TCF Financial Corporation
Q2 2017 Earnings Call Transcript

Published: 24 Jul 2017

[Operator:]

Good morning, and welcome to TCF’s 2017 Second Quarter Earnings Call. My name is Jamie and I will be the 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 that today’s conference call 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, Chairman and 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 future events or the future financial performance of the company. We caution that such statements are predictions and that actual events or results may differ materially. Please see the forward-looking statements disclosure in our 2017 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, 2017 and we undertake no duty to update this 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 with his second quarter observations, he will then discuss revenue, loans and leases, and credit. Mr. Maass will discuss deposits, interest rates, expenses and capital. Mr. Dahl will then provide closing comments and opening up for questions. I will now turn the conference call over to TCF Chairman and Chief Executive Officer, Craig Dahl.

[Craig Dahl:]

Thank you, Jason. We will turn you to Slide 3 of my second quarter approximations. As we move through 2017, we continue to operate with a focus on our four strategic pillars. We reported net income of $60.4 million, up 4.7% year-over-year. Our strategic shift in auto announced last quarter is progressing as expected and resulted in a more stable source of revenue. The benefit of our asset sensitive balance sheet and pricing discipline continues to show through as we saw another quarter of net interest margin expansion. Expenses were again impacted by investments to enhance technology capabilities that will drive efficiencies throughout the business moving forward, however, our year-over-year efficiency ratio improved. We remain pleased with the overall credit quality of the portfolio, annual reference to lower tax – effective tax rate due to a favorable state tax settlement. Turning now to Slide 4, our revenue summary. We are beginning to see a more stable source of revenue as gain on sale and servicing revenue is being replaced with increased net interest income. You should look for this shift to continue as we move forward. The increase in net interest income was primarily driven by the non-auto portfolio through a combination of higher yields on variable rate loans and loan and lease growth. The strong increase in the margin to 4.52% was driven by higher average yields in our variable and adjustable rate portfolios as interest rates have increased. This margin expansion further demonstrates the true asset sensitivity of our business model as we expected. In addition, the year-over-year reduction in gains on sales of auto loans was mostly offset by increased levels of leasing and equipment finance revenue, which continues to demonstrate the strength of our diversified model. Turning to Slide 5, our auto finance strategy. The shift in our auto finance business is progressing as planned. The chart on the right highlights the combined held for investment and held for sale auto balances following the first full quarter of this strategic shift. During the second quarter, we reclassified approximately $345 million of loans from held for sale to help for investment. This was the primary driver in the increase in loan yields to 5.01%. We indicated last quarter that our plan was to significantly reduce the level of auto originations. And you can see this was the case as auto originations declined by 42% year-over-year to $525 million. Net charge-offs declined on a linked quarter basis due to seasonality, but increased year-over-year as the portfolio continues to mature. Absent seasonality, we expect net charge-off to rise modestly going forward given the mix change within the portfolio and current market conditions. From a risk adjusted yield perspective, loan yields less net charge offs, we saw an increase from approximately 3% in the first quarter to over 4% in the second quarter. While this risk adjusted yield may not grow each quarter going forward due to some seasonality, we expect to maintain a meaningfully higher risk adjusted yield with our originate to hold strategy. Overall, we are pleased with the performance of the business and like the outlook of the business model going forward. Turning now to Slide 6, loan and lease portfolio. Our proven loan and lease origination platform continues to provide the basis for our long growth capabilities. We continue to see strong year-over-year growth in the wholesale businesses, which now make up 56% of the portfolio as commercial increase 12.7%, inventory finance increase 7.5% and leasing and equipment finance increase 5.2%. We expect loan and lease growth to be driven by our wholesale businesses going forward. Auto finance balances increased approximately 4% year-over-year, excluding the reclassification of $345 million of auto loans from held for sale to held for investment during the second quarter. In total, the auto portfolio now makes up roughly 18% of our total loan and lease portfolio. This is in line with what we said last quarter with an elevated concentration in the near-term as the shift continues to play out. We expect this to settle in around 15% to 16%. We are comfortable with our current mix, but our diversification philosophy gives us flexibility to continue optimizing the portfolio as we move forward. Turning now to Slide 7, our loan and lease yields. The increase in short-term rates and our pricing discipline continue to show up in our strong yield performance. Yield across all portfolios are up on a year-over-year basis especially in our variable and adjustable rate portfolios. This continues to demonstrate the true asset sensitivity of our model. As mentioned earlier, the increase in auto yields was largely due to reclassification of auto loans from held for sale to held for investment. Turning to Slide 8, credit quality trends. Overall, credit trends remain very positive. Excluding the impact of the consumer real estate nonaccrual loan sale, which resulted in the recovery of $8.7 million on previously charged off loans in the first quarter, provision and net charge-offs both declined slightly in 2Q. The provision in the second quarter was impacted by the reclassification of auto loans from held for sale to held for investment. In addition, we continue to see nice reductions in nonperforming assets due to improvements in commercial, consumer and inventory finance nonaccrual loans. In total, nonperforming assets declined by another 9 basis points during the quarter and are now 47 basis points below last year's levels. Turning to Slide 9, net charge-off ratio. Consumer net charge offs increased only 3 basis points year-over-year as the increase in auto finance was mostly offset by reductions in consumer real estate. As we previously indicated, we would expect auto net charge offs to increase modestly over time excluding seasonality given the mix changes within the portfolio. The year-over-year increase in wholesale net charge offs was due to two commercial credits in different segments in different markets. These are the same two loans we mentioned during the first quarter call. One credit has been fully resolved and the other is nearing resolution. We have no additional short-term concerns regarding the credit quality of the commercial portfolio as a whole as we have had clean credit performance for an extended period. We continue to see the value of our diversification strategy in our credit performance. Current net charge-offs levels remain in the low-end of our expected range. And now I’ll turn it over to Chief Financial Officer, Brian Maass.

[Brian Maass:]

Thank you, Craig. Turning to Slide 10, despite the rise in interest rates, our average rate on deposits is flat compared to Q1. We continue to see a favorable mix of deposits with 5% growth in checking balances year-over-year. We are excited as the relative value of our retail deposit base is beginning to show with the rise in interest rates. We continue to have the ability to raise deposits as needed based upon our asset growth needs. As a result, we could see a modest uptick in deposit costs as our loan portfolio grows. Turning to Slide 11. Regarding the impact of rising interest rates, the pie chart in the upper right highlights the low cost granularity of our deposit base as almost two-thirds of our deposits are at low or no interest costs in 2Q 2017. The graph on the left shows rising interest rates have a positive impact on our assets, at 40% our variable or adjustable rate, and 42% of our portfolio is short or medium duration fixed. Due to the quick turn nature of this fixed rate portfolio. These loans will reprise quickly as well. Last quarter, we added the chart at the bottom to highlight the year-over-year view of our margin, which increased 17 basis points in 2Q of 2017 and was impacted primarily by our balance sheet asset sensitivity due to variable rate loan reprising and our ability to lag on deposit prices. It is better to look at our margin on a year-over-year basis given the seasonality of inventory finance. We expect our margin to normalize around this level over the remainder of the year. Turning to Slide 12. Following the auto finance shift in 1Q 2017, we were able to get back to improving our operating leverage and the efficiency ratio in 2Q 2017. Revenue in 2Q 2017 increased 3.3% year-over-year while non-interest expense increased 2.5%. As indicated last quarter, we expected 2Q compensation expense to be flat or down year-over-year. It was actually down a little more than expected at 1.8% while other expense was down $4 million from Q1 of 2017, it was up slightly more than expected year-over-year. However, with the increase in revenue, we achieved a 50 basis points decrease in our efficiency ratio year-over-year. We expect to continue improving operating leverage and as mentioned last quarter, we are working towards a full year 2017 efficiency ratio similar to 2016. This includes the auto charge in the first quarter of 2017, which means we expect revenue to grow faster than expenses in the last two quarters of 2017. Turning to Slide 13. Capital ratios remain strong with earnings accumulation, generating profitable growth remains our capital priority. With that, I'll turn it over to Craig Dahl. Turning to Slide 14, which is our strategic pillar summary, we have a continued focus here. Our diversification strategy gives us growth, flexibility and is showing its value in terms of our strong overall product quality. The change in auto strategy is helping us to achieve a more stable revenue source while reducing earnings volatility and capital liquidity and operational risks. We are beginning to see improvements in operating leverage following the auto finance shift and remain focused on growing revenue faster than expenses. Our deposit base remains a strength to the company and the value as demonstrated becomes more clear in the rising rate environment we're seeing today. We are confident about the changes we are implementing and the positive impact it will have on the organization moving forward. And with that, I will open it up for questions.

[Operator:]

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Jon Arfstrom from RBC. Please go ahead with your question.

[Jon Arfstrom:]

Yeah, thanks. Good morning.

[Craig Dahl:]

Good morning.

[Brian Maass:]

Good morning.

[Jon Arfstrom:]

Just auto question. What's yet to be done in auto or I guess is that another way do you expect to maintain this type of pace of $500 million a quarter in originations?

[Mike Jones:]

Jon, this is Mike. I think that that's right. I think we've gotten the origination engine kind of where we want it to be. The only thing I would say around that Jon would be just market conditions and what market will bear and are we liking what we see and what were originating, how the launch profile is coming in and is that performing in line with our expectations. Those are the things that would drive a change in origination level.

[Jon Arfstrom:]

Okay, okay. So, essentially, you feel like you're there and the businesses has adjusted?

[Mike Jones:]

Yes.

[Jon Arfstrom:]

Okay. Bigger picture, maybe for you Craig, loan growth year-over-year for the company, do you a goal in mind or a range in mind?

[Craig Dahl:]

Well, we're still looking at that mid-single digits from that standpoint. You can see that our wholesale businesses are on top of that number and that would be our expectation for the leadership of growth. I would remind you that both inventory finance and equipment finance have seasonality with picking up asset levels in the fourth quarter. So that's kind of what we're looking there and we continue to try to be opportunistic around the portfolio acquisition standpoint as rates have started to move up on some of the more wholesale funded specialty finance companies are looking to flip some of their portfolios on the market.

[Jon Arfstrom:]

Okay. Well, that’s interesting. I will let that one [indiscernible] maybe somebody else will follow up on it, but just one of the questions I wanted to get in for Brian is the long yields. You expect those loan yields to continue to go up, are you telling us loan yields continue to move up modestly and funding costs move up along with that?

[Brian Maass:]

That's correct. I mean if you look on a year-over-year, right, the variable rate portion, I mean, we have a couple of variable rate portfolios, so like the consumer portfolio on a year-over-year basis, they're up 44 basis points. The commercial variable rate is up 45 and inventory finance is up 48. So those portions of the portfolio will move up especially with the additional change in interest rates that took place in June. But I do see some offset, we will have a mix shift that happens, kind of as you get into the second half of the year, we have a little bit less variable rate loans as a percentage of our overall total loans, so that’s some of the offset, as well as even though we've been able to really hold the line, I’d say, on deposit cost that part of that is a function of how much growth we've had to-date. But as we do continue to grow some of that will be offset by increasing deposit costs.

[Jon Arfstrom:]

Okay. Thank you.

[Operator:]

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

[Ken Zerbe:]

Great, thanks. If you don't mind, I would love to stick with the NIM topic, just for a second more, so TCF is probably one of most asset sensitive banks or one of the more asset sensitive banks in the entire bank space, but what I'm hearing from you is that – it sound like deposit costs go up same as asset yields essentially, so does that essentially mean that you're not asset sensitive at this point? I mean if – it’s because I’m thinking of the June rate hike, you should get some benefit unless so much has changed fundamentally with your funding base and how you think about growth going forward that it does meaningfully change that dynamic? I just want to make sure I really understand that, thanks.

[Brian Maass:]

Yes. Good question, Ken. So, let me kind of clarify. So, what you also see with TCF, we are asset sensitive and we will benefit from a net interest income perspective as a result of rates going higher and we still believe that to be true. From a net interest margin rate perspective, we also do have that seasonality of inventory finance. So, in Q1, right in as the beginning part of the year when we have more of those balances, we just have a higher percentage of variable rate loans as part of our total loans. As that portfolio goes down kind of through the course of the year before it starts building late in the fourth quarter that has some impact on our net interest margin rates, so that’s why – the one chart that we have kind of on page 11 shows some of that impact. If you just looked at 2016 right, we saw it kind of going down over the course of 2016, part of that is due to the mix shift. So the composition of the assets also matters to us. But you will see some offset as a result of increasing deposit costs.

[Ken Zerbe:]

Okay. I think I understand that. And then just on auto piece, the yields I recall roughly 400 basis points up to 500 basis points reclass $345 million on $3 billion portfolio. I'm just doing a rough math – I mean the yields would have to be insanely high on that reclassification piece, is there any unusual items in that like why did the entire portfolio yield go up so much? Thanks.

[Mike Jones:]

Ken, this is Mike. How I would look at that, the stuff that was sitting in or the assets or loans that were sitting in held for sale were higher yielding assets probably our highest yielding assets. And those are the ones that were moved into the held for investment book.

[Ken Zerbe:]

Got it. And as you retain more of the auto, are they going to be of similar yield?

[Mike Jones:]

No, I think how you have to look at it right from a yield perspective, kind of the 501, right, you have a full impact in both the yields and the losses of those higher yielding assets starting April 1. So that's – as you look at that 501, that's fully baked and that run rate will continue right. So how we look at it prospectively in 2017, there's a couple of dynamics right. In the beginning of 2017 we started increasing our yields, but that will take some time to flow through. So as the older lower yielding assets run off and you are originating at the higher yielding, that'll take some time. So you'll see that yield potentially creep up over time. Additionally, what we’ve also done is really focused on addressing our cost to originate, which will flow in in future quarters as well so that'll have a positive impact on the yield as well.

[Ken Zerbe:]

All right, great, thank you very much.

[Operator:]

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

[Scott Siefers:]

Good morning, guys.

[Craig Dahl:]

Good morning.

[Brian Maass:]

Good morning.

[Scott Siefers:]

Can you spend a second just talking about the leasing and equipment finance line? Obviously, a pretty strong quarter, I'm just trying to gauge the likelihood that level or number at this level is repeatable. I think it’s by a factor of almost 25% the best quarter you guys have had. So what would be sort of the outlook based on the backlog or however you would want to take a look at likely future levels?

[Craig Dahl:]

Well, we've talked over a long time period of time that there can be some volatility in that leasing revenue line. However, this was an outstanding quarter and we would continue to guide more on the $28 million to $30 million range, which is a number that we've talked about in the past.

[Scott Siefers:]

Okay. All right. Perfect, thank you. And then just a separate question, are you able to quantify how much of the provision was due to that auto move from available for sale to held for investment? Was it meaningful enough that is worth quantifying even?

[Brian Maass:]

Well, I don't have a specific number for you, but if you look at the provision for the quarter, I think it was around $19 million and charge-offs were $13 million. So that difference, a lot of that was made up of that transfer that’s what happened as well as we did also have some mix shift that took place in the portfolio as well as some growth. But a lot of that are the majority of that difference related to that, but there was some other items that make up the difference too between the provision and charge-offs this quarter.

[Scott Siefers:]

Okay. All right, that's helpful. All right, thank you guys very much.

[Operator:]

Our next question comes from Jared Shaw from Wells Fargo. Please go ahead with your question.

[Jared Shaw:]

Hi, good morning.

[Craig Dahl:]

Good morning.

[Brian Maass:]

Good morning.

[Jared Shaw:]

Just on the – one question on the auto. So when you look at the charge-off this quarter of 83 basis points was all that delta from the 112 due to seasonality and then I guess given the fact that we have this higher yielding component, should we assume that there's some higher loss there and that we could see normalizing for seasonality the auto charge offs increasing from the 112 level?

[Mike Jones:]

Yes, this is Mike. So, you have the full impact within the quarter of the higher yielding assets, but you also have the full impact in the in the loss number as well, so those are in there for the full quarter. So that's included in the 83 basis points. I would say the majority of the improvements in June's quarter was seasonality from that perspective. I think prospectively really I think the team is really focused on how we can improve loss performance. So I'm optimistic that the team will execute on those strategies as we kind of move forward. But to revert back to a comment that kind of Craig made, we would look to this modestly increase as we go forward in the future with the mix change that we've kind of have on the balance sheet as well as third and fourth quarter being our seasonally highest quarters from a charge off perspective.

[Jared Shaw:]

Okay, great. Thanks. And then shifting to deposits, I guess when you look at the growth in CDs this quarter, was that – how much of that was customer preference seeking out rates versus you trying to maybe prepositioning the deposit portfolio for higher rates? And then also correspondingly when you look at the yield on the money market accounts, it’s actually negative beta when you look year-over-year, how much of that was repositioning from money market into time deposits?

[Brian Maass:]

So, this is Brian. So a couple of comments. First on your CD question, it's kind of a combination of both right? There is – customers do have preference for CDs as rates go higher because they want to start a locking that in as well as we don’t mind locking in that rates as well, so some of that is customer preference and part of it is our desire to have on CD balances as well. The yield on the money market is down a quarter-over-quarter basis. That's part of just our normal reprising of different products. And we see customers remaining with that or potentially shifting to other preferred products as well.

[Jared Shaw:]

Great. Thank you.

[Operator:]

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

[Ebrahim Poonawala:]

Good morning, guys.

[Craig Dahl:]

Good morning.

[Ebrahim Poonawala:]

Just wondering in terms of the auto, we've talked about the higher yields coming on the new loans. Can you tell us like what the average origination yield on that book has been in the first quarter and also if you could remind us in terms of how the credit characteristics of the new loans that are coming on is different from what we were doing a year or so ago in terms of FICOs or whatever you think is appropriate?

[Craig Dahl:]

Yeah, we don’t break out kind of our different segment yields and origination yields there. We talk about kind of the overall book. I think you can take kind of the 501 for auto as a baseline and then our objective would be to kind of move it up from there and drive for kind of higher yields in the marketplace. I think kind of on the credit dynamics, from that perspective, the things that we focused in on in the first quarter a lot was around kind as the LTV and how can we lower the origination LTV to combat some of the severity that you kind of have been seeing in the marketplace across the industry and the used car prices because we’re predominantly a used car lender, so we've made some adjustments there. We’ve also looked at kind of our risk adjusted return on each of our different grades and made sure that we're also adjusting on the yield side to ensure that we're getting enough return to capture the increase in severity as well. So, you'll see that kind of flow through 2017. As you look back historically really 2015 and 2016 vintages have performed worse than 2014, we believe kind of the adjustments that we've made in 2017 is, is that trying to get that 2017 vintage to perform more like 2014’s vintages. So that's what kind of our focus is for the group.

[Ebrahim Poonawala:]

Understood, that’s helpful. And just – I want to make sure I understand sort of the outlook in terms of provisioning correctly, like, do you expect sort of as we think about charge offs to stay near 2Q levels as we think about the back half of the year, or do you expect the two wholesales credits going away sort of resetting charge-offs lower and how does sort of that feed into your outlook in terms loan loss reserves in terms of building the ratio or the dollar amount of the themselves [ph]?

[Brian Maass:]

Yeah, this is Brian. What I’d say from a charge-off perspective, as Mike alluded to, we would see from an auto perspective, those [ph] modestly going up probably as the year progresses. Away from auto, where you’re seeing quite a bit of stability, I’d say in our net charge-offs, other than we did have the recovery in Q1, so when you look at Q1, it’s abnormally low because of that. So, I think what I would expect is that we should see some stability, I'd say, in charge-offs when you look at the wholesale portfolios excluding some of the – even the one-time things that went through there from a commercial perspective.

[Ebrahim Poonawala:]

Understood. And do expect the reserve ratio to stay around this 90 bps or are you actively sort of trying to get that to 100 basis points or any particular number?

[Brian Maass:]

Yeah, I mean, it is obviously going to be a function of the risk that's inherent in the portfolio and many portfolio mix changes that happen from an ongoing perspective but we've seen quite a bit of stability from a provisioning perspective as well as from an allowance perspective and I don't see a lot of factors in the near-term that change that

[Ebrahim Poonawala:]

Thank you.

[Operator:]

Our next question comes from Steven Alexopoulos from JPMorgan. Please go ahead with your questions.

[Steven Alexopoulos:]

Hi, good morning, everybody.

[Craig Dahl:]

Good morning.

[Steven Alexopoulos:]

I wanted to follow up on Ebrahim’s question first. If we look at the auto loan originations in the quarter, what was the median FICO score of the auto loans that you held in portfolio?

[Mike Jones:]

You're talking about from an origination standpoint or portfolio?

[Steven Alexopoulos:]

The loans – yes, the ones you originated and held in your – the incremental loans added to the book this quarter?

[Mike Jones:]

Yeah, we haven’t historically disclosed kind of what we've had from a origination standpoint. I believe that we've disclosed kind of the portfolio. I don't have that figure in front of me, but if you follow up with Jason, he will be able to provide you kind of where that portfolio sits.

[Steven Alexopoulos:]

Okay. And I know you said you made some changes to the LTV, do you have what the average LTV at origination would be after the changes you made?

[Mike Jones:]

Again, we don't disclose that granularity on the auto portfolio, the different underwriting characteristics that we have on it. But just to say what we believe it will show up in the loss performance and the improvement in the loss performance in 2017 vintage.

[Steven Alexopoulos:]

Okay. And with the concentration being at 18%, I know you mentioned you thought it would go back to 15% to 16%, what's the rough timing, how long will it take you to get back down there?

[Mike Jones:]

This is Mike Jones. I would say that it's going to be over the next several quarters as the other businesses continue to grow from – and I think Craig mentioned it and talked a little bit about the wholesale businesses and kind of their trajectory and their growth rate. As those grow at a greater pace, the auto portfolio will naturally come down.

[Steven Alexopoulos:]

Okay. And then – thank you. Just one final one on deposits, with the loan to deposit ratio 105 how high – much higher you guys willing to take that and what are your thoughts on M&A here to maybe bolster deposit balances? Thanks.

[Brian Maass:]

This is Brian. Kind of on the loan to deposit ratio being higher than our peers, I do want to also mention, it’s not that we have less deposits than our peers, it’s just that we have more loans than our peers. So if you look at our total deposits, the total assets or how we're funding the balance sheet, it’s typically anywhere between 79% to 81%, which is probably 5% to 6% higher as a percentage of deposit funding from an organization perspective. So away from deposits, all we really have is a little bit of long-term debt and equity. So, we feel comparable with things the way it's sits from a liquidity perspective. From a longer term perspective, we feel we've got plenty of growth opportunities in the footprint that we have to continue growing the deposits. But obviously looking at acquisitions or deposit opportunities is something that we will do over the long-term as well.

[Steven Alexopoulos:]

Okay, thanks for all the color.

[Operator:]

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

[Chris McGratty:]

Hey, good morning. Thanks for the question. In the slide deck, you referenced the charge-off rates today are kind of running below – kind of at the low end of historical. Can you abide upon how you think or where you think your normalized charge-offs are for the bank given the strategy shift and then maybe when you might get that? Thanks.

[Brian Maass:]

I think it’s just the function – this is Brian – from where we are in the credit cycle. We think we are at the low range. I think a lot of people are saying that. I don't think that’s much of a surprise, obviously, it would be dependent on portfolio by portfolio, but generally we feel we are in a pretty stable credit environment when you look at kind of where unemployment is, but consumer feels pretty healthy. So we'll just have to see over time when we see any changes in that line, but over the near-term we don't see a lot of – we don't foresee a lot a lot of changes.

[Chris McGratty:]

So the 30 – Brian, if I understand it, the 30 is kind of the low-end, given the strategies, is 30 to 60 about right and is the timings kind of up to you know economic conditions, is that a fair range because I think you spoke about that in the past?

[Craig Dahl:]

This is Craig. I mean I think in the near-term I think the 60 would be high, the 30 is obviously heavily influenced by the auto number and I think you need to kind of look at it from isolating the auto versus the rest of the portfolio and so we're comfortable at that – where we are at – and the other thing I would point out is our consumer real estate, our equipment finance, and our auto portfolio, all going to be delinquency driven. So you are going to see changes in underlying credit quality leading into change in charge-offs. And you can see on page 8, our 60-day delinquencies are 11 basis points, consistent with 9 at the first quarter and 12 at year end. So we're not seeing any movement underlying any of those portfolios at this point.

[Chris McGratty:]

Great, thank you for that. If I could sneak one in on the [indiscernible] any notable changes on expectations to resolution that you could share with us?

[Craig Dahl:]

Well, we delivered our oral arguments on our motion to dismiss in the middle of June and we are still awaiting the court's ruling. So we don't have any more news beyond that.

[Chris McGratty:]

Okay. And then, Brian, lastly on the tax rate, can you help us with the go-forward rate given the unusually low number this quarter? Thanks.

[Brian Maass:]

Yeah, we had an unusually low rate this quarter due to the – there was a state tax item in there as well as we did have a little bit more stock compensation impact in Q2. For the rest of the year, we really only have – we’ll only expect impact from the stock compensation to really be in Q1 and Q2. So we don't expect really much impact in Q3 and Q4 and the state tax item really was a onetime item. So I would expect our normal or kind of core effective tax rate to still be in that 34% to 36%.

[Chris McGratty:]

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

[Dave Rochester:]

Hey, good morning, guys.

[Craig Dahl:]

Good morning.

[Brian Maass:]

Good morning.

[Dave Rochester:]

Just back on the auto reclass, I’m just wondering what the actual yield was on the reclass loans and then how much of that you would consider to be subprime?

[Mike Jones:]

This is Mike Jones. We're not going to disclose kind of the yields on specific segments of the portfolio, but it's moved as of April 1, so the full impact is on – is in the yield increase within the quarter, so you can utilize kind of that 501 as a run rate prospectively and we’ve kind of talked about some factors that we believe can drive that upward.

[Dave Rochester:]

Was the majority of that subprime?

[Mike Jones:]

No, I would say how we would look at is kind of more near prime in nature than subprime. I mean we don't really do kind of any deep subprime, so if you look at that portfolio kind of on an average standpoint, it was probably more near prime than subprime.

[Dave Rochester:]

Okay. And then just on the funding side, did you guys extend some borrowings this quarter, I just noticed the cost was up a little bit and if you did what were the terms on those in the timing?

[Brian Maass:]

They are federal home loan banks advances predominately; they do have a longer dated maturity, but the pricing on them tends to be more market driven, so that's why they moved up, it’s more floating rate in nature.

[Dave Rochester:]

Got you. And then just a question on the NIM trend in the back half. It sounds like you're expecting maybe NIM stability in 3Q and then maybe some pressure beyond 3Q, just given the dynamic you're talking about on the deposit cost side, is that fair?

[Brian Maass:]

Yeah, a lot of it just depends on, one, do we get additional rate hikes or not, it’s going to depend upon how much growth we have on the balance sheet and how much new or incremental deposits we're going after, but generally from just mix shift perspective as you go through the year, we would see pressure on the net interest margin in the second half of the year.

[Dave Rochester:]

Okay. And then I guess just given that backdrop and then your commentary on the equipment finance income trend you expect in 3Q with that being in that maybe $28 million to $30 million range. It kind of sounds like you're guiding to maybe flattish revenue in 3Q, maybe even a little bit of dip, is that generally what you're saying, just wanted to make sure I understood.

[Brian Maass:]

This is Brian. I still think from an overall, you will continue to see growth in that interest income. It's more when I'm speaking to the net interest margin rate that you can see that kind of flat lining or coming down in the second half, but we still – we'll expect to see growth in net interest income.

[Dave Rochester:]

Okay. And overall growth in revenues as well?

[Brian Maass:]

Yeah, I mean, we should see growth in revenue. Obviously, we won't have the gain on sale, we did have a really good quarter from a leasing perspective, so I think like Greg said, we don't necessarily expect that that number is going to repeat, so we would see that number potentially coming down.

[Dave Rochester:]

Yeah, okay.

[Craig Dahl:]

The only other thing I wanted to mention is, I kind of object a little bit to the word margin pressure because there is a seasonality to our business, and so when you look on page 11, how it declined last year throughout the year, it wasn't a permanent reduction. And when the first quarter came again, it goes back up based on the impact of inventory finance and some of our other variable rate asset category. So I kind of need you to understand that if it trends down in the fourth quarter, it's most likely going to go back up in the first quarter.

[Dave Rochester:]

Got you. Okay. All right, thanks guys.

[Operator:]

Our next question comes from David Chiaverini from Wedbush Securities. Please go ahead with your question.

[David Chiaverini:]

Hi, thanks. I wanted to follow-up on deposits. With you expecting a modest uptick in deposit costs as the loan portfolio grows, what type of deposit beta are you planning for?

[Brian Maass:]

Yeah, we don't have kind of one overall beta rate; obviously, our portfolio is made up of different segments. Just as a reminder, 90% of our deposits are retail in nature. So when you look at the – we've been very disciplined on the deposit pricing as I think kind of the market has in general around retail deposits, we expect that markets will remain somewhat rational from a deposit pricing perspective, but on the margin from a promotional perspective as you’re bringing in new deposits, that’s going to be the stuff that’s at the highest rate. So that’s going to have the highest beta. But a lot of our books is either noninterest bearing or very low cost and it’s going to have a very low beta. So it just depends what portion of the book you're looking at. And so really what will impact us depends on how much growth we have on the margin because that will be the stuffs that comes in probably at the highest margin – the highest beta, I should say.

[David Chiaverini:]

Okay. That makes sense. And then shifting to the Series A 7.5% perpetual preferred stock, that became callable last month. How do you view this from a capital planning perspective, do you have plans to redeem this paper and either eliminate it or refinance it at a lower rate?

[Brian Maass:]

We continue to look at all of our capital options that we have. Specifically related to the preferred, you're right, it is callable at that rate. You know we've also seen improvements in market rates, if we even wanted to refinance it. Obviously, to do that you have to pay new issuance costs. So there is a factor that we have to consider there. But continuing to look at our overall capital levels, not just preferred, but as well as common and other things is something that we will continue to do on a quarterly basis.

[David Chiaverini:]

Thanks very much.

[Operator:]

Our next question comes from Scott Valentin from Compass Point. Please go ahead you’re your question.

[Scott Valentin:]

Thank for taking my question. With regard to deposit fees and service charges although it was down year-over-year, wondering if that trend will continue or if there is any kind of seasonal impact in the second quarter?

[Mike Jones:]

Yes, this is Mike Jones. I would say that we've seen that over the last several years on a year-over-year basis. The decline, I think, you saw the uptick in 2Q from 1Q that was similar to last year, that's from a trend standpoint. I think it was up a little bit over 5% this year and that was the same uptick that we saw from a seasonality last year. But I think that's happening in the industry from a couple things I think more information is being shared and available and accessible to people that are banking as well as is what we're seeing is kind of people running with higher checking balance in their accounts.

[Scott Valentin:]

Okay. Thanks, that’s helpful. And then, I appreciate the guidance on the forward leasing and equipment finance, but I know in the press release you referenced customer driven event that drove the size of the increase. Anything specific there, a onetime, I guess, that's worth pointing to?

[Craig Dahl:]

That’s our common language regarding that meaning we didn't initiate it, but the customer restructured a transaction with us. So…

[Scott Valentin:]

Okay. And then one final question, just – I know you guys mentioned positive operating leverage with revenue growing faster than expansion in the second half, I’m just wondering how we should think about non-interest expense going forward if it should be stable around current levels you expect any type of increase going forward?

[Brian Maass:]

Yeah, I do expect it probably to more stabilize around the current levels that we had in 2Q, so I think that is good guidance.

[Scott Valentin:]

Okay. Thanks very much.

[Operator:]

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

[Lana Chan:]

Yes, good morning. Just follow-up on the last question about expenses. How much more is there to do in terms of rightsizing the expenses around the auto business or is that pretty much in the run rate at this point?

[Brian Maass:]

What I’d say from a non-interest expense perspective, you did see the decrease income from Q1 and part of that is seasonality. It is down couple of percent on a year-over-year basis as well. Couple of things are driving that right. We did have had some great closures over the last kind of 12 months or 18 months, so those are baked into that run rate now. And I’d say most of the changes in auto are baked into that run rate as well. We might see some small changes I think from auto over time, but the majority of the impact or majority of the headcount reductions is really in place by the end of second quarter there.

[Mike Jones:]

This is Mike Jones. I’d just reiterate. Yeah, I think, Brian’s spot on from that standpoint. And as we look forward, just like in every business, we're going to look at process improvements and how can we drive more efficiencies that will drive more operating leverage, but I think the heavy lifting and the heavy changes are behind us in auto and it's really more around how can we make the platform more efficient prospectively.

[Lana Chan:]

Okay. Thank you. And just one quick follow up on that. I might have missed it early on, but did you talk about why the auto loans were reclassified from held for sale to held for investment this quarter?

[Craig Dahl:]

Well, that's simply with the change in our strategy that we were no longer intending as part of our core platform to sell those loans and therefore the transfer made sense at this time. And as the guys have said, it was effective as of April 1. So it's fully in the quarter.

[Lana Chan:]

Okay, thank you.

[Operator:]

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

[Terry McEvoy:]

Hi, thanks, good morning. The servicing fees were down quarter-over-quarter and you state that there was a decline in the portfolio of auto loans sold with the servicing retained by TCF. As part of this new auto strategy, will the servicing component continue to come down and then on the expense side were there any personnel cuts or expenses incurred last quarter to account for lower revenue on servicing?

[Brian Maass:]

So, this is Brian. From a service revenue perspective, right, as we kind of – if we are not selling any more auto loans we will generally see that servicing book go down over time, so servicing revenue on the auto book will go down over time. That’s – as Mike mentioned, we will look to basically continue to operate that business as efficient as we can, so we would expect some expense offset over time as that revenue comes down. Most of the onetime charges related to auto were in the first quarter, there wasn’t really much if anything in the second quarter.

[Craig Dahl:]

The only thing I would add to Brian’s comment there, right, so we are not going to just cut the servicing staff based on only looking at the servicing revenue, we are also going to look at the loss performance and how that’s performing. So, for example, I’m not going to cut a dollar out of servicing revenue to spend $2 in the loss performance. So we are going to also look at how can we drive that loss performance to a better level and utilize our expense in servicing organization to do that.

[Terry McEvoy:]

And then just as a follow-up, could you talk about the strategic investments in technology that pushed up the other expense line year-over-year, is that primarily in the retail distribution or retail banking area and have those expenses peaked?

[Brian Maass:]

Yeah, it’s like we’ve talked about in the last couple of quarters. There is really two main things that are going down there, right. As we’ve closed branches, we are shifting the focus to more customer preferred channels, so we are making investments in digital, so a lot of it is happening in retail. As well as just generally on kind of our core operation side, we are looking at other investments called lifecycle upgrades, you know, those types of things that can help provide more efficiency over time. From a run rate perspective, I don’t really see it going up from this level, but you will see it kind of sustain at this level for some period of time.

[Terry McEvoy:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Nathan Race from Piper Jaffray. Please go ahead with your question.

[Nathan Race:]

All my questions have been answered. Thank you.

[Operator:]

[Operator Instructions] And ladies and gentlemen, I’m showing no additional questions. I’d like to thank everyone for joining today's conference call. 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. Now I’d like to turn the conference call back over to Mr. Craig Dahl for any closing remarks.

[Craig Dahl:]

Thank you. While we're encouraged by our second quarter results, we remain focused on executing in three primary areas

[Operator:]

And ladies and gentlemen, with that, today's conference call is concluded. You may now disconnect your lines.