Q4 2020 Old Second Bancorp Inc Earnings Call
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Good morning, everyone and thank you for joining us for today's old Second Bancorp, Inc. 's fourth quarter 2020 earnings call on the call today is Jim Eckert, the company's CEO, Gary Collins, Vice Chairman of our board and the company's CFO, Brad Adams I will start with a reminder, that old second com.
Rents today may contain forward looking statements about the company's business strategies and prospects, which are based on management's existing expectations and the current economic environment. These statements are not a guarantee of future performance and results may differ materially from those projected.
Management would like.
Or would ask you to refer to the company's SEC filings for a full discussion for the company's risk factors on the call today, we will be discussing certain non-GAAP financial measures. These non-GAAP financial measures are described in reconciling with their GAAP counterparts, and our earnings release, which is available on our website at old second dot com under the <unk>.
Investor Relations tab I will now turn the conference over to Mr. Jim <unk>. Please go ahead.
Good morning, and thank you for joining us today.
And I have several prepared opening remarks, and will give my overview of the quarter and then turn it over to Brad for additional details.
And we will then conclude with some summary comments and thoughts about the future before we open it up to questions.
Net income $8 million or 27.
Per diluted share and the fourth quarter.
Earnings and the quarter were negatively impacted by $1 3 million and <unk>.
MSR valuation mark to market losses, despite continuing strength and mortgage banking overall.
Fee income declined from last quarter based on some moderation and mortgage banking revenues relative to recent record results seasonal reductions and mortgages originated and the aforementioned mark to market losses on MSR is due to movements and interest rates.
Approximately $63 million of PPP loans were forgiven by the SBA during the quarter, which resulted in an increase and our net interest margin over the prior quarter from full recognition of net deferred fees on those loans upon pay off on.
Our loan to deposit ratio was a fraction over 80% at year end.
Relatively stable with last quarter, and a significant increase from 98% a year ago.
Expense discipline continues to be strong with a slight increase noted and noninterest expense for the current quarter.
Compared to the prior year quarter, due to higher salaries and employee benefit costs and.
And FDIC insurance expense due to assessment credits received in the fourth quarter of 2019.
Asset quality trends at this point remain remarkably stable and the bulk of our lending team continues to be focused on the second round of.
PPP loan origination and staying in close contact with our customers non.
Nonperforming and classified assets experienced slight increases only.
And we remain confident and the strength of our portfolios.
Details are available on the earnings release tables on these changes.
Loans and or modification stand at approximately one four per cent of the loan book today and.
And we are working closely with our borrowers to understand each and every situation.
On the original $231 3 million of loans, which were on COVID-19 related deferral.
$98 6 million or <unk> or 86%.
You've either return to payment status or paid off as of year end 2020.
As of year, and 51 loans totaling $32 7 million and balances are currently and deferral status.
Concurrent with our earnings release Old second also filed loan portfolio disclosures that will give investors additional detail on the composition for the portfolio current modification breakdowns and reserve levels.
Exclusive of PPP loans. The reserve currently stands at 1.73% of total loans during the fourth quarter.
And $1 million of reserves for unfunded commitments was reclassified into the allowance for credit losses on our loans.
And our outlook remains cautious given the uncertainties, but optimistic that the underlying economy will continue to improve.
We believe that we are more than adequately reserved under base case scenarios and have continue to overweight more pessimistic scenarios given the high degree of uncertainty.
Overall fundamentals and earnings trends were relatively stable and consistent with prior quarters with mortgage banking results continuing to reflect the positive impact of the low rate environment.
Loan growth trends exclusive exclusive of the pay offs and forgiveness of the PPP loans during the quarter was very strong and we are cautiously deploying liquidity.
And the short dated assets.
Profitability remains strong and we are extremely pleased with this level of performance.
Old second continues to be focused on the steps and protocols necessary to protect our employees customers and communities. During this pandemic for our customers our locations remain open and available, albeit with safety precautions.
We are continuing to work with those that have been directly impacted and we are offering the ability to defer payments as appropriate.
The vast majority of our staff, excluding retail continues to work remotely without issue.
Old second is proud to serve our communities and I couldn't be more grateful of the efforts of our employees and 2020.
We are fortunate that our core lending strengths have steered clear of many of the most impacted industries, we realize the potential exists for many industries to still be significantly impacted and the short to intermediate term from the implication implications of high unemployment and the potential for feed and consumer and commercial demand.
We are closely monitoring trends in both retail and office commercial real estate.
Both for our customers and and our operating footprint.
And our overall outlook remains cautious at this point, though we are seeking new lending relationships.
We do believe 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 on a strong as they have been.
And regards to the fourth quarter, specifically total loans increased $4 5 million from last quarter in spite of the $62 $6 million of PPP loans forgiven.
We did not see significant line of credit drawdowns and old second and the fourth quarter, thus far and 2020 light line Drawdowns has continued to remain muted.
Loan growth trends in 2021 should improve from from a year ago.
On the path to the overall economy and pandemic progression could impact that estimation.
Overall, we remain cautious, but surprisingly encouraged about our results and a number of areas and I'll turn it over to Brad to provide more color.
Thank you Jim and good morning, everybody.
Net interest income increased $1 $4 million relative to last quarter and 700000 relative to the fourth quarter of 2019.
And the margin was favorably impacted by the net loan fee income recorded due to the $62 $6 million on forget and PPP loans and the fourth quarter.
This net fee income offset the further expansion of excess liquidity on the balance sheet and the impact of lower yielding loans still outstanding.
We continued to have strong deposit inflows and substantial excess liquidity for the entirety of the quarter.
We have begun to cautiously deploy some of that excess liquidity, including the purchase of approximately $50 million and securities during the quarter.
And so made other short duration investments.
Strategy to deploy a portion of the excess liquidity will continue and the short term.
While we remain cautious on both duration and credit.
Our margin performance exclusive of the liquidity and PPP factors remained relatively stable this quarter.
I still and not assuming at this point any way that the deposit inflows will reverse quickly the outflow or bounce back is relatively quick on margin outlook would improve substantially.
And if economic conditions improve and loan growth returns and our margin outlook would improve substantially.
And do not currently expect either of those conditions to occur on the short term.
Fee income trends declined and the fourth quarter of 2020 compared to last quarter due to the seasonal slowdown and mortgage originations as well as the higher mark to market loss on MSR.
Net gains on the sale of mortgage loans were still approximately 200% over net gains from the fourth quarter of 2019.
Overall, the quarter was still very strong in this respect.
Service charges on deposits for slightly higher and the fourth quarter of 2020 compared to last quarter.
For 28% less and the fourth quarter of 2019.
Additional adult boldly death benefit of approximately 900000 was received and the fourth quarter of 2019, which was not repeated thankfully and this quarter.
No provision for loan losses was recorded this quarter following the approximate $10 4 million and provision expense recorded earlier in the year.
And the economic outlook for us assumes a slight improvement to the prolonged recessionary environment with an unemployment rate remaining and approximately 7% through September 30th for this year and elevated over the remaining lives for the loans.
And as Jim mentioned old second has minimal exposure to the hardest hit industries and very strong credit culture overall.
We spent a lot of time looking at things and it's extremely interesting to us that exclusive of a couple of credits that are just ridiculously obviously due to COVID-19.
And shut down our credit overall, including trends and classifieds and non accruals and and basically everything.
Has it has improved markedly this year.
Certainly not something we expected.
Still our consumer lending exposure is remains relatively modest we're not seeing any weakening there at all.
Reserves across the commercial book are up obviously, a great deal and excess of 50% this year.
I think at this point, we are extremely pleased with both how credit has performed in 2020.
And also what the trends for 2021 look like.
We couldnt be more surprise.
Our efforts in the coming quarters will be focused on continuing to help our customers funding quality loan growth, where we can.
Remaining short and duration and some extremely cautious on credit.
But we are open for business.
I currently expect a stable margin.
And maybe modest contraction.
And that assumes low liquidity remains robust and credit risk spreads remain on reasonably tight.
Our capital and liquidity levels are obviously extremely high at this point.
We continue to be interested and repurchasing stock and we're on the lookout for M&A opportunities as they present themselves.
Expenses for us, though modestly higher in the fourth quarter.
Due to some basically one off items.
We expect.
Relatively well controlled for the remainder of 2021.
And if we see things continuing to remain relatively difficult from an economic environment.
Our likelihood of some expense initiatives and the second half of the year It goes up.
And with that I'd like to turn the call back over to Jim.
Okay. Thanks, Brad and closing we remain encouraged with these trends confident and our balance sheet and ready for the challenges ahead.
We have taken the steps to position ourselves well for a slowdown and recession.
And as Brad mentioned, we believe our credit underwriting has remained disciplined and our funding and capital position is strong.
We remain optimistic that opportunities will be available to improve our franchise. The focus continues to be 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 would like to ask a question. Please press star one on your telephone keypad at this time.
A confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the queue for participants using speaker equipment and may be necessary to pick up your handset before pressing the star keys.
Once again that is star one to register your questions at this time.
Our first question is coming from Chris Mcgratty of Keefe Bruyette <unk> Woods. Please go ahead.
Hey, good morning.
Hey, Chris right Chris.
Hey, Bryan just want to start on capital.
Appreciate that Youre looking for for inorganic growth, but with your stock at tangible.
It isn't a play to get really aggressive with the buyback.
And where your capital levels are.
A powerful argument can certainly be made for that.
It's not something we'd be shy about.
And in terms of.
Net.
And that direction.
Would you entertain kind of and accelerated buyback given where the levels are.
Yes, I mean, that's certainly comes with with.
Certain expenses associated with it.
And it's more complicated and execution.
It's something that we've looked at over the last six months or so.
I think debt.
There's still a lot of uncertainty out there Chris and.
You can open up a web browser at any given point over the last week and see a number of things that will bother you if you let it.
So I would say that it's unlikely that we'll lurch at anything but given how much capital we built the strength of our earnings stream.
And the underlying trends that we're seeing on credit.
On the few problems that we have right now.
So obvious in terms of their COVID-19 nature, and so quantifiable in terms of the potential risk.
We don't see a ton to concerned about that being said there are some obvious structural things and the economy that are changing that will have a longer lasting implications that includes the appetite for office space downtown.
And as well as what brick and mortar retail looks like.
We're not a huge player and the former and obviously exists somewhat and the ladder.
And.
But <unk>.
Stress and those things will impact us.
Just as it will everyone.
And so.
And in times like these I don't feel and overarching desire to lurch at anything.
But buyback remains at this point anyway, I do say with confidence the most attractive thing that I see out there to do.
And with capital.
Great. Thanks for the color.
And just in terms of the revenue outlook as margins, obviously, it's pretty tough to predict but with liquidity.
How should we think about net interest income I guess for loss, Chris There Chris are you still there.
Yes, I'm here.
So there.
Yeah.
Yes, Sir I can hear you.
And the management team can you hear us at this time.
I'm, sorry, they seem to be having.
From a technical issue well it appears that we might have some tactical and technical difficulties, we are not able to hear anything thats coming through the line right now.
Ladies and gentlemen, please standby, while we get our management team back on the line.
Just one moment, please while Steve will bring you back in the queue.
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Yes.
Okay.
Okay.
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Okay.
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Ladies and gentlemen, we apologize for that and convenience.
Chris you are back on with the presenters for today.
Alright, great.
And thanks for the color on the on that on the buyback rate.
Wanted to switch on.
The outlook for for net interest income.
I understand the difficulties of margin given liquidity, how should we think about.
Net interest income growth for stability, excluding the PPP and in light of what you've talked about you do have some borrowings on the balance sheet I'm wondering if those are on the table at all and just any color on that.
Great. Thanks.
So on.
I feel pretty good that we can offset the runoff on the PPP loans with obviously significantly better yield and then what the GBP and giving us.
On.
And that should be basically on one to one washes and the remainder of our PPP loans are forgiven.
We will continue to deploy some of the excess liquidity.
And various short duration low credit risk ways.
In addition, the debt that you speak of on the balance sheet is callable at the very end of the year. So we'll provide any benefit this year, but will will provide substantial benefit next year, assuming that the issuance market remains the same.
And at the same level of spreads.
Overall I do believe that we'll grow net interest income quite nicely this year.
And.
What the margin is almost a separate discussion at this point given the.
And the impact and the liquidity and the sizable cash position.
Net.
We're holding that basically phases 10 basis points.
So.
Really the reported margin is just a function of that net interest income should so growth is in line with what we typically are produced.
And I expect 2021 will be a pretty good year on on the revenue growth from.
Okay.
Bryan what's left on the PPP fees.
Yes.
I think we've got about four or $500000 and Renee.
Okay, great. Thanks for the color.
That almost 70% of our PPP and forgiven already so we will be able to redeploy a lot of debt.
Great. Thanks.
Thank you. Our next question is coming from Bob Shone of Piper Sandler. Please go ahead.
Good morning, and follow on for NAV.
Yes, Sir.
Good how are you.
Alright, I just wanted to start on unexpected and maybe.
Know that when you get the <unk> compensation.
Increase that we usually see but maybe how should we think about the quarterly run rate and overall expense growth for 2021 and then in addition, maybe an update on any willingness to hire additional relationship managers given kind of the dislocation, we've seen and Chicago market.
So a big part of the underlying expense trends that we've seen aside from some other one timers that we discussed and the fourth quarter.
And we actually had some people will start going to the Doctor again.
And last part of the year so.
Claims within basically employee benefits were up rather sizeable Inc.
I think that a significant portion of the expense growth that we expect from 2021.
We'll be people, just actually going to the doctor and again as just fewer levels and sides and.
Employee benefits were down this year.
By a rather substantial amount just based on people not leaving the house.
I'd say, there's probably going to have in terms of the expense growth overall.
I think somewhere in the 3% to 4% range.
And that's been a pushy is somewhere around 20% to $21 million per quarter, and maybe closer to 21 and.
Total opex exclusive.
Mortgage banking activity.
That is assuming that mortgage banking activity stayed the same as it is right now, which I don't actually believe will occur.
Yes.
Yes.
To give you an idea on the underlying dynamics.
That's great color and then maybe turning to loan growth.
Maybe can you talk about some other drivers of the loan growth. Excluding PPP, we saw this quarter and maybe how pipelines have trended since last quarter.
Sure Bob we were obviously very very pleased with with the fourth quarter.
And there was a handful of large relationships that success.
And successfully were able to close some of them and we thought we were going to close and the third quarter and.
Build over into the fourth quarter.
We have further expansion and multifamily.
<unk> services healthcare.
Healthcare had an extremely successful year and we have continued expansion and leasing so.
Unusual for the fourth quarter, but we're very very pleased with it.
Looking into next year.
Had asked about adding to our talent base, we're certainly open minded about debt.
And I think we have the capacity to take on and.
The other team.
And becomes available.
And without really adding to the overall head count as we do expect.
Few retirements.
And some point this year.
Okay. Thanks, and then maybe if I could sneak one more in and your prepared remarks, you talked about.
The reserve and having more weighted on pessimistic scenarios.
Say that there is a little lastly on these pessimistic scenarios, what's a more normalized.
Reserve.
Level for the company under that situation.
That's.
That's a good question with a lot of variables to it.
I would say that.
If we were purely day.
Equal weight the base case scenarios that are out of the movies and bad right now.
Our reserve would probably be about 15% lower today.
Okay, Great I'll step back.
Thank you.
Thank you. Our next question is coming from Kevin <unk> of Janney Montgomery Scott. Please go ahead.
Hey, guys, Yeah, it's Evan and I'm on for Brian Martin This morning, and good morning.
Good morning.
Yeah. So first I think I'm going to start with.
And I know you guys gave some color on the criticized and classified levels.
And we just.
Would you anticipate that those levels for Q maybe.
Maybe they are at a peak with slightly better and Mac or macroeconomic outlooks and just I don't know just some color on your anticipation with that going forward.
Sure I guess, if you step back and look at your year over year on classifieds were.
Classified assets were down about eight 5% we're pleased with.
The overall progression.
And if macroeconomic factors improve obviously.
Expect to see continued improvement and the loan portfolio.
We do anticipate meaningful improvement and.
Some of the deferrals and the next quarters were already here and for borrowers.
Things are stabilizing and we expect to come on deferral.
Within the next quarter.
Credit holding nicely.
Okay, perfect and just kind of on that point I know last quarter you.
You guys don't have direct exposure to Covid industries like you said on the call but I'll.
Just curious you gave some color on stressed areas and.
And just if you could give an update on those areas that would be helpful.
And yet the most stressed areas now our investor CRE.
So multifamily.
And so retail CRE.
Surprisingly, we only have.
Really one.
Investor retail CRE on deferral on office and deferral, which is remarkable.
But all signs show that our deferral.
Okay.
Productivity continued to improve and the next quarter.
Okay perfect.
And then next I think.
You guys have given color on kind of a loan pipeline and you know.
Just curious your thoughts on that that loan production versus pay offs and just how youre looking at that and moving forward.
First quarter is always.
It's a challenging quarter.
For loan growth, obviously, very pleased with what we did and the fourth quarter a lot of that was.
Booked.
Later in the quarter so old.
And realized some nice benefit because.
And we head into the first quarter.
We're seeing some opportunities on our pipelines are building.
Would it be more pleased with our with our healthcare team and we.
We've got good momentum alone various verticals, so I think loan growth and in 'twenty and 'twenty one.
Be better than 2020.
Okay, Perfect and then last one for me just housekeeping.
Looking at your core fees on.
Yeah.
Looking at that level on <unk> is that a good stepping off patent and 21 are you comfortable with that or just how youre looking at our core fees going into 'twenty one.
I think debt.
Core fees is entirely dependent upon what kind of assumptions you place on mortgage.
And what happens there.
The other things are pretty much at run rate.
And we should do reasonably well growing that.
Within the other cash and if.
Commercial loan growth activity comes in and we start seeing some sort of a loan origination fees, we can get a nice balance there but.
Your guess on mortgages is as good as mine.
Okay perfect I appreciate the color and that's all for me so great quarter guys.
Thanks, Jeff.
Once again, ladies and gentlemen, if you do have a question. Please press star one on your telephone keypad. Our next question is coming from David long of Raymond James. Please go ahead.
Good morning, everyone.
Hey, David.
I know you mentioned M&A opportunities are always kind of looking looking there but.
We expected and may activity to be rather light, but it seems like volume is really picking up here and we even had a deal announced in Chicago here last week.
Curious if you're one actively having conversations today and two.
And.
What is the tone from potential partners on pricing and how has their expectations changed.
We are having conversations.
And as that has been the case for the bulk of this year, just you try and stay close to people. So you know what everybody is going through.
I think that.
When we see.
When we see six or seven months with valuations being depressed and all and <unk>.
Albeit universally so.
Everybody's expectations for come closer together and theirs.
Very little dispersion right now.
And at least and the community bank space in terms of where valuations are.
So I think the deals can get done in this environment.
And I'm optimistic that that's the case and I think the seller sellers are more rational today than they have been and probably two years.
Got it Okay and then Andrew.
And Youre, having these discussions.
And what is the.
And what is the key item that youre looking for and it.
Bank debt you'd like to partner with us it and I.
And I feel like it used to be.
Getting good core deposits for everyone has liquidity today, so just curious.
What what Youre looking to most accomplished with doing a transaction at this point.
I think enhanced Chicago distribution is a factor.
Bill to make the M&A math work a base level of profitability is required it doesn't have to be off the charts. Good.
But.
Between supplementing a Chicago presence.
And if it comes with a couple of good lenders that would be a bonus but that's not always the case.
Base level of profitability to make the M&A math work I think that we wouldn't be shy about and lever at this point.
And just something that debt.
Gives a return to our investors I think as is prudent given the level of capital that we're having so.
Maybe more so today than we would have even a year ago.
Simple lever it can be attractive.
Got it thanks, Brian and I appreciate the color.
Yes.
Thank you. Our next question is coming from David Konrad of D. A Davidson. Please go ahead.
Hey, good morning.
Can you hear me good morning.
Morning.
Right.
A couple of questions one is.
Housekeeping on the PPP, just wondered on the and that for.
Forgiveness this quarter, what was the dollar amount of debt fees that came through NII.
Yeah.
Yes.
And I think we'll get that number I think it's about $1 6 million.
Yes, okay.
And then Kevin.
And that will drop to $4 50, or so and the first half of next year with the remaining the remaining outstanding.
Outstanding debt.
That's correct.
Okay, and then more of a broader picture.
One of your peers are putting liquidity and our mortgage backed securities. Despite compressed spreads and obviously the convexity risk, but it looks like you guys are.
Doing something a little bit unique and go into the asset backed market. So just wondering what youre doing there and then what type of securities and kind of the yield versus maybe the MBS yield kind of debt the tradeoff there versus the shorter duration.
So the only thing that we've done at this point was we put on about $50 million into variable rate felt product.
And largely that was done.
And its entirety that was done before the chatter around.
Student loan forgiveness.
And.
So basically it was.
Dislocation there based on both the variable and.
And the opportunity for for some spread tightening based on the political chatter.
And.
Where does that fit broadly and what we're doing so.
You talked about relatively short duration based on that factor and then also theres.
There is an implicit 97% government guarantee on those assets as well so we're staying relatively at least effectively short and then also looking for.
Very strong and supportive credit.
The only other thing we've done is some issues that are likely to be callable.
Also variable.
Based on call trends within similar assets.
So basically effective short duration, where the credit guarantee is basically where we've been playing.
Great. Thank you.
Yes.
Thank you. Our next question is coming from Eric.
From a private investor. Please go ahead.
Yeah, Hi.
Morning, Jim and May have missed this at the beginning but did you mention your potential activity and the second round of the Triple P loans and.
What you might be doing there compared to the first round.
Yes, we have started Eric.
And I would say the loans and our pipeline now after the first couple of weeks and the program relative to the first round is significantly lower.
Yes.
Right now for US, we're probably 20, 20% to 25%.
The volume.
Today, where we were and the first and the first go around.
And it certainly doesn't look like we're going to have anywhere close to the activity, we had and the first round.
Hello, and impact on margin and is not going to be as meaningful as it was in the past.
If I had to guests and that would be somewhere between 25% and 50%.
Okay. Okay.
And so far.
Yeah, and I just had a unrelated question I think Brad had mentioned you had a question.
From David long about M&A and you use the word <unk>.
Distribution and Chicago and.
And I guess my question for you is is.
You know what's important and the distribution is at the physical location or is it really the bodies the lenders and the relationship managers and.
Is it how how hard are likely is it to try and lift people out you want rather than take.
Taking a risk of buying a whole institution.
Especially if you don't need the liquidity.
It's both.
And we've had the conversation for upwards of 20 years of brick and mortar distribution is going away and it tends to coincide with the movement of <unk>.
Interest rates, specifically five to 10 year interest rates every time it falls everybody assumes that nobody cares about branches anymore and everytime it rises.
Bofa announces they're going to build more branches.
The reality is if things don't change that quickly.
The bulk of depositors still grew up and a world and Noel World, where where physical presence matters.
And to think that people come out of this situation.
Once the pandemic subsides.
Subsides and.
Don't want to return to some level of normalcy, and running errands and walking into the branch and saying hi to Suzy Taylor.
And as naive.
So semi.
Similar to how I answered the stock buyback question is we tend not to lurch in any one direction with which way the wind is blowing and.
The reality is for at least probably the next 10 years as physical distribution and still is going to matter at some level.
To the degree it was 10 years ago, absolutely not.
And it's also not obsolete at this point either given the fact that the bulk of depositors are baby boomers.
For later.
So we still place a value on that there is still value on that and.
And we will evaluate it based on that fundamental assumption.
Okay, great. Thanks very much.
Thanks, Eric.
Thank you at this time I would like to turn the floor back over to management for closing comments.
And that concludes our presentation for today. Thank you for joining us and we look forward to talking to you again next quarter.
Okay.
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