Q2 2021 Old Second Bancorp Inc Earnings Call
Good morning, everyone and thank you for joining us today for old second Bancorp second quarter 'twenty 'twenty 1 earnings shortfall on the call today is Jim <unk>, the company's CEO, Gary Collins, Vice Chairman of our boy the company's CFO Brad Adams.
I will start with a reminder, that old second's comments today may contain forward looking statements about the company's business strategies and prospects.
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 ask you to refer to the company's SEC filings for a full discussion on the company's receptors on T.
Today's call. We will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts in our earnings release.
Available on our website at old second Dot com under the Investor Relations tab, well I was trying to go over to Jim.
Good morning, and thank you for joining us.
We're prepared opening remarks, and 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 $8.8 million or <unk> 30 per diluted share in the second quarter.
Earnings this quarter were favorably impacted by a $3.5 million reversal of provision for credit losses due to more favorable unemployment projections over the next year.
However earnings were negatively impacted by MSR valuation mark to market loss of $1 million due to decreases in market interest rates over the past quarter.
In addition.
Mortgage origination and refinancing markets have slowed resulting in a reduction of net gain on sale of mortgage loans of $1.8 million in the second quarter compared to the first quarter of 2021.
Our wealth management team continues to perform at a high level with solid fee income growth of 238000 over the prior quarter.
In regards to the balance sheet approximately $34 million on PPP loans were forgiven.
On the SBA during the second quarter of 2021, and $70.2 million PPP loans from both the first and second round remain outstanding as of June 32021.
To date over 65% of our PPP loans PPP loans have now been forgiven.
Our loan to deposit ratio was 71% at June 30, a decline from last quarter due to a decrease of $56.3 million 22 million net exclusive of PPP and total loans.
And deposit growth of $25.5 million over the prior quarter end.
This is a significant decrease from the 83, 7% loan to deposit ratio a year ago.
Loan growth is certainly a bit of a disappointment for us origination activity has remained relatively steady this year. So it was overwhelmed by $73 million in early payoffs this quarter.
Payoffs through June 30 are nearly identical to what we experienced in all of last year.
Additionally, we have seen a nearly $80 million decline in purchase participations year to date.
This is an area that is simply not a big part of our loan book. So I would expect this headwind to be significantly less in coming quarters.
Provide a little additional color around this we only have about $100 million on purchase participations on our books.
So almost 45% of our entire purchase participation book paid down or paid off year to date.
We simply don't see that trend continuing.
On a more positive note pipelines are building nicely and equipment leasing healthcare and CRE.
But we have a new.
CRE team, starting with us in the third quarter.
Specialty season, improving we've also hired additional C&I lender in the second quarter. Additionally.
Our pipeline for new new lenders it looks very promising.
Given these factors Im optimistic we can see loan growth net of PPP activity in the second half of this year.
Expense discipline continues to be strong with a slight decrease noted in noninterest expense for the current quarter compared to the prior quarter due to a reduction in salaries and employee benefit costs and.
Net occupancy furniture and equipment costs.
Asset quality trends at this point remain stable and we remain confident in the strength of our portfolios.
Details are available on the earnings release tables on these changes.
Loans under modification stand at approximately 4% of the loan book today, and we are working closely with our borrowers.
I understand each and every situation.
Of the original $237.8 million of loans, which were on our COVID-19 related deferral at some point in the past year, $228.7 million or over 96% have either returned to payment status or paid off as of June 30.
As of the most recent quarter end.
Only 18 loans are remaining totaling $9.1 million and balance is currently on deferral, we're very pleased with our our deferrals continue to wind down.
Concurrent with our earnings release Old second also filed loan portfolio disclosures that will give investors investors additional detail on the composition of loan portfolio current modification breakdowns on reserve levels.
Exclusive of PPP. The reserve currently stands at 1.5 per by 6% of total loans.
During the second quarter $2.3 million of provision for credit losses on loans was reversed.
$1.2 million of reserves for unfunded commitments was reverse based on on.
A review of line utilization trends and.
At $65.65000, net charge offs were recorded in the second quarter, resulting on a net decrease the allowance, including unfunded commitments of $3.6 million.
Our outlook is cautiously optimistic as the underlying economy continues to improve albeit with significant uncertainties.
We believe that we are more than adequately reserved under base case scenarios would continue to modestly overweight more pessimistic scenarios given the high degree of uncertainty.
Brad will provide additional color in his prepared remarks.
Thank you Jim and good morning, everybody net.
Net interest income decreased $1.6 million relative to last quarter and 750000 from the year ago quarter on.
Obviously, the big question for us relate around the large decline in the reported margin and the lack of loan growth.
Jim address the latter so I'll add some additional color on the margin.
The core reported margin declined by a little more than 40 basis points on the second quarter with interest income declining by a less dramatic amount the cash.
Contribution to the reported margin decline was as follows.
13 basis points resulted from a $140 million increase in average cash balances at the fed, earning 10 or 11 basis points.
10 basis points of contraction resulted from the decline in average loans. Neither of these were expected in our previous guidance.
A further 6 basis points of contraction resulted from a 97 basis points reinvestment rate within the bond portfolio.
The period end balance on that portfolio was down more than the average as we add some sales towards the end of the quarter.
7 basis points of contraction resulted from the issuance of the sub debt early in the quarter. The latter 2 factors were expected, but were forecast to be offset by loan growth.
We continue to have strong deposit inflows and substantial excess liquidity persistent for the entirety of the quarter.
The latest round of fiscal stimulus had a dramatic impact on our liquidity position with substantial inflows during the quarter given the preponderance of retail and the granularity of our deposit base.
The strategy to deploy a portion of the excess credit liquidity will continue on the short term, while being extremely cautious on both duration and credit.
I am not assuming at this point that the deposit inflows will reverse quickly.
With loan growth improves, which we currently expect our margin trends improved significantly.
If the excess liquidity flow reverses our margin outlook would improve significantly.
Its excess liquidity persists, which we currently expect net interest income trends will benefit our margin will remain artificially depressed as we continue to invest in short duration lower yielding assets.
I think it's important to note that our excess liquidity has resulted primarily from retail flows, which I expect will be absorbed quickly once the pace of stimulus lessons. So I don't believe it prudent to add significant duration.
If economic conditions improve on loan growth returns to a level commensurate with that growth our margin outlook, what again improve.
I remain surprised on loan demand has not followed reported economic conditions, but I expect that trend to narrow a little bit here in the very near future.
The sum total of the discussion is that we currently expect loan growth trends to meaningfully improve which will result in NII growth. We do not currently expect liquidity flows to lessen.
The recent backup in rates is not consistent with adding duration from that liquidity, we will remain cautious on patient on that front.
On the fee income side it declined modestly from last quarter with a decrease in margins and reduced refinance activity in mortgage attributable to a $2.1 million decrease in mark to market gains on msr's stemming from rate movements and.
On a $1.8 million decrease on sales on mortgage loans in the second quarter.
Mortgage activity remains above historical levels in our markets and I expect the backup in rates will boost refinance activity in the third quarter.
Mortgage impact to noninterest income were partially offset by $238000 increase in wealth management and a $218000 increase in card related income as we showed some signs of spending picking up.
Provision for credit losses reversal of a net $3.5 million was recorded in the second quarter compared to $3 million reversal last quarter.
Economic outlook for US assumes continued improvement to the recessionary environment, our former recessionary environment with an unemployment rate projection remaining at approximately 5.5 to 6 and 3 quarters percent through the end of the year and over the remaining life of the loans.
Which is a decline from the approximate 6 on a quarter to 7 half estimate that we gave you last quarter.
I recognize that our assumptions are probably more pessimistic than most at this point.
The severity of these assumptions to be lessened in the coming quarters I.
I am extremely pleased with how credit has performed through the pandemic credit metrics have remained stable to actually improved and a number of 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 funding quality loan growth with the expectation of a more stable margin.
Assuming liquidity remains robust and the risk spreads remain on reasonably tight.
Our capital and liquidity levels leave us well positioned with ample flexibility to continue the pursuit of quality relationships.
<unk> on excess capital to shareholders and to pursue M&A opportunities as warranted.
We repurchased 311000 shares during the second quarter on average price of $13.55 and.
On a substantially completed the existing authorization.
Since March of last year, we have repurchased approximately 5% of outstanding shares at an average price of $10.31.
Tangible book value per share is currently $10.29 per share after this quarter's results.
Obviously, if rates remain extremely low.
Share buyback would continue to be attractive to us and we will evaluate that in the near future.
Additionally, if rates remain low for a prolonged period of time, we will exercise extreme expense discipline, and we will look at it cuts as necessary.
Overall expenses remain well controlled though and we will continue to review for efficiencies as the year progresses.
I'd like to turn the call back over to Jim. Okay. Thanks breath in closing we are increasingly optimistic about the rest of the year confident in our balance sheet and ready for the challenges ahead.
Prolonged low rates is certainly not the best environment for deposit base like old second, but we remained extremely profitable given our focus on expense discipline.
We will remain so.
We believe our credit and underwriting has remained disciplined and our funding and capital position are strong today.
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 open it up to questions.
Thank you, ladies and gentlemen, if you'd like to ask a question. Please press star 1 on your telephone keypad. It comes from.
So on will indicate your line for questions.
You may from start you on your thoughts on keep all of you would like to remove your question on.
On my left.
Paul to your question please.
Our first question comes from the line of Chris Mcgratty with <unk>. Please proceed with your question.
Hey, good morning, guys.
Hey, Chris Good morning, Chris.
Brad maybe start with you on the on net growth in NII comments.
I want to make sure I heard the guidance on loan growth I think Jimmy said exceeds the runoff of PDP. So is that suggesting reported loans growth are you guiding to core loan growth in the back half a day.
So I believe that PPP run off next quarter should be relatively light. So I would expect that we actually show Bottomline loan growth next quarter.
Okay.
And then if I kind of try.
Try to solve for net interest income.
Is the message Youre trying to leave with us set off the.
After this quarter's NII. This is a trough and we grow or is it a little bit more pressure before you trough in growth.
I believe we grow from here.
Okay.
And then.
Just on the on the capital comments.
A little over 300000 shares in the quarter.
On your stock's about 10% lower.
Given liquidity I mean, your stock can you step up the pace or is this about what you can do on a quarter.
So given assumes.
Assuming that volume trends remain the same that we had seen over the last kind of 6 to 9 months or so.
We could potentially get upwards of <unk> 5 million shares a day, if we were to be active in the market.
On a quarter sorry.
Big Misspeak there.
Okay enrichment.
So you can do a little bit more.
And just a last comment on on loan pricing I've heard a couple of your peers. This morning talk about perhaps that need to get more competitive on rate because theres just.
There's just a lack of growth opportunities.
Is that something is that how youre going to get some of the loan growth just a little bit less less picky on rate, but hold on the structure.
Yes, that's certainly that's certainly 1 way Chris I mean, we certainly tried to hold the line on on pricing.
Opportunities are.
Our aggressively bid and it is competitive out there. So we will we will certainly sharpen our pencil on pricing as needed for the rate relationships.
Got it thanks, Thanks a lot.
Thanks, Chris.
Thank you. Our next question comes from the line of Nathan race with Piper Sandler. Please proceed with your question.
Yes, hi.
Good morning.
Hey, Nate.
On the core margin outlook in the back half of this year I. Appreciate your comments, Brad that the excess liquidity levels are likely to remain elevated hopefully they don't increase much.
From the level year on QQ, and just kind of frame it up the comments around some continued pressure on loan pricing just now how should we kind of think about additional pressure on the on the margin in terms of.
Basis points from the 291 level, we saw ex PPP here into Q.
The challenge is is just how much an end cash do we have at the fed rate I had no idea that we'd be up another $150 million.
On the balance sheet. So the reported margin is just.
It's a tough thing to call obviously because.
On the scale of how badly I missed is off the charts relative to that.
So I think it's difficult to tell you what that reported margin is going to do.
I can tell you that we are far more confident in loan growth and we've been at any time in the last 6 months.
It's been a little frustrating to see how slow Chicago has reopened and what the pace of loan demand has looked like.
Relative to other areas of the country.
But it does show some signs that there is some momentum building around reopening in this market as well.
At long last.
That said it is certainly is competitive.
But I feel good about where we are I feel.
Better about the team Jim and I were talking about this yesterday better about the team that we've ever felt.
We have a level of talent that we simply didn't have 2 years ago.
Yes, Nate also.
When we look at new loan originations through the first half of the year. They are not they're not too far off of where we were a year ago, maybe slightly slightly lower but when you couple massive payoffs and paydowns that we experienced in the first half.
Along with a line utilization rate that is more than a 5 year low.
As seen on our commercial clients with extremely healthy balance sheets, and using that liquidity to pay down debt. So we.
We're certainly not expecting the level of Paydowns.
Given.
The pipeline activity that we're seeing in loan committee, we're we're optimistic that.
We are at or near an inflection in loan growth rate now.
I also think that maybe 6 to 9 months ago and.
And up until recently, we probably would've content see relationships that were kind of below the median in terms of.
Right.
Our favorite relationships.
The bank given the uncertainty in the economic environment I think we're on a very different place in terms of the mindset on that as well now.
Got it that's great color and just thinking about some of the teams that you've added recently is it mostly coming from larger banks. So is your expectation coupled with.
The folks that you guys have had over the last couple of years as well.
In the wake of the M&A related disruption Chicago that a lot of the growth that you guys are going to see going forward is more.
I'm going to be driven by share gains versus existing client credit demand decreasing.
Yes.
I think what we're really excited about with the new CRE team that's joining us here in the third quarter is that they are known to us from a prior life proof.
Proven performers.
Seasoned lenders that have a track record that.
We're going to be able to count on so that coupled with the new C&I lender, we hired along with a potential.
Additional team that we're having.
Sales conversations with now.
We are optimistic about getting some share gain here.
If if.
If we werent confident or at least optimistic in terms of our ability to hire over the next 6 months, we probably would've been guiding expenses down at this point.
Understood.
And maybe just lastly, just going back to the capital discussion, obviously with total risk based capital short up pretty noticeably on the sub debt raised in the quarter, how you guys feel about.
Acquisition prospects over the back half of this year obviously.
Relative environment out there and you guys are a little bit of a currency.
Disadvantage relative to some so just any kind of updated thoughts on optimism.
Minimum level along M&A.
I mean, obviously M&A is difficult with our evaluation, but it is possible something that gets done.
We do have.
Our senior debt issuance is callable at the end of the year, so that would probably be a wash if nothing materializes.
Okay, Great I appreciate all the color thanks, guys.
Alright, Thanks, Dave.
Thank you. Our next question comes from the line of David Long with Raymond James. Please proceed with your question.
Good morning, everyone.
David on David.
You talked a little bit about the mortgage pipeline. This pullback in rates can you provide a little bit more color are you seeing an increase in the pipeline or your expectations for volumes to pick up here in the third quarter.
David It's Gary Collins, Yes, we've actually kind of trough hit on 1 point there on the loss.
But it's actually it's been picking up quite nicely last couple of weeks again.
1 of the challenges in the purchase market is obviously, a limited supply of homes available.
Sales.
Sure.
Things are definitely moving out.
Okay.
And then.
Credit side I recall your day, 1 C sold pre pandemic was you talked about about a 128% level.
You are not there yet.
That the right level, we should think of you eventually getting to or has the risk profile of your loan portfolio changed enough to adjust that day, 1 level, assuming we get back to a similar economic backdrop.
We had pre pandemic.
I think that is the right level, but I also think our risk profile of our loan portfolio is down.
We have lost.
Number of credits that we would have been concerned about in terms of being higher risk.
But that being said I don't know that I feel comfortable being below that level theres still an awful lot of hair on day.
But I think the trend do you think the trend is down in terms of provision levels.
Our still overweight bearish scenarios and I don't think thats going to continue to be the case.
If things continue on the same trajectory that they have been.
Got it thank you guys.
Thank you.
Thank you.
Ladies and gentlemen, if you'd like to ask a question. Please press star 1 on your telephone keypad.
Our next question comes from the line of Brian Martin with Janney Montgomery. Please proceed with your question.
Guys good morning.
Hey, Brian Brian.
Hey, just a question Jim on the pipeline for new hires I mean, I guess can you. It sounds like you brought on a C&I lender you kind of ran through it there, but C&I lender. You also have the CRE team you talked about just a minute ago in third quarter, but just the pipeline beyond that sounds like it's still strong I mean, I guess can you just comment a little bit on that.
And then just as that team with the currency, where it's at today in M&A opportunities on the hiring and kind of that aspect is the way to think about where you guys grew.
Growth going next yes. The next 6 to 12 months, rather than doing M&A as that seem more likely.
Yes.
Yes, a couple a couple of ways to answer that Brian.
Certainly our healthcare equipment leasing and legacy CRE teams are showing.
Significantly higher pipelines today than we did 90 days ago.
We are.
Pleasantly surprised with how low activity.
<unk> is building.
As far as the new teams new team that we hired along with a lender we hired.
They've been known to us for quite some time, so there are proven performers.
Along with another potential team that were talking to that we know very well so.
We think back half of the year, we will definitely see some.
Low to mid and low single digit.
Organic loan growth and then on.
On the M&A side, I think Brad kind of alluded to that we're certainly open for business here, if we can find the right partner.
Okay, and then just as far as the utilization.
Obviously still at low levels, and then I guess in kind of your guide are you expecting any rebound on that utilization at this point I would like the earlier question just on market share movement at this point from from the team as you brought on.
Saw almost no movement in utilization rates, our commercial line utilization was down about $10 million during the quarter.
Our guidance assumes that that doesn't move and continues to flatline, along a very low level yes.
Yes, okay. So there's upside if we start to see some.
Any of the economy get some pickup on that component.
Okay, and then maybe Brian just on the buyback it sounds like the authorization is.
And at this point I guess what are the plans on on the buyback at this point.
We will go through the steps, we need to do to evaluate that as a possibility.
Okay, that's still on the table on them.
Okay, and then just as far as the PPP goes.
Fair to assume Brad I guess or at least big picture that the remaining piece.
Piece of that TPP, I think there's a little bit over 2 million Bucks.
The bulk of that gets collected in in the second half of the year is that how youre thinking about it or is it too unknown to many unknowns on that to get some kind of put a fence around what you're thinking in the next couple of quarters.
Yes, I think certainly over the next 9 months the bulk of that will be gone.
Okay, Alright, and then just your comments, Brad I guess ill go back and I can listen to the call, but just the.
High level on on the margin guide over the next quarter or 2 I guess the high level I guess can you just run back through what that was it was just on with liquidity stays stay towards that and get some loan growth.
Something else I missed there.
If liquidity stays where it's at and we get loan growth the margin will be better if liquidity goes up the margin will be down.
Regardless of what happens with loan growth the big driver here is how much cash we've got at the fed.
I think that what our investors should know is that.
At this point it feels to me like like Securities portfolio today's securities portfolio growth is tomorrow's restructuring charge.
I just don't see a return in terms of plowing out in duration.
We're hanging around kind of 1.5 to 2 and a half effective duration with the.
With the flow purchases that we've made earning a whopping 97 basis points. So yes.
That's where the appetite is right now.
Margin is purely a function of how much retail deposits flows into our shop.
The cost of funds will continue to eat down as we see time deposit pay off come off.
And well move any stragglers in rate down as well.
But margin is a tough game to predict right now given just how badly you can miss on on retail flows in terms of cash into your bank.
Alright, Okay and then.
The retail flows have you started to see them stabilize and I know what the stimulus is obviously.
No they accelerated through the quarter with the child tax credit flows.
Okay and even into <unk>.
First part of the third quarter here still still building or.
<unk> got a lot of cash right, yeah, a lot of cash yes, okay.
Alright, thanks for taking the questions guys.
Thank you feel free.
Free call Granddad.
Thank you. Our next question is a follow up from Chris Mcgratty with <unk>. Please proceed with your question.
Hey, thanks for the follow up.
I just wanted to make sure I got the debt comment right Brad.
The instrument you're talking about is the $45 million.
At 5.5 and 3 quarters net what youre talking about.
That's correct.
And I guess, what would what would prevent that from happening just kind of automatically or is that just kind of well we have to actually add to actually call. It. So it doesn't happen automatically but that is our expectation at this point and we can't rate, but theres no theres no.
There is no need for it in the capital right now because you are so flush not not it does not at this moment for sure got it alright. Thank you.
Thank you.
Thank you ladies and gentlemen at this time there are no further questions I would like to turn the floor back to management for closing comments.
Okay. Thank you for joining us this morning, and we'll look forward to speaking with you again next quarter Goodbye.
Thank you ladies and gentlemen. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation.