Old Second Bancorp, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Old Second Bancorp is an Illinois-focused bank holding company providing commercial and retail banking, trust, and wealth-management services. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance and condition
| Metric | Q2 2011 / June 30, 2011 | Comparison |
|---|---|---|
| Net interest income | $16.5 | $20.0 in Q2 2010 |
| Provision for loan losses | $0.5 | $44.6 in Q2 2010 |
| Noninterest income | $9.4 | $10.8 in Q2 2010 |
| Noninterest expense | $24.4 | $25.5 in Q2 2010 |
| Net income (loss) | $1.0 | $(23.4) in Q2 2010 |
| Net loss available to common shareholders | $(0.2); diluted loss per share $(0.01) | $(24.5); diluted loss per share $(1.75) in Q2 2010 |
| Total assets | $1,981.4 | $2,123.9 at December 31, 2010 |
| Total loans / allowance for loan losses | $1,530.4 / $66.0 | $1,690.1 / $76.3 at December 31, 2010 |
| Deposits | $1,769.1 | $1,908.5 at December 31, 2010 |
| Cash and cash equivalents | $105.8 | $98.8 at December 31, 2010 |
| Total borrowings | $109.3 | $110.0 at December 31, 2010 |
| Stockholders’ equity | $81.0 | $84.0 at December 31, 2010 |
- For the first half, net interest income was $33.0 versus $41.0 in 2010; net loss was $2.1 versus $31.9. The company recorded a $4.5 provision for loan losses versus $63.8 in the prior-year period. No income tax benefit was recorded in 2011 despite the pretax loss.
- Tax-equivalent net interest margin was 3.59% in Q2, versus 3.61% a year earlier; for the first half it was 3.54%, versus 3.70%. Management attributed weaker interest income to smaller earning assets, higher nonaccrual loans, and asset repricing; lower funding costs partly offset the decline.
- First-half operating cash flow was $11.3, investing cash flow $135.9, and financing cash flow $(140.2). Cash increased $7.0 to $105.8. Financing outflow mainly reflected a $139.5 net decline in deposits; investing inflow included $114.4 from net loan reductions and $19.8 from OREO sales.
- Bank regulatory capital ratios at June 30 were 12.61% total risk-based capital, 11.33% Tier 1 risk-based capital, and 9.10% Tier 1 leverage. These exceeded the OCC Consent Order minimums of 11.25% total risk-based and 8.75% Tier 1 capital. Consolidated ratios were lower: 12.13%, 6.35%, and 5.10%, respectively.
Material changes and asset quality
- Assets declined 6.7% from year-end; loans fell 9.5%, reflecting weak qualified-borrower demand, charge-offs, and management’s focus on asset quality. Deposits decreased 7.3%, particularly time deposits, while noninterest-bearing demand and savings balances increased.
- Nonperforming loans declined to $179.4 from $228.9 at December 31, 2010. Net charge-offs were $14.8 in the first half, compared with $47.4 in the first half of 2010. The allowance was 4.31% of loans and covered 36.8% of nonperforming loans.
- Real-estate-related loans represented 90.2% of the portfolio at June 30. Commercial real estate nonperforming loans were $82.7, or 46.1% of nonperforming loans; construction and development nonperforming loans were $52.9, representing 55.9% of that loan category.
- OREO rose to $82.6 from $75.6 at year-end. First-half OREO valuation adjustments were $6.5; 40 properties were added in Q2, and the portfolio totaled 248 properties at quarter-end.
- Available-for-sale securities were $145.6. The portfolio included $11.7 of collateralized debt obligations (CDOs), with $6.2 of unrealized losses. Management reported no other-than-temporary impairment and said it did not intend to sell, and was more likely than not to hold, the securities until recovery. CDO valuations use Level 3 inputs and assumptions because market activity is limited and sporadic.
Outlook, regulatory matters, and risks
- No numerical earnings or revenue guidance is provided. Management said it expects construction-loan losses to continue trending downward and anticipates reducing the real-estate share of lending over time; it cautioned that actual credit and property losses could exceed current estimates.
- The OCC issued a Consent Order to the Bank on May 16, 2011, requiring a strategic and capital plan, credit-risk reduction measures, improved real-estate valuation processes, liquidity controls, and specified capital levels. The Bank reported meeting the required capital ratios at June 30.
- On July 22, 2011, after quarter-end, the holding company entered into a Federal Reserve Written Agreement. It restricts dividends, debt increases, stock repurchases, and distributions on subordinated debentures and trust preferred securities without prior approval, and requires capital and cash-flow plans and reports.
- The company remained out of compliance with two Bank of America credit-facility financial covenants. The lender may accelerate the $0.5 term loan and exercise remedies; the $45.0 subordinated debt is not subject to those acceleration remedies for this covenant default. The senior term debt was already subject to the default interest rate.
- The company had deferred interest on $58.4 of junior subordinated debentures; accrued unpaid interest was $4.5. It also deferred TARP preferred dividends, which totaled $3.2. Common dividends were suspended, and unpaid subordinated-debt interest and preferred dividends must be paid before common dividends can resume.
- Deferred tax assets related to operations were fully offset by a valuation allowance at June 30, reflecting management’s conclusion that realization was not more likely than not. The filing also reports a former employee’s ERISA class-action complaint seeking unquantified relief; the company moved to dismiss and intends to defend the claims.
Important facts for investors to verify
- Subsequent compliance with the OCC capital targets and all requirements of the OCC Consent Order and Federal Reserve Written Agreement.
- Trends in nonperforming loans, charge-offs, troubled debt restructurings, allowance coverage, and the high concentration in real-estate lending.
- OREO additions, sales, carrying values, and valuation losses, including whether property values stabilize as management expects.
- Liquidity and deposit trends, covenant status and lender rights, and the ability to meet deferred interest and preferred-dividend obligations.
- CDO valuation assumptions and credit performance, realization of deferred tax assets, and the outcome of the ERISA litigation.