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Old Second Bancorp Inc (OSBC -1.52%)
Q4Â 2019 Earnings Call
Jan 23, 2020, 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 for today's Old Second Bancorp, Inc.'s Fourth Quarter 2019 Earnings Call. On the call today is Jim Eccher, CEO; Gary Collins, Vice Chairman; and the Company's CFO, Brad Adams. I will 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 you prefer -- I'm sorry, refer to the Company's 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 oldsecond.com under the Investor Relations tab.
Now, I will turn the call over to Jim Eccher. Please go ahead sir.
James L. Eccher -- President and Chief Executive Officer
Thank you. Good morning and thank you for joining us today. I have several prepared opening remarks and will give you my overview of the quarter and then turn it over to Brad for more additional details. I will then conclude with some summary thoughts and open it up to -- open up for questions after that.
Net income for the quarter was $9.5 million or $0.31 per diluted share in the fourth quarter. Our earnings this quarter were negatively impacted by compression in the net interest margin, that totaled 28 basis points from third quarter levels. The core net interest margin contracted a somewhat more modest 15 basis points, excluding the impacts of purchase accounting income and acquired loans recorded in the third quarter.
This is a bit more than we were expecting, although still within the range we provided of 3 basis points to 5 basis points for each Federal Reserve reduction in the overnight rate. Brad will provide some additional color on the margin in his prepared comments. Earning trends were positively impacted by a BOLI death benefit of $872,000 during the quarter.
Absent these items, earnings trends were relatively stable and consistent with last quarter, but we did see mortgage banking results soften from a seasonal slowdown in the quarter. Returns on assets and equity continue to be very strong, driven by a still healthy net interest margin, solid expense control, sustained performance across our fee-based businesses and a stable credit outlook. High level of profitability has afforded us the ability to invest significantly in the future growth of the bank.
In regards to the quarter specifically, total loans increased by $31 million from last quarter with a strong level of originations mitigated by continuing payoff activity.
Loan payoff activity accelerated every quarter in 2019, and we're hopeful the pace of pay-offs will moderate in 2020. We continue to be surprised by the level of payoff activity, however, loan pipelines remain healthy. The competition for credit in our market still remains very aggressive, both in terms of pricing and structure and with the tailwinds provided by an expanding margin having lessened, we expect to increase efforts to grow the loan book and capitalize upon recent additions to our staff.
We're optimistic we can achieve 5% to 7% loan growth in 2020 exclusive of any merger activity. Lastly, as it pertains to the loan book, yields on the portfolio declined substantially from last quarter due to the benefit of accelerated accretion from the early payoff from an acquired loan in the prior quarter.
Total deposits bounced back nicely on both a period end and average basis and growth here remains a key focus for us. Our net total transaction account activity has largely been stable with declines [Phonetic] primarily focused in higher cost relationships acquired in 2018. The loan to deposit ratio for the fourth quarter of 2019 remains unchanged at 91%. We believe we can remain at these levels in the near-term with loan growth funded by a mix of deposit growth and modest balance sheet optimization. We remain very comfortable with asset quality trends overall. Nonperforming assets and classifieds loans increased modestly relative to last quarter, but remain well controlled.
Overall, we remain very encouraged about our results in a number of areas and Brad will provide additional color in his prepared comments.
Bradley S. Adams -- Chief Financial Officer
Thank you, Jim. Net interest income declined by $1.6 million relative to last quarter, about half of that decreased due to negative variances, accelerated accretion on acquired loans. Fee income suffered a bit as mortgage banking and income returned to a more normalized level. The reported taxable equivalent margin decreased by 28 basis points as Jim said in last quarter, with about half of that contraction due to 15% pay downs in the acquired ABC portfolio during the prior quarter.
A few additional basis points were lost on the margin due to the sale of the securities during the third quarter, though the trade in aggregate was a very good one with the subsequent movement in interest rates. Pricing movement on the liability side of the balance sheet has been limited at this point, and we should begin to see reductions in funding costs in the fourth quarter -- in the first quarter of 2020.
Notably, margin trends in future periods will be impacted modestly by the adoption of CECL on January 1st, 2020 with a further reduction in accretable discount offset by movement into the allowance for credit losses. Equity levels will also be modestly impacted by the change. The overall level -- the overall increase in the level of credit loss reserves currently estimated at a $4 million to $6 million increase in the loss reserve will be largely derived by the reclassification of purchase accounting credit discount into the loss reserve. As these loans mature, we will begin to see these reserve levels migrate down to levels not inconsistent with historical trends for us given the relatively short duration nature of our loan portfolio.
Our efforts in the coming quarters will be focused on quality loan growth, in core funding with the expectation of further modest contraction in 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 -- optimize the earning asset mix and fund future loan growth going forward through a mixture deposit growth in earning asset optimization. Core margin trends in the future should be relatively stable with a modest negative bias absent any movement in the fed funds rate.
Notably, we saw significant decreases in the LIBOR rate during the third quarter or during the fourth quarter that were in excess of our expectations. We are incredibly sensitive to movements in LIBOR rate should it recover and start moving in the other direction, obviously this guidance will prove conservative should it continue to trend downward, we would not do as well.
Overall, loan growth will become a much more important factor for us with the outlook for short-term rates having changed, but I believe we have a significant opportunity in front of us. On the fee income side, mortgage banking reflected a decline in gain on sale margins during the quarter and more modest pipelines, although MSR valuations for the fourth quarter compared to the third quarter were more favorable.
Trust and wealth management remains steady and Retail Banking Trends slowed modestly in both fees and card activity during the quarter. Expenses remained very well controlled as you can see with additional sales hires largely offset by seasonal factors during the first quarter and continuing investments for future growth are largely baked into a run rate trends you've been seeing from us.
With that, I'll turn the call back over to Jim.
James L. Eccher -- President and Chief Executive Officer
Thanks, Brad. In closing, we remain encouraged with these trends and optimistic about the future. On an organic basis, operating leverage remains strong and we are excited about the quality of talent added to the organization in the last two quarters. Profitability remains excellent. We are pleased that the outlook for short-term rate movement is stabilized since we last spoke.
Capitals continue to build significantly for our Company and though we remain very comfortable with the returns we are generating, we will be evaluating opportunities to return capital to the shareholders and reduce high cost debt versus our outlook for opportunities to invest capital. 2019 overall was a very good year for us. 2020 will be more difficult if interest rates hold here or decline further. We are taking steps to position ourselves well for either continued strength in local economy or the possibility of a potential slowdown. We believe our credit underwriting has remained disciplined and our funding and capital position is strong. Overall, the team here has never been better, and I remain optimistic that opportunities are available to improve our footprint.
The focus for us is on timing and making sure that we have access to the capital we need in order to take advantage. Periods of significant changes in the volatility of bank valuations make M&A more difficult in the community bank space, but things can change quickly on that front, especially as we move through what may well be a more difficult year for some banks.
That concludes our prepared comments this morning, so I will turn it over to the moderator, and open it up to questions.
Questions and Answers:
Operator
Thank you, sir. [Operator Instructions]. We'll go first to Chris McGratty with KBW.
Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst
Hey, good morning, Jim. Hey, Brad.
James L. Eccher -- President and Chief Executive Officer
Good morning, Chris.
Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst
Could you maybe start on expenses, you guys have done a pretty good job keeping the expenses flat, in light of your comments on revenue growth being more of a challenge for the Group, how do we think about the trajectory of expenses, given what you're doing on the hiring front?
James L. Eccher -- President and Chief Executive Officer
You know, I think that given some momentum on the loan growth side, I don't think there's anything that aggressive needs to be done there. We have talked in the past, kind of a low-single -- a low single-digit number on the expense growth line. We're watching things carefully relative to loan growth. I'd say the prepayments are still very highly elevated. We saw a number of significant prepayments during the fourth quarter. If that trend continues, we may need to get more aggressive on expenses, but for now we're still comfortable with the [Phonetic] thinking for the year.
Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst
Okay, great. And then you talked about the balance sheet optimization. You guys have obviously done a lot of work on the balance sheet in the last couple of years, how do we think about if your loan growth, I think you said 5% to 7% to be assuming earning asset growth trails at in the security book like is flat to down or how do we think about that mix, Brad?
Bradley S. Adams -- Chief Financial Officer
I -- at this point, given some positive momentum on the deposit side, I think that we can hold relatively steady on the securities portfolio. That would be our lever if deposit growth isn't there to shrink that portfolio modestly. But again, our real exposure is to down short rates and adding additional funding that does reprice with the short end of the curve is not something that I would shy away from at this point, given where we are in that cycle, and what our overall positioning based on just the character of what we are, which is an extremely well core funded community bank.
Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst
Got it. Great. And maybe just last one for you, Jim. You touched upon in your -- in your closing remarks, the capital. How do we think about the ranking of the priorities of returning capital and redeeming the debt. You talked about it last quarter, but obviously the rate outlook has gotten a little harder. Thanks.
James L. Eccher -- President and Chief Executive Officer
Yeah. Obviously we're focused internally on organic loan growth first, but we certainly are taking a very hard look at TruPS redemption and reducing some of this high-cost debt. That is probably right at the top of the list.
Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst
Thanks.
Operator
We'll take our next question from David Long with Raymond James.
David Long -- Raymond James -- Analyst
Good morning, everyone.
James L. Eccher -- President and Chief Executive Officer
Hey, David, how are you?
David Long -- Raymond James -- Analyst
Good. The paydowns that you've been having. What are you baking into the pay-down levels for 2020 when you talk about a 5% to 7% loan growth outlook?
James L. Eccher -- President and Chief Executive Officer
Yeah, that's been -- David, that's been the challenge obviously. In 2019, we saw pretty significant acceleration and pay-downs, each and every quarter. Partially the reason for that partially is our -- the dynamics of our portfolio are changing, the durations relatively short, but we had unusually very high pay downs in the third and fourth quarter. So we do expect that to moderate, and it's hard to -- it's hard to peg that because we're seeing a lot of clients sell properties that we -- that we didn't even really know about.
So given the pace of loan originations, we're optimistic that's going to -- that's going to slow to more normalized levels in 2020.
David Long -- Raymond James -- Analyst
Got it, OK. And from an operating leverage perspective, can you guys put up positive operating leverage in 2020 even with the NIM challenges or does the NIM -- the headwinds from the NIM make that too difficult at this point?
James L. Eccher -- President and Chief Executive Officer
I think all we really need to see for positive operating leverage is for LIBOR to quit contracting relative to overnight rate. The LIBOR rate has shown great deal of compression during the fourth quarter and to a level that surprised me to be honest. If that seizes, if it stabilizes, then I believe we can show operating leverage.
David Long -- Raymond James -- Analyst
Got it. And then as it relates to CECL, I think Brad you made some comments about the purchase accounting. And did I hear right that you will move the credit marks out of the purchase loans into the reserve, meaning that you're considering the loans PCD at this point?
Bradley S. Adams -- Chief Financial Officer
Yes. So overall, the reserve level should go up like I said $4 million to $6 million, a significant portion of that rather than being an adjustment to equity will be an adjustment from the credit loss reserve on acquired loans. And the adjustment overall from an equity standpoint should be relatively small for us.
Again, those loan books that have a short duration, i.e., more commercial bench, are not going to see the type of impact that residential and consumer balance sheets are going to see.
David Long -- Raymond James -- Analyst
Got it. I appreciate the additional color there. Thanks guys.
Bradley S. Adams -- Chief Financial Officer
Yup.
Operator
And we'll go next to Evan Lisle with Janney.
Evan Lisle -- Janney Montgomery -- Analyst
Hey, good morning. I'm on the call for Brian Martin.
James L. Eccher -- President and Chief Executive Officer
Okay.
Evan Lisle -- Janney Montgomery -- Analyst
First, I appreciate the color on margin and I just -- or we're just kind of curious how you're thinking about the margin in '20 with a flat rate environment, and then possibly with forecasting one cut later in the year?
James L. Eccher -- President and Chief Executive Officer
Well, I don't think we're going to see one cut. If we see any cuts, we'll probably see a number of them. One cut doesn't make a whole lot of sense to me. I think that a stable rate environment applying the methodology that nothing changes anywhere on the curve, and you take the steepening that we saw, I would feel pretty good about that.
If you're talking about any rate cuts that doesn't excite me in the slightest. I think loan growth can overcome one rate cut and that's been a scenario you want to talk about. But, in general, nothing changes, I think that we would lose a couple of basis points with CECL and delayed impacts of the LIBOR moves that have occurred and I think we'll be relatively stable from that point.
Evan Lisle -- Janney Montgomery -- Analyst
Okay.
Bradley S. Adams -- Chief Financial Officer
The challenges in margin guidance is taking the rate moves that have happened, telling everybody they're static and then accounting for the lagged effects of those rate moves that have occurred. In general, over a full cycle irrespective of when quarter cut offs are, we lose 3% to 5% for a rate cut, it's not doesn't always fit well within to a quarter, but that is the overall impact.
Evan Lisle -- Janney Montgomery -- Analyst
Okay. Yeah, -- No, I appreciate that. And next, just talking about the people you hired in '19, can you just give a quick outlook about that and then potential hires in '20 and just your outlook for that in the future?
James L. Eccher -- President and Chief Executive Officer
You know, we made an -- we obviously made a number of adds in the latter half of 2019 all-seasoned, Chicago-based lenders about six of them, but we've also added to the retail bank and our treasury group, so we feel real good about the talent we've added. A large -- the large portion of our loan growth in the fourth quarter came very late in the quarter two.
So while our footings were up, we really didn't see much benefit of that in the margin. So we continue to be opportunistic on the new talent front. So if those opportunities come along, we will selectively continue to add.
Bradley S. Adams -- Chief Financial Officer
Awesome. And just touching on the loan pipeline, the Chicago hires, it looks like last quarter most of your originations are coming from the Chicago market. Is that still fair to say in this quarter?
James L. Eccher -- President and Chief Executive Officer
I would say, yes.
Evan Lisle -- Janney Montgomery -- Analyst
Okay, awesome. And then just a housekeeping thing. Just can you discuss how you're thinking about your provisioning in '20 under CECL?
Bradley S. Adams -- Chief Financial Officer
As we said previously, it -- wouldn't expect it to be materially different than historical trends. The provision level with the adjustment itself will be higher given the size of the acquired loan portfolio, but from our ongoing originations standpoint, I doubt we'll see much of a difference.
Evan Lisle -- Janney Montgomery -- Analyst
All right, perfect. Yeah. That's all I have. Thank you for that color.
James L. Eccher -- President and Chief Executive Officer
All right.
Operator
[Operator Instructions]. We'll go next to Nathan Race with Piper Sandler.
Nathan Race -- Piper Sandler & Co -- Analyst
Good morning. [Speech Overlap] How're you doing?
James L. Eccher -- President and Chief Executive Officer
Hey.
Nathan Race -- Piper Sandler & Co -- Analyst
I wanted to touch on the $2.5 million in loans past 90 days that appeared this quarter. Could you provide some color on that, maybe the industry focus and collateral back up and what you guys expect from that going forward. Thank you.
James L. Eccher -- President and Chief Executive Officer
Yeah, we had -- we had a couple of just administrative past dues at the quarter that weren't classified. We did see a moderate uptick in classifieds where we expect to -- we expect to have those remediated in the first quarter of this year.
Nathan Race -- Piper Sandler & Co -- Analyst
Okay. And then turning to kind of loan pricing, do you guys by chance have the weighted average rate on new production this quarter?
James L. Eccher -- President and Chief Executive Officer
Yeah. This quarter we were -- we obviously fell off a little bit with LIBOR dropping, but we were in the mid to high fours, on a weighted average yield.
Nathan Race -- Piper Sandler & Co -- Analyst
And how do -- OK, and that dropped. Is that -- how that compared to third quarter?
James L. Eccher -- President and Chief Executive Officer
We dropped about 30 to 40 basis points.
Nathan Race -- Piper Sandler & Co -- Analyst
Okay, thanks. And then maybe could you provide a little color on the loan pricing dynamics you're seeing in the market right now and maybe where the competition is coming from, is it the larger guys or is it the smaller community banks that are pushing the pricing?
James L. Eccher -- President and Chief Executive Officer
Well, obviously in Chicago, we're seeing competition from the larger banks, and then in our more rural areas, the smaller community banks provide pretty competitive pressures there. But the primary growth engine for us has been in Chicago, so we're competing with the larger banks there.
Nathan Race -- Piper Sandler & Co -- Analyst
Okay, thanks. I'll step back.
James L. Eccher -- President and Chief Executive Officer
Thank you.
Operator
Mr. Eccher, there appears to be no further questions at this time, I'd like to turn the call back over to you for any closing comments.
James L. Eccher -- President and Chief Executive Officer
Okay. Thank you everyone for joining us this morning and we look forward to speaking with you again next quarter. Goodbye.
Operator
[Operator Closing Remarks].
Duration: 23 minutes
Call participants:
James L. Eccher -- President and Chief Executive Officer
Bradley S. Adams -- Chief Financial Officer
Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst
David Long -- Raymond James -- Analyst
Evan Lisle -- Janney Montgomery -- Analyst
Nathan Race -- Piper Sandler & Co -- Analyst
