Old Second Bancorp, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2019. Old Second is an Illinois community bank holding company operating 29 banking centers, with retail and commercial banking, trust and wealth-management services. Comparisons are with Q3 and the first nine months of 2018 unless otherwise noted. The 2018 periods include the April 2018 acquisition of Greater Chicago Financial Corp. (GCFC); no acquisition-related costs were incurred in the first nine months of 2019.
Financial results and condition
- Profitability: Q3 net income was $12.2 million, or $0.40 diluted EPS, versus $9.6 million, or $0.32, a year earlier. Nine-month net income was $29.9 million, or $0.98 diluted EPS, versus $25.4 million, or $0.84.
- Revenue and net interest: Q3 net interest and dividend income rose to $24.8 million from $23.7 million; nine-month income increased to $73.6 million from $66.6 million. Total noninterest income was $11.9 million for Q3 (versus $7.8 million) and $26.6 million for nine months (versus $24.9 million). The filing does not present a single revenue line.
- Margins and expenses: Tax-equivalent net interest margin was 4.14% in Q3, up 14 basis points year over year; nine-month margin was 4.13%, up 21 basis points. Q3 noninterest expense rose 6.6% to $20.0 million; nine-month expense rose 1.6% to $59.3 million. The adjusted efficiency ratio was 58.53% for Q3 and 60.03% year to date; these are non-GAAP measures.
- Balance sheet: At September 30, total assets were $2.61 billion, down $61.7 million from year-end 2018. Loans were $1.90 billion, up $2.8 million from year-end and 3.5% from September 2018. Deposits were $2.07 billion, down $42.2 million from year-end; noninterest-bearing demand deposits increased while interest-bearing and time deposits declined.
- Credit quality: Nonperforming loans were $13.4 million, or 0.7% of loans, compared with $16.3 million (0.9%) at year-end 2018 and $11.8 million (0.6%) a year earlier. Q3 net charge-offs were $271,000; the allowance was $19.7 million, 1.04% of average loans, and 146.6% of nonperforming loans. Real-estate-related loans were 75.4% of the portfolio.
- Cash flow and liquidity: For nine months, operating cash flow was $37.5 million, investing cash flow $74.6 million, and financing cash flow negative $113.3 million; cash and equivalents ended at $54.0 million. The company reported $277.0 million of unused FHLB borrowing capacity, $159.6 million of unpledged available-for-sale securities, and an undrawn $20 million third-party line of credit.
- Debt and capital: Borrowings totaled $243.7 million, down from $313.4 million at year-end, mainly reflecting lower short-term FHLB advances. Senior notes were $44.2 million and junior subordinated debentures $57.7 million. The Bank’s Tier 1 leverage and total risk-based capital ratios were 12.68% and 15.72%, respectively; both exceeded the company’s stated internal thresholds. Stockholders’ equity was $270.0 million, up from $229.1 million at year-end.
Material changes, outlook, and risks
- Q3 noninterest income benefited materially from $3.5 million in net securities gains and higher gains on mortgage-loan sales. The securities gains mainly reflected sales of tax-exempt municipal securities to reduce spread risk. Mortgage servicing rights had a $946,000 Q3 mark-to-market loss, driven by interest rates; the nine-month MSR mark-to-market loss was $2.9 million.
- Management attributed higher net interest income to loan growth and a more profitable loan mix. It cited commercial lending competition and pressure to keep loan renewal rates low. Q3 provision for loan losses was $550,000, compared with none in Q3 2018; management said the allowance methodology had no material change.
- Management reported stable asset quality overall, declining classified assets, and ongoing monitoring and remediation. However, real-estate lending remains a significant portfolio exposure; $4.0 million of OREO had been held for five years or more.
- No numerical earnings or growth guidance is provided. Management said it believed the company was positioned for further loan growth, while noting results are not necessarily indicative of full-year outcomes.
- The filing identifies risks including economic and real-estate weakness, borrower credit performance, interest-rate and funding changes, competition, cyber and vendor risks, regulatory changes, litigation, and the integration and expected benefits of the GCFC acquisition. Management described interest-rate risk as moderate; modeled net interest income changed by +1.2% for an immediate 0.5% rate increase and −2.1% for a 0.5% decrease. The model excludes management actions and is not a forecast.
- The company authorized repurchases of up to approximately 1.5 million shares over 18 months; none had been repurchased under the program as of the filing. The Board declared a $0.01-per-share dividend after quarter-end, paid November 4, 2019.
- The company was assessing adoption of the expected-credit-loss standard (CECL) in 2020; its financial-statement impact was not yet stated. Management reported effective disclosure controls, no material change in internal controls, and no material change to previously disclosed risk factors. Management did not expect ordinary-course legal proceedings to have a material adverse effect.
Important facts for investors to verify
- How much of earnings growth is repeatable after excluding securities gains, and what further securities sales or portfolio changes are planned?
- Whether loan growth, deposit trends, funding costs, and net interest margin remain resilient as rates change and competition pressures loan pricing.
- Credit trends in commercial and real-estate exposures, including classified and nonperforming loans, charge-offs, allowance adequacy, and aged OREO.
- The expected effect of CECL adoption and any changes to allowance assumptions or models.
- Whether the share repurchase authorization is used, and how any repurchases would affect capital, liquidity, and dividends.