Q2 2020 Old Second Bancorp Inc Earnings Call
Good morning, everyone and thank you for joining us today for old second Banc Corps incorporated second quarter 2020 earnings call.
On the call today is Gen Eckert the company CEO, Gary Collins, Vice Chairman of our board and the company's CFO, Brad Adams I will 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 in the current economic.
Environment.
These statements are not a guarantee of future performance and results may differ materially from those projected management from those projected management would like you to 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 measure.
Our described and reconciled to their GAAP counterparts in our earnings release, which is available on our web site at old second dotcom under the Investor Relations tab now I will turn it over to Jim Eccher, Sir the floor is yours.
Good morning, and thank you for joining us today.
I have several prepared opening remarks, we'll give you my overview of the quarter and then turn it over to Brad for additional details.
I will then conclude with some summary comments and thoughts about the future before we open it up for questions.
Net income was 9.2 million or 31 cents per diluted share in the second quarter earnings.
Earnings this quarter were positively impacted by girls in mortgage banking income specifically net gains on sale of mortgage loans, which was partially offset by a sizable provision for credit losses of 2.1 million.
Associated with changes in economic assumptions, primarily driven by cold that 19.
Net interest income was essentially unchanged from last quarter. Despite shrinkage in the core loan books.
The strength of a full quarters reduction in funding cost.
The impact of 134 million in P.P.P. loans.
Massive increase in core deposits without corresponding earning asset growth.
Resulted in a sizable reduction that are reported taxable equivalent margin of 29 basis points.
This was higher than our expectations, because we're not anticipated the magnitude of the increased liquidity.
Taking our loan to deposit ratio from 89% to 84%.
Expense discipline was strong with deferral of expenses related to the origination at PPP loans.
Reduced hours of operations and lower overall volumes.
Asset quality trends at this point remain remarkably stable in the bulk of our lending team is focused on monitoring and staying in close contact with our customers.
Non performing classified assets increased somewhat modestly.
And we remain confident in the strength of our loan portfolios.
Details are available in the earnings release tables on these changes.
Loans under modifications stand at approximately 90% of the loan book today.
We are working closely with our borrowers to understand each and every situation.
Early indications are that approximately 60% of these loans will not require an extension of the original modification.
[noise] concurrent with our earnings release.
Second has also filed additional detail.
And our loan portfolio on a local photo gives investors additional detail on the composition of loan portfolio, Kurt modification breakdowns and reserve levels.
Exclusive of P.P.P. loans. The reserve currently stands at 1.63% of total loans and 1.89% if the reserve for unfunded commitments is also considered.
Overall fundamentals and earnings trends are relatively stable and consistent with prior quarters with mortgage banking results, reflecting a positive impact of the low rate environment.
We're extremely proud of this performance.
Well 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 are continuing to work with those that had been directly impacted and we are offering the ability to for payments as appropriate.
She's have also been waived in many cases.
The vast majority of our staff is now working remotely for well over three months without issue.
Well second is proud to serve our communities and I couldn't be more proud of the efforts of our employees over the last few months.
We are fortunate there a core lending strengths that Steve is clear.
Many of the most impacted industries as a reminder, we had zero direct energy or air aircraft exposures and our loan portfolio.
I will tell lending is extremely limited and restaurant lending is similar scarce in our portfolio.
We realized the potential exists for many other industries to be significantly impacted in the short to intermediate term.
The implications of rising unemployment and falling consumer and commercial demand.
Our base economic for credit forecasted June Thirtyth contemplated a significant decrease in GDP.
And in unemployment rate in the low double digit percent both for the remainder of 2020.
And remain highly elevated over the life of loan portfolio.
Our assumptions were notably more bearish than most last quarter.
And were again adjusted downward in the second quarter.
We will have losses at some point, but we believe our portfolio is well diversified and will hold up much better than most.
Importantly, we believe our capital and liquidity position, our strongest they ever had best.
In regard to the second quarter specifically.
Total loans increased 95.1 million from last quarter to 233.9 million of PPP loan originations.
In addition to a strong level of lease in commercial real estate originations mitigated by continuing payoff activity.
We did not see significant line of credit drawdowns, it'll second in the second quarter and thus far in 2020 line drawdowns it continued to be relatively muted.
In a very short period of time, we saw robust pipeline of loan demand mostly disappear.
Concurrent with this we quickly froze any lending activity that featured cash out refinancing.
The about pace and economic outlook means that the loan growth expectations that we shared in January or no long irrelevant.
We did not expect to see significant loan growth for the balance of 222020.
Thus far through July Twentyth, we have process deferrals on our loan portfolio for 462 loans totaling approximately 220 million in principle.
The largest contributors to these requests have been churches child care services in residential mortgages, which together make up approximately half of the request.
In terms of the Paycheck protection plan old second is funded approximately 134 million in loans in the second quarter 2020.
Overall, we remain cautious but surprisingly encouraged about.
Results in a number of areas and I'll turn it over to bread to provide additional color.
Thank you Jim net interest income increased 49000 relative to last quarter as the prior quarter included an acceleration of 635000 of interest costs associated with the termination of 32 million a trust preferred securities.
Absent this item spread income was down but has held up very well considering the core loan portfolio contraction during the quarter.
And should continue to benefit from interest savings on this retirement of traps going forward.
Fee income trends were soft relative to last quarter with the exception is very strong mortgage banking activity.
Mortgage banking increased by 2.4 million or more than 100% in the second quarter 2020 over the first quarter.
Servicing rights experienced a more modest write down based on declines in interest rates during the quarter as well.
The reported taxable equivalent margin decreased by 29 basis points from last quarter with the majority of the contraction due to a lower yield on PPP loans.
And the impact of unprecedented growth and liquidity on the balance sheet.
Deposit growth has been nothing short of eye popping.
As expected the elevated spread between LIBOR and overnight swap rates evaporated quickly during the second quarter I think with about an hour of of our earnings call.
Recall that we had reduced deposit pricing across the board in late March based on fed movements and experienced a full quarter. The impacts of these actions in the second quarter.
We expect much more modest overall margin contraction going forward.
Not extending at this point anyway that the deposit inflows will reverse quickly.
If the outflow or bounce back is relatively quick our margin outlook would improve dramatically if he economic conditions improve and loan growth returns our margin outlook would improve dramatically.
I do not expect either of these conditions do occur this year.
The provision for loan losses totaled 2.1 million in the second quarter. Following an approximate 8 million dollar increase in the allowance in the first quarter 2020.
Economic outlook for us assumes a prolonged recessionary environment with unemployment rate remaining above 10% through the remainder of the year.
And above 8% through June Thirtyth of next year.
It reflects the high single digit unemployment rate over the remaining life of the loans.
As Jim mentioned old second as minimal exposure to the hardest hit industries and very strong credit culture overall.
Our consumer lending exposure is relatively modest compared to peers very much to actually and extremely well seasoned.
Reserves across the commercial book of increased dramatically this year in excess of 50% relative to last year.
Our efforts in the coming quarters, we'll be focused on helping our customers funding quality loan growth in maximizing core funding with the expectation of from artist modest contraction in margin trends.
And then liquidity remains robust as I said and risk spreads remain on reasonably tight.
Our capital and liquidity levels leave us well position that we have ample flexibility continue to pursue to quality relationships in protecting the franchise.
On the fee income side mortgage banking reflected a significant increase in gain on sale margins and volumes during the quarter.
I expect mortgage banking trends to continue to remain strong in the near term.
Trust and wealth management bounce back quite a bit and retail banking transload dramatically with be rationalization undertaken during the quarter.
I'm not sure when we were returned to standard policy here yet.
Expenses remain extremely well controlled and we will likely pursue some modest expense initiatives in the remainder of the year, it's a debt to the economic strain becomes clear.
I think broadly.
What investors should take away is that we're by no means assuming anything resembling a V shaped recovery and expect this the strain to continue.
In both the near and intermediate term.
We will continue to pursue quality relationships and we are on the look out for opportunities to expand expand the franchise when appropriate.
With that I'll turn the call back over to Jim.
Okay. Thanks, Brad in closing, we remain encouraged with these trends competent our balance sheet and ready for the challenges ahead.
We have taken steps to position ourselves well for a slow down and recession.
We believe our credit and underwritings remain discipline.
Our funding and capital position is strong.
Overall, the team has never been better and at some point to Brad point I do 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 capital that we need in order to take advantage.
That concludes our prepared comments. This morning, so I will turn it over to the moderator to open it up for questions.
Thank you ladies and gentlemen, the floor is now open for questions. If you do have a question. Please press star one on your telephone keypad.
If you're using a speaker phone, we ask that while closing your question you pick up your handset to provide the best sound quality again, ladies and gentlemen, if you do have a question or comment. Please press star one on your telephone keypad at this time.
Well take our first question from Nathan Weiss with Piper Sandler. Please go ahead Sir.
Yes, hi, guys good morning.
Data.
Red was maybe just hoping to start on your expense comments sounds like you guys. They're looking at some opportunities to kind of refined the cost structure in back half of this year. We're just wanted to press you could elaborate on the magnitude of central cost.
Let's say you guys are contemplated at this point.
I think it's too early to tell I think that some of the the.
Large infrastructure spends that we had contemplated and that were consistent with the guidance that we had provided largely be on hold.
We are doing are absolutely very best to make sure that nobody is sent home.
During the pandemic and and we run a pretty lean shop as it is as evidenced by the profitability ratios that we.
Usually reports and our again reporting this quarter.
I think that the way.
Think about us is being extremely cautious on any investment opportunity.
We're in one of those rare scenarios, where there is going to be opportunities to acquire things for less than than you can grow them organically at some point. The key is evaluating where asset values are going to be.
We certainly don't have clarity on that yet.
But.
I think that for the near term.
Operating expense run rate around $20 million is gonna be appropriate.
Got it that's helpful and just keep changing gears a little bit in thinking about that reserve build trajectory from here.
That's the classified.
Loans came down the quarter.
Imagine that provision that you guys incurred this quarter is largely just a function of qualitative.
So just kind of as we sit here today and as you guys look out should we continue to expect the reserve to increase as a level that we saw here in the third quarter I'm, saying the same quarter into third quarter or kind of what you're seeing from internal perspective, not really.
Supporting that said build this point.
I think that.
If I had the answer to that I would tell you.
You know we saw a strong rebounded and a number of economic indicators that my strong suspicion is largely a factor of unprecedented levels of stimulus.
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Broadly speaking.
You know.
We're still running somewhere in the neighborhood of down 15% on consumer spending.
That is going to have profound implications and I don't know what the government response is going to be and I don't know what the availability of credit is going to be broadly in the economy.
All of these things are are.
Fundamental in determining what the path of things is going to be the visibility is quite simply very low.
I think it's possible that we'll continue to see reserve builds consistent with this quarter in the next two and I think it's possible that we will begin to taper off.
I don't know, what's going to happen on that front, so I wouldn't want to lead anybody astray.
Fair enough understandable.
And then just last one for me on the cord.
Margin from here.
Yeah disclosures in the deck around the impact from.
Uh huh.
TPP loans, and so forth, but I guess.
I mean that out going forward and it doesn't sound like you guys expect excess liquidity levels to come down near term just any thoughts you kind of trajectory of the core NIM in the third quarter.
At this point.
Well my opinion on on what core deposits are going to do is worth about nothing because I did not expect to have.
200 million and cash, earning 11 basis points.
Yeah that is simply a major with on the forecast exclusive of that impact an exclusive of PPP. The margin was only down a few basis points.
Which would have been consistent with my expectations I don't know what's going to happen. My strong suspicion is is that based on what we see is that a fair amount of this deposit growth is not in any way related to PPP.
And reflects a change in the savings rate per within our customer base.
Our desire to have a cushion.
I don't know how long that last I do know that the last time, we went from low eightys loan to deposit ratio back to 90%. It added 30 basis points to our margin.
So at some point is a significant.
Driver profitability in earnings growth.
If it is more than transient.
We have a very good deposit franchise.
And I think that at some point that becomes worse something again.
And.
Jim and I talk every day in terms of when's, the right time to to look forward and get back to doing something other than than playing defense and I don't think we're there yet.
But I based on the amount of effort that our lenders it put in and getting close remaining close to our customers and having conversations in understanding their financial situation.
It it would be remarkably difficult to be more bearish than I was last quarter.
Got it that's very helpful appreciate that and and all the other color and congrats on the.
Our next quarter thanks, guys.
Thanks.
Our next question comes from Chris Mcgratty with KBW. Please go ahead Sir.
Hey, Mike.
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Brian when it correctly the margin question asked several different understanding the balloon in the balances.
In some ways, just just a percentage right, we care about and I.
I don't think about core core and I.
Excluding the TPP it sounds like.
Core loans will conduct retail loan growth near term.
And margin, it's still bias downward to feel like.
We're still dollar bias and I.
Just any color on that would be great.
Yeah I.
Yeah, I don't think we'll see a ton of growth, but I'm not prepared to the throwing the towel on on loan growth in 2020 either.
I think that there are opportunities out there because I believe that others will struggle.
I think.
I think that were largely contrarian in nature at least we had been for the last 18 months.
We spent the bulk of last year pruning.
And not chasing relationships that were border line in nature.
And to continue that now doesn't make sense, we did most of the hard work last year.
In addition to growing capital into this which is you know why raising capital now makes little sense for us given how much we've built.
You know.
Earnings visibility is tough here you run the chance of being very wrong like I certainly wouldn't have expected that that we would report.
Or near 14% return on tangible common this quarter.
And this level of strength, especially with with the balance sheet, ballooning, and low, earning or non earning asset, namely cash.
But I think it's certainly possible that that we can maintain this level of profitability absent.
A turn down.
And overall economic conditions, a dramatic scale.
Okay. Thanks.
You have you had to do there in terms of the people who do you have a couple of details just for modeling purposes. The amount of fees that are going to come through midyear. Your thoughts on timing and then what might the average balances of triple P. alone.
So.
I think we'll begin to see forgiveness in the fourth quarter.
Our gain is around four and a half million dollars that will be somewhat muted my expense deferrals that had been realized.
But you should see if I had to gas I would say half of it in the fourth quarter and the remainder in the first quarter of next year and somewhere around 95% forgiven.
Maybe higher.
The car our PPP loan originations I would remind people were entirely to existing customers.
And with only a couple of loans.
Of any size whatsoever.
You can see in the credit disclosures that we provided last night that this is a very granular loan portfolio with average exposures across every loan category.
Below half million dollars.
[music].
Very very granular very small very solid lending portfolio.
And I can tell you that the work with what we've done over the last five months.
I put myself in that group, but that's not remotely accurate it's entirely the work of our lending team.
Has made us very confident in where we sit.
Relative to current economic conditions.
Yeah, Chris if you look at the <unk> the second to last page of the that's a deck.
We averaged average tickets about 200000, so we've done 454 of these loans, but to Brad's point.
You know very small ticket.
Okay.
Last question and I'll step back.
Got it artisan pretty cautious on the environment for some time.
But you bought stock in the quarter, which is.
In the very small minority of banks this quarter, how do we think about isn't buybacks continuing.
Going forward.
I think it'll we'll be opportunistic.
Thanks.
Thank you as a reminder, ladies and gentlemen, if you'd like to ask a question. Please press star one and your telephone keypad at this time, we'll take our next question from Stan.
That investor. Please go ahead Sir.
Good morning, gentlemen.
Good morning Stan.
Yep.
Hey, good morning throughout Asia.
I meant to.
To say hey.
Pass colleagues and friends second.
Okay.
At the bank is almost 160 years old I think.
That it's.
Demonstrated in the past.
It's worth city hits the directors.
Officers.
Right, Okay, and then I think it's clear that.
That's what you guys are doing now and I just wanted to see who knows on a great quarter.
Yeah, great management's job it seems like to thank Mike and a little better since I retired assisted coincidence.
[laughter] I'll take that obviously you are a big part of building. This foundation. So Oh, we have to give you some credit for those two so thank you for the for the kind kind words.
I appreciate it adds a wish jail.
The best and.
Keith to keep making any money and my stock portfolio.
We will do.
We'll take our next question from Brian with Janney Montgomery. Please go ahead Sir.
Hey, guys good morning.
Orient bright he just one question, Jim I think you sounded deferrals.
So far I guess if you.
60% of the total is what you expect to be kind of go back to normal. So can you get down to a low low single digit level of deferrals, when we look quarter to out when they when they kind of roll through.
That that's based that early conversations we've been having with a lot of our clients and we think that those numbers could potentially be better.
Okay, and I guess, if you're seeing any second deferrals today I guess.
Are you seeing it sounds like you're not seeing much at all on that on the request for a second to pearls correct.
No, but we certainly expect them you know with some of these harder hit industries. Certainly you know certainly in retail part of the retail book will certainly have a second wave Brian but you know again, we don't have a lot of exposure to those other hard hit.
Dr. So.
We will we won't be immune from from doing second deferrals, but we're very pleased with.
The conversations we're having was with clients, we've actually had a number of clients Brian that have taken modifications, but yet continue to make total payments [laughter].
Oh, Okay. We do expect these numbers to improve you know next quarter.
Okay. That's helpful and just the.
Yes, I think you guys talked about loan growth being obviously pretty muted here, but you also kind of talked about the other opportunities to buy cheaper as opposed to growing organically I guess can you just give any sense on I mean, I realize it's early and we're out in the uncertainty of the pandemic, but just sounds as though there is there's more thinking I surrounding M&A or it is an EMV.
They were to just be more lift asking your thinking Eric we create these opportunities as you go forward.
Well I mean, obviously with organic growth is obviously something that we're very focused on internally.
Loan committees or I would I wouldn't say a robust at this point, but we are starting to see more activity on a weekly basis. We are confident we're going to be able to redeploy some of this liquidity in the coming quarters.
After that certainly lift outs or our fair fair game for US continue to looked added talent whenever we can and then.
Probably a little bit early let Brad speak to M&A, but probably a little bit early.
In the cycle, but Oh, we certainly a lot of looked for those opportunities to improve our footprint.
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I think M&A would require a great deal of due diligence right now [noise].
Right, Okay, Hi, I [laughter].
More more on the plane and not so okay and then maybe just lastly, let me guys. It's just on the on the fee income this quarter some of that you talked about.
Eliminating some of the service charge income in a deposit service charges, what how does the fee is how do you think those fees that are kind of customer related.
Trend here in the next quarter, two or just any near term visibility on that.
I think they'll slowly returned to normal over the next six months.
Okay.
The retail side.
On the service charge income Okay. So next year kind of looks a little bit more normal then the next couple of quarters.
Thanks, So yes, okay.
I think that's all I had so thanks guys.
Alright, Thank you Brian right.
As a reminder, ladies and gentlemen, if you'd like to ask a question. Please press star one on your telephone keypad at this time.
And your telephone keypad, if you'd like to ask a question.
Our next question comes from Eric.
A private investor. Please go ahead Sir.
Hi, good morning, instead of a question on your the loans with a human modification.
You look at that I guess, you have a balance is shown on the chart of about 216 million outstanding.
How much of those are actually just on interest only payments versus some other kind of modification.
Good morning America agenda.
Third adult.
About a third those Eric on interest only.
Third full payment deferral.
But the vast majority of them.
Over 85% or or for 90 days or less the remainders you know over 120 or 180.
Yeah, I saw that in the in the a and the detail it really would not you have there so.
Okay. So that's.
Oh, Okay, Yeah, I'm, sorry, I see I saw you had that in their third rock, Ohio, Okay I missed that.
But anyway, good a good to hear anything from there okay. Thanks a lot.
Thanks, Sir.
Once more ladies and gentlemen, if you'd like to ask a question you May press star one on your telephone keypad at this time.
And it appears we have no further questions at this time I'd like to turn the floor back to you must tracker.
Okay. Thank you everyone for joining us this morning, and we look forward to speaking with you again next quarter.
Goodbye.
Thank you ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation you may disconnect. Your lines at this time and have a great day.
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Oh.
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