Old Second Bancorp, Inc. — Q2 2023 Form 10-Q
Business context and reporting period. Old Second is an Illinois bank holding company operating Old Second National Bank, with 48 banking centers. This unaudited report covers the quarter and six months ended June 30, 2023; income comparisons are year over year, while balance-sheet comparisons are primarily against December 31, 2022. Amounts below are in millions unless noted.
Financial performance and condition
| Metric | Q2 2023 / June 30, 2023 | Comparable period / prior date |
|---|---|---|
| Interest and dividend income | $73.9 | $47.4 in Q2 2022 |
| Net interest and dividend income | $63.6 | $45.3 in Q2 2022 |
| Noninterest income | $8.2 | $9.2 in Q2 2022 |
| Net income; diluted EPS | $25.6; $0.56 | $12.2; $0.27 in Q2 2022 |
| Net interest margin, GAAP | 4.61% | 3.16% in Q2 2022; 4.72% in Q1 2023 |
| Total assets | $5,883.9 | $5,888.3 at December 31, 2022 |
| Total loans; net loans | $4,015.5; $3,960.2 | $3,869.6; $3,820.1 at December 31, 2022 |
| Total deposits | $4,717.6 | $5,110.7 at December 31, 2022 |
| Cash and cash equivalents | $112.6 | $115.2 at December 31, 2022 |
| Total borrowings | $601.6 | $260.8 at December 31, 2022 |
| Stockholders’ equity | $514.0 | $461.1 at December 31, 2022 |
- For the first six months, net income was $49.2 million, versus $24.3 million in 2022; diluted EPS was $1.08 versus $0.54. Net interest margin was 4.66%, versus 3.00%.
- Six-month operating cash flow was $5.6 million, down from $27.1 million. Investing activities provided $49.0 million, compared with $349.7 million used in 2022; financing activities used $57.1 million, including $392.4 million of net deposit outflows and $395.0 million of net short-term borrowing proceeds. Cash declined $2.6 million over the six months.
- At June 30, the Bank’s Tier 1 leverage ratio was 9.70% and total risk-based capital ratio was 12.83%; both exceeded the Bank’s stated internal thresholds. The consolidated tangible common equity-to-tangible-assets ratio was 7.21% on the company’s non-GAAP basis.
Material changes versus comparable periods
- Q2 net income more than doubled year over year, mainly as loan growth and higher asset yields lifted net interest income. Higher funding costs partly offset the benefit; quarterly net interest margin declined 11 basis points from Q1 2023.
- Q2 noninterest income fell $1.0 million year over year, including $1.5 million of net securities losses from strategic sales. Six-month noninterest income declined $7.1 million, reflecting securities losses and lower mortgage banking revenue, including a $3.5 million year-over-year reduction in mortgage-servicing-rights mark-to-market results.
- Q2 noninterest expense declined $2.4 million year over year to $34.8 million, partly because the prior-year quarter included West Suburban acquisition-related costs. For six months, expense fell 6.3% to $70.8 million; acquisition-related technology and teller costs drove much of the reduction, while compensation and FDIC insurance costs rose.
- Loans increased $145.9 million, or 3.8%, from year-end, with growth concentrated in investor commercial real estate, multifamily, and leases. Deposits decreased $393.1 million, or 7.7%, primarily due to seasonal municipal outflows and retail deposit attrition.
- Nonperforming loans rose to $61.2 million from $32.9 million at year-end; nonperforming loans were 1.5% of total loans versus 0.9%. Management attributed the increase chiefly to several larger commercial real-estate credits, including office properties and a health-care facility. Classified assets increased to $128.3 million.
Outlook, management commentary, risks, and unusual items
- Management expects loan growth to continue, likely at a slower pace, and said recent deposit levels appeared stable. No quantified earnings or margin guidance was provided.
- Management described the Bank as having strong liquidity and an outsized securities portfolio, while noting it funded deposit and loan needs with securities sales and FHLB advances. FHLB short-term advances were $485.0 million at quarter-end; the Bank also reported $551.3 million of excess collateral available for borrowings. It had not requested or received Bank Term Funding Program funds and reported $17.4 million of unused Federal Reserve Discount Window capacity.
- Uninsured deposits were estimated at $1,171.9 million, approximately one-quarter of total deposits. Management noted the risk that deposit withdrawals could accelerate if confidence weakens, as well as uncertainty about the effects of 2023 bank failures and potential FDIC special assessments.
- Available-for-sale securities were $1,335.6 million, down $203.7 million from year-end. The portfolio had $112.9 million of gross unrealized losses; management attributed these to market-rate movements, reported no identified credit losses, and recorded no securities credit-loss provision in Q2. Securities sales produced $3.2 million of net losses for the first six months.
- The allowance for loan losses was $55.3 million, or 1.4% of loans, after a $5.5 million provision for the first six months. Management cited loan growth, higher historical loss estimates, risk-rating migration, and expected future losses. It cautioned that actual losses could exceed estimates, particularly amid inflation, recession risk, and collateral-value changes.
- On June 30, the company redeemed $45.0 million of senior notes; the related $362,000 deferred issuance cost was expensed, contributing to a 12.85% effective cost for the quarter. FHLB advances increased substantially as deposits declined. The company also paid off a $9.0 million term-note balance in February.
- Interest-rate sensitivity analysis estimated annual pretax income would increase 3.7% for an immediate 0.5 percentage-point rate increase and decrease 3.7% for a comparable decline. Management cautioned that modeled results are not forecasts and exclude potential management actions.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. It reported no material changes to previously disclosed risk factors and said ordinary-course legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the increase in nonperforming and classified commercial real-estate credits is contained, especially office and health-care exposures, and how it affects provisions and charge-offs.
- Deposit retention, uninsured-deposit trends, deposit pricing, and the cost and availability of FHLB or other replacement funding.
- Whether loan growth and higher yields can continue to support net interest income as deposit and borrowing costs reprice.
- The adequacy of the allowance and the effect of economic assumptions and collateral values on expected credit losses.
- Future securities sales, realized losses, and the effect of interest-rate movements on securities values, liquidity, and capital.
- Any increase in FDIC assessments and the company’s subsequent liquidity and capital disclosures.