Old Second Bancorp Inc (OSBC) 2014 Q4 法說會逐字稿

Greetings and welcome to the fourth-quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Doug Cheatham. Thank you. 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 and 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.

And now I'll turn it over to our President and CEO, Jim Eccher, to get things started.

Good morning. And thank you for joining us today. The fourth quarter was a good one for the Company on many levels. I'll start by giving you my view of the quarter, and Doug will follow with a more detailed report on the financial statements. And then we'll open it up for questions.

Operating performance in the fourth quarter showed good improvement on many fronts. While our core earnings are still in recovery mode, we were able to make positive strides in loan growth, net interest income, and credit quality. Reported fourth-quarter net income available to stockholders is $1.9 million or $0.06 per diluted share. For our year-to-date 2014, net income available to common was $11.9 million or $0.46 per diluted share.

Moving on to our key business lines, we had a 1.6% increase in total loans over the prior quarter and finished the year up 5.3% from 2013. C&I loans was a positive story in the quarter. They increased slightly over 10%, and most of that was on the strength of new business and higher line utilization.

Our Wealth Management and Trust group had a 6.5% increase in income for the quarter, but was relatively flat year-over-year. Performance was in line with our expectations for the year, and we are encouraged with our pipeline in this division.

Our Real Estate and Mortgage Banking unit remains profitable, and generated $1.1 million in revenue in the quarter. And while this was $240,000 lower from the third quarter, and year-to-date results were well-off 2013 levels, it does remain an important part of our business. And we are optimistic heading into 2015 that we'll have better results in this division.

Turning to the balance sheet, asset quality improved significantly in the fourth quarter, as nonperforming assets, nonaccrual loans and OREO all declined in the quarter. Classified assets resumed their downward trend and declined 18% in the quarter, which included a sharp reduction in Oreo. More importantly, outflow exceeded inflow in both nonperforming loans and Oreo categories. Net charge-offs were very modest in the quarter, although Oreo costs were somewhat higher as we took some write-downs on legacy Oreo assets.

Overall, it was our most successful quarter as far as classified asset remediation. And while there's more work to do, we feel classified assets are at manageable levels.

Lastly, on January 2nd, we announced that we will be redeeming one-third of our remaining $47.3 million of preferred stock that was issued under the TARP Program. We will be redeeming these at par at the end of January, which will leave us 31,533 shares outstanding.

Doug will now give you more insight on fourth-quarter performance, and then we'll open it up to questions.

Okay. Thanks, Jim. Jim mentioned that earnings for the quarter and year, in 2013, we recovered nearly all of the valuation allowance on the deferred tax assets. So, using income before income taxes for comparative purposes, that metric increased from $11.8 million in 2013 to $15.9 million in 2014 -- an increase of about 35%. We released $1.3 million of the loan loss reserve in the fourth quarter, bringing the 2014 total to $3.3 million. And this compares to releases totaling $8.55 million in 2013.

Net interest income was $15.1 million in the fourth quarter of 2014 compared to $13.7 million in the fourth quarter of 2013. And the net interest margin was 3.19% in 2014 and 3.35% in the fourth quarter. This compares to 3.16% in 2013 and 3.13% in the fourth quarter of 2013.

Several things contributed to this improvement. In comparing the fourth quarter of 2014 to the fourth quarter of 2013, the average yield on earning assets remained unchanged, at 3.83%. The average amount of interest-earning assets increased by $59 million to $1.8 billion. The average cost of interest-bearing liabilities declined by 24 basis points, while the average amount of interest-bearing liabilities declined by $9.4 million, while noninterest-bearing deposits increased by $27 million.

So, changes in mix on both sides of the balance sheet as well as spread helped to increase net interest revenue. With loans now growing at a good rate, this is moving in the right direction.

Setting aside securities gains and losses, year-over-year noninterest income was down in both the quarter and the full-year. The largest decline was in mortgage banking income, which was down $1.9 million in the fourth quarter of 2014 compared to the fourth quarter of 2013, and was down $4.4 million for the full-year. At this point in the interest cycle, refinances are not nearly what they were over the last couple of years, and the real estate market, while improved, has not made up the difference.

Noninterest expenses were $18.9 million in the fourth quarter of 2014 compared to $20.1 million in the fourth quarter of 2013. For the full-year, expenses were down $9.4 million to $73.7 million in 2014 compared to $83.1 million in 2013. $3.8 million of the reduction came in other real estate expenses, but the rest of it was spread across a number of categories.

A number of these have been mentioned in the past as areas of opportunity, notably FDIC insurance, D&O insurance, and legal expenses. And also the core deposit intangible is now fully amortized and net expense is no longer a factor.

Turning to the balance sheet, as Jim mentioned, loans grew 5.3% in 2014. And in dollar terms, loans grew $58 million in total, while nonperforming loans declined $12.7 million. Put another way, performing loans grew over $70 million during the year. This has a material impact on our net interest margin, as I mentioned earlier, as non-earning assets are replaced with earning assets.

Deposits were flat in 2014, but this was by design. As we've indicated previously, we are very liquid and we can fund loan growth with sales of maturities in the investment portfolio as needed. Regulatory capital ratios at the Bank remain in good shape. Tier 1 leverage was at 12.02%; Tier 1 risk-based at 17.46%; and total risk-based at 18.72%. And at the consolidated company level, leverage -- Tier 1 leverage was 9.93%; Tier 1 risk-based, 14.43%; total risk-based 17.67%; and the tangible common equity ratio was 7.12%.

So that's an overview of the financials. At this point, we'd be glad to open it up to questions. And I believe the operator can take those now.

(Operator Instructions) Andrew Liesch, Sandler O'Neill.

Doug, could you talk a little bit more about the margin, like what drove the expansion this quarter? Was there any interest recoveries? And on, previously, I guess reversed interest on some bad loans? And then where do you think it can go from here?

Well, on the first part of that, there really was nothing too unusual in the quarter. No real noise. We had a full quarter of interest on the CLO's that we had purchased in the third quarter. We had more loan growth, as you saw, and further decline in the cost of funds. So that has all helped out in the quarter. But there was no unusual noise there.

As far as the second part of your question, I'm not really going to give guidance on where I think it's going to go, but I think you can see the trends that we've experienced in the last three months.

Got you. And then, kind of curious how you're looking at provisioning now with the negative provision -- I guess you took three of them in 2014. I mean, if at this same level here in the fourth quarter, I mean to get the reserve ratio down below 1.5 pretty quickly, still how are you looking at the reserve going forward?

Well, we have to -- we look at it on an accounting basis. I mean, we have not changed our methodology at all through the cycle. We're pretty diligent about taking an objective view of what we have in the portfolio and the trends that we see. So, we are -- it's going to be a fairly mechanical mathematic process. We're not trying to position it up or down one way or the other.

So I can't really give guidance. I think we are seeing a real good progress on unloading the nonperforming loans. So that will help. At the same time, we are beginning to experience some decent loan growth. And so, of course, you have to take that into account and provisioning as well.

So I know that's not a definitive answer, but I think we have competing trends there with declines in nonperforming loans but increases in performing loans. So, I'm not going to give you a forward-looking statement there, but we'll keep the same methodology that we have had and analyze it each quarter.

Yes. I think, Andrew, if you look at the trends, obviously, the trend has been declining releases in over the last 24 months. And obviously, with loan growth starting to pick up a little bit, we are more than likely going to be growing into that number. But, at the same point, we have to follow the accounting rules, as Doug mentioned.

Got you. That is helpful. Thank you so much. I'll step back.

Evan Plisner, Trishield Capital.

So just a few quick things. First is, what is headcount at the end of the year? And how do you view that going forward in 2015?

We had full-time equivalents of [485] at the end of the year. That was down from [492] at the end of the prior year. You know, that's something that we try to manage carefully all the time. We did close a couple of branches last year and we'll be taking a close look at our operations this year.

Okay. And then when I look at C&I loans, obviously, a big increase there year-over-year and also quarter-over-quarter. What is driving that? Because that seems to be an especially bright spot.

Yes. Obviously, we've been putting the focus on that, Evan, over the last year or so. Really trying to remix the loan portfolio, being less -- trying to be less dependent on commercial real estate and more on C&I. And we've been focusing our business development efforts in that area.

There was -- there really weren't any large transactions in the quarter. Rather it was more of a granular situation. We had a lot of new accounts. I'd say 25% to 30% of that growth in the fourth quarter was new business, and 65% to 75% was really higher line utilizations from existing or legacy clients.

Got it. And then, obviously, the TARP redemption was announced at the end of the year. But when I look at how that would affect capital levels today, how would those change?

The impact is not all that great. We have -- I think the impact on the leverage ratio is less than a point. And we are in good shape on that. Obviously, it doesn't affect the tangible common equity ratio at all, because there's no common involved with the transaction.

So, Bank level, we are funding that with a dividend from the Bank to the Holding Company. The Bank capital ratios are very strong. And the impact on the Holding Company level ratios is relatively minimal.

Yes, I asked because it seems again like you just mentioned that the capital levels at the operating company are quite strong. And so we are trying to figure out when we should expect the rest of the TARP to be called.

That's a good thing to figure out. (laughter) We're -- obviously, we'd like to work our way out of that. We wanted -- we have to get regulatory approval, which we did get, and would anticipate the next time we ask that they will agree again. And so we are trying to pick the right time for that ourselves.

And I've got to press you on that. Is that a first half, second half? What are you thinking?

Yes. You know, there's a little lead-time on that, because we have to get through the regulators. We're just a week away from completing the first sort of installment on that. I -- I'm not going to give you a quarter, but -- well, rest assured that it's definitely a high priority on our radar.

And the other thing, Evan, we really need to balance that with our classified asset ratio. Obviously, that's something the regulators look closely at. And moving that money from the Bank to the Holding Company is going to have a -- it's going to have -- we'll have a little bit of an uptick in the classified asset ratio next quarter. So, we are balancing that with obviously trying to clean up the balance sheet here.

Yes. That's a real good point, Jim. Evan, the -- you see the capital ratios at the Bank and the Holding Company, but the classified asset ratio, which utilizes Tier 1 capital in the calculation, and it's calculated at the Bank level, is really more of a trigger point for us in the short run here than the capital ratios themselves.

Understood. Thank you guys, very much.

Okay.

Thank you.

Brian Martin, FIG Partners.

Just wondering -- just back to that classified number, Doug. What does that number change with the redemption? What was the classified ratio using bank capital in this quarter versus what it looks like, I guess, with the capital reduction? How much of a change is there?

I don't have an exact calculation on the change. The ratio ended the year at 28.1%, and -- which was the first time it's been under 30% for -- it's been dropping every quarter just about. And we are real happy to have it under 30%.

The dividend from the Bank to the Holding Company will increase that ratio. But, of course, at that same time, we are hoping that classified assets are lower. So, by the end of the first quarter, it could be a wash. In isolation, this probably adds 3 points or so to that ratio.

Okay. And I mean, have the regulators -- I guess is there kind of a new bar as far as where it needs to be set to be below to kind of proceed with what you guys are expecting, as far as upstream with more capital and kind of tabling the rest of it in? Is kind of 30% a level you need to be below? Or is there no hard and fast rule, but is there kind of a sense in your part where you need to maintain the classified level?

Well, it's kind of like playing limbo. Every time the bar gets lowered, it doesn't get raised back up. So, under 30% is a good benchmark. Under 25% is an even better one. We expect the positive trends to continue. And so, with a little more time, we'll have room to redeem more of the TARP.

Okay. And just to make sure, the full redemption -- so that the upstream from the Bank to the parent this quarter was -- did it match the amount of the redemption? Is that kind of what we'll see when the call reports come out?

We are actually dividending a little bit more than that to bring some operating cash to the Holding Company.

Okay. So nothing earmarked presently in the upstream for additional redemptions?

Right, right.

Okay. Okay, perfect. And then maybe just secondly, on the margin, I know you don't necessarily give guidance, but can you just talk about what the positive influence and the negative influence is kind of, directionally, what's -- at least kind of help me sort through what the margin looks like, prospective in it. It had some pretty big jumps through the last two quarters. So just trying to understand what the positive influences could be versus a negative, and kind of what you are thinking about --?

Sure. Yes. A lot of it is mix. Because as I mentioned, we -- the decline in nonperforming loans almost masks how good loan growth was, because we are replacing not only runoff but also adding to the portfolio. So, loan growth definitely is a positive.

Also, recall that we purchased over $90 million in CLOs in the third quarter, so we had a full quarter of earnings on that investment. So that helps as well. You know, there was -- I think we had continued sort of slippage in the cost of funds. When we don't need to grow deposits to fund the loan growth, we don't have to overpay for deposits. So that has continued to slide a little bit to our benefit.

Yes, Brian, I think that's a pretty important part, too. I mean, we've -- because we're so liquid, we've really tried to be methodical about changing the mix on the deposit side as well. Our CD portfolio was down about 8.5% year-over-year, and a lot of that was higher cost type CDs. And then our noninterest-bearing deposit checking was up over 7% for the year. So that's a pretty positive mix change. And I think because we are so liquid, that's afforded us the opportunity to do that.

And in terms of going forward, when and if interest rates rise, we are in position where that won't hurt. In fact, more likely than not to help us a bit.

Yes. What is the GAAP sensitivity? Like I mean, for 100 basis point rate increase, what's the NII do? I guess is that material?

Yes. I would say we are a slight positive, but I can't give you an exact number on that.

Okay. All right. I think that is -- that takes care of all my questions except for maybe just one on the expense front. And just kind of separating out, let's say, the credit-related costs versus just kind of the core expenses. And the outlook on core expenses, is it pretty flat as you look at 2015, with some -- still some lumpiness in the credit costs? Is that, I guess, maybe a downward trend on credit costs but still lumpy, but the core expenses are ex-those credit costs are pretty flattish or maybe up incrementally?

Well, I think we've been running fairly flat -- if you set aside OREO-related expenses, we've been running fairly flat on non-Oreo, noninterest expense in around the $16 million kind of range. That's something that we are looking at closely, especially with some little bit of a disappointment on the noninterest income side. So, you know, that -- there may be some progress we can make there.

Okay. All right, that's helpful. I appreciate the color. Thanks, guys.

All right. Thanks, Brian.

Chris McGratty, KBW.

Doug, maybe on the ongoing earning asset remix that's going on, without giving too much specific in terms of guidance, is the right way to think about the balance sheet as a whole, just cash flows from the securities book going into what seemingly is improved loan growth and kind of earning assets, to kind of stay around the $1.8 billion level? Or will we see growth in earning assets?

Well, that's -- we've approached it over the last year or so from the standpoint that we would keep assets fairly flat and remix the assets. I think with strong capital ratios, there may be some room for net growth in the future, but we'll have to kind of take that one quarter at a time. With the liquidity position we have, we are actually in a pretty good spot to be flexible on that.

Okay, that's helpful. And kind of piggybacking on the expense question I was just asked, as you kind of look out the next 12 to 24 months, your efficiency ratio is obviously still not where it needs to be. Is there anything more immediate that you guys may be considering that maybe analysts and investors aren't necessarily considering, in terms of trying to bring that ratio efficiency down a little bit quicker?

Well, as I mentioned to Brian, I think there's some more progress we can make on that front. And we're definitely going to be taking a close look at our operation, and seeing if we can make it more efficient. And as we've done in the past, we'll -- everything's on the table. We closed a couple of branches in the past. Don't know what will happen exactly in the future, but everything will be evaluated.

Great. And last one is the tax rate. Can you help me on a decent rate going forward effectively?

Yes, Illinois just had a reduction in the state income tax rate from 9.5% to 7.75%. So we'll have the benefit of a lower tax rate in Illinois; although it's not a low tax state, it will be lower going forward. You know, the effective rate has been running in that mid-30s range. And that may come down a little bit. But because we have the -- we need to capture that deferred tax asset, which we are, but you need to generate taxable income, not nontaxable income, in order to capture that benefit. So I would anticipate that will come down a little bit from what you are seeing, but not by a lot.

Okay. Very helpful. Thank you.

(Operator Instructions) It appears that there are no further questions at this time. At this point, I'd like to turn the floor back over to management for closing remarks.

Okay. Thank you, everyone, for joining us this morning. And we look forward to speaking with you again next quarter. Good bye.

Thank you.

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