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OSBC > SEC Filings for OSBC > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for OLD SECOND BANCORP INC

Form 10-Q for OLD SECOND BANCORP INC


14-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

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. The following management's discussion and analysis is presented to provide information concerning our financial condition as of June 30, 2013, as compared to December 31, 2012, and the results of operations for the three-month and six-month periods ended June 30, 2013, and 2012. This discussion and analysis should be read along with our consolidated financial statements and the financial and statistical data appearing elsewhere in this report and our 2012 Form 10-K.

The economies in our chosen markets continued to recover slowly as did the national financial infrastructure. Troubled real estate markets in the Company's market areas continue to directly affect borrowers' ability to repay their loans. This has resulted in a continued elevated, but improving level of nonperforming loans. The Company has, however, seen signs of stabilization in all real estate markets. Overall economic weakness is reflected in the Company's operating results, and management remains vigilant in analyzing the loan portfolio quality, estimating loan loss provision and making decisions to charge-off loans. The Company recorded a $4.3 million loan loss reserve release and net income of $8.9 million prior to preferred stock dividends in the first half of 2013. This compared to a $6.3 million provision for loan losses and a net loss of $1.7 million prior to preferred stock dividends the same period in 2012.

The Company recorded a $1.8 million loan loss reserve release after $1.8 million in net charge offs in second quarter. Net income of $3.5 million (prior to preferred stock dividends) was recorded in second quarter down from $5.5 million for the first three months of 2013. Second quarter 2012 results included $200,000 in provision for loan losses and $1.3 million net income prior to preferred stock dividends and accretion.

Summary information shown as graphs can be found at our investor relations website or go to
https://www.snl.com/irweblinkx/QuarterlyResults.aspx?iid=100625. The graphs and information included on the investor relations website are being furnished for reference purposes only and are not incorporated in, or to be considered filed with this, Form 10-Q.

Results of Operations

The net income for the second quarter of 2013 was $3.5 million, or $0.15 earnings per diluted share, after preferred stock dividend and accretion discount, as compared with $1.3 million net income, or $0.00 earnings per diluted share after preferred stock dividend and accretion discount, in the second quarter of 2012. The net income for the first half of 2013 was $8.9 million or $0.45 earnings per diluted share after preferred stock dividend and accretion, as compared to $1.7 million in net loss, or $0.29 loss per diluted share after preferred stock dividend and accretion in the first half of 2012. The Company recorded a $4.3 million release from the loan loss reserve in the first half of 2013, which included a release of $1.8 million in the second quarter. Net loan recoveries totaled $745,000 the first half of 2013, which included $1.8 million of net charge-offs in the second quarter. The net income available to common stockholders was $2.2 million for the second quarter of 2013 and $6.4 million for the first half of 2013, as compared to a net income to common shareholders of $14,000 and a net loss to common shareholders of $4.2 million for the second quarter and first half of 2012, respectively.

Net Interest Income

Net interest and dividend income decreased $3.5 million, from $30.8 million in the first half of 2012, to $27.3 million in the first half of 2013. Average earning assets increased $27.9 million to $1.77 billion from the first half of 2012 to the first half of 2013, as management continued to emphasize asset quality with sharply higher portfolio securities (up 61.1%) while new loan originations continued to be limited. The


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$194.3 million decrease in year to date average loans and loans held-for-sale was primarily due to the lack of expansion by local businesses leading to lower utilization of available credit lines. Simultaneously, difficult competitive pricing, paydowns and maturities contributed to the year over year decrease. To utilize available liquid funds, management continued to increase securities available-for-sale in the first half of 2013 to 30.3% of total assets up from 28.3% at the end of 2012. At the same time, the Company's stable deposit base was impacted by expiration of the Federal Deposit Insurance Corporation Transaction Account Guarantee (TAG) program on large deposit balances, income and property tax payments and the loss of some retail deposits as customers took advantage of other investment opportunities. As a result, average interest bearing deposits decreased $32.0 million year over year for the six month period ended June 30. At this time, management sees no need to grow deposits to fund loan or investment opportunities and management expects that securities sales and maturities will provide cost effective liquidity as those opportunities arise.

The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, decreased from 3.57% in the first half of 2012 to 3.13% in the first half of 2013. The average tax-equivalent yield on earning assets decreased from 4.46% in the first half of 2012 (yield would have been 4.35% except for collection of previously reversed or unrecognized interest on loans that returned to performing status) to 3.89% (yield would have been 3.82% except for adjustments noted above) in the first half of 2013. At the same time, however, the cost of funds on interest bearing liabilities decreased from 1.13% to 0.96% helping to offset the decrease in earning asset yield. The growth of lower yielding securities (compared to reductions in higher yielding loans) was the main cause of decreased net interest income. Reductions in higher yielding loans come from the factors discussed in the paragraph above. Additionally, management continued to see pressure to reduce interest rates on loans retained at renewal and found it necessary to accept rate concessions to keep the business.

Net interest income decreased $2.3 million from $15.7 million in the second quarter of 2012 to $13.4 million in the second quarter of 2013. Higher yielding average loans were down $174.6 million year over year in the three month period ended June 30 while lower yielding average securities were up $215.0 million in the same period. Quarterly average interest bearing deposits were essentially flat year over year (down $35.44 million to $1.35 billion from $1.38 billion) while other interest bearing liabilities showed a $20.1 million increase in year over year quarterly averages in low cost securities sold under repurchase agreements and a minimal decrease in other borrowings, essentially FHLB advances. The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets decreased from 3.65% in the second quarter of 2012 to 3.07% in the second quarter of 2013. The average tax-equivalent yield on earning assets decreased from 4.52% in the second quarter of 2012 to 3.83% in the second quarter of 2013. The cost of interest-bearing liabilities also decreased from 1.09% to 0.96% in the same period. Consistent with the year to date margin trend, the decreased overall average earning assets resulting from reduced levels of higher yielding loans and the movement to lower yielding securities combined with the repricing of interest bearing assets and liabilities in a lower interest rate environment to decrease interest income to a greater degree than found in interest expense decreases.

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, 2013, and 2012.

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


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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 30, 2013 and 2012

                   (Dollar amounts in thousands - unaudited)



                                        2013                                    2012
                          Average                                  Average
                          Balance        Interest      Rate        Balance        Interest     Rate
Assets
Interest bearing
deposits                $    43,933      $     27      0.24 %    $    56,486      $     35      0.25 %
Securities:
Taxable                     569,877         2,698      1.89          364,475         1,856      2.04
Non-taxable (tax
equivalent)                  20,752           268      5.17           11,165           157      5.62
Total securities            590,629         2,966      2.01          375,640         2,013      2.14
Dividends from FRB
and FHLBC stock              10,742            76      2.83           12,382            77      2.49
Loans and loans
held-for-sale 1           1,118,892        13,974      4.94        1,293,446        17,688      5.41
Total interest
earning assets            1,764,196        17,043      3.83        1,737,954        19,813      4.52
Cash and due from
banks                        22,948             -         -           34,279             -         -
Allowance for loan
losses                      (38,228 )           -         -          (48,353 )           -         -
Other non-interest
bearing assets              194,782             -         -          240,075             -         -
Total assets            $ 1,943,698                              $ 1,963,955

Liabilities and
Stockholders' Equity
NOW accounts            $   297,918      $     65      0.09 %    $   279,205      $     67      0.10 %
Money market
accounts                    319,236           115      0.14          310,497           135      0.17
Savings accounts            230,822            41      0.07          214,873            52      0.10
Time deposits               497,262         1,800      1.45          576,099         2,342      1.64
Interest bearing
deposits                  1,345,238         2,021      0.60        1,380,674         2,596      0.76
Securities sold
under repurchase
agreements                   24,692             -         -            4,636             1      0.09
Other short-term
borrowings                      769             -         -            3,132             1      0.13
Junior subordinated
debentures                   58,378         1,314      9.00           58,378         1,220      8.36
Subordinated debt            45,000           205      1.80           45,000           224      1.97
Notes payable and
other borrowings                500             4      3.16              500             4      3.16
Total interest
bearing liabilities       1,474,577         3,544      0.96        1,492,320         4,046      1.09
Non-interest bearing
deposits                    357,802             -         -          373,869             -         -
Other liabilities            35,202             -         -           26,774             -         -
Stockholders' equity         76,117             -         -           70,992             -         -
Total liabilities
and stockholders'
equity                  $ 1,943,698                              $ 1,963,955
Net interest income
(tax equivalent)                         $ 13,499                                 $ 15,767
Net interest income
(tax equivalent)
to total earning
assets                                                 3.07 %                                   3.65 %
Interest bearing
liabilities to
earning assets                83.58 %                                  85.87 %

1. Interest income from loans is shown on a tax equivalent basis as discussed below and includes fees of $551,000 and $519,000 for the second quarter of 2013 and 2012, respectively. Nonaccrual loans are included in the above stated average balances.


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                         ANALYSIS OF AVERAGE BALANCES,

                       TAX EQUIVALENT INTEREST AND RATES

                    Six Months ended June 30, 2013 and 2012

                   (Dollar amounts in thousands - unaudited)



                                       2013                                    2012
                          Average                                 Average
                          Balance        Interest      Rate       Balance        Interest      Rate
Assets
Interest bearing
deposits                $    56,395      $     69     0.24 %    $    50,252      $     60       0.24 %
Securities:
Taxable                     559,114         4,996     1.79          345,681         3,354       1.94
Non-taxable (tax
equivalent)                  15,407           451     5.85           10,872           316       5.81
Total securities            574,521         5,447     1.90          356,553         3,670       2.06
Dividends from FRB
and FHLBC stock              10,971           152     2.77           12,854           151       2.35
Loans and loans
held-for-sale 1           1,131,210        28,945     5.09        1,325,558        35,462       5.29
Total interest
earning assets            1,773,097        34,613     3.89        1,745,217        39,343       4.46
Cash and due from
banks                        26,411             -        -           25,344             -          -
Allowance for loan
losses                      (38,609 )           -        -          (49,857 )           -          -
Other non-interest
bearing assets              199,076             -        -          240,031             -          -
Total assets            $ 1,959,975                             $ 1,960,735

Liabilities and
Stockholders' Equity
NOW accounts            $   294,504      $    129     0.09 %    $   278,141      $    139       0.10 %
Money market
accounts                    324,279           238     0.15          305,629           301       0.20
Savings accounts            226,380            82     0.07          210,019           114       0.11
Time deposits               501,450         3,653     1.47          584,830         4,947       1.70
Interest bearing
deposits                  1,346,613         4,102     0.61        1,378,619         5,501       0.80
Securities sold
under repurchase
agreements                   22,490             1     0.01            3,156             1       0.06
Other short-term
borrowings                   22,182            19     0.17            6,648             4       0.12
Junior subordinated
debentures                   58,378         2,601     8.91           58,378         2,417       8.28
Subordinated debt            45,000           401     1.77           45,000           461       2.03
Notes payable and
other borrowings                500             8     3.18              500             8       3.16
Total interest
bearing liabilities       1,495,163         7,132     0.96        1,492,301         8,392       1.13
Non-interest bearing
deposits                    355,651             -        -          370,815             -          -
Other liabilities            34,398             -        -           24,367             -          -
Stockholders' equity         74,763             -        -           73,252             -          -
Total liabilities
and stockholders'
equity                  $ 1,959,975                             $ 1,960,735
Net interest income
(tax equivalent)                         $ 27,481                                $ 30,951
Net interest income
(tax equivalent)
to total earning
assets                                                3.13 %                                    3.57 %
Interest bearing
liabilities to
earning assets                84.32 %                                 85.51 %

1. Interest income from loans is shown on a tax equivalent basis as discussed below and includes fees of $1.2 million and $936,000 for the first six months of 2013 and 2012, respectively. Nonaccrual loans are included in the above stated average balances.


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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           Effect of Tax Equivalent Adjustment
                                          Three Months Ended                             Six Months Ended
                                               June 30,                                      June 30,
                                     2013                   2012                   2013                   2012

Interest income (GAAP)         $           16,932     $           19,736     $           34,422     $           39,186
Taxable equivalent
adjustment - loans                             17                     22                     33                     46
Taxable equivalent
adjustment - securities                        94                     55                    158                    111
Interest income (TE)                       17,043                 19,813                 34,613                 39,343
Less: interest expense
(GAAP)                                      3,544                  4,046                  7,132                  8,392
Net interest income (TE)       $           13,499     $           15,767     $           27,481     $           30,951
Net interest and income
(GAAP)                         $           13,388     $           15,690     $           27,290     $           30,794
Average interest earning
assets                         $        1,764,196     $        1,737,954     $        1,773,097     $        1,745,217
Net interest income to
total interest earning
assets                                      3.04%                  3.63%                  3.10%                  3.55%
Net interest income to
total interest earning
assets (TE)                                 3.07%                  3.65%                  3.13%                  3.57%

Provision for Loan Losses

In the first half of 2013, the Company recorded a $4.3 million release of reserve for loan losses, which included a release of $1.8 million in the second quarter primarily as a result of continuing improvement in asset quality as evidenced by reductions in nonperforming loans and continued moderate charge off experience. In the first half of 2012, the provision for loan losses was $6.3 million, which included an addition of $200,000 in the second quarter. Provisions for loan losses are made to recognize probable and estimable losses inherent in the loan portfolio. Nonperforming loans decreased to $62.7 million at June 30, 2013, from $69.8 million at March 31, 2013. Charge-offs, net of recoveries, totaled a recovery of $745,000 in the first half of 2013 with net charge offs of $18.0 million in the first half of 2012. Net charge-offs totaled $1.8 million in the second quarter of 2013 and $7.5 million in the second quarter of 2012. These data along with the distribution of the Company's nonperforming loans and charge-offs net of recoveries for the periods are included in the following tables.

                                                                                 June 30, 2013
                                         Nonperforming Loans as of             Dollar change From
(in thousands)                     June 30,      March 31,     June 30,     March 31,      June 30,
                                     2013          2013          2012          2013          2012
Real estate-construction            $  6,303    $     8,040    $  20,213     $ (1,737)     $ (13,910 )
Real estate-residential:
Investor                              13,662          8,524       13,631         5,138            31
Owner occupied                         7,927          8,269       15,103         (342)        (7,176 )
Revolving and junior liens             3,431          3,776        3,138         (345)           293
Real estate-commercial, nonfarm       31,190         38,588       57,123       (7,398)       (25,933 )
Real estate-commercial, farm              53          2,417        2,278       (2,364)        (2,225 )
Commercial                               104            210        1,091         (106)          (987 )
                                    $ 62,670    $    69,824    $ 112,577     $ (7,154)     $ (49,907 )

Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due still accruing. The largest decrease in the nonperforming loans since June 30, 2012, was


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in the real estate-commercial, nonfarm segment as this segment's upgrades and migration to OREO were greater than the migration of loans to nonperforming status.

Loan Charge-offs, net of recoveries        Three Months Ended          Year to Date
(in thousands)                                  June 30,                 June 30,
                                           2013          2012        2013        2012
Real estate-construction
Homebuilder                              $   (305 )    $   287      $ (302 )    $    919
Land                                           (1 )          -          (2 )        (666 )
Commercial speculative                        718        1,514         (49 )       1,798
All other                                       2          137           1           120
Total real estate-construction                414        1,938        (352 )       2,171
Real estate-residential
Investor                                       64        1,887         (85 )       3,047
Owner occupied                                 70          427          51         1,097
Revolving and junior liens                    701          513       1,050           809
Total real estate-residential                 835        2,827       1,016         4,953
Real estate-commercial, nonfarm
Owner general purpose                         (19 )        309         (38 )       1,139
Owner special purpose                        (260 )     (1,150 )      (143 )       1,226
Non-owner general purpose                     161        3,342        (156 )       4,374
Non-owner special purpose                       -          124        (824 )          78
Retail properties                             631            2        (542 )       3,901
Total real estate-commercial, nonfarm         513        2,627      (1,703 )      10,718
Real estate-commercial, farm                    -            -           -             -
Commercial                                      -           93         235            97
Other                                          30           39          59            56
                                         $  1,792      $ 7,524      $ (745 )    $ 17,995

Charge-offs for second quarter 2013 were primarily from previously established specific reserves on nonaccrual loans deemed uncollectible. Charge-off activity continued to be improved from last year.

                                                                                 June 30, 2013
                                  Classified loans as of                       Dollar Change From
(in thousands)             June 30,      March 31,      June 30,         March 31,            June 30,
                             2013          2013           2012             2013                 2012
Real
estate-construction        $   7,005     $   12,656     $  25,180     $      (5,651 )             $      (18,175 )
Real
estate-residential:
Investor                      13,968          8,913        19,198             5,055                       (5,230 )
Owner occupied                11,008         10,463        17,908               545                       (6,900 )
Revolving and junior
liens                          5,086          5,722         4,324              (636 )                        762
Real
estate-commercial,
nonfarm                       43,827         61,442        85,135           (17,615 )                    (41,308 )
Real
estate-commercial,
farm                              53          2,417         2,278            (2,364 )                     (2,225 )
Commercial                       705            747         1,409               (42 )                       (704 )
Other                              1              1             7                 -                           (6 )
                           $  81,653     $  102,361     $ 155,439     $     (20,708 )             $      (73,786 )

Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. All three components are down since June 30, 2012. Classified assets include both classified loans and OREO. Management monitors a ratio of classified assets to the sum of Bank Tier 1


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capital and the allowance for loan and lease loss reserve. This ratio reflects another measure of overall change in loan related asset quality. The decline in both classified loans and OREO in second quarter improved this ratio for the tenth straight quarter.

Allowance for Loan and Lease Losses


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