TCF Financial Corporation
Q2 2013 Earnings Call Transcript

Published: 23 Jul 2013

[Operator:]

Good morning, and welcome to TCF's Second Quarter Earnings Call. My name is Sarah, and I'll be your conference operator today. [Operator Instructions] At this time, I would like to introduce Mr. Jason Korstange, Director of TCF Corporate Communications, to begin the conference call.

[James E. Korstange:]

Good morning. Mr. William Cooper, Chairman and CEO, will host this conference. Joining Mr. Cooper will be Mr. Barry Winslow, Vice Chairman of Corporate Development; Mr. Tom Jasper, Vice Chairman of Funding, Operations and Finance; Mr. Craig Dahl, Vice Chairman of Lending; Mr. Mike Jones, Chief Financial Officer; and Mr. Earl Stratton, Chief Operations Officer. During this presentation, we may make projections and other forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements and -- are predictions and that actual events or results may differ materially. Please see the forward-looking statement disclosure contained in our 2013 second quarter earnings release for more information about risk and uncertainties which may affect us. The information we will provide today is accurate as of June 30, 2013, and we undertake no duty to update the information. During the remarks today, we will be referencing a slide and presentation that is available on our Investor Relations section of TCF's website ir.tcfbank.com. On today's call, Mr. Cooper will begin with the second quarter highlights; Mike Jones will discuss credit and expenses; Craig Dahl will then provide an overview of lending; Tom Jasper will review deposits, fee generations and capital; and then Mr. Cooper will wrap up with a summary. We will then open it up for questions. I will now turn the conference call over to TCF Chairman and CEO, William Cooper.

[William A. Cooper:]

Thanks, Jason. This morning, TCF reported earnings per share of $0.21, that's up 31.3% from the first quarter of 2013. It's up a similar amount on a core basis from a year ago second quarter as well. The ROA was 0.90% and the ROE was 8.4%, also substantially improved from prior periods. Total revenue was $302 million, that's up about 3.5% from the first quarter of 2013. Pretax pre-provision profit, which is really the best measure of a core profitability of a bank, was $93.3 million. That's up 6.3% from the first quarter. We kept net interest margin essentially flat at 4.72%. And the provision for credit losses was 30 -- $32.6 million, that's down 15% from the first quarter. Charge-offs were at 0.70 basis points, and that's down from 1.18% last year, also significant improvements. Non-accrual loans and leases and other real estate owned decreased $70 million or 17% from the first quarter. All of the credit metrics in the bank improved significantly from prior quarters. The revenue growth, we had $302 million of revenue. $100 million of that was fee income of various kinds and $202 million was net interest margin where there's a 4.72% net interest margin rate which is flat with the previous quarter, which is contrary with most of our competitors. The revenue was impacted by an increased customer-driven leasing revenue. We had a recovery in our leasing revenue, increased banking fees which is mostly seasonal and the gains on sale of consumer and auto loans which are regular quarterly events today. The net interest margin was impacted by a continued compression in the pricing. As the higher-yielding loans made in prior periods run off and new loans come on, with the difficulty of reducing cost of funds any lower than their very low rates today, has presented some pressure on the net interest margin. Changes in mix and so forth are what permitted us to stay at a healthy 4.72% net interest margin, which is one of the highest in the banking business. Lower average liquidity balances also contributed to the margin. The TCF's strong pretax pre-provision return on assets and core earnings is largely driven by the structure of its balance sheet. TCF has 85% of its assets and loans, as compared to our peers of $10 billion to $50 billion banks that are about 65%, with a lower level of securities in only about 3.5% versus 24% for our peers. That results in us having a higher net interest margin, as I just mentioned. Net interest income as a percentage of assets, total assets, is 4.39% at TCF versus 3% at our peers. And our core noninterest income is over 2% versus 1.16% at our peers, giving us revenue of almost 6.5%, as compared to 4.16% at our peers, and a pre-provision profit of almost 2%, as compared to about 1.5% in our peers. We have a higher net interest margin. We have a higher yield on our loans, 5.3% versus 4.8%; and a higher yield on our securities of 2.8% versus 2.4%; and a lower rate on our deposits at 27 basis points versus 40 basis points. All of that generates a higher core profitability, which generates a higher pretax pre-provision profit. As our provision for loan losses continue to improve, it's the reason we're seeing improved net income and earnings per share. Key issues on credit quality on consumer real estate, which has been our home equity portfolio, our residential portfolio, has been the biggest issue associated with credit. 60-day delinquencies decreased 1.2% from a year ago. Non-accrual loans and leases and other real estate owned decreased $58.4 million or 22% from the first quarter. And charge-offs decreased on the consumer portfolio $6.7 million or 22% from the first quarter, all significant improvements driven largely by improving economy and improving home values, which improves this portfolio overall. I'm optimistic we will continue to see improvements in this area in coming quarters. On the commercial side, non-accrual loans and other real estate decreased $10 million or 7.5% from the first quarter. Classified assets were down $10 million. Net charge-offs were only $2.4 million, down $5.5 million or 68% from the first quarter. I think we're going to see improved credit in this area, too, as we're seeing significantly more upgrades on credits than we're seeing downgrades. Leasing and equipment finance, audit -- auto, inventory finance, our national platform businesses, continue to have pristine credit. Charge-offs are only 7 basis points. Over-60-day delinquency is only 5 basis points, very, very clean portfolios. All of these portfolios are growing, some modestly and some better than modestly. With that, I'll turn it over to Mike.

[Michael Scott Jones:]

Thanks, Bill. Turning your attention to Slide 7 of the earnings presentation. Slide 7 depicts the positive trends in credit quality over the last 8 quarters, especially since the third quarter of 2012 where credit improvement started to accelerate. Nonperforming assets, delinquencies and net charge-offs all declined over that period. Slide 8 shows the consistency of credit performance through the worst recession experienced in decades, with delinquencies capping out at 41 basis points and net charge-offs of 91 basis points in our national lending businesses. Year-to-date charge-offs for these businesses is 12 basis points annualized. These businesses have performed through the cycles, and we look for them to continue this performance. Slide 9 shows the home price index. A big contributor to an improvement in credit quality in our consumer business is the improvement experienced in the home prices. All of our 4 markets, as you can see, experienced improvement in April on a year-over-year basis, with Phoenix, Detroit and Minneapolis all outperforming the 20-city composite average. Even Chicago, which has lagged most of the U.S. in home price improvement, increased 9.4% in April. Continuation in this improvement will bode well for our consumer portfolio going forward. Now turning your attention to core operating expenses on Slide 10. Our core operating expenses increased 3% on a linked-quarter basis and 6% year-over-year, mainly driven by higher compensation expenses as we continue to build infrastructure in our growth businesses. Additionally, we had increased expenses in the quarter related to higher commissions based on production. We still look to grow our revenue into this expense base throughout 2013. With that, I'll turn the call over to Craig Dahl.

[Craig R. Dahl:]

Thank you, Mike. We'll start on Page 11. This is our loan and lease portfolio and, as we did last quarter, showing you by asset segment and by our wholesale-retail split. You can see we have maintained our 53%, 47% wholesale, retail percentages. We believe we get great opportunities here to invest capital in light of the competitive environments where it makes the most sense, and we're going to maintain our disciplined loan growth approach. We still had year-to-date loan growth despite $829 million in loan sales and our seasonal decline in inventory finance where the ending balance at quarter end was $218 million, below the prior quarter end. Moving to Page 12, our loan and lease balance roll-forward. We had strong originations in the quarter. You can also see the impact of the increased run-off of the inventory finance seasonal decline and then the impact of the loan sales to the ending balance. Moving to the box for the change in volume and sales. We had good sales growth in -- origination growths in nearly all our businesses, with leasing being rather flat compared to the second quarter of last year. And we believe our originate-to-sell capability is now a core competency and it allows us to manage several concentration risks. Moving to Page 13, which is the loan and lease sale detail. This -- as I just mentioned, this is a part of our core strategy. We will sell assets to assist in managing our asset concentration, managing our geographic concentrations; and to generate gains to help fund the infrastructure expansion of our growing businesses. The pie charts show the full year 2012 versus 6 months of 2013, and you can see we've already sold more assets in the first -- more loans in the first half of 2013 than we did in all of 2012. We have built a very efficient asset sale capability, building off of our base for model finance, and look to continue with both existing and expansion buyers. Turning to Page 14, the 5-quarter view of our loan and lease yields. Our diverse portfolio and continued asset growth allow us to mitigate much of the impact from the low rate environment. As Bill mentioned, our amortizing loans have higher yields than the new business. However, we do expect to continue to see some yield compression as the rate environment remains low, especially in that 2- to 3-year-portion of the yield curve. Now turning to Page 15. Here's a little discussion on the impact of a rising rate environment. The implementation of our strategy has lowered our long-duration fixed rate portfolio to only 25% of the total loan portfolio while growing the variable component to 37%. So as you can see, 75% of our assets are variable rate or short- or medium-duration fixed, and this is funded with our low- or no-cost checking and savings deposits of $10.5 billion, with an average cost of 9 basis points, in the second quarter of 2013. We believe this strategy sets us up well for any interest rate environment, including a rising rate one. With that, I'll turn it over to Tom Jasper.

[Thomas F. Jasper:]

Thank you, Craig. If you could turn to Page 16, a little discussion around deposits. As it relates to our growth, the 11th consecutive quarters of growth in the average deposits, and it's coming from the origination and retention of different products and strategies in different markets. The $2.6 billion of non-interest-bearing deposits sets us up well for rising rates as those deposits will reprice at 0% when rates eventually rise. The year-over-year growth in checking and savings and CDs has enabled a 30% decrease in total borrowings year-over-year. I'd just mention that the teams in the branches continue to perform at a high level in supporting the funding needs on the lending -- of the lending organization. If you turn to Page 17. Fee and service charges and card revenue and ATM revenue are down approximately 4% from second quarter of 2012 to second quarter of 2013, before consideration of the monthly maintenance fees that were affected by the return to free checking. The themes from the first quarter in regards to a decrease in customer transactions continued into the second quarter. On a year-over-year basis, customer transactions per account are down approximately 5.5%. In addition, seasoned accounts average balances are up about 2% since year end. And these 2 points are having an impact on banking fees. Checking account production was up 27% year-over-year, while attrition was down 29%. This led to our best quarter in net checking production over the last 4 quarters. We have made good progress over the last year since the return to free checking, and we look forward to a continued progress going forward. If you turn to Page 18 real briefly. As it relates to capital, you can see on this slide that capital is up from the first quarter across all metrics. And with that, I'll turn the call back over to Bill Cooper.

[William A. Cooper:]

A little more discussion on capital. The Basel rules are starting to be formalized. And the new rules are coming out very favorable to mid-sized banks, and particularly TCF, as it relates to the Basel rules revolving around residential loans and so forth. And that picture looks significantly better for us than it has in prior periods. The -- again, the story of TCF is the implementation of our strategy, of diversifying our asset-generation capacity; generating excess assets for gains on sale; developing a gain-on-sale capacity that's allowed us to diversify our concentrations and to sell off various categories. They give us a better risk on our rate of return and still grow the balance sheet and had -- maintain a strong margin. We've had continued credit improvement. Rising home values and improved economy are having a significant positive impact on our residential portfolio, with the potential for losses sinking considerably as home values move up and exceed the loan values. We're building a real diversified revenue base. A net interest margin in various forms of fee income and leasing income and checking and deposit-level fee income and so forth has built the strongest revenue base in the banking business at 6.5% of assets. The -- our following provision for loan losses has generated a improved return on assets, return on equity, where our equity generation now exceeds our asset growth, which I think will accelerate, which means we're building capital through core operations, which is also a positive attribute. So all in all, things are operating as pretty much as planned. As both Tom and Craig mentioned, we feel we're very well positioned for rising interest rates. Our asset portfolio is either variable or short term that has an impact in terms of rising rates and a credit impact, frankly. And our deposit portfolio is not very rate sensitive. And over the pool, a higher rate environment would result in an even higher net interest margin at TCF. And at some point, we believe that's going to happen over the next couple of years. And with that, I will open up to questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Jon Arfstrom with RBC Capital Markets.

[Jon G. Arfstrom:]

Just a question -- a couple of questions on credit. In terms of the consumer nonperforming loan sale, can you talk a little bit about that and what the trigger was, whether or not we might see more? And then maybe touch on commercial, if you're seeing the same kind of improvement in commercial and the potential to move some of those balances out.

[William A. Cooper:]

The loans we sold were the bankrupt loans, as you remember, that were an issue back in the third quarter of last year. They have a kind of a new set of accounting principles associated with those loans in that they stay on a non-accrual status permanently under the Generally Accepted Accounting Principles as it relates to bankrupt loans. And we sold, I think, some $44 million of those loans. We actually booked a small gain on the sale. And it was basically to improve the credit picture associated with the bank as a whole. We have another $60 million of those loans. We'll probably, probably, sell some more of those, there is a market for them, in the coming quarters. On the commercial side, the nonperforming loans are -- we're selling off REO non-accrual loans of -- many of them are improving. We are able to sell a lot of our non-accrual assets we're being taken out of and expect to see a continuing improvement in that area. I wouldn't look for a sale, a big sale, of nonperforming loans in a similar manner as we see in the -- that we see now in the consumer side. On the consumer side, another aspect that might -- we might look at in the future and particularly as things continue to improve might be the sale of the TDR loans as well. And those loans are performing fine, but again in terms of cleaning up the balance sheet and improving the optics, we may sell some or all of those at some point in the future. Mike, have you got anything to add up?

[Michael Scott Jones:]

Yes. Jon, this is Mike Jones. I would just add, I mean, truly, our focus is, if we can get them out into the marketplace and accelerate the decrease of those levels on a non-dilutive way to the bank, we're going to take advantage of those opportunities. I would say the market has been fluid and has changed over the last several quarters to the positive from the standpoint of market price. So we've just taken advantage of that in this quarter.

[Jon G. Arfstrom:]

Okay, okay, good. And then just one quick question for Craig on leasings and equipment fees. I know the number bounces around a lot, but it was probably one of the bigger negative surprises in Q1 and, obviously, bounced back in Q2. When you look back kind of Q2 to Q1 to Q4, do you feel like there's any aberration in that line? And are we back to normal, or is this just still too difficult to predict?

[Craig R. Dahl:]

Well, Jon, this is Craig Dahl. We do talk about it. It is customer driven. And however, Mike gave guidance last time that we look for a range of, like, $20 million to $23 million per quarter in that line item. So I think that's still good guidance. And I still think, if you average the fourth and first quarters, we're still right in that time frame. And as we talked about last time, there were some tax motivations and other things people were concerned about where we believe they pulled some things forward into the fourth quarter, which meant that the first quarter was a little less than normal.

[Operator:]

Your next question comes from the line of Steve Scinicariello with UBS Securities.

[Stephen Scinicariello:]

Just want to get some color on kind of the loan growth trajectory from here. I know that inventory finance can also be seasonal, it moves around. But as I look at that slide on Page 12, as we look forward, I mean, originations continue to be strong. And might we see less sales and less run-off going forward, resulting in kind of more net loan growth as well, or -- just trying to get some color on that?

[William A. Cooper:]

I'll say, there's -- that area is a work in process. The -- and we make judgments associated with what we should sell versus what we should keep. And a fair amount of that is credit driven. In other words, do -- how much concentration do I want to have in a particular state, in a particular category of assets or a credit aspect of a particular portfolio? And so we kind of make those judgments in terms of what happens with origination on a risk-weighted return. When you sell a loan, you get a gain, and you don't have the balance sheet aspect of capital and you do have the capital aspect of taking the gain. And the risk-weighted return is obviously very good. Whether that's the best return over the pool remains to be seen. So I'll say this, our loan origination capacity has enabled TCF to sell a significant amount of loans and still grow loans in -- on a net basis. I think, as time goes on, we'll probably weigh more towards putting more loans on the balance sheet and less gains through the sale, but I think that's going to be over a transitional period of a number of quarters. That would be my guess on it.

[Stephen Scinicariello:]

Perfect. And just the other question I had was just on the expense kind of other line, saw that kind of tick up, like, $4 million or so. I'm just kind of curious what might be in there. What is -- what should we still be using or thinking about as a run rate on that line?

[Michael Scott Jones:]

Steve, this is Mike Jones. I think, from that perspective, there was no large, material item. I think one of the things that we have going on in the short term which will benefit us long term is a lot of consulting and professional services fees. As these new regulations come out and new guidance come out, we want to ensure that we're getting the best perspective across-the-board around implementing these things and complying with those new regulations. So in the short term, it's a little bit pain, but we believe that, long term, it will be in the best interest of the organization.

[William A. Cooper:]

We want to make sure that we have a world-class stress testing program, et cetera, for those new things that are coming down the pike from a regulatory perspective. We're spending up to make sure that we get those things done properly.

[Operator:]

Your next question comes from the line of Ken Zerbe with Morgan Stanley.

[Ken A. Zerbe:]

I had a question on credit. It -- obviously, provision is getting better, the underlying charge-off is getting better. When you look ahead over the next, I don't know, 6 months, 12 months, and you -- and we'd look at housing getting better, is there any reason to think that credit improvement, provision specifically, accelerates in terms of coming down? Or should we think about this more as just an ongoing steady, slow decline from here?

[William A. Cooper:]

I think, optimistically -- I'm not going to make a prediction on credit, but optimistically, you would see a steady decline. One of the things that -- at TCF is that -- and in the banking industry in general is that, to some degree, this improvement is going to allow us to build stronger reserves relative to our credit picture than perhaps the industry or TCF has had in the past. And some of -- many of our areas, particularly growth areas, have pristine credit, virtually, no charge-offs and no credit issues, but we're going to want to maintain healthy reserves in the bank as a whole for lots of reasons. One, in that, if anything has been proven in the last 2 years, you can never tell what's going to happen. And so as charge-offs come down, you're going to see improved provisions. I -- you're not going to see as much at TCF, as perhaps you've seen in other places, of us reversing reserves.

[Ken A. Zerbe:]

Got it. So I guess, when you say optimistically a steady decline, so realistically, it sounds like maybe the decline of provision slows, you keep the reserve at, whatever it is, 1 70 1 65, somewhere in that range, and then it may stabilize and even grow as you grow the loan portfolio over time.

[William A. Cooper:]

Yes. You could -- you can come up with that. And the new trend in the world is to keep good environmental reserves in these various categories for loans in anticipation of things that may happen, or that maybe you have a somewhat of an unclear future and so forth. So you're going to see more of that in the industry and you're going to see more of it at TCF.

[Operator:]

Your next question comes from the line of Steven Alexopoulos with JPMorgan.

[Steven A. Alexopoulos:]

I want to start, in regards to Basel III capital, where do you estimate pro forma tier 1 common adjusted for the final NPR? I thought, in prior quarters, you said down about 150 basis points.

[William A. Cooper:]

Yes, that's still a work in process. Mike, do you want to comment on that? I know it's a recent rule, so it's still some haze around it, but I think we have some soft numbers.

[Michael Scott Jones:]

Yes, I -- Steve, we're still reviewing through the documents and the ultimate impact to the organization. We haven't gotten all the way through. But with that said, I would say that our preliminary calculations, with the final rules impacting TCF, will be at a small fraction, a small percentage, of that original guidance provided.

[William A. Cooper:]

And to add on that, on the Basel thing, this is kind of a general banking issue, but to a greater or lesser degree, and I've spoken out on this in the past, the cost of regulation is a fixed cost and it's borne heavier on smaller institutions simply because of the size. Some of these Basel rules and other rules, as they're coming down, which bear less heavily on the midsized banks, are going to perhaps switch the playing field around a little bit. Wherein, I think, in a lot of cases, the biggest banks were -- carried less capital, now we're going to be required to carry more. And with the stress testing results in these Basel rules and so forth, I believe we play in national markets in a lot of our loan categories. And I think it's going to help over time to level the playing field and make TCF even more competitive than it's been in the past. And these are big things for the banking industry, and the way they've come down are big positives for the regional banks.

[Steven A. Alexopoulos:]

That's helpful. And Bill, to follow up, speaking of new rules, regarding the auto business, and the consumer protection bureau put out that bulletin in March limiting dealer markup, what impact do you expect? I know it's still early on that, but what do you expect at this stage from that?

[William A. Cooper:]

We were already doing what -- overwhelmingly what that -- what those rules came down on. We have -- we did a -- we've done lot of work in anticipation of the consumer finance division coming in and doing and examine at TCF in a lot of areas, including the auto area. And it is a -- again a work in process, but we believe that we have done everything that we can virtually in preparation on that. And for a long time, we have structured our product structure the way we handle to pay dealers, the way we market dealers, the way we train dealers in connection with this business that we hope that we have moderated that risk to a significant degree. Barry, do you have anything to add on that?

[Barry N. Winslow:]

No, other than we've had some preliminary conversations of about the CFPB is going to come in, in August. And I think we feel relatively confident, at least as we can feel right now, with the work we've done.

[Steven A. Alexopoulos:]

That's helpful. And maybe just one final question?

[William A. Cooper:]

Let me add on that. This CFPB bogeyman thing that the industry has been very afraid of, I think that the CFPB to date has held themselves up in a much more stature in terms of doing logical things and not the illogical things that people were afraid of. And I think a lot of that was bogeyman of bad things that were going to happen. And I think, as they've gone through their examination process in other banks, it's been a much more logical and worthwhile process than a lot of people thought was going to happen.

[Steven A. Alexopoulos:]

Bill, maybe just one final question, with the consumer real estate sales roughly $140 million versus $280 million in 1Q. I know it's very volatile, but can you help us think about the reduction in sales activity in the quarter? And how should we be thinking about a run rate and what's driving that quarterly volatility?

[William A. Cooper:]

The -- a lot of it has to do with just what happens in the marketplace, and the -- where the origination comes from, it kind of drives it. And Craig, do you want to add on that?

[Craig R. Dahl:]

No. We have a proactive approach on identifying, circling a number for sales, but then we also have to react within the quarter based on where the production comes and states, as Bill has already indicated, whether it's in states or credit quality classes. So it's a mixture of anticipation but also reaction to what we're actually originating.

[Operator:]

Your next question comes from the line of Nicholas Karzon with Credit Suisse.

[Nicholas Karzon:]

I guess, just with the strong growth in the auto loan portfolio, just thinking down the road, how large? Are there any size constraints on that portfolio? Or how big could that ultimately come as a percentage of the total portfolio?

[William A. Cooper:]

I mentioned in general things about risk and concentrations and so forth. The sales generation capability of the bank that we've generated over the last year, that Craig and Mike have really invented, has really enabled us to engage in a lot of activities on a broader scale and manage the concentrations in a lot -- much more proactive way. We now -- we used to have basically consumer loans and commercial real estate loans, and then we got into equipment financing, now we're into inventory finance, now we're in the auto and we're in the ROU unit and so forth. That's given us a lot of ability to manage concentrations. And the concentration of residential portfolio has been shrinking and will continue to shrink. The -- obviously, any loan category has a limit in connection with that aspect of it. I think we're quite a ways away from that. Our board reviews that limit each quarter in terms of the evaluation of the concentrations, but we have a fair amount of room in that category. And as I said, the ability to sell loans allows us to kind of release that overcapacity to the degree that it occurs in the future.

[Nicholas Karzon:]

Okay, got it. I guess, just kind of more specifically, I mean, so we're thinking north of 10% on that limit at the moment? Or is it -- I mean, just kind of ballpark, trying to think about what that portfolio could be like in 2 to 3 years if you were to manage to a target.

[William A. Cooper:]

Yes. I really can't. I'd be honest with you, I can't remember what percentage we came up with. And we actually measure it as a percentage of capital, as opposed to loans. But -- and I can't remember what -- we've got an internal guideline. And the internal guideline sometimes is just a whistle, "Hey, we're here, let's reevaluate it." But the auto portfolio, through the credit crisis, held up very well, much better than other asset classes. And it wouldn't bother me to have it be a little larger than perhaps even we've designated out, but we'll make that judgment a period at a time in terms of where we end up on the portfolio as a whole.

[Operator:]

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

[Christopher McGratty:]

Bill, on the balance sheet, it's not growing as much as, I think, some of us had projected. Basel III is coming in better. Can you speak to your capital priorities and then what -- where you're ultimately comfortable running the bank on a tangible common equity basis?

[William A. Cooper:]

I think our tangible common equity is probably at an acceptable level right now. We've actually got a cushion in it. And as I mentioned, one of the things that's happening is our return on assets, return on equity is now generating an after-dividend return of growth in capital that supports a stronger asset growth than we've experienced over the last several quarters. And we indeed manage it that way, and that's part of that gain on sale thing, as I mentioned earlier. When to a degree we take again, I haven't -- I don't increase the denominator and I increase the capital level through increased earnings. But I believe one of the -- the Basel thing, as I mentioned, is a big deal for us. It really gives us much more comfort as to what may be coming down the pike on that and really more clearly defines what the regulatory capital requirements are going to be. TCF will always maintain more capital than the regulatory requirements. We will maintain capital based on what we believe is prudent. But I believe our capital levels today are more than adequate and, I think, pretty well do the job.

[Christopher McGratty:]

Okay. And one more, Bill. The loan-to-deposit is still above 100%. You talked about your expectations that deposits will stay with the bank even in a rate -- rising rate environment. Can you let me know what your comfort level is on running the loan-to-deposit ratio in a higher rate environment? And then also, would you ever consider going out and buying another bank at this point in the cycle?

[William A. Cooper:]

The -- let me mention something about loan-to-deposit ratio. TCF's deposit-to-asset ratio is higher than the -- our peers. We fund the bank with deposits. We simply have very little investments than we have more loans. We have more loans because we believe it's more prudent to have more loans. Investments, particularly in today's interest rate environment, in my judgment, have more risks than loans because of the mark, because I think, over time, it's likely that rates will rise. A 300-basis-point rating rise will depreciate in -- a loan MBS portfolio by 30%. I mean, what loan category would I want to put on that where I think I could lose 30% on? And so that loan-to-deposit ratio is not as meaningful at TCF as it is at banks that are only at 65% loans. In addition to that, my deposits -- or an overwhelming majority of my deposits are insured deposits. That means they're relatively low-balance deposits, which means it isn't hot money, which means it's better from a liquidity perspective and better from a pricing perspective when rates rise. And so I'm very happy with where we are in all of these ratios today in connection with how it constructs our profitable P&L and balance sheet and capital levels looking forward and our liquidity levels looking forward.

[Operator:]

Your next question comes from the line of Erika Penala with Bank of America.

[Erika Penala:]

My first question is on charge-offs and sort of where charge-off levels can bottom from here. I see that there can be a lot of improvement on the Commercial Real Estate line, but could you help us think about what you think, in an improving economy, normal losses would be in the commercial leasing and equipment finance, inventory finance and auto finance books, where all of which had quite low charge-offs this quarter? And also going back to consumer real estate, do you think it can continue to improve even if short rates started to go up?

[William A. Cooper:]

Yes. The -- it's going to improve simply because the portfolio is subject to problems in that. 90% of TCF's charge-offs in the last quarter were loans made in 2008 and prior. And that portfolio continues to shrink in both the residential and the commercial portfolio. Originations made since 2008 at TCF remained pristine. How low charge-off rates can go, that's a function of the economy, of the loan mix and what category of loans that we're in, but I'm confident that it can continue to improve and should continue to improve in all the categories. One other things about charge-offs I'll mention, particularly on the commercial side, it's fairly common for us to reserve an asset a year ago or quarters ago, and then we take some action on it and charge it off. And so a charge-off -- we took the provision and we ran it through the P&L in prior periods, the charge-off runs in current periods. And we're doing some of that today and particularly in the commercial portfolio.

[Erika Penala:]

Got it. And also, it's a follow-up question on credit. I thought it was interesting that you're open to selling your TDR book. Could you give us a sense of what the reperformed yield is on that TDR book?

[William A. Cooper:]

The yield is a little above -- around 3% its current yield. The -- it's $550 million of residential performing TDR loans, and it has a reserve of $100 million on it. So there's plenty of room potentially to sell that portfolio. Did I get the right numbers on that, Mike?

[Michael Scott Jones:]

Yes. I mean, the yields are around what current market rates are right now for originations in the mortgage space.

[Erika Penala:]

Got it. And my last question

[William A. Cooper:]

We think we're, within those rules, very liquid today. And we exceed those liquidity rules today. And so I'm very comfortable with where we are from a liquidity point of view. One of the things you have to remember, when you -- again, when you look at our balance sheet, we have very little short-term borrowings. Our -- since our deposit base is mostly insured deposits, in a crisis, it doesn't go anywhere. In the last crisis, the liquidity crisis that occurred, TCF never knew it happened. And so we have a -- and the turn in our assets is so strong. The equipment finance, inventory finance, auto portfolios, all of which turned very fast, you stop or slow origination, liquidity just pours into TCF, as compared to banks that have huge, long portfolios of commercial and commercial real estate or even the credit card businesses. Tom, did you want to add anything of those?

[Michael Scott Jones:]

No.

[Michael Scott Jones:]

The only thing that -- this is Mike Jones, that I would add, I would say that, over the last 1.5 years, we've significantly strengthened our liquidity position in the bank. And as Bill discussed, we are very comfortable with those levels.

[Operator:]

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

[Emlen B. Harmon:]

Bill, in your prepared remarks, you kind of -- you mentioned kind of continued infrastructure investment and focusing on developing some of your new businesses. Could you just give us a sense of kind of where you're focusing your investment dollars at this point? And just kind of within that, it feels like expenses have kind of -- have been kind of tracking along with revenues lately. Just kind of being curious when you feel like you're going to start to get some real operating leverage.

[William A. Cooper:]

Well, I think we already have gotten operating leverage in a lot of these areas. Our inventory finance business, for instance, is now a very profitable business. Its asset growth is now grown up and absorbed the overhead that we put on for that business. And we're now looking in that business, as a matter of fact, of a lot of expense control as it has matured in the business. The auto business is still on a growth mode. And there is -- has been more increased competition in that business. And originations have slowed in some areas, but that is still a big investment business where we can lever the operating expenses. And even my deposit business

[Operator:]

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

[Terence J. McEvoy:]

The first question, how does the impact in or increase in rates or the steepening of the curve impact the profitability of selling those auto loans? And what other variables do you look at beyond concentration when evaluating selling those assets at an acceptable return?

[William A. Cooper:]

Well, for instance, the auto loan portfolio, the credit scores of the loans that we're selling is an impact, what credit buckets that we want to own versus we want to sell. On the other categories of assets, it's geographic concentrations in terms of how much do you want to have in this particular city or this particular category. I would say, the rise in the 10-year had no impact on the gain on sale. And that rise, it's kind of interesting. It has had virtually no impact. We're not seeing it. We're -- our loan rates didn't rise with it, except to the degree that you had loans that were fixed to Treasury. And even there, the index fell. And so the Treasury rate rose, but nothing else seemed to change with it. Is that fair to say, Craig?

[Craig R. Dahl:]

Yes.

[Michael Scott Jones:]

The other thing I -- that I would add, this is Mike Jones, is as we -- as Craig Dahl discussed in the shift in the portfolio more to the short- and medium-term assets, clearly, the focus for us is kind of in the 2- to 5-year range from a rate perspective. So as those rates increase, that will have an impact on the portfolio.

[William A. Cooper:]

So it's really gain on sale of loans. Most of the financial industry is really starved for loans right now, and so there's a lot of demand for it. And that's really what's creating the pricing, not the interest rate environment. And a lot of the loans that we're selling on the real estate side are variable rate, that's what we've primed. And so that isn't impacted by the rate changes that have occurred.

[Terence J. McEvoy:]

And just a follow-up. About 10% of your branches are in the Detroit MSA. Any thoughts on the bankruptcy of that city? And any implications for your business in that market?

[William A. Cooper:]

Well, they're in Detroit MSA, but they are -- very few of them are in Detroit per se. Detroit, interestingly enough, is a great market for us. It's a very profitable market for us, and we're very happy. And we haven't seen any impact one way or the other in terms of the Detroit bankruptcy. It'll probably have some unintended consequences somewhere, but to date, it has had none.

[Operator:]

Your next question comes from the line of Dan Werner with MorningStar.

[Dan Werner:]

I was -- had just a couple of questions about loan origination. First of all, on the commercial side, can -- has there been any changes in your commercial line utilization rates? Or has most of the growth come from new customers? And then secondly, on the auto side, are you seeing any -- is the auto loan origination level still pretty steady to growing? I know one of another national lender says, "Well, we're going to kind of keep it steady where -- from the current levels." And do you see any seasonal impact with the change in the model year through third quarter?

[William A. Cooper:]

Most of our origination in the auto business is used car, so that new car unit doesn't really have a big impact. But we don't have much line utilization because we don't have many lines in the commercial side of the business, in the C&I world. The -- I'd -- I'll let Craig comment on this, but one of the things that is clear is there's huge competition in this area. And one of the things we're very happy about is that it's not our only business. And what -- having businesses like inventory finance, the auto business, equipment finance, et cetera, reduces our necessity to compete in this "1.40% over LIBOR" war in the commercial business that most of our competitors have to engage in and we don't. And so we can be more selective from a credit perspective and a rate perspective in connection with what we do because of the increasing diversification of our asset-generation capacity. Craig, do you want to add anything to that?

[Craig R. Dahl:]

No. That was right on.

[Operator:]

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

[Andrew Marquardt:]

In terms of the margin, sorry if I missed it, do you guys still anticipate the NIM bottoming at about 4.60%? Or has that changed because of the rate environment, because of the balance sheet shifts?

[William A. Cooper:]

The rate environment would indeed change that depending on what happens. What's happened already, probably not much, but if rates continue to rise, then that would change it. I'll say this, that 4.60% that Mike mentioned, I think that was a year ago, the world changes. So then -- so I wouldn't go out there and chip that in stone anywhere. And if rates stayed very low, I think it's fair to say, with the continuing shifts in the balance sheet, it would be difficult to keep the margin at what it's at, and we'd see some reduction in that net interest margin over time. Mike, do you want to comment on that?

[Michael Scott Jones:]

No. I think that, that's right. There are just so many different variables that go into that number

[Andrew Marquardt:]

Okay, that's helpful. And then in terms of deposit service fees, you had mentioned there were 2 factors impacting results. One was lower activity by customers. What was the other? I -- sorry, I just missed that.

[Thomas F. Jasper:]

Yes, this is Tom Jasper. We were just looking at the balances, Andrew, within the seasoned accounts since year end. Balances in those accounts are up from the area of about 2%, on average, for seasoned accounts. So as the balances are higher and transaction level is lower, there's an impact to fee revenue in various categories.

[Andrew Marquardt:]

Got it. But is it fair to say that -- as you pointed out in your Slide 17, that we've kind of bottomed out in banking fees in terms of stabilization? Or is there still room for pressure there given that phenomenon -- those phenomenons?

[Thomas F. Jasper:]

I would look at it as we're -- we've been consistent with last quarter. When we're on the call last quarter, we talked about, do you see any signs of any improvement? And at that time, we said no, we don't see anything that says consumer spending is picking up. There are other -- some signs in the economy that things are getting better, but they haven't necessarily been reflected in consumer spending. So we're still waiting for some of that impact to occur, but it seems like more of the industry signs are that it's getting better versus getting in worse at this time. So that's how I look at it right now.

[William A. Cooper:]

The positive on that, too, is for the last several quarters, TCF has grown its base. And even if the revenue per account stays lower, volumes stay lower, at some point, the new account volume picks up that slack and, assuming that it doesn't continue to deteriorate, picks up that slack and you see improvement in that line item.

[Andrew Marquardt:]

That's helpful. And then my last question is just on expenses. You'd mentioned how you plan to grow into it. How quickly should we think about that growth into the expense base? And what's the ultimate goal in terms of what you think you should run at in terms of an efficiency ratio versus, I guess, you're right now kind of in the pretty high 60s?

[William A. Cooper:]

We don't look at the efficiency ratio. I think I look at that as being a random number, in a lot of ways. There's a -- there's no direct relationship between efficiency ratios and return on assets, if you analyze the banking business. But we -- the way we look at it is expense is a percentage of assets in terms of driving to a return of asset number, and we'd like to get that expense number down to 4% of assets. It's currently running around the 4.50%. And that's not a fast turn. That's going to take a while.

[Michael Scott Jones:]

The only thing, this is Mike Jones, that I would add is we have a different dynamic that goes on here due to the loan sales because we continue to service those assets and we have the infrastructure to service those assets. So clearly, that impacts us when you take it into consideration when you're calculating a total asset-to-expense ratio.

[Operator:]

And your final question comes from the line of Peyton Green with Sterne Agee.

[Peyton N. Green:]

A question with regard to the deposit fees and service fees. Historically, there's been pretty good volatility between the second and third quarter. And I was just wondering how much volatility you would expect this year compared to last 2 or 3? I think, generally, it's been down between 8% to 10% on a linked-quarter basis. And I was just wondering, is that a reasonable expectation, or are things different?

[Earl D. Stratton:]

This is Earl Stratton. There is seasonality in those numbers, and one would expect that seasonality would continue. However, as Tom mentioned, the consumer spending will have a lot to do with how volatile it is. So it's difficult to predict, but I would expect seasonality.

[Peyton N. Green:]

Okay. And then, Tom, with regard to the branch network and trying to push more product out and maybe get more utilization out of your network and your associates, how is that going? And what should we expect to the back half of the year?

[Thomas F. Jasper:]

Well, this is Tom Jasper. So the big things that we've done this year, we've accomplished, we have a good cross-sell ratio that we've improved as it relates to new savings products. We have a good product that works for our checking base. We've done a good job on that. Our primary mission is around making sure that we're in a position to fund the balance sheet growth that we have projected and maintain the liquidity that we need. We're -- we have other efforts. We've -- well, we launched a new marketing campaign in the last couple of months, and that's gone well, trying to build up the brand and roll out additional things such as a new mobile app and other things to make sure that our customers enjoy the experience of banking with us. We've done well across many boards. And as it relates to new initiatives, I would say that, for the rest of this year, we'll continue to focus on the customer experience, but I would expect some new product initiatives will be announced in 2014.

[Peyton N. Green:]

Okay, great. And then just generally, I mean, as expense growth is -- would you expect it to slow in terms of a rate of growth? Or would you expect it to possibly go down over the next couple of quarters as you work on some efficiency? Or it -- would you expect more earning asset and net interest income growth and still have modest expense growth?

[William A. Cooper:]

What I would expect to happen over coming quarters is the expenses as a percentage of assets to come down, which is the key...

[Peyton N. Green:]

Right. So I guess, you -- do you expect more asset growth, or less expense?

[William A. Cooper:]

Yes, both. So I'll just wrap it up and say thank you. We appreciate all your support. And it's been a real transitional year. We spent a lot of money and time reinventing the bank last year, and we're -- it's beginning to pay off this year. Thank you very much.

[Operator:]

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