Old Second Bancorp, Inc. — Q1 2022 10-Q
Reporting period: Three months ended March 31, 2022. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise.
Business context
Old Second is an Illinois-based bank holding company operating 62 banking centers and providing retail and commercial banking, treasury, fiduciary and wealth-management services. Results include a full quarter of West Suburban Bancorp, acquired December 1, 2021. The acquisition added approximately $2.94 billion of assets, including $1.50 billion of loans and $2.69 billion of deposits, and 34 branches.
Financial performance and position
- Earnings: Net income was $12.0 million, up from $11.9 million in Q1 2021. Diluted EPS was $0.27 versus $0.40, reflecting a larger share count after the acquisition. Adjusted net income, a non-GAAP measure excluding merger costs, was $16.1 million; adjusted diluted EPS was $0.36.
- Revenue and margin: Net interest income was $41.2 million versus $23.5 million; noninterest income was $13.5 million versus $11.3 million. Net interest margin was 2.85%, down from 3.27% year over year and up from 2.82% in Q4 2021. Management attributed growth principally to West Suburban; lower asset yields and elevated liquidity weighed on year-over-year margin.
- Expenses and profitability: Noninterest expense rose 76% to $38.3 million, including $5.6 million of acquisition-related costs. The GAAP efficiency ratio was 72.72%; adjusted efficiency ratio was 61.38% (non-GAAP). Income before taxes was $16.4 million and income tax expense was $4.4 million.
- Loans and credit: Loans were $3.40 billion, down $19.6 million from year-end, mainly as PPP loans were forgiven or repaid and borrowers paid down balances; loans were up $1.44 billion year over year, primarily from the acquisition. Nonperforming loans were $38.0 million, or 1.1% of loans, versus $44.7 million and 1.3% at year-end. Net charge-offs were $0.3 million. The loan allowance was $44.3 million, or 1.3% of loans. A $0.32 million loan provision was offset by a corresponding reduction in the unfunded-commitment reserve, leaving no net provision effect reported for the quarter.
- Liquidity and funding: Cash and cash equivalents were $634.7 million, down $117.4 million from year-end. Deposits were $5.54 billion, up $78.5 million. Total borrowings were $181.0 million, down from $198.9 million. The company also reported an undrawn $30 million correspondent-bank credit line and available borrowing capacity at the FHLB. Operating cash flow was $0.3 million; investing cash outflow was $176.5 million and financing cash inflow was $58.8 million.
- Capital and securities: Total assets were $6.22 billion, broadly unchanged from year-end. Stockholders’ equity fell $35.7 million to $466.3 million, principally due to a $46.3 million after-tax decline in accumulated other comprehensive income as market rates reduced available-for-sale securities values. The securities portfolio’s fair value was $1.82 billion. The Bank’s Tier 1 leverage ratio was 8.61% and total capital ratio was 13.83%; management said capital exceeded applicable requirements.
Changes, outlook and risks
- Year-over-year earnings were nearly flat despite substantial revenue growth: higher acquisition-related and ongoing operating costs absorbed much of the increase. The diluted share count also increased materially following the West Suburban transaction.
- Of approximately $31 million in projected West Suburban acquisition costs, $30.7 million had been expensed cumulatively by March 31. Management anticipated additional expenses in Q2 2022 for data and systems conversion.
- No specific earnings or full-year financial guidance is provided. Management said it was positioned for moderate loan growth and expected higher rates and inflation to be favorable to near-term net interest margin, while noting higher operating costs and potential borrower-credit deterioration as risks.
- Management expected the business to remain affected by COVID-19 through the remainder of 2022. It also cited inflation, labor and supply-chain pressures, geopolitical uncertainty including the war in Ukraine, interest-rate movements, competition, credit quality, and acquisition integration as risks. Over 97% of loan balances previously in pandemic deferral status had resumed payments or paid off by March 31.
- Available-for-sale securities had $54.4 million of gross unrealized losses at quarter-end; management reported no identified credit losses and recorded no securities credit-loss provision. The filing warns that future market or issuer changes could lead to impairment or further reductions in other comprehensive income.
- The company was transitioning LIBOR-referenced exposures ahead of the expected June 30, 2023 cessation for relevant tenors. It had updated systems for SOFR-based indexes and was continuing work on existing exposures.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It stated that ordinary-course legal matters were not expected to have a material adverse effect; no material risk-factor changes were reported.
Important facts for investors to verify
- How much of the acquisition-related cost burden remains, and whether integration and conversion deliver the expected efficiencies.
- Whether net interest margin benefits from rate increases, considering deposit repricing, asset mix, securities duration and the company’s interest-rate sensitivity disclosures.
- Credit trends in commercial and real-estate lending, including classified assets, nonperforming loans, and adequacy of loan and unfunded-commitment allowances.
- The effect of securities’ unrealized losses on reported equity and tangible-equity measures, and whether any losses become realized or credit-related.
- Deposit stability, cash deployment, borrowing capacity and capital ratios as the balance sheet and acquisition integration evolve.
- Progress on LIBOR-to-SOFR contract transitions and any resulting operational or financial effects.