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 March 31, 2021
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) 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☐
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 ☒
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
OSBC
The Nasdaq Stock Market
As of May 4, 2021, the Registrant has 28,859,521 shares of common stock outstanding at $1.00 par value per share.
OLD SECOND BANCORP, INC.
Form 10-Q Quarterly Report
Cautionary Note Regarding Forward-Looking Statements
PART I
Page Number
Item 1.
Financial Statements
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
38
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
59
Item 4.
Controls and Procedures
60
PART II
Legal Proceedings
Item 1.A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
61
Defaults Upon Senior Securities
Mine Safety Disclosure
Item 5.
Other Information
Item 6.
Exhibits
62
Signatures
63
2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report and other publicly available documents of the Company contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act, including with respect to management’s expectations regarding future plans, strategies and financial performance, including regulatory developments, industry and economic trends, and other matters. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, can be identified by the inclusion of such qualifications as “expects,” “intends,” “believes,” “may,” “will,” “would,” “could,” “should,” “plan,” “anticipate,” “estimate,” “possible,” “likely” or other indications that the particular statements are not historical facts and refer to future periods. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and may be outside of the Company’s control. Actual events and results may differ materially from those described in such forward-looking statements due to numerous factors, including:
3
Because the Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain, there can be no assurances that future actual results will correspond to any forward-looking statements and you should not rely on any forward-looking statements. Additionally, all statements in this Form 10-Q, 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, except as required by applicable law.
4
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)
March 31,
December 31,
2021
2020
Assets
Cash and due from banks
$
25,448
24,306
Interest earning deposits with financial institutions
415,497
305,597
Cash and cash equivalents
440,945
329,903
Securities available-for-sale, at fair value
593,280
496,178
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock
9,917
Loans held-for-sale
7,842
12,611
Loans
1,959,625
2,034,851
Less: allowance for credit losses on loans
30,967
33,855
Net loans
1,928,658
2,000,996
Premises and equipment, net
45,055
45,477
Other real estate owned
2,163
2,474
Mortgage servicing rights, at fair value
5,889
4,224
Goodwill and core deposit intangible
20,661
20,781
Bank-owned life insurance ("BOLI")
63,436
63,102
Deferred tax assets, net
8,067
8,121
Other assets
40,739
47,053
Total assets
3,166,652
3,040,837
Liabilities
Deposits:
Noninterest bearing demand
982,664
909,505
Interest bearing:
Savings, NOW, and money market
1,290,937
1,202,134
Time
382,941
425,434
Total deposits
2,656,542
2,537,073
Securities sold under repurchase agreements
77,321
66,980
Junior subordinated debentures
25,773
Senior notes
44,402
44,375
Notes payable and other borrowings
22,314
23,393
Other liabilities
29,187
36,156
Total liabilities
2,855,539
2,733,750
Stockholders’ Equity
Common stock
34,957
Additional paid-in capital
120,075
122,212
Retained earnings
248,165
236,579
Accumulated other comprehensive income
13,266
14,762
Treasury stock
(105,350)
(101,423)
Total stockholders’ equity
311,113
307,087
Total liabilities and stockholders’ equity
March 31, 2021
December 31, 2020
Common
Stock
Par value
1.00
Shares authorized
60,000,000
Shares issued
34,957,384
Shares outstanding
29,018,637
29,328,723
Treasury shares
5,938,747
5,628,661
See accompanying notes to consolidated financial statements.
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended March 31,
Interest and dividend income
Loans, including fees
22,207
23,597
55
36
Securities:
Taxable
1,615
Tax exempt
1,307
1,455
Dividends from FHLBC and FRBC stock
115
125
Interest bearing deposits with financial institutions
92
75
Total interest and dividend income
25,391
27,451
Interest expense
Savings, NOW, and money market deposits
241
635
Time deposits
500
1,766
31
116
Other short-term borrowings
-
109
280
1,364
673
123
130
Total interest expense
1,848
4,793
Net interest and dividend income
23,543
22,658
(Release of) provision for credit losses
(3,000)
7,984
Net interest and dividend income after (release of) provision for credit losses
26,543
14,674
Noninterest income
Wealth management
2,151
1,906
Service charges on deposits
1,195
1,726
Secondary mortgage fees
322
270
Mortgage servicing rights mark to market gain (loss)
1,113
(2,134)
Mortgage servicing income
567
468
Net gain on sales of mortgage loans
3,721
2,246
Securities losses, net
(24)
Change in cash surrender value of BOLI
334
(49)
Card related income
1,447
1,287
Other income
450
626
Total noninterest income
11,300
6,322
Noninterest expense
Salaries and employee benefits
13,506
12,918
Occupancy, furniture and equipment
2,467
2,301
Computer and data processing
1,298
1,335
FDIC insurance
201
57
General bank insurance
276
246
Amortization of core deposit intangible
120
128
Advertising expense
Card related expense
593
532
Legal fees
131
Other real estate expense, net
237
Other expense
3,126
3,008
Total noninterest expense
21,738
21,002
Income (loss) before income taxes
16,105
(6)
Provision (benefit) for income taxes
4,226
(281)
Net income
11,879
275
Basic earnings per share
0.41
0.01
Diluted earnings per share
0.40
Dividends declared per share
6
Consolidated Statements of Comprehensive Income
(In thousands)
Net Income
Unrealized holding losses on available-for-sale securities arising during the period
(4,813)
(6,376)
Related tax benefit
1,371
1,797
Holding losses after tax on available-for-sale securities
(3,442)
(4,579)
Less: Reclassification adjustment for the net losses realized during the period
Net realized losses
7
Net realized losses after tax
(17)
Other comprehensive loss on available-for-sale securities
(4,562)
Changes in fair value of derivatives used for cash flow hedges
2,703
(2,530)
Related tax (expense) benefit
(757)
711
Other comprehensive income (loss) on cash flow hedges
1,946
(1,819)
Total other comprehensive loss
(1,496)
(6,381)
Total comprehensive income
10,383
(6,106)
Accumulated
Total
Unrealized Gain
Accumulated Other
(Loss) on Securities
(Loss) on Derivative
Comprehensive
Available-for -Sale
Instruments
Income/(Loss)
For the Three Months Ended
Balance, December 31, 2019
6,827
(2,265)
4,562
Other comprehensive loss, net of tax
Balance, March 31, 2020
2,265
(4,084)
Balance, December 31, 2020
17,413
(2,651)
Other comprehensive (loss) income, net of tax
Balance, March 31, 2021
13,971
(705)
Consolidated Statements of Cash Flows
(Unaudited)
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium / discount from amortization on securities
534
506
Securities losses , net
24
Originations of loans held-for-sale
(78,284)
(50,418)
Proceeds from sales of loans held-for-sale
85,914
45,706
Net gains on sales of mortgage loans
(3,721)
(2,246)
Mortgage servicing rights mark to market (gain) loss
(1,113)
2,134
Net discount from accretion on loans
(520)
(409)
Net change in cash surrender value of BOLI
(334)
49
Net gains on sale of other real estate owned
(20)
(23)
Provision for other real estate owned valuation losses
158
Depreciation of fixed assets and amortization of leasehold improvements
765
662
Amortization of core deposit intangibles
Change in current income taxes receivable
3,557
(1,430)
Deferred tax expense (benefit)
668
(333)
Change in accrued interest receivable and other assets
2,200
(4,081)
Change in accrued interest payable and other liabilities
(3,375)
9,607
Stock based compensation
114
729
Net cash provided by operating activities
15,390
9,022
Cash flows from investing activities
Proceeds from maturities and calls, including pay down of securities available-for-sale
7,259
16,046
Proceeds from sales of securities available-for-sale
18,126
Purchases of securities available-for-sale
(109,708)
(6,100)
Net change in loans
75,858
(27,716)
Proceeds from sales of other real estate owned, net of participations and improvements
325
311
Net purchases of premises and equipment
(343)
(887)
Net cash used in investing activities
(26,609)
(220)
Cash flows from financing activities
Net change in deposits
119,469
68,893
Net change in securities sold under repurchase agreements
10,341
2,543
Net change in other short-term borrowings
(42,125)
Redemption of junior subordinated debentures
(32,604)
Issuance of term note
20,000
Repayment of term note
(1,000)
Net change in notes payable and other borrowings, excluding term note
(78)
(76)
Dividends paid on common stock
(293)
(300)
Purchase of treasury stock
(6,178)
(2,627)
Net cash provided by financing activities
122,261
13,704
Net change in cash and cash equivalents
111,042
22,506
Cash and cash equivalents at beginning of period
50,632
Cash and cash equivalents at end of period
73,138
8
Consolidated Statements of Changes in
Additional
Other
Paid-In
Retained
Treasury
Stockholders’
Capital
Earnings
Income (Loss)
Equity
34,854
120,657
213,723
(95,932)
277,864
Adoption of ASU 2016-13
(3,783)
Dividends declared and paid, ($0.01 per share)
Vesting of restricted stock
103
(305)
202
Purchase of treasury stock from taxes withheld on stock awards
(411)
Purchase of treasury stock from stock repurchase program
(2,216)
121,081
209,915
(98,357)
265,777
(2,251)
2,251
(577)
(5,601)
9
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data, unaudited)
Note 1 – Basis of Presentation and Changes in 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 March 31, 2021, are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. 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, 2020. Unless otherwise indicated, dollar 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.
Recent Accounting Pronouncements
In June 2016, the Financial Standards Board, or FASB, issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Measurement of Credit Losses on Financial Instruments (Topic 326),” also known as Current Expected Credit Losses, or CECL. 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 reflects 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 also requires available-for-sale debt securities to have a credit loss recorded through an allowance rather than write-downs through an other than temporary impairment analysis. In addition, an allowance must be established for the credit risk related to unfunded commitments. ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and was adopted as of January 1, 2020, by the Company. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” and Note 1 – Summary of Significant Accounting Policies, both found in our Annual Report on Form 10-K for the year ended December 31, 2020 for further discussion of our Allowance for Credit Losses methodology and assessment as a critical accounting policy.
Change in Significant Accounting Policies
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, 2020. 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. During the first quarter of 2021, the Company had no changes to significant accounting policies.
Risks and Uncertainties
The coronavirus (COVID-19) pandemic, which was declared a national emergency in the United States in March 2020, continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. In particular, the COVID-19 pandemic has severely restricted the level of economic activity in the Company’s markets. Federal and state governments have taken, and may continue to take, unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed and businesses and schools have reopened with some level of success, in many states and localities the
10
number of individuals diagnosed with COVID-19 has increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief.
The impact of the COVID-19 pandemic is fluid and continues to evolve. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower bank equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates declined significantly, with the 10-year Treasury bond falling to a low of 0.52% in early August 2020, but increasing significantly since that time to 1.75% at March 31, 2021. In March 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range to 0% to 0.25% percent, and this low rate was still in effect as of March 31, 2021. These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on the Company’s business, financial condition and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental, and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strains, and the ability for customers and businesses to return to their pre-pandemic routine.
As of March 31, 2021, our consolidated balance sheet included goodwill of $18.6 million. For each quarter end of 2020, we considered whether a quantitative assessment of goodwill was required as a result of the significant economic disruption caused by the COVID-19 pandemic. In addition, we performed the annual analysis to assess if any goodwill impairment existed as of November 30, 2020. Impacts of the economic disruptions were noted from the latter half of March through the remainder of 2020, specifically, the decline in the trading price of our common stock and an increase in the U.S. unemployment rate. After considering qualitative factors regarding the expected impacts of the pandemic on our business, operations and financial condition, we determined that these conditions did not indicate that it is more likely than not that the Company’s carrying value exceeded our fair value as of December 31, 2020. However, further delayed recovery or further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.
Subsequent Events
On April 6, 2021, we sold and issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”). The Notes were offered and sold to eligible purchasers in a private offering in reliance on the exemption from the registration requirements of Section 4(a)(2) of the Securities Act of 1933, as amended and the provisions of Regulation D promulgated thereunder. The Company intends to use the net proceeds from the offering for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions. The Notes will bear interest at a fixed annual rate of 3.50%, from and including the date of issuance to but excluding April 15, 2026, payable semi-annually in arrears. From and including April 15, 2026 to, but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an interest rate per annum equal to Three-Month Term SOFR (as defined in the Note) plus 273 basis points, payable quarterly in arrears.
On April 20, 2021, the Company’s Board of Directors declared a cash dividend of $0.05 per share payable on May 10, 2021, to stockholders of record as of April 30, 2021; dividends of $1.5 million are scheduled to be paid to stockholders on May 10, 2021.
Note 2 – 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
11
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.
Federal Home Loan Bank of Chicago (“FHLBC”) and Federal Reserve Bank of Chicago (“FRBC”) stock are considered nonmarketable equity investments. FHLBC stock was recorded at $3.7 million at March 31, 2021, and December 31, 2020. FRBC stock was recorded at $6.2 million at March 31, 2021, and December 31, 2020.
The following tables summarize the amortized cost and fair value of the securities portfolio at March 31, 2021, and December 31, 2020, and the corresponding amounts of gross unrealized gains and losses:
Gross
Amortized
Unrealized
Fair
Cost1
Gains
Losses
Value
Securities available-for-sale
U.S. Treasury
4,015
87
4,102
U.S. government agencies
6,506
(145)
6,361
U.S. government agencies mortgage-backed
69,427
1,476
(301)
70,602
States and political subdivisions
227,336
16,189
(1,379)
242,146
Corporate bonds
34,750
108
(15)
34,843
Collateralized mortgage obligations
72,801
2,386
(251)
74,936
Asset-backed securities
129,118
1,389
(139)
130,368
Collateralized loan obligations
29,923
71
(72)
29,922
Total securities available-for-sale
573,876
21,706
(2,302)
4,014
4,117
6,811
(154)
6,657
16,098
1,112
(1)
17,209
229,352
21,269
(1,362)
249,259
53,999
2,866
(280)
56,585
130,959
1,370
(511)
131,818
30,728
15
(210)
30,533
471,961
26,735
(2,518)
1 Excludes accrued interest receivable of $2.6 million and $2.7 million at March 31, 2021 and December 31, 2020 respectively, that is recorded in other assets on the consolidated balance sheet.
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The fair value, amortized cost and weighted average yield of debt securities at March 31, 2021, by contractual maturity, are listed in the table below. Securities not due at a single maturity date are shown separately.
Weighted
Average
Cost
Yield
Due in one year or less
420
2.09
%
422
Due after one year through five years
7,025
2.50
7,318
Due after five years through ten years
61,065
1.79
61,813
Due after ten years
204,097
3.02
217,899
272,607
2.73
287,452
Mortgage-backed and collateralized mortgage obligations
142,228
2.08
145,538
1.35
1.93
2.22
At March 31, 2021, the Company’s investments included $103.3 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. While the program was modified several times before elimination in 2010, FFEL securities are generally guaranteed by the U.S Department of Education (“DOE”) at not less than 97% of the outstanding principal amount of the loans. The guarantee will reduce to 85% if the DOE receives reimbursement requests in excess of 5% of insured loans; reimbursement will drop to 75% if reimbursement requests exceed 9% of insured loans. In addition to the DOE guarantee, total added credit enhancement in the form of overcollateralization and/or subordination amounted to $9.7 million, or 9.26% of outstanding principal.
At March 31, 2021, the Company had invested in securities issued from two originators that individually amounted to over 10% of the Company’s stockholders’ equity. Information regarding these issuers and the value of the securities issued follows:
Issuer
Towd Point Mortgage Trust
33,107
34,955
Village Capital & Investment LLC
50,700
51,409
Securities with unrealized losses with no corresponding allowance for credit losses at March 31, 2021 and December 31, 2020, 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
145
301
5,912
304
14,036
1
1,075
3,689
1,379
17,725
1,931
52
17,988
199
7,397
251
25,385
28
1,622
111
3,202
139
4,824
72
10,601
700
41,489
1,602
31,250
20
2,302
72,739
13
154
141
1,362
3,433
279
8,142
146
8,288
509
49,572
511
49,823
7,468
179
21,477
210
28,945
313
16,002
2,205
81,285
2,518
97,287
Each quarter we perform an analysis to determine if any of the unrealized losses on securities available-for-sale are comprised of credit losses as compared to unrealized losses due to market interest rate adjustments. Our assessment includes a review of the unrealized loss for each security issuance held; the financial condition and near-term prospects of the issuer, including external credit ratings and recent downgrades; and our ability and intent to hold the security for a period of time sufficient for a recovery in value. We also consider the extent to which the securities are issued by the federal government or its agencies, and any guarantee of issued amounts by those agencies. No credit losses were determined to be present as of March 31, 2021, as there was no credit quality deterioration noted. Therefore, no provision for credit losses on securities was recognized for the first quarter of 2021.
The following table presents proceeds from sale and net realized gains (losses) on securities available-for-sale for the three months ended March 31, 2021 and 2020:
Three Months Ended
Proceeds from sales of securities
Gross realized gains on securities
17
Gross realized losses on securities
(41)
Income tax benefit on net realized losses
Effective tax rate applied
0.0
29.2
As of March 31, 2021, securities valued at $313.9 million were pledged to secure deposits and borrowings, and for other purposes, a decrease from $335.8 million of securities pledged at year-end 2020.
14
Note 3 – Loans and Allowance for Credit Losses on Loans
Major segments of loans were as follows:
Commercial 1
392,380
407,159
Leases
138,240
141,601
Commercial real estate - Investor
567,475
582,042
Commercial real estate - Owner occupied
326,857
333,070
Construction
93,745
98,486
Residential real estate - Investor
52,176
56,137
Residential real estate - Owner occupied
107,303
116,388
Multifamily
178,258
189,040
HELOC
75,604
80,908
HELOC - Purchased
17,078
19,487
Other 2
10,509
10,533
Total loans
Allowance for credit losses on loans
(30,967)
(33,855)
Net loans3
1 Includes $104.5 million and $74.1 million of Paycheck Protection Program (“PPP”) loans at March 31, 2021 and December 31, 2020, respectively.
2 The “Other” segment includes consumer and overdrafts in this table and in subsequent tables within Note 3 - Loans and Allowance for Credit Losses on Loans.
3 Excludes accrued interest receivable of $6.8 million and $7.0 million at March 31, 2021 and December 31, 2020, respectively, that is recorded in other assets on the consolidated balance sheet.
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 seeks to assure access to collateral, in the event of borrower default, through adherence to lending laws, the Company’s lending standards and credit monitoring procedures. Although the Bank makes loans primarily 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. The real estate related categories listed above represent 72.4% and 72.5% of the portfolio at March 31, 2021, and December 31, 2020, respectively, and include a mix of owner and non-owner occupied, residential, construction and multifamily loans.
The following tables represent the activity in the allowance for credit losses for loans, or the ACL, for the three months ended March 31, 2021 and March 31, 2020:
Provision
(Release)
Beginning
for Credit
Ending
Allowance for credit losses
Balance
Charge-offs
Recoveries
Three months ended March 31, 2021
Commercial
2,812
446
3,276
3,888
(506)
3,382
9,205
(1,317)
7,908
(734)
208
1,722
4,054
(335)
3,719
Real estate - Investor
1,740
(203)
266
1,803
Real estate - Owner occupied
2,714
(235)
2,528
3,625
640
4,265
1,749
(48)
1,713
96
295
1,618
(1,274)
25
37
356
(3,470)
42
624
Impact of
Adopting
for Loan
ASC 326
Three months ended March 31, 2020
3,015
(292)
539
97
3,177
1,262
501
127
1,890
6,218
(741)
536
21
6,021
3,678
(848)
329
1,109
2,051
513
1,334
2,184
4,031
601
740
1,896
1,257
1,320
769
23
3,368
1,444
1,732
674
3,850
1,161
1,526
(485)
83
2,260
850
607
(558)
98
651
19,789
5,879
5,499
1,401
30,045
The ACL on loans excludes $3.5 million, $3.0 million and $4.2 million of allowance for unfunded commitments, recorded within Other Liabilities, as of March 31, 2021, December 31, 2020 and March 31, 2020, respectively.
The following tables presents the collateral dependent loans and the related ACL allocated by segment of loans as of March 31, 2021 and December 31, 2020:
Accounts
ACL
Real Estate
Receivable
Equipment
Allocation
1,646
1,648
300
2,380
307
2,687
791
4,085
39
7,201
2,046
966
855
4,412
50
4,462
3,790
948
51
402
209
23,337
761
28,124
2,906
1,070
1,125
56
2,377
597
2,974
880
4,179
84
9,726
195
1,891
952
928
3,535
3,838
378
1,053
78
25,150
656
29,253
2,637
16
Aged analysis of past due loans by segments of loans was as follows:
90 days or
90 Days or
Greater Past
30-59 Days
60-89 Days
Total Past
Due and
March 31, 20211
Past Due
Due
Current
Total Loans
Accruing
207
392,171
603
749
137,491
996
1,545
2,541
564,934
366
1,092
2,973
4,065
322,792
3,340
90,405
495
724
1,219
50,957
903
137
574
1,614
105,689
147
2,731
2,660
69
5,460
172,798
517
718
74,886
399
16,679
467
469
10,040
11,545
3,056
6,182
20,783
1,938,842
December 31, 2020 1
407,107
613
316
988
140,613
163
1,439
1,108
2,547
579,495
958
7,309
10,115
322,955
1,237
97,249
1,022
484
54,611
157
859
286
717
1,862
114,526
3,282
3,749
185,291
549
206
805
80,103
47
19,440
10,513
10,916
1,840
10,192
22,948
2,011,903
434
1 Loans modified under the CARES Act are considered current if they are in compliance with the modified terms.
There were 504 loans which totaled $237.7 million modified under the CARES Act. As of March 31, 2021, 40 loans of the original 504 loans deferred, or $19.2 million, had an active deferral request and were in compliance with modified terms; 464 loans which totaled $218.5 million had resumed payments or paid off. Details of loans in active deferral is below:
1st Deferral
2nd Deferral
3rd Deferral
Loans modified under CARES Act, in deferral
5,782
8,927
4,526
19,235
Loans modified under CARES Act, in nonaccrual, within deferral above
183
1,731
2,416
4,330
The table presents all nonaccrual loans as of March 31, 2021, and December 31, 2020:
Nonaccrual loan detail
933
2,562
2,638
1,547
1,632
7,427
9,262
3,182
3,206
2,398
2,437
1,052
20,379
22,280
The Company recognized $32,000 of interest on nonaccrual loans during the three months ended March 31, 2021.
Credit Quality Indicators
The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparison to 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 Bank will sustain some loss if the deficiencies are not corrected. The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.
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 loan segment and loan origination date at March 31, 2021 were as follows:
18
Revolving
Converted
To Term
2019
2018
2017
Prior
Pass
73,345
70,268
33,301
13,439
5,467
2,969
187,576
386,365
Special Mention
2,772
447
3,618
Substandard
260
1,344
793
2,397
Total commercial
73,300
33,700
14,783
188,816
9,407
53,691
47,433
14,305
5,542
4,541
134,919
174
1,429
798
869
3,147
Total leases
53,865
48,862
15,103
5,593
5,410
24,011
169,705
149,475
86,518
63,401
56,733
1,110
151
551,104
1,804
9,437
11,241
2,155
424
1,131
1,225
5,130
Total commercial real estate - investor
26,166
171,933
160,043
86,713
57,958
17,923
68,497
51,974
68,105
44,122
65,217
1,308
461
317,607
598
4,077
1,748
80
1,469
1,278
8,652
Total commercial real estate - owner occupied
73,172
53,722
68,185
45,591
66,495
11,019
51,091
16,576
1,398
5,139
81
87,291
1,088
3,283
2,083
5,366
Total construction
20,947
3,481
358
8,660
12,654
7,769
7,635
12,510
1,155
50,741
503
1,435
Total residential real estate - investor
8,994
8,367
13,013
895
17,859
21,165
9,116
14,088
37,800
2,232
103,155
412
218
3,471
4,148
Total residential real estate - owner occupied
17,906
9,528
14,306
41,271
4,692
40,077
29,772
42,259
30,499
16,021
191
163,511
6,901
4,491
2,353
7,846
Total multifamily
40,146
36,673
46,750
31,432
18,374
2,403
2,138
1,241
1,652
1,268
65,586
74,288
85
287
797
1,303
Total HELOC
2,501
1,326
1,688
1,555
66,396
19
Total HELOC - purchased
685
1,197
533
240
164
535
6,753
10,107
Total other
1,596
243
142,335
483,448
365,021
244,390
173,102
216,127
271,050
693
1,896,166
5,348
17,825
460
23,633
5,708
7,591
10,089
2,707
9,986
1,590
39,826
144,490
494,504
390,437
254,479
175,809
226,113
273,100
Credit quality indicators by loan segment and loan origination date at December 31, 2020 were as follows:
2016
101,796
42,294
14,519
6,265
1,825
1,691
230,388
398,778
425
68
76
5,702
273
1,524
830
2,679
107,199
42,771
16,111
1,828
231,294
56,605
52,168
16,830
6,545
5,242
138,041
175
338
1,434
481
3,222
56,780
53,765
17,628
6,604
5,692
1,132
173,781
158,677
92,156
66,762
55,963
15,966
1,319
564,624
2,394
9,592
220
95
12,301
2,709
1,126
340
871
5,117
178,884
169,395
92,447
56,398
16,837
72,605
52,809
73,719
45,315
50,000
25,507
1,324
321,279
604
1,564
2,154
1,780
1,664
3,524
11,187
74,773
54,963
75,499
46,979
50,501
29,031
50,170
24,163
7,203
1,261
9,702
93,256
3,135
2,057
5,192
50,208
27,298
9,260
9,371
14,194
8,522
7,775
2,431
11,184
1,144
54,621
349
610
91
466
1,516
9,720
9,132
2,522
11,650
18,308
23,450
10,808
15,409
10,394
31,325
2,654
112,348
219
526
2,836
4,040
18,355
11,220
15,628
10,920
34,161
40,671
30,849
44,301
38,133
12,147
7,735
197
174,033
548
7,449
4,254
927
118
2,190
7,558
40,740
37,750
48,555
39,608
12,265
9,925
2,511
2,174
1,679
2,120
504
803
69,483
79,274
94
86
271
1,055
1,540
1,765
2,157
775
894
70,632
569
229
559
341
6,702
10,529
573
527,373
401,352
270,306
189,092
139,283
115,951
322,913
1,966,270
8,341
17,081
288
170
26,526
5,011
7,901
11,596
2,297
10,459
1,885
42,055
540,725
426,334
282,190
192,546
141,678
126,410
324,968
The Company had $624,000 and $546,000 in residential real estate loans in the process of foreclosure as of March 31, 2021, and December 31, 2020, respectively.
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. Additionally, in accordance with interagency guidance, short-term deferrals granted due to the COVID-19 pandemic are not considered TDRs unless the borrower was experiencing financial difficulty prior to the pandemic.
The specific allocation of the allowance for credit losses for TDRs is determined by calculating the present value of the TDR cash flows by discounting the original payment less an assumption for probability of default at the original note’s issue rate, and adding this amount to the present value of collateral less selling costs. 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 credit 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 credit losses also includes an allowance based on a loss migration analysis for each loan category on loans and leases that are not individually evaluated for specific impairment. All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.
There was no TDR activity for the period ended March 31, 2021 and March 31, 2020. 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 periods ended March 31, 2021, and March 31, 2020, for loans that were restructured within the prior 12 month period.
Note 4 – Other Real Estate Owned
Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation allowance, for the periods presented are itemized in the following tables:
Balance at beginning of period
5,004
Property additions, net of acquisition adjustments
491
Less:
Proceeds from property disposals, net of participation purchase and of gains/losses
305
Period valuation adjustments
Balance at end of period
5,049
Activity in the valuation allowance was as follows:
1,643
6,712
Provision for unrealized losses
Reductions taken on sales
(466)
1,649
6,404
Expenses related to OREO, net of lease revenue includes:
Gain on sales, net
Operating expenses
54
102
Lease revenue
Net OREO expense
22
Note 5 – Deposits
Major classifications of deposits were as follows:
Savings
429,256
399,057
NOW accounts
522,760
486,612
Money market accounts
338,921
316,465
Certificates of deposit of less than $100,000
193,291
200,107
Certificates of deposit of $100,000 through $250,000
132,514
164,982
Certificates of deposit of more than $250,000
57,136
60,345
Note 6 – Borrowings
The following table is a summary of borrowings as of March 31, 2021, and December 31, 2020. Junior subordinated debentures are discussed in more detail in Note 7:
Total borrowings
169,810
160,521
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 $77.3 million at March 31, 2021, and $67.0 million at December 31, 2020. The fair value of the pledged collateral was $114.8 million at March 31, 2021, and $94.4 million at December 31, 2020. At March 31, 2021, 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 March 31, 2021 and December 31, 2020 the Bank had no short-term advances outstanding under the FHLBC. The Bank also assumed $23.4 million of long-term FHLBC advances with the ABC Bank acquisition in 2018. At March 31, 2021, one advance remains in long-term status, with a total outstanding balance of $6.3 million, at a 2.83% interest rate, and is scheduled to mature on February 2, 2026. FHLBC stock as of March 31, 2021, was valued at $3.7 million, and any potential FHLBC advances were collateralized by loans with a principal balance of $631.4 million, which carried a FHLBC-calculated combined collateral value of $457.7 million. The Company had excess collateral of $330.2 million available to secure borrowings at March 31, 2021.
The Company also has $44.4 million of senior notes outstanding, net of deferred issuance costs, as of March 31, 2021 and December 31, 2020. The senior notes were issued in December 2016 with a ten year maturity, 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. As of March 31, 2021, and December 31, 2020, unamortized debt issuance costs related to the senior notes were $598,000 and $625,000, respectively, and are included as a reduction of the balance of the senior notes on the Consolidated Balance Sheet. These deferred issuance costs will be amortized to interest expense over the ten year term of the notes and are included in the Consolidated Statements of Income.
On February 24, 2020, the Company originated a $20.0 million term note, of which $16.0 million is outstanding as of March 31, 2021, with a correspondent bank related to the Company’s redemption of the 7.80% cumulative trust preferred securities issued by Old Second Capital Trust I and related junior subordinated debentures. See the discussion in Note 7 – Junior Subordinated Debentures. The term note was issued for a three year term at one-month Libor plus 175 basis points, requires principal and interest payments quarterly, and the balance of this note is included within Notes Payable and Other Borrowings on the Consolidated Balance Sheet. The Company also has an undrawn line of credit of $20.0 million with a correspondent bank to be used for short-term funding needs; advances under this line can be outstanding up to 360 days from the date of issuance. This line of credit has not been utilized since early 2019.
Note 7 – Junior Subordinated Debentures
On March 2, 2020, the Company redeemed the 7.80% cumulative trust preferred securities issued by Old Second Capital Trust I (“OSBCP”) and related junior subordinated debentures, which totaled $32.6 million. These debentures were originally issued in 2003 for a term of 30 years at 7.80%, and subject to regulatory approval, were able to be called in whole or in part by the Company after June 30, 2008. The Company received regulatory approval to redeem the debentures in early 2020, and notified OSBCP stockholders of the redemption in late January 2020. Cash disbursed for the redemption, including accrued interest on the debentures, totaled $33.0 million, or $10.13 per OSBCP share. The OSBCP redemption was funded by cash on hand and the $20 million term note discussed in Note 6 – Borrowings. Upon redemption of the junior subordinated debentures related to OSBCP in March 2020, the Company recognized the remaining unamortized debt issuance costs of $635,000.
The Company issued $25.0 million of cumulative trust preferred securities through a private placement completed by another 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. Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 4.41% for the quarter ended March 31, 2021, compared to the rate paid for the quarter ended March 31, 2020, of 4.40%. 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.
The junior subordinated debentures issued by the Company are disclosed on the Consolidated Balance Sheet, and the related interest expense for each issuance is included in the Consolidated Statements of Income. As of March 31, 2021, and December 31, 2020, the remaining unamortized debt issuance costs related to the junior subordinated debentures were $1,000 and are included as a reduction to the balance of the junior subordinated debentures on the Consolidated Balance Sheet. The remaining deferred issuance costs on the junior subordinated debentures related to the issuance of Old Second Capital Trust II will be amortized to interest expense over the remainder of the 30-year term of the notes and are included in the Consolidated Statements of Income.
Note 8 – Equity Compensation Plans
Stock-based awards are outstanding under the Company’s 2019 Equity Incentive Plan (the “2019 Plan”). The 2019 Plan was approved at the May 2019 annual stockholders’ meeting and the number of authorized shares under the 2019 Plan was fixed at 600,000. Following approval of the 2019 Plan, no further awards were to be granted under any other prior Company equity compensation plan. The 2019 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights (“SARs”). Awards may be granted to selected directors, officers, employees or eligible service providers under the 2019 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors. As of March 31, 2021, 225,020 shares remained available for issuance under the 2019 Plan.
Under the 2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, all stock options and SARs then held by the participant will become fully exercisable immediately if, and all stock awards and cash incentive awards will become fully earned and vested immediately if, (i) the 2019 Plan is not an obligation of the successor entity following a change in control or (ii) the 2019 Plan is an obligation of the successor entity following a change in control and the participant incurs a termination of service without cause or for good reason following the change in control. Notwithstanding the immediately preceding sentence, if the
vesting of an award is conditioned upon the achievement of performance measures, then such vesting will generally be subject to the following: if, at the time of the change in control, the performance measures are less than 50% attained (pro rata based upon the time of the period through the change in control), the award will become vested and exercisable on a fractional basis with the numerator being equal to the percentage of attainment and the denominator being 50%; and if, at the time of the change in control, the performance measures are at least 50% attained (pro rata based upon the time of the period through the change in control), the award will become fully earned and vested immediately upon the change in control. 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 of restricted stock 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. Awards of 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 217,964 and 137,944 restricted stock units issued under the 2019 Plan during the three months ended March 31, 2021 and March 31, 2020, respectively. Compensation expense is recognized over the vesting period of the restricted stock units based on the market value of the award on the issue date. Total compensation cost that has been recorded for the Plan was $125,000 in the first three months of 2021 and $735,000 for the first three months of 2020.
A summary of changes in the Company’s unvested restricted awards for the three months ended March 31, 2021, is as follows:
Restricted
Stock Shares
Grant Date
and Units
Fair Value
Unvested at January 1
532,609
13.15
Granted
217,964
11.32
Vested
(191,653)
13.95
Forfeited
(42,111)
14.15
Unvested at March 31
516,809
11.99
Total unrecognized compensation cost of restricted awards was $4.0 million as of March 31, 2021, which is expected to be recognized over a weighted-average period of 2.27 years.
Note 9 – Earnings Per Share
The earnings per share, both basic and diluted, are as follows:
Basic earnings per share:
Weighted-average common shares outstanding
29,225,775
29,929,763
Diluted earnings per share:
Dilutive effect of unvested restricted awards 1
558,982
560,842
Diluted average common shares outstanding
29,784,757
30,490,605
1 Includes the common stock equivalents for restricted share rights that are dilutive.
Note 10 – 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 risk-based capital regulatory guidelines, the Bank’s Board of Directors has established an internal guideline requiring the Bank to 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 March 31, 2021, the Bank exceeded those thresholds.
At March 31, 2021, the Bank’s Tier 1 capital leverage ratio was 10.78%, an increase of 4 basis points from December 31, 2020, and is well above the 8.00% objective. The Bank’s total capital ratio was 15.80%, an increase of 80 basis points from December 31, 2020, and also well above the objective of 12.00%.
Bank holding companies are generally 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 March 31, 2021, and December 31, 2020.
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. The Basel III Rules are applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” generally holding companies with consolidated assets of less than $3 billion. The Company is currently considered a “small bank holding company.” If we have total assets in excess of $3.0 billion as of June 30, 2021, we will no longer be considered a small bank holding company in March of 2022. 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, 2020, under the heading “Supervision and Regulation.”
At March 31, 2021, and December 31, 2020, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.
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Capital levels and industry defined regulatory minimum required levels are as follows:
Minimum Capital
Well Capitalized
Adequacy with Capital
Under Prompt Corrective
Actual
Conservation Buffer, if applicable1
Action Provisions2
Amount
Ratio
Common equity tier 1 capital to risk weighted assets
Consolidated
282,302
12.43
158,979
7.000
N/A
Old Second Bank
331,118
14.59
158,864
147,517
6.50
Total capital to risk weighted assets
334,614
14.73
238,523
10.500
358,430
15.80
238,197
226,854
10.00
Tier 1 capital to risk weighted assets
307,302
13.53
193,057
8.500
192,906
181,559
8.00
Tier 1 capital to average assets
10.02
122,675
4.00
10.78
122,864
153,580
5.00
277,199
11.94
162,512
318,466
13.75
162,128
150,548
331,178
14.26
243,855
347,408
15.00
243,186
231,605
302,199
13.01
197,440
196,870
185,289
10.21
118,393
10.74
118,609
148,262
1 Amounts are shown inclusive of a capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes.
2 The prompt corrective action provisions are only applicable at the Bank level. The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized.”
As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopted CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we elected to utilize the five-year CECL transition. The cumulative amount that is not recognized in regulatory capital, in addition to the $3.8 million
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Day 1 impact of CECL adoption, will be phased in at 25% per year beginning January 1, 2022. As of March 31, 2021, the capital measures of the Company exclude $5.1 million, which is the modified CECL transition adjustment.
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, and were fully phased in as of January 1, 2019, the Bank must keep a capital conservation buffer of 2.50% above the new regulatory minimum capital requirements, which must consist entirely of Common Equity Tier 1 capital in order to avoid additional limitations on capital distributions and certain other payments.
Stock Repurchase Program
In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase Program”). The Repurchase Program expired on September 19, 2020, however, on October 20, 2020, the Company received notice of non-objection from the Federal Reserve Bank of Chicago to extend the Repurchase Program through October 20, 2021. Repurchases by us under the Repurchase Program may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. During the first quarter of 2021, we repurchased 455,134 shares of our common stock at a weighted average price of $12.31 per share, pursuant to the Repurchase Program. As of March 31, 2021, 1.2 million shares have been repurchased since the program’s inception, and 320,419 shares remain available for repurchase under the Repurchase Program.
Note 11 – 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.
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:
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Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The tables below present the balance of assets and liabilities at March 31, 2021, and December 31, 2020, respectively, measured by the Company at fair value on a recurring basis:
Level 1
Level 2
Level 3
Assets:
237,505
4,641
Mortgage servicing rights
Interest rate swap agreements
6,126
Mortgage banking derivatives
1,234
599,739
10,530
614,371
Liabilities:
Interest rate swap agreements, including risk participation agreements
7,147
244,940
4,319
9,388
840
510,581
8,543
523,241
13,159
30
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are as follows:
Three Months Ended March 31, 2021
States and
Mortgage
Political
Servicing
Subdivisions
Rights
Beginning balance January 1, 2021
Total gains or losses
Included in earnings
(3)
1,485
Included in other comprehensive income
299
Purchases, issuances, sales, and settlements
Purchases
58
Issuances
552
Settlements
(32)
(372)
Ending balance March 31, 2021
Three Months Ended March 31, 2020
Beginning balance January 1, 2020
5,419
5,935
(1,859)
(325)
6,100
(31)
(275)
Ending balance March 31, 2020
11,157
4,108
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of March 31, 2021:
Measured at fair value
Unobservable
on a recurring basis:
Valuation Methodology
Inputs
Range of Input
of Inputs
Discounted Cash Flow
Discount Rate
11.0 - 15.0%
11.0
Prepayment Speed
4.7 - 41.7%
13.5
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of December 31, 2020:
5.5 - 59.1
19.5
In addition to the above, Level 3 fair value measurement included $4.6 million for state and political subdivisions representing various local municipality securities at March 31, 2021. This was classified as securities available-for-sale, and was 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 March 31, 2020, was $11.2 million. These securities 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.
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 individually evaluated (formerly, impaired) loans and OREO. For assets measured at fair value on a nonrecurring basis at March 31, 2021, and December 31, 2020, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:
Individually evaluated loans1
7,542
Other real estate owned, net2
9,705
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 of $10.4 million and a valuation allowance of $2.9 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $269,000 for the three months ended March 31, 2021.
2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $2.2 million at March 31, 2021, which is made up of the outstanding balance of $3.8 million, net of a valuation allowance of $1.6 million.
9,675
12,149
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 of $12.3 million and a valuation allowance of $2.6 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $1.4 million for the year ended December 31, 2020.
2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $2.5 million at December 31, 2020, which is made up of the outstanding balance of $4.1 million, net of a valuation allowance of $1.6 million.
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.
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Note 12 – 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. March 31, 2021 and December 31, 2020, the fair values of loans and leases are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors. 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.
The carrying amount and estimated fair values of financial instruments were as follows:
Carrying
Financial assets:
584,537
FHLBC and FRBC stock
1,920,676
Interest rate lock commitments and forward contracts
Interest receivable on securities and loans
9,476
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
1,673,878
1,675,943
19,511
44,837
Note payable and other borrowings
22,815
7,106
Interest payable on deposits and borrowings
999
33
487,742
2,009,773
9,698
1,627,568
1,630,109
14,658
44,600
24,043
13,071
418
Note 13 – Derivatives, Hedging Activities and Financial Instruments with Off-Balance Sheet Risk
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s loan portfolio.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. In December of 2019, the Company also executed a loan pool hedge of $50 million to convert variable rate loans to a fixed rate index for a five year term.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest income/expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are received on the Company’s variable-rate borrowings. During the next twelve
34
months, the Company estimates that an additional $181,000 will be reclassified as an increase to interest income and an additional $169,000 will be reclassified as an increase to interest expense.
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives with financial counterparties are recognized directly in earnings.
The Company 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.
Disclosure of Fair Values of Derivative Instruments on the Balance Sheet
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, 2021, 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 liabilities with changes in fair value recorded in other comprehensive income, net of tax. 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. The trust preferred securities changed from fixed rate to floating rate on June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.
In December 2019, the Company also executed a loan pool hedge of $50.0 million to convert variable rate loans to a fixed rate index for a five year term. This transaction falls under hedge accounting standards and is paired against a pool of the Bank’s Libor-based loans. Overall, the new swap only bolsters income in down rate scenarios by a modest degree. We consider the current level of interest rate risk to be moderate but intend to continue looking for market opportunities to hedge further. The Bank held $1.0 million and $1.4 million of cash collateral related to one correspondent financial institution to cover the loan pool hedge mark to market valuation at March 31, 2021, and December 31, 2020, respectively.
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. The Bank had $17.2 million of cash collateral held by one correspondent financial institution to support interest rate swap activity and no investment securities were required to be pledged to any correspondent financial institution at March 31, 2021 and December 31, 2020. At March 31, 2021, the notional amount of non-hedging interest rate swaps was $177.7 million with a weighted average maturity of 5.6 years. At December 31, 2020, the notional amount of non-hedging interest rate swaps was $189.1 million with a weighted average maturity of 4.7 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of March 31, 2021 and December 31, 2020.
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Fair Value of Derivative Instruments
No. of Trans.
Notional Amount $
Balance Sheet Location
Fair Value $
Derivatives designated as hedging instruments
75,774
Other Assets
1,832
Other Liabilities
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers
177,709
4,294
150
57,494
Other contracts
18,857
41
Total derivatives not designated as hedging instruments
5,528
4,335
2,697
6,380
189,126
6,691
205
84,472
26,523
88
7,531
6,779
Disclosure of the Effect of Fair Value and Cash Flow Hedge Accounting
The fair value and cash flow hedge accounting related to derivatives covered under ASC Subtopic 815-20 impacted Accumulated Other Comprehensive Income (“AOCI”) and the Income Statement. The loss recognized in AOCI on derivatives totaled $705,000 as of March 31, 2021, and $4.1 million as of March 31, 2020. The amount of the gain or (loss) reclassified from AOCI to interest income or interest expense on the income statement totaled $12,000 and ($86,000) for the three months ended March 31, 2021, and March 31, 2020, respectively.
Credit-risk-related Contingent Features
For derivative transactions involving counterparties who are lending customers of the Company, the derivative credit exposure is managed through the normal credit review and monitoring process, which may include collateralization, financial covenants and/or financial guarantees of affiliated parties. Agreements with such customers require that losses associated with derivative transactions receive payment priority from any funds recovered should a customer default and ultimate disposition of collateral or guarantees occur.
Credit exposure to broker/dealer counterparties is managed through agreements with each derivative counterparty that require collateralization of fair value gains owed by such counterparties. Some small degree of credit exposure exists due to timing differences between when a gain may occur and the subsequent point in time that collateral is delivered to secure that gain. This is monitored by the Company and procedures are in place to minimize this exposure. Such agreements also require the Company to collateralize counterparties in circumstances wherein the fair value of the derivatives result in loss to the Company.
Other provisions of such agreements include the definition of certain events that may lead to the declaration of default and/or the early termination of the derivative transaction(s):
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 March 31, 2021, and December 31, 2020.
The following table is a summary of letter of credit commitments:
Fixed
Variable
Letters of credit:
Borrower:
Financial standby
8,979
9,308
9,051
9,380
Commercial standby
Performance standby
6,514
6,870
4,517
4,873
15,493
16,178
13,568
14,253
Non-borrower:
67
Total letters of credit
15,560
16,245
13,635
14,320
Unused loan commitments:
124,118
320,101
444,219
88,883
316,298
405,181
As of March 31, 2021, the Company evaluated current market conditions, including the impacts related to COVID-19 and market interest rates during the first quarter of 2021, and based on that analysis under the CECL methodology, the Company determined credit losses related to unfunded commitments totaled $3.5 million. The increase in the ACL for unfunded commitments of $470,000 for the first quarter of 2021, compared to the prior quarter end, is primarily related to an increase in the commercial unfunded commitments funding rate assumptions based on our analysis of the last 12 months of utilization. The Company will continue to assess the credit risk at least quarterly, and adjust the allowance for unfunded commitments, which is carried within other liabilities on our Consolidated Balance Sheet, as needed, with the appropriate offsetting entry to the provision for credit losses on our Consolidated Statements of Income.
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion provides additional information regarding our operations for the three months ended March 31, 2021, compared to the three months ended March 31, 2020, and our financial condition at March 31, 2021, compared to December 31, 2020. This discussion should be read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our Form 10-K for the year ended December 31, 2020. The results of operations for the three months ended March 31, 2021, are not necessarily indicative of future results. Dollar amounts presented in the following tables are in thousands, except per share data, and March 2021 and 2020 amounts are unaudited.
In this report, unless the context suggests otherwise, references to the “Company,” “we,” “us,” and “our” mean the combined business of Old Second Bancorp, Inc. and its subsidiary bank, Old Second National Bank (the “Bank”).
We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” on page 3 of this report.
Business Overview
The Company is a bank holding company headquartered in Aurora, Illinois. Through our wholly-owned subsidiary bank, Old Second National Bank, a national banking organization also headquartered in Aurora, Illinois, we offer a wide range of financial services through our 29 banking centers located in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois. These banking centers offer access to a full range of traditional retail and commercial banking services including treasury management operations as well as fiduciary and wealth management services. We focus our business on establishing and maintaining relationships with our clients while maintaining a commitment to provide for the financial services needs of the communities in which we operate. We emphasize relationships with individual customers as well as small to medium-sized businesses throughout our market area. We also have extensive wealth management services, which includes a registered investment advisory platform in addition to trust administration and trust services related to personal and corporate trusts and employee benefit plan administration services.
Recent Events—COVID-19
The COVID-19 pandemic continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world.
The impact of the COVID-19 pandemic is fluid and continues to evolve, adversely affecting many of our clients. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets. Market interest rates, after falling to historically low levels due to the COVID-19 pandemic through the second quarter of 2020, have generally stabilized, while intermediate and longer-term Treasury rates have begun to rise. The low interest rate environment, and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on our business, financial condition and results of operations. For instance, the pandemic has had negative effects on our interest income, ACL, and certain transaction-based line items of noninterest income. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strain, and the ability for customers and businesses to return to their pre-pandemic routine.
Results of Operation and Financial Condition
We are monitoring the impact of the COVID-19 pandemic on our results of operation and financial condition. To date, the COVID-19 pandemic has not significantly impacted the health of the overall real estate industry in our markets, which have reflected relative stability over the past three years. In addition, we have not experienced significant incurred losses on loans or received communications from our borrowers that significant losses are imminent. While management does not currently expect the next year to result in the precipitous decline in the value of certain real estate assets similar to the declines seen in 2009 to 2010, our forecast includes assumptions for certain
loss scenarios that may occur due to the exhaustion of federal stimulus funds or a decrease in market valuations. Accordingly, we determined it prudent to increase our allowance for credit losses to $33.9 million as of December 31, 2020, driven by both our adoption of the new CECL methodology and the expected impact of the COVID-19 pandemic and market interest rate reductions in anticipation of continued market risk and uncertainty. During the first quarter of 2021, unemployment expectations and other market indicators reflected an improving economic outlook, which resulted in a net benefit of $3.0 million in our provision for credit losses, comprised of a $3.5 million reserve release on loans and an additional $470,000 of expense in our provision for credit losses on unfunded commitments.
We also adjust our investment securities portfolio to fair value each period end and review for any impairment that would require a provision for credit losses. At this time, we have determined there is no need for a provision for credit losses related to our investment securities portfolio. Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments in the future on the securities we hold as well as experience reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.
As of March 31, 2021 and December 31, 2020, we had $18.6 million of goodwill. At November 30, 2020, we performed our recurring annual review for any goodwill impairment. We determined no goodwill impairment existed, however, continued delayed recovery or further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.
Lending Operations and Accommodations to Borrowers
To more fully support our customers during the pandemic, we established client assistance programs, including offering commercial, consumer, and mortgage loan payment deferrals for certain clients. As of March 31, 2021, we have executed 504 of these deferrals on loan balances of $237.7 million since March 31, 2020. In accordance with interagency guidance issued in March 2020, these short term deferrals were not considered troubled debt restructurings. As of March 31, 2021, 464 loans previously in deferral status, representing loan balances of $218.5 million, had resumed payments or paid off, and 40 loans totaling $19.2 million remained in active deferral status, of which only $4.3 million were in nonaccrual status. We also suspended late fees for consumer loans through June 30, 2020, and, although consumer late fees have been reinstated, we will continue to evaluate any late fee suspension based on the borrower’s financial situation and prior payment history. In addition, we paused new foreclosure and repossession actions through March 31, 2021, and will continue to re-evaluate these activities based on the ongoing COVID-19 pandemic. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time. Future governmental actions may require these and other types of customer-related responses.
We are also participating in the CARES Act. During 2020, as part of the first round of the SBA PPP program, we processed 746 PPP loan applications, representing a total of $136.7 million. In early October, we started the application process for PPP loan forgiveness, and have received $90.8 million of funds from payment forgiveness as of March 31, 2021. We expect this application process to continue through the second quarter of 2021, with funds to be received from the SBA for the forgiven loans into the third quarter of 2021. Due to the governmental authorization of the second round of the SBA PPP in late 2020, we originated an additional $58.3 million on 481 PPP loans in the first quarter of 2021, and anticipate filing for forgiveness of these loans with the SBA in the latter half of 2021. We recorded $504,000 of net fee income on PPP loans in the first quarter of 2021, and as of March 31, 2021, unearned net fee income on both first and second round PPP loans totaled $2.5 million. In addition, as of March 31, 2021, we had originated two loans for $305,000 under the Main Street Lending Program.
Capital and Liquidity
As of March 31, 2021, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by credit losses.
We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic. For instance, as customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit.
We have developed new processes to monitor our liquidity on a daily basis, and have run stress testing based on various economic assumptions under stress and severe stress scenarios. In addition, management continues to communicate bi-weekly in structured meetings with key staff to ensure all current events related to the COVID-19 pandemic, such as federal government stimulus check receipt, PPP loan fundings and the forgiveness application process, are managed appropriately.
Financial Overview
Our community-focused banking franchise experienced a decrease in total loans in the first quarter of 2021, compared to the year ended December 31, 2020, but an increase in total loans compared to the first quarter of 2020, and we believe we are positioned for moderate loan growth as we continue to serve our customers’ needs in a competitive economic environment. Given the ongoing, dynamic and unprecedented nature of the COVID-19 pandemic, it is difficult to predict the full impact the pandemic will have on our business; however, we expect the pandemic will make it challenging for us to attain the levels of profitability and growth we have experienced in the past five years. We are continuing to seek to provide value to our customers and the communities in which we operate, by executing on growth opportunities in our local markets and developing new banking relationships, while ensuring the safety and soundness of our Bank, our customers and our employees during the COVID-19 pandemic.
The following provides an overview of some of the factors impacting our financial performance for the three month period ended March 31, 2021, compared to the like period ended March 31, 2020:
40
Critical Accounting Policies
Our consolidated financial statements are prepared based on the application of accounting policies in accordance with generally accepted accounting principles (“GAAP”) and follow general practices within the banking industry. These policies require the reliance on estimates and assumptions, which may prove inaccurate or are subject to variations. 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. Changes in underlying factors, assumptions, or estimates could have a material impact on our future financial condition and results of operations.
Of the significant accounting policies used in the preparation of our consolidated financial statements, we have identified certain items as critical accounting policies based on the associated estimates, assumptions, judgments and complexity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2020. There have been no material changes to our critical accounting policies or the estimates made pursuant to those policies during the most recent quarter from those disclosed in our 2020 Annual Report in Form 10-K.
Non-GAAP Financial Measures
This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the presentation of net interest income and net interest margin on a tax equivalent (“TE”) basis, our adjusted efficiency ratio, our tangible common equity to tangible assets ratio, and our core net interest margin on a TE basis. Management believes that the presentation of these non-GAAP financial measures (a) provides important supplemental information that contributes to a proper understanding of our operating performance, (b) enables a more complete understanding of factors and trends affecting our business, and (c) allows investors to evaluate our performance in a manner similar to management, the financial services industry, bank stock analysts, and bank regulators. Management uses non-GAAP measures as follows: in the preparation of our operating budgets, monthly financial performance reporting, and in our presentation to investors of our performance. However, we acknowledge that these non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered an alternative to our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented below or alongside the first instance where each non-GAAP financial measure is used.
Results of Operations
Three months ended March 31, 2021 and 2020
Our income before taxes was $16.1 million in the first quarter of 2021 compared to a pretax loss of $6,000 in the first quarter of 2020. This increase in pretax income was primarily due to a net benefit of $3.0 million related to the provision for credit losses driven primarily by a reserve release on loans in the first quarter of 2021, compared to provision expense of $8.0 million in the first quarter of 2020. In addition, noninterest income increased $5.0 million in the first quarter of 2021, compared to the first quarter of 2020, primarily due to growth in mortgage banking revenue, which increased $4.9 million due to more favorable mark to market adjustments on MSRs and an increase in net gain on sales of mortgage loans due to higher origination volumes in the low rate environment. Net interest income also increased $885,000 in the first quarter of 2021, compared to the first quarter of 2020. Partially offsetting these increases to net income was a $736,000 increase in noninterest expense in the first quarter of 2021, compared to the first quarter of 2020, primarily due to growth in salaries and employee benefits expenses, occupancy, furniture and equipment, and FDIC insurance costs. Our net income was $11.9 million, or $0.40 per diluted share, for the first quarter of 2021, compared to net income of $275,000, or $0.01 per diluted share, for the first quarter of 2020.
Net interest and dividend income was $23.5 million in the first quarter of 2021, compared to $22.7 million in the first quarter of 2020. The $885,000 increase was primarily driven by a $2.9 million reduction in interest expense, due to the redemption of the Old Second Capital Trust I trust preferred securities and related subordinated debentures in the first quarter of 2020, as well as the market interest rate reductions year over year, which contributed to the decrease in the cost of deposit interest expense related to time deposits of $1.3 million, and savings, NOW and money market accounts of $394,000. Interest and dividend income also decreased in the first quarter of 2021 compared to the first quarter of 2020, but at a lesser rate than the decline in interest expense. A $2.1 million decrease in interest and
dividend income in the first quarter of 2021, compared to the first quarter of 2020, was driven by the reduction in market interest rates on loans and securities. Loan growth of $2.4 million was recorded in the year over year period, but interest income on loans declined $1.4 million in the first quarter of 2021, compared to the like period in 2020. Securities available-for-sale increased $143.6 million as of March 31, 2021, compared to March 31, 2020, but interest income recorded on securities available-for-sale decreased $696,000 in the year over year period.
Management has remained diligent in reviewing our loan portfolio to analyze and determine if charge-offs are required. Average loan growth, including loans held for sale, in the first quarter of 2021, compared to the first quarter of 2020, totaled $64.4 million, stemming primarily from 481 PPP loans originated in the first quarters of 2021 totaling $58.3 million, as well organic growth primarily in our commercial, leases, commercial real estate-investor and construction portfolios.
Net Interest Income
Net interest income, which is our primary source of earnings, is the difference between interest income earned on interest-earning assets, such as loans and investment securities, as well as accretion income on purchased loans, and interest incurred on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends upon the relative mix of interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and movements in market interest rates. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and OREO, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Our net interest and dividend income increased by $885,000 to $23.5 million, for the first quarter of 2021, from $22.7 million for the first quarter of 2020. This increase was attributable to a $2.9 million, or 61.4%, decrease in interest expense for the first quarter of 2021 compared to the first quarter of 2020, partially offset by a $2.1 million decrease in interest and dividend income. The decline in interest expense was due to lower rates for all interest earning deposits in the first quarter of 2021, as well as the redemption of the Old Second Capital Trust I preferred securities and related subordinated debentures in the first quarter of 2020, which increased interest expense by $635,000 due to the acceleration of unamortized debt issuance costs. Net interest and dividend income for the first quarter of 2021 reflected a decrease of $334,000, or 1.4%, compared to the fourth quarter of 2020.
Average earning assets for the first quarter of 2021 were $2.92 billion, reflecting an increase of $116.8 million, or 4.2%, compared to the fourth quarter of 2020, and an increase of $457.5 million, or 18.6%, compared to the first quarter of 2020. Average interest earning deposits with financial institutions totaled $359.6 million for the first quarter of 2021, which reflected an increase of $84.5 million compared to the fourth quarter of 2020, and an increase of $331.6 million compared to the first quarter of 2020. The yield on average interest earning deposits decreased to ten basis points for the first quarter of 2020, from 108 basis points for the first quarter of 2020, which drove the overall reduction in the yield on interest earning assets year over year. Total average loans, including loans held-for-sale, totaled $2.01 billion in the first quarter of 2020, which reflected a decrease of $18.0 million compared to the fourth quarter of 2020, but an increase of $69.4 million compared to the first quarter of 2020. The growth in average loan balances year over year was primarily due to an increase in commercial loans related to PPP loan originations, and organic growth in our leases, commercial real estate-investor, and construction loan portfolios. This growth in loan volumes was offset by the reduction in market interest rates over the past year, which resulted in a decrease in interest income of $1.4 million related to loans in the year over year period. For the first quarter of 2021, the yield on average loans decreased to 4.48%, compared to the yield on average loans of 4.51% for the fourth quarter of 2020, and 4.89% for the first quarter of 2020. Securities also reflected a reduction in interest income year over year, due to decreases in market interest rates over the past year, partially offset by growth in volumes. Total average securities for the first quarter of 2021 increased $50.3 million from the fourth quarter of 2020, and increased $56.5 million from the first quarter of 2020. The yield on average securities declined to 2.49% for the first quarter of 2021, compared to 2.55% for the fourth quarter of 2020 and 3.39% for first quarter of 2020.
Average interest bearing liabilities increased $68.0 million, or 3.9%, in the first quarter of 2021, compared to the fourth quarter of 2020, and increased $161.0 million, or 9.8%, compared to the first quarter of 2020. The growth in average interest bearing deposits of $59.0 million from the prior linked quarter and $162.2 million from the first quarter of 2020 was primarily due to federal stimulus funds received by depositors and growth in depositor liquidity due to market uncertainty related to the COVID-19 pandemic. In addition, we experienced growth in average noninterest bearing deposits of $33.7 million from the prior linked quarter, and $260.3 million from the year over year period, as reductions in market interest rates over the past year have provided less incentive to maintain funds in interest bearing deposits.
Due to the significant increase in cash and due from banks stemming from federal stimulus funds received and PPP loan forgiveness, we had no average other short-term borrowings, which consist of FHLBC advances, in the first quarter of 2021, compared to the $5.4 million in the fourth quarter of 2020 and $23.1 million in the first quarter of 2020. The average rate paid on short-term FHLBC advances was impacted by the reduction in interest rates in 2020, resulting in an average rate of 0.88% for the fourth quarter of 2020, compared to 1.90% for the first quarter of 2020. As of March 31, 2021, notes payable and other borrowings consisted of one long-term FHLBC advance of $6.3 million, and $16.0 million outstanding on a term note with a correspondent bank originated in the first quarter of 2020 to fund our redemption of the Old Second Capital Trust I trust preferred securities and related junior subordinated debentures of $32.6 million. This redemption occurred in March 2020 and was the primary cause of the decrease of 721 basis points in the cost of the average junior subordinated debentures for the first quarter of 2021 compared to the first quarter of 2020. The rate paid on the redeemed junior subordinated debentures was 7.8%, in comparison to the rate to be paid going forward on the newly executed $20.0 million term note of one month Libor plus 175 basis points.
Our net interest margin, expressed as a percentage of average earning assets, was 3.27% for the first quarter of 2021, reflecting a 12 basis point decrease from the fourth quarter of 2020, and a 44 basis point decrease from the first quarter of 2020. Our net interest margin, on a tax-equivalent (TE) basis, expressed as a percentage of average earning assets, was 3.32% for the first quarter of 2021, reflecting a 12 basis point decrease from the fourth quarter of 2020, and a 45 basis point decrease from the first quarter of 2020. The average tax-equivalent yield on earning assets decreased to 3.58% for the first quarter of 2021, compared to 3.74% for the fourth quarter of 2020, and 4.55% for the first quarter of 2020. The decreases in net interest margin and the yield on average earning assets for the first quarter of 2021, compared to the fourth quarter of 2020, was primarily attributable to growth in lower yielding interest earning deposits with financial institutions, as well as a decline in loan volumes and interest rate reductions which impacted loans and securities in the first quarter of 2021. Average PPP loans for the first quarter of 2021 totaled $94.1 million, which resulted in an increase to our net interest margin (TE) of one basis point for the quarter as $27.8 million of these loans were forgiven in the first quarter of 2021, which accelerated the unamortized fee recognition on these loans. The cost of funds on interest bearing liabilities was 0.41% for the first quarter of 2021, 0.49% for the fourth quarter of 2020, and 1.17% for the first quarter of 2020. The decrease in our cost of funds in the first quarter of 2021 compared to the fourth quarter of 2020 and the first quarter of 2020 was primarily driven by a decline in the rates paid on deposits, a decline in volume and rates paid on short-term borrowings, and the redemption of our junior subordinated debentures in the first quarter of 2020 which resulted in the average yield on our junior subordinated debentures of 4.41% for the first quarter of 2021, compared to 11.62% in the prior year like quarter.
We continue to observe competitive pressure to maintain reduced interest rates on loans retained at renewal. While our loan prices are targeted to achieve certain returns on equity, significant competition for commercial and industrial loans 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 table sets forth certain information relating to our average consolidated balance sheet and reflect the yield on average earning assets and cost of average interest bearing liabilities for the periods indicated. These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP TE basis using a marginal rate of 21% in 2021 and 2020 to more appropriately compare returns on tax-exempt loans and securities to other earning assets.
43
Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates
(Dollars in thousands - unaudited)
Quarters Ended
March 31, 2020
Income /
Rate
Expense
359,576
0.10
275,087
73
0.11
27,989
1.08
340,873
1.92
288,089
1,458
2.01
273,429
3.18
Non-taxable (TE)1
191,357
1,655
3.51
193,859
1,637
3.36
202,289
1,842
3.66
Total securities (TE)1
532,230
3,270
2.49
481,948
3,095
2.55
475,718
4,005
3.39
Dividends from FHLBC and FRBC
4.70
4.73
5.07
Loans and loans held-for-sale1, 2
2,014,773
22,266
4.48
2,032,741
23,067
4.51
1,945,383
23,636
4.89
Total interest earning assets
2,916,496
25,743
3.58
2,799,693
26,353
3.74
2,459,007
27,841
4.55
28,461
30,086
32,549
(34,540)
(33,255)
(23,507)
Other noninterest bearing assets
187,488
192,421
172,712
3,097,905
2,988,945
2,640,761
Liabilities and Stockholders' Equity
495,384
0.08
474,470
422,065
233
0.22
329,050
77
0.09
317,780
280,828
236
0.34
Savings accounts
412,743
0.07
391,904
322,618
166
0.21
399,310
0.51
393,297
741
0.75
448,763
1.58
1,636,487
0.18
1,577,451
991
0.25
1,474,274
2,401
0.66
82,475
0.15
67,059
47,825
0.98
5,448
0.88
23,069
1.90
4.41
283
4.37
47,200
11.62
44,389
6.15
44,363
6.04
44,284
6.11
23,330
2.14
24,407
135
2.20
3.54
Total interest bearing liabilities
1,812,454
1,744,501
2,129
0.49
1,651,414
1.17
937,039
903,383
676,755
37,801
39,281
28,490
Stockholders' equity
310,611
301,780
284,102
Total liabilities and stockholders' equity
Net interest income (GAAP)
23,877
Net interest margin (GAAP)
3.27
3.71
Net interest income (TE)1
23,895
24,224
23,048
Net interest margin (TE)1
3.32
3.44
3.77
Core net interest margin (TE - excluding PPP loans)1
3.33
Interest bearing liabilities to earning assets
62.14
62.31
67.16
1Represents a non-GAAP financial measure. See the discussion entitled “Non-GAAP Presentations” below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2021 and 2020.
2 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 50, and includes fees of $1.3 million, $2.3 million, and $294,000 for the first quarter of 2021, the fourth quarter of 2020, and the first quarter of 2020, respectively. Nonaccrual loans are included in the above-stated average balances.
Reconciliation of Tax-Equivalent Non-GAAP Financial Measures
Net interest and dividend income (TE) and net interest income (TE) to average interest earning assets are non-GAAP measures that have been adjusted on a TE basis using a marginal rate of 21% for 2021 and 2020 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:
44
Net Interest Margin
Interest income (GAAP)
26,006
Taxable-equivalent adjustment:
348
344
387
Interest and dividend income (TE)
Interest expense (GAAP)
Net interest income (TE)
Paycheck Protection Program ("PPP") loan - interest and net fee income
1,777
NA
Net interest income (TE) - excluding PPP loans
23,154
22,447
Average interest earning assets
Average PPP loans
94,149
111,491
Average interest earning assets, excluding PPP loans
2,822,347
2,688,202
Net interest margin (TE)
Core net interest margin (TE - excluding PPP loans)
45
Noninterest Income
The following table details the major components of noninterest income for the periods presented:
1st Quarter 2021
Percent Change From
(Dollars in thousands)
2,112
1.8
12.9
(11.1)
(30.8)
Residential mortgage banking revenue
(16.8)
19.3
(1,260)
188.3
152.2
12.7
21.2
3,396
9.6
65.7
Total residential mortgage banking revenue
5,723
3,026
89.1
573.3
100.0
291
14.8
781.6
0.8
12.4
577
(22.0)
(28.1)
8,785
28.6
78.7
Noninterest income increased $2.5 million, or 28.6%, in the first quarter of 2021, compared to the fourth quarter of 2020, and increased $5.0 million, or 78.7%, compared to the first quarter of 2020. The increase from both the linked quarter and the prior year quarter was primarily driven by an increase in residential mortgage banking revenue, primarily due to favorable adjustments on the mark to market valuation of MSRs and net gain on sales of mortgage loans, both stemming from the low market interest rate environment over the past year. In addition, the change in cash surrender value of BOLI increased from both the linked quarter and the year over year period due to market interest rate growth since March 31, 2020. Wealth management income also increased from both the linked quarter and year over year, as the valuation of assets under management increased due to market interest rate growth, which impacted fees assessed.
Partially offsetting these increases was a $149,000 decrease in service charges on deposits in the first quarter of 2021 compared to the linked quarter and a $531,000 decrease year over year, as federal stimulus funds were received by many of our depositors over the past year, and customer spending decreased due to uncertainty stemming from the COVID-19 pandemic, causing overdraft fees to decrease commensurately. Other income also decreased $127,000 for the first quarter of 2021, compared to the linked quarter due to various miscellaneous recoveries recorded in the fourth quarter of 2020, and decreased $176,000 compared to the prior year period, primarily due to a reduction in commercial interest rate swap fees.
46
Noninterest Expense
The following table details the major components of noninterest expense for the periods presented:
Salaries
9,216
9,978
9,761
(7.6)
(5.6)
Officers incentive
1,653
680
143.1
72.5
Benefits and other
2,043
2,199
29.1
19.9
Total salaries and employee benefits
12,701
6.3
4.6
Occupancy, furniture and equipment expense
2,259
9.2
7.2
(2.8)
194
3.6
252.6
3.8
12.2
Amortization of core deposit intangible asset
(6.3)
70
(14.3)
(45.0)
583
1.7
11.5
285
(80.7)
(58.0)
Other real estate owned expense, net
(75.3)
(84.8)
3,294
(5.1)
3.9
21,253
2.3
3.5
Efficiency ratio (GAAP)1
63.98
61.87
66.28
Adjusted efficiency ratio (non-GAAP)2
63.16
61.10
65.48
N/M - Not meaningful
1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs.
2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities and mark to market gains or losses on MSRs, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI.
See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” on page 48 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent.
Noninterest expense for the first quarter of 2021 increased $485,000, or 2.3%, compared to the fourth quarter of 2020, and increased $736,000, or 3.5%, compared to the first quarter of 2020. The linked quarter increase is primarily attributable to an $805,000 increase in salaries and employee benefits in the first quarter of 2021 and a $588,000 increase in salaries and employee benefits from the first quarter of 2020, driven by an increase in officer incentive expense and related increases in payroll taxes and company 401K matching expense. These increases to officer incentive and benefits expense were partially offset by an increase in deferrals of new loan origination costs related to PPP loans in the first quarter of 2021, which reduced salary expense in the first quarter of 2021 by $1.1 million, compared to new loan origination cost deferrals of $705,000 in the fourth quarter of 2020 and $733,000 in the first quarter of 2020.
The increase in noninterest expense for the first quarter of 2021 compared to the linked quarter and prior year quarter was also due to an increase in occupancy, furniture and equipment expense, FDIC insurance expense and general bank insurance expense. FDIC insurance expense increased $144,000 year over year due to assessment credits received in the first quarter of 2020, and general bank insurance expense increased year over year due to an increase in policy costs. These increases were partially offset by decreases in legal fees of $230,000 and $76,000 for the linked quarter and year over year, respectively, due to a decline in loan volumes and related legal fees, as
well as reductions in other real estate owned expense, net, of $110,000 and $201,000 for the linked quarter and year over year, respectively, due to a reduction in other real estate held.
Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures
GAAP
Non-GAAP
Efficiency Ratio / Adjusted Efficiency Ratio
Less amortization of core deposit
Less other real estate expense, net
Noninterest expense less adjustments
21,582
20,987
20,637
Net interest income
Net interest income including adjustments
Less death benefit related to BOLI
Less securities losses, net
Less MSRs mark to market gains (losses)
89
(13)
Noninterest income (less) / including adjustments
10,187
10,045
8,480
10,276
10,122
8,467
Net interest income including adjustments plus noninterest income (less) / including adjustments
33,730
33,922
31,138
34,171
34,346
31,515
Efficiency ratio / Adjusted efficiency ratio
48
Income Taxes
We recorded income tax expense of $4.2 million for the first quarter of 2021 on $16.1 million of pretax income, compared to income tax expense of $3.4 million on $11.4 million of pretax income in the fourth quarter of 2020, and an income tax benefit of $281,000 on $6,000 of pretax loss in the first quarter of 2020. The effective tax rate was 26.2% for the first quarter of 2021 and 29.5% for the fourth quarter of 2020; the effective tax rate was not meaningful for the first quarter of 2020, due to the pretax loss.
Income tax expense reflected all relevant statutory tax rates and GAAP accounting. There were no significant changes in our ability to utilize our deferred tax assets during the quarter ended March 31, 2021. We had no valuation reserve on the deferred tax assets as of March 31, 2021.
Financial Condition
Total assets increased $125.8 million to $3.17 billion at March 31, 2021, from $3.04 billion at December 31, 2020, due primarily to an increase in cash and cash equivalents of $111.0 million and securities available-for-sale of $97.1 million, partially offset by a reduction in loans of $75.2 million. We continue to actively assess potential investment opportunities for this excess liquidity. Total deposits were $2.66 billion at March 31, 2021, an increase of $119.5 million from December 31, 2020, primarily due to increases in noninterest bearing demand accounts, savings, money market and NOW accounts due to a decrease in consumer spending during the COVID-19 pandemic, and federal stimulus funds received by many depositors.
As of
U.S. Treasuries
4,152
(0.4)
(1.2)
7,723
(4.4)
(17.6)
17,255
310.3
309.2
255,095
(2.9)
53,403
32.4
40.3
77,727
(1.1)
67.7
34,339
(2.0)
(12.9)
Total securities
449,694
19.6
31.9
Securities available-for-sale increased $97.1 million as of March 31, 2021, compared to December 31, 2020, and increased $143.6 million compared to March 31, 2020. Available-for-sale security purchases during the quarter ended March 31, 2021, totaled $109.8 million and consisted of $55.2 million of U.S. agency mortgage backed securities, $34.8 million of corporate bonds, and $19.8 million of collateralized mortgage–backed securities. These purchases were partially offset by $7.3 million of calls, maturities and paydowns during the first quarter of 2021, as well as an unrealized mark to market loss of $4.8 million and net premium amortization of $535,000. During the first quarter of 2021 and the fourth quarter of 2020, no security gains or losses were recorded, compared to $24,000 of security losses, net, in the first quarter of 2020.
364,626
(3.6)
7.6
126,237
(2.4)
9.5
503,905
(2.5)
12.6
349,595
(1.9)
(6.5)
78,159
(4.8)
69,429
(7.1)
(24.8)
129,982
(7.8)
(17.4)
195,297
(5.7)
(8.7)
93,165
(6.6)
(18.8)
30,880
(12.4)
(44.7)
Other (1)
15,929
(0.2)
(34.0)
1,957,204
(3.7)
0.1
1 The “Other” segment includes consumer and overdrafts.
Total loans were $1.96 billion as of March 31, 2021, a decrease of $75.2 million from December 31, 2020. The decrease in total loans in the first quarter of 2021 was due primarily to forgiveness of 294 PPP loans that totaled $27.8 million within commercial loans, as well as reduction in all loan segments due to paydowns as commercial and consumer liquidity increased primarily due to the receipt of federal stimulus funds and decreases in capital expenditures during the COVID-19 pandemic. Total loans increased $2.4 million from March 31, 2020 to March 31, 2021, primarily due to loan growth in our commercial loans related to PPP loan originations and organic growth in our leases, commercial real estate-investor, and construction loan portfolios, partially offset by reductions in our commercial real estate-owner occupied, residential real estate-investor, residential real estate-owner occupied, HELOC, and HELOC-purchased portfolios. As required by CECL, the balance (or amortized cost basis) of purchased credit deteriorated loans, or PCD loans (discussed below) are carried on a gross basis (rather than net of the associated credit loss estimate), and the expected credit losses for PCD loans are estimated and separately recognized as part of the ACL.
The quality of our loan portfolio is impacted not only by our credit decisions but also by the economic health of the communities in which we operate. Since we are located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial real estate, construction, residential, multifamily, and HELOCs) has been and continues to be a sizeable portion of our portfolio. These categories comprised 72.4% of the portfolio as of March 31, 2021, compared to 72.5% of the portfolio as of December 31, 2020. We continue to oversee and seek to manage our loan portfolio in accordance with interagency guidance on risk management.
Asset Quality
Nonperforming loans consist of nonaccrual loans, performing restructured accruing loans and loans 90 days or greater past due. Remediation work continues in all segments. Nonperforming loans decreased by $1.8 million to $21.2 million at March 31, 2021 from $23.0 million at December 31, 2020. Purchased credit deteriorated loans, or PCD loans, are purchased loans that, as of the date of acquisition, the Company determined had experienced a more-than-insignificant deterioration in credit quality since origination. PCD loans and their related deferred loan costs are included in our nonperforming loan disclosures, if such loans otherwise meet the definition of a nonperforming loan. 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 were 1.1% as of March 31, 2021, December 31, 2020, and March 31, 2020. The distribution of our nonperforming loans is shown in the following table.
Nonperforming Loans
2,418
(17.1)
(61.4)
2,801
187
(8.5)
N/M
1,913
1,809
17.2
5.7
7,436
(19.8)
(0.1)
2,800
(95.4)
1,085
(21.2)
(0.5)
3,567
3,561
4,736
0.2
(24.7)
(1.6)
1,000
1,142
1,400
(28.6)
(100.0)
Other 1
Total nonperforming loans
21,182
23,045
21,837
(8.1)
(3.0)
The components of our nonperforming assets are shown in the following table.
Nonperforming Assets
(Dollars in Thousands)
Nonaccrual loans
19,497
4.5
Performing troubled debt restructured loans accruing interest
290
331
934
(69.0)
Loans past due 90 days or more and still accruing interest
1,406
18.2
(63.5)
(12.6)
(57.2)
Total nonperforming assets
23,345
25,519
26,886
(13.2)
30-89 days past due loans and still accruing interest
11,326
16,173
Nonaccrual loans to total loans
1.0
1.1
Nonperforming loans to total loans
Nonperforming assets to total loans plus OREO
1.2
1.3
1.4
Allowance for credit losses to total loans
1.6
Allowance for credit losses to nonaccrual loans
152.0
154.1
Loan charge-offs, net of recoveries, for the current quarter, prior linked quarter and year over year quarter are shown in the following table.
Loan Charge-offs, Net of Recoveries
% of
Total1
(18)
3.1
(93)
(169.1)
(11)
(20.0)
3.4
471
856.4
(8)
(0.7)
(205)
35.2
156.4
98.8
(171)
(310.9)
(266)
45.7
(12)
(21.8)
(21)
8.4
(130)
(236.4)
(22)
2.1
(97)
(176.4)
(58)
(5.2)
21.8
Net (recoveries) charge-offs
(582)
1,122
1 Represents the percentage of net charge-offs attributable to each category of loans.
2 The “Other” segment includes consumer and overdrafts.
Net recoveries of $582,000 were recorded for the first quarter of 2021, compared to net charge-offs of $55,000 for the fourth quarter of 2020, and net charge-offs $1.1 million for the first quarter of 2020, reflecting continuing management attention to credit quality and remediation efforts. The net recoveries for the first quarter of 2021 were primarily due to recoveries on two large charge-offs recorded prior to 2021. We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs.
Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. Classified assets include both classified loans and OREO. 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 we will sustain some loss if deficiencies remain uncorrected.
The following table shows classified assets by segment for the following periods.
Classified Assets
11,260
(10.5)
(78.7)
264
(2.3)
6,073
0.3
(15.5)
10,504
(22.7)
2,414
122.3
1,452
(5.3)
4,568
2.7
(9.2)
5,374
46.0
1,628
(15.4)
15.2
Total classified loans
44,000
(9.5)
Total classified assets
41,989
44,529
49,049
(14.4)
Total classified loans and classified assets decreased as of March 31, 2021, from the levels at both December 31, 2020 and March 31, 2020, primarily due to continued remediation efforts and the high level of paydowns and payoffs we have experienced due to increased borrower liquidity stemming from federal stimulus funds received by borrowers and other COVID-19 relief funding, such as PPP loans. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the ACL on loans as another measure of overall change in loan related asset quality, which is referred to as the “classified assets ratio.” The classified assets ratio was 11.60% for the period ended March 31, 2021, compared to 12.64% as of December 31, 2020, and 15.26% as of March 31, 2020. The decrease in the classified assets ratio for the period ended March 31, 2021, compared to March 31, 2020, is also due to the remediation efforts and borrower liquidity noted above, as well as growth in our capital level over the past year.
Allowance for Credit Losses on Loans
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. As of January 1, 2020, we adopted ASU 2016-13, or CECL.
We recorded a net benefit of $3.0 million in our provision for credit losses due to a reserve release for the first quarter of 2021, comprised of a $3.5 million reserve release to loans and $470,000 of additional provision expense for credit losses on unfunded commitments, compared to no provision for credit losses recorded in the fourth quarter of 2020, and an $8.0 million provision for credit losses recorded for the first quarter of 2020, due to both our adoption of the CECL accounting standard on January 1, 2020 and the potential impact of the COVID-19 pandemic. In the first quarter of 2021, we determined a reserve release on loans was appropriate, after considering our net recoveries for the quarter of $582,000, as well as the impact of changes to our future loss rate assumptions based on a decrease to the unemployment factor projected for the life of the loans over the one year forecast period. In addition, we recorded a $470,000 provision for credit losses on unfunded commitments in the first quarter of 2021, primarily due to an updated analysis of line utilization rates over the past twelve months, as well as the roll off of prior historical periods with lower losses within the CECL model.
Management estimates the amount of provision required on a quarterly basis and records the appropriate provision expense, or release of expense, to maintain an adequate reserve for all potential and estimated credit losses on loan, leases and unfunded commitments. Our ACL on loans to total loans was 1.6% as of March 31, 2021, compared to 1.7% and 1.6% at December 31, 2020, and March 31, 2020, respectively. See Item 2 – Critical Accounting Policies in the Management Discussion and Analysis in this report for discussion of our ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.
53
Below is a reconciliation of the activity in the allowance for credit losses on loans for the periods indicated (dollars in thousands):
Allowance at beginning of period
32,918
Charge-offs:
(85)
497
217
Total charge-offs
810
Recoveries:
171
Total recoveries
755
Adoption of ASC 326
Provision for credit losses on loans
992
Allowance at end of period
Average total loans (exclusive of loans held-for-sale)
2,006,157
2,023,238
1,941,760
Net charge-offs / (recoveries) to average loans
(0.03)
0.00
0.06
Allowance at period end to average loans
1.54
1.67
1.55
The coverage ratio of the ACL on loans to nonperforming loans was 146.2% as of March 31, 2021, which was a decrease from the coverage ratio of 146.9% as of December 31, 2020, but an increase from 137.6% as of March 31, 2020. When measured as a percentage of average loans, our total ACL on loans was 1.54% for the three months ended March 31, 2021, and 1.55% for the like period of March 31, 2020, reflecting minimal change year over year.
In management’s judgment, an adequate ACL has been established to encompass the current lifetime expected credit losses at March 31, 2021, and general changes in lending policy, procedures and staffing, as well as other external factors, such as the impacts of the COVID-19 pandemic. 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. Further delayed recovery or further deterioration in market conditions related to COVID-19 and the associated impacts on our customers, changes in business climates and the condition of collateral at the time of default or repossession may revise our current expectations of future credit losses in future reporting periods.
Other Real Estate Owned
As of March 31, 2021, OREO totaled $2.2 million, reflecting a $311,000 reduction from the $2.5 million at December 31, 2020, and a $2.9 million reduction from the $5.0 million at March 31, 2020. One property sale of $305,000 net book value and no transfers to OREO from loans were recorded in the first quarter of 2021. There were two property additions totaling $491,000 in the first quarter of 2020. The net book value of four property disposals in the first quarter of 2020 totaled $288,000. Valuation write-downs occurred in the first quarter of 2021 which totaled $6,000, compared to $93,000 of OREO valuation write-downs in the fourth quarter of 2020, and $158,000 of valuation write-downs recorded in the first quarter of 2020.
OREO
2,686
(7.9)
(50.6)
119
156.3
5.9
93
(93.5)
(96.2)
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 $1.4 million, or approximately 65.8% of total OREO at March 31, 2021, have been in OREO for five years or more. The appropriate regulatory approval has been obtained for any OREO properties held in excess of five years.
OREO Properties by Type
% of Total
Single family residence
430
Lots (single family and commercial)
1,381
64
1,387
3,747
74
Vacant land
352
Commercial property
0
811
Total other real estate owned
100
Deposits and Borrowings
Deposits
702,598
8.0
39.9
338,134
26.9
428,419
7.4
22.0
277,018
7.1
22.3
231,704
(3.4)
(16.6)
150,185
(19.7)
(11.8)
67,584
2,195,642
4.7
21.0
Total deposits were $2.66 billion at March 31, 2021, which reflects a $119.5 million increase from total deposits of $2.54 billion at December 31, 2020, and an increase of $460.9 million from total deposits of $2.20 billion at March 31, 2020. The increase in deposits at March 31, 2021, compared to both December 31, 2020, and March 31, 2020, was due to increases in noninterest bearing demand,
savings, NOW, and money market accounts, with decreases noted in all maturity categories of certificates of deposit. These total deposit increases in the linked quarter as well as the year over year periods were primarily due to federal stimulus funds received by depositors and a decrease in consumer spending due to the COVID-19 pandemic.
In addition to deposits, we obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled $77.3 million at March 31, 2021, a $10.3 million, or 15.4%, increase from $67.0 million at December 31, 2020, and a $51.2 million increase from March 31, 2020. Our notes payable and other borrowings is comprised of one remaining $6.3 million long-term FHLBC advance, which matures on February 2, 2026, and $16.0 million outstanding on a $20.0 million term note originated with a correspondent bank in the first quarter of 2020, to facilitate the redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures, completed on March 2, 2020. Notes payable and other borrowings of $22.3 million as of March 31, 2021, decreased $1.1 million from December 31, 2020, and decreased $4.3 million from March 31, 2020.
The Company is indebted on senior notes originated in December 2016, totaling $44.4 million, net of deferred issuance costs, as of March 31, 2021. These notes mature in December 2026, and include interest payable semi-annually 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 $25.8 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust II (“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, we initiated a cash flow hedge which resulted in the total interest rate paid on this debt of 4.41% as of March 31, 2021, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017, rate reset. The Company also redeemed $32.6 million of trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust I, on March 2, 2020, as noted above. The cash paid at redemption of $33.0 million included accrued interest of $438,000 on the debentures, and resulted in a payment of $10.13 per preferred share.
As of March 31, 2021, total stockholders’ equity was $311.1 million, which was an increase of $4.0 million from $307.1 million as of December 31, 2020. This increase is attributable to an increase in retained earnings of $11.6 million, comprised of net income year to date of $11.9 million, less a reduction to retained earnings $300,000 for payment of dividends to our common stockholders in the first quarter of 2021. In addition, a decrease to accumulated other comprehensive income of $1.5 million was recorded due to a net decrease in unrealized gains on available-for-sale securities, net of unrealized losses on swaps. Total stockholders’ equity was reduced by an increase of $3.9 million to our treasury stock in the first quarter of 2021, primarily due to repurchases of our common shares pursuant to our stock repurchase program.
In the third quarter of 2019, our Board of Directors authorized a stock repurchase program, under which we were authorized to repurchase up to approximately 1.5 million shares (or approximately 5%) of our outstanding common stock through open market purchases, trading plans established in accordance with U.S. Securities and Exchange Commission rules, privately negotiated transactions, or by other means. The stock repurchase program expired on September 19, 2020; however, we received a notice of non-objection from the Federal Reserve Bank of Chicago to extend the previously authorized stock repurchase program through October 20, 2021. The actual means and timing of any repurchases, quantity of purchased shares and prices will be, subject to certain limitations, at the discretion of management and will depend on a number of factors, including, without limitation, market prices of our common stock, general market and economic condition, and applicable legal and regulatory requirements. These share purchases are anticipated to be funded by our cash on hand. During the first quarter of 2021, we repurchased 455,134 shares of our common stock at a weighted average price of $12.31 per share pursuant to our stock repurchase program. To date, we have repurchased 1,174,407 shares of our common stock at a weighted average price of $9.45 per share, under our stock repurchase program.
The following table shows the regulatory capital ratios and the current well capitalized regulatory requirements for the Company and the Bank as of the dates indicated:
Adequacy with
Under Prompt
Capital Conservation
Corrective Action
Buffer, if applicable1
Provisions2
The Company
Common equity tier 1 capital ratio
7.00
10.85
Total risk-based capital ratio
10.50
13.09
Tier 1 risk-based capital ratio
8.50
11.93
Tier 1 leverage ratio
10.57
The Bank
12.89
14.07
11.36
2 The prompt corrective action provisions are only applicable at the Bank level.
As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopt CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we elected to utilize the five-year CECL transition. The cumulative amount that is not recognized in regulatory capital, in addition to the $3.8 million Day One impact of CECL adoption, will be phased in at 25% per year beginning January 1, 2022. As of March 31, 2021, the capital measures of the Company exclude $5.1 million, which is the modified CECL transition adjustment.
As of March 31, 2021, the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” and met the now fully phased-in capital conservation buffer requirements. In addition to the above regulatory ratios, our GAAP common equity to total assets ratio, which is used as a performance measurement for capital analysis and peer comparisons, decreased from 10.10% at December 31, 2020, to 9.82% at March 31, 2021. Our GAAP tangible common equity to tangible assets ratio was 9.23% at March 31, 2021, compared to 9.48% as of December 31, 2020. Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, decreased from 9.49% at December 31, 2020, to 9.24% at March 31, 2021, due to the growth in total tangible assets.
In November 2019, the federal banking agencies published final rules to provide an optional simplified measure of capital adequacy for qualifying community banking organizations, which we refer to as the community bank leverage ratio (“CBLR”) framework. Generally, under the CBLR framework, qualifying community banking organizations with total assets of less than $10 billion, and limited amounts of off-balance-sheet exposures and trading assets and liabilities, may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9%. Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of the FDIC’s Prompt Corrective Action framework. The final rule became effective on January 1, 2020. We do not have any immediate plans to elect to use the community bank leverage ratio framework, but may make such an election in the future.
Reconciliation of Tangible Common Equity to Tangible Assets Ratio Non-GAAP Measure
Tangible common equity
Total Equity
Less: Goodwill and intangible assets
Add: Limitation of exclusion of core deposit intangible (80%)
411
435
Adjusted goodwill and intangible assets
20,250
20,346
290,452
290,863
286,306
286,741
Tangible assets
Less: Adjusted goodwill and intangible assets
3,145,991
3,146,402
3,020,056
3,020,491
Common equity to total assets
9.82
10.10
Tangible common equity to tangible assets
9.23
9.24
9.48
9.49
The non-GAAP intangible asset exclusion reflects the 80% core deposit limitation per Basel III guidelines within risk based capital calculations, and is useful for us when reviewing risk based capital ratios and equity performance metrics.
Liquidity
Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments. Our liquidity principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds. We monitor our borrowing capacity at the FHLBC as part of our liquidity management process as supervised by our Asset and Liability Committee (“ALCO”) and reviewed by our Board of Directors. In addition, due to the potential impacts on our liquidity stemming from the COVID-19 pandemic, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs. As of March 31 2021, our cash on hand liquidity totaled $440.9 million, an increase of $111.0 million over cash balances held as of December 31, 2020.
Net cash inflows from operating activities were $15.4 million during the first three months of 2021, compared with net cash inflows of $9.0 million in the same period of 2020. Funds used to originate loans held-for-sale, net of proceeds from sales of loans held-for-sale, were a source of inflows for the first three months of 2021 and outflows for the like period of 2020. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of outflows for the three months ended March 31, 2021, but were a source of inflows for the like period of 2020. The 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 $26.6 million in the three months ended March 31, 2021, compared to net cash outflows of $220,000 in the same period in 2020. In the first three months of 2021, securities transactions accounted for net outflows of $102.4 million, and the principal change on loans accounted for net inflows of $75.9 million. In the first three months of 2020, securities transactions accounted for net inflows of $28.1 million, and net principal on loans funded accounted for net outflows of $27.7 million. Proceeds from sales of OREO accounted for $325,000 and $311,000 in investing cash inflows for the three months ended March 31, 2021 and 2020, respectively.
Net cash inflows from financing activities in the three months ended March 31, 2021 were $122.3 million, compared with net cash inflows of $13.7 million in the three months ended March 31, 2020. Net deposit inflows in the first three months of 2021 were $119.5 million compared to net deposit inflows of $68.9 million in the first three months of 2020. Other short-term borrowings had no net cash outflows in the first three months of 2021, compared to $42.1 million in the first three months of 2020. Changes in securities sold under repurchase agreements accounted for $10.3 million and $2.5 million in net inflows for the three months ended March 31, 2021 and 2020, respectively. The redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures resulted in cash outflows of $32.6 million in the first quarter of 2020, which was partially offset by a $20.0 million term note cash inflow which was originated to partially fund this trust preferred redemption; $16.0 million of this term note remains outstanding as of March 31, 2021.
Cash and cash equivalents for the three months ended March 31, 2021, totaled $440.9 million, as compared to $73.1 million as of March 31, 2020. In addition to cash and cash equivalents on hand or held as deposits with other financial institutions, we rely on funding sources from customer deposits, cash flows from securities available-for-sale and loans, and a line of credit with the FHLBC to meet potential liquidity needs. These sources of liquidity are immediately available to satisfy any funding requirements due to depositor or borrower demands through the ordinary course of our business. Additional sources of funding include a $20 million undrawn line of credit held by the Company with a third party financial institution, as well as unpledged securities available-for-sale.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As part of our normal operations, we are subject to interest-rate risk on the assets we invest in (primarily loans and securities) and the liabilities we fund (primarily customer deposits and borrowed funds). Fluctuations in interest rates may result in changes in the fair market values of our financial instruments, cash flows, and net interest income. Like most financial institutions, we have an exposure to changes in both short-term and long-term interest rates.
In the first quarter of 2020 the Federal Reserve cut the Fed Funds rate three times down to a target range of 0% to 0.25%. Additionally, the Federal Reserve has been aggressively purchasing various assets since March 2020 in an effort to stabilize the economy from the continuing effects of COVID-19. Overall, the Federal Reserve’s balance sheet has increased from about $4.2 trillion in early March 2020 to about $7.7 trillion as of March 31, 2021, the current pace of asset purchases is expected to continue. Despite the market pricing in a rate hike in late 2022, the Federal Reserve maintained the statement that the Fed Funds rate will remain in the 0% to 0.25% range through 2023. We manage interest rate risk within guidelines established by policy which are intended to limit the amount of rate exposure. In practice, we seek to manage our interest rate risk exposure well within our guidelines so that such exposure does not pose a material risk to our future earnings.
We seek to manage various market risks in the normal course of our 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 our business activities and operations. In addition, since we do not hold a trading portfolio, we are not exposed to significant market risk from trading activities. Our interest rate risk exposures at March 31, 2021 and December 31, 2020 are outlined in the table below.
Our 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. Our asset-liability committee seeks to manage interest rate risk under a variety of rate environments by structuring our balance sheet and off-balance sheet positions, which includes interest rate swap derivatives as discussed in Note 20 of our consolidated financial statements included in this annual report. We seek to monitor and manage interest rate risk within approved policy guidelines and limits.
We use simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by us are incorporated into the simulation model. Earnings at risk are calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a different interest rate environment in order to determine the percentage change. As of December 31, 2020, we had notable amounts of earnings gains (in both dollars and percentage) should interest rates rise. Due to relatively low current market interest rates, it was not possible to calculate any down rate scenarios because many of the market interest rates would fall below zero in that scenario. The projected increases in income across all up rate interest rate shock scenarios as of March 31, 2021 were moderately lower than December 31, 2020. This was primarily the result of a second round of PPP loans.
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%, 1%, and 2% and no change in the slope of the yield curve. Due to the low interest rate environment, it was not possible to calculate any down rate scenarios because rates would fall below zero in all down rate scenarios.
Analysis of Net Interest Income Sensitivity
Immediate Changes in Rates
(1.0)
0.5
2.0
Dollar change
2,793
5,985
12,200
Percent change
3.2
6.9
14.1
3,405
6,879
13,145
7.8
14.9
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 March 31, 2021. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2021, 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 March 31, 2021, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
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
Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Note Regarding Forward-Looking Statements” and in our other filings with the SEC.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Stock Repurchases
In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase Program”). The Repurchase Program expired on September 19, 2020. However, on October 20, 2020, the Company received notice of non-objection from the Federal Reserve Bank of Chicago to extend the Repurchase Program through October 20, 2021. Repurchases by the Company under the Repurchase Program may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means.
The actual means and timing of any repurchases, quantity of purchased shares and prices will be, subject to certain limitations, at the discretion of management and will depend on a number of factors, including, without limitation, market prices of our common stock, general market and economic conditions, and applicable legal and regulatory requirements. Repurchases under the Repurchase Program may be initiated, discontinued, suspended or restarted at any time provided that repurchases under the Repurchase Program after October 20, 2021, would require Federal Reserve non-objection or approval. We are not obligated to repurchase any shares under the Repurchase Program.
The following table presents our stock repurchases for the quarter ended March 31, 2021.
Total Number of
Maximum Number
Shares Purchased
of Shares that May
as Part of Publicly
Yet Be
(Dollars in thousands, except for per share
Shares
Price Paid
Announced Plans
Purchased Under
amounts)
Purchased (a)
per Share (b)
or Programs (c)(1)
the Plans or Programs (d)
January 1, 2021 - January 31, 2021
775,553
February 1, 2021 - February 28, 2021
249,557
11.44
525,996
March 1, 2021 - March 31, 2021
205,577
13.35
320,419
455,134
12.31
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
Item 6. Exhibits
Exhibits:
10.1
Compensation and Benefits Assurance Agreement dated as of March 16, 2021, between Old Second Bancorp, Inc. and Richard A. Gartelmann, Jr., Executive Vice President (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on March 19, 2021).
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
32.1
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.
32.2
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.
101
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at March 31, 2021, and December 31, 2020; (ii) Consolidated Statements of Income for the three months ended March 31, 2021 and 2020; (iii) Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2021 and 2020; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.*
104
Cover Page Interactive Data File (the cover page XBRL tags are embedded within the Inline XBRL document).
* 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: May 7, 2021