Old Second Bancorp, Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; comparisons are primarily with 2014. Unless stated otherwise, amounts are USD millions. The company is a community bank holding company operating 24 locations in the Chicago-area counties of Illinois. Financial statements received an unqualified audit opinion; management and its auditor reported effective internal control over financial reporting.
Financial performance and condition
| Metric | 2015 | 2014 | Change or context |
|---|---|---|---|
| Total assets, year-end | $2,077.9 | $2,061.8 | Up 0.8% |
| Net interest income | $59.1 | $57.1 | Up 3.6%; tax-equivalent net interest margin was 3.23% versus 3.19% |
| Noninterest income | $29.3 | $29.2 | Nearly flat; mortgage banking improved, offset partly by securities losses |
| Noninterest expense | $68.4 | $73.7 | Down 7.1% |
| Net income | $15.4 | $10.1 | Diluted EPS was $0.46 in both years |
| Net income available to common shareholders | $13.5 | $11.9 | 2014 included preferred-stock redemption-related items |
| Return on average assets / equity | 0.74% / 8.87% | 0.50% / 5.57% | Improved year over year |
| Net cash from operating activities | $21.1 | $(6.3) | Cash and cash equivalents ended at $40.3, down $3.9 |
Net income in 2013 was $82.1 million, unusually elevated by a $74.1 million deferred-tax valuation-allowance benefit; it is not a directly comparable recurring earnings baseline. 2015 income taxes were $9.0 million.
Loans, credit quality, and funding
- Gross loans declined 2.2% to $1,133.7; commercial loans grew while residential and construction balances fell. Construction loans decreased to $19.8 from $44.8.
- Real-estate-related lending represented 86.1% of loans. Commercial real estate loans were $605.7, approximately 53% of the portfolio.
- Nonperforming assets fell 42.8% to $33.8, including $14.6 of nonperforming loans and $19.1 of other real estate owned. Net charge-offs declined to $1.0 from $2.3.
- The allowance for loan losses ended at $16.2, or 1.43% of loans, versus $21.6, or 1.87%, in 2014. The company recorded a $4.4 reserve release; 2015 methodology changes increased the allowance by approximately $1.3.
- Deposits grew 4.4% to $1,759.1, with growth in transaction and savings accounts offsetting lower time deposits. Year-end cash and cash equivalents were $40.3.
- Year-end borrowings included $34.1 under repurchase agreements, $15.0 in FHLB advances, $58.4 in junior subordinated debentures, and $45.0 in subordinated debt. The company reported compliance with credit-facility covenants; the $45.5 correspondent credit facility matures in March 2018.
Capital and shareholder matters
Stockholders’ equity decreased to $155.9 from $194.2, principally reflecting redemption of the remaining $47.3 of Series B preferred stock during 2015. The company and Bank exceeded applicable well-capitalized thresholds. At year-end, the Bank’s Tier 1 leverage and total capital ratios were 9.94% and 15.23%; consolidated ratios were 8.69% and 15.56%, respectively. No common dividends were paid in 2015 or 2014.
Material changes, outlook, and risks
- Results improved with lower funding costs and expenses and improving credit quality, but loan balances contracted amid muted qualified-borrower demand and intense competition.
- Noninterest expense fell 7.1%, reflecting lower foreclosed-property costs, insurance costs, staffing reductions, and no further core-deposit-intangible amortization. Staffing declined to 450 full-time equivalents from 485.
- Mortgage banking revenue increased; the company sold $190.6 of residential mortgage loans and recognized $5.8 of gains on loan sales. Securities sales produced a net loss of $0.2, compared with a $1.7 gain in 2014.
- Unusual items included an approximately $1.1 noncash impairment/loss associated with the closed Batavia branch property and approximately $0.9 of revenue from a one-time service-provider payment.
- The company provided no specific earnings or growth guidance. Management described local real estate conditions as improving but still difficult, and continued to emphasize credit quality, expense control, balance-sheet stabilization, and developing loan pipelines.
- Key risks include the substantial real estate concentration, continued exposure to Illinois and local economic conditions, uncertain collateral values and allowance estimates, weak loan demand, competition for deposits and lending, interest-rate and liquidity risk, regulatory requirements, cyber and third-party technology risk, and potential mortgage repurchase or litigation exposure. Management said pending legal matters were not expected to have a material adverse effect based on information then available.
- The $64.6 net deferred tax asset depends on future taxable income; the company reported no valuation allowance at year-end. Its tax-benefits rights plan was extended to September 2018, subject to shareholder ratification.
Important facts for investors to verify
- Whether credit quality improvements and lower nonperforming assets persist, and whether the smaller allowance remains adequate relative to portfolio risks.
- How commercial real estate concentration, local property values, and Illinois fiscal conditions affect loan performance and collateral recoveries.
- Whether loan production can resume sustainable growth and support recurring net interest income amid competition and rate changes.
- The valuation, credit exposure, liquidity, and concentration of the securities portfolio, including student-loan-backed asset-backed securities; year-end available-for-sale unrealized losses were $15.0 before tax.
- Whether deferred tax assets are realizable and how preferred-stock redemption, debt service, and regulatory capital constraints affect future capital distributions.