Q3 2020 Old Second Bancorp Inc Earnings Call
Good morning, everyone and thank you for joining us today for old second Bancorp Inc. third quarter 2020 earnings call on the.
On the call today is Jim anchor the company's CEO Gary.
Gary Coleman, Vice Chairman of our board and the company see Oh, Brad Adam.
I will start with a reminder, that Oh second.
Okay 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 before.
These statements are not guarantees of future performance and results may differ materially from those predicted.
<unk> I would ask you to refer to the Companys SPC finally, we're thrilled to succeed [laughter] factor.
On today's call. We will also be discussing certain non D.A.P. finance to measure. These nine he and his team members are described and reconciled to their D.A.P. counterparts in our earnings release, which is available on our website Oh second dotcom under the Investor Relations tab.
Now I will turn it over to Jim Eccher.
Good morning, and thank you for joining us today.
Several prepared opening remarks, I will give 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 10.3 million or 34 cents per diluted share in the third quarter earned.
Earnings this quarter were positively impacted by continued higher volumes of mortgage banking activity, resulting income specifically net gains on sale of mortgage loans.
Net interest income declined slightly from last quarter based on continued reductions of interest rates on variable rate loans.
Impact of a $137 million in P.P.P. loans, and a massive increase in core deposits.
Without a corresponding earning asset growth resulted in a sizable reduction and a reported taxable equivalent margin of 31 basis point.
The NIM compression was more significant than our expectations, because we had not anticipated the magnitude of the increased liquidity, which taken our loan to deposit ratio from 84% to 82% this quarter.
Expense discipline was strong with deferral expenses related to the origination of P.P.P. loans reduced hours of operation and lower overall volumes.
Asset quality trends at this point remain remarkably stable and the bulk of our lending team is focused on monitoring and staying in close contact with our clients.
Nonperforming and classified assets increased somewhat modestly and we remain confident in the strength of our portfolios due to.
Details are available in the earnings release tables I need.
These changes.
Loans that are modification stands at approximately 2.4% of the loan book today.
And we are working closely with our borrowers to understand each and every situation.
Well the original $226.2 million of loans, which were on cold at 19 related deferral.
About 172 million or 76% have already returned to payment status.
As of October 19th 49 loans totaling 26 point Sixmillion and balances are received a second deferral period.
Concurrent with our earnings release old second also.
While the additional detail on our loan portfolio that will give investors additional detail on the composition of the loan portfolio current modification breakdowns and reserve levels.
Exclusive of P.P.P. loans. The reserve currently stands at 1.74% of total loans and 1.9% if the reserve for unfunded commitments is also considered.
During the quarter 1 million of reserves for unfunded commitments was reclassified.
Into the allowance for credit losses on loans.
Overall fundamentals in earning trends were relatively stable and consistent with prior quarters with mortgage mortgage banking results, reflecting the positive impact of the low rate environment, where it is.
We are extremely pleased with this performance.
Oh second has taken a number of steps to protect our employees customers and communities for our customers our locations remain open and available, albeit with necessary safety precautions.
We are continuing to work with those there's been directly impacted and we're offering the ability to defer payments as appropriate.
Fees have also been waived in many cases.
The vast majority of our staff has been working remotely since March without issue.
Oh second is proud to serve our communities and I couldn't be more grateful for the efforts of our employees over the last few months.
We are fortunate that our core lending strengths of steers clear of many of the most impacted industries.
As a reminder for last quarter, we had zero direct energy or aircraft exposure in our loan portfolio.
Hotel lending is extremely limited and restaurant lending is similarly scarce in our portfolio.
We realized the potential exist for many other industries to be significantly impacted in the short to intermediate term and the implications of rising unemployment is falling consumer and commercial demand.
We are closely monitoring trends in both the retail and office commercial real estate, both for our customers and in our footprint.
Our overall outlook remains cautious at this point, although we are seeking new lending relationships.
Our base economic forecast at September Thirtyth continues to project significant economic stress and an elevated unemployment rate over the life of the loan portfolio.
Oh, no, we do not worsen or base case economic scenarios in the third quarter, although we have not as of yet upgraded them either.
We will have losses at some point, though we believe our portfolio is well diversified and will hold up much better than most importantly, we.
Importantly, we believe our capital and liquidity position are strong as they have ever been.
In regards to the third quarter, specifically total loans decreased by 22 million from last quarter due to continuing payoff activity and softer origination volume.
We did not see significant line of credit draw downs it old second in the third quarter. Thus.
Thus far in 2020 line draw Downs has continued to remain mostly muted.
In a very short period of time, we saw a robust pipeline of loan demand mostly disappear.
Concurrent with this we quit quickly froze any lending activity that featured cash out refinancing.
Loan growth trends in the fourth quarter and beyond should improve based on current pipelines from the levels build a path or the overall economy and pandemic progression could impact that estimation.
In the third quarter 2020 old second began the forgiveness application process with the S.P.A. and we'll continue to process forgiveness applications through the remainder of the year with an expectation of receipt of funds from SB, a well into two till 2021.
Overall, we remain cautious, but surprisingly encouraged about our results in a number of areas.
And I'll turn it over to Brad who will give you more color in his prepared comments.
Thank you Jen and interest income decreased only 198000 relative to last quarter.
Net interest margin has declined due to further expansion of excess liquidity on the balance sheet reduce rates and lower yielding P.P.P. loans.
We had expected more margin more modest margin compression than us.
Continued deposit inflows in substantial excess liquidity persisted for the entirety of the quarter.
Our margin performance exclusive of these factors has remained within shouting distance of our expectations.
We will modestly look to deploy some of the access in coming periods over extremely short durations and with the Conns extremely conservative credit profile.
This should stabilize the margin in future periods I'm not assuming at this point anyway that deposit inflows will reverse quickly if the.
If the outflow or bounce back is relatively quick our margin outlook would improve.
If economic conditions improve in loan growth returns our margin outlook would improve.
I do not currently expect either of these conditions to occur in the short term.
The income trends were strong relative to last quarter as mortgage banking income increased 950000.
Primarily due to net gain on sale of mortgage loans and reduction in NSR losses in the third quarter of two to 2020 over the second quarter.
Service charges on deposits also reflecting growth of its customer banking activity increased.
Consumer slowly start to spend again independent like environment.
The provision for loan losses totaled 300000 in third quarter falling in approximate 8 million in the allowance for credit losses in the first quarter of 2020 and $2.1 million in the second quarter.
This economic outlets for us it seems prolong recessionary environment with an unemployment rate remaining above 8%.
Through September of next year and highly elevated over the remaining life of the loans.
As Jim mentioned old second as minimal minimal exposure to the hardest hit industry is in a very strong credit culture overall arc.
Our consumer lending exposure as both relatively modest end 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 customers funding quality loan growth and maximizing core funding with the expectation of further modest contraction in margin trends.
It's ending liquidity remains robust in risk spreads remain on.
Unreasonably tight our capital and liquidity levels leave us well position and we have ample flexibility continue the pursuit of quality relationships, while protecting the franchise.
<unk> expenses remain extremely well controlled and we will likely pursue some modest expense initiatives in the remainder of the year as the depth of the economic stream becomes more clear.
With that I'll turn the call back over to Jim.
Okay. Thanks, Brad in closing we remain encouraged with these trends confident in our balance sheet and feel like we're ready for the challenges ahead, we have taken the steps to position ourselves well for a slowdown and recession.
We believe our credit underwriting has remained disciplined in our funding and capital position is strong I read.
I remain optimistic that opportunities will be available to improve our franchise.
And a focus for us is on timing, making sure that we have the right.
Liquidity balance sheet and access to capital we need in order to take advantage.
I'd also like to mention that we announced two new additions to our board of directors. This week.
Jill York, a longtime executive with MB financial and aligns with more than 30 years of bank regulation experience with the L.C.C. have agreed to join us.
We welcome their perspective and believe they can help us reach our long term goals.
That concludes our prepared comments. This morning, so I will turn it over to the moderator and we can open it up for questions.
Thank you the floor is now open for questions. If you do have a question. Please press star one on your telephone keypad at this time.
Okay.
Our first question comes from Nathan race with Piper.
Thank you question.
Yes, hi, guys good morning.
Morning.
We just started the loan growth outlook.
Loans declined in the quarter.
Declined in the quarter or that was.
Or that was <unk>.
Two billable to lower line utilization, which I think also resulted in you guys are bursting.
Unfunded.
You mean that Hcl as well so just trying to think.
Loans kind of Troughed at these levels here in Twoq and Threeq U.S.P.P. and how should we kind of think about the unfunded commitment pizza Bcl going forward.
Yeah, I mean, I guess I would say you know based on the last few weeks, we're definitely seeing a pipeline starting to build again, you know things there things are very difficult to predict.
You know going out more than two three weeks, but certainly with the uncertainty in the economy covered.
But we are we are seeing a more active loan committee.
Well, we're we're encouraged with the quality of the opportunities that we're looking at and and.
And expect Oh, we can stabilize the portfolio.
And hopefully show some growth and in the fourth quarter.
As it relates to the provision for unfunded commitments. It's it's.
I think that's largely.
A factor of how much uncertainty there was in the first quarter and maybe ended the second quarter.
In terms of how bad things were looking at that time or our actual commitments are down pretty substantially as you can see in overall loan trends.
But that provision level that still exists for unfunded commitments I would I would still characterize it as as indicative of.
Very severe economic stress.
So it's it's possible that can continue to come down there.
The question is does it go into the General reserve as it as it has in the third quarter or or does it get reversed.
But I think it's more indicative of the level of stress that we saw earlier in the year versus the level that stressed stressed that exist today.
Okay got it.
And then on the core NIM outlook going forward it sounds like.
The levels are expected to remain elevated at least in the near term. So it sounds like the expectation is for some core NIM compression from the 334 level.
Into the fourth quarter this year and perhaps.
Sure.
I'm, just hoping you know.
Magnachip that you're kind of compression expectation spread over the next couple of quarters.
Your guess would be as good as mine Nate I think that you know.
Yeah, we saw on an average basis 130 million dollar increase in net fed funds sold position a third quarter relative to the second I would not have expected that I did not expect that.
Obviously, there's a whole heck of a lot of money sloshing around and we're not the only ones seeing this dynamic.
I think that margin trends from here for the industry I will be largely dependent upon issuers desire to plough that liquidity back in.
No certainly when you look around and investment opportunities that are available to those that are cautious right now credit spreads are.
In my opinion unreasonably tight.
And not indicative of the risk that's out there.
I think that we obviously have to do something in terms of of putting some of that liquidity to work.
But my strong preference is that that a it would be extremely short in duration and.
And with credit guarantees.
So that will help the margin because anything.
'cause anything's better than a 10 basis point fed funds sold position.
But it it's now.
It's not going to improve that as long as excess liquidity remains around.
It's going to be a margin that step Don.
I will also say that it doesn't necessarily bother me.
Yeah, I think at least internally, we're running two margin calcs, what's the core margin and what's the margin impacted by excess liquidity.
Our core margin is incredibly stable as we know.
As we measure it internally.
So I'm not too terribly concerned by the possibility of future margin contraction at this point.
Okay understood.
That's helpful. And then just lastly for me credit performance was quite exceptional in the quarter.
The only item that maybe stood out to me was the uptick in classified loans. It looks like there was an increase in construction classified so just any color along those lines would be helpful.
Yeah, we had a a modest uptick or Nate you know what I think.
We tried to be very proactive in our credit Committee and I you know.
We had one you know one small condo project that is struggling but you know of the 23 loans that you got it that came off abatement.
In the first round that were downgraded.
You know two T to special mention or substandard.
Most of those reside and either churches.
And our leasing portfolio, specifically in transportation or motor coach.
You know, we don't see losses at this point, but the common theme is its cash flows under some duress here.
We expect some of these two to get upgraded the next couple of quarters, but importantly, we don't.
We don't we don't see any losses with with these downgrades.
Hi, I agreed to here.
I appreciate taking the questions nice quarter.
Thank you <unk>.
Okay. Our next.
I think comes from David long with Raymond James.
Your question.
Good morning, everyone.
Okay Fine Dave.
Yeah. It sounds like you guys are are cautious, but still optimistic on what types as well.
Losses, you guys haven't Jim you said the bank will record losses, where do you expect those losses to come at this point in time.
Well I'll give you an exact I guess, Dave <unk> <unk>, the <unk> or the lease portfolios, probably got Uh huh.
The highest risk for potential losses as I mentioned, there's there's a.
There's a number of borrowers in a in a motor coach industry and transportation and I'd say today. They you know.
You know they are under either.
These are the first debate manner, the second abatement or potentially could get extended again, which would which would create a TDR, but none of them at this point.
I ready to hand over the keys to us, but if I had to guess that you know that provided.
This extends cobot extends longer that that sector could could be under more.
More duress absent that you know a retail concentration is hanging in there.
You know we don't have we only have a couple of credits that are on the second abatement, there, but yeah and then you know the church portfolio is certainly a underdressed.
You know many of them have adapted to virtual tightening a number of them haven't been able to.
You know.
Make that change so you know that that's always a challenging situation if ER and my guess is we'll continue to work with them and provide more payment relief even beyond the second deferral.
Got it okay. Thank you and it sounds like the accounting then if he do once you go past 180 days at that point doesn't then become a TDR.
It would it would yes.
Okay got it.
As we sit here because we're sitting here today are our second deferrals that are in the mid 20 million. So it's it's you know.
In the 1% range in terms of total loan portfolio.
So what we're talking about here is tiny specifics in terms of where we're seeing strain.
You know we had we been surprise.
We've been surprised to the upside in this forces to be more optimistic in terms of what the cat underlying cash flow dynamics in our customers looks like today relative to what it looked like six months ago.
So things on that front are pretty encouraging.
Got it and then a last question I had is in looking at your reserve today.
What do you have built into your reserves.
Assumptions for or what is your assumption for a stimulus package in the reserve.
We do not currently have an expectation of a stimulus package and the reserve.
Got it thank you.
Our next question comes from Chris Mcgratty.
KBW basically.
Hey, good morning, everybody.
Hi, Chris worry Chris.
Brad or Jim could you just elaborate on your comments about expenses seems to be a hot hot topic with the but in the industry today in response to covert and low rates.
I guess, maybe the magnitude of what you might be considering.
Not a lot we run lean we have run lean and my on my honest opinion, if you announced a draconian expense cut then you probably weren't doing what you should have been doing a year ago.
So for US it's it's it's trending at the edge is a little bit here.
Yeah, we have migrated from 60 Uh huh.
Mid to high 60% efficiency ratio to a sub 60% efficiency ratio over the last several years.
We remain there. Despite a margin that is has come down in a low rate environment.
Well, we run a tight ship.
I'm very proud of the efforts that had been made by everybody here in terms of keeping expenses locked down.
We also have you know a great many capital improvement and caught up on on any deferred maintenance and 2018 and 19 when the when the margin was expanding.
And that involves also some significant tech investments.
Some of which allowed us to be pretty darn seamless when when we let full remote.
So I just don't see.
Any significant capex increases relative to the base years, where it did have some and I think we can hang out around this $20 million quarterly level.
And I think that can drive.
Basically returns on tangible common equity that are pretty damn close to mid teens.
Which I'm happy with.
Got it.
On capital I mean, you guys are kind of one of the few that it had been returning capital through the buyback.
Thoughts on you know pace of expectations going forward. She is it fair to assume given you've done for a couple of quarters that you might continue if the visibility is improving.
Yes.
Okay.
And then.
The last question.
Right.
Obviously, the industry benefited from lower tax rates, a couple of years ago [noise] anything different in your I know you've done some stuff that's their portfolio Brad.
Materially different from the sensitivity that we had all the way down on that might be at risk all the way up.
Yes.
No not really.
I I think that if if tax rates change. It's a it's a step change kind of back to where we are or we didn't lean and anything over the over the new tax regime.
Certainly that wouldn't be my preference, but yeah, we'll see if we had that way.
Got it thanks.
Okay. Our next question comes from.
Hi, Martin [noise] Montgomery.
Montgomery Please state your question.
Hey, guys good morning.
Just one question right there [laughter] classified but was there any migration in the in the watch list are there any special mention credits this quarter of any magnitude or is it pretty stable there as well.
Yeah, we had a couple of we had a few a handful of credits Brian migrate to special mention and and no surprises. It's like this aforementioned or the leasing portfolio strain. We had one yeah, one hospitality loan that we took to special mention but ironically we.
We understand that they are coming up that they don't need a second deferral.
We'll be returning to normal payments.
And ER in the fourth quarter.
As far as any any surprises that you know I cant say there were any you know there was pretty minor movement really.
To non accrual and and we obviously had a few upgrades to and had some <unk>.
Resolutions on some some some oreo properties properties that we were able to sell.
Okay. So just a mile a modest increase or semi increase to what we saw in classified and how about just your take on and there was just a reserve build in general how how credit it sounds.
I guess do you guys feel like you have got most of the reserve build from co bid kind of completed at this point you know absent any significant underlying.
Yeah deterioration from here or change in trends.
Yes that is the nature of of Cecil modeling I would say that the only risk for meaningful provision growth from here is.
Duration of the economic stress.
Yeah, Yeah, you should you shorten your forecast period, one recession becomes evident.
To what extent does the recession extend beyond or continue to extend beyond your forecast period.
And what is the magnitude of losses that you began to see.
In context with that so.
Yeah, we got a lot of reserves, we got a lot of capital we got a lot of quality, we're in really good shape.
I don't know how to put it other than that yeah.
Yeah, I mean, I guess the change it seems like Moody's made some changes to the better this quarter, Brad I guess, but it sounds like you guys.
Didn't change your forecast I guess is that just an abundance of caution or is it just wait another quarter or just.
What you know whats kind of the explanation there or it did your forecast not change yeah.
Our forecast has not changed meaningfully and I would say that that you can get whipsawed pretty good if you start changing your outlook as fast as some of the stuff has changed.
I I'll be honest my personal bias is that the unemployment rate is the real unemployment rate is substantially above 8%.
And the implications of that do not happen quickly.
Despite the market movements that seem to indicate that it does.
You know.
We're by no means out of the woods here.
You know.
You know as far as old second goes it to our profitability is very strong and our credit quality is holding up very well.
Our underwriting has remained disciplined.
You know when we say things like we expect losses will occur.
I don't know how unemployment goes from three.
You know.
Above 10% on a real basis and.
And you don't experience some stress I don't care, how much liquidity you throw at it.
<unk>.
Okay.
Just one last one Brad just on the deeper in the deposit growth this year I mean.
How much do you think I guess, how much of that do you think it's just long term permanent customer that you guys are deposits it stick around versus kind of something that is more transitory that.
It's going to you know.
Exit the bank.
Yeah, Brian It's I mean, it's a great question I you know.
You know, we're certainly seeing you know.
Lack of spending right Bowl both on the consumer side and on the commercial side. You know we're still we've been hovering between 215 300 million and as you know in fed funds sold how much of that is going to stick I.
You know, it's pretty hard to hurt pretty hard to tell and normally we see some blue.
Some bleed down in the fourth quarter as our municipal depositors deploy their their cash you know we do we do feel better about loan growth in the fourth quarter, but then on the flip side. We've got a 130, some odd million in P.P.P. loans that could be forgiven here in short order. So your guess is.
As good as mine.
Okay, all right and just maybe lastly, just you touched on it Jim that the TPP forgiveness.
It sounds as though I guess is your expectation that most of that.
Yeah, there's not much in the fourth quarter and most of its probably the first half of 21 at this point.
Based based on the response or lack thereof, I I would say.
Probably more into the first quarter, although we do have a handful in process and then they have one process, but looks like.
It looks like the way things are going it's going to be into the end of the first quarter.
Yeah, Okay, and then just any update on just kinda there you talked about the retail and office portfolios you touched any other ones Jim that have this.
The stress with the leases and some of the other items, but just any any items. When you look at the retail or office that are noteworthy based on you know analysis over the last quarter here. So.
Yeah, I think it's important to know Brad first of all we have we have no office is no large office properties in downtown Chicago, there, they're all in the suburbs we have.
We have zero loans on deferral in the office portfolio right now we have a couple in the retail portfolio, but you know we're we're reading the same news you are we we know things are changing.
Rapidly. So we you know we're in constant contact with our clients and.
And.
You know trying to get our arms around.
Rental rates and cap rates and and.
That that does concern us and we're going to we're going to continue to be vigilant over that book, but right now, it's holding up pretty well.
Okay and the areas of most concern in the retail book, Jim would be what you I guess when you look at it today.
Oh, you know what I would say Oh.
Small smaller retail strips you know some standalones would would would concern me you know.
Those those are the areas that I would be most concerned with.
Okay.
Okay. I appreciate you guys, taking my questions. Thanks.
Thanks, Brian.
Again, ladies and gentlemen, if you would like a question. Please press star one on your telephone keypad.
Our next question comes from David Conrad.
[laughter] State your question.
Hey, good morning, just a couple of follow up questions ones on P.P.P. can you remind us of the the fee income potential out there there's still a ticket to earnings if there's that prepayment going in the first quarter.
So in terms of the net bottom line earnings impact you know we had told people that there was you know.
Around a four and a half million dollar gain the bottom line impact, though is impacted by the amount of expense deferral that occurred last quarter. So I would say, Matt economics to the to the balance sheet exclusive of lost field, if that portfolio pays and we do not redeploy at this.
Same or better rate.
As we still got somewhere between two an app and $3 million in outside.
Perfect. Thanks, and then last question just following up on the on the loan growth and loan portfolio.
Yeah, most of the asset classes were down quarter over quarter, but I didn't find it interesting that Syria investor category was up about 4.5% I know you guys have been really conservative in this area, but just any color there on the gross to call out.
Not to mention given given that gross.
Is that what you said specifically used to see every investor loans.
Correct, Yeah, Yeah, you know I.
Yeah, I don't think it was I don't I thought it was pretty pretty moderate growth that David I'd love to get back to you on that but you know overall originations were were softer in the quarter. We do we do see a better fourth quarter, but I'll have to get back to you on that one.
[laughter].
Broadly the loans that we have looked at doing over the last six months or so and then two well established operators with with substantial recourse.
I mean, if I look at look at the main <unk> the largest buckets that we that we funded in the quarter were were you know larger multi family and a and some manufacturing, but I can get you some more color on that.
Perfect. Thank you.
Okay.
Right.
Okay, well that concludes our presentation today, thanks for joining us and we'll talk to you next quarter.
Thank you [laughter] today's conference call. Thank you for your participation you may disconnect. Your lines. This time and have a great day.
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