Business Context and Reporting Period
Company: Old Second Bancorp, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2010
Business Overview: A Delaware bank holding company operating Old Second National Bank, a full-service community bank with 27 locations in the Chicago metropolitan area (primarily Aurora, Illinois, and surrounding counties). The company focuses on commercial and retail lending, trust services, and wealth management.
Key Financial Metrics
Profitability:
- Net Loss (2010): $108.6 million (compared to a $65.6 million loss in 2009).
- Return on Average Assets: -4.48%.
- Return on Average Equity: -61.79%.
- Total Gross Loans: $1.69 billion (down from $2.06 billion in 2009).
- Nonperforming Assets: $308.0 million (14.5% of total assets), up from $231.4 million in 2009.
- Nonperforming Loans: $228.9 million (13.5% of total loans).
- Net Charge-offs: $77.9 million (4.10% of average loans).
- Allowance for Loan Losses: $76.3 million (4.5% of total loans).
- Regulatory Capital Status: The Bank failed to meet the heightened Tier 1 leverage ratio (8.10% actual vs. 8.75% required) agreed upon with the OCC, though it met the total risk-based capital ratio (11.63% actual vs. 11.25% required).
- TARP Participation: Holds $73.0 million in Series B Preferred Stock issued to the U.S. Treasury. Dividends on this stock were deferred starting August 2010.
- Dividends: Common stock dividends were suspended in Q3 2010. The company is prohibited from paying common dividends until deferred interest on junior subordinated debentures and deferred dividends on TARP preferred stock are paid in full.
- Net Interest Income (Tax Equivalent): $79.7 million (down from $90.2 million in 2009).
- Net Interest Margin (TE): 3.64%.
Material Changes vs. Prior Period
- Increased Losses: Net loss widened significantly from $65.6 million in 2009 to $108.6 million in 2010 due to higher provisions for loan losses and increased nonperforming assets.
- Loan Portfolio Contraction: Gross loans decreased by approximately $372 million year-over-year, driven by a sharp reduction in construction loans (from $273.7 million to $129.6 million) and commercial real estate loans.
- Deteriorating Asset Quality: Nonperforming assets increased by 33% year-over-year, with nonaccrual loans rising to $212.2 million.
- Regulatory Compliance: The Bank lost compliance with its agreed-upon heightened Tier 1 leverage ratio, a deviation from its status in 2009 and early 2010.
Outlook, Risks, and Management Commentary
Regulatory Enforcement: Management expects the Office of the Comptroller of the Currency (OCC) to replace the current Memorandum of Understanding (MOU) with a formal regulatory enforcement action due to the failure to meet heightened capital ratios and continued asset quality issues. This could restrict growth, increase funding costs, and limit dividend payments.
Capital Strategy: The company attempted several capital transactions in 2010 but was unsuccessful. Future capital raising may be dilutive given the low stock price. The company is subject to the Dodd-Frank Act and Basel III, which will impose stricter capital requirements.
Risk Factors:
- Real Estate Concentration: Real estate-related loans (commercial, construction, residential) comprise 89.2% of the portfolio, exposing the bank to significant risk from declining property values in its primary market area.
- Liquidity Constraints: Reliance on deposits and loan repayments is high due to limited access to capital markets. Negative publicity could trigger deposit outflows.
- Stock Price Volatility: The common stock price has declined substantially (trading below $1.00), raising the risk of delisting from NASDAQ.
- Legal Proceedings: A class action lawsuit was filed in February 2011 regarding the company's 401(k) plan under ERISA.
Investor Verification Checklist
- Capital Adequacy: Verify the specific terms of the expected formal enforcement action from the OCC and the company's plan to restore the Tier 1 leverage ratio to 8.75%.
- Asset Quality Trends: Monitor the trajectory of nonperforming assets and the adequacy of the allowance for loan losses (currently 33.3% of nonperforming loans) against future charge-offs.
- Dividend Restrictions: Confirm the timeline for paying down deferred interest on junior subordinated debentures ($2.2 million deferred as of year-end) and TARP preferred dividends ($1.4 million deferred) to determine when common dividends might resume.
- Stock Listing Status: Track the common stock price relative to the $1.00 NASDAQ minimum bid price requirement to assess delisting risk.
- Real Estate Exposure: Assess the impact of local Illinois real estate market conditions on the 89.2% real estate loan concentration.