Old Second Bancorp, Inc. — Q1 2013 Form 10-Q
Business context and reporting period
Old Second Bancorp is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. This filing covers the quarter ended March 31, 2013; income and cash-flow comparisons are against Q1 2012, while balance-sheet comparisons are generally against December 31, 2012. Dollar amounts below are in millions unless otherwise noted.
Financial performance and condition
- Earnings: Net income was $5.5 million, versus a net loss of $3.0 million in Q1 2012. Net income available to common shareholders was $4.2 million, or $0.30 per diluted share, compared with a $4.2 million common-shareholder loss, or $(0.30) per diluted share. No income tax expense was recorded.
- Interest income and margin: Net interest income was $13.9 million, down from $15.1 million. Tax-equivalent net interest margin declined to 3.18% from 3.48%; average earning-asset yield fell to 3.94% from 4.41%, partly offset by lower funding costs.
- Other income and expenses: Noninterest income was $10.6 million, slightly above $10.5 million. Noninterest expense declined to $21.5 million from $22.5 million. Securities-sale gains were $1.5 million; other income included a $0.6 million benefit from recaptured restricted-stock expense.
- Credit costs and asset quality: The company recorded a $2.5 million loan-loss provision release, compared with a $6.1 million provision in Q1 2012. Net recoveries were $2.5 million, versus net charge-offs of $10.5 million. Nonperforming loans fell to $69.8 million from $82.6 million at year-end 2012 and $125.4 million a year earlier. The allowance was $38.6 million, or 55.33% of nonperforming loans. Classified loans declined to $102.4 million from $116.2 million at year-end.
- Balance sheet and liquidity: Total assets were $1.954 billion, down 4.5% from year-end; loans were $1.113 billion, down $36.7 million. Deposits were $1.718 billion, essentially flat. Cash and cash equivalents fell to $81.1 million from $128.5 million. The company repaid a $100 million FHLB advance during the quarter; it reported $34.7 million of unused FRB borrowing capacity.
- Cash flow: Operating activities provided $2.2 million, investing activities provided $46.7 million, and financing activities used $96.2 million. Cash and cash equivalents decreased $47.4 million during the quarter.
- Debt and capital: Borrowings totaled $124.7 million, including $58.4 million of junior subordinated debentures and $45.0 million of subordinated debt. Total stockholders’ equity was $75.9 million. The Bank’s total risk-based capital ratio was 15.79%, Tier 1 risk-based ratio 14.52%, and Tier 1 leverage ratio 9.94%; the Bank reported exceeding the higher capital targets in its OCC Consent Order.
Material changes, outlook, and risks
- Management attributed lower net interest income and margin primarily to reduced loan balances and the shift toward lower-yielding securities in a low-rate environment. Average loans, including loans held for sale, were down $214 million year over year. Management said loan pipelines were building, but loan growth remained difficult.
- Other real estate owned (OREO) declined to $65.7 million from $72.4 million at year-end, but remained material. The company recorded $2.0 million of OREO valuation expense; a substantial portion of OREO had been held for more than one year.
- Credit risk remains concentrated in real estate-related lending, which represented approximately 90% of loans. Management cited economic and real-estate market weakness, while noting reduced nonperforming loans and limited new migration to nonaccrual.
- The Bank remains subject to an OCC Consent Order and the holding company to an FRB Written Agreement, including capital, reporting, dividend, debt, and other restrictions. The Bank must obtain regulatory approval before paying dividends to the holding company.
- The company was out of compliance with one financial covenant under its Bank of America credit agreement at March 31, 2013. The agreement permits remedies including a higher interest rate, acceleration of the $0.5 million term debt, and enforcement against collateral. The filing says required interest payments were made on time.
- Interest payments on $58.4 million of junior subordinated debentures have been deferred since 2010; unpaid interest totaled $13.0 million. Deferred Series B preferred dividends totaled $10.2 million. Common dividends cannot resume until specified arrears are paid, and regulatory restrictions also apply. After Treasury’s sale of its Series B shares, the Board stopped accruing the preferred dividend for part of Q1 and did not anticipate accruing it through Q2; the stated rate rises from 5% to 9% in 2014.
- The company reported no formal earnings guidance. Management’s forward-looking comments included efforts to grow relationship-based lending and reduce real-estate concentration; actual results remain subject to economic, credit, interest-rate, and regulatory risks. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
- A purported ERISA class action settlement had received preliminary court approval; a final approval hearing was scheduled for June 14, 2013. The company expected insurance to cover the settlement, if approved.
Important facts for investors to verify
- Whether loan growth, net interest margin, and earnings can improve without reliance on provision releases, securities gains, or other unusual items.
- Whether asset-quality improvement continues, including nonperforming and classified loans, recoveries, OREO dispositions, and valuation reserves.
- Current covenant compliance and the status or terms of any lender waiver or other agreement relating to the Bank of America facility.
- Compliance with OCC and FRB requirements, capital levels, and the consequences of restrictions on dividends, debt, and preferred-stock payments.
- The sustainability of liquidity after repayment of the FHLB advance, and the availability and terms of contingent borrowing sources.
- Developments in the ERISA settlement and confirmation of the expected insurance coverage.