Q3 2021 Old Second Bancorp Inc Earnings Call

Good morning, everyone and thank.

For joining us today for old Second Bancorp, Inc. 's third quarter 2021 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, Brad Adams I will start with a reminder, that old second's comments today may contain forward.

Thank you for your 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 ask you to refer to the company's S E C filings.

For a full discussion of the Companys risk factors.

On 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, which is available on our website at old second Dot com under the Investor Relations.

Now I will turn it over to Jim Aker.

Yeah.

Good morning, and thank you for joining us today I have several prepared opening remarks.

Mike will review the quarter, and then turn it over to Brad for additional detail.

I will then conclude with some summary comments and thoughts about the future before we open it up for.

<unk>.

Net income was $8 4 million or 29 cents per diluted share in the third quarter earnings. This quarter were favorably impacted by a $1 $5 million reversal of provision for credit losses due to more favorable unemployment projections over the next year.

However earnings were negatively impacted by it.

Question, MSR valuation mark to market loss of 282002.

Due to decreases in market interest rates and merger related costs incurred in the third quarter totaling 425000.

In regards to the balance sheet loans were essentially unchanged on a core basis this quarter, excluding approximately <unk> 30.

Half of $35 $5 million of PPP loans forgiven by the SBA during.

During the third quarter.

Only $34 7 million PPP loans from both the first and second round remain outstanding as of September 30.

Approximately 83% of our PPP loans originated have now been forgiven.

Loan growth has certainly been a bit of a disappointment for us this year, but I am encouraged that our pipeline at quarter end is by far the strongest we've seen since the pandemic began.

We're seeing significant pipeline builds an equipment leasing healthcare and CRE, although C&I activity in line utilization remains somewhat soft.

We have a new CRE team that started with us in the third quarter.

And our senior leasing officer was added in October.

Given these factors and our strong pipeline I'm optimistic we can see.

Solid loan growth net of PPP and the last quarter of this year.

Expense discipline continues to be strong with a slight increase.

Put it in noninterest expense for the current quarter compared to the prior quarter due to growth.

Occupancy furniture and equipment costs, as well as computer and data processing costs.

Exclusive of merger related costs of 425000 occurred in the quarter noninterest expenses increased one 4%.

Sent over the prior quarter.

Nonperforming loans increased by $5 9 million compared to the prior quarter with two loans added to non accrual status. However, past dues declined and although although there was an uptick in non performers total classified assets declined seven 3% compared to the linked quarter.

<unk> no im confident in the strength of our loan portfolios.

Details are available in the earnings release tables on these changes.

One is that our modification standard approximately half a percent of the loan book today, and we are working closely with our borrowers to understand each and every situation.

Of the original $237 eight.

Million of loans, which are on COVID-19 related deferral at some point in the past year.

$229 million or more than 96% of either returned to payment status or paid off as of September 30.

As of the most recent quarter and 12 loans totaling $8 8 million and balances are currently on deferral status.

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 current modification breakdowns and reserve levels exclusive of PPP loans. The reserve currently stands at 147% of total loans.

During the third quarter of two.

2020, 115 million of provision for credit losses on loans was.

It reversed.

47000 of reserves for unfunded commitments was reverse based on a review of the line utilization trends at 237000 of net charge offs were recorded in the third quarter, resulting in a net decrease to the allowance for credit loss.

Losses, including unfunded commitments of $1 7 million.

Our outlook is cautiously optimistic as the underlying economy continues to improve albeit with a significant with significant uncertainties. We believe that we are more than adequately reserved under base case scenarios, but continue to modestly overweight more pessimistic.

Mr scenarios.

Even the high degree of uncertainty.

I'll turn it over to Brad now for more color in his prepared comments.

Thank you Jim net.

Net interest income increased 664000 relative to last quarter and $109 from the year ago quarter.

Margin trends stabilized with securities portfolio growth.

Getting continuing increases in liquidity.

The reinvestment rate on the portfolio purchases was slightly less than 100 basis points as we continue to avoid duration at this point in the rate cycle.

<unk> continued to have strong deposit inflows and substantial excess liquidity persisted for the entirety of the quarter.

The cautious strategy to deploy.

A portion of that liquidity will continue in the short term.

Loan growth improves which we currently expect.

Our margin trend should improve significantly.

If the excess liquidity flow reverses our margin outlook would improve dramatically.

If excess liquidity persist.

Net interest income trends will.

<unk> made a 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 at this point.

If economic conditions continue.

But move in loan growth returns to a level commensurate with that growth our margin outlook would improve.

I continue to remain surprised that loan demand is not followed reported economic conditions, though as Jim mentioned that appears to be changing.

The sum total of that discussion is that we currently expect loan growth trends to meaningfully improve which will result.

To improve continue to result in net interest income growth.

We do not currently expect liquidity flows to lessen and which should leave the margin artificially depressed.

In short, we remain cautious and patient.

Noninterest income increased from last quarter with an increase of 291000 quarter over quarter and that gain on sale of mortgages.

<unk>.

And a reduction of 750000 in the MSR valuation loss recorded.

Wealth management income remained strong with $2 4 million in both the current quarter and prior quarter.

Securities gains net of 244000 were also recorded in the third quarter.

Those were minimal in the second quarter.

Mortgage loan vision for credit losses, and reversal of a net $1 5 million was recorded in the third quarter compared to $3 5 million last quarter.

The economic outlook for US assumes continued improvement with an unemployment rate projection remaining at approximately five in the quarter to $6 75 through September 32022.

And over the remaining life of the.

This is this is a decline from the previous estimate of five 5% to 675 from last quarter.

I recognize that our assumptions are probably still more pessimistic than most at this point and expect the severity of these assumptions to be lessened in the coming quarters.

I'm extremely pleased with our credit has performed.

I continue to be pleased with the direction and classified assets.

Credit metrics have remained stable to improving for a number of quarters now.

And the number of credits that I would've been concerned about had been resolved favorably.

Our efforts in the coming quarters will be focused on helping our customers and funding quality loan growth with the expectation.

Along with stable to improving margin.

Assuming liquidity remains robust and risk spreads remain unreasonably tight.

Expenses are well controlled at this point and we will continue review for efficiencies as the year progresses.

With that I'd like to turn the call back over to Jim.

Thanks, Brad.

In closing we are increasingly optimistic about the remainder 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 are extremely profitable given our focus on expense discipline, we expect to remain so.

Although 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.

Customers and employees.

We are excited about the opportunities that exist for old second in 2022 and beyond.

That include that concludes our prepared comments. This morning, So I will turn it over back over to you Kate to open it up for questions.

Thank you ladies and gentlemen, the floor is now open.

<unk> questions.

You have any questions or comments. Please press star one on your phone at this time, we do ask that if you are listening via speakerphone. Please pick up your handset for optimum sound quality. Once again, if you have any questions or comments. Please press star one on your phone at this time.

Our first.

First question today is coming from David long at Raymond James Your line is live.

Good morning, everyone.

Hey, David.

I know it was suburban transaction.

I think you've got the proper approvals is that still expected to close maybe early December.

Number and then if that's the case and then also as a follow up to that wanted to just hear about any progress you've made in and preparing for the integration and when the French integration and system conversion may happen.

So David we are we have all we have all regulatory approvals in hand.

We are.

Basically just need to have.

Shareholder meetings on both sides, which we're targeting for the end of November.

Anticipating in early December.

So yes, we are.

Knee deep in working through integration plans.

<unk> targeting <unk>.

Mid to late.

April for system conversions.

Got it okay and.

You've got 17% of your earning assets and cash Youre talking about are you putting yielding or.

Do you think some of that in some short duration yields what securities are you willing to add.

At this point on the yield and the duration side.

We've been targeting a little under a two year duration the purchases in the last six months have been primarily concentrated in <unk>.

Variable government guaranteed student loan paper.

Some AAA rated CMO and CLO basically.

Got it okay, and what would it take to get you to to extend that duration.

Higher rates.

Easy enough and then finally on the liability side of the balance sheet.

Any any noncore funding that you think you can shore up I.

Got some senior debt that becomes callable here soon just curious if there's any opportunities to make the liability side, even more efficient than it is now.

There are some opportunities as the senior debt issue is in the $40 million range and it goes variable at the end of the year.

The rate it will be.

I think the variable term will be a substantial improvement in the cost of that.

It's likely that we will evaluate the potential for replacing that in the first quarter of next year.

But nothing is definitive at this point.

I think there is a lot of things you can do from the capital management perspective, especially.

With the with the fundamental balance sheet change, we've got coming at US we will continue to look for opportunities there.

And believe that the projections as we've laid them out in the proxy statement still appear reasonable.

Excellent great. Thanks, guys I appreciate it.

Thank you David.

Thank you. Our next question today is coming from Nathan race at Piper Sandler Your line is live.

Yeah, Hi, guys good morning.

Good morning, Nick Good morning Adrian.

I appreciate the constructive outlook for loan growth ex PPP in the fourth quarter.

Thanks for some of the hires that you guys have had recently along those lines I'm. Just curious as you kind of look out to 2022, obviously the law of large numbers is working against you in terms of.

The percentage of loan growth, but.

When you kind of look at the team you have in place now and just the opportunity to continue to hire them across the Chicago land area what are kind.

Congrats.

Good.

Kind of a range of expectations in terms of the organic growth.

In 2022.

I think David.

Go ahead Brad.

I think that the trend that we have right now on the hiring front and what we expect in.

Kind of our repayments.

We're getting increasingly optimistic that by the end of next year, we may very well double our loan origination capability.

<unk>, which is a very exciting thing for us obviously that doesn't come cheaply and we're investing a lot in salespeople.

But we have a lot of reasons to be excited and.

In terms of the level of talent and the conversations that we've been able to have over the last several months.

So were getting increasingly optimistic on what we're capable of doing from an asset generation standpoint, while still staying in our credit box.

Go ahead David.

I would just.

In terms of the third quarter, while while it was flat.

Was relatively active.

New fundings on production.

Ben what's been a little frustrating as our early Paydowns.

Basically are running at a two X level from where they were last year.

His dad had at our line utilization is down about 8%. So the a factor both of those factors and if we have returned to a more normalized run rate and then see any kind of increase in line utilization coupled with the talent and the pipelines that are building.

Should meet our.

Your throat year next year.

Yeah.

Okay, Great and then just in terms of kind of providing for that growth expectation into next year. Obviously, you have the seasonal date to double count in the fourth quarter as the acquisition closes. So how should we kind of think about excess reserves that exist today.

In terms.

Various I'm thinking about just the trajectory of credit cost and provisioning in 2022 as well.

I think independent of any merger considerations, which those calculations arent arent fully done yet, though our estimates as detailed in the proxy statement appear reasonable.

I think that.

As I said, we're probably more conservative than maybe others in terms of what our estimates are for economic activity.

And I would expect just on a stand alone core basis that all segments reserve will continue to trend down.

So well.

Well, if we do achieve.

Loan growth next year on a scale that which we are hopeful for.

There will be some level of prison at provisioning I would expect it to be.

Pretty muted by continuing economic improvement.

Got it very helpful.

Appreciate all the color. Thank you guys.

Thank you.

Once again, ladies and gentlemen, if you have any questions or comments. Please press star one at this time.

Our next question today is coming from Chris Mcgratty at <unk>. Your line is live.

Hey, good morning, guys.

Hey, Chris Hey, Chris Good morning.

I want to start just on NII, a couple of housekeeping items before the main question could you quantify the.

Level of Triple fee income in the quarter and also the size of that prepay.

Yes.

So the prepay was a few hundred thousand dollars.

Calling it large probably wasn't the best word choice.

That kind of stuff happens quite frequently, especially here lately over the last nine months or so.

In terms of PPP income.

We've only got about $30 million of the portfolio left it looks like.

It was two or 300000, Brad it wasn't that much yeah.

It wasn't significant okay.

And so you're kind of putting it the loan growth in the securities caution together, how do we think about just the trajectory of NII from from here on in Oregon.

Panic basis.

As we said last quarter and we saw this quarter, we would expect to grow NII from these levels in all linked quarter periods.

Okay.

Okay and then.

If I could be.

Two more questions a little bit of color on those non accrual that you talked about would be great and then.

Once the deal closes.

Given the valuation like how are you thinking about.

I mean the buyback.

Sure.

The uptick in non accruals, Chris really two credits.

One is a large big big box retailer.

I don't watch list for a long time and classified last year actually lost lost a major tenant single.

Single tenant property.

We had put on allocation.

A couple of quarters ago, so not a surprise by us they are actively negotiating a new lease with another tenant.

So we don't we don't see any further charges there the other one is.

Couple of million dollars Crane, operator that was hit extremely hard by the pandemic.

We are very well secured on that I don't see any any further losses.

Absent that overall classifieds were.

We're down about 7% for the quarter.

Okay.

And then on the buyback.

Gotcha.

No eminent plans I would say that just from a.

From a theoretical standpoint.

I would view a buyback at these valuations to be an extremely good use of capital.

Okay.

Thank you.

Thanks, Chris Thanks, Chris.

Thank you. Our next question today is coming from Brian Martin at Janney Montgomery Scott Your line is live.

Hey, good morning, guys.

Good morning, Brian.

Can you give a little bit of color just on the hiring you've.

I mean, just I mean to brad's comment about potentially I guess doubling your capability and just kind of.

Does that assume that you're going to pick up more more talent here is that kind of baked in with what you have and just so those couple of questions and just kind of at the hiring outlook given some of the disruption in the market.

Can you just kind of update us on that.

Dunn General how that's progressing.

Sure Brian So we added.

The new commercial real estate team.

Earlier in the quarter.

Very optimistic that that team is going to.

Hit the ground running and even produce yet.

Fourth quarter.

<unk> and then our senior leasing.

Our executive that's been in the business North of 25 years joined US a couple of weeks ago.

We continue.

To have very constructive dialog with a number of additional.

Lenders in the Chicago market.

Optimistic that we will be successful in landing a number of them over the next couple of quarters. So.

We feel real good about that.

Okay, and how about just as far as maybe I don't know.

<unk>, Brad Tim just kind of the expense outlook I mean, I guess the hires.

We're currently in the run rate just the you know how do we think about that with in conjunction with some optimistic thoughts on hiring additional folks here.

Yes. So good question I mean, these folks are certainly good.

It's going to be an investment, but we have we have also recently seen.

<unk> got a few retirements along with the departure too so.

As of now we're probably net net equal.

We certainly.

Look to to see further investments over the coming quarters that will probably.

Pick up our run rate on that overhead.

Gotcha.

Think that we're all under some some fairly significant wage pressure across the franchise. There is there is no secret in terms of what's going on out there in the question maintaining workforce wage inflation is significant in the Chicago marketplace.

I don't know that will be as successful as holding the cost down.

As we were in 2021.

But it is our effort to find efficiencies where we can.

We would expect to see increases in benefit costs and an overall salary levels commensurate with the level of inflation that we're seeing in the Chicago marketplace.

But we will do our best to Lockdown efficiencies.

We can.

We've done some of that on the it side.

There are number of investments that we've made in the last two years that that won't be there in 2022.

So we got a good handle on it but certainly it's not going to be as easy in 2022 as it was in 'twenty one.

Got you that makes sense and just your comment Brian about the kind of doubling the origination capability I guess I guess, that's kind of just driven off of the people you already have got hired so you're expecting.

That is that is not the case, we have not made that kind of expansion yet what I would tell you is is that every hire.

<unk>, we're looking at in the various stages of getting there.

Is evaluated based on what the earn back is just as we look at an M&A transaction.

And we don't expect anybody not to pay for themselves in relatively short order in terms of the salespeople we're looking at so.

I.

Well, it's quite possible that over the next six to nine months that we will have achieved the ability to double our loan origination capability.

Got you. Okay. That's helpful. And then just last one for me just on your.

With west suburban coming on just kind of your mix of what you're doing on the liquidity front kind of what.

I think securities to asset levels or I guess, how are you thinking about that the combined.

Balance sheet issue as you look with the combination on that front.

I'd point, you to the proxy statement on that the information. That's in there is pretty detailed and we do have some discussions on what the pro forma balance sheet looks like.

I would just say this.

What are they said.

We're going to run with substantial excess liquidity.

I also don't believe that the risk versus return in terms of plowing that that excess liquidity at a point in time into a securities portfolio is a good idea at all.

I've spoken quite plainly about that in the past.

I see no reason.

As do it we will be patient.

We've got we've got growth out there in the in the overall economy and we also have a great deal of inflation.

Neither one of those things is consistent with rates staying where they are.

And if it takes one to two years to get there I got to tell you that doesn't bother me.

And today I would rather wait and then.

Announced some sort of portfolio restructuring goes.

Plowed into 30 year mortgages or did something stupid like that.

Yes, all of that makes sense, okay, well, thanks for taking the questions guys. Thanks.

Alright, Thank you Brian.

Thank you we have no further questions in the queue at this time Mr. <unk> do you have any closing comments you'd like to finish with.

Okay. Thanks, Kate Okay. Thanks, everyone for joining us this morning, and we will look forward to speaking with you again next quarter have a good day.

Yes.

Ladies and gentlemen, this does conclude todays event you may disconnect at this time and have a wonderful day. Thank you for your participation.