Old Second Bancorp Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 18, 2024

There are 9 speakers on the call.

Operator

Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Incorporated's Second Quarter 2024 Earnings Call. On the call today are Jim Ecker, the company's Chairman, President and CEO Brad Adams, the company's COO and CFO and Gary Collins, the Vice Chairman of our Board. I will start with a reminder that Old Second's comments today will contain forward looking statements about 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 SEC filings for a full discussion of the company's risk factors.

Operator

The company does not undertake any duty to update such forward looking statements. 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 oldsecond.com, on the homepage and under the Investor Relations tab. Now, I will turn it over to Jim Ecker.

Speaker 1

Okay. Good morning, everyone, and thank you for joining us. I have several prepared opening remarks, and I'll give my overview of the quarter and then turn it over to Brad for additional details. I will then conclude with certain summary comments and thoughts about the future before we open it up for questions. Net income was $21,900,000 or $0.48 per diluted share in the Q2 of 2024 and return on assets was 1.57%.

Speaker 1

2nd quarter of 2024 return on average tangible common equity was 17.66 percent and the tax equivalent efficiency ratio was 53.29%. 2nd quarter 2024 earnings were negatively impacted by $3,800,000 of provision for credit losses in the absence of significant loan growth, which reduced the after tax earnings by $0.06 per diluted share. However, despite this profitability, Old Second remains exceptionally strong and balance sheet strengthening continues with our tangible equity ratio increasing by 35 basis points linked quarter to 9.39%. Common Equity Tier 1 increased to 12.41 percent in the Q2 of 2024 and we remain we feel very good about profitability and our balance sheet position at this point. Our financials continue to be positively impacted by higher market interest rates.

Speaker 1

Pre provision net revenues remained stable and exceptionally strong. For the Q2 of 2024 compared to the prior year like period, income on average earning assets decreased $663,000 or 0.9 percent, while interest expense on average bearing liabilities increased $3,200,000 or 31.3 percent. The increase in interest expense is rate driven and primarily due to remixing and exception pricing on certain commercial deposits. Our average other short term borrowings and other borrowings were significantly less in the Q2 of 2024 compared to the prior linked quarter and year over year quarter as our daily funding needs were reduced. And in the Q2 of 2023, we retired $45,000,000 of senior debt.

Speaker 1

These actions reduced interest expense on borrowings, stemming from higher rates offered on deposits. The Q2 of 2024 reflected an increase in total loans $7,200,000 from the prior linked quarter, primarily due to growth in commercial lease and construction portfolios, net of payoffs on a few large credits during the quarter. Comparatively, loan growth in the Q2 of 2023 was 12,200,000 dollars and a net decrease in loans of $73,500,000 in the Q1 of 2024. The historical trend for our bank is loan growth in the second and third quarters of the year due to seasonal demand and business activities. 2023 was an anomaly as the Savvy commercial customers realized interest rates were about to increase and sought funding prior to those market rate increases in late Q1 2023.

Speaker 1

By the Q2 of 2023, loan growth had tempered to market rate increases in the late Q1 and Q2 of 2023. Currently, activity within our loan committee has picked up as pipelines are at their highest level at 18 months and up 3x from Twelvethirty onetwenty 3 providing optimism for loan growth in the second half of the year. Net interest margin increased slightly this quarter, driven by continuing higher rates on variable securities and loans, partially offset by higher funding costs. Loan yields reflected a 5 basis point increase during the Q2 of 2024 compared to the linked quarter and 21 basis point increase year over year. Funding costs increased due to increases in both rates and growth and time deposit balances.

Speaker 1

The tax equivalent net interest margin was 4.63 percent for the 2nd quarter compared to 4.58% for the Q1 of 2024 and 4.64% in the Q2 of 2023. The margin has remained relatively stable in the year over year period due to the impact of rising rates on both the variable portion of the loan and securities portfolio as well as the deposit base and our short term borrowing costs. The loan to deposit ratio is 88% as of June 30, 2024 compared to 86% last quarter and 85% as of June 30 last year. As we have said, our focus continues to be balance sheet optimization. I will let Brad talk about this in a moment.

Speaker 1

The Q2 of 2024 saw improving asset quality metrics and moderate actions taken on substantial credits, continued remediation trends noted primarily since late last year. Our belief remains that the Q4 of 2023 represented an inflection point in our credit trends. Old Second began substantially downgrading large amounts of commercial real estate loans, including office and healthcare at the end of 2021 and accelerating through 2022. Substandard and criticized loans went from approximately $60,000,000 or a little more than 1% of loans in the Q3 of 'twenty one to a peak of nearly $300,000,000 or 7% of loans in the Q1 of 2023. At the end of the Q2 2024, substandard and criticized loans are down to $187,400,000 which is approximately $15,900,000 less than year end 2023 and more than 40% below peak levels.

Speaker 1

The expectation remains for further improvement throughout the rest of the year. Encouragingly, our special mentioned loans decreased more than 55% from 1 year ago and are at their lowest levels in over 2 years. We continue to expect realization of a relatively less costly resolution on a number of non performers in the near future and remain hopeful we can recover some of the losses realized in the second half of twenty twenty three. Commercial real estate valuations are heavily dependent upon the market level of interest rates as a primary determinant of cash flow for a given property. A movement in rates such as we have seen is substantial enough to significantly impair the equity positions in a large percentage of commercial real estate credits.

Speaker 1

Additionally, the residual stress brought upon by the pandemic at commercial real estate office and healthcare has not abated. We believe we have been proactive and realistic in addressing commercial real estate loans facing deterioration from higher interest rates, declining appraisal values and cash flow pressures. As we discussed last quarter on the call and consistent with our expectations, we recorded net charge offs of $5,800,000 in the 2nd quarter compared to $3,700,000 in the Q1 of 2024. One specific current period charge off of $4,100,000 on a previously allocated loan, one final charge off of $1,500,000 related to a note sale and charge offs related to a transfer to OREO of $550,000 were partially offset by approximately $217,000 of net recoveries during the Q2 of 2024. The good news is that criticized and classified loans continue to decline and the remainder of the portfolio remains well behaved.

Speaker 1

Continued stress testing has not raised any new red flags for us and the bulk of our loan portfolio has transitioned and is seasoning into this higher rate environment. We have said this before, but it's worth repeating that being short duration on the asset side has probably put us at the vanguard in terms of commercial real estate stress. We remain disciplined and did not offer 7 or 10 year maturities of commercial real estate assets a few years ago. The allowance for credit losses on loans decreased 42,300,000 dollars decreased to $42,300,000 as of June 30, 2024 or 1.1 percent of total loans from $44,100,000 dollars at March 31, 2024, which was also 1.1 percent of total loans. Unemployment and GDP forecast used in future loss rate assumptions remain fairly static from last quarter.

Speaker 1

The change in provision level quarter over linked quarter reflects the reduction in our allowance allocations on substandard loans, which largely relates to the 29% reduction in criticized assets since June 30, 2023. I think investors should know that with our continuing level of strong profitability, we will be aggressive in addressing weak credits and that we remain confident in the strength of our portfolios. Non interest income continued to perform well with growth noted quarter over linked quarter and wealth management fees, card related income and mortgage banking income, excluding the impact of mortgage servicing rights mark to market. The death benefit of $893,000 was realized on a one BOLI contract in the Q2 of 2024 with no life benefit in the linked quarter or prior year life period. Expense discipline continues to be strong with the Q2 of 2024 total non interest expense of $364,000 less than the prior linked quarter, primarily due to reductions in salaries and employee benefits and a gain on the sale of an OREO property.

Speaker 1

Our efficiency ratio continues to be excellent. As we look forward, we are continuing on doing more of the same, which is managing liquidity, building capital and also building commercial loan origination capability for the long term. The goal is to continue to build towards a more stable long term balance sheet mix featuring more loans and less securities in order to maintain the returns on equity commensurate with our recent performance. I'll now turn it over to Brad for additional color.

Speaker 2

Thank you, Jim. Net interest income decreased by $93,000 or 0 point 2 percent to $59,700,000 for the quarter ended June 30, relative to the prior quarter of $59,800,000 dollars down $3,900,000 or 6.1 percent from the year ago like quarter. Securities yields increased 16 basis points due to the variable portion of the portfolios and loan yields were 5 basis points higher in the Q2 compared to the Q1 of 2024. Total yield on interest earning assets increased 6 basis points linked quarter to 567 basis points. This was partially offset by a 15 basis point increase in the cost of interest bearing deposits and a 2 basis point increase to interest bearing liabilities in aggregate.

Speaker 2

The end result was a 5 basis point increase in the tax equivalent NIM to 4.63 compared to 4.58 last quarter. We believe this continues to be exceptional margin performance and surpassed our expectations modestly. Deposit flows this quarter continue to display signs of seasonality and overall stabilization from what we saw last year. Average deposits decreased $4,300,000 linked quarter and period end total deposits decreased $86,500,000 from the prior quarter. Deposit pricing in our markets remains exceptionally aggressive relative to the treasury curve and is still largely pricing off overnight borrowing level costs.

Speaker 2

Public funds provided a bit of a headwind this quarter as fixed income markets offer an attractive alternative. On an overall basis, we are continuing to add duration, albeit at a more modest pace than I would like. In totality, marginal spreads remain unattractive at this point and Old Second does not feel the pressure to swell in order to overcome expected margin pressures. Marginal returns on allocated equity remain poor for outsized growth and flat NII performance for the year is more difficult in the absence of loan growth, but we have made progress in extending duration and the outlook for loan growth is improving. My position remains that markets continue to believe inflationary trends are far easier to kill than they actually are in real life.

Speaker 2

Rate cuts right around the corner is not a realistic expectation without significant declines in real demand and consumption. Regardless, the deeply inverted yield curve poor spreads in our industry, so we're continuing to focus on compounding book value and maximizing returns. For us, that means being careful with expenses and pricing risk appropriately. Credit protected securities have been a better avenue at times this year. The point is that we are being careful.

Speaker 2

As a result, margin trends for the remainder of the year are expected to be relatively flat, maybe slightly down. If I'm wrong and a couple of rate cuts actually occur, we would lose a few basis points. Absolute NII growth from 2nd quarter levels will be a function of our ability to find some loan growth. The loan to deposit ratio remains low at 87.9% and our ability to support source liquidity from the securities portfolio remains. Old Second should continue to build capital as evidenced by the 35 basis point improvement in the TCE ratio over the linked quarter, which means we have added an astonishing 2 22 basis points of TCE and $2.37 of tangible book value per share over the last 12 months.

Speaker 2

I expect at least 2 people will ask in a few moments what we are going to do with all this capital. It's a fair question. Sometimes I'm wrong, but I always try to be safe when that occurs. Building capital today earns a nice return relative to the recent past, and I continue to have conviction in the belief that an opportunity to invest that excess capital is coming. M and A looks like it's starting to get interesting.

Speaker 2

If that does not come to fruition, we will return capital. A buyback is in place and is on the table. Dividend levels will be considered as well. Non interest expense decreased $364,000 from the previous quarter, primarily due to reduction in salaries and benefits due to a timing of officer incentive accruals and related payroll taxes paid in the Q1, as well as a small decrease in occupancy costs, primarily due to seasonal maintenance and a small gain recorded on an OREO sale. As noted last quarter, quarterly wages and benefits are closer to $23,000,000 run rate going forward in the near term.

Speaker 2

Given the revenue performance, employee investment costs have been running high for a while now, but we will maintain the ability to dial back as conditions warrant. With that, I'd like to turn the call back over to Jim.

Speaker 1

Okay. Thanks, Brad. In closing, we are confident in our balance sheet and the opportunities that are ahead. Our focus remains on assessing and monitoring risks within the loan portfolio and optimizing the earning asset mix in order to reduce our overall sensitivity to interest rates. Net interest margin trends are stable and income statement efficiency remains at record levels.

Speaker 1

The expectation for continuing efficiency gives me confidence we are well positioned to deliver a solid year. That concludes our prepared comments this morning. So I'll turn it over to the moderator and then open it up for

Operator

And we do have our first questioner, Jeff Rulis from D. A. Davidson.

Speaker 3

Thanks. Good morning. Brad, I'll stay off the capital questions. But maybe on the credit side, just possibly an update on the credits we talked about, either the Chicago office or the California Health Care, just to try to get an update on timing and status, if we could?

Speaker 1

Sure. Sure. Well, I think that the big story this quarter, we had 2 major charge offs and really that was the extent of the pain we took this quarter. They were both credits have been on the horizon here for several quarters. One was a Chicago office building that we took a final charge of $4,000,000 and then the other was a note sale that we were able to execute on that required about $1,500,000 additional charge.

Speaker 1

So we feel good about resolving those 2. I think what investors should know is we have made significant headway in reducing non accrual loans this quarter with more than a dozen credits that we resolved. As far as office, obviously still a very important part of the portfolio that we are watching over. We only have $23,000,000 now in office exposure, dollars 9,000,000 in Chicago and $14,000,000 in the suburbs. We've got a reserve against the entire portfolio north of 5%.

Speaker 1

So we feel like we've got our arms around that pretty well. Healthcare has been a slower remediation process, but we've seen no new red flags pop up in that portfolio and actually starting to see some improvement in occupancy and performance.

Speaker 3

And Jim, just on your tone, it sounded as if the kind of the net charge off outlook barring surprises. It seems like the second half chunkier than the back half and the expectation just to confirm is that you'd expect losses to be more modest ahead?

Speaker 1

Yes, that's correct. I feel momentum is still very strong in credit remediation, but I don't see chunkier charges in the coming quarters anyway.

Speaker 3

Okay. And maybe hop into the pipeline pickup trends. I wanted to kind of get your sense of is that more something you're doing in house? Do you feel like it's just the market picking up or maybe a combo of both? And then the second part of that question is could you frame up what the second half looks like?

Speaker 3

Is that kind of low or mid single digit growth on that?

Speaker 1

Yes. I mean, we've been pretty disciplined, Jeff. I would say the first half of this year, we were not seeing the risk adjusted spreads that we would have liked to have seen. So we were really on the sidelines. We've seen more opportunities.

Speaker 1

And what I'm encouraged about now is that the pipelines are broad based along many of our verticals, and we got to get them across the finish line here. But I would expect, hopefully, low to mid single digit growth for 3Q and 4Q this year.

Operator

We now hear from Chris McGrady with KBW. I'm sorry, we have Terry McEvoy with Stephens.

Speaker 4

Hi, good morning everyone.

Speaker 1

Good morning, Terry. Good morning.

Speaker 5

Maybe if I could just ask a question on the expense outlook for the second half of this year, the personnel and expenses overall came in a bit above what was discussed on the last call and would be curious with your outlook for the second half of the year.

Speaker 2

Relatively flat. I thought I said $23,000,000 last quarter, but so maybe a $400,000 above that level. Second half of the year is always about how your overall year performance is tracking relative to budget and how that works with incentive accruals. So it you can be wrong by $500,000 in any given quarter and still be pretty darn close. It's kind of a horseshoes and hand grenades kind of thing.

Speaker 2

But I don't see anything labor market conditions have improved. We've been able to hire who we wanted. I don't see any real surprises coming at us at this point. So I think we are where we are. I'll say I'm broadly very happy with what expense trends have done over the last year and also over the last 3 years.

Speaker 2

It's no secret this is a wildly it's been a wildly inflationary time and I feel like we've done a really good job keeping a lid on things.

Speaker 6

And then there seems to

Speaker 5

be fears that when CRE loans mature, that's when the losses materialize That wasn't obviously what happened last quarter. So when I look at the $25,000,000 of maturities in Q3 and was it $40,000,000 of Q4, are those loans built into the reserve today? And ultimately, how should I how are you thinking about potential loss content there?

Speaker 2

Yes, we've been cynical depressed people on upcoming maturities for the better part 2 years now. That's a function of why we were downgrading credits 2 years ago and felt like we were alone in doing so. There is no surprises coming. We have looked at maturities that are less than 24 months out for a while now. And we've been very cynical depressing people that you wouldn't want to talk to at cocktail parties.

Speaker 2

I think that the kind of bowling ball through a garden hose has been the preponderance of our industry offer 7 10 year maturities, which Jim alluded to back in 2020 2021. That's not a game that we played in. So we're a short duration asset shop, always have been, believe we always will be. There's nothing coming at us that is either unexpected or outsized in terms of maturities.

Speaker 5

Appreciate that. And then maybe one last one, Brad, I think you said M and A starting to get interesting might have been the quote there. So I don't mean to ask a capital question, but have to kind of take the bait on your statement there.

Speaker 2

Yes. Our statements have been our strategy has been to build capital. I think that there are several reasons to do that. The first of which is that at this point greater than any point over the last 10 years is that capital earns a nice return. The cost of funding is now 5.4% in the market.

Speaker 2

So a levered return on equity is pretty darn good even if you're not using it at this point. So it allows you to have a margin of safety. That margin of safety is also is both economic based is a recession around the corner and that's something people like to talk about. But it's also if times are difficult in our industry, which they have been with very low returns, some people might begin to throw in the towel. We have capital flexibility to include cash in a deal so you can balance accretion.

Speaker 2

I don't know whether a deal is going to happen for us and that I realize that's the question. But I can tell you that if we do get an opportunity, we will be exceptionally disciplined on price. That hasn't changed. If we don't get an opportunity, as I said, we will return the capital. Yes, sir.

Speaker 2

Thank you.

Operator

We now have Chris McGrady with KBW.

Speaker 2

Chris, are you

Operator

having Can

Speaker 4

you hear me now, Brad?

Speaker 7

Yes, I can.

Speaker 4

All right, cool. The optimization of the balance sheet was mentioned a couple of times in prepared remarks by you and Jim. What's left to do? Obviously, hedging is probably hard in this environment because of the curve, but what's left to do? What's coming off the bond portfolio every month?

Speaker 4

Just help us a little bit on that.

Speaker 2

Well, we've had a lot come off the bond portfolio. The structure of the yield curve for the bulk of this quarter meant that we simply laddered it back out short, which did offer a pickup in yield. What I'd like to see is a steepening. I don't know. I think a steepening is coming.

Speaker 2

I don't know whether it's recession driven with a short end falling or if it's things people become less pessimistic and the long end picks up. If we can get a steepening, obviously, the latter would be better. If we can get that, then what we would do is take off adoration aggressively by selling variable securities and reduce the overall size of the bond portfolio with loan growth to more like a 15% level from a 20% level. That would be the ideal scenario. I would remind investors that we are what we are, and smarter people than us have tried to bet on interest rates, and a large percentage of them wind up with a tin cup in their hand on street corners.

Speaker 2

Betting on interest rates is a fool's errand. We will always be inherently sensitive and better off if rates are higher because of being a very good deposit base. And anybody that wants us to bet that away is would be making a mistake. So we do better when rates are high. That's no secret.

Speaker 2

And we are doing quite well. If short rates fall, we will do slightly worse. But we will invest capital wisely and we will earn nice returns in any environment.

Speaker 3

Thanks for that.

Speaker 4

Maybe just a follow-up, kind of combining the expense in the NII commentary, efficiency ratio, Brad or Jim, like if we get the forward curve, we get 100 basis points of cuts. Obviously, margins will go down. You're obviously going to probably be a little bit more careful on costs. So like where is the efficiency ratio settling if the futures market is right with 100 of cuts?

Speaker 2

So low 50s and higher rates, mid to high 50s and very low rates. I don't see us going back above 60, given our size and scale that we have now. But I also don't think we're ever going back to 0 given all the things that resulted from that. And I think it would take an absolute idiot to think that was a good idea at this point. So in a world where rates aren't 0, deposits are worth fundamentally more than most investors have a memory of.

Speaker 2

So I think that as long as short rates don't cross 200 basis points at any time soon, We are above 4% margin shot as we are structured today.

Speaker 4

So mid to upper 50s with 50s. Yes.

Speaker 1

The big difference today versus where we were last time we were in a potential scenario where rates were going to be cut was our balance sheet just wasn't as optimized, right? We were sitting at low to mid-60s on our loan to deposit ratio. So we've got much stronger pretax pre provision earnings power now.

Speaker 6

Perfect. Thank you.

Speaker 1

Yes, Eric.

Operator

Our next questioner is Nathan Race with Piper Sandler.

Speaker 8

In terms of funding loan growth in 3Q and 4Q, is that mostly going to be source from securities portfolio runoff? And does that imply maybe the margin can expand a little bit more here in 3Q?

Speaker 2

I would like to say flat on the margin. It wasn't my expectation that it would go up this quarter. Yes, I would say that if loan growth is strong, which we believe is trending in that direction, that at least half of it would come out of the bond portfolio and you may see overnight borrowings tick up a bit or you may see deposit growth. We had deposit growth last quarter. We had some lumpiness happen this quarter.

Speaker 2

I don't see any reason why deposits can't grow.

Speaker 8

Okay, great. And then, Brad, can you just remind us the impact on the margin with each 25% cut

Speaker 2

in the Fed? 5 to 7 basis point decline. Can you just

Speaker 8

remind us in terms of the floating rate assets that you have on the balance sheet both in loans and securities coming out of the quarter?

Speaker 2

About 50%. We're about fifty-fifty, but the fixed portion of the balance sheet generally has an effective duration a little over 3. So rates down will hit us without a lot of weight. There is no question about that. But also you get a pickup in the benefit of the free funding and deposit costs will come down.

Speaker 2

So and that's when you start looking at growth as well.

Speaker 8

Got it. That's helpful. Just one last one. It sounds like charge offs may there may be some additional cleanup here in the Q3, and I imagine those are already largely allocated for. But just in terms of kind of where you guys want to see the reserve settle out coming out of the 3rd quarter, any thoughts on what that level should be relative to total loans?

Speaker 1

Yes. I think the reserve at these levels as a percentage of total loans is probably an appropriate level for us. But to answer your earlier question, I don't see the magnitude of charge offs in the second half of this year based on the remediation progress we're making on a number of loans and have already realized some progress this quarter. So I think a reserve level in close proximity where we're at now is appropriate.

Speaker 8

Okay, great. I appreciate all the color. Thanks, guys.

Speaker 6

Thanks, Nate. Thank you.

Operator

We now hear from David Long with Raymond James.

Speaker 7

Good morning, everyone. Brad, I wanted to ask you about the deposit pricing. Obviously, you guys have a great core deposit base, total deposit costs amongst the lowest of your peer group. In your marketplace, where I reside, I'm still getting some pretty nice offers, 5% plus on savings accounts. How much do you see the deposit if we stay higher for longer for the back half of the year, how much higher do you see that deposit total deposit cost for Old Second changing?

Speaker 2

So I think what's largely going on here is that a bank such as ourselves, which is a good retail deposit bank, a natural mix of the deposits is probably like 25% time deposits. We got down around 10% or 12% because time deposits became a bad deal for consumers. And that's what happens and with a curve that is at 0 across any level of duration. So time deposits became just simply not a thing. And what we're seeing now is that as that mix shift going back and there is a transition and we'll probably start trending towards a 20% time deposit mix.

Speaker 2

I don't see any reason why it shouldn't be that. That's going to be the primary determinant of pickup in deposit costs for us. Now there is a percentage of the deposit base that is a lot of money. For us that's much lower than everybody else. We have very few accounts that have more than $10,000,000 or $15,000,000 in them.

Speaker 2

You can count them on fingers and toes. So for that customer, for our industry, fixed income markets are simply a better deal. And fighting with fixed income markets for that money results in the big pickups in deposit costs that you've seen in our industry and that's simply not a game that we're in to win. That's not what banks should be doing. Sophisticated large public funds and commercial customers should have a diversified liquidity portfolio.

Speaker 2

It's simply true that banks are having to fight with fixed income markets for funding because they got duration wildly wrong when rates were low and going higher. And that's what happens when you're stuck. We are simply not stuck.

Speaker 7

Got it. Thank you for that color. And then on the credit side of things, a lot of talk about commercial, particularly the office space. Hearing more from Chief Credit Officers that C and I needs to be more closely watched and regulators need to look more at C and I. I.

Speaker 7

How is the performance of your C and I book? And are there any segments there that you're a little bit more concerned about?

Speaker 1

Yes. I mean, so far, Dave, our C and I portfolio is holding up very well. We've got about, I think, a little over a third of our portfolios now in C and I, which we're pleased about. Only about less than $20,000,000 is classified in that book. We have seen a couple of credits that we're keeping an eye on.

Speaker 1

But by and large, a lot of our C and I clients still have a relatively low leverage balance sheet and producing pretty good top line results. But we are obviously watchful with the very significantly variable portion of that portfolios in C and I, we're seeing a little bit of stress, but right now it's behaving very well.

Speaker 7

Got it. Thanks for taking my questions, guys.

Operator

We now have Brian Martin with Janney Montgomery Scott.

Speaker 6

Hey, good morning guys.

Speaker 1

Hey, Brian. Hey, good morning, Brad.

Speaker 6

Hey, most of my questions were answered. But just Brad, just on the securities portfolio, just for clarity, how much of that is coming off in the second half of the year? And the percentage of that is variable rate just on the securities book, it goes about 20% last quarter. It sounds like it dropped a bit this quarter? Yes, not much.

Speaker 2

I mean, you have the type of volatility that we've seen has been not much to dropping that is. The type of volatility that we've seen means that there are times when variable securities are quite simply a better deal and they had they were for the bulk of the Q2. So you take the best value for your money. In terms of coming off the bond portfolio, I would expect no less than $100,000,000 over the remainder of the year. So it feels fine to support loan growth for the bulk of it.

Speaker 2

I said at least half a few minutes ago. All the flexibility we need, feel very good.

Speaker 6

Yes. And what that comes off to what Brad, I mean, is it pretty low rate that $100,000,000

Speaker 2

Yes. I mean, it's certainly lower than the blended overall securities portfolio yield, which I think is like $320,000,000 or something like that. So it's significantly lower than that.

Speaker 6

Got you. Okay. And then just on the credit front, just the progress you made this quarter and kind of some of the comments, I guess, the resolutions at this point seem to be less costly. But in terms of any lumpy resolutions you expect during the back half of the year, I mean, do you expect another meaningful decline in the non performers or the classifieds or criticize here as you kind of get to the back half of the year? Is it more of a slower decline now given some of the heavy lifting you've done?

Speaker 1

Yes. I mean, I don't know if we'll get 23% reduction in non accruals next quarter, but we are already realizing some remediation on a number of fronts. Momentum is good. What's encouraging is there's been very little migration into non accrual this quarter. We only saw $1,000,000 and saw obviously $22,000,000 reduction.

Speaker 1

So when you have a slowdown in migration that allows you to really work on work at some credits out and we expect that momentum to continue in the next quarter.

Speaker 6

Got you. Okay. Thanks, Jim. And then Brad not to disappoint you on at least getting questions on capital.

Speaker 1

Thank

Speaker 6

you. You had one. The second one on the buyback, and I know you talked about if you go that route or it's a possibility the pricing kind of where it was making sense. But given the rally in the market here, at least some of the banks, can you I guess, has your if you go that route, has your outlook changed then how you would think about the profitability of that? At what pricing it would look more attractive?

Speaker 2

No, I started flirting with the buyback talk about a year ago. And I think our stock is up 25%, 30% or something like over that. I don't know what it is. It's probably about like that. I think it's up 20% a month.

Speaker 2

Tangible book value is up 26%. On a relative basis, it's the same. Certainly, it would have been I could have acted all smug that we bought back a big slug of stock at $12.50 or something, but ultimately, it's a relative game and nothing has really changed.

Speaker 6

Got you. Okay. That's all I had guys. Thank you.

Speaker 1

All right. Thanks, Brian.

Operator

We have reached the end of the question and answer session. And I will now turn the call back over to James Ecker for closing remarks.

Speaker 1

Okay. Thanks everyone for your interest in our company and we look forward to speaking with you again next quarter. Goodbye and have a great day.

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Key Takeaways

  • In Q2 2024, Old Second reported net income of $21.9 million ($0.48 per diluted share), a return on assets of 1.57%, and an efficiency ratio of 53.29%, with earnings reduced by $3.8 million of credit loss provisions (-$0.06 EPS).
  • The bank’s balance sheet remains strong, with tangible equity up 35 bps to 9.39% and Common Equity Tier 1 at 12.41%, as management focuses on building capital and optimizing the earning asset mix.
  • The tax-equivalent net interest margin held steady at 4.63% (up 5 bps q/q), driven by higher loan and security yields (loan yields +5 bps q/q, +21 bps y/y) offset by rising funding costs; margins are expected to be flat to slightly down for the remainder of 2024.
  • Loan balances grew modestly by $7.2 million q/q, led by commercial lease and construction loans, and the loan pipeline is at an 18-month high (3x year-ago levels), supporting expectations of low- to mid-single-digit loan growth in H2.
  • Credit quality continued to improve, as substandard and criticized loans fell over 40% from peak to $187.4 million, special mention loans are down 55% y/y, and net charge-offs totaled $5.8 million in the quarter, with the allowance stable at 1.1% of loans.
AI Generated. May Contain Errors.
Earnings Conference Call
Old Second Bancorp Q2 2024
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