Old Second Bancorp Inc (OSBC) 2011 Q2 法說會逐字稿

Greetings and welcome to the Old Second Bancorp second-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). It is now my pleasure to introduce your host, Bill Skoglund, Chairman and CEO of the Old Second Bancorp.

Yes, good morning. I'm going to start with turning it over to Doug Cheatham, and he will read some of the necessary disclosures.

Okay, 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 Skoglund, President, Chairman and CEO of Old Second Bancorp and Jim Acker, President and CEO of Old Second National Bank and Chief Operating Officer of Old Second Bancorp. And I am Doug Cheatham, Executive Vice President and CFO of the Bancorp. And now I'll turn it over to Bill to get things getting started.

Yes, good morning, again, and I appreciate your calling in and interest today in Old Second. I would like to take a few moments by updating you on the second-quarter highlights, which we released yesterday after close of business, and then I'll turn it over to Doug for some detailed financial numbers and Jim for some comments on the loan portfolio.

I would like to start though by saying I am encouraged by our continued progress and positive progress made this quarter and in the first quarter. And I particularly would like to share four positive results to start us off.

Number one, for the Bancorp, we made some profit. So we had a net income for the second quarter that was a positive $1 million and that was compared to a net loss of $23.4 million in the second quarter of 2010.

Number two, for the Bank, we showed a quarterly profit of $2.8 million. And year to date, the Bank is now profitable with an annual income of approximately $1.4 million.

Number three, we're also encouraged by our continued progress toward nonperforming loans. Nonperforming loans declined $49.5 million during the first six months of 2011, which was a 22% decline. And since June 30 of 2010, which was our high point, they were down $63.5 million. So we recognize we still have a lot of work to do, but good trends three of the last four quarters leaves us cautiously optimistic.

Number four, regulatory capital ratios at the Bank, which as been our main focus, also improved. And I am pleased to announce that the capital ratio objectives we agreed to with the OCC have not only been met ahead of time, but have been exceeded and we're now showing a leverage capital ratio at the Bank of 9.1% and a total capital ratio of 12.61%. That is versus the required ratios of 8.75% and 11.25%.

And finally, I'd like to share that the company also today announced the expected written agreement with the Federal Reserve Bank that is designed to maintain the financial soundness of the Bank. The agreement calls for a measure of oversight to ensure the Bank remains on course to continually meet the OCC capital ratio objectives.

And with that, I'd like to turn it over to Doug, who will give you more detailed information on the quarterly performance.

Thanks, Bill. Yesterday, we reported net income for the second quarter of $1 million and net income available to common shareholders of a loss of $162,000. For the year to date, we have a net loss of $2.1 million and a loss available to common of $4.4 million.

Compared to last year when we were at the peak of providing for loan losses, earnings have improved by about $24 million for the quarter and $30 million for the year to date. The provision for loan losses was $500,000 this quarter and $4.5 million for the year to date. This compares to a $44.6 million provision in the second quarter of 2010 and a $64.8 million for the first six months of 2010. This year, the net interest margin was 3.59% in the second quarter and 3.54% for the year to date. The margin was 3.61% in the second quarter of 2010 and 3.70% for the first six months of 2010, so the margin is holding in there pretty well.

The margin has benefited from the deleveraging strategy as we allow a certain amount of deposits to run off without chasing it with higher rates. Deposits declined to less than $1.8 billion at the end of the second quarter from $1.9 billion as of year end 2010. A year-ago deposits totaled $2.2 billion.

While deposits have declined, our core deposit base has held up very well. Our internal tracking shows an increase of $20 million in retail core deposits so far this year.

Total assets were $1.981 billion at June 30, down $134 million in the quarter and down $481 million since June 30, 2010. This right sizing of the balance sheet has helped to strengthen the capital ratios at the Bank level, as Bill mentioned.

Noninterest income was $9.4 million in the second quarter, up slightly from the first quarter, but still down $1.5 million from second quarter of 2010. For the year to date, noninterest income was down $777,000 from the first half of 2010. Most of the decrease is related to a market-wide decline in residential lending.

Noninterest expenses were down for both the quarter and the year to date, and expense reduction was spread across most of the major income statement categories. Notable exceptions were general bank insurance, which increased at our last renewal, and legal expenses, which are running at a higher level than in the past, much of it related to solving credit issues.

Other real estate expenses were just less than $6 million in the quarter. This is down about $800,000 from the second quarter of 2010. Other real estate expenses were $11.3 million for the year to date, or down about $2 million from a year ago.

The decline in other real estate expense between the first half of 2010 and the first half of 2011 is primarily due to a reduction in loss allocations on property values. The year-to-date loss allocation on other real estate was $10.7 million in the first half of 2010 and $6.4 million in the first half of 2011.

And finally regarding capital, while the tangible common equity ratio is 0.28% at the consolidated level, the Old Second National Bank capital ratios have increased. The total capital ratio was 12.61%; Tier 1 risk base was 11.33%; and the leverage ratio was 9.10%. This represents increases of 188 basis points each in the total capital ratio and the Tier 1 risk-based ratio, and a 134 basis point increase in the leverage ratio since a year ago.

At this point, as Bill mentioned, we have exceeded the OCC's expectations in this regard.

And with that, I'll now turn it over to Jim to discuss the loan portfolio.

Okay, thank you, Doug. The main theme in the second quarter is that favorable overall credit trends continued. Nonperforming loans, classified assets and accruing loans 30 to 89 days past due all declined again this quarter. Non-accrual loans declined 11% in the quarter and are now down 31% from the peak one year ago.

Total classified loans declined 13% in the quarter and are now at their lowest level since January 2009. We continued to focus on capital preservation in the quarter while working to reduce our exposure in construction and land development loans. And those efforts are proving successful and remain on track.

Loan growth obviously has not been a priority the past few quarters, but as we begin transitioning from capital preservation to stabilization, business development will become more of a priority over the next few quarters.

We do continue to see muted loan demand in our core markets, and competition remains very fierce for high-quality borrowers.

Our primary focus in the quarter continues to be in credit remediation and disposition of OREO, while accelerating the inflow into OREO.

We did resolve our second-largest nonaccrual loan in the quarter, netting over $10 million in proceeds and more than a $2 million positive adjustment to our allowance for loan losses. We continue to control adverse loan migration in the quarter through strong portfolio management and extensive loan review.

Continuing trends from the first quarter -- we were effective in reducing nonperforming assets through a variety of remediation efforts. Our special assets group continues to make good progress on several fronts. And as we continue to investigate both loan sale opportunities, we still feel the bid/ask spreads are still too wide for us and would result in significant losses.

Now we did execute a single smaller loan sale in the quarter that netted 93% of par on that one transaction.

Similar to the first quarter, credit quality in the second quarter showed improved results in several areas. Nonperforming loans, classified assets and early-stage delinquencies all declined again.

Total nonaccruals declined $20 million in the quarter. OREO dispositions totaled nearly $11 million for the quarter and inflows about the same. We had about $10.8 million in inflow. And we did have an additional $3 million OREO write-down resulting in a net decrease of $3 million in the OREO portfolio the second quarter.

Current properties under contract for sale in the OREO portfolio increased for the second consecutive quarter and we're starting to see some good activity on the portfolio and we have got several properties contracted for sale with potential closings in the third and fourth quarter.

As Doug mentioned, our provision expense of $500,000 in the quarter was down materially from the first quarter as asset quality continued to stabilize. Total adversely rated loans were down almost $67 million on a linked-quarter basis, while the aforementioned $2 million positive reserve adjustment from a large problem loan sale helped us offset the need for higher provisioning.

Nonperforming commercial real estate loans declined 12% in the quarter and represents the second consecutive quarter of double-digit declines in the CRE portfolio. Substandard CRE loans also declined in the quarter as we continue to gain traction on various credit remediation efforts.

After edging higher in the first quarter, our watchlist declined 10% in the quarter, and is now 28% lower from a year ago. The quarterly decrease was due mostly to internal upgrades as operating performance improved for several of our borrowers. Our accruing 30 to 89 days past due loan bucket totaled only $10 million in the quarter and declined for the third consecutive quarter, giving us optimism that early-stage delinquencies had finally moderated.

Just if we looked at the portfolio one loan type at a time, we mentioned in the first quarter that construction and development loans continue to wind through the cycle. We feel that is continuing on a positive momentum. We feel the worst is definitely behind us in this part of the portfolio. That portfolio is now down to $95 million, which is now down over 80% from the peak back in the third quarter of 2008.

Of the $95 million, over half of it is nonperforming and $11 million rated substandard. The total nonperforming construction loans declined again in the quarter, mostly due to OREO migration and some disposition.

We continue to see modest increases and opportunities to sell these assets, and on the valuation side, we are still seeing a few construction and development appraisals with valuation declines. Most of that is in the retail lot segment.

Many construction and development properties are declining at a much slower rate as we took very heavy discounts in prior periods.

Our watchlist construction loans are now down to $5 million, and we really haven't seen any new migration in this segment in over three quarters.

Most of the stress in the commercial real estate portfolio remains in the retail category, mostly strip malls and special-purpose real estate. We still see weakness in net operating income from many of our borrowers, mostly due to diminished market conditions.

And while the retail category represents only 5% of our entire portfolio, it does represent about 29% of our nonperforming loans in the commercial real estate segment.

The retail segment did decline slightly in the quarter, mostly due to continued charge-offs and some small dispositions.

Beyond commercial real estate and construction and development, our next largest category of nonperformance continues to be in the 1-to-4 family residential portfolio. Our local housing market remains very challenging, and we currently have about 16% of our portfolio in 1-to-4 families.

Nonperformers, however, did decline in this category for the third straight quarter, and overall losses remain a very low percentage of the portfolio and a modest percentage of total charge-offs. We feel this trend will continue.

Our C&I exposure remains relatively low and represents only about 10% of the portfolio. That portfolio is holding up very well. We've only got about $4 million in nonperforming in that portfolio. And we recognize no losses in the quarter. So overall, that portfolio continues to perform well and we do not anticipate large losses in C&I.

So with that, I will now turn it back over to the moderator, and we can certainly address any questions you may have.

(Operator Instructions) John Barber, KBW.

Jim, you mentioned that the watch list was down 10% this quarter and a lot of it had to do with upgrades. Can you just tell us kind of when you hit that inflection point of upgrades kind of outweighing downgrades? Thanks.

Sure. John, we do a pretty extensive review every quarter, and a lot of the improvement came when we received financial statements and tax returns from a lot of our borrowers. We generally start getting those into the second quarter, end of first quarter, early second quarter. And a lot of our borrowers, while top-line revenues are flat or maybe lower, many of them who really controlled expenses have returned to profitability. And that really created the opportunity to finally upgrade some of our credits.

Okay. And you had another nice reduction in your nonperforming loans. You mentioned that you resolved your second largest NPL; were the other kind of resolutions smaller dollar or do you have any other large credits in there?

You know, we had a handful; the largest one we resolved was about $10 million. So that I think was about 50% of the positive adjustment, and then we had a handful of smaller ones. But pretty good progress across, and we had many more upgrades than downgrades.

All Right. Any chance you have the nonaccrual inflow number for the quarter?

Of the larger credits, I want to say it was probably close to $11 million or $12 million total.

All right. And I guess switching gears a little bit, could you comment on how your consent order and your agreement -- how that impacted your day-to-day operations at the bank, as well as your ability to comply with administrative requirements and meet any required deadlines?

This is Bill Skoglund, John. You know the -- we were making continual progress on that. We had till September 30 to get to the capital requirements. We were confident we could get that done by June 30, but we're glad to have a little room to work with, with the OCC.

They've been good to work with. I mean we've got positive trends moving in all directions so they have been pretty positive to work with. We did -- in order to get to those ratios we continued our capital preservation strategy, which means that we did allow some shrinkage in the quarter and year to date to offset some of the other losses or declines in capital. So that was the strategy. Let's -- at some point let's get to these capital ratios; let's be under the capital preservation strategy. And we communicated that to the OCC and they were positive towards that.

And then I think once we hit the capital ratios, which we have, and we've got a pretty good cushion on them, we've decided -- and they are aware of that -- our strategic plan is to move forward with trying to grow enough to offset some of the runoff of nonperforming loans and other runoffs that we may have just from paydowns. So we call it more of a capital stabilization strategy now. And we are not in a position that we could say we would just go all out growth. But the markets aren't there for that anyway now. So we are determined to stay in the capital preservation mode. And we think we can -- I'm sorry -- the capital stabilization mode. And we think we can work through that.

At some [former] point, we'll look towards maybe a growth mode and look towards raising some capital when the time is right, when the markets are there and when it's not quite so dilutive to our shareholders.

So we've looked at three different strategies; one is capital preservation. We think we've earned the way to move through that. We're in capital stabilization. And ultimately, we would like to be back in more of a growth mode as these markets and the economy improves. Does that answer your question?

Yes, that's very helpful. Thanks. I guess the last one, you know you mentioned you entered into a written agreement. Do you have to submit a formal capital plan to them, and when would the timing be on that, if you did?

Well, the capital plan has already been submitted. So that much of it is completed. We don't have any official response from them yet on that.

That was from the OCC. The Fed is kind of expected to -- whenever the OCC want -- has an agreement, the Fed will also want an agreement for the Bancorp. And so a lot of these reports and plans overlap with them. And so you know we have already sent the OCC our strategic plan and capital plans, and so we just need to continue working with both the regulators now. So we'll work with them on the Bancorp capital where we stand with that.

But their main interest is that -- and I think rightfully so -- that the Bancorp is a source of strength for the Bank and they're looking towards the bank as the main focus, as we are. And the capital in the bank is their main focus of both regulators. And as long as we can continue to work and see positive movements there, they seem to be satisfied with that.

(Operator Instructions). David Tomell, Berthel Fisher.

Good morning, congratulations. Can you say anything about Gas City? Has that been all resolved or not?

You know, that was a public liquidation and that was one of the loans that was involved with the gain that we were talking about.

Daniel Cardenas, Raymond James.

A couple of questions on your other real estate owned. And we did see some reduction in that quarter. Can you comment a little on the priors and interest? Is that beginning to pick up a little bit or is it still a little sluggish?

No, Dan, I think it's -- we've seen pretty good activity on the OREO portfolio. I mean obviously, the construction assets in that portfolio are much more challenging to move. We have marked them pretty aggressively and even some of those assets are now moving. So anything that is income-producing, obviously, has a lot more interest, and we are able to move that pretty well. But I would say compared to a year ago, activity is definitely picked up in our market here.

And you know, Dan, our goal is to move as much of the nonperforming loans to OREO as we can and then market those. So certain parts of that have strong markets. the vacant lots and some of that is still difficult, but for the right price, some of that stuff can still move.

Okay. So then of the sales that you had this quarter, was that primarily sales to individuals or was it larger developers maybe sniffing around looking for bargains right now?

I would say some of both, Dan. Our largest disposition was a multifamily property with decent cash flow. We did sell several large commercial lots, but we probably had over 30 different properties that we disposed of through internal efforts. Our special efforts group has a lot of contacts the commercial real estate arena, and we continue to work with those contacts.

And then when is your next regulatory exam?

I don't think we can disclose, but under our consent order, we're talking to the regulators quite often.

Okay, fair enough, fair enough. And then I guess just looking at the margin in terms of sustainability, are there any more leverage you can pull that can help you keep that margin afloat?

I think as -- and this is Doug. I think as we continue to cure the non-earning assets, that will naturally help us out by increasing earning assets.

We've also been fairly liquid, so at some point here we may be able to put a little bit more of that liquidity to work for us. And from an asset liability standpoint, there is a bit of upward bias at this point. So, nothing is certain, and you could see spreads narrow as competition increases. But at this point, I think it is fairly sustainable.

All right, great. Thank you.

Alex Washburn, Columbia Pacific.

Hi, congratulations on a great quarter, guys. Hey, at what point in time would the company, if all things stay the same with regard to pricing of stock, pricing of preferred, and as your fundamentals improve, at what point in time could you look to potentially buy in some of the preferreds at $0.50 on the dollar, which seems like a better return on investment, than even making some loans, you said?

You know Alex, we have a couple of issues there. One is liquidity in the Bancorp is something that we watch, and we're not able to dividend money up to the Bancorp at this point until we have more consistent earnings. So anything like that of buying back the preferred could be done with a capital raise. I remember when we were talking about it last time, we looked at that possibility, but from just a liquidity standpoint, that would have to go in line with a potential capital raise.

And we would look towards -- I had mentioned earlier that we would still look towards a possibility of doing that when the markets are better and it's not so dilutive to our shareholders.

Great. And then also, I know it is early in the quarter, but you may have mentioned this, I may have missed it. But are the trends so far this quarter tracking the trend to last quarter?

You know we really don't post earnings projections but we're not seeing this hit a wall at all. Things are more positive with us overall and it continues to be that way. You know the main reason, there are -- a lot of companies in our markets did better in 2010.

We have a lot of owner-occupied commercial real estate and we're starting to see stabilization in some of the certain types of commercial real estate, or if not that, less decline, so --. And we're also seeing more buyers stepping out now. So that trend continues and then it will continue to be positive. And we're not seeing it abate in any way. So we are cautiously optimistic.

All right, terrific. Keep up the good work. Thanks a lot.

(Operator Instructions).

Well, if we have no more questions, operator, maybe we should wrap it up then.

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Okay. I appreciate everyone calling in, and we're positive that we finally got to the point where we made some money. So we are very optimistic on the past quarter and we're cautiously optimistic for future quarters. And we look forward to continuing these trends and hopefully the economy and markets will continue to work for us. So we thank you for calling in, and with that, we would wrap it up.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.