Q1 2022 Old Second Bancorp Inc Earnings Call
Good morning, everyone and thank you for joining us today for old Second Bancorp, Inc. 's first quarter 2022 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 would start with a reminder, that old second banks.
Comments today may contain forward looking statements about the company's business strategies and prospects, which are based on management's existing expectations and the correct acting now.
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 Companys risk factors.
On today's call. We will also be discussing certain non G. A a P financial measures. These non G. A a P measures are described and reconciled to their G. A a P counterparts in our earnings release, which is available on our website at old second Dot com on the homepage under the Investor Relations tab now I will turn it.
Over to Jim Aker.
Good morning, and thank you for joining us.
<unk> prepared opening remarks.
And we'll give Mike will review the quarter, and then turn it over to Brad for additional detail.
I'll, then conclude with some summary comments and thoughts about the future before we open it up to questions.
Net income was 12 million or <unk> 27 per diluted share in the first quarter net income adjusted to exclude west suburban acquisition related costs was $16 1 million or <unk> 36 per share in the first quarter of 2022.
On the same adjusted basis return on assets was 1.05% returns on tangible common equity was 16, 97% and the efficiency ratio was 60, 138%.
Earnings this quarter were favorably impacted by MSR valuation mark to market gain of $3 million and of course by the inclusion of a full quarter of legacy West suburban net interest income.
The first quarter marks our first full quarter with the impacts of the west suburban acquisition in our financial statements.
At this point, we are far ahead of schedule on the cost save realization and outperforming our own expectations on both the fee and interest revenue that we had set for ourselves internally.
We completed the systems conversions and sign changes this past weekend with no significant customer disruption overall.
Overall, we could not be more pleased with where things stand today from both a balance sheet positioning and operational standpoint.
Our only area of disappointment internally was bottom line loan growth, which was up only modestly excluding paydowns within the PPP portfolio.
The trends here, though are deceptively good with extremely strong originations mitigated by acquired loan participation payoffs.
Over the last two years old second has averaged annual originations of approximately $500 million, including unfunded commitments at origination.
In the first quarter of 2022, we originated over $300 million on the same basis.
Activity within loan committee remains extremely strong.
Line Utilizations contracted modestly from 64% to 63% in the quarter.
We do not currently expect this level of runoff within the participation portfolio to continue.
Loan growth within legacy old second totaled 82 million in the first quarter and early indications are positive for the second quarter as activity within loan committee is extremely strong.
Recent hires are starting to hit their stride and the cultural fit has been fantastic.
We're seeing significant pipeline builds in commercial real estate healthcare and importantly sponsored finance.
We are busier than we have been in many years.
The net interest margin expanded modestly this quarter. Despite the two additional months of west suburban.
Tier two we consider ourselves ahead of schedule and the trends underneath the surface are much more positive than the bottomline indicates.
The stabilization and improvement that you've seen thus far in the margin or more product of liquidity deployment than an upward movement in rates.
The story will be very different quarters ahead, and I'll, let Brad talk more about that in a minute.
Nonperforming loans decreased $6 7 million compared to the prior quarter with upgrades of various credits and payoffs of others.
We recorded net charge offs of 293000 in the first quarter compared to $4 7 million of net charge offs in the fourth quarter of 2021.
Due to two large credits last quarter, one in commercial from legacy old second and one in commercial real estate from legacy West suburban both of those large credits were fully allocated.
Total classified loans decreased $8 1 million to $66 6 million.
We remain very pleased with where credit stands today and confident in the strength of our portfolios.
Other real estate owned did not change materially in the first quarter of 2022.
The allowance for credit losses totaled $44 3 million at the end of the quarter, which is one 3% of total loans, which is consistent with the total ACL.
December 31 2021.
At quarter end 320000 of provision for credit losses on loans was recorded.
Which was offset by a lake total reversal reserves for unfunded commitments based on our review of line utilization trends.
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, but continue to modestly overweight more pessimistic scenarios.
Given the high degree of uncertainty.
Expense discipline continues to be strong and we are far ahead of schedule on cost saving targets announced with the acquisition.
Total merger related costs of $5 6 million were recorded in the first quarter of 2022, which includes data deconversion fees for multiple systems.
Legal and other consulting fees.
As we look forward, we are focused on deploying liquidity in order to more fully leverage the quality of the deposit base by building commercial loan origination capability for the long term.
And making prudent investments in the securities portfolio in the short term.
That do not carry excess spread or credit risk.
The goal is obviously to build back towards an 80% plus loan to deposit ratio in order to drive the returns on equity commensurate with our recent historical performance.
I'll now turn it over turn it over to Brad for additional color.
Thank you Jim.
Net interest income increased $12 6 million relative to last quarter, and $17 7 million from the year ago quarter.
<unk> trends increased slightly due to the securities portfolio growth and reductions in funding costs. Following the close of the transaction.
These factors overcame declining loan yields and an increase in liquidity from significant linked quarter deposit growth.
The reinvestment rate on the portfolio purchases increased to 214% this quarter.
Significant increase relative to the one 1% we had been experiencing in prior quarters.
This is an outcome of a move up in rates at the short end of the curve as we continue to add avoid duration during the quarter given.
Given the more recent moves we are willing to go a bit longer but we do remain decidedly cautious.
First quarter saw a significant move in rates all along the curve, but none more dramatic than the under three year portion.
This was essentially the move that we have been preparing for but the speed at the short end of the curve surprised us a bit.
The Mark on the Securities portfolio recognized through OCI went from a $9 million gain to a $37 5 million unrealized loss position of <unk>.
Kris and portfolio value of two 5%.
We would like investors to know that we have been exceptionally cautious in deploying excess liquidity the portfolio.
So duration of $3 31 was $2 seven years the.
The weighted average life was four five years and approximately 35% of the entire portfolio is variable or.
Our fixed rate MBS exposure is and was many multiples less than peers and our absolute exposure to fixed rate issues is and was also extremely short going into this move.
While it's not fun to see the impact on the portfolio of this move was exactly what we were preparing for and I wouldn't change much with the benefit of hindsight.
When the under two year portion of the current gaps like it has even extremely cautious portfolios can initially looked dislocated.
I am confident my belief that we had the right positioning and that the relative conservatism will serve as well.
Im also thankful, we got the opportunity to reposition the acquired portfolio ahead of this move in early December .
Going forward, we will continue to leg into the new regime cautiously and let the rest of the balance sheet carry the day.
While collecting the whole of our money back in relatively short order.
The rest of the balance sheet looks fantastic.
With one rate hike in hand, and several more projected on the near term horizon old second will undergo a step change in profitability and performance.
Posit base as many of you know is extremely granular and insensitive to rates on.
On the loan side exiting existing balances feature high concentrations of variable rate structures and relatively short duration on the fixed side.
Barring a change in current macro expectations old second will transition quickly into a higher rate world with rapidly improving profitability.
On the cost save front, we are performing better than I expected.
I expect we will recognize greater than expected savings in both facilities and information technology and far ahead of the schedule. We originally provided with the announcement of the transaction. We are continuing to be aggressive in recruiting and believe we have a compelling story to tell perspective sales additions.
So I'm hopeful we'll be able to spend some of the upside and the savings to enhance the core asset organic growth rate.
From a cultural standpoint, there are always challenges to overcome.
I would say that the communication is very good and we're getting to the right answers and things feel even better than we expected.
Continue to have strong deposit inflows and substantial excess liquidity persisted for the entirety of the quarter.
Our margin trends are now a function of overnight rates first and loan growth second confidence.
Confidence is high but I would still love to see positive developments in C&I and utilization rates.
Both remain somewhat subdued, but as Jim mentioned, we do feel quite a bit better on the loan growth side of things.
The end result is the margin trends are expected to trend strongly in the right direction.
Forward curve is accurate the first two rate hikes will benefit us, but not to the degree of subsequent moves would.
I would stand by the guidance I gave last quarter that each 25 basis point hike would benefit us by $2 million to $3 million and net after tax.
Noninterest income increased from last quarter with an increase of $1 5 million.
Due to MSR market gains card related income increased growth of 583000 and service charges on deposits of 466000.
Wealth management income also increased quarter over quarter by 276000 growth in assets under management or advisory services those balances now stand at $1 $71 billion at quarter end.
No material provision for credit losses was recorded during the quarter, although our economic outlook has improved.
With an unemployment rate projection decreasing to approximately three 5% to 5% through March 31, 2023 and over the remaining life of the loans.
This is a decline from the approximate 5% to six in a quarter from last quarter.
I would expect loan growth to outpace provision over the near term. We are pleased with how credit has performed with credit metrics improving.
There are credits that I would have been concerned about haven't been resolved favorably.
As noted with our $8 $1 million decline in classified assets this quarter.
Expenses are difficult to manage in 2022 overall with mid single digit increases in salaries and double digit increases in benefits, reflecting wage inflation in a difficult environment to hire.
We are managing through this and are thankful for the flexibility and opportunities for synergies that exists for us right now.
Our efforts in the coming quarters will be to finish delivering on the synergies continuing to bring additional talent on board, helping our customers and funding quality loan growth with the expectation of an improving margin we.
We need to build capital back a bit and we'll focus on delivering bottom line earnings.
With that I'd like to turn the call back over to Jim. Thanks, Brett in closing we are.
We're confident in our balance sheet and loan growth opportunities that are ahead rising interest rates will certainly be beneficial to our bank profitability in 2022 and.
And we continue to focus on expense discipline.
We believe our credit and underwriting has remained disciplined and our funding position is strong.
Today, we have the balance sheet and liquidity to take advantage of a rising rate environment and have the financial strength to wait for this to occur.
We continue to be active in the effort to bring additional salespeople on board and we completed systems integration last week of our core loan deposit and general Ledger, which is a smooth transition for less suburban customers and employees.
We're excited about the opportunities that exist for old second in 2022 and beyond.
So that concludes our prepared comments this morning, and I'll turn it over to the moderator and open it up to any questions.
Certainly the floor is now open for questions. If you have any questions or comments. Please press star one on your phone at this time.
While posing your question. Please pickup your handset is listening on speaker phone to provide optimum sound quality. Please I will just a moment, while we poll for questions.
Your first question is coming from Chris Mcgratty at <unk>. Please pose your question. Your line is open.
Hey, good morning.
Hey, Chris Sorry, Chris.
Brad maybe start with just the balance sheet you guys.
Certainly weighted on liquidity.
How do we think about just the balance sheet mix over the course of the year is it as simple as drawing cash down.
Bringing the investments that flatter down and just remixing.
Or do you think deposits will grow and Youll continue to grow the earning asset base.
So.
I think the trend in deposits is.
The Big question right now.
I'm not a big figure, but I also don't pretend to know what's going to happen. The liquidity came out is much faster than I would have ever expected.
I think what you can expect us to be cautious, we're not going to plough $600 million in any which direction over any quick timeframe.
Loan growth is going to pick up.
But it's certainly not going to eat up that kind of cushion.
The good news front as <unk>.
Even just.
Just sitting in cash, it's a meaningfully accretive to the margin.
I wouldn't expect us to lurch at anything there Chris will continue to add modestly to the securities portfolio.
Some of the issues that we were buying before that were.
Variable are very short.
Have gone from 1% to 2% yields two 3% to 4% yields on the same securities.
So certainly there is a better risk adjusted return there at this point.
I think it's just going to be kind of steady as she goes for us in terms of and not lurching anything.
Okay, and then maybe a follow up the deposit base, obviously is a hallmark of the company.
Loan to deposit sitting at call. It 60 versus 80 is your target.
I guess two questions. How long do you think it will take to get in that ZIP code and then two can you remind us the mix of commercial and retail deposits.
But we're about 85% retail.
West suburban was was accretive to that number.
And it's exceptionally granular and.
I think getting back to an 80% loan to deposit ratio is a two year plus type of scenario absent any significant kind of macro moves in the absolute level of liquidity and banking systems.
If liquidity runs out which I don't see happening at this point, then that obviously can be quicker.
Okay. Thanks.
Your next question is coming from Nathan race with Piper Sandler. Please pose your question. Your line is open.
Yes, hi, guys good morning.
Okay.
I just want to make sure I'm thinking about the kind of margin outlook.
Really in terms of kind of your guidance Brad in terms of the impact from each 25 base.
Basis point increase in fed funds.
And just relative to kind of the latest NII disclosures from the K that implied would be up almost 20% with a 100 basis point move so I guess, putting all those pieces together and assuming the fed moves by half a percent in both May and June I mean is it fair to expect that the margins north of $3.
20, or so by the end of this year.
Yes, that's fair.
I would hope framework.
Yes.
Understood.
Within that context, I assume just going back to the last question that you guys arent seeing much need to move on deposit rates at least this quarter or next.
Yes, I mean, nobody has moved at a basis point, yet I mean, there are some people that are going out with kind of a three year time deposit rates to kind of play the forward curve, which you always see.
We may do that but I don't see any reason to at this point.
Okay understood.
And then maybe just turning to expenses obviously it seems like you guys are ahead.
Ahead of schedule on the west suburban cost saves.
Just given that you guys.
Seem like you make feature target there with some additional saves likely in <unk> post the recent conversion.
Are you guys targeting any reinvestments or anything over the course of this year that would cause the run rate to maybe deviate or maybe move.
Higher from what we saw here in the first quarter.
No.
We do have more open positions than we would like to have at this point given the difficulty in hiring at the retail level.
That's modestly accretive, but I doubt I don't think you'd see that show up in terms of as a trend.
I certainly think we'll give more savings on an occupancy then than we originally thought as we continue our branch rationalization strategy.
Okay. So fair to expect kind of the run rate.
Staying with $32 million range, if not a little bit lower over the balance of this year.
Yes, I mean, theres going to be relative to kind of what we reported now it's going to maybe tick down a little bit further.
And then we will stabilize.
Okay understood.
Favorite <unk>.
Brad, but just on the tax rate going forward.
I'm going to say 25.
My inability to get that number is reached legendary status at this point.
SaaS okay.
I appreciate you guys, taking the questions and I'll step back thanks. Thanks.
Thanks Nathan.
Your next question is coming from David long with Raymond James. Please pose your question. Your line is live.
Thank you and good morning, everyone.
Hey, David Good morning, Dave.
You talked about the average originations in the quarter being around $500 million I think you said $300 million in the first quarter given given some key hires earlier this year in the latter part of last year and it seems like you're somewhat optimistic here, where can that quarterly origination levels go this year.
Yes first day.
At $500 million level, we were running at but those are our annual originations.
For the last on average the last two or three years.
So.
We had over $300 million in Q1.
By far our strongest quarter.
Many years.
Do I think we can sustain that level of momentum probably not but I certainly feel.
We shouldnt be knocking on the door of 800 to two 1 billion in originations by the end of the year.
Paul.
Almost two weeks, where we were in the last couple of years.
Got it thanks for thanks for the clarity there.
And then in the core.
You had a nice MSR write up.
Have any write ups available or or are you back to original cost there.
I think there is a bit more room for that to go higher.
Pretty conservatively valued.
And obviously.
Average lives are likely to get longer.
Got it and then the last one just within the margin.
What are your what are your expectations on purchase accounting accretion impacting the margin here going forward versus where it was in the first quarter.
Pretty flat to first quarter levels for the next two years.
Got it thanks, guys I appreciate it.
Thank you David.
Your next question is coming from Manuel Nava with D. A Davidson. Please pose your question your line is open.
Hey, good morning.
Meanwhile, well how are you.
Well, so I wanted to get a little more detail on <unk>.
Lending team that progress.
Seems like a big part of the growth this quarter was amazing and you had a pretty senior hire there recently.
Higher already producing a major driver of that.
And then CRE was really strong as well and if you can add any color on the <unk>, helping CRE.
Now that would be to start.
Sure, Matt well, yes, obviously it.
An exceptional quarter by way of originations.
It was pretty broad based right. So I think we had.
Significant contributions from.
Commercial real estate from healthcare.
Investment grade leasing equipment finance and.
C&I. So we're very pleased with the <unk>.
Granularity of the mix.
Sponsor finance is obviously our newest team.
Momentum is.
There is building in that group were.
We're hopeful for a very strong.
The remainder of the year out of that team so.
We're very bullish on.
The near term with loan loan prospects.
Would you say most teams are in place and producing.
Outside with the sponsor finance team.
Yes, yes.
Okay.
And.
I think last time, we talked Brad you had you were up about a net 10 lenders have you added more people and how is the pipeline for talent there.
We haven't had.
Any major additions in the last 30 to 45 days or so.
We're always on the look out there's a number of conversations that we're having right now.
There is a huge opportunity for us to continue to expand within the Chicago MSA.
We've got additional geographies now that we can leach into with the west suburban footprint.
And I think we've got a great story to tell.
Got a meaningful shot here.
Really had strong footings through through areas of geography that we previously couldn't touch.
So we're going at it.
We've got the operating leverage going forward that I believe we need.
To not even have to explain.
Any corresponding movements in expenses.
It's a nice position to be in.
That's great.
Okay.
Is the right way to think about.
Expenses is that they are going to tick down a little bit youre going to probably outperform.
Cost saves and any further outperformance just kind of be reinvested into new talent.
The franchise.
That would be my hope yes.
Okay.
I appreciate that and I think.
I think I'm good for now thank you.
Alright, Sir thank you.
Your next question is coming from Brian Martin with Janney Montgomery Scott. Please pose your question your line is like.
Hey, good morning, guys.
Hey, Brian Hey, just.
Brad I think you had commented maybe unless I missed it there was on the rate increases and just kind of the benefits.
I guess with your comment that I guess it was going to slow after the first hike or two I guess I missed what you said there, but it sounded like that's what you're suggesting on the benefits.
No not really.
That actually gets better after the first couple, but the first couple of given just the absolute level of the margin.
Is pretty dramatic.
We've got we've got an awful lot of the balance sheet.
Re prices very quickly and we've got a big slug that asked to burn through about 50 basis points of floors.
And after that.
On the on kind of a naturally pessimistic person. So I don't want to start counting chickens or anything like that but.
Higher rates or.
Nearly good for us right.
Right Okay.
And that amount that it affords we peaked out at a 425 margin last time, there's nothing structurally different about this balance sheet actually this balance sheet is structurally better and higher rates than it was two years ago. It's a hell of a lot more variable on the asset side.
It's it's exceptionally well positioned.
Got you and can you just remind me spend what's the what's the variable rate piece that moves immediately with rates.
You said you have to burn through some floors, but what what moves immediately today versus getting through the rest of those on the floor as well.
50% of the loan portfolio is variable 35% of the securities portfolio is a variable about 35% of the variable loan portfolio.
35% at $50 $60, 60%, Brian at a variable rate portfolio will move immediately.
Okay and then.
And then all of the and that's all of the investment Securities.
Cash, yes, 35% investment securities will reprice instantly.
Okay.
Gotcha Okay.
The optimism I have that wrong. So okay, and then maybe just add Jim that loan growth sounds great. Just the payoffs and their participation book is that is there still a lot left there it sounds like.
The originations are going to be great or at least the optimism is there today, but I mean, I guess, there's payoffs it sounds like theyre going to slow or is it just a function of that book is pretty small at this point or.
Maybe just any color on that.
Legacy old second participation book is relative.
Relatively modest the west suburban syndication book is still pretty meaningful Brian I do think this last quarter was an aberration.
I don't recall ever seen.
A quarter, where we had over $200 million in Paydowns and payoffs.
I certainly expect that to subside in.
Pipelines.
Throughout the company, including included legacy West suburban or building so.
At least for the for the second quarter, we're very optimistic.
And have you I mean, given the optimism you have got I guess it is kind of the I don't know if you guys have kind of given your targets on loan growth, but is it picked up I mean, if you look 90 days ago versus today, given the success of the hiring and the momentum it sounds like it's building I guess it sounds good.
Yes, we are.
Very optimistic Rami normally the first quarters is pretty sluggish for us.
Keeping in mind, we're coming off.
The exceptionally strong fourth quarter.
First quarter originations were surpassed expectations and the pipelines continue to be.
Very robust so.
We're very close to click on all cylinders with our long teams.
Gotcha, Okay, and maybe just the last one for me it sounds like Youre, most near term least optimistic on the <unk>.
Potential for the sponsor Finance group can you give any thought on just how you're thinking about that business growing kind of what the appetite is to how I'd like publicly you'd like to see that get bigger.
Quite a bit.
So.
We were relatively conservative in terms of our internal modeling assumptions.
And thought maybe you could give us a $100 million of growth this year.
I believe there is upside to that number.
Again, not counting chickens, yet but.
Longer term it can be.
Many multiples of that in terms of its composition on the balance sheet.
No.
The reason it can be bigger than $500 million in relatively short order.
Okay, and how big is that today Brad.
Nonexistent today.
Couple of originations at this point.
Yeah, Okay. So not in the numbers at all yet so okay perfect.
Well congrats on a nice quarter, guys and thanks for taking the questions.
Alright, thank you.
You have a follow up question coming from Nathan race of Piper Sandler. Please pose your question. Your line is open.
Yes, I appreciate guys, taking the follow up I apologize if I didnt catch in the release, but just the purchase accounting accretion that was in the quarter.
Just in terms of thinking about your guidance spreads being flat going forward.
So total accretable mark of $9 million recorded on loans.
Okay.
The accretion.
And December was 540000.
Sure.
Income in Q1, 2022 total was $2 4 million.
That should be relatively stable.
The bulk of that almost all of it was related to west suburban there was a tiny bit from a legacy deal a couple of years ago.
Okay. So two four is the number to kind of model in future periods in terms of accretion.
Yes.
Okay.
Got it and then I know, it's difficult with all the macro uncertainty out there.
The seasonal framework just in terms of the kind of thinking about the reserve from here, but it sounds like with credit metrics improved in the quarter.
I imagine within that context, you guys arent seeing much in the way of losses on the horizon. So I guess, how are you guys thinking about providing for.
That kind of high single digit loan growth outlook going forward.
Thanks, Ed.
The level of provisioning will be far below <unk>.
Provisioning at the current percentage basis.
Should be modest.
Okay great.
Thank you for taking the follow ups.
Right.
Once again, if there are any remaining questions or comments. Please press star one.
On your phone at this time, please hold while we poll for questions.
There appear to be no further questions in queue. At this time I would now like to turn the floor back over to Jim <unk> for any closing remarks.
Okay. Thanks for your interest in our company and thank you for joining us this morning.
And we look forward to speaking with you again next quarter Goodbye.
Thank you ladies and gentlemen, this does conclude today's conference call. You may disconnect. Your phone lines at this time and have a wonderful day. Thank you for your participation.
Yes.