Q4 2019 Earnings Call

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Hello.

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Hello.

Thank you. Thank you for calling May have to conference you're joining.

I would like to Jack for Old second Bancorp incorporated earnings call.

I may have this spelling of your first and last name.

First name DB D.A.B. I'd.

And last same brown be our old level you end.

That last name B.R.W., Unlike the color.

Yes.

What's your company names.

I era A.I.E.R.A.

Thank you all join you now.

And.

Stable credit outlook.

Hi level profitability has afforded us the ability to invest significantly in the future growth of the bank.

In regards to the quarter, specifically total loans increased by 31 million from last quarter with a strong levels originations mitigated by continuing payoff activity.

Loan payoff activity accelerated every quarter in 2019, and we're hopeful the pace of payoffs will moderate in 2020.

We continue to be surprised by the level payoff activity.

However loan pipelines remain healthy.

The competition for credits in our market.

Still remains very aggressive both in terms of pricing and structure and with the Tailwinds provided by an expanding margin having lessened.

We expect to increase efforts to grow the loan book and capital capitalize upon recent additions to our staff.

We're optimistic we can achieve 5% to 7% loan growth in 2020 exclusive of any merger activity.

Lastly, as it pertains to the loan book yields on the portfolio declined substantially from last quarter due to the benefit of accelerated accretion from the early payoff from an acquired loan in the prior quarter.

Total deposits bounced back nicely both of period and average basis growth here remains a key focus for us.

Our net total transaction account activity has largely been stable with declines primarily focused in higher cost relationships acquired in 2018.

The loan to deposit ratio for the fourth quarter 2019 remains unchanged at 91%.

We 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 overall.

Nonperforming assets in classified loans increased modestly relative to last quarter, but remain well controlled.

Overall, we remain very encouraged about our results in a number of areas and Brad will provide additional color in his prepared comments.

Thank you Jim net interest income declined by 1.6 million relative to last quarter about half of that decrease due to negative variances accelerated accretion on acquired loans.

Fee income suffered a bit as mortgage banking income returned to a more normalized level.

The reported taxable equivalent margin decreased by 20 basis points as Jim said from last quarter was about half of that contraction due to 15% paydowns in the acquired HBC portfolio during the quarter.

A few additional basis points were lost on the margin due to the sale of the securities during the third quarter, though the trade in aggregate was a very go along with the subsequent movement in interest rates.

Pricing movement on the liability side of the balance sheet has been limited to this point that we should begin to see reductions in funding costs in the fourth quarter in the first quarter 2020.

Notably margin trends in future periods will be impacted modestly by the adoption of Cecil on January Onest 2020.

Further reduction on Accretable discount offset by movement into the allowance for credit losses.

Equity levels will also be modestly impacted by the change.

The overall level the overall increase in the level of credit loss reserves currently estimated at a four to 6 million dollar increase and a loss reserve.

We will be largely derived by the reclassification of purchase accounting credit discount into the loss reserve.

As these loans mature we will begin to see these reserve levels migrate down to levels not inconsistent with historical trends for us given the relatively short duration nature of our loan portfolio.

Our efforts in the coming quarters, we'll be focused on quality loan growth in core funding with the expectation of further modest contraction in margin trends going forward.

The loan to deposit ratio leaves us well position than we have ample flexibility both to continue to pursue growth while protecting our core deposit base.

As Jim mentioned it is likely we will seek to optimize the to optimize the earning asset mix and fund future loan growth going forward through a mixture deposit growth in earning asset optimization.

For modeling margin trends in the future should be relatively stable with a market modest negative bias absent any movement in the fed funds rate.

Notably we saw significant decreases in the LIBOR rate during the third quarter or during the fourth quarter that were in excess of our expectations.

We are incredibly sensitive to movements in LIBOR rate should recover and start moving the other action. Obviously this this guidance will prove conservative should it continue to trend downward.

We would not do as well.

Overall loan growth will come a much more important factor for us.

The outlook for short term rates, having change, but I believe we had a significant opportunity in front of us.

On the fee income side mortgage banking reflected a decline gain on sale margins during the quarter and more modest pipelines.

Though MSR valuations for the fourth quarter compared to the third quarter were more favorable.

Trust and wealth management remains steady and retail banking transload modestly in both fees and card activity during the quarter.

Expenses remained very well controlled as you can see with additional cerus sales hires largely offset by seasonal factors.

During the first quarter and continuing investments for future growth are largely baked into a run rate trends you've been seeing from us.

With that ill turn the call back over to Jim.

Thanks, Brad and closings, we remain encouraged with these trends and optimistic about the future.

On an organic basis operating leverage remains strong and we're excited about the quality of talent added to the organization in the last two quarters.

Profitability remains excellent we're pleased with the outlook for short term rate movements have stabilized since we last fall.

Capitals continue to build significantly for a company and though we remain very comfortable with the returns we are generating we'll be evaluating opportunities to return capital to the shareholders and reduce high cost debt versus our outlook for opportunities to invest capital.

2019 overall was a very good year for US 2020 will be more difficult if interest rates hold here or decline further.

We are taking steps to position ourselves well for either continued strength in the local economy or the possibility of of potential slowdown.

We believe our credit underwriting.

As we remain disciplined in our funding and capital position is strong.

Overall the team here has never been better and I remain optimistic that opportunities are available to improve our footprint.

The focus for us is on timing and making sure that we have access to the capital we need in order to take advantage.

Periods of Susan significant changes in the volatility of bank valuations make M&A more difficult in the community bank space, but things can change quickly on that front.

Especially as we move through what may well be a more difficult year for some banks.

That concludes our prepared comments. This morning, so I will turn it over to the moderator and open it up to questions.

Thank you, Sir and ladies and gentlemen, if we'd like to ask questions. At this time. It is star one on your touched on telephone. Please make sure. Your mute function is turned off to layer signal to reach our equipment also please pick up your handset. So we continue to clearly over the phone again that star one at this time, if you'd like to ask a question.

We'll go first to Chris Mcgratty with KBW.

Hi, Good morning, Jim Hey, Rick.

Could you maybe maybe start on expenses you guys have done a pretty good job keeping expenses flat.

In light of your comments on revenue growth the more and more of a challenge for the group.

How do we think about the trajectory of expenses, given what you're doing on hiring front.

I think that.

Given some some momentum on the loan growth side, I don't think theres anything the aggressive needs to be done there we talked in the past it kind of a low single a low single digit number on the expense growth line.

We're watching things carefully John relative to loan growth I'd say that prepayments are still very highly elevated we saw a number of significant repayments during the fourth quarter.

If that trend continues with 90 to give more aggressive expenses, but for now we're still comfortable.

Thinking for the year.

Okay, Great and then.

You talked about the balance sheet optimization.

You guys, obviously done I want to work on the balance sheet in last couple of years.

How do we think about if your loan growth I think you said five to seven.

To be assuming earning asset growth trail that in the security book like flat to down or how do we how do we think about that mix Brian .

I at this point.

Given some some positive momentum on the deposit side I think that we can hold relatively steady on the securities portfolio.

That would be our lever if deposit growth isn't there.

To shrink that portfolio modestly.

But again, our real exposure is to down short rates and adding additional funding that does reprice with the short end of the curve is not something that is that.

I would shy away from at this point.

Given where we are in that cycle.

And what our overall positioning based on just the character of what we are which is an extremely well core funded community bank.

Got it great and maybe just just last one for you Jim.

Asked about in your within your closing remarks the capital.

How do we think about the ranking and other priorities are returning capital and redeeming the debt you talked about last quarter, but obviously the rate outlooks gotten a little harder. Thanks.

Yes, obviously were.

Focused internally on organic loan growth first but we certainly are taken a very hard look at.

Trups redemption and reducing some of those.

Hi cost that is probably.

Right right at the top list.

Thanks.

We'll take your next question from David Long with Raymond James.

Good morning, everyone.

Hey, David how are you.

Good the paydowns that you've been having would what are you baking into the paydown levels for 2020, when you talk about a 5% to 7% loan growth outlook.

Yes, that's that's been data that's been the challenge obviously.

In 2019 of we've pretty.

Terrific and acceleration and paydowns, each and every quarter.

Partially the reason for that partially as are the dynamics of our portfolio are changing durations relatively short.

But we had unusually very high paydowns in the third and fourth quarter. So we do expect that.

To moderate.

It's hard to its hard to peg that because we're seeing a lot of clients sell properties that we.

That we.

Didnt, even really know about so.

Given the pace of loan originations.

We're optimistic that is going to that's going to slow to more.

Normalized levels in 2020.

Okay.

Got it okay.

And from an operating leverage perspective can you guys put up positive operating leverage in 2020.

Even with the the NIM challenges or does the NIM.

The headwinds from the NIM.

Make that too difficult at this point.

I think all we really need to see for positive operating leverage is for LIBOR to quit contracting relative to.

Over and I agree.

The LIBOR rate is great deal of compression during the fourth quarter and to a level that surprised me to be honest.

If that ceases if it stabilizes then I believe we can show operating leverage.

Got it and then as it relates to see so I think Fred you made some comments about the.

The purchase accounting and did I hear right that you will move the credit marks.

Out of the purchase loans into the reserve, meaning that you are considering the loans.

PCD at this point.

Yes. So overall the reserve level should go up like I said $4 million to $6 million a significant portion of that.

Rather than being an adjustment to equity will be.

An adjustment from from the.

The credit loss reserve on acquired loans.

And the adjustment overall from an equity standpoint should be relatively small for us.

Those loan books that have a short duration I.E. more commercial bent are not going to see the type of impacted the residential and consumer balance sheets are going to see.

Got it.

I appreciate the add additional color thanks, guys.

Yes.

And we'll go next to Evan while with Janney.

Hey, good morning.

On the call for Brian Martin.

Okay. Okay.

First I appreciate the color margin and I, just we're just kind of curious how you're thinking about the margin in 20 with flat rate environment, and then possibly with.

Forecasting one kite later in the year.

Well I don't think we're going to see one cut if we'd see any cats, we'll probably see a number of them.

Okay, one cut it doesn't make a whole lot it sounds to me.

I think that.

Hey.

A stable rate environment applying applying the methodology that nothing changes anywhere along the curve and you take a steepening than we saw I would feel pretty good about that.

If you're talking about any rate cuts that doesnt excite me in the slightest.

Yes, I think loan growth can overcome one rate got effects than a scenario you want to talk about that.

In general nothing changes I think that would be with.

Lose a couple of basis points with with.

With seasonal and delayed impacts of the LIBOR moves that have that have occurred and I think we'd be relatively stable from that point.

Okay Austin challenges into the challenges in margin guidance is taking the rate moves that have happened.

Telling everybody there static and then accounting for the lag effects of those rate moves that have occurred.

In general over a full cycle irrespective of when quarter cut offs are.

Hello.

We lose three to five for a rate cut.

It's not.

Doesnt always fit well within do a quarter.

But that is the overall impact.

Okay, Yes, no I appreciate that.

And next just talking about.

The people you hired a 19 can you just give a quick outlook about that and then.

Potential hires in 20, and just your outlook for that in the future.

We made it obviously made a number of a number of ads.

In the latter half of 2019 all season.

Chicago based lenders.

About six of them.

We've also added to the retail bank and our Treasury group.

So we feel we feel real good about the talent we've added.

A large.

A large portion of our loan growth.

In the fourth quarter came very late in the quarter, two so while or footings were up we really didn't see much benefit of that.

In the margin so.

We continue to be.

Opportunistic.

New talent front, so those opportunities come along we will selectively continue to add.

Awesome and just touch on the loan pipeline in the Chicago hires.

It looks like.

Last quarter that most of your originations are coming from Chicago market is is that still fair to say.

This quarter.

I would say yes.

Okay Awesome, and then just housekeeping thing.

Just can you discuss.

How are you thinking about your provisioning and 20 under Cecil.

As we said previously it wouldnt expect it to be materially different than historical trends the provision level with the adjustment itself will be higher given the size of the acquired loan portfolio that from our ongoing origination standpoint, I don't see much of a difference.

Alright, perfect data, that's that's all I have thanks for that color.

All right.

And again, ladies and gentlemen, if we do have a question star one on your Touchtone telephone Star one to ask a question at this time, we'll go next Nathan race with Piper Sandler.

Good morning.

Hi, Dan.

Hey.

I wanted to touch on the 2.5 million in loans past 90 days on that appeared this quarter could you provide some color on that maybe the industry focus.

And.

Collateral backup and what you guys expect from that going forward.

Yes, we had we had a couple of.

Just administrative.

Past dues at the quarter, we want to classified.

Well, we did see we did see of modern uptick.

Classified but we expect to.

We expect to have those remediated.

The first quarter this year.

Okay, and then on turning to.

Loan pricing.

Do you guys my chance have the weighted average rate on new production this quarter.

Yes, this quarter we were.

Obviously fell off a little bit with LIBOR drop it what we were the mid to high fours.

On a weighted average yield.

And how it okay and that drop is there.

How that compared to third quarter.

Yes dropped about 30 to 40 basis points.

Okay. Thanks.

And then maybe can you provide a little color on the loan pricing dynamics, you're seeing and the market right now and maybe where the competition is coming from.

Larger guys or is it the smaller community banks that are.

Pushing pricing.

Well, obviously in Chicago, where we're seeing competition from from the larger banks.

And then in our.

More rural areas.

You mean, the smaller community banks provide.

Due to competitive pressures there but.

Yeah.

The primary growth engine for us has been in Chicago, So we're competing with the larger banks there.

Okay. Thanks, I'll step back.

Thank you.

Mr. After there appears to be no further questions at this time I'd like to turn call back over to you for any closing comments.

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

Goodbye.

Ladies and gentlemen, this does conclude today's teleconference. We appreciate your participation.

A disconnect. Your line is at this time and have a good day.