Old Second Bancorp, Inc. — 2012 Form 10-K
Business context and reporting period. This annual filing covers the year ended December 31, 2012; quarterly figures are included, including fourth-quarter results. Old Second is an Illinois-focused community banking and trust company operating 27 branches, primarily in the Chicago metropolitan area. Its business includes commercial and consumer lending, deposits, mortgage banking, and wealth management.
Key financial results
| Metric | 2012 | 2011 |
|---|---|---|
| Total assets at year-end | $2.046 billion | $1.941 billion |
| Net interest and dividend income | $59.3 million | $64.0 million |
| Tax-equivalent net interest margin | 3.43% | 3.54% |
| Provision for loan losses | $6.3 million | $8.9 million |
| Noninterest income | $42.9 million | $36.0 million |
| Noninterest expense | $96.0 million | $97.6 million |
| Net income (loss) | $(72,000) | $(6.5) million |
| Net loss available to common shareholders | $(5.1) million | $(11.2) million |
| Basic and diluted loss per share | $(0.36) | $(0.79) |
| Operating cash flow | $43.3 million | $29.3 million |
- Fourth quarter: Net income was $1.524 million, compared with a $3.001 million loss in fourth-quarter 2011; no loan-loss provision was recorded in either the third or fourth quarter of 2012. Fourth-quarter results included $269,000 of securities gains.
- Revenue and margin: Annual net interest income declined 7.2%, largely as average earning assets and loans contracted. Lower funding costs helped, but the average tax-equivalent yield on earning assets fell 38 basis points to 4.28%, and the tax-equivalent margin eased to 3.43%.
- Credit and lending: Gross loans fell 16.0% to $1.150 billion. Real-estate-related loans remained 90.1% of the portfolio. Nonperforming loans declined to $82.6 million from $138.9 million; nonperforming assets fell to $155.0 million from $232.2 million. Net charge-offs were $19.7 million, down from $33.2 million. The allowance was $38.6 million, 3.36% of loans and 46.7% of nonperforming loans.
- Balance sheet, liquidity, and funding: Securities available for sale rose $272.3 million to $579.9 million as management invested liquid funds amid weak qualified loan demand. Deposits declined 1.4% to $1.717 billion; year-end cash and cash equivalents were $128.5 million. Financing cash inflow of $93.3 million included $100 million of short-term FHLB advances. Management reported $69.5 million of available borrowing capacity and $388.8 million of additional unencumbered securities available to pledge.
- Capital and debt: Stockholders’ equity was $72.6 million, down from $74.0 million. The Bank’s total risk-based capital ratio was 14.86% and Tier 1 leverage ratio was 9.67%, exceeding the heightened OCC Consent Order minimums of 11.25% and 8.75%. The consolidated company’s Tier 1 leverage ratio was 4.85%. Total borrowings were $221.8 million, including $100 million of FHLB advances, $45 million of subordinated debt, and $58.4 million of junior subordinated debentures.
Material changes versus the prior year
- Losses narrowed substantially: the annual net loss improved to $72,000 from $6.5 million, although common shareholders still had a $5.1 million loss after preferred dividends and accretion.
- Asset quality improved: nonperforming loans and assets declined, and net charge-offs and the loan-loss provision were lower. OREO decreased 22.4% to $72.4 million, but the company recorded $16.8 million of OREO valuation adjustments during 2012.
- Balance-sheet composition shifted from loans toward securities: loans declined $218.9 million while available-for-sale securities increased 88.5%. Total assets rose 5.4%.
- Mortgage banking income strengthened: income from mortgage banking activities was $11.7 million, up $5.5 million, reflecting higher loan sales. Trust income fell $776,000, partly due to three significant client departures.
Outlook, constraints, and risks
- Management emphasized asset quality, capital and liquidity management, reducing real-estate concentration, and expense control rather than pursuing loan growth. It reported muted demand from qualified borrowers and continued economic and real-estate-market uncertainty. The filing gives no numerical earnings or growth guidance.
- The Bank remained subject to an OCC Consent Order and the holding company to a Federal Reserve Written Agreement. These impose capital, planning, reporting, and supervisory approval requirements, including restrictions on dividends, capital distributions, debt, and certain share repurchases.
- Common and Series B preferred dividends were suspended. At year-end, $11.7 million of deferred junior subordinated interest and $9.1 million of deferred Series B preferred dividends had accrued. The company stated it could not resume common dividends until applicable arrears are paid and approvals and other restrictions are satisfied.
- The company was out of compliance with two financial covenants under its Bank of America credit agreement at year-end, constituting an event of default; the lender may have remedies, including accelerating the $500,000 term debt and enforcing collateral rights. The filing says required interest payments on outstanding principal had been made.
- Credit exposure remains concentrated in Illinois real estate, particularly commercial real estate. Further weakness in property values, borrower cash flows, employment, or local economic conditions could increase losses and impair collateral recovery. Allowance and OREO values depend on significant management estimates.
- The $10.0 million Trapeza collateralized debt obligation portfolio remained below amortized cost, with $8.0 million of unrealized losses and downgraded ratings; management reported no impairment and said it intended and expected to be able to hold the securities until recovery.
- The company maintained a full valuation allowance on operating deferred tax assets; the net deferred tax asset reported was $928,000, relating to unrealized securities losses. Realization of tax benefits depends on future taxable income and other factors.
- A proposed settlement of an ERISA class action was awaiting court approval; the company expected insurance to cover the settlement. Auditors issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective.
Most important facts for investors to verify
- Whether the improvement in nonperforming loans, charge-offs, and OREO continues, and whether actual collateral recoveries support management’s allowance and valuation estimates.
- The Bank’s ongoing compliance with OCC capital targets and both entities’ regulatory agreements, including the status of any supervisory restrictions.
- The status and terms of the credit-facility covenant default, short-term FHLB funding and maturities, and current liquidity and borrowing capacity.
- The accumulation and eventual payment or treatment of deferred trust-preferred interest and Series B dividends, and the resulting limits on common dividends.
- The credit quality, valuation assumptions, and realized performance of the expanded securities portfolio, especially the Trapeza CDOs and mortgage- and asset-backed securities.
- Whether the full deferred-tax-asset valuation allowance remains appropriate, and the outcome of the pending tax examinations and ERISA settlement approval.