WINTRUST FINANCIAL CORP quarterly report, Q2 FY2012

Wintrust Financial Corporation — Q2 2012 Form 10-Q

Business context and reporting period

Wintrust is a financial holding company focused on community banking in the Chicago metropolitan area and southeastern Wisconsin, with national and Canadian specialty-finance operations and wealth management. This unaudited quarterly report covers the three and six months ended June 30, 2012; balance-sheet comparisons are principally with December 31, 2011 and June 30, 2011.

Financial performance and position

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Net interest income	$128.3 million	$108.7 million	$254.2 million	$218.3 million
Non-interest income	$50.9 million	$36.7 million	$98.0 million	$77.5 million
Non-interest expense	$117.2 million	$97.2 million	$234.9 million	$195.3 million
Provision for credit losses	$20.7 million	$29.2 million	$38.1 million	$54.5 million
Net income	$25.6 million	$11.8 million	$48.8 million	$28.2 million
Diluted earnings per common share	$0.52	$0.25	$1.02	$0.60
Net interest margin, fully taxable-equivalent	3.51%	3.40%	3.53%	3.44%

Net revenue, defined as net interest income plus non-interest income, was $179.2 million for Q2, up 23%; first-half net revenue was $352.1 million, up 19%.
Q2 return on average assets was 0.63% and return on average common equity was 6.08%. The reported adjusted pre-tax earnings measure was $68.8 million for Q2 and $132.5 million for the first half; this non-GAAP measure excludes credit-loss provision and specified items.
At June 30, total assets were $16.58 billion, total loans including covered loans were $11.82 billion, deposits were $13.06 billion, and shareholders’ equity was $1.72 billion. Versus June 30, 2011, assets rose 13%, loans excluding covered loans rose 13%, and deposits rose 16%.
Cash and cash equivalents were $191.8 million; interest-bearing deposits with banks were $1.12 billion, including $659.0 million restricted for securitization investors. Management reported over $1.3 billion in overnight liquid funds and interest-bearing bank deposits.
For the first half, operating cash flow was negative $180.6 million, investing cash flow was negative $257.2 million, and financing cash flow was positive $459.8 million. Cash and cash equivalents increased $22.1 million to $191.8 million. Mortgage-loan originations and purchases, net of sale proceeds, were a major operating-cash-flow use.
Loans excluding covered loans were $11.20 billion, up from $10.52 billion at year-end 2011. Commercial real estate accounted for 31% of the total loan portfolio; 91.4% of those loans were in Illinois and Wisconsin.
Total deposits were $13.06 billion; non-interest-bearing deposits were $2.05 billion, or 16%. Brokered deposits were $870.6 million, or 6.7% of deposits.
Reported notes payable, FHLB advances, other borrowings, securitization borrowings and subordinated notes totaled $1.32 billion; junior subordinated debentures were a further $249.5 million. Securitization borrowings fell to $360.8 million after the company repurchased $239.2 million of notes during the first half. The company reported compliance with debt covenants.
Regulatory capital ratios at June 30 were 10.2% leverage, 12.2% Tier 1 risk-based capital and 13.4% total risk-based capital. The company reported tangible common equity of 7.4%, or 8.4% assuming full conversion of preferred stock.

Material changes versus comparable periods

Q2 net income increased 118% year over year, driven by higher net interest income, mortgage-banking and wealth-management revenue, and lower credit-loss provision. First-half net income increased 73%.
Q2 net interest income rose 18%, reflecting higher average earning assets and lower funding costs. The fully taxable-equivalent margin rose 11 basis points year over year, but declined 4 basis points sequentially from Q1 2012 to 3.51%.
Q2 non-interest income rose 39%, chiefly as mortgage-banking revenue doubled to $25.6 million and wealth-management revenue increased 26%. Mortgage loans sold were $853.6 million, versus $458.5 million a year earlier.
Q2 non-interest expense rose 21%; salaries and benefits increased 28%, reflecting acquisition-related staffing, business growth, and higher bonuses and commissions. First-half expense rose 20%.
Non-performing loans excluding covered loans were $120.9 million, or 1.08% of loans, compared with $156.1 million, or 1.57%, a year earlier. Net charge-offs were $17.4 million for Q2, versus $26.0 million. However, non-performing loans rose from $113.6 million at March 31, 2012, partly due to one $13 million commercial relationship.
The allowance for loan losses excluding covered loans was $111.9 million, or 1.00% of loans, versus $117.4 million and 1.18% a year earlier. Covered-loan allowance was $20.6 million, up from $7.4 million a year earlier; the FDIC loss-sharing arrangements reimburse 80% of qualifying losses, subject to their terms.
Other real estate owned was $72.6 million, down from $82.8 million a year earlier. Restructured loans totaled $172.3 million, including $156.6 million accruing; this was up from $103.0 million a year earlier.

Outlook, management commentary, risks and unusual items

Management described continued loan growth, stable credit measures and a favorable shift toward lower-cost deposits. It said it would continue disciplined lending and seek opportunities created by market dislocation and other institutions’ reduced lending activity. No specific earnings or financial guidance was provided.
Management cited stressed economic conditions and depressed real-estate values as ongoing concerns, particularly for commercial real estate and construction-related credits. Further deterioration could increase defaults, foreclosures, credit provisions and asset-value losses.
Key risks include interest-rate and funding-market changes, commercial real-estate concentration, borrower and counterparty credit risk, premium-finance fraud or delinquencies, FDIC loss-share compliance and estimates, mortgage repurchase or indemnification claims, acquisition integration, and regulatory changes.
Q2 included a $928,000 net trading loss; first-half bargain-purchase gain was $785,000, compared with $10.6 million in the first half of 2011. Management’s adjusted earnings exclude provision for credit losses and specified items, so this measure is not directly comparable to GAAP income.
The company issued $126.5 million of Series C preferred stock in March 2012, with a 5% non-cumulative dividend rate and conversion feature. It acquired Charter National, a Canadian premium-finance business, a bank branch and trust operations during 2012; acquisition activity increased goodwill by $25.4 million in the first half.
Management changed the general-reserve historical loss-rate analysis from a five-year average to a three-year average, citing greater relevance to current portfolio conditions. The company said the qualitative annual goodwill impairment assessment found no impairment at June 30.
A July 20, 2012 subsequent event: a subsidiary assumed substantially all non-brokered deposits and banking operations of Second Federal Savings and Loan Association of Chicago, which had $175.9 million in deposits at March 31, 2012.
In June 2012, banking agencies proposed revised capital rules incorporating Basel III and Dodd-Frank provisions, including changes to capital composition and risk-weighted assets. The company warned that materially higher capital requirements could affect returns, financial condition and business opportunities; final rules and their timing were uncertain.

Important facts for investors to verify

Whether loan growth is sustained by organic originations and underwriting quality, and whether commercial real-estate and construction credit performance continues to improve.
How non-performing loans, net charge-offs, restructured loans, OREO and the allowance evolve, including the adequacy of reserves after the historical loss-rate methodology change.
Whether mortgage-banking gains and volumes remain durable in changing interest-rate and refinancing conditions, and whether repurchase or indemnification exposure changes.
How acquisition integration, goodwill, Canadian premium-finance growth and FDIC loss-share asset estimates affect earnings and capital.
The impact of proposed capital rules, preferred-stock conversion or dividend terms, and the company’s capital and liquidity capacity under adverse conditions.
Why first-half operating cash flow was negative despite higher net income, and whether mortgage production, loan growth and funding needs remain manageable.