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| OSBC > SEC Filings for OSBC > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
Quarterly Report
Overview
Old Second Bancorp, Inc. (the "Company") is a financial services company with its main headquarters located in Aurora, Illinois. The Company is the holding company of Old Second National Bank (the "Bank"), a national banking organization headquartered in Aurora, Illinois and provides commercial and retail banking services, as well as trust services. The Company has offices located in Cook, Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois. As a result of the February 2008 acquisition of Heritage, the franchise expanded into the southwestern section of Cook County, which includes the higher growth markets of the south Chicago suburbs. This acquisition provided additional market penetration by adding five retail-banking locations and allowed the Company to fill in its footprint surrounding the Chicago metropolitan area. The Company also offers insurance products through Old Second Financial, Inc.
The first quarter 2008 earnings included the contribution of the Heritage acquisition from the February 8, 2008 closing date. The Company paid consideration of $43.0 million in cash and 1,563,636 shares of the Company's common stock valued at $27.50 per share to consummate the Heritage acquisition. Details related to the allocation of the purchase price for this business combination are discussed in Note 2 of the financial statements included in this quarterly report. The terms of the credit facilities that were established to complete the acquisition are detailed in Note 9 of the financial statements included in this quarterly report.
The financial system in the United States, including our credit markets and markets for real estate and related assets, have been in a state of unprecedented disorder since early 2008. These nationwide disruptions have resulted in extraordinary declines in the values of real estate and associated asset types, including the availability of ready markets, and have impacted the ability of many borrowers to continue to pay on their obligations. Because of these ongoing economic conditions in the second quarter, the Company greatly increased the provision for loan losses, and experienced an increase in both loans charged off and nonperforming assets. Net income declined considerably as a result of these occurrences. These factors, coupled with the decrease in the market capitalization of our common stock, have resulted in the impairment of goodwill, which caused us to record a noncash charge to earnings of $57.6 million. That charge was offset by a substantial tax benefit of $22.0 million and is discussed in the "Results of Operations" section below along with the additional details provided in Note 6 of the financial statements included in this quarterly report.
Results of Operations
The net loss for the second quarter of 2009 was $58.4 million, or $4.29 loss per diluted share, as compared with $7.3 million in net income, or $0.53 of earnings per diluted share, in the second quarter of 2008. The net loss for the first half of 2009 was $57.4 million, or $4.28 loss per diluted share, as compared to $12.9 million in net income, or $.95 of earnings per diluted share. The Company recognized a pre-tax goodwill impairment charge of $57.6 million in the second quarter of 2009, which was partially offset by a $22.0 million tax benefit as described below. The Company also recorded a $56.9 million provision for loan losses in the first half of 2009, which included an addition of $47.5 million in the second quarter. Net loan charge-offs totaled $23.6 million in the first half of 2009, which included $19.2 million of net charge-offs in the second quarter. The provision for loan losses in the first half of 2008 was $2.8 million, which included an addition of $1.9 million in the second quarter of 2008. Net loan charge-offs totaled $1.1 million in the first half of 2008, which included $464,000 of net charge-offs in the second quarter of 2008. The net loss available to common stockholders was $59.7 million and $59.5 million, respectively, for the second quarter and first half of 2009, as compared to net income available to common shareholders of $7.3 million and $12.9 million, respectively, for the same periods in 2008.
Goodwill arises from business acquisitions and represents the value attributable to unidentifiable intangible elements in the business acquired. Of the $57.6 million second quarter 2009 noncash charge, $55.4 million originated from the February 8, 2008 acquisition of HeritageBanc, Inc. and Heritage Bank. Management regularly reviews the operating environment and strategic direction of the Bank in accordance with accounting guidance, to assess if the fair value of that reporting unit exceeds its carrying amount. With the decline in the market price per share and earnings, and the increase in nonperforming assets, particularly loans, and the related increase in charge-offs, the second quarter 2009 analysis and valuation process resulted in management's determination that goodwill was impaired. The portion of the goodwill intangible asset charge that was attributable to Heritage is tax deductible and has an associated $22.0 million tax benefit. Although not anticipated, there can be no guarantee that a valuation allowance against the resultant deferred tax asset will not be necessary in future periods. Given the noncash nature of a goodwill impairment charge, this noninterest expense item had no adverse affect upon the Company's liquidity position. Additional details related to goodwill are provided in Note 6 of the financial statements included in this quarterly report.
Net Interest Income
Net interest income increased $1.4 million, from $42.5 million in the first half of 2008, to $43.9 million in the first half of 2009. Average earning assets increased slightly, by $25.4 million, or .95%, from June 30, 2008 to June 30, 2009, as management continued to place increasing emphasis upon asset quality over growth and loan demand from qualified borrowers provided fewer opportunities. Average interest bearing liabilities decreased $23.3 million, or .98%, during the same period. The decrease in average interest bearing liabilities was influenced by these same factors. The net interest margin (tax equivalent basis), expressed as a percentage of average earning assets, increased from 3.32% in the first half of 2008 to 3.39% in the first half of 2009. The average tax-equivalent yield on earning assets decreased from 6.12% in the first half of 2008 to 5.24%, or 88 basis points, in the first half of 2009. At the same time, however, the cost of funds on interest bearing liabilities decreased from 3.27% to 2.20%, or 107 basis points, and the general decrease in interest rates lowered interest expense to a greater degree than it reduced interest income.
Net interest income decreased $854,000 from $22.5 million in the second quarter of 2008 to $21.7 million in the second quarter of 2009. The decrease in average earning assets on a quarterly comparative basis was $96.3 million, or 3.5%, from June 30, 2008 to June 30, 2009 due in part to the lack of demand from qualified borrowers. Average interest bearing liabilities decreased $173.8 million, or 7.1%, during the same period. The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, decreased from 3.44% in the second quarter of 2008 to 3.42% in the second quarter of 2009. The average tax-equivalent yield on earning assets decreased from 5.96% in the second quarter of 2008 to 5.20% in the second quarter of 2009, or 76 basis points. The cost of interest-bearing liabilities also decreased from 2.92% to 2.15%, or 77 basis points in the same period, but the continued higher level of nonaccrual loans combined with the repricing of interest bearing assets and liabilities in a lower interest rate environment decreased interest income to a greater degree than it decreased interest expense.
Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios. This includes tax-equivalent net interest income (including its individual components) and net interest margin (including its individual components) to total average interest-earning assets. 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 tables and notes below for supplemental data and the corresponding reconciliations to GAAP financial measures for the three and six-month periods ended June 30, 2009 and 2008.
The following tables set forth certain information relating to the Company's average consolidated balance sheets and reflect the yield on average earning assets and cost of average liabilities for the periods
indicated. Dividing the related interest by the average balance of assets or liabilities derives rates. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets on the following tables have been adjusted to a non-GAAP tax equivalent ("TE") basis using a marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets.
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
Three Months ended June, 2009 and 2008
(Dollar amounts in thousands - unaudited)
2009 2008
Average Average
Balance Interest Rate Balance Interest Rate
Assets
Interest bearing
deposits $ 2,823 $ 2 0.28 % $ 1,218 $ 7 2.27 %
Federal funds sold 4,700 1 0.08 11,362 55 1.92
Securities:
Taxable 198,595 2,173 4.38 355,072 4,197 4.73
Non-taxable (tax
equivalent) 145,612 2,178 5.98 155,918 2,328 5.97
Total securities 344,207 4,351 5.06 510,990 6,525 5.11
Dividends from FRB and
FHLB stock 13,044 57 1.75 10,416 17 0.65
Loans and loans
held-for-sale (1) 2,270,933 30,194 5.26 2,198,032 34,492 6.21
Total interest earning
assets 2,635,707 34,605 5.20 2,732,018 41,096 5.96
Cash and due from banks 41,936 - - 50,625 - -
Allowance for loan
losses (49,766 ) - - (20,641 ) - -
Other non-interest
bearing assets 238,929 - - 204,620 - -
Total assets $ 2,866,806 $ 2,966,622
Liabilities and
Stockholders' Equity
NOW accounts $ 336,467 $ 304 0.36 % $ 299,556 $ 655 0.88 %
Money market accounts 429,582 1,028 0.96 560,212 2,693 1.93
Savings accounts 150,648 214 0.57 118,547 156 0.53
Time deposits 1,152,368 9,062 3.15 1,137,788 11,431 4.04
Interest bearing
deposits 2,069,065 10,608 2.06 2,116,103 14,935 2.84
Securities sold under
repurchase agreements 26,728 17 0.26 47,818 202 1.70
Federal funds purchased 26,157 31 0.47 32,711 193 2.33
Other short-term
borrowings 37,390 74 0.78 112,289 612 2.16
Junior subordinated
debentures 58,378 1,072 7.35 58,378 1,072 7.35
Subordinated debt 45,000 309 2.72 45,000 477 4.19
Notes payable and other
borrowings 500 3 2.37 24,723 211 3.38
Total interest bearing
liabilities 2,263,218 12,114 2.15 2,437,022 17,702 2.92
Non-interest bearing
deposits 319,673 - - 309,022 - -
Accrued interest and
other liabilities 19,860 - - 18,815 - -
Stockholders' equity 264,055 - - 201,763 - -
Total liabilities and
stockholders' equity $ 2,866,806 $ 2,966,622
Net interest income
(tax equivalent) $ 22,491 $ 23,394
Net interest income
(tax equivalent) to
total earning assets 3.42 % 3.44 %
Interest bearing
liabilities to earning
assets 85.87 % 89.20 %
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ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
Six Months ended June, 2009 and 2008
(Dollar amounts in thousands - unaudited)
2009 2008
Average Average
Balance Interest Rate Balance Interest Rate
Assets
Interest bearing
deposits $ 1,845 $ 4 0.43 % $ 1,010 $ 11 2.15 %
Federal funds sold 6,494 3 0.09 7,631 84 2.18
Securities:
Taxable 259,051 5,969 4.61 374,695 8,926 4.76
Non-taxable (tax
equivalent) 146,055 4,380 6.00 155,010 4,611 5.95
Total securities 405,106 10,349 5.11 529,705 13,537 5.11
Dividends from FRB and
FHLB stock 13,044 113 1.73 10,109 34 0.67
Loans and loans
held-for-sale (1) 2,278,426 60,676 5.30 2,131,084 69,066 6.41
Total interest earning
assets 2,704,915 71,145 5.24 2,679,539 82,732 6.12
Cash and due from banks 43,661 - - 49,282 - -
Allowance for loan
losses (46,550 ) - - (19,801 ) - -
Other non-interest
bearing assets 236,692 - - 187,592 - -
Total assets $ 2,938,718 $ 2,896,612
Liabilities and
Stockholders' Equity
NOW accounts $ 305,730 $ 580 0.38 % $ 277,485 $ 1,457 1.06 %
Money market accounts 476,703 2,457 1.04 541,938 6,515 2.42
Savings accounts 135,431 355 0.53 110,750 342 0.62
Time deposits 1,166,626 18,763 3.24 1,104,820 23,755 4.32
Interest bearing
deposits 2,084,490 22,155 2.14 2,034,993 32,069 3.17
Securities sold under
repurchase agreements 38,333 115 0.60 45,790 538 2.36
Federal funds purchased 30,148 73 0.48 71,573 1,163 3.21
Other short-term
borrowings 79,990 221 0.55 99,277 1,401 2.79
Junior subordinated
debentures 58,378 2,144 7.35 58,211 2,137 7.34
Subordinated debt 45,000 799 3.53 35,852 792 4.37
Notes payable and other
borrowings 9,506 114 2.39 23,471 454 3.83
Total interest bearing
liabilities 2,345,845 25,621 2.20 2,369,167 38,554 3.27
Non-interest bearing
deposits 313,242 - - 318,094 - -
Accrued interest and
other liabilities 19,814 - - 18,669 - -
Stockholders' equity 259,817 - - 190,682 - -
Total liabilities and
stockholders' equity $ 2,938,718 $ 2,896,612
Net interest income (tax
equivalent) $ 45,524 $ 44,178
Net interest income (tax
equivalent) to total
earning assets 3.39 % 3.32 %
Interest bearing
liabilities to earning
assets 86.73 % 88.42 %
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As indicated previously, net interest income and net interest income to earning assets have been adjusted to a non-GAAP tax equivalent ("TE") basis using a marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets. The table below provides a reconciliation of each non-GAAP TE measure to the GAAP equivalent for the periods indicated:
Effect of Tax Equivalent Effect of Tax Equivalent
Adjustment Adjustment
Three Months Ended Six Months Ended
June 30, June 30,
2009 2008 2009 2008
Interest income (GAAP) $ 33,788 $ 40,230 $ 69,501 $ 81,022
Taxable equivalent adjustment -
loans 55 51 111 96
Taxable equivalent adjustment -
securities 762 815 1,533 1,614
Interest income (TE) 34,605 41,096 71,145 82,732
Less: interest expense (GAAP) 12,114 17,702 25,621 38,554
Net interest income (TE) $ 22,491 $ 23,394 $ 45,524 $ 44,178
Net interest and income (GAAP) $ 21,674 $ 22,528 $ 43,880 $ 42,468
Average interest earning assets $ 2,635,707 $ 2,732,018 $ 2,704,915 $ 2,679,539
Net interest income to total
interest earning assets 3.30 % 3.32 % 3.27 % 3.19 %
Net interest income to total
interest earning assets (TE) 3.42 % 3.44 % 3.39 % 3.32 %
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Provision for Loan Losses
In the first half of 2009, the Company recorded a $56.9 million provision for loan losses, which included an addition of $47.5 million in the second quarter. In the first half of 2008, the provision for loan losses was $2.8 million, which included an addition of $1.9 million in the second quarter. An additional $3.0 million of allowance for loan losses was also assumed in the Heritage acquisition in the first quarter of 2008. Nonperforming loans increased to $178.6 million at June 30, 2009 from $108.6 million at December 31, 2008, and $30.7 million at June 30, 2008. Charge-offs, net of recoveries, totaled $23.6 million and $1.1 million in the first six months of 2009 and 2008, respectively. Net charge-offs totaled $19.2 million in the second quarter of 2009 and $464,000 in the second quarter of 2008. Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio. The distribution of the Company's nonperforming loans at June 30, 2009 is included in the chart below (in thousands):
90 Days Restructured Total Non % Non
Nonaccrual or More Loans performing Performing Specific
Total (1) Past Due (Accruing) Loans Loans Allocation
Real
Estate-Construction $ 94,898 $ - $ - $ 94,898 53.1 % $ 11,603
Real
Estate-Residential:
Investor 28,315 400 - 28,715 16.1 % 2,134
Owner Occupied 14,983 430 2,871 18,284 10.2 % 652
Revolving and Junior
Liens 1,233 - - 1,233 0.7 % 149
Real Estate-Commercial,
Nonfarm 22,814 8,846 298 31,958 17.9 % 2,041
Real Estate-Commercial,
Farm 638 1,392 - 2,030 1.1 % 218
Commercial and
Industrial 721 222 - 943 0.5 % 390
Other 530 - - 530 0.3 % 376
$ 164,132 $ 11,290 $ 3,169 $ 178,591 100.0 % $ 17,563
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On a linked quarter basis, the largest increase in nonperforming loans was in the real estate construction segment of the loan portfolio. This segment increased $29.4 million, or 45.0%, despite second quarter charge-offs totaling $15.7 million and year to date charge offs totaling $19.2 million. This increase was primarily attributable to the continued weakening of economic conditions within that sector, which also hampers the individual borrower's ability to service its debt from the sale of completed units. In addition to the general lack of readily available markets for real estate, the problems in this sector are compounded by the continued decline in valuations of the related real estate assets. The subcomponent detail for the real estate construction segment is as below at June 30, 2009 (in thousands):
Real Estate - Construction
90 Days Restructured Total Non % Non
Nonaccrual or More Loans performing Performing Specific
Total Past Due (Accruing) Loans Loans Allocation
Homebuilder $ 55,853 $ - $ - $ 55,853 58.9 % $ 8,695
Commercial 14,930 - - 14,930 15.7 % 328
Land 18,863 - - 18,863 19.9 % 1,185
Other 5,252 - - 5,252 5.5 % 1,395
$ 94,898 $ - $ - $ 94,898 100 % $ 11,603
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Commercial real estate was the Company's second largest category representing 17.9% of the nonperforming loan portfolio, and 39.6% of this amount consists of strip mall or other retail properties where cash flows are insufficient to support the debt. Management has been in the process of administering a variety of workout strategies with the borrowers and such remedies could include a restructure option to allow more time to obtain additional tenants for a specific property or liquidation of the borrower. Management estimated that a loss allocation of $1.4 million was adequate coverage on that category. The remaining nonperforming commercial real estate loans include a variety of owner occupied and non-owner occupied properties. Management estimated that a loss allocation of $619,000 was sufficient after charging off $288,000 in the second quarter of 2009.
Approximately 27.7% of the nonperforming commercial real estate category was past due ninety days or more and still accruing. As of the end of the quarter, management was in various stages of collection on these credits, and believed them to be sufficiently secured in terms of current collateral valuation and/or guarantor support. Negotiations were in process to bring those loans current via a variety of means, ranging from the borrower selling a property, to a possible refinance, to modified terms that would not meet the threshold for a troubled debt restructuring. Management believed it is likely these loans can be brought current and returned to performing status, but that outcome is not certain.
Nonperforming residential investor loans consist of multi-family and one to four family properties that totaled $28.7 million and accounted for 16.1% of the nonperforming loan total. Approximately 13.5% of the Company's single-family investor loans and 6.8% of the multi-family investor loans were nonperforming as of June 30, 2009. A significant portion of these totals was attributable to a single borrower relationship totaling $14.7 million and was comprised of approximately $8.3 million in multi-family investment properties and $6.3 million in one to four family investment properties. This relationship accounted for 51.1% of the total residential investor nonperforming loan total. Management charged off $867,000 related to that borrower during the second quarter of 2009 and estimated that no additional specific allocations were needed as of June 30, 2009 based upon a review of recent appraisals.
A second single relationship accounted for $6.4 million, or 22.4%, of the nonperforming loans in the residential investor category. In the aggregate, . . .
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