Q1 2021 Old Second Bancorp Inc Earnings Call
Good morning, everyone and thank you for joining us today for old Second Bancorp, Inc. 's first quarter, 2020 one earnings call on the call today is Jim <unk>, the company's CEO, Gary Collins, Vice Chairman of our board and the company's CFO, Brian Adams.
Start with a reminder, that old second's 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 would ask you to refer to the company's SEC filings for a full discussion of the company's risk factors on <unk>.
And as call. We will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts, and our earnings release, which is available on our website at old second Dot com under the Investor Relations Tab I will now turn the call over to Jamaica.
Hey, good morning, everyone and thank you for joining us.
And I have several prepared opening remarks, and 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 to questions.
Net income was $11 9 million or <unk> 40 per diluted share and a quarter.
Earnings this quarter were favorably impacted by a $3 million reversal of provision for credit losses.
As well as MSR valuation mark to market gains of $1 1 million due to increases in market interest rates over the past quarter.
Fee income increased from last quarter based on and increase in mortgage banking revenues due to growth and net gain on sales of mortgage loans stemming from continued elevated demand for new mortgages and refinances.
Yesterday, we announced an increase on our quarterly cash dividend from <unk> <unk> per common share.
And with <expletive>et quality, continuing to improve and a very strong capital position.
We believed it was time for shareholders for further benefit from our company's strong tracker for profitability.
And regards to the balance sheet.
<unk> $28 million of PPP loans were forgiven by the SBA during the first quarter compared to approximately 63 million and the prior quarter, which resulted in a decrease to our net interest margin.
Quarter over quarter from full recognition of net deferred fees on those loans upon pay offs.
Our loan to deposit ratio was 73, 8% at March 31, 2021, a decline from.
From last quarter due to additional federal stimulus funds received by our deposit customers.
As well as a $75 $2 million decrease and loans.
Which is a significant decrease from the 89, 1% loan to deposit ratio a year ago.
Expense discipline continues to be strong with a slight increase noted and noninterest expense for.
For the current quarter compared to the prior year light quarter due to higher salaries and employee benefit cost and.
FDIC insurance expense due to <expletive>essment credits received and the first quarter of 2020.
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 originations and staying in close contact with our customers.
Nonperforming and cl<expletive>ified <expletive>ets experienced decreases from the prior quarter and we remain.
Main confident and the strength of our portfolio's dita.
Details are available on the earnings release tables on these changes.
Loans under modification stand at approximately 8% of the loan book today.
And we are working closely with our borrowers to understand each and every situation.
On the original $237 7 million of loans, which were on a COVID-19 related deferral at some point and the last year $218 $4 million and nearly 92% have either returned to payment status or paid off as of March 31 2021.
As of the recent quarter and for 40 total loans.
Totaling $19 2 million and balances are currently and deferral status.
Yeah.
Concurrent with our earnings release Old second also filed loan portfolio disclosures that will give investors additional detail on the composition of the loan portfolio Curt modification breakdowns on reserve levels.
Exclusive of PPP loans. The reserve currently stands at 167% of total loans during the first quarter $3 5 million of provision for credit losses on loans was reversed due to more favorable unemployment.
Unemployment projections over the next year and 500000 of additional reserves for unfunded commitments, which was recorded based on our review of line utilization trends, resulting a net decrease to the allowance for credit losses of $3 million.
We also recorded a $582000 a recovery and the first quarter.
Our outlook is cautiously optimistic as the underlying economy continues to improve albeit with significant uncertainty.
We believe that we are more than adequately reserved under base case scenarios.
But we continue to overweight more pessimistic scenarios given the high degree of uncertainty.
Our overall fundamentals and earnings trends were relatively stable and consistent with prior quarters.
And with mortgage banking results continuing to reflect a positive impact due to the low rate environment.
Loan payoff trends and forgiveness of PPP loans during the quarter were very high and we are cautiously deploying liquidity and the short dated <expletive>ets.
Profitability remained strong and we are extremely pleased with this level of performance overall.
Old second continues to be focused on the steps and protocols necessary to protect our employees our customers and our communities. During this pandemic.
For our customers our locations remain open and available, albeit with safety precautions. The majority of our staff continues to work remotely.
But we are currently evaluating return to work policies across the bank.
Old second is proud to serve our communities I couldnt be more grateful of the efforts of our employees over the past year.
We are fortunate that our core lending strengths have steered us clear of many of the most impacted industries.
And we do realize the potential exists for many industries. There is still be significantly impacted and the short to intermediate term from.
From the 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 sectors, both for our customers and and our operating footprint on.
Our overall outlook remains cautious at this point, though we are seeking new lending relationships.
Retail and office have undergone significant dislocations this year and we believe there will be evaluation and implications for real estate and operating companies and these sectors.
Losses will certainly materialize 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 are stronger than they ever have been.
And regards to the first quarter, specifically total loans decreased $75 2 million from last quarter.
Due to PPP forgiveness of.
The decline from seasonal demand contraction and line utilization and a high level of pay offs.
The overall level of loan demand and our markets remain tepid at best but we are seeing signs of an uptick on our pipelines as of late.
Loan growth trends as 2021 progresses should improve as the economy strengthens.
Overall, we remain cautious, but encouraged about our results and a number of areas and Brad will provide additional color and his prepared comments.
Thank you Jim net interest income decreased 334000 relative to last quarter.
But increased almost 900000 compared to the first quarter last year.
The margin was favorably impacted by the net loan fee recorded due to the PPP loan forgiveness and the first quarter, but this impact was less than the prior quarter $163 million was forgiven.
This net PPP fee income offset further expansion of excess liquidity on the balance sheet and the impact of lower yielding PPP loans still outstanding.
Positive net interest income variance compared to last year was due to the redemption of the OSB C Capital Trust, one junior subordinated debentures and March last year that resulted in an acceleration of 635000 and debit.
Issuance costs.
Increasing interest expense and the year ago period.
We continue to have strong deposit inflows and substantial excess liquidity persisted for the entirety of the quarter.
The second round of fiscal stimulus and a further dramatic impact on our liquidity position with substantial inflows towards the and.
The strategy to deploy a portion of the excess liquidity, we will continue and the short term, while being extremely cautious on both duration and credit.
As expected our margin performance was stable on a core basis exclusive of the PPP factors.
And improving reported core trend this quarter was mitigated by the second round of stimulus checks.
I am not <expletive>uming at this point anyway that the deposit inflows will reverse quickly at the outflow or bounce back is relatively quick on margin outlook would improve and.
And if economic conditions improve and loan growth returns to a level commensurate with that growth our margin outlook would improve.
And do not currently expect either of those conditions to occur and the short term based on what we're saying and remained surprised that loan demand has not followed reported economic conditions.
Fee income increased and the first quarter this year compared to last quarter due to the growth and mortgage banking revenues mark to market gains on Msr's, and an increase and wealth management income.
Net gain on the sales and mortgage loans were approximately 325000 or 10% over net gains for fourth quarter 2020.
And mark to market gains on MSR for $1 1 million.
Compared to losses of $1 3 million last quarter.
Mortgage activity remains extremely robust and our markets we are pretty much full in terms of the pipeline still.
Wealth management income increased modestly from the first and fourth quarter last year and from the first quarter of 2020.
Provision for credit losses reversal of a net $3 million was recorded and the first quarter compared to no provision expense last quarter and $8 million recorded and the first quarter of last year.
The economic outlook for US <expletive>umes continued improvement to the prolonged recessionary environment.
And then unemployment rate projections remaining and approximately 6% quarter to seven five.
Through December of this year and over the remaining life of the allowance.
This is a decline from the approximate 8% estimate from the fourth quarter of last year.
And I recognize that our <expletive>umptions are probably more pessimistic than most at this point and expect the severity of those <expletive>umptions to be lessened and the coming quarters.
Im extremely pleased without credit has performed through the pandemic credit metrics have remained stable to improving and a number on the credits that I would've been concerned about have been resolved favorably.
Our efforts in the coming quarters will be focused on helping our customers and funding quality loan growth with the expectation of a stable to modestly contracting margin.
Assuming liquidity remains robust and risk spreads remain on reasonably tight.
This outlook is inclusive of the impact of the recently issued $60 million and sub debt.
The timing of this issuance came quite a bit sooner than some may have expected, but we thought it prudent given that spreads for us and tightened significantly and there were a few competing issuers and the market.
On cold it was the lowest coupon ever for a community bank under accrual rating.
Our capital and liquidity levels leave us well positioned and we have ample flexibility to continue the pursuit of quality quality relationships.
And continue to repurchase common stock and to pursue M&A opportunities.
We repurchased 455000 shares during the first quarter and and average price of $12 31, and have approximately 320000 shares remaining under the existing authorization.
Since March of last year, we have repurchased a little less and 4% of outstanding shares at an average price of $9 45.
I expect we will finish the current authorization and the second quarter, we don't expect capital levels to build from from these levels and believe we both have the capital and balance sheet flexibility to respond to strategic opportunities as they present themselves.
Expenses remain well controlled and we will continue to review for efficiencies as the year progresses with that I'll turn the call back over to Jim Okay. Thanks, Brad and in closing we remain encouraged.
With these trends, we're confident and our balance sheet and ready for the challenges ahead.
Prolonged low rates is certainly not the best environment for a deposit base like old second, but we remain extremely profitable given our focus on expense discipline.
We will remain so.
We have taken the necessary steps to position ourselves well for a slowdown and recession, we believe our credit and underwriting has remained disciplined and our funding and capital position are strong.
Today, we have the balance sheet and liquidity to take advantage as things improve.
That concludes our prepared comments. This morning, so I will turn it over to the moderator and we can open it up to questions.
Thank you.
At this time, we'll be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is and the question queue. You May press star two and if you'd like to remove your question from the queue participants using speaker equipment and may be necessary and pickup your handset before pressing the star fees.
One moment, please while we poll for questions.
And our first question is from question Mcgratty with K B W.
Hey, good morning, everybody.
Morning, Chris.
And Brian maybe a question for you just on your margin and balance sheet comments.
Understanding the margins, obviously really challenging one with all the liquidity, but if I think about net interest income from from the first quarter levels.
And we hit a point where.
We should see growth.
And in the future quarters.
Yes, I believe we are.
I don't expect anything like what we saw in terms of paydowns towards the end of the quarter to happen again and.
And.
We still expect that we'll be able to achieve some some pretty meaningful growth this year on the loans.
Our margin this quarter.
Absent that and if you exclude the impact from the loan runoff would have been up pretty significantly.
So.
The comments, we've made over the last couple of quarters in terms of bottomed and potentially turning on the margin.
Especially if we deploy more of the liquidity, we should see growth from here.
Okay, so that so that probably means.
Maybe earning <expletive>ets don't grow but the mix.
And it's better and maybe don't buy as many bonds.
Thank you to cause that rate.
Yes, I would expect to see earning <expletive>ets grow I would expect to see a stable relatively stable margin.
And we obviously have counted day count.
<unk> advantage next quarter as well.
Okay.
And then in terms of the capital obviously the debt was opportunistic.
And you've talked in the past about some of these higher issues you have on the balance sheet I guess what are the thoughts about taking.
Taking those out and can you remind us whats there and then beyond.
100, and on the buyback would be the expectation too.
And to reauthorize additional buybacks.
Yes.
And a requirement for an approval exists there, but I cant I would point you to the comments around we don't expect capital and meaningfully grow from here.
And we've got enough to.
To fund both growth and strategic opportunities that may present themselves here.
Okay.
And on those on the higher cost of debt is that just.
Quarter to quarter or is there something perhaps more imminent.
No no so the higher cost debt.
That would be a termination at the very end of the year.
And that would obviously benefit next year.
Okay. Thank you.
And our next question is from Nathan race with Piper Sandler.
Yes.
Yes.
Hi, guys good morning, and.
Morning.
I was just hoping to expand a little bit on the loan growth outlook and ex PPP over the balance of this year and I. Appreciate there's some pay offs in the quarter that kind of loan growth on the ended period basis.
And as you guys kind of look out over the next quarter or two.
It sounds like Theres still some sluggish demand with existing clients, but we'd love to hear your guidance past just in terms of the opportunities to take market share on the commercial side of things across the Chicago land area, and then just kind of what youre seeing with some of your old specialty.
<unk> is well lately.
Yes.
Yes, and obviously, a tough tough quarter on the on the origination side.
There was a confluence of factors that led to a pretty weak quarter really along pretty much every loan sector right first we had an extremely strong fourth quarter.
That kind of depleted the pipeline.
Heading into the year, but.
Certainly originations were were not what we had hoped.
Our clients and many of our borrowers are very flush with liquidity and certainly on.
Doing any capex right now.
We had declines as I've mentioned on pretty much every every bucket.
And also in line utilization contraction, we had several clients on its unexpectedly sold properties and obviously the.
One of the for family and HELOC portfolios contracted due to a lot of refinancing so.
Leasing was soft as well.
We are seeing we are seeing an uptick and and activity and our leasing group along with our health care group.
And I'd love to tell you that the second half of next year is going to be going to be strong, but thats going to be largely dependent on.
On the economic recovery and our markets.
I feel better today than I did 90 days ago based on loan committee activity.
And.
We'd still like to think we can get.
So some low to mid single digit growth by the end of the year if things do recover.
Got it.
For color.
And Brad maybe just thinking about kind of the.
ACL trajectory from here.
<unk>.
It came down a little bit here on the first quarter ex PPP.
And the thing about just the macro environment and.
It seems like credit.
Metrics internally are continuing to perform well.
And any thoughts just in terms of kind of if you guys kind.
Tends to yourselves getting back to kind of a pre pandemic reserve level.
This year or is that just can be kind of a gradual step down all else equal similar to what we saw here and the first quarter.
I think it's probably too soon to call it whether it's the end of this year or not I.
I think that over the next two quarters.
And if things progress like they have been I think are over waiting of more bearish scenarios will be over.
Certainly and the next 100.
Third 20 days or so.
Which would have a pretty meaningful impact on the next two quarters.
Beyond that.
I think there is some level of reserving that debt.
Of reserving over pre pandemic levels, that's necessary just based on structural changes and the economy.
And I E brick and mortar retail and office space and proliferation of work from home and what is the all that do.
But I don't think it's anywhere near the level that we're at today and and I think without any blips or large one offs.
Which to be clear, we see no evidence of.
And our portfolio debt.
And certainly by 12 months from now we should be down to a level that's closer to pre pandemic than it is current levels.
Got it that's helpful and if I could just ask one other on the margin outlook ex PPP.
And just with your expectations for the excess liquidity levels to remain elevated.
And can we expect a similar degree of securities portfolio purchases that we saw here and <unk> over.
Over the next quarter or two or.
How should we kind of be thinking about the degree of earning <expletive>et growth share earlier highlights.
I would expect probably half the level of growth that you saw this quarter.
Okay, Great I appreciate all the color guys. Thank you. Thank.
Thank you.
And as a quick reminder, if you'd like to ask a question. Just please press star one on your telephone keypad, a confirmation tone will indicate your line is and the question queue.
Our next question is from David long with Raymond James.
Good morning, everyone.
Hey, Dave Hey, Dave.
As it relates to M&A, obviously, it looks like Theres, some and acceleration of activity here and the industry.
How has your diet how has your dialogue on with other banks and M&A and do you are there.
I guess, maybe it's first of all and what's your appetite to do a deal here with your excess capital and now that the economic backdrop looks a little clearer and then secondly, how receptive are.
Potential acquire ease if you will.
So those conversations.
Yes, David.
Yes.
Bottom line is we are very interested in and M&A at this point now that the credit fog has lifted here.
And obviously, our capital levels are pretty robust.
And I will say that.
The.
<unk> are active and I would agree with you that.
Certainly appears.
M&A is before us and Chicago so.
We are we are ready and very interested in finding a strategic partner.
And that being said our appetite remains the same just in terms of.
What is the return on the incremental capital invested.
And relative to the cost of equity capital.
But certainly we have the flexibility within the balance sheet.
Substantial liquidity at the holding company.
And strong capital levels at the bank.
I think there is.
A little bit of a sigh of relief out there in terms of some smaller banks.
Everybody thought they were looking at two years of some very difficult sledding.
And that doesn't look like it's going to be the case. So I think people feel like it's a second chance if they were on the fence before about whether it was the right time I think there's a fair amount of people who were thinking it might be the right time.
Sure and then.
Sorry, how comfortable you are with your capabilities is there a size limit or a size minimum from.
And from an <expletive>et perspective that you would consider.
I don't think it makes sense and and we said this before.
Not really worth our time and the application process kind of.
That's getting real FTE around $300 million.
Below that is okay.
In terms of.
Now.
Upper bounds.
We would be very cautious on anything above a 1 billion for sure and make sure. It's the right deal.
But I don't see anything imminent there.
Got it thanks guys.
Thanks, Dave.
And our next question is from Brian Martin with Janney Montgomery.
Hey, good morning, guys.
Hi, Brian.
Hey, Jim and I guess just going.
I guess, maybe it's for Brad just kind of that the over weighting on that pessimistic scenario that I guess.
I guess can you kind of quantify that if we if we think about what the impact could be as you do that I don't know if you said you thought about it was going to happen maybe later in the year. It could happen later in the year or the next couple of quarters, but just kind of understanding what that impact will be I appreciate the color on that.
The reserve level kind of getting back to some level of pre pandemic maybe.
And maybe a year out or seller, but just kind of quantifying that if he could.
Yes, Brian I think the best way I can answer that is to point you to what we just did I mean, we released a net three here and we came off the unemployment rate by 50 to 75 basis points.
And may be under weighted the bearish case scenario by an additional 10% to 15%.
Commensurate with that we had $75 million and loan run off.
And $500000 recovery. So if you put all those pieces together.
A reasonable person would probably approach that debt.
On your weighting the bearish scenarios, a little bit more probably knocked one two off.
Got you okay.
Alright, and how about just the yes.
And you talked Brad.
And the guys on the NII, but just the margin impact with debt sub debt and there you are.
It sounded like your guide was stable on the margin with the drag of the sub debt and then the offset to that as you look at <unk> and beyond I mean, whereas the offset to kind of get back to kind of your neutral outlook. If you will I mean, I guess, depending on the loan environment.
Sure.
On the debt.
The excess liquidity and deploying some of that it sounds like youre cautious on that but just understanding that that's the reconciliation.
Well I mean, having the sub debt out there for the remainder of the year is going to cost us about $1 million rate so right.
If loans don't run out and then there's pretty much your offset.
<unk>.
Additionally, if we deploy more liquidity and use up some of the cash position that is earning a whopping 10 basis points.
Which is a big number for us I mean.
We've got more than 10% of our <expletive>ets by a healthy margin, earning 10 basis points.
And I don't even really think about the reported margin anymore I think about the margin exclusive of the excess cash that's on the balance sheet.
Right.
And every time, we get something deployed.
Something happens like another fiscal stimulus and the government wires is 150 million Bucks.
And all of a sudden we're right back where we were.
But we have seen.
Remarkable hoarding of cash by small business.
Very little loan demand, which is just completely out of line with with the character of the economic numbers that are being thrown around and the broader discussion on the economy.
It is quite surprising.
Obviously.
And as long as my career has been we've never seen economic growth numbers like this with with absolutely no participation and from loan demand aggregate loan demand.
It is truly remarkable.
And.
I wouldn't have said that can continue but I would have been wrong.
And through the first three months of this year.
And I think that I think some of the impact to us is that I do.
Thanks, Chicago is participating quite as fast as some other areas and the country.
Certainly our unemployment rate here locally is more sticky than others. Some of that has to do with just the pace of reopening and.
And some of that.
As.
And I'll say regulatory or government based in terms of mandates.
And some of it's just pure caution.
But theres a lot of factors that can drive micro economic performance to differ from national.
Got it.
Okay I appreciate the color and just the <unk>.
And the liquidity you guys still seeing deposit inflows kind of into second quarter here have you started to see that stabilize.
And now we're still getting money on every day.
Okay. So it's still happen and maybe just the last one on M&A, just kind of your ideal target and kind of what you guys are looking for and a target if you.
<unk> and potential opportunities out there.
Is it is it more.
And then geographically and maybe and just kind of on that if you have you prioritize what's important to get out of an acquisition.
If you could give a little thought on that.
Chicago distribution is important.
Base level of profitability, something 50 basis point ROA or better.
And the opportunities for expense saves that are important.
That will allow us the additional expense dollars and we can allocate to hire organically.
And all the things that we've talked about in the past.
Yes.
We don't think Theres very few opportunities that are.
Really additive on the <expletive>et generation side so.
It's a deposit game, which obviously, we don't need the degree that we would have needed a year ago.
But long term.
Rates don't stay low forever, either through inflation or growth or some combination thereof, theyre going higher.
And profitability over the long term and this business is 70% on the funding side and 30% on the <expletive>et side.
Once you adjust for charge offs and cost of capital.
That's not going to change based on.
Some new economic paradigm.
And so our focus is over the long term and its quality deposit franchises and to the extent we can.
Additional expense dollar savings that we can allocate towards organically hiring teams.
Got you Okay I appreciate all the color Brad and Jim Thanks.
Yes, Thanks, Brian.
Ladies and gentlemen, we have reached the end for question and answer session and I'd like to turn the call back over to Jim <unk> for any closing remarks, okay. Thank you for joining us This morning, and we look forward to speaking with everyone again.
And next quarter Goodbye.
And this concludes today's conference you may disconnect your lines at this time.
And for your participation and have a great day.
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