Old Second Bancorp, Inc. — Q3 2021 Form 10-Q
Business context and reporting period
Old Second Bancorp is an Illinois bank holding company operating Old Second National Bank, with 29 banking centers and commercial, retail, treasury management, fiduciary and wealth management services. This unaudited filing covers the quarter and nine months ended September 30, 2021; comparisons are with the corresponding 2020 periods unless otherwise noted. Dollar figures below are in millions unless stated otherwise.
Financial performance and condition
- Q3 earnings: Net income was $8.4 million ($0.29 diluted EPS), versus $10.3 million ($0.34) a year earlier. Pretax income was $11.3 million versus $13.6 million.
- Nine-month earnings: Net income was $29.1 million ($0.99 diluted EPS), versus $19.8 million ($0.65). The improvement primarily reflected an $8.0 million release of credit-loss provision in 2021 versus a $10.4 million provision in 2020.
- Interest income and margin: Q3 net interest and dividend income was $22.6 million, nearly flat year over year. GAAP net interest margin was 2.91%, down from 3.23% year over year; tax-equivalent margin was 2.95% versus 3.28%. Nine-month net interest income was $68.1 million versus $67.9 million, while GAAP margin declined to 3.02% from 3.44%.
- Other income and expenses: Q3 noninterest income was $9.3 million, down 20.1%, mainly because mortgage banking revenue fell. Noninterest expense rose 9.2% to $22.1 million, including $425,000 of merger-related costs. The Q3 GAAP efficiency ratio increased to 68.73% from 58.27%. For nine months, noninterest income was $28.6 million, down 0.5%, and expense was $65.3 million, up 8.5%.
- Balance sheet and liquidity: Total assets were $3.28 billion, up $234.3 million from year-end 2020. Cash and cash equivalents were $519.3 million, up $189.4 million; available-for-sale securities were $715.2 million, up $219.0 million. Deposits were $2.71 billion, up $177.3 million. Management attributed deposit and liquidity growth partly to pandemic-related stimulus funds and loan paydowns.
- Loans and credit: Loans totaled $1.87 billion, down $166.9 million from year-end, largely reflecting PPP forgiveness/payoffs and borrower paydowns. The allowance for loan losses was $26.9 million, or 1.4% of loans, versus $33.9 million, or 1.7%, at year-end. Nonperforming loans rose to $29.0 million from $23.0 million at year-end; nonperforming loans were 1.5% of loans versus 1.1%. Net charge-offs were $237,000 in Q3.
- Cash flow: For the first nine months, operating activities provided $50.8 million, investing activities used $57.0 million and financing activities provided $195.6 million. Cash and cash equivalents increased $189.4 million to $519.3 million.
- Debt and capital: Total borrowings were $192.5 million, compared with $160.5 million at year-end, including $59.2 million of subordinated debentures issued in April. Stockholders’ equity was $321.2 million. The Bank’s total risk-based capital ratio was 16.69%, and its Tier 1 leverage ratio was 10.83%; both exceeded the stated internal targets and regulatory thresholds.
Material changes versus comparable periods
- Q3 net income declined despite a $1.5 million credit-loss provision release, as lower mortgage banking revenue and higher operating costs more than offset modestly higher net interest income.
- For the first nine months, earnings increased substantially, chiefly because credit-loss estimates improved and the provision shifted from expense to an $8.0 million release. Results also benefited from lower deposit funding costs; lower market rates and reduced loan balances pressured asset yields and margins.
- Loans contracted while deposits, cash and securities grew. The securities portfolio increased materially as the company invested excess liquidity.
- Asset quality was mixed: classified assets declined to $36.8 million from $44.5 million at year-end, but nonperforming loans increased. The allowance coverage of nonaccrual loans fell to 97.9% from 152.0% at year-end.
Outlook, commentary and risks
- Management said it was positioned for moderate loan growth in late 2021 and 2022, while noting competitive pressure on loan pricing and uncertainty about the pandemic’s effects. No quantified earnings or margin guidance was provided.
- The proposed West Suburban Bancorp merger was expected to close in December 2021, subject to shareholder approvals and customary conditions. Regulatory approvals had been received by the filing date. Old Second shareholders were expected to own approximately 64% of the combined company and West Suburban shareholders approximately 36%, based on stated share counts and exchange terms.
- COVID-19, variants, economic conditions, real estate values and borrower repayment capacity remain risks. Twelve loans totaling $8.8 million remained in active pandemic-related deferral at quarter-end; $4.6 million of those were nonaccrual. The company had recorded 260 PPP loans totaling $34.7 million still outstanding.
- Interest-rate exposure is material: management’s model projected pretax income increases of 6.4%, 12.9% and 26.5% under immediate rate increases of 0.5%, 1.0% and 2.0%, respectively. Down-rate scenarios were not meaningful because rates could fall below zero. The filing cautions that simulations are not forecasts of actual results.
- The $44.5 million senior notes were scheduled to move from a fixed rate to a floating rate beginning December 2021, at three-month LIBOR plus 385 basis points. The subordinated notes issued in 2021 carry a 3.50% fixed rate through April 2026, then reset to a SOFR-based rate.
- Management reported no material expected adverse effect from routine legal proceedings. It said the allowance reflected its current expected losses but warned actual losses could exceed estimates if economic or collateral conditions deteriorate. The company also disclosed risks related to merger execution and integration, funding, interest rates, regulation, cybersecurity and the LIBOR transition.
Important facts for investors to verify
- Whether the West Suburban merger closed on schedule, its final terms, integration costs and realized benefits.
- Whether rising nonperforming loans and lower allowance coverage lead to further provision expense, charge-offs or additional reserve needs.
- Whether loan growth, deposit mix and reinvestment of excess cash support margins as rates and funding conditions change.
- The use of subordinated-note proceeds, the senior-note rate reset and resulting interest expense and capital effects.
- Whether pandemic-related deferrals, PPP forgiveness and economic conditions materially alter borrower performance or liquidity.