Business Context and Reporting Period
Company: Old Second Bancorp, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Headquarters: Aurora, Illinois
Old Second Bancorp is a registered bank holding company operating as a full-service community bank. Its primary market area includes Aurora, Illinois, and surrounding counties (Kane, Kendall, DeKalb, DuPage, LaSalle, and Will). The Company conducts business through three banking subsidiaries: The Old Second National Bank of Aurora, Old Second Bank-Yorkville, and Old Second Bank-Kane County. As of December 31, 2006, the Company employed 582 full-time equivalent employees and operated 31 banking locations.
Key Financial Metrics
Note: All dollar amounts in the tables below are in thousands, except per share data.
Balance Sheet Highlights (Average Balances)
| Item | 2006 | 2005 |
|---|---|---|
| Total Assets | $2,377,771 | $2,239,334 |
| Total Loans (Gross) | $1,763,912 | $1,704,382 |
| Total Deposits | $1,992,249 | $1,883,351 |
| Stockholders' Equity | $154,690 | $144,843 |
Income Statement Highlights (Tax Equivalent Basis)
| Item | 2006 | 2005 |
|---|---|---|
| Total Interest Income | $144,953 | $123,025 |
| Total Interest Expense | $70,830 | $46,224 |
| Net Interest Income (TE) | $74,123 | $76,801 |
| Net Interest Margin (TE) | 3.34% | 3.64% |
| Provision for Loan Losses | $1,244 | $353 |
Asset Quality and Capital
- Nonperforming Assets: $2,263 (0.10% of total assets), down significantly from $6,848 in 2005.
- Allowance for Loan Losses: $16,193 (0.92% of total loans).
- Net Charge-offs: $380 (0.02% of average loans).
- Return on Average Assets: 0.99% (down from 1.24% in 2005).
- Return on Average Equity: 15.29% (down from 19.11% in 2005).
- Capital Status: All bank subsidiaries were "well-capitalized" as of December 31, 2006.
Material Changes vs. Prior Period
- Net Interest Income Decline: Net interest income (TE) decreased by $2.68 million (3.5%) to $74.1 million. This was primarily driven by a $5.7 million decrease due to higher interest rates paid on liabilities, which was only partially offset by a $3.0 million increase due to higher rates earned on assets.
- Loan Portfolio Growth: Gross loans increased by approximately $59.5 million (3.5%) to $1.76 billion. Real estate loans (commercial, residential, and construction) comprised 88.8% of the portfolio.
- Improved Asset Quality: Nonperforming loans dropped from $6.597 million in 2005 to $2.215 million in 2006. Nonaccrual loans decreased from $3.845 million to $1.632 million.
- Increased Provision: The provision for loan losses increased to $1.244 million from $353 million, reflecting management's assessment of portfolio risks despite lower charge-offs.
- Deposit Mix: Interest-bearing deposits increased, with the cost of funds rising significantly. The cost of time deposits increased from 3.18% in 2005 to 4.32% in 2006.
Guidance, Outlook, Risks, and Contingencies
Management Commentary & Outlook: Management noted a slower rate of real estate building and development activity in the market area in 2006, expecting this trend to continue into 2007. The Company maintains a "right size" strategy, focusing on community banking with personal service. While the Company anticipates existing capital resources will satisfy requirements for the foreseeable future, future growth may require raising additional capital.
Key Risks:
- Geographic Concentration: Operations are heavily concentrated in northeastern Illinois; economic declines in this specific region could materially impact results.
- Real Estate Exposure: Approximately 88.8% of the loan portfolio is real estate-related (commercial, residential, construction), exposing the Company to local real estate value fluctuations.
- Interest Rate Risk: Profitability is sensitive to the spread between asset yields and liability costs. Rising rates increased funding costs significantly in 2006.
- Competition: Intense competition from larger regional banks and non-bank financial intermediaries.
Contingencies & Legal Proceedings:
- Legal Judgment: A verdict of approximately $2.0 million was entered in favor of Old Second Bank-Yorkville against an insurance company in January 2007. The insurance company appealed, and the Company will not record this as income until the appeal is resolved.
- REIT Affiliate: The Company holds assets in a Real Estate Investment Trust (REIT) affiliate. Failure to maintain REIT qualification could result in a higher consolidated effective tax rate.
Investor Verification Checklist
- Net Interest Margin Compression: Verify the sustainability of the 3.34% net interest margin given the rising cost of deposits (4.32% on time deposits).
- Real Estate Concentration: Assess the credit quality of the 88.8% real estate loan portfolio in the context of the noted slowdown in local development activity.
- Capital Adequacy: Confirm that the "well-capitalized" status is maintained as the Company grows its loan portfolio and faces potential future capital needs.
- Legal Outcome: Monitor the status of the $2.0 million insurance judgment appeal to determine if it will be recognized as income.
- Share Repurchases: Note that the Company repurchased 40,000 shares in Q4 2006 at an average price of $30.55, with 65,000 shares remaining authorized under the plan.