Old Second Bancorp, Inc. — Q1 2012 Form 10-Q
Business context and reporting period. The Illinois-based bank holding company provides commercial and retail banking, trust and wealth-management services. This filing covers the three months ended March 31, 2012; balance-sheet comparisons are with December 31, 2011 unless noted. Amounts below are in U.S. dollars and rounded to millions.
Financial performance and condition
| Metric | Q1 2012 / March 31, 2012 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $15.1 million | $16.5 million in Q1 2011 |
| Provision for loan losses | $6.1 million | $4.0 million in Q1 2011 |
| Noninterest income | $10.5 million | $8.9 million in Q1 2011 |
| Noninterest expense | $22.5 million | $24.6 million in Q1 2011 |
| Net loss / loss per diluted share | $3.0 million / $0.30 loss | $3.1 million / $0.30 loss in Q1 2011 |
| Net loss available to common shareholders | $4.2 million | $4.3 million in Q1 2011 |
| Net interest margin, tax-equivalent | 3.48% | 3.50% in Q1 2011 |
| Total assets | $1,981.5 million | $1,941.4 million |
| Loans, gross | $1,322.3 million | $1,369.0 million |
| Deposits | $1,763.9 million | $1,740.8 million |
| Cash and cash equivalents | $76.6 million | $50.9 million |
| Available-for-sale securities | $359.4 million | $307.6 million |
| Total borrowings | $120.7 million | $104.8 million |
| Stockholders’ equity | $70.6 million | $74.0 million |
| Operating / investing / financing cash flow | $11.3 million / ($24.6 million) / $38.9 million | Net cash increased $25.7 million in Q1 2012 |
Material changes and credit quality
- Net interest income fell 8.7% year over year as average earning assets contracted and loan balances declined; lower funding costs largely offset lower asset yields. Average earning assets declined 9.1%, and average loans, including loans held for sale, fell $298.9 million year over year.
- Noninterest income rose 17.0%, led by higher mortgage-loan sale gains and OREO lease revenue. Expenses declined 8.7%, including lower FDIC insurance and OREO expenses. No income-tax benefit was recorded on the quarterly loss because deferred tax assets were fully reserved, apart from the separately reported securities-related deferred tax asset.
- Loan balances declined $46.6 million during the quarter. Net charge-offs were $10.5 million; the allowance for loan losses was $47.6 million, or 3.6% of loans. Nonperforming loans were $125.4 million, down from $138.9 million at year-end and $193.0 million a year earlier. Allowance coverage of nonperforming loans was 38.0%.
- OREO rose $8.4 million during the quarter to $101.7 million, reflecting $15.9 million of property additions, offset partly by sales and valuation adjustments. The company recorded $2.5 million of OREO valuation expense.
- Real-estate-related lending represented 90.8% of the loan portfolio. Management cited ongoing weakness in local real estate markets and limited demand from qualified borrowers. Commercial real estate, especially retail properties, remained a significant source of credit stress.
Outlook, risks and unusual items
- The filing provides no formal earnings or revenue guidance. Management said it expected construction-and-development credit losses to continue trending downward, while cautioning that actual loan and property losses could exceed estimates. Loan demand remained weak; management continued shifting available funds into securities and pursuing portfolio diversification.
- The Bank remained subject to an OCC Consent Order and the holding company to an FRB Written Agreement. The Bank’s March 31 total risk-based capital ratio was 12.88% and leverage ratio 9.22%, above the respective OCC-required levels of 11.25% and 8.75%. Consolidated ratios were 11.79% total risk-based capital, 5.90% Tier 1 risk-based capital, and 4.68% Tier 1 leverage. Consolidated tangible common equity was negative $5.0 million.
- The company was still out of compliance with two Bank of America credit-facility financial covenants. The senior term-debt balance was $0.5 million; the lender could accelerate that debt and exercise remedies following a covenant default. Separately, the company had $45.0 million of subordinated debt and $58.4 million of junior subordinated debentures.
- Interest payments on the junior subordinated debentures had been deferred since 2010; accrued unpaid interest was $8.0 million. Series B preferred dividends were also deferred, with $6.1 million accrued. Common dividends were suspended, and regulatory and contractual restrictions limit distributions and stock repurchases.
- Liquidity included $76.6 million of cash and cash equivalents and $81.0 million of unused FRB borrowing capacity. A $15.0 million FHLB advance outstanding at quarter-end matured April 20, 2012, without replacement.
- The available-for-sale portfolio included $9.7 million of Level 3 collateralized debt obligations with $17.9 million amortized cost and $8.2 million unrealized losses. The CDO tranches were rated CCC+ and CCC- by S&P; management cited increased collateral deferrals and defaults and limited market liquidity, but said it did not intend to sell and expected to hold until cost recovery.
- A purported class action alleging ERISA-related disclosure and fiduciary-duty violations remained unresolved; mediation in May 2012 had not produced meaningful progress. Management said other ordinary-course legal matters were not expected to have a material adverse effect.
Most important facts for investors to verify
- Whether loan-loss provisioning, charge-offs, nonperforming loans, and OREO valuations continue to improve, particularly in retail commercial real estate and construction lending.
- Whether the Bank maintains its OCC capital thresholds and complies with the OCC Consent Order and FRB Written Agreement; also monitor the holding company’s negative tangible common equity.
- Whether the Bank of America covenant defaults are waived or otherwise resolved, and whether deferred debenture interest and preferred dividends can be serviced or distributions resumed.
- How the April 2012 maturity of the FHLB advance affected liquidity, and whether available borrowing capacity and deposit trends remain adequate.
- Whether the value and credit performance of the Level 3 CDO portfolio deteriorate further, and the status and potential exposure of the ERISA class action.