Old Second Reports Third Quarter Net Income of $2.9 million.

 

   Average Loans increased $15.3 million in the quarter.  Net interest income improved $1.0 million quarter to quarter on higher average loans and increased securities yields, especially collateralized loan securities, along with reduced interest expense on subordinated debentures

 

 

AURORA, IL, October 22, 2014 – Old Second Bancorp, Inc. (the “Company” or “Old Second”) (NASDAQ: OSBC), parent company of Old Second National Bank (the “Bank”), today announced financial results for the third quarter of 2014.  The Company reported net income of $2.9 million for the third quarter of 2014, compared to a net income of $72.9 million in the third quarter of 2013.  The Company’s net income available to common stockholders of $1.9 million or $0.06 per diluted share, for the quarter, compared to a net income available to common stockholders of $71.6 million, or $5.08 per diluted share, in the third quarter of 2013.  The net income available to common stockholders in the third quarter 2013 reflected an income tax benefit of $70.0 million largely related to the reversal of a deferred tax asset valuation allowance.

“Old Second’s business model, based on exceptional community banking service, continued to show resilience in an unchanged and fitful economic growth environment,” said Chairman Bill Skoglund.  “While some indications are that economic activity shows improvement, other indicators show little change including important labor market and housing market measures.  Despite the economic conditions, Old Second continued to add loans and controlled operating expenses while maintaining our commitment to personal contact with our valued customers.”

Mr. Skoglund announced his retirement as Chief Executive Officer and President of the Company effective January 1, 2015.  James Eccher will assume new responsibilities as Chief Executive Officer and President of the Company also effective as of that date.  Mr. Skoglund will continue to serve as Chairman of the Board of both the Company and the Bank after his retirement.

 

 

Financial Highlights/Overview

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Capital Ratios

 

 

 

Asset Quality & Earning Assets

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Net Interest Income1

ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

Three Months Ended September 30, 2014 and 2013

(Dollar amounts in thousands - unaudited)

 

 

 

1 Interest income from loans is shown on a tax equivalent basis as discussed in the table on page 17 and includes fees of $600,000 and $793,000 for the third quarter of 2014 and 2013, respectively.  Nonaccrual loans are included in the above stated average balances.

 

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

 

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ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

Nine Months Ended September 30, 2014 and 2013

(Dollar amounts in thousands - unaudited)

 

 

 

 

 

1 Interest income from loans is shown on a tax equivalent basis as discussed in the table on page 17 and includes fees of $1.7 million and $2.0 million for the first nine months of 2014 and 2013, respectively.  Nonaccrual loans are included in the above stated average balances.

 

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

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Net interest and dividend income on a linked quarter basis increased $1.0 million.  Quarterly average earning assets increased $42.3 million from the third quarter 2013 total of $1.76 billion.  Management continued to emphasize asset quality in all securities purchases and the year over year quarterly average total securities decreased.  Loan growth in each of the last three quarters, resulted in a year over year third quarter average loans increase.  On a linked quarter basis, third quarter average earning assets decreased $16.5 million with decreases in securities and increases in loans.

Asset Quality

Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due but still accruing.  Total nonperforming loans were $31.7 million at September 30, 2014,  an increase from $28.9 million at June 30, 2014.    The increase in nonaccrual loans is driven by a small number of specific relationships and does not reflect issues throughout the portfolio.

 

Net charge-offs for the third quarter of 2014 were slightly lower on a linked quarter basis and reflected increases in both charge-offs and recoveries compared to the second quarter. 

Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard.  Management review of classified loans concluded that the September 30, 2014 total was driven by a few specific relationships and does not reflect issues throughout the portfolio

 

 

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Allowance for Loan and Lease Losses

The Bank’s allowance for loan loss methodology generates an accounting estimate of loan and lease losses as of the financial statement date and incorporates management’s current judgments about the credit quality of the loan portfolio.  The methodology is subject to periodic review by the Company’s independent auditors and banking regulators.  No significant methodology changes were made in 2014. 

 

Under established and reviewed methodology, management updated the appropriate specific allocations in the third quarter after receiving more recent appraisal valuations or information on cash flow trends related to the impaired credits.  Specific allocations decreased markedly from December 31, 2013, and also decreased from the second quarter 2014.  Loan balances subject to general factors increased as of September 30, 2014, from year end 2013 and June 30, 2014.  Management determined the estimate for the allowance for loan losses based upon a number of factors, including an evaluation of

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credit market circumstances, loan growth or contraction, the quality of the loan portfolio and loan loss experience.

 

As discussed in the Asset Quality & Earning Assets section, management concluded that the loan loss reserve was adequate, and therefore, no additional reserve release or provision was recorded in the quarter.

 

Other Real Estate Owned

OREO increased by $1.6 million from $39.2 million at June 30, 2014, to $40.9 million at September 30, 2014, but was down from $41.5 million at December 31, 2013.  While additions to the OREO portfolio slowed in the third quarter, compared to the second quarter, dispositions also slowed in the third quarter.  One addition to the OREO portfolio in the quarter reflects management’s expenditure of $506,000 on improvements to a property in otherwise severe disrepair. Additionally, management reclassified the New Lenox branch property to OREO reflecting the third quarter decision to close that location at end of business on October 24, 2014.  Last, the overall total was reduced by the $1.5 million in reserve writedown expense in the quarter or  almost double the amount recorded in the second quarter of 2014.  This includes a few large adjustments, 57.1% of quarterly writedown expense, to reflect new appraisals or management judgment about property value based on nominal levels of buyer interest.  Overall, a net gain on sale of $201,000 was realized in the third quarter.

 

 

 

 

 

Noninterest Income

 

 

On a linked quarter as well as year over year basis, gains from securities sales drove improved noninterest income.  Debit card interchange income also strengthened while residential mortgage banking revenue improved in a difficult market.  On a year to date basis, residential mortgage banking revenue declined approximately 48.9%, primarily as a sharp reduction in gains on the sale of mortgage loans.    Trust income declined from second quarter’s level reflecting stronger than normal estate administration fees in the second quarter that returned to normal quarterly results.  Second quarter trust income also included nonrecurring tax preparation fees.  Year to date noninterest income is down 19.0% from 2013 essentially across all categories with the large dollar and percentage declines found in residential mortgage banking revenue and securities gains.

 

 

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Noninterest Expense 

 

 

Noninterest expense decreased on a linked quarter basis primarily on reduced compensation costs, cessation of the core deposit amortization expense and reduced advertising.  The linked quarter increase in OREO expense was driven by valuation expenses that were greater than gains on sales and the Company’s other reductions in OREO expense.  Reduced compensation costs reflect lower bonus accrual and health care costs quarter to quarter.  The core deposit intangible asset was fully amortized in July.  Lower advertising expense resulted from reduced expense for online and print advertising of retail products.  Expenses decreased in the third quarter 2014 compared to the same period in 2013 in most categories, including total OREO expense, net.  On a year to date basis, noninterest expense is down 12.9% from 2013.  All expense information in this release incorporates a year end 2013 Company decision to reclassify OREO revenues from noninterest income to noninterest expense.

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Additional Loan Detail

 

 

Third quarter 2014 loan production resulted in an  increase of $8.1 million in loans outstanding from the  second quarter.  Ongoing slow paced demand from qualified borrowers and the competitive environment hindered greater growth in the loan portfolio.  Management continued to emphasize loan portfolio quality and transactions in our core market area that the Company expects will develop as long term relationship opportunities.  Current client relationships more closely reflect core clientele with resulting reduction in portfolio runoff.

Commercial relationship managers continue to focus on building the loan pipeline with opportunities from both current and prospective clients.  Despite the competitive landscape within the Chicago market and a prolonged period of economic headwinds, new business development continues to be a key focus and management believes good progress is being made.

 

 

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Additional Securities Detail

 

 

 

The total investment portfolio reached $625.3 million at September 30, 2014.  The Available-for-Sale (“AFS”) portfolio increased $32.4 million during the third quarter to end at $362.2 million.  Collateralized loan obligations (“CLO”) totaling $94.2 million were purchased early in the quarter.  Asset-backed security (“ABS”) sales for the quarter were $95.3 million, partially offset by purchases of $42.4 million.  Sales of ABS, some late in the second quarter, provided funding for the CLO purchases.  The Company had no purchase or sale activity in the Held to Maturity portfolio in the third quarter.

 

Realized gains totaled $1.2 million for the third quarter 2014.  Unrealized losses on the AFS portfolio before deferred taxes were $5.2 million at September 30, 2014 an increase of $3.5 million for the quarter.

 

The Company is holding investments by four issuers where each issuer holding exceeds 10% of stockholders’ equity.  Company investment managers have assessed the quality of the issuers to confirm that underwriting standards meet expectation and requirements under the Investment Policy.  All of the investments for these issuers are guaranteed by the U.S. Department of Education.

 

 

 

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Deposits Detail

 

 

The September 30, 2014, decline in total deposits of $44.1 million compared to the end of second quarter 2014 results from two main factors.  First, certificates of deposit are down as deposits taken in during a higher interest rate environment have matured and are not renewed at the current rate structure.      Second, deposits have been removed from the Bank following the announcement of two upcoming branch closings.    Also contributing to the decline, deposits from businesses, both commercial and retail, experienced a drop at September 30, 2014, and customers paid property tax payments when due. The Bank’s business deposits are subject to periodic movement, both increases and decreases.  The availability of Federal Home Loan Bank of Chicago (“FHLBC”) advances as a liquidity source reduced the need for deposit funding.

Borrowings

The Company's borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC.   Total borrowings are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans.  As of September 30, 2014, the Bank had $40.0 million outstanding under FHLBC advances compared to no outstanding advances at June 30, 2014.

At  September 30, 2014, the Company was out of compliance with two covenants contained in the credit agreement supporting the $45.5 million credit facility with a correspondent bank.  As of June 30, 2014, the Company reported being out of compliance performance on one of the financial covenants contained in the referenced credit agreement.

 

The Company is also indebted on $58.4 million of junior subordinated debentures related to the trust preferred securities issued by its two statutory trust subsidiaries, Old Second Capital Trust I and Old Second Capital Trust II.  In April, 2014, the Company concluded a successful capital raise and used some of the capital raise proceeds to pay interest accrued but previously unpaid on the trust preferred securities and the Company is current on the payments due on these securities. 

 

 

Capital

At September 30, 2014, the Bank’s Tier 1 capital leverage ratio was 11.67%, up 39 basis points from June 30, 2014.  The Bank’s total capital ratio was 18.47%, up 18 basis point from June 30, 2014.    The Bank’s board of directors has determined that the Bank should maintain a Tier 1 leverage capital ratio at or above 8% and a total risk-based capital ratio at or above 12%.  The Bank currently exceeds those thresholds.    All capital ratios discussed in this paragraph reflect additional capital from the

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previously disclosed capital raise.

 

At September 30, 2014, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “adequately capitalized” under current regulatory defined capital ratios.  The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies.  In addition to the above regulatory ratios, the Company’s non-GAAP tangible common equity to tangible assets increased to 7.15% at September 30, 2014, compared to 7.09% at June 30, 2014.  The Tier 1 common equity to risk weighted assets increased to 6.50% at September 30, 2014, compared to 6.48% at June 30, 2014.

Non-GAAP Presentations: Management has traditionally disclosed certain non-GAAP ratios to evaluate and measure the Company’s performance, including a net interest margin calculation.  The net interest margin is calculated by dividing net interest income on a tax equivalent basis by average earning assets for the period.  Management believes this measure provides investors with information regarding balance sheet profitability.  Consistent with industry practice, management also disclosed the tangible common equity to tangible assets and the Tier 1 common equity to risk weighted assets in the discussion immediately above and in the following tables.  The tables provide a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. 

Forward Looking Statements: This report may contain forward-looking statements.  Forward looking statements are identifiable by the inclusion of such qualifications as expects, intends, believes, may, likely or other indications that the particular statements are not based upon facts but are rather based upon the Company’s beliefs as of the date of this release.  Actual events and results may differ significantly from those described in such forward-looking statements, due to changes in the economy, interest rates or other factors.  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.  For additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results or cause actual results to differ substantially from those discussed or implied in forward looking statements contained in this release, please review our filings with the Securities and Exchange Commission.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

 

 

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands, except share data)

 

 

 

 

 

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Old Second Bancorp, Inc. and Subsidiaries

Quarterly Consolidated Statements of Operations

(In thousands, except share data, unaudited)

 

 

 

 

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Old Second Bancorp, Inc. and Subsidiaries

Quarterly Consolidated Average Balance

(In thousands, except share data, unaudited)

 

 

 

 

 

 

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The table below provides a reconciliation of each non GAAP tax equivalent measure to the GAAP equivalent for the periods indicated:

 

 

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