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OSBC > SEC Filings for OSBC > Form 10-Q on 13-May-2014All Recent SEC Filings

Show all filings for OLD SECOND BANCORP INC

Form 10-Q for OLD SECOND BANCORP INC


13-May-2014

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 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 March 31, 2014, as compared to December 31, 2013, and the results of operations for the three months ended March 31, 2014, and 2013. This discussion and analysis is most comprehensively read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our 2013 Form 10-K.

In the markets where the Company primarily operates, economies continued to recover in an uneven fashion. The economies in these markets continued to show gradual improvement in the first quarter of 2014 as did the national financial infrastructure. Real estate markets in the Company's market areas are well short of robust and continue to pressure borrower financial strength. This has resulted in still elevated, but improved and improving levels of nonperforming loans and other real estate owned. Management remains vigilant in analyzing loan portfolio quality and making decisions to charge-off loans. To that end, the Company recognized improved asset quality by recording a $1.0 million loan loss reserve release in the quarter with net income of $2.2 million prior to Series B Stock dividends in the period. This compared to a $2.5 million loan loss reserve release and a net income of $5.5 million prior to Series B Stock dividends for the same period in 2013. The $1.0 million loan loss reserve release for the period was appropriate in light of ongoing improvements in loan portfolio quality.

Net income of $3.4 million (before taxes) in the first quarter of 2014 compares to $5.5 million for the first quarter of 2013. In addition to the larger loan loss reserve release in first quarter 2013, last year's quarter included stronger net interest income and significantly stronger residential mortgage banking revenue as well as $1.5 million in securities gains compared to nominal securities losses in the 2014 first quarter.

In April, 2014 the Company concluded a successful capital raise issuing 15,525,000 common shares with net proceeds in excess of $64.0 million. To date proceeds have been used to pay $19.7 million accrued but previously unpaid interest on trust preferred securities and to repurchase certain shares of Series B Stock. On April 28, 2014 the Company repurchased Series B Stock at an agreed upon price reached in private negotiations. Payments of $22.9 million were made to a large private investor with other payments totaling $1.4 million made to directors of the Company. See Note 17 for additional information. In May, 2014 the Company will apply proceeds to pay the accumulated but unpaid dividends on Series B Stock. Any remaining proceeds will be used for general corporate purposes including payment for various services required during the offering.

Results of Operations

Earnings per share for the first quarter of 2014 was $.04 per diluted share on $2.2 million of net income. This compares to $.30 per diluted share, on net income of $5.5 million for the first quarter of 2013. The net income available to common stockholders was $630,000 for the first quarter of 2014 after preferred stock dividends and accretion of $1.6 million. The first quarter 2014 preferred stock dividend incorporates an increase in the dividend rate from 5% to 9% in February 2014. First quarter 2013 net income available to common stockholders was $4.2 million for the first quarter of 2013 after Series B Stock dividends and accretion of $1.3 million.


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Net Interest Income

Net interest and dividend income decreased $307,000, from $13.9 million for the quarter ended March 31, 2013, to $13.6 million for the quarter ended March 31, 2014. Average earning assets decreased $6.6 million, or 0.4%, from a total of $1.78 billion in the first quarter of 2013. Management continued to emphasize asset quality. New loan originations while improved continued to be limited, business leader confidence remained moderate and the competitive landscape was intense in our markets. Average loans, including loans held for sale, decreased $37.3 million from the first quarter of 2013 to the first quarter of 2014. On a linked quarter basis, average loan volume, including loans held for sale, increased $31.2 million reversing a 2013 trend of declining volume of this metric.

Management continues to develop loan pipelines and expects that pipeline volume will generate future loan growth. As loan volume continues measured but slow paced growth, management increased total securities in the first quarter of 2014 to 32.3% of total assets up from 31.4% at the end of 2013 to utilize available liquid funds.

The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, decreased from 3.18% in the first quarter of 2013 to 3.13% in the first quarter of 2014. The average tax-equivalent yield on earning assets decreased from 3.94% in the first quarter of 2013 to 3.79% in the first quarter of 2014. For the same comparative period, the cost of funds on interest bearing liabilities decreased from 0.95% to 0.86% providing some offset to the decrease in earning asset yield.

The growth of lower yielding securities (average balance up again in the first quarter period on a linked quarter basis continuing a 2013 trend of increasing volume of this metric) and reductions in higher yielding loans were the main causes of decreased net interest income. Period loan yields are reflective of competitive pressures on new loan yield. 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.

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-month periods ended March 31, 2014, and 2013.

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 the disclosed 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.


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                         ANALYSIS OF AVERAGE BALANCES,

                       TAX EQUIVALENT INTEREST AND RATES

                  Three Months ended March 31, 2014, and 2013

                   (Dollar amounts in thousands - unaudited)



                                          2014                                   2013
                             Average                                Average
                             Balance      Interest     Rate         Balance       Interest      Rate
Assets
Interest bearing
deposits                    $    23,775    $     15     0.25%    $       68,995    $     42      0.24%
Securities:
Taxable                         616,433       3,502      2.27           548,231       2,298       1.68
Non-taxable (tax
equivalent)                      18,561         228      4.91            10,002         183       7.32
Total securities                634,994       3,730      2.35           558,233       2,481       1.78
Dividends from FRB and
FHLB stock                       10,292          76      2.95            11,202          76       2.71
Loans and loans
held-for-sale 1               1,106,409      12,988      4.70         1,143,666      14,971       5.24
Total interest earning
assets                        1,775,470      16,809      3.79         1,782,096      17,570       3.94
Cash and due from banks          29,901           -         -            29,913           -          -
Allowance for loan
losses                         (27,102)           -         -          (38,994)           -          -
Other noninterest
bearing assets                  236,356           -         -           203,417           -          -
Total assets                $ 2,014,625                          $    1,976,432

Liabilities and
Stockholders' Equity
NOW accounts                $   303,553    $     64     0.09%    $      291,051    $     64      0.09%
Money market accounts           314,803          94      0.12           329,377         123       0.15
Savings accounts                234,353          41      0.07           221,889          41       0.07
Time deposits                   468,138       1,321      1.14           505,685       1,853       1.49
Interest bearing
deposits                      1,320,847       1,520      0.47         1,348,002       2,081       0.63
Securities sold under
repurchase agreements            24,539           1      0.02            20,264           1       0.02
Other short-term
borrowings                        4,111           1      0.10            43,833          19       0.17
Junior subordinated
debentures                       58,378       1,387      9.50            58,378       1,287       8.82
Subordinated debt                45,000         196      1.74            45,000         196       1.74
Notes payable and other
borrowings                          500           4      3.20               500           4       3.20
Total interest bearing
liabilities                   1,453,375       3,109      0.86         1,515,977       3,588       0.95
Noninterest bearing
deposits                        373,711           -         -           353,476           -          -
Other liabilities                38,966           -         -            33,585           -          -
Stockholders' equity            148,573           -         -            73,394           -          -
Total liabilities and
stockholders' equity        $ 2,014,625                          $    1,976,432
Net interest income (tax
equivalent)                                $ 13,700                                $ 13,982
Net interest income (tax
equivalent) to total
earning assets                                          3.13%                                    3.18%
Interest bearing
liabilities to earning
assets                           81.86%                                  85.07%

1. Interest income from loans is shown on a TE basis as discussed below and includes fees of $550,000 and $671,000 for the first quarter of 2014 and 2013, respectively. Nonaccrual loans are included in the above-stated average balances.


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As indicated previously, the Company adjusts net interest income and net interest income to earning assets to a non-GAAP TE basis using a marginal rate of 35% to more appropriately compare returns on TE 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
                                                                   March 31,
                                                          2014                   2013

Interest income (GAAP)                              $           16,704     $           17,490
Taxable equivalent adjustment - loans                               25                     16
Taxable equivalent adjustment - securities                          80                     64
Interest income (TE)                                            16,809                 17,570
Less: interest expense (GAAP)                                    3,109                  3,588
Net interest income (TE)                            $           13,700     $           13,982
Net interest and income (GAAP)                      $           13,595     $           13,902
Average interest earning assets                     $        1,775,470     $        1,782,096
Net interest income to total interest earning
assets                                                           3.11%                  3.16%
Net interest income to total interest earning
assets (TE)                                                      3.13%                  3.18%

Provision for Loan Losses / Loan Loss Reserve Release

The Company's $1.0 million loan loss reserve release in the first quarter of 2014 compares to a $2.5 million reserve release in the first quarter of 2013. The provision for loan loss creates a reserve for probable and estimable losses inherent in the loan portfolio. Reserve releases reflect management's measured decision that probable and estimable losses have been reduced. On a quarterly basis, management estimates the amount required and records the appropriate provision or release to maintain an adequate reserve for these potential and estimated loan losses. The $1.0 million loan loss reserve release in the first quarter of 2014 continues a 2013 trend of quarterly reserve releases. In each quarter of 2013, management concluded that quarterly releases were justified with quarterly amounts ranging from $1.8 million to $2.5 million.

Nonperforming loans decreased to $38.6 million at March 31, 2014 from $39.8 million at December 31, 2013. Net charge-offs totaled $805,000 in first quarter 2014 while net recoveries totaled $2.5 million for the first quarter of 2013. The distribution of the Company's remaining nonperforming loans are included in the following table.

                                                                                March 31, 2014
                                    Nonperforming Loans as of                 Dollar change From
(in thousands)              March 31,     December 31,     March 31,      December 31,      March 31,
                               2014           2013            2013            2013            2013
Real estate-construction     $   2,888     $      2,729     $   8,040     $         159     $  (5,152)
Real estate-residential:
Investor                         3,876            6,615         8,524           (2,739)        (4,648)
Owner occupied                   5,901            6,190         8,269             (289)        (2,368)
Revolving and junior
liens                            2,726            3,209         3,776             (483)        (1,050)
Real estate-commercial,
nonfarm                         23,172           21,024        38,588             2,148       (15,416)
Real estate-commercial,
farm                                 -                -         2,417                 -        (2,417)
Commercial                          24               27           210               (3)          (186)
Other                                -                -             -                 -              -
                             $  38,587     $     39,794     $  69,824     $     (1,207)     $ (31,237)

Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due. The only increase of significance in nonperforming loans since


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December 31, 2013 was in the real estate - commercial, nonfarm segment as migration of loans to nonaccrual were in excess of upgrades and migration to OREO. Remediation work continues in all segments. Importantly, new migration to nonaccrual continues to be minimal.

Loan Charge-offs, net of recoveries                Three Months Ended
(in thousands)                          March 31,     December 31,    March 31,
                                           2014           2013           2013
Real estate-construction
Homebuilder                              $    (35)    $           -    $       3
Land                                             1              (1)          (1)
Commercial speculative                           -               62        (767)
All other                                       65                1          (1)
Total real estate-construction                  31               62        (766)
Real estate-residential
Investor                                        92              547        (149)
Owner occupied                                   8             (15)         (19)
Revolving and junior liens                     499              139          349
Total real estate-residential                  599              671          181
Real estate-commercial, nonfarm
Owner general purpose                            -                -         (19)
Owner special purpose                          259              (3)          117
Non-owner general purpose                       18          (1,258)        (317)
Non-owner special purpose                        -                -        (824)
Retail properties                             (89)              296      (1,173)
Total real estate-commercial, nonfarm          188            (965)      (2,216)
Real estate-commercial, farm                     -                -            -
Commercial                                    (11)              (7)          235
Other                                          (2)                5           29
                                         $     805    $       (234)    $ (2,537)

Charge-offs for the first quarter 2014 were, in many instances, from previously established specific reserves on nonaccrual loans deemed uncollectible. Gross charge-offs for the first quarter of 2014 were $1.4 million compared to $1.5 million for the first quarter of 2013 and $1.9 million for the fourth quarter of 2013 reflecting our efforts to improve loan quality in better but still challenging markets. Recoveries were $555,000, $4.1 million and $2.1 million for the same time periods, respectively.

                                                                                   March 31, 2013
                                       Classified loans as of                    Dollar Change From
(in thousands)                March 31,      December 31,     March 31,      December 31,      March 31,
                                2014             2013            2013            2013            2013
Real estate-construction     $      6,430     $      3,024     $  12,656     $       3,406     $  (6,226)
Real estate-residential:
Investor                            7,674            9,750         8,913           (2,076)        (1,239)
Owner occupied                      6,847            7,699        10,463             (852)        (3,616)
Revolving and junior
liens                               3,645            3,971         5,722             (326)        (2,077)
Real estate-commercial,
nonfarm                            27,633           37,297        61,442           (9,664)       (33,809)
Real estate-commercial,
farm                                    -                -         2,417                 -        (2,417)
Commercial                            455              481           747              (26)          (292)
Other                                   -                1             1               (1)            (1)
                             $     52,684     $     62,223     $ 102,361     $     (9,539)     $ (49,677)

Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral pledged to secure the loan, if any. These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and carry the distinct possibility that the Company will sustain some loss if deficiencies remain uncorrected.


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Classified assets include both classified loans and OREO. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the allowance for loan and lease loss reserve as another measure of overall change in loan related asset quality. With the decline in both classified loans and OREO in the first quarter, this ratio improved to 38.44% at March 31, 2014, down from 43.44% at December 31, 2013.

Allowance for Loan and Lease Losses



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



                                                            Three Months Ending
                                                March 31,      December 31,      March 31,
                                                   2014            2013             2013
Allowance at beginning of quarter               $    27,281     $     29,547     $    38,597
Charge-offs:
Commercial                                                4                8             254
Real estate - commercial                                329              608             508
Real estate - construction                               68               63               4
Real estate - residential                               849            1,100             585
Consumer and other loans                                110              123             172
Total charge-offs                                     1,360            1,902           1,523
Recoveries:
Commercial                                               15               15              19
Real estate - commercial                                141            1,573           2,724
Real estate - construction                               37                1             770
Real estate - residential                               250              429             404
Consumer and other loans                                112              118             143
Total recoveries                                        555            2,136           4,060
Net charge-offs (recoveries)                            805            (234)         (2,537)
Loan loss reserve release                           (1,000)          (2,500)         (2,500)
Allowance at end of period                      $    25,476     $     27,281     $    38,634

Average total loans (exclusive of loans
held-for-sale)                                  $ 1,104,065     $  1,072,320     $ 1,138,579
Net charge-offs to average loans                      0.07%           -0.02%          -0.22%
Allowance at period end to average loans              2.31%            2.54%           3.39%

Ending balance: Individually evaluated for
impairment                                      $     1,247     $      2,395     $     5,038
Ending balance: Collectively evaluated for
impairment                                      $    24,229     $     24,886     $    33,596

The coverage ratio of the allowance for loan losses to nonperforming loans was 66.0% as of March 31, 2014, which reflects a slight decrease from 68.6% as of December 31, 2013. Management updated the estimated specific allocations in the first quarter after receiving more recent appraisals for detailed collateral valuations or information on cash flow trends related to the impaired credits. This update resulted in a lower amount required in the reserve for estimable losses on these credits at the end of the first quarter 2014 compared to year end 2013. The estimated general allocation was essentially unchanged from December 31, 2013, as the overall credit condition of our loan portfolio adjusted for environmental factors remained relatively stable during the quarter. The third component of the Company's loan loss reserve analysis showed lower required reserves, most notably in the pooled commercial real estate category. Management determined that the dollar amount of loans in this component was markedly lower at period end first quarter 2014 compared to year end 2013. In summary, after careful and detailed review, management determined an appropriate amount to release from the allowance for loan losses. Factors considered include loan growth or contraction, the quality and composition of the loan portfolio and loan loss experience.

The above changes in estimates were made by management to be consistent with observable trends within loan portfolio segments and in conjunction with market conditions and credit review administration activities. Management also reviewed and evaluated several environmental factors. These


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factors are evaluated on an ongoing basis and are included in the assessment of the adequacy of the allowance for loan losses.

After a review of the adequacy of the loan loss reserve at March 31, 2014, management concluded that a $1.0 million reserve release was justified. When measured as a percentage of loans outstanding, the total allowance for loan losses decreased slightly from 2.5% of total loans as of December 31, 2013 to 2.3% of total loans at March 31, 2014. In management's judgment, an adequate, measured and entirely appropriate allowance for estimated losses has been established for inherent losses at March 31, 2014; however, there can be no assurance that actual losses will not exceed the estimated amounts in the future.

Other Real Estate Owned

OREO decreased modestly by $1.3 million from $41.5 million at December 31, 2013, to $40.2 million at March 31, 2014. Disposition activity and valuation writedowns in the first quarter exceeded additions to OREO as shown below. As a result, holdings in lots suitable for development and commercial property decreased in the quarter. The dollar value of vacant land was unchanged at end of the first quarter. Overall, a net gain on sale of $386,000 was realized in the first quarter. Lower total OREO (down from $65.7 million at March 31, 2013) has resulted in reduced expenses to carry and operate remaining properties.

                                         Three Months Ended
(in thousands)                 March 31,    December 31,    March 31,
. . .
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