Old Second Bancorp Inc (OSBC) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Old Second Bancorp Third Quarter 2017 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. Jim Eccher, who is the CEO. Thank you, Mr. Eccher, you may begin.

Thank you, and good morning, everyone. Thank you for joining us today for our third quarter earnings call. With me on the call today is Gary Collins, Vice Chairman; along with our CFO, Brad Adams. I will start with a customary reminder that our comments today may contain forward-looking statements which are based on management 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 would ask you to refer to our SEC filings for a full discussion of the company's risk factors. Please refer to our website, under the Investor Relations tab for access to our earnings release.

I have several prepared opening remarks and I will give you my overview of the quarter, then turn it over to Brad for more detail on our third quarter performance.

Let me first say, there is a lot to like about our third quarter results. Net income was $8.1 million or $0.27 per diluted share. Our core earnings were $0.22 per diluted share, it represents our strongest quarter of core earnings since the third quarter of 2008. On a core basis, these numbers represent an 83% increase over the third quarter of last year and a 29% increase over last quarter.

Before we review third quarter highlights, just a couple of brief comments. We believe that over the last few quarters, we have been building momentum on a number of key initiatives, that momentum continued in the third quarter in a meaningful way. Strong loan growth and net interest margin expansion highlighted the quarter as we continue to focus on improving operating leverage. Total loans increased 3.5% on a linked-quarter basis and are up 7.8% year-to-date.

A recent pattern of strong asset generation in the second and third quarters continued this year. We traditionally have softer first and fourth quarters and we expect that trend to continue next quarter as we anticipate a number of large loan payoffs.

Competition for quality loans remains fierce in our primary markets but we have remained disciplined in our loan pricing and credit discipline. Asset quality remains well controlled as well without any significant changes during the quarter beyond a reasonable reduction in the OREO portfolio. OREO balance did decline about $2.7 million or 23% as we had a number of successful resolutions in disposing of these assets.

A provision of $300,000 was recorded during the quarter based on the strength of loan growth, and the flow of ratings changes continues to be positive overall in the portfolio.

Aside from a solid loan growth, we were very encouraged about our results on a number of areas that Brad will provide additional color in his prepared comments.

And with that, I'll turn it over to Brad.

Thank you, Jim. Good morning, everybody. First on the revenue side. Revenue increased by over $1 million from second quarter levels, and noninterest expense decreased by $1.1 million as well. Net interest income, preprovision, made up a little more than half of this, driven by modestly higher loan yields.

On loans and securities, the impacts of loan growth and modest mix shifts within the earnings space, specifically funding a little bit of loan growth out of the securities portfolio during the quarter due to some seasonal softness on the deposit side.

I'd like to point out first off that margin comparisons in 2017 are impacted by the adoption of ASU 2017-08, which accelerated the bond amortization premiums in all periods in 2017. So that's been restated since the last time you guys looked at it. It was adopted on a modified retrospective basis. The impact on last quarter was approximately 10 basis points, which we discussed on the last earnings call. So it's been restated from 381 to 371.

During the third quarter, the taxable equivalent margin increased 6 basis points from this level, and that was driven largely by loan growth with modestly higher yields. There continues to be very little pricing movement on the liability side of the sheet. On a GAAP, the margin increased 7 basis points. Overall, we continue to be very pleased with this level of performance, and Old Second is well positioned in the near term.

Continues to be all about deposits. I think that's true of our industry as a whole. The granularity and long-term nature of the deposit franchise here at Old Second is characterized by high concentration and low-cost transaction accounts. Now third quarter is typically a seasonally weak for us with the run-off of tax deposits, and we saw that with a modest decline from second quarter levels. I'm optimistic, as I sit here today, that we'll see a bit of a rebound in the fourth quarter. So far, very early on in the quarter that looks to be the case. We continue to have very solid traction on the loan and lease side, as Jim mentioned. Linked-quarter loan growth totaled $54.5 million during the quarter and the loan-to-deposit ratio is currently at 84%.

Looking forward, Jim mentioned the seasonal challenges in loan growth for the fourth quarter, and fourth quarter and first quarter are typically our softest with a lot more strength in the second and third quarters. I think we'll see that, but I do maintain some optimism on trends based on the level of originations. I think the variable for us is going to be the degree at which we get payoffs on the loan portfolio. I think origination trends still look very solid.

Core margin trends are currently stable, though they could expand further with additional movements in interest rates. I'm a bit OCD. I come in and check the probabilities based on Fed fund futures basically every day. December, obviously, I think most of you know what that looks like. It certainly looks more than probable at this point. I think the degree of expansion from here will depend upon those rate moves and also upon deposit pricing trends in our market.

It still looks to me like margin pressure that's out there for banks like us is focused on high-balance money market accounts. We haven't seen a lot of movements on -- in more granular side of things, that continues to be true as we talked about last quarter. On the fee income side, wealth management and trust income continues to perform above budgeted expectations for us despite a seasonal decline from second quarter.

Mortgage banking margins had a slight decline during the quarter that was partially offset by a decrease in the magnitude of interest-rate driven valuation impairment non-MSRs. Commercial swap fee income continues to be a very strong performer and was responsible for the bulk of the growth during the quarter.

Expenses, overall, remained very well controlled with positive comparisons to last quarter from the onetime HR expenses that we talked about previously. Operating leverage, as Jim said, remains the focus for us. And obviously, that's a pretty good story this quarter. Not much really to talk about in terms of trends within individual line items on the face of the income statement, but we are continuing to invest and continuing to look to hire, as Jim mentioned, and we've made some progress there. We are also looking at infrastructure investments in risk management. We've increased headcount there. It's already in the run rate. And we'll enhance our management reporting capabilities and compliance as well.

The effective tax rate for the quarter was obviously below trend. There was a $1.6 million benefit or $0.05 per diluted share recognized during the quarter related to the increase in Illinois tax rates. Best guess going forward given the current makeup of the bond portfolio would be in the neighborhood of 30% to 31% for an effective tax rate.

That's really all I have. With that, I'll turn the call back over to Jim?

Okay. Thanks, Brad. In closing, yes, we're obviously very encouraged about the quarter. And although we anticipate a seasonal slowdown in 4Q as it relates to loan growth, we are nonetheless pleased with where the company is heading. Operating leverage remains very strong. We continue to remix the balance sheet. Solid growth along most of our business units. And as Brad mentioned, expense control is very strong. The efficiency ratio for the quarter was well below 60% and has moved -- has improved dramatically in recent quarters.

I am perhaps most encouraged by the traction we are getting in meeting with new potential relationship managers. We have added a few lenders on the commercial side here recently and continue to look to hire talented bankers. You'll probably see additional impact here from those efforts as we believe our story is becoming more compelling with the increased Chicago presence. That covers it for us. It concludes our prepared comments so I'll turn it over to moderator and open it up for questions.

(Operator Instructions) Our first question comes from the line of Michael Perito of KBW.

Mike, I'm pinching in for Chris today. I wanted to maybe start on just the near-term expense outlook. It had a nice rebound back down this quarter, but it does sound like there were maybe a couple adds on the commercial in Q3. I'm just kind of curious if there's any kind of near-term outlook you could help us with the expense line item maybe for the next couple of quarters here?

Yes, I will comment on the new hires. We have had a couple. They're really more in the second and third quarter, but as it relates to headcount, it was net neutral as we had a couple of lenders also exit. So I wouldn't expect the run rate on salaries to really change materially. As far as the other expense line items, we're not anticipating any meaningful changes.

Okay. That's helpful. And then on the commercial swap income, I think the fees were pretty much about $7.7 million, x securities gains for the last couple of quarters here. I mean it sounds like you guys are a little -- feeling good about some of the opportunities on the swap side and within trust. I mean is there an expectation to kind of see some continued modest growth in noninterest income as we move into 2018?

Yes, obviously, the swap fee income is something we'd certainly like to see that trend continue. That's, obviously, contingent on the loan originations and closings. As I've mentioned, we do expect a little bit of slowdown here in the fourth quarter. But we certainly expect to see consistent results on the swap side in 2018. As far as other noninterest income line items, we continue to see pretty steady progress in our wealth management group. The mortgage -- the residential mortgage side of the shop is heading for a seasonal slowdown in 4Q. But we have been delivering pretty consistent results there. So we expect '18 to be similar to '17.

Okay. Just couple of more quick ones for you. Maybe 1 for you, Brad, just on the margins. You talked about how -- obviously, we're not 100% sure yet which way the Fed's going to go in December. But can you maybe frame for us what kind of positive impact you think you would see if we do get another hike in the short term -- shorter part of the curve here as with your balance sheet as it stands today?

So yes, this is the conjecture part and that's always fun, but -- with all the usual caveats, but certainly what's in there right now is the December rate hike and that leaves the bulk of the quarter unchanged. I certainly don't feel worse than stable. And I have been pretty consistently long to the conservative side at this point, given the degree of expansion that we've seen over the last 9 months. So it's hard not to feel pretty darn good. To say it is in December, I would think that would positively impact it by at least a few basis points.

That being said, some of that depends on what we actually do with the balance sheet. I'm not particularly enamored with levering into this curve, and I don't level out of the spreads that are available from a fixed income side. So I'm a little averse to lever into it. We could certainly make more money if we did so but that doesn't feel prudent at this point. So modest to slightly higher, if that rate hike occurs, I think is about all I can say.

Yes. No, that's helpful. And that kind of moves me into my last question. I mean, you -- Jim mentioned that the Q4/1Q seasonal slowness in the loan book, but it sounds like deposit growth might pick up in the fourth quarter and you guys have had some pretty strong fourth quarter deposit growth performance in the past. I mean, is it going to -- it's kind of sit heavy in cash for a quarter or two potentially or do you expect it could be some built back up in that investment portfolio in the fourth quarter?

No, I don't anticipate growing the bond portfolio, given the spreads that are out there right now, that just doesn't feel like smart play to me. So I think we'll ride with that where it is. I think that to the degree deposit growth returns, the magnitude of the such will determine the level of borrowings. Like I said, I'm not anxious to lever and it -- what looks not all that enticing from a fixed-income investment standpoint to me.

On the loan growth side, originations remain very strong. The variable for absolute level of loan growth for us is going to be the degree of payoffs. We've had substantial payoffs this year and still managed to produce some growth. So I'm cautiously optimistic, but origination trends remain very solid, that obviously bodes well for swap fee income. But the level of net balance sheet growth will, as I said, be a function more of payoffs than anything else.

Our next question comes from the line of Andrew Liesch of Sandler O'Neill.

Just curious, was there -- was any of the loan growth this quarter purchased similar to that last quarter?

No. There was some participation activity club deal, but the bulk of it was organic.

Got you. And then, now we've got -- we've built up -- the capital ratio is pretty strong, TCs over 8%. Just -- what's the thought on more acquisitions, anything like the Talmer branch deal, a whole bank -- of a whole bank deal. What's your -- what are your thoughts there?

Well, banks are sold and not bought. So certainly, our phone lines are open, we will remain disciplined. Can't foresee when those things will happen, but we're certainly open to evaluating it. Discipline is the name of the game. And what is important to us as we've said now for last 6 months is the integrity of the deposit base. And in a rate environment like this and the outlook for rates in the future, deposits are the name of the game.

Andrew, obviously, our strategic focus continues to be original organic loan growth, one; hiring or lift-outs would be our second strategy; and then M&A, obviously, would be our third option. And we certainly would be willing to look at that if it is a strategic move for us.

Our next question comes from the line of Kevin Reevey of D.A. Davidson.

Brad, could you talk a little bit about the yields on the new loans that you're putting on relative to over the last couple of quarters and the trends?

Yes. So the weighted average yield for new originations in the third quarter was down a little bit due to the nature of the originations and the magnitude of the swap fee income. So we were kind of in the 4.15%, 4.10%, 4.15% range in terms of what was originated, given the swap activity that's associated with that. A little bit below second quarter levels. But so far in the third quarter, that should bounce back a little bit -- or in the fourth quarter, should bounce a little bit.

And then, can you also talk about the -- Jim, if you could talk about the competition for talent. I know everybody I talked to in Chicago is looking at team lift out.

Yes, it's -- our opportunities have improved significantly since we've made the commitment to move into Chicago. We're having active dialogue with more lenders. And you're right, Kevin, it is very competitive. But our story is becoming more compelling. And I think when you look at the Chicago landscape, there's fewer and fewer banks in that $2 billion to $3 billion range. And that is an attractive size for a lot of lenders.

And then, my last question is for you Brad. Can you talk about -- it looks like your deposit service charges were up almost 7% linked-quarter, did you change your deposit pricing? Was that NSF fees? Or just higher? Can you kind of talk about the growth in that line item?

No real pricing changes. I think that we have seen -- the rate of decay on overdraft fees has certainly slowed, that helps just opening new accounts. I mentioned it before, we are a net account grower at Old Second and have been for a long time, but those trends continue to be positive, which is unusual despite what people say in our industry. And I think it's just going to be a function of account growth driving those fees going forward. And the headwinds certainly don't feel as substantial as they've been over the last 2 years.

The -- that's exactly right, Kevin. The other consistent pattern we're seeing is a seasonal uptick in debit card swipes and income in the third quarter, typically with higher consumer spending. So that was a nice trend that's continued.

And so you expect to see that trend in the fourth quarter, I guess, with the holiday season as well?

We typically do, yes.

(Operator Instructions) Our next question comes from the line of Brian Martin of FIG Partners.

Sorry, I joined late so I may have missed some of this, Jim. But just the -- can you talk about -- you -- Brad touched on it too, the payoffs that you guys have seen, I mean, have -- were they high this quarter as well. I guess, I know you talked about in the year they've been high, but were they elevated this quarter? And just kind of can you talk -- can you give a little background on what the production was versus what the payoffs were this quarter?

Yes, so I -- this quarter -- third quarter, we did not have as many payoffs. And these large loan payoffs really stem from sale of various real estate investments from a lot of our clients, they are not due to refinancing in large part. We did have one large credit that did exit. That was not the result of a loan sale, but I would say the second quarter was a little bit lower than the third quarter. The fourth quarter will have more due to properties that are under contract that we expect to see close later in the quarter. So there is some lumpiness in that. It's hard to predict. But second and fourth quarters this year look like larger payoff quarters.

Okay. And the loan pipeline today, did you give a little color on where that sits today? Maybe I missed it or...

Yes. In our prepared comments, Brian, we typically see a seasonal slowdown in 4Q and even lagging into the first quarter, that appears to be the case. Although, it feels better this year than last year. Pipelines are certainly not as robust as the second and third quarter. So we're hopeful that we see some moderate growth in the quarter, but it would not be surprising if we were flat.

I got you. And then, maybe just one last question for Brad, just as it relates to the loan yield comment you just made about maybe a little bit of a drop in that loan yield. It looked like the loan yields were actually up on a linked-quarter basis. I guess, just in -- kind of tying together your comments about maybe being a little bit lower. I guess, the loan yields in the quarter, I guess, what was driving -- did I miss that, Brad?

Well that's -- what that comment was that -- answer to that question was strictly around originations during the quarter. We still got the impact of originations last quarter. And certainly, even that level of origination is still a margin pick up for us. When you see large loan payoffs to -- typically the larger loans are at lower yields than the smaller, more granular type. So those trends still feel very positive to me. We continue to watch the deposit side and that will drive the margin, but there's nothing to be upset about at this point on the asset generations side.

And what we did generate in the quarter, Brian, more than half of it was floating in nature. So that's, obviously, where the swap income came from. So we're positioned well in the event that the rates continue to tick higher.

Right. So the outlook is more -- like Brad said, more positive than negative on the margin. And then, did you guys comment on the -- I know you had the tax benefit in the quarter, but just the -- what the outlook is for the tax rate? How we should think about that?

Yes, given the makeup with the muni concentration, somewhere around 30% to 31% feels kind of right to me.

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to management for closing remarks.

Okay. Thank you, everyone, for joining us today. And we look forward to speaking with you again next quarter. Goodbye.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.