Old Second Bancorp, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Old Second Bancorp is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. Unless otherwise stated, figures below are in U.S. dollars; financial statement amounts are in millions.
Financial results and key metrics
| Metric | Q1 2015 | Comparable period |
|---|---|---|
| Interest and dividend income | $16.9 million | $16.7 million in Q1 2014 |
| Net interest income | $14.6 million | $13.6 million in Q1 2014 |
| Net interest margin, tax-equivalent | 3.26% | 3.13% in Q1 2014; 3.35% in Q4 2014 |
| Noninterest income | $8.0 million | $6.3 million in Q1 2014 |
| Noninterest expense | $17.2 million | $17.5 million in Q1 2014 |
| Income before income taxes | $5.4 million | $3.4 million in Q1 2014 |
| Net income | $3.5 million | $2.2 million in Q1 2014 |
| Net income available to common shareholders | $2.7 million | $0.6 million in Q1 2014 |
| Diluted earnings per share | $0.09 | $0.04 in Q1 2014 |
| Operating cash flow | $3.4 million | $(4.9) million in Q1 2014 |
Growth in net interest income and noninterest income, together with lower expenses, lifted pretax and net income year over year. Net interest income declined $0.5 million from Q4 2014, and tax-equivalent margin narrowed by 9 basis points. The efficiency ratio was 68.77%, compared with 78.86% in Q1 2014 and 74.22% in Q4 2014.
Financial position, liquidity, and capital
- Total assets were $2.10 billion at March 31, up 1.7% from year-end 2014. Total loans were $1.15 billion, down 0.7%; commercial real estate loans increased while most other loan categories declined.
- Deposits totaled $1.745 billion, up $59.7 million from December 31. Noninterest-bearing demand deposits increased $31.4 million. Cash and cash equivalents were $74.2 million, up from $44.2 million at year-end.
- Total stockholders’ equity was $181.8 million, down $12.3 million from year-end, primarily reflecting the redemption of 15,778 shares of Series B preferred stock during the quarter.
- Reported borrowings totaled $160.4 million, versus $169.9 million at year-end. This included $26.5 million in repurchase agreements, $30.0 million in FHLB advances, $58.4 million in junior subordinated debentures, and $45.0 million in subordinated debt. The company reported compliance with its credit-facility covenants and available excess FHLB collateral of $112.1 million.
- The Bank’s Tier 1 leverage ratio was 12.15% and total risk-based capital ratio was 18.18%, above management’s stated objectives of 8% and 12%, respectively, and above regulatory well-capitalized thresholds.
- Net cash from financing activities was $33.3 million, principally reflecting $59.7 million of deposit inflows, partly offset by preferred-stock redemption and dividend payments. Investing activities used $6.8 million of cash.
Material changes and credit quality
- No loan-loss provision or release was recorded in Q1 2015, compared with releases of $1.0 million in Q1 2014 and $1.3 million in Q4 2014. The allowance was $21.2 million, or 1.83% of loans; coverage of nonperforming loans was 90.7%.
- Nonperforming loans declined to $23.4 million from $27.1 million at year-end. Classified loans fell to $36.4 million from $40.9 million. Net charge-offs were $456,000, compared with $805,000 in Q1 2014.
- Other real estate owned (OREO) increased to $35.5 million from $32.0 million at year-end, as $6.1 million of additions exceeded dispositions and valuation adjustments. Real estate-related lending represented 87.9% of the loan portfolio.
- Q1 mortgage-loan sale gains rose to $1.6 million from $0.7 million in Q1 2014; management said mortgage originations reached their highest level in two years. Other income included a nonrecurring $917,000 service-provider incentive payment and a life-insurance death benefit.
- Available-for-sale securities increased to $399.3 million from $385.5 million at year-end. The portfolio’s pretax net unrealized loss narrowed by $1.0 million during the quarter to $5.2 million. Management attributed securities fair-value movements primarily to interest-rate changes and reported no other-than-temporary impairment.
Outlook, commentary, and risks
Management described local economic growth as steady but sluggish, with customer caution, intense competition, and modest loan demand. It said loan pipelines were expected to support future growth, while noting competitive pressure on new and renewed loan yields. The company provided no specific earnings or revenue guidance. Management characterized interest-rate risk as low and within policy limits; its simulation estimated annual pretax income increases of 3.2% under an immediate 1% rate increase and a 1.5% decrease under a 0.5% decline. The filing says valid simulations for declines of 1% or more were unavailable in the low-rate environment.
Key exposures include the high concentration in real estate-related loans, ongoing OREO valuation and disposition risk, loan-credit uncertainty, competition, and sensitivity of earnings to rates and balance-sheet behavior. After quarter-end, the Bank completed a sale of several related problem loans on April 23 under terms consistent with specific reserves and received a $504,000 insurance payment on April 24, expected to be recorded as a Q2 recovery. Management stated that ordinary-course legal matters were not expected to have a material adverse effect. Risk factors were unchanged from the 2014 Form 10-K. Disclosure controls were reported effective.
James L. Eccher became President and CEO effective January 1, 2015; William B. Skoglund retired as CEO and remained board chair. Management noted the company was evaluating possible further Series B preferred-stock redemptions but would act only after considering short- and long-term factors.
Important facts for investors to verify
- How much of the earnings improvement is sustainable, given the nonrecurring incentive payment, insurance benefit, and strong mortgage-banking contribution.
- Whether the post-quarter problem-loan sale and insurance recovery affect reported credit metrics or reserves as expected, and whether OREO additions and valuations stabilize.
- The trajectory of loan growth, deposit mix, net interest margin, and loan yields amid sluggish demand and competitive pricing.
- Future Series B preferred-stock redemptions, dividend obligations, and the effect on common-shareholder earnings and capital.
- Interest-rate sensitivity assumptions and the impact of real-estate concentration and other credit risks on capital and liquidity.