Old Second Bancorp, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet comparisons are to December 31, 2019. The company is an Illinois-focused bank holding company operating through Old Second National Bank.
Financial performance and condition
- Earnings: Net income was $275,000, or $0.01 per diluted share, versus $8.47 million, or $0.28 per share, in Q1 2019. Pretax results were a $6,000 loss; a $281,000 income-tax benefit produced positive net income.
- Revenue and margin: Net interest and dividend income was $22.66 million, down from $24.04 million. Tax-equivalent net interest margin was 3.77%, compared with 4.09%. Noninterest income was $6.32 million versus $6.48 million. Noninterest expense rose to $21.00 million from $19.19 million.
- Credit costs and asset quality: Provision for credit losses was $7.98 million, versus $450,000, including $5.50 million for loans and $2.50 million for unfunded commitments. The loan allowance was $30.05 million, or 1.55% of loans. Nonperforming loans increased to $21.84 million (1.1% of loans) from $15.85 million (0.8%) at year-end. Net charge-offs were $1.12 million, compared with $140,000 in Q1 2019.
- Cash flow: Operating activities provided $9.02 million, investing activities used $220,000, and financing activities provided $13.70 million. Cash and cash equivalents increased $22.51 million to $73.14 million.
- Balance sheet and liquidity: Total assets were $2.66 billion; loans were $1.96 billion and deposits were $2.20 billion. Deposits rose $68.89 million from year-end. Cash and cash equivalents were $73.14 million, and management reported additional available funding sources, including borrowing capacity and an undrawn $20 million line of credit.
- Debt and capital: Total borrowings were $154.29 million, down from $205.87 million at year-end. The company redeemed $32.6 million of trust-preferred securities and related debentures, partly funded by a new $20 million term note. The Bank’s total risk-based capital ratio was 14.07% and Tier 1 leverage ratio was 11.36%; both exceeded stated thresholds. Stockholders’ equity was $265.78 million, down from $277.86 million.
Material changes versus comparable periods
- Net income fell sharply year over year, chiefly reflecting the larger credit-loss provision, lower net interest income, and higher operating expenses.
- Lower market rates reduced loan and securities yields. Average loan balances grew year over year, but loan interest income still declined. The redemption of the trust-preferred securities also caused recognition of $635,000 in deferred issuance costs.
- Mortgage banking gains improved: net gains on mortgage loan sales were $2.25 million versus $762,000. These gains were partly offset by a $2.13 million mortgage-servicing-rights mark-to-market loss.
- CECL was adopted January 1, 2020. Day-one allowance increases were $5.9 million for loans and $1.7 million for unfunded commitments, with a $3.8 million after-tax reduction to retained earnings. The first-quarter provision reflected subsequent COVID-19 and economic-condition assessments.
- Unrealized losses on available-for-sale securities and cash-flow hedges contributed to a $6.38 million first-quarter other comprehensive loss.
Outlook, commentary, and risks
- Management said COVID-19 had restricted economic activity and was expected to adversely affect business and results, but the ultimate impact was uncertain. The company provided no specific earnings or financial forecast; management cautioned that achieving prior profitability and growth levels would be challenging.
- As of May 4, 2020, the company had executed 239 loan deferrals covering $104.1 million in balances and processed 267 PPP applications totaling $96.3 million. These are post-quarter figures. It also temporarily suspended consumer-loan late fees and paused new foreclosure and repossession actions through June 30, subject to reassessment.
- Key risks include borrower distress and collateral-value declines, further allowance increases under CECL, low interest rates and pressure on margins, deposit or liquidity stress, increased use of credit lines, and operational, cybersecurity, vendor, and PPP-related legal or guarantee risks.
- No goodwill impairment was recorded at March 31, 2020, but management warned that prolonged or worsening economic conditions could lead to impairment. Management also noted that no credit loss was identified in the available-for-sale securities portfolio at quarter-end.
- The board declared a $0.01-per-share dividend on April 21, payable May 11, 2020. The company repurchased 312,723 shares during Q1 at a weighted-average $7.06 per share.
Important facts for investors to verify
- How much of the Q1 credit provision reflects CECL adoption and how much reflects expected COVID-19-related deterioration, and how those estimates change in later quarters.
- Subsequent trends in deferrals, PPP lending, borrower delinquencies, nonperforming loans, classified assets, and net charge-offs.
- Whether deposit growth and borrowing capacity remain sufficient if customers draw on the $439.5 million of unused loan commitments or liquidity needs increase.
- How persistently low rates affect net interest margin, mortgage-servicing-rights valuations, and capital; the filing could not calculate down-rate sensitivity scenarios because modeled rates would fall below zero.
- Capital levels after credit losses and the company’s use of the five-year CECL regulatory-capital transition; also verify the implications of continued repurchases and dividends.