Old Second Bancorp Inc (OSBC) 2018 Q3 法說會逐字稿

Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Inc.'s Third Quarter Earnings Call. On the call today is Jim Eccher, CEO and President; and the company's CFO, Brad Adams.

I will start with a reminder that Old Second's comments today may contain forward-looking statements about the company's business, strategies and prospects, 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 this projected -- from those projected. Management would ask you to refer to the company's SEC filings for a full discussion of the company's risk factors.

On today's call, we will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts in our earnings release, which is available on our website at oldsecond.com under the Investor Relations tab.

Now I will turn the call over to Jim Eccher. Please go ahead.

Okay. Good morning, and thank you for joining us. I have several prepared opening remarks and will give you my review of the quarter, and then turn it over to Brad for more detail on our third quarter performance. I will then conclude with some summary comments and thoughts about the future, before we open it up to questions.

Results overall continue to be very strong. Net income was $9.6 million or $0.32 per diluted share in the quarter. Earnings this quarter were benefited mostly by the resolution of a few impaired credits acquired in our most recent acquisition and negatively impacted higher effective tax rate relative to recent periods.

On a quarter basis, earnings growth this quarter approximated 3.5% unannualized relative to last quarter, excluding merger-related charges in both periods. Results continue to be very positive overall with an expanding core margin, solid expense control, sustained performance across our fee-based businesses and sustained credit improvement.

In regards to the third quarter specifically, total loans declined modestly relatively -- relative to last quarter and continues to be a little softer than we expected at the beginning of the year. Payoffs continued to impact the absolute level of loan growth, although originations remained only modestly below our budgeted expectations.

The competition for credit in our market remains more aggressive than we expected both in terms of pricing and structure. With the tailwinds provided, with the recent acquisition and an expanding margin, we are in a strong position and expect to remain very selective on the credit side. Yields on the portfolio increased nicely during the quarter.

Deposit trends remained solid in the second quarter and third quarter with most -- with modest seasonal outflows and solid overall repricing trends. As expected, most of the decline was realized in time deposits, while our core deposits remained stable.

Loan-to-deposit ratio is now at 86%, and I believe we can remain at these levels in the near term with forecasted run-off from broker deposits offset by growth in other captions.

Asset quality remains very well controlled. Nonperforming assets are now down to 1% of total loans plus OREO. The allowance for loan and lease losses was essentially unchanged during the quarter, despite the lack of loan growth.

In general, loan rating changes continue to trend positively. We continue to feel good about credit trends at this point.

And overall, we remain very encouraged about our results in a number of areas, and Brad will provide additional color in his prepared comments.

Thank you, Jim. Net total revenue, pre-provision and excluding the impacts of securities gains in noncore items showed modest growth from last quarter.

Net interest income was up due to increases in loan yields across variable-rate loan portfolios, with outperform -- outpacing liability cost increases. Fee income was a little softer due to a difficult mortgage banking environment and swap fee reductions.

The reported taxable equivalent margin increased by 1 basis point from last quarter despite a smaller contribution from purchase accounting. Obviously, then it follows the core margin trends exclusive of these impacts did a bit better than that, approximately 5 basis points when you look at it from an excess accretable yield perspective. That is applying the contractual yield to some portion of the accretable yield.

Margin improvement this quarter was somewhat more modest than prior periods due to the outsized movements in LIBOR-based lending rates in the second quarter relative to movements in the Fed funds rate.

Overall, core margin trends are excellent, as Jim mentioned. Pricing movement on the liability side of the balance sheet remains extremely well controlled, albeit with a pickup and time deposit competition continuing during the quarter that I mentioned previously.

We continue to see a great deal of yield being thrown out between 12 and 20 months, looking to capture some portion or giving up some portion of projected future Fed funds increases by those that are not in as good a funding position as Old Second is today.

We have moved rates modestly higher and checking money market and savings captions in response to recent rate hikes. With the goal of remaining within reasonable proximity to the median pricing in our markets, I can say that we are there today, and we are one of the few who have moved base rates at this point.

Overall, deposit betas have significantly outperformed our expectations over the last 12 months and our outlook remains very positive. We continue to be pleased with the outlook for loan and margin trends going forward. The loan-to-deposit ratio leaves us well positioned for higher rates and increased only modestly to 86%. At this level, we have ample flexibility both to continue pursuit of loan growth, while continuing to do the right thing for our customers and protecting our core deposit base, which is our greatest asset, as Jim mentioned.

At this point, I think it likely we'll look at a small portfolio purchase in the fourth quarter to supplement our loan growth trends. I think that loan -- pricing dynamics and competition remain aggressive, to put it mildly, seeing some of the trends out there. That is not something that we are extremely anxious to participate in.

On the fee income side, wealth management and trust income continue to perform above budgeted expectations for us. Mortgage banking, as I mentioned, experienced a decline in gain on sale margins during the quarter and decreases -- significant decreases in the level of refinance activity, a trend I'm sure you're seeing elsewhere.

Expenses remain well controlled, not a ton to talk about here other than the gains in OREO resulting from the resolution of 4 acquired assets, 1 purchase credit impair that was relatively well marked, I guess.

The net contribution of purchase accounting to our income statement was essentially unchanged from last quarter despite some differences in geography on the income statement, spread benefit last quarter and OREO benefit this quarter. Investments for future growth are largely baked into the run rate trends that you have seen from us, including the addition of additional sales personnel.

The effective tax rate for the current quarter was higher than we would've expected. As I mentioned previously, I am largely out of the forecasting business in regards to the tax rate, given demonstrated ineptitude. I do expect we can do a bit better than this going forward, but it obviously impacted the bottom line with pretax earnings up a significant amount relative to last quarter.

With that, I'll turn the call back over to Jim.

Thanks, Brad. In closing, we are very encouraged about the quarter, and we're pleased where the company is heading. On an organic basis, operating leverage remains strong with solid growth across business units and well-controlled expenses.

Returns on tangible equity are excellent, in the mid- to high teens on a core basis, and the interest rate environment provides an opportunity for us to demonstrate our strengths for the first time in a long time. We remain well positioned for higher rates and profitability level is very strong. Credit remains well controlled and improving.

We continue to invest in new talent and look for opportunities to further diversify our loan portfolio. We are comfortable with current capital levels, given the strength of our recent earnings performance and the speed at which we are rebuilding capital. We continue to be on the lookout for acquisition opportunities that meet our return thresholds and are optimistic those opportunities can be realized. And that concludes our prepared comments this morning, so I will turn it over to the moderator to open it up for questions.

(Operator Instructions) Our first question comes from Chris McGratty with KBW.

Maybe Brad to start. On the balance sheet strategy, I think in your prepared remarks, you talked about a portfolio purchase. I know you've done that in the past. Maybe help size up that potential look there? And also help us with the securities portfolio. I know there's some movement in the deposit base. I'm just trying to figure out how the direction of the securities book will trend?

In terms of a portfolio purchase, thinking right now is somewhere around $20 million. Certainly, we haven't been there on the loan growth side. I would call that half strategic and half having payoffs well ahead of our expectations largely and very high quality commercial real estate loans. As Jim mentioned, our overall origination activity is largely within spitting distance of what generated 10% growth organically last year, which is interesting in terms of trends. In terms of the securities portfolio, it is not my expectation that you will see any growth there whatsoever. It remains the most significant source of duration on our balance sheet, which is proven to be obviously very asset sensitive. And it largely needs to stay where it is, especially given the overall dynamic without any significant loan growth at this point. Deposit trends feel good, deposit betas feel excellent and we continue to only see pricing pressure within the time deposit caption due to competitive moves. We have made it through a big glut of repricing that came at us during the quarter. It is somewhat more subdued going forward. I think that largely gets at the things you wanted to, Chris, unless I missed something.

Yes. The only other question, a couple of quarters ago you talked about bringing some deposits back on. I'm just interested if you've done any of that through magnitude and any thoughts about that going forward.

We have done some. We have aligned on potentially upwards of another $20 million or $30 million that could come on in the fourth. That is relatively higher cost funding. I would reiterate that our exposure to high balanced deposit relationships at Old Second is a fraction of what you would expect to see at a bank this size. It's a huge advantage in rate environments like this, and it makes me look smart when I've had nothing to do with it, which is kind of fun.

Makes up for the tax rate, I guess.

Correct.

Just if I could ask one more on the expenses. You had the recovery in the quarter. You talked about really kind of being aligned with where you need to be, but maybe a little help next few quarters on the run rate of expenses?

I don't see anything that would be a departure from the trends that we've shown this quarter. There is not -- I don't see any significant pressure on specifically the salary and benefits line in the fourth quarter. It could back off a bit. Obviously, we're through a lot of the FICA seasonal stuff that you typically see and get some relief on in the fourth quarter. I think that will continue. I think, looking forward, we should be looking at something in terms of comp increases that are in the neighborhood of 3% all-in, and then probably within health benefits, something that's mid-single digits. So there is nothing that makes me uneasy on the expense side either in the fourth quarter or into 2019.

(Operator Instructions) Our next question comes from Andrew Liesch with Sandler O'Neill.

This is actually Thomas Gagen on for Andrew today. So just to go a little bit deeper into loan -- looking at loans. Is there -- I know that the growth is tough, but is there anywhere where you are seeing any optimism maybe by loan type or specific locations?

Yes. Thomas, most of our success in growing the portfolio this year has been really in the C&I book and also particularly in the leasing vertical that we're building out. We have added new talent in that group over the last 2 quarters, so we're optimistic that pipeline continues to build, but our C&I book is up. I think it was up 9% on a linked quarter basis this quarter. Where we're seeing the pressure is on, as Brad alluded to, is quality CRE borrowers are taking advantage of market opportunities and selling their properties at an accelerated pace, significantly more than we had budgeted. So that's the nature of that portfolio -- that, coupled with the fact that we are getting a lot of looks at some quality transactions, but have chosen to not pursue those due to aggressive structure and pricing.

Okay. Got it. And then just a little bit deeper into the M&A outlook. What is the tone then with potential sellers lately?

Yes. I have said previously that this is among the best M&A environments that I have seen in my career, I think, from a buyer's perspective, just to be clear. I think that remains the case. Our priorities are unchanged. We have an intense belief that value in community banking comes from the liability side of the sheet and that is what we are looking for. We think that reasonable pricing, if you're focused on the liability side of the sheet, can drive exceptional returns, where everybody wins. And that's the focus. And I think that I'm quite confident that the opportunities will be there for Old Second, and I hope that investors trust that we will remain disciplined and selective on that, given what we've done up to this point and just sharing our knowledge on how we look at things.

There are no further questions. I would like to turn the floor over to Jim.

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