Old Second Bancorp, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; comparisons are primarily with 2018. The company is an Illinois-focused community bank holding company operating through Old Second National Bank, with 29 banking centers. It completed its Greater Chicago Financial Corp./ABC Bank acquisition in April 2018.
Financial results and condition
| Metric | 2019 | 2018 |
|---|---|---|
| Total assets, year-end | $2.636 billion | $2.676 billion |
| Loans, year-end | $1.931 billion | $1.897 billion |
| Deposits, year-end | $2.127 billion | $2.117 billion |
| Net interest income | $96.8 million | $90.9 million |
| Net interest margin, GAAP | 3.98% | 3.87% |
| Net income | $39.5 million | $34.0 million |
| Diluted EPS | $1.30 | $1.12 |
| Net cash from operating activities | $52.6 million | $54.9 million |
| Cash and cash equivalents, year-end | $50.6 million | $55.2 million |
| Total borrowings, year-end | $205.9 million | $313.4 million |
| Stockholders’ equity, year-end | $277.9 million | $229.1 million |
- Interest and dividend income was $115.6 million; noninterest income was $35.8 million. Noninterest expense was $79.1 million and the loan-loss provision was $1.6 million. The effective tax rate was 23.9%.
- Net interest income rose 6.4%, driven by higher average loan balances, the full-year contribution from ABC Bank and $2.1 million of acquired-loan discount accretion; higher deposit and borrowing costs partly offset the increase. Tax-equivalent net interest margin was 4.06%, versus 3.96% in 2018.
- Fourth-quarter net income was $9.5 million and diluted EPS was $0.31, compared with $8.6 million and $0.28 in fourth-quarter 2018. Fourth-quarter net interest income was $23.2 million, down from $24.3 million.
- Annual net securities gains rose to $4.5 million from $0.4 million, with $191.3 million of securities sale proceeds. Mortgage-servicing-rights mark-to-market losses widened to $2.7 million from $0.7 million.
- Operating cash flow remained positive. Investing activities provided $42.2 million, largely reflecting net securities cash inflows; financing activities used $99.5 million, including a $101.0 million reduction in short-term borrowings.
- The Bank’s year-end regulatory ratios were 14.35% CET1, 15.23% total risk-based capital and 12.50% Tier 1 leverage. Management reported the Bank was well-capitalized. Remaining borrowing availability at the Federal Home Loan Bank was $327.3 million.
Material changes and credit quality
- Gross loans grew $33.8 million, or 1.8%, through organic growth in commercial, lease and commercial real estate lending. Lease balances rose to $119.8 million from $78.8 million; construction loans fell to $69.6 million from $108.4 million.
- Commercial real estate represented about 44.8% of loans; total real estate-related lending was 75.4% of the portfolio. Management said it intended to diversify lending and reduce real estate concentration over time.
- Nonperforming assets declined 11.3% to $20.9 million; OREO fell 30.3% to $5.0 million. The allowance for loan and lease losses was $19.8 million, or 1.02% of loans. Net charge-offs were $0.8 million, versus net recoveries of $0.3 million in 2018.
- Total past-due loans increased to $25.7 million from $18.4 million, and the past-due ratio rose to 1.33% from 0.97%. Classified commercial loans increased sharply, from $0.1 million to $11.7 million, although total classified assets decreased to $46.6 million from $53.4 million.
- Available-for-sale securities declined $56.6 million to $484.6 million. Stockholders’ equity increased, supported by earnings and improved securities fair values; year-end accumulated other comprehensive income was $4.6 million, versus a $4.1 million loss in 2018.
- Noninterest expense rose 2.6% to $79.1 million, reflecting a full year of ABC Bank operating costs and property improvements. The FDIC insurance expense declined substantially with assessment credits.
Outlook, risks and unusual items
- The filing provides no formal earnings, revenue or margin guidance. Management described stable local real estate conditions, competitive lending markets, continued focus on organic growth, credit quality, expense control and deposit funding.
- CECL became effective for the company on January 1, 2020. Management estimated an increase in the allowance for credit losses of $4–$6 million, an additional $1.5–$2.5 million reserve for unfunded commitments and a $3–$5 million reduction in retained earnings. Estimates depend on credit quality, forecasts and portfolio composition.
- On March 2, 2020, after year-end, the company redeemed the 7.80% Trust I securities and related $32.6 million subordinated debentures. The securities were delisted. Trust II subordinated debt remained outstanding.
- Key risks include Illinois and Chicago-area economic concentration, commercial and residential real estate exposure, borrower and collateral deterioration, interest-rate and funding-cost sensitivity, competition, regulatory requirements, cybersecurity and third-party vendor risks, and the transition away from LIBOR. The filing also identified possible coronavirus-related economic and customer disruptions as a forward-looking risk.
- Interest-rate sensitivity modeling estimated annual pretax income increases of 1.1% for a 50-basis-point rise and 4.1% for a 200-basis-point rise; a 100-basis-point decline implied a 6.6% reduction. These are modeled scenarios, not forecasts. A $50 million, five-year receive-fixed swap was entered into in December 2019 to hedge a pool of variable-rate loans.
- Common dividends were $0.04 per share for 2019. A repurchase authorization covered up to 1,494,826 shares, but no program repurchases were made in 2019. The board declared a further $0.01-per-share dividend in January 2020.
- The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also reported effective disclosure controls and internal control over financial reporting.
Important facts for investors to verify
- Whether CECL adoption and subsequent credit trends fall within or outside management’s estimated allowance and retained-earnings impacts.
- The causes and status of the increase in past-due loans and classified commercial credits, and the adequacy of reserves against real estate and commercial exposures.
- How much of earnings growth is recurring versus securities gains, acquired-loan discount accretion and other nonrecurring items; also monitor deposit pricing and net interest margin.
- Liquidity and funding needs as borrowings change, including the availability and cost of FHLB funding and the maturity profile of deposits and debt.
- The financial and capital effects of the Trust I redemption, and the remaining terms and interest-rate exposure of Trust II and senior notes.