Table of Contents
I
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period from to
Commission File Number 0 -10537
(Exact name of Registrant as specified in its charter)
Delaware
36-3143493
(State or other jurisdiction
(I.R.S. Employer Identification Number)
of incorporation or organization)
37 South River Street, Aurora, Illinois 60507
(Address of principal executive offices) (Zip Code)
(630) 892-0202
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of ‘‘large accelerated filer,’’ ‘‘accelerated filer,’’ ‘‘smaller reporting company,’’ and ‘‘emerging growth company’’ in Rule 12b–2 of the Exchange Act.
Large accelerated filer☐Accelerated filer☒
Non-accelerated filer☐Smaller reporting company☐Emerging growth company☐
(Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes ☐ No ☒
As of August 4, 2017, the Registrant had 29,627,086 shares of common stock outstanding at $1.00 par value per share.
OLD SECOND BANCORP, INC.
Form 10-Q Quarterly Report
PART I
Page Number
Item 1.
Financial Statements
3
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
32
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
44
Item 4.
Controls and Procedures
45
PART II
Legal Proceedings
Item 1.A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosure
Item 5.
Other Information
46
Item 6.
Exhibits
Signatures
47
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)
June 30,
December 31,
2017
2016
Assets
Cash and due from banks
$
32,614
33,805
Interest bearing deposits with financial institutions
18,483
13,529
Cash and cash equivalents
51,097
47,334
Securities available-for-sale, at fair value
568,227
531,838
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock
8,593
7,918
Loans held-for-sale
5,440
4,918
Loans
1,539,647
1,478,809
Less: allowance for loan losses
15,836
16,158
Net loans
1,523,811
1,462,651
Premises and equipment, net
38,061
38,977
Other real estate owned
11,724
11,916
Mortgage servicing rights, net
6,528
6,489
Goodwill and core deposit intangible
8,968
9,018
Bank-owned life insurance ("BOLI")
61,041
60,332
Deferred tax assets, net
45,356
53,464
Other assets
14,595
16,333
Total assets
2,343,441
2,251,188
Liabilities
Deposits:
Noninterest bearing demand
546,463
513,688
Interest bearing:
Savings, NOW, and money market
971,715
950,849
Time
391,967
402,248
Total deposits
1,910,145
1,866,785
Securities sold under repurchase agreements
36,361
25,715
Other short-term borrowings
75,000
70,000
Junior subordinated debentures
57,615
57,591
Senior notes
44,008
43,998
Other liabilities
29,182
11,889
Total liabilities
2,152,311
2,075,978
Stockholders’ Equity
Common stock
34,626
34,534
Additional paid-in capital
117,186
116,653
Retained earnings
138,442
129,005
Accumulated other comprehensive loss
(2,668)
(8,762)
Treasury stock
(96,456)
(96,220)
Total stockholders’ equity
191,130
175,210
Total liabilities and stockholders’ equity
June 30, 2017
December 31, 2016
Common
Stock
Par value
1.00
Shares authorized
60,000,000
Shares issued
34,625,734
34,534,234
Shares outstanding
29,627,086
29,556,216
Treasury shares
4,998,648
4,978,018
See accompanying notes to consolidated financial statements.
Consolidated Statements of Income
(In thousands, except per share data)
Quarters Ended June 30,
Six Months Ended June 30,
Interest and dividend income
Loans, including fees
17,385
13,039
33,994
26,097
37
39
61
67
Securities:
Taxable
2,607
4,382
5,570
Tax exempt
1,975
220
3,040
399
Dividends from FHLBC and FRBC stock
92
84
177
168
31
15
54
34
Total interest and dividend income
22,127
17,779
42,896
35,358
Interest expense
Savings, NOW, and money market deposits
233
193
456
384
Time deposits
1,025
869
2,004
1,691
150
26
258
1,059
1,083
2,143
2,167
672
-
1,345
Subordinated debt
243
482
Notes payable and other borrowings
4
Total interest expense
3,139
2,416
6,206
4,774
Net interest and dividend income
18,988
15,363
36,690
30,584
Provision for loan losses
750
Net interest and dividend income after provision for loan losses
18,238
35,940
Noninterest income
Trust income
1,638
1,502
3,096
2,871
Service charges on deposits
1,615
1,646
3,233
3,205
Secondary mortgage fees
223
280
473
Mortgage servicing rights mark to market loss
(429)
(733)
(562)
(1,774)
Mortgage servicing income
444
422
879
843
Net gain on sales of mortgage loans
1,473
1,642
2,620
2,854
Securities loss, net
(131)
(267)
(61)
Increase in cash surrender value of BOLI
350
319
709
604
Debit card interchange income
1,081
1,049
2,056
1,996
Gain (loss) on disposal and transfer of fixed assets, net
12
10
(1)
Other income
1,041
1,150
2,172
2,542
Total noninterest income
7,317
7,277
14,345
13,552
Noninterest expense
Salaries and employee benefits
10,545
8,814
21,118
17,840
Occupancy, furniture and equipment
1,462
1,346
3,028
2,927
Computer and data processing
1,112
1,063
2,202
1,988
FDIC insurance
165
362
313
565
General bank insurance
264
272
534
570
Amortization of core deposit intangible
25
50
Advertising expense
452
435
838
782
Debit card interchange expense
620
748
823
Legal fees
184
191
288
352
Other real estate expense, net
539
1,248
1,617
Other expense
2,839
2,718
5,673
5,500
Total noninterest expense
17,986
16,700
36,040
32,964
Income before income taxes
7,569
5,940
14,245
11,172
Provision for income taxes
2,112
2,095
4,216
4,005
Net income
5,457
3,845
10,029
7,167
Basic earnings per share
0.19
0.13
0.34
0.24
Diluted earnings per share
0.18
0.33
Consolidated Statements of Comprehensive Income
(In thousands)
Net Income
Unrealized holding gains on available-for-sale securities arising during the period
6,269
8,076
10,347
5,767
Related tax expense
(2,520)
(3,233)
(4,134)
(2,308)
Holding gains after tax on available-for-sale securities
3,749
4,843
6,213
3,459
Less: Reclassification adjustment for the net (losses) gains realized during the period
Net realized losses
Income tax benefit on net realized losses
52
106
Net realized losses after tax
(79)
(161)
(36)
Other comprehensive income on available-for-sale securities
3,828
6,374
3,495
Accretion and reversal of net unrealized holding gains on held-to-maturity securities
5,715
5,939
(2,354)
(2,446)
Other comprehensive income on held-to-maturity securities
3,361
3,493
Changes in fair value of derivatives used for cashflow hedges
(613)
(1,597)
(464)
(4,024)
Related tax benefit
245
640
1,612
Other comprehensive loss on cashflow hedges
(368)
(957)
(280)
(2,412)
Total other comprehensive income
3,460
7,247
6,094
4,576
Total comprehensive income
8,917
11,092
16,123
11,743
5
Consolidated Statements of Cash Flows
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation of fixed assets and amortization of leasehold improvements
1,193
1,097
Change in fair value of mortgage servicing rights
562
1,774
Loan loss reserve
Provision for deferred tax expense
4,052
3,717
Originations of loans held-for-sale
(75,079)
(83,698)
Proceeds from sales of loans held-for-sale
76,649
83,324
(2,620)
(2,854)
Net discount accretion of purchase accounting adjustment on loans
(850)
Change in current income taxes (payable) receivable
(66)
259
(709)
(604)
Change in accrued interest receivable and other assets
1,665
(3,152)
Change in accrued interest payable and other liabilities
16,895
(185)
Net premium amortization/discount (accretion) on securities
293
(385)
Securities losses, net
267
Amortization of core deposit
Amortization of junior subordinated debentures issuance costs
24
Amortization of senior notes issuance costs
Stock based compensation
625
325
Net gain on sale of other real estate owned
(178)
(67)
Provision for other real estate owned losses
710
940
Net (gain) loss on disposal of fixed assets
(11)
1
Loss on transfer of premises to other real estate owned
Net cash provided by operating activities
34,304
7,744
Cash flows from investing activities
Proceeds from maturities and calls including pay down of securities available-for-sale
78,564
25,687
Proceeds from sales of securities available-for-sale
100,856
44,993
Purchases of securities available-for-sale
(205,755)
(122,700)
Proceeds from maturities and calls including pay down of securities held-to-maturity
3,372
Net proceeds from (purchases) sales of FHLBC stock
(675)
600
Net change in loans
(64,585)
(28,805)
Improvements in other real estate owned
(12)
Proceeds from sales of other real estate owned
3,280
2,996
Proceeds from disposition of premises and equipment
13
Net purchases of premises and equipment
(375)
(439)
Net cash used in investing activities
(88,677)
(74,308)
Cash flows from financing activities
Net change in deposits
43,360
23,039
Net change in securities sold under repurchase agreements
10,646
9,068
Net change in other short-term borrowings
5,000
35,000
Payment of senior note issuance costs
(42)
Dividends paid on common stock
(592)
(296)
Purchase of treasury stock
(236)
(254)
Net cash provided by financing activities
58,136
66,557
Net change in cash and cash equivalents
3,763
(7)
Cash and cash equivalents at beginning of period
40,338
Cash and cash equivalents at end of period
40,331
6
Consolidated Statements of Cash Flows - Continued
Supplemental cash flow information
Income taxes paid, net
230
100
Interest paid for deposits
2,448
2,053
Interest paid for borrowings
3,787
2,665
Non-cash transfer of loans to other real estate owned
3,525
968
Non-cash transfer of premises to other real estate owned
95
Non-cash transfer of securities held-to-maturity to securities available-for-sale
244,823
7
Consolidated Statements of Changes in
Accumulated
Additional
Other
Total
Paid-In
Retained
Comprehensive
Treasury
Stockholders’
Capital
Earnings
Loss
Equity
Balance, December 31, 2015
34,427
115,918
114,209
(12,659)
(95,966)
155,929
Other comprehensive gain, net of tax
Dividends declared and paid
Vesting of restricted stock
(106)
Tax effect from vesting of restricted stock
174
Balance, June 30, 2016
34,533
116,311
121,080
(8,083)
167,621
Balance, December 31, 2016
(92)
Balance, June 30, 2017
8
Notes to Consolidated Financial Statements
(Table amounts in thousands, except per share data, unaudited)
Note 1 – Summary of Significant Accounting Policies
The accounting policies followed in the preparation of the interim consolidated financial statements are consistent with those used in the preparation of the annual financial information. The interim consolidated financial statements reflect all normal and recurring adjustments that are necessary, in the opinion of management, for a fair statement of results for the interim period presented. Results for the period ended June 30, 2017, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. These interim consolidated financial statements are unaudited and should be read in conjunction with the audited financial statements and notes included in Old Second Bancorp, Inc.’s (the “Company”) annual report on Form 10-K for the year ended December 31, 2016. Unless otherwise indicated, amounts in the tables contained in the notes to the consolidated financial statements are in thousands. Certain items in prior periods have been reclassified to conform to the current presentation.
The Company’s consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (“GAAP”) and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the consolidated financial statements. Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts reported in the consolidated financial statements.
All significant accounting policies are presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09 "Revenue from Contracts with Customers (Topic 606)." The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In August 2015, the FASB issued ASU 2015-14 “Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date.” This accounting standards update defers the effective date of ASU 2014-09 for an additional year. ASU 2015-14 will be effective for annual reporting periods beginning after December 15, 2017. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this update recognized at the date of initial application. Early application is not permitted. In March 2016, the FASB issued ASU 2016-08 “Revenue from Contracts with Customers (TOPIC 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” and in April 2016, the FASB issued ASU 2016-10 “Revenue from Contracts with Customers (TOPIC 606): Identifying Performance Obligations and Licensing.” ASU 2016-08 requires the entity to determine if it is acting as a principal with control over the goods or services it is contractually obligated to provide, or an agent with no control over specified goods or services provided by another party to a customer. ASU 2016-10 was issued to further clarify ASU 2014-09 implementation regarding identifying performance obligation materiality, identification of key contract components, and scope. The Company is assessing the impact of ASU 2014-09 and other related ASUs as noted above on its accounting and disclosures within noninterest income, as any interest income impact was not included in the scope of this final ASU pronouncement. Adoption of this ASU is expected to affect the methodology used to record certain recurring revenue streams within trust and asset management fees, but this impact is not anticipated to be significant to the Company’s financial statements. The Company will adopt ASU 2015-14 and related issuances on January 1, 2018, with a cumulative effect adjustment to opening retained earnings, if an adjustment is deemed to be material.
In February 2016, the FASB issued ASU No. 2016-02- “Leases (Topic 842).” This ASU was issued to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. One key revision from prior guidance was to include operating leases within assets and liabilities recorded; another revision was included which created a new model to follow for sale-leaseback transactions. The impact of this pronouncement will affect lessees primarily, as virtually all of their assets will be recognized on the balance sheet, by recording a right of use asset and lease liability. This pronouncement is effective for fiscal years beginning after December 15, 2018. The Company is assessing the impact of ASU 2016-02 on its accounting and disclosures.
In March 2016, the FASB issued ASU No. 2016-09 “Stock Compensation - Improvements to Employee Share-Based Payment Accounting (Topic 718).” FASB issued this ASU as part of the Simplification Initiative. This ASU involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or
9
liability, and classification on the statement of cash flows. ASU 2016-09 is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. This standard was adopted by the Company effective January 2017; the adoption of this standard did not have a material effect on the Company’s operating results or financial condition.
In June 2016, the FASB issued ASU No. 2016-13 “Measurement of Credit Losses on Financial Instruments (Topic 326).” ASU 2016-13 was issued to provide financial statement users with more useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date to enhance the decision making process. The new methodology to be used should reflect expected credit losses based on relevant vintage historical information, supported by reasonable forecasts of projected loss given defaults, which will affect the collectability of the reported amounts. This new methodology will also require available-for-sale debt securities to have a credit loss recorded through an allowance rather than write-downs. ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019. The Company is assessing the impact of ASU 2016-13 on its accounting and disclosures, and is in the process of accumulating data and evaluating model options to support future risk assessments.
In March 2017, the FASB issued ASU No. 2017-08 “Receivables-Nonrefundable Fees and Other Costs – Premium Amortization on Purchased Callable Debt Securities (Subtopic 310-20).” This ASU was issued to shorten the amortization period for the premium to the earliest call date on debt securities. This premium will now be recorded as a reduction to net interest margin during the shorter yield to call period, as compared to prior practice of amortizing the premium as a reduction to net interest margin over the contractual life of the instrument. This ASU does not change the current method of amortizing any discount over the contractual life of the debt security, and this pronouncement is effective for fiscal years beginning after December 15, 2018, with earlier adoption permitted. The Company is assessing the impact of ASU 2017-08 on its accounting and disclosures, as this pronouncement will reduce net interest income over the period until the security’s call date, as compared to a net interest income reduction for all remaining premium as of the date of call if earlier than the date of maturity. As the Company has a significant unamortized premium on tax exempt debt securities, management has determined that early adoption will be implemented under a modified retrospective basis. Adoption of ASU 2017-08 is expected to reduce the net interest margin by approximately 10 basis points a quarter going forward as the premium amortization recorded will increase over current levels.
Subsequent Events
On July 18, 2017, the Company’s Board of Directors declared a cash dividend of $0.01 per share payable on August 7, 2017, to stockholders of record as of July 28, 2017; dividends of $296,000 were paid to stockholders on August 7, 2017.
Note 2 – Acquisitions
On October 28, 2016, the Bank acquired the Chicago branch of Talmer Bank and Trust, the banking subsidiary of Talmer Bancorp, Inc. (“Talmer”). As a result of this transaction, the Bank recorded assets with a fair value of approximately $230.9 million, including approximately $221.0 million of loans, and assumed deposits with a fair value of approximately $48.9 million. Goodwill of $8.4 million was included within the total assets recorded upon acquisition; net cash of $181.5 million was paid for the purchase.
Note 3 – Securities
Investment Portfolio Management
Our investment portfolio serves the liquidity needs and income objectives of the Company. While the portfolio serves as an important component of the overall liquidity management at the Bank, portions of the portfolio also serve as income producing assets. The size and composition of the portfolio reflects liquidity needs, loan demand and interest income objectives. Portfolio size and composition will be adjusted from time to time. While a significant portion of the portfolio consists of readily marketable securities to address liquidity, other parts of the portfolio may reflect funds invested pending future loan demand or to maximize interest income without undue interest rate risk.
Investments are comprised of debt securities and non-marketable equity investments. Securities available-for-sale are carried at fair value. Unrealized gains and losses, net of tax, on securities available-for-sale are reported as a separate component of equity. This balance sheet component changes as interest rates and market conditions change. Unrealized gains and losses are not included in the calculation of regulatory capital.
FHLBC and FRBC stock are considered nonmarketable equity investments. FHLBC stock was recorded at $3.8 million at June 30, 2017, and $3.1 million at December 31, 2016, and is necessary to maintain access to FHLBC advances, which are utilized as a component to meet the Bank’s daily funding needs. FRBC stock was recorded at $4.8 million at June 30, 2017, and December 31, 2016.
The following table summarizes the amortized cost and fair value of the securities portfolio at June 30, 2017, and December 31, 2016, and the corresponding amounts of gross unrealized gains and losses:
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Securities available-for-sale
U.S. government agencies mortgage-backed
21,039
(199)
20,846
States and political subdivisions
222,098
4,472
(1,052)
225,518
Corporate bonds
12,807
58
(249)
12,616
Collateralized mortgage obligations
102,717
159
(1,963)
100,913
Asset-backed securities
144,812
557
(4,984)
140,385
Collateralized loan obligations
67,735
305
(91)
67,949
Total securities available-for-sale
571,208
5,557
(8,538)
42,511
(977)
41,534
68,718
(273)
68,703
10,957
(336)
10,630
174,352
374
(3,799)
170,927
146,391
341
(8,325)
138,407
102,504
29
(896)
101,637
545,433
1,011
(14,606)
The fair value, amortized cost and weighted average yield of debt securities at June 30, 2017, by contractual maturity, were as follows in the table below. Securities not due at a single maturity date are shown separately.
Weighted
Average
Yield
Due in one year or less
11,600
2.60
%
11,636
Due after one year through five years
1,847
4.65
1,844
Due after five years through ten years
18,178
2.88
18,202
Due after ten years
203,280
3.01
206,452
234,905
2.99
238,134
Mortgage-backed and collateralized mortgage obligations
123,756
2.54
121,759
2.21
4.01
2.82
At June 30, 2017, the Company’s investments include $119.3 million of asset-backed securities that are backed by student loans originated under the Federal Family Education Loan program (“FFEL”). Under the FFEL, private lenders made federally guaranteed student loans to parents and students and packaged and sold them as asset-backed securities. While the program was modified several times before elimination in 2010, not less than 97% of the outstanding principal amount of the loans made under FFEL are guaranteed by the U.S. Department of Education. In addition to the U.S. Department of Education guarantee, total added credit enhancement in the form of overcollateralization and/or subordination amounted to $13.4 million, or 10.43%, of outstanding principal.
The Company has invested in securities issued from one originator that individually amounts to over 10% of the Company’s stockholders equity. As of June 30, 2017, GCO Education Loan Funding Corp’s amortized cost was $27.5 million and fair value was $26.0 million within the Company’s portfolio.
11
Securities with unrealized losses at June 30, 2017, and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands except for number of securities):
Less than 12 months
12 months or more
in an unrealized loss position
Number of
Securities
178
17,764
21
805
199
18,569
1,052
16,372
108
4,892
141
5,205
249
10,097
1,776
64,987
187
10,898
14
1,963
75,885
274
4,281
4,710
106,755
4,984
111,036
91
7,905
3,479
116,201
19
5,059
123,663
8,538
239,864
957
40,636
20
898
977
273
35,241
183
4,817
153
5,328
336
10,145
16
3,402
117,752
397
18,109
23
3,799
135,861
328
17,604
7,997
107,112
8,325
124,716
896
81,613
5,143
216,050
9,463
213,060
78
14,606
429,110
Recognition of other-than-temporary impairment was not necessary in the three and six months ended June 30, 2017, June 30, 2016, or the year ended December 31, 2016. The changes in fair value related primarily to interest rate fluctuations. Our review of other-than-temporary impairment determined that there was no credit quality deterioration.
Note 4 – Loans
Major classifications of loans were as follows:
Commercial
256,760
228,113
Real estate - commercial
706,103
736,247
Real estate - construction
93,661
64,720
Real estate - residential
398,170
377,851
Consumer
2,878
3,237
Overdraft
316
436
Lease financing receivables
70,138
55,451
10,943
11,537
1,538,969
1,477,592
Net deferred loan costs
678
1,217
Total loans
It is the policy of the Company to review each prospective credit prior to making a loan in order to determine if an adequate level of security or collateral has been obtained. The type of collateral, when required, will vary from liquid assets to real estate. The Company’s access to collateral, in the event of borrower default, is assured through adherence to lending laws, the Company’s lending standards and credit monitoring procedures. With selected exceptions, the Bank makes loans solely within its market area. There are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single economic sector, although the real estate related categories listed above represent 77.8% and 79.7% of the portfolio at June 30, 2017, and December 31, 2016, respectively.
Aged analysis of past due loans by class of loans was as follows:
Recorded
Investment
90 days or
90 Days or
Greater Past
30-59 Days
60-89 Days
Total Past
Due and
Past Due
Due
Current
Nonaccrual
Total Loans
Accruing
256,523
216
Leases
68,780
460
Owner occupied general purpose
629
139,964
141,053
Owner occupied special purpose
170,186
366
170,552
Non-owner occupied general purpose
835
215,423
1,085
217,343
Non-owner occupied special purpose
116,218
Retail properties
44,781
1,144
45,925
Farm
1,305
13,707
15,012
Homebuilder
1,947
Land
2,870
Commercial speculative
31,268
68
31,336
All other
57,356
152
57,508
Investor
98
59,113
686
59,897
Multifamily
1,390
92,896
4,824
99,110
Owner occupied
279
119,355
4,187
123,821
Revolving and junior liens
74
631
113,685
1,026
115,342
2,867
Other1
11,937
5,640
448
6,088
1,518,876
14,683
57
131
227,742
240
286
54,799
758
135,599
137,236
177,755
385
178,140
667
379
1,046
229,315
1,930
232,291
118,052
1,013
119,065
53,474
1,179
54,653
1,353
13,509
14,862
3,883
3,029
22,654
22,728
364
34,509
207
35,080
237
54,924
936
56,097
96,502
116,900
6,452
123,626
225
405
630
99,374
1,622
101,626
36
3,191
13,176
13,190
3,959
1,180
5,139
1,458,387
15,283
1 The “Other” class includes overdrafts and net deferred costs.
Credit Quality Indicators
The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparison against industry averages, historical payment experience, and current economic trends. This analysis includes loans with outstanding balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and residential mortgages. Loans with a classified risk rating are reviewed quarterly regardless of size or loan type. The Company uses the following definitions for classified risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Credits that are not covered by the definitions above are pass credits, which are not considered to be adversely rated.
Credit Quality Indicators by class of loans were as follows:
Special
Pass
Mention
Substandard 1
Doubtful
238,814
17,691
255
136,655
3,174
1,224
165,945
4,241
215,604
654
112,543
3,675
Retail Properties
43,535
1,246
12,494
1,213
31,267
69
56,286
894
59,054
94,286
118,320
566
4,935
113,379
2,869
1,486,585
30,577
22,485
214,028
11,558
2,527
53,366
976
1,109
135,503
53
1,680
172,353
5,402
229,448
913
114,293
4,772
52,207
1,267
11,840
1,240
1,782
34,696
55,001
1,096
115,831
7,225
99,286
2,340
3,236
13,165
1,430,321
22,004
26,484
1 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.
The Company had $991,000 and $1.8 million residential assets in the process of foreclosure as of June 30, 2017, and December 31, 2016, respectively. The Company also had $986,000 and $225,000 in residential real estate included in OREO as of June 30, 2017, and December 31, 2016, respectively.
Impaired loans, which include nonaccrual loans and troubled debt restructurings, by class of loans for the June 30, 2017 periods listed were as follows:
Six Months Ended
As of June 30, 2017
Unpaid
Interest
Principal
Related
Income
Balance
Allowance
Recognized
With no related allowance recorded
368
128
Commercial real estate
495
1,170
510
376
1,143
1,425
1,443
507
1,209
1,161
Construction
79
72
156
180
Residential
1,576
2,065
1,708
4,965
2,412
8,209
9,543
9,016
65
1,971
2,211
2,227
105
Total impaired loans with no recorded allowance
20,358
23,280
20,798
101
With an allowance recorded
120
123
402
Total impaired loans with a recorded allowance
645
Total impaired loans
20,598
23,520
21,443
Impaired loans by class of loans as of December 31, 2016, and for the six months ended June 30, 2016, were as follows:
As of December 31, 2016
June 30, 2016
388
299
371
1,881
2,131
2,494
518
650
1,744
2,010
1,573
1,649
1,235
1,017
636
81
80
221
1,841
2,308
1,879
9,824
11,391
10,124
2,484
3,018
2,673
21,238
25,321
21,425
246
595
306
825
803
853
222
1,448
1,377
22,287
26,769
22,802
Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist: (1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-by-case basis during the loan collection process with modifications generally initiated at the request of the borrower. These modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an opportunity to refinance into more affordable monthly payments.
17
The specific allocation of the allowance for loan losses for all loans, including TDRs, is determined by either discounting the modified cash flows at the original effective rate of the loan before modification or is based on the underlying collateral value less costs to sell, if repayment of the loan is collateral-dependent. If the resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance (i.e., specific reserve) as a component of the allowance for loan losses or charges off the impaired balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. The allowance for loan losses also includes an allowance based on a loss migration analysis for each loan category on loans that are not individually evaluated for specific impairment. All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.
TDRs that were modified during the period are as follows:
TDR Modifications
Quarter Ended June 30, 2017
Six Months Ended June 30, 2017
# of
Pre-modification
Post-modification
contracts
recorded investment
Troubled debt restructurings
155
147
Quarter Ended June 30, 2016
Six Months Ended June 30, 2016
312
HAMP2
239
469
438
1,020
895
1 Other: Change of terms from bankruptcy court
2 HAMP: Home Affordable Modification Program
TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. There was no TDR default activity for the six months ended June 30, 2017, and June 30, 2016, for loans that were restructured within the 12 month period prior to default.
18
Note 5 – Allowance for Loan Losses
Changes in the allowance for loan losses by segment of loans based on method of impairment for three and six months ended June 30, 2017, were as follows:
Real Estate
Allowance for loan losses:
Three months ended June 30, 2017
Beginning balance
1,672
603
7,831
978
3,056
764
837
15,741
Charge-offs
1,066
Recoveries
60
411
Provision (Release)
479
188
234
(181)
247
118
(335)
Ending balance
2,150
791
8,107
857
2,576
848
Six months ended June 30, 2017
1,629
633
9,547
389
2,692
833
117
278
1,171
1,757
391
121
685
521
275
(1,243)
394
664
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
693
15,738
Loans:
3,113
16,580
256,544
69,678
702,990
93,441
381,590
1,519,049
Changes in the allowance for loan losses by segment of loans based on method of impairment for June 30, 2016, were as follows:
Three months ended June 30, 2016
2,173
8,793
250
1,664
2,101
16,246
690
171
145
290
56
512
(753)
706
124
(208)
(1,110)
1,420
8,954
380
2,933
862
998
15,822
Six months ended June 30, 2016
2,041
55
9,013
265
1,694
1,190
1,965
16,223
692
437
1,311
228
519
127
910
(614)
104
1,157
(305)
(980)
752
8,202
15,064
127,709
42,013
600,942
22,204
352,595
2,966
12,722
1,161,151
528
9,604
14,508
24,718
127,181
591,338
22,126
338,087
1,136,433
Note 6 – Other Real Estate Owned
Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation reserve, for the periods presented are itemized in the following table:
Quarters Ended
Balance at beginning of period
13,481
17,745
19,141
Property additions
204
586
3,620
Property improvements
Less:
Proceeds from property disposals, net of gains/losses
1,569
1,590
3,102
2,929
Period valuation adjustments
392
489
Balance at end of period
16,252
Activity in the valuation allowance was as follows:
9,659
14,399
9,982
14,127
Provision for unrealized losses
Reductions taken on sales
(1,747)
(1,511)
(2,388)
(1,690)
8,304
13,377
Expenses related to OREO, net of lease revenue includes:
Gain on sales, net
(104)
(25)
Operating expenses
420
816
856
Lease revenue
42
112
Net OREO expense
Note 7 – Deposits
Major classifications of deposits were as follows:
Savings
265,643
256,159
NOW accounts
429,205
419,417
Money market accounts
276,867
275,273
Certificates of deposit of less than $100,000
221,806
228,993
Certificates of deposit of $100,000 through $250,000
115,279
110,992
Certificates of deposit of more than $250,000
54,882
62,263
Note 8 – Borrowings
The following table is a summary of borrowings as of June 30, 2017, and December 31, 2016. Junior subordinated debentures are discussed in detail in Note 9:
FHLBC advances1
Total borrowings
212,984
197,304
1 Included in other short-term borrowings on the balance sheet.
The Company enters into deposit sweep transactions where the transaction amounts are secured by pledged securities. These transactions consistently mature overnight from the transaction date and are governed by sweep repurchase agreements. All sweep repurchase agreements are treated as financings secured by U.S. government agencies and collateralized mortgage-backed securities and had a carrying amount of $36.4 million at June 30, 2017, and $25.7 million at December 31, 2016. The fair value of the pledged collateral was $44.4 million at June 30, 2017 and $43.0 million at December 31, 2016. At June 30, 2017, there were no customers with secured balances exceeding 10% of stockholders’ equity.
The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC. Total borrowings are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans. As of June 30, 2017, the Bank had $75.0 million advances outstanding under the FHLBC as compared to $70.0 million outstanding as of December 31, 2016. As of June 30, 2017, FHLBC stock held was valued at $3.8 million, and any potential FHLBC advances were collateralized by securities with a fair value of $100.0 million and loans with a principal balance of $176.7 million, which carried a FHLBC calculated combined collateral value of $205.6 million. The Company had excess collateral of $94.3 million available to secure borrowings at June 30, 2017.
The Company completed a debt retirement and simultaneous senior debt offering in the fourth quarter of 2016. Subordinated debt of $45.0 million and $500,000 of senior debt outstanding were paid off with the proceeds of a $45.0 million senior notes issuance and cash on hand. The senior notes mature in ten years, and terms include interest payable semiannually at 5.75% for five years. Beginning December 2021, the senior debt will pay interest at a floating rate, with interest payable quarterly at three month LIBOR plus 385 basis points. The notes are redeemable, in whole or in part, at the option of the Company, beginning with the interest payment date on December 31, 2021, and on any floating rate interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest. Debt issuance costs incurred for the senior note issuance totaled $1.0 million, and are being deferred and recorded to expense over the ten year term of the notes.
Note 9 – Junior Subordinated Debentures
The Company completed the sale of $27.5 million of cumulative trust preferred securities by its unconsolidated subsidiary, Old Second Capital Trust I, in June 2003. An additional $4.1 million of cumulative trust preferred securities were sold in July 2003. The trust preferred securities may remain outstanding for a 30-year term but, subject to regulatory approval, can be called in whole or in part by the Company after June 30, 2008. When not in deferral, distributions on the securities are payable quarterly at an annual rate of 7.80%. The Company issued a new $32.6 million subordinated debenture to Old Second Capital Trust I in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.
The Company issued an additional $25.0 million of cumulative trust preferred securities through a private placement completed by an additional, unconsolidated subsidiary, Old Second Capital Trust II, in April 2007. These trust preferred securities also mature in 30 years, but subject to the aforementioned regulatory approval, can be called in whole or in part on a quarterly basis commencing June 15, 2017. The quarterly cash distributions on the securities were fixed at 6.77% through June 15, 2017, and float at 150 basis points over three-month LIBOR thereafter. The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points on June 15, 2017. Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 4.34%, as compared to the rate paid prior to June 15, 2017 of 6.77%. The Company issued a new $25.8 million subordinated debenture to Old Second Capital Trust II in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities. Both of the debentures issued by the Company are disclosed on the Consolidated Balance Sheet as junior subordinated debentures and the related interest expense for each issuance is included in the Consolidated Statements of Income.
Note 10 – Equity Compensation Plans
Stock-based awards are outstanding under the Company’s 2008 Equity Incentive Plan (the “2008 Plan”) and the Company’s 2014 Equity Incentive Plan (the “2014 Plan,” and together with the 2008 Plan, the “Plans”). The 2014 Plan was approved at the 2014 annual meeting of stockholders; a maximum of 375,000 shares were authorized to be issued under this plan. Following approval of the 2014 Plan, no further awards will be granted under the 2008 Plan or any other Company equity compensation plan. At the May 2016 annual stockholders meeting, an amendment to the 2014 Plan authorized an additional 600,000 shares to be issued, which resulted in a total of 975,000 shares authorized for issuance under this plan. The 2014 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights. Awards may be granted to selected directors and officers or employees under the 2014 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors. As of June 30, 2017, 443,209 shares remained available for issuance under the 2014 Plan.
There were no stock options granted or exercised in the second quarter of 2017 and 2016. All stock options are granted for a term of ten years. There is no unrecognized compensation cost related to unvested stock options as all stock options of the Company’s common stock have fully vested.
A summary of stock option activity in the Plans for the six months ended June 30, 2017, is as follows:
Weighted-
Remaining
Exercise
Contractual
Aggregate
Shares
Price
Term (years)
Intrinsic Value
Beginning outstanding
94,500
25.82
Canceled
Expired
Exercised
Ending outstanding
0.6
Exercisable at end of period
Generally, restricted stock and restricted stock units granted under the Plans vest three years from the grant date, but the Compensation Committee of the Company’s Board of Directors has discretionary authority to change some terms including the amount of time until the vest date.
Awards under the 2008 Plan will become fully vested upon a merger or change in control of the Company. Under the 2014 Plan, upon a change in control of the Company, if (i) the 2014 Plan is not an obligation of the successor entity following the change in control, or (ii) the 2014 Plan is an obligation of the successor entity following the change in control and the participant incurs an involuntary termination, then the stock options, stock appreciation rights, stock awards and cash incentive awards under the 2014 Plan will become fully exercisable and vested. Performance-based awards generally will vest based upon the level of achievement of the applicable performance measures through the change in control.
The Company granted restricted stock under its equity compensation plans beginning in 2005 and it began granting restricted stock units in February 2009. Restricted stock awards under the Plans generally entitle holders to voting and dividend rights upon grant and are subject to forfeiture until certain restrictions have lapsed including employment for a specific period. Restricted stock units under the Plans are also subject to forfeiture until certain restrictions have lapsed including employment for a specific period, but do not entitle holders to voting rights until the restricted period ends and shares are transferred in connection with the units.
There were 158,500 restricted awards issued under the 2014 Plan during the six months ended June 30, 2017. There were 120,000 restricted awards issued during the six months ended June 30, 2016. Compensation expense is recognized over the vesting period of the restricted award based on the market value of the award on the issue date. Total compensation cost that has been recorded for the 2014 Plan was $645,000 and $325,000 in the first six months of 2017 and 2016, respectively.
22
A summary of changes in the Company’s unvested restricted awards for the six months ended June 30, 2017, is as follows:
Restricted
Stock Shares
Grant Date
and Units
Fair Value
Nonvested at January 1
409,000
5.89
Granted
158,500
11.02
Vested
(91,500)
5.07
Forfeited
(1,000)
5.38
Nonvested at June 30
475,000
7.76
Total unrecognized compensation cost of restricted awards was $2.3 million as of June 30, 2017, which is expected to be recognized over a weighted-average period of 2.31 years. Total unrecognized compensation cost of restricted awards was $1.2 million as of June 30, 2016, which was expected to be recognized over a weighted-average period of 2.16 years.
Note 11 – Earnings Per Share
The earnings per share – both basic and diluted – are included below as of June 30 (in thousands except for share and per share data):
Basic earnings per share:
Weighted-average common shares outstanding
29,587,095
29,535,915
29,573,881
29,509,672
Diluted earnings per share:
Dilutive effect of nonvested restricted awards1
426,264
305,324
400,232
313,832
Dilutive effect of stock options
2,546
2,431
Diluted average common shares outstanding
30,015,905
29,841,239
29,976,544
29,823,504
Number of antidilutive options and warrants excluded from the diluted earnings per share calculation
900,839
977,839
1 Includes the common stock equivalents for restricted share rights that are dilutive.
The above earnings per share calculation did not include a warrant for 815,339 shares of common stock, at an exercise price of $13.43 per share, that was outstanding as of June 30, 2017, and June 30, 2016, because the warrant was anti-dilutive. Of note, the ten year warrant was issued in 2009, and was sold at auction by the Treasury in June 2013 to a third party investor.
Note 12 – Regulatory & Capital Matters
The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighted Bank assets, developed by the Office of the Comptroller of the Currency (the “OCC”) and the other bank regulatory agencies. In connection with the current economic environment, the Bank’s current level of nonperforming assets and the risk-based capital guidelines, the Bank’s Board of Directors has determined that the Bank should maintain a Tier 1 leverage capital ratio at or above eight percent (8%) and a total risk-based capital ratio at or above twelve percent (12%). At June 30, 2017, the Bank exceeded those thresholds.
At June 30, 2017, the Bank’s Tier 1 capital leverage ratio was 10.23%, a decrease of 1 basis point from December 31, 2016, but well above the 8.00% objective. The Bank’s total capital ratio was 13.30%, a decrease of 15 basis points from December 31, 2016, but also slightly above the objective of 12.00%.
Bank holding companies are required to maintain minimum levels of capital in accordance with capital guidelines implemented by the Board of Governors of the Federal Reserve System. The general bank and holding company capital adequacy guidelines are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of June 30, 2017, and December 31, 2016.
In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital requirements for U.S. banking institutions, which went into effect on January 1, 2015. A detailed discussion of the Basel III Rules is included in Part I, Item 1 of the Company’s Form 10-K for the year ended December 31, 2016, under the heading “Supervision and Regulation.”
At June 30, 2017, and December 31, 2016, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.
Capital levels and industry defined regulatory minimum required levels are as follows:
Minimum Capital
To Be Well Capitalized Under
Adequacy with Capital
Prompt Corrective
Actual
Conservation Buffer if applicable1
Action Provisions2
Amount
Ratio
Common equity tier 1 capital to risk weighted assets
Consolidated
161,114
8.55
108,352
5.750
N/A
Old Second Bank
234,644
12.46
108,283
122,407
6.50
Total capital to risk weighted assets
228,754
12.14
174,298
9.250
250,475
13.30
174,203
188,327
10.00
Tier 1 capital to risk weighted assets
208,397
11.06
136,607
7.250
136,530
150,654
8.00
Tier 1 capital to average assets
9.09
91,704
4.00
10.23
91,747
114,684
5.00
154,537
8.76
90,411
5.125
221,153
12.53
90,456
114,724
216,769
12.29
152,126
8.625
237,306
13.45
152,176
176,436
191,988
10.88
116,904
6.625
116,930
141,199
8.90
86,287
10.24
86,388
107,985
1 As of June 30, 2017, amounts are shown inclusive of a capital conservation buffer of 1.25%; as compared to December 31, 2016, of 0.625%.
2 The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized.”
Dividend Restrictions
In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be paid by a bank without prior regulatory approval. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital requirements described above. Pursuant to the Basel III rules that came into effect January 1, 2015, the Bank must keep a buffer of 0.625% for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter of minimum capital requirements in order to avoid additional limitations on capital distributions and certain other payments.
Note 13 – Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the
measurement date. The fair value hierarchy established by the Company also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair value are:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own view about the assumptions that market participants would use in pricing an asset or liability.
There were no transfers of securities between levels for the three-month period ended June 30, 2017, or June 30, 2016. The Company purchased states and political subdivisions securities of $10.5 million, which were deemed as Level 3 for the six month period ended June 30, 2017. There were no securities purchased deemed as Level 3 for the six month period ended June 30, 2016.
The majority of securities available-for-sale are valued by external pricing services or dealer market participants and are classified in Level 2 of the fair value hierarchy. Both market and income valuation approaches are utilized. Quarterly, the Company evaluates the methodologies used by the external pricing services or dealer market participants to develop the fair values to determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value. The Company uses the following methods and significant assumptions to estimate fair value:
·
Government-sponsored agency debt securities are primarily priced using available market information through processes such as benchmark spreads, market valuations of like securities, like securities groupings and matrix pricing.
Other government-sponsored agency securities, MBS and some of the actively traded real estate mortgage investment conduits and collateralized mortgage obligations are priced using available market information including benchmark yields, prepayment speeds, spreads, volatility of similar securities and trade date.
State and political subdivisions are largely grouped by characteristics (e.g., geographical data and source of revenue in trade dissemination systems). Because some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities.
Auction rate securities are priced using market spreads, cash flows, prepayment speeds, and loss analytics. Therefore, the valuations of auction rate asset-backed securities are considered Level 2 valuations.
Asset-backed collateralized loan obligations were priced using data from a pricing matrix supported by our bond accounting service provider and are therefore considered Level 2 valuations.
Annually every security holding is priced by a pricing service independent of the regular and recurring pricing services used. The independent service provides a measurement to indicate if the price assigned by the regular service is within or outside of a reasonable range. Management reviews this report and applies judgment in adjusting calculations at year end related to securities pricing.
Residential mortgage loans available for sale in the secondary market are carried at fair market value. The fair value of loans held-for-sale is determined using quoted secondary market prices.
Lending related commitments to fund certain residential mortgage loans, e.g., residential mortgage loans with locked interest rates to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party investors, as well as forward commitments for future delivery of MBS are considered derivatives. Fair values are estimated based on observable changes in mortgage interest rates including prices for MBS from the date of the commitment and do not typically involve significant judgments by management.
The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income to derive the resultant value. The Company is able to compare the valuation model inputs, such as the discount rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates to widely available published industry data for reasonableness.
Interest rate swap positions, both assets and liabilities, are based on valuation pricing models using an income approach reflecting readily observable market parameters such as interest rate yield curves.
The fair value of impaired loans with specific allocations of the allowance for loan losses is essentially based on recent real estate appraisals or the fair value of the collateralized asset. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are made in the appraisal process by the appraisers to reflect differences between the available comparable sales and income data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are based on third party appraisals of the property,
resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The tables below present the balance of assets and liabilities at June 30, 2017, and December 31, 2016, respectively, measured by the Company at fair value on a recurring basis:
Level 1
Level 2
Level 3
Assets:
205,170
20,348
98,235
2,678
Mortgage servicing rights
Other assets (Interest rate swap agreements)
Other assets (Mortgage banking derivatives)
551,345
29,554
580,899
Liabilities:
Other liabilities (Interest rate swap agreements, including risk participation agreements)
1,843
46,477
22,226
167,808
3,119
673
287
512,371
31,834
544,205
1,667
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are as follows:
Collateralized
States and
Mortgage
Political
Servicing
Obligation
Subdivisions
Rights
Beginning balance January 1, 2017
Total gains or losses
Included in earnings (or changes in net assets)
Included in other comprehensive income
(289)
Purchases, issuances, sales, and settlements
Purchases
10,456
Issuances
601
Settlements
(463)
(12,045)
(282)
Ending balance June 30, 2017
Beginning balance January 1, 2016
111
5,847
Transfers out of Level 3
(1,464)
(78)
(310)
Ending balance June 30, 2016
4,698
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of June 30, 2017:
Measured at fair value
Unobservable
on a recurring basis:
Valuation Methodology
Inputs
Range of Input
of Inputs
Discounted Cash Flow
Discount Rate
10.0 - 206.3%
10.2
Prepayment Speed
7.0 - 68.3%
10.0
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of December 31, 2016:
10.0 - 17.0%
6.5 - 77.8%
9.6
27
In addition to the above, Level 3 fair value measurement included $20.3 million for state and political subdivisions representing various local municipality securities and $2.7 million of collateralized mortgage obligations at June 30, 2017. Both of these were classified as securities available-for-sale, and were valued using a discount based on market spreads of similar assets, but the liquidity premium was an unobservable input. The state and political subdivisions securities balance in Level 3 fair value at June 30, 2016, was zero; the securities were transferred to Level 3 in the fourth quarter of 2016. Given the small dollar amount and size of the municipality involved, this is categorized as Level 3 based on the payment stream received by the Company from the municipality. That payment stream is otherwise an unobservable input.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:
The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP. These assets consist of impaired loans and OREO. For assets measured at fair value on a nonrecurring basis at June 30, 2017, and December 31, 2016, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:
Impaired loans1
142
Other real estate owned, net2
11,866
1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans; had a carrying amount and a valuation allowance of $98,000 resulting in a decrease of specific allocations within the allowance for loan losses of $705,000 for the six months ended June 30, 2017.
2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $11.7 million, which is made up of the outstanding balance of $21.6 million, net of a valuation allowance of $8.3 million and participations of $1.6 million, at June 30, 2017.
1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans; had a carrying amount and a valuation allowance of $1.0 million, resulting in an increase of specific allocations within the allowance for loan losses of $1.0 million for the year ended December 31, 2016.
2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $11.9 million, which is made up of the outstanding balance of $23.5 million, net of a valuation allowance of $10.0 million and participations of $1.6 million, at December 31, 2016.
The Company has estimated the fair values of these assets based primarily on Level 3 inputs. OREO and impaired loans are generally valued using the fair value of collateral provided by third party appraisals. These valuations include assumptions related to cash flow projections, discount rates, and recent comparable sales. The numerical ranges of unobservable inputs for these valuation assumptions are not meaningful.
Note 14 – Fair Values of Financial Instruments
The estimated fair values approximate carrying amount for all items except those described in the following table. Securities available-for-sale fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the security. The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC or another member institution at par. FHLBC stock is carried at cost and considered a Level 2 fair value. Fair values of loans were estimated for portfolios of loans with similar financial characteristics, such as type and fixed or variable interest rate terms. Cash flows were discounted using current rates at which similar loans would be made to borrowers with similar ratings and for similar maturities. The fair value of time deposits is estimated using discounted future cash flows at current rates offered for deposits of similar remaining maturities. The fair values of borrowings were estimated based on interest rates available to the Company for debt with similar terms and remaining maturities. The fair value of off balance sheet volume is not considered material.
28
The carrying amount and estimated fair values of financial instruments were as follows:
Carrying
Financial assets:
545,201
23,026
FHLBC and FRBC Stock
Loans, net
1,519,216
Accrued interest receivable
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
1,363,682
1,375,085
60,534
33,472
27,062
46,258
Interest rate swap agreements
1,458
Borrowing interest payable
89
Deposit interest payable
611
506,493
25,345
1,453,429
5,928
1,353,097
1,351,000
55,163
32,404
22,759
Subordinated debenture
994
202
599
Note 15 – Financial Instruments with Off-Balance Sheet Risk and Derivative Transactions
To meet the financing needs of its customers, the Bank, as a subsidiary of the Company, is a party to various financial instruments with off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to originate and sell loans as well as financial standby, performance standby and commercial letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Bank’s exposure to credit loss for loan commitments and letters of credit is represented by the dollar amount of those instruments. Management generally uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Interest Rate Swap Designated as a Cash Flow Hedge
The Company entered into a forward starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017. This transaction had a notional amount totaling $25.8 million as of March 31, 2017, was designated as a cash flow hedge of certain junior subordinated debentures and was determined to be fully effective during the period presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other assets with changes in fair value recorded in other comprehensive income. The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. The Company expects the hedge to remain fully effective during the remaining term of the swap. The Bank will pay the counterparty a fixed rate and receive a floating rate based on three month LIBOR. Management concluded that it would be advantageous to enter this transaction given that the Company has trust preferred securities that changed from fixed rate to floating rate on June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.
Summary information about the interest rate swap designated as a cash flow hedge is as follows:
As of
Notional amount
25,774
Unrealized loss
(1,458)
(994)
Other Interest Rate Swaps
The Bank also has interest rate derivative positions to assist with risk management that are not designated as hedging instruments. These derivative positions relate to transactions in which the Bank enters an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. Per contractual requirements with the correspondent financial institution, the Bank had $4.2 million in securities available-for-sale pledged to support interest rate swap activity with two correspondent financial institutions at June 30, 2017. The Bank had $6.2 million in securities pledged to support interest rate swap activity with two correspondent financial institutions at December 31, 2016.
In connection with each transaction, the Bank agreed to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Bank agreed to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to convert a variable rate loan to a fixed rate loan and is part of the Company’s interest rate risk management strategy. Because the Bank acts as an intermediary for the client, changes in the fair value of the underlying derivative contracts offset each other and do not generally affect the results of operations. Fair value measurements include an assessment of credit risk related to the client’s ability to perform on their contract position, however, and valuation estimates related to that exposure are discussed in Note 13 above. At June 30, 2017, the notional amount of non-hedging interest rate swaps was $101.6 million with a weighted average maturity of 7.2 years. At December 31, 2016, the notional amount of non-hedging interest rate swaps was $85.8 million with a weighted average maturity of 7.3 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.
The Bank also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans as well as selling forward mortgage-backed securities contracts. Loan interest rate lock commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to originate residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue. Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.
30
The following table presents derivatives not designated as hedging instruments as of June 30, 2017, and periodic changes in the values of the interest rate swaps are reported in other noninterest income. Periodic changes in the value of the forward contracts related to mortgage loan origination are reported in the net gain on sales of mortgage loans.
Asset Derivatives
Liability Derivatives
Notional or
Balance Sheet
Location
Interest rate swap contracts net of credit valuation
101,613
Other Assets
Other Liabilities
Interest rate lock commitments and forward contracts
37,142
704
1 Includes unused loan commitments and interest rate lock commitments.
2 Includes forward MBS contracts and forward loan contracts.
The following table presents derivatives not designated as hedging instruments as of December 31, 2016.
85,807
31,980
960
The Bank also issues letters of credit, which are conditional commitments that guarantee the performance of a customer to a third party. The credit risk involved and collateral obtained in issuing letters of credit are essentially the same as that involved in extending loan commitments to our customers. In addition to customer related commitments, the Company is responsible for letters of credit commitments that relate to properties held in OREO. The following table represents the Company’s contractual commitments due to letters of credit as of June 30, 2017, and December 31, 2016.
The following table is a summary of letter of credit commitments (in thousands):
Fixed
Variable
Letters of credit:
Borrower:
Financial standby
167
3,979
4,146
137
4,047
4,184
Commercial standby
122
126
Performance standby
66
8,315
8,381
83
8,499
8,582
12,416
12,649
12,672
12,892
Non-borrower:
524
619
Total letters of credit
12,838
13,071
315
13,196
13,511
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, that 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 presents information concerning our financial condition as of June 30, 2017, as compared to December 31, 2016, and the results of operations for the three and six months ended June 30, 2017, and June 30, 2016. This discussion and analysis is best read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our 2016 Form 10-K. The results of operations for the quarter ended June 30, 2017, are not necessarily indicative of future results.
Our community-focused banking franchise has experienced growth in the past year, and is positioned for further success as an enduring entity following our strong fundamental approach. We continue to work through industry and regulatory developments which make it challenging to attain the levels of profitability and growth reflected a decade ago. As we look to provide value to our customers and the communities in which we operate, growth opportunities identified in our local markets are being developed into new banking relationships. We are encouraged by sustained quality in our credit performance as nonperforming loan totals remain at low levels and strong sales efforts have driven moderate loan growth and portfolio diversity. The Company generated increased net interest income in the three month period ended June 30, 2017, as compared to the like period ended June 30, 2016. The Company’s noninterest income growth also contributed to the overall increase in earnings for the second quarter of 2017 as compared to the prior year. However, the positive earnings impact of the growth in net interest income and noninterest income for the second quarter of 2017 was partially offset by an increase in noninterest expense. Noninterest expenses were negatively impacted by certain one-time charges within salaries and employee benefits for the three months ended June 30, 2017, as compared to the three months ended June 30, 2016. In addition, the period ended June 30, 2017, reflected an increase of nine full time equivalent employees as compared to June 30, 2016, stemming from the Talmer branch acquisition in late 2016.
Results of Operations
Net income before taxes of $7.6 million in the second quarter of 2017 compares to $5.9 million in the second quarter of 2016. When compared to the second quarter of 2016, the second quarter of 2017 reflected higher levels of net interest and dividend income, a provision for loan loss of $750,000, and increased levels of noninterest income and noninterest expense. Noninterest income in the 2017 period was favorably impacted by a reduced loss taken on the valuation of mortgage servicing rights as compared to the year over year period, as well as an increase in trust revenue due to growth in our customer base. Noninterest expense increased in the second quarter of 2017 when compared to the second quarter of 2016 primarily due to $294,000 of one-time charges to salaries and employee benefits in the 2017 quarter, as well as nine additional full item equivalent employees in the year over year period.
Net income before taxes of $14.2 million for the six months ended June 30, 2017, was favorable as compared to the $11.2 million pretax income for the six months ended June 30, 2016. Net interest margin was the largest contributor to this favorable variance, as loan growth and securities repositioning have resulted in increased volumes and more favorable yields for the year to date period.
Management has remained diligent with loan portfolio review to analyze loan quality and decide whether charge-offs are required. In the second quarter of 2017, management’s review of the loan portfolio concluded that an additional provision for loan losses should be recorded of $750,000, stemming from second quarter 2017 loan growth and collateral shortfalls on a few credits. The allowance for loan losses was adequate and appropriate for estimated incurred losses at June 30, 2016; neither a loan loss reserve release nor an additional loan loss provision was deemed necessary for the like 2016 quarter.
Earnings for the second quarter of 2017 were $0.18 per diluted share on $5.5 million of net income as compared to $0.13 per diluted share on net income of $3.8 million for the second quarter of 2016. For the six month period ended June 30, 2017, earnings were $0.33 per diluted share on $10.0 million of net income, as compared to $0.24 per diluted share on $7.2 million of income for the prior year like period. Earnings growth in the 2017 period, as compared to the like 2016 period, stems from the acquisition of the Chicago branch of Talmer Bank and Trust, which was completed on October 28, 2016. This acquisition resulted in a cash payment of $181.5 million for loans, net of purchased loan discount totaling $221.0 million, deposits of $48.9 million, goodwill of $8.4 million, core deposit intangible of $659,000, and other immaterial assets and liabilities. The performance of the acquired loan portfolio, security portfolio restructuring to higher yielding instruments, and robust organic loan growth in the year over year period were the primary factors driving the earnings increase for the 2017 quarter.
Net Interest Income
Net interest and dividend income increased by $3.6 million from $15.4 million for the quarter ended June 30, 2016, to $19.0 million for the quarter ended June 30, 2017. Total average loans, including loans held-for-sale, increased by $118.7 million in the second quarter
of 2017 as compared to the last quarter of 2016, and $359.1 million as compared to the second quarter of 2016. Average earning assets were $2.12 billion for the second quarter of 2017, which reflected an increase of $129.0 million compared to the fourth quarter of 2016, and an increase of $180.8 million as compared to the second quarter of 2016. The significant increase in interest and dividend income of $4.3 million, or 24.5%, in the three months ended June 30, 2017, as compared to the like 2016 period, was driven by growth in the loan portfolio primarily due to the Talmer branch acquisition. In addition, the average yield on the securities portfolio increased by 138 basis points in the year over year period due to portfolio repositioning to higher yielding tax exempt securities; the average tax exempt securities portfolio increased by $181.9 million, and earned 226 basis points more in the second quarter of 2017 as compared to the second quarter of 2016.
Quarterly average interest bearing liabilities as of June 30, 2017, increased $66.9 million, or 4.5%, and $74.4 million, or 5.0%, when compared to December 31, 2016, and June 30, 2016, respectively. Significant deposit volume increases, due to seasonal tax refunds and commercial deposit growth, and higher rates paid on other borrowed funds and senior debt in the 2017 period resulted in the escalation of interest expense.
The net interest margin (on a tax-equivalent basis), expressed as a percentage of average earning assets, was 3.81% in the second quarter of 2017, reflecting an increase of 27 basis points from the fourth quarter of 2016, and growth of 59 basis points from the second quarter of 2016. The average tax-equivalent yield on earning assets increased to 4.35% for the second quarter of 2017, as compared to 4.03% for the fourth quarter of 2016 and 3.68% for the second quarter of 2016. Increases in net interest margin and yield on average earning assets for the 2017 period as compared to prior periods presented was attributable to the securities portfolio repositioning to higher yielding tax exempt holdings, as discussed above. The cost of funds on interest bearing liabilities was 0.80% for the second quarter of 2017, and 0.65% for the second quarter of 2016. The increase in the cost of funds stems from the December 2016 senior debt issuance, which was outstanding in 2017, as compared to the subordinated debt outstanding for the majority of 2016, which incurred a lower rate of interest expense. In addition, the rising interest rate environment affected the rate paid on other short-term borrowings, which are FHLBC overnight advances.
Net interest and dividend income increased by $6.1 million from $30.6 million for the six months ended June 30, 2016, to $36.7 million for the six months ended June 30, 2017. Average earning assets for the six months ended June 30, 2017 increased $176.2 million as compared to the like average period in 2016, and the yield on average earning assets for the six months of 2017 was 4.24% as compared to 3.69% for the like 2016 period. Average interest bearing liabilities for the six months ended June 30, 2017, increased $67.8 million, or 4.6%, when compared to like prior year period. Net interest margin for the six months ended June 30, 2017, was 3.70%, as compared to 3.24% for the six months ended June 30, 2016, for an increase of 46 basis points.
Management continued to observe competitive pressure to maintain reduced interest rates on loans retained at renewal. While the Bank prices loans to achieve certain return on equity targets, significant competition for both commercial and industrial as well as commercial real estate loans has put pressure on loan yields, and our stringent underwriting standards limit our ability to make higher-yielding loans.
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, on an annualized basis, by the average balance of assets or liabilities drives 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.
33
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
(In thousands - unaudited)
Rate
11,938
1.03
54,865
71
0.51
12,048
0.49
361,504
495,687
3,318
2.68
721,837
2.43
Non-taxable (TE)
225,182
3,039
5.40
37,546
404
4.30
43,241
339
3.14
Total securities
586,686
5,646
3.85
533,233
3,722
2.79
765,078
4,721
2.47
Dividends from FHLBC and FRBC
7,699
4.78
7,911
82
4.15
7,431
4.52
Loans and loans held-for-sale1
1,509,188
17,445
4.57
1,390,537
16,485
4.64
1,150,130
13,101
4.51
Total interest earning assets
2,115,511
23,214
4.35
1,986,546
20,360
4.03
1,934,687
17,921
3.68
39,425
28,928
28,597
Allowance for loan losses
(15,779)
(15,388)
(16,415)
Other noninterest bearing assets
189,928
197,072
192,896
2,329,085
2,197,158
2,139,765
Liabilities and Stockholders' Equity
432,248
107
0.10
405,338
97
386,485
88
0.09
280,482
86
0.12
274,423
76
272,583
Savings accounts
265,066
40
0.06
253,461
261,321
392,779
1.05
404,507
1,018
402,912
0.87
1,370,575
1,258
0.37
1,337,729
1,230
1,323,301
1,062
0.32
35,652
0.05
31,019
37,433
0.01
58,572
146
0.99
27,940
28,187
0.35
57,609
7.35
57,585
57,561
7.53
43,995
6.11
8,155
36,685
45,000
2.14
408
500
1.58
Total interest bearing liabilities
1,566,403
0.80
1,499,521
2,686
0.71
1,491,982
0.65
557,265
510,161
472,450
18,047
12,609
12,511
Stockholders' equity
187,370
174,867
162,822
Total liabilities and stockholders' equity
Net interest income (TE)
20,075
17,674
15,505
to total earning assets
3.81
3.54
3.22
Interest bearing liabilities to earning assets
1 Interest income from loans is shown on a TE basis as discussed below and includes fees of $573,000, $731,000 and $531,000 for the second quarter of 2017, the fourth quarter of 2016 and the second quarter of 2016, respectively. Nonaccrual loans are included in the above-stated average balances.
Analysis of Average Balances,
Tax Equivalent Interest and Rates
Six Months Ended June 30, 2017, and 2016
12,029
0.89
13,781
391,646
2.84
712,392
2.41
183,708
4,677
5.09
36,994
614
3.32
575,354
10,247
3.56
749,386
9,207
2.46
7,657
4.62
7,974
4.21
1,498,268
34,100
4.53
1,146,014
26,211
2,093,308
44,578
4.24
1,917,155
35,620
3.69
36,521
28,205
(16,034)
(16,336)
191,374
195,077
2,305,169
2,124,101
429,443
208
383,506
172
282,042
169
276,460
134
262,240
258,190
393,579
405,328
0.84
1,367,304
2,460
0.36
1,323,484
2,075
32,745
0.04
36,605
57,348
252
27,995
0.31
57,603
7.44
57,555
43,987
6.12
2.12
1,558,987
1,491,139
0.64
541,447
461,300
21,535
11,771
183,200
159,891
38,372
30,846
Net interest income (TE) to total earning assets
3.70
3.24
1 Interest income from loans is shown on a TE basis as discussed below and includes fees of $1.1 million for the first six months of 2017 and 2016. Nonaccrual loans are included in the above-stated average balances.
35
Non-GAAP Financial Measures
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 June 30, 2017, December 31, 2016, and June 30, 2016.
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:
Net Interest Margin
Interest income (GAAP)
20,196
Taxable-equivalent adjustment:
1,064
119
1,637
215
Interest income (TE)
Interest expense (GAAP)
Net interest income (GAAP)
17,510
Average interest earning assets
Net interest margin (GAAP)
Net interest margin (TE)
Asset Quality
The Company recorded a provision for loan losses expense of $750,000 in the second quarter of 2017. On a quarterly basis, management estimates the amount required and records the appropriate provision or release to maintain an adequate reserve for all potential and estimated loan losses.
Nonperforming loans decreased by $383,000 at June 30, 2017, from $16.0 million at December 31, 2016. Credit metrics continue to be relatively stable regarding nonperforming loan levels, and management is carefully monitoring loans considered to be in a classified status. Nonperforming loans as a percent of total loans decreased to 1.0% as of June 30, 2017, from 1.1% as of December 31, 2016, and 1.6% as of June 30, 2016. The distribution of the Company’s nonperforming loans is included in the following table.
Nonperforming Loans
Percent Change From
(in thousands)
Real estate-construction
281
(21.7)
182.1
Real estate-residential:
931
(26.7)
(26.3)
N/M
4,285
6,552
5,859
(34.6)
(26.9)
1,863
2,240
2,519
(16.8)
(26.0)
Real estate-commercial, nonfarm
3,055
5,386
8,507
(43.3)
(64.1)
(10.0)
(59.1)
25.7
Total nonperforming loans
15,618
16,001
18,422
(2.4)
(15.2)
N/M - Not Meaningful
Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due. Remediation work continues in all segments.
Loan Charge-offs, net of recoveries
% of
March 31,
Total1
(0.2)
(17)
(4.1)
(5)
(1.2)
(48)
(7.3)
(1.7)
0.7
Total real estate-construction
(60)
(9.2)
(14)
(3.4)
(6)
(1.4)
Real estate-residential
(16)
3.8
129
19.7
(9)
(2.2)
(39)
723
110.4
(2)
(0.5)
17.5
(109)
(16.6)
15.6
(170)
(40.1)
Total real estate-residential
727
111.1
12.7
(119)
(28.0)
Owner general purpose
(25.0)
Owner special purpose
(0.9)
Non-owner general purpose
(6.0)
59.9
314
74.1
Non-owner special purpose
342
80.7
Total real estate-commercial, nonfarm
(6.5)
57.3
545
128.6
Real estate-commercial, farm
0.2
28.1
5.2
6.0
2.6
(0.8)
(1.8)
Net charge-offs / (recoveries)
655
100.0
417
424
1 Represents the percentage of total charge-offs attributable to each category of loans.
Net charge-offs for the second quarter of 2017 reflected continuing management attention to credit quality. Gross charge-offs for the quarter ended June 30, 2017 were $1.1 million compared to $936,000 for the quarter ended June 30, 2016. Gross recoveries for the quarter ended June 30, 2017 were $411,000 compared to $512,000 for the quarter ended June 30, 2016. In comparison to the linked quarter, the second quarter of 2017 continued to reflect conservative loan valuations and aggressive recovery efforts on prior charge-offs.
Classified Loans
458
257
(13.3)
54.5
1,310
(23.1)
(35.6)
6,540
(31.7)
(24.5)
3,370
(16.1)
(41.8)
7,494
9,946
13,665
(24.7)
(45.2)
(26.8)
(89.9)
(84.5)
813
(58.5)
(43.4)
Total classified loans
27,658
(15.1)
(18.7)
Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. Loans classified as substandard are inadequately protected by either the current net worth and ability to meet payment obligations 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.
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 losses as another measure of overall change in loan related asset quality. This ratio ended at 13.66% for the period ended June 30, 2017.
Allowance for Loan Losses
Below is a reconciliation of the activity for loan losses for the periods indicated (in thousands):
Allowance at beginning of period
14,983
Charge-offs:
149
415
94
Total charge-offs
682
Recoveries:
613
Total recoveries
1,107
(425)
1,072
401
Loan loss reserve provision
Allowance at end of period
Average total loans (exclusive of loans held-for-sale)
1,505,572
1,386,487
1,145,892
1,495,122
1,142,439
Net charge-offs / (recoveries) to average loans
(0.03)
0.07
Allowance at period end to average loans
1.17
1.38
1.06
15,109
The coverage ratio of the allowance for loan losses to nonperforming loans was 101.4% as of June 30, 2017, which was greater than the coverage of 101.0% as of December 31, 2016, and 85.9% as of June 30, 2016. When measured as a percentage of period end loans as of June 30, 2017, total allowance for loan and lease losses dropped to 1.03% of total loans from 1.09% as of December 31, 2016, and decreased from 1.36% of total loans at June 30, 2016. The total allowance for loan and lease losses as a percent of total period end loans was 1.15% as of June 30, 2017, excluding the loans acquired from the Talmer branch acquisition, which are effectively “reserved” for potential future losses in the remaining $830,000 credit mark component of the purchase accounting discount recorded. In management’s judgment, an adequate allowance for estimated losses has been established for inherent losses at June 30, 2017, and general changes in lending policy, procedures and staffing, as well as other external factors. However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession. Loan loss provision increased $750,000 as compared to like quarter of 2016 and was unchanged as compared to fourth quarter of 2016.
38
Other Real Estate Owned
OREO at June 30, 2017, ended at $11.7 million. This compares to $11.9 million at December 31, 2016 and $16.3 million at June 30, 2016. New additions to the OREO portfolio of $204,000 in the second quarter of 2017 were minimal. Valuation write-downs continued with an expense of $392,000 in the second quarter of 2017, compared to $265,000 in the fourth quarter of 2016 and $489,000 in the second quarter of 2016. The OREO net book value decreased in the first six months of 2017 due to 15 property sales which provided $3.3 million in total proceeds, and contributed $178,000 in net OREO gains on sale. In addition, net valuation reserve write-downs of $710,000 on 24 OREO properties were recorded in the first six months of 2017; both of these reductions were partially offset by ten property transfers into OREO from nonaccrual or fixed asset status totaling $3.6 million.
OREO
14,144
(4.7)
(24.0)
(63.7)
(65.2)
Property disposals
2,525
(37.9)
(1.3)
47.9
(19.8)
Total other real estate owned
(1.6)
(27.9)
In management’s judgment, the property valuation allowance as established presents OREO at current estimates of fair value less estimated costs to sell; however, there can be no assurance that additional losses will not be incurred on disposals or upon updates to valuations in the future. Of note, properties valued in total at $5.6 million, or approximately 48.1% of total OREO at June 30, 2017, have been in OREO for five years or more. The appropriate annual or bi-annual regulatory approval has been obtained for any OREO properties held in excess of five years.
OREO Properties by Type
% of Total
Single family residence
986
Lots (single family and commercial)
6,305
7,322
9,828
Vacant land
627
Multi-family
Commercial property
3,469
3,419
Total OREO properties
2nd Qtr 2017
Noninterest Income
12.3
9.1
1,618
(1.9)
Residential mortgage banking revenue
1,711
1,625
1,611
5.3
6.2
(136)
3.7
359
(2.5)
9.7
975
10.9
3.1
Gain (loss) on disposal and transfer of fixed assets
1,131
(8.0)
(9.5)
7,028
4.1
0.5
Of the noninterest income categories, trust income experienced the largest increases on both a linked quarter and year over year basis, as shown above, primarily due to favorable market conditions and an expanded clientele. Debit card interchange income also improved slightly compared to first quarter 2017, due to increased customer volumes. Residential mortgage banking income also experienced
fluctuations on both a linked quarter and year over year basis, as shown above, primarily due to the variability of mortgage servicing rights (“MSR”) valuations stemming from a rising interest rate environment in late 2016 and the second quarter of 2017. MSR valuation losses of $429,000 were recorded in the second quarter of 2017, as compared to MSR losses of $133,000 in the first quarter of 2017, and MSR losses of $733,000 in the second quarter of 2016. Excluding these items, the three quarters presented have minimal variation.
Noninterest Expense
Salaries
7,972
8,057
6,999
(1.1)
13.9
Bonus
854
465
83.7
88.9
Benefits and other
1,719
2,051
1,363
(16.2)
26.1
Total salaries and employee benefits
10,573
(0.3)
19.6
Occupancy, furniture and equipment expense
1,566
(6.6)
8.6
1,090
2.0
4.6
148
11.5
(54.4)
270
(2.9)
Amortization of core deposit intangible asset
386
17.1
3.9
349
14.3
76.9
(3.7)
Other real estate owned expense, net
(38.7)
2,834
4.5
18,054
(0.4)
7.7
Efficiency ratio (defined below)
62.87
67.51
68.92
The efficiency ratio shown in the table above is calculated as noninterest expense excluding OREO expenses, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains and losses on securities and includes a tax equivalent adjustment on the increase in cash surrender value of BOLI.
Second quarter 2017 noninterest expense decreased $68,000 from the first quarter of 2017, and increased $1.3 million from the second quarter of 2016. These variances are primarily due to certain one-time salaries and employee benefits expenses recorded in the 2017 quarters. The second quarter of 2017 included a one-time cost incurred related to executive relocation and recruitment of $294,000, as well as higher levels of employee insurance costs as compared to the prior year. The first quarter of 2017 included $298,000 for an executive salary continuation agreement upon retirement, $276,000 related to a deferred loan costs adjustment, and $440,000 related to higher than anticipated employee health insurance premium accruals. Also, the addition of nine full time equivalent employees due to the Talmer branch acquisition in late 2016 increased the quarterly 2017 noninterest expense over the June 30, 2016, quarter.
Other expenses have minimal fluctuations, as continued efficiencies with operational processes have contributed to maintaining the majority of noninterest expense components with insignificant variation.
Income Taxes
The Company recorded a tax expense of $2.1 million on $7.6 million pre-tax income for the second quarter of 2017. Income tax expense reflected all relevant statutory tax rates and GAAP accounting. The effective tax rate for the second quarter of 2017 was 27.9%, a decrease from 31.5% in the first quarter of 2017. The full quarter impact of the tax exempt securities growth in the first quarter of 2017 was the primary driver of the decrease, as well as a more modest impact from vested stock option tax benefits being recorded as a direct credit to income tax expense.
There have been no significant changes in the Company’s ability to utilize the deferred tax assets through June 30, 2017. The Company has no valuation reserve on the deferred tax assets as of June 30, 2017.
Financial Condition
Total assets increased $92.3 million from $2.25 billion as of December 31, 2016, to $2.34 billion at June 30, 2017, due primarily to securities and loan growth, and to a lesser extent, cash on hand. Total securities increased $36.4 million, which were funded by
significant deposit growth and FHLBC advances. Cash and cash equivalents increased $3.8 million, or 8.0%, while loans increased $60.8 million, or 4.1%, when compared to December 31, 2016.
U.S. government agencies
1,522
U.S. government agency mortgage-backed
43,646
(49.8)
(52.2)
42,621
228.3
429.1
30,208
18.7
(58.2)
289,225
(41.0)
(65.1)
250,959
1.4
(44.1)
106,370
(33.1)
(36.1)
764,551
6.8
(25.7)
The securities portfolio ended the second quarter of 2017 at $568.2 million, an increase of $36.4 million from $531.8 million at December 31, 2016, but less than the June 30, 2016 total by $196.3 million. The total securities held-to-maturity portfolio was reclassified to available-for-sale in the second quarter of 2016 to allow for portfolio restructuring and to fund loan growth. Available-for-sale purchases during the second quarter of 2017 and year over year periods were primarily tax exempt state and political subdivisions securities, such as revenue bonds and tax anticipation warrants. This portfolio repositioning was performed to enhance overall asset yield due to the rising interest rate environment. During the second quarter of 2017 security sales resulted in net realized losses of $131,000, as compared to $193,000 for the fourth quarter of 2016 and none for the second quarter of 2016.
Total loans were $1.54 billion as of June 30, 2017, an increase of $60.8 million from the total as of December 31, 2016, driven by modest growth in the commercial, real estate-construction and lease financing receivables portfolios. In addition, a home equity portfolio purchase of $16.7 million from TCF Bank in the second quarter of 2017 resulted in residential real estate loan growth. Loan portfolio repositioning continued to drive reductions in commercial real estate concentrations, and to grow commercial and lease financing to diversify the portfolio. Total loans increased $378.5 million from June 30, 2016.
12.6
101.1
44.7
321.8
5.4
12.9
(11.1)
(3.0)
504
(27.5)
(37.3)
26.5
66.9
11,127
(5.1)
1,160,060
4.2
32.7
1,091
(44.3)
32.6
The quality of the loan portfolio is impacted by not only Company credit decisions but also the economic health of the communities in which the Company operates. The local economies continue to experience the economic headwinds that have been the subject of extensive discussion on state, national and international levels. As the Company is located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial, residential, and construction) has been and continues to be a sizeable portion of the portfolio. These categories comprised 77.8% of the portfolio as of June 30, 2017, compared to 79.7% of the portfolio as of December 31, 2016. The Company continues to oversee and manage its loan portfolio in accordance with interagency guidance on risk management.
41
Deposits and Borrowings
Deposits
477,883
6.4
14.4
258,269
2.9
378,622
2.3
13.4
265,685
231,862
(3.1)
(4.3)
108,047
6.7
61,757
(11.9)
1,782,125
7.2
Total deposits were $1.91 billion on June 30, 2017, which reflects a $43.4 million increase from total deposits of $1.87 billion as of December 31, 2016, and $1.78 billion as of June 30, 2016. Total noninterest bearing demand and NOW accounts experienced increases of $42.6 million, or 4.6%, in volumes for the first six months of 2017, while certificates of deposit reflected a decrease of $10.3 million, or 2.6%, for the same period. Growth in deposits in the second quarter of 2017 was attributed to seasonal tax refunds, as well as strong commercial demand deposit growth stemming from seasonal and operational funds increases.
In addition to deposits, the Bank obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled $36.4 million at June 30, 2017, an increase from $25.7 million at December 31, 2016. The Bank also recorded an advance of $75.0 million from Federal Home Loan Bank of Chicago at June 30, 2017, as compared to $70.0 million at December 31, 2016.
The Company is indebted on senior notes totaling $44.0 million, net of deferred issuance costs, which were issued in the fourth quarter of 2016. These notes mature in December 2026, and include interest payable semiannually at 5.75% for five years. Beginning December 2021, the interest becomes payable quarterly at three month LIBOR plus 385 basis points. The Company is also indebted on $57.6 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its two statutory trust subsidiaries, Old Second Capital Trust I and Old Second Capital Trust II. The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points on June 15, 2017. Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on debt of 4.34%, as compared to the rate paid prior to June 15, 2017, of 6.77%.
As of June 30, 2017, total stockholders’ equity was $191.1 million, which was an increase of $15.9 million from $175.2 million as of December 31, 2016. This increase is directly attributable to three months of increased net income and reduced accumulated other comprehensive net loss, offset slightly by $592,000 of dividends paid to common shareholders in 2017.
In 2015, the Company redeemed all outstanding shares of the Company’s Series B preferred stock; as of September 30, 2015, no shares of the Series B Stock remained outstanding. After this redemption, the Company’s total stockholders’ equity continues to include $4.8 million to reflect the value of a ten year warrant to purchase shares of its common stock, with an exercise price of $13.43 per share, issued in January 2009 as part of the original Series B issuance. A discussion of the 2009 issuance, including this warrant, is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Form 10-K for the year ended December 31, 2016, under the heading “Capital.
The Company’s non-GAAP tangible common equity to tangible assets ratio was 7.80% at June 30, 2017, compared to 7.76% at June 30, 2016.
As of June 30,
As of December 31,
Tier 1 capital
Total equity
Tier 1 adjustments:
Trust preferred securities allowed
52,099
47,997
47,069
Cumulative other comprehensive loss
2,668
8,762
8,083
Disallowed intangible assets
(8,849)
(8,761)
Disallowed deferred tax assets
(28,651)
(31,220)
(34,497)
188,276
Tangible common equity
Total Equity
Less: Intangible assets
8,849
8,761
182,281
166,449
Tangible assets
2,159,774
Less: Goodwill and intangible assets
2,334,592
2,242,427
Liquidity
Liquidity is the Company’s ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments. The liquidity of the Company principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and its ability to borrow funds. The Company monitors the borrowing capacity at the FHLBC as part of its liquidity management process as supervised by the Asset and Liability Committee (“ALCO”) and reviewed by the Board of Directors.
Net cash inflows from operating activities were $34.3 million during the first six months of 2017, compared with net cash inflows of $7.7 million in the same period in 2016. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, were a source of inflows for the first six months of 2017 and outflows in the same period in 2016. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of inflows for the first six months of 2017 and outflows for the first six months of 2016. Management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows. Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process.
Net cash outflows from investing activities were $88.7 million in the first six months of 2017, compared to net cash outflows of $74.3 million in the same period in 2016. In the first six months of 2017, securities transactions accounted for net outflows of $27.0 million, and net principal disbursed on loans accounted for net outflows of $64.6 million. In the first six months of 2016, securities transactions accounted for net outflows of $48.0 million, and net principal disbursed on loans accounted for net outflows of $28.8 million. Proceeds from sales of OREO accounted for $3.3 million and $3.0 million in investing cash inflows for the first six months of 2017 and 2016, respectively.
Net cash inflows from financing activities in the first six months of 2017 were $58.1 million, compared with net cash inflows of $66.6 million in the first six months of 2016. Net deposit inflows in the first six months of 2017 were $43.4 million compared to net deposit inflows of $23.0 million in the first six months of 2016. Other short-term borrowings had net cash inflows related to FHLBC advances of $5.0 million in the first six months of 2017 and inflows of $35.0 million in the first six months of 2016. Changes in securities sold under repurchase agreements accounted for $10.6 million and $9.1 million in net inflows in the first six months of 2017 and 2016, respectively.
43
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As part of its normal operations, the Company is subject to interest-rate risk on the assets it invests in (primarily loans and securities) and the liabilities it funds (primarily customer deposits and borrowed funds), as well as its ability to manage such risk. Fluctuations in interest rates may result in changes in the fair market values of the Company’s financial instruments, cash flows, and net interest income. Like most financial institutions, the Company has an exposure to changes in both short-term and long-term interest rates.
In June 2017, the Federal Reserve raised short-term interest rates by 0.25%. Although a great deal of domestic and international economic uncertainty remains, there is general market expectation that the Federal Reserve may move short-term interest rates higher in the latter half of 2017. Generally, Federal Reserve actions have not had a significant impact on long-term rates, although Federal Reserve officials have indicated they may end reinvestment in their securities portfolio sometime in 2017, which could result in increases in long-term rates. The Company manages interest rate risk within guidelines established by a policy which limits the amount of rate exposure. In practice, interest rate risk exposure is maintained well within those guidelines and does not pose a material risk to the future earnings of the Company.
The Company manages various market risks in its normal course of operations, including credit, liquidity risk, and interest-rate risk. Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of the Company’s business activities and operations. In addition, since the Company does not hold a trading portfolio, it is not exposed to significant market risk from trading activities. The Company’s interest rate risk exposures estimated at June 30, 2017, and December 31, 2016, are outlined in the table below.
The Company's net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such as LIBOR and prime), and balance sheet growth or contraction. The Company's ALCO seeks to manage interest rate risk under a variety of rate environments by structuring the Company's balance sheet and off-balance sheet positions, which include interest rate swap derivatives as discussed in Note 15 of the financial statements included in this quarterly report. The risk is monitored and managed within approved policy limits.
The Company utilizes simulation analysis to quantify the impact of various rate scenarios on net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by the Company are incorporated into the simulation model. Earnings at risk is calculated by comparing the net interest income of a stable interest rate environment to the net interest income of different interest rate environments in order to determine the percentage change. Significant declines in interest rates that occurred during the first half of 2012 have made it impossible to calculate valid interest rate scenarios for rate declines of 2.0% or more, a situation that continues to date. As of December 31, 2016, the Company had modest amounts of earnings gains (in both dollars and percentage) should interest rates rise. The gains in the rising rate scenarios as of June 2017 were somewhat less compared to December 2016, largely due to continued changes in the investment portfolio. A large amount of fixed-rate securities issued by state and political subdivisions was purchased during first and second quarter, while the company experienced significant amounts of calls within its collatereralized loan obligations portfolio, which is comprised of adjustable rate securities. However, management considers the current level of interest rate risk to be moderate, but intends to continue closely monitoring changes in that risk in case corrective actions might be needed in the future. Federal funds rates and the Bank’s prime rate rose 0.25% in June of 2017, to 1.25% and 4.25%, respectively.
The following table summarizes the effect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 0.5% and 1%, and an increase of 2% assuming no change in the slope of the yield curve.
Analysis of Net Interest Income Sensitivity
(dollars in thousands)
Immediate Changes in Rates
(1.0)
1.0
Dollar change
(4,487)
(2,122)
1,043
2,196
4,413
Percent change
(5.9)
5.8
(4,404)
(2,141)
1,145
2,406
4,866
(3.2)
1.7
3.6
7.3
The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies. The above results do not take into account any management action to mitigate potential risk.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of June 30, 2017. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of June 30, 2017, the Company’s internal controls were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities and Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified.
There were no changes in the Company’s internal controls over financial reporting during the quarter ended June 30, 2017, that have materially affected, or are reasonably likely to affect, the Company’s internal control over financial reporting.
Forward-looking Statements
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries, are detailed in the “Risk Factors” section included under Item 1.A. of Part I of the Company’s most recent Annual Report in Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company and its subsidiaries, from time to time, are involved in collection suits in the ordinary course of business against its debtors and are defendants in legal actions arising from normal business activities. Management, after consultation with legal counsel, believes that the ultimate liabilities, if any, resulting from these actions will not have a material adverse effect on the financial position of the Bank or on the consolidated financial position of the Company.
Item 1.A. Risk Factors
There have been no material changes from the risk factors set forth in Part I, Item 1.A. “Risk Factors,” of the Company’s Form 10-K for the year ended December 31, 2016. Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Exhibits:
Offer letter, dated April 3, 2017, between the Company and Bradley Adams.
Compensation and Benefits Assurance Agreement, dated May 2, 2017, between the Company and Bradley Adams.
Calculation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at June 30, 2017, and December 31, 2016; (ii) Consolidated Statements of Income for the six months ended June 30, 2017 and 2016; (iii) Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2017 and 2016; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.*
* As provided in Rule 406T of Regulation S-T, these interactive data files shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 as amended, or otherwise subject to liability under those sections.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
BY:
/s/ James L. Eccher
James L. Eccher
President and Chief Executive Officer
(principal executive officer)
/s/ Bradley S. Adams
Bradley S. Adams
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)
DATE: August 7, 2017
EXHIBIT INDEX
Exhibit No.
Description