TCF Financial Corporation
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Good morning, everyone, and welcome to TCF’s 2018 Second Quarter Earnings Call. My name is Jamie, and I will be your conference operator today. [Operator Instructions] Please also note today’s conference call is being recorded. At this time, I’d like to introduce Mr. Jason Korstange from Investor Relations to begin the conference call.

[Jason Korstange:]

Good morning and thanks for joining us for the TCF’s second quarter 2018 earnings call. I’m happy to be here today for my last of 78 continuous earnings calls. As many of you know, I will be retiring. And I’ve certainly enjoyed working with all of you and many of your predecessors. But I’m looking forward to spending more time traveling and on the golf course. Joining me today will be Craig Dahl, Chairman and Chief Executive Officer; Tom Jasper, Chief Operating Officer; Brian Maass, Chief Financial Officer; Mike Jones, EVP of Consumer Banking; and Jim Costa, Chief Risk Officer and Chief Credit Officer. In just a few moments, Craig, Brian and Jim will provide an overview of our second quarter results. They will be referencing a slide presentation that is available on the Investor Relations section of TCF’s website, ir.tcfbank.com. Following their remarks, we will open it up for questions. During today’s presentation, we may make projections and other forward-looking statements regarding future events or the future financial performance of the company. We caution that such statements are predictions and that actual events or results may differ materially. Please see the forward-looking statement disclosure in our 2018 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, 2018, and we undertake no duty to update the information. And now, for my last time, I will turn the conference call over to TCF Chairman and CEO, Craig Dahl.

[Craig Dahl:]

Thank you, Jason. Good morning and thank you all again for joining us today. Before we begin, I want to take a moment to recognize Jason for his 30-plus-years of service at TCF. He has led the Investor Relations department for nearly as long as I’ve been here. Many of you have gotten to know Jason over the years and understand his dedication and commitment to establishing strong relationships with the investment community. He certainly been a great resource for me and I’m truly grateful for all Jason has done for TCF. For the rest of the year, Jason will continue to lead the TCF Foundation, which he is very passionate about. In the meantime, we have added Tim Sedabres as our new Director of Investor Relations. Some of you have spoken with him already and I know he looks forward to speaking with more of you over the coming days and weeks. Again, Jason, congratulations on your retirement, and thank you for moving your teatime back. Now, before I comment on our second quarter results. I want to take a minute and talk about the settlement with the BCFP and OCC we announced last week. This settlement resolved the legacy overdraft opt-in litigation and resulted in a pre-tax charge of $32 million in the second quarter including related expenses. We are pleased to have a resolution to this matter and believe it is in the best interest of all of our shareholders to put this legacy issue behind us. From a go-forward standpoint, we don’t anticipate a material impact to any of our current practices or programs. And in addition, we continue to maintain a good working relationship with both regulators. With this matter behind us, we can focus all of our attention on the positive momentum we have been building over the past several quarters, and our current and future initiatives to drive value for shareholders. We continue to see this positive momentum in the second quarter. Looking at Slide 2, we reported net income of $58.7 million and diluted earnings per share of $0.34. Excluding the settlement charge, adjusted earnings were very strong with net income of $84.3 million and diluted earnings per share of $0.49, up 48.5% compared to the second quarter of 2017. We previously outlined three strategic themes for 2018, which we demonstrated strong execution against in the second quarter. As a result, our second quarter performance included five key highlights

[Brian Maass:]

Thank you, Craig. Starting on Slide 3, you can see that we have continued to make progress in driving core operating leverage, as our adjusted efficiency ratio of 65.78% in the second quarter, declined 241 basis points year-over-year. This was driven by 6.8% revenue growth, as net interest income increased 10.4%. Meanwhile, non-interest income remained relatively flat, but reflected a more favorable mix with a lower gain on sale concentration. Reported non-interest expense included the BCFP/OCC settlement and related expenses of $32 million. As we indicated last quarter, adjusted non-interest expense excluding operating lease depreciation remained well controlled at $222 million, and was relatively in line compared to the prior year. On a year-to-date basis, our adjusted efficiency ratio of 67.47%, which is within our full-year guidance range of 66% to 68%. We are pleased with the progress we have made improving our operating leverage and feel confident our ability to hit our target range for 2018. Turning to Slide 4. The net interest margin saw a nice expansion of 8 basis points on a linked quarter basis, driven by a favorable impacts from the higher yields on variable rate consumer real estate and commercial portfolios. Seasonally higher average balance and increased yields in the inventory finance portfolio and higher leasing and equipment finance yields. These tailwinds outweigh the headwinds, which included higher funding costs and an impact from auto loan run-off being reinvested into the securities portfolio. Keep in mind, that we experienced extended seasonality this year as the longer winter resulted in higher seasonal inventory finance balances carrying over into the second quarter, impacting the margin favorably. At the beginning of the year, we expected marginal declines in net interest margin as we progressed through 2018. However, we have experienced several favorable items to date including additional rate hikes, faster inventory finance growth, higher reinvestment rates on securities purchases and disciplined on non-promotional deposit pricing, which was reflected with just a 2 basis point linked quarter increase in deposit costs. As a result, our year-to-date margin was higher than expected, implying a full year margin that will now likely be flat to modestly higher than it was in 2017. However, we do expect lower average inventory finance balances in the third quarter as period end balances were lower than average balances in the second quarter. We are also cautious around both promotional and non-promotional deposit costs going forward, as the next 100 basis points of rate change will likely be more expensive than the last. Turning to Slide 5. Second quarter earning asset yields of 5.33% are up 39 basis points year-over-year. Despite the run-off of the auto portfolio, as loan and lease yields continue to expand. Loan yields increased 52 basis points year-over-year, driven by increases in nearly all of our loan and lease portfolios. Our strategy of competing as experts along with our pricing discipline and increases in short-term rates continued to drive our strong yield performance. In addition, our security yields are becoming more impactful, as we continue to reinvest run-off from the auto portfolio into the securities portfolio. The securities repurchased in the second quarter had an average tax equivalent yield of 3.38%, up 27 basis points from last quarter. Looking at Slide 6. We have seen year-over-year stability in non-interest income, but with a more favorable mix as the gain on sale and servicing fee income now make up just 13% of non-interest income down from 18% a year-ago. We believe this will drive more stable and predictable revenue. In addition, last quarter we talked – we began talking about our net leasing and equipment finance non-interest income, which is the net of leasing non-interest income and operating lease depreciation. This came in at $25 million for the quarter in line with our guidance. While, we have seen stability in this line in recent quarters, we are optimistic that we could see some improvement in the second half of the year. Turning to Slide 7. Average deposit balances in the second quarter increased 6% year-over-year with checking and saving balances up 9.7%. We would expect this quarter checking and saving balances to be the deposit growth driver going forward in 2018. We will continue to base our funding needs around our loan and lease growth outlook. With our auto portfolio continuing to run-off, we have less pressure to grow promotional deposits. We saw deposit costs increased just 2 basis points from the first quarter, which speaks to the value of our retail deposit franchise. As interest rate continue to increase, we expect upward pressure on deposit costs going forward due to competition as well as our very low non-CD deposit beta today. Over the past year, we have only seen a 9 basis point increase in non-CD deposit costs, which will likely increase in the future periods. Turning to Slide 8. Loan and lease balances increased 5.9% year-over-year, excluding the auto finance portfolio in line with our mid-single-digit growth guidance for the year. Keep in mind, that we did see the expected seasonal decline of inventory finance balances of nearly $453 million in the second quarter. We continue to see strong year-over-year growth from our wholesale portfolios, as inventory finance increased 19.8%, leasing and equipment finance 7.3%, and commercial 6.2%. The run-off of the auto finance portfolio also continued with balances down $596 million year-to-date, nearly matching the mid-point of our guidance of $1.5 billion of run-off in 2018. We saw strong originations of $4 billion in the second quarter, up from $3.5 billion of non-auto originations a year-ago. As we look towards the second half of the year, we are optimistic about our loan growth opportunities. With that, I’ll turn it over to Jim to cover risk and credit.

[James Costa:]

Thank you, Brian. If you turn to Slide 9, you can see that we are continuing to reduce the risk profile of our balance sheet as the auto portfolio runs off. Overall credit quality trends remain positive. Non-performing assets are down just 54 basis points, declining 32 basis points year-over-year. This reflects $36.7 million of consumer real estate non-accrual loans that were transferred to held for sale during the second quarter, which we expect to sell in the third quarter. 60-day delinquencies continue to remain stable at just 11 basis points, while delinquencies excluding auto have remained at 10 basis points or lower for the last eight quarters. Consistent with the first quarter provision remains in the lower-teens at $14 million. In addition to our stable credit quality, we are also seeing reduced credit and liquidity risk as the auto portfolio is being reinvested in the cash and securities. In fact, cash and securities now make up nearly 13% of total assets compared to just 10% a year-ago, while our loan to deposit ratio have declined from 105% to 101% during the same period. Our largest securities portfolio allows us to manage our aggregate interest rate risk increased our on balance sheet liquidity and improve our capital efficiency. If you turn to Slide 10, we’ll take a closer look at net charge-offs. Slide 10 provides more detail on the net charge-off trends. Here, while we continue to operate in a benign credit environment, the benefits of our reduced risk profile and diversification philosophy are driving our strong net charge-off trends across the portfolio. Total net charge-offs of 27 basis points are down 1 basis point year-over-year, while net charge-offs excluding auto remained consistently low at just 10 basis points in the second quarter, down 7 basis points year-over-year. We have added chart at the bottom of the slide showing a breakout of net charge-off dollars, two-thirds of which were made up of auto, with just $4 million coming from other loan and lease portfolios. Auto net charge-offs of $8.5 million are declining along with the run-off of the auto portfolio, following the shift to discontinued originations in the fourth quarter of 2017. Overall, we are very pleased with credit quality of our portfolios. With that, I’ll turn it back to Brian.

[Brian Maass:]

Thank you, Jim. Turning to Slide 11. I think, our focus on improving return on capital has to evident so far at this morning. Our adjusted ROATCE increased to 15.39% in the second quarter and our CET1 ratio increased to 10.6%, all while improving our risk profile. As Craig mentioned earlier, we are now 90% complete with our initial $150 million share repurchase program. Today, we announced an additional $150 million share repurchase authorization. There are many variables that can impact the pace, at which we will repurchase our stock, but we now have the optionality to continue to buy that additional shares moving forward. With that, I’ll turn it back over to Craig.

[Craig Dahl:]

Thanks, Brian. I think our second quarter results show real progress towards our key 2018 strategic themes on reducing our risk profile, deposit of outlook for our non-auto businesses, and improving our return on capital. Earlier in the year, we provided 2018 target range for ROATCE of 11.5% to 13.5%. As the years progressed, while keeping in mind the seasonality of our business, we are more confident that we can be at or above the higher end of this range on an adjusted basis for the full year. Similarly, we remain on target with our adjusted efficiency ratio range of 66% to 68%. I feel really good about the progress we made to date and how we’re positioned for future success. I believe we are focused on the right strategies to drive shareholder value moving forward. With that, I’ll open it up for questions.

[Operator:]

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] At this time, we will pause momentarily to assemble the roster. And our first question today comes from Jon Arfstrom from RBC Capital Markets. Please go ahead with your question.

[Jon Arfstrom:]

Thanks. Good morning.

[Craig Dahl:]

Good morning.

[Jon Arfstrom:]

Congratulations, Jason.

[Jason Korstange:]

Thank you.

[Jon Arfstrom:]

Yeah, 70 and sunny, I know where you’re headed. Brian, just on the margin, I understand, I think, what you’re talking about going forward. But given us an idea of – I think you’re saying modest contraction in Q3 and possibly Q4. Give us an idea of what you’re thinking in terms of magnitude. And then, if we get a couple of more rate increases later in the year, how do you think that plays out for the margin?

[Brian Maass:]

Yeah, now, good question. I mean, there continues to be a couple of headwinds for the margin, right, the auto balances running off that remix in the securities. We try to quantify some of the components of the margin that kind of help out on that, right, so that’s call it 3 to 4 basis point impact cumulatively each quarter as that run-off takes place. In addition, contributing to our margin expansion in the second quarter was really inventory finance. 6 basis points of that expansion was really due to the average balances being higher in the second quarter for that business. So as we end the quarter, right, the balances are lower than what the average balance was. So that’s a little bit of a headwind as well on the net interest margin. However, to the extent that we can continue to maintain the discipline on our deposit pricing, that’s where the optimism comes in, and that we continue to see obviously a high margin. Yet, it could come off some amounts, whether it’s a few basis points or something, as we progress the 3Q and 4Q in light of the headwinds that are there.

[Jon Arfstrom:]

Okay. Okay, that helps. And then, to the loan categories, it seems like you guys called out a little bit. I don’t know if it’s for Bill or Craig. But you talked about potentially operating lease income improving and some of the equipment finance and leasing strengthening. So talk a little bit about that. And then, also curious, on the home loan business, Craig, you called that out a little bit. What’s possible there in terms of balances and fee growth? Thanks.

[Craig Dahl:]

Sure, what was the first one, what was the first one?

[Brian Maass:]

Leasing revenue.

[Jon Arfstrom:]

Leasing, yeah.

[Craig Dahl:]

Yeah, leasing revenue, with the acquisition that we made on the platform in the middle of last year and then there is a little bit we added in the third quarter were operating leases, we have a little more predictable revenue stream coming off of those acquisitions. So we have a little – or sightlines not quite as episodic as it been maybe looking back. So that’s a little bit behind our confidence there. And just basically the general outlook there is – as rates start to move of the leasing product with their fixed rate options becomes a lot better conversation and that’s bringing us into more conversations on that as well. As far as TCF Home Loans, what I’m trying to guide there, Jon, is in fact that this is going to be a footprint addition. This is not going to be an international business for us. But we want to up our game on the offering we have for the mortgage products through our branch system for our customers and potential new customers. And that’s why those investments, as you know, we’ve been selling all of those through a correspondent relationship. And now, we’re going to be originating those and managing those ourself, so that’s what that outlook is.

[Jon Arfstrom:]

Okay. And that, you would say that’s early to nascent right now?

[Craig Dahl:]

Yeah, we bought the – we bought TCF Home Loans, which was a mortgage company here in the Twin Cities. We’ve been adding to it in other markets. But 2018 is really going to be a transformational year and 2019 is really the year that is expected to start to be additive.

[Jon Arfstrom:]

Yeah, okay. Okay, thank you.

[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.

[Scott Siefers:]

[indiscernible] I appreciate the commentary on sort of the nuance within the expenses and outlook. I’m just wondering as we look on a sort of an all-in basis, you got this adjusted base of $240 million. What’s your best guess as to how that trajects here as we go through the remainder of the year?

[Brian Maass:]

Yes, I don’t have specific items for you. We are committed to improving the operating leverage of the company. And I think you can see that in our results. We expect to stay within that range as we continue to the end of the year. You could see some increase on a year-over-year basis in expenses as we get into the second half. But you also have to take into consideration, even with this quarter, right, we’re up $23 million of revenue from last year and we have flat core operating expenses. So we think we’re doing a really good job and that we’re being disciplined on expenses. But as we’ve alluded to we are making some investments in other areas, including technology as Craig mentioned, in the TCF Home Loans, we’re making investments in talent. All of those investments that we’re making are going to continue to provide growth and revenue for the longer term for the organization.

[Scott Siefers:]

Yeah, okay. Thank you. And then, if I can switch to credit for just a second, so – and I guess, as I look at things that would impact the provision, so you got – the run-off of auto, since we’re going about as planned with – as planned credit performance as well. You moved some of these non-accrual commercial real estate loans over to held-for-sale. So presumably, those will – they’re just no longer a risk on the balance sheet. And then, additionally, you have very, very minimal charge-offs outside of auto. So what are the major puts and takes see you them – as you see them, when you look at provisioning needs going forward?

[Craig Dahl:]

Yeah, I’ll have Jim Costa comment on that.

[James Costa:]

Yeah, you could see, Scott, with the credit quality trends we really are in the benign part of the credit cycle here. We do like to call out the difference between the auto and non-auto portfolio, but really a 10 basis points charge-offs and low levels of delinquencies. Things really are quite stable, what I call well behaves. We love that. Any difference in provision might just come from select movement and maybe on the wholesale side where you would see a downgrade here or there. And for that, we watch for some added [ph] trends. None of which we’re seeing today. That’s probably what would change the provision profile or if we did entertain another asset sale, which we’re not signaling here. But historically, that unfortunately had made a movement in provision. But I would say things look pretty quiet on the provision side other than what we’ve already guided here, which is that as the auto portfolio runs off, we’d expect that the allowance levels of provision would fall accordingly.

[Scott Siefers:]

Yeah, okay. All right, well, that sounds. Thank you, guys, very much.

[Operator:]

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

[Christopher McGratty:]

Hey, good morning.

[Craig Dahl:]

Good morning, Chris.

[Christopher McGratty:]

Brian, maybe a question on the balance sheet, I think you alluded to in your comment that the auto run-off was around $800 million in the first half of the year. Could you talk about the pace of securities reinvestments, based on your mid-single-digit, loan growth guidance? So we just simply just put the excess into the securities portfolio. If so, interested in kind of what you’re buying and the spreads or the yields arriving [ph]. Thanks.

[Brian Maass:]

Yes, so, couple of things, Chris. One on the auto run-off for the first half of the year, it’s been closer to about $600 million, which is right in the midpoint of our guidance of the $1 billion to $1.5 billion. We did see about $500 million increase from a point in time perspective in our investment portfolio in the first half of the year. So a lot of those proceeds are winding up there. I think as we’ve been describing over the last couple of quarters, that’s where we plan to put the proceeds at least initially. If another opportunity comes along, that can provide us with a higher return on the capital. We obviously have the liquidity on balance sheet that we could also use for that growth. I did give in my opening remarks, kind of what the yields are there. I think it was 3.38% for the second quarter. We’re predominantly or almost exclusively buying U.S. agencies’ MBS securities, longer dated, call it 20 to 30 year type of paper.

[Christopher McGratty:]

Okay. That’s helpful. Thanks for that. And then, maybe a quick one on the tax rate, you have the $1.8 million you called out in the release. What should we be thinking about kind of prospectively in the back-half of the year?

[Craig Dahl:]

Yeah, we had, as we alluded to in the release, there is a couple of discrete items that made it lower within the quarter, but our guidance that we’ve been giving since beginning of the year, the 23% to 25%, that’s really what you should be thinking about. And we should less discrete items in the second half of the year. We tend to have more stock compensation in Q1 and Q2, which is really one of the main drivers that makes our tax rate lower, call it, in Q1 and Q2, but 23% to 25% is what you should expect.

[Christopher McGratty:]

Great. Thanks a lot.

[Operator:]

Our next question comes from David Long from Raymond James. Please go ahead with your question.

[David Long:]

Good morning, guys.

[Craig Dahl:]

Good morning, David.

[Brian Maass:]

Good morning, David.

[David Long:]

With regard to the inventory finance portfolio, obviously there was some seasonality that we saw hit the results here in the first and the second quarter. Can you talk about the back half of the year and how – any seasonality that we may see here? How we should think about the size of that portfolio on a period end and an average balance?

[Craig Dahl:]

Yeah, this is Craig. It typically comes down or stays relatively flat in the third quarter. And then, it starts to grow again in the fourth quarter. And as I talk about we always should look at this business year-over-year, not on a linked quarter basis, because the seasonality is fairly consistent. So that’s really what our outlook is. In addition, as you know, the yields go up as the inventory ages, and so there is some upward movement in the yields in the third quarter, whereas in the fourth quarter we have a higher amount of the newly shift inventory, so it tends to have a little bit of flattening there.

[David Long:]

Got it. And you talked a bit about the exclusive program, and it sounds like the exclusive program wins and the signings are going well. Can you talk about the momentum there and then at this point what is the percentage of that total portfolio that are on these exclusive programs?

[Craig Dahl:]

Yeah, we’re over 70% in exclusive programs. 70% of our balances. And it’s – there is a long selling cycle and there is a very strong competition. We have two primary competitors, Well Fargo and NorthPoint, which is now owned by the Laurentian Bank in Canada. And they have their own unique business models and we’ve been very successful at new program acquisition here in the end of 2017 and 2018.

[David Long:]

Got it. And last thing that I had, you guys have done well on the expense management side relative to the revenue growth that you’ve been generating. When you look out to 2019, any early tweaks as to what we may see any efficiency ratio for next year.

[Brian Maass:]

This is Brian. No real guidance towards 2019 at this point, but what we are trying to do as an organization is continuing to find ways to make the organization more efficient.

[David Long:]

Got it. Thanks, guys.

[Operator:]

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

[Nathan Race:]

Hey, guys, good morning.

[Craig Dahl:]

Good morning.

[Nathan Race:]

The question on auto credit for Jim. I think previously you’ve guided to auto net charge-offs rate increases that portfolio runs off. Obviously, we saw net charge-off rates within auto step down this quarter. So I just curious on your outlook for auto credit quality, is that portfolio continues to decline?

[James Costa:]

It’s working up, Nathan, as we’ve expected, what you’re going to see is, just changes in the aging of the portfolio as there is no inflow and then seasonality, those are the two dynamics that we’ll be watching. They’re working on as expected. What I’d really encourage to do is watch the decline in the levels of delinquency, the levels of charge-offs and balances as well. Obviously, with the dynamics of seasonality and aging, those rates will change. And so really a run-off portfolio, we’d encourage you to keep an eye on the balances themselves, which are all falling in line as expected.

[Nathan Race:]

Okay. Got it. And then kind of changing gears a little bit and thinking about commercial loan growth had good growth this quarter, but I was just curious if payoffs on the commercial real estate side of things may have impacted growth this quarter and if so how payoffs are trending so far in the third quarter?

[Craig Dahl:]

This is Craig. We’ve got a pretty good sight line. There isn’t anything that happened differently than our sort of forecast was. So there wasn’t any outsized reduction or increase. And it’s really just been pretty consistent growth across all of our markets.

[Nathan Race:]

Okay. I appreciate the color. Congratulations on your time, Jason.

[Jason Korstange:]

Thank you.

[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:]

Maybe just on the inventory finance. Do you feel that as rates start to go higher that you’re going to see those dealers be more active in managing their inventory and will most of that growth when you start looking year-over-year from this point, really be more dependent upon adding new dealer relationships? Or are you seeing them maintain their level of inventory?

[Craig Dahl:]

Well, I think, the small business lending index and confidence factors are up. That’s one thing. They’re expecting continued strong operations. Secondly, they already actively managed that inventory basin. Remember, for our exclusive programs there’s a free floor plan period that covers 90 to 120 days of that selling period. And they take good advantage of that. So we are always sensitive to – and then, third thing I would say is 11,000 dealers and 70% of those credit lines are under $300,000. So we have a concentration of fairly small balances that turnover frequently. So it’s always something that we watch. But right now, we’re not calling any alarms on that at this time.

[Jared Shaw:]

Okay. All right, great. And then, when you spoke about the new hires, the potential for making some new hires in Chicago, Denver, Detroit, Twin Cities. Is that more on the traditional small and middle market C&I site? Or what type of person you’re looking for in those hires?

[Craig Dahl:]

Yeah, I would – we were targeting both C&I, and obviously the opportunity to get a team would be very encouraged around that, and then CRE as well. I don’t think everyone always recognizes the diversification we have built in, just with our various footprints. So it’s not like we’ve got $3 billion of commercial real estate in Minneapolis, it’s really spread across our footprint, and then with some portion of it, where sponsors, local sponsors are doing transactions in other market. So we would look at either side of that equation for talent at this time.

[Jared Shaw:]

Yeah, thanks. And then finally, just for me on the deposit side. Can you highlight a little bit like what you’re looking to implement for some of those deposit promotions. Is that growing customers or growing product or markets?

[Brian Maass:]

Yeah, this is Brian. So I’d say, where we’re seeing a lot of our growth come over last year 9.7% year-over-year growth in our checking and savings account. So we’re really focused as we made our investment in technology. We’re really interested in growing the core book. We do offer promotions at promotional rates. We like the market have had to adjust – make some adjustments to the promotional rates that we offer. So that’s where we definitely expect to see some rate sensitivity, we have promotions in various of our markets across the footprint. In general, but we’ve actually again been able to manage from deposit cost increase perspective has been in the non-promotional part of our book. We have not had much increase at all, I mean, if you look at with 175 basis point move in fed funds since beginning of this rate hike cycle. Our non-CD portion of our book is only up 6 basis points. So again some of the cautious words I have was that we could see some increased pressure on that. But as we stand here today, we feel really good about the composition that we have for that portion of our customer base. It’s less above the rate. It’s more above the features and functionality of the account as well as the convenience, ATMs, digital mobile app, all those types of things, which the investments we have made over the last couple of years, we think put us in good position.

[Jared Shaw:]

Okay, thanks. And just wanted to say congratulations also to Jason and Tim on the new role.

[Jason Korstange:]

Thanks, Jared.

[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.

[Brian Maass:]

Good morning.

[Ebrahim Poonawala:]

I just had one remaining question actually around capital. So I mean, I think – as we think about the buyback that you announced today. Should we expect the execution on that to occur as fast as we saw with first one? Or given sort of the move in the stock, this is going to be a little more opportunistic than what we’ve seen over the last three quarters?

[Brian Maass:]

Yeah, this is Brian. What I say is, we were pretty intentional on kind of outlining a period that we intended to do our first buyback. As you know, we executed kind of accordingly with that. I’d say, with this announcement, we’re saying there is many variables that can impact the timing and pace at which we buyback. So not signaling kind of a period that can be over, but obviously share price as well as other growth opportunities that represent themselves could alter the timing or pace of that buyback.

[Ebrahim Poonawala:]

Understood. And then capital level that we adopting, Brian, maybe you want to get to over time or…

[Brian Maass:]

There’s not a specific target capital ratio that we’ve announced to the market. I will note that our capital ratios on a – not only are we improving our returns on capital on a year-over-year basis. But our capital ratios are actually higher than they were a year-ago as well as we think we’ve got reduced risk profile as an organization.

[Ebrahim Poonawala:]

Would you at least say that you’d believe you have excess capital right now, where you are?

[Brian Maass:]

Yeah, I would agree that we have excess capital as we sit here today based upon the comments that I just made with our capital ratios being up on a year-over-year basis. But we don’t have necessarily a specific target that we’ve announced.

[Ebrahim Poonawala:]

Understood. And just one last one on tied to that. In terms of any portfolio or just standalone business acquisition opportunities, is conversation ongoing or the opportunities?

[Craig Dahl:]

Yeah, this is Craig. I mean, we continue through the specialty finance, primarily to the specialty finance angle, as credit really can’t get better for the independence that it is now, where funding costs tend to move up now. And I think those conversations are occurring. So we would – again be opportunistic, but we would be disciplined about how we approach it.

[Ebrahim Poonawala:]

Understood. Thanks for taking my questions. And Jason, good luck.

[Jason Korstange:]

Thanks, Ebrahim.

[Operator:]

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

[Lana Chan:]

Just following on the last question on acquisition. Craig, could you update us on your thoughts about bank M&A? And we’re seeing a lot of pickup in smaller bank M&A activity recently?

[Craig Dahl:]

We’re really focused on the positive momentum we’re creating and running the business, but really focused on these returns on capital, and those are going on around us.

[Lana Chan:]

And in terms of the return on capital, clearly, you’ve made significant strides and achieving the full year ROATCE targets. Could you talk about where you think you could go from there, and if we could get any updated targets on that?

[Craig Dahl:]

Sure, Lana. This is Craig. It’s really hard to do that with – while we’re still managing that the run-off of the auto portfolio. And so, we – I think, I mentioned last quarter that we intend to give some guidance, but it would be a future guidance number. And we really have to make sure that we understand the pace and performance of continuing that auto run-offs. So it’s still $2.6 billion end of the quarter, it’s still a big number, and we still have a lot of work to do there.

[Lana Chan:]

Okay. Thanks, Craig. Jason, good luck with your retirement.

[Jason Korstange:]

Thank you, Lana.

[Operator:]

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

[Steven Alexopoulos:]

Hey, good morning, everybody. And I echo my congratulations, Jason, on your retirement.

[Jason Korstange:]

Thanks, Steve.

[Steven Alexopoulos:]

Yeah, I want first follow-up on the inventory finance side. This was a second quarter, we had year-over-year growth of 20%. I’m trying to understand, why growth is running so strong again this quarter. Can you walk through that, I mean, our customers are holding more inventory for some reason? Thanks.

[Craig Dahl:]

Sure. When you look back quarter, March to March, for the last two to three years, I don’t have exact number in my head. But our year-over-year was in 10% to 20% range. Okay, so that is additional product being shift new program additions things like that. This year, what we identified at the end of the first quarter was there was new program acquisition that was another 10%. So to us, this number is consistent, because that year-over-year growth is roughly half of that and new program addition would represent the other half. Now in addition, it’s hung on a little longer, because of the poor springs in almost all parts of the country. So primarily through that lawn and garden product, which has it big shipment in that February, March, April timeframe that was slower to be sold through. And that has added a little bit to it as well.

[Steven Alexopoulos:]

Okay. So we think about the second half, do you see it going back to the more typical year-over-year range?

[Craig Dahl:]

No. I think, it’s going to be higher than that, because of the…

[Steven Alexopoulos:]

Higher than the 10% to 20% range?

[Craig Dahl:]

Yeah, because of the addition of the new programs.

[Steven Alexopoulos:]

Do you think we could be 20% for the year?

[Craig Dahl:]

This is a very difficult category to predict. And I wouldn’t be predicting that level. So I would say it’s in between that and our historical range.

[Steven Alexopoulos:]

Okay. It’s interesting. We have quite a few banks particularly heavy on the commercial real estate side, turning more towards specialty C&I, which includes things like leasing and equipment finance. What are you guys seeing in the competitive environment? Are spreads compressing at all?

[Craig Dahl:]

Well, the short answer is yes. And there are really two reasons there. Part of it is competition, but more of it is due to the flatness of the yield curve, because you’re pricing on a term basis and you’re funding it – you’re pricing it basically on more of a mid-term type of an index. So – but that’s – we’ve been in the business now a long time. It’s – we have a focused market strategy. And, yes, there is more competition and, yes, it’s having an impact. But, our yields are also augmented starting in the fourth quarter by that acquisition we made as well. So we remain competitive as – we remain competitive as well so.

[Steven Alexopoulos:]

Okay. And then, finally, if I look at the loan portfolio and back out the auto loans which are in run-off mode, leasing and equipment finance loans are around 30% of total. Inventory finance is around 20%. How do you think about these from a concentration risk view? How high could those go?

[Craig Dahl:]

Well, one of the advantages we have is we’ve been growing all of our portfolios outside of the auto portfolio. And so, we’re within the range. Concentration management is a core competency here when you have a diversified business model. And so, we’re going to continue to predict and track these, but they are moving within our expectations. And again, we’re growing all of the debts too.

[Steven Alexopoulos:]

Okay, okay. Thanks for answering my questions.

[Operator:]

Our next question comes from Brock Vandervliet from UBS. Please go ahead with your question.

[Brock Vandervliet:]

Thanks for taking my question. Congrats again, Jason.

[Jason Korstange:]

Thank you, Brock.

[Brock Vandervliet:]

Just going back to the deposits, I think your trends this quarter are a departure from what we’re seeing in a lot of other companies where not only are costs – deposit costs are under pressure, but balances are shifting. And your – for example, your noninterest deposits were up 3.5% on an average basis. And what do you make of these trends, because the deposit picture seems much more benign here? Is this simply a reflection of a more granular retail strategy or is there something more at play here?

[Brian Maass:]

No, I think you hit it – this is Brian. Brock, I think you hit it right on the head. It is that our deposit composition I think is different than lot of others and we stand out that way. And it’s hard for a long period of time when interest rates were flat. It was hard to kind of message that story, right? But we do have a granular deposit base. Almost 90% of our deposits are consumer. So again, with that more granular account base, lower average balance, it’s a little bit less about the rate, and more about the features and functionalities of the account. So that’s why I think we had good performance to date. Again, I still think we will see some – we will continue to see increasing deposit cost as we go forward. But I think we can continue to outperform our peers in that regard.

[Brock Vandervliet:]

Is there – is something you’re seeing already in some of the end-of-period deposit costs that are leading to that concern that you’ve voiced a couple of times or is that just basically your caution on cost moving in the same direction as the rest of the sector?

[Brian Maass:]

I think there is – especially in the promotional deposits, what I would say, right, as we do have CDs, as those CDs mature there is a renewal price that is likely higher than what it’s rolling off at. So there is some expected increase in deposit cost that’s real, as well as promotional rates. I mean, as you hear from other people, are going up. So it really does come down to what’s the percentage of your book that is subjected to that re-pricing. We have a – we have CDs, so some of that costs will go up. But there is still, when you look at the non-CD portion of our book, we feel good about how that’s performed to date over the last couple of years. And we think we can continue to outperform on deposit cost.

[Brock Vandervliet:]

Excellent. Thank you.

[Operator:]

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

[Ken Zerbe:]

Great. Thanks. Just going back to your NIM outlook, I just want to be really clear about what exactly you’re saying, because I thought I heard it was flat to modestly higher than 2017. But to reach that flat number, that would imply a meaningful reduction from where your NIM is currently for both the third quarter and the fourth quarter. Can you just clarify that guidance a little bit? Thanks.

[Brian Maass:]

Yeah, no, I think you point out, I mean, the reason we’re upping our guidance there is due to the first half performance, right, it is higher than what we expected. So obviously, the full year will be higher on a year-over-year basis. However, there are a couple of tailwinds. Again, that will present themselves as we get into the second half of the year, primarily being again the remix of the auto portfolio and the securities – what’s the other item that I was going to say. But there are a couple of items that will be headwinds on that. But you’re right, in that depending – and outlook for deposit cost, right. It’s hard to predict exactly how many more rate hikes we’re going to get, how the market reaction is going to be to that, what happens to promotional rates. That can…

[Craig Dahl:]

Inventory finance balances is a…

[Brian Maass:]

Oh, yeah, that was [indiscernible].

[Craig Dahl:]

And our ability to really accurately understand exactly what happens, in addition that adjusting yields on that as it moves from more of the dealer rate, back to the manufacturer rate with fourth quarter shipments so.

[Brian Maass:]

I mean, exactly. And inventory finance specifically, right, 8 basis point lift in the quarter. 6 basis points was due to inventory finance, having higher yields and higher average balances. As we move to third quarter, those balances aren’t expected to be as high. But again, we feel really good about our net interest margin, the rate that it’s at, and the outlook. So the fact that we’re exceeding where 2017 was means that we’re overcoming some of these headwinds that we’re cautious about at the beginning of the year. So overall, I think it’s a really good story for us from a net interest margin perspective.

[Ken Zerbe:]

Got you, understood. I guess, it’s the word flat that really kind of freaks me out a little bit, just given you’re so much above – currently, in second quarter, you’re so much above last year. And then, how – maybe it’s a point you’re looking at. When you say modestly higher, like I guess 0 is the lower end, what is modestly higher in terms of basis points in the high end roughly?

[Brian Maass:]

Yeah, I wasn’t going to quantify it into basis points. But I think flat would be the low point and it will likely be higher.

[Ken Zerbe:]

Got it. Okay, okay, fine. And then, Craig, can you just elaborate? You made a comment that higher rates are making acquisitions more attractive. Could you just explain that a little bit, why is that the case?

[Craig Dahl:]

Yeah, what I was referring to is an independent specialty finance company today that has its own borrowing relationship. Its cost of funding is going up as these indexes move. That’s what I was referring to. And so, therefore – and their credit, we got to believe, especially lot of the things we’ve looked at, the credits been really good in the equipment finance industry and others. So they can’t get – they can’t get a better credit performance. And tomorrow their funding cost is could be higher today, and they’re more interested in maybe making a move than they would have been. When we went through that flat interest rate period, really there was very little differentiation between their cost of funds and our cost of funds.

[Ken Zerbe:]

Got it. But these types of companies also presumably have close to a 100% variable rate loans. Is that also there? No?

[Craig Dahl:]

No, that’s – no, they typically are fixed rate, typically a fixed rate originator. So if their funding cost goes up they’re going to see their margin degrade over time. And the expectation is there is going to be end of this credit cycle, and that therefore, they’re trying to sort of, I would say, time it.

[Ken Zerbe:]

Understood. Okay, thank you very much.

[Craig Dahl:]

Okay.

[Operator:]

[Operator Instructions] Our next question comes from David Chiaverini from Wedbush Securities. Please go ahead with your question.

[David Chiaverini:]

Hi, thanks. I have a question on origination, so I’m looking at Slide 8. And originations have been trending up very nicely over the past year, up 14% year-over-year. So it’s a two-part question, the first is should this trend, this upward trend continue? And then the second part, is this being driven mainly by the new programs in inventory finance or is it other areas too?

[Craig Dahl:]

This is Craig. It’s by all of the segments. But it is influenced by inventory finance. I wouldn’t say that the new programs are what’s created that angle of increase. But it’s contributed to it. But it is heavily influenced by the inventory finance business. I will remind you that inventory finance paper has quite a more rapid turnover than sort of the term nature of our commercial transactions or consumer transactions or our leasing and equipment finance transactions.

[David Chiaverini:]

And the upward trend, should that continue?

[Craig Dahl:]

That’s what we incent our teams to do, so that would be our expectation that they’re going to continue to perform.

[David Chiaverini:]

Fair enough. And then, shifting gears to – the loan-to-deposit ratio came down to 101%, which is good to see. Do you have a target or expectation on the loan-to-deposit ratio in the incoming quarters?

[Brian Maass:]

Yeah, this is Brian. We don’t have a target per se for the loan-to-deposit ratio. We continue to reinvest the auto run-off into the securities portfolio. We continue to see – we could continue to see improvement there. It’s not necessarily a goal of ours. We feel good with the level that it’s at. And if we see other opportunities that can provide us a greater return on capital, we could see some of that reinvestment go towards other place as well, which time we wouldn’t necessarily continue to see improvement in the loan-to-deposit ratio.

[Craig Dahl:]

And the other thing I – this is Craig – I talk about all the time is how our funding and our lending are directly linked. So we don’t have a branch banking team with a CD goal that’s irrespective of what the loan goal is. And so, we’re funding the bank. We do not believe the loan to deposit ratio is a governor on our ability to fund the bank so.

[David Chiaverini:]

Got it. Thanks very much.

[Craig Dahl:]

Thanks, David.

[Operator:]

And, ladies and gentlemen, thank you for your questions today. Should any investors have further questions, Tim Sedabres, Director of Investor Relations will be available for the remainder of the day at the telephone number listed on the earnings release. And I’d like to turn the conference call back over to Mr. Craig Dahl for any closing remarks.

[Craig Dahl:]

Thank you all for listening this morning. We appreciate your interest and investment in TCF. And good luck, Jason.

[Jason Korstange:]

Thank you.

[Operator:]

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