Greetings, and welcome to the Old Second Bancorp First Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr.

Doug Cheatham, Executive Vice President and Chief Financial Officer for Old Second. Thank you. Sir, please go ahead..

Thank you. Good morning, everyone, and thank you for joining us. I will start with a reminder that our comments today may contain forward-looking statements, which are based on management’s existing expectations in the current economic environment.

These statements are not a guarantee of future performance and results may differ materially from those projected. I ask you to refer to our SEC filings for a full discussion of the company’s risk factors. And now, at this point, I’ll turn it over to our President and CEO, Jim Eccher..

Good morning and thank you for joining us today. I’ll start by giving you my view of the quarter, and then Doug will follow up with a more detailed report on the financial statements, and then we will take your questions. Our first quarter was positive in many areas as we look to improve our core profitability.

As we’ve discussed in our prior quarters, we continue to put a lot of focus on strengthening our balance sheet. And as we mentioned on our last call, we did execute on the redemption of one-third of the outstanding shares of the company’s Series B Preferred Stock on January 31.

The redemption was successfully completed and 31,553 shares remain outstanding. We will continue to evaluate the timing and feasibility of further redemptions over the next few quarters and we view this as a high priority initiative as we continue to work towards deleveraging the balance sheet.

As far as noninterest income, we have solid performance by our mortgage and wealth management business, which helped to offset lower service charges on deposits. Our mortgage banking group in particular had strong originations in the quarter and this business line remains strong.

Mortgage originations reached the highest level in the last two years and were up 57% from the fourth quarter. We also continue to build up on our strong core funded deposit base, noninterest bearing deposits were up over 7.8% from the prior quarter and up over 11.5% from a year ago.

Overall, core deposits, which exclude CDs, are up 5% from the prior quarter and we continue to focus on building our core deposit base, which now comprises 76% of our total deposits and is up 5% from a year ago. After five consecutive quarters of loan growth, loan totals declined slightly in the quarter.

The performing loan portfolio declined about $4 million and the nonperforming loan portfolio declined by a similar amount. The performing portfolio was down modestly in the quarter as most of the decline was attributable to pay downs on the consumer loan portfolio.

Overall, loan demand was relatively soft in our footprint in the first quarter along with the seasonal slowdown, but we do expect stronger demand in the coming quarters. We do expect some headwinds in overall growth as we continue to move nonperforming loans out of the bank or into our other real estate portfolio.

Reported first quarter net income available to common stockholders is $2.7 million or $0.09 per diluted share, compared to $630,000 or $0.04 per diluted share in the first quarter of 2014. Asset quality improved again in the first quarter, although not as significantly as the prior quarter.

Nonperforming loans declined, however, OREO assets increased $3.5 million as a large nonperforming loan finally reached resolution and moved into our OREO portfolio. Classified assets resumed their downward trend and we continue to position the portfolio for further credit remediation.

Net charge-offs were modest in the quarter and OREO cost were moderately lower than a year ago. Okay, at this time, I will turn it over to Doug to give you more insight on first quarter performance and he will open it up for questions..

Thanks, Jim. As we announced yesterday, first quarter 2015 net income available to common stockholders was $2.7 million or $0.09 per share, compared to $630,000 or $0.04 per share in the first quarter of 2014 and $1.9 million or $0.06 per share in the fourth quarter of 2014. Improvements were seen in a number of areas.

Net interest income was up $1 million from the first quarter of 2014, $14.6 million in the first quarter of 2015. Although, net interest income was down about $1.5 million from the fourth quarter 2014, the fourth quarter did include some recovered interest and it had two more days of interest accruals than the first quarter of 2015.

That alone accounts for more than $300,000. In percent terms, the net interest margin was 3.26% in the first quarter of 2015, compared to 3.13% in the first quarter of 2014. If you look back over our past five or six quarters, you can see that we have been at a higher level beginning second half of 2014.

This is attributable to moderate loan growth last year, the addition of CLOs in the investment portfolio and the continued decline in the cost of funds. Noninterest income of about $8 million was 26% higher than the first quarter of 2014.

Residential lending income was $932,000 higher than the first quarter of 2014 and $559,000 higher than the fourth quarter of 2014. Other income of $2.1 million was $1.062 million higher than the fourth quarter of 2014 and $787,000 higher than the first quarter of 2014.

A one-time nonrecurring fee of $917,000 explains the bulk of the increase in other income. Noninterest expenses in the first quarter of 2015 were at the lowest level in over seven years at $17.2 million.

In comparing expenses in the first quarter of 2015 with the first quarter of 2014, the main differences were an increase in net other real estate expenses offset by a decline in amortization expense. Compared to the fourth quarter of 2014, the decline in expenses was primarily in other real estates.

In addition to generally declining staffing over the course of the past year, last week we reduced staff by 21 full-time equivalents. Severance cost will be recognized in the second quarter and the full effect of the reduction will begin in the third quarter. We continue to look for ways to improve our efficiency ratio.

As defined in the release at 68.77% the ratio was more than 10 points lower than a year earlier and more than 5 points lower than the fourth quarter of 2014. And finally as most of you know this was the first quarter of reporting capital ratios under Basel III, which became effective January 1, 2015.

The new regulatory ratio, common equity tier 1 was 9.12% as of March 31, 2015. Even with the redemption of preferred shares in the transition to Basel III the tier 1 leverage ratio was unchanged from the fourth quarter to the first quarter at 9.93%. And now with that I will open it up for questions. Operator we can open it up for questions..

[Operator Instructions] our first question comes from the line of Chris McGratty with KBW. Please proceed with your question..

Hi good morning everybody..

Good morning..

Hi, Chris..

Jim on your prepared remarks and TARP can you remind us, it sounds like it is a priority it going to be kind of addressing in the coming quarters, can you remind us the cash you guys currently have at the hold co.

and what annual needs you may have to kind of frame the timing and the method of which you may take [indiscernible]?.

I will let Doug comment on the cash, as you know Chris we’ve talked in prior quarters about our desire to get that TARP repaid, but we do have to continue to work with our regulators on that and work through the capital ratios.

When we did the common equity raise about a year ago at this point, we did keep some money up into the holding company, we’ve got – I can get you the exact number or Doug can but we’ve got plenty of cash and we also have the ability to continue to dividend money up from the bank up to the hold co..

Okay, [indiscernible] the cash on hand handy, let me now move on to credit, you made a hire from a local competitor I believe last week whom we all know, when he was at the prior institution I think he was fairly active with their kind of accelerated remediation efforts.

Wondering if there is anything to read into there I mean your non-performing assets are still on a relative basis about 5% a little bit high, is there any contemplation of kind of expediting the – now that your capital is a little bit stronger expediting the kind of the divorce from the credit cycle?.

Yes, I guess as far as the hire of our new Chief Credit Officer we had an opening in our credit group, we feel Mr. Kozak is a great addition to our team.

We also feel and agree with you that we would like to continue to work these classifieds down and I think we continue to position, particularly OREO portfolio and also a few of our non-accruals to get them more velocity out of those and out of the bank here in the next few quarters..

So, it sound like it will be kind of methodical as opposed to kind of a one aggressive step, is that really interpretation..

I would agree with that yes..

Okay. Thank you very much. Thanks.

Thanks Chris..

Thank you. Our next question comes from the line of Andrew Liesch with Sandler ONeill. Please proceed with your question..

Hey guys I just want to look at the margin, Doug can you just give us your thoughts and the way you think it may try to turn like there is some interest recoveries in the prior quarter and with those away where do you think you can go from here?.

Well I think if you look just kind of taking a step back, if you look over the last few quarters we have – we were at 3.26 in the third quarter, 3.35 in the fourth quarter and back to 3.26 in the first quarter.

I think it is always going to move around a little bit quarter-to-quarter, but I think we are in the – in sort of the new range with the first quarter results compared to where first two quarters of last year was 3.13 and 3.04 and then it really kind of stepped up with some of the progress that we’ve made, so I think this is a good level right now..

Okay and then just looking at FDIC insurance, it looked like that it was down pretty substantially from the fourth quarter was that a true down or are you going to be occurring that at a different rate now?.

It is a little bit – the reduction was a little bit over stated if that makes sense it is – we did have an accrual adjustment where we had – and I apologize I don’t remember the exact amount, but we had over accrued by a little bit that we had a reverse in the first quarter, but so we may be slightly higher than this..

Got you, alright thank you..

Thank you..

Thank you..

Thank you. [Operator Instructions] our next question comes from the line of Evan Pilsner with Trishield Capital Management. Please proceed with your question..

Good morning guys how are you?.

Good how are you?.

How are you?.

Fantastic. Thank you.

So, just a few questions from me the first being, so residential mortgage banking revenue obviously very strong, so congratulations on that, have you seen that continue through in the second quarter?.

It continued. We generally don’t give a lot of guidance, however I can tell it has been pretty steady, obviously low rates have been a good contributor there, but we’ve just seen a general uptick in overall activity in our markets and we’ve obviously been very pleased with the level of origination. So we are optimistic in the near term..

Excellent.

And then going back to the $917,000 incentive payment from the service provider, could you provide some more color on that?.

Well, we actually have a contractual obligation not to go into any detail on that. So we’ve pretty much put out there what we can and we’ve got the amount out there and it is a non-recurring item..

Got it. Okay. And then the last thing was, when I look at the time deposit trends, so year-over-year it looks like the interest rates have come down about 36 basis points.

How much lower do you think that can go over the next call it 12 months?.

Well, yeah, I think it can – I don’t want to put a number on that, but I mean I think there is room for it to continue to drift lower. We still see some older CDs running off and that’s been helpful to lower our cost of funds. We have stem the tide little bit on that to try to manage the levels that we are at.

So we are offering some competitive CDs but it’s still more a retention tool than – it’s not a objective of ours to grow the CD portfolio at this point..

Got it. And then the last thing was, in terms of The Federal Home Loan Bank of Chicago, so on December 31 you had $45 million outstanding. At the end of first quarter, you had $30 million outstanding but then you took a term advance on the 31, would you just mind walking through the rationale behind that..

Well, sure. That’s just partly managing short term funding and really it’s quite inexpensive short term funding. We pay depending on it. If it’s overnight or a short-term term advance, those things cost 12 basis points, 13 basis points and we are getting 25 basis points from the Fed. So even on overnight funds, there is a small positive spread.

So as long as we are in that kind of a range, we have plenty of liquidity to manage that. We don’t consider that to be a necessarily a permanent situation but it’s something that for the time being a little bit more on the borrow side than the excess funding side is a net benefit..

Perfect. Thank you guys very much. Congrats on the quarter and we really appreciate the focus on expense reduction, it’s very impressive..

Thank you..

Thanks, Evan..

Thank you. Our next question comes from the line of Brian Martin with FIG Partners. Please proceed with your question..

Hi guys..

Hi, Brad..

Brad..

Hey guys, I joined a little bit late so may be this was already covered since it sounds like your last question talked about the expense reduction. But maybe just any thoughts on the staff reductions that you made here in April or just the – any thoughts on the branch structure I think you just talked a little bit about that last quarter.

So I apologize if you’ve already covered it..

Yeah, Brian. This is Jim. We obviously are really working hard towards becoming a lot more efficient in the number of areas and it is unfortunate that we had a little bit of a reduction but we really started to see and realize some efficiencies through technology and have been able to really do a lot more with less, so a lot of backroom reductions.

As far as branch rationalization, we are looking at that all the time. We are down six or seven branches from the peak. We continue to look at that both – and we are also conscious of the fact that we’ve done a great job at building core deposits.

And for last two or three years, we’ve opened up record amounts of check-in accounts and we want to keep that momentum. We feel that that will serve us well long term and continuing to build a low cost funding basis is critical. But again, we continue to look at branch rationalization and then at this point we don’t have anything to report..

Okay. Alright. Thanks..

Thanks, Brian..

Thank you. At this time, there are no further questions. I would like to turn the floor back to Mr. Eccher for any final remarks..

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

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation..