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Old Second Bancorp Inc. (NASDAQ:OSBC)

Q1 2013 Earnings Call

April 25, 2013 11:00 AM ET

Executives

Douglas Cheatham – EVP and CFO

Bill Skoglund – President, CEO and Chairman

Jim Eccher – EVP and COO; President & CEO, Old Second Bank

Joe Marchese – EVP and Chief Credit Officer

Analysts

Brian Condrad – Private Investor

Brett Ladendorf – New Salem

Brian Martin – FIG Partners

Jim Koran – New Salem

Robert Krauss – Private Investor

Operator

Greetings and welcome to the Old Second Bancorp’s First Quarter 2013 Earnings Conference Call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation.

If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad.

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Doug Cheatham, Executive Vice President, and Chief Financial Officer. Thank you. Sir, you may begin.

Douglas Cheatham

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.

Now, with me this morning are Bill Skoglund, President, Chairman and CEO of Old Second Bancorp, President and CEO of Old Second Bank, and Chief Operating Officer of Old Second Bancorp, Jim Eccher, and Executive Vice President and Chief Credit Officer Joe Marchese.

And now, I will turn it over to Bill to get things started.

Bill Skoglund

Okay, Doug. Thank you for your interest in our stock and the bank and for joining us this morning. This year, we started with four main goals; one was to continue to reduce problem loans and assets, second achieve consistent profitability of the bank and the Bancorp, and three, maintaining growth capital, and then new in 2013, start growing loans and deposits. And I’m pleased to report that we’re off to a good start on all these goals.

First on the classified asset reduction, this is the ninth consecutive quarter we got a reduction in classified assets and overall classified assets went down another 20 million this quarter.

The end of the quarter was 65 million in non-accrual loans which is down 13 million from the year end, and down 72% from the peak in June of 2013 which we had 230 million in classified in the non-accrual loan.

In OREO, we ended the quarter with 66 million which is down 6.8 million from the year end. Our ratio that our regulators follow closely is our total classified assets to tier one capital plus the allowance for loans.

This ratio at the end of the quarter was 71.66% and then down from the peak of 180% in December of 2010. In addition to reducing classified assets, we’re able to show loan recoveries this quarter of $4 million and new charge off of only 1.5 million for a net recovery of $2.5 million.

As a result, we were able to take the $2.5 million out of the reserve and add this to earnings and our reserve level is basically the same as it was at the end of the year.

Regarding earnings, this quarter, we’re happy to report earnings of both the Bancorp and the bank at the Bancorp, we earned 5.5 million in net income and at the bank, 6.5 million.

And on the capital side, from a regulatory standpoint of the bank, we have a leverage ratio of 9.94% in total capital, 15.56% both well above the regulatory requirements of eight in three-quarter and 11 in the quarter.

At the Bancorp, we need all regulatory ratios and do now show a small positive tangible capital ratio. And we understand the need to continue to improve this tangible equity ratio and we’ll continue to evaluate ways to address is as we heal ourselves.

Before – start growing loans and deposits, part of this growing loans may take some time to achieve, but we’re making good progress in getting there.

Loans were down 37 million from year end, but most of this was coming from pay downs and our problem in watch loans and I am however encouraged by our ability to add new lenders and our building, our pipelines, rather well.

Deposits are mainly all core and are up slightly from year end, and we continue to maintain our number one market share in Kane and Kendo [ph] counties. Meanwhile, until loans do start to grow again, we continue to build liquidity and our security portfolio is now at 576 million.

And although we still have more to do, I’m gratified that we start seeing all of our hard work beginning to show good results. And we’re optimistic that this will continue in 2013.

Also by continuing to improve in these four areas, we continue to strengthen the bank which if these trends continue, could eventually lead to the removal of the consent order and recovery of our deferred tax assets which is $76 million.

In addition in the quarter, the treasury did auction off their TARP investment in the bank and although this auction went for a lower amount than I would have predicted.

A look at this sale as a positive for our shareholders as it removes most of the TARP rules and gives us additional strategic opportunities in the future.

And with that, I’ll turn it back over to Doug for his additional comments.

Douglas Cheatham

Thanks, Bill. In the first quarter, we had a net income of 5.5 million compared to a loss of 3 million in the first quarter of 2012. Net income available to common stock holders was 4.2 million compared to a loss of 4.2 million a year ago.

This was the fourth straight quarters of earnings. The negative loan loss provision of 2.5 million was the most notable item from an earnings perspective because we’ve seen material and consistent improvement in asset quality and as various problem loans have been settled or a property sold, the release of excess reserves was required.

Net interest income of 13.9 million was flat compared to the fourth quarter, but down 1.2 million from the first quarter of last year.

The net interest margin ratio was 3 18 in the first quarter of 2013 and 3 48 in the first quarter of 2012. The ratio was up one basis point essentially flat compared to the fourth quarter of 2012.

The reason for the ratio decline year over year is asset mix while loans decline by 209 million, the securities portfolio increased by 240 million.

Although we have been able to capture positive margins and securities, the overall impact is to decrease margin ratio.

During the first quarter, we were net acquirers of asset back securities, all sales paper and agency step up notes. We divested CMOs and mortgage back securities and that result is that we sold longer duration securities dropping the portfolio duration from four – excuse me, from 2.44 to 2.15 while the portfolio yield increased. This restructuring also resulted in a $1.5 million gain.

The non-interest income was 10.6 million compared to 10.5 million a year ago. The first quarter of 2013 includes the securities gains of about 1.5 million that I mentioned. We had a gain of 100,000 in the first quarter of 2012.

This year, we also had a $600,000 income item related to the call back of restricted shares as the result of the treasury auction of preferred stock.

Non-interest expenses in the first quarter were 925,000 lower than the first quarter of 2012 and down 2.6 million from the fourth quarter.

The most ordinary operating expenses were flat to slightly down. In addition, other real estate valuation expense was 513,000 lower than a year ago and 2.3 million lower than the fourth quarter of 2012.

Other expenses of OREO properties were 455,000 lower than a year ago and legal fees was 362,000 lower than a year ago.

As we get rid of non-performing loans and other real estate, these are the kinds of expense reductions that will benefit the bottom line.

The positive earnings tangible capital moved up in the quarter bringing the tangible common equity ratio to 0.05. A regulatory ratio of the holding company level continue to increase and remain within regulatory guidelines. The leverage ratio was 5 11 and the total capital ratio was 14 13.

Capital ratios at the bank level were very strong. The bank’s leverage ratio was 9.94 and the total capital ratio was 15.56 and these ratios continue to increase.

The debt to re-capital financial provision and earnings at this point, I’ll turn it over to Jim Eccher.

Jim Eccher

Thanks, Doug. I’ll keep my comments brief and then open it up to questions. As both Bill and Doug noted, credit quality was the highlight again for the quarter. We had very positive momentum from prior quarters and those continued in the first quarter.

Those remediation efforts led to pretty meaningful reductions in many problem loan areas. Several loan cases reached resolution which drove nice recoveries in the quarter.

Cases continue to work through the remediation process and we’re accelerating our efforts to resolve this as quickly as possible.

Classified assets declined 11% in the quarter, down 44% from a year ago, non-accruals down 16% in the quarter now fallen 42% from a year ago.

More importantly, non-accrual inflow continues to be minimal. We only had one meaningful credit totaling about $2.5 million that migrated to non-accrual in the quarter while several other relationships were upgraded as a result of improved operating results as non-accrual outflow totaled $5 million of which about 490,000 migrated to OREO.

Again, the highlight in the quarter was the meaningful reduction in the OREO portfolio and the recovery of a significant deficiency judgment from the litigation settlement.

Total OREO of about 65.7 million declined 9% in the quarter, has now declined four consecutive quarters.

OREO outflow exceeded inflow by better than a 2 to 1 ratio as we have 14.6 million in outflow and 7 million in inflow for the quarter.

We expect OREO inflow to continue to accelerate in the coming quarters as more problem loan cases make the way towards resolution. We’re seeing real estate valuations now only adversely affecting portions of our OREO portfolio mainly special purpose commercial real estate and retail assets.

But that rate of decline is slowing. And most other asset classes, we are seeing valuations beginning to stabilize.

The residential OREO property sales were brisk [ph] in the quarter, we continue to see a steady stream of sales in the one to four family properties as outflows exceed inflows for the quarter.

Larger, more complex properties continue to take additional time, but we’re seeing investor interest continue to improve.

We successfully sold large positions and a sizeable retail property, two large multifamily properties and most encouraging, a large track of raw land zone for residential development.

Similar to the fourth quarter, we netted values and excess of our carrying cost in the quarter and we realized a gain on sale of OREO of 2.5 million in the quarter.

As Bill mentioned, prospects for new loan growth remains very challenging in our primary market area and we continue to see declines in our loan footings in the quarter and run off and problem related assets has exceeded our new loan fundings.

And while that loan demand remains relatively weak in our core market, our business development efforts are beginning to slowly build.

Pipelines are ramping up and while growth remains elusive at this point, we’re optimistic that we will be able to extend [ph] the run off later this year.

We have, as Bill mentioned, we’ve been successful in our recruiting efforts in hiring several new relationship managers as we’re working to rebuild the commercial bank.

On the residential banking and wealth management side, both continue to drive solid non-interest income for the company as both divisions continue to see increase in opportunities for new business.

Our retail bank continues to grow core deposits as their funding mix continues to improve and we continue to be primarily core funded and had no broker deposits at quarter end.

Our strategy remains to attract and build core relationship business and continue to improve our core funding mix.

With that, I will turn it over to the moderator and we can open it up to questions.

Question-and-Answer Session

Operator

(Operator instructions) Thank you. Our first question is coming from [inaudible]. Please proceed with your question.

Unidentified Analyst

Good morning.

Douglas Cheatham

Good morning.

Bill Skoglund

Good morning.

Unidentified Analyst

Just quick question. Is the bank prepared to make loans to home builders?

Bill Skoglund

You know, maybe we should have Jim answer that one, but you know, we’re prepared to make good loans to anyone. It’s difficult to do spec at a lending or land development, but you know, if someone has a property that’s pre sold or cost back [ph], then we’re doing a little bit of construction on commercial and residential.

It’s not huge numbers yet, but we would be prepared to dip our toes back in that again if it’s under the right conditions. And Jim, I don’t know if you would comment.

Jim Eccher

Yes. You know, that’s part of the portfolio obviously, an area we’ve taken a lot of pain and over the cycle, it’s now about 3.5% of the loan portfolio. We’re continuing to work that down. We’re not seeing a lot of demand in construction and homebuilding opportunities in our market, but I would say that we would consider perhaps some pre sold construction loans at this point and be very careful of anything speculative or significant volume in land development.

Unidentified Analyst

Thank you.

Operator

Sir, did you have any other questions? Okay, we’ll move on. Our next question is coming from Brian Conrad [ph], private investor. Please proceed with your question.

Brian Condrad – Private Investor

First, congratulations on an excellent quarter. My first question is, when do you expect to be able to see a relief of that deferred tax asset? I mean you’ve had four quarters of profitability. Would you expect to see that after five quarters of profitability?

Bill Skoglund

Well, I can’t really say exactly when that will be. We don’t know until the analysis is done and I don’t want to try to predict exactly what will happen in the future, but I will answer by saying that we have seen other banks take that back in anywhere from four quarters on up to eight quarters.

Usually it’s more like six to eight quarters, but that’s just a general guideline, it’s not a hard and fast rule. It depends a lot on the individual circumstances of the bank.

Our trends are really good, we’re starting to make some money. So with each quarter, I’m more optimistic that we’ll be able to take all or part of it. I always want to point out that it’s no necessarily all or nothing. It could be partial recovery of that.

So without trying to put an exact date on that, I guess I’d still continue to characterize that in a positive way, but I’m not going to try to predict which quarter it will be.

Brian Condrad – Private Investor

And you talked about raising additional capital, before. And one of the options was to convert the Trust Preferred and now, with the auction of the TARP, I would imagine that it would be an option to perhaps convert the former TARP funds into equity. If there – one of those categories that would be more beneficial to the bank versus the other?

Bill Skoglund

This is Bill Skoglund. You know, our approach today is to continue to heal ourselves and get our stock price up to where it makes sense from the existing shareholders, and then to look at all of our strategic options.

So I see the stock price up a little today, but we just need to – I think the best approach for everybody is heal yourself, get a stronger footing, you know, work towards things like getting the consent order off, get the DTA back, and then look at our capital options and try and solve for the deferrals that we’ve been taking and trends prefer and look at what the least we’ll do – buyers buy [ph] one on TARP.

But I think it’s a little early for us to start thinking of those. I think it would still be too dilutive to our existing share holders to try and jump into the capital markets today, or give away too much stock.

If we give away too much stock, we lose the DTA and so we’re very cognizant of getting of the consent order, getting the DTA, taking those steps, improving the earnings, and then later in the year, hopefully, to take a look at all of our strategic options might be at that time.

Brian Condrad – Private Investor

Is there any more flexibility that you gained with pre regards to saying the deferred dividend is on the Trust Preferred because of the auction of the TARP?

Bill Skoglund

No. I think those are separate issues. You know, we haven’t have the cash in the Bancorp in order to pay those dividends to both those entities. And right now, we don’t have that cash in the Bancorp in order to do that.

So over time, could we earn enough cash, you know, possibly, it would take, at the right time when we get some capital, to either take care of those or work on other strategic options, we would do that. But today, we don’t have enough cash in the Bancorp to catch up on the dividends. And we’re hoping that as we continue to earn those strategic options open for us, and we look at it.

The Trust Preferred have a deadline where we can defer for 60 quarters on the trust preferred which is in the latter part of 2015 for us. And we could continue to defer on the TARP as long as we wanted, but we couldn’t give dividends to the share holder.

But our strategic plan is not defer those any longer than we have to until it makes sense for our share holders to do anything with capital. And it’s possible we could earn our way through some of this too. In that way, right size the capital.

You know, I looked at some of the banks in the Chicago area and their capital versus their asset side is much higher than ours. So some of the banks that went in early and got capital, got too much capital and they have a problem of having to grow and earn for that capital.

I think on benefit, you know, we suffered a lot the last two years for now having a lot of excess capital, but now, to me, it seems like this is the best time for us to right size the capital, in other words, not get too much, to get enough at the right time. I think that will work out the best for our share holders that we don’t have 20 times as much capital, but only four times as much earnings as some of the Chicago banks.

Brian Condrad – Private Investor

I think I might have heard you wrong, but the deferral is 20 quarters, right?

Bill Skoglund

Deferral is 20 quarters. I’m sorry. Did I say – I said 60, didn’t I? It’s 20 quarters, you’re correct.

Brian Condrad – Private Investor

Okay.

Bill Skoglund

It’s the fall of 2015. You are correct.

Brian Condrad – Private Investor

60 months.

Bill Skoglund

60 months.

Brian Condrad – Private Investor

Okay. All right. And it looks like as last quarter, you continue to see positive values on your real estate. Are you all going to consult and you still expect that to continue?

Bill Skoglund

Joe, can you answer that one?

Joe Marchese

We’re still seeing some devaluations on certain types of properties. But by and large, we do expect positive recoveries for the larger assets in the ORE portfolio, some of the assets of lesser value. We would expect to take some moderate losses on, but selectively, at least base on what we have in the portfolio right now, I would expect this scenario to continue for a little while longer.

Brian Condrad – Private Investor

All right. Thank you very much. That’s all my questions.

Bill Skoglund

Thank you.

Operator

Thank you. Our next question is coming from Brett Ladendorf of New Salem. Please proceed with your question.

Brett Ladendorf – New Salem

Good morning. My question is...

Bill Skoglund

Good morning, Brett.

Brett Ladendorf – New Salem

Good morning. My question is really to the REO, number one, could you speak to the nature of the additions for the quarter albeit they’re small at 7 million?

And could you also talk about the trend of the OREO expenses as a percentage of OREO – it seems like the trend has been, to go down. Is that a trend you expect to continue?

Jim Eccher

Yes, I’ll answer part of that. This is Jim Eccher, and I’ll let Joe Marchese answer part as well. Obviously the OREO portfolio has come down nicely from a peak of over 100 million where it’s 65 million. So the very nature of the size of portfolio shrinking, we’re going to have lots of carrying cost.

Furthermore, of that 66 million, about half of that is now in construction related assets. Largest part being residential lots and some commercial lots. And while historically, those have been hard to move, we’re seeing more activity as of late. But I think one of the characteristics of construction related asset, the carrying cost are much lower obviously with asset like that.

So for the quarter, we had about 7 million in inflow. Over half of that was residential properties. We did have one large income producing property that actually came in and was sold shortly after that. But nothing unusual. I think more of what we’ve seen in the prior quarter.

Joe Marchese

Yes. Brett, this is Joe Marchese. The number of larger properties in OREO is way down from what it was previously.

And we really have reduced the number of properties that have the higher carrying cost as Jim alluded to. A good segment of this is properties that have very, very little carrying cost. So that is what is supporting that trend in reducing ORE expense.

Brett Ladendorf – New Salem

Okay. Thank you.

Operator

Thank you. Our next question is coming from Brian Martin of FIG Partners. Please proceed with your question.

Brian Martin – FIG Partners

Hey guys.

Bill Skoglund

Hi, Brian.

Brian Martin – FIG Partners

Doug, can you just talk a little bit about kind of your read – I’m talking about that recovery of the DTA, I mean is it primarily just a function of profitability, I mean this kind of credit quality, other factors weigh into that, or I guess, what have been your discussions of that?

Douglas Cheatham

Well, if entire picture really comes into play, it starts with earnings trend. It relies heavily on anticipated future earnings because the concept being that in the future, you will generate taxable income that will allow you to capture the tax benefit of the different tax asset.

So it really comes down to are you going to earn enough money in the future to capture that through your tax return? So it’s the forecast of earnings, it’s how reliable is the forecast, are there any threats to earnings, in other words when we were at much higher non-performing levels, that was always a threat to earnings because some of the non-performing assets could result in future payoff as the balance sheet becomes more secure, there’s less of threat to future earnings.

So it’s really quite a whole analysis that has to support that. So we’ll be putting together, as time goes here, we’ll be putting together our documentation and support for how we should treat that.

Brian Martin – FIG Partners

Okay. Perfect. And then as it pertains to recoveries, I mean I guess given what you saw this quarter, what are your expectations, just in general, as far as how many more recovery could be possible? I mean I guess I realize they’ll likely be lumpy as you go through the remainder of the cycle, but is your expectation, is there a fair amount of potential for recoveries as you move forward?

Bill Skoglund

Brain, we think we have the reserve of covering the loans that we have today. One of the positives that we get with recoveries is, in the past, sometimes, it’s litigation that takes so long, and sometimes, it will be debt recoveries from guarantors that after we’ve sold all the properties and we’ve already written all of it off.

And one of the big recoveries we got this quarter was from a guarantor that could, but didn’t want to, after we sold other properties, we eventually got – the court got them to pay and settled it.

I think there’s more of those in there, but we think we’ve got the portfolio marked to the appraisals now. so you know, I think in order to get recoveries, the values have to increase a little bit instead of going down. So that’s possible, if they could.

The other way that we look at our loan loss reserve is we have historical factor that’s based on average losses over longer period of time and as that average – as we don’t have the charge off, the averages improve and theoretical ability to take the money back out the reserve because the historical average is just aren’t there anymore.

So there could be a couple of ways we could get recoveries. I think this guarantor thing is a possibility. I think values we’re starting to see move up, so that’s a possibility. And I think the historical average is improving the way we look at those gives the possibility for a recovery from the reserve. Jim or Joe, would you add anything to that?

Joe Marchese

Yes. Brian, this is Joe Marchese. We see a lot more investors in the market, serious investors, not bottom feeders, they’re offering real estate market prices for the assets and so the OREO that’s out there, a good part of it will continue to do well.

And as Bill said, through some aggressive litigation strategies, we’ve done well with the recoveries on many of these aged litigations. We’ve hung in there, and had good results. I mean historically, our legal fees ran high and they continue to be a significant number, but the end result is that we’re prevailing on some of these cases in a very material way.

Brian Martin – FIG Partners

Okay. And just last couple of things. From the OREO expense, that was a number I guess that we are kind of waiting for to come down after the levels it’s been at. It showed a pretty nice decline this quarter. I guess, can you talk about just your expectation of how you look at that, as you go forward here, I guess? Do you think it’s going to be pretty lumpy, maybe you feel good about maybe sustaining where we are in trending lower or just – how should we think about that?

Jim Eccher

Yes. I think, Brian, this is Jim. Just the fact that the OREO portfolio is down 40% is going to have a significant [ph] lower carrying cost. If we have an opportunity to move a property that has high carrying cost, and take the opportunity to sell it, our basis are slightly below, we’re going to do that.

But the other point I’d make, when you have about half the portfolio in land construction,. You know, those carrying cost are relatively lower.

So we’ll continue to have elevated legal fees although turning lower, insurance, and taxes, et cetera, will continue to be there, but as we continue to wind this portfolio down, we fully expect those carrying cost to decline and you know, as property value stabilize and improve, you know, that will also help our valuation expense.

Joe Marchese

Brian, this is Joe again. It should be less lumpy than it’s been in the past.

Brian Martin – FIG Partners

Okay. Perfect. And then last two things. From an overall non-performing standpoint, you know, kind of where is the most opportunity to reduce things from current levels and you know, I guess targets or expectations you guys have maybe on an annual basis as you look forward here?

Bill Skoglund

We don’t give forecast, Brian, or hesitant to say that. All we can say is look at the trends that we’ve had and we’re optimistic that we can keep that going although some of them are getting a little craftier that have been in there, but the markets are improving. So we’re still optimistic. We can see a reducing trend.

Joe Marchese

Yes, Brian, this is Joe again. I think our first order of concentration is to rehab, to work with these borrowers, to rehab them so that the credits can get upgraded, and aggressively intervening at a very early stage to try to prevent things from getting too far out of hand.

And these strategies have helped us tremendously in keeping this NPA number moving down quickly.

Brian Martin – FIG Partners

Okay. And just the last thing, in the sort of margin stand point. I mean the continued improvement in I guess in the credit here, should that give you some benefits for the margin as you’re perceiving that, I guess realize funding cost are not coming down further, but is that the way to think about it from a bigger picture standpoint as you go forward?

Douglas Cheatham

Well I think, Brian, if the non-accrual piece goes down and we replace that with earning assets, that certainly true. The real benefit to the margin will be when we have more loan growth kicking in where we’re actually getting not only replacement of loans that are maturing or that we’re selling out on non-accruals, but actual net loan growth, then I think you’ll see a more material benefit to the margin.

But right now, we’re doing everything we can in the investment portfolio. But I would be glad to reduce the investment portfolio size and debt to fund the loans.

Brian Martin – FIG Partners

Okay, perfect. My other questions were answered. So thanks.

Bill Skoglund

Thanks, Brian.

Jim Eccher

Thanks, Brian.

Operator

(Operator instructions) Our next question is coming from Jim Koran of New Salem. Please proceed with your question.

Jim Koran – New Salem

Hi. You were talking earlier about the TARP’s dividend potentially. I assume you’re going to have to dividend money from the bank up the hold call to get that done, so I guess, could you talk more specifically about what the restrictions are or limitations, or hurdles that need to be passed to be able to dividend up to the hold call?

Bill Skoglund

At this point, we’re restricted from paying those kind of dividends under the consent order that we have at the bank level from the OCC. So until that order is lifted, we simply can’t do that.

I guess technically we could with special permission, but I don’t think that’s likely while the consent is in place.

We’re optimistic about that consent order coming off in due course, but that’s a regulatory action and we can’t really predict when that will be necessarily.

Jim Koran – New Salem

So the conditions are not fully, is not a specific condition for getting lifted as far as a full review process?

Bill Skoglund

We are in full compliance with all of the items in the consent order, so we’re fully complying with the order. But it comes down to an evaluation process from them to decide when they want to formally lift that order.

Jim Koran – New Salem

How often do they review that?

Bill Skoglund

Well we have a full examination annually and they come in and do a more abbreviated visit with us on the semiannual basis. And they review, keep up with how we’re doing quarterly on our offsite basis. So they monitor where we are throughout the year.

Jim Koran – New Salem

When is your next annual review?

Bill Skoglund

I don’t believe we’re supposed to be able to say when our next annual exam is.

Jim Koran – New Salem

Okay. Does that review have anything to do with determination of reversing the valuation of allowance from the different tax asset?

Bill Skoglund

It’s a positive indicator, but it’s not directly related. We would include that as more subjective evidence of improved trend.

Jim Koran – New Salem

So that’s an internal call about when to reverse it?

Bill Skoglund

Yes, it is.

Jim Koran – New Salem

So what degree, I mean – I’m sorry?

Bill Skoglund

I was just going to add, I mean it’s management’s call when to, you know, our financial statements are ours, but the order is, we’ll have to agree with that determination. The external auditors.

Jim Koran – New Salem

Can you give, what you talked earlier about future earnings as being a big part of it, I mean it sounds like you’re really – you haven’t given a lot of color on your loan growth potential, very minor anecdotal stuff about what’s going on. I guess two questions over that, I mean to what degree would ramping some on loan growth, that loan growth help of your – reversing of deferred tax asset allowance.

And can you give a little more color on where you’re seeing the potential for loan growth?

Bill Skoglund

I’ll let Jim speak a potential that’s more in his area, but in terms of how that would impact the deferred tax asset, that would definitely help because as I said in my answer to Brian, a lot of that analysis rests on being able to demonstrate that you will generate taxable income in the future to the extent that we’re growing loans and making profitable loans and to the extent that those yields are higher than we’re able to get, I mean that’s one portfolio.

Yes, definitely additive to being able to get the EPA back. As far as the potential on that, I’ll let Jim answer that.

Jim Eccher

Yes. I think next to resolving additional problem loan issues, reinvigorating new business and generating new loans is probably one of our largest challenges today.

We’ve hired five new commercial relationship managers, we need to rebuild the commercial bank. We had a pretty sizable calling group before the cycle hits and cuts down in half and now we’re in the process of rebuilding that and adding new talent.

And we’re optimistic that we’ll be able to continue to do that, but it’s going to take some time. Pipelines are building. Our existing clients on the commercial side are not utilizing the lines of credit as heavily as we like I mean we track line utilizations monthly. There’s a building in pockets [ph], but the overall economy in our market is just recovering very slowing.

So it’s something we’ve very focused on, we’re working hard to again add new talent and intensify our calling efforts. But it’s going to take some time.

Bill Skoglund

Yes, I might add too. I do think it’s a little bit of a long range issue, but one, because of the economy, but the second is, most of the small businesses in our market don’t like banking with huge mega banks. They just don’t like it, they like community banks.

We think that our size at almost 2 billion, we can give them a lot of things that the small community banks can’t give them, like full relationship, treasury management, trust management, wealth management, and plus aggressive loans with swaps and all kinds of things.

So I think the outlook is good but it’s not, some of it is, when is the economy going to turn? Right now, what’s happening is most banks are stealing good customers from each other. And there is a little bit of growth, but is very competitive with interest rates, whatsoever is the margin.

But I don’t look at that as a – that’s kind of a short term issue. As the economy improves, I think our strategy of community banking, markets we’re in, the reduced competition with smaller banks leave, still bodes well for the future. It’s just a matter of – it will take a little bit of time. And we just started the growth.

Remember, not too long ago, we were in the kind of a honker down space as Jim mentioned, and we lost quite a few, or moved out quite a few lenders, I guess I should say.

And so we need to rebuild that and it’s encouraging to see us be able to hire new people, very experienced people, they come in, they like the community banking model and it’s encouraging to see that, the pipeline starting to build. But is going to take some time to get back to that.

First quarter, most of the loss and loans were problem loans as we ran off quite a few big problem loans.

Jim Koran – New Salem

Just a real anecdotal question, I guess Illinois, you know, the way the state is being run proves to be kind of a basket case to a certain ad from the governor of Texas up in Illinois recruiting Illinois business to escape down to Texas. With what degree did you – and people just really frustrated with the governance and business climate that the government is creating in Illinois.

Bill Skoglund

Quite a lot of people are frustrated with it, we don’t see too many moving, but we do find people frustrate with the state of the economy specially in Illinois.

But I don’t see wholesale people moving out, I see people, small businesses being cautious, and they’re just not expanding and adding people as fast than you normally might think they would, but so far, we haven’t seen anybody move to Texas.

Jim Koran – New Salem

All right. Thanks a lot.

Operator

Thank you. Our next question is coming from [inaudible]. Please proceed with your question.

Unidentified Analyst

Good morning again. Do you have any, other than the options of the banks that bough the B TARP or Preferred, who else bough it? Do you know?

Bill Skoglund

You know, that’s kind of a confidential issue for us, it’s like telling people who our share holders are. We just can’t or we’ve been advised by our attorneys that we can’t discuss that.

It’s like I can’t tell you who our customer is, I can’t tell you who our share holders are you know. It’s just not something that we’re being told we can do that.

Unidentified Analyst

Thank you.

Operator

Thank you. At this time, we’re showing no further questions. I’m sorry, if we do have any more question, please press star 1 on your telephone keypad at this time. Gentlemen, we’re showing no further questions in queue. Do you have any additional or closing comments?

Bill Skoglund

No. I just like to thank everyone.

Operator

Gentlemen, I apologize for interrupting, we did have one more person join in to the queue if you would like to take their question.

Bill Skoglund

Sure.

Operator

Our next question is coming from Robert Krauss [ph], private investor. Please proceed with your question.

Robert Krauss – Private Investor

Okay. First, I want to congratulate you people, you have a decent quarter.

Bill Skoglund

Thank you.

Jim Eccher

Thank you.

Robert Krauss – Private Investor

And just keep up the deferred work, let’s put it that way. Just one question I want to clarify. When you came out with your EPS, was that 0.30, or you lost 0.30? I’m a little confused in that EPS.

Douglas Cheatham

We made 0.30 per share...

Bill Skoglund

Last year, we lost 0.30. So in 2012, we lost 0.30 in the first quarter, I think that the numbers this year, we made 0.30, so maybe that’s where the confusion...

Douglas Cheatham

Yes, coming from a 0.30 loss a year ago, to a 0.30 profit this year.

Robert Krauss – Private Investor

Yes, right. That’s probably a little confusing with the same number, I made a mistake. I was confused that’s why.

Douglas Cheatham

Yes the time is important.

Robert Krauss – Private Investor

Pardon me?

Douglas Cheatham

The time is important on that number, yes.

Bill Skoglund

Yes. It’s the same number, but one is a positive, one is a negative.

Robert Krauss – Private Investor

Which is what actually counts, right? Now I wanted to say one thing. You’re saying that’s all right about your revenue, was it a revenue growth, did it go down like you mentioned nothing about the revenue [inaudible].

Bill Skoglund

We did discuss net interest income and the impact of the decline in loans and reporting that with the securities with lower yields than we can get on loans, but we also thought critically about what happened on the non-interest income side. Is there some particular area that you’d like us to talk? Pardon me?

Robert Krauss – Private Investor

I was just curious about that like the revenue, like a lot of these have me interested. Mention like revenue were there increase or what’s that on your revenue. You didn’t mention anything about that stuff, something about that’s why I want to ask that other question.

Bill Skoglund

Well our revenue comes from different sources. One is interest income and that we earn our loans and our interest and the interest income we earn on investments.

Our revenue from that side was down a couple of million from a year ago because the interest margin is lower, and we have less loans that’s why we’re talking about needing to roll loans, hopefully the margin improves.

We also though make revenue from non-interest income sources like our trust department, our mortgage group. That revenue was up a little bit, but not enough to offset that. So if you look at the other pieces, our expenses were down that made up the difference in profitability.

Robert Krauss – Private Investor

That’s the most important you can keep what you got like the expenses down with your top line which is in your profit after that.

Bill Skoglund

Right. And we have a lot of expenses related to this credit issue like OREO expenses and all kinds of expenses related to that that are coming down that’s very helpful. Plus we’ve been managing our other expenses as well.

Robert Krauss – Private Investor

Okay, that’s the most important. You know, you also mentioned something about a $71 million of credit that you’re trying to get from the government that’s still pending or something like that. Do they expect to get that through even from the government, for about $71 million or something like that?

Bill Skoglund

I think you’re referring to this deferred tax asset which is 76 million.

Robert Krauss – Private Investor

Yes that’s what I meant. Somewhere around that amount.

Douglas Cheatham

Yes, actually not money coming from the government through our future tax returns. That is something that’s for accounting purposes. It’s like a receivable from the government that you would expect to get your future tax return.

A couple of years ago, we wrote that, passed that off because we were not making money and we couldn’t justify saying that we would necessarily earn that in a reasonable period of time.

Now, what we’re talking about is as we return to profitability, the recovery of debt assets through our tax returns, becomes more certain.

Robert Krauss – Private Investor

I understand.

Bill Skoglund

We don’t have to pay taxes for quite some time here. And you can put that on your book as an asset.

Robert Krauss – Private Investor

I’m making a lot of sense.

Bill Skoglund

They make an offer book even though we have the credits there that if we earn enough, we look at $76 million worth of income tax credits.

Robert Krauss – Private Investor

Wow.

Bill Skoglund

That would help us earn a lot of money without paying taxes. And that’s a valuable asset for us.

Robert Krauss – Private Investor

Yes, I would say so. I meant to ask another question. How much cash does the bank have at this point, let’s say after the first quarter?

Bill Skoglund

We’re talking about cash in the holding company or in the bank?

Robert Krauss – Private Investor

No, in the bank itself.

Bill Skoglund

The bank has a lot of cash. It has 570 some million in securities and other cash.

Robert Krauss – Private Investor

I see.

Bill Skoglund

But that’s different than the cash in the holding company that we don’t have. We don’t have as much as the holding company to pay TARP dividends of the Trust Preferred dividends, we don’t have that much cash. We have maybe 3 million.

Douglas Cheatham

Something like that.

Bill Skoglund

3 million in the holding company. We have a lot of cash in the bank.

Robert Krauss – Private Investor

A lot of cash in the bank and 3 million in the holding company. Actually most of your cash is actually in the bank rather than at the holding company.

Bill Skoglund

Correct.

Robert Krauss – Private Investor

Thanks

Operator

Thank you. Gentlemen, would you like to go with your concluding comments at this time?

Bill Skoglund

Yes. I just like to again, thank everyone for their interest. We’re encouraged to see a good quarter. Looks like our stock started to move up a little bit, at least financially, and so that’s encouraging also.

Again, we’re working towards specific goals of getting the consent order off, getting the deferred tax asset back, and then at that point looked at our strategic options which we feel that serves our share holders. And I think there’s some real value to right size the capital at the right time and for the right amount depending on what our needs at that time.

So we’re in a healing process right now. I think it’s strategically, the best interest for everybody to continue that process. And I don’t think it’s going to take that long to get where those other options become available to us, but we’ll just have to see. We have to continue the trend. So far so good.

So again, thank you for your interest. And we’ll see where we go.

Operator

Ladies and gentlemen, thank you for your participation. This does concludes today’s teleconference. You may disconnect your lines at this time. And have a wonderful day.

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