Old Second Bancorp, Inc. — Q1 2016 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 three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q1 2016 / March 31, 2016 | Comparable period / prior date |
|---|---|---|
| Net interest and dividend income | $15.2 | $14.6 in Q1 2015; $14.8 in Q4 2015 |
| Net interest margin, tax-equivalent | 3.25% | 3.26% in Q1 2015; 3.17% in Q4 2015 |
| Noninterest income | $6.3 | $8.0 in Q1 2015 |
| Noninterest expense | $16.3 | $17.2 in Q1 2015 |
| Net income | $3.3 | $3.5 in Q1 2015 |
| Net income available to common shareholders; diluted EPS | $3.3; $0.11 | $2.7; $0.09 in Q1 2015 |
| Total assets; stockholders’ equity | $2,121.3; $156.7 | $2,077.0; $155.9 at December 31, 2015 |
| Loans; deposits | $1,138.8; $1,796.7 | $1,133.7; $1,759.1 at December 31, 2015 |
| Cash and cash equivalents | $36.6 | $40.3 at December 31, 2015 |
Q1 operating cash flow was $3.1 million, investing cash flow was negative $49.2 million, and financing cash flow was positive $42.4 million, resulting in a $3.7 million decrease in cash and cash equivalents. Investing outflows chiefly reflected securities purchases. Total borrowings were $156.9 million, including $57.6 million of junior subordinated debentures and $45.0 million of subordinated debt. The $45.0 million subordinated debt and $0.5 million term debt mature March 31, 2018; the company reported compliance with credit-facility covenants.
The Bank’s March 31 capital ratios included a 10.04% Tier 1 leverage ratio and 15.49% total risk-based capital ratio. These exceeded the board’s stated targets of 8% and 12%, respectively. The company reported a 7.39% tangible common equity-to-tangible assets ratio, a non-GAAP measure.
Material changes versus comparable periods
- Net interest income increased $0.6 million year over year, supported by higher average earning assets, while tax-equivalent net interest margin declined one basis point.
- Net income was lower year over year, but common earnings per share rose to $0.11 from $0.09. Q1 2015 earnings available to common shareholders included $0.8 million of preferred dividends and accretion; preferred stock was fully redeemed during 2015.
- Noninterest income fell $1.7 million year over year. Mortgage servicing revenue was affected by a $1.0 million valuation write-down, and mortgage loan sale gains were lower. Q1 2015 other income included a $0.9 million incentive payment and a life-insurance death benefit.
- Noninterest expense declined $0.9 million year over year, principally reflecting lower OREO and salary-related costs. The efficiency ratio rose to 71.12% from 68.77% in Q1 2015.
- Loans increased $5.1 million from year-end, despite $14.6 million in unexpected payoffs from two large customers; loans were down $12.2 million year over year. Deposits increased $37.6 million from year-end.
Outlook, risks, contingencies, and unusual items
- Management described local market growth as moderate and noted continued uncertainty and reluctance among individuals and businesses to invest. It reported competitive pressure on loan pricing, maintained stringent underwriting, and cited sustained credit quality. No formal earnings or financial guidance was provided; management cautioned that quarterly results are not necessarily indicative of full-year results.
- Nonperforming loans were $14.0 million, down from $14.6 million at year-end. The allowance for loan losses was $16.2 million, or 115.7% of nonperforming loans; Q1 had $23,000 of net recoveries and no loan-loss provision. Management considered the allowance adequate but cautioned actual losses could exceed estimates.
- Real-estate-related loans represented 85.3% of the loan portfolio. Other real estate owned was $17.7 million; approximately 19% had been held for five years or more. Management cautioned that further OREO losses could arise on disposal or revaluation.
- The securities portfolio totaled $746.9 million. Available-for-sale securities had $18.3 million of gross unrealized losses; management attributed changes primarily to interest-rate fluctuations and reported no credit deterioration requiring impairment. The portfolio included $240.8 million of FFEL-backed student-loan securities, with at least 97% of principal guaranteed by the U.S. Department of Education.
- Management described interest-rate risk as moderate. Its model estimated annual pre-tax income changes of negative 3.4% for an immediate 0.5% rate decrease and positive 1.4%, 3.3%, and 7.0% for increases of 0.5%, 1.0%, and 2.0%. The filing cautions that simulated results are not forecasts; larger rate-decrease scenarios were unavailable because of the low-rate environment.
- On April 19, 2016, the board declared a dividend of $0.01 per share, payable May 9 to shareholders of record April 29. The filing reported no material change in risk factors, effective disclosure controls, and legal proceedings not expected to have a material adverse effect.
Most important facts for investors to verify
- Whether mortgage servicing valuations and mortgage banking income stabilize, and whether lower noninterest income persists.
- Loan quality trends, especially commercial and residential real-estate exposures, classified loans, OREO valuations, and eventual realization of OREO sale proceeds.
- The credit, market-value, and liquidity risks of the investment portfolio, particularly asset-backed securities and the FFEL-backed holdings.
- Net interest margin and earnings sensitivity as rates change, including assumptions underlying the company’s simulations and the cash-flow hedge.
- Capital, liquidity, and refinancing position ahead of the March 2018 debt maturities, together with continued compliance with borrowing covenants and regulatory requirements.