OLD SECOND BANCORP INC quarterly report, Q2 FY2021

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Old Second Bancorp, Inc. — Q2 2021 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2021. The unaudited consolidated financial statements are in thousands of dollars unless stated otherwise; comparisons are with Q2 and first-half 2020 or December 31, 2020, as applicable.

Business context

Old Second is an Illinois bank holding company operating 29 banking centers through Old Second National Bank. It serves retail and commercial customers and provides wealth-management services. The filing describes the continuing effects of COVID-19, including high customer liquidity, reduced loan balances and elevated cash holdings.

Financial results and condition

  • Q2 earnings: Net income was $8.8 million, or $0.30 diluted EPS, versus $9.2 million, or $0.31, in Q2 2020. Pretax income was $12.0 million versus $12.4 million.
  • First-half earnings: Net income was $20.7 million, or $0.70 diluted EPS, versus $9.5 million, or $0.31, in the first half of 2020. Pretax income increased to $28.1 million from $12.4 million.
  • Interest income and margin: Q2 net interest and dividend income was $22.0 million, down from $22.7 million. GAAP net interest margin was 2.88%, compared with 3.42% a year earlier and 3.27% in Q1 2021. First-half net interest and dividend income was $45.5 million versus $45.4 million; GAAP margin was 3.07% versus 3.56%.
  • Other income and expenses: Q2 noninterest income fell to $7.9 million from $10.7 million, largely on lower mortgage loan sale gains and a less favorable mortgage-servicing-rights valuation. First-half noninterest income rose to $19.2 million from $17.0 million. Noninterest expense increased 13.3% year over year in Q2 to $21.4 million and 8.1% in the first half to $43.1 million.
  • Credit provision and asset quality: The company recorded a $3.5 million net provision release in Q2 and a $6.5 million release for the first half, versus a $2.1 million provision in Q2 2020 and a $10.1 million provision in first-half 2020. The June 30 loan allowance was $28.6 million, or 1.5% of loans, down from $33.9 million and 1.7% at year-end 2020. Nonperforming loans were $23.1 million, or 1.2% of loans, versus $23.0 million and 1.1% at year-end.
  • Balance sheet and liquidity: Total assets were $3.25 billion, up $209.8 million from year-end. Cash and cash equivalents rose $262.9 million to $592.8 million; available-for-sale securities increased $83.8 million to $579.9 million. Deposits increased $144.9 million to $2.68 billion, principally in noninterest-bearing and other transaction accounts.
  • Loans: Total loans declined $131.5 million from year-end to $1.90 billion, primarily because of PPP loan forgiveness and borrower paydowns. Real estate-related loans represented 73.2% of the portfolio.
  • Cash flow: For the first half, operating activities provided $24.5 million, investing activities provided $47.0 million and financing activities provided $191.4 million. Cash and cash equivalents increased $262.9 million.
  • Debt and capital: Total borrowings were $219.2 million, up from $160.5 million at year-end, including $59.2 million of net proceeds from $60 million of subordinated notes issued in April. The company and bank exceeded applicable regulatory capital requirements; the bank’s total capital ratio was 16.33% and Tier 1 leverage ratio was 10.63%. Stockholders’ equity was $315.9 million.

Material changes and management commentary

  • Q2 net income declined modestly despite the credit-reserve release. Lower loan yields and balances, weaker mortgage banking revenue and higher operating expenses offset much of the benefit.
  • Management attributed the first-half earnings improvement largely to the reversal of credit-loss provisions established amid 2020 uncertainty. It cited improving unemployment expectations and low net charge-offs, while noting estimates remain subject to economic conditions.
  • Mortgage loan sale gains were $1.9 million in Q2, versus $4.6 million a year earlier. Management also reported $832,000 of PPP loan interest and net fee income in Q2; $70.2 million of PPP loans remained outstanding at June 30.
  • The company issued $60 million of 3.50% fixed-to-floating subordinated notes due 2031. Proceeds may be used for general corporate purposes, including potential senior-debt redemption, repurchases or acquisitions. Separately, $44.4 million of senior notes are scheduled to begin floating-rate pricing in December 2021, based on three-month LIBOR plus 385 basis points.
  • The company repurchased 310,900 shares during Q2 at an average $13.55 per share. The repurchase program was extended through October 20, 2021, subject to its terms and regulatory requirements.
  • After quarter-end, Old Second announced an agreement to acquire West Suburban Bancorp in a cash-and-stock transaction. The filing anticipated closing in Q4 2021, subject to regulatory, stockholder and other approvals. The transaction terms provide West Suburban shareholders 42.413 Old Second shares and $271.15 cash per West Suburban share.

Outlook, risks and contingencies

  • No quantitative earnings guidance is provided. Management said it believes the bank is positioned for moderate loan growth, but described the outlook as uncertain.
  • COVID-19, variants, economic conditions, interest rates, borrower repayment capacity, real-estate values and customer liquidity remain risks. Management noted that deterioration in conditions could increase expected credit losses and adversely affect capital, liquidity and results.
  • Management reported 18 loans totaling $9.1 million still in active COVID-related deferral at June 30; $2.4 million of those loans were nonaccrual. Of 506 loans previously modified, 488 had resumed payments or paid off.
  • The proposed West Suburban merger carries approval, integration, execution, customer-retention, employee-retention, cost and timing risks; failure to complete it could also have adverse consequences.
  • Interest-rate sensitivity modeling estimated pretax income increases of 6.4%, 13.2% and 26.7% under immediate rate increases of 0.5%, 1.0% and 2.0%, respectively. Down-rate scenarios were not meaningful because rates would fall below zero. The filing cautions that modeled outcomes are not forecasts and exclude possible management actions.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected by management to have a material adverse effect.

Important facts for investors to verify

  • Whether the West Suburban transaction receives required approvals, closes on the expected timetable and achieves its anticipated benefits.
  • Whether loan growth, PPP forgiveness and borrower paydowns stabilize, and whether credit quality or active deferrals deteriorate.
  • Whether credit-reserve releases remain appropriate as economic forecasts change; first-half profit benefited materially from releases rather than provision expense.
  • Whether net interest margin stabilizes amid low rates, substantial cash balances and upcoming floating-rate debt terms, including the senior notes’ December 2021 reset.
  • How the subordinated-note proceeds are deployed and how repurchases, dividends and the merger affect capital and liquidity.