Old Second Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Old Second Bancorp is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. Financial statements are unaudited; amounts below are in U.S. dollars.
Financial results and condition
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $15.4 million | $14.9 million | $30.6 million | $29.5 million |
| Noninterest income | $7.3 million | $8.3 million | $13.6 million | $16.2 million |
| Noninterest expense | $16.7 million | $18.9 million | $33.0 million | $36.1 million |
| Income before taxes | $5.9 million | $6.6 million | $11.2 million | $12.0 million |
| Net income | $3.8 million | $4.1 million | $7.2 million | $7.6 million |
| Diluted EPS | $0.13 | $0.12 | $0.24 | $0.21 |
- Q2 net interest margin was 3.19% on a GAAP basis and 3.22% on a tax-equivalent basis; tax-equivalent margin was 3.25% in Q2 2015. The six-month tax-equivalent margin was 3.24%, versus 3.26%.
- Q2 noninterest income declined year over year, notably due to a $1.0 million mortgage-servicing-rights write-down and lower deposit service charges. Six-month noninterest income was down $2.7 million, largely reflecting mortgage servicing valuation changes.
- Expenses fell year over year, including lower salaries and OREO costs. Q2 expense increased 2.7% sequentially, partly due to a $317,000 debit-card contract renewal accrual. The reported efficiency ratio was 68.92% for Q2.
- At June 30, total assets were $2.16 billion, loans $1.16 billion, deposits $1.78 billion, and stockholders’ equity $167.6 million. Since December 31, 2015, loans rose 2.4%, deposits rose 1.3%, and equity increased $11.7 million.
- Cash and cash equivalents were $40.3 million, essentially unchanged from year-end. Six-month operating cash flow was $7.7 million; investing cash outflow was $74.3 million and financing cash inflow was $66.6 million. Financing included $35.0 million of additional short-term borrowings.
- Total borrowings were $196.2 million, up from $152.1 million at year-end. This included $50.0 million in FHLB advances, $43.1 million in repurchase agreements, $57.6 million in junior subordinated debentures, and $45.0 million in subordinated debt. The company reported compliance with debt covenants.
- The Bank’s Tier 1 leverage ratio was 10.26% and total risk-based capital ratio 15.74%; both exceeded management’s stated objectives. Consolidated tangible common equity to tangible assets was 7.76%.
Material changes and notable items
- In Q2, the company reclassified its entire $244.8 million held-to-maturity securities portfolio to available-for-sale to permit portfolio restructuring and support loan growth. The transfer means it cannot hold securities to maturity for two years. Available-for-sale securities totaled $764.6 million at quarter-end.
- Loan growth was led by commercial and industrial lending. Real-estate-related loans remained 84.0% of the portfolio, down from 86.1% at year-end.
- Nonperforming loans rose to $18.4 million from $14.6 million at year-end, primarily due to two commercial real estate relationships affected by the loss of major tenants. Classified loans increased to $27.7 million from $25.2 million.
- The allowance for loan losses was $15.8 million, or 1.36% of loans and loans held for sale; coverage of nonperforming loans was 85.9%, down from 111.0% at year-end. Q2 net charge-offs were $424,000. Management recorded no loan-loss provision or release in Q2; Q2 2015 included a $2.3 million reserve release.
- OREO declined to $16.3 million from $19.1 million at year-end. The company recorded $940,000 of OREO valuation adjustments in the first half; about 20.8% of quarter-end OREO had been held for at least five years.
- Common shareholders received a $0.01-per-share dividend during the first half. A further $0.01 dividend was declared July 19, payable August 9, 2016.
Outlook, commentary, risks, and contingencies
- Management described local market growth as moderate and noted continued uncertainty and reluctance among consumers and businesses to invest. It cited competitive pressure on loan pricing and low interest rates as challenges to profitability and mortgage-servicing income. No numerical earnings or revenue guidance was provided.
- Management said credit performance remained generally sound, but highlighted the commercial real estate tenant losses, rising nonperforming loans, and uncertainty that actual credit losses could exceed estimates. Real estate represents a substantial share of lending, creating exposure to regional property and economic conditions.
- Interest-rate sensitivity modeling estimated annual pretax income changes of -3.6% under an immediate 0.5% rate decline, +1.4% under a 0.5% increase, +3.1% under a 1.0% increase, and +6.2% under a 2.0% increase. Larger rate-decrease scenarios were unavailable because of the low-rate environment; actual results may differ from model estimates.
- On August 1, the company announced an agreement to acquire Talmer Bank and Trust’s Chicago branch, including approximately $82 million of deposits and $237 million of loans. Closing was expected in Q4 2016, subject to regulatory approval, Talmer’s pending merger, and customary conditions.
- Other commitments include $11.7 million of letters of credit. Management said ordinary-course legal proceedings are not expected to have a material adverse effect. No material risk-factor changes were reported; the filing refers readers to the 2015 Form 10-K.
Important facts for investors to verify
- Whether the two commercial real estate borrowers secure replacement tenants or refinance, and how nonperforming and classified loans evolve.
- Whether allowance coverage remains adequate as charge-offs, OREO valuations, and the two-year securities classification restriction affect results and flexibility.
- How mortgage-servicing-rights marks and low-rate conditions affect noninterest income and margins.
- Completion, regulatory approval, funding, and final balance-sheet impact of the Talmer branch acquisition.
- Borrowing costs, deposit trends, capital ratios, and dividend capacity; the filing notes regulatory limits on bank dividends.