Old Second Bancorp, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; financial statements are unaudited. Old Second is an Illinois-focused bank holding company operating through Old Second National Bank, with 29 banking centers. Results include the acquired ABC Bank for a full quarter in 2019 versus only part of the comparable 2018 quarter.
Financial performance and position
Amounts are in millions except per-share data and ratios.
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Net interest and dividend income | $24.8 | $23.2 | +$1.5 |
| Provision for loan and lease losses | $0.45 | $1.45 | -$1.00 |
| Noninterest income | $8.1 | $8.5 | -$0.4 |
| Noninterest expense | $20.1 | $22.3 | -$2.2 |
| Income before taxes | $12.3 | $8.0 | +$4.3 |
| Net income | $9.3 | $6.3 | +$3.0 |
| Diluted earnings per share | $0.31 | $0.21 | +$0.10 |
- For the first six months, net income was $17.7 million versus $15.8 million; diluted EPS was $0.58 versus $0.52. Net interest income was $48.8 million versus $42.9 million, while noninterest income declined to $14.6 million from $17.0 million.
- Q2 tax-equivalent net interest margin was 4.15%, up 16 basis points year over year; six-month margin was 4.12%, up 24 basis points. The Q2 average cost of interest-bearing liabilities rose to 1.13% from 0.92% a year earlier.
- At June 30, total assets were $2.62 billion, loans $1.90 billion, deposits $2.08 billion, and stockholders’ equity $257.3 million. Compared with December 31, 2018, assets decreased $52.4 million, loans increased $5.9 million, deposits decreased $38.9 million, and equity increased $28.2 million.
- Six-month operating cash flow was $39.9 million; investing cash inflow was $62.2 million and financing cash outflow was $99.1 million. Cash and equivalents ended at $58.2 million, up $3.0 million from year-end.
- Total borrowings were $254.2 million, down from $313.4 million at year-end, largely reflecting a $62.4 million reduction in other short-term borrowings. The company reported $317.2 million of unused FHLB borrowing capacity and $153.5 million of unpledged available-for-sale securities.
- The Bank’s June 30 capital ratios included a 13.96% common equity Tier 1 ratio, 14.83% total risk-based capital ratio, and 11.96% Tier 1 leverage ratio. Management reported ratios above applicable well-capitalized thresholds.
Material changes and asset quality
- Q2 earnings growth reflected higher interest income—supported by the ABC Bank acquisition, organic loan growth and higher loan yields—lower provision expense, and reduced noninterest expense. Acquisition-related conversion and employee costs had elevated Q2 2018 expenses.
- Noninterest income was pressured by a $1.1 million Q2 mortgage servicing rights (MSR) mark-to-market loss, compared with a $0.1 million loss a year earlier. This was partly offset by $986,000 of securities gains. Six-month MSR marks were a $2.0 million loss versus a $0.2 million gain in 2018; the prior-year period also included a $1.0 million BOLI death benefit.
- Nonperforming loans were $12.7 million, or 0.7% of loans, down from $16.3 million and 0.9% at December 2018; the ratio was 0.6% in June 2018. Net charge-offs were $394,000 in Q2, compared with $140,000 in Q1 and $317,000 in Q2 2018. The allowance was $19.4 million, 153.0% of nonperforming loans.
- Classified loans were $35.9 million, up from $35.3 million at year-end and $26.3 million a year earlier. Management attributed the increase primarily to one large commercial credit classified in Q1 2019. Real-estate-related lending represented 75.7% of loans.
- Other real estate owned declined to $5.7 million from $7.2 million at year-end. About 80% of OREO had been held for five years or more; management noted that required regulatory approval had been obtained for properties held beyond five years.
Outlook, risks and notable items
- No specific earnings, revenue, margin, or loan-growth guidance was provided. Management described stable market conditions and pursued local-market growth, while noting competitive pressure on commercial and commercial real estate loan pricing and underwriting constraints.
- Management characterized interest-rate risk as moderate. Its simulation estimated annual pretax income increases of 1.4%, 2.8%, and 5.4% for immediate rate increases of 0.5%, 1%, and 2%, respectively, and decreases of 2.2% and 5.5% for rate declines of 0.5% and 1%. A 2% decline was not modeled because rates would fall below zero. These scenarios are estimates and exclude potential management actions.
- Disclosed risks include economic deterioration affecting borrowers and real estate values, interest-rate and funding changes, acquisition integration and customer attrition, competition, technology and cybersecurity exposures, regulatory changes, litigation, and mortgage repurchase or indemnification claims. Management said no material changes had occurred to the risk factors in the 2018 Form 10-K.
- The company adopted lease accounting in January 2019, recording $817,000 of right-of-use assets and lease liabilities at adoption; each was $561,000 at June 30. It was assessing the expected-credit-loss standard for adoption in 2020 and planned parallel testing in the second half of 2019.
- The board declared a $0.01-per-share dividend payable August 5, 2019. Management stated that ordinary-course legal matters were not expected to have a material adverse effect. Disclosure controls were reported effective, with no material control changes during the quarter.
Important facts for investors to verify
- Whether loan growth and stronger net interest margin can persist as deposit and borrowing costs rise and competition pressures loan pricing.
- The drivers, valuation assumptions, and future sensitivity of MSR losses, and whether securities gains are recurring or were primarily portfolio repositioning.
- Performance and credit trends in the large commercial exposure newly classified in Q1, alongside the increase in classified loans and Q2 net charge-offs.
- Deposit trends, funding mix, liquidity capacity, and the cost and maturity profile of FHLB advances and other borrowings.
- How ABC Bank integration benefits, cost savings, and any customer attrition compare with management’s expectations; and the eventual impact of the 2020 expected-credit-loss standard.