Old Second Bancorp, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. Old Second is an Illinois-focused community bank holding company operating 25 branches, primarily in the western and southern Chicago metropolitan area. Its sole operating segment is community banking.
Financial performance and condition
| Metric | 2017 | 2016 |
|---|---|---|
| Total assets at year-end | $2.383 billion | $2.251 billion |
| Gross loans at year-end | $1.618 billion | $1.479 billion |
| Total deposits at year-end | $1.923 billion | $1.867 billion |
| Net interest and dividend income | $74.9 million | $63.4 million |
| Net income | $15.1 million | $15.7 million |
| Diluted earnings per share | $0.50 | $0.53 |
| Net interest margin, tax-equivalent | 3.70% | 3.31% |
| Return on average assets / equity | 0.65% / 7.89% | 0.73% / 9.43% |
- Revenue and earnings: Net interest income rose 18.0%, supported by loan growth and $1.3 million of accretion on acquired loans. Noninterest income increased 6.3% to $30.4 million; noninterest expense rose 3.6% to $69.1 million.
- Unusual tax item: Income tax expense was $19.2 million, including a $9.5 million charge to remeasure deferred tax assets after federal tax reform reduced the corporate rate to 21%. A $1.6 million benefit from an Illinois tax-rate increase partially offset it. Fourth-quarter net loss was $2.5 million; annual net income remained positive.
- Cash flow and liquidity: Operating cash flow was $37.1 million; investing cash outflow was $132.5 million and financing cash inflow was $103.9 million. Year-end cash and cash equivalents were $55.8 million, up from $47.3 million. The Bank reported $132.0 million of remaining FHLB funding availability after outstanding advances and letters of credit.
- Credit quality: Nonperforming assets declined to $24.0 million from $27.9 million; nonperforming loans were $15.6 million. Net charge-offs fell to $497,000 from $815,000. The allowance for loan and lease losses was $17.5 million, or 1.08% of gross loans.
- Capital and debt: Stockholders’ equity increased to $200.4 million from $175.2 million. The Bank’s year-end capital ratios were 12.88% CET1, 13.78% total risk-based capital and 10.79% Tier 1 leverage; it was reported well-capitalized. Borrowings included $115.0 million of FHLB advances, $29.9 million of repurchase agreements, $57.6 million of junior subordinated debentures and $44.1 million of senior notes.
Material changes versus 2016
- Loans grew 9.4% year over year, reflecting organic lending and purchases of $16.7 million of home-equity lines and $17.1 million of leases. Real estate-related lending was 78.0% of the portfolio, down from 79.7%.
- Deposits increased 3.0%, including growth in commercial demand, money-market and savings balances. FHLB advances increased by $45.0 million to $115.0 million.
- Tax-equivalent net interest margin rose 39 basis points. Net interest income increased, but net income declined because of the tax-reform charge and higher provision, compensation and funding costs.
- Nonperforming assets declined 14.0%; other real estate owned fell to $8.4 million from $11.9 million.
- The securities portfolio was substantially repositioned toward state and municipal securities and away from mortgage-related and asset-backed holdings. Net unrealized securities gains improved equity compared with the prior-year unrealized loss position.
Outlook, risks and other notable matters
- Proposed acquisition: In December 2017, Old Second agreed to acquire Greater Chicago Financial Corp. and ABC Bank for approximately $41.1 million in cash, and to retire $6.3 million of its subordinated debentures. ABC Bank had $342.6 million of assets, including $234.4 million of net loans, at year-end. Shareholders approved the deal; regulatory approval and customary conditions remained outstanding. Closing was expected in the second quarter of 2018. Management cautioned that integration costs, delays, customer attrition or lower-than-expected savings could impair expected benefits.
- Interest-rate sensitivity: Management described interest-rate risk as moderate. Its model estimated annual pretax income would increase 6.7% with an immediate 2% rate rise and decline 12.0% with a 2% decline; modeled outcomes are not forecasts.
- Principal risks: Concentration in Illinois and real estate lending; borrower defaults and collateral-value declines; construction and commercial real estate exposure; deposit competition and funding costs; interest-rate changes; regulatory and capital requirements; cybersecurity and vendor dependence; and execution risks from acquisitions. Commercial real estate loans equaled 298.7% of risk-based capital.
- Accounting and legal matters: Management expected the CECL expected-credit-loss standard, applicable in 2020, could materially affect the allowance and increase its volatility. Routine litigation was disclosed; management believed any resulting liability would not materially affect the company, based on information then available.
- Audit and controls: The auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
- Guidance: The filing provides no quantified earnings or revenue guidance. Management cited improving but still challenging local real estate and economic conditions, competitive lending markets, and expectations for further rate increases.
Key facts for investors to verify
- Regulatory approval, final consideration and closing progress for the Greater Chicago Financial/ABC Bank acquisition, along with integration costs and realized synergies.
- Recurring earnings and tax impact after the one-time $9.5 million deferred-tax remeasurement charge; monitor deferred tax asset realizability and tax attributes.
- Loan growth quality, real estate concentration, construction exposure, nonperforming assets, charge-offs and allowance adequacy.
- Deposit retention and pricing, use and cost of FHLB advances, and liquidity under stress.
- Actual sensitivity of net interest income to changing rates versus the model estimates, including deposit repricing and funding costs.
- Capital buffers, dividend capacity and the eventual impact of CECL adoption.