Old Second Bancorp Inc (OSBC) 2011 Q1 法說會逐字稿

Greetings and welcome to Old Second Bancorp's first quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation.

(Operator instructions.)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Doug Cheatham, Executive Vice President and CFO for Old Second Bancorp. Sir, you may begin.

Thank you. Good morning everyone and thank you for joining us. I will start with a reminder that our comments today may contain forward-looking statements which are based on management's existing expectations in the current economic environment. These statements are not a guarantee of future performance, and results may differ materially from those projected. I ask you to refer to our SEC filings for a full discussion of the Company's risk factors.

With me this morning are Bill Scoglund, President, Chairman and CEO of Old Second Bancorp, and Jim Eccher, President and CEO of Old Second Bank and Chief Operating Officer of Old Second Bancorp. Now, I'll turn it over to Bill to get things started.

Good morning, and thank you for joining us. I wanted to go over a few highlights, and then I'll turn it back over to Doug for some more financial information and then to Jim for basically more loan information.

This quarter, we are seeing positive improvement in a number of key areas. First profitability -- although we're still working towards profitability, we're not quite there yet. We saw good improvement from both a year ago and from the year end. On the regulatory capital front at the bank level, we are seeing improvement in both of the key two ratios we follow the most. Total capital as of 3/31 was 11.97%, and that's up 24 basis points from the year end, and it's up a 124 basis points from June 30th of 2010. Our leverage ratio of 3/31 was 8.63%, which was up 53 basis points from 12/31 and up 87 basis points from June 30th. As we previously reported, we have an agreement with our regulators for higher capital levels, 11.25% total, which we exceed, and 8.75% leverage, which we're 12 basis points below now. We think we have a good chance to meet the list leverage ratio in the second quarter.

We saw good reductions in our nonperforming loans and assets. Nonperforming loans as of 3/31 was $193.0 million. That's still high, but it was down $36.0 million from 12/31 or almost 16%, and it's down $50.0 million from June 30th. Our strategy to get the property to OREO for disposition seems to be working. Our OREO numbers were up to $85.0 million. That's up from $76.0 million from the year end, and we're continuing to see in-flow into that area. We see that as a good thing, as it's a step closer to disposal. Our non-performing assets were $279.0 million, down $29.0 million from 12/31. Our loan loss reserve was $73.0 million which is 4.57% of loans and 38% of nonperforming loans. In the first quarter, we did sell one of our construction and development loans for $10.0 million, which was around 90% of the original balance.

And lastly, liquidity is still good. We're selling about $130.0 million in fed funds, no borrowings from the Fed or Federal Home Loan Bank. Really, almost all of our deposits are now core, very little in the way of any brokered deposits or noncore deposits, and actually our noninterest bearing deposits were up substantially in the quarter.

Overall, I'm cautiously optimistic. The economy is slowly improving. I think we're pretty much through the construction and development cycle. We're seeing many types of commercial real estate values starting to stabilize, and there are definitely more buyers for the OREO property than we've seen in the past few years. We also have less new problem loans developing, as evidenced by our 30 to 89 past due loans, which were the lowest since 2008. We are still, though, in the capital preservation strategy. We know we still have a lot of work to do, but with improving regulatory ratios at the bank, we feel we have time to work through our remaining issues, and we're hopeful to get back to profitability and growth later this year.

So with that, I'll turn it over to Doug, and he can go over some of the financial details.

Okay. Thanks, Bill. As we reported late yesterday, the net loss narrowed to $3.1 million in the first quarter and $4.3 million after preferred dividends. This compares to losses after preferred dividends of $77.8 million in the fourth quarter of 2010. The fourth quarter, though, included a nearly $70.0 million valuation allowance on the deferred tax assets. To keep it on a comparative basis, the pre-tax loss narrowed by $8.5 million from the fourth quarter to the first quarter. The primary difference, of course, is the provision for loan losses. The provision was $4.0 million this quarter compared to $19.2 million a year ago and $14.0 million in the fourth quarter of 2010. The net interest margin was 342 compared to 355 in the fourth quarter.

In the first quarter we held excess liquidity for much of the quarter, as we balanced the need to continue deleveraging with the need to maintain strong liquidity. This means, basically, that overnight funds were up, and the size and average yield of the bond portfolio were down. Total assets did not decline as much as in recent quarters, but as we continue to push the deleveraging strategy, this was the most prudent way to manage the balance sheet and to prepare for further progress in that direction. It's better to let loan reductions get ahead of deposit reductions than the other way around in order to maintain liquidity.

Noninterest income was $9.3 million in the first quarter. This was down $1.9 million from the fourth quarter but up $1.0 million from the first quarter of last year. The biggest difference across these periods is the fluctuations in mortgage banking income, which was very strong in the second half of last year. The first quarter of 2011, mortgage banking income was a little better than the previous first quarter. In comparing noninterest expenses, most major categories were down. The largest expense, salaries and benefits, was $8.9 million, down about $800,000 from last quarter. The items that were up were FDIC insurance and general bank insurance, which are difficult to influence in the short run. Other real estate expenses were down from the fourth quarter as well to $5.3 million from $7.8 million.

And regarding capital, as Bill mentioned, we're focusing on the bank-level ratios. At the consolidated level, tangible common equity was 0.22%. The regulatory ratios at the bank level increased during the quarter, and this is where our focus is right now. As Bill mentioned, the total capital ratio was 11.97%, well above the 11.25% that the OCC has called for. The leverage ratio was 864, up 54 basis points from year end and just 11 basis points below the OCC target. So we're very positive about the direction of capital at the bank level.

So that's a summary of the results for the quarter, and now, I'll turn it over to Jim.

Thank you, Doug. The lending climate in the western suburbs of our market continues to be fairly subdued. Strong credits are still commanding very competitive pricing, and, while overall loan demand remains relatively weak, we are seeing some signs of activity beginning to emerge in our core markets. We remain in a balance sheet contraction mode, as our efforts to change our loan mix has been successful. As we focus on capital preservation, loan growth has not been a priority for us the pass few quarters. We continue to focus internally to reduce exposure to construction and development and commercial real estate, and we've made some significant progress over the last several quarters in this area. Our main focus continues to be in credit remediation and disposition of OREO while accelerating the in-flow into OREO. We've controlled adverse loan migration in the quarter through strong portfolio management and extensive loan review. The first quarter was our most successful to date in terms of disposing nonperforming assets and reducing nonaccrual loans.

Credit quality in the first quarter showed improved results in several areas. Nonperforming loans, classified assets, and early-stage delinquencies all declined in the quarter. Total nonperforming loans declined $36.0 million or 15% in the quarter. OREO dispositions totaled nearly $12.0 million, while in-flow increased $22.0 million, resulting in a net increase of about $10.0 million in the quarter to $86.0 million. Current properties under contract for sale in the OREO portfolio increased for the second consecutive quarter, and we view this as a positive indicator, as it brings these assets one step closer to disposal. As Doug mentioned, our provision for the quarter of $4.0 million was down $10.0 million from the fourth quarter, as asset quality showed signs of stabilization. Nonperforming commercial real estate loans declined 14% in the quarter and represents the first time during this economic cycle that non-performing commercial real estate loans have declined. Substandard commercial real estate loans also declined for the first time, and our various credit remediation efforts were successful.

We were also successful in executing a significant loan sale for one relationship in the quarter without taking a material discount. Our watch list edged higher in the quarter but is still down 63% from a year ago. The quarterly increase was due mostly to internal upgrades, as the operating performance for some of our borrowers improved in the quarter. Our accruing 30-to-89-day past due loans totaled only $12.0 million in the quarter and declined for the second consecutive quarter, giving us optimism that early-stage delinquencies have finally moderated.

Now, let's take a look at the portfolio one type at a time. First, on the construction loan front, our construction and development portfolio continues to wind through the cycle, and we feel the worst is behind us in this part of the portfolio. The construction and development portfolio is now down to $105.0 million, which is now down almost 80% from the peak in the third quarter of 2008 when that segment was over $500.0 million. Of that $105.0 million, $54.0 million is nonperforming and $9.0 million rated substandard. Nonperforming construction loans declined 18% from the prior quarter due mostly to OREO migration and disposition.

We continue to see some modest increases in opportunities to sell these assets, and we're seeing fewer and fewer homebuilder credits in the mix. On the valuation side, we are still seeing a few construction and development appraisals with valuation declines mostly in the retail lot segment. Many of our construction development properties are declining at a much slower rate, as heavy discounts were applied in prior periods. Our watch list construction loans are also down in the quarter, and we haven't seen any new migration in this segment. Losses were minimal for the first time in this quarter in this segment, and we've made good progress reducing our exposure in this portfolio, and all indicators point that 2011 construction losses will be significantly lower than 2010.

Most of the commercial real estate stress still remains in our retail category, mainly strip malls and special purpose real estate, where the net operating income in these properties is diminished due to economic conditions in our market. And while the retail category represents only 5% of the entire loan portfolio, it does represent about 28% of our non-performers in the commercial real estate segment. There were some positive developments in this category, as several large credits migrated into OREO while others are in various stages of contract or sale negotiations. In addition, we feel significant portions of this portfolio will be repositioned as underlying cash flows will provide opportunities for restructuring rather than liquidation.

Looking at the high stress segment of the commercial real estate portfolio, the retail nonperforming category trend declined in the quarter and charge-offs were minimal. Most of our nonperformers in the retail strip category are in properties that are 75%-plus leased or more, which should produce some opportunities for restructuring. The owner-occupied special purpose category is the other area of elevated risk, but the nonperforming trend declined in the quarter and is showing more signs of stability from the prior quarter.

Beyond commercial real estate and construction and development, we do have 1-to-4-family residential make up the next largest share of our nonperformers. The local housing market remains challenging in our markets, and we do have about 16% of the portfolio in 1-to-4 family. Non-performers declined in this category for the second straight quarter, and losses still remain a very low percentage of the portfolio and a modest percentage of our total charge-offs. We feel this trend will continue.

Our C&I exposure remains relatively low and represents only 8% of the portfolio, and our losses and nonperforming totals within that portfolio remain very small. Only $3.0 million in this category is nonperforming, and no losses were recognized in the segment in this quarter. So our credit metrics really in this portfolio remain very solid, and we do not anticipate large losses in C&I.

At this point, I'll turn it back over to our moderator, and we can certainly address any questions that you may have.

Thank you, gentlemen. We will now be conducting a question-and-answer session.

(Operator instructions.)

Our first question is coming from Stephen Geyen of Stifel Nicolaus.

Thank you. Good morning, guys. Maybe just a couple of questions. You mentioned the sale this quarter. Just curious if there are some potential additions -- additional sales that you see out there? Actually, you did mention some. Just curious if those might be coming in commercial real estate or C&D, or where do you see the benefit to really reduce the nonaccruals and OREO through sales?

Yes. Thanks, Stephen. This is Jim Eccher. We were successful in executing a pretty significant sale in the quarter through our internal special assets group. Because of our capital position, we're not in a position to really execute a bulk loan sale, but we are continuing to see more brisk activity on the investor and speculator side. I think we feel pretty confident that we have more opportunities mostly on the commercial real estate side to execute more meaningful sales. We do see increased activity on the construction and development side, but those generally tend to be smaller transactions. But clearly, activity has picked up really along all segments.

Okay. And last question, you mentioned that nonaccurals in commercial real estate and that a fair number or percentage are better than 75% leased. Is that kind of the point where it makes sense to look at restructuring and split it into an AB note?

Exactly. I think -- we are seeing concessions made to a lot of the tenants in these retail strips; but, nonetheless, a fairly large portion of that portfolio does have pretty good occupancy and some good cash flow underlying and supporting the property. So we definitely do see more AB restructuring opportunities, and we're working toward those every day.

Okay. Thank you.

Thanks.

Thank you. Our next question is coming from Daniel Cardenas of Raymond James.

Good morning, guys.

Dan.

Hey, Dan.

Can you comment a little bit on watch list trends, what they're looking like? Are you feeling a little bit more comfortable with how the numbers are settling out, or is it still -- still seeing some good in-flows into the watch list?

Yes, Dan, we don't provide a whole lot of color on watch list totals, but year over year, that bucket is down 63%. Did tick up in the quarter, mostly due to upgrades from substandard and some nonaccruals that were upgraded. But early stage migration, we watch that watch list pretty closely along with that 30-to-89-day and still accruing bucket. Those continue to trend lower, and we have not seen any material in-flow or adverse migration into the watch list [at least] for the quarter.

Has that 30-to-89 bucket, has that been a good predictor for you guys as to how the watch list was going to behave?

You know, Dan, on -- this is Bill Skoglund. That was not a good predictor for the construction and development piece. It seemed like when those went bad, they pretty much threw their hands up and said, "I can't pay anymore," and so it wasn't a good predictor. I think it is a good predictor for the commercial real estate and other real estate pieces, because those will slowly get worse instead of throwing their hands up like that.

All right. That will do me for right now. Thank you.

Thanks, Dan.

Thank you, ladies and gentlemen. (Operator instructions)

Feel free to jump in, folks.

We have a follow-up question coming from Daniel Cardenas.

All right, I guess, since nobody else will step up. On the net interest margin, the decline that we saw in the quarter, how much of that was attributable to nonaccrual -- reversal of interest of NPA's?

Certainly part of it was. I can't really give you a number at this point, but the -- there were some reversal of interest in the quarter. However, as I mentioned in my comments, we also were maintaining excess liquidity in the quarter. We -- and that also had a significant impact. As we've said many times, we're shrinking the balance sheet to support those bank level capital ratios. And although we're getting pretty steady declines in the loan portfolio, which is good at this point, the deposits are pretty sticky. We're down to -- some of the low-hanging fruit on the liability side has already been picked, and so we're having to work at that a bit. I think we're making some good progress. We have some things in the works to balance that out. It is -- as I also mentioned in my comments, if we get a little bit ahead of the game on the assets side, that improves liquidity. We can't afford to have liabilities decreasing faster than assets. So it's part of the continuing process. I expect to see further asset reductions in the second quarter.

Dan, just to throw in, too, you know, I mentioned in my part that we had $130.0 million in fed funds, and that was actually not the high point. There were some times we were up to almost $160.0 million. Those are only at a 0.25%, and we were just -- we were cautious, wanted that insurance. I think we can start moving those numbers down, and that'll start improving the margin. Between that and getting rid some of the non-performers, we would hope we could see some improvement in that. But we were cautious on the liquidity side and wanted to have high numbers of fed funds.

But excess liquidity is kind of acting as a headwind right now, and so there's -- sounds like there's still some levers that can be pulled, but the impact's probably not going to be that great?

Yes. I mean, we are doing some things in deposit pricing and also restructuring some of our commercial and public fund deposits to get some reductions there. So there's some positives in the works here, but, yes, the excess liquidity is a bit of a headwind.

All right. Thank you.

Thank you. Our next question is coming from David [Pomtel] of Berthel Fisher.

Good morning. Good quarter.

Thank you.

Thank you.

Can you say anything about your estimated recovery from the Gas City bankruptcy auction?

You know, that's -- there was an auction for that. We do expect to recover from what we have it on the books for. The total will be a net loss for the customer, but we wrote it down pretty heavily. So the sale is not completely finalized. It's been approved by the courts. We expect to get the money in mid May, and I think there'll be a good recovery. But I don't know the exact number as we sit here, because some of the costs are still being worked out. But it should be a reduction of about $8.0 million to $10.0 million in loans and a recovery of a good amount, maybe a couple million dollars.

Thank you.

That's a second quarter event, David, not first.

Yes. Yes, I understand. It took place here earlier this month, right?

Yes.

Our next question is coming from Stephen Geyen of Stifel Nicolaus.

Maybe just a couple -- a follow-up question. On the fee income line, with that coming down a little bit -- a couple of those line items, I'm wondering if there's some additional work you could do in noninterest expense and maybe your thoughts on what the FDIC expense might look like going forward?

Okay. I guess with the FDIC insurance first, there was a step up -- our bill went up from the FDIC going -- in the first quarter, there was a little bit of a catch-up entry there. But the level you see in the first quarter is probably in the ballpark of what you're going to see. It might be a little on the high side. Fee income, service charges on deposits were down.

Yeah. We probably don't see any material changes going forward, although we continue to remix the deposit portfolio. We are seeing more growth in noninterest bearing and demand. We'd like to think that will hopefully improve our service charge income in the coming quarters. But beyond that, as Doug mentioned, the mortgage company does provide pretty substantial fee income for us, and, generally, there's some seasonality there. The fourth quarter activity is generally lighter, and that usually provides a headwind in the first quarter. But as the spring market is upon us, we generally see an up-tick in 2Q and the -- in the third quarter there.

Yeah, I guess another couple of comments on the service charges on deposits. One is there is a little bit of seasonality in that the first quarter tends to be on the lower side compared with the middle portion of the year. We also have seen some reductions in overall deposit size over the course of the year. And while that -- a lot of that has been in CD's which don't relate to service charges on deposits, we have had some reductions in that area, particularly in public funds and that sort of thing. So some of that will relate to volume.

Great. Thank you.

(Operator instructions) We have a follow-up question coming from Daniel Cardenas of Raymond James.

All right. Sorry for jumping in and out here.

That's all right. If it weren't for you and Steve, it would be a pretty short call.

Question on the loan sales. Do you have any more buckets of loans that you're working on right now? Can we expect additional loans sales going forward, or is that kind of -- is that market kind of dried up?

Well, Dan, that -- the loan sale we had was just on one isolated transaction. So we view that as pretty positive. We are working on a number of fronts. We'd love to do a bulk loan sale if we could, but the bid-ask spreads are still too wide, and we don't have the capital cushion to really execute one of any scale. We continue to investigate that with different parties. But we do feel the upcoming quarters will provide more opportunities to move some of these assets. We're definitely seeing activity pick up on the OREO front.

And we're able occasionally to get a loan sale before we get it into OREO if we have a cooperative borrower. I think David, the caller earlier, talked about this Gas City which we -- that's through a court order, and that will be a loan sale. It'll be $8.0 million to $10.0 million. So there are some one-off loan sales like that, but we're not looking at a bulk sale at this point.

And I guess regarding the bid-ask spread, is it -- over the last couple of quarters, is it narrowing or is it staying the same?

Yes, I think it's narrowing a little bit. You know, I think the -- I think buyers are becoming a little more aggressive. I don't know if you're seeing that with some of the other banks you're following. But there's definitely more interest from a lot of third parties, looking to buy different portfolios. And we continue to run those down and look for those opportunities. I think we may have a better opportunity to do -- and execute a smaller loan sale. If we get to a point where we were able to generate some profitability, we may be able to deploy some of that toward executing a sale.

Dan, we looked at -- for example, the one that we talked about earlier that we sold for $10.0 million, which was about 90% of our value, that was one we put in a pile for to look -- for loan buyers to look at at one time, and they were offering like $0.45 on the dollar for that. So there's a real savings if you can do a one-off rather than in a bulk. The bulk markets are still pretty tough. I had -- one time we asked the bulk -- the buyers in the bulk market, well, if we put a good performing loan in there what would you give us for that, and they wanted to discount that 15% or 20%. So we think that's still not -- for our purposes, it's still not functioning as well as we'd like. And as Jim said, we're starting to get individual buyers now that are stepping up that we've never seen that kind of activity in the past, especially on the straight commercial real estate pieces, certain specific ones. So we're encouraged by that.

And then for the $10.0 million sale that you had in the quarter, what was the original value on that?

It was about 11 -- a little over $11.0 million.

And you sold it for $9.0 million, so --

Sold it for $10.0 million.

It sold for $10.0 million. Okay. All right. Thank you.

Gentlemen, I'm showing no further questions in queue at this time.

Okay. Thank you. Thanks everyone for calling in. We appreciate your interest.

Thank you.