Old Second Bancorp Inc (OSBC) 2016 Q3 法說會逐字稿

Greetings and welcome to the Old Second Bancorp's third-quarter 2016 earnings conference call.

(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, think 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 today are Mike Kozak, Executive Vice President and Chief Credit Officer and Jim Eccher, President and CEO. And now I'll turn it over to Jim.

Thanks of Doug and good morning everyone. Thank you for joining us today for our third-quarter earnings call. I have a few opening remarks and then we will give you my overview of the quarter and turn it over to Doug and Mike for a more detailed report on our operating performance and our recently announced acquisition of the Talmer branch and then we'll take your questions at the end.

Third-quarter operating performance was mostly positive in many areas. Core earnings continued to show improvement as key business lines reported improved results. As we have discussed in prior quarters we have been very focused on building and growing quality earning assets and we feel we made very good progress particularly in building the loan book this quarter.

Reported third-quarter net income available to common stockholders is $3.5 million or $0.12 per diluted share, compared to $3.6 million or $0.12 per diluted share in the third quarter of 2015. We did incur some meaningful acquisition related expenses in the quarter that led to lower earnings. Adjusting for the non-core items would have added an additional $0.04 to earnings per in the quarter which is about 23% greater than last quarter, and approximately 33% better than the same quarter a year ago. Doug will provide additional color in his prepared remarks shortly.

On August 1, we agreed to acquire the Chicago branch of the Michigan-based Talmer Bank and Trust including approximately $80 million of deposits and approximately $238 million in loans. We have received all regulatory approvals and expect to close in the fourth quarter.

We view this acquisition is very attractive and strategic for our Company on many levels. In addition to bringing aboard a veteran Chicago management team we are adding several end market commercial managers with deep relationships in the Chicago market. Our new relationship managers with the Talmer group had done a great job with client retention and have actually started cultivating new opportunities during a challenging transitional period.

For our Company expanding into an attractive Chicago office will provide additional future organic growth opportunities along with the potential to add additional Chicago-based bankers. We expect the financial impact of the transaction to be accretive to earnings per share in 2017 by greater than 15%.

Additional highlights in the quarter include a solid loan growth, a stable net interest margin, a very strong performance in our mortgage business, controlled noninterest expenses and continued good credit performance. Overall we're very encouraged by our progress this quarter and we feel we're very well positioned with our low cost deposit base and future prospects for quality growth heading into 2017.

With that I'll turn it over to Doug.

Thanks Jim. As Jim mentioned, net income in the quarter was $3.5 million or $0.12 per share compared to $3.6 million or $0.12 per share in the third quarter of 2015. For the year-to-date net income was $10.7 million or $0.36 per share compared to $9.7 million or $0.33 or share in 2015.

Earnings in the quarter, and the year to date, were impacted primarily by $2 million in losses on security sales. These securities were sold in order to execute the purchase of the Chicago branch of Talmer Bank, which is now Chemical Bank, that we announced on August 1.

As far as it's immediate impact on earning assets we are shifting from securities to loans at a materially higher yield. I would also add that while the investment portfolio was reduced by over $200 million during the third quarter, the book yield increased from 2.32% to 2.55%. As Jim mentioned, on an after-tax basis the loss on securities related to the branch purchase was about $0.04 per share for both the quarter and year to date.

The net interest income was $15.3 million in the third quarter compared to $14.8 million in the third quarter of 2015. For the first three quarters of the year, net interest income was $45.9 million in 2016 compared to $44.3 million in 2015. In large part the increases are related to loan growth of $70 million from September 30, 2015 to September 30, 2016, which increased earning assets by a similar amount.

The net interest margin was 3.22% in the third quarter of both 2015 and 2016. The net interest margin was 3.25% in the first nine months of 2015 and 3.23% in the first nine months of 2016. Noninterest income was $6.6 million in the third quarter of 2016 compared to $5.6 million in the third quarter of 2015.

The securities lost in the third quarter of 2016 and the loss on disposal of fixed assets in the third quarter of 2015, skew this comparison. Excluding these two items, noninterest income increased from $6.8 million in the third quarter of 2015 to $8.6 million in the third quarter of 2016.

However, for the year to date this figure declined from $23.1 million in the first nine months of 2015 to $22.1 million in the first nine months of 2016. These differences were significantly impacted by two related items. The mortgage division had an excellent quarter and at the same time the value of mortgage servicing rates continued to decline.

Gains on sales and mortgage loans were $2.2 million in the third quarter of 2016 compared to $1.4 million in the third quarter of 2015, an increase of $800,000. For the year-to-date gains on sales with mortgage loans were $5 million in 2016 compared to $4.7 million in 2015, or about $300,000 higher. Also we had mark-to-market losses of $147,000 in the third quarter of 2016 compared to a loss of $688,000 in the third quarter of 2015.

However we had mark-to-market losses of $1.9 million in the first three quarters of 2016 compared to $1.2 million in the first three quarters of 2015. This is a category that tends to be negative when interest rates fall and positive when interest rates rise.

Noninterest expenses were $16.6 million in the third quarter this was an increase of $338,000 from the third quarter of 2015, and a decline of $118,000 from the second order of 2016. Noninterest expenses were $52.3 million in the first nine months of 2015 and declined to $14.5 million in the first nine months of 2016, a decline of $2.8 million or 5.3%. Efficiency has improved as the efficiency ratio declined from 73.66 in the third quarter pf 2015 to 66.69 in the third quarter of 2016 and for the year to date period the ratio was 70.88 in 2015 and 68.83 in 2016.

And, finally want to return to the overall earnings picture. For comparative purposes if we use pretax, pre-provision earnings and also exclude the security's loss in 2016 and the loss on disposal of fixed assets in the third quarter of 2015, we have what I would call core earnings.

This figure was $7.3 million in the third quarter of 2016 compared to $5.4 million in the third quarter of 2015. For the year to date, core earnings were $18.6 million in 2016 and $15.2 million in 2015 an increase of $3.3 million or 21.9%.

Now, that hopefully provides some perspective on earnings for the quarter and the year to date. And now I will turn it over to Mike.

Okay, thanks Doug. As Jim mentioned our loan growth was strong during the third quarter and reporting an increase in the portfolio of 3.6% from the June 30 quarter end and up 6.1% from 12/31/2015 year-end. This increase for the nine-month period was over 60% in the C&I Books and we're very pleased about that.

Credit quality continues to trend favorably as well. Our credit metrics improved with NPAs at 2.59% at quarter end, compared to 2.94% for the prior quarter. With the expected addition of the approximately $238 million in purchase loans from Talmer bank the NPA ratio would reduced to below 2.2% based on nonaccrual payoff commitments and OREO sales contracts that we have in place, NPAs are expected to further reduce to probably around a 2% level by year-end. So again we continue to make good progress on that front.

In terms of the categories nonaccrual loans decreased by approximately $1.5 million in the quarter due in large part to charge downs based on updated appraisals on two of our nonaccrual loans. Problem accruing loans did increase by $2 million in the quarter as a result of the migration of two loans that we previously had in special mention to the problem loan status.

OREO assets decreased by $2.1 million in the quarter largely due to the sale of the 11 properties. Valuation write-downs for the quarter totaled $365,000 compared to $489,000 in the prior quarter. As far as charge-offs, for the quarter the gross charge-offs were $1.197 million against recoveries of $358,000 for a net number of $839,000.

Just a comment on the pending purchase of the Talmer loans, the $238 million portfolio, we do not expect this to have a significant impact on our portfolio mix. Our calculation is that investor real estate loans in the combined portfolio will increase from 26% to 29%, C&I loans will increase from 15% to 17%, and owner occupied real estate loans will actually reduce slightly from 24% to 22%.

With those comments, I will now turn it over to Jim.

Thanks, Mike. At this point. Matt, we can turn it over to you and open it up to questions.

(Operator Instructions)

Chris McGratty, KBW.

Jim maybe a question for you. You are getting the loan growth that we've been waiting for which has been great and then you have the momentum with Talmer. How should we be thinking about any expenses that need to come from additional hiring of lenders? Or as you build out the C&I business, maybe a little help on the expense run rate the next few quarters.

With the Talmer group we're picking up, obviously, a very seasoned management team but we are also -- it's almost like a team left out if you look at it that way, Chris. But we will be picking up six very experienced Chicago-based lenders. We do anticipate some cost saves with the integration. So we will have, probably on a net basis, probably an addition of three lenders when it's all said and done.

Okay. So, we should think of the expense run rate that is in the low 16's tick up from here as you are investing in the business? Or are there other areas to pull costs out of the Company?

I think we can probably expect some moderate increase in overhead because we're picking up a pretty good lending team here. But as always we continue to look for operating efficiencies and we've got some things we're working on in future quarters.

Maybe Doug on the credit quality. It continues to move in the right direction. As we think about the accounting impact from this portfolio purchase, how should we be thinking about future provisioning requirements? You have not done a provision in quite some time.

But if growth is picking up I assume this will be mark-to-market so you won't have to provide for what is on the books. But help us, maybe little bit on the reserve ratio and provision requirements. Thanks.

Obviously we've had some pretty good growth, so we are -- and we haven't done a provision in a while, so logically we're getting closer to that point. However trends are all still good. We will have to run into the process and see where we are in the fourth quarter.

I do think the portfolio that we are buying is very clean so we did a very deep dive in due diligence headed by Mike, so we feel really good about the quality of the portfolio we're taking on. But with growth it is logical that at some point we will need to take a look at that.

Right and then maybe just on one last one and the I will hop back. The earning asset remix that is being told here, naturally that will be accretive to your margin. Working your way through that and balancing the environment, is the high 330s low -- around low 340 about where the Company operates in this environment when it is all said and done?

I don't want to put a prediction out there on where the margin will be. Certainly the addition of that loan portfolio is a pretty significant boost and with the securities we selected for sale in order to do the transaction we were able to increase the overall yield of our investment portfolio at the same time. So, I feel very safe saying it is going to be higher but I hesitate to give you a number on the call here.

Andrew Liesch, Sandler O'Neill.

Good to see the loan growth coming in this quarter. Just curious if you have some comments on where the pipeline stands heading here into the fourth quarter with some of this growth in the third quarter pulled forward? Or what is your outlook, generally, for loan growth coming up?

Andrew, generally, fourth quarter for us historically has not been as strong as the second and third. But we're seeing pretty good activity and deal [falls] still early in the quarter. We expect it to slow down obviously around the holidays and then we've obviously got the Chicago Talmer group team joining us as well. We are hesitant to give a lot of guidance but we are more optimistic about the fourth quarter -- first quarter than maybe we were over the past couple of years.

One quick question the security sales. You aren't planing any more? That was done all in third quarter is that correct?

That is correct.

(Operator Instructions)

Joe Simon, Simon Capital.

Most my questions have been answered. I just want to confirm something. Doug, I think when you said you cleansed the quarter, if I'm not mistaken it looked like then operating earnings would have been about $0.16 for the third quarter. I just wanted to make sure that is in line with what you guys said.

Yes, if we take the $2 million loss and we have some other deal related expenses and tax effect, that it would have been about $0.04 per share.

And then again, the accretion income to 2017, that's based upon your run rate for 2016, correct? Was it that?

Yes.

Nice quarter, guys. Thank you.

(Operator Instructions)

Brian Martin, FIG Partners.

I joined a bit late here, so if you covered this I will apologize in advance. But just when -- Doug if you could just talk a little bit about the expenses going forward and opportunities to improve the run rate or if there's anything you guys are looking at specifically that could help that number going forward. And then maybe just separately, on the credit expense, the thought would be the trend is continuing to lower.

Right, first on noninterest expenses we don't have any specific things to announce or anything like that. Of course we have been pretty successful over time of bringing things down -- expenses down as opportunities present themselves but nothing specific on the horizon.

We will, of course, have some expenses with the branch acquisition, obviously that is a clear net positive but we will have some expenses associated with that. We will try to offset that, at least in part, by saving on this side on the old second side of it, but I don't see anything major that we can do on the expense side just more of a hit singles and doubles instead of home runs, to continue the playoff metaphor.

As far as credit expense I just answered that. I think we are -- with the portfolio getting bigger and bigger credit trends have been very good but at some point we will have to. And we run it to a fairly rigorous process each quarter and at some point that is going to result in a provision. But I hesitate to try to predict exactly what will happen and when.

Brian during the call, in our comments, we indicated our valuation write-downs for the quarter were $365,000 compared to roughly $500,000 in the prior quarter. So valuations seem to be stabilizing, we sold 11 properties during the quarter, so things are moving along quite well.

Maybe just the question on the loan growth. Obviously with the new addition coming on it's going to benefit you, but we've heard from some other the banks just that the C&I demand is a bit sluggish or little bit down. When you guys look at legacy absent the acquisition here. How would you characterize the C&I demand across the market and if you did not have the acquisition would you expect to see some sluggishness? And I know you talked about the seasonal fourth and first quarter but beyond the seasonal issues, just -- are you seeing a slowdown or maybe if you can comment a little bit on that it would be helpful.

Well when we look at our production numbers for the last three quarters, we are consistently seeing roughly around 60% of it is C&I. So while I would acknowledge that the market is very competitive we're getting our looks and we're seeing a number of opportunities.

We have been purchasing some [lease] paper from one of our correspondent banks, which has helped a little bit as well. But again, pretty consistent at about 60% of our new growth for our new production for the last three quarters. Obviously we hope that continues to sustain itself.

I'd now like to turn the floor back over to management for any closing comments.

Thank you for calling in today and we appreciate your support and we look forward to talking with you again in the fourth quarter. Thank you.

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