Washington, D.C. 20549

 

FORM 10-Q

 

 

Commission File Number 0 -10537

 

OLD SECOND BANCORP, INC.

(Exact name of Registrant as specified in its charter)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  ý No  o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of July 15, 2004, the Registrant had outstanding 6,708,840 shares of common stock, $1.00 par value per share.  On June 16, 2004, the Company declared a 2-for-1 common stock split effected in the form of a one hundred percent stock dividend payable on July 28, 2004, to stockholders of record on July 16, 2004.

 

 

OLD SECOND BANCORP, INC.

 

Form 10-Q Quarterly Report

 

Table of Contents

 

	PART I
Item 1.	Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
	PART II
Item 1.	Legal Proceedings
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
	Signatures

 

2

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

 

		(Unaudited)
		June 30, 2004			December 31, 2003
Assets
Cash and due from banks		$	49,513		$	54,999
Interest bearing balances with banks		555			169
Federal funds sold		31,500			—
Cash and cash equivalents		81,568			55,168
Securities available for sale		418,093			411,035
Loans held for sale		15,283			14,756
Loans		1,425,361			1,319,538
Allowance for loan losses		18,314			18,301
Net loans		1,407,047			1,301,237
Premises and equipment, net		33,468			33,033
Other real estate owned		—			663
Goodwill, net		2,130			2,130
Core deposit intangible assets, net		888			1,066
Accrued interest and other assets		42,594			19,756
Total assets		$	2,001,071		$	1,838,844
Liabilities
Deposits:
Demand		$	230,274		$	214,439
Savings		804,114			737,838
Time		674,807			572,357
Total deposits		1,709,195			1,524,634
Securities sold under repurchase agreements		42,868			47,848
Other short-term borrowings		80,877			106,046
Trust preferred debentures		30,243			30,216
Notes payable		500			500
Accrued interest and other liabilities		14,903			12,606
Total liabilities		1,878,586			1,721,850
Stockholders’ Equity
Preferred stock, no par value; authorized 300,000 shares; none issued		—			—
Common stock, $1.00 par value; authorized 20,000,000 shares; issued 8,244,954 in 2004 and 8,229,854 in 2003; outstanding 6,708,840 in 2004 and 6,693,740 in 2003		8,245			8,230
Additional paid-in capital		12,373			11,940
Retained earnings		152,795			144,157
Accumulated other comprehensive income		(590		)	3,005
Treasury stock, at cost, 1,536,114 shares in 2004 and 2003		(50,338		)	(50,338		)
Total stockholders’ equity		122,485			116,994
Total liabilities and stockholders’ equity		$	2,001,071		$	1,838,844

 

See accompanying notes to consolidated financial statements.

 

3

 

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except share data)

 

		(Unaudited)						(Unaudited)
		Three months ended June 30,						Six months ended June 30,
		2004			2003			2004			2003
Interest income
Loans, including fees		$	20,028		$	17,948		$	39,624		$	34,878
Loans held for sale		249			646			363			1,152
Securities:
Taxable		2,555			2,659			5,380			5,635
Tax-exempt		763			611			1,481			1,198
Federal funds sold		6			10			7			70
Interest bearing deposits		1			—			1			—
Total interest income		23,602			21,874			46,856			42,933
Interest expense
Savings deposits		1,327			1,607			2,641			3,394
Time deposits		4,277			4,318			8,288			8,778
Repurchase agreements		79			159			173			324
Other short-term borrowings		379			155			750			178
Trust preferred debentures		635			—			1,252			—
Notes payable		3			—			8			—
Total interest expense		6,700			6,239			13,112			12,674
Net interest income		16,902			15,635			33,744			30,259
Provision for loan losses		—			863			—			1,718
Net interest income after provision for loan losses		16,902			14,772			33,744			28,541
Noninterest income
Trust income		1,491			1,383			2,864			2,645
Service charges on deposits		1,824			1,620			3,532			3,238
Secondary mortgage fees		271			470			468			922
Gain on sale of loans		1,680			3,371			2,897			6,489
Securities gains (losses), net		(251		)	5			389			39
Other income		1,412			1,079			2,488			2,005
Total noninterest income		6,427			7,928			12,638			15,338
Noninterest expense
Salaries and employee benefits		8,285			8,669			16,711			17,204
Occupancy expense, net		892			816			1,838			1,665
Furniture and equipment expense		1,235			1,213			2,254			2,276
Amortization of core deposit intangible assets		89			89			178			178
Litigation Settlement		1,750			—			1,750			—
Other expense		2,995			3,067			6,284			5,687
Total noninterest expense		15,246			13,854			29,015			27,010
Income before income taxes		8,083			8,846			17,367			16,869
Provision for income taxes		2,562			3,207			5,776			6,023
Net income		$	5,521		$	5,639		$	11,591		$	10,846
Per share information:
Basic earnings per share		$	0.82		$	0.76		$	1.73		$	1.46
Diluted earnings per share		$	0.81		$	0.75		$	1.71		$	1.45
Dividends paid per share		$	0.24		$	0.20		$	0.44		$	0.40

 

See accompanying notes to consolidated financial statements.

 

4

 

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Six Months Ended June 30, 2004 and 2003

(In thousands)

 

		(Unaudited)			(Unaudited)
		2004			2003
Cash flows from operating activities
Net income		$	11,591		$	10,846
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Depreciation		1,491			1,353
Changes in mortgage servicing rights,net		(9		)	44
Provision for loan losses		—			1,718
Net change in mortgage loans held for sale		(527		)	(11,164		)
Change in income taxes payable		(814		)	(447		)
Change in accrued interest receivable and other assets		(22,829		)	(2,049		)
Change in accrued interest payable and other liabilities		5,215			6,977
Premium amortization and discount accretion on securities		1,716			2,285
Securities gains, net		(389		)	(39		)
Amortization of core deposit intangible assets		178			178
Tax benefit from stock options exercised		159			235
Net cash provided (used) by operating activities		(4,218		)	9,937
Cash flows from investing activities
Proceeds from sales and maturities of securities available for sale		64,010			129,950
Purchases of securities available for sale		(78,367		)	(113,656		)
Net change in loans		(105,810		)	(121,375		)
Sales of other real estate		663			131
Net purchases of premises and equipment		(1,926		)	(3,030		)
Net cash used by investing activities		(121,430		)	(107,980		)
Cash flows from financing activities
Net change in deposits		184,561			93,511
Net change in repurchase agreements		(4,980		)	(21,316		)
Net change in other borrowings		(25,169		)	18,138
Proceeds from issuance of trust preferred debentures		27			26,330
Proceeds from exercise of stock options		289			615
Dividends paid		(2,680		)	(2,963		)
Purchase of treasury stock		—			(30,919		)
Net cash provided by financing activities		152,048			83,396
Net change in cash and cash equivalents		26,400			(14,647		)
Cash and cash equivalents at beginning of period		55,168			73,064
Cash and cash equivalents at end of period		$	81,568		$	58,417
Supplemental cash flow information
Income taxes paid		$	6,333		$	6,181
Interest paid		10,883			10,587

 

5

 

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

Note 1 – Summary of Significant Accounting Policies

 

The accounting policies followed in the preparation of interim consolidated financial statements are consistent with those used in the preparation of annual financial information. The interim consolidated financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim period presented.  Results for the period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.  These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s 2003 Form 10-K.  Unless otherwise indicated, amounts in the tables contained in these Notes are in thousands.

 

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the consolidated financial statements. Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts, reported in the consolidated financial statements.

 

All significant accounting policies are presented in Note 1 to the consolidated financial statements for the year ended December 31, 2003. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.

 

6

 

Note 2 – Securities

 

Securities available for sale are summarized as follows:

 

		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
June 30, 2004:
U.S. Treasuries		$	2,002		$	1		$	—		$	2,003
U.S. Government agencies		305,856			1,236			2,201			304,891
States and political subdivisions		103,484			1,255			1,292			103,447
Mortgage backed securities		1,015			21			—			1,036
Other securities		6,716			—			—			6,716
		$	419,073		$	2,513		$	3,493		$	418,093
December 31, 2003:
U.S. Treasuries		$	2,004		$	7		$	—		$	2,011
U.S. Government agencies		317,353			3,726			540			320,539
States and political subdivisions		80,559			2,133			396			82,296
Mortgage backed securities		1,479			62			—			1,541
Other securities		4,648			—			—			4,648
		$	406,043		$	5,928		$	936		$	411,035

 

Note 3 – Loans

 

Major classifications of loans were as follows:

 

		June 30, 2004			December 31, 2003
Commercial and industrial		$	184,247		$	192,444
Real estate - commercial		466,845			459,014
Real estate - construction		274,281			218,519
Real estate - residential		461,423			408,789
Installment		41,539			44,449
		1,428,335			1,323,215
Unearned origination fees		(2,974		)	(3,677		)
		$	1,425,361		$	1,319,538

 

7

 

Note 4 – Allowance for Loan Losses

 

Changes in the allowance for loan losses as of June 30, are summarized as follows:

 

		2004			2003
Balance, January 1		$	18,301		$	15,769
Provision for loan losses		—			1,718
Loans charged-off		(215		)	(959		)
Recoveries		228			356
Balance, end of period		$	18,314		$	16,884

 

Note 5 – Deposits

 

Major classifications of deposits were as follows:

 

		June 30, 2004			December 31, 2003
Noninterest bearing		$	230,274		$	214,439
Savings		122,449			116,565
NOW accounts		268,125			234,184
Money market accounts		413,540			387,089
Certificates of deposit of less than $100,000		440,704			390,353
Certificates of deposit of $100,000 or more		234,103			182,004
		$	1,709,195		$	1,524,634

 

Note 6 – Borrowings

 

The Company had a $30 million line of credit available with Marshall & Ilsley under which there was an outstanding balance of $500,000 as of June 30, 2004, and also had a $20 million line of credit available with Marshall & Ilsley under which there was an outstanding balance of $500,000 as of December 31, 2003.  A revolving business note dated April 30, 2004 secures the line of credit and is guaranteed by the Company.   The note provides that any outstanding principal will bear interest, at the Company’s option, at the rate of either 1% over the previous month average Federal Reserve targeted rate (federal funds rate) or 0.90% over the adjusted interbank rate, with a minimum interest rate of 2.20%.  This borrowing is for general corporate purposes.

 

The Company enters into sales of securities under agreements to repurchase (repurchase agreements).  Repurchase agreements may be of varying maturities but are generally under one year.  Underlying securities remain in the Company’s portfolio during the term of the repurchase agreement and are treated as collateral pledged to the customer.  Repurchase agreements generally consisted of U.S. government agencies at June 30, 2004 and December 31, 2003.

 

8

 

The Company borrowings at the FHLB are limited to the lesser of 35% of total assets or 60% of the book value of certain mortgage loans. In addition, these notes are collateralized by FHLB stock of $5.7 million at June 30, 2004 and $3.7 million at December 31, 2003.

 

The Company is a Treasury Tax & Loan (TT&L) depository for the Federal Reserve Bank (FRB), and as such, it accepts TT&L deposits. The Company is allowed to hold these deposits for the FRB until they are called. The interest rate is the federal funds rate less 25 basis points. U.S. Treasury Securities with a face value greater than or equal to the amount borrowed are pledged as a condition of holding TT&L deposits. As of June 30, 2004 and December 31, 2003, the TT&L deposits were $1.1 million and $3.1 million, respectively.

 

At June 30, 2004 and December 31, 2003, total short-term borrowings totaled $124.2 million at a weighted average rate of 1.2% and $154.4 million at a weighted average rate of 1.2%, respectively.   The decrease in short-term borrowings was primarily the result of deposit growth during 2004 that exceeded asset growth. During the six-months ended June 30, 2004, loans and securities grew $113.4 million while deposits grew $184.6 million.

 

The following table reflects categories of short-term borrowings having average balances during the period greater than 30% of stockholders’ equity of the Company at the end of the period. For the year ended December 31, 2003, securities sold under repurchase agreements met the criteria. For the six months ended June 30, 2004, federal funds sold met the criteria.   Information presented is as of or for the periods indicated:

 

		June 30, 2004			December 31, 2003
Balance at end of period		$	53,499		$	47,848
Weighted average interest rate		1.22		%	0.85		%
Maximum month-end amount outstanding during the year		$	119,499		$	63,681
Average amount outstanding during the year		$	95,424		$	46,990
Weighted average interest rate during the year		1.30		%	1.09		%

 

Note 7–Trust Preferred Debentures

 

During June 2003, the Company completed its tender offer for shares of its common stock, in which 723,053 shares were repurchased at $42.50 per share.  The total cash payment required to complete the tender offer was approximately $30.7 million, which was funded by the sale of trust preferred securities.  The Company completed the sale of $27.5 million of cumulative trust preferred securities by its subsidiary, Old Second Capital Trust I in June 2003.  An additional $4.1 million of cumulative trust preferred securities was sold in the first week of July 2003.  The costs associated with the tender offer of the cumulative trust preferred securities are being amortized over 30 years using the straight-line method.  Cash distributions on the securities are payable quarterly at an annual rate of 7.80% and are included in interest expense in the consolidated financial statements.

 

9

 

Note 8– Long-Term Incentive Plan

 

The Long-Term Incentive Plan (the “Incentive Plan”) currently authorizes the issuance of up to 666,000 shares of the Company’s common stock, including the granting of qualified stock options, nonqualified stock options, restricted stock and stock appreciation rights. Stock based awards may be granted to selected directors and officers or employees at the discretion of the board of directors. The Incentive Plan requires the exercise price of any incentive stock option issued to an employee to be at least equal to the fair market value of Company common stock on the date the option is granted. All stock options are granted for a maximum term of ten years, with vesting occurring during the first three years.

 

Nonqualified stock options may be granted to directors based on a formula. These options, along with other awards under the Incentive Plan, may be granted subject to a vesting requirement, and would become fully vested upon a merger or change in control of the Company. Since December 31, 1998, there have been no nonqualified stock options, stock appreciation rights, or restricted stock issued under the Incentive Plan.

 

A summary of activity in the Incentive Plan and options outstanding is included below:

 

		June 30, 2004					December 31, 2003
		Shares		Weighted Average Exercise Price			Shares		Weighted Average Exercise Price
Beginning outstanding		285,133		$	30.381		264,400		$	24.802
Granted		—		—			55,000		50.150
Exercised		(14,800	)	19.173			(34,267	)	19.064
Expired		—		—			—		—
Ending outstanding		270,333		$	30.995		285,133		$	30.381
At period-end:
Options exercisable		161,998					176,798
Range of exercise price				$11.70 - $50.15					$11.70 - $50.15
Weighted average contractual life in years		7.4					7.5
Weighted average fair value of options granted during the year				$	—				$	15.95

 

The Company accounts for stock options in accordance with APB No. 25, as allowed under SFAS No. 123.  No expense for stock options is recorded, as the grant price equals the market price of the stock at grant date.  There were no stock options granted in 2004.

 

10

 

The following pro forma information presents net income and earnings per share had the fair value method of SFAS No. 123 been used to measure compensation cost for stock option plans.

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Net income as reported		$	5,521		$	5,639		$	11,591		$	10,846
Pro forma net income		5,426			5,571			11,405			10,710
Basic earnings per share as reported		0.82			0.76			1.73			1.46
Pro forma basic earnings per share		0.81			0.75			1.70			1.44
Diluted earnings per share as reported		0.81			0.75			1.71			1.45
Pro forma diluted earnings per share		0.80			0.75			1.68			1.43

 

The pro forma effects were computed using option-pricing models with the following assumptions

 

Risk free interest rate		4.00	%	-	4.45	%
Expected option life, in years		10
Expected stock price volatility		24.3	%	-	26.7	%
Dividend yield		2.00	%

 

Note 9 – Earnings Per Share

 

Earnings per share is included below (share data not in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Basic earnings per share:
Weighted-average common shares outstanding		6,706,588			7,412,559			6,703,315			7,413,451
Net income		$	5,521		$	5,639		$	11,591		$	10,846
Basic earnings per share		$	0.82		$	0.76		$	1.73		$	1.46
Diluted earnings per share:
Weighted-average common shares outstanding		6,706,588			7,412,559			6,703,315			7,413,451
Dilutive effect of stock options		67,065			64,288			67,985			61,125
Diluted average common shares outstanding		6,773,653			7,476,847			6,771,300			7,474,576
Net income		$	5,521		$	5,639		$	11,591		$	10,846
Diluted earnings per share		$	0.81		$	0.75		$	1.71		$	1.45

 

11

 

Note 10 – Comprehensive Income

 

Comprehensive income is included below:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Change in net holding gains on available for sale securities arising during the period		$	(8,184	)	$	757		$	(5,972	)	$	135
Related tax expense		3,257			(302		)	2,377			(54		)
Net unrealized gains / (losses)		(4,927		)	455			(3,595		)	81
Less: Reclassification adjustment for the net gains realized during the period
Realized net gains (losses)		(251		)	5			389			39
Related tax expense		88			(2		)	(136		)	(14		)
Net realized gains		(163		)	3			253			25
Total other comprehensive income		$	(5,090	)	$	458		$	(3,342	)	$	106

 

Note 11 – Retirement Plans

 

The Company has a tax-qualified noncontributory defined benefit retirement plan covering substantially all full-time and regular part-time employees of the Company. Generally, benefits are based on years of service and compensation. Certain participants in the defined benefit plan are also covered by an unfunded supplemental retirement plan. The purpose of the supplemental retirement plan is to extend full retirement benefits to individuals without regard to statutory limitations under tax-qualified plans.

 

		Six Months Ended June 30,
		Pension Benefits						Other Benefits
		2004			2003			2004			2003
Service cost		$	354,864		$	272,416		$	19,791		$	15,849
Interest cost		217,689			184,212			24,553			20,795
Expected return on plan assets		(190,508		)	(166,821		)	—			—
Amortization of transition obligation / (asset)		—			(21,488		)	—			—
Amortization of prior service cost		1,360			1,360			4,254			4,254
Recognized net actuarial (gain) / loss		55,724			26,481			14,254			7,551
Net periodic benefit cost		$	439,129		$	296,160		$	62,852		$	48,449

 

Key assumptions:		2004		2003
Discount rate		5.80	%	5.80	%
Long-term rate of return on assets		7.50	%	7.50	%
Salary increases		5.00	%	5.00	%

 

12

 

The Company maintains tax-qualified contributory and non-contributory profit sharing plans covering substantially all full-time and regular part-time employees. The expense of these plans was $764,000 and $817,000 for the six-months ended June 30, 2004 and 2003, respectively.

 

Note 12 – Subsequent events

 

On June 16, 2004, the Company declared a 2-for-1 common stock split effected in the form of a one hundred percent stock dividend payable on July 28, 2004, to stockholders of record on July 16, 2004.

 

13

 

Item 2.   Managements’ Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

Old Second Bancorp, is a financial services company with its main headquarters located in Aurora, Illinois.  The Company has offices located in Kane, Kendall, DeKalb, DuPage and LaSalle counties in Illinois.  The Company provides financial services through its three subsidiary banks at its twenty-four banking locations.  Old Second Mortgage provides mortgage-banking services at its four offices.  Old Second Financial, Inc. provides insurance products.  The Old Second National Bank of Aurora, the Company’s lead subsidiary bank, also engages in trust operations.

 

Critical Accounting Policies

 

Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances.  Some of the facts and circumstances that could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers.  Management has determined that its accounting policies with respect to the allowance for loan losses is the accounting area requiring subjective or complex judgments that is most important to the Company’s financial position and results of operations, and therefore, is its only critical accounting policy.  The Company’s critical accounting policies are discussed in detail in the Annual Report for the year ended December 31, 2003 (incorporated by reference as part of the Company’s 10-K filing) in Note 1 of the Notes to the Consolidated Financial Statements.

 

Results of Operations

 

The Company earned $1.71 diluted earnings per share in the first half of 2004, a 17.9% increase over the $1.45 earned in the first half of 2003.  Net income was $11.59 million in the first half of 2004 compared with $10.85 million in the first half of 2003.  This was a 6.82% increase in earnings.  The Company earned $.81 diluted earnings per share in the second quarter of 2004, a 6.75% increase over the $.75 in the second quarter of 2003.  Net income was $5.5 million in the second quarter of 2004, compared with $5.6 million in the second quarter of 2003.  Earnings were impacted in the second quarter by a $1.17 million reserve, net of tax, for the settlement of a damage award.

 

The return on equity increased to 19.07% in the first half of 2004, from 15.88% for the same period of 2003.   The return on equity was enhanced by the tender offer for common stock related to the issuance of cumulative trust preferred securities in June 2003.  Earnings for the first half of 2004 were enhanced by strong asset growth, the gain on sale of securities, the reduction of the loan loss provision and a decrease in the tax provision.  The return on equity increased to 17.95% in the second quarter of 2004, from 16.18% for the same period of 2003.

 

14

 

Net Interest Income

 

Net-interest income increased from $30.3 million in the first half of 2003 to $33.7 million in the first half of 2004, an 11.22% increase. The increase was primarily the result of an increase in interest income on loans of $4.7 million, offset by the increase in interest expense related to the interest paid on the trust preferred debentures of $1.3 million.

 

Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios. These include taxable-equivalent net interest income (including its individual components) and net interest margin (including its individual components). Management believes that these measures and ratios provide users of the financial information with a more accurate view of the performance of the interest-earning assets and interest-bearing liabilities and of the Company’s operating efficiency for comparison purposes. Other financial holding companies may define or calculate these measures and ratios differently. See the following two tables for supplemental data and the corresponding reconciliation to GAAP financial measures for the six months ended June 30, 2004 and 2003.

 

Yields on certain asset categories and the net interest margin of the Company and its banking subsidiaries are reviewed on a fully taxable-equivalent basis (“FTE”). In this non-GAAP presentation, net interest income is adjusted to reflect tax-exempt interest income on an equivalent before-tax basis. This measure ensures comparability of net interest income arising from both taxable and tax-exempt sources.

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
(A) Interest income (GAAP)		$	23,602		$	21,874		$	46,856		$	42,933
Taxable-equivalent adjustment - Loans		52			48			106			96
Taxable-equivalent adjustment - Investments		411			330			798			646
Interest income - FTE		24,065			22,252			47,760			43,675
(B) Interest expense (GAAP)		6,700			6,239			13,112			12,674
Net interest income - FTE		$	17,365		$	16,013		$	34,648		$	31,001
(C) Net interest income - (GAAP) (A minus B)		$	16,902		$	15,635		$	33,744		$	30,259
Net interest margin (GAAP)		3.71		%	3.97		%	3.76		%	3.94		%
Net interest margin - FTE		3.81		%	4.07		%	3.86		%	4.03		%

 

15

 

The following table sets forth certain information relating to the Company’s average consolidated balance sheets and reflects the yield on average earning assets and cost of average liabilities for the periods indicated. The rates are determined by dividing the related interest by the average balance of assets or liabilities. Average balances are derived from daily balances.

 

ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

For the six-month periods ended June 30, 2004 and 2003

 

		2004								2003
		Average Balance			Interest			Rate		Average Balance			Interest			Rate
Assets
Interest bearing deposits		$	300		$	1		1.01	%	$	56		$	0		1.19	%
Federal funds sold		1,263			7			1.08		12,353			70			1.14
Securities:
Taxable		317,747			5,379			3.39		315,184			5,635			3.61
Non-taxable (tax equivalent)		87,878			2,280			5.19		62,118			1,940			6.30
Total securities		405,625			7,659			3.78		377,302			7,575			4.05
Loans and loans held for sale		1,397,569			40,093			5.77		1,160,825			36,029			6.26
Total interest earning assets		1,804,757			47,760			5.32		1,550,536			43,675			5.68
Cash and due from banks		49,753			—			—		44,365			—			—
Allowance for loan losses		(18,387		)	—			—		(16,390		)	—			—
Other noninterest-bearing assets		63,707			—			—		50,240			—			—
Total assets		$	1,899,830							$	1,628,751
Liabilities and stockholders’ equity
Interest bearing transaction accounts		$	612,334		2,492			0.82		574,306			3,112			1.09
Savings accounts		122,523			149			0.24		114,730			282			0.50
Time deposits		631,171			8,288			2.64		525,998			8,778			3.37
Interest bearing deposits		1,366,028			10,929			1.61		1,215,034			12,172			2.02
Repurchase agreements		37,917			173			0.92		55,323			324			1.18
Federal funds purchased and other borrowed funds		115,147			750			1.31		22,464			178			1.60
Trust preferred debentures		30,230			1,252			8.33		145			—			0.00
Notes payable		724			8			2.19		—			—			0.00
Total interest bearing liabilities		1,550,046			13,112			1.70		1,292,966			12,674			1.98
Noninterest bearing deposits		216,039			—			—		186,004			—			—
Accrued interest and other liabilities		11,516			—			—		12,056			—			—
Stockholders’ equity		122,229			—			—		137,725			—			—
Total liabilities and stockholders’ equity		$	1,899,830							$	1,628,751
Net interest income (tax equivalent)					$	34,648							$	31,001
Net interest income (tax equivalent) to total earning assets								3.86	%							4.03	%
Interest bearing liabilities to earnings assets		85.89		%						83.39		%

 

Notes:             Nonaccrual loans are included in the above stated average balances.

Tax equivalent basis is calculated using a marginal tax rate of 35%.

 

16

 

Provision for Loan Losses

 

The Company did not make a provision for loan losses during the first half of 2004 compared to a provision of $1,718,000 during the first half of 2003. The determination by management to maintain the level of the allowance for loan losses at the year-end level was based on a number of factors, including the quality of the loan portfolio and past favorable loan loss experience.  Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the amount of past due accruing loans (90 days or more), the amount of non-accrual loans and management’s overall view on current credit quality.  Net recoveries for the first half of 2004 were $13,000 compared with net charge-offs of $603,000 in the first half of 2003.  Total loan charge-offs were $215,000 during the first six months of 2004, compared with $959,000 during the first six months of 2003, while recoveries for the same periods were $228,000 and $356,000, respectively.

 

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet.

 

One measure of the adequacy of the allowance for loan losses is the ratio of the allowance to total loans. The allowance for loan losses as a percentage of total loans was 1.28% as of June 30, 2004, compared to 1.39% as of December 31, 2003 and 1.43% as of June 30, 2003.  In management’s judgment, an adequate allowance for estimated losses has been established; however, there can be no assurance that such loss will not exceed the estimated amounts in the future.

 

Nonperforming loans of $2.4 million as of June 30, 2004, were down from $2.6 million as of December 31, 2003. Nonperforming loans include loans in nonaccrual status, renegotiated loans, and loans past due ninety days or more and still accruing.  Nonaccrual loans decreased from $2.3 million as of December 31, 2003 to $1.6 million as of June 30, 2004.  The allowance for loan losses as a percentage of nonperforming loans was 755.22% at June 30, 2004 as compared to 691.65% as of December 31, 2003.  Asset quality has remained strong, as demonstrated by net charge-offs decreasing from $603,000 in the first half of 2003 to net recoveries of $13,000 in the first half of 2004.

 

17

 

Past due and nonaccrual loans for the six-month periods ended June 30, 2004 and December 31, 2003 were as follows:

 

		6/30/04			12/31/03
Nonaccrual loans		$	1,614		$	2,265
Interest income recorded on nonaccrual loans		282			183
Interest income which would have been accrued on nonaccrual loans		60			165
Loans 90 days or more past due and still accruing interest		811			381

 

Noninterest Income

 

Noninterest income was $6.4 million during the second quarter of 2004 and $7.9 million during the second quarter of 2003, a decrease of $1.5 million, or 18.9%.  A decrease in loan originations in the second quarter of 2004 resulted in a decrease in the gain on sale of loans of $1.7 million, or 50.2% and a decrease in secondary mortgage fees of $199,000 or 42.3%.  The decrease in loan originations in the first half of 2004 resulted in a decrease in the gain on sale of loans of $3.6 million, or 55.4% and a decrease in secondary mortgage fees of $454,000 or 49.2% over the first half of 2003.  The first half of 2003 produced an unprecedented volume of mortgage originations while mortgage rates were near historically low levels.  The decrease in loan originations in 2004 was primarily the result of rising mortgage rates during the second half of 2003, which lead to decreased mortgage refinance activity and decreased demand for home mortgages and this has carried over to 2004.  Management does not expect that the high level of gains on sale of loans experienced during 2003 will be repeated during 2004.

 

During the first half of 2004, increased investment activity resulted in a gain on the sale of securities of $389,000, compared with $39,000 in the first half of 2003.  Service charges on deposits increased $294,000, or 9.08% for the six-month period.  Trust assets under management increased from $746.8 million at June 30, 2003 to $818.5 million at June 30, 2004 resulting in an increase in trust income of  $219,000 or 8.28% for the first half of 2004. Service charges on deposits increased $204,000, or 12.6% for the quarter and $294,000, or 9.1% for the six-month period.

 

Noninterest Expense

 

Noninterest expense was $15.2 million during the second quarter of 2004, an increase of $1.3 million, or 9.4%, from $13.9 million in the second quarter of 2003.  Noninterest expense was $29.0 million during the first half of 2004, an increase of $2.0 million, or 7.4%, from $27.0 million in the first half of 2003.  Salaries and benefits, which is the largest component of noninterest expense, decreased in the first six months of 2004 by $493,000, or 2.87% from the first six months of 2003.  Salaries and benefits expense was $8.3 million during the second quarter of 2004, a decrease of $384,000, or 4.43%, from $8.7 million in the second quarter of 2003.  The full-time equivalent number of employees was 546 as of June 30, 2004, as compared with 539 one year earlier.  Increased staffing and merit increases were offset in both periods by decreases in commissions and incentives tied to earnings performance for the mortgage company.

 

18

 

Employee benefit expenses increased during the second quarter of 2004 by $150,000 from the second quarter of 2003 and increased in the first six months of 2004 by $345,000 from the first six months of 2003.   Employee benefit expenses were also affected by higher employee healthcare insurance and retirement benefits.

 

Net occupancy and furniture and equipment expenses decreased $97,000, or 4.8% from the second quarter of the of 2003 to the second quarter 2004 and increased $150,000, or 3.8%, from the first half of 2003 to the second half 2004.   As the Company has expanded into and developed new markets, related facility and employee expenses have increased accordingly.  There were two new branch openings in the first six months of 2004.  Other expense, which consists primarily of postage, professional fees and marketing, increased from $5.7 million in the first half of 2003 to $6.3 million in the first half of 2004 related to the expansion into and developing of new markets.

 

On July 28, 2004, the Company and the plaintiff reached an agreement to settle a jury verdict against a subsidiary of the Company.  Under the terms of the settlement, the Company paid the plaintiff $1.75 million, or $1.17 million, net of tax.

 

Income Taxes

 

The Company’s provision for Federal and State of Illinois income taxes was $2.6 million and $3.2 million for the second quarters of 2004 and 2003 respectively and $5.8 million and $6.0 million for the first halves of 2004 and 2003 respectively.  The average effective income tax rates for the second quarters of 2004 and 2003 were 31.7% and 36.3% respectively and 33.3% and 35.7% for the first halves of 2004 and 2003 respectively.   The decrease in the average effective tax rate for 2004 was related to the $1.17 million accrual for litigation, net of $580,000 in taxes, recorded in the second quarter.

 

Financial Condition

 

Assets

 

Total assets reached $2.0 billion at June 30, 2004 for the first time in the Company’s history, an increase of $160.0 million or 8.70% from $1.84 billion at December 31, 2003.

 

Loans

 

Total loans were $1.43 billion as of June 30, 2004, an increase of $110.0 million or 8.33% during the six-month period, from $1.32 billion as of December 31, 2003. The largest increases in loan classifications were in real estate construction and real estate residential loans, which increased $55.8 million and $47.8 million, respectively. These changes reflected the continuing loan demand in the markets in which the Company operates.  The loan portfolio generally reflects the profile of the communities in which the Company operates. Because the Company is located in growing areas, real estate lending (including commercial, residential, and construction) is a significant portion of the portfolio. These categories comprised 82.1% of the portfolio as of December 31, 2003 and 84.2% of the portfolio as of June 30, 2004.

 

19

 

Securities

 

Securities totaled $418.1 million as of June 30, 2004, an increase of $7.10 million from $411.0 million as of December 31, 2003.  During March 2004, the Company purchased $20 million in bank-owned life insurance (BOLI) that was reported in other assets on the consolidated financial statements. The BOLI purchase was funded by the sale of $20 million of securities, which resulted in a net gain of $629,000.   The net unrealized gains, net of deferred taxes, in the portfolio decreased from a $3.0 million net gain as of December 31, 2003 to a $590,000 net loss as of June 30, 2004.

 

Deposits and Borrowings

 

Total deposits were $1.71 billion as of June 30, 2004, an increase of $190.0 million, or 12.5% from $1.52 billion as of December 31, 2003.  Demand deposits increased $15.8 million during the first half of the year from $214.4 million to $230.3 million or 7.37%.  At the same time, savings deposits, which include money market accounts, increased $66.3 million or 9.0% from $737.8 million to $804.1 million.  Time deposits increased $102.5 million from $572.4 million to $674.8 million or 17.9% during the same period.  Given the lower interest rate environment in which retail time deposits were maturing, pricing and sales strategies targeted growth in transactional deposit accounts and customer reinvestment of maturing time deposit balances in longer-term maturities.  Successful selling efforts in these areas resulted in an increase in new account relationships and core funding sources.

 

Securities sold under repurchase agreements, which are typically of short-term duration, decreased from $47.8 million as of December 31, 2003, to $42.9 million as of June 30, 2004. Other short-term borrowings decreased from $106.0 million to $80.9 million due to a decrease in federal funds purchased of $49.2 million offset by a Federal Home Loan advance of $26.5 million.  The Company is currently maintaining liquid assets and delivering consistent growth in core funding to provide funding for loan growth.

 

20

 

Capital

 

The Company and its three subsidiary banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines provide for five classifications, the highest of which is well capitalized. The Company and its subsidiary banks were categorized as well capitalized as of June 30, 2004. The accompanying table shows the capital ratios of the Company and Old Second National Bank, the Company’s largest subsidiary bank, as of June 30, 2004.

 

Capital levels and minimum required levels:

 

		Actual					Minimum Required for Capital Adequacy Purposes					Minimum Required to be Well Capitalized
		Amount			Ratio		Amount			Ratio		Amount			Ratio
June 30, 2004:
Total capital to risk weighted assets
Consolidated		$	168,614		11.29	%	$	119,478		8.00	%	$	149,348		10.00	%
Old Second National Bank		117,432			11.82		79,480			8.00		99,350			10.00
Tier 1 capital to risk weighted assets
Consolidated		150,300			10.06		59,761			4.00		89,642			6.00
Old Second National Bank		105,013			10.57		39,740			4.00		59,610			6.00
Tier 1 capital to average assets
Consolidated		150,300			7.74		77,674			4.00		97,093			5.00
Old Second National Bank		105,013			7.82		53,715			4.00		67,144			5.00
December 31, 2003:
Total capital to risk weighted assets
Consolidated		$	158,377		11.40	%	$	111,142		8.00	%	$	138,927		10.00	%
Old Second National Bank		110,872			11.79		75,231			8.00		94,039			10.00
Tier 1 capital to risk weighted assets
Consolidated		140,993			10.14		55,619			4.00		83,428			6.00
Old Second National Bank		99,105			10.54		37,611			4.00		56,417			6.00
Tier 1 capital to average assets
Consolidated		140,993			7.91		71,299			4.00		89,123			5.00
Old Second National Bank		99,105			7.98		49,677			4.00		62,096			5.00

 

During June 2003, the Company completed its tender offer for shares of its common stock, in which 723,053 shares were repurchased at $42.50 per share.  The total cash payment required to complete the tender offer was approximately $31.6 million, which was funded by the issuance of cumulative trust preferred securities by its subsidiary, Old Second Capital Trust I (Nasdaq:OSBCP).  The costs associated with the tender offer of the cumulative trust preferred securities are being amortized over 30 years using the straight-line method.  Cash distributions on the securities are payable quarterly at an annual rate of 7.80%, and are included in interest expense in the consolidated financial statements.

 

21

 

Liquidity and Market Risk

 

Liquidity is the Company’s ability to fund its operations, to meet depositor withdrawals, to provide for customers’ credit needs, to meet maturing obligations and its existing commitments, and to withstand fluctuations in deposit levels.  The liquidity of the Company principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and its ability to borrow funds in the money or capital markets.

 

Net cash outflows from operating activities were $4.2 million in the first half of 2004, compared with net cash inflows of $9.9 million in the first half of 2003. The decrease in cash inflows was related to the increase in accrued interest receivable and other assets of $22.8 million offset by a decrease in accrued interest payable and other liabilities of $5.2 million.  The increase in accrued interest receivable and other assets was directly related to the $20 million purchase of BOLI recorded in other assets. The increase in accrued interest payable and other liabilities were related to the changes in income taxes payable.  Interest received, net of interest paid, was the principal use of operating cash outflows in both periods reported.  Management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows.  Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, so that balance sheet growth is the principal determinant of growth in net interest cash flows.

 

Net cash outflows from investing activities were $121.4 million in the six months ended June 30, 2004, compared to $108.0 million a year earlier. In the first six months of 2004, securities transactions accounted for a net outflow of $14.4 million, and net change in loans accounted for net outflows of $105.8 million. In the first six months of 2003, securities transactions accounted for a net inflow of $16.3 million, and net change in loans accounted for net outflows of $121.4 million.  Cash outflows for property and equipment were $1.9 million in the first six months of 2004 compared to $3.0 million in the first six months of 2003.

 

Cash inflows from financing activities included an increase in deposits of $184.6 million and a decrease in repurchase agreements of $5.0 million in the first six months of 2004, offset by a $25.2 million decrease in federal funds purchased and other short-term borrowings.  This compares with a net cash inflow of $83.4 million as a result of an increase in deposits of $93.5 million, and an increase in federal funds purchased and other short-term borrowings of $18.1 million, offset by a reduction to repurchase agreements of $21.3 million during the first six months of 2003.   The issuance of $26.3 million in trust preferred debentures during June 2003 was directly offset by the repurchase of $30.9 million in treasury stock.

 

22

 

Interest Rate Risk

 

The impact of movements in general market interest rates on a financial institution’s financial condition, including capital adequacy, earnings, and liquidity, is known as interest rate risk. Interest rate risk is the Company’s primary market risk. As a financial institution, accepting and managing this risk is an inherent aspect of the Company’s business. However, safe and sound management of interest rate risk requires that it be maintained at prudent levels.

 

The Company analyzes interest rate risk by examining the extent to which assets and liabilities are interest rate sensitive. The interest sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period, and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest sensitive assets exceeds the amount of interest sensitive liabilities. A gap is considered negative when the amount of interest sensitive liabilities exceeds the amount of interest sensitive assets. During a period of rising interest rates, a negative gap would tend to result in a decrease in net interest income, while a positive gap would tend to positively affect net interest income. The Company’s policy is to manage the balance sheet so that fluctuations in the net interest margin are minimized, regardless of the level of interest rates.

 

23

 

The accompanying table does not necessarily indicate the future impact of general interest rate movements on the Company’s net interest income, because the repricing of certain assets and liabilities is discretionary, and is subject to competitive and other pressures. As a result, assets and liabilities indicated as repricing within the same period may in fact reprice at different times and at different rate levels. Assets and liabilities are reported in the earliest time frame in which maturity or repricing may occur. Although securities available for sale are reported in the earliest time frame in which maturity or repricing may occur, these securities may be sold in response to changes in interest rates or liquidity needs.

 

Expected Maturity of Interest-Earning Assets and Interest-Bearing Liabilities

 

6/30/2004

 

		Expected Maturity Dates
		1 Year			2 Years			3 Years			4 Years			5 Years			Thereafter			Total
Interest-earning Assets
Deposit with banks		$	555		$	—		$	—		$	—		$	—		$	—		$	555
Average interest rate		1.31		%	0.00		%	0.00		%	0.00		%	0.00		%	0.00		%	1.31		%
Federal funds sold		$	31,500		$	—		$	—		$	—		$	—		$	—		$	31,500
Average interest rate		1.25		%	0.00		%	0.00		%	0.00		%	0.00		%	0.00		%	1.25		%
Securities		$	77,185		$	47,137		$	106,262		$	45,532		$	37,664		$	104,313		$	418,093
Average interest rate		2.81		%	2.85		%	2.98		%	3.21		%	3.84		%	3.85		%	3.26		%
Fixed rate loans		$	97,067		$	77,008		$	63,007		$	209,856		$	90,493		$	92,080		$	629,511
Average interest rate		6.02		%	6.61		%	6.61		%	6.06		%	6.02		%	5.83		%	6.14		%
Adjustable rate loans		$	283,033		$	49,578		$	40,564		$	46,150		$	19,779		$	372,029		$	811,133
Average interest rate		5.06		%	4.56		%	4.56		%	4.56		%	4.56		%	4.95		%	4.91		%
Total		$	489,340		$	173,723		$	209,833		$	301,538		$	147,936		$	568,422		$	1,890,792
Interest-bearing Liabilities
Interest-bearing deposits		$	863,460		$	112,911		$	160,608		$	32,184		$	14,246		$	295,512		$	1,478,921
Average interest rate		1.56		%	3.07		%	2.58		%	3.67		%	2.92		%	0.46		%	1.62		%
Short-term borrowing		$	123,745		$	—		$	—		$	—		$	—		$	—		$	123,745
Average interest rate		0.92		%	0.00		%	0.00		%	0.00		%	0.00		%	0.00		%	0.92		%
Notes payable		$	500		$	—		$	—		$	—		$	—		$	—		$	500
Average interest rate		2.22		%	0.00		%	0.00		%	0.00		%	0.00		%	0.00		%	2.22		%
Subordinate debentures note		$	—		$	—		$	—		$	—		$	—		$	30,243		$	30,243
Average interest rate		0.00		%	0.00		%	0.00		%	0.00		%	0.00		%	7.80		%	7.80		%
Total		$	987,705		$	112,911		$	160,608		$	32,184		$	14,246		$	325,755		$	1,633,409
Period gap		$	(498,365	)	$	60,812		$	49,225		$	269,354		$	133,690		$	242,667		$	257,383
Cumulative gap		(498,365		)	(437,553		)	(388,328		)	(118,974		)	14,716			257,383

 

24

 

Recent Regulatory Developments

 

Trust Preferred Securities.  On May 6, 2004, the Board of Governors of the Federal Reserve System (the “Board”) issued a Notice of Proposed Rulemaking in which it proposed to allow the continued inclusion of trust preferred securities in the tier 1 capital of bank holding companies, subject to stricter standards.  The Board is proposing to limit the aggregate amount of a bank holding company’s cumulative perpetual preferred stock, trust preferred securities and other minority interests to 25% of the company’s core capital elements, net of goodwill.  Current regulations do not require the deduction of goodwill.  The proposal also provides that amounts of qualifying trust preferred securities and certain minority interests in excess of the 25% limit may be included in tier 2 capital but would be limited, together with subordinated debt and limited-life preferred stock, to 50% of tier 1 capital.  The proposal provides a three-year transition period for bank holding companies to meet these quantitative limitations.  At this time, it is not possible to predict the impact that this proposal would have on the Company.

 

Bank Sales of Securities.  On June 17, 2004, the Securities and Exchange Commission issued a Proposed Rule in which it described the parameters under which banks may sell securities to their customers without having to register as broker-dealers with the Securities and Exchange Commission in accordance with Title II of the Gramm-Leach-Bliley Act of 1999.  The proposal, which is designated as Regulation B, clarifies, among other things: (i) the limitations on the amount that unregistered bank employees may be compensated for making referrals in connection with a third-party brokerage arrangement; (ii) the manner by which banks may be compensated for effecting securities transactions for its customers in a fiduciary capacity; and (iii) the extent to which banks may engage in certain securities transactions as a custodian.  At this time, it is not possible to predict the impact that this proposal would have on the Company and its subsidiaries.

 

Illinois Department of Financial and Professional Regulation.  On July 1, 2004, the Office of Banks and Real Estate (the “OBRE”), the Department of Financial Institutions, the Department of Insurance and the Department of Professional Regulation were consolidated into a new agency known as the Illinois Department of Financial and Professional Regulation (“IDFPR”).  The OBRE is now designated as the Division of Banks and Real Estate within the IDFPR.

 

Item 4.   Controls and Procedures

 

An evaluation was performed under the supervision and participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2004. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls, or in other factors that could significantly affect internal controls.

 

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SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

 

This document contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.

 

Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:

 

•                                         The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets.

 

•                                         The economic impact of past and future terrorist attacks, acts of war or threats thereof, and the response of the United States to any such threats and attacks.

 

•                                         The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.

 

•                                         The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.

 

•                                         The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.

 

•                                         The inability of the Company to obtain new customers and to retain existing customers.

 

•                                         The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.

 

•                                         Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive

 

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than anticipated or which may have unforeseen consequences to the Company and its customers.

 

•                                         The ability of the Company to develop and maintain secure and reliable electronic systems.

 

•                                         The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.

 

•                                         Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.

 

•                                         Business combinations and the integration of acquired businesses that may be more difficult or expensive than expected.

 

•                                         The costs, effects and outcomes of existing or future litigation.

 

•                                         Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

 

•                                         The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results is included in the Company’s Form 10-K for the year ended December 31, 2003 and in its other filings with the Securities and Exchange Commission.

 

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PART II - OTHER INFORMATION

 

Item 1.           Legal Proceedings

 

On September 24, 2001, Kuzma v. Clarage, et al. was filed against Yorkville National Bank, now known as Old Second Bank-Yorkville, a wholly owned subsidiary of the Company, in the 12th Judicial Circuit Court, Will County, Illinois.  The plaintiff alleged defamation by the bank and a bank official and sought monetary damages.  On March 30, 2004, a jury verdict in favor of the plaintiff was entered awarding $700,000 in compensatory damages and $1.5 million in punitive damages against the bank and the bank official.  The Company filed a post-trial motion requesting the court to overturn the verdict or grant a new trial or, in the alternative, reduce the amount awarded by the jury.  The motion was subsequently denied.  The Company planned to appeal the verdict and on July 28, 2004, the Company and the plaintiff reached an agreement to settle and release the Company from the lawsuit and discontinue the appeal process.  Under the terms of the settlement, the Company will pay the plaintiff $1.75 million.

 

The Company and its subsidiaries have, from time to time, collection suits in the ordinary course of business against its debtors and are defendants in legal actions arising from normal business activities. Management, after consultation with legal counsel, believes that the ultimate liabilities, if any, resulting from those actions will not have a material adverse effect on the consolidated financial position of the Company and its subsidiaries.

 

Item 2.   Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

None.

 

Item 3.           Defaults Upon Senior Securities

 

None.

 

Item 4.           Submission of Matters to a Vote of Security Holders

 

The annual meeting of stockholders of the Company was held on April 20, 2004.  At the meeting, stockholders voted to elect six nominees to the board of directors having staggered terms of service; to approve an amendment to the certificate of incorporation to increase the number of authorized shares of common stock from 10,000,000 to 20,000,000; and to ratify the selection of Ernst & Young LLP as the Company’s independent auditors for the year ending December 31, 2004.

 

At the meeting, the stockholders elected Walter Alexander (to serve as director until 2005 when he will turn 70 and will be unable to serve as a director after that time pursuant to the Company’s bylaws).  J. Douglas Cheatham was appointed to serve as a director in October 2003 and was elected by the stockholders to continue to serve until 2006.  Edward Bonifas, William Meyer, William B. Skoglund and Christine Sobek were elected to continue as directors with their terms expiring in 2007.  Marvin Fagel, William Kane, Kenneth Lindgren, and Jesse Marberry will continue as directors with their terms expiring in 2005.  D. Chet McKee, Gerald Palmer, and James Carl Schmitz will also continue as directors with their terms expiring in 2006.  The amendment to the certificate of incorporation was approved and the stockholders also

 

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ratified the selection of Ernst & Young LLP to serve as the Company’s independent auditors.  The matters approved by stockholders at the meeting and the number of votes cast for, against or withheld (as well as the number of abstentions) as to each matter are set forth below:

 

1.                                       The election of directors for a staggered terms expiring in 2005, 2006 and 2007.

 

 

2.                                       The amendment to the certificate of incorporation of to increase the number of authorized shares of common stock from 10,000,000 to 20,000,000.

 

FOR		AGAINST		ABSTAIN		BROKER NON-VOTES
5,639,507		296,895		48,702		N/A

 

3.                                       The ratification of Ernst & Young LLP, as the auditors for the year ending   December 31, 2004.

 

FOR		AGAINST		ABSTAIN		BROKER NON-VOTES
5,898,274		70,421		16,409		N/A

 

Item 5.           Other Information

 

None.

 

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Item 6.           Exhibits and Reports on Form 8-K

 

Exhibits:

 

31.1                           Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)

 

31.2                           Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)

 

32.1                           Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2                           Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Reports on Form 8-K:

 

A report on Form 8-K was filed on April 16, 2004, which reported the Company’s first quarter financial information in the form of a press release, under Item 12, and a jury verdict in connection with litigation involving a subsidiary of the Company, under item 5.

 

A report on Form 8-K was filed on June 16, 2004, under Item 5, which reported, in the form of a press release, that the Company’s board of directors had declared a cash dividend of 24 cents per share and had declared a two-for-one stock split of its common stock, affected in the form of a dividend.

 

A report on Form 8-K was filed on July 16, 2004, under Item 12, which reported the Company’s second quarter financial information in the form of a press release.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

	OLD SECOND BANCORP, INC.
		BY:	/s/ William B. Skoglund
			William B. Skoglund
			Chairman of the Board, Director
			President and Chief Executive Officer
			(principal executive officer)
		BY:	/s/ J. Douglas Cheatham
			J. Douglas Cheatham
			Senior Vice-President and
			Chief Financial Officer, Director
			(principal financial officer)
DATE: August 6, 2004

 

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