Old Second Bancorp, Inc. — Q1 2014 Form 10-Q
Business and period. Old Second Bancorp is an Illinois-based bank holding company providing commercial and retail banking, trust, and wealth-management services. This unaudited filing covers the three months ended March 31, 2014; balance-sheet comparisons are to December 31, 2013. Amounts below are in U.S. dollars; financial statement figures are generally in millions.
Financial performance and condition
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior date |
|---|---|---|
| Net interest and dividend income | $13.6 million | $13.9 million in Q1 2013 |
| Net interest margin, tax-equivalent | 3.13% | 3.18% in Q1 2013 |
| Noninterest income | $6.3 million | $10.0 million in Q1 2013 |
| Noninterest expense | $17.5 million | $20.9 million in Q1 2013 |
| Pre-tax income | $3.4 million | $5.5 million in Q1 2013 |
| Net income | $2.2 million; $0.04 diluted EPS | $5.5 million; $0.30 diluted EPS in Q1 2013 |
| Net income available to common shareholders | $0.6 million after $1.6 million preferred dividends and accretion | $4.2 million after $1.3 million in Q1 2013 |
| Cash and cash equivalents | $54.5 million | $47.7 million at December 31, 2013 |
| Total assets / total deposits | $2.06 billion / $1.72 billion | $2.00 billion / $1.68 billion at December 31, 2013 |
| Total loans / allowance for loan losses | $1.11 billion / $25.5 million | $1.10 billion / $27.3 million at December 31, 2013 |
| Total borrowings | $147.1 million | $131.4 million at December 31, 2013 |
| Total stockholders’ equity | $149.5 million | $147.7 million at December 31, 2013 |
Net cash used in operating activities was $4.9 million, versus $2.2 million provided in Q1 2013. Investing activities used $46.0 million, while financing activities provided $57.8 million, chiefly reflecting $42.2 million of deposit growth and a $15.0 million short-term borrowing increase. The quarter ended with $54.5 million of cash and cash equivalents.
The Bank reported March 31 capital ratios of 17.83% total risk-based capital, 16.58% Tier 1 risk-based capital, and 11.12% Tier 1 leverage. Each exceeded the Bank’s regulatory “well-capitalized” thresholds and its stated board targets for total risk-based capital and leverage.
Material changes and management commentary
- Q1 net income and common earnings fell year over year. Management attributed the decline primarily to the prior-year quarter’s larger reserve release, stronger net interest income, $1.5 million of securities gains, and higher residential mortgage revenue. Q1 2014 also included a $1.2 million income-tax expense, compared with none in Q1 2013.
- Net interest income declined $0.3 million and tax-equivalent margin fell 5 basis points. Management cited lower average loan balances and yields, competitive pressure on loan pricing, and growth in lower-yielding securities; lower funding costs provided some offset.
- Noninterest income declined $3.7 million year over year, including lower mortgage-loan sale gains and mortgage servicing results, and a swing from prior-year securities gains to a small loss. Noninterest expense decreased $3.4 million, notably as FDIC insurance and OREO costs fell.
- Total loans increased $10.0 million from year-end, with commercial real estate growth partly offset by a decline in residential loans. Real estate-related lending remained 88.8% of the portfolio. Management said it was emphasizing relationship lending and commercial and industrial lending, while local economic and property-market conditions remained uneven and challenging.
- Asset-quality measures improved overall: nonperforming loans declined to $38.6 million from $39.8 million at year-end; classified loans fell to $52.7 million from $62.2 million; and OREO decreased to $40.2 million from $41.5 million. The allowance was 2.3% of loans and covered 66.0% of nonperforming loans. Net charge-offs were $0.8 million, compared with net recoveries of $2.5 million in Q1 2013.
- Management recorded a $1.0 million loan-loss reserve release, versus $2.5 million in Q1 2013, citing improved loan quality and lower estimated reserve needs. It cautioned that actual losses could exceed estimates. OREO valuation and collateral estimates remain subject to uncertainty.
Outlook, material events, and risks
No numerical earnings or revenue guidance is provided. Management said loan pipelines were developing and expected to support future growth, but characterized growth as measured and cited competition, moderate business confidence, and weak real-estate conditions. Mortgage refinancing activity was sharply lower; management reported some improvement in the purchase pipeline but at a slower pace.
- Post-quarter capital actions: In April, the company completed a public offering of 15,525,000 common shares, receiving net proceeds exceeding $64 million. It used proceeds to pay approximately $19.7 million of deferred trust-preferred interest and approximately $24.3 million to repurchase 25,669 Series B preferred shares. It declared approximately $15.8 million of Series B dividends for payment in May; remaining proceeds were designated for general corporate purposes. The company expected the preferred-share repurchase to produce an income-statement benefit in Q2.
- Debt covenant: At March 31, the company was out of compliance with one financial covenant in its credit agreement. The filing describes potential lender remedies, including acceleration of the $0.5 million term debt, but states that subordinated debt is not subject to those remedies for this covenant default. The senior line of credit had been terminated.
- Regulatory status: The Federal Reserve terminated its Written Agreement in January 2014; the OCC Consent Order had been terminated in October 2013. The company nevertheless expected to seek Federal Reserve approval before common dividends or additional indebtedness.
- Dividend restrictions: Common dividends remained restricted until deferred trust-preferred interest and Series B dividends were paid. The company reported that it paid the deferred trust-preferred interest in April and declared the Series B dividend after quarter-end. Common dividends were not paid in Q1.
- Other risks: The loan portfolio is heavily concentrated in real estate-related lending; nonperforming assets and OREO, borrower repayment capacity, collateral values, interest-rate exposure, securities valuations, and the company’s ability to realize deferred tax assets remain important risks. Management said there were no material changes to the risk factors in its 2013 Form 10-K. Ordinary-course legal proceedings were not expected by management to have a material adverse effect.
Important facts for investors to verify
- Whether the April common-stock offering, preferred-share repurchase, and dividend payments materially improve capital, liquidity, and future earnings per share after dilution.
- Resolution and continuing implications of the credit-agreement covenant breach, including any lender action or waiver.
- Whether credit-quality improvements persist, and whether reserve releases remain appropriate given net charge-offs, real-estate concentration, OREO, and allowance coverage.
- Trends in net interest margin, loan growth, deposit mix and cost, and mortgage-banking income.
- Future common-dividend eligibility and regulatory approvals, including the status of all accrued preferred dividends and trust-preferred obligations.
- Valuation and realization assumptions for the $74.5 million net deferred tax asset and significant securities measured using unobservable inputs.