Old Second Bancorp, Inc. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; comparative results are for 2013 and 2012. Old Second is an Illinois-focused community bank holding company operating 25 branches in the Chicago-area counties it serves.
Financial performance and condition
| Metric | 2014 | 2013 | Change or context |
|---|---|---|---|
| Total assets, year-end | $2.062 billion | $2.004 billion | Up 2.9% |
| Gross loans, year-end | $1.159 billion | $1.101 billion | Up 5.3%; real estate was 87.6% of the portfolio |
| Deposits, year-end | $1.685 billion | $1.682 billion | Essentially unchanged |
| Net interest income | $57.1 million | $55.3 million | Up 3.3%; net interest margin was 3.17% GAAP, or 3.19% tax-equivalent |
| Net income | $10.1 million | $82.1 million | 2013 included a $74.1 million reversal of deferred-tax valuation allowance |
| Net income available to common shareholders | $11.9 million | $76.8 million | Reported diluted EPS was $0.46 and $5.45, respectively |
| Noninterest income | $29.2 million | $31.2 million | Down 6.3%, notably from lower mortgage banking revenue |
| Noninterest expense | $73.7 million | $83.1 million | Down 11.4%, including lower OREO and FDIC expenses |
| Cash and cash equivalents, year-end | $44.2 million | $47.7 million | Down $3.5 million |
- Credit quality: Nonperforming assets fell 27.3% to $59.1 million, or 2.86% of assets. Nonperforming loans declined 31.9% to $27.1 million; OREO was $32.0 million.
- Credit costs: The company recorded a $3.3 million loan-loss reserve release, versus an $8.6 million release in 2013. Net charge-offs were $2.3 million, down from $2.8 million. The allowance was $21.6 million, 1.87% of loans, compared with $27.3 million, or 2.48%, a year earlier.
- Capital and funding: Stockholders’ equity rose to $194.2 million from $147.7 million, primarily following a $64.3 million net common-stock offering. The Bank’s year-end Tier 1 leverage and total capital ratios were 12.02% and 18.73%; it was reported well-capitalized under requirements then in effect.
- Debt: Year-end borrowings totaled approximately $169.9 million, including $58.4 million of junior subordinated debentures and $45.0 million of subordinated debt. The company also had a $45.0 million FHLB advance and $21.0 million in repurchase agreements. Its $45.5 million correspondent-bank credit facility was in covenant compliance at year-end; debt under the facility matures in 2018.
- Cash flow: Operating cash flow was negative $6.3 million, investing cash flow negative $66.1 million, and financing cash flow positive $69.0 million. Financing included $64.3 million of common-stock proceeds and $40.0 million of additional short-term borrowings, offset in part by preferred-stock redemption and dividends.
Material changes and unusual items
- The April 2014 offering issued 15.525 million common shares and raised more than $64 million net, substantially increasing equity but also increasing the weighted-average common shares outstanding. Proceeds funded $19.7 million of deferred trust-preferred interest, $10.3 million of accumulated Series B dividends, a $24.3 million Series B repurchase, and general corporate purposes.
- The remaining deferred-tax valuation allowance was reversed in 2014; the company reported a $70.1 million net deferred tax asset at year-end. The 2014 reversal was $2.4 million, compared with $74.1 million in 2013. Management’s realization judgment depends on future taxable income.
- The 2013 comparison includes a $4.1 million pretax loss on sale of collateralized debt obligations and a substantial tax benefit from the valuation-allowance reversal. These items make the sharp decline in reported net income in 2014 a poor standalone measure of operating trends.
- In 2014, loans grew after declining in 2013; commercial, commercial real estate, and construction balances increased, while residential real estate loans declined. Securities increased $16.4 million to $645.2 million, with additions to collateralized loan obligations and reductions in asset-backed securities.
- The company paid all previously deferred trust-preferred interest and Series B dividends in 2014 and was current at year-end. It paid no common dividends. A further redemption of approximately one-third of remaining Series B shares was completed in January and February 2015.
- The Federal Reserve Written Agreement was terminated in January 2014 and the Bank’s OCC Consent Order in October 2013. James L. Eccher became company President and CEO on January 1, 2015; William B. Skoglund remained Chairman.
Outlook, risks and contingencies
- No quantified earnings, revenue, loan-growth, or dividend guidance is provided. Management’s stated priorities include continued problem-asset reduction, rebuilding loan growth, expense control, and maintaining capital and liquidity. Management expected the company and Bank to qualify as well-capitalized under Basel III in 2015; this was an expectation, not a reported 2015 result.
- Management described local real estate conditions as improving but still challenging, and qualified-borrower demand and competition as constraints. Real estate lending remains a concentration, with collateral values, borrower cash flows, and the Illinois and local economies key risks.
- Other material risks include potential further loan losses and OREO write-downs, interest-rate and liquidity risk, deposit competition, securities valuation and credit exposure, regulatory changes, cybersecurity and third-party service-provider risks, and the company’s ability to realize deferred-tax assets.
- Commitments to extend credit and letters of credit totaled $243.6 million at year-end. Ordinary-course legal proceedings were disclosed; management did not expect them to have a material adverse effect based on information then available.
- Basel III capital requirements became effective in 2015 with phase-in through 2019. The company expected to elect the option to exclude most accumulated other comprehensive income effects from regulatory capital.
Important facts for investors to verify
- Reconcile reported net income, common-shareholder income, EPS, preferred-stock charges, and the tax-valuation-allowance reversals; assess earnings excluding these unusual tax and capital-structure items.
- Review the sustainability of the loan-loss reserve release, coverage of nonperforming loans, classified assets, OREO valuation assumptions, and the continuing concentration in real estate lending.
- Check post-offering share dilution, the remaining Series B preferred balance after the 2015 redemption, restrictions on common dividends, and the company’s capacity to service debt.
- Assess liquidity and funding after the negative 2014 operating cash flow and increase in FHLB borrowing, including maturities and the availability of contingent funding.
- Examine securities composition, unrealized losses, and valuation inputs; $52.9 million of available-for-sale asset-backed securities was classified as Level 3 at year-end, and three student-loan-related issuers each represented more than 10% of stockholders’ equity.
The independent auditor issued an unqualified opinion on the financial statements and internal controls over financial reporting as of December 31, 2014.