Old Second Bancorp, Inc. (NASDAQ:OSBC)
Q4 2015 Earnings Conference Call
January 21, 2016, 11:00 am ET
Doug Cheatham - EVP & CFO
Jim Eccher - President & CEO
Michael Perito - KBW
Andrew Liesch - Sandler O'Neill
Greetings, and welcome to the Old Second Bancorp Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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. Thank you, Mr. Cheatham. You may now begin.
Thank you. Good morning, everyone, and thank you for joining us. I will start with a reminder that our comments today may contain forward-looking statements, which are based on management's existing expectations in the current economic environment. These statements are not a guarantee of future performance and results may differ materially from those projected. I ask you to refer to our SEC filings for a full discussion of the company's Risk Factors.
And now, I'll turn it over to our President and CEO, Jim Eccher.
Good morning, everyone, and thank you for joining us this morning for our fourth quarter earnings call. I'll start by giving you my overview of the quarter, and then Doug will follow-up with a more detailed report on the financial statements. I'll keep my comments brief and then turn it over to Doug and then will open it up to questions.
Operating performance in the fourth quarter was very similar to that of the third quarter, really highlighted by continued improvement in asset quality, higher mortgage banking income, and strong expense control, as we reported fourth quarter net income available to common stockholders of $3.8 million or $0.13 per diluted share. For year-to-date 2015, net income available to common is $13.5 million or $0.46 per diluted share. Overall it was very clean quarter with no unusual or one-time events.
Net interest income in the quarter is essentially unchanged from the third quarter and was up 3.6% year-to-date. The margin, net interest margin compressed in the quarter, Doug will give you little more color on that went down from 3.22% to 3.17% as we continue to see pricing pressure on loan renewals. Our strong core deposit base should help stabilize our margin in future quarters.
Growing top-line revenues continues to remain challenging as loan demand remains relatively limited in our core markets. Wealth management income was relatively flat in the quarter, although was a very good quarter for new account originations.
Residential mortgage income continues to be a strong driver of fee income and had solid linked quarter and year-over-year improvement. Originations remain consistent and we did experience some lift in mortgage servicing income as a result of higher interest rates. Overall, we're relatively pleased with the performance of both lines of business in the quarter.
Net loans were essentially unchanged in the quarter's problem credit resolutions and slack line of credit utilization provided some headwinds from a year ago. Despite the growth challenges in loan book, we're working hard to stay disciplined with loan concentration, structure, and pricing, as we continue to try to build our pipelines.
We are pleased with the progress we made in diversifying the portfolio as the C&I book increased 5.6% for the year, while commercial real estate and construction loans declined moderately. And while, it was a challenging year from a growth perspective, we continue to make good strides in strengthening our balance sheet as credit costs are well controlled.
Non-interest expenses were down 1% from the third quarter and down 14.2% year-over-year. We have meaningful reductions in OREO cost and lower salaries and benefits really drove the improvement over the last 12 months. Asset quality improved in the fourth quarter mostly due to declines in non-accrual loans and successful other real estate resolutions. We had several OREO properties sold in the quarter which led to a 22% decline in the overall OREO portfolio.
Non-accrual outflow exceeded inflow in the quarter as overall credit quality continues to strengthen.
Net charge-offs in the quarter were relatively modest with gross charge-offs of $788,000, recoveries of $398,000 for net charge-offs of $390,000. Year-to-date charge-offs totaled just over $1 million.
So overall we're pleased that our efficiency initiatives are taking hold and we're encouraged by our continued efforts to improve credit quality. We recognize loan growth has been uneven over the past few quarters but we're placing a lot of emphasis on that and focused to make this a high priority as we look forward to 2016.
Doug will now give you a more insight on the fourth quarter performance and then we'll open it up to questions.
Thanks, Jim. The margin compression from 3.22% to 3.17% on a linked quarter basis resulted from a slight reduction in asset yield while the cost of funds remain relatively flat. After years of very low interest rates the decline in the cost of deposits had flattened and now with the FED move in December we may see deposit begin to rise. However we have not seen any real movement in competitor deposit rates at this point. Because we are very liquid and we have over $700 million in securities, we can't afford to be selective in setting deposit prices. Instead, we can fund loan growth at least in part with bond sales and maturities.
We continue to estimate a slight positive impact on earnings from future interest rates should they occur but this does depend on the shape of the yield curve going forward.
On the non-interest income side, Jim mentioned wealth management and residential lending, there was nothing too unusual in the fourth quarter, but I want to mention a couple of one-time items affecting non-interest income for the full-year.
First, in the third quarter, we took a $1.1 million charge for the closure of one of our branches. Also in the first quarter of 2015, we recorded a one-time fee of $917,000 related to an outside service provider. Although these two items nearly offset each other, I want to point them out for purposes of evaluating our full-year numbers.
We have continued to make good progress in keeping the expenses down. Year-over-year expenses were down $5.2 million or 7.1%. Other real estate expenses combined including carrying cost as well as valuation adjustments were down from $6.9 million in 2014 to $5.2 million in 2015. Even excluding other real estate expenses, overhead was down $3.5 million or 5.3%.
The largest decline was in salaries and employee benefits and most of that improvement was in the second half of the year. In the third and fourth quarters of 2015, salaries and benefits were $8.3 million and $8.4 million respectively. This compares to $9.3 million and $9.1 million in the first and second quarters. I have to go back to the fourth quarter of 2012 to find a lower employee cost than our current run rate.
As previously reported, we redeemed the preferred stock issued under TARP in the third quarter of 2015. This obviously eliminated the cost for the fourth quarter. By way of comparison, the preferred stock dividend was about $1.1 million in the fourth quarter of 2014.
And finally, capital ratios were all at good levels. At the bank we have Tier 1 leverage of 9.94% and total capital of 15.23%. At the consolidated level, Tier 1 leverage was 8.69%, total capital was 15.56%, and common equity Tier 1 was 10.55%, and tangible common to tangible assets was 7.5%.
And with that, I will open it up to questions.
Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions].
Thank you. Our first question is from the line of Michael Perito with KBW. Please go ahead with your question.
I guess kind of a high level question, Jim. So the credit profile has made some big strides this year and non-performers were down. But it seems like also the kind of the credit earnings tailwind, if you will, from the credits of the provision is also winding down. I understand it will probably be a bit choppy quarter-to-quarter. But do we return to a positive provision in 2016 versus the last few years of credits to the provision?
Well, yes, I think that really depends on what type of loan growth we see in 2016. We're little more optimistic heading into the first quarter but we're still -- we still feel like we have a pretty healthy reserve balance. But I think we'll be inclined to probably see provisionings before we see any type of meaningful releases.
And I guess with that as the backdrop and you -- when you guys are kind of thinking about 2016 budgeting, I mean where should -- where are you expecting to kind of really see the earnings growth come from. I mean, it doesn't seem like it's going to be as credit driven as in the past. I mean is there more to do on the expense side or is it really just kind of dependent on growing the loan book on a consistent basis at this point?
Yes, I think the primary driver is going to have to be on driving more organic loan growth. With our markets slowly recovering, we are forecasting some modest growth next year. We feel like we've got some pretty good momentum in our wealth management group from fourth quarter to new assets originations. We still think we're going to see some tailwinds from the credit, from the reductions in non-performers and OREO carrying costs and things of that nature. But the LION's share of the growth is going to have to come from new asset originations. We have added three pretty season commercial loan officers in the last 30 days and we're optimistic about that is going to come to us from larger Chicago banks, so combination of all those things.
And so I guess --
Yes, Mike --
Sorry go ahead, Doug.
Yes, Mike on the -- and on the expense side there is not a lot more we can do but I would point out that the expenses were kind of at a new run rate in the second half compared to the first half of 2015. So we're starting off 2016 at a, I think a pretty good level from an expense standpoint.
Okay, thanks. And so I guess just on the last question on the growth and I'll let someone else jump in. But the -- so I mean is it given the pipelines and the hires and what you're seeing from the slowly improving economy I mean is the hope to kind of put growth up that was more similar to 2014 and 2015 kind of next year?
Yes, I think that's fair. yes.
Thank you. [Operator Instructions].
Our next question is from the line of Andrew Liesch with Sandler O'Neill. Please proceed with your question.
Hey guys just one follow-up question here on the expense run rate. Doug, you mentioned something about that, like just the compensation, salaries and benefits but may be with these new hires that might and jump a little bit in the first quarter. And then as they bring on loan growth that they can pay for themselves that way but just kind of curious on what do you think a good run rate on the salaries and benefits line might be?
Well, I'm not going to put a number out there but that's a fair point. We had some several significant hires but we have really kept a lid on the new hires as we and it's an evolving thing, as new positions open up. We see if we can reengineer to avoid filling vacancies and so it's there are things pushing in the other direction as well. I think the level we're at is of course good longtime performing employees will deserve a salary adjustment.
And so there may be some normal course of business kind of increases. But I would think these kind of officers that we're hiring will pay for themselves before the year is out.
And the other thing Andrew, I think, there is a consistent amount of turnover at and the officer -- commercial banking area and the lower end are the performers. And then, we're still seeing some savings with reductions in our special assets group as well. So we're not expecting material changes in salaries and overhead.
Our next question is from the line of Michael Perito with KBW. Please go ahead with your question.
Hey guys, thanks. Just a quick follow-up we spoke about the loan growth and I apologize if I missed this in the prepared remarks but the deposit growth in last year was pretty strong, I mean any outlook there into 2016. I mean it doesn't seem like rates are going to move a ton. So I mean are you guys thinking you are going to continue to grow deposits and obviously hope to put that to loans but if not into securities?
Yes, I think, we don't want to pay off on balloon deposits. I think a modest local growth, I think is finding deposits we can always, our capital ratios and our liquidity level are at the point where we can always put that to work in the bond portfolio profitably without paying out for deposits too much. But obviously with the real driver we hope will be some more growth on the loan side.
I think the other thing I would add Mike, we've been very consistent in the retail bank as far as opening up core checking accounts. We had another very strong year this year. We expect that to continue. Our mixed change continues to move more towards core checking and money markets and savings in away from time. So we're expecting I think more of the same in '16.
Okay. And actually just one more on the credit, I think in the past you guys have said at this point everything left is pretty granular. Was there anything left in the NPLs or OREO that of decent size that you guys are thinking you can resolve in the next call it six to 12 months?
Yes, non-accruals are down to $14 million so very manageable. We have won sizable credit that's may be a third of that little less than a third that we we're in contract negotiations now. So there is an opportunity to move that one potentially at some point this year. And then of course OREOs are continuing to decline. So we're thinking though, and we will continue to make granular improvement there. But there's not a lot of large OREO properties and aside from the one large non-accrual it's pretty granular portfolio at this point.
There are no additional questions at this time. I would turn the floor back to management for any further comments.
Okay. Thank you everyone for joining us this morning and we look forward to speaking to you again next quarter. Good bye.
Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.
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