Q1 2020 Earnings Call
Good morning, everyone and thank you for joining us for today's the old second Bancorp Inc.'s first quarter 2020 earnings conference call on the call today, It's Jim Eckard, The company CEO, Gary Collins, Vice Chairman of our board and the company's CFO Brad Adam.
Well start with a reminder, that old seconds comments today may contain forward looking statements about the company's business.
Strategies and prospects, which are based on management's existing expectations any current economic environment.
These statements are not a guarantee of future performance and results may differ materially from those projected.
But what else you should refer to the company's FCC 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 gap counterparts in our earnings release, which is available on our website at old second Dot com.
At the Investor Relations tab.
I'll turn the call over to Mr., Jim Aker, Sir the floor is yours.
Thank you [laughter] good morning, and thank you all for joining us today [laughter] I have several prepared opening remarks, and we'll give you my overview the quarter turn it over to Brad for additional details.
I will then conclude with some summary comments some thoughts about the future before we open it up for some Tonight [laughter] net income was 275000 or one cents per diluted share in the first quarter earnings.
Earnings this quarter were negatively impacted by a sizeable provision for credit losses of $8 million associated with changes in economic assumptions, primarily driven by cold at 19.
We also recognized 635000, an accelerated interest expenses due to the redemption of Trups and $2.1 million and mark to market losses on the value of mortgage servicing rights.
We'll see it with the movement of interest rates during the quarter.
The core net interest margin showed strength during the quarter due to reductions in deposit rates and a muted contraction of like more relative to other rates.
Ted will provide additional color on the margin in a moment.
Absent these items overall fundamentals and earnings trends were relatively stable and consistent with last quarter. So we did see mortgage banking results rebound from a seasonal slowdown in the prior quarter.
Second is taking a number of steps to protect our employees customers and communities.
For our customers are locations remain open and available, albeit with necessary safety precautions.
We're continuing to work with those that have been directly impacted.
And we're offering the ability to defer payments as appropriate.
The vast majority of our staff has been working remotely for well over a month without issue.
Second is proud to serve our communities and I couldn't be more proud of the efforts of our employees and supporting our customers and each other and what it did what is proving to be a very difficult time.
We are fortunate that are poor lending strengths of stewardess clear of many the most impacted industries. We currently have zero direct energy or aircraft exposures and our loan portfolio.
Hotel lending is limited to three mature credits.
At low loan to values totaling approximately $14 million.
Direct restaurant exposure is less than $20 million across both.
Commercial real estate and see it and see an eye portfolios and a significant percentage are those is focused in major fast food franchises.
We realized the potential exists for these industries to be significantly impacted in the short term.
We also believe few sectors will be spare difficulty any immediate near term funding applications of rising unemployment and falling consumer and commercial demand.
Our base economic forecast at March 31st contemplated a significant decrease in GDP.
And then unemployment rate in the high single to low double digit preset, both in 2020 and over the life of loan portfolios.
And only a two week time period, we went to zero fed funds rate and inevitable near term recession at a low to flat yield curve that gives all commercial bankers nightmares.
Industry wide stress tests are one of the real positives that came out of the last financial crisis.
I think we've done a real good job with our stress testing.
However, I doubt any bank. This imagine let alone model. These circumstances I don't recall ever seen any consult propose modeling, 50% drop off rather than it was in certain industries in less than a month.
This is new territory.
We will have losses at some point, but we do believe our portfolio is well diversified.
Not much better than most.
Certainly, we believe our capital and liquidity position.
Our strong.
In regard to the first quarter, specifically total loans increased 26 point fourmillion from last quarter.
With a strong level originations mitigated by continuing payoff activity.
We did not see a significant line of credit drawdown second in the first quarter.
Thus far in April line Drawdowns has continued to remain muted.
In a very short period of time, we saw a fairly robust loan pipeline.
Mostly disappear concurrent with this we quickly froze any lending activity that featured cash out refinancing.
I used an economic outlook means that the loan growth expectations that we shared with you a few months ago are no longer relevant.
I do not expect to see significant loan growth for the remainder of 2020.
Total deposits bounced back nicely on both a period on an average basis and growth has remained strong thus far in April as well despite the reduction in rates.
The loan to deposit ratio for the first quarter of 2020 is modestly improved at 89%.
I believe we can remain at this level for the near term with with modest long girls funded by a mix of deposit growth at modest balance sheet optimization.
Thus far through April 21st.
We have process deferrals on our loan portfolio for 130 loans totaling approximately $40 million in principle or 1.8% of commitments outstanding.
The largest contributors to these requests event churches, childcare services and residential mortgages, which together make up approximately half to half of their requests.
In terms of the pay cheque protection plan. Both second is approved in funded approximately $80 million in April we have another 43 million waiting processing and believe some additional <unk> request will continue to come in.
We are committed to doing what we can to help our customers on this front.
We'll attempt to isolate and report on the impact participating in this program has on our financial statements for investors.
Overall, we remain cautious, but surprisingly encouraged about our results on a number of areas.
And I'll turn it over to Brad who can give you more color in his prepared comments.
Thank you Jim.
Net interest income declined by 531000 relative to last quarter.
Due to an acceleration of $635000 of interest costs associated with the termination 32 million of trust preferred securities.
Absent this item spread income has held up very well and should continue to benefit from interest savings on this retirement going forward.
Approximately 20 million or the payoff was financed.
And do a turn a three year termed out at LIBOR plus 175.
Substantial savings relative to the 77.8% cost or the trups.
The income trends were soft relative to last quarter with the exception of mortgage banking sale gains.
Servicing rights experienced a sizable write down based on declines in interest rates during the quarter as well.
The reported taxable equivalent margin decreased by nine basis points from last quarter with the majority of the contraction due to the onetime accelerated amortization of Trump issuance costs.
We reduced deposit pricing across the board in late March.
Based on federal reserve rate movements.
A full quarter impact of these actions should be evident in the second quarter results with reductions beyond that more modest in effect as time deposits mature and reprice.
The adoption of Cecil resulted in 8 million dollar increase in the allowance for credit losses for both funded loans and unfunded commitments.
This is at the high end as yet.
So.
And $6 million exclusive of unfunded commitments. This is at the high end of the range previously provided in resulted in an adjustment to equity net of purchase accounting implications of deferred tax adjustments.
3.7 million on January 1st.
A change in economic outlook resulted an additional $8 million preferred for credit losses in the first quarter.
This economic outlook for us is characterized by a near double digit unemployment rate.
And a 15% to 20% under employment rate.
Notably it reflects a high single digit unemployment rate over the remaining life of the loans.
A substantial change.
As Jim mentioned old second has minimal exposure to the hardest hit industries and a very strong credit culture overall.
This quarter's provisions result in reserves in excess of 2.5% on the consumer lending book.
Which features no subprime exposure at origination.
Reserves across the commercial book has been increased by 25% relative to January onest and by 46% relative to December 31st.
Our efforts in the coming quarters will be on helping customers finding quality loan growth.
As we find it and maximizing core funding with the expectation of further modest modest contraction in margin trends beginning after the second quarter of 2020.
The degree of contraction in the margin will be completely dependent on LIBOR trends.
I do not currently expect that the current level of spread between overnight swap rates in short term LIBOR rates is sustainable.
The longer this spread remains elevated the better our margin trends will remain and vice versa.
Our capital and liquidity levels leave us extremely well positioned and we have ample flexibility you continue the pursuit of quality relationships, while protecting the franchise and our customers.
On the fee income side mortgage banking reflected a significant increase in gain on sale on margins and volumes during the quarter.
Although the MSR valuations for the first quarter compared to the fourth quarter was ugly.
Trust and wealth management softened a bit and retail banking transload modestly in both fees and card activity.
Notably card activity continues to be even softer in April.
Expenses remained well controlled with additional sales hires in 2019.
Our interest of anticipated be largely offset by seasonal factors and the remainder of the year in some likely modest expense initiatives in the remainder of the year as the debt to the economic strain becomes clear.
With that I'll turn the call back over to Jim.
Thanks, Brad.
In closing we remain encouraged with these trends confident in our balance sheet and ready for the challenges ahead.
Core basis old second is operating at a very high level. We are excited about the quality of talent added to the organization.
We have taken steps to position ourselves well for a potential slowdown and recession.
We believe our credit and underwriting has remained disciplined and our funding a capital position is strong.
Overall, the team has never been better and at some point I remain optimistic that opportunities will be available to improve our footprint. The focus for us is on timing and making sure that we have the balance sheet liquidity and access to the capital we need in order to take advantage.
That concludes our prepared comments. This morning, so I will turn it over to just to open it up for questions.
Thank you ladies and gentlemen, if you have a question or comment to the star one on your telephone keypad at this time using a speaker phone we ask that will pose your question you pick up your handset to provide the best sound quality again, ladies and gentlemen for any questions or comments at a star one on your telephone.
We'll go first to Chris Mcgratty at KBW.
Hey, Maria.
Good morning, Chris.
Robbins start with a question on the margin just want to make sure I understand kind of the the numbers.
Back to the charts that ran through the margins and the prefer or the Trump redemption. It looks like margins were kind of into high mid to high three eightys. If I take your prior comments that each cut was roughly where three to five and effectively we got six last quarter.
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That would suggest somewhere in the realm of 25 to 30 basis point the pressure assuming.
The the LIBOR dynamic plus itself out.
Is that the right way to think about margin kind of.
Trending towards the 360 range.
More or less over the next several quarters that relations bolt.
I agree with that completely Chris.
Okay. So theresa.
Could you speak too.
I guess just couple of items on the margin was there a notable accretion in the quarter that we should right.
No I accretion is you know the accretion volatility that we saw is was largely due to credit outcomes, which has now been removed undersea. So.
It is much more predictable and you get into a discussion of what is excess accretion versus what is normal accretion I define excess accretion as the amount that is accretable overnight over and above the contractual coupon or the asset.
The excess accretion for this quarter was less than $200000.
So.
Largely going forward I expected to be remarkably stable and don't expect to be talking about it much.
Okay.
Okay.
And then kind of a question for you there the given the revenue backdrop that we're all facing could you speak to investments that you may or may not be making and kind of the pace of.
<unk> expense growth from here I think first quarter is a little bit higher you know understandably was all seasonal thanks.
[laughter].
Well I suppose as far as our biggest investments last year, where it was obviously a new talent.
Weve.
Yeah, we brought on half a dozen.
No new lenders in the fourth quarter, which we're very pleased about absent that.
We're not projecting anything in the near term we've got.
Potentially a couple of a couple of capital projects, we will probably be suspend the remainder of the year, but we do not see any sizable investments outside of some software upgrades.
[laughter].
Okay, and so if I take the yeah, there's roughly 21 million bucks the yet this quarter.
My guess, Brad is that that number comes down from seasonal and just kind of.
Holds in there that you got a fair assumption.
Yeah, I spec will trend towards that 20 million dollar level before we we move 20 million dollar quarterly level before we move to any expense cut initiatives.
Got it okay.
Oh go ahead. Thanks.
Thanks, Chris.
Well go next to Nathan Ray Sandpiper Sandler.
Hi, guys. Good morning, PC, taking the questions.
Maybe just fares curious to hear what you guys are seen from clients in terms of loan deferral requests and just what your outreach efforts with your customer base and lucky or set of things has resulted in terms of.
You know how you guys are trip, perhaps stress in the loan book, just given everything going on today.
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Got it made surprisingly you know weve, thus far at about 1.8% of loan book that have made request for abatements or interest only we certainly expect that to take celebrate.
You know as long as.
The shutdown.
Last but.
We continue to to stress test the portfolio.
On a quarterly basis, you know so a lot of it we feel pretty good about the loan book overall.
One of the sectors. We were very worried about was our church exposure, which is about 2% to 5% of the loan book.
Surprisingly that sector has been very resilient, we're hearing there they're they're doing a lot of services on social media and tightening continues so that that's kind of surprised us.
Absent that you know we have no direct exposure to some of these hard hit areas, obviously the indirect exposure.
It is what we're focused on today.
Particularly retail and were diving deep into that portfolio now, but so far we feel we feel pretty darn good about.
That's great to hear I appreciate that commentary, Jim and then just going back to the margin.
Brad I think you alluded. The fact that you guys have deposit rates at some point in the first quarter Im just curious if that occurred more so late in the quarter.
And then we should expect kind of been more perhaps relatively pronounced drop in deposit costs into Twoq. Obviously, you guys had a pretty low beta over the course of several second measures are tender in there, but just curious terms or would you expect the magnitude of deposit deposit cost cuts in second quarter.
I think the cost of our non time deposits will trend.
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Towards 10 basis points relatively quickly.
Okay.
And as promos wear off over the remainder of the year, namely 150, 150% promo money market that we were offering for a period of time is that matures they should trend towards.
<unk> basis points.
Time deposits over the next two years.
Probably more like 12 months' will trend towards 50 basis points.
Our all in cost of deposit funding will be very very low.
I. Thank everyone understands that we are in a zero rate environment.
Hi, Thanks safety and soundness matters.
Thanks, Ed the quality of a deposit franchise, despite low rates will still matter, especially in times of stress.
Wouldn't trade our position on the liability side for anyone.
And the same is true on the asset side.
Understood. That's helpful. And then just lastly on wealth management Trust fees I appreciate there's obviously some headwinds there.
But I guess I'm just curious it's the one Q run rate is largely reflective of the equity market valuation pressures that we've seen recently or if you guys are expecting another step down in that line item enter into Q.
No I think given the fact, how far markets have bounced back the percentage that market sensitive revenues I don't expect a lot of pressure from that level.
Okay, Great I appreciate guys, taking the questions.
Once again it was star one if you had a question or comment we will go next to David long at Raymond James.
Good morning, guys.
David David.
Jumped around here, a little bit but on the fees fees on your year payroll protection program loans.
Most faces in talking about running in the vicinity of 3%, where where do you guys stand on that and and the loans that you guys just gotten approval for.
Yeah. It's you know we've were taken request as they come in and they're far arranging right, but I think tune at 3% as is probably the right way to think about that.
Okay got it and then.
You guys were pretty.
Opportunistic to hold off on buying back stock and then this quarter you did move forward with the stock repurchase in got at a pretty good discount here.
What are your plans for share repurchases here in the near term and then again looking out over the longer term as well.
You know I I actually don't know I think that.
So we executed at a weighted average price of a little over $7.
And the and the first quarter, specifically the last part of March.
It's difficult right I am extremely comfortable with our capital position I am extremely comfortable with what our credit quality looks like I am extremely comfortable with our reserve levels based on economic scenario that we see right now.
That being said there are 26 million jobless claims, which implies an unemployment rate somewhere just south of 20%.
That has profound implications.
I also know that the safety and soundness of the bank is in my opinion very strong.
And a component of that in the perception of that which I believe has been out of line.
Has been devaluation of the stock relative to to others either.
So it's difficult for me to rule out that we wouldn't be there to repurchase the stock.
Given what we see relative to what the perception S.
That being said our first priority is to safety and soundness of the bank and the safety and soundness of our customers in serving them.
So I can't tell you that our thoughts are fully formed on that front.
Got it no I appreciate your thought process on that it makes sense makes complete sense. So.
The reserve building side.
And any any you know.
Any guidance on what how you're thinking about that as we get to June you know, what and what scenario come June Thirtyth would it would it caused another Brazil reserve build similar to what we saw here in the March quarter.
So I think the most significant part of our reserve build is the underemployment factor.
Hi, everybody is coming in at it and an assumption of a double digit our near double digit anyway.
Unemployment rate.
And I think that that they are assuming based on some surprisingly low reserve levels that I've seen elsewhere that it is a short duration phenomenon.
I I don't believe that to be the case I think that when you talk about.
The level of revenue stoppages for walks lost the economy, you talk about something as persistence.
And so we have assumed persistently low under employment.
For a long period of time, specifically the entire life of the loan portfolio.
I can't tell you that doesn't mean more reserves in the second quarter.
As I sit here today it doesn't.
But if we continue to see five and $6 million and if we continue to see white collar jobless claims.
Following what has been largely a service sector phenomenon at this point.
Which I believe will happen.
Then then there could be modest further additions to the reserve.
I think that.
Anybody that that tells you that things are going to be better.
In September.
Isn't looking at the same data that I am in terms of the overall economy.
And.
We have seen very little change in delinquency, we have seen very little change in terms of have line of credit drawdowns, we have seen relatively.
I'm extremely light modification requests up to this point relative to others.
But I am under no delusion that that will continue if people continue to lose their jobs.
Got it thanks appreciate it.
Well go next to Brian Martin at Janney Montgomery.
Hey, guys good morning.
Hey, Brian Foran, Bright Hey, Brad if you went to.
Greater unemployment percentage found that.
Eight to 10, maybe you've got now how much would how much of a reserve build with that necessitate. If you went to a 15% level in the short term and then maybe moving back down at least if you're saying kind of data, suggesting 20, I guess, if you go higher earlier, and then have a tail off how much could that necessitate based on the models you guys look data that.
To to the reserve.
Frankly, not that much because what we've assumed is is that the unemployment rate is persistent I'm not sure that others are doing are doing that.
The a short term spike and is a high teens are low twentys.
That isn't persistent wouldn't wouldn't have.
A great deal of.
The impact on reserve levels.
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That being said.
I see.
I don't believe that a 20% unemployment rate is remotely possible over a sustained period of time sustained period of time being three years.
The American economy assembly stronger than that.
But I do believe that a 15% to 20% unemploy under employment rate over the life of our loan portfolio is an extremely a bearish assumption for which we have already taken.
Right Okay.
I appreciate it.
You guys outlined.
Limited risk to these sectors that are.
You know kind of more.
Highly to be impacted by call it but the.
If you look at the portfolio today, where do you guys view the greatest risk in the portfolio.
All right I mean, as you know our portfolio looks vastly different than than it did you know during the last recession. We've spent the better part of the last decade diversifying the loan book, we feel pretty darn good about it.
That being said you know, there's always risk and and construction lending.
No.
Going back to the last recession, it was over 20% of our book.
Today, you know.
It's it's 5% roughly.
Lot of that's commercial construction, it's still ongoing and we've got pretty good sponsors behind it.
Absent that.
You know anything with a retail.
It's anyway at retail focus right now poses rest of the longer this the shutdown happens right. So that's that's where our main focus is.
Okay, and the retail I guess exposure Jimmy just how big is that and just you guys have kind of have you disclosed kind of some any loan to values or debt service coverage levels that you can share is that yes, I mean I can tell you Brian before before Colgate hit we did have complete review of the retail portfolio and.
There were no real issues. There tenancy was was strong good good sponsorship ltvs and were in line. Obviously now all bets are off.
That that sector bears bears watching and we're starting to see some loan deferment requests.
But the reality is all over the next 90 to 180 days you know, we're prepared to do abatements and deferrals.
During this during this tough times. So we feel we still feel pretty good about you know the sponsorship behind it in the quality of the tenants but.
No the retail sector will not be immune to those that as long as this goes on.
Okay. If you if you if you look at the grass and the release that were provided one thing we amended is the actual balances there that make up those those PPI charge. The first one represents a balance of 850 million and the second which is the and investor commercial real estate makes up the balance of 514 million.
Now I would tell you this looks very different from a number of banks in our market that level of concentration and real estate an owner occupied properties is something that's very unique and the Chicago I must say I don't know than other bank that looks like us from that standpoint.
When you talk about if you look at the first Grafton indicates a 10% retail trade position.
Relative to an $850 million number.
A substantial portion of that.
As Dan and essential industries, namely gas stations.
There are.
When you look at the accommodation and foodservice number of 2% a substantial portion of that as grocery stores.
So we have.
I wouldn't get caught up in terms of something valuable retail in these pie charts and be assuming that that is a high risk area.
'cause it's simply not.
The the overall portfolio.
We'll be very resilient and my estimation at based on the information I add today.
For at least the next 180 days.
My concern is largely off a broader pull through and a wider slice of the economy.
Which is what Cecil is meant to do.
Which is why our economic forecast change I want to be quite clear on the fact that our reserving is not based on anything that we've seen in terms of trends in delinquencies or communications with customers. It is strictly a byproduct of the of economic numbers that are evident and financial releases up to this.
Point.
Got you know that's helpful. Brad.
Yes, maybe just the last one for me just understand it yet.
Pvp program, Brad just as far as the benefit as it works through the income statement.
Is that a a margin margin event and just I guess, if you kind of quantified I mean, I guess, if it plays out the way you're anticipating in your whenever I think you said 75 million or so is the number and if you use it to and a half 3% level. It's about 2 million Bucks that benefit you realize can you kind of give a timeline of how you're thinking about that.
Manifesting itself into the income statement.
Well, it's $80 million and in terms of what's been funded so far based on the expansion of the program Weve got for another 40 million in the pipe.
You know that that weighted average fee is going to be as Jim mentioned somewhere between two an app in 3% I don't know this stuff that's still working its way through is got to be in the 5% bucket.
So I think it's there's some upside to that number in terms of how that does now that the field work itself through.
This bad on these assets is obviously very low.
And.
It would be we are in a fed funds sold position as substantial one.
We will use that excess funding so we'll see that the full poultry spread.
To the extent that we get significantly more than the 80 million that's approved now.
We may access the the fed provided facility in order to fund that.
But these are short duration assets.
My intention as I sit here today is to is to breakout specifically.
Both the interest income and expense that results from this.
And give you a and margin that is independent of participation and the program.
Okay, and as far as yes, I guess the timing as you sit today, Brad just that benefit in most of it you would think is at Threeq you event. If it. If these credits are kind of a 90 day type of term is that.
Fair to say I mean, it's a minimal amount give them on.
I would say that the bulk of the benefit will be into Q.
In Twoq, Okay, Yeah, Alright, I got you all right. That's all I had guys I appreciate it.
Thank you Brian.
Thanks, Brett.
And with no other questions holding at this time I'll turn the conference back to Mr. Aker for any additional or closing comment.
Okay. Thank you everyone for joining us this morning, and we look forward to speaking you would again next quarter have a good day.
Ladies and gentlemen that will conclude today's call. We thank you for your participation you may disconnect. Your phone line at this time and have a great day.
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Okay.