Old Second Bancorp, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Old Second is an Illinois community banking holding company serving the Chicago area through Old Second National Bank. Results include Greater Chicago Financial Corp. and ABC Bank from their April 20, 2018 acquisition.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $23.7 million | $19.3 million | $66.6 million | $55.5 million |
| Provision for loan losses | $0 | $0.3 million | $0.7 million | $1.1 million |
| Noninterest income | $7.8 million | $7.8 million | $24.9 million | $22.2 million |
| Noninterest expense | $18.7 million | $16.9 million | $58.4 million | $53.0 million |
| Net income | $9.6 million | $8.1 million | $25.4 million | $17.7 million |
| Diluted EPS | $0.32 | $0.27 | $0.84 | $0.59 |
| Tax-equivalent net interest margin | 4.00% | 3.77% | 3.92% | 3.68% |
Q3 pretax income was $12.8 million versus $9.9 million; the effective tax rate was 24.9% versus 18.5%. The nine-month effective tax rate was 21.6% versus 25.4%. The filing presents the margin on a tax-equivalent, non-GAAP basis.
Financial condition, liquidity and capital
- At September 30, 2018, total assets were $2.61 billion, loans were $1.835 billion, deposits were $2.132 billion, and stockholders’ equity was $218.1 million. Versus December 31, 2017, assets rose $229.0 million, loans $217.3 million and deposits $209.4 million, principally reflecting the ABC Bank acquisition.
- Cash and cash equivalents were $50.3 million, down from $55.8 million at year-end 2017. For the first nine months, operating cash flow was $40.0 million, investing cash flow was $35.4 million, and financing cash flow was negative $81.0 million. Financing outflows included $39.1 million of net deposit outflows and $44.0 million of net reductions in short-term borrowings. Acquisition cash paid, net of cash retained, was $35.7 million.
- Total borrowings were $246.1 million, broadly flat with $246.6 million at year-end. They included $44.3 million of repurchase agreements, $81.9 million of other short-term borrowings, $57.7 million of junior subordinated debentures, $44.1 million of senior notes, and $18.1 million of notes payable and other borrowings. The Bank reported $133.0 million of excess collateral available to secure borrowings.
- Bank capital ratios were 13.26% common equity Tier 1, 14.16% total risk-based capital, and 11.05% Tier 1 leverage. The Bank exceeded its stated internal objectives and regulatory “well capitalized” thresholds. Consolidated tangible common equity to tangible assets was reported as 7.57% on a GAAP basis and 7.60% on a non-GAAP basis, down from 8.06% and 8.07%, respectively, at year-end.
Material changes and operating drivers
- ABC Bank added four Chicago-area branches, $227.6 million in loans and $248.5 million in deposits, net of purchase accounting adjustments. The acquisition included $9.9 million of goodwill and a $3.1 million core deposit intangible. Preliminary purchase accounting remained subject to refinement.
- Q3 net interest income rose $4.5 million year over year, driven by acquisition-related loan growth, higher interest rates and securities portfolio positioning. Average loan and held-for-sale yields increased to 5.04% from 4.60%; funding costs also rose, to 1.00% from 0.80%.
- Nine-month noninterest income increased $2.7 million, including a $1.0 million BOLI death benefit and improved mortgage servicing rights marks. Q3 noninterest income was essentially unchanged year over year.
- Noninterest expense increased 10.6% year over year in Q3 and 10.2% for the first nine months. Nine-month acquisition-related costs were $3.3 million pretax, including conversion and data-processing costs. Q3 GAAP efficiency ratio was 60.06%; the adjusted non-GAAP ratio was 59.11%.
- Loans grew 13.4% from year-end, although management reported no net loan growth in Q3 versus the prior quarter amid loan paydowns and competitive origination conditions. Real-estate-related loans represented 78.1% of the portfolio.
Outlook, risks and unusual items
- The filing provides no specific earnings or financial guidance. Management said it believed the franchise was positioned for further growth, while noting competitive loan pricing and underwriting standards that constrain higher-yielding lending.
- Nonperforming loans were $11.8 million, or 0.6% of loans, down from $15.6 million and 1.0% at December 31, 2017. The allowance was $19.3 million, or 164.1% of nonperforming loans. Classified assets, including acquired PCI loans, rose to $51.9 million; management attributed the increase principally to the ABC Bank acquisition. Acquired PCI loans were $10.9 million net of purchase accounting adjustments.
- Other real estate owned declined to $7.0 million, but $4.5 million, about 65% of the balance, had been held for five years or more. Management cautioned that further valuation or disposal losses could occur.
- Available-for-sale securities had $11.2 million of gross unrealized losses at quarter-end, compared with $4.7 million at year-end. Management attributed changes primarily to interest rates and reported no credit deterioration or other-than-temporary impairment.
- Interest-rate sensitivity modeling estimated pretax income would increase 6.7% under an immediate 2% rate increase and decrease 15.7% under an immediate 2% decrease. Management described overall interest-rate risk as moderate; modeled results are not forecasts and exclude possible management actions.
- Forward-looking risks include economic and real estate weakness, borrower defaults, acquisition integration and realization of expected benefits, interest-rate and funding changes, competition, regulatory and capital requirements, cyber and vendor risks, and legal or mortgage-repurchase exposure. Management reported no material change in the risk factors from its 2017 Form 10-K. It also said disclosure controls were effective and ordinary-course legal matters were not expected to have a material adverse effect.
- The Board declared a $0.01-per-share dividend after quarter-end, payable November 5, 2018. The company adopted several accounting standards in 2018 without a material opening retained-earnings adjustment; it was assessing the future lease standard and expected to adopt the credit-loss standard in 2020.
Important facts for investors to verify
- How much of loan, deposit and earnings growth reflects ABC Bank versus organic growth, and whether acquisition integration produces expected benefits after the $3.3 million of reported costs.
- Credit quality behind the increase in classified assets, acquired PCI loan cash-flow assumptions, and the adequacy of reserves as acquired discounts accrete or credit expectations change.
- Deposit pricing, funding mix and net interest margin sensitivity as rates and competition change.
- Valuation and liquidity exposure in the securities portfolio, including unrealized losses and the concentration in real-estate-related lending.
- The filing gives two tangible common equity ratios—7.57% GAAP and 7.60% non-GAAP—and separately describes the non-GAAP ratio as 7.60%; investors should confirm the definitions and reconciliation when comparing periods.