Old Second Bancorp, Inc. — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; unaudited. Old Second Bancorp is an Illinois-focused bank holding company operating Old Second National Bank. Financial statement amounts below are in U.S. dollars; amounts identified as millions are rounded.
Financial performance and position
- Earnings: Net income was $11.9 million ($0.40 diluted EPS), versus $0.3 million ($0.01 diluted EPS) in Q1 2020. Pretax income was $16.1 million, compared with a $6,000 pretax loss.
- Interest income and margin: Net interest and dividend income was $23.5 million, up $0.9 million year over year. Net interest margin was 3.27% (3.32% tax-equivalent), down 44–45 basis points year over year. The average cost of interest-bearing liabilities fell to 0.41% from 1.17%.
- Noninterest income and expenses: Noninterest income rose 78.7% to $11.3 million, chiefly reflecting mortgage banking revenue of $5.7 million, including a $1.1 million MSR mark-to-market gain and $3.7 million of mortgage loan sale gains. Noninterest expense increased 3.5% to $21.7 million. The reported efficiency ratio was 63.98% (63.16% adjusted, non-GAAP).
- Assets and loans: Total assets were $3.17 billion at quarter-end, up $125.8 million from December 31, 2020. Loans were $1.96 billion, down $75.2 million, or 3.7%, from year-end; the filing attributes the decrease chiefly to PPP forgiveness and borrower paydowns. Loans were up 0.1% from March 2020.
- Credit quality: The allowance for credit losses on loans was $31.0 million, or 1.6% of loans, versus $33.9 million, or 1.7%, at year-end. The quarter included a $3.5 million loan allowance release and $470,000 of provision expense for unfunded commitments, producing a net $3.0 million benefit. Nonperforming loans were $21.2 million, 1.1% of loans, versus $23.0 million at year-end; net recoveries were $582,000.
- Cash flow and liquidity: Operating activities provided $15.4 million; investing activities used $26.6 million; financing activities provided $122.3 million. Cash and cash equivalents ended at $440.9 million, up $111.0 million from year-end. Deposits increased $119.5 million to $2.66 billion, primarily from stimulus-related inflows and lower spending.
- Debt and capital: Borrowings totaled $169.8 million, including $44.4 million of senior notes, $25.8 million of junior subordinated debentures, and $77.3 million of repurchase agreements. Bank capital ratios were 14.59% common equity Tier 1, 15.80% total risk-based capital, and 10.78% Tier 1 leverage; the Bank exceeded stated regulatory thresholds. Stockholders’ equity was $311.1 million.
Material changes versus comparable periods
- Net income improved sharply from Q1 2020, when results included an $8.0 million provision for credit losses; Q1 2021 instead recorded a net $3.0 million benefit. The comparison also reflects higher mortgage banking revenue and lower funding costs.
- Interest expense declined $2.9 million year over year, partly due to lower deposit rates and the 2020 redemption of $32.6 million of trust preferred securities and related debentures. Interest and dividend income declined $2.1 million as market rates fell, partly offset by higher average earning assets.
- Noninterest income increased $5.0 million year over year, while expenses rose $736,000. Service charges on deposits fell $531,000, which management associated with reduced overdraft activity amid pandemic-related stimulus and spending patterns.
- Compared with year-end 2020, securities available-for-sale increased $97.1 million to $593.3 million, while loans declined $75.2 million. Total deposits rose $119.5 million.
Outlook, commentary, and risks
- Management said it believes the company is positioned for moderate loan growth, but expects the continuing COVID-19 pandemic to make achieving historical profitability and growth levels challenging. No specific earnings or revenue guidance was provided.
- Management cited improving unemployment expectations and other indicators as support for the Q1 loan reserve release, but cautioned that delayed recovery or worsening conditions could increase future credit losses. Real estate-related lending represented 72.4% of the loan portfolio.
- COVID-19 remained a material uncertainty affecting borrowers, the economy, interest rates, liquidity, and asset values. Of 504 loans previously modified under CARES Act-related deferrals, 40 loans totaling $19.2 million remained in active deferral at quarter-end; $4.3 million of those were nonaccrual. The company reported $104.5 million of PPP loans outstanding at March 31 and $2.5 million of unearned net PPP fee income.
- Management reported no credit losses identified in the available-for-sale securities portfolio at March 31, but warned that future impairments or reductions in other comprehensive income remain possible. Goodwill was $18.6 million; management reported no impairment at its November 2020 annual review but noted future deterioration could lead to impairment.
- Interest-rate sensitivity modeling estimated that an immediate 100-basis-point increase would raise annual pretax net interest income by about $6.0 million. The filing says the model is not a forecast and that down-rate scenarios could not be calculated because rates would fall below zero.
- Subsequent events: On April 6, 2021, the company issued $60 million of 3.50% fixed-to-floating subordinated notes due 2031 for general corporate purposes, potentially including debt redemption, repurchases, or acquisitions. On April 20, the board declared a $0.05-per-share dividend payable May 10.
- The company reported ordinary-course collection suits and other legal actions; management did not expect any resulting liability to materially affect financial position. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether credit performance, active deferrals, classified loans, and the CECL allowance remain consistent with the assumptions supporting the Q1 reserve release.
- How loan demand and PPP forgiveness affect loan balances, net interest margin, and unearned PPP fee recognition; monitor funding costs as deposits and market rates change.
- Whether mortgage banking gains and MSR valuations are sustainable, given their significant contribution to the year-over-year earnings improvement.
- Use and terms of the $60 million subordinated note proceeds, including any debt redemption, share repurchases, or acquisitions; also track capital and liquidity after these actions.
- Confirm the pace and remaining authorization of repurchases: 455,134 shares were repurchased in Q1 at a weighted average $12.31, with 320,419 shares remaining under the program at March 31.