Old Second Bancorp, Inc. — Q2 2014 Form 10-Q
Business and period. Old Second is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. This unaudited filing covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013.
Financial results and condition
Amounts below are in millions except per-share data and ratios.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $13.7 | $13.4 | $27.2 | $27.3 |
| Provision for loan losses | $(1.0) release | $(1.8) release | $(2.0) release | $(4.3) release |
| Noninterest income | $7.5 | $9.8 | $13.8 | $19.8 |
| Noninterest expense | $19.1 | $21.6 | $36.6 | $42.5 |
| Net income | $2.0 | $3.5 | $4.2 | $8.9 |
| Diluted EPS | $0.26 | $0.15 | $0.38 | $0.45 |
- Earnings quality: Q2 net income available to common shareholders was $7.5 million, including a $1.3 million benefit from redeeming preferred shares below liquidation value and $5.4 million from preferred dividends waived by redeemed holders. Management said EPS excluding these benefits was $0.02. GAAP net income was $2.0 million.
- Margins: Q2 net interest margin was 3.02% GAAP (3.04% tax-equivalent), versus 3.04% (3.07%) a year earlier. Tax-equivalent earning-asset yield fell to 3.66% from 3.83%; cost of interest-bearing funds declined to 0.82% from 0.96%.
- Balance sheet at June 30: Assets were $2.05 billion, up 2.1% from year-end. Loans were $1.13 billion, up 2.9%; deposits were $1.70 billion, up 1.1%. Cash and cash equivalents were $93.1 million, compared with $47.7 million at year-end. Stockholders’ equity was $192.6 million, up from $147.7 million.
- Cash flow, first half: Operating activities used $20.0 million, investing activities provided $6.4 million, and financing activities provided $59.0 million. Cash rose $45.4 million to $93.1 million. Financing included $64.4 million of common-stock proceeds; operating cash use included payment of $19.7 million of previously deferred trust-preferred interest.
- Debt and liquidity: Deposits were the principal funding source. Borrowings totaled $142.0 million, including $58.4 million of junior subordinated debentures, $45.0 million of subordinated debt, $38.1 million of repurchase agreements, and $0.5 million of term debt. The senior revolving line had been terminated with no balance outstanding. The Bank reported $114.5 million of excess collateral available to secure FHLB borrowings and no FHLB advances outstanding.
- Capital: The April common-stock offering issued 15.525 million shares and generated net proceeds exceeding $64 million. The Bank’s Tier 1 leverage ratio was 11.28% and total risk-based capital ratio was 18.29%; both exceeded management’s stated objectives of 8% and 12%, respectively.
Changes, outlook, and risks
- Compared with Q2 2013, lower mortgage-banking revenue, fewer securities gains, and the absence of a prior-year BOLI death benefit reduced noninterest income. Lower OREO and FDIC expenses helped bring noninterest expense down 11.6%.
- Management reported improving asset quality: nonperforming loans fell to $28.9 million from $38.6 million at March 31 and $39.8 million at year-end. Classified loans declined to $38.5 million from $62.2 million at year-end. The allowance was $23.9 million, or 82.5% of nonperforming loans; OREO was $39.2 million, down from $41.5 million at year-end. The company recorded a $1.0 million Q2 reserve release, citing improved portfolio quality. Management cautioned that actual losses could exceed estimates.
- Credit exposure remains concentrated in real estate-related lending, which comprised 88.3% of loans. Management described local economic recovery as modest and uneven, noted intense loan competition and pressure on loan yields, and said residential mortgage demand remained below 2013 levels. It expected the loan pipeline to support future growth but gave no specific numeric guidance.
- Material covenant risk: The company was out of compliance with one financial covenant under its credit agreement at June 30. The lender may have remedies relating to the remaining $0.5 million senior term debt, including acceleration; the filing states the subordinated debt has no additional acceleration remedies for this covenant breach. Verify the status of the breach and any waiver or cure.
- The Federal Reserve Written Agreement was terminated in January 2014, and the OCC Consent Order was terminated in October 2013. The company nevertheless expected to continue seeking Federal Reserve approval before paying dividends or incurring additional debt. Basel III requirements were scheduled to apply beginning January 1, 2015; management was assessing their impact.
- Management cited interest-rate, credit, liquidity, economic, and competitive risks. It reported that modeled net interest income declined under immediate rate increases at June 30; actual results may differ from the simulation. No material change to the prior annual report’s risk factors was reported. Ordinary-course legal matters were not expected by management to have a material adverse effect.
- Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Reconcile reported common EPS with the preferred-stock redemption and waived-dividend benefits; assess the underlying earnings run rate.
- Check the status and consequences of the financial covenant noncompliance and the terms of remaining borrowings.
- Track whether loan growth continues and whether net interest margin stabilizes amid competitive pricing and shifting asset mix.
- Validate continued improvement in nonperforming and classified loans, reserve adequacy, charge-offs, and OREO sales and valuations.
- Review cash generation excluding the one-time equity offering and deferred-interest payment, and monitor liquidity, capital, and Basel III readiness.