Old Second Bancorp, Inc. — Q3 2012 Form 10-Q
Business context and reporting period. Old Second Bancorp is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. This unaudited report covers the three and nine months ended September 30, 2012; balance-sheet comparisons are with December 31, 2011. Unless noted, amounts below are in millions.
Key financial results
| Metric | Q3 2012 / Sept. 30, 2012 | Comparable period / prior year-end |
|---|---|---|
| Net income (loss) | $0.12 in Q3; $(1.60) for nine months | Q3 2011: $(1.39); nine months 2011: $(3.50) |
| Net loss available to common shareholders | $(1.14) in Q3; $(5.31) for nine months; loss per share $(0.08) and $(0.37) | Q3 2011: $(2.58), or $(0.18) per share; nine months 2011: $(7.02), or $(0.49) per share |
| Net interest income | $14.64 in Q3; $45.43 for nine months | Q3 2011: $15.92; nine months 2011: $48.93 |
| Tax-equivalent net interest margin | 3.44% in Q3; 3.52% for nine months | Q3 2011: 3.63%; nine months 2011: 3.57% |
| Noninterest income / expense | Q3: $10.35 / $24.86; nine months: $31.21 / $71.95 | Q3 2011: $8.51 / $22.82; nine months 2011: $26.85 / $71.78 |
| Total assets | $1,903.4 | $1,941.4 at Dec. 31, 2011 |
| Loans, net / allowance for loan losses | $1,168.0 / $40.3 | $1,317.0 / $52.0 at Dec. 31, 2011 |
| Deposits | $1,696.9 | $1,740.8 at Dec. 31, 2011 |
| Cash and cash equivalents | $72.2 | $50.9 at Dec. 31, 2011 |
| Stockholders’ equity | $70.7 | $74.0 at Dec. 31, 2011 |
For the first nine months, operating cash flow was $28.7, investing cash flow was $35.7, and financing cash flow was $(43.1); cash increased by $21.3. The investing inflow included $115.7 of net loan principal collections, partly offset by net securities purchases. Debt included $58.4 of junior subordinated debentures, $45.0 of subordinated debt, and $0.5 of term debt. The company also had $1.7 of repurchase-agreement borrowings.
Material changes and credit condition
- Loans declined 11.7% from year-end, to $1.21 billion, amid weak qualified-borrower demand, charge-offs, repayments, and transfers of collateral to foreclosed property. Available-for-sale securities rose 34.1% to $412.3 million as liquid funds were redeployed.
- Net interest income fell 7.2% year over year for the first nine months. Average earning assets declined 6.1%; lower asset yields were partly offset by lower funding costs. Management reported a Q3 tax-equivalent margin of 3.44%, versus 3.63% a year earlier.
- Noninterest income rose 16.2% for nine months, notably from mortgage-loan sale gains and securities gains. Noninterest expense was nearly flat year over year for nine months; higher salaries and foreclosed-property costs offset lower FDIC, legal, and other expenses.
- Nonperforming loans were $105.8 million, down from $138.9 million at year-end 2011. Classified loans fell to $138.8 million from $238.1 million. Net charge-offs were $18.0 million for nine months, versus $24.0 million in 2011; Q3 2012 net charge-offs were $29,000.
- The allowance was $40.3 million, or 38.0% of nonperforming loans, compared with 37.4% at year-end. Management cautioned that actual losses may exceed estimates. Real estate-related loans remained 91.6% of the portfolio.
- Other real estate owned (OREO) was $88.1 million, down from $93.3 million at year-end, but the nine-month OREO valuation charge was $12.1 million. A larger portion of OREO had been held for more than one year, indicating extended disposition timelines.
Outlook, risks, contingencies, and unusual items
- No specific earnings or financial guidance was provided. Management said construction-and-development credit performance had improved and expected losses in that segment generally to continue trending downward, while acknowledging possible further adverse credit migration and uncertainty in loss estimates.
- The Bank remained subject to an OCC Consent Order and the holding company to an FRB Written Agreement. The Bank exceeded the order’s capital targets, but the order and agreement impose operating, capital, reporting, and dividend restrictions; the Bank was formally classified as adequately capitalized while under the order.
- The company remained out of compliance with two Bank of America facility financial covenants. The lender could, subject to the agreement, terminate credit commitments, raise rates, accelerate the $0.5 million term debt, or enforce collateral rights. The $45.0 million subordinated debt is not subject to those covenant remedies.
- The company had deferred interest on $58.4 million of junior subordinated debentures since August 2010; unpaid interest was $10.5 million. It had also deferred Series B preferred dividends, totaling $8.1 million. Common dividends cannot resume until required deferred payments are satisfied, and regulatory consent restrictions also apply.
- Despite a nine-month pretax loss of $1.6 million, no income-tax benefit was recorded because the company maintained a valuation allowance that reduced operating deferred tax assets to zero. Management’s ability to realize those assets depends on future taxable income.
- The securities portfolio included $9.5 million fair value of collateralized debt obligations, with $8.4 million of unrealized losses. These were Level 3 valuations using unobservable inputs; management said it did not intend, and was more likely than not would not need, to sell before recovery of cost.
- A certified class action alleging ERISA violations concerning the company’s 401(k) plan remained pending. A November 2, 2012 court ruling denied defendants’ motion to dismiss. The company had insurance, but plaintiffs’ counsel asserted potential damages could substantially exceed coverage; the claim was not quantified in the filing.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Proposed Basel III rules were still under review, and management had not established their final impact.
Important facts for investors to verify
- Whether nonperforming loans, charge-offs, the allowance, and OREO valuations continue to improve—and whether collateral values support recorded estimates.
- Progress toward compliance with the OCC Consent Order, FRB Written Agreement, and the two breached Bank of America covenants, including any regulatory or lender actions.
- Liquidity and capital resilience, including deposit trends, available borrowing capacity, deferred debenture interest, preferred dividends, and restrictions on distributions.
- Whether earnings can recover despite shrinking loans and margin pressure, and whether mortgage gains or securities gains are sustainable sources of noninterest income.
- Developments in the 401(k) litigation, potential insurance coverage, and the realizability of deferred tax assets.
- Changes in the Level 3 CDO valuation and the effects of final Basel III requirements.