Old Second Bancorp Inc (OSBC) 2015 Q3 法說會逐字稿

Greetings and welcome to the Old Second Bancorp third-quarter 2015 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I'd 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 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.

And now I will turn it over to our President and CEO, Jim Eccher.

Good morning, and thank you for joining us today for our third-quarter conference call. I will start by giving you my overview of the quarter, and then Doug will follow with a more detailed report on the financial statement. Both Doug and I will keep our comments brief, and then we will open it up for questions.

Operating performance in the third quarter was highlighted by continued improvement and asset quality and expense control, as we reported third-quarter net income available to common at $3.6 million or $0.12 per diluted share. Year to date, net income available to common is $9.7 million or $0.33 per diluted share. As a result of continued improvement in credit quality, the $2.1 million reserve release helped drive earnings for the quarter.

Net interest income in the quarter was up 1% from the third quarter last year, and up 5.8% year to date. Interest income was up marginally, with most of the margin benefit coming from lower cost of funds. The net interest margin compressed in the quarter from 3.25% to 3.22% as we continue to try to hold the line and maintain pricing discipline with our loan renewals.

Growing topline revenues remains challenging in our markets as loan demand remains soft in the suburbs. That along with a softer residential mortgage market resulted in lower revenues in the quarter. While residential mortgage revenue was down from the second quarter, originations remain seasonably strong and have continued along those lines early in the fourth quarter. December is historically a slower month, but overall we have been pleased with the performance of this line of business in 2015.

Net loans declined $26 million in the quarter and are flat from a year ago, but of the $26 million decline, over $20 million paydowns were from relationships that were either criticized or criticized at one time over the past few years.

In addition, revolving line utilization unpredictably contracted in the quarter. Despite the contraction in the loan portfolio, we are working hard to stay disciplined with structure and pricing as we continue to try to build our pipelines. Overall, our pipelines aren't where we'd like them, but we are seeing more opportunities early in the fourth quarter and we're placing a lot of emphasis on business development as we gear up for 2016.

On a positive note, we continue to make good strides in strengthening our balance sheet, and our efficiency initiatives are continuing to drive noninterest expenses lower. Overall, noninterest expenses were down better than 14% from the second quarter as a result of lower salaries and benefits, and lower valuation expense on our OREO portfolio.

As we mentioned earlier in the quarter, on July 14 we provided notice for the redemption of the remaining 31,553 issued and outstanding shares of our fixed-rate cumulative perpetual preferred, with an effective date for redemption on August 14. We are pleased to have this behind us, and Doug will give you a little more color on this in his prepared comments.

Asset quality improved again in the third quarter, mostly due to effective OREO resolutions. We had numerous OREO sales which led to a 23% decline in our overall OREO portfolio. In addition, nonaccrual loan outflow exceeded inflow in the quarter, as overall credit quality continues to improve. Net charge-offs were modest with gross charge-offs of $576,000 and recoveries of $968,000, for a net recovery quarter of $392,000. Year to date, net charge-offs remain pretty low at $624,000.

So overall, we are pleased with our execution on our cost reduction initiatives and encouraged by our continued efforts to improve credit quality. And we recognize loan growth has been uneven over the past few quarters, but we are placing a lot of emphasis on this and focus to make this a high priority as we look forward to 2016.

So I'll turn it over to Doug. He can give you more insight on third-quarter performance, and then we'll open it up to questions.

Okay. First, I want to give you some color on earnings in the quarter. Net interest income was off slightly quarter over quarter, but year over year was up slightly compared to the third quarter of 2014. For the year to date, net interest income was up $2.4 million over the first nine months of 2014, an increase of 5.8%. The year-to-date net interest margin improved from 3.14% in the first three quarters of 2014 to 3.25% in the first three quarters of 2015. However, it was off slightly in the third quarter of 2015 to 3.22%.

Noninterest income was affected by a few items that I'll note. We took a charge of $1.1 million in the third quarter for the closure of one of our branches. This branch was not profitable and the customer base will not be materially impacted because we have another branch in the same general area.

I want to mention that mortgage servicing income includes a write-down of the mortgage servicing rights asset that we carry on the balance sheet. The write-down was $688,000 in the third quarter and $1.2 million for the year to date. This is a required adjustment that is directly related to changes in interest rates, and it is fully recoverable when interest rates rise.

Aside from the servicing asset write-down, our mortgage group has done quite well this year. Net gains on sales of mortgage loans were $1.4 million in the third quarter of 2015, compared to $914,000 in the third quarter of 2014. For the year to date, net gains on sales of mortgage loans were $4.7 million in 2015 and $2.6 million in 2014, an increase of 79% or over $2 million.

Noninterest expenses declined to $16.2 million in the third quarter of 2015. This compares to $18.3 million in the third quarter of 2014, a reduction of $2.1 million. Excluding other real estate expenses, other overhead costs were down over $1 million in the quarter or about 6.5%. With or without real estate expenses, we'd have to go back to 2007 to see quarterly expenses this slow.

As I mentioned in prior earnings call, the impact of our staff reduction earlier this year would not be fully realized until the third quarter. Salaries and employee benefits were $8.3 million in the third quarter of 2015, a reduction of 6.7% from the $8.9 million in the third quarter of 2014.

Expenses related to other real estate were down for the quarter, but flat for the year to date. Other real estate expenses were $977,000 in the third quarter of 2015, compared to $2 million in the third quarter of 2014. For the year to date, other real estate expenses were $4.7 million in 2015 and in 2014.

We reduced other real estate from $32 million to $24.5 million in the third quarter. And although it can vary from quarter to quarter, we expect the related costs to continue declining.

And finally, as Jim mentioned, we completed the redemption of the remaining shares of the preferred stock originally issued under TARP. As with prior redemptions, this was funded entirely from bank retained earnings paid up to the holding company, and we are pleased to have taken care of this without the need to issue additional capital or incur more debt.

And that concludes our prepared comments. At this point, we would be glad to open it up to questions.

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

Just a couple questions from me here. The salaries and benefits line, it was down nicely. But I'm just curious, is this a good run rate to use going forward or were there maybe some higher bonus accruals or something like that in the prior quarter?

We accrue for bonuses throughout the year, so that shouldn't -- although sometimes we will need to make a year-end adjustment, it shouldn't have a big effect. I guess about the only things that can affect that line item quarter to quarter are we do have some commission LOs in the mortgage department. That can change quarter to quarter.

Sometimes our health insurance costs may change quarter to quarter. And we are looking for producing commercial lenders, so there could be some of that. So it can change a bit, but this is a good base.

Okay, great. And then just looking at the margin, down here a little bit, but it's been in this like mid-3.2% level over the last few quarters. Just kind of curious on your thoughts there. It seems like it should remain stable, but just kind of curious what you are thinking.

Yes, I think we are in a -- and have been for a few quarters now -- in a fairly stable range. There's always competing pressures in the market, but we are very liquid right now. We don't need to pay up for deposits, so we can maintain pretty good control on the cost side of that. And we are being disciplined on loan pricing in spite of some of the challenges of growing loans.

It doesn't enter into the net interest margin calculation, but with the redemption of TARP, there is a significant reduction in that dividend cost.

Right.

So that helped, too.

Great, those are my questions. Thanks.

Chris McGratty, KBW.

Jim, on the loan growth can you just elaborate a little bit more what's going on in the suburban markets? It seemed like you have contraction. I am not sure if this is a kind of unusual paydown quarter, or is the growth really just not coming back at all in the suburbs?

That's a good question, Chris. We have seen just fits and start in the Western suburbs, as opposed to Chicago. Obviously, in the city you are seeing more expansion. In the Western suburbs, last year was -- we saw some resurgence and our growth was in the mid-5%s, and even higher if you back out the migration out of the nonaccrual portfolio.

This year, it's been a lot more sluggish. We are seeing a little bit of economic expansion, but not to the extent we saw last year. Also, historically, we have seen line of credit expansion in the latter half of the year, particularly in the third and fourth quarters. And this year we saw contraction that we hadn't seen really in the last two or three years in the third quarter.

So we don't know if that's an anomaly or if we'll see -- we expect that to reverse course in the fourth quarter based on historical usage.

Okay. I want to talk about the capital position a little bit. Can you give us an update on -- I saw it tick up in classifieds a little bit. Can you provide us, Doug, with a bank level classified ratio that's your governor for capital?

Yes. At the end of the quarter, the classified asset ratio was 20.12%. It had been 19.54% the quarter before. The paydown of the TARP did affect that. It really would have been even lower if we hadn't done that in the quarter because it changed, obviously, the denominator in that equation.

Okay. I think you've talked about in the past, you have the trust preferreds that are still out; I think it's 7.35%. Where do you stand in terms of now that you are through the legacy TARP?

Well, at this point we have two issuances of TruPS out there. We have a 7.8% fixed. Because it's grandfathered, we do get capital treatment on that. We get tier 1 up to a limit, and anything beyond that limit falls to tier 2. I think I mentioned last quarter, we've considered whether at some point it might be beneficial to refinance that in some way. But the alternatives and to still get tier 1 capital treatment are limited.

The other issuance is a trust preferred that is floating at 150 over LIBOR. We had originally swapped it -- well, it will go to floating. We had swapped it to fixed at a 6.766% fixed rate for the first 10 years of that instrument. We have recently entered into a swap to fix the cost on that after it goes to floating in 2017.

So what would have gone to floating 150 over LIBOR in 2017, we've now -- it will be fixed at that time. We did a two-year forward starting swap. It will be fixed at that time at -- I think the rate is around 4.35%. We thought that that was a good long-term rate. Who knows where rates will be for the next 20 years of that instrument, but 4.35% seemed like a good deal for tier 1 capital.

Okay, that's helpful. So if I am kind of connecting the dots, it doesn't -- on the first issuance it doesn't sound like there's an immediate kind of consideration to take those out, or is that just maybe too soon given what happened with the TruPS -- or the TARP?

Yes, probably. It's an open question. At this point, there's no particular plans. It's just as we move through the capital stack that's with TARP out, that is now our most expensive piece. But we do get the capital treatment and it is fixed, so there's no question of increasing costs or anything like that.

We may let it sit; we may try to do something creative with it, but we don't have any plans at this point.

Okay. Maybe the last question and I'll hop out, for Jim. To the extent this quarter's loan growth is maybe not indicative but just indicative a little bit of the slower growth into next year, what's the plan? You've addressed the expenses and the credit costs. Is there anything more dramatic on a standalone basis you can do, or conversely is there something along the lines of partnering that would make sense for shareholders?

Obviously, we are not happy with the decline in the quarter being flat from a year ago. We do feel we are still in attractive markets. We are continuing to try to bolster our commercial loan team, and we are optimistic the markets are going to turn, but we also understand the importance to get some growth. But in the interim, we feel like we are executing on the cost saves and our debt instruments. And when the market does turn, we are confident we are going to be able to get our share of the growth.

All right, thank you.

Brian Martin, FIG Partners.

Jim, can you just talk about -- I mean, is there anything specifically you are doing? You talk about the loan generation just at, I guess, maybe an increased focus. Is there anything you can point to that you think is really going to, I guess, speed things up absent a recovery and the economy, or is it just trying to add some staff?

And maybe to that extent have you been successful in adding anyone over the last six months or so? How does the pipeline of talent look to adding people?

Brian, good question. I think it's important to remember at times we get compared to some of the Chicago banks, but being 40 to 45 miles West of the city, our markets are very different. The growth -- the economic expansion has clearly lagged in the Western suburbs. We have added a couple of new lenders.

We're continuing to look for new talent. It's becoming a higher priority. We have bolstered our treasury management group, but we understand that's obviously a high priority for us moving forward, not only the fourth quarter but into 2016. We feel like we have the structure and the staff in place.

We're just trying to be disciplined not to put on a lot of long-term fixed rates or stretch on credit at this point. We feel that would not be the prudent thing to do. So we are waiting for the markets to come back, but we're also looking to add to talent as well.

Okay. And then maybe just one for Doug, the branch closure in the quarter, Doug. Then I guess is that -- are there more opportunities to do that, or is this a one and done type of thing? I guess how are you thinking about the branch structure at this point?

Well, we have closed a number of branches over a period of time. Most of those did not involve write-downs on the real estate as we saw in this case. But in this instance, it was the prudent thing to do. I don't think we have any more on our radar at this point. All options are always open when it comes to managing expenses, but I don't have anything on my radar at this point.

Okay, that's it for me, guys. Thanks.

Sounds like we're done with the questions, Matt.

Okay, if you would like to make any closing remarks.

Thank you, everyone, for joining us this morning, and we look forward to speaking with you again next quarter. Goodbye, and have a great day.