Old Second Bancorp, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are primarily with December 31, 2018. Financial statements are unaudited. Old Second is an Illinois-focused bank holding company operating 29 banking centers. Q1 2019 was its fourth quarter including Greater Chicago Financial Corp. (GCFC/ABC Bank), acquired in April 2018.
Financial performance and condition
- Profit: Net income was $8.5 million, or $0.28 per diluted share, versus $9.5 million, or $0.31, in Q1 2018. Pretax income was $10.9 million versus $11.5 million.
- Net interest income and margin: GAAP net interest income rose 22.5% to $24.0 million from $19.6 million. Tax-equivalent net interest margin was 4.09%, up from 3.76% a year earlier. Loan and loans-held-for-sale yield was 5.16%, versus 4.75%; the cost of interest-bearing liabilities rose to 1.12% from 0.90%.
- Noninterest income and expenses: Noninterest income decreased 23.8% to $6.5 million from $8.5 million. Noninterest expense increased 10.6% to $19.2 million from $17.4 million; the adjusted efficiency ratio was 60.98% versus 61.10% (non-GAAP).
- Credit costs and asset quality: The company recorded a $450,000 provision for loan and lease losses, compared with a $722,000 provision release in Q1 2018. Net charge-offs were $140,000, versus net recoveries of $1.4 million a year earlier. Nonperforming loans were $14.9 million, or 0.8% of loans, versus $12.8 million and 0.8% a year earlier. Classified loans rose to $41.3 million from $35.3 million at year-end; management attributed the increase in part to one large commercial credit newly classified during the quarter.
- Assets, loans and deposits: Total assets were $2.62 billion, down from $2.68 billion at year-end. Loans were $1.90 billion, up $6.1 million from year-end and 18.8% from March 2018. Deposits were $2.12 billion, up $6.8 million from year-end and 8.2% year over year. Real-estate-related lending represented 76.9% of the loan portfolio.
- Cash flow and liquidity: Operating cash flow was $12.5 million; investing activities provided $37.4 million, primarily reflecting securities activity; financing activities used $64.8 million, including a $64.5 million net reduction in short-term borrowings. Cash and cash equivalents ended at $40.3 million, down from $55.2 million at year-end. The bank reported $405.1 million of excess collateral available to secure FHLB borrowings.
- Debt and capital: Total borrowings were $242.4 million, down from $313.4 million at year-end, mainly due to repayment of short-term advances. Stockholders’ equity was $243.3 million, up from $229.1 million. The bank’s Tier 1 leverage ratio was 11.54% and total risk-based capital ratio was 14.47%; the company reported capital above applicable regulatory thresholds.
- Dividend: The company declared a $0.01 per-share dividend after quarter-end, payable May 6, 2019.
Material changes and notable items
- Year-over-year earnings benefited from higher loan balances and yields, including the ABC Bank acquisition, but were more than offset by lower noninterest income, higher expenses, and the shift from a prior-year provision release to a current-quarter provision.
- Q1 2019 noninterest income included an $819,000 mortgage servicing rights mark-to-market loss. Q1 2018 included a $1.0 million nontaxable bank-owned life insurance (BOLI) death benefit, which did not recur; the effective tax rate increased to 22.1% from 17.4%.
- Available-for-sale securities had a $9.2 million pretax unrealized holding gain in Q1 2019, contributing to a $5.8 million increase in other comprehensive income after tax. Management said securities valuation changes primarily reflected interest-rate movements and reported no credit-quality deterioration requiring impairment.
- The company adopted lease accounting on January 1, 2019, recording $817,000 of right-of-use assets and corresponding lease liabilities at adoption. It is preparing for the expected 2020 adoption of the current expected credit loss standard (CECL); management planned test calculations during 2019.
Outlook, commentary and risks
Management described market conditions as generally stable and said it was pursuing local growth and new banking relationships. It provided no specific financial guidance in the supplied filing text. Management cited competition for commercial and commercial real-estate lending, pressure on loan pricing, and rising funding costs. It characterized interest-rate risk as moderate; its modeled immediate rate scenarios showed annual pretax income increasing 1.3% with a 0.5% rate rise and decreasing 2.2% with a 0.5% rate decline. The filing cautions that these simulations are not forecasts and exclude potential management actions.
Key risks include economic weakness and changes in real-estate values, borrower credit deterioration, interest-rate and liquidity changes, competition, technology and cybersecurity risks, vendor performance, regulatory and capital changes, litigation, and realizing expected benefits from the GCFC acquisition. Management said ordinary-course legal matters were not expected to have a material adverse effect and reported no material changes to the risk factors in its 2018 Form 10-K. Disclosure controls were assessed as effective as of March 31, 2019.
Important facts for investors to verify
- Whether classified commercial exposures, nonperforming loans, and charge-offs remain contained; pay particular attention to the newly classified commercial credit and the rising classified-asset ratio.
- Whether loan growth and asset yields can continue to offset deposit and borrowing cost increases and competitive pressure on loan pricing.
- Whether recurring fee income and mortgage servicing rights valuations recover, given the Q1 mark-to-market loss and the absence of the prior-year BOLI death benefit.
- How cash, deposit trends, short-term FHLB advances, and available borrowing capacity evolve as the company funds lending and other obligations.
- The eventual financial and operational effects of CECL adoption and ongoing integration of the ABC Bank acquisition.