Old Second Bancorp, Inc. — Q2 2020 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 retail, commercial, treasury, fiduciary and wealth-management services. This unaudited filing covers the quarter and six months ended June 30, 2020; balance-sheet comparisons are to December 31, 2019. Dollar amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q2 2020 | Prior comparable period |
|---|---|---|
| Net interest and dividend income | $22.7 | $24.8 in Q2 2019 |
| Provision for credit losses | $2.1 | $0.45 in Q2 2019 |
| Noninterest income | $10.7 | $8.1 in Q2 2019 |
| Noninterest expense | $18.9 | $20.1 in Q2 2019 |
| Income before taxes | $12.4 | $12.3 in Q2 2019 |
| Net income | $9.2 | $9.3 in Q2 2019 |
| Diluted earnings per share | $0.31 | $0.31 in Q2 2019 |
| Net interest margin, GAAP | 3.42% | 4.06% in Q2 2019 |
- For the first six months, net interest income was $45.4 million versus $48.8 million; provision for credit losses was $10.1 million versus $0.9 million; and net income was $9.5 million versus $17.7 million. Diluted EPS was $0.31 versus $0.58.
- Q2 tax-equivalent net interest margin was 3.48%, down from 4.15% a year earlier. The reported GAAP efficiency ratio was 55.13% in Q2 versus 59.78% in Q2 2019; the adjusted non-GAAP ratio was 54.28% versus 58.62%.
- Q2 comprehensive income was $17.5 million, including $8.2 million of other comprehensive income, primarily reflecting unrealized gains on available-for-sale securities.
Financial condition, liquidity and capital
- At June 30, total assets were $2.93 billion, up $296.9 million from year-end 2019. Loans were $2.05 billion, up $121.5 million; deposits were $2.45 billion, up $324.6 million; and cash and cash equivalents were $257.5 million, up $206.9 million.
- Growth in deposits was concentrated in noninterest-bearing demand, savings and NOW accounts. Management attributed the increase largely to lower consumer spending and federal stimulus funds held by customers.
- Six-month operating cash flow was $20.8 million versus $39.9 million in 2019. Investing activities used $83.7 million, while financing activities provided $269.7 million. Cash increased $206.9 million over the period.
- Total borrowings were $156.0 million, down from $205.9 million at year-end. This included $44.3 million of senior notes, $25.8 million of junior subordinated debentures, and $25.5 million of notes payable and other borrowings. The company also reported a $20 million undrawn line of credit and $335.2 million of excess collateral available to secure FHLB advances.
- Stockholders’ equity was $282.5 million, compared with $277.9 million at year-end. The Bank’s June 30 Tier 1 leverage and total capital ratios were 10.86% and 14.71%, respectively; both exceeded stated internal objectives and applicable regulatory thresholds. The Bank’s ratios were lower than at year-end, partly due to a $30 million dividend to the parent in March.
- Nonperforming loans were $20.2 million, or 1.0% of loans, versus $15.8 million, or 0.8%, at year-end. The allowance for credit losses on loans was $31.3 million, or 1.5% of loans, versus $19.8 million, or 1.0%, at year-end. Q2 net charge-offs were $0.17 million.
Material changes and drivers
- Q2 net income was broadly stable year over year despite lower net interest income and a higher credit-loss provision. Increased mortgage banking revenue and lower expenses largely offset those headwinds.
- Lower market rates reduced loan and securities yields. Average loan yield fell to 4.40% from 5.28% in Q2 2019; average securities yield fell to 3.07% from 3.80%. Lower funding costs partly offset the revenue decline.
- Q2 noninterest income rose $2.6 million year over year, chiefly because net gains on mortgage loan sales increased to $4.6 million from $1.2 million and MSR mark-to-market losses narrowed. Lower deposit service charges and card income partially offset the increase.
- Q2 noninterest expense declined $1.2 million year over year, including lower salaries and benefits, data-processing costs and advertising. Six-month noninterest expense, by contrast, increased 1.5% to $39.9 million.
- PPP lending contributed materially to growth: 669 PPP loans totaling $133.9 million were originated in Q2. The low 1.00% PPP loan rate and increased cash balances weighed on margin.
Outlook, risks and unusual items
- Management said the pandemic’s effects remained uncertain and could materially affect borrowers, credit quality, liquidity, capital, demand and results. It anticipated that achieving profitability and growth levels of recent years would be challenging, while expressing an expectation of further moderate loan growth.
- As of August 5, the company had executed 469 loan payment deferrals covering $231.1 million of outstanding balances. It had processed 727 PPP applications totaling $136.9 million. Management noted that customer assistance programs could reduce near-term revenue and that risks could persist if they do not mitigate borrower stress.
- CECL adoption on January 1, 2020 increased the loan allowance by $5.9 million and established a $1.7 million allowance for unfunded commitments; the cumulative after-tax reduction to retained earnings was approximately $3.8 million. The company elected a five-year regulatory-capital transition for CECL.
- Management recorded a $2.1 million Q2 provision for credit losses, including $1.4 million for loans and $734,000 for unfunded commitments. It said estimates depend on credit quality, economic forecasts and pandemic developments. No credit loss allowance was recorded on available-for-sale securities at quarter-end.
- On March 2, the company redeemed $32.6 million of 7.80% trust preferred securities and related debentures, funded with cash and a term note. It recognized $635,000 of remaining debt issuance costs in Q1.
- Goodwill was $18.6 million. Management concluded no impairment was required at June 30, but warned that a delayed recovery or worsening conditions could lead to future impairment. The filing does not provide numerical earnings or margin guidance.
- The board declared a $0.01-per-share dividend in July, payable August 10, 2020. Q2 share repurchases totaled 145,932 shares at a weighted average $6.97 per share; continued repurchases after September 19 required Federal Reserve non-objection or approval.
Important facts for investors to verify
- Whether borrower deferrals, PPP exposures and local economic conditions lead to further credit deterioration, charge-offs or allowance increases.
- How much deposit growth is durable after stimulus-related balances and reduced spending normalize, and whether cash can be redeployed without further margin pressure.
- Whether mortgage sale gains and lower MSR valuation losses persist, given their importance to Q2 noninterest income.
- The trajectory of nonperforming and classified loans, including the effects of CECL’s change in treatment of purchased credit-deteriorated loans.
- Capital and liquidity resilience under prolonged stress, including the effects of credit losses, deposit outflows, loan-line utilization and any further repurchases or distributions.
- Potential goodwill impairment and the status of the long-held OREO portfolio; the company reported that a small parcel exceeding the usual holding period was sold on July 10, 2020.