Old Second Bancorp, Inc. (OSBC) CEO Jim Eccher on Q2 2019 Results - Earnings Call Transcript

Jul. 27, 2019 9:54 AM ETOld Second Bancorp, Inc. (OSBC)
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Old Second Bancorp, Inc. (NASDAQ:OSBC)

Q2 2019 Earnings Conference Call

July 25, 2019, 11:00 AM ET

Company Participants

Gary Collins - Vice Chairman

Jim Eccher - President and CEO

Brad Adams - EVP and CFO

Conference Call Participants

Andrew Liesch - Sandler O’Neill

Kelly Motta - Keefe, Bruyette & Woods, Inc.

Brian Martin - Janney Montgomery Scott

Operator

Good morning, everyone, and thank you for joining us today for Old Second Bancorp Inc.'s Second Quarter Earnings Conference Call. On the call today is Jim Eccher, CEO and President; Gary Collins, Vice Chairman; 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 in the current economic environment. These statements are not a guarantee of future performance and results may differ materially 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 Web site at oldsecond.com under the Investor Relations tab.

Now I will turn the conference over to Mr. Jim Eccher. Please go ahead, sir.

Jim Eccher

Good morning, everyone, and thank you for joining us. I have several prepared opening remarks and will give you my overview of the quarter and then turn it over to Gary and Brad for additional details. I will then conclude with summary comments and thoughts about the future before we open it up for questions.

Our results and overall momentum continue to be quite strong. Net income was 9.3 million or $0.31 per diluted share in the second quarter. Earnings this quarter were negatively impacted by approximately 849,000 of MSR interest rate impairment pretax. Securities gains taken during the quarter roughly offset the impact of MSR impairment. Absent these items, earnings trends in the net interest income and fee-based revenues were favorable overall.

Returns on assets and equity continue to be very strong driven by the net interest margin, solid expense control, sustained performance across our fee-based businesses and a stable credit outlook. The high level of profitability has afforded us the ability to invest significantly in the future growth of the bank.

During the quarter, we welcomed several seasoned additions to our commercial banking leadership team, and I’ll let Gary speak a little bit more about that in a minute. But let me say that the amount of disruption in Chicago, in the Chicago area financial institutions and the markets they serve provide a unique opportunity for Old Second to expand our reach. We will continue to be aggressive in looking to both upgrade and grow our commercial sales capabilities in the quarters ahead.

In regards to the second quarter specifically, total loans were unchanged from last quarter with a reasonably strong level of originations mitigated by continued payoff activity. Activity picked up considerably in June and our pipelines are at the healthiest levels we have seen in quite some time.

The competition for credit in our market remains aggressive, both in terms of pricing and structure. With the tailwinds provided by an expanding margin lessening, we expect to increase efforts to grow the loan portfolio and capitalize upon recent additions to our sales staff.

Absent elevated loan payoffs in the third and fourth quarters which at times are unpredictable, we are optimistic we can achieve mid-single digit loan growth for 2019. Yields on the portfolio picked up nicely from last quarter due to some lagged re-pricing impacts and the impact of new originations relative to payoffs.

Total deposits were down very modestly on seasonal factors with some mix improvement and stable re-pricing trends. Growth in transaction accounts partially offset decreases in time deposits. Loan-to-deposit ratio increased modestly to 91%, and I believe we can remain at these levels in the near term with loan growth funded by a mix of deposit growth and modest balance sheet optimization.

We remain very comfortable with asset quality trends. Nonperformers and OREO both declined relative to last quarter and past dues remain well controlled. The level of classified loans declined relative to last quarter as well.

Overall, we remain very encouraged about our results in a number of areas and Brad will provide additional color in his prepared comments. Prior to that though, I will turn it over to Gary who has some color on the new hires.

Gary Collins

Thank you, Jim. During the quarter, we are pleased to have made some significant additions to our leadership and sales teams.

First, we added Louis Weinzelbaum who has been named Group Market President and Senior Managing Director and will work from our Chicago-Loop office. Louis has over 30 years of commercial banking experience. Previously, he served as a Commercial Group President with MB Financial, leading the Professional Services business.

In addition, we’ve hired Alan Kohn of Chicago, and he has been named Group Market President and Senior Managing Director and will also be located in the Chicago-Loop location. Alan has over 30 years of commercial banking experience in Chicago. Previously, he served as Senior Managing Director with MB Financial in their National Healthcare Banking Group and as a Managing Director previous to that at The PrivateBank.

Also joining Alan in the healthcare lending group is Donald Clark. He has been named Senior Vice President and will be responsible for developing and growing relationships in the senior housing and healthcare space. Don was most recently with MB Financial as well.

We are extremely excited about these additions and believe Alan and Louis and Don bring incredible experience to our leadership team and additional credibility in our expansion into the Chicago metropolitan area. We will make sure that the resources are in place to continue our momentum and accelerate our growth into the market.

We are happy to answer any questions about these additions, but I will leave it at that for now and turn the call over to Brad for some additional financial review.

Brad Adams

Thank you, Gary. Net interest income increased nicely from last quarter with yields on loans benefiting from better origination activity and zero cost funding growth and lagged loan re-pricing benefits.

Fee income bounced back very nicely despite a difficult mortgage banking environment, specifically the large MSR impairment related to the further backup in interest rates during the quarter.

The reported and core taxable equivalent margin increased by 6 basis points from last quarter with a largely stable contribution from purchase accounting. Pricing movement on the liability side of the balance sheet remains well controlled and recently market pricing in time deposits has shown signs of abating just a bit.

Our efforts in the coming quarters will be focused on quality loan growth and core funding with the expectation of a more stable margin trends going forward. The loan-to-deposit ratio leaves us well positioned, and we have ample flexibility both to continue the pursuit of growth while protecting our core deposit base.

As Jim mentioned, it is likely we will seek to optimize the earning asset mix and fund future loan growth through a mixture of deposit growth and earning asset optimization, some of which is likely to come on the time deposit side.

Looking forward, core margin trends should remain relatively stable absent any movement in the Fed funds rate. A modest portion of the expected decrease in the Fed funds next week is already reflected in Q2 results.

If the rate is lowered, I would currently expect our margin to decrease between 3 and 5 basis points for each 25 basis point move in rates. Loan growth will become much more important for us with the outlook for short-term rates having changed, but we believe we have a significant opportunity in front of us on the growth side.

The fee income, mortgage banking reflected a significant improvement in gain on sale margins during the quarter and pipelines have built quickly with a pickup in the level of refinance activity. The quarter was significantly impacted by the previously mentioned rate-driven impairment in the MSR portfolio.

Trust and wealth management had a very strong quarter and retail banking trends were solid in both fees and card activity. Expenses remain well controlled, though we did see some increases in back office and advertising expenses.

Additional sales hires will largely be offset by seasonal factors in the remainder of the year, and continuing investments for future growth are largely baked into run rate trends you’ve seen from us.

The effective tax rate for the current quarter was a bit higher than I had previously expected compared to the prior quarter due to tax credits recorded related to RSU vesting in Q1.

With that, I’d like to turn the call back over to Jim.

Jim Eccher

Okay. Thanks, Brad. In closing, we are encouraged with these trends and excited about the future. On an organic basis, operating leverage remains strong and we are excited about the possibilities to continue to add quality talent to the organization.

Returns on tangible equity are excellent in the mid-teens on a core basis and the challenging interest rate environment provides an opportunity for a bank like Old Second to demonstrate its strengths. Our efforts will be focused on adding quality relationships to the bank while remaining mindful on the credit front.

On the capital front, we will have some decisions to make given the speed at which we are building capital. We will be evaluating alternatives to continue to be efficient here and balance that evaluation with a careful examination of our M&A outlook.

We remain optimistic in the opportunities that are out there to improve our footprint and we’ll remain disciplined in the evaluation of those opportunities. Periods of significant changes and the volatility of bank valuations make M&A more difficult today, but things can change quickly on that front.

That concludes our prepared comments this morning. So I will turn it over to --

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions. [Operator Instructions]. We’ll go first to Andrew Liesch with Sandler O’Neill.

Andrew Liesch

Good morning, guys.

Jim Eccher

Hi, Andrew.

Andrew Liesch

Brad, you mentioned some lagged benefits catching up on loan yields this quarter from some production. Is there still some of that remaining that could come in this quarter or is that going to be just offset by the rate side?

Brad Adams

Well, I think there would have been absent what’s happened into one and three-month LIBOR. I think that one month and three-month LIBOR if you look at what those curves have done, they’ve largely reflected the strong expectation of a rate cut in a few days. So I think that that’s been swamped by that at this point.

Andrew Liesch

And then can you just remind us what – how much of the loan portfolio is tied to one and three months LIBOR?

Brad Adams

Roughly a third or so.

Andrew Liesch

Okay. And then on the – Jim, just additional comments on M&A if you can. It sounds like you guys are trying to remain active, but how are discussions going in the Chicago area versus maybe the pace they were maybe just a few months ago?

Jim Eccher

Yes. I think things, Andrew, have cooled off obviously the last quarter or so. Valuations have certainly come down quite a bit, which makes discussions very challenging. But we expect things to turn around and accelerate as the year unfolds and we continue to have good discussions with a lot of partners, and we’re hopeful as the year unfolds that those opportunities will continue to be there in front of us.

Andrew Liesch

Okay, great. That covers my questions. Thanks.

Brad Adams

Thanks, Andrew.

Jim Eccher

Thanks, Andrew.

Operator

We’ll go next to Chris McGratty at KBW.

Kelly Motta

Hi. This is actually Kelly Motta on for Chris this morning. Thanks for taking my questions. Following up on Andrew’s question with the NIM, can you also provide how much of your loan book is indexed to LIBOR? And just a clarification on your NIM guidance about stability, that does not include the Fed cut. Is that correct?

Brad Adams

Roughly a third in terms of the immediate flow through of pricing changes in that metric with some lagged benefits, as I mentioned. So it doesn’t all go on the day the curve shifts. So it can be on a one month or a three-month or something like that. So there are some movements but we are tied to it. In terms of stability with no changes, I would caveat that with the curve does reflect expected changes. And if you look at the LIBOR curve, it reflects the expectation of the rate cut. However, with the rate cut actual happening, it would be 3 to 5 basis points as we said a couple of minutes ago in contraction.

Kelly Motta

Great. And then maybe a question on the recent hires you had. You mentioned you continue to look to pick up additional commercial bankers. I was wondering if your expense trajectory that you gave in the prepared commentary includes any additional hires and when these hires occurred in the second quarter. Thank you.

Brad Adams

They occurred in the middle of the second quarter. We do have additional hires in the budget. I think that we could hire a lot of people. Old Second has a very compelling story at this point in terms of its positioning in Chicago and our trajectory. I think that we have to be disciplined, no different than how you approach M&A in terms of looking at what paybacks are, what your overall expense structure can bear, what expertise they add. I think that the people that we’ve added so far bring in a high level of talent to Old Second and I think it raises the bar for all of us. If we have opportunities to continue to raise the bar, we will do it. Just as if we found somebody better than me, Jim would do it tomorrow. So I think that’s the obligation we have to shareholders. And I tell you what, it’s a good time to be a Chicago bank and to have the momentum that Old Second does. So I think we’re very excited here.

Kelly Motta

Great. I’ll step back. Thank you so much.

Jim Eccher

Thank you.

Operator

[Operator Instructions]. We’ll go next to Brian Martin at Janney.

Brian Martin

Hi, guys.

Jim Eccher

Hi, Brian.

Brad Adams

Good morning.

Brian Martin

Brad, just to your comment on the LIBOR-based loans, I guess the 3 to 5 basis point decline given – what portion of the deposits are indexed I guess if you will? And I guess the 3 to 5 basis point kind of guidance or just input there, does that assume your ability to make some changes on the funding side or just those two would be helpful?

Brad Adams

So I think that – first off, just generally speaking, our level of deposits that are indexed is almost zero. We are a pristine retail core funded balance sheet for the most part. We certainly have some ability to lower deposit pricing. I think that relative to budget, the real flexibility for us is that the compression we’ve seen on time deposits has the potential to go away, which is a welcome change. Jim is committed to doing the right thing by our core retail depositors, and we’ll continue to do that. I don’t think there’s a ton of room to bring down pricing on the bulk of our deposits, but the spread relative to loan growth and re-pricing and just flow from the asset side of the sheet should be relatively stable.

Brian Martin

Okay. That’s helpful. And just the – I guess you mentioned something about I guess in the prepared remarks on the time deposits and maybe some remix. I guess maybe I missed what you said there. But what were you kind of referring to when you talked about the time deposits and what you’re seeing there?

Jim Eccher

Yes, so Brian we’re still seeing some runoff in high-priced time deposits from the ABC acquisition. That will continue to some extent. But at this point, our focus is on core deposits and growing transaction accounts. And there will come a point and if loan growth does accelerate in the next couple of quarters, which we expect, we’ll have to solve for that and we’re confident we’ll be able to do that.

Brian Martin

Got you. Okay, understood. And just on the I guess the people you hired, Jim, and I guess maybe more potential out there, I guess fair to say today that there’s – given the environment, how you described M&A that there is more opportunity today to hire people than there is to do transactions? Is that how we should think about at least the near term?

Jim Eccher

I’ll let Gary comment on that.

Gary Collins

Yes. This is Gary Collins. Yes. Certainly, the M&A market has been quiet as of late. But with the recent sale of MB, there’s a disruption in the market. But it’s more than just MB. Some of the larger banks, the commercial lending teams seem to be willing to talk. So we’ve been fortunate to have a really decent flow of conversations ongoing.

Brad Adams

I think that the near-term stuff just over the last six months or so has been public company valuations have taken a significant hit where expectations within private companies have not necessarily followed that. That’s what Jim spoke to in terms of volatility of valuations. In the meantime, the math on lift-outs and the opportunity on lift-outs is the latter has increased, the former has been stable. So the relative value proposition on hiring versus M&A has been pretty skewed for the last six months. So that’s where we’ve been focused.

Brian Martin

Yes. Okay, understood. And the people – you didn’t really change much in your guidance for the year despite hiring a few people and it sounds like a pretty robust pipeline today. I guess is there more to that than kind of what I’m hearing there or is maybe where you’re at a bit conservative given the trends you’re seeing today?

Jim Eccher

Well, I guess, Brian, to get mid-single digit loan growth when you’re essentially flat through six months is --

Brian Martin

It’s double digit.

Jim Eccher

Yes, it’s not going to be real easy, right. But the other factor that’s been unpredictable is some payoff that can come down the road that some we expect, others we haven’t been able to expect. But we do see some in the third quarter. And certainly going into 2020, we’re feeling pretty good about the elevated talent we have and our ability to grow on a more consistent basis.

Brian Martin

Okay. All right, understood. Thanks for taking the questions, guys.

Jim Eccher

Thank you.

Brad Adams

Thank you.

Operator

[Operator Instructions]. I have no other questions holding at this time. I’ll turn the conference back to management for any additional or closing remarks.

Jim Eccher

Okay. Thanks, everyone, for joining us this morning, and we look forward to speaking with you again next quarter.

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