Old Second Bancorp, Inc. (OSBC) Q1 2019 Earnings Conference Call Transcript
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Old Second Bancorp Inc (NASDAQ: OSBC)
Q1 2019 Earnings Conference Call
April 25, 2019, 11:00 a.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Inc.'s First Quarter Earnings Call. On the call today is Jim Eccher, CEO and President; and the Company's CFO, Brad Adams.
I would like to start with a reminder that Old Second's comments today may contain forward-looking statements about the Company's business, strategies and prospects, which are based on management's existing expectations 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 that you refer to the Company's SEC filings for a full discussion of the Company's risk factors. And 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 earnings release, which is available on our website at oldsecond.com under the Investor Relations tab.
And now to get us started, I'm pleased to turn the floor over to Mr. Jim Eccher. Sir, the floor is yours.
James L. Eccher -- President & Chief Executive Officer
Good morning and thank you for joining us. I have several prepared opening remarks and will give you my overview of the quarter and then turn it over to Brad for more detail on our first quarter performance. I will then conclude with some summary comments and thoughts about the future before we open it up for questions.
Results and overall momentum continue to be quite strong. Net income was $8.5 million or $0.28 per diluted share in the first quarter. Earnings this quarter were negatively impacted by approximately $642,000 of MSR interest rate impairment pre-tax. Absent this charge, earning trends were overall favorable with modest increases in the net interest margin and loan growth.
Return on assets and equity continue to be very strong overall, driven by the net interest margin, solid expense control, sustained performance across our fee-based businesses and a stable credit outlook. A high level of profitability has afforded us the ability to invest significantly in the future growth of the Bank.
In regards to the first quarter specifically, total loans increased modestly relative to last quarter, with a reasonably strong level of originations mitigated by continuing payoff activity. 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. Yields on the portfolio were essentially unchanged from fourth quarter levels with the December rate hike fully mitigated by decreases in market rates.
Total deposits increased modestly from last quarter with solid overall repricing trends. Growth in transaction accounts partially offset decreases in time deposits. The loan-to-deposit ratio was unchanged and remains at 89%, and we believe we can remain at these levels in the near-term with loan growth funded by a mix of deposit growth and modest runoff with the securities portfolio.
We remain very comfortable with asset quality trends overall. Non-performers and OREO both declined relative to last quarter, and past dues remain well controlled. Level of classified loans increased modestly relative to last quarter due to the downgrades of two acquired loans. However, at this point, we do not expect any losses to occur on these credits. Both loans are amortizing as agreed and remain current.
Overall, we remain very encouraged about our results in a number of areas. And I'll turn it over to Brad to provide more color in his comments.
Bradley S. Adams -- Chief Financial Officer
Thanks, Jim. Net interest income was essentially unchanged from last quarter with the impact of the December rate hike mitigated by declines from purchase accounting and LIBOR lending rates; the latter was down some 20 basis points intra-quarter. Fee income remains soft due to a difficult mortgage banking environment, specifically a large MSR impairment related to the back up in interest rates during the quarter.
The reported taxable equivalent margin increased by 2 basis points from last quarter. Despite the smaller contribution from purchase accounting, core margin exclusives of those trends obviously did quite a bit better than that. Pricing movement on the liability side of the sheet remains well controlled, albeit with a pick-up in time deposit competition continuing during the quarter.
Additionally, as short rates have begun to stabilize and our balance sheet has grown, we have brought back some relatively higher cost, larger balance deposit relationships from core customers that had been offloaded. These trends did result in some modest increases in funding costs and we have continued to remain within reasonable proximity to the median pricing in our markets.
Overall deposit betas have significantly outperformed our expectations over the cycle. Our efforts in the coming quarters will be focused on quality loan growth and core funding with the expectation of more stable margin trends going forward. The loan-to-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 future loan growth through a mixture of deposit growth and earning asset optimization.
Looking forward, core margin trends are expected to remain stable and Old Second is not assuming any additional increases in the Fed funds rate during 2019 obviously. It remains true that the bulk of deposit pricing pressure is isolated in larger balance deposit relationships, to which, our exposure is extremely limited relative to competitors.
On the fee income side, mortgage banking experienced another tough quarter with the previously mentioned impairment and without a pickup in the level of activity commensurate with the movement in rates. More recently, the pipelines have picked up a bit, but not to the degree that I would have liked to see given the scale of the movement in rates.
Expenses remain well controlled. There's not a ton to talk about here, obviously, a pick-up back in the first quarter relative to the fourth with a return of some payroll taxes. The net contribution of purchase accounting to our income statement decreased by roughly $0.01 per share from last quarter due to the lack of early payoffs in the purchase portfolio.
Investments for future growth are largely baked into the run rate trends you're seeing from us and we're optimistic about the ramp rates of recent sales hires. Effective tax rate for the quarter was a bit lower than I previously expected due to some impacts from stock-based compensation; a refreshing change from recent periods.
With that, I'd like to turn the call back over to Jim.
James L. Eccher -- President & Chief Executive Officer
Okay. Thanks, Brad. In closing, we're encouraged with the start of the year and excited about the opportunities that are in front of us. 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 difficulty of the current interest rate environment provides an opportunity for a bank like Old Second to demonstrate its strengths.
With margin trends expected to stabilize in coming periods, our efforts will be focused on adding quality relationships to the Bank, while remaining mindful on the credit front. We are comfortable with current capital levels given the strength of our recent earnings performance and the speed at which we are rebuilding capital.
We continue to be on the lookout for acquisition opportunities that meet our return thresholds and are optimistic those opportunities can be realized. Periods of significant changes in the volatility of bank valuations make M&A more difficult in the community bank space today, but things can change quickly on that front. We will continue to approach opportunities as an investor.
And that concludes our prepared comments this morning. So I'll turn it over to our moderator to open it up for questions.
Questions and Answers:
Operator
Gentlemen, thank you for your remarks. (Operator Instructions) We'll go first to Chris McGratty with KBW.
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Hey. Good morning.
James L. Eccher -- President & Chief Executive Officer
Hi, Chris.
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Maybe, Brad, a balance sheet question for you to start. You guys have really remixed quite a bit over the past couple of years, since you joined. How much is left to do from securities to loans? And maybe a comment in terms of loan growth expectations. (inaudible) is that you're saying loan growth is going to exceed earning asset growth for the time being, but just wanted to kind of see when they kind of might mirror each other. Thanks.
Bradley S. Adams -- Chief Financial Officer
I don't think that there's a ton left to come out of the securities portfolio. We're working on some remixing within that portfolio as well. I think, it's prudent to add duration where we can on the balance sheet. Given the stabilization in rates and where we are at that point, I think that we can largely fund the loan growth we anticipate on the core deposit side. I expect that the CD deposit pricing that we've seen will begin to lessen in terms of the aggressiveness that we've seen out there and number of people are in excess of 50 basis points above long-term Treasuries, which is an interesting strategy. So I've got some optimism there. In terms of loan growth, I think that we're talking about something that's mid and approaching high single digits, and that range is what we'd like to see. And second and third quarter are typically our stronger quarters as well.
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Okay. So the loan growth, it seems, based on the hires, is that a bit of a step-up, Jim, to the kind of the 4% to 5% range, 3% to 5% that we've been talking about before; just trying to get a...
James L. Eccher -- President & Chief Executive Officer
I think, based on the current talent pool we have, mid-single digits is reasonable, presuming we can continue to add to talent. I would echo Brad's comments, you know, we're obviously targeting a little higher growth if we can bring more talent on board. We have been successful building out our leasing team over the last couple of quarters or we're seeing pretty good momentum out of that vertical.
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Okay. Maybe on capital and then I'll jump back. You guys have rebuilt it pretty sufficiently post the deal. And based on kind of what were you telling us on the balance sheet, you're going to continue to accumulate it pretty quickly. What's the, I guess, what's the expectation for, kind of, optimizing capital levels? Our deals, I guess, do you think you'll be able to get a deal done in 2019? Would you kind of consider a cash component to draw down the capital levels a little bit, any color would be great.
Bradley S. Adams -- Chief Financial Officer
Yeah, I'm optimistic that the potential exists for us to get a deal done. I think that being efficient with our capital structure is important. It obviously does build back quickly. Investors have seen that when there is a deal opportunity that it has the potential to dip down. So we want to be prepared for that eventuality, but we don't see a lot of reason to build capital aggressively from here. So we'll evaluate that and with the Board and make sure that we do have the absolute right level and are focused on return on tangible common equity.
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Great. Maybe one more on the tax rate, Brad, which would be assuming, kind of, couple of 100 basis points above this going forward or...
Bradley S. Adams -- Chief Financial Officer
You know how much I love talking about that. I would expect it to tick up a bit going forward.
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Okay. Thanks.
Operator
And next we'll move through a question coming from Kevin Reevey with D.A. Davidson. Your line is open.
Kevin Reevey -- D.A. Davidson & Co. -- Analyst
Good morning.
James L. Eccher -- President & Chief Executive Officer
Good morning, Kevin.
Kevin Reevey -- D.A. Davidson & Co. -- Analyst
So earlier in your prepared remarks it sounded like while the pipeline is good, it seemed as though you were disappointed with the pipeline going into the second quarter, if I understood you correctly. Could you tell us kind of where you're seeing the pipeline? Is it more C&I, is it more leasing? And if you can, give us kind of the industries that you think are contributing to the pipeline and where you're seeing the disappointment.
James L. Eccher -- President & Chief Executive Officer
Well, I don't know if we're disappointed, Kevin. I mean, we had obviously very strong growth in the fourth quarter in what is normally a seasonally slower quarter. So we sort of dried up the pipeline in the fourth quarter coming into the first quarter was a little bit slower post holidays. But our originations in the first quarter were 2x what they were in the first quarter of 2018, so we're pleased about that. Traditionally, we've seen the portfolio shrink in the first quarter, so we had a modest uptick. Our pipelines were where we'd like them; heading into the second quarter, we're reasonably pleased with them. We'd like to see that ramp up over the next several weeks obviously, but we think momentum is improving. So on the mix, it's been a good -- it's really been a pretty good mix. We've had, I'd say, a-third C&I, a-third CRE, and a-third leasing. So we kind of like that mix.
Kevin Reevey -- D.A. Davidson & Co. -- Analyst
And then, earlier you talked about the two downgrades of acquired loans, which resulted in the linked-quarter increase in classified assets. Was there any commonality of those two loans with respect to client or industry?
James L. Eccher -- President & Chief Executive Officer
No, Kevin. One is a CRE credit, that's -- we're at a very good collateral position. The other is a C&I credit. Both are just struggling with cash flow. With regards to the C&I credit, we've got a pretty strong sub-debt sponsorship behind us. So we're pretty comfortable that we're not going to lose any money with -- given a default. So again, both are current, both are amortizing and we're actively seeking exits to both relationships.
Kevin Reevey -- D.A. Davidson & Co. -- Analyst
Great. Thank you for taking my questions.
James L. Eccher -- President & Chief Executive Officer
Thanks, Kevin.
Operator
(Operator Instructions) We'll take a question next from Andrew Liesch with Sandler O'Neill.
Andrew Liesch -- Sandler O'Neill & Partners -- Analyst
Good morning, guys. Just a question, Jim, in your prepared comments, you discussed capitalizing on some recent additions to the sales staff. Can you just talked about more on like who these lenders are, where they're located, where -- what the type of background they have and if there are any industries that they specifically focus on?
James L. Eccher -- President & Chief Executive Officer
Yeah. So, to the extent of the talent that's joined us most recently, it's been in our leasing group. These are seasoned relationship managers, 20-plus years of experience in the Midwest, some in the South. We continue to have very constructive dialog with other Chicago-based lenders as a reputation continues to grow in Chicago. So we're optimistic we can continue to add the talent and most of that will probably come into our Chicago office.
Andrew Liesch -- Sandler O'Neill & Partners -- Analyst
Got you. And then, just back to the capital question. It sounds like the Board's going to be discussing other uses of it beyond just letting it build. So I mean, would this include like maybe a dividend increase or share repurchases, what the Board's viewpoint is on that and what would you guys prefer?
Bradley S. Adams -- Chief Financial Officer
I think that the Board will evaluate all opportunities, but I continue to believe that if a transaction is out there that adds to our deposit base and allows us to build back a funding cushion that the opportunities on the lending side in this market given the disruption are fantastic, M&A would be our preferred choice. I think, people know that we have very high return hurdles and how we evaluate M&A deals. And we remain optimistic that there is something to do there.
Andrew Liesch -- Sandler O'Neill & Partners -- Analyst
Great. You guys have covered all my other questions. Thanks.
James L. Eccher -- President & Chief Executive Officer
Thank you.
Operator
Next we'll move to David Long with Raymond James. Sir, your line is open.
David Long -- Raymond James & Associates -- Analyst
Thanks. Good morning, everyone.
James L. Eccher -- President & Chief Executive Officer
Hi, David.
David Long -- Raymond James & Associates -- Analyst
You guys talked about the Chicago marketplace and being able to bring in some additional lenders. The question that I have related to that would be, are these lenders coming from larger institutions or other community banks? And then, as a second part to that, why Old Second? What's the attraction to your Bank? What do you bring that you can offer these guys?
Bradley S. Adams -- Chief Financial Officer
So, there aren't a lot of small banks that add incrementally to our talent base in terms of what we can bring. Our focus is on experienced lenders who bring a next level of Chicago exposure for us.
In terms of why Old Second, we have a fantastic funding base and a lot of room to grow in the City of Chicago. But I think, most importantly, for us to drive very strong earnings growth is one or two quality people can make a huge difference. And there are not a lot of banks that, that is true that offer the same kind of ability to compete across structures and offer the same servicing capability to large customers or mid-sized middle market customers that Old Second can. The Chicago market has been barbelled, and banks in the middle there are fewer of us now than there have ever been. And I think it's a very compelling value proposition. Have the scale and capital to compete, the resources to compete, the product set to compete, but we offer people the ability to make a difference with some significant momentum.
David Long -- Raymond James & Associates -- Analyst
Got it. And then as a follow-up, Jim, you mentioned in your prepared remarks investing for growth, having a lot of opportunities. I'm assuming that this is a large part of it, but any other specific investments that you might want to highlight?
James L. Eccher -- President & Chief Executive Officer
Not on the earning asset front, but we're certainly investing in other areas that are going to position us to add scale in the future. So operations, compliance, areas like that.
David Long -- Raymond James & Associates -- Analyst
Got it. Thanks, guys.
James L. Eccher -- President & Chief Executive Officer
Thank you, David.
Operator
(Operator Instructions) We'll move to Brian Martin with FIG Partners.
Brian Martin -- FIG Partners -- Analyst
Hey, guys. Good morning.
James L. Eccher -- President & Chief Executive Officer
Good morning, Brian.
Brian Martin -- FIG Partners -- Analyst
Hey, Brad. I just wanted to ask you on the margin it sounds as though you guys are seeing some abatement on the funding side. Just kind of what you're seeing on the loan side with the flattening of the yield curve and kind of new production worth coming on adding just -- kind of how are you viewing the margin? It sounds as though it's kind of stable, but just kind of putting it all together.
Bradley S. Adams -- Chief Financial Officer
Margin would have performed significantly better this quarter, were it not for two things. One, there were not any significant acceleration at discount within the purchase portfolio; and two, LIBOR back up. Now, absent those two scenarios, our margin performance would have -- I would have looked stupid relative to what I said last quarter. So in that sense, on a core basis, I wildly missed.
In terms of a flat outlook, I would say that that is the good guess as far as everything remaining absolutely steady, which I think, we all know from experience is about the least likely thing to happen. So while overall short rates going up is very good for us, it's not necessary for stable margin performance, which is what our comments have been framed around.
Brian Martin -- FIG Partners -- Analyst
Okay. And how about just as it relates to accretion that was a little bit lower. I mean, anything -- any change? I knew you talked about the payoffs being less, but just any change to your kind of previous kind of comments on accretion...
Bradley S. Adams -- Chief Financial Officer
Hey, Brian, I got to tell you, I got none of that. You must have stepped into a dead spot or something. You broke up.
Brian Martin -- FIG Partners -- Analyst
Okay. I'm sorry. Just on accretion, Brad, any changes on your previous commentary on accretion? What you expect there?
Bradley S. Adams -- Chief Financial Officer
You sound like a binary robot.
James L. Eccher -- President & Chief Executive Officer
We can't hear you at all, Brian.
Brian Martin -- FIG Partners -- Analyst
Yeah, I can try and dial back in. Is that better now or no?
Bradley S. Adams -- Chief Financial Officer
Hey, Brian. Give us a call. We'll (Technical Difficulty) whatever you need.
Brian Martin -- FIG Partners -- Analyst
Yes. All right.
Bradley S. Adams -- Chief Financial Officer
Unfortunately, we can't understand.
Operator
And gentlemen, we'll move next to Eric Grubelich with -- a private bank investor.
Eric Grubelich -- -- Analyst
Yeah. Hi. Good morning, Jim. You just answered one of the questions about loan pricing. But you talked a little bit about your pipeline. Now, if you look at where the pipeline was a year ago versus now, is there much change in the mix of the pipeline like lease, commercial, commercial real estate?
And then just with regard to the leasing business, is there any better or maybe less pricing pressure there compared to other lending that you're doing or not?
James L. Eccher -- President & Chief Executive Officer
Yes. So a good question. On the pipeline, to the extent we can share some of this information. It's a lot more diversified this year than it was a year ago, less dependent on CRE, more C&I, more leasing, which is very good.
With regard to pricing, we're seeing more opportunities for better yields on smaller ticket type lease opportunities relative to larger ones. We're seeing a lot more competition on larger ticket lease opportunities. So as far as weighted average yield, to Brad's point, it's been flattish the last couple of quarters.
Eric Grubelich -- -- Analyst
Jim, can you just give me a -- what's your definition -- give an example of what you consider smaller ticket versus larger types of leases.
James L. Eccher -- President & Chief Executive Officer
Yeah, I'd say anything on the small side under say $350,000.
Eric Grubelich -- -- Analyst
Okay. That's really kind of draw the line. Okay. That's fine. Thank you.
James L. Eccher -- President & Chief Executive Officer
Thank you.
Operator
And gentlemen, we have no further questions from the audience. I will turn it back to you for any additional or closing remarks.
James L. Eccher -- President & Chief Executive Officer
Okay. Thank you, everyone, for joining us this morning. And we look forward to speaking with you again next quarter. Thank you. Goodbye.
Operator
Ladies gentlemen, this does conclude today's teleconference. And we thank you all for your participation. You may now disconnect and please enjoy the rest of your day.
Duration: 26 minutes
Call participants:
James L. Eccher -- President & Chief Executive Officer
Bradley S. Adams -- Chief Financial Officer
Christopher McGratty -- Keefe, Bruyette & Woods, Inc. -- Analyst
Kevin Reevey -- D.A. Davidson & Co. -- Analyst
Andrew Liesch -- Sandler O'Neill & Partners -- Analyst
David Long -- Raymond James & Associates -- Analyst
Brian Martin -- FIG Partners -- Analyst
Eric Grubelich -- -- Analyst
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