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Old Second Bancorp, Inc.

OSBC US

Old Second Bancorp, Inc.United States Composite

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Q2 2015 · Earnings Call Transcript

Jul 23, 2015

Executives

Doug Cheatham – Executive Vice President and Chief Financial Officer Jim Eccher – President and Chief Executive Officer

Analysts

Chris McGratty – KBW Andrew Liesch – Sandler ONeill Brian Martin – FIG Partners

Operator

Greetings, and welcome to the Old Second Bancorp Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode.

A 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, Executive Vice President and CFO.

Thank you Mr. Cheatham, you may now begin.

Doug 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. And now, I’ll turn it over to our President and CEO, Jim Eccher.

Jim Eccher

Good morning, and thank you for joining us today for our second 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, and then we will open it up for questions.

Operating performance in the second quarter was pretty positive in many areas. Core earnings continued to show improvement as many of our key business lines reported stronger results.

And as we discussed in prior quarters, we continue to put a lot of focus on strengthening our balance sheet and we feel we made good strides again this quarter, especially in asset quality. Reported second quarter net income available to common stockholders is $3.4 million or $0.12 per diluted share for the year.

Net income available to common is $6.1 million or $0.21 per diluted share. Looking at some of our key business lines, overall loan totals grew modestly in the quarter and we’re up $7.8 million from the prior quarter.

And while loan demand did increase in the quarter, corresponding $15.5 million reduction in classified loans offset any meaningful growth. As far as non-interest income, once again we had solid performance by our mortgage and wealth management businesses, while service charge income on deposits rebounded from the first quarter.

Our residential banking group in particular had strong originations once again in the quarter and this business line remained strong. Through the first half of the year, closed loan volume in our mortgage banking group has doubled from a year ago; production is almost evenly split as 48% of the volume is purchased business, while 52% stemming from refinance business.

Based on current rates, we believe the mix will change with more volume expected in coming quarters in the purchase market. Asset quality, as I mentioned improved significantly in the second quarter, effective problem loan resolutions reflect our continued focus on improving our asset quality.

Total classified loans declined $15.5 million and OREO declined $3.5 million. Overall, classified assets were down $19 million or 26% from the first quarter.

Net charge offs were modest, gross charge-offs were $2.1 million, recoveries were $1.6 million. And finally, we announced last week that we will be regaining the remaining 31,533 shares of preferred stock that was originally issued under the TARP program.

We will be regaining these at par later in the quarter, and this completes the final redemption of $73 million of TARP at par value, and I think positions our company for improved earnings in the coming quarter. Doug will now give you more insight on the second quarter performance and then we’ll open up for questions.

Doug Cheatham

Thanks. As Jim mentioned, second quarter net income available to common shareholders was $3.4 million or $0.12 per share, and for the year to date it was $6.1 million or $0.21 a share.

Net income to common shareholders was up 27.8% from the first quarter of 2015. We released $2.3 million from the loan losses in the second quarter and at the same time we took $2.1 million in other real estate valuation expense in the quarter.

Now, 62% of our non-performing assets are in other real estate rather than in loans as of June 30. The shift to an OREO issue, rather than loans, it eases the pressure on the loss for loan losses and it brings us closer to disposition in these cases.

Net interest income was up $338,000 from the first and second quarter. The net interest margin ratio was 3.25% of the in the second quarter of 2015 compared to 3.26% in the first quarter, and the second quarter of 2014 the margin was 3.04%.

Looking to the year-to-date, the margin was 3.26 in the first half of 2015, and 3.08 in the first half of 2014. Most of the improvement was the result of declining cost of funds.

Non-interest income of $8.3 million in the second quarter of 2015 was 10.5% higher than the second quarter of 2014, most of this is due to increased income in our residential lending area. For the year-to-date, residential lending income more than doubled last year's results from $2 million in the first half of 2014 to $4.1 million in the first half of 2015.

In addition to the $2.1 million write-down in other real estate in the second quarter, we also had $542,000 in other real estate expenses and $242,000 in gains on other – sales of other real estate. Collectively, this $2.4 million in other real estate expenses in the second quarter compares to $1.3 million in the first quarter.

The year-to-date totals were $3.7 million in the first half of 2015 and $2.79 million in the first half of 2014. Excluding other real estate, operating expenses were $16.5 million in the second quarter compared to $17.4 million in the second quarter of 2014.

Operating expenses were $32.3 million in the first half of 2015 and $33.9 million in the first half of 2014. The largest decline was in amortization core deposit intangible.

This expense was $1 million in the first half of 2014 and went to zero in 2015 after becoming fully amortized. Salaries and benefits were nominally higher in the first of 2015 compared to the first half of 2014.

And staff reduction we instituted in the first quarter of this year will begin to show up in the third quarter. Jim mentioned that we are regaining the remaining preferred shares issued under the TARP program, I want to know – that we are doing this by paying a dividend from the banks to the holding company and a capital ratios at both the bank and the holding company will remain strong after the redemption.

We’re especially pleased to accomplish this through retained earnings, rather than adding debt [ph]. And at this point, I will – that concludes our prepared comments and I’ll be glad to throw it open to questions.

Operator

[Operator Instructions] Our first question is from the line of Chris McGratty with KBW. Please go ahead with your questions.

ChrisMcGratty

Hi, good morning guys.

Doug Cheatham

Good morning, Chris.

ChrisMcGratty

Jim or Doug, with preferred announced last week, in the dividend disclosure that you talked about in the prepared remarks, can you tell us where the pro forma of classified asset ratio of the bank was, I think it was 27% last quarter?

Jim Eccher

Yeah, we had it just slightly under 20%, on 19.5%.

ChrisMcGratty

So the next question, may a little bit soon to ask. But you’ve got the trust preferred that they talked about potentially, looking at those.

With the improvement in credit, how do you think about that potential earnings lever?

Doug Cheatham

Well, you know, we've indicated before that the 7.8% TruPS the old outage is, it’s cheap capital, but expensive debt. At this point, not all of the accounting is Tier 1 capital; I’m increasingly viewing it as expensive debt.

So that would be one of the things that we would take a look at going forward, we don't have any specific plans at this point.

Jim Eccher

The only other thing I would add Chris, we obviously still have some work to do with the OREO portfolio still above $32 million. We still see some headwinds obviously with carrying those assets, but we’re fairly aggressive this quarter taking some valuation adjustments on several properties trying to position those for future sales.

So obviously that’s – it’s a major contributor for us, we can eliminate some of those assets.

ChrisMcGratty

Okay, that’s helpful. Thanks.

Just a follow-up on maybe the margin and the expenses, you’re margins are pretty stable last couple of quarters. How should we be thinking about it entering the end of the year and kind of next, maybe higher rates?

Then also the expenses with the OREO write-down, kind of fair one, with kind of what you’re doing initiative wise, thanks?

Doug Cheatham

Okay, on the margin, it has been fairly stable and we’re glad about that. I think if we do get a rising rate environment, I think that would be beneficial to us.

The extended period of low rates as well as – it’s help reduce our cost of funds, it's hard to find good yielding assets. We could use some loan growth of course, which would help the margin, but we’re sticking to guns on asset quality, and Jim can speak to that side of it.

But I think the margin is going to be fairly stable, there is some pressure on this, unless we do get an increase in rates eventually, but I think we’ll be more or less in the range we’re in.

ChrisMcGratty

Okay. And then on the expenses, I think the branch closures, how should we be thinking about back half run rates?

Doug Cheatham

We had announced that – two customers of the branch that we are closing, one of our branches is a very small branch and I don't think operating income going forward is going to be really affected all that much, but it was – it make sense if both of that branch, given the – it’s lack of growth and the size of it. So I don’t think that will have a real impact on the run rate.

Q – ChrisMcGratty

Okay, thanks. Last one is, do you have the share count [indiscernible] in the release?

Doug Cheatham

Sure. For the quarter, we had – we ended with 29,478,429 [ph] and the average diluted was – in the quarter was 29,742,253 and we’ll add that back in the future releases.

We paired down the size our release a few quarters ago and I think that may have been a oversight.

Q – ChrisMcGratty

Thanks a lot, Doug.

Operator

Our next question is from the line of Andrew Liesch with Sandler ONeill. Please proceed with your questions.

Andrew Liesch

Hey guys.

Jim Eccher

Andrew.

Doug Cheatham

Andrew.

Andrew Liesch

Jimmy mentioned loan demand increased a little bit. Can you just expand on that a little bit more, what positive are you seeing out there or where does the pipeline stand and I guess, maybe how optimistic for loan growth on the commercial side relative to say a quarter ago and a year ago?

Jim Eccher

You know, that remains one of our bigger challenges, is trying to get some meaningful growth from the portfolio. I say that the economic activity in the western suburbs of Chicago remained fairly muted, but not a whole lot going on.

We're starting to see a little bit of pick-up in housing developments, but not robust by any means. Our growth in the quarter was largely on the C&I side, competition remains fearsome, I’m sure you’re hearing that from everyone.

But we’re – our pipelines are slowly building, they’re not where they need to be at yet, but we’re generally – the third quarter is positive as far as how do I feel about compared to a year ago, having not as positive as maybe 12 months ago, but there is starting to be signs of some life particularly in housing in our markets, which is encouraging.

Andrew Liesch

Great. That’s my only question.

Thank you.

Jim Eccher

Okay.

Operator

The next question is coming from the line of with [indiscernible], Private Investor. Please go ahead with your questions.

Unidentified Analyst

Hi, good morning, could you just repeat one thing from – you were talking about the OREO valuation expense, and you mentioned, like you had $542,000 ORE like carry expenses, was that correct?

Doug Cheatham

Yes. We had – the valuation write-down was $2.1 million, but on top of that we had just other expenses of carrying the other real estate of $542,000 and then we also had gains on sales of other real estate of $242,000.

Unidentified Analyst

That was my next question. Okay, $242,000.

And then just one or two other things, on the mortgage banking side, what was the volume that you originated and sold in the quarter and your comment about being more of a purchase money market going forward, what are your expectations for volume in the business over the next couple of quarters?

Jim Eccher

Yeah, I can get you the exact details, Eric on the amount of activity. The third quarter generally, we definitely specifically see more purchase activity – particularly the latter portion of the quarter.

We don't probably expect overall volume to be maybe as high as the first two quarters, but we expect the business to continue to be profitable. It’s hard to really look too much further had then, a quarter at a time in the residential business.

Unidentified Analyst

Okay. That’s fine.

Thank you.

Jim Eccher

Okay.

Operator

Thank you. [Operator Instructions] The next question is from the line of Brian Martin with FIG Partners.

Please proceed with your questions.

Brian Martin

Hi guys.

Jim Eccher

Hi, Brian.

Doug Cheatham

Hi, Brian.

Brian Martin

Doug, can you just talk about the – you talked about streaming from the bank to the parent to kind of resolve the preferred. Just kind of – what the plan is there and then kind of what the capital level look like post that transaction just kind of, you know roughly what you’re thinking about as far as where you would like to maintain it and going forward?

Doug Cheatham

Okay. Well, we are dividending the entire amount from the bank to the holding company.

We have a lot of capital at the bank level, so I can’t really tell you where we think the bank capital ratios will be after the redemption exactly, but they’ll still be well safe territory. At the holding company, the redemption of TARP does affect the Tier 1 capital level.

The Tier 1 leverage ratio will still, pro forma is still expected to exceed 8% and then comfortable at that level.

Brian Martin

Okay, perfect, that’s helpful. Then just the OREO cost in the quarter I guess the – what was on the write-downs, I mean what was the primary driver of those write-downs, is it more related to kind of the rule exposure or I guess what type of profit you two were talking about, you took these write-downs out.

Is there any, I guess something with – unusual there or is it the pretty much the rule properties or kind of construction credits?

Jim Eccher

It was, first of all we have to follow the appraisal rules and take our marks on an annual basis or more frequently, but we’ve took a pretty hard look at a lot of our properties that we’ve held in OREO for quite some time and felt it was a good time to be a little more aggressive with some of the write-downs and position them for sale. It wasn’t any one or two properties.

It was probably a couple of dozen that we felt we needed to adjust our list price, get them down and move them out as quickly as possible. As Doug mentioned, classified – it’s becoming more of an OREO issue for us now than really, kind of loan issue, so we’re just trying to be proactive and positioning them for sale.

Brian Martin

Alright. And just you mentioned the staff cost and just kind of the savings to kick-in this quarter or is that what I heard, I’m thorough here?

Doug Cheatham

That’s correct.

Brian Martin

Can you just give us some color on that? As far the impact – as far as the benefits from that actions, just…

Doug Cheatham

Well, last quarter we announced that we had released 21 of full time employees, most of that was in either backroom areas or some on the retail side. The savings on that, there was some severance which ran through the second quarter, but in the third quarter we will begin to kick in.

We’re estimating about a $1.3 million annualized savings from that.

Brian Martin

Okay. And that $1.3 million annualized, none of that was in second quarter, correct?

Doug Cheatham

That’s correct.

Brian Martin

Alright. I appreciate the color.

Half of my questions were answered.

Doug Cheatham

Alright, Brian. Thank you.

Operator

Our next question is a follow-up from the line of [indiscernible] Private Investor. Please go ahead with your questions.

Unidentified Analyst

Yeah, hi. Sorry, I forgot asking one thing before.

So your comment about the relative stability of the margin and the outlook, can you remind me if I'm looking at your loan portfolio, looks played the big chunks to commercial and the commercial real estate. Can you give me the rough numbers on how much of that is roughly fixed and maybe what part of the portfolio has some type of floor hurdle to get through if there is a 50 basis point rise in rates?

Jim Eccher

The largest, obviously the commercial real estate portfolio, the bulk of that, Eric is fixed, so we generally don't go out longer than five years. I think the duration on that is probably 2.5 to 3 right now.

As far as such a fixed – float percentage, I would say probably 80% to 90% of the real estate portfolios is – has fixed rate. On the floating instruments, floors were more common few years ago, but at this point we don't have a material part of the portfolio that has you know high floors that – we’ll need to blow through to see any kind of lift when rates do go up.

Unidentified Analyst

Okay. That’s fine.

I just wasn’t familiar with the floored part of the adjustable portfolio. Thank you.

Jim Eccher

We’ve been very careful not to go out too long on term with any type of real estate transactions. The market has been very aggressive, we’re seeing a lot of seven and ten year taper out there.

And we’ve refrained from going that long. So we think we’re pretty well positioned when rates do go up.

Unidentified Analyst

Okay. Thanks very much.

Jim Eccher

Thank you.

Operator

Thank you. There are no additional questions at this time.

I would like to turn the floor back to management for further comments.

Jim Eccher

Okay. Thank you everyone for joining us this morning.

And we look forward to speaking with you again next quarter. Goodbye.

Operator

This concludes today’s teleconference. Thank you for your participation.

You may now disconnect your lines at this time.

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