Business Context and Reporting Period
Company: Old Second Bancorp, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: A financial services holding company headquartered in Aurora, Illinois, operating Old Second National Bank. The company provides commercial and retail banking services and trust/wealth management services across several Illinois counties. The company is currently subject to a Memorandum of Understanding (MOU) with the Office of the Comptroller of the Currency (OCC) regarding credit risk reduction and capital ratios.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 | Dec 31, 2010 (Balance Sheet) |
|---|---|---|---|
| Net Interest Income | $16.19 million | $20.98 million | N/A |
| Provision for Loan Losses | $4.00 million | $19.22 million | N/A |
| Net Loss | $(3.12) million | $(8.55) million | N/A |
| Net Loss Available to Common Shareholders | $(4.28) million | $(9.68) million | N/A |
| Loss Per Share (Diluted) | $(0.30) | $(0.69) | N/A |
| Total Assets | $2.12 billion | N/A | $2.12 billion |
| Total Loans (Gross) | $1.60 billion | N/A | $1.69 billion |
| Allowance for Loan Losses | $73.13 million | N/A | $76.31 million |
| Total Deposits | $1.90 billion | N/A | $1.91 billion |
| Stockholders' Equity | $80.19 million | N/A | $83.96 million |
| Net Cash Provided by Operating Activities | $6.48 million | $17.32 million | N/A |
Material Changes vs. Prior Period
- Improved Loss Position: The net loss narrowed significantly to $3.12 million in Q1 2011 compared to $8.55 million in Q1 2010. This improvement was driven primarily by a substantial reduction in the provision for loan losses ($4.0 million vs. $19.2 million) and lower net charge-offs ($7.2 million vs. $16.9 million).
- Asset Deleveraging: Total assets decreased slightly to $2.12 billion. Loans decreased by $88.4 million (5.2%) from the prior quarter due to declining demand, charge-offs, and a strategic shift to reduce asset size to strengthen capital ratios.
- Nonperforming Assets: Nonperforming loans decreased to $193.0 million (down from $228.9 million at year-end 2010). However, Other Real Estate Owned (OREO) increased by $10.0 million to $85.6 million as collateral from problem loans was converted.
- Net Interest Margin: The net interest margin (tax-equivalent basis) decreased to 3.42% from 3.78% in Q1 2010, reflecting a decline in average earning assets and yields, partially offset by lower funding costs.
Guidance, Outlook, Risks, and Unusual Items
- Regulatory Compliance: The Bank is currently out of compliance with the heightened Tier 1 capital to adjusted total assets ratio (8.64% actual vs. 8.75% required) agreed upon in its MOU with the OCC. Management expects the OCC may replace the current MOU with a formal regulatory enforcement action.
- Dividend Restrictions: The Company has suspended dividends on its common stock and TARP Series B Preferred Stock. It has also deferred interest payments on $58.4 million of junior subordinated debentures. Dividends on common stock cannot be reinstated until all deferred preferred dividends ($2.3 million) and subordinated debenture interest ($3.4 million) are paid in full.
- Credit Quality Risks: Commercial Real Estate (CRE) remains the largest component of nonperforming loans (47.9%). Retail properties (strip malls) and owner-occupied special purpose properties are experiencing significant stress. Management maintains that specific allocations are sufficient but notes no guarantee that actual losses will not exceed estimates.
- Legal Proceedings: A class action complaint was filed in February 2011 by a former employee alleging violations of ERISA regarding the 401(k) plan. The Company intends to vigorously defend the allegations.
- Unusual Items: The Company recorded no income tax benefit for the quarter due to a valuation allowance against deferred tax assets, as realization was not deemed "more likely than not."
Investor Verification Checklist
- Regulatory Capital Status: Verify the Bank's ability to meet the heightened Tier 1 leverage ratio (8.75%) required by the OCC MOU and the potential impact of a formal enforcement action.
- Dividend Resumption: Confirm the timeline and capital requirements necessary to pay down the $5.7 million in accrued/deferred obligations (preferred dividends and subordinated interest) before common dividends can resume.
- OREO Disposition: Monitor the pace of sales and valuation adjustments for the $85.6 million OREO portfolio, which continues to grow and impact earnings.
- Credit Concentration: Assess the specific exposure to retail strip malls and special purpose commercial real estate, which represent high-risk segments within the nonperforming loan portfolio.
- Deferred Tax Assets: Review future earnings projections to determine if the valuation allowance against deferred tax assets can be reversed, which would impact future tax benefits.