Business Context and Reporting Period
Company: Old Second Bancorp, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Overview: Old Second Bancorp is a financial services holding company headquartered in Aurora, Illinois, operating Old Second National Bank. The reporting period was significantly impacted by the acquisition of HeritageBanc, Inc., consummated on February 8, 2008. This transaction expanded the Company's footprint into southwestern Cook County and the south Chicago suburbs, adding five retail locations and one mobile banking operation. The acquisition was funded through a combination of cash and stock issuance.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2008 | Six Months Ended June 30, 2007 |
|---|---|---|
| Net Income | $12.9 million | $11.5 million |
| Diluted Earnings Per Share (EPS) | $0.95 | $0.88 |
| Net Interest Income | $42.5 million | $33.5 million |
| Net Interest Margin (TE Basis) | 3.32% | 3.09% |
| Noninterest Income | $19.0 million | $16.1 million |
| Noninterest Expense | $40.3 million | $33.4 million |
| Provision for Loan Losses | $2.8 million | $0.6 million |
| Total Assets | $2.96 billion | $2.66 billion (Dec 31, 2007) |
| Total Loans | $2.22 billion | $1.89 billion (Dec 31, 2007) |
| Total Deposits | $2.42 billion | $2.11 billion (Dec 31, 2007) |
| Allowance for Loan Losses | $21.6 million | $16.8 million (Dec 31, 2007) |
| Nonperforming Loans | $30.7 million | $5.2 million (June 30, 2007) |
| Return on Average Equity | 13.59% | 14.91% |
Material Changes vs. Prior Period
- Acquisition Impact: The HeritageBanc acquisition drove significant growth in assets ($297.4 million increase) and loans ($324.8 million increase). Approximately $283.6 million of loan growth was attributed to the acquisition.
- Profitability: Net income increased 12.3% year-over-year for the six-month period. Core net income (excluding transaction costs) was $13.5 million, or $0.99 per diluted share.
- Interest Rates: The net interest margin improved to 3.32% (TE basis) from 3.09% in the prior year, despite a decrease in the average yield on earning assets (6.12% vs. 6.68%). This improvement was driven by a larger decrease in the cost of interest-bearing liabilities (3.27% vs. 4.16%).
- Asset Quality: Nonperforming loans increased sharply to $30.7 million from $6.0 million at year-end 2007. Approximately 62.5% of this increase is attributed to six residential homebuilder relationships facing inventory challenges. Consequently, the provision for loan losses increased to $2.8 million from $0.6 million in the prior year.
- Noninterest Income: Increased 17.7% to $19.0 million, driven by higher mortgage banking income ($4.5 million vs. $3.0 million) and realized gains on securities ($1.4 million vs. $0.5 million).
Guidance, Outlook, and Risks
- Management Commentary: Management believes the exclusion of one-time transaction costs ($0.6 million net of tax for the six months) provides a better view of continuing operations. The efficiency ratio improved to 63.75% (62.81% on a core basis) compared to 65.24% in the prior year.
- Capital Markets: The Company notes that current conditions in capital markets may limit its ability to raise inexpensive capital for future growth or acquisitions in the near term.
- Interest Rate Risk: The Company maintains a policy to minimize fluctuations in net interest margin. As of June 30, 2008, the Company had a negative interest sensitivity gap of approximately $706 million for the first year, meaning interest-sensitive liabilities exceed assets in that period.
- Regulatory Capital: Both the Company and its subsidiary bank are categorized as "well capitalized" as of June 30, 2008. Total capital to risk-weighted assets was 10.54% for the consolidated entity.
- Tax Law Changes: A change in Illinois tax law regarding the deductibility of REIT dividends and the inclusion of an investment subsidiary in the unitary tax return is expected to increase the effective tax rate beginning in 2009.
Investor Verification Checklist
- Asset Quality Concentration: Verify the status of the six residential homebuilder relationships comprising 62.5% of nonperforming loans and the adequacy of the $1.7 million specific reserve allocated to them.
- Acquisition Integration: Confirm the realization of projected synergies and the timeline for the elimination of transitional employee costs associated with the HeritageBanc merger.
- Capital Constraints: Assess the impact of tight capital markets on the Company's ability to fund future loan growth or pursue additional acquisitions.
- Interest Rate Sensitivity: Review the negative interest rate gap for the first year and the Company's hedging strategies to manage potential margin compression if rates rise.
- Tax Rate Volatility: Monitor the impact of the Illinois tax law changes on the effective tax rate and future earnings projections starting in 2009.