Oct 23, 2014
Executives
Doug Cheatham - EVP and Chief Financial Officer Bill Skoglund - President, Chairman and CEO Jim Eccher - Chief Operating Officer
Analysts
Mike Perito - KBW Evan Pilsner - Trishield Capital
Operator
Greetings and welcome to the Old Second Bancorp Third Quarter 2014 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. Thank you, you may 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.
With me this morning are Bill Skoglund, President, Chairman and CEO of Old Second Bancorp, and President and CEO of Old Second Bank and Chief Operating Officer of Old Second Bancorp, Jim Eccher. And now, I will turn it over to Bill to get things started.
Bill Skoglund
Good morning and thank you for joining us today. Net income for the quarter increased to $2.9 million and net income available to common shareholders was $1.9 million.
Year-to-date, net income is at $7.1 million and net income available to common shareholders is $9.9 million. Capital at the Bancorp also increased in most categories as of 9/30.
Our leverage ratio was 9.68, total capital of 17.56 intangible, little over 7% at 7.15. At the Bank, these ratios were even stronger at 11.67, 18.47 and 13.26 respectively.
Loans were up in the third quarter by $8.1 million and we’ve shown loan growth for four consecutive quarters. For the last four quarters, we have been able to grow loans by $63 million which is an annualized growth rate of 5.9%.
This quarter for the first time in 3.5 years, we had an uptick in our non-performing and classified loans. Non-performing loans were at $31.7 million as of September 30 and increased by $2.7 million from the second quarter.
And although there were a few new additions to our non-accrual and classified totals, the increase was mainly the result of one credit of $7.8 million moving from special mentioned to non-accrual. Year-to-date, non-performing loans are still down by $8.1 million and OREO also had a small increase of $1.7 million but mainly as a result of our branch closing in New Lenox that moved into OREO.
As a result, our classified ratio actually went up a little bit and is now at 35.15%. And on a personal note, I recently announced that after 43 years, I’ll be retiring effective January 1, 2015.
I will however be staying on as Board Chairman in a non-executive role. And as part of succession management plan, Jim Eccher who is now CEO of the Bank will also be taking over as President and CEO of the Bancorp.
And with that I’ll turn it over to Jim for his further comments.
Jim Eccher
Okay. Good morning.
And as Bill mentioned, credit quality metrics reversed its long recent trend and we had mixed results in the quarter. The positive news is that early stage past due loans and special mentioned loans continue to decline and are now at below pre-cycle levels, obviously these are positive indicators and bode well towards future credit trends.
On the flip side, non-performing loans that’s up by $2.7 million from the second quarter and again this is mainly attributable to one legacy relationship that reported weaker operating performance. That company continues to pay as agreed and is taking steps towards improving their internal operations and we believe they have the well to navigate through this period.
Similarly problem accruing loans were up about $6 million in the quarter mainly due to three relationships that also reported weakness in cash flow. All three continue to pay as agreed.
We believe we’re well secured and the company is on the right track to report improved profitability in future quarters. Other real-estate owned remained relatively unchanged in the quarter.
We reported OREO of $40.8 million; it was up slightly from $39.2 million in the second quarter, but as previously mentioned includes the inflow of a bank branch property that is actually closing at the end of business today. Absent the branch property, OREO totals would have been slightly lower in the quarter.
Following a pretty active second quarter when OERO sales activity was more brisk, the third quarter was relatively inactive. 15 properties were sold in the quarter, while 15 properties migrated into the portfolio.
OREO evaluation adjustments were about $1.5 million in the quarter and we continue to position the portfolio for disposition. Overall market conditions are continuing to slowly stabilize and we’re beginning to see increased interested for potential fourth quarter OREO sales.
On the origination side, new loan originations were slightly higher in the quarter as commercial loan demand remains relatively modest in our primary markets. After stronger second quarter, loan demand moderated in the quarter, but we are seeing the positive mix changes in the portfolio as commercial loan growth continues to outpace residential and consumer loan footings.
Excluding the decline in non-performing loans for the year, our performing loan portfolio is up about 7.5% this year due primarily to growth in the commercial loan portfolio. Our competition remains very intense in our markets especially in the C&I segment.
We are seeing many competitors beginning to lengthen duration on term loan proposals with looser loan conditions. Our commercial pipelines continue to slowly build as loan run-off and pay downs continue to stabilize.
We maintain our comments from prior quarters that we are on the right track to position the company for moderate organic growth in the coming quarters. Okay.
That concludes my comments and I’ll turn it over to Doug for more color on the financial results.
Doug Cheatham
Hey, thanks Jim. Yesterday we reported net income available to common stockholders of $1.9 million or $0.06 per share in the third quarter.
Income before income taxes was $4.7 million in the third quarter of 2014 compared to $2.9 million in the third quarter of 2013. And I’m using income before income taxes for comparison purposes because of third quarter of 2013 included $71.2 million one-time benefit from reversal of a valuation allowance on deferred tax assets.
For the year-to-date, net income before income taxes was $11.1 million in 2014 compared to $11.9 million in 2013. In the third quarter of 2014, net interest income reached its highest level since the second quarter of 2012.
This is a significant driver of core earnings. Higher interest income is due to loan growth and increased securities income.
Total loans have grown about 5.9% in the last year. In addition, interest expense is lower than at any point in at least 10 years.
In percentage terms, the net interest margin was 3.26% in the third quarter compared to 3.25% in the third quarter of 2013. For the year-to-date, the margin was 3.14% this year compared to 3.17% for the first three quarters of 2013.
Although, the extended period of low, very low interest rates was pressure on pricing, declining cost of deposits, securities portfolio management and loan growth have had maintain the margin. Non-interest income was $8.3 million in the third quarter of 2014.
Although this was an increase from $7.5 million in the third quarter of 2013, it includes $1.2 million in security claims. Year-over-year, the mortgage business is lower than it was in 2013.
For the year-to-date, mortgage income was $3.3 million in 2014 compared to $6.5 million in the first three quarters of 2013. However, mortgage income has increased in each of the past two quarters.
Fortunately much of the mortgage business’s expenses are variable which has helped to reduce overhead. Non-interest expenses were $18.3 million in the third quarter of 2014, which is a reduction of $2.2 million from the third quarter of 2013.
Excluding other real estate expenses, non-interest expenses were $16.3 million compared to $18 million in the third quarter of 2013, a decline of $1.7 million. Salaries and benefits and amortization of core deposit intangible posted the largest declines in the quarter other than other real estate.
Salaries and benefits of $8.9 million in the third quarter of 2014 were down $443,000 from the third quarter of 2013 and down $327,000 on a linked-quarter basis. The core deposit assets which previously carried a quarterly expense in excess of $1.5 million amortized the final $154,000 in the third quarter of 2014.
This resulted in a decline of $350,000 in the quarter and will result in the zero expense for that item going forward. Capital ratios, Bill mentioned, I’ll give you some comparisons.
Leverage ratio of 9.68% at the end of the third quarter of 2014 compared to 9.51% at the end of the second quarter of 2014 and 7.11% a year earlier. Total capital was 17.56% compared to 17.66% in the second quarter and 14.47% a year earlier.
And finally the tangible common equity ratio was 7.15% at the end of the third quarter after 7.09% at the end of the second quarter, and those are up from 3.33% at the end of the third quarter of 2013. That concludes my comments and now I’ll turn it over to the operator to open it up for questions.
Operator
At this time, we will be conducting a question-and-answer session. (Operator Instructions).
Our first question comes from the line Mike Perito with KBW. Please proceed with your question.
Mike Perito - KBW
Hey, good morning everybody.
Bill Skoglund
Good morning Mike.
Mike Perito - KBW
Hey, Doug. So if I could start on the margin, I was looking at last quarter’s transcript when spoke the expectation was relative stability and obviously the earning asset remix helped the margin a little bit this quarter.
But I guess near-term, is this a level that you think will be relatively stable or do you expect that there to be some compression going into next year?
Doug Cheatham
Well, we had a couple of things happening in the third quarter that should help us sustain the margin. I mean there is -- out in the market there is still pricing pressure.
But what happened in the third quarter was we had a lot of over CDs roll off which really helped reduce our cost of funds. And also we purchased collateralized loan obligations which had a higher yield of -- than we had been achieving in the investment portfolio and that really added to income in the quarter as well.
So, both of those I think are go forward influences up against pricing pressures. But I think it’s -- I think what you saw in the third quarter is in the ballpark.
Mike Perito - KBW
Okay. And then just a quick question on the provision expense, obviously this quarter you guys spoke in your prepared remarks about the one credit and you expect a zero dollar provision up at the reserve.
I guess on a relative basis it’s still pretty high. How are you thinking about that expense, a recent year term going forward?
Could we -- you guys have been booking the credit for almost six straight quarters, is that something you expect to reoccur or should we kind of be expecting the zero provision to be the case near-term?
Doug Cheatham
We obviously have to [chew] that up every quarter. And I think we felt with the tick up in non-performers this quarter, we thought it was prudent not to do any release.
We’re doing now as the reserve is still very healthy. We’re mindful of that and we certainly could take a different approach next quarter.
We don’t believe we’re going to get any major surprises in credit. We think we have the handful of these issues under control, but we’ll have to look at that again next quarter and we certainly potentially could see release.
But we’re also mindful of the fact that we’d like to continue to grow the portfolio and don’t want to be in a position where releasing one quarter and adding provisions to following quarter too.
Mike Perito - KBW
Okay, all right. Thanks a lot for the color guys.
I appreciate it.
Doug Cheatham
Thank you.
Operator
Our next question comes from Evan Pilsner with Trishield Capital. Please proceed with your question.
Evan Pilsner - Trishield Capital
Good morning guys. Thanks for taking my question.
Bill Skoglund
Hi Evan.
Evan Pilsner - Trishield Capital
So, just a few quick things; first being, can you just confirm that CLOs and structured [curve] is going to be an ongoing part of the investment portfolio?
Doug Cheatham
Yes. I can confirm that.
Evan Pilsner - Trishield Capital
Great. And then in terms of OREO expense, is this quarter the peak or would you say this is more of a run rate given the current environment?
Bill Skoglund
One of the things we do each -- we get new appraisal then and we tend to be heavier in the third quarter so that we don’t see as much noise in the fourth on OREO. So, if we want to true up some of these things and get these in order get a little more movement in OREO.
So, I think this is a little heavier than we would normally see. Jim if you…
Jim Eccher
I would agree with that.
Evan Pilsner - Trishield Capital
And similarly on the classified loans, obviously year-over-year the construction lending segment has been tough. Do you feel like the construction lending portfolio is classified appropriately or but there is still be something to do there?
Jim Eccher
Yes. We continue to align that portfolio.
Now we don’t have a lot in that portfolio to begin with. We have done a little bit of commercial construction of some strong medical clients, but we’re not lending into the residential homebuilder business.
We’ve got what we have left in the construction portfolio. We think we have it marked right.
But it’s on a pretty normal wind down basis right now.
Evan Pilsner - Trishield Capital
Great. And then the last thing was, obviously you still have a good chunk of TARP outstanding.
Is that something you don’t specially give in the leverage ratio at the operating company? Is that something that you feel like can be addressed in the near-term?
Bill Skoglund
Yes Evan. We redeemed about a third of the TARP in April and at the time we had a six month kind of stay period where we couldn’t redeem anymore as far as being fair to the people we redeemed it from.
That period is up in October. And frankly we’re looking at all of our options of what to do with that now.
It’s pretty expensive at 9%. The best thing to do would be to be able to take some of it out of bank maybe the bank dividend; we have pretty solid capital ratios at the bank.
But we do need regulatory approval for any kind of payback on TARP. And so we’re looking at our options.
We’re told that there were some sub-debt markets might be available to us today. And so we’re just looking at all of those and working through what’s best for everybody.
So, we want to come on that probably.
Evan Pilsner - Trishield Capital
Again just to get some additional clarity. Do you think that’s a 2014 event or are we looking more early next year?
Bill Skoglund
Well, it depends on our approach. We could take an approach to chip add it and start paying some of it back which could be sooner than later.
If we will take the approach of paying it all that may take a little more time because there is not much time left in the fourth quarter and the Fed doesn’t move real quickly on things. And so, we’re just working through and I’m not sure if it could be some this year next year or next, but we are looking at our options and we’ll -- let’s save this money if we can do something with it.
But we want to do what’s best for the long run not just as it’s today and we’re little hesitant to add more debt to the bank at this time.
Evan Pilsner - Trishield Capital
Got it. That’s all for me.
Thank you guys very much and Bill congratulations on more than 40 years.
Bill Skoglund
Thank you.
Operator
There are no further questions at this time. I would now like to turn the call over to Bill Skoglund for closing remarks.
Bill Skoglund
Again, thank you for calling in and we appreciate your interest in the company. And it remained optimistic that we will continue to move forward.
So with that, thank you for calling.
Operator
This concludes today’s teleconference. Thank you for your participation.
You may disconnect your lines at this time.