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OSBC > SEC Filings for OSBC > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for OLD SECOND BANCORP INC

Form 10-Q for OLD SECOND BANCORP INC


12-Nov-2013

Quarterly Report


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

Overview

The Company is a financial services company with its main headquarters located in Aurora, Illinois. The Company is the holding company of the Bank, a national banking organization headquartered in Aurora, Illinois and the Bank 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 reviews our financial condition as of September 30, 2013, compared to December 31, 2012, and the results of operations for the three-month and nine-month periods ended September 30, 2013 and 2012. This discussion and analysis should be read in conjunction 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 gather strength slowly in the third quarter of 2013 as did the national financial infrastructure. Troubled real estate markets in the Company's market areas continue to detract from borrowers' ability to repay their loans. This has resulted in still elevated, but improving level of nonperforming loans. The Company has seen signs of stabilization in all real estate markets. Management remains vigilant in analyzing loan portfolio quality and making decisions to charge-off loans. To that end, the Company recorded a $6.1 million loan loss reserve release and net income of $81.9 million prior to preferred stock dividends (and including the reversal of a significant portion of the valuation allowance against the deferred tax assets) in the first nine months of 2013. This compared to a $6.3 million provision for loan losses and a net loss of $1.6 million prior to preferred stock dividends for the same period in 2012.

The Company recorded a $1.8 million loan loss reserve release after $3.7 million in net charge-offs in the third quarter of 2013. Net income of $72.9 million (prior to preferred stock dividends and including the reversal of a significant amount of the valuation allowance against the deferred tax assets) was recorded in the third quarter of 2013 up from $3.5 million for the second quarter of 2013. Third quarter 2012 results did not include a provision for loan losses but reflected $120,000 net income prior to preferred stock dividends.

Results of Operations

The net income for the third quarter of 2013 was $72.9 million, or $5.08 earnings per diluted share after preferred stock dividend and accretion discount, as compared with $120,000 net income, or $0.08 loss per diluted share after preferred stock dividend and accretion discount, in the third quarter of 2012. The net income for the first nine months of 2013 was $81.9 million or $5.52 earnings per diluted share after preferred stock dividend and accretion, as compared to $1.6 million in net loss, or $0.37 loss per diluted share after preferred stock dividend and accretion in the first nine months of 2012. The Company recorded a $6.1 million release from the loan loss reserve in the first nine months of 2013, which included a release of $1.8 million in the third quarter. Net loan charge-offs totaled $3.0 million the first nine months of 2013, which included $3.7 million of net charge-offs in the third quarter. The net income available to common stockholders was $71.6 million for the third quarter of 2013 and $78.0 million for the first nine months of 2013, as compared to a net loss to common shareholders of $1.1 million and a net loss to common shareholders of $5.3 million for the third quarter and first nine months of 2012, respectively. Net income for the third quarter of 2013 and the first nine months of 2013 included a $70.0 million tax benefit which includes the reversal of a valuation allowance of $74.1 million.

Net Interest Income

Net interest and dividend income decreased $3.9 million, from $45.4 million in the first nine months of 2012, to $41.6 million in the first nine months of 2013. Average earning assets increased $36.1 million, or 2.1%, to $1.77 billion from the first nine months of 2012 to the first nine months of 2013. Management


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continued to emphasize asset quality with higher portfolio securities (nine month average up 56.8%) while new loan originations continued to be limited. The $176.6 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. Finally, the Bank declined to compromise on loan structures to secure new business. To utilize available liquid funds, management continued to increase total securities during the first nine months of 2013 to 31.1% of total assets up from 28.3% at the end of 2012. At the same time, the Company's historically stable deposit base was impacted by the loss of some retail deposits as customers took advantage of other investment opportunities. As a result, average interest bearing deposits decreased $27.7 million year over year for the nine month periods ended September 30, 2013 and 2012. 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 3.52% in the first nine months of 2012 to 3.17% in the first nine months of 2013. The average tax-equivalent yield on earning assets decreased from 4.39% in the first nine months of 2012 (yield would have been 4.27% except for collection of previously reversed or unrecognized interest on loans that returned to performing status) to 3.92% (yield would have been 3.84% except for adjustments noted above) in the first nine months of 2013. At the same time, however, the cost of funds on interest bearing liabilities decreased from 1.09% to 0.95% 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 were caused by 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 $346,000 from $14.6 million in the third quarter of 2012 to $14.3 million in the third quarter of 2013. Higher yielding average loans were down $141.2 million year over year in the three month period ended September 30 while lower yielding average securities were up $205.1 million in the same period. Quarterly average interest bearing deposits were down $19.0 million year over year (down to $1.31 billion from $1.33 billion) while securities sold under repurchase agreements increased $14.5 million and other borrowings comprised of FHLBC advances increased $15.1 million. The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets decreased from 3.44% in the third quarter of 2012 to 3.25% in the third quarter of 2013. The average tax-equivalent yield on earning assets decreased from 4.24% in the third quarter of 2012 to 3.99% in the third quarter of 2013. The cost of interest-bearing liabilities also decreased from 1.02% to 0.94% in the same period. Consistent with the year to date margin trend, the changed 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 decreased 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 nine-month periods ended September 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 income to total earning assets on the following tables have been adjusted to a non-GAAP tax equivalent


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("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, 2013, and 2012

                   (Dollar amounts in thousands - unaudited)



                                             2013                                2012
                                 Average                             Average
                                 Balance      Interest     Rate      Balance     Interest     Rate
Assets
Interest bearing deposits       $    36,456    $     22   0.24 %   $    46,138    $     29   0.25 %
Securities:
Taxable                             605,546       3,113   2.06         404,855       1,868   1.85
Non-taxable (tax equivalent)         13,937         228   6.54           9,518         151   6.35
Total securities                    619,483       3,341   2.16         414,373       2,019   1.95
FRB and FHLB stock and
dividends                            10,292          76   2.95          11,984          77   2.57
Loans and loans
held-for-sale 1                   1,088,936      14,382   5.17       1,230,180      16,279   5.18
Total interest earning
assets                            1,755,167      17,821   3.99       1,702,675      18,404   4.24
Cash and due from banks              19,584           -      -          31,850           -      -
Allowance for loan losses          (34,197)           -      -        (40,823)           -      -
Other noninterest bearing
assets                              190,836           -      -         228,859           -      -
Total assets                    $ 1,931,390                        $ 1,922,561

Liabilities and
Stockholders' Equity
NOW accounts                    $   283,192    $     63   0.09 %   $   270,908    $     65   0.10 %
Money market accounts               311,213         104   0.13         321,762         137   0.17
Savings accounts                    225,825          39   0.07         213,927          51   0.09
Time deposits                       493,722       1,674   1.35         526,314       1,973   1.49
Interest bearing deposits         1,313,952       1,880   0.57       1,332,911       2,226   0.66
Securities sold under
repurchase agreements                21,646           1   0.02           7,164           1   0.06
Other short-term borrowings          15,707           5   0.12             652           -      -
Junior subordinated
debentures                           58,378       1,336   9.15          58,378       1,243   8.52
Subordinated debt                    45,000         209   1.82          45,000         223   1.94
Notes payable and other
borrowings                              500           4   3.13             500           5   3.91
Total interest bearing
liabilities                       1,455,183       3,435   0.94       1,444,605       3,698   1.02
Noninterest bearing deposits        366,889           -      -         380,226           -      -
Other liabilities                    37,466           -      -          28,130           -      -
Stockholders' equity                 71,852           -      -          69,600           -      -
Total liabilities and
stockholders' equity            $ 1,931,390                        $ 1,922,561
Net interest income (tax
equivalent)                                    $ 14,386                           $ 14,706
Net interest income (tax
equivalent) to total earning
assets                                                    3.25 %                             3.44 %
Interest bearing liabilities
to earning assets                    82.91%                             84.84%

1 Interest income from loans is shown on a tax equivalent basis as discussed in the table on page 45 and includes fees of $793,000 and $498,000 for the third 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

                 Nine Months ended September 30, 2013, and 2012

                   (Dollar amounts in thousands - unaudited)



                                        2013                               2012
                            Average                            Average
                            Balance      Interest    Rate      Balance      Interest    Rate
Assets
Interest bearing
deposits                   $    49,676    $     91   0.24%    $    48,871    $     89   0.24%
Securities:
Taxable                        574,761       8,109    1.88        365,549       5,222    1.90
Non-taxable (tax
equivalent)                     14,912         679    6.07         10,417         467    5.98
Total securities               589,673       8,788    1.99        375,966       5,689    2.02
FRB and FHLB stock and
dividends                       10,742         228    2.83         12,562         228    2.42
Loans and loans
held-for-sale 1              1,116,964      43,327    5.12      1,293,533      51,741    5.26
Total interest earning
assets                       1,767,055      52,434    3.92      1,730,932      57,747    4.39
Cash and due from banks         24,110           -       -         27,528           -       -
Allowance for loan
losses                        (37,122)           -       -       (46,824)           -       -
Other noninterest
bearing assets                 196,298           -       -        236,281           -       -
Total assets               $ 1,950,341                        $ 1,947,917

Liabilities and
Stockholders' Equity
NOW accounts               $   290,691    $    192   0.09%    $   275,712    $    204   0.10%
Money market accounts          319,876         342    0.14        311,046         438    0.19
Savings accounts               226,193         121    0.07        211,331         165    0.10
Time deposits                  498,846       5,327    1.43        565,183       6,920    1.64
Interest bearing
deposits                     1,335,606       5,982    0.60      1,363,272       7,727    0.76
Securities sold under
repurchase agreements           22,206           2    0.01          4,502           2    0.06
Other short-term
borrowings                      20,000          24    0.16          4,635           4    0.11
Junior subordinated
debentures                      58,378       3,937    8.99         58,378       3,660    8.36
Subordinated debt               45,000         610    1.79         45,000         684    2.00
Notes payable and other
borrowings                         500          12    3.16            500          13    3.42
Total interest bearing
liabilities                  1,481,690      10,567    0.95      1,476,287      12,090    1.09
Noninterest bearing
deposits                       359,438           -       -        373,975           -       -
Other liabilities               35,432           -       -         25,629           -       -
Stockholders' equity            73,781           -       -         72,026           -       -
Total liabilities and
stockholders' equity       $ 1,950,341                        $ 1,947,917
Net interest income
(tax equivalent)                          $ 41,867                           $ 45,657
Net interest income
(tax equivalent) to
total earning assets                                 3.17%                              3.52%
Interest bearing
liabilities to earning
assets                          83.85%                             85.29%

1 Interest income from loans is shown on a tax equivalent basis as discussed in the table on page 45 and includes fees of $2.0 million and $1.4 million for the first nine 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 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              Nine Months Ended
                                     September 30,                   September 30,
                                  2013            2012            2013            2012

Interest income (GAAP)         $    17,724     $    18,333     $    52,146     $    57,519
Taxable equivalent
adjustment - loans                      17              18              50              64
Taxable equivalent
adjustment - securities                 80              53             238             164
Interest income (TE)                17,821          18,404          52,434          57,747
Less: interest expense
(GAAP)                               3,435           3,698          10,567          12,090
Net interest income (TE)       $    14,386     $    14,706     $    41,867     $    45,657
Net interest and income
(GAAP)                         $    14,289     $    14,635     $    41,579     $    45,429
Average interest earning
assets                         $ 1,755,167     $ 1,702,675     $ 1,767,055     $ 1,730,932
Net interest income to
total interest earning
assets (GAAP)                        3.23%           3.42%           3.15%           3.51%
Net interest income to
total interest earning
assets (TE)                          3.25%           3.44%           3.17%           3.52%

Provision for Loan Losses

In the first nine months of 2013, the Company recorded a $6.1 million release of reserve for loan losses, which included a release of $1.8 million in the third quarter. The Company experienced continuing improvement in asset quality, notably from reductions in nonperforming loans and continued moderate charge-off experience. In the first nine months of 2012, the provision for loan losses was $6.3 million, which did not include a provision in the third quarter. Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio. Nonperforming loans decreased to $47.8 million at September 30, 2013 from $82.6 million at December 31, 2012, and $105.8 million at September 30, 2012. Charge-offs, net of recoveries, totaled $3.0 million and $18.0 million in the first nine months of 2013 and 2012, respectively. Net charge-offs totaled $3.7 million in the third quarter of 2013 and $29,000 in the third 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.

                                                                                     September 30, 2013
                                      Nonperforming Loans as of                      Dollar change From
(in thousands)              September 30,       June 30,      September 30,      June 30,      September 30,
                                2013              2013            2012             2013            2012
Real
estate-construction          $        5,928     $   6,303     $       16,035    $    (375)     $     (10,107)
Real
estate-residential:
Investor                              8,307        13,662             13,007       (5,355)            (4,700)
Owner occupied                        6,212         7,927             14,875       (1,715)            (8,663)
Revolving and junior
liens                                 2,543         3,431              3,306         (888)              (763)
Real
estate-commercial,
nonfarm                              24,754        31,190             55,642       (6,436)           (30,888)
Real
estate-commercial,
farm                                      -            53              1,790          (53)            (1,790)
Commercial                               29           104              1,157          (75)            (1,128)
                             $       47,773     $  62,670     $      105,812    $ (14,897)     $     (58,039)

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 September 30, 2012, was 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.


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Loan Charge-offs, net of (recoveries)     Three Months Ended        Year to Date
(in thousands)                              September 30,           September 30,
                                           2013         2012       2013       2012
Real estate-construction
Homebuilder                              $     (5)     $ (151)    $ (307)   $    768
Land                                            44        (57)         42      (723)
Commercial speculative                           -     (1,130)       (49)        668
All other                                      (1)          45          -        165
Total real estate-construction                  38     (1,293)      (314)        878
Real estate-residential
Investor                                     2,218         187      2,133      3,234
Owner occupied                                 350         343        401      1,440
Revolving and junior liens                     817         481      1,867      1,290
Total real estate-residential                3,385       1,011      4,401      5,964
Real estate-commercial, nonfarm
Owner general purpose                          (5)        (39)       (43)      1,100
Owner special purpose                          (5)          62      (148)      1,288
Non-owner general purpose                        -         119      (156)      4,492
Non-owner special purpose                       73           -      (751)         78
Retail properties                              265         137      (277)      4,038
Total real estate-commercial, nonfarm          328         279    (1,375)     10,996
Real estate-commercial, farm                     -           -          -          -
Commercial                                    (31)        (20)        204         78
Other                                           25          52         84        108
                                         $   3,745     $    29    $ 3,000   $ 18,024

Charge-offs for the third quarter 2013 were primarily from previously established specific reserves on nonaccrual loans deemed uncollectible. Charge-off activity continued to improve for the year to date period in 2013 compared to the same year to date period in 2012, reflecting an improved economy in our target markets and our efforts to improve loan quality.

                                                                                    September 30, 2013
                                        Classified loans as of                      Dollar Change From
(in thousands)               September 30,     June 30,      September 30,      June 30,      September 30,
                                 2013            2013            2012             2013            2012
Real estate-construction     $        6,236     $  7,005     $       22,387    $    (769)     $     (16,151)
Real estate-residential:
Investor                             10,642       13,968             16,406       (3,326)            (5,764)
Owner occupied                        7,292       11,008             17,684       (3,716)           (10,392)
Revolving and junior
liens                                 3,675        5,086              5,053       (1,411)            (1,378)
Real estate-commercial,
nonfarm                              40,832       43,827             73,720       (2,995)           (32,888)
Real estate-commercial,
farm                                      -           53              1,790          (53)            (1,790)
Commercial                              264          705              1,748         (441)            (1,484)
Other                                     1            1                  5             -                (4)
                             $       68,942     $ 81,653     $      138,793    $ (12,711)     $     (69,851)

Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. All three components are down since September 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 improvement in loan related asset quality. The decline in both classified loans and OREO as well as improved Tier 1 capital in the third quarter improved this ratio for the eleventh straight quarter.

Allowance for Loan and Lease Losses



Below is a reconciliation for the activity for the periods indicated (in
thousands):



                                                       Three Months Ending
                                            9/30/2013       6/30/2013       9/30/2012

Allowance at beginning of quarter          $     35,042    $     38,634    $     40,286
Charge-offs:
Commercial                                           29              25               2
. . .
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