Old Second Bancorp, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. The company is an Illinois-focused bank holding company operating through Old Second National Bank, with 29 banking centers. Financial statements are unaudited; amounts below are in U.S. dollars.
Financial results and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest and dividend income | $22.5 million | $24.8 million | $67.9 million | $73.6 million |
| Provision for credit losses | $0.3 million | $0.6 million | $10.4 million | $1.5 million |
| Noninterest income | $11.7 million | $11.9 million | $28.7 million | $26.6 million |
| Noninterest expense | $20.3 million | $20.0 million | $60.2 million | $59.3 million |
| Net income | $10.3 million | $12.2 million | $19.8 million | $29.9 million |
| Diluted earnings per share | $0.34 | $0.40 | $0.65 | $0.98 |
| Net interest margin, GAAP | 3.23% | 4.06% | 3.44% | 4.04% |
- Balance sheet at September 30: Assets were $2.975 billion, up $339.3 million from year-end 2019. Loans were $2.030 billion, up $99.5 million; deposits were $2.479 billion, up $352.5 million. Stockholders’ equity was $296.3 million.
- Liquidity and cash flow: Cash and cash equivalents were $313.1 million, versus $50.6 million at year-end 2019. For the first nine months, operating cash flow was $16.8 million, investing cash outflow $54.4 million, and financing cash inflow $300.2 million. Deposit growth was the principal source of financing inflows.
- Credit reserves and asset quality: The allowance for credit losses on loans was $32.9 million, or 1.6% of loans, compared with $19.8 million, or 1.0%, at year-end 2019. Nonperforming loans were $20.8 million (1.0% of loans), versus $15.8 million (0.8%) at year-end. Q3 net recoveries were $365,000.
- Debt and capital: Total borrowings were $160.0 million, down from $205.9 million at year-end. The company redeemed $32.6 million of trust preferred securities and related debentures in March, partly funded by a $20 million term note; $18 million remained outstanding at quarter-end. The Bank’s Tier 1 leverage ratio was 10.90% and total capital ratio 15.49%; management reported capital above regulatory requirements.
- Margins and efficiency: Q3 GAAP net interest margin fell 83 basis points year over year. The Q3 GAAP efficiency ratio was 58.27%, compared with 57.82% in Q3 2019. The reported non-GAAP adjusted efficiency ratio was 57.47%.
Material changes versus comparable periods
- Q3 net income declined $1.9 million year over year; nine-month net income declined $10.1 million. Lower interest income and the year-to-date credit-loss provision were major drivers.
- Q3 net interest income fell $2.3 million as rate cuts reduced loan and securities yields, despite year-over-year loan growth. Lower funding costs partly offset the decline.
- Nine-month provision expense rose to $10.4 million from $1.5 million, reflecting CECL adoption and pandemic-related expected losses. The Q3 provision was relatively low after reserve increases earlier in the year.
- Nine-month noninterest income increased $2.1 million, principally because mortgage loan sale gains and mortgage banking revenue rose; this was partly offset by lower deposit service charges and the absence of prior-year securities gains.
- Deposits and cash increased substantially amid pandemic-related customer liquidity, reduced spending, and stimulus funds. Loan growth included $136.7 million of PPP originations.
Outlook, commentary, risks and unusual items
- Management expects only moderate loan growth and said the pandemic is likely to make it challenging to achieve profitability and growth levels seen in recent years. No numerical earnings or revenue guidance was provided.
- COVID-19, economic weakness, low interest rates, borrower repayment capacity, collateral values, and potential renewed restrictions create uncertainty. Management said the pandemic had not yet caused a significant incurred-loss impact at September 30, but future periods could be materially affected.
- CECL was adopted January 1, 2020, reducing retained earnings by approximately $3.8 million after tax. The company elected a five-year regulatory-capital transition for CECL effects.
- The company processed 746 PPP loans totaling $136.7 million. Forgiveness applications began in October 2020, with SBA reimbursements expected to continue into 2021. It had not used the Federal Reserve PPP liquidity facility as of the filing.
- Goodwill was $18.6 million; management found no impairment required at quarter-end, but warned that further economic deterioration could result in future impairment charges.
- The board extended the share repurchase program through October 20, 2021, subject to Federal Reserve non-objection; 898,415 shares remained available as of October 20, 2020. A $0.01-per-share dividend was declared after quarter-end.
- Management considered ordinary-course litigation liabilities immaterial. The November 4, 2020 bylaw amendments changed advance-notice and information requirements for stockholder proposals and director nominations.
Important facts for investors to verify
- Whether pandemic-related borrower stress leads to higher nonperforming loans, charge-offs, and further reserve builds; review the allowance assumptions and remaining loan deferrals.
- How PPP forgiveness, fee recognition, and repayment affect loan balances, earnings, and liquidity.
- Whether low rates and excess liquidity continue to pressure net interest margin and whether management can reinvest cash at acceptable yields.
- Capital and liquidity capacity under adverse scenarios, including the effect of any credit deterioration and planned share repurchases.
- Potential goodwill impairment and the valuation of collateral-dependent loans and other real estate owned.