OLD SECOND BANCORP INC quarterly report, Q3 FY2016

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Old Second Bancorp, Inc. — Q3 2016 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2016; unaudited consolidated financial statements. The company is an Illinois-based banking and financial services holding company. Unless stated otherwise, dollar amounts below are in millions.

Financial results and condition

  • Q3 earnings: Net interest income was $15.35 million, up from $14.80 million a year earlier. Net income was $3.50 million versus $3.92 million; diluted EPS was $0.12 in both periods. The prior-year quarter included a $2.1 million loan-loss reserve release; Q3 2016 had no provision or release.
  • Nine-month earnings: Net interest income was $45.93 million versus $44.34 million. Net income was $10.67 million versus $11.55 million; diluted EPS was $0.36 versus $0.33. Common earnings were $10.67 million versus $9.68 million, as the 2015 comparison included preferred-stock dividends and accretion.
  • Management-adjusted results: Excluding $2.0 million of securities losses and $115,000 of Talmer acquisition costs, management stated Q3 common earnings would have been $4.9 million, or $0.16 per diluted share; nine-month common earnings would have been $12.0 million, or $0.40 per diluted share.
  • Margins and expenses: Tax-equivalent net interest margin was 3.22% in Q3, unchanged year over year; nine-month margin was 3.23% versus 3.25%. Q3 noninterest income was $6.59 million and noninterest expense $16.58 million. The reported efficiency ratio was 66.69%, versus 73.66% a year earlier.
  • Balance sheet at September 30: Assets were $2.113 billion, loans $1.203 billion, deposits $1.777 billion, and stockholders’ equity $171.6 million. Loans grew 6.1% from year-end 2015; deposits grew 1.0%.
  • Liquidity and cash flow: Cash and cash equivalents were $189.9 million, compared with $40.3 million at December 31, 2015. For nine months, operating cash flow was $17.2 million, investing cash flow $117.4 million, and financing cash flow $15.0 million; cash increased $149.6 million. Investing inflows chiefly reflected securities activity.
  • Debt and capital: Total borrowings were $149.7 million, including $57.6 million of junior subordinated debentures and $45.0 million of subordinated debt. The Bank reported a 10.65% Tier 1 leverage ratio and 16.24% total capital ratio, above its stated internal objectives of 8% and 12%; the Bank also exceeded regulatory “well capitalized” thresholds.

Changes, material events, and management commentary

  • In Q3, the company sold approximately $233.5 million of securities to prepare for the Talmer branch acquisition, recognizing $2.0 million of pretax losses. Earlier in 2016, it reclassified $244.8 million of held-to-maturity securities to available-for-sale; the filing says this prevents held-to-maturity classification for two years.
  • On October 28, 2016, after quarter-end, the Bank completed its acquisition of Talmer Bank and Trust’s Chicago branch, acquiring approximately $48.9 million of deposits and $223.4 million of loans. These acquired balances are not included in the September 30 balance sheet.
  • Management described local-market growth as moderate, with continued uncertainty and reluctance among businesses and individuals to invest. It cited competitive pressure on loan pricing, while emphasizing underwriting standards and sustained credit quality.
  • Nonperforming loans increased to $17.38 million from $14.62 million at year-end 2015. Management attributed the increase mainly to two commercial real estate relationships affected by the loss of a large tenant at each property. Classified loans rose to $28.26 million. The allowance was $14.98 million, equal to 86.2% of nonperforming loans; Q3 net charge-offs were $839,000.
  • Other real estate owned fell to $14.14 million from $19.14 million at year-end. However, $4.8 million, or about one-third of OREO, had been held for at least five years. Management cautioned that additional valuation or disposal losses remain possible.
  • The company declared a one-cent-per-share dividend on October 18, payable November 7, 2016. It reported no material change in risk factors, no material legal-proceeding exposure, and effective disclosure controls.

Outlook, risks, and unusual items

  • The filing provides no quantified earnings or revenue guidance. Management said results for the interim period are not necessarily indicative of full-year results and highlighted local economic uncertainty, loan-pricing competition, and the challenge of achieving pre-2008 profitability and growth.
  • Key exposures include real-estate concentration (83.5% of loans), potential credit deterioration and collateral losses, interest-rate movements, deposit withdrawals, funding and liquidity needs, and execution of the Talmer acquisition. Management stated that the allowance was adequate but actual losses could exceed estimates.
  • Interest-rate sensitivity modeling estimated annual pretax income increases of $1.16 million, $2.48 million, and $5.09 million for immediate rate increases of 0.5%, 1%, and 2%, respectively; a 0.5% decrease showed a $2.08 million decline. The filing cautions that model outcomes are not forecasts and that certain larger rate-decrease scenarios could not be calculated in the low-rate environment.
  • Other notable items: securities losses associated with acquisition funding; the prior-year $2.1 million loan-loss reserve release and $1.1 million fixed-asset write-down on transfer to OREO; and $5.2 million of unrealized securities losses in accumulated other comprehensive income during the first nine months, partly offset by other comprehensive gains.

Investor verification priorities

  1. Verify Talmer acquisition integration, funding, and subsequent reported contribution, including the acquired loan and deposit balances.
  2. Track the two tenant-affected commercial real estate credits, nonperforming/classified loans, charge-offs, and allowance coverage.
  3. Assess whether underlying earnings support the reported management-adjusted figures after securities losses and acquisition costs.
  4. Monitor liquidity and securities portfolio composition and valuation, including unrealized losses and the two-year held-to-maturity restriction.
  5. Review capital ratios, borrowing covenant compliance, and the March 2018 maturity of the $45.5 million correspondent-bank facility.