TCF Financial Corporation
Q3 2018 Earnings Call Transcript

Published: 22 Oct 2018

[Operator:]

Good morning. And welcome to TCF 2018 Third Quarter Earnings Call. My name is Denise, and I will be your conference operator today. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions] Please note the conference call is being recorded. At this time, I would like to introduce Mr. Tim Sedabres from Investor Relations to begin the conference call.

[Tim Sedabres:]

Good morning. And thank you for joining us for the TCF’s third quarter 2018 earnings call. Joining me on today’s call 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; Bill Henak, EVP of Wholesale 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 third quarter results. They will be referencing a slide presentation that is available on the Investor Relations section of TCF’s Web site, ir.tcfbank.com. Following their remarks, we will open up for questions. During today’s presentation, we may make projections and other forward-looking statements relating to future events or the future financial performance of the Company. We caution that such statements or predictions and that actual events or results may differ materially. Please see the forward-looking statement disclosure and our 2018 third quarter earnings release for more information about risks and uncertainties, which may affect us. The information we will provide today is accurate as of September 30, 2018, and we undertake no duty to update the information. I would now like to turn the call over to TCF's Chairman and CEO, Craig Dahl.

[Craig Dahl:]

Thank you, Tim. Good morning, and thank you all again for joining us today. I’ll be speaking from Slide 2, our third quarter themes. I am pleased to report another strong quarter of financial performance as we produced net income of $86 million and diluted earnings per share of $0.51. Our strong results this quarter were highlighted by positive operating leverage, a stable net interest margin, improved mix and growth of earning assets, continued reduction of our risk profile, and improving returns on capital. First, we continued to deliver positive operating leverage. I’ve talked all year about our focus on improving our efficiency ratio. Our third quarter efficiency ratio of 67.4% was down over 100 basis points year-over-year and was our lowest reported efficiency ratio in the past several years. On a year-to-date basis, our efficiency ratio was 67.5%, in line with our full year guidance. We have been able to lower the efficiency ratio by generating strong revenue growth along with a more stable asset mix, all while making investments in people and technology that position us to grow the business going forward. From a revenue standpoint, we saw strong year-over-year growth driven by both net interest income and non-interest income despite lower gain on sale and servicing fee income. On the expense side, we are investing in our digital banking strategy, enhancing our overall customer experience and building out our TCF Home Loans business with the addition of key talent. We believe our investments in TCF Home Loans will support our branch network, fill the gap that has existed in our suite of products and will help to better serve our customer needs. Overall, we have made good progress on improving the efficiency ratio during ‘18 and this will remain a key focus for us as we move forward. Secondly, our net interest margin was stable in the third quarter. Despite the continued remix of our balance sheet, we were able to maintain a strong net interest margin of 4.66%, down just 1 basis point from the second quarter. As we talked about last quarter, we have several moving pieces that impact our net interest margin on both sides of the balance sheet. First, our asset sensitive balance sheet has resulted in strong loan and lease yield performance as rates have risen, especially in our variable rate portfolios for both balances and yields. Second, the seasonality of our inventory finance business results in various fluctuations in our net interest margin. Third, our retail focused deposit base continues to be a real differentiator for us compared to our peers. As rising deposit costs have become a key focus for banks given where we are in the interest rate cycle, we have been able to outperform from a deposit cost standpoint due to our large granular retail deposit base. We are not immune to rising deposit costs, but as commercial deposits are repricing much faster than retail, we are seeing the benefit of our retail focused deposit base, especially given the relatively slow pace of the current tightening cycle. And lastly, the remix from higher yielding auto loans to lower yielding securities is providing a headwind to the margin. That said, it is important to keep in mind that this shift is also resulting in improved capital efficiency and reduced credit, operational and liquidity risks. Our focus is not on managing to our specific level of net interest margin. We view the margin as more of an outcome on the strategies we have in place in order to drive higher returns on capital. Next, we saw average year-over-year earning asset growth of 4.6% despite the continued run-off of the auto finance portfolio. As a result, we are seeing a more favorable asset mix evolving toward more capital efficient assets. This is evident given our declining auto balances, which are now down $925 million year-to-date right in the middle of our full year guidance, and are being reinvested into both securities and other loans and leases. Given our strong diversification of loan and lease portfolios, we have the opportunity to be more selective where we grow without having to stretch on price or structure in order to produce growth. We compete as experts in multiple diverse segments, which provide us with competitive advantage in the market. In inventory finance, we continue to see strong growth both through our expansion of existing programs, as well as new program. In leasing and equipment finance, we maintain a strong backlog and also believe there are more portfolio purchase opportunities out there as interest rates rise and non-bank specialty finance companies see additional pressure on their margins. On the commercial side, we have great teams in place that are generating new business with strong originations. Although, in total, commercial growth has been somewhat muted by higher payoffs. That said, we are being disciplined and thoughtful given the current competitive environment. And I’ll remind you, it only represents 23% of our total loan book. Finally, as I mentioned earlier, we are building out our TCF Home Loan business, which we expect to have more of a full year impact as we move into 2019. Fourth, we continue to reduce our overall risk profile during the quarter. This is coming in a variety of ways, including the remix of the balance sheet as the auto portfolio run-off is reinvested into securities and loans, which has resulted in lower percentage of risk weighted assets. We are also seeing stable credit quality across our portfolios. Non-performing assets declined year-over-year as we completed another non-accrual sale during the third quarter. Net charge-offs, excluding auto and the recovery from the non-accrual sale remain stable at just 10 basis points annualized. While we are actively monitoring delinquencies, which are a good early indicator for many of our portfolios, we are not seeing early warning signs to-date. As I mentioned, we are being prudent as we look at the competitive landscape, especially in commercial real estate. We recognize the loosening of price and structure and given our diverse lending businesses, we do not need to stretch in commercial to generate growth. Fifth, is our improved return on capital, I think we have been very clear throughout '18 in highlighting our focus on improving return on capital. We were successful again in the third quarter with return on average tangible common equity of 15.8%. Our year-to-date adjusted ROATCE of 14.5% is above the top end of our target range for '18. Our focus on this area is playing a significant role in the strategic decisions we are making internally regarding capital allocation. It is important to recognize that we are improving our return on capital while maintaining higher capital ratios and a reduced risk profile. During the quarter, we repurchased over 900,000 shares at a cost of $24 million. Although, this pace was slightly slower than in prior quarters, we would expect to remain active in buying back our stock given the current valuation. All of these highlights demonstrate our focus on driving returns for shareholders. Standing here today with one quarter to go in '18, we have made significant progress as evidenced by our financial results. We remain focused on continuing to grow our core businesses, funding that growth with core deposits, being disciplined on expenses, while still investing in our businesses in '18 and beyond. Our focus on ROATCE and efficiency ratio will not change as we feel these are the most important metrics for us, both as operators of the company and as stewards of shareholder capital. These targets are important to us as they demonstrate our commitment to improving in these areas, which we believe are key to driving shareholder value overtime. As I look at all of the hard work being done across our organization, I am optimistic about the outlook for our businesses. And believe our diversification provides us with the opportunity for sustained growth as we are not tied to anyone market or geography. Let me remind you that our footprint; however, some of the top metro markets, including Minneapolis, Chicago, Milwaukee, Detroit and Denver; in these markets, we operate branch locations in the consumer banking space and have in-market commercial banking teams for both real estate and C&I; each of these markets has its own dynamics today, whether it's the strength of the economy in Denver or Minneapolis, or in Minneapolis Saint Paul; for example, we have the lowest unemployment rate in the country amongst large MSAs at just 2.5%. In Chicago and Milwaukee, there has been quite a bit of competitive disruption due to recent M&A activity that brings within its own set of opportunities; add to that, the continued resurgence going on in Detroit, which has been well publicized; so from my view, these are great set of markets to drive our business growth from; and coupled with our national lending platform, gives us ample opportunity to continue to grow the franchise. With that being said, I will now turn it over to Brian, to provide more detail around our third quarter financial results.

[Brian Maass:]

Thank you, Craig. Starting on Slide 3, you can see that we have continued to make progress in driving operating leverage as our efficiency ratio of 67.4% in the third quarter declined 105 basis points year-over-year; revenue growth of 6.5% year-over-year, which outpaced core expense growth of 3.4%, which excludes operating lease depreciation; the revenue growth came equally from net interest income and non-interest income. We saw a slight increase in our core expense based on a linked quarter basis, which we indicated on last quarters' call could happen as we continue to make investments in the business. We believe we can manage towards additional operating leverage and an improved efficiency ratio overtime. Turning to Slide 4. Our net interest margin was stable despite the balance sheet remix as the margin declined just 1 basis point linked quarter to 4.66%. As Craig mentioned, there are a number of factors that affect our margin in each production, which we have laid out for you in the bottom left corner of the slide. During the third quarter, we saw margin pressure from higher funding costs, seasonally lower inventory finance balances and the mix shift from auto into securities. Additionally, we benefited from higher earning asset yields, including the full impact of the June rate hike, as well as seasonally higher inventory finance yields. Our net interest margin has continued to outperform expectations so far this year. That said, we remain cautious around both promotional and non-promotional deposit costs. Over the past 100 basis points of rate increase, our total deposit cost increased just 21 basis points. As we have said previously, we expect the next 100 basis points of interest rate increases to likely be more expensive than the last. Lastly, we have included some information regarding our variable rate loans tied to the LIBOR index. 48% of our loan and lease balances are variable and adjustable rate, and of these approximately 55% are tied to LIBOR. Turning to Slide 5. Third quarter earning asset yields of 5.36% were up 29 basis points year-over-year despite the run-off of the auto portfolio as loan and lease yields continued to expand. Loan yields increased 42 basis points year-over-year with all loan and lease portfolio showing stable or growing yields. Our strategy of competing as experts, along with our pricing discipline and increases in short-term rates, continue to drive the strong yield performance. Our securities yields are also increasing as new purchases in the third quarter had an average tax equivalent yield of 3.4%, up slightly from last quarter and above the blended portfolio yield of 2.71%. Turning to Slide 6. As rising deposit costs continue to be a focus across the industry, the value of our retail focus deposit base is becoming more clear as 83% of our average deposit balances are consumer related. After increasing only 2 basis points in the second quarter, our deposit costs increased 7 basis points in the third quarter. The largest increase this quarter was from CDs as more came up for renewal, which will be at the higher current market rates. As I mentioned earlier, we expect upward pressure on deposit costs going forward due to competition, as well as our low non-CD deposit beta today. Over the past year, we have only seen 13 basis point increase in non-CD deposit costs, which will likely increase in future periods. Rates on the CD book were 1.56% for the third quarter, while the average cost of all other deposits was 0.24%. From an average balance standpoint, our deposits continued to grow, up 3.6% year-over-year with checking and savings balances up 9.3%. We would expect these core checking and savings balances to be the deposit growth drivers going forward. As the auto portfolio continues to run-off, the cash generated provides a good source of liquidity and lessens our need to raise promotional CDs. Turning to Slide 7. Average earning assets increased 4.6% year-over-year, including the run-off of the auto portfolio. What is important here is the improving mix shift towards more capital efficient assets as we have grown earning assets. Auto has declined from 16% of earning assets a year ago to 11% currently, while the securities portfolio has increased from 8% to 12%. As a result of this mix shift from auto to both the securities portfolio and other loans and leases, our risk-weighted assets as a percentage of total assets has begun to decline. We expect increasingly more capital efficient assets and a lower risk profile to help us drive higher returns on capital moving forward. Turning to Slide 8. Loan and lease balances increased 2.5% year-over-year excluding the auto finance portfolio driven by growth in inventory finance of nearly 12% and commercial of over 7%; the run-off of the auto finance portfolio also continued with balances down $328 million during the quarter and $925 million year-to-date; right in the middle of our guidance of $1 billion to $1.5 billion of run-off in 2018. Looking ahead to the fourth quarter, we expect strong origination volumes to continue, especially in leasing which tends to see higher volumes late in the year. In addition, our consumer real estate first mortgage portfolio, which had been declining, saw modest growth during the quarter. As we reinvest the auto run-off into longer duration assets, both in securities and loans, we could see consumer real estate balances increase modestly going forward. We expect this remix activity would continue to increase our return profile and capital efficiencies. As Craig mentioned earlier, we continue to have a diverse set of long and lease businesses with the capacity to grow. Looking at Slide 9, we have seen year-over-year growth in non-interest income, along with a more favorable mix towards higher quality income. Gain on sale and servicing fee income now makes up just 13% of non-interest income, down from 16% a year ago. This growth in non-interest income is also happening, while our servicing fee income is declining due to the auto run-off. Total servicing fees income of $6 million declined $4 million year-over-year. Keep in mind that $4.4 million of this servicing fee income is related to auto loan service for others. This will eventually go to zero as the servicing book runs up. However, we still have an additional $1.6 million of non-auto related servicing fee income. The growth in leasing and equipment finance non-interest income is helping to offset the loss of gain on sale and servicing fee income. We saw leasing non-interest income net of the operating lease depreciation of $25.5 million in the third quarter, up from $18.4 million a year ago. This line has stabilized over the past several quarters. With that, I’ll turn it over to Jim Costa to cover credit and risk.

[Jim Costa:]

Thanks, Brian. Turning to Slide 10, you can see that we are continuing to reduce the risk profile of the balance sheet as the auto portfolio runs off. Overall, as Craig has indicated, credit quality remains stable. Non-performing assets of 59 basis points declined 18 basis points year-over-year. You may recall that we moved $37 million of consumer real estate non-accrual loans to held-for-sale during the second quarter, and we completed the sale of these loans in the third quarter. We did see a small uptick in NPAs during the third quarter driven by higher consumer real estate non-accrual loan balances, again resulting from the sale and an increase in other real estate own balances. The increase in REO was primarily due to the addition of one of our corporate operation centers we are now marketing for sale. 60 day delinquencies remain stable at just 12 basis points, down 1 basis point from a year ago. You will note delinquencies, excluding auto, have remained at 10 basis points or lower for the last nine quarters. Provision for credit losses came in at $2.3 million for the quarter. This reflected $6.6 million recovery related to the consumer real estate non-accrual loan sale, as well as a continued run off and maturation of the auto finance portfolio. Lastly, we are exceeding improved liquidity as balance sheet remix progresses, as well as a loan to deposit ratio which now stands at 100% as of September 30th. Turning to Slide 11, we are continuing to see favorable impact our diversification model having on our credit losses. Net charge-offs excluding the consumer real estate non-accrual loan sales and the auto portfolio were just 10 basis points. As you can see, the majority of our net charge-off dollars are coming from the run-off of the auto portfolio was just $14 million coming from non-auto portfolios. Overall, we remain very pleased with our credit performance and don’t see any story from a credit quality perspective. With that, I’ll turn it back to Craig.

[Craig Dahl:]

Thank you, Jim. And I’ll bring in a Slide 12 here, improved return on capital. We talked a lot this morning about our focus on improving our return on capital and not only we've been successful in increasing it in 2018, we've done so with a higher capital ratio and a lower risk profile. In addition, as I mentioned earlier, we did repurchase over 900,000 shares of stock during the quarter and have $141 million of our share repurchase authorization remaining as of quarter end. Turning to Slide 13, I want to draw your attention to the 2018 targets we provided earlier this year for adjusted ROATCE and efficiency ratio. The purpose of providing these targets was to highlight the metrics we are managing toward and though as we feel are important to driving shareholder value going forward. For the full year '18, we have been targeting ROATCE of 11.5% to 13.5%, adjusted for the CFPB settlement. And we are exceeding this year-to-date at 14.5%. We have also been targeting a 2018 adjusted efficiency ratio of 66% to 68%, and our results are in line at this range at 67.5% year-to-date. I continue to be pleased with our execution against these targets, and I look forward to updating you again next quarter. With that, I will open it up for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session [Operator Instructions]. And your first question will be from Jon Arfstrom of RBC Capital Markets. Please go ahead.

[Jon Arfstrom:]

Brian, maybe a question for you on the margin. Can you give us an idea of some of your near-term and longer term thoughts on the margin? There's lot of moving parts here, but you’re talking about, obviously, maybe a little less asset sensitive going forward but at the same time, some good growth in core checking and savings on one side and then you have the asset mix shift on the other side. So, give us an idea of how you want us to think about the margin trends?

[Brian Maass:]

What I'd say is the margins really outperformed from where we thought it would start at the beginning of the year. There’s been a lot of positive things as far as rate increases that have helped and the extra growth that we had in inventory finance earlier in the first half that have really helped maintain the NIM and I’d say at really high level. We are seeing deposit cost increase like everybody else. Ours has been very, I’d say [good] [ph], was up 7 basis points this quarter. As we go forward, we’re going to continue to see the mix shift in balances right from auto into the securities portfolio, so that continues to be a headwind. The rest of our portfolio, we do -- we don’t really have sequential growth in our loan balances, as you know with inventory finance. So, now we’re going to get into the period where inventory finance balances start to grow again in fourth quarter and into Q1, so that obviously has impacts on the net interest margin. As Craig mentioned, we’re trying to manage to a specific outcome on the net interest margin. It really is a combination of all of the other things. But that being said, we’re only down 1 basis point in the third quarter, I don’t know if we can maintain it at this exact level. When you think about some of the incremental growth that goes on the balance sheet, it's not all accretive to the net interest margin yield that we have. So I do think that our net interest margin will come down a little bit over time. But I don’t think that says that we’re not asset sensitive. I mean if we just stayed in the things that we have and we continue to reprice, we would see positive impacts on the margin.

[Jon Arfstrom:]

And then obviously you had the seasonal headwinds on inventory finance and obviously auto. But it feels like you're saying the pipelines are stronger going into Q4. And maybe Craig I am just wondering if you're seeing the typical inventory finance lift. And then maybe touch a bit on some of the leasing backlogs as well you talked about?

[Craig Dahl:]

So you’re exact -- I mean, those are going to be my comments. I mean the fourth quarter is typically our strongest quarter of originations and leasing and equipment finance, and we would expect that to be there again. I would remind you, we’re fighting a little bit over the run-off of the portfolio we acquired a year ago, but that’s getting diluted as far as its impact. So we’re looking positive there. I would also point out in the commercial book that if you look at those five quarterly balances in the earnings release, we've been able to maintain that portfolio and that’s due to a great job of originations. We've not been reaching on credit or price in those, and we’re really pleased with how that book has performed. Inventory finance is really going to be driven by those customers and the shipment of the winter product. And so that that is expected again to give us lift into the fourth quarter. So, when you look at our books and then Brian commented a little bit about our consumer real estate, maybe being at least holding serve on the first side and having some additional increases on our HELOCs. So, I think our outlook is pretty good for the fourth quarter based on where we sit today.

[Operator:]

And the next question will be from Nathan Race of Piper Jaffray. Please go ahead.

[Nathan Race:]

I want to start on the share repurchases in the quarter. Obviously, stepped down a little bit relative to the pace you guys were on in the first half this year. So just curious if there is anything to read into in terms of you guys seeing increased opportunities in terms of portfolio acquisitions? Or if we should maybe expect the rate of buybacks to step up into 4Q and 2019 as well?

[Brian Maass:]

What I’d say on that is if you -- our share price on average was higher in the third quarter than it was in Q1 or Q2. So we did have a lower amount of purchases. As you note, there's many different variables that can affect the speed and timing of our repurchase, but the share price is one of those variables. It is lower now than it would have been on average in the third quarter. So that does seem attractive. Market conditions as well as other capital or growth opportunities can also impact the pace. But generally speaking, it didn’t necessarily have a specific target in mind as far as how much or when this is going to end. But we see it -- where the share price is we see it as an opportunity.

[Nathan Race:]

And Craig, any updated thoughts on what you’re seeing in terms of portfolio acquisition opportunities and the like?

[Craig Dahl:]

We’re totally focused on any kind of opportunity. As I've commented frequently, these lenders are fixed rate lenders and when their borrowing costs start to move, their margins get compressed. And also, we’re still in that benign credit period as you've seen by our results. So there's plenty of opportunity out there, it’s just finding the right transactions. But if I were to put it in order of priority, organic growth is clearly our most preferred. And the ability to acquire a platform would be the second that we’d be looking at. And lastly would be portfolio, as I think you're seeing a little bit of the impact. We really benefited from the portfolio we acquired last year. But once it goes away, you have to replace it either with stronger organic growth or with other portfolio opportunities. So, we’re aware of those and we’re working on those. But there really isn’t anything to announce right now.

[Nathan Race:]

And if I could just sneak one last one in on expenses. Obviously, you had a little bit of a step up this quarter. I’m just curious if there is any cost associated with that operation center that you guys moved into OREO that may have inflated expenses on the occupancy side this quarter or in any other category? Just how we should be thinking about expenses in the fourth quarter in 2019 as the auto portfolio continues to run-off as well?

[Brian Maass:]

Expenses were up a little bit on a linked quarter basis. On the O&E side, as you mentioned, we did have some higher maintenance and repair costs related to one of our operation center building. So that was included in that number for the third quarter. As well as we continue to have some IT investments, both in our digital banking platform, as well as other initiatives that we’re working on that will both improve customer experience, as well as reduce long-term cost.

[Operator:]

The next question will be from Scott Siefers from Sandler O’Neill and Partners. Please go ahead.

[Scott Siefers:]

I wanted to just follow up on the expense side. So the third quarter’s 246.5 rough base of cost, maybe a little higher than what I would have expected. Although, Brian you had noted some of the tech investments could elevate things a little sequentially in the third quarter. I mean, are costs going to grow from here or can you take them down absolutely from the $246.5 million? In other words, are they going to be on an upward trend regardless of what happens, or as the auto infrastructure needs wane, can you actually take that base down on an absolute basis?

[Brian Maass:]

We’re not necessarily trying to manage to a specific number. I think expenses are well controlled where we are in here. We are choosing to make a couple of investments in the business. And we think that those will provide us growth in revenue in the future as well. We are really trying to manage the things on efficiency ratio basis and continuing to show improvement on our efficiency ratio overtime. It’s not necessarily going to quarter-to-quarter. Some of our businesses as you know are seasonal so we don’t necessarily have sequential results always. But I do think that we can continue to have improvement in our efficiency ratio over time as we look out into next year.

[Scott Siefers:]

And then I think you guys quantified what you think the FDIC cost can go away next year. What the quarterly or annual impacts you guys see from that?

[Brian Maass:]

I don’t have very specifics to say on FDIC expense as it relates to next year.

[Operator:]

The next question will from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.

[Ebrahim Poonawala:]

Just one quick follow-up on expenses, I believe last quarter you have talked about expenses ex-leasing depreciation hitting somewhere between 2.25 to 2.30 in the fourth quarter. Is that still good or any change there?

[Brian Maass:]

I mean as I said in the last question, not really trying to give a specific target on the expenses. They’re going to -- I think they’re well controlled. They’re going to move around within a few percent of where we round up third quarter. But I -- not really going to get too specific as to the exact dollar amount I guess.

[Ebrahim Poonawala:]

And just taking a step back, so you talked about time deposits coming in. Can you talk to in terms of as you think about deposit growth? Yes, there will be a mix shift. But your ability to still grow core checking account deposits. Is that something that we should think about? Or given where the rate cycle is, it's hard to grow those balances going forward?

[Brian Maass:]

No. I mean, if you look at on a year-over-year basis, we're up 10% average growth in non-interest bearing deposits. So, we are growing accounts. We are growing those balances. We’re focused on growing, call it core checking and savings accounts. You've seen our CD balances flat line, I'd say from last year. We can certainly use that on a promotional basis if we need to augment for a portfolio purchase or something. But what we’re focused on in this meanwhile, while we’ve got liquidity coming off of the auto portfolio, we’re really focused on growing our checking and savings account balances. And I think we've shown that over the last year.

[Ebrahim Poonawala:]

And then if I can sneak in one more on just for Craig. There has been a lot of concern around housing slowing down. Some of the industrials have been acting quite poorly recently. Just in terms of as you look through your businesses, do you see -- means there’s been a lot of this late cycle concern. Are you seeing that in the customer dialog as you look into 2019 or do you expect 2019 where things stand today to be another good quarter from a growth standpoint?

[Craig Dahl:]

I think the seasonality of the fourth quarter, I think, offset some of that negativity and maybe has been around there. We have, as I mentioned in my comments, we really had consistent delinquency performance going back like 15 quarters or 12 quarters on our overall delinquency rate. So, we have not seen anything start to move. And I'll also remind you and I made those comments about the different markets we’re in. We’re very diverse in our commercial real estate book as well. So it's not like we’re sitting here with billion dollars of apartments of Minneapolis, they're spread across our footprint and including some other markets where we followed our developers there. So, I am not seeing -- I am looking toward good quarter in the fourth quarter again led by the seasonality of inventory finance and equipment finance.

[Operator:]

The next question will be from Jared Shaw of Wells Fargo. Please go ahead.

[Jared Shaw:]

Just looking at the leasing and equipment finance revenue, when you look back over the last few years, third quarter has actually been a decline. What happened this year where we saw some strength there on a third quarter basis? Is that just a shift in seasonality or a function of growth overall?

[Craig Dahl:]

No, I think the real reason is the acquisition of that platform that we announced in the middle of last year, which gives us a more defined set of operating lease revenues and expenses on these newer transactions. And so it's that activity that’s going to bring it more consistent and have -- there’s still going to be customer volatility but we’re going to have more of a percentage that’s going to be from a fixed repayment and amortization standpoint.

[Jared Shaw:]

And then as you talked about the continued de-risking of the balance sheet and growing the securities portfolio, where could we see the securities go as a percentage of assets and so how you feel comfortable with that?

[Brian Maass:]

As I said in my remarks, it has increased on a year-over-year basis from 8% to 12%. What we’ve said as the auto book runs off, we are planning to put a lot of those proceeds into the securities portfolio at least initially. And if we see another or better alternative use of that cash and capital, we can redeploy into something else. But we noted that where we started off from an asset liquidity or from a securities portfolio perspective, it was pretty -- it was where our peers were. Our peers are probably closer to 18%. So we feel like we’ve got runway to continue to add securities there if needed.

[Jared Shaw:]

And then looking at that and tying it into the deposit question with the loan to deposit ratio here over a 100%, and you haven’t really done much on the promotional CD side. Could you see a desire at some point to, in addition to the growth of the core checking and savings accounts look to grow the time deposits here as a way to maybe bring in new customers and lower that loan to deposit ratio? Or you're comfortable with the overall structure right now?

[Brian Maass:]

What I’d say is I am very comfortable with our liquidity position overall. You can see asset liquidity on balance sheet has increased, but also you'd have to look at our liability and liquidity. We have lots of -- we don’t have any short term borrowings, we don’t have any repurchase agreements, we have lots of liability and liquidity. We’ve got over $2 billion of funding available to us from the Federal Home Loan Bank. So we’ve got plenty and available liquidity to us. We don’t necessarily manage to a specific loan to deposit ratio that has come down over time. But we have a lot of capital and liquidity, as referring back to what Craig mentioned for a portfolio purchase would be no problem for us.

[Craig Dahl:]

And I just wanted to add a couple of things or two. We don't see the loan to deposit ratio as a governor to our business. So we talked about that a lot. And I know that I’ve talked to most of you regarding our senior funding process where our fundraising and our lending activities are totally linked and we’re not asking the retail bank to go out and raise CDs if we don’t have a need for them. And I think that’s I think talks about the efficient funding model that we do have.

[Operator:]

The next question will be from Chris McGratty of KBW. Please go ahead.

[Chris McGratty:]

Brian, on the margin, do you happen to have where the spot deposit cost was on September 30th?

[Brian Maass:]

I don’t know that number off the top of my head…

[Chris McGratty:]

Okay, I can follow up offline. And maybe Craig for you, in your capital remarks, you talked about portfolio acquisitions and growth. I don’t think I heard anything about potential depository acquisitions or thoughts around there. I am interested in if anything has changed there if that is a strategy you would consider looking at and if so profile of a desired institution if you could draw it up? Thanks.

[Craig Dahl:]

I think I’ve been consistent that platforms and portfolios are more likely for us other than any other form of M&A, and that remains our point of view at this time.

[Chris McGratty:]

And then, Brian, the tax rate. Is it third quarter about the go-forward rate that we should be using?

[Brian Maass:]

Yes, I think we’re right in the middle of our 23% to 25% guidance. So we didn’t have a lot of unusual items. We have more of those items in the first half for the year. So, yes, this is a good run-rate going forward.

[Operator:]

The next question will be from Kevin Reevey of D.A. Davidson. Please go ahead.

[Kevin Reevey:]

So getting back to expenses, the comp and benefit expense came in a little higher than we were looking for. Is that driven mostly by -- with continued investment in TCF Home Loan business, or is there something else going on there? And is that a good run rate to use going into fourth quarter?

[Brian Maass:]

What I'd say there is you’re correct. We are continuing to build out some talent on the TCF Home Loan side. I would say this quarter we also did have slightly higher medical claims as well large medical claims in there. In addition, we do have slightly higher branch wages in there too on a go forward basis.

[Kevin Reevey:]

And then related to the recent disruption in Minneapolis and Chicago. Can you talk about some of the opportunities that you’re seeing there?

[Craig Dahl:]

Well, it's still I guess too soon to call that, I mean -- but we would interested in both customer opportunities and individual or platform opportunities. And so, we’re actively engaged in those discussions currently but there isn’t anything to announce at that point.

[Kevin Reevey:]

And just from an organic basis, can you elaborate there at all?

[Craig Dahl:]

Specifically on commercial or all…

[Kevin Reevey:]

Yes, commercial specifically…

[Craig Dahl:]

Yes, I think I’m pleased by holding serve on the balances that we have, it's taken a strong origination group. This team has been -- most of them have been with us now for over two years. And we were really pleased with both the activity and the engagement level we have by this group. So, our outlook wouldn’t be any different in the fourth quarter than it’s been in the short run.

[Operator:]

The next question will be from Dave Rochester of Deutsche Bank. Please go ahead.

[Dave Rochester:]

On the expenses again, sorry to revisit this and I know you don’t manage to a dollar amount, but just bigger picture. I think ex-operating lease depreciation and credit cost and the expenses, you’re up maybe like 3% to 4% year-over-year. So any reason you guys should change materially from that ex that FDIC surcharge roll off over the next year?

[Brian Maass:]

I wasn’t really planning to give much guidance toward 2019 and what expense levels will be. I think we’re going to be very mindful of where the revenue is and where the revenue trajectory is. And we’re going to ensure that from an operating leverage perspective or from an efficiency ratio perspective that we’re keeping those two things in line with each other. And we’re looking to improve our efficiency ratio overtime as we go forward.

[Dave Rochester:]

How much improvement are you expecting over the next year? And then what are you factoring in for rate hikes since that is supportive of the NIM and NII?

[Brian Maass:]

I'd probably be able to give you better guidance on 2019 on the next call.

[Dave Rochester:]

And then just back on the NIM, maybe just wanted to make sure I understood your thoughts near-term. It sounded like you think the NIM could possibly decline modestly in 4Q even though we just had a September hike. Is that right? And is that just because the incremental production NIM is a little bit lower?

[Brian Maass:]

Again, it’s the compensation of everything and the changes that we have quarter-to-quarter in that portfolio. We do expect our deposit costs to be increasing as we get into the fourth quarter compared to where they were in the third quarter. So we do think that there will be modest amount of pressure. Again, on a year-over-year basis, I think we’re at 4.64, 4.65 on a year-to-date basis, which is up 10, 11 basis points versus last year. So, I think we’re doing really good. But it could see a little bit of pressure in the fourth quarter just to the mix and the deposit cost increase.

[Dave Rochester:]

And then just one last one maybe on the securities purchase you mentioned, those had a yield of 3.4%. I was just curious where those yields are now following the backup in the middle of the curve?

[Brian Maass:]

So as you know, we have been purchasing a little bit longer dated securities in the portfolio, I’d say month-to-date and those yields are probably closer to 3.8%, 3.85%.

[Operator:]

The next question will be from Lana Chan of BMO Capital Markets. Please go ahead.

[Lana Chan:]

I guess, couple of questions. One is, looks like the loan growth ex auto this quarter was 2.5%, little bit lower than the mid single-digit growth rate I think you had previously been targeting. Are you still expecting mid single digits or is elevated pay down activity changing that outlook?

[Brian Maass:]

So you’re right. On a point-in-time basis, we’re up 2.5% excluding auto. Our average balances though on a year-over-year basis were probably 5.7% on a year-over-year basis, so call that 3% to 6%. So, I think that is mid single digits. I feel comfortable with that range on a full year basis. And as Craig been pointed out, I mean, we have strong originations happening in our commercial book. Our leasing is typically stronger later in the year. Our IF seasonality always sits its low point as you get into late into third quarter, so we expect those balances to start increasing in the fourth quarter. So, overall, we see good growth opportunities across most of our -- across most of the portfolios.

[Lana Chan:]

And second question is around -- the securities build up this quarter was a little bit less than I expected. It looks like you used some of the cash flow and deposit growth to pay down long-term borrowings, which came down pretty nicely. And I assume that helped your margin as well this quarter. Can you talk about further opportunities there?

[Brian Maass:]

From a securities portfolio perspective, we do expect to get more run-off from auto in the fourth quarter and especially with yields being higher now, we do expect to see growth in the securities portfolio in the fourth quarter, maybe even at a little faster pace than what you saw in the third quarter.

[Lana Chan:]

And borrowing staying around the same level then?

[Brian Maass:]

Correct. It depends on just overall growth of the balance sheet, yes…

[Lana Chan:]

And just last question on fees and services charges. It seems like there’s still some modest pressure on that line item year-over-year. Can you talk about what’s going on there and what’s driving that pressure?

[Brian Maass:]

Fees and service charges, I think overall that line on the income statement, which hit multiple things, is probably down 2% to 3%. There continues to be -- we have added functionality, we have added convenience for our customers. We think there is a lot of transparency about what’s happening on that. But in addition, we think with the investments that we've made in our digital banking platform, one of the ways that we can outrun some of the declines that you see on a year-over-year basis in some of the fee lines is by growing accounts. And we are being able to do that with -- in our retail banking area.

[Operator:]

The next question will be from Ken Zerbe of Morgan Stanley. Please go ahead.

[Ken Zerbe:]

I guess question on credits. You mentioned that the provision expense or the reserve, in general, is affected by the maturation of the auto portfolio. Is there any way to quantify what or how much of benefit came from the auto portfolio declining in the provision line this quarter?

[Jim Costa:]

I think it’s really primarily coming from the non-accrual loan sales what impacted the provision. If you go back and look, we’re running -- I think we’re at 10 plus on the provision. I think this quarter would have fallen in line with that absent the non-accrual loan sales. So really your driver this quarter was the impact to non-accruals loans still rather than a change in the complexion of the auto portfolio.

[Ken Zerbe:]

And I’d presume that also holds true on a go forward basis that the run-off of the auto portfolio will not -- or is it fair to say that the run-off of auto portfolio doesn’t meaningfully affect your provision expense as that declines?

[Jim Costa:]

Ken, I would say we reevaluate it every quarter as we need to, of course. And the run-off in the auto portfolio is following a trajectory that we expected. It will meaningfully impact the provision proportionally, but nothing inconsistent with what you have seen the prior quarters. So there’s really no change in the trajectory. There’s no change in the reserve models that we’re seeing. Things were running up as planned. So I wouldn’t factor in any specific change on a go forward basis.

[Operator:]

The next question will be from Steven Alexopoulos of JPMorgan. Please go ahead.

[Steven Alexopoulos:]

I wanted to start on the deposit re-pricing side. Did you guys see any notable migration from customers out of savings and money market and into time deposits in the quarter, whether they’re your time deposits or what competitors are offering?

[Brian Maass:]

I wouldn’t say that there was any noticeable shift.

[Steven Alexopoulos:]

Can you talk about your expectations? What you expect to see from a migration view?

[Brian Maass:]

We continue to see, as growth in our core accounts, we continue to see some growth technically in average balances still in our checking account and savings account balances. So we’re continuing to win a greater percentage of our customers' balances. I think from a -- so we're happy with the growth that we have. As I mentioned earlier, on a year-over-year basis, our average balances of non-interest bearing deposits are up 10%. So we think that’s solid growth. We have availability and capacity if we -- we haven’t been growing our CD book from a promotional perspective, but that is available capacity to us. But we'll only do that if we really had a true incremental asset opportunity on the other side.

[Mike Jones:]

I think what you’re really seeing is our focus on growing core deposits. I think, you’re also seeing the pay-off of some of the technology investments that we’ve made; and providing the features and functionalities that core customers want; and a movement away from money markets and more of the savings, which we believe is more core.

[Steven Alexopoulos:]

And then maybe just a few questions on the loan side. Looking at the inventory finance loans, they were up just under 12% year-over-year this quarter. Are we back to a more normalized growth trajectory for that business here?

[Mike Jones:]

I think, what’s reflected there is that that’s -- liquidation of that lawn and garden portfolio that was delayed and then some of the other seasonality in the other books. And so we would expect that that would build back up again into the fourth quarter with the shipment of the snow product and then into the first quarter with again, starting all over with the same cycle.

[Steven Alexopoulos:]

And then with regarding the growth in the consumer real estate loans we saw in the quarter? Could you help frame for us your appetite to grow that moving forward?

[Brian Maass:]

I think from an asset sensitive perspective, we’re looking at where we’re at or we look at where we are in the credit cycle, where we are in the rate cycle and what might be on the horizon. As we’ve noted, the average duration of our loan portfolio has gotten a lot shorter over the last, call it, five to eight years. So having to duration back onto the balance sheet we think will be prudent as over the next 12 months to 24 months. We’ve started in the investment securities portfolio but we would feel comfortable at least maintaining the balances on the mortgage side if not growing them a little bit into 2019 or 2020.

[Steven Alexopoulos:]

And what type of loans are you adding there? Can you give us a sense for second lien LTV, et cetera? Thanks.

[Brian Maass:]

I’d say, it’s a combination. So we do have our home equity originations both of which we keep some, as well as we do sell some of those for credit concentration purposes. So that’s growth on the second side. On the first side, it could be jumbo as well as conforming loans overtime as well.

[Operator:]

[Operator Instructions] The next question will be from David Chiaverini from Wedbush Securities. Please go ahead.

[David Chiaverini:]

Question on credit quality, so consumer real estate, NPAs increased about $5 million in the quarter. Could you provide some color as to what could be driving that?

[Jim Costa:]

This is the dynamic of having a non-accrual loan still your portfolio balances are reduced. So, really from an inflow standpoint, the NPAs and the consumer real estate are consistent as they've been for the last many quarters. It’s really the outflow, because you have a smaller portfolio. There is not a change in quality. Does that make sense?

[David Chiaverini:]

Yes, it does. And going back to the prior question on the TCF home loans, so are most of that new loans that are coming on-board. Are they fixed rate or variable rate?

[Jim Costa:]

Most of what’s coming on balance sheet in the first will be fixed rate likely. And the growth in HELOCs would be variable.

[David Chiaverini:]

And what yields are you getting on these that new where TCF Home Loans, I know the overall is about 6.1%. Are you getting a similar rate on the new loans?

[Brian Maass:]

What I’d say is that we’re not that different than what market rates would be on the first mortgage side. So, we’d be at or right around where market is.

[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 phone number listed on the earnings release. I will now turn the call back over to Mr. Craig Dahl for any closing remarks.

[Craig Dahl:]

Well, thank you for joining the call this morning. And we appreciate your interest, the level of questions and your continued investment in TCF. Thank you.

[Operator:]

Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today’s presentation. You may now disconnect your lines.