Old Second Bancorp, Inc. — FY 2011 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2011, with comparison to FY 2010. Old Second is an Illinois-focused community bank operating 27 locations in the Chicago metropolitan area. Financial figures below are in U.S. dollars; “m” means millions and “bn” means billions.
Financial performance and position
| Metric | FY 2011 / Dec. 31, 2011 | FY 2010 / Dec. 31, 2010 |
|---|---|---|
| Net interest and dividend income | $64.0m | $78.6m |
| Noninterest income | $36.0m | $44.9m |
| Net loss | $(6.5)m | $(108.6)m |
| Net loss available to common shareholders | $(11.2)m; $(0.79) per diluted share | $(113.2)m; $(8.03) per diluted share |
| Net interest margin, tax-equivalent | 3.54% | 3.64% |
| Net cash from operating activities | $29.3m | $69.2m |
| Total assets | $1.94bn | $2.12bn |
| Gross loans | $1.37bn | $1.69bn |
| Deposits | $1.74bn | $1.91bn |
| Stockholders’ equity | $74.0m | $84.0m |
Cash and cash equivalents were $50.9m at year-end, down from $98.8m. Investing activities provided $95.9m of cash and financing activities used $173.1m. Noninterest expense was $97.6m, compared with $100.6m. There was no income tax expense in 2011; the 2010 loss included $41.9m of tax expense, primarily from a valuation allowance against deferred tax assets.
Total borrowings were approximately $104.8m, including $58.4m of junior subordinated debentures, $45.0m of subordinated debt, and a $0.5m term note. The Company was out of compliance with two financial covenants under its credit facility at year-end. The filing reports $131.6m of available borrowing capacity with the FHLB and Federal Reserve and $230.1m of additional unencumbered securities that could be pledged.
At the Bank, regulatory capital ratios were 12.97% total risk-based capital, 11.70% Tier 1 risk-based capital, and 9.34% Tier 1 leverage, exceeding the heightened OCC targets. The Company’s corresponding consolidated ratios were 12.38%, 6.21%, and 4.98%.
Material changes versus FY 2010
- Net loss narrowed substantially, chiefly as provision for loan losses fell to $8.9m from $89.7m. Net charge-offs declined to $33.2m from $77.9m.
- Nonperforming loans fell 39.3% to $138.9m; nonperforming assets fell 24.6% to $232.2m. Other real estate owned (OREO), however, rose 23.4% to $93.3m.
- Loans contracted 19.0%, while available-for-sale securities increased 106.9% to $307.6m as management deployed liquidity amid weak qualified loan demand. Real-estate-related loans remained 91.5% of the portfolio.
- Net interest income declined 18.7%, reflecting a smaller earning-asset base; the tax-equivalent net interest margin narrowed 10 basis points.
- Deposits fell 8.8%, including a substantial reduction in time deposits and brokered CDs. Stockholders’ equity declined 11.9%.
Outlook, management commentary, risks and unusual items
- Management prioritized asset quality, capital and liquidity over loan growth, and intended to continue reducing real estate concentrations. It expected construction lending demand and activity to remain flat in 2012. No specific earnings or revenue guidance is provided.
- The Bank remained subject to an OCC Consent Order requiring, among other things, heightened capital ratios, credit-risk reduction, updated real estate appraisals, liquidity controls and prior OCC approval for dividends. The Company was also subject to a Federal Reserve Written Agreement restricting dividends, debt, share repurchases and distributions, and requiring capital and cash-flow plans.
- The Company had deferred interest on $58.4m of junior subordinated debentures; accumulated deferred interest was $6.8m at year-end. It had also suspended dividends on $73m of Treasury Series B preferred stock; accrued unpaid preferred dividends were $5.2m. After six missed quarterly preferred dividends, Treasury had the right to appoint two board representatives; it had sent an observer and indicated its intention to appoint representatives.
- The loan portfolio’s real-estate concentration, continued weakness in local property markets, borrower cash flows, foreclosures and potential further losses remain material risks. The allowance for loan losses was $52.0m, or 3.8% of gross loans and 37.4% of nonperforming loans; management cautioned actual losses could exceed estimates.
- The investment portfolio included $10.0m of Level 3 collateralized debt obligations with $7.9m of unrealized losses and low credit ratings. Management reported no other-than-temporary impairment in 2011 and said it did not intend, and was not more likely than not required, to sell before recovery.
- A purported ERISA class action relating to the Company’s 401(k) plan sought unquantified relief; mediation was being pursued. Management said ordinary-course legal matters were not expected to have a material adverse effect.
- The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether credit quality improvements continue, particularly the trajectory of nonperforming loans, OREO, charge-offs and the allowance for loan losses.
- Compliance with the OCC Consent Order’s capital and risk-management requirements, and with the Federal Reserve Written Agreement.
- The Company’s ability to meet debt covenants and maintain adequate liquidity as deposits and assets contract.
- Whether and when deferred trust-preferred interest and Treasury preferred dividends can be resumed, and the resulting effects on common shareholders and governance.
- The assumptions and valuation support for deferred tax assets, OREO and the Level 3 CDO holdings, as well as the outcome of the ERISA litigation.