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| OSBC > SEC Filings for OSBC > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-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 a full complement of trust and wealth management 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. Management believed this transaction provided funding diversification with the acquisition of a strong core deposit base that also expanded our ability to offer Trust and other services as well as commercial loan and treasury management products at these locations. This acquisition provided additional market penetration by adding five retail-banking offices 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 the credit markets and markets for real estate and related assets, have been in a state of disarray since early 2008. The nationwide disorder in markets 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. While some economic indicators have begun to show improvement, the inability of some borrowers to repay continues to be experienced in the Company's local market and has affected the ability of some Old Second clientele to perform on their obligations. Because of these ongoing economic conditions and the related impact upon borrower's ability to perform, the Company greatly increased the provision for loan losses in 2009, and has experienced an increase in both loans charged off and nonperforming assets that continued into the third quarter. As a result of these events, and the second quarter 2009 goodwill impairment charge discussed below, net income declined considerably as compared to prior financial periods. The Company remains committed and focused on maintaining and enhancing its procedures regarding its asset quality and general underwriting standards.
Results of Operations
Net income for the third quarter of 2009 decreased to $1.5 million, or $0.03 diluted earnings per share, compared with $4.1 million, or $0.30 diluted earnings per share, in the third quarter of 2008. In the first nine months of 2009, the Company recorded a loss of $4.26 per diluted share, on $56.0 million in net loss, as compared to $1.25 per diluted share in the first nine months of 2008, on net income of $17.0 million. The year to date loss incurred in 2009 included a second quarter pretax goodwill impairment charge of $57.6 million that had an associated tax benefit of $22.0 million as described below. Generally, for both the quarter and year to date periods, the decrease in earning assets combined with the increases in both the provision for loan losses and other expenses more than offset increases in noninterest income and reductions to interest expense. The Company recorded a $66.6 million provision for loan losses in the nine months ended September 30, 2009, which included an addition of $9.7 million in the third quarter. Net charge-offs in the same period were $49.8 million for the nine months ended September 30, 2009 and $26.2 million for the third quarter. In the same period in 2008, the provision for loan losses was $9.1
million, $6.3 million of which was added in the third quarter. Net charge-offs in the same period were $4.8 million for the nine months ended September 30, 2008 and $3.7 million for the third quarter. The net income available to common stockholders was $351,000 for the third quarter, which decreased the net loss available to common shareholders to $59.1 million for the first nine months of 2009. This compared to net income available to common shareholders of $4.1 million and $17.0 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 described above, $55.4 million originated from the February 8, 2008 acquisition of HeritageBanc, Inc. and Heritage Bank. 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 decreased from $66.1 million in the first nine months of 2008 to $64.9 million in the first nine months of 2009. Average earning assets decreased $32.2 million, or 1.2%, from September 30, 2008 to September 30, 2009, as management continued to place emphasis upon asset quality and loan growth was limited due to the general decline in the number of qualified borrowers. Average interest bearing liabilities decreased $86.6 million, or 3.6%, during the same period. The decrease in average interest bearing liabilities was due in large part to an initiative to retain relationships when they reprice and not to focus on attracting or retaining new deposit relationships where the depositor will utilize no other product or service. The net interest margin (tax equivalent basis), expressed as a percentage of average earning assets, decreased from 3.41% in the first nine months of 2008 to 3.39% in the first nine months of 2009. The average tax-equivalent yield on earning assets decreased from 6.02% in the first nine months of 2008 to 5.17%, or 85 basis points, in the first nine months of 2009. The cost of funds on interest bearing liabilities decreased from 3.03% to 2.13%, or 90 basis points in the same period, but the continued level of nonaccrual loans combined with the general decrease in interest rates lowered interest income to a greater degree than it reduced interest expense.
Net interest income decreased from $23.6 million in the third quarter of 2008 to $21.0 million in the third quarter of 2009. The decrease in average earning assets on a quarterly comparative basis was $145.5 million, or 5.4%, from September 30, 2008 to September 30, 2009 due in part to a continued lack of demand from qualified borrowers coupled with a decrease in securities available-for-sale. Average interest bearing liabilities decreased $211.2 million, or 8.8%, during the same period. The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, decreased from 3.61% in the third quarter of 2008 to 3.39% in the third quarter of 2009. The average tax-equivalent yield on earning assets decreased from 5.83% in the third quarter of 2008 to 5.02% in the third quarter of 2009, or 81 basis points. The cost of interest-bearing liabilities also decreased from 2.57% to 1.97%, or 60 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 nine-month periods ended September 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 September 30, 2009 and 2008
(Dollar amounts in thousands- unaudited)
2009 2008
Average Average
Balance Interest Rate Balance Interest Rate
Assets
Interest bearing deposits $ 39,792 $ 27 0.27 % $ 2,277 $ 30 5.16 %
Federal funds sold 45,503 14 0.12 8,217 40 1.90
Securities:
Taxable 108,299 1,278 4.72 298,949 3,574 4.78
Non-taxable (tax
equivalent) 138,727 2,066 5.96 150,496 2,283 6.07
Total securities 247,026 3,344 5.41 449,445 5,857 5.21
Dividends from FRB and FHLB
stock 13,044 56 1.72 10,521 17 0.65
Loans and loans
held-for-sale(1) 2,208,507 29,277 5.19 2,228,863 34,110 5.99
Total interest earning
assets 2,553,872 32,718 5.02 2,699,323 40,054 5.83
Cash and due from banks 46,072 - - 51,600 - -
Allowance for loan losses (76,902 ) - - (22,114 ) - -
Other non-interest bearing
assets 210,376 - - 208,456 - -
Total assets $ 2,733,418 $ 2,937,265
Liabilities and
Stockholders' Equity
NOW accounts $ 404,657 $ 362 0.35 % $ 322,074 $ 760 0.94 %
Money market accounts 400,223 974 0.97 577,267 2,658 1.83
Savings accounts 163,417 250 0.61 112,364 145 0.51
Time deposits 1,094,151 7,972 2.89 1,029,253 8,987 3.47
Total interest bearing
deposits 2,062,448 9,558 1.84 2,040,958 12,550 2.45
Securities sold under
repurchase agreements 22,563 13 0.23 45,285 182 1.60
Federal funds purchased - - - 34,350 196 2.23
Other short-term borrowings 8,659 36 1.63 160,301 848 2.07
Junior subordinated
debentures 58,378 1,071 7.34 58,378 1,072 7.35
Subordinated debt 45,000 241 2.10 45,000 495 4.30
Notes payable and other
borrowings 500 2 1.57 24,484 219 3.50
Total interest bearing
liabilities 2,197,548 10,921 1.97 2,408,756 15,562 2.57
Non-interest bearing
deposits 309,692 - - 307,664 - -
Accrued interest and other
liabilities 16,723 - - 17,423 - -
Stockholders' equity 209,455 - - 203,422 - -
Total liabilities and
stockholders' equity $ 2,733,418 $ 2,937,265
Net interest income (tax
equivalent) $ 21,797 $ 24,492
Net interest income (tax
equivalent) to total
earning assets 3.39 % 3.61 %
Interest bearing
liabilities to earnings
assets 86.05 % 89.24 %
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ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
Nine Months ended September 30, 2009 and 2008
(Dollar amounts in thousands- unaudited)
2009 2008
Average Average
Balance Interest Rate Balance Interest Rate
Assets
Interest bearing deposits $ 14,633 $ 31 0.28 % $ 1,435 $ 41 3.75 %
Federal funds sold 19,639 17 0.11 7,828 124 2.08
Securities:
Taxable 208,248 7,247 4.64 349,263 12,500 4.77
Non-taxable (tax
equivalent) 143,586 6,446 5.99 153,494 6,894 5.99
Total securities 351,834 13,693 5.19 502,757 19,394 5.14
Dividends from FRB and
FHLB stock 13,044 169 1.73 10,247 51 0.66
Loans and loans
held-for-sale(1) 2,254,864 89,953 5.26 2,163,915 103,176 6.26
Total interest earning
assets 2,654,014 103,863 5.17 2,686,182 122,786 6.02
Cash and due from banks 44,474 - - 50,061 - -
Allowance for loan losses (56,778 ) - - (20,578 ) - -
Other non-interest bearing
assets 227,823 - - 194,597 - -
Total assets $ 2,869,533 $ 2,910,262
Liabilities and
Stockholders' Equity
NOW accounts $ 339,068 $ 942 0.37 % $ 292,457 $ 2,217 1.01 %
Money market accounts 450,930 3,431 1.02 553,800 9,173 2.21
Savings accounts 144,862 605 0.56 111,292 487 0.58
Time deposits 1,142,202 26,735 3.13 1,079,447 32,742 4.05
Total interest bearing
deposits 2,077,062 31,713 2.04 2,036,996 44,619 2.93
Securities sold under
repurchase agreements 33,018 128 0.52 45,621 720 2.11
Federal funds purchased 19,988 73 0.48 59,075 1,359 3.02
Other short-term
borrowings 55,952 257 0.61 119,767 2,249 2.47
Junior subordinated
debentures 58,378 3,215 7.34 58,267 3,209 7.34
Subordinated debt 45,000 1,040 3.05 38,923 1,287 4.34
Notes payable and other
borrowings 6,471 116 2.36 23,811 673 3.71
Total interest bearing
liabilities 2,295,869 36,542 2.13 2,382,460 54,116 3.03
Non-interest bearing
deposits 312,046 - - 314,592 - -
Accrued interest and other
liabilities 18,772 - - 18,250 - -
Stockholders' equity 242,846 - - 194,960 - -
Total liabilities and
stockholders' equity $ 2,869,533 $ 2,910,262
Net interest income (tax
equivalent) $ 67,321 $ 68,670
Net interest income (tax
equivalent) to total
earning assets 3.39 % 3.41 %
Interest bearing
liabilities to earnings
assets 86.51 % 88.69 %
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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 Adjustment
Three Months Ended Nine Months Ended
September 30, September 30,
2009 2008 2009 2008
Interest income (GAAP) $ 31,943 $ 39,195 $ 101,444 $ 120,217
Taxable equivalent adjustment -
loans 52 60 163 156
Taxable equivalent adjustment -
securities 723 799 2,256 2,413
Interest income (TE) 32,718 40,054 103,863 122,786
Less: interest expense (GAAP) 10,921 15,562 36,542 54,116
Net interest income (TE) $ 21,797 $ 24,492 $ 67,321 $ 68,670
Net interest and income (GAAP) $ 21,022 $ 23,633 $ 64,902 $ 66,101
Average interest earning assets $ 2,553,872 $ 2,699,323 $ 2,654,014 $ 2,686,182
Net interest income to total
interest earning assets 3.27 % 3.48 % 3.27 % 3.29 %
Net interest income to total
interest earning assets (TE) 3.39 % 3.61 % 3.39 % 3.41 %
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Provision for Loan Losses
In the first nine months of 2009, the Company recorded a $66.6 million provision for loan losses, which included an addition of $9.7 million in the third quarter. In the first nine months of 2008, the provision for loan losses was $9.1 million, which included an addition of $6.3 million in the third 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 $176.1 million at September 30, 2009 from $108.6 million at December 31, 2008, and $65.7 million at September 30, 2008. On a linked quarter basis, however, nonperforming loan totals decreased from the June 30, 2009 level of $178.6 million. Charge-offs, net of recoveries, totaled $49.8 million and $4.8 million in the first nine months of 2009 and 2008, respectively. Net charge-offs totaled $26.2 million in the third quarter of 2009 and $3.7 million in the third quarter of 2008
Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio. Management closely monitors portfolio quality and when available information indicates that specific loans or portions of loans are uncollectible, management charges off those amounts to reduce the outstanding loan balance. While this reduces specific allocation estimates in the allowance for loan losses, it simultaneously reduces the estimated remaining risk of loss. The distribution of the Company's gross charge-off activity for the periods indicated is detailed in the first table below and the remaining nonperforming loans at September 30, 2009 are included in the table immediately following (in thousands):
Loan Charge-offs, Gross Three Months Ended Nine Months Ended
September 30, September 30,
2009 2008 2009 2008
Real Estate-Construction $ 21,653 $ 3,571 $ 41,055 $ 4,007
Real Estate-Residential:
Investor 1,114 66 2,403 339
Owner Occupied 472 14 599 70
Revolving and Junior Liens 400 26 765 236
Real Estate-Commercial, Nonfarm 1,622 42 2,323 156
Real Estate-Commercial, Farm - - - -
Commercial and Industrial 171 - 934 58
Other 942 93 2,175 213
$ 26,374 $ 3,812 $ 50,254 $ 5,079
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Nonperforming Loans as of September 30, 2009
90 Days Restructured Total Non % Non
Nonaccrual or More Loans performing Performing Specific
Total (1) Past Due (Accruing) Loans Loans Allocation
Real Estate -
Construction $ 87,042 $ 400 $ - $ 87,442 49.7 % $ 2,203
Real Estate -
Residential:
Investor 28,719 - 317 29,036 16.5 % 141
Owner Occupied 16,460 - 7,128 23,588 13.4 % 1,149
Revolving and Junior
Liens 960 - - 960 0.5 % 120
Real Estate -
Commercial, Nonfarm 30,330 218 298 30,846 17.5 % 972
Real Estate -
Commercial, Farm 2,243 - - 2,243 1.3 % -
Commercial and
Industrial 888 284 - 1,172 0.7 % 154
Other 771 - - 771 0.4 % 305
$ 167,413 $ 902 $ 7,743 $ 176,058 100.0 % $ 5,044
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The largest component of nonperforming loans continues to be in the real estate construction sector, at $87.4 million, or 49.7% of total nonperforming loans. This is a $7.5 million decrease on a linked quarter basis. Management estimated that a loss allocation of $2.2 million was adequate coverage for this category. Migration to nonperforming status occurred primarily from loans that had been previously rated as substandard. In addition to the general lack of demand for new construction in our market area, the problems in this sector were compounded by a continued decline in real estate valuations. The subcomponent details for the real estate construction segment at September 30, 2009 (in thousands) is set forth below:
90 Days Restructured Total Non % Non
Nonaccrual or More Loans performing Performing Specific
Real Estate -
Construction Total Past Due (Accruing) Loans Loans Allocation
Homebuilder $ 53,690 $ - $ - $ 53,690 61.4 % $ 2,034
Commercial 13,010 400 - 13,410 15.3 % -
Land 14,505 - - 14,505 16.6 % 46
Other 5,837 - - 5,837 6.7 % 123
$ 87,042 $ 400 $ - $ 87,442 100 % $ 2,203
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Commercial real estate was the Company's second largest category of nonperforming loans representing $30.8 million, 17.5% of the nonperforming loan portfolio, a decrease of $1.1 million on a linked-quarter basis. Within this segment, 45.8% consisted of strip mall or other retail properties where cash flows were 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 specific loss allocation of $510,000 was adequate coverage on that category after charging off $1.1 million in the third quarter of 2009. The remaining nonperforming commercial real estate loans included a . . .
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