TCF Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 25 Oct 2013

[Operator:]

Good morning, and welcome to TCF's third quarter earnings call. My name is Ginger, and I will be your conference operator today. [Operator Instructions] At this time, I would like to introduce Mr. Jason Korstange, Director at TCF Corporate Communications, to begin the conference.

[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; Mr. Earl Stratton, Chief Operations Officer; and Mr. Jim Costa, Chief Risk 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 are predictions and that actual events or results may differ materially. Please see the forward-looking statement disclosure contained in our 2013 third quarter earnings release for more information about risk and uncertainties which may affect us. The information we'll provide today is accurate as of September 30, 2013, and we undertake no duty to update the information. During our remarks today, we will be referencing a slide presentation that is available on the Investor Relations section of TCF's website, ir.tcfbank.com. On today's call, Mr. Cooper will begin by discussing third quarter highlights, Mike Jones will discuss credit and expenses, Craig Dahl will provide an overview of lending, Tom Jasper will review deposits, fee generation and capital, and Mr. Cooper will wrap up with a summary of the quarter. We will then open it to questions. I will now turn the conference call over to TCF Chairman and CEO, William Cooper.

[William A. Cooper:]

Thanks, Jason. TCF continued to have improved results in the third quarter. Net income was almost $38 million, $0.23 a share. That's up from $0.21 in the prior quarter and $0.06 from a year ago. Our pre-provision pretax return on assets was over 2% again at 2.04% and in the top quartile of our peers. Our return on assets is approaching 1%, we're at 0.97%, and return on equity is approaching 10% at 9.25%. Core revenue of $306 million is up about 2% from a year ago. Core revenue is now, which is margin plus fee income, as a percentage of total assets, is up to 6.56%, which exceeds our base case and far exceeds our peers who are running around 4.25%. All the credit metrics continued to improve. Provision for credit losses were $24.6 million. That's down almost 75% from a year ago. And our provision for loan losses is now approaching 50 basis points of assets, which, again, is close to our base case. Non-accrual loans, a lot of numbers moved around there, but we had, on a real core basis, very significant improvement in non-accruals. They're $283 million. That's down 33% from a year ago. Delinquencies decreased $59 million. That's a 60% reduction from a year ago. Loan and lease originations increased by almost $600 million, almost 25% from the third quarter of 2012. Average deposits increased $750 million, almost 6% from a year ago. So all of our core businesses and core performances continue to improve. As I mentioned, the revenue is up almost 1.5% from the second quarter at $306 million. We saw some nice improvements in the fee income, particularly in our leasing. As we previously talked about, that number tends to be somewhat lumpy, growing and shrinking as a results in transactions that occurred during the quarter. A margin at 4.62% -- those of you who are listening to this regularly, remember that we talked about our margin probably zeroing in around 4.60%. We think it has zeroed in on there, and we think it's likely that it will stabilize close to that level. And net interest margin dollars are over $200 million. Impacting the margin in the quarter was a higher level of liquidity, higher than our goals. We're anticipating some of that liquidity to come down in the fourth quarter, which will be another contributor to improve margins. On Page 5 of the deck, we compare ourselves to our peers, and the peers are all U.S. publicly traded banks and thrifts between $10 billion and $50 billion. We're comparing to second number quarters because we don't have all the third quarter numbers, but it is a telling, very interesting data. Net -- these are percentage of total assets. Our net interest income is 4.38% versus 3.05%; our noninterest income, 2.18% versus 1.17%. And our core revenue, as I mentioned, is 6.56% versus 4.22%. Our core pretax pre-provision profit is over 2%, and that's -- compares to around 1.50% with our peers. That's a 30% higher core earning capacity, if you will, in terms of the bank, in terms of the way it sits today, than our average peer. I talked about the net interest margin. The -- and one of the reasons that we have superior performance is that the yield on our loans is higher, 5.30% versus 4.81%. Yield on our securities is higher. We don't have very many securities, but it's higher, 2.82% versus 2.44%. And the cost of our deposits is lower, 27 basis points versus 39 basis points. And as I mentioned, we only have 3.5% of our assets in securities. Loans and leases continue to be over 85% of our assets and funded primarily with core deposits. It's 75% -- 77% of total assets. We only have a bit less than 10% borrowing funding our growth. With that, I'll turn it over to Mike Jones who'll talk a little more about the details in credit.

[Michael Scott Jones:]

Thanks, Bill. Turning your attention to Slide 6. Credit quality continues to get better for the organization with another consecutive quarter of improvement, in our consumer real estate business, home values continue to improve or stabilize in the markets. With that said, a lot of the credit has to go to the personnel in our retail business, who day in and day out, are making decisions that improve the credit quality in that business. They have done a fantastic job, which has resulted in non-accrual and REOs decreasing $64.4 million year-over-year, and this is despite an increase of $48.6 million within the quarter related in the change in our accounting policy related to when we place loans on non-accrual. Consumer real estate loans are now placed on non-accrual at 90 days past due versus 150 days past due. There was an offsetting decrease in our over 60 days delinquencies. With that 60-day delinquencies, we're down 70.7% from the third quarter of 2012. Net charge-offs in this business decreased $5.5 million or 23% from the second quarter and reached its lowest level since the second quarter of 2008. Turning to Slide 7. Commercial had another great quarter driven by our special asset group working out problem loans. Non-accrual loans decreased $39.8 million from second quarter, and it's down $125.1 million from prior year. Our other platforms, leasing and equipment finance, auto finance and inventory finance, continue to perform, 60-day delinquencies at 7 basis points and 13 basis points of annualized charge-offs. These teams continue to outperform the market. Slide 8 shows the improvement over the last 5 quarters. The graph on the left depicts non-accrual loans and leases plus REO. We moved from a high of $542 million to the current levels of $348 million. If you back out the non-accrual accounting policy change from this number, the decrease would have been down to $300 million in non-accrual and other REO. The graph on the right shows both delinquency, which is a leading indicator in charge-offs, generating positive trends over the last 4 quarters. Turning to Slide 9, noninterest expense increased $3 million in the quarter driven by our investments in our growth businesses and our regulatory infrastructure. This was partially offset by lower foreclosed real estate expenses due to improved real estate property values. Over the last couple of years, we have worked very close with the regulators to improve our risk management processes in the bank, working towards best in class in these areas. While this has increased our cost base, we believe it will pay dividends in the future as it is a core structure that we can leverage as we grow. We look at expenses in our business due to our concentration in lending, as Bill alluded to, that 85% of our balance sheet is in loans and leases as a percentage of total average assets. This metric has improved over 2013. It's down 13 basis points to 4.64% as a percentage of total average assets. Again, our target for noninterest expense as a percentage of total average assets is 4%. This will be achieved over time as we grow our balance sheet, leveraging the current expense base along with the decline in foreclosure expenses. Additionally, we are actively looking at other expense reduction opportunities across the company that could positively impact earnings over the next 4 quarters. We're focused on activities that do not change our risk profile and do not impact the customer experience. There's more to come on this. I'll now turn the presentation over to Craig Dahl.

[Craig R. Dahl:]

Thank you, Mike. Slide 10 is a portrayal of our loan and lease portfolio split between wholesale and retail. And you can see we continue to run very close on a percentage basis with wholesale, now 52% of the portfolio, and retail, 48% of the portfolio. And we show year-to-date loan growth here despite $1.2 billion in loan sales. Turning now to Page 11, which is our loan and lease balance roll-forward. Once again, we're displaying solid origination growth, with leasing the only segment below last year's third quarter. In the center of the slide, our annual growth rate there after runoff is 12% prior to loan sales, which is very encouraging for the business line. And as Bill commented, our total lending growth is just around $600 million of origination in the quarter versus a year ago. Turning to Slide 12, loan and lease sales detail, which continues to be part of our core strategy. It's fairly well split here between consumer real estate and auto at right around $560 million each. That would be the year-to-date number. We will sell assets to a assist in managing our asset concentration, managing our geographic concentrations and to generate gains to help fund the infrastructure expansion of our growing businesses. And we have built an efficient sales capability here building off of our process and auto finance and continue to expand our syndication base. Turning to Slide 13, which is loan and lease yields. Again, we have a diverse lending mix, and we're staying competitive and focused within our niche lending business. I would point out that our inventory finance is coming off a seasonally low balance, which should increase in the fourth quarter. And our consumer portfolio continues to evolve, moving to more of a variable rate nature. On Page 14 is the impact of a rising rate environment. And we believe with our diversification strategy, we believe we will benefit in a rising rate environment. 75% of our assets are variable rate or short- and medium-duration fixed, and 73% of our deposits are low or no interest cost. You can see there on our funding side an average balance of $10.4 billion with an average cost of 7 basis points in the third quarter. And with that, I'll turn the presentation over to Tom Jasper.

[Thomas F. Jasper:]

Thank you, Craig. We turn to Page 15. TCF continues to generate and grow low-cost deposits through its retail distribution platform. Year-over-year, for the third quarter, deposits increased over $750 million. While the average cost of deposits for the third quarter of 2013 were 27 basis points, down 5 basis points from the previous year. TCF's deposit generation philosophy is to fund the growth in our loan and lease portfolio through deposit growth in various markets through selected channels with a diverse group of products. However, TCF is mindful of the cost of excessive balance sheet liquidity and the negative impact it can have on the net interest margin. You turn your attention to Page 16. TCF continues to experience lower transaction activity on a per account basis. Average transaction levels per account decreased about 1.7% from the third quarter of prior year, which is a driver for the 1.9% decrease in banking fee revenues over the same period. Banking fees increased 1.5% from the second quarter of 2013. Year-over-year, the number of checking accounts have increased 5.3%, and the average balance on checking accounts has increased 5.5%. Checking account attrition decreased 6.8% from the third quarter of 2012. Our team is focused on improving the customer experience for our deposit customers, and the team is making good progress in that regard. If you turn your attention to Page 17, the capital ratios from the second quarter to the third quarter have increased in all categories on this page. The company continues to have sufficient capital levels for its growth strategy, and we look for this trend to continue. With that, I'll turn the presentation back over to Bill Cooper.

[William A. Cooper:]

To summarize things, the -- we continue to have strong revenue. We have significant improvements in credit quality virtually in every metric, which we can expect to continue. Some of the areas, it can't get any better, frankly. The -- our revenue diversification strategy and asset diversification strategy is starting to prove itself. The -- we are positioned for rising rates, and one of these days, indeed, rates will rise. And we have significantly lower securities portfolio that -- where you have a mark-to-market risk as it relates to capital. And with what -- in the banking industry as a whole extending maturities in that portfolio, most of our asset generation is either very short-term or variable rate. And we're actually becoming more asset-sensitive as time goes on, which, by the way, has somewhat of a negative impact on the margin today, but we'll improve it in the future. And we have continued growth in our -- what has been so far high-quality lending businesses, some of which are relatively new and some of which aren't. Our leasing, equipment finance and inventory finance businesses -- we've been in leasing for 15 years. That has outperformed the industry for 15 years. Inventory finance, we're going in on 6 years now. Again, very high quality. Credit quality held up fine through the credit crunch, continues to operate fine. Nice growth. We expect to see more growth in the fourth quarter. And our new auto business is operating right on plan, particularly from a credit perspective. We're expanding our -- continue to expand that -- our capacity in that. We've been able to sell off certain categories of loans at gains, which has been very positive. And our strengthening deposit franchise, we're now growing checking accounts. The growth that has occurred in checking accounts in the last year or so is a reversal of a 3- or 4-year trend. We're fighting very significant regulatory changes that happened in that area with the Durbin Amendment, Reg E, et cetera, but -- and a weak economy still that has resulted in fewer transactions in consumer customers. We're making up that difference slowly with account growth and improving balance mix. So all in all, it was a pretty good quarter, and I remain optimistic. Looking out into the future, I think it's pretty clear that the business changes that we did as a result of the change in both the marketplace and the regulatory world are beginning to pay dividends, and I expect to see continuing improvements in subsequent quarters. And with that, I would open up to questions. Hello?

[Operator:]

[Operator Instructions] Your first question is from Jon Arfstrom from RBC Capital Markets.

[Jon G. Arfstrom:]

A question for you, Mike, on expenses. It seems like you guys are in a pretty good shape from a revenue outlook point of view. So the outlook probably comes down to expenses and provision, and you hinted at it a bit. But I guess, what can you do in terms of bending the curve on expense growth? And I guess the other related question is, how much is left in terms of business, kind of building the business pressure on expenses and also regulatory expense pressure?

[Michael Scott Jones:]

I'll kind of take those in the order that you kind of hit them from the standpoint -- I think as Bill alluded to probably in his last comment, I mean, the -- if you look at the fees that we generate throughout the branch network now versus historical levels, they're significantly down, and it significantly has impacted that network. So clearly, as we look forward into the future, we were looking at ways that we can make that branch network more efficient. So that's going to be clearly a focus for us as we move out into the future. And clearly, we want to do that in a prudent way that we don't impact the customer experience. And then I would say on the growth side, we still have a little ways to go in our auto finance business. I think we're very pleased on where inventory finance business has gotten to from a leverage standpoint. And that will continue to be accretive and positive from a leverage perspective as we roll into 2014 on those sides of the businesses. I would say on the regulatory front, we continue to make investments there. We're preparing ourselves for our first stress testing submission in the first quarter of '14. So we've made a lot of investments in there. And I think all of those investments will pay dividends in 2014 from a regulatory perspective and ones that I think will just continue to leverage that cost structure as we move forward.

[Jon G. Arfstrom:]

Okay. And I guess the other question I have is on the nonperforming consumer loans. You had a sale last quarter, and I guess now you have maybe even more of the book with your 90-day past dues with reserves against them. And you had the housing values rising in your markets. I guess the question is how aggressive can you be, do you want to be in terms of really cleaning out and moving out some of the consumer problem loans?

[William A. Cooper:]

Well, the consumer problem loans, first of all, those that are non-accrual, with the exception of the bankruptcy loans, kind of move through the system pretty quick after they get to a non-accrual status. Assuming they get that far, they go into foreclosure, we end up with the real estate owned, and we liquidate it. The improved credit quality in that portfolio will -- and is -- particularly is apparent in the higher -- in lower delinquencies, which is the leading edge of that. That will continue to improve. The non-accrual loans that we sold were these Chapter 7 bankruptcy loans, which are on a permanent non-accrual status, at least as it relates to the rules as they're presently situated. Depending on what happens with those rules, we may or may not liquidate some of those as well. The -- but I think the nonperforming assets numbers will continue to improve, albeit at a lower rate because they're at a lower level. But they will continue to improve simply through improved performance in all the areas.

[Operator:]

The next question is from Ken Zerbe from Morgan Stanley.

[Ken A. Zerbe:]

A question on expenses here. The -- obviously, you guys may have been investing in the new business lines. We're seeing that in the expense numbers. I just want to make sure that we're all kind of on the same page in terms of expectation because it seems like a lot of this investment, you've been doing and talking about for several quarters, but we're really not seeing a huge amount on the revenue generation side. At what point does this -- does the revenue or the asset generation start catching up to the investments that you're making in the business?

[Michael Scott Jones:]

I think it's over the next 15 to 18 months. I think that, that gets -- the auto finance business kind of gets to the level that we want it to be from an asset standpoint that we'll get clear leverage around that.

[William A. Cooper:]

A good example of that, we sit now with about $1 billion in the auto portfolio. Expectations are over that period, over the coming periods that, that could go to $2 billion. And the operating expenses in that division will not double. And that is an example of the benefits that we'll see out of these asset businesses that we've built over the last few years. And the -- as Tom mentioned or Mike, there has been a significant impact in our branch system, some of these regulatory changes, Durbin, Reg E, and so forth that have made -- are going to give us an increased focus in terms of how we manage that branch system. And there -- we believe there's significant potential for reduction in operating expenses in that area over the next year or so.

[Ken A. Zerbe:]

Okay. And then I just want to follow up, in the release, you had mentioned that you saw lower average checking account balances. Just given your focus on growing these accounts, is there anything structurally different about the types of customers or how you're getting new customers that would drive a lower average balance?

[Thomas F. Jasper:]

[indiscernible]

[William A. Cooper:]

Go ahead.

[Thomas F. Jasper:]

Ken, it's Tom Jasper. Actually, the -- on the year-over-year, the checking account average balances are up 5.5%.

[William A. Cooper:]

Are you talking per account or in total?

[Thomas F. Jasper:]

I'm talking in total. [indiscernible]

[Ken A. Zerbe:]

Understood. Sorry, but then per account is actually what I was asking about.

[Thomas F. Jasper:]

Okay. Well, there are some changes in the -- on a per account basis. When we went back to the free checking product, we did expect some of that to occur over time. So when we launched that in July of last year, from the product lineup standpoint, you are going to get some accounts that have a lower balance just with that as your lead product offering. So some of that is expected.

[William A. Cooper:]

And there is a seasonal impact. I mean, things come and go.

[Operator:]

Your next question is from Keith Murray from ISI.

[Keith Murray:]

Just a question on the net interest margin dynamic from here. If we think about Slide 13, the loan -- loan yields you show, where do you think the different categories can head? I mean, I know there's a lot of loan competition out there. And then conversely, on the deposit cost side, there -- it was up a couple of basis points this quarter. What's the near-term outlook there?

[William A. Cooper:]

Say, on the deposit side, there isn't much room there. Maybe it's at 27 basis points. It could go down to 25, up to -- et cetera. There just isn't much room, and there isn't much action in that area, period. And the same thing with our borrowing costs. The -- let -- so I remind you that we talked about a year ago that we've thought our margin would settle in around 4.60%. And it turns out those projections were pretty accurate. We've seen some pressure in the margin, as I mentioned, on the higher liquidity. We keep liquid assets out there, and we earn 25 basis points on it to the degree we bring that down to what our goals are for liquidity. That will improve the margin a little bit. But long and the short of it, what's going on there is that more than even the lower rates on origination, which is occurring because of competition, the higher -- the outflow of higher-yielding assets, particularly in the consumer residential area, is slowing. It's simply going away. There isn't as much -- there aren't as many 7% loans out there to run off as there were a year ago. And so that's slowing. And so the impact of the switch that's occurring through the overall level of lower interest rates is slowing. And the yield on our -- many of our categories, because of the mix, is changing. Craig, do you want to elaborate on that?

[Craig R. Dahl:]

Yes, this is Craig Dahl. I just want to add -- I mean, I'm not going to make a forecast of where yields are going to be in the fourth quarter, but I think it's safe to say, when you look at the asset classes, commercial actually increased in the quarter their yield. Leasing and equipment finance was flat to their yield, and inventory finance was up slightly on their yield. Those businesses are going to expected to perform in similar manners going forward. Our consumer real estate, I commented that we can -- we're still having amortization of higher-yielding fixed rates. And we continue to evolve to more of a variable rate nature that has a short-term impact, but we think that's better long term. And obviously, there's an impact of our auto finance, and we're watching the pricing, and that's really a market-driven yield. So that -- I guess that's what my summary would be.

[Thomas F. Jasper:]

This is -- can I just -- Tom Jasper. And the only thing I would add on the deposit side is that slight uptick comes with a growth in overall deposits. So your expectation should be we're going to grow the balance sheet, and we're going to fund it with deposits. It is going to come at a slightly higher cost and 2 basis point increase for a trade of $200 million growth in average deposits. You should expect just a nominal amount if we grow. If we're not going to grow deposits, and I would expect that, that average cost is going to remain flat to down.

[Keith Murray:]

Okay. And then just on the credit side, the change in the non-accrual policy on the consumer real estate, was that regulatory-driven? Why change this quarter? Just curious.

[William A. Cooper:]

We're primarily driven by -- there is, I think, a move in the marketplace. More and more companies are putting those at -- moving from 90 days. But analysis of that portfolio, we reserve those non-accruals from a interest perspective and so forth in any case. But an analysis showed that a higher and higher percentage, albeit a smaller dollar amount, but a higher and higher percentage of loans that reached that level eventually went into foreclosure. And so it used to be 50% or less, and it's grown. And so as that percentage increased, it makes sense that those things go on a non-accrual status faster because that's overwhelmingly where they're heading. So we think it's simply a better measure of what's happening given the changes that have happened in the portfolio as a whole. Mike, would you agree with that?

[Michael Scott Jones:]

Yes, that's correct.

[Operator:]

Your next question is from Steven Alexopoulos from JPMorgan.

[Steven A. Alexopoulos:]

Not to beat the dead horse on the margin, but when you say expect a stable NIM, do you mean flat or are you just looking for less pressure than we've seen in recent quarters?

[William A. Cooper:]

Not sure what the difference is. But I think as we said, we thought our margin would target in around 4.60%. We think it will target in around 4.60%, that's the best I can say. Things can change. The -- but everything being equal, we think it should hang in around that level.

[Steven A. Alexopoulos:]

Okay. And on the auto business, which I guess drove most of the loan growth in the quarter, at what yield was that business added approximately in 3Q?

[William A. Cooper:]

You can -- there has been a rate pressure in the loan portfolio. I don't have that number at hand. But as you can see from the chart in there, yields on the loan -- on the auto portfolio have come down, but they're still at a satisfactory level. And the margins in that business just aren't as good. We expect that might change going forward for us in particular. But I don't -- I can't tell you what the rate was on the new loans went in the last quarter. I just don't have that data in front of me.

[Michael Scott Jones:]

I think...

[Steven A. Alexopoulos:]

Okay. And just to follow up on the expenses, maybe I missed this, but why were comp expenses up $5 million quarter-over-quarter? Was that investment in new people, accrual for bonuses? What was that?

[Michael Scott Jones:]

It was...

[William A. Cooper:]

We could hope.

[Michael Scott Jones:]

Driven by a couple of things. One, it's growth in our new businesses. Also, as you looked at the fee income as well, that was up specifically in our leasing businesses. So there was production-related commissions associated with those fee generations that increased on a quarter-over-quarter basis as well.

[Operator:]

Your next question is from Steve Scinicariello.

[Stephen Scinicariello:]

Just a quick one for you. I know you mentioned the seasonality should positively impact the inventory finance in the fourth quarter. Was just kind of curious on the leasing and equipment finance side. Any seasonality to look out for in terms of the fourth quarter and beyond on that front?

[Craig R. Dahl:]

This is Craig Dahl. Yes, we do typically have -- from an origination standpoint, our fourth quarter is our largest quarter in the year. So we would be optimistic on that level as well.

[William A. Cooper:]

One of the things that I'll mention on the equipment finance area -- I saw some data the other day. That business is also economy-driven to some degree. And our origination and growth is better than the industry average. I mean, we are gaining market share.

[Stephen Scinicariello:]

Got it. And then in terms of the leasing fees, which I know can really move around, like you said, by kind of customer-driven type events. But I'm just kind of curious, from what you've seen there, maybe get some color and some examples of what those events may have been and maybe the outlook for -- if those types of things could continue going forward.

[Craig R. Dahl:]

I mean, we have talked for a long period of time that these are customer-driven events. So that's usually where a customer is making a change in their platform in the middle near the -- or near the end of a lease where they are going to continue to lease or they may be ending the lease. And so there really isn't anything I can give you that would be a good indication of what's going to happen. But that is part of our business, and we have tried to talk about that. We've seen the average be more like in the $23 million, $24 million range. And I think when you look back in the quarters, that average is -- continues to be a good one. We've had an outlier low in the first quarter of this year. We have an outlier high in the third quarter this year. But on average, it's still performing within expectations.

[Operator:]

The next question is from Nicholas Karzon from Crédit Suisse.

[Nicholas Karzon:]

I guess starting off on the auto loan portfolio again, can you give us a little bit more color on the average credit quality, I guess the FICO score of the new loan production and then also the mix between used and new in the quarter?

[Craig R. Dahl:]

The origination -- remember, our held-for-investment portfolio is impacted by the credit quality of the loans and the yields on the loans that we sell as well. So in our book, I think, our originations are right around 708 on average. But on our retained book, it's closer to 770.

[Nicholas Karzon:]

And then the mix between new and used?

[Craig R. Dahl:]

Oh, yes. It's roughly 80% used at this point

[Nicholas Karzon:]

Got it. And then as a follow-up, we're starting to see a little bit of a kind of capital build, and wondering how you're thinking about the potential for a dividend increase, buyback or potentially thinking about M&A opportunities?

[William A. Cooper:]

That's really 3 questions, and those are 3 pretty big questions, in particular the last one. The -- a dividend increase at TCF would occur when we're generating or accumulating capital at a faster rate than asset growth or risk profile would dictate that we keep capital. We're -- as I mentioned, our return on equity is now up, getting close to 10%, and we are growing capital. And we're one of the fastest-growing capital growers in the banking business if we compare to our peers. And so that's an evaluation our board does periodically. I would say that it's more likely that we would, in the future, increase the dividend than buy the stock back. We had been, in the past, a big buyer of stock. I think from our shareholders' perspective and the stock price perspective and trying to represent our shareholders in the best way possible that I think we would get a better bang for our buck of an increased dividend than we were with a stock buyback. The M&A world, we continue to always look at what's out there. And we have focused on, over the last couple of years, building our businesses. And I think as this quarter demonstrates, we're seeing the payoff from that. And we have had less focus on M&A work, which, in my opinion, on about -- it's only about 50% an M&A ever works per se. But we do evaluate that. There may be some opportunities come up in the future. There's probably more sellers out there in the world than there are buyers. It would have to be what is we would judge to be a very attractive situation before we would enter that business because our businesses are growing. And if you look at our capacity, we can grow our deposits a lot -- within our present system. And we can grow our loans a lot within our present system and lever our existing overhead without taking on unknown risks. Or at least we hope we're not taking on unknown risks. So I would say that that's less likely, but I wouldn't rule it out. And someday, there probably will be some kind of transaction. And it's also very -- more likely, and which is what we've done in the past with Gateway in the equipment finance area and so forth. That we'll find a line of business to acquire as opposed to a -- as a bank acquisition per se.

[Craig R. Dahl:]

Yes, this is Craig Dahl. I didn't -- I want to issue just a correction on the FICO of our retained portfolio. While our origination is the 708, our retained portfolio, the FICO is about 723. So -- and want -- just want to make a correction on that.

[Operator:]

Your next question is from Bob Ramsey from FBR.

[Bob Ramsey:]

I wanted to ask a question about provision. I mean, you guys have obviously had pretty meaningful improvement over the last year in a number of credit metrics. I know you've talked about getting net charge-offs to or below sort of 50 basis point level. Is that a good way to think about provision on a go-forward basis, as that it should be 50-ish basis points depending on credit trends?

[William A. Cooper:]

Tom mentioned, if you look at TCF's history, we just -- Jim Costa, our new Chief Risk Officer, did a little study. It was pretty interesting. If you go back to 2003, TCF's charge-offs have been on average 40% lower than banks over $10 billion. The -- and it's only in recent quarters that those things have kind of emerged where the rest of the industry has kind of merged in closer to TCF. The -- our base case shows a provision level of about 50 basis points. That is significantly higher than we have averaged over the life of our bank, where our charge-offs and credit quality has been significantly better. Many of our credit areas have had and continue to have very good credit quality, particularly those that are growing the fastest. Credit at TCF, it really revolved -- problems revolved around, to a large degree, what happened in the residential world. But our -- and TCF has not, as many banks have, scooped out its reserves either. The improvements in our provisions have been as a result of lower charge-offs, overwhelmingly. The -- and a -- so we -- as I mentioned, our base case is -- which is in our investor presentation, our base case is revenue at $650 million, the provision at 50 basis points and operating expenses at 4%, which gets us in something over $120 million [ph] return on assets. And right now, I don't know anything -- that's still our base case, and that's the direction that we're heading.

[Bob Ramsey:]

Okay, great. That's helpful. I wanted to ask you. We talked about auto a few different ways. I know you said that you see that potentially as a $2 billion portfolio. How do you go about sizing that? Is it a target percent of the loan mix? Is it a target percent of capital? Or how do you think about where you draw the concentration limits?

[William A. Cooper:]

Well, concentration limit business is a -- now today, a hot button and a very significant part of our risk control, how we engage in that. It's interesting, a lot of people look at the stress testing that's going on and go, why do we have to screw around with that? The stress testing has had a -- has a value to the industry in connection with, what happens when things go to s***, okay, and in what category? And the -- and so where our -- these are a lot of judgments and a lot of wonk and analysis that goes into these things. But they do generate good valuable data. And that helps us in connection with, gee, how much do we want to have in a particular category? And one of the real truisms of the banking business is one of the reasons why we've expanded, for instance, in the auto business and inventory finance and capital funding, et cetera. One of the truisms is that you're better off if you don't have too much of anything. And $2 billion in our auto portfolio would still be a relatively small concentration in terms of our assets. But it is something that we study and we review with our board, we review with our risk committee. And a lot of analytics go in, and it's a part of the stress testing of the bank in connection with how we go forward. So there's just a lot of work that goes into it. I know this is a long explanation, but it is an important aspect of the banking business. And I think a really good example of that is we -- years ago, TCF had 80% or 90% of its assets in residential. Now when the crisis hit, we had over 50%. We now have maybe less than 40% or around 40%. The -- we would like -- that used to be the safest category. And all the analysis in the world would show you that it was going to continue to be the safest category. Well it turns out it wasn't. And the reason that it hurt us more than it did others, we had more of it. And so having a diversification of asset categories is one of our goals. And the big benefit that we've had through the reinvention of our business, we used to basically have residential loans and commercial real estate. Now we have residential loans, various categories of residential loans, various categories of commercial real estate, auto business, the equipment finance business, the inventory finance business, capital funding, et cetera, that has brought much more diversity and reduction in concentration into our balance sheet as a whole.

[Bob Ramsey:]

Okay. And -- okay, okay, that's helpful on auto. I guess I'll shift direction once again and ask one last question. I know you all have been asked a lot about margin. You've been pretty clear you're going to be somewhere around 4.60%. Maybe the better question is how are you thinking about net interest income as you take out some of the volatility of money going in and out of fed funds and so forth? Can net interest income grow from this quarter's level if margin is more or less stable and you continue to have loan growth?

[William A. Cooper:]

Well, if you keep your margins stable and grow your assets, your net interest income grows. That's very simple.

[Operator:]

Your next question is from Chris McGratty from KBW.

[Christopher McGratty:]

Mike or Bill, on the expense discussion, in the past, you've talked about a 4%. Do the actions you guys are talking about potentially with the branch network, does that make 4% a reality or a possibility at some point next year?

[William A. Cooper:]

I think I -- speaking very frankly on it, I think it's unlikely we'll get there next year. But we can make significant progress. A big portion of that reduction in the expense rate, okay, is the leveraging of it, and that leveraging takes time. And so we have to grow the assets, and we have to grow the deposits around that expense base. And that takes a while. Now that -- as we've talked about before, it can come from 2 ways

[Michael Scott Jones:]

Chris, this is Mike Jones. The other thing that I would add, I mean, we are laser-focused on improving the customer experience throughout our network. So -- and for us, in order for us to do that, we got to look at efficiency more with a scalpel versus a chopping block. So that's going to take some time, and we're going to do it with precision. And we're going to do it in ways that we can take away activities that don't add value to that customer experience.

[Christopher McGratty:]

Okay. And maybe a follow-up. In the context of your loan-to-deposit ratio, can you talk about if the decision is to shut some branches, how you would work on customer retention to make sure there's not upward pressure on loan deposits?

[William A. Cooper:]

Well, first of all, we didn't talk about cutting branches or closing branches. We haven't talked about that. But -- and in general, if you -- if we did, it would be branches without very many deposits. That's why we'd close it, if you follow me. So -- and within our -- we have got 400 branches. Within our footprint, as we've mentioned, when we put our foot to the pedal, we can raise money, as we've shown in the past. And we have a lot of capacity to do that. So -- and particularly in a lot of our markets, if you close a branch, we end up keeping most of the deposits anyway because people simply go somewhere else. So we take out the overhead, and we keep the deposits. So, Tom, did you want to add anything to that?

[Thomas F. Jasper:]

No, I was just going to echo your comment, Bill, around that we analyze the potential growth in the balance sheet from a loan and lease perspective and look at our capacity to fund that with core deposits in various types of environments in the individual markets, et cetera, and feel very good about our capacity -- our current capacity levels to really meet an exceptional amount of loan growth going forward through the branch system.

[Christopher McGratty:]

Okay, just one follow-up on Durbin. Obviously, it's been in the news for the last few months. Can you remind us what the incremental hit would be if we do get another regulatory bomb, if you will?

[William A. Cooper:]

Well, if that lawsuit stood, it would be something in excess of another $20 million reduction in revenue.

[Christopher McGratty:]

That's an annual number, right?

[William A. Cooper:]

Yes.

[Operator:]

Your next question is from Emlen Harmon from Jefferies.

[Emlen B. Harmon:]

It looks like the spreads on the auto sales are tightening somewhat. Then obviously, an effect of some of the rates on auto coming in. Are there others factors at play there? Or is that exclusively it? I'm just hoping you can give us a little color around kind of what you're seeing on the spreads there?

[Michael Scott Jones:]

This is Mike Jones. That has -- that comes into play. As well, the other thing that we're seeing in that portfolio and in the industry is just a pickup in prepayments, which naturally would impact the gain calculation as well.

[William A. Cooper:]

Which, by the way, worse things could happen, than people paying you too soon.

[Emlen B. Harmon:]

Okay, got you. And then just one quick one. A -- some -- a number of dealers of the dealer footprint within the auto business is -- could you give us -- just maybe quantify just kind of what the growth has been in that the last couple of quarters?

[William A. Cooper:]

All right, Craig's just looking that up.

[Emlen B. Harmon:]

Sure.

[Craig R. Dahl:]

Yes. I've got that number here in front of me. So in March time framework, let me just give you a basis. As of December, we had about 6,000 dealers, active dealers in our network, and today, we have about 8,000.

[Operator:]

Your final question comes from Andrew Marquardt from Evercore Partners.

[Andrew Marquardt:]

Just in terms of the balance sheet and the loan growth, how should we think about it going forward? I guess maybe the best way is maybe x sales -- it was helpful in your Slide, I think, 11, where you talked about maybe recently, it's been high single-, low double-digit year-over-year. Is that pace the right way to think about it x sales or should be maybe mid- to upper single-digit?

[Craig R. Dahl:]

This is Craig Dahl. I think that's the best way to look at it, is that subtotal of volume less runoff because that can be heavily influenced by that inventory finance number, which has much faster turnover than the other asset categories. But I think it's -- we don't necessarily manage it in total. We're managing it based on the opportunities within those specific niches, and we're going to continue to be focused there. We do not believe that we want to be a generic competitor in these categories. We want to be specifically focused. And so I think that, that is the way to look at our business model.

[William A. Cooper:]

One other thing I'll add on that is, we've mentioned earlier, we sell these loans for a couple of reasons. One is to mitigate risk as we see it in terms of a regular old credit risk and also geographic concentration risk, which as we've measured it. And the -- our analytics on that continue to improve. And as you mentioned, if the spreads on the gain on sale get smaller, the risk-adjusted return of keeping some loans versus selling them changes. And so the -- we are constantly evaluating what level of loan sales that we would like to have versus what level that we would put in the balance sheet. The tradeoffs are obviously, you don't get the gain unless you do get the margin over a longer period of time, you do leverage the balance sheet and use up capital and take risk, et cetera, but -- and I'm not dropping a shoe here or whatever. I'm just telling you that what -- the percentages that we're selling today and what we're selling, as we continue to do analytics and improve our optics on that stuff, could change in the future and, matter of fact, likely will.

[Emlen B. Harmon:]

Perhaps to more retention, is that what you're kind of implying?

[William A. Cooper:]

Yes, or retention of some things and sale of others, whatever.

[Emlen B. Harmon:]

Got it. That's helpful. And then separately, in terms of expenses, just want to make sure I understood, are you saying that with maybe more focus on expenses maybe over the next year, that we should anticipate the absolute level of the expense base from maybe third quarter level to come down? Or the rate of expense growth would be slower? How should we think about it?

[Michael Scott Jones:]

I think it's a little bit of both, and I know that that's not a great answer for you. But clearly, what our objective would be, would be to find opportunities to potentially keep the expenses at the level and start leveraging that more as we grow the assets. However, we still have some investments to do in our growth businesses, particularly auto finance, over the next several quarters. So that would be the objective.

[Emlen B. Harmon:]

Got it. And then just lastly, any updates in terms of the status of the OCC consent order? Is that closer to the end now? It's been a while. And does that free you up in terms of once that is lifted to be more opportunistic in terms of looking at businesses, as you were saying, or otherwise?

[William A. Cooper:]

We're optimistic as it -- we're at the end of that tunnel, not at the beginning, I guess is the best way to say it. The -- we have made huge progress in our BSA operations. We are now complimented big-time by law enforcement agencies and so forth in terms of the sophistication of the way that we're identifying criminal activity and potential terrorist activity and so forth. And like I say, we've made huge progress in it. In some ways, we were lucky, which I already said. It's easier to say that in retrospect. We were lucky that we were required to address these things earlier than other banks. Many other banks are at the beginning of this tunnel, and we believe we're at the end. I think we have the potential of exiting it, and I don't want to make any predictions of when that's going to happen, but we're hopeful it will be soon. But the potential of exiting that while others are in it would be good news for us.

[Operator:]

There are no further questions. I would now like to turn the call back over to Mr. Cooper for any closing remarks.

[William A. Cooper:]

Well, I'd like to thank you, all, for your questions. I think we had a pretty good quarter, and I think it really is starting to become apparent that our strategies that we've developed over the last couple of years are really starting to pay off. With that, thank you, and you all have a good day.

[Operator:]

Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.