Old Second Bancorp, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also provides unaudited quarterly results, including fourth-quarter 2018. Old Second is an Illinois community bank holding company operating 29 banking centers in the Chicago metropolitan area. It completed its acquisition of Greater Chicago Financial Corp. and ABC Bank on April 20, 2018, adding four branches.
Key financial results
Amounts below are in millions except per-share data and ratios.
| Metric | 2018 | 2017 | Change or context |
|---|---|---|---|
| Interest and dividend income | $107.6 | $87.5 | Up 23.0% |
| Net interest income (GAAP) | $90.9 | $74.9 | Up 21.4% |
| Net interest margin (tax-equivalent) | 3.96% | 3.70% | Up 26 basis points |
| Noninterest income | $31.4 | $30.4 | Up 3.2% |
| Noninterest expense | $77.1 | $69.1 | Up 11.5% |
| Provision for loan and lease losses | $1.2 | $1.8 | Net recoveries were $0.3 million in 2018 |
| Net income | $34.0 | $15.1 | Up 124.7% |
| Diluted earnings per share | $1.12 | $0.50 | 2018 basic EPS was $1.14 |
| Return on average assets / equity | 1.33% / 16.08% | 0.65% / 7.89% | Improved year over year |
Balance sheet, liquidity, and capital
- Total assets were $2.68 billion, up 12.3%; gross loans were $1.90 billion, up 17.3%; and deposits were $2.12 billion, up 10.1% from year-end 2017.
- Stockholders’ equity was $229.1 million, compared with $200.4 million. Cash and cash equivalents were $55.2 million, approximately unchanged from $55.8 million.
- Cash from operating activities was $54.9 million, compared with $37.1 million in 2017. Investing activities used $25.8 million; financing activities used $29.7 million. Net cash decreased $0.6 million.
- Total borrowings were $313.4 million, including $149.5 million in short-term borrowings, $57.7 million in junior subordinated debentures, $44.2 million in senior notes, and $15.4 million in notes payable and other borrowings. Repurchase agreements were an additional $46.6 million.
- The Bank reported $69.6 million of remaining FHLBC funding availability at year-end, after outstanding advances and letters of credit. Management reported strong liquidity and monthly contingency-funding stress tests.
- The Bank’s year-end capital ratios were 13.29% CET1, 14.14% total risk-based capital, and 11.36% Tier 1 leverage; each exceeded the applicable well-capitalized threshold. The Company’s tangible common equity to tangible assets ratio was 7.83%, versus 8.07% in 2017.
Material changes and operating drivers
- Net income rose primarily with higher loan volumes, a wider net interest margin, acquired-loan discount accretion, organic growth, and lower income-tax expense. The 2017 comparison was depressed by a $9.5 million one-time tax expense from federal tax reform; a $1.6 million Illinois tax-rate-related benefit partly offset that charge.
- The ABC Bank transaction contributed $227.6 million of acquired loans and $248.5 million of deposits, net of purchase accounting adjustments. Acquisition-related costs were $3.5 million pretax in 2018; computer and data-processing expense also increased with conversion costs.
- Average loan yield rose to 5.00% from 4.55%, while the average cost of interest-bearing liabilities rose to 0.97% from 0.81%. Management attributed the margin expansion to loan growth, acquired-loan accretion, and higher-yielding municipal securities; rising deposit and borrowing costs were a partial offset.
- Residential mortgage banking revenue declined 13.2% to $5.7 million, attributed mainly to rising rates and lower mortgage-sale activity. Trust income increased 3.4% to $6.4 million; average wealth-management assets under management rose 6.5% to $1.18 billion.
- Fourth-quarter 2018 net income was $8.6 million, or $0.28 diluted EPS, compared with a $2.5 million loss, or $0.08 loss per share, in fourth-quarter 2017. The 2017 quarter included the federal tax-reform charge.
Credit quality, risks, and outlook
- Real-estate-related lending represented 77.9% of the loan portfolio at year-end. Commercial real estate was about 43.5% of loans. Management seeks to diversify the portfolio, but remains exposed to local real-estate values and the Illinois/Chicago-area economy.
- Nonperforming assets excluding acquired purchased-credit-impaired (PCI) loans were $23.5 million, down from $24.0 million. Nonperforming loans increased to $16.3 million from $15.6 million; nonaccrual loans decreased to $13.7 million from $14.4 million. PCI loans of $11.0 million were excluded from reported nonperforming assets because expected cash flows remained estimable and collectible.
- Classified assets, including PCI loans, increased to $53.4 million from $31.7 million; classified loans excluding PCI rose to $35.3 million from $23.3 million. The allowance for loan and lease losses was $19.0 million, or 1.00% of gross loans, compared with $17.5 million, or 1.08%, in 2017.
- Management described asset quality and local economic conditions as stable but cautioned that recession, falling real-estate values, borrower weakness, and higher interest rates could increase delinquencies and losses. Other principal risks include interest-rate and funding-cost sensitivity, competition, acquisition integration, cybersecurity and vendor dependence, regulatory compliance, and the ability to retain deposits and control costs.
- Interest-rate simulations estimated annual pretax income changes of +1.1% for an immediate 0.5% rate rise and +4.2% for a 2.0% rise, versus declines of 2.1% and 12.2% for corresponding rate decreases. Management characterized interest-rate risk as moderate; modeled results are not forecasts and exclude mitigating management actions.
- No company earnings or growth guidance is provided in the filing. Management noted a general market expectation that the Federal Reserve would hold short-term rates steady during 2019; this is not company guidance. The company expected CECL implementation in 2020 and was testing its loss-rate model.
- The company reported no material effect expected from ordinary-course litigation. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective at year-end.
Most important facts for investors to verify
- Whether acquired and organic loan growth can continue without deterioration in classified credits, real-estate concentrations, or allowance adequacy.
- How ABC Bank integration, customer retention, and the $3.5 million of 2018 acquisition costs affect future expense levels and earnings.
- Whether net interest margin gains persist as deposit costs and short-term funding costs rise; review the company’s rate-sensitivity assumptions alongside actual results.
- The composition and stability of funding, including short-term FHLBC advances, deposit maturities, available borrowing capacity, and the effect of deposit competition.
- The effect of CECL adoption on the allowance, earnings, and capital, as well as the realization of the $21.3 million net deferred tax asset.
- Clarify the filing’s differing brokered-CD disclosures: the MD&A cites $16.5 million at year-end 2018, while a financial-statement note cites $30.4 million.