Welcome to the Old Second Bancorp First Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Jim Eccher, President and CEO. Thank you. You may begin.

Thank you and good morning, everyone and thank you for joining us today for our first quarter earnings call. I'm joined on the call by Gary Collins, Vice Chairman; Mike Kozak, Chief Credit Officer; and Stan Fairie, Senior Vice President Treasurer. 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 would ask you to refer to our SEC filing for a full discussion of the company's risk factors. Please refer to our website under the Investor Relations tab for access to our earnings release. I have several prepared opening remarks and will give you my overview of the quarter and then turn it over to Stan for more detail on the securities portfolio for the quarter followed by Mike for more detailed report on asset quality and the loan portfolio. As we announced in an 8-K filing Tuesday, I am pleased to announce we have hired Brad Adams as our new CFO. Prior to joining our executive team, Brad was an Executive Vice President and Director of Corporate Development and Strategy at TCF. And prior to that, an Executive Managing Director of Corporate Development and Strategy for Talmer Bankcorp. Brad is in the process of transitioning to our company and not able to join us on the call today, but will be involved in all shareholder related calls in future quarters. Before I review first quarter highlights, just a couple of brief comments. We believe that over the past few quarters, we have been successful in executing our strategy to improve and grow our earning asset mix which is led to a more diversified balance…

Thanks, Jim. There were significant shifts in the composition of the securities portfolio between year-end 2016 and March 31, 2017. Securities issued by state and political subdivisions, generally referred to as munies, increased 220% from $69 million to $220 million while collateralized mortgage obligations declined 37% from $171 million to $108 million. These actions were prompted by several factors. First, after the election of President Trump in November 2016, long term rates rose and muni spreads widened significantly. This was due to President Trump's pro-growth agenda that included potentially significant tax cuts which would negatively impact the tax equivalent yields of munies. Second, the increasing profitability of the company and corresponding decline in the deferred tax assets. The company is in better position to take advantage of the munie's exemption from federal taxes. Third, there was a favorable risk reward trade-off between munies and the Ginnie-Mae CMOs backed by multi-family properties that were sold during the quarter. Generally, the munies provided better nominal yields while having little negative impact on the company's interest rate risk profile. On a tax equivalent basis, the increase in portfolio yield was significant. The vast majority of the muni growth was in general market munies referring to larger, nonlocal issues. A careful selection process was employed when purchasing such securities, the goal being to build a portfolio with attractive spreads and yields, minimum credit risk and maximum liquidity. Purchase criteria included the following elements, first, stringent credit requirements were applied that hindered [indiscernible] Any issues below a AA rating by Moody's or Standard & Poor's and in some cases even excluded securities that carried a AA rating. Such instances, for example, included securities that have been placed on negative watch, had concerning negative trends, lacked bondholder protections or had general economic concerns involving the region…

Okay. Thanks Stan. Net loans increased by $10 million or 0.7% from the fourth quarter 2016 as our loan volume has historically been very slow in the first quarter of each year. Our pipelines however, do continue to build. Our portfolio composition as of March 31, end of the first quarter, was as follows, C&I together with owner-occupied real estate at 41% of the portfolio; investor real estate 27%; construction and development loans 6%; multifamily 6%; agriculture 1%; consumer 7% and residential mortgages 12%. Our credit metrics continued to improve in the quarter with NPAs reducing to 1.73% compared to 1.87% at year end and 2.75% at 3/31/16. In terms of the components of our problem areas. Nonaccrual loans were reduced by $3.6 million from the prior quarter to $11.7 million with approximately $3.4 million of the reduction due to the transfer of 7 loans from nonaccrual to OREO. There were 10 loans totaling 1. -- that were repaid, remediated or charged-off during the quarter. Five loans totaling $1 million were added in the quarter. As for problem loans, they were reduced by $1.2 million from the prior quarter to $9.3 million. There were 4 loans totaling $1 million that were removed from problem status due to upgrade or payoff. There was one loan totaling $100,000 that moved to problem status. And there was $300,000 decrease in the balance on various problem loans. OREO did increase by $1.6 million to $13.5 million from the prior quarter, largely due to the above-referenced transfer of the 7 loans from nonaccrual to OREO. There were 7 properties totaling $1.5 million that were sold in the quarter, while again there were 8 properties, totaling $3.4 million that moved into OREO. Valuation write-downs for the quarter totaled $318,000, with one property accounting for the substantial portion of the write down. Approximately 55% of the OREO is land carry. However, there are only 2 properties with a bases over $1 million, with one valued at $2 million and the other at $1.6 million. This latter property consists actually of 2 separate buildings, the largest of which is now under contract. And I'll now turn it over to Jim for concluding comments.

Okay. Thanks, Mike. I will provide some final comments on operating performance and then open it up to questions. Net interest income was $17.7 million in the quarter, $2.5 million increase or 16.3% year-over-year. And $192,000 or 1.1% increase over the fourth quarter. In percentage terms, the NIM was 3.58% compared to 3.54% in the fourth quarter of '16 and 3.25% in the first quarter of '16. And as we outlined in the earnings release, the repositioning in the investment portfolio and the acquisition of the Chicago branch helped fuel the increase with $221 million in loans recorded in the fourth quarter of 2016 driving increased loan interest income and purchase accounting accretion of $355,000 in the first quarter of 2017. Noninterest income was $7 million in the quarter compared to $8.4 million in the fourth quarter of '16 and $6.3 million in the first quarter of '16. Each of the quarters presented was subject to variability of the mortgage servicing rate's valuation. In the first quarter of '17, MSR valuation losses were nominal, $133,000 as compared to MSR valuation gains of $1 million in the fourth quarter of '16 and losses of $1 million in the first quarter of '16. In addition, other income for the first quarter of last year reflected an increase due to recovery from an SBA loan of $292,000 on an OREO properties disposed of in a prior year. Other components of noninterest income were relatively static for the first quarter as compared to prior quarters. Noninterest expense was $18.1 million in the first quarter compared to $17.2 million in the fourth quarter of last year. And $16.3 million in the first quarter of '16. As explained in the earnings release, the increase was primarily related to various one-time expenses related to salaries and employee…

[Operator Instructions]. Our first question is from Andrew Liesch from Sandler O'Neill.

Just a few questions here on the margin. Just curious what loan yields you're getting on new production relative to where the existing portfolio yield is?

Well on the floating rate side, we're generally looking to price anywhere between $250,000 to $350,000 over LIBOR as kind of a benchmark. On the fixed rate side we're probably in the upper-4s to low-5s.

Okay. I would imagine then that it'd be slightly accretive to the margin. Have you guys have seen some lift in the market and the yields that you're able to get with the rate hikes?

Yes. We have seen a little bit. We're still working through some floors Andrew. But we're definitely seeing a little bit of benefit moving forward.

And have you seen much on in the way of deposit pricing competition yet?

We have not. We did have a very good quarter with inflows. However, we're seeing a little bit of pressure from some competitors, but a lot of our growth in the quarter was derived from commercial demand and then seasonal tax deposits that rolled in.

[Operator Instructions]. Our next question is from Chris McGratty from KBW.

Jim, you guys have done a lot to the balance sheet over the past couple of quarters. And obviously that the top line growth's been pretty impressive year-over-year. I guess where are we in terms of -- the repositioning of the investment portfolio? Are we done after this quarter? Or is there any other tweaks to the investments that you may have been making in April?

Yes. There's still some more repositioning to be done, Chris. We have a significant portion of the portfolio in CLOs that are being actively called away right now. I'm going to let Stan maybe give you a little more color on that.

Right, Chris. That's probably the biggest effect we're seeing. We acquired most of our portfolio in 2014. And all of these issues are currently callable. And you should probably aware the spreads have just collapsed in the CLO sector, down 90 basis points in discount margin. So we're obviously looking to redeploy that cash. And it's a challenging environment. Spreads are tight across-the-board, but we're assessing alternatives that we will see some additional repositioning during second quarter.

I mean, Chris. Ideally, we've got about 25%, 26% of our assets in securities. We'd like to obviously work that lower with loan growth. I think we've done a pretty good job getting it to where it is today. We'd like to see that drift around 20%, if we can and do it through organic growth. But we will likely see some additional repositioning in the second quarter.

Okay. So the message is lower proportional investments to improve the mix. I guess for the next couple of quarters, Jim, does the -- do the balances shrink, given the repositioning? Or do you just grow loans at a faster rate to dilute the percentage?

We'd like to see loan growth accelerate in the second quarter and third quarter and historically that's been the case. We did foresee it. Traditionally, slow first quarter in loan growth. And a lot of that was because we had accelerated fundings in the fourth quarter. So we did deliberately take on a little bit of a leverage strategy in the first quarter using our FHLB advances to take advantage of some opportunities in the muni side. So yes, ideally we're going to change the mix. And we'll work it down through loan growth.

Okay. And Stan, I missed it. What's the pro forma duration of the book at March 31?

March 31, nominal was 3.68%. And by nominal, you have to take into consideration that's just standard duration for the munies, but they don't respond one-for-one with market rate. So effective duration would be lower than that.

That's on the whole portfolio, right? 3.7%?

That is correct.

Maybe a question, if I could, on expenses. How should we be thinking -- obviously you called out the $500,000, $600,000 of one-timers in the quarter. Is this 17.5% a decent starting point, understanding first quarter was probably a little bit elevated for seasonal factors.

Yes. It was almost close to over $800,000 in one-timers in salaries and benefits, insurance costs. So we don't foresee that going forward. So I think your number's probably a pretty good run rate.

Okay. And based on the pipeline of the credit and your growth outlook, I guess what's the expectation to take either the reserve lower or the provision, perhaps, in depositor territory, as you kind of grow the balance sheet?

Yes. I think we're still looking at mid-to high single-digit loan growth for '17 -- so we still feel we're at an inflection point with provisioning. So any material future growth is going to lead to more moderate provisioning I think in the next couple quarters.

Our next question is from Brian Martin with FIG Partners.

Jim, just you kind of alluded to the comment on your outlook for loan growth. But like you said, a little slower start to the year, but some seasonality in there. I guess the optimism you got on kind of getting to whatever mid-to high single-digit growth for the year. And I guess are you seeing good trends currently in the pipeline? Or I guess just kind of what are you basing your outlook on right now? Is there anything that is pointing to upper single-digit is a good target or realistic at this point.

I'll let Mike comment on that.

Yes, Brian, I'd point to a couple things. One you alluded to the pipeline is continuing to build. You're never happy that it's high enough, but it is building in a good manner. We also do a series of what we call screening loan screening meetings on a weekly basis. And the activity at those screening meetings has really picked up in the last month. So we have seen some -- we're seeing some looks on a very preliminary basis at some strong transactions that should result over the next month to several months in the actual closings. So on that basis, we feel pretty good about our estimates.

Okay. And then maybe just jump into the margin for a second. The commentary about the CLOs. And obviously we saw the yields on the portfolio go up sharply this quarter. I guess if you have that runoff and not very attractive option, I guess should we think about the yields -- the overall yield on securities going lower in the second quarter given that repositioning is still to be done? Or is just a more big picture maybe for, Stan, on kind of how that plays out later in the quarter?

It's going to be a challenge because the CLOs are one of the best performing assets we had in the portfolio. But we're looking at reinvestment and a mix of possibilities that still include some of munies which is I still think are very attractive sector. So we're --it's kind of my job to see if I can't maintain that portfolio yield as best as I can.

Okay. And how big is the CLOs on the dollar basis relative to the size of the portfolio?

The CLOs represented at the end of the year -- actually let me give you the quarter. It's about 12%. So it's not going to be a monstrous hit, but they were throwing off very attractive income levels, especially on a floating rate basis.

Okay. And then maybe just secondly on the margin. Jim, you talked about maybe burning through some -- still working through some floors. I guess what -- and not seeing a whole lot of pressure yet on the funding side. The rate increase your saw in December. And I guess if you look at the rate, what -- the increase in margin? How much of an impact, I guess, do we expect on -- or I guess how are you thinking about that impact on the margin at least in maybe the second quarter? And how to think about future rate increases given the asset sensitivity?

Yes. I guess couple of things. We put on quite a bit of these munies midway through the quarter or later in the quarter. So we didn't really have the full effect of that in the first quarter. So we think that will be a little bit of a tailwind. We've been pretty disciplined with our loan pricing. So I don't see the margin really eroding. Our cost of deposits actually was down in the quarter. The mix change was positive. Time deposits declined and demand went up. So we think the margin at $350,000 to $355,000 range is a good number.

Okay. All right. And maybe just as it relates to the -- you talked about the expenses. But just anything on the -- I know you guys seemed a little bit more optimistic last quarter. I guess with the remarks on fee income. I guess do you expect that? I guess are you seeing anything different there, anything encouraging on the fee income side. How do we think about the run rate there absent the seasonality of this quarter?

A lot of it, Brian, is tied to what's going to happen with MSRs on the residential side. But we're definitely seeing a little bit of a tail off in the residential mortgage business. That's down roughly 25%. Although, we're seeing pipelines build there. So we're expecting better results in the second quarter. And then the other largest fee income driver's on the wealth side and that's performing above last year's levels and we expect with market performance that's going to continue to be a positive driver. Service charges and fee income, we expect that to be relatively flat.

Okay. And then just funding the loan growth. Jim, I guess it sounds like that's -- maybe deposit growth is pretty minimal. And it's just being funded by the securities portfolio. Would that kind of be the plan going forward?

Yes. We did -- as I mentioned, the deposits were up pretty strong in the quarter, up almost 4% from year-end. A lot of it was driven by the commercial bank. So we think we've got pretty good momentum there. But we certainly have ample liquidity in the securities portfolio to fund loan growth going forward as well. Ideally, we'd like to just change the mix.

[Operator Instructions]. Okay ladies and gentlemen, we have reached the end of the question-and-answer session. I would now like to turn the call back over to our speakers for closing remarks.

Okay. Thank you, everyone for joining us this morning and for your interest in the company and we look forward to speaking with you again next quarter. Goodbye.

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