Q2 2019 Earnings Call

Good morning, everyone and thank you for joining us today for old second Bancorp Inc. second quarter earnings Conference call.

On the call today is Jim Achar, CEO , and President, Gary Collins, Vice Chairman and the company's CFO Brad Adams.

I will start with a reminder, that old seconds 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 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 assay SEC filings for a full discussion of the company's 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 tab.

Now I will turn the conference over to Mr., Jim Aker <unk>. Please go ahead Sir.

Good morning, everyone and thank you for joining us.

I have several prepared opening remarks, I will give you my overview of the quarter and then turn it over to Gary inbred for additional details.

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

Results in overall momentum continued to be quite strong net income was 9.3 million or 31 cents per diluted share in the second quarter.

Earnings this quarter were negatively impacted by approximately 849000 of MSR interest rate impairment pre tax.

Securities gains taken during the quarter, roughly offset the impact of MSR impairment.

Absent these items earnings trends in the net interest income and fee based revenues were favorable overall.

Returns on assets and equity continue to be very strong driven by the net interest margin solid expense control.

Sustained performance across our fee based businesses and a stable credit outlook.

The high level of profitability has afforded us the ability to invest significantly in the future growth of the bank.

During the quarter, we welcome several seasons additions to our commercial banking leadership team.

And I'll, let Gary speak a little bit more about that in a minute, but let me say that the amount of disruption in Chicago, the Chicago or financial institutions in the markets. They serve provide.

A unique opportunity for old second to expand our reach.

We will continue to be aggressive and looking to both upgrade and grow our commercial sales capabilities in the quarters ahead.

In regards to the second quarter, specifically total loans were unchanged from last quarter with a reasonably strong level of originations mitigated by continued payoff activity.

Activity picked up considerably in June at our pipelines are at the healthiest levels, we have seen in quite some time.

The competition for credit in our market remains aggressive both in terms of pricing and structure.

With the Tailwinds provided by an expanding margin lessening, we expect to increase efforts to grow the loan portfolio and capitalize upon recent additions to our sales staff.

Absent elevated loan payoffs in the third and fourth quarters, which at times are unpredictable.

We are optimistic we can achieve mid single digit loan growth for 2019.

Yields on the portfolio picked up nicely from last quarter due to some lag repricing impacts and the impact of new originations relative to pay offs.

Total deposits were down very modestly and seasonal factors with some mix improvement and stable repricing trends.

Growth in transaction accounts, partially offset decreases in time deposits loan to deposit ratio.

Increased midas modestly to 91%.

And I believe we can remain at these levels in the near term.

Loan growth funded by a mix of deposit growth and modest balance sheet optimization.

We remain very comfortable with asset quality trends nonperformers.

And Oreo both declined relative to last quarter and past dues remain well controlled.

The level of classified loans declined relative to last quarter as well.

Overall, we remain very encouraged about our results in a number of areas and bad and Brad will provide additional color in his prepared comments prior to that though I will turn it over to Gary.

We have some color on the new hires thank you Jim.

During the quarter. We are pleased to have made some significant additions to our leadership and sales teams.

First we added Louis Weisel BAAM has been named group market, President and senior managing director and we'll work from our Chicago Loop Office Lewis has over 30 years of commercial banking experience previously he served as a commercial group president of MB financial leading the professional services business.

In addition, Weve hired Allen cone of Chicago, and he has been named group market, President President and senior managing director and will also be located in the Chicago loop location. Alan has over 30 years of commercial banking experience in Chicago.

Previously he served as senior managing director with MB financial in their National Healthcare banking group and as a managing director previous to that at the private bank.

Also joining in on the healthcare lending group is dollar Clark.

He has been named senior Vice President and will be responsible for developing and growing relations.

Relationships in the senior housing and healthcare space.

Don was most recently with MB financial as well.

We are extremely excited about these additions and believe Allen and Louis and Don.

Bring incredible experience to our leadership team and additional credibility and our expansion into the Chicago Metropolitan area.

We will make sure that the resources are in place to continue our momentum and accelerate our growth into the market.

We are happy to answer any questions about these additions, but I will leave it at that for now and turn the call over to Brad for some additional financial review.

Thank you Gary.

Net interest income increased nicely from last quarter with yields on loans benefiting.

From.

Better origination activity.

And zero cost funding growth in lag longer pricing benefits.

Fee income bounced back very nicely, despite a difficult mortgage banking environment, specifically, the large MSR impairment related to the further backup in interest rates during the quarter.

The reported and core taxable equivalent margin increased by six basis points from last quarter with a largely stable contribution from purchase accounting.

Pricing move and on the liability side of the balance sheet remains well controlled.

And recently market pricing and time deposits as shown signs of abating just a bit.

Our efforts in the coming quarters, we'll be focused on quality loan growth in core funding with the expectation of a more stable margin trends going forward.

The loan deposit ratio leaves us well positioned and we have ample flexibility both to continue the pursuit of growth.

While protecting our core deposit base.

As Jim mentioned it is likely we will seek to optimize the earning asset mix and fund and fund future loan growth through a mixture of deposit growth and earning asset optimization, some of which is likely to come on the time deposit side.

Looking forward core margin trends should remain relatively stable absent any movement in the fed funds rate.

A modest portion of the expected decrease in the fed funds next week is already reflected in Q2 results.

If the rate is lowered I would currently expect our margin to decrease between three and five basis points for each 25 basis point move in rates.

Loan growth will become much more important for us with the outlook for short term rates having changed.

But we believe we have a significant opportunity in front of us on the gross side.

The fee income mortgage banking reflected a significant improvement in gain on sale margins during the quarter and pipelines have built quickly with a pickup in the level of refinance activity.

The quarter was significantly impacted by the previously mentioned rate driven impairment in the MSR portfolio.

Trust and wealth management had a very strong quarter and retail banking trends were solid in both fees and card activity.

Expenses remain well controlled though we did see some increases in back office and advertising expenses.

Additional sales hires will largely be offset by seasonal factors in the remainder of the year and continuing investments for future growth are largely baked into run rate trends you are seeing for us.

The effective tax rate for the current quarter was a bit higher than previously expected compared to the prior quarter due to tax credits recorded related RSU vesting in Q1.

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

Okay. Thanks, Brad in closing we are encouraged with these trends and excited about the future.

On an organic basis operating leverage remains strong and we are excited about the possibilities to continue to add quality talent to the organization.

Returns on tangible equity are excellent in the mid teens on a core basis and the challenging interest rate environment provides an opportunity for a bank like old second to demonstrate its strikes.

Our efforts will be focused on adding quality relationships to the bank, while remaining mindful on the credit front.

On the capital front, we will have some decisions to make given the speed at which we are building capital we will be evaluating alternatives to continue to be efficient here.

And balance that evaluation with a careful examination of our M&A outlook, we remain optimistic and the opportunities that are out there to improve our footprint and we will remain disciplined in the evaluation of those opportunities.

Periods of significant changes in the volatility of bank valuations make M&A more difficult today.

But things can change change quickly on that front.

That concludes our prepared comments. This morning, so I will turn it over to.

Thank you the floor is now open for questions. If you do have a question. Please press star one on your telephone keypad at this time.

Using a speaker phone, we ask that while posing your question you pick up your handset to ride the bus sound quality again, ladies and gentlemen, if you do have a question or comment. Please press star one on your telephone keypad at this time.

We'll go first to Andrew Liesch with Sandler O'neill.

Good morning, guys.

Andrew.

Uh huh.

Brady mentioned some lag the benefits catching up on on your loan yields this quarter from from production is there still some of that.

Remaining that could come in this quarter or is that can be just offset by the.

Well I think there is I think there would have been absent what's happened and to one in three month LIBOR I think that one month and three month LIBOR. If you look at what that those curves of Don.

They've largely reflected the strong expectation of a rate cut and a few days. So I think that thats been swamped by that at this point.

And then can you just remind us what a well how much of the loan portfolio loan portfolio is tied to one and three month LIBOR.

Oh, roughly a third or so.

Okay.

And then on the.

Hi, Jim.

Additional comments on M&A, if you carry that sounds like you guys are trying to remain active but how are discussions going in the Chicago area.

And.

Versus maybe the pace they were maybe just a few months ago.

Yeah, I think things Andrew have cooled off obviously, the last last quarter or so.

Valuations have certainly.

Come down quite a bit, which which makes a discussion is very challenging.

But we expect things to.

To turn around and accelerate as the year unfolds and we continue to.

Have a good discussions with.

With a lot of partners and.

We are hopeful.

You know as the year unfolds, what those opportunities will.

We continue to be there in front of us.

Okay great.

That covers my questions. Thanks.

Thanks, Andrew et cetera.

Well go next to Chris Mcgratty at KBW.

Hi, This is actually Kelly motta on for Chris. This morning, Thanks for taking my question.

Following up on Andrew's question with the NIM.

Can you also provide how much of your loan book is.

Indexed to LIBOR and just a clarification on your NIM guidance for.

About stability that does not include the fed cuts is that correct.

Roughly a third.

In terms of the immediate.

Flow through of pricing changes in that metric with some lag benefits as I mentioned, so it doesnt all go on the day that curve shift. So you can be on a one month or three month or something like that so.

There are some movements, but we are tied to it.

In terms of stability with with.

No changes I would caveat that with that.

The curve does reflect expected changes and if you look at the LIBOR curve. It reflects the expectation of the rate cut.

However, with the rate cut actual happening it would be three to five basis points as we said.

A couple of minutes ago and contraction.

Great and then maybe I'll ask a question on the recent hires you had.

You mentioned you continue to look to pick up additional commercial bankers I was wondering if youre expense trajectory trajectory that you gave in the prepared commentary include.

Any additional hires and when the hires occurred in the second quarter. Thank you.

They occurred in the middle of the second quarter.

We do have additional hires in the budget.

I think that we could hire a lot of people.

Old second has a very compelling story at this point in terms of its positioning in Chicago in our trajectory I think that we have to be.

Disciplined no different than how you approach M&A in terms of looking at what paybacks are what's your overall expense structure can bear.

What expertise they add I think that the people that we've added so far bringing a high level of talent told second and I think it raises the bar for all of us.

If we have opportunities to continue to raise the bar we will do it.

Just as if we found somebody better than me Jim would do it tomorrow.

So.

I think thats, where the obligation we have to shareholders and and I tell you what it's a good time to be a Chicago bank and.

And to have the momentum that old second does so I think we're very excited here.

Great I'll step back thank you so much.

Thank you.

Again, ladies and gentlemen, if you had a question or comment it is star one on your phone and we'll go next to Brian Martin at Janney.

Hey, guys.

Hey, Brian morning.

Hey, Brad just to your comment on that on the LIBOR based loans, what I guess, the three to five basis point decline given what portion of the deposits are indexed I guess, if you will and I guess, the three to five basis point kind of guidance or just input there does that assume youre your ability to make some changes on the funding side or just those two would be helpful.

So I think that first off just generally speaking.

Our level of deposits that are indexed is almost zero.

We are a.

Pristine retail core funded balance sheet for the most part we certainly have some ability to lower deposit pricing I think that.

Relative to budget the real flexibility for us is that the compression weve seen on time deposits has potential to go away.

Which is.

A welcome change.

You know.

Jim.

Is committed to doing the right thing.

By our core retail depositors and we'll continue to do that I don't think theres a ton of room to bring down pricing on the bulk of our deposits.

But the spread on relative to loan growth and repricing.

And just flow from the asset side of the sheet should be relatively stable.

Okay.

That that's helpful and just the.

Yes, I guess, you mentioned something about I guess in the prepared remarks on the time deposits and maybe some remix I guess I, maybe I missed what you said there, but what were you kind of referring to when you talked about the time deposits and.

So what you're saying, yes, Brian we're still we're still seeing some run off and high priced time deposits from from the APC acquisition.

That that will continue to some extent.

But.

At this point.

Our focus is on core deposits and growing transaction accounts and there will come a point is if loan growth does accelerate in the next couple of quarters, which we expect.

Well, we'll have to solve for that we're confident we will be able to do that.

Got you, Okay understood and just on the I guess the people you hired Jim and I guess.

Maybe more potential out there I guess, it's fair to say today that there is given the environment. How you described M&A that there's more opportunity today to hire people then there is to do transactions.

Yes, how we should think about Lisa let me, let Gary comment on that yes. This is Gary Collins.

Yes, certainly the M&A market has been quiet as of late but with the recent sale of them made theres a disruption in the market, but it's more than just on B. There's some of the larger banks commercial lending teams seem to be.

Willing to talk and so we've we've been fortunate to have are really.

Decent flow of conversations ongoing.

I think that the near term stuff just over the last six months or so has been.

Public company valuations have taken a significant hit where expectations within private companies have not necessarily follow that.

That's what Jim spoke to in terms of volatility evaluations.

In the meantime.

The math on on lift outs and the opportunity unless ounces.

The latter is increase the former has been stable so.

The relative value proposition on hiring versus M&A has been pretty skewed for the last six months, so thats, where weve been focused.

Yes, Okay understood and I mean, the people you didn't really change much in your guidance for the year. Despite hiring a few people in.

Sounds like a pretty robust pipeline today, I mean, I guess is there.

Yes, something more to that than kind of what I'm hearing there is maybe the where you're at a bit conservative given the trends you are seeing today.

Well I mean to get I guess, Brian to get to to get mid single digit loan growth.

When you are essentially flat through six months is double digits.

It's not going to be real easy right.

But the other factor that's been unpredictable is some payoffs of that income come down the road that.

So we expect others others.

We havent been able to to expect but we do see some in the third quarter and.

Certainly going into 2020.

We're feeling we're feeling pretty good about.

The elevated talent, we have and our ability to grow on a more consistent basis.

Yes, Okay, alright understood. Thanks for taking the questions guys.

Thank you.

And a final reminder to star one if you had any questions or comments.

I have no other questions holding at this time I'll turn the conference back to management for any additional or closing remarks.

Okay. Thanks, everyone for joining us this morning, and we look forward to speaking with you again next quarter.

Thank you, ladies and gentlemen that will conclude today's teleconference. We thank you for your participation you may disconnect. Your phone lines at this time and have a great day.