Old Second Bancorp - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2001

OR

o         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

OLD SECOND BANCORP, INC.

(Exact name of Registrant as specified in its charter)

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  ý  No  o

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of November 1, 2001, the Registrant had outstanding 5,719,594 shares of common stock, $1.00 par value per share.

OLD SECOND BANCORP, INC.

Form 10-Q Quarterly Report

Table of Contents

PART I – FINANCIAL INFORMATION

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

See accompanying notes to consolidated financial statements.

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except share data)

See accompanying notes to consolidated financial statements.

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2001 and 2000

(In thousands)

See accompanying notes to consolidated financial statements.

OLD SECOND BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting policies followed in the preparation of interim financial statements are consistent with those used in the preparation of annual financial information. The interim financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim periods presented.  Results for the periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001.  Unless otherwise indicated, amounts in the tables contained in these Notes are in thousands.

The Company adopted Financial Accounting Standards Board (“FASB”) Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, on January 1, 2001. Because of the Company’s minimal use of derivatives, the adoption of the Statement does not have a significant effect on earnings or the financial position of the Company.

NOTE 2 – SECURITIES

Securities available for sale are summarized as follows:

In June 2001, the FASB issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001.  Under the new rules, goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements.  Other intangible assets will continue to be amortized over their useful lives.  The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002.

NOTE 3 – LOANS

Major classifications of loans were as follows:

NOTE 4 – ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses

   as of September 30, are summarized as follows:

NOTE 5 – NOTES PAYABLE

The Company has a $40 million line of credit available with a third party bank under which $11.9 million was outstanding as of September 30, 2001 and $3.4 million was outstanding as of December 31, 2000. The note bears interest at the rate of 1% over the Federal Funds rate. This borrowing is for the purpose of funding loans held for sale at the Maple Park Mortgage subsidiary and other corporate purposes.

NOTE 6 – EARNINGS PER SHARE

Earnings per share were as follows (share data not in thousands):

NOTE 7 – COMPREHENSIVE INCOME

Comprehensive income was as follows:

OLD SECOND BANCORP, INC. AND SUBSIDIARIES

MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Old Second Bancorp is a financial services company with its main headquarters located in Aurora, Illinois.  It currently has nineteen banking locations and four mortgage banking offices located in Kane, Kendall, DeKalb, DuPage, Lake, LaSalle and Winnebago counties in Illinois.

RESULTS OF OPERATIONS

Net income for the third quarter of 2001 was $4,559,000, or 79 cents per share, compared to $3,269,000 or 56 cents per share in the third quarter of 2000. This was a 41.1% increase in earnings on a per share basis.  For the nine months ended September 30, 2000, net income was $10,163,000, or $1.72 per share, compared to $12,500,000, or $2.15 per share during the first nine months of 2001, a 25.0% increase in earnings per share.  The increase in net income for the period was primarily a result of an increase in net interest income. Noninterest income increased $3,135,000 and noninterest expenses increased $2,734,000 from the first nine months of 2000 to the first nine months of 2001. The return on equity increased to 14.10% in the first nine months of 2001, from 12.98% for the same period of 2000.

Net interest income was $12.6 million and $10.5 million during the three months ended September 30, 2001 and 2000 respectively, an increase of $1.8 million, or 20.4%.  For the nine months ended September 30, 2001, net income was $35.7 million or  $5.2 million (16.9%) higher than net interest income of $30.6 million during the similar period in 2000.  A combination of growth of earning assets and a decline in interest rates was primarily responsible for the increase in net interest income.  Interest earning assets grew from $952.3 million at the first of the year to $1.16 billion at September 30, 2001, an increase of $205.7 million or 21.6%.  Interest bearing liabilities grew $163.2 million from $783.2 to $946.4 during the same period.

The Company's net interest margin was 4.30% for the three months ended September 30, 2001, and 4.21% a year earlier.  Net interest income was $35.7 million and $30.6 million during the nine months ended September 30, 2001 and 2000, an increase of 17.0%.  The Company's net interest margin was 4.27% for the nine months ended September 30, 2001, and 4.34% a year earlier. The decline in the ratio was primarily the result of a higher cost of funds in the first six months of 2001, when compared with the first six months of 2000. The increase in the third quarter of 2001 was primarily due to a decline in the cost of funds, which began in the third quarter of 2000 and continued through September 2001.  The net interest margin was 4.30% for the three months ended September 30, 2000, compared with 4.17% in the fourth quarter of 2000, and 4.22% and 4.28%, in the first and second quarters of 2001.

The provision for loan losses amounted to $2,025,000 and $920,000 for the nine-month periods ended September 30, 2001 and 2000, respectively.  For the three-month periods ended September 30, 2001 and 2000, the provisions amounted to $755,000 and $390,000, respectively.  These provisions reflected a number of factors, including the size of the loan portfolio, the amount of past due accruing loans (90 days or more), the amount of non-accrual loans and management’s overall view on current credit quality.

Noninterest income was $5,491,000 during the third quarter of 2001 and $4,024,000 in the third quarter of 2000, an increase of $1,467,000, or 36.5%. Noninterest income was $15,728,000 during the nine months ended September 30, 2001 and $12,593,000 during the nine months ended September 30, 2000, an increase of $3,135,000 or 24.9%.  The increases in both periods were primarily due to the increase in residential mortgage originations as a result of the decrease in interest rates since December 31, 2000.  Gains on sales of mortgage loans increased to $1,897,000 in the third quarter of 2001 from $959,000 in the third quarter of 2000 and from $5,381,000 to $2,694,000 for the nine-month periods ended 2000 and 2001, respectively.

During 2000, Maple Park Mortgage sold the majority of its mortgage servicing rights. A gain of $844,000 was recorded at the time of the sale and was included in other income.   Maple Park Mortgage now sells mortgage loans on a servicing-released basis instead of retaining originated servicing rights. As a result, mortgage-servicing income declined from $332,000 in the first nine months of 2000 to $60,000 in the first nine months of 2001.  Other income was $516,000 lower in the first three quarters of 2001, due primarily to the gain on the sale of mortgage servicing rights in 2000.  Excluding the gain, other income would have increased $328,000 over the first three quarters of the prior year due to increased miscellaneous fee revenues.

Noninterest expense was $10,245,000 during the third quarter of 2001, an increase of $785,000, or 8.30%, from $9,460,000 in the third quarter of 2000. Noninterest expense was $30,265,000 for the first nine months of 2001, an increase of $2,734,000, or 9.93%, from $27,531,000 in 2000. The increase in noninterest expense was primarily the result of an increase in expenses of Maple Park Mortgage as their business increased significantly as a result of a decrease in interest rates. Salaries and benefits, which account for most of the noninterest expenses, increased $2,223,000 due to higher commissions paid by Maple Park Mortgage.

FINANCIAL CONDITION

Assets

Total assets were $1.33 billion at September 30, 2001, an increase of $183,000, or 15.94%, from $1.15 billion at December 31, 2000.

Loans

Total loans were $827.3 million as of September 30, 2001, an increase of $97.6 million for the nine-month period, from $729.7 million as of December 31, 2000. The largest increases in loan classifications were in real estate loans, which increased $83.3 million, and commercial and industrial loans, which increased $17.6 million. These changes reflect the continuing loan demand in the markets in which the Company operates.

Asset quality has improved, with nonperforming loans of $2.0 million as of September 30, 2001, down from $2.5 million as of December 31, 2000. Nonperforming loans include loans in nonaccrual status, renegotiated loans, and loans past due ninety days or more and still accruing.The provision for loan losses was $2,025,000 for the first nine months of 2001 and $920,000 for the first nine months of 2000. One measure of the adequacy of the allowance for loan losses is the ratio of the allowance to total loans. The allowance for loan losses as a percentage of total loans was 1.38% as of September 30, 2001, compared to 1.33% as of December 31, 2000. In management's judgment, an adequate allowance for estimated losses has been established, however there can be no assurance that such losses will not exceed the estimated amounts in the future.  Management, along with other financial institutions, shares a concern for the possible continued softening of the economy.  Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of non-performing loans, charge-offs and delinquencies could rise.

Securities

Securities totaled $333.1 million as of September 30, 2001, an increase of $14.4 million from $318.7 million as of December 31, 2000.  The net unrealized gains in the portfolio increased from $2.4 million as of December 31, 2000 to $10.3 million as of September 30, 2001.

Deposits and Borrowing

Total deposits were $1,126.8 million as of September 30, 2001, an increase of $130.4 million from $996.5 million as of December 31, 2000. Savings deposits, which include money market accounts, increased $70.10 million during the third quarter and demand deposits increased from $146.6 million to $154.8 million.  Time deposits declined $24.0 million to $398,000 during this period.

Securities sold under repurchase agreements, which are typically of short-term duration, increased from $21.2 million as of December 31, 2000, to $39.3 million as of September 30, 2001. Other short-term borrowings, which primarily consists of treasury tax and loan notes, increased from $2.5 million to $13.6 million as of September 30, 2001. The Company also uses notes payable, primarily as a means of financing loans held for sale at the Maple Park Mortgage subsidiary. In order to fund the significant growth in loans, notes payable increased from $3.4 million as of December 31, 2000, to $11.9 million as of September 30, 2001.

Capital

In June 1999, the Company announced that the board of directors had authorized the repurchase of up to 300,000 shares of the Company’s common stock, or 4.9% of the company’s 6,102,362 shares outstanding. On April 19, 2000, the Company announced that the board of directors had authorized the purchase of up to an additional 300,000 shares, bringing the total number of shares authorized to 600,000.  The purchase of 124,500 shares during 2001, together with 190,236 and 81,500 shares purchased during 2000 and 1999 respectively, total 396,236 shares repurchased.

The Company and its three subsidiary banks (the “Banks”) are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines provide for five classifications, the highest of which is well capitalized. The Company and the Banks were categorized as well capitalized as of September 30, 2001. The accompanying table shows the capital ratios of the Company and Old Second National Bank as of September 30, 2001.

Capital levels and minimum required levels:

Liquidity

Liquidity measures the ability of the Company to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers' credit needs. The liquidity of the Company principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and its ability to borrow funds in the money or capital markets.

Net cash inflow from operating activities was $9.3 million in the first nine months of 2001 compared to the net cash inflow of $22.2 million in the first nine months of 2000. Theincrease in inflows is directly related to the increased loan activity of Maple Park Mortgage.  Interest received net of interest paid was the principal source of operating cash inflows in both periods reported. In addition, the sale of mortgage servicing rights resulted in a gain $844,000 for the first half of 2000.  Management of investing and financing activities, and market conditions, determine 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, so that balance sheet growth is the principle determinant of growth in net interest cash flows.

Net cash outflows from investing activities were $107.6 million in the nine months ended September 30, 2001, compared to $124.4 million a year earlier. In the first nine months of 2001, net principal disbursed on loans accounted for net outflows of $98.0 million, and securities transactions aggregated a net outflow of $6.6 million. In the first nine months of 2000, net principal disbursed on loans accounted for a net outflow of $97.9 million, and securities transactions resulted in net outflows of $31.6 million. The sale of mortgage servicing rights resulted in net cash inflows of $8.3 million.

Cash inflows from financing activities included an increase in deposits of $130.4 million in the first nine months of 2001. This compares with a net inflow associated with deposits of $147.5 million during the first three quarters of 2000. Short-term borrowing resulted in net cash inflows of $29.2 in the nine months of 2001, and inflows of $8.7 million in the nine months of 2000. Net cash inflows associated with notes payable totaled $8.5 million in the first nine months of 2001 compared to outflows of $6.4 million in the first nine months of 2000.

The impact of movements in general market interest rates on a financial institution’s financial condition, including capital adequacy, earnings, and liquidity, is known as interest rate risk. Interest rate risk is the Company’s primary market risk. As a financial institution, accepting and managing this risk is an inherent aspect of the Company’s business. However, safe and sound management of interest rate risk requires that it be maintained at prudent levels.

The Company analyzes interest rate risk by examining the extent to which assets and liabilities are interest rate sensitive. The interest sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest sensitive assets exceeds the amount of interest sensitive liabilities. A gap is considered negative when the amount of interest sensitive liabilities exceeds the amount of interest sensitive assets. During a period of rising interest rates, a negative gap would tend to result in a decrease in net interest income while a positive gap would tend to positively affect net interest income. The Company's policy is to manage the balance sheet such that fluctuations in the net interest margin are minimized regardless of the level of interest rates.

The accompanying table does not necessarily indicate the future impact of general interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. As a result, assets and liabilities indicated as repricing within the same period may in fact reprice at different times and at different rate levels. Assets and liabilities are reported in the earliest time frame in which maturity or repricing may occur. Although securities available for sale are reported in the earliest time frame in which maturity or repricing may occur, these securities may be sold in response to changes in interest rates or liquidity needs.

Expected Maturity of Interest-Earning Assets and Interest-Bearing Liabilities