Old Second Bancorp, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance-sheet comparisons are to December 31, 2022. The company is an Illinois-based bank holding company operating Old Second National Bank. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and position
- Earnings: Net income was $23.6 million, or $0.52 per diluted share, versus $12.0 million, or $0.27, in Q1 2022. Pretax income was $32.0 million; the effective tax rate was 26.3%.
- Interest income and margin: Interest and dividend income was $70.2 million and interest expense was $6.1 million, producing net interest income of $64.1 million, up from $41.2 million. Net interest margin was 4.72% GAAP (4.74% tax-equivalent).
- Other income and expenses: Noninterest income was $7.4 million, down from $13.5 million. Noninterest expense was $35.9 million, down from $38.3 million. Provision for credit losses was $3.5 million, versus none in Q1 2022.
- Cash flow: Operating activities provided $35.0 million; investing activities used $42.9 million; financing activities used $4.2 million. Cash and cash equivalents ended the quarter at $103.0 million, down from $115.2 million at year-end.
- Balance sheet: Total assets were $5.92 billion and stockholders’ equity was $496.9 million. Loans totaled $4.00 billion, up $133.7 million from year-end. Available-for-sale securities were $1.46 billion, down $84.3 million.
- Funding and debt: Deposits were $4.90 billion, down $213.5 million from year-end. Total borrowings were $472.6 million, including $315.0 million of short-term FHLB advances, compared with $90.0 million of such advances at year-end. The $9.0 million term note was repaid during the quarter.
- Capital: The Bank’s Tier 1 leverage ratio was 9.83% and total capital ratio 13.10%; both exceeded the company’s stated internal thresholds. The consolidated company’s common equity Tier 1 ratio was 9.91%.
Material changes versus comparable periods
- Net income nearly doubled year over year, principally as loan growth and higher loan and securities yields lifted net interest income. Higher funding costs, increased credit-loss provision, lower mortgage-related income, and realized securities losses partly offset the improvement.
- Total loans increased $601.0 million year over year, led by commercial real estate-investor, commercial, lease, and multifamily lending. Management expects loan growth to continue, likely at a slower pace.
- Noninterest income fell $6.1 million year over year. Mortgage banking revenue declined $4.8 million, while the company recorded $1.7 million of net securities losses from strategic sales.
- Noninterest expense declined $2.3 million year over year, largely because Q1 2022 included West Suburban acquisition-related costs. Q1 2023 included $306,000 of net gains on branch sales.
- Nonperforming loans rose to $64.5 million from $32.9 million at year-end; nonperforming loans were 1.6% of total loans versus 0.9%. Classified assets increased to $126.5 million from $110.5 million. Management attributed the increase mainly to several larger credits, including office buildings and a healthcare/assisted-living facility.
Outlook, commentary, and risks
- No specific full-year earnings or margin guidance is provided. Management described the bank as having strong liquidity metrics and an outsized securities portfolio, and said it actively manages daily liquidity and interest-rate exposure.
- Management’s interest-rate simulation estimated annual pretax income would increase 4.0% for an immediate 0.5% rate rise and 8.1% for a 1.0% rise; a 2.0% decline would reduce it 16.3%. The filing cautions that modeled results are not forecasts and exclude potential management actions.
- Deposits declined amid seasonal municipal outflows and customers moving balances to pursue higher yields. The company funded needs through FHLB advances and securities sales. Management noted recent bank failures could raise FDIC assessment costs and contribute to deposit outflows, liquidity competition, reputational risk, and credit risk.
- Other key exposures include rising funding costs, interest-rate-driven securities valuation changes, inflation and recession risks, real-estate collateral values, borrower performance, and increased credit losses. Real-estate-related loans represented 70.9% of the portfolio.
- Available-for-sale securities had $106.9 million of gross unrealized losses at quarter-end; management attributed these to market-rate changes and recorded no securities credit-loss provision. Strategic sales produced the quarter’s $1.7 million realized loss.
- The board declared a $0.05-per-share dividend after quarter-end, payable May 8, 2023. Management reported no material change in critical accounting policies and concluded disclosure controls were effective. Ordinary-course legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether deposit trends stabilize and how much reliance on short-term FHLB advances and securities sales continues.
- Whether the rise in nonaccrual loans and classified assets persists, particularly in commercial real estate and larger office and healthcare-related credits.
- How deposit pricing and funding costs affect net interest margin as rates and competition change.
- Whether securities sales, unrealized losses, or liquidity needs materially affect earnings, accumulated other comprehensive income, or capital.
- The actual amount and timing of any special FDIC assessment and its effect on expenses.
- Whether management’s expectation of continued, slower loan growth and its interest-rate sensitivity assumptions prove consistent with subsequent results.