Old Second Bancorp, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Old Second is an Illinois-based bank holding company whose subsidiary provides commercial and retail banking, trust and wealth-management services. Financial amounts below are in millions unless otherwise noted.
Financial performance and condition
| Metric | Q2 2015 / June 30, 2015 | Comparable period / prior date |
|---|---|---|
| Net interest income | $14.9 | $13.7 in Q2 2014 |
| Net interest margin, tax-equivalent | 3.25% | 3.04% in Q2 2014; 3.26% in Q1 2015 |
| Noninterest income | $8.3 | $7.5 in Q2 2014 |
| Noninterest expense | $18.9 | $19.1 in Q2 2014 |
| Net income | $4.1 | $2.0 in Q2 2014 |
| Net income available to common shareholders | $3.4; diluted EPS $0.12 | $7.5; diluted EPS $0.26 in Q2 2014 |
| Six-month net income / common income | $7.6 / $6.1; diluted EPS $0.21 | $4.2 / $8.1; diluted EPS $0.38 in H1 2014 |
| Total assets | $2,065.1 | $2,061.8 at Dec. 31, 2014 |
| Total loans / net loans | $1,158.9 / $1,140.6 | $1,159.3 / $1,137.7 at Dec. 31, 2014 |
| Total deposits | $1,713.6 | $1,685.1 at Dec. 31, 2014 |
| Cash and cash equivalents | $38.5 | $44.2 at Dec. 31, 2014 |
| Stockholders’ equity | $185.2 | $194.2 at Dec. 31, 2014 |
- For the first half, net interest income rose $2.3 million year over year as loan income increased and interest expense declined, particularly on time deposits and junior subordinated debentures. Noninterest income increased to $16.2 million from $13.8 million, reflecting stronger mortgage banking revenue and a nonrecurring $917,000 service-provider incentive payment received in Q1 2015.
- Q2 net income improved year over year, but common earnings and EPS were lower because Q2 2014 included preferred-stock dividend waivers and a preferred-stock redemption gain. These prior-period items make the common-income comparison less representative of underlying operations.
- Q2 2015 net interest margin edged down from Q1. Average earning assets increased sequentially, while the average earning-asset yield fell to 3.69% from 3.71%; funding cost decreased to 0.61% from 0.63%.
- Operating cash flow was $7.2 million in H1 2015, versus an outflow of $20.0 million in H1 2014. Investing activities used $10.1 million and financing activities used $2.7 million; cash declined $5.7 million during the half.
- Loans were essentially flat versus year-end, with commercial lending growth offset by declines in construction and other categories. Deposits increased from year-end, though they fell $31.2 million in Q2. Available-for-sale securities increased $14.4 million from year-end; held-to-maturity securities declined $6.3 million.
Credit quality, capital, and liquidity
- The company recorded a $2.3 million loan-loss reserve release in Q2. The allowance fell to $18.3 million, or 1.6% of loans, from $21.6 million, or 1.9%, at year-end. Q2 net charge-offs were $560,000; allowance coverage of nonperforming loans was 95.0%.
- Nonperforming loans were $19.3 million at June 30, down from $23.4 million at March 31 and $27.1 million at December 31, 2014. Classified loans declined to $20.9 million from $40.9 million at year-end; management cited loan sales and ongoing credit-quality work.
- Other real estate owned (OREO) was $32.0 million, little changed from year-end and down from $39.2 million a year earlier. Q2 OREO expense was $2.4 million, including $2.1 million of valuation adjustments. The OREO valuation reserve was $20.1 million; properties totaling $2.5 million had been held for at least five years.
- The loan portfolio is concentrated in real estate-related lending, which represented 87.2% of loans. Management cautioned that actual loan or OREO losses could exceed estimates.
- The Bank’s June 30 capital ratios included a 12.33% Tier 1 leverage ratio, 17.42% common equity Tier 1 ratio, and 18.68% total capital ratio. The Bank exceeded management’s stated 8% leverage and 12% total risk-based capital objectives and regulatory “well capitalized” thresholds.
- Borrowings totaled $156.3 million, including $58.4 million of junior subordinated debentures and $45.0 million of subordinated debt. The company reported compliance with its credit-facility covenants. It had $100.2 million of excess collateral available to secure FHLB borrowings.
Outlook, risks, and notable items
- Management described local economic growth as steady but sluggish, with continued uncertainty, cautious investment, and strong competition. It cited competitive pressure on new and renewed loan pricing, while continuing to develop loan pipelines and expecting pipeline volume to generate future loan growth. No quantitative earnings or growth guidance was provided.
- Management said the residential mortgage business performed strongly in H1 2015. Q2 mortgage banking revenue was $2.5 million, up from $1.3 million in Q2 2014. The company expects a Batavia, Illinois branch closure scheduled for September 30, 2015, to have no material performance impact.
- In July 2015, the company announced redemption of its remaining 31,553 Series B preferred shares on August 14, 2015, at $1,000 per share plus accrued unpaid dividends. The redemption follows the January 2015 redemption of 15,778 shares and will reduce preferred equity and related dividend obligations.
- Interest-rate risk modeling estimated annual pretax income increases of 0.8%, 2.1%, and 4.4% under immediate rate increases of 0.5%, 1%, and 2%, respectively; a 0.5% rate decline modeled a 1.6% decrease. Scenarios for rate declines of 1% or more were unavailable because of the low-rate environment. Management characterized current exposure as low; model results are not forecasts and exclude management actions.
- Risks include economic and real-estate conditions, credit losses, OREO valuation and disposal, loan and deposit competition, interest-rate changes, and the ability to realize deferred tax assets. The filing reported no material changes to the 2014 Form 10-K risk factors. Routine legal proceedings were not expected by management to have a material adverse effect. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the planned August 14, 2015 Series B redemption was completed as announced, and its effects on capital, liquidity, and common earnings.
- Whether the $2.3 million reserve release is sustainable: monitor subsequent provisions, charge-offs, nonperforming loans, classified credits, and allowance coverage.
- Whether OREO valuations and disposition activity result in additional expenses or losses, particularly for long-held properties.
- Whether loan growth and mortgage-banking revenue continue, and how competitive pricing affects net interest margin.
- How deposit balances, cash levels, collateral availability, and borrowing needs evolve after the preferred-stock redemption.
- How the $917,000 nonrecurring incentive payment and other unusual items affect comparisons of recurring revenue and expenses.