’ve kind of watched and experience that, right, so if you look at our gain rate in the first quarter of 2016, it was 2.68%, right? So, if you’re going to originate loans to sell at 2.68%, it makes a ton of sense from a return to the overall shareholder. But as that declined throughout 2016 based on market conditions, we had to really reevaluate, do you really originate that loan to get a sub-par return associated with it. So, our readjustment of our strategy really focused around the earnings volatility and how do we reduce that earnings volatility prospectively, get more consistent around the delivery of our performance out of the auto book and right-size it, so that we could achieve that.

[Scott Siefers:]

Okay. All right. Thank you.

[Operator:]

Our next question comes from Lana Chan from BMO Capital Markets. Please go ahead with your question.

[Lana Chan:]

Thanks. Good morning. Just one more follow-up on the auto credit quality. The delinquency trend is definitely a positive near-term, but if we look at some of the prior securitizations that TCF has done, it seems like the estimated charge-offs have risen. Just wondering, is there also a strategic shift from the new car market versus used and how do you get comfortable with sort of the pressure point on used car prices, given the level of inventory just coming on market over the next year or so?

[Michael Jones:]

This is Mike Jones. I think that’s a fair question. And I think what we've done kind of in the late January or early February time frame in kind of reaction to kind of what we’re seeing, just the same things that you just talked about. We made several changes to kind of our underwriting criteria to help drive better results within each of those different grades kind of in reaction to that marketplace. We’ve consistently been a used car originator. The majority of our loans somewhere between that 75%, 80% range, has been used cars. So, we’ve always kind of focused on that. And now going into 2017, we’re looking to make changes from an underwriting standpoint and credit lock standpoint to drive more consistency of credit results within each of those different grades.

[Lana Chan:]

So, we should think about the overall mix of used versus new over time shifting a bit to more of a balanced approach?

[Michael Jones:]

No, it’s been pretty consistent. And we’ll stay with that consistent. I don’t see it changing over time. That is clearly our dealer network and our expertise, is the use market.

[Lana Chan:]

Okay, thank you. And just one quick question on fees, this quarter. If I look at deposit service fees in general, it seems like it’s still under some pressure year-over-year. Could you talk about expectations there and kind of seeing any pressure in terms of pricing in that line item?

[Brian Maass:]

This is Brian. So, you’re correct. Fee income continues to be impacted, I’d say, by changes in consumer behavior, as well as just in general higher average checking account balances, right? So, I don’t think the percentage down that it is now. It’s kind of in line with numbers that we’ve seen over the last couple of years. I’d expect there to continue to be some decline in that line as we go forward. And one of the benefits is that – part of it is because we have average checking balances. We are getting those checking balances which is providing us with free funding.

[Craig Dahl:]

I would add just a couple other points, just general points here. I think the investments that we’re making in 2017 are clearly on the digital side for retail banking as you have the shift kind of in the industry where the industry is defining convenience on customer's ability to bank when and where they want. So, digital is becoming more and more an important channel and we’re doing investments into 2017 to upgrade our capabilities there to drive more accounts. We’ve been really good at maximizing the deposits and gathering wallet share within the accounts that we have. Now, as we go into a rising rate environment and we have this great retail portfolio, how can we add more retail customers to that associated with that. So, I think that that’s one. The second thing is how can we provide more solutions to them and garnish more of their wallet. We've instituted, back over a couple years ago, on an agency relationship, credit card for them. So, we’re not originating those for our balance sheet, but through an agency relationship. We put the correspondent back into the footprint to allow them to originate mortgages. So, how can we find more of those solutions to gain more of the wallet share of the solutions that those customers need. So that’s what we’ll look forward to in the future to combat some of that pressure.

[Lana Chan:]

Okay, great. Thanks for the color.

[Operator:]

Our next question comes from Nathan Race from Piper Jaffray. Please go ahead with your question.

[Nathan Race:]

Great. Thanks for taking the question. Brian, just going back to your previous comments about deferring some expenses in light of the transition in the auto book, can you kind of give us a sense of the magnitude and the type of expenses that you guys are perhaps deferring to 2018 in light of that transition?

[Brian Maass:]

Couple of things. I broke out more at the beginning of the Q&A. But part of it is on the comp side, right, the headcount. So, between the closure of branches as well as in the shift of auto, we’re really going to see the benefit coming through the top line, where quarter-over-quarter for the next three quarter, on a year-over-year basis, you’re going to see comping flat to slight down. So, there’s definitely some benefit that we’re realizing there. On the other expense side, yes, we’re going to have some higher strategic IT investments. And like I said, it’s just some general belt tightening around a lot of other expenses and just making sure that we’ve got discipline and that we’re focused on making sure that we’re optimizing where we can and getting some efficiencies across our businesses [indiscernible] some of these initial investments. Otherwise, you see expenses going up further if we weren’t doing that. We’re focused on that. Again, I think as we’ve said over a long time, it’s operating leverage, it’s important to us and we want to make sure that we’re growing revenue. It’s not just about general expense takeout. We’re focused on growing revenue, but we also want to make sure that over time we’re slowing the growth of that expense line.

[Nathan Race:]

And then for Craig, can you just kind of update on the acquisition opportunity that you’re seeing both on depository and non-depository side of things at this point?

[Craig Dahl:]

Well, we’ve been going through this reassessment. We’ve been pretty quiet on that front. We’re always going to opportunistic on the wholesale asset side. We know those categories very well, continue to look to opportunities, and we’ll have Tom Jasper give us a little comment on the corporate development side.

[Thomas Jasper:]

This is Tom. I think as you look out, we’re still looking for those opportunities. And it’s really how it fits into our overall strategy when it comes to things like profitable growth. So, in terms of the opportunities in more of our national business within leasing equipment finance and some others, we’re seeing those opportunities, as Craig mentioned. On the banking side there’s still an opportunity for us as we look at balance sheet growth, as we look at whether or not there’s opportunities for us to enhance our deposit base through an acquisition. We’re still analyzing those opportunities in the market and it does appear that there will be some opportunity for us to grow as we move ahead. And so, we’re going to continue to evaluate those prospects in a really buy versus build analysis.

[Nathan Race:]

Okay, great. Appreciate all the color.

[Operator:]

Our next question comes from Kevin Reevey from D.A. Davidson. Please go ahead with your question.

[Kevin Reevey:]

Good morning, guys. Question on the commercial loan growth, looked like it was pretty strong compared to what we've seen from other banks that have reported thus far this quarter. Could you give us some color on where the loan growth was coming from, the types of loans and kind of where in your footprint?

[Craig Dahl:]

This is Craig. I’ve talked about our opportunity to reinvest in this segment during a period of time when there was a lot of competition as other banks didn't have as many as class opportunities as we did. And we did talk about on the fourth quarter earnings call that we did see some opportunities in really all of our segments. We restaffed our team with some significant upgrades and talent in Detroit, in Minneapolis, in Denver and other markets. And so – and we have new leadership that’s now been in place over 18 months and giving us really a strong run rate. So, the opportunities continue to be focused on sponsors in our footprint and will follow them to other markets, but primarily within our footprint.

[William Henak:]

This is Bill Henak. The one other comment that I would make there is that we focused on reducing the prepaying the paydowns on those as well, and that helped retain those loans this quarter.

[Kevin Reevey:]

Great. And then, on your investment securities portfolio, I noticed that the yields were up a lot during the quarter. Was there any changes in either direction and/or mix of securities?

[Brian Maass:]

There’s no real changes. We didn't have much as far as purchases in the quarter. I believe that we had a little mark against additional prepayment speed in the fourth quarter that made the yield a little bit lower in the fourth quarter. It’s probably why you’re seeing the increasing on a linked-quarter basis, but very minimal changes in the investment portfolio in the last quarter.

[Kevin Reevey:]

Great. Thank you.

[Operator:]

Our next question comes from Terry McEvoy with Stephens. Please go ahead with your question.

[Kevin Reevey:]

Thanks. Good morning. How are you managing relationships with the auto dealers? And if some point, you decided to turn that volume back up and move back to originate and sell, essentially, will they still be willing to do business with TCF?

[Michael Jones:]

Well, this is Mike. I think I made this comment earlier. We've been very intentional, methodical around how we brought the originations down to ensure that we’re taking care of the dealers. I think what we’ve really kind of focused our efforts on is the dealers that we have great relationships with that understand the type of loans that we want to originate and making sure that we’re servicing their needs associated with that. So, I'm very confident in the sales team that we have, the relationships that they built over time and how can we maximize those going forward?

[Craig Dahl:]

And then, I would add – this is Craig. I would add to that. Going back to how we discussed our original strategy, it was one to two deals per dealer per months. We don't have concentration of originations from dealers, and so that allows us to expand and contract that based on our origination plans.

[Kevin Reevey:]

Thanks. And then, just as a follow-up, I appreciate the details around the shift in auto and the earnings impact. I was expecting to see a slide in the deck highlighting some renewed growth areas to offset what's going on in auto, whether it's commercial lending, some portfolio purchases. So, outside of expenses, what can be done to help offset the dilution? And that $0.07 and $0.08 number that was out there, do you assume any uptick in any of the other businesses to minimize what’s happening in auto?

[Brian Maass:]

This is Brian. What I’d say is, fortunately, as we stand here in 2017, one of the good things we’re seeing is a higher interest rate environment, right? I think you’re already seeing the benefit of that as we have higher yields across all of our loan categories on a year-over-year basis, as well as on the deposit pricing side we’ve seen a lot of advantages. So, I think that's where there’s some potential upside for 2017. And definitely, as we get into 2018 and we kind of get on the other side of some of these technology investments that we’re making this year.

[Kevin Reevey:]

Understood, thank you.

[Operator:]

Our next question comes from Scott Valentin from Compass Point. Please go ahead with your question.

[Scott Valentin:]

Good morning. Thank you for taking my question. Just, Craig, if you could give more color on the two commercial credits you talked about. I know you said they were from different geographies in different segments, just wondering if you can provide me what segments they were from? And then, as a follow on to that, what your retail exposure is and maybe what you're seeing in terms of credit performance in the retail book?

[Craig Dahl:]

One of the charge-offs was in a CRE transaction and one was in a CNI transaction. And they were in wide markets. We have very little retail exposure and have – that's down to less than 10% of the whole book.

[Scott Valentin:]

Okay, thanks. And then just real quickly, any update on the CFPB litigation?

[Craig Dahl:]

No. No, not really. We’re just going through the legal process and we continue to remind everyone we believe we were in compliance with the laws in the spirit and the title of the law.

[Scott Valentin:]

Thanks very much.

[Jason Korstange:]

I’ll remind everybody. It’s now 10 o’ clock. So, we’ll take one more question if we have it.

[Operator:]

And our next question comes from Jared Shaw from Wells Fargo Securities. Please go ahead with your question.

[Unidentified Analyst:]

Hi, good morning. This is actually [indiscernible] filling in for Jared. Maybe just on the timing of the auto strategy, should we expect that to hit in the second quarter, meaning that the gain on sale is going to pretty much falloff and all of the production is going to be held on balance sheet or is there still a portion of the pipeline that’s going to be sold in the second quarter?

[Michael Jones:]

I would say – I would talk about it in this way. I would say that you'll see the reduction in the originations coming through in the second quarter. I think you'll see the reductions in the loan sales coming through in the second quarter as well. And as we take that shift and we adjust to the higher risk-adjusted yield, I think that impact will come through, you'll see that impact more predominantly in the fourth quarter. As you know probably, as you shift from an originate to sell to originate to hold, you're just not going to get that benefit in 90 days or 180 days. So, we look to see that happening towards the fourth quarter.

[Unidentified Analyst:]

Okay, that’s good color. Appreciate that. And then just looking at some of the restructuring that was done in the portfolio and the 200 staff reduction, is there an associated expense with that that you can quantify?

[Brian Maass:]

Yeah. This is Brian. Back on page five in the deck, we have a page on the auto finance strategic shift. And there was a one-time impact in the first quarter pretax of $5.4 million.

[Unidentified Analyst:]

No, but just going forward, what’s the associated expenses going to be taken out just from the auto portfolio specifically?

[Unidentified Analyst:]

Yeah. We did not break out that number. I don’t expect to have any one-time charges in the subsequent quarters, but we will see that run rate of expenses come down in the auto business over the subsequent quarters.

[Jared Shaw:]

Okay, thank you. And then just lastly, maybe on inventory finance, it looks like origination activity was fairly strong this quarter, although the actual growth was a little bit weaker than in some prior years. Anything in particular going down on the paydown front or maybe you can provide just a little bit of color on what we saw in that business?

[Craig Dahl:]

It’s a very difficult business to really talk about because originations are shipments in the quarter, but it doesn’t really talk about how the dealers are doing and what they’re selling and that’s really what can happen. Or some time, we had a lot of shipments of snowmobiles in the last week in December, so our point in time balance was down. And then they had more originations in the quarter to follow. So, it’s really just a matter of – there isn’t anything unusual going on other than the normal rhythm of new product shipments and the dealers selling through and repaying the loans underlying them.

[Unidentified Analyst:]

Okay. And with the rising rate environment, has there been any kind of shift in consumer sentiment towards those types of products?

[Craig Dahl:]

Not at this time, no.

[Unidentified Analyst:]

Okay, thank you for taking the questions.

[Operator:]

Ladies and gentlemen, 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 at the phone number listed on the earnings release. We’d now like to turn the conference call back over to Mr. Craig Dahl for any closing remarks.

[Craig Dahl:]

Thank you. As we move forward, we expect to see the following three things come out of this. Number one, higher risk-adjusted returns aided by the higher interest rate environment; two, less reliance on gain on sale revenue resulting in reduced earnings volatility; and three, we’re going to leverage our investments in 2017 to drive better overall operating leverage across the organization as we head into 2018. I’m proud of the team in place to execute on this strategy. I want to thank you for joining us on the call today.

[Operator:]

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending. You may now disconnect your lines.