Old Second Bancorp, Inc. — 2021 Form 10-K
Reporting period: Fiscal year ended December 31, 2021. The filing reports full-year results and quarterly data; it is not a standalone fourth-quarter report. Old Second is a community bank serving the Chicago-area suburbs of Illinois.
Business context and reporting period
On December 1, 2021, Old Second completed its acquisition of West Suburban Bancorp for approximately $295.2 million in cash and stock. The transaction added 34 branches and materially expanded the company’s assets, loans, securities, deposits and workforce. 2021 results include West Suburban only after closing; the 2020 comparison excludes it.
Key financial metrics
| Metric | 2021 | 2020 |
|---|---|---|
| Total assets, year-end | $6.21 billion | $3.04 billion |
| Gross loans, year-end | $3.42 billion | $2.03 billion |
| Deposits, year-end | $5.47 billion | $2.54 billion |
| Net interest income | $96.8 million | $91.8 million |
| Net interest margin | 2.96% | 3.43% |
| Noninterest income | $39.2 million | $37.5 million |
| Noninterest expense | $103.8 million | $81.4 million |
| Provision for credit losses | $4.3 million | $10.4 million |
| Net income | $20.0 million | $27.8 million |
| Diluted earnings per share | $0.65 | $0.92 |
| Operating cash flow | $31.0 million | $26.0 million |
| Cash and cash equivalents, year-end | $752.1 million | $329.9 million |
Full-year net income declined 28%. Management attributed the decline principally to $14.6 million of acquisition-related Day Two credit-loss provision and $13.2 million of merger-related costs. The company reported adjusted net income of $41.9 million, a non-GAAP measure excluding those items. The 2021 net interest margin fell 47 basis points, reflecting lower asset yields despite higher average earning assets.
Fourth-quarter 2021 net loss was $9.1 million, or $0.26 per diluted share, compared with net income of $8.0 million in fourth-quarter 2020. Fourth-quarter provision for credit losses was $12.3 million.
Year-end total borrowings were $198.9 million, compared with $160.5 million a year earlier. This included $59.2 million of subordinated debentures issued in connection with $60 million principal amount of notes sold in 2021, $44.5 million of senior notes, and $25.8 million of junior subordinated debentures. The company reported $313.1 million of remaining FHLB funding availability. Its consolidated capital ratios were 9.46% CET1, 12.55% total risk-based capital, 10.06% Tier 1 risk-based capital and 7.81% leverage; the Bank was reported well-capitalized.
Material changes versus the prior comparable period
- Assets rose 104%, loans 68% and deposits 116%, primarily because of the West Suburban acquisition. Acquired balances included $1.50 billion of loans and $2.69 billion of deposits.
- Noninterest expense increased 27.5%, including acquisition costs and $3.8 million in branch impairment charges. The company identified 13 overlapping locations for closure and potential sale.
- Nonperforming loans increased to $44.7 million from $23.0 million, mainly due to acquired loans. Nonperforming assets were $47.0 million, or 0.76% of total assets, versus $25.5 million, or 0.84%, in 2020.
- The allowance for credit losses on loans was $44.3 million at year-end, up from $33.9 million; the allowance on unfunded commitments was $6.2 million. Net charge-offs increased to $4.4 million from $1.0 million.
- The company issued 15.7 million shares as part of the merger consideration. Year-end shares outstanding increased to 44.5 million from 29.3 million.
Outlook, management commentary, risks and unusual items
- Management expected the pandemic to continue affecting the business in 2022 and cited uncertainty around borrower health, supply-chain disruption, labor shortages, inflation and economic conditions. No specific numerical earnings or growth guidance is provided.
- Commercial real estate is a significant exposure: real estate-related loans were 71.6% of the portfolio. Non-owner-occupied CRE loans and undrawn commitments were 313.4% of Tier 1 capital plus the allowance, above the 300% supervisory concentration indicator. Management said it intended to bring the measure below 300% and described enhanced monitoring and stress testing.
- Management anticipated closing 13 branches identified as overlapping, with closures and potential sales expected in the second and third quarters of 2022. Four identified branches had already contributed to $3.8 million of impairment charges in 2021.
- Rate sensitivity modeling indicated pretax income could increase 9.4% under an immediate 0.5% rate rise and 19.5% under a 1% rise; the filing cautions that modeled results are not forecasts and exclude management actions. Down-rate scenarios were not available due to low prevailing rates.
- The company had transitioned new contracts away from LIBOR by year-end 2021 but still needed to address existing exposures before the stated June 30, 2023 cessation date.
- Management said pending ordinary-course legal matters were not expected to have a material adverse effect. The auditor gave unqualified opinions on the financial statements and internal control; West Suburban, representing 47.5% of year-end assets, was excluded from the company’s 2021 internal-control assessment while integration proceeded.
Most important facts for investors to verify
- How West Suburban integration, the 13 planned branch closures, and any additional purchase-accounting adjustments affect future costs, earnings and expected synergies.
- Whether acquired-loan credit quality and the allowance for credit losses prove adequate, especially given higher nonperforming and classified assets and the CRE concentration.
- Whether margin, deposit pricing and earnings respond as management’s interest-rate sensitivity model suggests; also monitor uninsured deposits, which totaled $1.42 billion.
- How the expanded balance sheet affects capital, tangible common equity, funding costs and dividend capacity; the filing reported $9.5 million of Bank dividend availability under regulatory guidelines.
- Whether reported GAAP earnings and company-presented adjusted earnings reconcile as expected, and distinguish acquisition-related effects from ongoing operating performance.