Old Second Bancorp, Inc. — Q3 2015 Form 10-Q
Business context and reporting period
Old Second Bancorp is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. This unaudited filing covers the quarter and nine months ended September 30, 2015. Unless otherwise noted, financial amounts below are in millions.
Key financial results and position
| Metric | Q3 2015 / Sep. 30, 2015 | Comparable period / prior date |
|---|---|---|
| Net interest income | $14.8 | $14.7 in Q3 2014 |
| Net income | $3.9 | $2.9 in Q3 2014 |
| Net income available to common shareholders | $3.6; diluted EPS $0.12 | $1.9; diluted EPS $0.06 in Q3 2014 |
| Net interest margin, tax-equivalent | 3.22% | 3.26% in Q3 2014; 3.25% in Q2 2015 |
| Efficiency ratio | 73.73% | 73.51% in Q3 2014; 70.44% in Q2 2015 |
| Total assets | $2,049.6 | $2,061.8 at Dec. 31, 2014 |
| Loans / deposits | $1,132.9 / $1,720.5 | $1,159.3 / $1,685.1 at Dec. 31, 2014 |
| Cash and cash equivalents | $53.8 | $44.2 at Dec. 31, 2014 |
| Allowance for loan losses | $16.6, or 1.46% of average loans | $21.6 at Dec. 31, 2014 |
| Other real estate owned (OREO) | $24.5 | $32.0 at Dec. 31, 2014 |
| Total stockholders’ equity | $153.6 | $194.2 at Dec. 31, 2014 |
For the first nine months, net interest income was $44.3 versus $41.9 in 2014; net income was $11.6 versus $7.1. Net income available to common shareholders was $9.7 versus $9.9, and diluted EPS was $0.33 versus $0.41. The 2014 common-shareholder comparison included preferred-stock redemption-related benefits.
Nine-month cash flows were $15.3 provided by operating activities, $12.7 provided by investing activities, and $18.4 used in financing activities. Cash and cash equivalents increased $9.6 from year-end.
Total borrowings were $166.0, including $58.4 of junior subordinated debentures and $45.0 of subordinated debt. The Bank’s Tier 1 leverage ratio was 11.26% and total capital ratio was 17.10%; both exceeded the Bank’s stated internal targets of 8% and 12%, respectively. The company reported $135.8 of excess FHLB collateral available to support borrowing.
Material changes versus comparable periods
- Q3 net income rose year over year, while nine-month net income increased substantially. Lower interest expense, lower noninterest expense, and a larger loan-loss reserve release supported the nine-month improvement.
- Q3 noninterest income declined to $5.6 from $8.3 a year earlier, including a $1.1 loss related to closing a Batavia branch, mortgage-servicing valuation losses, and securities losses. Q3 noninterest expense fell to $16.2 from $18.3.
- Loans declined 2.3% from year-end, with construction loans down 47.6% and residential real estate loans down 4.3%. Deposits increased 2.1% from year-end.
- Nonperforming loans were $18.5, down 31.6% from $27.1 at year-end. Classified loans were $24.6, down 39.8% from year-end but up 17.6% from June. OREO declined 23.5% from year-end.
- The company redeemed its remaining Series B preferred stock in August; none remained outstanding at quarter-end. The redemption was a principal reason equity declined from year-end.
Outlook, management commentary, risks, and unusual items
- No numerical earnings or growth guidance was provided. Management described local-market growth as sluggish, loan demand as constrained, and competition as intense. It reported strong residential mortgage performance over the first nine months, while noting that Q3 mortgage revenue was lower than Q2.
- Management recorded a $2.1 loan-loss reserve release in Q3, following a $2.3 release in Q2. It revised reserve methodology; the estimated effect of the methodology changes on required reserves was approximately $1.4. Management considered the reserve adequate but cautioned that actual losses could exceed estimates.
- Management cited interest-rate, credit, liquidity, competitive, and economic risks. Real-estate-related loans represented 87.2% of the portfolio. The filing reports $2.7 of OREO held for at least five years and $3.8 of OREO valuation adjustments for the first nine months.
- A $25.8 notional forward-starting interest-rate swap was entered into to hedge certain trust-preferred debt expected to float beginning in 2017. The swap had a $0.8 unrealized loss recorded in other comprehensive income at quarter-end.
- The company reported covenant compliance and timely debt-interest payments. Management expected ordinary-course legal matters, if any liabilities arise, not to have a material adverse effect. It reported no material changes to the prior annual report’s risk factors and stated disclosure controls were effective.
Important facts for investors to verify
- Whether reserve releases and the updated allowance methodology remain appropriate as credit conditions and classified loans evolve.
- The sustainability of earnings given reduced loan balances, competitive pressure on loan yields, and lower Q3 noninterest income.
- OREO sale progress and potential additional valuation losses, particularly for long-held properties.
- Liquidity and capital after preferred-stock redemption, including access to FHLB funding and compliance with regulatory and debt covenants.
- The effect of interest-rate changes on net interest income and the effectiveness and accounting treatment of the new cash-flow hedge.