Table of Contents
I
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2024
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 000-10537
(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)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
OSBC
The Nasdaq Stock Market
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 ☒
As of August 6, 2024, the Registrant has 44,849,591 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
39
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
63
Item 4.
Controls and Procedures
64
PART II
Legal Proceedings
65
Item 1.A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosure
66
Item 5.
Other Information
Item 6.
Exhibits
67
Signatures
68
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, but not limited to, management’s expectations regarding future plans, strategies and financial performance, including regulatory developments, industry and economic trends and estimates and assumptions underlying accounting policies. Forward-looking statements are based on our current beliefs, expectations and assumptions and on information currently available and, can be identified by the use of words such as “expects,” “intends,” “believes,” “may,” “will,” “would,” “could,” “should,” “plan,” “anticipate,” “estimate,” “possible,” “likely” or the negative thereof as well as other similar words and expressions of the future. Forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict as to timing, extent, likelihood and degree of occurrence, which could cause our actual results to differ materially from those anticipated in or by such statements. Potential risks and uncertainties include, but are not limited to, the following:
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)
June 30,
December 31,
2024
2023
Assets
Cash and due from banks
$
54,888
55,534
Interest earning deposits with financial institutions
66,004
44,611
Cash and cash equivalents
120,892
100,145
Securities available-for-sale, at fair value
1,173,661
1,192,829
Federal Home Loan Bank Chicago (“FHLBC”) and Federal Reserve Bank Chicago (“FRBC”) stock
32,005
33,355
Loans held-for-sale
2,291
1,322
Loans
3,976,595
4,042,953
Less: allowance for credit losses on loans
42,269
44,264
Net loans
3,934,326
3,998,689
Premises and equipment, net
82,871
79,310
Other real estate owned
6,920
5,123
Mortgage servicing rights, at fair value
10,488
10,344
Goodwill
86,478
Core deposit intangible
10,063
11,217
Bank-owned life insurance (“BOLI”)
110,535
109,318
Deferred tax assets, net
28,710
31,077
Other assets
63,460
63,592
Total assets
5,662,700
5,722,799
Liabilities
Deposits:
Noninterest bearing demand
1,728,487
1,834,891
Interest bearing:
Savings, NOW, and money market
2,161,426
2,207,949
Time
631,815
527,906
Total deposits
4,521,728
4,570,746
Securities sold under repurchase agreements
46,542
26,470
Other short-term borrowings
330,000
405,000
Junior subordinated debentures
25,773
Subordinated debentures
59,425
59,382
Other liabilities
59,897
58,147
Total liabilities
5,043,365
5,145,518
Stockholders’ Equity
Common stock
44,908
44,705
Additional paid-in capital
204,012
202,223
Retained earnings
432,037
393,311
Accumulated other comprehensive loss
(60,769)
(62,781)
Treasury stock
(853)
(177)
Total stockholders’ equity
619,335
577,281
Total liabilities and stockholders’ equity
June 30, 2024
December 31, 2023
Common
Stock
Par value
1.00
Shares authorized
60,000,000
Shares issued
44,907,619
44,705,150
Shares outstanding
44,849,591
44,697,917
Treasury shares
58,028
7,233
See accompanying notes to consolidated financial statements.
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended June 30,
Six Months Ended June 30,
Interest and dividend income
Loans, including fees
62,151
61,561
124,824
118,771
19
33
31
Securities:
Taxable
8,552
9,930
16,644
20,665
Tax exempt
1,292
1,337
2,598
2,674
Dividends from FHLBC and FRBC stock
584
396
1,219
676
Interest bearing deposits with financial institutions
625
643
1,235
1,228
Total interest and dividend income
73,223
73,886
146,553
144,045
Interest expense
Savings, NOW, and money market deposits
4,317
1,742
8,354
2,891
Time deposits
4,961
1,156
9,002
1,820
83
7
169
16
3,338
5,160
7,895
7,505
288
281
568
560
546
1,092
Senior notes
-
1,414
2,408
Notes payable and other borrowings
87
Total interest expense
13,533
10,306
27,080
16,379
Net interest and dividend income
59,690
63,580
119,473
127,666
Provision for credit losses
3,750
2,000
7,250
5,501
Net interest and dividend income after provision for credit losses
55,940
61,580
112,223
122,165
Noninterest income
Wealth management
2,779
2,458
5,340
4,728
Service charges on deposits
2,508
2,362
4,923
4,786
Secondary mortgage fees
76
115
135
Mortgage servicing rights mark to market (loss) gain
(238)
96
(144)
(429)
Mortgage servicing income
513
499
1,001
1,015
Net gain on sales of mortgage loans
468
398
782
704
Securities (losses) gains, net
(1,547)
1
(3,222)
Change in cash surrender value of BOLI
820
418
1,992
660
Death benefit realized on BOLI
893
Card related income
2,577
2,690
4,953
4,934
Other income
742
773
1,772
2,262
Total noninterest income
11,127
8,223
21,628
15,573
Noninterest expense
Salaries and employee benefits
23,424
21,798
47,736
44,046
Occupancy, furniture and equipment
3,899
3,639
7,826
7,114
Computer and data processing
2,184
1,290
4,439
3,064
FDIC insurance
616
794
1,283
1,378
Net teller & bill paying
578
515
1,099
1,017
General bank insurance
312
306
621
611
Amortization of core deposit intangible
574
618
1,154
1,242
Advertising expense
472
103
664
245
Card related expense
1,323
1,222
2,600
2,438
Legal fees
238
283
464
602
Consulting & management fees
797
520
1,133
1,310
Other real estate expense, net
(87)
(98)
(41)
208
Other expense
3,547
3,840
7,140
7,477
Total noninterest expense
37,877
34,830
76,118
70,752
Income before income taxes
29,190
34,973
57,733
66,986
Provision for income taxes
7,299
9,411
14,530
17,817
Net income
21,891
25,562
43,203
49,169
Basic earnings per share
0.48
0.57
0.96
1.10
Diluted earnings per share
0.56
0.95
1.08
Dividends declared per share
0.05
0.10
6
Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
Net Income
Unrealized holding gains (losses) on available-for-sale securities arising during the period
2,405
(8,360)
1,529
7,850
Related tax (expense) benefit
(673)
2,342
(428)
(2,194)
Holding gains (losses), after tax, on available-for-sale securities
1,732
(6,018)
1,101
5,656
Less: Reclassification adjustment for the net gains (losses) realized during the period
Net realized (losses) gains
Related tax benefit
434
905
Net realized (losses) gains, after tax
(1,113)
(2,317)
Other comprehensive income (loss) on available-for-sale securities
(4,905)
1,100
7,973
Changes in fair value of derivatives used for cash flow hedges
1,194
(3,017)
1,246
(1,415)
(334)
836
380
Other comprehensive income (loss) on cash flow hedges
860
(2,181)
912
(1,035)
Total other comprehensive income (loss)
2,592
(7,086)
2,012
6,938
Total comprehensive income
24,483
18,476
45,215
56,107
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, April 1, 2023
(76,014)
(3,086)
(79,100)
Other comprehensive loss, net of tax
Balance, June 30, 2023
(80,919)
(5,267)
(86,186)
Balance, April 1, 2024
(61,222)
(2,139)
(63,361)
Other comprehensive income, net of tax
Balance, June 30, 2024
(59,490)
(1,279)
For the Six Months Ended
Balance, January 1, 2023
(88,892)
(4,232)
(93,124)
Other comprehensive income (loss), net of tax
Balance, January 1, 2024
(60,590)
(2,191)
Consolidated Statements of Cash Flows
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium / discount amortization on securities
1,544
1,626
Securities (gains) losses, net
(1)
3,222
Originations of loans held-for-sale
(22,114)
(24,570)
Proceeds from sales of loans held-for-sale
21,650
24,271
Net gains on sales of mortgage loans
(782)
(704)
Mortgage servicing rights mark to market loss
144
429
Net accretion of discount on loans and unfunded commitments
(258)
(2,093)
Net change in cash surrender value of BOLI
(1,992)
(660)
Net gains on sale of other real estate owned
(259)
(158)
Provision for other real estate owned valuation losses
269
Depreciation of fixed assets and amortization of leasehold improvements
2,721
2,135
Net gains on disposal and transfer of fixed assets
(635)
Amortization of core deposit intangibles
Change in current income taxes receivable
(17)
(456)
Deferred tax expense
1,605
2,204
Change in accrued interest receivable and other assets
1,191
(50,594)
Accretion of purchase accounting adjustment on time deposits
(106)
(701)
Change in accrued interest payable and other liabilities
1,998
(5,709)
Stock based compensation
2,107
1,774
Net cash provided by operating activities
59,038
5,562
Cash flows from investing activities
Proceeds from maturities and calls, including pay down of securities available-for-sale
171,708
73,981
Proceeds from sales of securities available-for-sale
5,331
140,166
Purchases of securities available-for-sale
(157,886)
(4,186)
Net redemptions (purchases) of FHLBC/FRBC stock
1,350
(16,200)
Net change in loans
53,983
(143,966)
Purchases of BOLI policies
(460)
Proceeds from claims on BOLI, net of claims receivable
Proceeds from sales of other real estate owned, net of participations and improvements
1,850
1,165
Proceeds from disposition of premises and equipment
1,105
Net purchases of premises and equipment
(6,293)
(3,047)
Net cash provided by investing activities
70,818
49,018
Cash flows from financing activities
Net change in deposits
(48,912)
(392,440)
Net change in securities sold under repurchase agreements
20,072
(624)
Net change in other short-term borrowings
(75,000)
395,000
Repayment of term note
(9,000)
Repayment of senior notes
(45,000)
Dividends paid on common stock
(4,478)
Purchase of treasury stock
(791)
(605)
Net cash used in financing activities
(109,109)
(57,147)
Net change in cash and cash equivalents
20,747
(2,567)
Cash and cash equivalents at beginning of period
115,177
Cash and cash equivalents at end of period
112,610
8
Consolidated Statements of Changes in
Additional
Other
Paid-In
Retained
Treasury
Stockholders’
Capital
Earnings
(Loss) Income
Equity
200,121
331,890
(746)
496,870
Dividends declared on common stock, ($0.05 per share)
(2,233)
842
200,963
355,219
513,955
203,129
412,388
(905)
596,159
(2,242)
Vesting of restricted stock
(67)
950
Purchase of treasury stock from taxes withheld on stock awards
(15)
202,276
310,512
(3,228)
461,141
Dividends declared on common stock, ($0.10 per share)
(4,462)
(3,087)
3,087
(4,477)
203
(318)
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 June 30, 2024, are not necessarily indicative of the results that may be expected for the year ending December 31, 2024. These interim consolidated financial statements and accompanying notes 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, 2023. 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
The following is a summary of recent accounting pronouncements that have impacted or could potentially affect the Company:
ASU 2023-06 – On October 9, 2023, the FASB issued ASU 2023-06 “Disclosure Improvements: Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative.” The amendments in the ASU modify the disclosure or presentation requirements of a variety of topics in the codification. Certain of the amendments represent clarifications to, or technical corrections of, the current requirements. Each amendment in the ASU will only become effective if the SEC removes the related disclosure or presentation requirement from its existing regulations by June 30, 2027. The amendments in this ASU are not expected to have a material impact on the financial statements of the Company.
ASU 2023-09 – On December 14, 2023, the FASB issued ASU 2023-09 “Income Taxes (Topic 740): Improvements to Income Tax Disclosures.” The amendments require that public business entities on an annual basis (1) disclose specific categories in the rate reconciliation, and (2) provide additional information for reconciling items that meet a quantitative threshold (if the effect of those reconciling items is equal to or greater than 5 percent of the amount computed by multiplying pretax income (or loss) by the applicable statutory income tax rate). The amendments require that all entities disclose on an annual basis the following information about income taxes paid: (1) The amount of income taxes paid (net of refunds received) disaggregated by federal (national), state, and foreign taxes, and (2) The amount of income taxes paid (net of refunds received) disaggregated by individual jurisdictions in which income taxes paid (net of refunds received) is equal to or greater than 5 percent of total income taxes paid (net of refunds received). The amendments also require that all entities disclose the following information: (1) Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign, and (2) Income tax expense (or benefit) from continuing operations disaggregated by federal (national), state, and foreign. The ASU is effective for public business entities for annual periods beginning after December 15, 2024. Early adoption is permitted for annual financial statements that have not yet been issued or made available for issuance. The amendments should be applied on a prospective basis. Retrospective application is permitted. The Company will adopt this ASU for the reporting period beginning January 1, 2025, and does not expect the amendments to have a material impact to the financial statements of the Company.
ASU 2024-01 – On March 21, 2024, the FASB issued ASU 2024-01 “Compensation - Stock Compensation (Topic 718) - Scope Application of Profits Interest and Similar Awards,” which clarifies how an entity determines whether a profits interest or similar award is within the scope of Topic 718 or is not a share-based payment arrangement and, therefore is within the scope of other guidance. ASU 2024-01 provides an illustrative example with multiple fact patterns and also amends certain language in the “Scope” and “Scope Exceptions” sections of Topic 718 to improve its clarity and operability without changing the guidance. Entities can apply the amendments either retrospectively to all prior periods presented in the financial statements or prospectively to profits interest and similar awards granted or modified on or after the date of adoption. If prospective application is elected, an entity must disclose the nature of and reason for the change in accounting principle. ASU 2024-01 is effective January 1, 2025, including interim periods, and is not expected to have a material impact on the financial statements of the Company.
10
ASU 2024-02 – On March 29, 2024, the FASB issued ASU 2024-02 “Codification Improvements – Amendments to Remove References to the Concepts Statements” amends the codification to remove references to various concept statements and impacts a variety of topics in the codification. The amendments apply to all reporting entities within the scope of the affected accounting guidance, but in most instances the references removed are extraneous and not required to understand or apply the guidance. Generally, the amendments in ASU 2024-02 are not intended to result in significant accounting changes for most entities. ASU 2024-02 is effective January 1, 2025, and is not expected to have a material impact the financial statements of the Company.
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, 2023. 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 second quarter of 2024, the Company had no changes to significant accounting policies or estimates.
Subsequent Events
On July 16, 2024, our Board of Directors declared a cash dividend of $0.05 per share of common stock payable on August 5, 2024, to stockholders of record as of July 26, 2024; dividends of $2.2 million were paid to stockholders on August 5, 2024.
11
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 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 $17.1 million at June 30, 2024, and $18.5 million at December 31, 2023. FRBC stock was recorded at $14.9 million at June 30, 2024, and December 31, 2023.
The following tables summarize the amortized cost and fair value of the securities portfolio at June 30, 2024, and December 31, 2023, 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
193,615
146
(2,487)
191,274
U.S. government agencies
39,653
(2,355)
37,298
U.S. government agencies mortgage-backed
109,490
(12,618)
96,872
States and political subdivisions
232,373
470
(12,578)
220,265
Collateralized mortgage obligations
436,623
321
(50,889)
386,055
Asset-backed securities
67,634
(2,763)
64,877
Collateralized loan obligations
176,897
195
(72)
177,020
Total securities available-for-sale
1,256,285
1,138
(83,762)
174,602
(5,028)
169,574
60,011
(3,052)
56,959
118,492
(12,122)
106,370
236,072
1,325
(10,332)
227,065
442,987
421
(50,864)
392,544
71,616
42
68,436
173,201
30
(1,350)
171,881
1,276,981
1,818
(85,970)
1 Excludes accrued interest receivable of $6.7 million and $6.6 million at June 30, 2024 and December 31, 2023, respectively, that is recorded in other assets on the consolidated balance sheets.
12
The fair value, amortized cost and weighted average yield of debt securities at June 30, 2024, 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
122,815
1.69
%
120,302
Due after one year through five years
127,580
3.63
125,243
Due after five years through ten years
58,374
2.77
53,383
Due after ten years
156,872
3.11
149,909
465,641
2.84
448,837
Mortgage-backed and collateralized mortgage obligations
546,113
2.52
482,927
4.08
6.98
3.35
At June 30, 2024, the Company had no securities issued from any one originator, other than the U.S. Government and its agencies, which individually amounted to over 10% of the Company’s stockholders’ equity.
Securities with unrealized losses with no corresponding allowance for credit losses at June 30, 2024, and December 31, 2023, 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
U.S. Treasuries
29,806
2,475
97,328
2,487
127,134
2,355
128
12,618
763
86,106
35
11,815
125,519
12,578
211,625
142
50,889
349,308
5,064
18
2,753
59,306
20
2,763
64,370
59
32,944
13
28,279
72
61,223
40
844
153,920
337
82,918
793,910
377
83,762
947,830
5,028
3,052
12,122
137
27,974
25
10,195
106,138
37
10,332
134,112
734
143
50,856
376,236
145
50,864
376,970
63,941
150,902
14
28,708
353
85,825
1,030,120
367
85,970
1,058,828
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. The portfolio continues to consist of a mix of fixed and floating-rate, high quality securities, largely rated AA (or better), displaying an overall effective duration of approximately 3.0 years. No credit losses were determined to be present as of June 30, 2024, as there was no credit quality deterioration noted. Therefore, no provision for credit losses on securities was recognized for the second quarter of 2024.
The following table presents net realized gains (losses) on securities available-for-sale for three and six months ended:
Three Months Ended
Six Months Ended
Proceeds from sales of securities
73,996
Gross realized gains on securities
Gross realized losses on securities
Income tax benefit on net realized losses
Effective tax rate applied
N/M
28.1
N/M – Not meaningful.
As of June 30, 2024, securities valued at $762.2 million were pledged for borrowings and for other purposes, a decrease from $810.2 million of securities pledged at year-end 2023.
Note 3 – Loans and Allowance for Credit Losses on Loans
Major segments of loans were as follows:
Commercial
809,443
841,697
Leases
452,957
398,223
Commercial real estate – investor
1,014,345
1,034,424
Commercial real estate – owner occupied
745,938
796,538
Construction
185,634
165,380
Residential real estate – investor
50,371
52,595
Residential real estate – owner occupied
218,974
226,248
Multifamily
388,743
401,696
HELOC
99,037
103,237
Other 1
11,153
22,915
Total loans
Allowance for credit losses on loans
(42,269)
(44,264)
Net loans 2
1 The “Other” segment includes consumer loans and overdrafts in this table and in subsequent tables within Note 3 – Loans and Allowance for Credit Losses on Loans.
2 Excludes accrued interest receivable of $19.4 million and $20.5 million at June 30, 2024, and December 31, 2023, respectively, that is recorded in other assets on the consolidated balance sheets.
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 ensure 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 68.0% and 68.8% of the portfolio at June 30, 2024, and December 31, 2023, respectively, and include a mix of owner occupied and non-owner occupied commercial real estate, 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 and six months ended June 30, 2024 and 2023:
Provision for
Beginning
(Release of)
Ending
Allowance for credit losses
Balance
Credit Losses
Charge-offs
Recoveries
Three months ended June 30, 2024
6,382
327
22
6,728
2,959
(900)
81
1,978
16,270
6,132
4,580
17,842
10,992
(2,650)
1,281
119
7,180
1,097
923
2,020
636
(30)
609
1,660
(51)
1,618
2,593
211
2,804
1,508
(40)
15
1,483
28
29
44,113
3,950
6,011
217
Six months ended June 30, 2024
3,998
2,653
95
2,952
(933)
17,105
5,230
4,596
12,280
(70)
5,168
138
1,038
982
669
(65)
1,821
(220)
17
2,728
1,656
(205)
32
46
136
80
7,494
9,999
510
Three months ended June 30, 2023
11,511
319
82
11,532
2,766
(83)
15,260
4,822
71
20,031
15,576
(2,816)
201
12,562
1,045
134
1,179
746
(8)
743
1,722
110
36
1,868
2,665
2,737
1,788
(118)
24
1,694
313
(5)
51
278
53,392
2,427
733
228
55,314
Six months ended June 30, 2023
11,968
(262)
407
233
2,865
691
882
10,674
9,391
15,001
(2,243)
1,546
(367)
768
(49)
2,046
(224)
2,453
284
1,806
(165)
53
23
194
49,480
7,079
1,755
At June 30, 2024, our allowance for credit losses (“ACL”) on loans totaled $42.3 million, and our ACL on unfunded commitments, included in other liabilities, totaled $2.5 million. During the first six months of 2024, we recorded net provision for credit losses on loans of $7.5 million based on historical loss rate updates driven by higher charge offs in commercial real estate-investor, downward risk rating migration, and our assessment of estimated future credit losses. The ACL on loans excludes an allowance for unfunded commitments of $2.5 million as of June 30, 2024, and $2.7 million as of both December 31, 2023, and June 30, 2023, which is recorded within other liabilities.
Generally, the Bank considers a loan to be collateral dependent when, based on current information and events, it is probable that foreclosure could be initiated. Additionally, the Bank will review all loans meeting the criteria for individual analysis, to determine if repayment or satisfaction of the loan is expected through the sale of collateral. This will generally be the case for credits with high loan-to-values. Exceptions to this policy would include loans with guarantors or sponsors that have the means and willingness to support the obligation. Non-accruing loans with an outstanding balance of $500,000 or more are assessed on an individual loan level basis. When a financial asset is deemed collateral-dependent, the level of credit loss is measured by the difference between amortized cost of the financial asset and the fair value of collateral adjusted for estimated cost to sell. The Company had $38.5 million and $63.1 million of collateral dependent loans secured by real estate or business assets as of June 30, 2024, and December 31, 2023, respectively.
The following tables present the collateral dependent loans and the related ACL allocated by segment of loans as of June 30, 2024, and December 31, 2023:
Accounts
ACL
Real Estate
Receivable
Equipment
Allocation
825
508
1,227
2,560
1,229
9,955
3,482
17,207
5,739
732
523
1,640
839
62
35,965
38,525
5,443
837
1,634
320
15,735
3,656
34,894
3,900
7,162
422
1,506
1,402
61,997
63,115
7,878
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
Past Due
Due
Current
Total Loans
Accruing
914
3,127
4,883
804,560
479
451
108
451,919
8,150
710
838
9,698
1,004,647
2,103
20,733
22,944
722,994
4,835
5,740
179,894
49,750
390
70
1,870
2,330
216,644
235
1,054
1,289
387,454
371
309
98,294
74
12,642
4,529
32,115
49,286
3,927,309
4,909
2,210
839,487
1,155
599
347
946
397,277
1,209
6,087
7,296
1,027,128
3,726
15,645
21,474
775,064
2,540
307
7,161
10,008
155,372
540
579
168
1,287
51,308
553
125
1,944
2,622
223,626
1,085
1,318
400,378
565
1,396
2,230
101,007
41
22,914
10,176
6,134
33,082
49,392
3,993,561
1,196
The table presents all nonaccrual loans as of June 30, 2024, and December 31, 2023:
Nonaccrual loan detail
With no ACL
2,654
1,427
870
639
318
9,954
2,481
16,572
8,926
17,256
34,946
8,429
1,280
1,331
2,599
3,078
1,395
1,775
795
1,210
41,957
33,257
67,583
33,099
The Company recognized $2,000 and $36,000 of interest on nonaccrual loans during the three months and six months ended June 30, 2024, respectively.
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 June 30, 2024, were as follows:
2022
2021
2020
Prior
RevolvingLoans
RevolvingLoansConvertedTo TermLoans
Pass
115,506
264,234
111,600
25,429
9,219
18,900
221,006
765,894
Special Mention
227
2,043
2,771
50
19,316
24,407
Substandard
6,227
12,751
19,142
Total commercial
264,481
119,870
28,344
9,269
253,073
131,338
186,396
87,390
31,893
10,335
3,290
450,642
300
775
947
2,031
Total leases
186,696
88,449
32,840
3,299
55,037
190,938
334,504
188,015
93,138
104,176
7,398
973,206
4,200
1,645
5,272
16,936
12,249
36,939
Total commercial real estate – investor
192,583
193,052
98,410
121,112
19,647
17,675
131,499
150,692
159,537
86,192
113,781
14,700
674,076
18,605
2,844
2,026
23,475
13,560
12,925
17,067
48,387
Total commercial real estate – owner occupied
182,857
167,216
99,117
132,874
15,841
44,518
90,851
26,377
91
1,614
254
179,546
348
Total construction
96,939
1,321
3,908
14,032
7,851
6,062
13,199
2,089
48,462
566
378
902
1,343
Total residential real estate – investor
14,410
8,480
14,101
9,551
31,099
36,751
38,750
23,967
75,320
802
216,240
101
2,633
2,734
Total residential real estate – owner occupied
24,068
77,953
16,590
76,747
70,903
115,700
39,835
51,594
371,943
9,990
1,135
3,337
514
1,824
6,810
Total multifamily
72,038
129,027
40,349
53,418
1,471
2,629
2,421
430
1,469
4,167
85,425
98,012
287
698
1,025
Total HELOC
1,509
4,454
86,123
2,800
1,953
1,401
884
129
3,889
11,152
Total other
3,890
367,130
933,921
900,545
594,866
270,404
386,170
336,137
3,789,173
527
21,771
21,318
2,035
65,017
1,665
27,324
9,216
18,852
39,649
25,699
122,405
936,113
949,640
625,400
289,306
427,854
381,152
Credit quality indicators by loan segment and loan origination date at December 31, 2023, were as follows:
2019
318,569
136,668
35,901
11,983
18,390
3,426
298,931
1,408
825,276
707
171
4,392
8,007
2,099
199
5,970
8,414
141,504
36,754
12,154
18,589
309,293
219,163
113,074
42,275
14,663
6,975
1,255
397,405
818
113,481
42,478
7,183
159,654
367,512
218,084
108,384
54,322
63,281
8,122
979,359
11,267
5,327
15,658
9,648
12,327
43,798
230,189
113,711
69,980
72,929
20,449
124,059
134,383
177,553
103,109
42,839
91,062
33,243
706,248
1,650
17,415
9,585
3,128
218
3,681
35,677
14,630
18,817
4,571
14,809
1,786
54,613
125,709
166,428
205,955
110,808
57,866
96,529
42,808
66,513
32,942
100
1,593
1,083
3,186
148,225
9,993
17,155
10,093
8,245
5,062
14,434
9,027
6,508
8,469
51,198
408
533
14,824
9,093
6,916
32,574
41,528
40,335
25,322
14,233
68,277
223,032
191
685
2,340
3,216
25,513
14,918
70,617
55,310
79,060
123,834
72,539
12,231
40,825
562
384,361
13,425
322
15,560
1,009
766
80,237
137,259
72,861
13,876
41,591
2,735
2,679
490
1,757
1,756
2,995
89,161
101,573
184
1,389
1,664
2,704
491
1,798
1,780
3,179
90,550
4,060
2,278
1,569
153
85
73
14,697
963,994
958,129
682,010
344,237
158,932
280,746
450,136
3,839,592
20,320
35,050
3,621
1,863
70,577
18,560
20,005
20,123
31,991
22,419
19,686
132,784
965,644
997,009
737,065
367,981
192,786
306,846
474,214
The gross charge-offs activity by loan type and year of origination for the six months ended June 30, 2024 and June 30, 2023, were as follows:
RevolvingLoansConverted To TermLoans
4,128
452
5,135
4,156
5,640
187
364
43
179
159
895
274
372
202
The Company had $431,000 and $170,000 in residential real estate loans in the process of foreclosure as of June 30, 2024, and December 31, 2023, respectively.
There were six loans modified during the six-month period ending June 30, 2024, totaling $16.4 million in aggregate, which were experiencing financial difficulty. There were eleven loans modified during the six-month period ending June 30, 2023, totaling $32.7 million in aggregate, which were experiencing financial difficulty. There were no modified loans experiencing financial difficulty in payment default as of June 30, 2024, and June 30, 2023.
The following tables present the amortized costs basis of loans at June 30, 2024, and June 30, 2023, that were both experiencing financial difficulty and modified during the period ended June 30, 2024, and June 30, 2023, by class and by type of modification. The percentage of the amortized cost basis of loans that were modified to borrowers in financial distress as compared to the amortized cost basis of each class of financing receivable is also presented below.
Term Extension
Combination - Term Extension, Interest Rate Modification, Payment Modification, and Principal Reduction
Combination - Term Extension and Interest Rate Modification
Combination - Term Extension and Payment Modification (1)
Total Loans Modified
% of Total Loan Segment Modified to Total Loan Segment
247
0.0%
12,156
3,269
212
16,128
2.2%
12,403
16,375
0.4%
21
June 30, 2023
Combination - Term Extension and Payment Modification 1
859
979
1,838
0.2%
12,664
14,438
1.3%
16,318
2.0%
60
0.1%
29,901
32,654
8.0%
1 Payment modifications are either contractual delays in payment or a modification of the payment amount.
The Company closely monitors the performance of loan modifications to borrowers experiencing financial difficulty. The following tables present the performance of loans that have been modified as of June 30, 2024, and June 30, 2023.
30-59 days past due
60-89 Days Past Due
90 Days or Greater Past Due
Total Past Due
30,880
The following tables summarize the financial effect of the loan modifications presented above to borrowers experiencing financial difficulty for the period ended June 30, 2024, and June 30, 2023. The Company had two loans that had a payment modification as of June 30, 2024. One had an increase of monthly payment until maturity and the other had a reduction of monthly payment until maturity; the financial impact of these modifications is immaterial. As of June 30, 2023, there was one loan that had a payment modification to a single payment at maturity.
Weighted-Average Term Extension (In Months)
Weighted-Average Interest Rate Change
Weighted-Average Delay of Payment (In Months)
4.00
5.12
0.33
5.10
4.90
5.00
11.50
7.00
12.00
24.00
11.40
Note 4 – Other Real Estate Owned
Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation reserve, for the periods presented are itemized in the following table:
Balance at beginning of period
1,561
Property additions, net of acquisition adjustments
3,388
185
476
Less:
Proceeds from property disposals, net of participation purchase and gains/losses
1,591
679
1,007
Period valuation write-down
Balance at end of period
761
Activity in the valuation allowance was as follows:
118
853
856
Provision for unrealized losses
Reductions taken on sales
(739)
(1,011)
114
Expenses related to OREO, net of lease revenue, includes:
Gain on sales, net
(186)
Operating expenses
239
92
352
Lease revenue
Net OREO expense
Note 5 – Deposits
Major classifications of deposits were as follows:
Savings
908,826
971,334
NOW accounts
557,469
565,375
Money market accounts
695,131
671,240
Certificates of deposit of less than $100,000
304,195
266,035
Certificates of deposit of $100,000 through $250,000
223,137
180,289
Certificates of deposit of more than $250,000
104,483
81,582
Note 6 – Borrowings
The following table is a summary of borrowings as of June 30, 2024, and December 31, 2023. Junior subordinated debentures are discussed in more detail in Note 7.
Junior subordinated debentures1
Total borrowings
461,740
516,625
1 See Note 7: Junior Subordinated Debentures.
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 $46.5 million at June 30, 2024, and $26.5 million at December 31, 2023. The fair value of the pledged collateral was $73.6 million at June 30, 2024, and $45.7 million at December 31, 2023. At June 30, 2024, there were no customers with secured balances exceeding 10% of stockholders’ equity.
The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC. Total borrowings are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans. As of June 30, 2024, the Bank had $330.0 million in short-term advances outstanding under the FHLBC, and $405.0 million in short-term advances as of December 31, 2023. FHLBC stock held at June 30, 2024, was valued at $17.1 million, and any potential FHLBC advances were collateralized by loans and securities with a principal balance of $1.38 billion, which carried a FHLBC-calculated combined collateral value of $933.9 billion. The Company had excess collateral of $603.9 million available to secure borrowings at June 30, 2024.
In the second quarter of 2021, we 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 Company used the net proceeds from the offering for general corporate purposes. The Notes 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 Secured Overnight Financing Rate (“SOFR”) (as defined by the Note) plus 273 basis points, payable quarterly in arrears. As of June 30, 2024, and December 31, 2023, we had $59.4 million of subordinated debentures outstanding, net of deferred issuance cost.
The Company issued senior notes in December 2016 with a ten-year maturity, and terms included interest payable semiannually at 5.75% for five years. Beginning December 31, 2021, the senior debt began to pay interest at a floating rate, with interest payable quarterly at three month LIBOR plus 385 basis points. The notes were 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. On June 30, 2023, we redeemed all of the $45.0 million senior notes, at which point the interest rate was 9.39%. Upon redemption, the related deferred debt issuance costs of $362,000 was also recorded as interest expense, resulting in an effective cost of this debt issuance of 12.85% for the second quarter of 2023.
On February 24, 2020, the Company originated a $20.0 million three-year term note with a correspondent bank. The term note was issued at one-month LIBOR plus 175 basis points, and required principal payments quarterly and interest payments monthly. This note was included within Notes payable and other borrowings on the Consolidated Balance Sheets, and the remaining $9.0 million balance of the note was paid off on February 24, 2023. The Company also has an undrawn line of credit of $30.0 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
The Company issued $25.0 million of cumulative trust preferred securities through a private placement completed by an unconsolidated subsidiary, Old Second Capital Trust II, in April 2007. These trust preferred securities mature in 30 years, but subject to 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 now have a floating rate of 150 basis points over three-month SOFR. Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 4.49% and 4.37% for the quarters ended June 30, 2024, and June 30, 2023, respectively. The Company issued a $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 Sheets, and the related interest expense for each issuance is included in the Consolidated Statements of Income. As of June 30, 2024, and December 31, 2023, the remaining unamortized debt issuance costs related to the junior subordinated debentures were less than $1,000 and are included as a reduction to the balance of the junior subordinated debentures on the Consolidated Balance Sheets. 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, as amended and restated (the “2019 Plan”). The 2019 Plan was originally approved at the May 2019 annual stockholders’ meeting and authorized 600,000 shares, and at the May 2021 annual stockholders’ meeting, the Company obtained stockholder approval to increase the number of shares of common stock authorized for issuance under the 2019 Plan by 1,200,000 shares, from 600,000 shares to 1,800,000 shares. Following the approval of the 2019 Plan, no further awards will be granted under any other prior 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 June 30, 2024, 718,193 shares remained available for issuance under the 2019 Plan. The Company has granted only restricted stock units under the 2019 Equity Plan.
Generally, restricted stock units granted under the 2019 Plan vest three years from the grant date, but the Compensation Committee of the Company’s Board of Directors has discretionary authority to change the terms of particular awards including the vesting schedule.
Under the 2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, all equity awards 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.
Awards of restricted stock under the 2019 Plan 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 2019 Plan 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 339,235 and 238,149 restricted stock units issued under the 2019 Plan during the six months ended June 30, 2024, and June 30, 2023, 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 2019 Plan was $2.2 million for the six months ended June 30, 2024, and $1.8 million for the six months ended June 30, 2023.
A summary of changes in the Company’s unvested restricted awards for the six months ended June 30, 2024, is as follows:
Restricted
Stock Shares
Grant Date
and Units
Fair Value
Unvested at January 1
709,237
14.26
Granted
339,235
13.44
Vested
(209,969)
11.38
Forfeited
(8,954)
14.09
Unvested at June 30
829,549
14.65
Total unrecognized compensation cost of restricted awards was $6.2 million as of June 30, 2024, which is expected to be recognized over a weighted-average period of 2.03 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
44,846,848
44,665,127
44,802,704
44,642,250
Diluted earnings per share:
Dilutive effect of unvested restricted awards 1
835,391
759,291
800,358
728,556
Diluted average common shares outstanding
45,682,239
45,424,418
45,603,062
45,370,806
1 Includes the common stock equivalents for restricted share rights that are dilutive.
26
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 June 30, 2024, the Bank exceeded those thresholds.
At June 30, 2024, the Bank’s Tier 1 capital leverage ratio was 11.43%, an increase of 102 basis points from December 31, 2023, and is above the 8.00% objective. The Bank’s total capital ratio was 14.42%, an increase of 118 basis points from December 31, 2023, and also 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 June 30, 2024, and December 31, 2023.
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,” which are generally holding companies with consolidated assets of less than $3.0 billion. 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, 2023, under the heading “Supervision and Regulation.”
At June 30, 2024, and December 31, 2023, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.
27
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
587,746
12.41
331,525
N/A
Old Second Bank
638,977
13.50
331,321
307,656
6.50
Total capital to risk weighted assets
716,185
15.12
497,351
10.50
682,416
14.42
496,905
473,243
10.00
Tier 1 capital to risk weighted assets
612,746
12.94
402,499
8.50
402,319
378,653
8.00
Tier 1 capital to average assets
10.96
223,630
11.43
223,614
279,517
547,721
11.37
337,207
592,413
12.32
336,598
312,556
677,076
14.06
505,640
636,768
13.24
504,990
480,943
572,721
11.89
409,430
408,727
384,684
10.06
227,722
10.41
227,632
284,540
1 Amounts are shown inclusive of a capital conservation buffer of 2.50%.
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 the Current Expected Credit Losses (“CECL”) methodology 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. As of June 30, 2024, the above capital measures of the Company include $951,000, 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. As of June 30, 2024, the Bank had capacity to pay dividends of $117.3 million to the Company without prior regulatory approval. Pursuant to the Basel III rules, the Bank must keep a capital conservation buffer of 2.50% above the 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.
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.
There were no transfers between levels during the six-month period ended June 30, 2024, however the Company reclassified one states and political subdivisions security to an asset-backed security in all periods presented. During the six-month period ended June 30, 2023, $14.9 million of asset-backed securities and $6.8 million of collateralized mortgage obligations were transferred to Level 2 from Level 3.
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:
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The tables below present the balance of assets and liabilities at June 30, 2024, and December 31, 2023, respectively, measured by the Company at fair value on a recurring basis:
Level 1
Level 2
Level 3
Assets:
207,738
12,527
62,210
2,667
Mortgage servicing rights
Interest rate derivatives 1
6,095
Mortgage banking derivatives
975,643
25,682
1,192,599
Liabilities:
Interest rate swap agreements, including risk participation agreements
7,835
1 Interest rate derivatives includes interest rate swaps, a rate cap and risk participation agreements.
214,006
13,059
66,166
2,270
5,391
1,014,639
25,673
1,209,886
8,324
8,334
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are as follows:
Six Months Ended June 30, 2024
States and
Mortgage
Asset-backed
Political
Servicing
Subdivisions
Rights
Beginning balance January 1, 2024
Transfers out of Level 3
Total gains or losses
Included in earnings
(66)
88
Included in other comprehensive income
(390)
Purchases, issuances, sales, and settlements
Purchases
547
Issuances
Settlements
(52)
(76)
(232)
Ending balance June 30, 2024
Six Months Ended June 30, 2023
Collateralized
Obligations
Beginning balance January 1, 2023
16,740
6,770
12,501
11,189
Transfers into Level 3
(14,885)
(6,764)
(11)
6,155
206
(6)
642
406
(521)
(74)
(6,584)
Ending balance June 30, 2023
1,935
13,003
11,041
The following table and commentary present quantitative and qualitative information about Level 3 fair value measurements as of June 30, 2024:
Measured at fair value
Significant Unobservable
on a recurring basis:
Valuation Methodology
Inputs
Range of Input
of Inputs
Discounted Cash Flow
Discount Rate
4.2 – 4.3%
4.3
Liquidity Premium
0.5 – 0.5%
0.5
5.6 – 5.6%
5.6
9.0 – 11.0%
9.0
Prepayment Speed
2.8 – 30.6%
6.7
The following table and commentary present quantitative and qualitative information about Level 3 fair value measurements as December 31, 2023:
3.2 – 5.4%
4.7
5.1 – 33.0%
6.6
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 loans and OREO. For assets measured at fair value on a nonrecurring basis at June 30, 2024, and December 31, 2023, 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
Other real estate owned, net2
40,002
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, which had a carrying amount of $38.5 million and a valuation allowance of $5.4 million resulting in a decrease of specific allocations within the allowance for credit losses on loans of $5.7 million for the six months ended June 30, 2024.
2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $6.9 million at June 30, 2024, which is made up of the outstanding balance of $7.0 million, net of a valuation allowance of $118,000.
66,180
71,303
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, which had a carrying amount of $77.3 million and a valuation allowance of $11.1 million resulting in a decrease of specific allocations within the allowance for credit losses on loans of $6.5 million for the year December 31, 2023.
2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $5.1 million at December 31, 2023, which is made up of the outstanding balance of $5.2 million, net of a valuation allowance of $118,000.
The Company has estimated the fair values of these assets based primarily on Level 3 inputs. OREO and individually evaluated loans are generally valued using the fair value of collateral provided by third party appraisals. These valuations include assumptions related to cash flow projections, discount rates, and recent comparable sales. The numerical ranges of unobservable inputs for these valuation assumptions are not meaningful.
Note 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. At June 30, 2024, and December 31, 2023, the fair values of loans are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors. The fair value of time deposits was 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 was not considered material.
The carrying amount and estimated fair values of financial instruments were as follows:
Carrying
Financial assets:
967,193
15,194
FHLBC and FRBC stock
3,857,223
Interest rate swap and rate cap agreements
6,051
Interest rate lock commitments and forward contracts
Interest receivable on securities and loans
26,086
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
2,793,241
2,783,984
20,620
50,075
7,827
Interest payable on deposits and borrowings
3,483
34
1,007,926
15,329
3,876,381
5,302
27,159
2,735,855
2,726,223
20,361
47,982
8,234
2,962
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 income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. The aggregate fair value of the swaps is recorded in other assets or 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. 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 or interest 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 income or expense as interest payments are received on the variable rate loan pools or paid on the Company’s fixed-rate borrowings.
Interest rate swaps with notional amounts totaling $300.0 million as of June 30, 2024, and December 31, 2023, were designated as cash flow hedges of certain variable rate commercial and commercial real estate loan pools. Each of these hedges were executed to pay variable and receive fixed rate cash flows. Each of these hedges was determined to be effective during all periods presented and the Company expects the hedges to remain effective during the remaining terms of the swaps.
An interest rate swap with a notional amount of $25.8 million as of June 30, 2024, and December 31, 2023, is designated as a cash flow hedge of junior subordinated debentures and was executed to pay fixed and receive variable rate cash flows. The hedge was determined to be effective during all periods presented and the Company expects the hedge to remain effective during the remaining terms of the swap.
During the next twelve months, the Company estimates that an additional $5.1 million will be reclassified as an increase to interest income and an additional $608,000 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 and rate cap agreements with commercial banking customers to facilitate their respective risk management strategies. The notional amounts of interest rate swaps with its loan customers as of June 30, 2024, and December 31, 2023 were $97.9 million and $104.8 million, respectively. The notional amounts of interest rate cap with its loan customers were $32.9 million as of June 30, 2024, and there were no interest rate caps at December 31, 2023. Those interest rate swaps and rate cap agreements 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 are recognized directly in earnings.
At June 30, 2024, and December 31, 2023, the Company had $6.8 million and $7.3 million of cash collateral pledged with two correspondent financial institutions, respectively. The Company held $5.4 million and $4.1 million of cash pledged from one correspondent financial institution to support the interest rate swap activity during the periods presented, respectively. No investment securities were required to be pledged to any correspondent financial institution during 2024 through June 30, 2024, or during 2023. The Company offsets derivative assets and liabilities that are subject to a master netting arrangement.
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. The notional amount of these commitments at June 30, 2024, and December 31, 2023 was $13.7 million and $8.4 million, respectively. 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.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheets as of June 30, 2024, and December 31, 2023.
Fair Value of Derivative Instruments
No. of Trans.
Notional Amount $
Balance Sheet Location
Fair Value $
Derivatives designated as hedging instruments
Interest rate swap agreements
325,774
Other Assets
3,618
Other Liabilities
5,394
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers and rate cap
130,775
2,433
45
13,687
Other contracts
39,021
44
Total derivatives not designated as hedging instruments
2,541
2,441
2,576
5,598
Interest rate swaps with commercial loan customers
104,777
2,726
8,375
(10)
44,790
89
2,805
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 $1.3 million as of June 30, 2024, and $5.3 million as of June 30, 2023. The amount of the loss reclassified from AOCI to net interest income on the income statement was $3.2 million for the six months ended June 30, 2024, and $2.4 million for the six months ended June 30, 2023.
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 June 30, 2024, and December 31, 2023.
The following table is a summary of letter of credit commitments:
Fixed
Variable
Letters of credit:
Borrower:
Financial standby
229
17,190
17,419
173
16,621
16,794
Performance standby
12,467
13,029
13,689
14,251
791
29,657
30,448
735
30,310
31,045
Non-borrower:
Total letters of credit
29,724
30,515
30,377
31,112
Unused loan commitments:
158,385
635,560
793,945
140,305
694,960
835,265
As of June 30, 2024, the Company evaluated current market conditions, including any impacts related to market interest rate changes and unused line of credit utilization trends during the second quarter of 2024, and based on that analysis under the CECL methodology, the Company determined credit losses related to unfunded commitments totaled $2.5 million. The resultant decrease in the ACL for unfunded commitments of $199,000 for the second quarter of 2024, compared to the prior quarter end, is primarily driven by adjustments to historical benchmark assumptions, such as the funding rates and the period used to forecast those rates within the ACL calculation. 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 Sheets, as needed, with the appropriate offsetting entry to the provision for credit losses on our Consolidated Statements of Income.
38
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 and six months ended June 30, 2024, compared to the three and six months ended June 30, 2023, and our financial condition at June 30, 2024, compared to December 31, 2023. 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, 2023. The results of operations for the three and six months ended June 30, 2024, are not necessarily indicative of future results. Dollar amounts presented in the following tables are in thousands, except per share data, and June 30, 2024 and 2023 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 48 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.
Our results of operations depend generally on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, we are subject to interest rate risk to the degree that our interest-earning assets mature or reprice at different times, or at different speeds, than our interest-bearing liabilities. Our results of operations are also affected by noninterest income, such as service charges, wealth management fees, loan fees, gains from the sale of newly originated loans, gains or losses on investments and certain other noninterest related items. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, professional fees, data processing expenses and provision for credit losses.
We are significantly impacted by prevailing economic conditions, including federal monetary and fiscal policies, and federal regulations of financial institutions. Deposit balances are influenced by numerous factors such as competing investments, the level of income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing and the interest rate pricing competition from other lending institutions.
As of June 30, 2024, 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, our reported and regulatory capital ratios could be adversely impacted by credit losses.
Financial Overview
Net income for the second quarter of 2024 was $21.9 million, or $0.48 per diluted share, compared to $25.6 million, or $0.56 per diluted share, for the second quarter of 2023. The reduction in net income was primarily due to a decrease in net interest and dividend income of $3.9 million year over year driven by a $3.2 million increase to interest expense as a result of higher interest rates offered on deposits, as well as a reduction in interest and dividend income as the securities portfolio decreased $162.0 million during the last twelve months. Also contributing to the decrease in net income compared to the prior year like quarter was an increase in provision for credit losses of $1.8 million. Adjusted net income, a non-GAAP financial measure that excludes certain nonrecurring items, as applicable, was $21.0 million for the second quarter of 2024, compared to $21.3 million for the first quarter of 2024, and $25.6 million for the second quarter of 2023. Adjusted net income was $42.3 million for the six months ended June 30, 2024, compared to $49.0 million for the six months ended June 30, 2023. See the discussion entitled “Non-GAAP Financial Measures” on page 40, as well as the table below, which provides a reconciliation of this non-GAAP measure to the most comparable GAAP equivalents.
Quarters Ended
March 31,
Income before income taxes (GAAP)
28,543
Pre-tax income adjustments:
Death benefit related to BOLI
(893)
Losses (gains) on branch sales, net
(277)
Adjusted net income before taxes
28,297
35,002
56,840
66,709
Taxes on adjusted net income
7,231
9,419
17,745
Adjusted net income (non-GAAP)
20,998
21,312
25,583
42,310
48,964
Basic earnings per share (GAAP)
Diluted earnings per share (GAAP)
0.47
Adjusted basic earnings per share (non-GAAP)
0.46
0.58
0.94
Adjusted diluted earnings per share (non-GAAP)
0.93
The following provides an overview of some of the factors impacting our financial performance for the three month period ended June 30, 2024, compared to the like period ended June 30, 2023:
Critical Accounting Estimates
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 Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2023. 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 2023 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, adjusted net income, adjusted basic and diluted earnings per share, our adjusted efficiency ratio, and our tangible common equity to tangible assets ratio. 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 of our performance to investors. 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 measures 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 June 30, 2024 and 2023
Our income before taxes was $29.2 million in the second quarter of 2024 compared to $35.0 million in the second quarter of 2023. This decrease in pretax income was primarily due to a $3.9 million decrease in net interest and dividend income, a $1.8 million increase in provision for credit losses, and a $3.0 million increase in noninterest expenses. Income before taxes was positively impacted by a $2.9 million increase in noninterest income, primarily due to no security gains or losses in the second quarter of 2024 compared to $1.5 million of security losses, net, in the second quarter of 2023, as well as an $893,000 death benefit realized on BOLI; no death benefit was recorded in the prior year like period. Noninterest expense increased by $3.0 million primarily due to a $1.6 million increase in salary and employee benefits expense, an $894,000 increase in computer and data processing expenses, and a $369,000 increase in advertising expenses in the second quarter of 2024. Our net income was $21.9 million, or $0.48 per diluted share, for the second quarter of 2024, compared to net income of $25.6 million, or $0.56 per diluted share, for the second quarter of 2023. The Bank remains well positioned to navigate uncertain macroeconomics; we have mitigated interest rate risk, controlled expenses in an inflationary environment, and actively managed daily liquidity. Furthermore, we continue to possess strong liquidity metrics and a short duration securities portfolio for short term funding needs.
Net interest and dividend income was $59.7 million in the second quarter of 2024, compared to $63.6 million in the second quarter of 2023. The $3.9 million decrease was driven by an increase in interest expense in the second quarter of 2024, compared to the second quarter of 2023, primarily due to exception pricing on deposit accounts and product migration into term deposits. Decreases in our securities portfolio also contributed to the decrease in net interest and dividend income during the second quarter of 2024. Partially offsetting the decrease in net interest and dividend income during the second quarter of 2024, compared to the like quarter a year ago, was growth in our loan related interest income due to the effect of higher market interest rates on our loan portfolios.
Six months ended June 30, 2024 and 2023
Our income before taxes was $57.7 million for the six months ended June 30, 2024, compared to $67.0 million for the six months ended June 30, 2023. This decrease in pretax income was primarily due to an $8.2 million decrease in net interest and dividend income, a $1.7 million increase in provision for credit losses, and a $5.4 million increase in noninterest expenses. These changes were partially offset by a $6.1 million increase in noninterest income, primarily due to no security gains or losses in the first six months of 2024 compared to $3.2 million of security losses, net, recorded in the first six months of 2023, a $1.3 million increase in the cash surrender value of BOLI, and an $893,000 death benefit realized on BOLI. Our net income was $43.2 million, or $0.95 per diluted share, for the six months ended June 30, 2024, compared to net income of $49.2 million, or $1.08 per diluted share, for the same period of 2023.
Net interest and dividend income was $119.5 million for the six months ended June 30, 2024, compared to $127.7 million for the same period of 2023. The $8.2 million decrease was primarily driven by an increase in interest expense in the first six months of 2024, compared to the first six months of 2023, driven by a rise in deposit interest rates stemming from exception pricing on deposit accounts. Also contributing to the decrease in net interest and dividend income was a $4.1 million decrease in securities related income due to the year over year decrease in the securities portfolio. Higher interest expenses were partially offset by the effect of higher market interest rates on our loan portfolio, which contributed to the $6.1 million increase in loan related income. Also offsetting the decrease in net interest and dividend income year over year was a reduction in senior debt expense recorded in the first six month of 2024 as the senior notes were redeemed on June 30, 2023, resulting in no senior debt interest expense after that time.
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.
The increased yield of six basis points on interest earning assets compared to the linked period was driven by repricing within the loan and taxable securities portfolios. Changes in the market interest rate environment impact earning assets at varying intervals depending on the repricing timeline of loans and securities, as well as securities maturity, paydown and purchase and sale activities.
The year over year increase of 28 basis points on interest earning assets was primarily driven by increases to benchmark interest rates over the past twelve months, primarily impacting variable rate loans. Increases to market rates also impacted securities available for sale income during the quarter ended June 30, 2024. Average balances of securities available for sale decreased $225.2 million in the second quarter of 2024 compared to the prior year like quarter; however, the tax equivalent yield on the securities available for sale portfolio increased 15 basis points year over year due to variable security rate resets.
Average balances of interest-bearing deposit accounts have increased steadily during the second quarter of 2024, from $2.76 billion to $2.81 billion, as NOW and money market account average balances increased as well as time deposits average balance increases due to CD rate specials. The increase in average balances of interest-bearing deposit accounts was partially offset by reductions in savings accounts as customers sought higher yielding products. We have continued to control the cost of funds over the periods reflected, with the rate of overall interest-bearing deposits increasing to 133 basis points for the quarter ended June 30, 2024, from 118 basis points for the quarter ended March 31, 2024, and from 40 basis points for the quarter ended June 30, 2023. A 20 basis point increase in the cost of money market funds for the quarter ended June 30, 2024, compared to the prior linked quarter, and a 105 basis point increase compared to the prior year like quarter were both due to select deposit account exception pricing, and drove a significant portion of the overall increase. The increase in transactional account average balances for the linked quarter were slightly offset by a 15 basis point decrease in NOW accounts driven by a large commercial deposit customer moving into an off-balance sheet sweep product, which reduced the overall rates paid on exception priced NOW accounts. Average rates paid on time deposits for the quarter ended June 30, 2024, increased by 36 basis points and 221 basis points in the quarter over linked quarter and year over year quarters, respectively, primarily due to CD rate specials we offered.
Borrowing costs decreased in the second quarter of 2024, compared to the first quarter of 2024, primarily due to the $89.3 million decrease in average other short-term borrowings stemming from a decrease in average FHLB advances over the prior quarter. The decrease of $159.6 million year over year of average FHLB advances was based on daily liquidity needs, and was the primary driver of the $1.8 million decrease to interest expense on other short-term borrowings. Subordinated and junior subordinated debt interest expense were essentially flat over each of the periods presented. Senior notes had the most significant interest expense decrease year over year, as we redeemed all of the $45.0 million senior notes, net of deferred issuance costs, in June 2023, resulting in senior notes having no balance after that time.
Our net interest margin (GAAP) increased five basis points to 4.60% for the second quarter of 2024, compared to 4.55% for the first quarter of 2024, and decreased one basis point compared to 4.61% for the second quarter of 2023. Our net interest margin (TE) increased five basis points to 4.63% for the second quarter of 2024, compared to 4.58% for the first quarter of 2024, and decreased one basis point compared to 4.64% for the second quarter of 2023. The increase in the second quarter of 2024, compared to the prior quarter, was driven by market rates as well as the composition of assets and liabilities as interest income and expense remained relatively flat compared to the prior quarter while there was a $65.9 million reduction in interest earning assets. Matured securities were replaced with higher yielding positions and the decrease in average loans was primarily driven by lower yielding or nonaccrual credits due to the payoff, charge-off or upgrade of loans year-to-date. Higher deposit interest expense was offset by lower borrowing interest expense due to a decline in average other short-term borrowing. The decrease in our net interest margin (TE) in the second quarter of 2024, compared to the prior year like quarter, is primarily due to an increase in market interest rates, and the related increase in costs of interest-bearing deposits. See the discussion entitled “Non-GAAP Financial Measures” and the table on page 47 that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent.
The year over year increase of 35 basis points on interest earning assets was driven by increases to benchmark interest rates over the past twelve months. The securities portfolio was primarily impacted by maturities and paydowns of lower yielding assets and timely purchase of higher yielding securities as we work to increase the weighted average yield in the portfolio. Average securities available-for-sale decreased $272.7 million for the six months ended June 30, 2024, compared to the six months ended June 30, 2023, due to maturities, paydowns, and strategic sales. Due to market interest rate increases year over year, securities available-for-sale interest income yields were slightly higher in the six months ended June 30, 2024; however, the decrease in balances resulted in a reduction of securities income to $19.9 million for the six months ended June 30, 2024, compared to $24.1 million for the like 2023 period. Average loans, including loans held for sale, increased $2.3 million in the six months ended June 30, 2024, compared to the six months ended June 30, 2023. The rising interest rate environment resulted in $124.9 million of loan and dividend interest income in the six months ended June 30, 2024, compared to $118.8 million in the like 2023 period.
Average balances of interest bearing deposit accounts have decreased steadily since June 30, 2023, through the six months ended June 30, 2024, from $2.93 billion to $2.78 billion, with these decreases reflected in all categories other than time deposits. We have continued to control the cost of funds over the periods reflected, with the rate of overall interest bearing deposits increasing by 93 basis points to 125 basis points from 32 basis points as of June 30, 2023. A 108 basis point increase in the cost of money market funds as of June 30, 2024, compared to June 30, 2023, was due to select deposit account exception pricing and drove a significant portion of the overall increase. Interest expense paid on time deposits also contributed to the growth in cost of deposits year over year, as the cost of average time deposits increased 226 basis points to 310 basis points for the six months ended June 30, 2024, compared to 84 basis points for the six months ended June 30, 2023, primarily due to CD rate specials we offered.
Market rates associated with borrowings increased in the six months ended June 30, 2024, compared to the like prior year period. Our borrowing interest expense was controlled over the past twelve months due to lower FHLB advance volumes and the redemption of senior notes and notes payable in 2023. Subordinated and junior subordinated debt interest expense remained flat over the periods presented. Senior notes had the most significant interest expense decrease year over year, as we redeemed all of the $45.0 million senior notes, net of deferred issuance costs, in June 2023, resulting in senior notes having no balance after that time. In February 2023, we paid off the remaining balance of $9.0 million on the original $20.0 million term note issued in 2020, resulting in notes payable and other borrowings having no balance after that time.
Our net interest margin (GAAP) decreased eight basis points to 4.58% for the six months ended June 30, 2024, compared to 4.66% for the six months ended June 30, 2023. Our net interest margin (TE) decreased nine basis points to 4.60% for the six months ended June 30, 2024, compared to 4.69% for the six months ended June 30, 2023. The decrease in the current period, compared to the prior year like period, is primarily due to higher interest expense related to the current interest rate environment and its effect on interest bearing deposits.
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 tables set forth certain information relating to our average consolidated balance sheets 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 2024 and 2023 to compare returns more appropriately on tax-exempt loans and securities to other earning assets.
Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates
(Dollars in thousands - unaudited)
March 31, 2024
Income /
Rate
Expense
50,740
4.95
48,088
610
50,309
5.13
1,016,187
3.38
1,016,112
8,092
3.20
1,231,994
3.23
Non-taxable (TE)1
163,243
1,636
4.03
166,776
1,653
3.99
172,670
1,692
3.93
Total securities (TE)1
1,179,430
10,188
3.47
1,182,888
9,745
3.31
1,404,664
11,622
3.32
FHLBC and FRBC Stock
27,574
8.52
31,800
635
8.03
34,029
4.67
Loans and loans held-for-sale1, 2
3,958,504
62,180
6.32
4,019,377
62,698
6.27
4,040,202
61,591
6.11
Total interest earning assets
5,216,248
73,577
5.67
5,282,153
73,688
5.61
5,529,204
74,252
5.39
54,286
54,533
56,191
(43,468)
(44,295)
(53,480)
Other noninterest bearing assets
388,392
384,332
379,576
5,615,458
5,676,723
5,911,491
Liabilities and Stockholders' Equity
570,523
0.45
553,844
829
0.60
600,957
0.21
691,214
2,915
1.70
689,996
2,575
1.50
762,967
1,245
0.65
Savings accounts
934,161
958,645
633
0.27
1,073,172
0.07
610,705
3.27
558,463
4,041
2.91
436,524
1.06
2,806,603
9,278
1.33
2,760,948
8,078
1.18
2,873,620
2,898
0.40
37,430
0.89
30,061
86
1.15
25,575
0.11
242,912
5.53
332,198
4,557
5.52
402,527
5.14
4.49
280
4.37
59,414
3.70
59,393
59,329
3.69
44,134
12.85
Total interest bearing liabilities
3,172,132
1.72
3,208,373
13,547
3,430,958
1.20
1,769,543
1,819,476
1,920,448
68,530
60,024
48,434
Stockholders' equity
605,253
588,850
511,651
Total liabilities and stockholders' equity
Net interest income (GAAP)
59,783
Net interest margin (GAAP)
4.60
4.55
4.61
Net interest income (TE)1
60,044
60,141
63,946
Net interest margin (TE)1
4.63
4.58
4.64
Interest bearing liabilities to earning assets
60.81
60.74
62.05
1 Represents a non-GAAP financial measure. See the discussion entitled “Reconciliation of Tax-Equivalent Non-GAAP Financial Measures” 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 2024 and 2023.
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 47, and includes loan fee expense of $936,000 for the second quarter of 2024, $867,000 for the first quarter of 2024, and $242,000 for the second quarter of 2023. Nonaccrual loans are included in the above-stated average balances.
49,414
5.03
49,812
4.97
1,016,150
3.29
1,280,873
3.25
165,009
3,289
4.01
172,995
3,385
3.95
1,181,159
19,933
3.39
1,453,868
24,050
3.34
Dividends from FHLBC and FRBC
29,687
8.26
29,492
4.62
Loans and loans held-for-sale 1, 2
3,988,941
124,878
6.30
3,986,644
118,819
6.01
5,249,201
147,265
5.64
5,519,816
144,773
5.29
54,410
55,668
(43,882)
(51,450)
386,362
381,070
5,646,091
5,905,104
562,184
1,468
0.53
600,993
555
0.19
690,605
5,490
1.60
798,199
2,073
0.52
946,403
0.30
1,099,460
263
584,584
3.10
435,595
0.84
2,783,776
17,356
1.25
2,934,247
4,711
0.32
33,746
1.01
28,312
287,555
302,238
4.99
4.43
59,404
59,318
Senior note
44,365
10.92
2,685
6.52
3,190,254
1.71
3,396,938
0.97
1,794,509
1,961,397
64,277
49,849
597,051
496,920
4.66
120,185
128,394
4.69
60.78
61.54
1Represents a non-GAAP financial measure. See the discussion entitled “Reconciliation of Tax-Equivalent Non-GAAP Financial Measures” 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 2024 and 2023.
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 47, and includes fee expense of $1.8 million and $973,000 for the six months ended June 30, 2024 and 2023, respectively. Nonaccrual loans are included in the above-stated average balances.
Reconciliation of Tax-Equivalent (TE) 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 2024 and 2023 to compare returns more appropriately on tax-exempt loans and securities to other earning assets. The table below provides a reconciliation of each non-GAAP (TE) measure to the GAAP equivalent for the periods indicated:
Net Interest Margin
Interest income (GAAP)
73,330
Taxable-equivalent adjustment:
344
355
711
Interest and dividend income (TE)
Interest expense (GAAP)
Net interest income (TE)
Average interest earning assets
Net interest margin (TE)
Noninterest Income
The following table details the major components of noninterest income for the periods presented:
2nd Quarter 2024
Percent Change From
(Dollars in thousands)
2,561
8.5
13.1
2,415
3.9
6.2
Residential mortgage banking revenue
30.0
(14.5)
MSRs mark to market (loss) gain
94
(353.2)
(347.9)
488
5.1
2.8
314
49.0
17.6
Total residential mortgage banking revenue
808
1,069
14.6
(24.4)
Securities gains (losses), net
1,172
(30.0)
96.2
100.0
2,376
(4.2)
1,030
(28.0)
(4.0)
10,501
6.0
35.3
47
Noninterest income increased $626,000, or 6.0%, in the second quarter of 2024, compared to the first quarter of 2024, and increased $2.9 million, or 35.3%, compared to the second quarter of 2023. The increase from the first quarter of 2024 was primarily driven by a $218,000 increase in wealth management income, an $893,000 death benefit realized on BOLI, and a $201,000 increase in card related income. Partially offsetting the increase in noninterest income from the prior quarter was a $138,000 decrease in residential mortgage banking revenue primarily due to a decrease of $332,000 in MSRs mark to market valuation, and a $352,000 decrease in the cash surrender value of BOLI, both of which were due to market interest rate changes, while MSRs were also impacted by a slight increase in prepayment speeds in the second quarter. Also offsetting the increase in noninterest income from the prior quarter was a $288,000 decrease in other income primarily due to a $172,000 incentive related to check order volumes received in the first quarter of 2024.
The increase in noninterest income of $2.9 million in the second quarter of 2024, compared to the second quarter of 2023, is primarily due to a $321,000 increase in wealth management income, a $146,000 increase in service charges on deposits, no security sales activity in the second quarter of 2024 compared to net losses on the sale of securities of $1.5 million in the second quarter of 2023, a $402,000 increase in the cash surrender value of BOLI due to changes in market interest rates, and an $893,000 death benefit realized on BOLI. These increases were partially offset by a $261,000 decrease in residential mortgage banking revenue mainly due to a decrease of $334,000 in MSRs mark to market valuation, and a $113,000 decrease in card related income.
Percent
Change
12.9
2.9
(14.8)
MSRs mark to market loss
(66.4)
(1.4)
11.1
1,754
1,425
23.1
201.8
0.4
(21.7)
38.9
Noninterest income increased $6.1 million, or 38.9%, for the six months ended June 30, 2024, compared to the six months ended June 30, 2023. This increase was primarily driven by $1,000 of securities gains, net, compared to $3.2 million of security losses, net, in the prior year like period, a $1.3 million increase in the cash surrender value of BOLI due to market interest rate changes, an $893,000 death benefit realized on BOLI, a $612,000 increase in wealth management income primarily due to an increase in advisory fees, and a $137,000 increase in service charges on deposits. In addition, the current six month period increased due to a $329,000 increase in mortgage banking revenue, comprised primarily of a $285,000 decrease in MSRs mark to market losses. Partially offsetting these increases was a $490,000 decrease in other income, as the 2023 period reflected credits from a data service provider.
48
Noninterest Expense
The following table details the major components of noninterest expense for the periods presented:
Salaries
17,997
17,647
16,310
2.0
10.3
Officers' incentive
1,482
2,148
2,397
(31.0)
(38.2)
Benefits and other
3,945
4,517
3,091
(12.7)
27.6
Total salaries and employee benefits
24,312
(3.7)
7.5
Occupancy, furniture and equipment expense
3,927
(0.7)
7.1
2,255
(3.1)
69.3
667
(7.6)
(22.4)
521
10.9
12.2
1.0
Amortization of core deposit intangible asset
580
(1.0)
(7.1)
192
145.8
358.3
1,277
3.6
8.3
226
5.3
(15.9)
336
137.2
53.3
Other real estate owned expense, net
(289.1)
(11.2)
3,593
(1.3)
38,241
8.7
Efficiency ratio (GAAP)1
53.29
53.59
46.84
Adjusted efficiency ratio (non-GAAP)2
52.68
53.09
46.49
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 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, OREO expenses, litigation expense, and net gains on branch sales, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities, death benefits realized on BOLI, 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 discussion entitled “Non-GAAP Financial Measures” above and the table on page 51 that provides a reconciliation of this non-GAAP financial measure to the most comparable GAAP equivalent.
Noninterest expense for the second quarter of 2024 decreased $364,000, or 1.0%, compared to the first quarter of 2024, and increased $3.0 million, or 8.7%, compared to the second quarter of 2023. The decrease in the second quarter of 2024 compared to the first quarter of 2024 was attributable to a $888,000 decrease in salaries and employee benefits, with decreases reflected primarily in restricted stock expense, officers’ incentives, payroll taxes, and deferred executive compensation due to changes in market interest rates. Also contributing to the decrease in the second quarter of 2024 was a $71,000 decrease in computer and data processing expenses, a $51,000 decrease in FDIC insurance, and a $133,000 reduction in other real estate owned expense, net, as a gain of $259,000 was recorded on an OREO sale in the second quarter of 2024. Partially offsetting the decreases in noninterest expense in the second quarter of 2024 compared to the first quarter of 2024 was a $57,000 increase in net teller & bill paying expenses, a $280,000 increase in advertising expense primarily due to a new overdraft disclosure mailed to retail deposit customers, and a $461,000 increase in consulting & management fees primarily driven by ongoing systems projects and a deposit compliance matter.
49
The year over year increase in noninterest expense is primarily attributable to a $1.6 million increase in salaries and employee benefits, primarily due to increases in annual base salary rates, restricted stock expense, and deferred employee compensation due to market interest rate changes. Also contributing to the increase was a $260,000 increase in occupancy, furniture and equipment due to facilities improvements year over year, an $894,000 increase in computer and data processing primarily due to credits from our core data provider in the prior year period, a $369,000 increase in advertising expense, a $101,000 increase in card related expense, and a $277,000 increase in consulting & management fees. Partially offsetting the increases in noninterest expense in the second quarter of 2024, compared to the second quarter of 2023, was a $178,000 decrease in FDIC insurance, and a $293,000 decrease in other expenses.
35,644
32,397
10.0
3,630
4,224
(14.1)
8,462
7,425
14.0
8.4
44.9
(6.9)
8.1
1.6
171.0
(22.9)
(13.5)
(119.7)
(4.5)
7.6
53.44
47.18
52.88
47.08
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, OREO expenses, and net gains on branch sales, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities, death benefits realized on BOLI, 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 discussion entitled “Non-GAAP Financial Measures” above and the table on page 51 that provides a reconciliation of this non-GAAP financial measure to the most comparable GAAP equivalent.
Noninterest expense for the six months ended June 30, 2024, increased $5.4 million, or 7.6%, compared to the six months ended June 30, 2023, primarily due to a $3.7 million increase primarily from increases in salaries and employee benefits due to higher annual base salary rates, restricted stock expense, and deferred employee compensation due to market interest rate changes. Computer and data processing increased $1.4 million as credits were received from our core data provider in the prior year period. Occupancy, furniture and equipment increased $712,000, or 10.0%, as multiple branch improvements and office updates were completed over the past year. Advertising expenses increased $419,000 primarily due to a new overdraft disclosure mailed to retail deposit customers in 2024. In addition, card related expense increased $162,000 primarily due to additional customer volumes. Partially offsetting these increases were a $95,000 decrease in FDIC insurance, a $138,000 decrease in legal fees, a $177,000 decrease in consulting & management fees, a $249,000 decrease in net OREO expenses, and a $337,000 decrease in other expenses.
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
Less losses on branch sales, net
Noninterest expense less adjustments
37,390
37,615
34,310
34,281
Net interest income
Net interest income including adjustments
Less death benefit related to BOLI
Less securities gains (losses)
Less MSRs mark to market (losses) gains
456
311
111
Noninterest income (excluding) / including adjustments
10,472
10,406
9,674
10,928
10,717
9,785
Net interest income including adjustments plus noninterest income (excluding) / including adjustments
70,162
70,189
73,254
70,972
70,858
73,731
Efficiency ratio / Adjusted efficiency ratio
N/A - not applicable
Less amortization of core deposit intangible
Less gains on branch sales
75,005
69,302
69,579
Less securities gains (losses), net
Less MSRs mark to market losses
767
175
20,878
19,224
21,645
19,399
140,351
146,890
141,830
147,793
Income Taxes
We recorded income tax expense of $7.3 million for the second quarter of 2024 on $29.2 million of pretax income, compared to income tax expense of $7.2 million on $28.5 million of pretax income in the first quarter of 2024, and income tax expense of $9.4 million on $35.0 million of pretax income in the second quarter of 2023. Our effective tax rate was 25.0% in the second quarter of 2024, 25.3% for the first quarter of 2024, and 26.9% for the second quarter of 2023.
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 June 30, 2024. We had no valuation reserve on the deferred tax assets as of June 30, 2024.
Financial Condition
Total assets decreased $60.1 million to $5.66 billion at June 30, 2024, from $5.72 billion at December 31, 2023, due primarily to the decrease of $19.2 million in securities available-for-sale and the decrease of $66.4 million in total loans. The decrease in securities available-for-sale and loans is primarily due to maturities and paydowns. These decreases were partially offset by increases in cash and cash equivalents of $20.7 million, increases in premises and equipment of $3.6 million, increases in other real estate owned of $1.8, and increases in BOLI of $1.2 million. We continue to actively assess potential investment opportunities to utilize our excess liquidity. Total deposits were $4.52 billion at June 30, 2024, a decrease of $49.0 million from December 31, 2023.
As of
214,613
12.8
(10.9)
55,981
(34.5)
(33.4)
115,140
(8.9)
227,599
(3.0)
(3.2)
Corporate bonds
4,882
(100.0)
407,495
(1.7)
(5.3)
136,254
(5.2)
(52.4)
173,658
3.0
1.9
Total securities
1,335,622
(1.6)
(12.1)
52
Securities available-for-sale decreased $19.2 million as of June 30, 2024, compared to December 31, 2023, and decreased $162.0 million compared to June 30, 2023. The decrease in the portfolio during year to date 2024 was driven by paydowns totaling $74.7 million, securities sales totaling $5.3 million, and maturities totaling $97.0 million, partially offset by $157.9 million in purchases. We continue to position the portfolio in higher credit quality, shorter duration securities with an appropriate mix of fixed- and floating-rate exposures.
820,027
(3.8)
314,919
13.7
43.8
1,080,073
(1.9)
(6.1)
824,277
(6.4)
(9.5)
189,058
(1.8)
55,935
(9.9)
218,205
383,184
1.5
102,058
(4.1)
27,789
(51.3)
(59.9)
4,015,525
1 The “Other” segment includes consumer loans and overdrafts.
Total loans were $3.98 billion as of June 30, 2024, a decrease of $66.4 million from December 31, 2023. The decrease in total loans in the first six months of 2024, compared to December 31, 2023, was due primarily to paydowns, net of originations, within commercial real estate – owner occupied of $50.6 million, commercial of $32.3 million, commercial real estate – investor of $20.1 million and multifamily of $13.0 million, partially offset by net increases in leases of $54.7 million and construction of $20.3 million. Total loans decreased $38.9 million from June 30, 2023, to June 30, 2024, primarily due to paydowns, net of originations, within commercial real estate – owner occupied of $78.3 million, commercial real estate - investor of $65.7 million, and commercial of $10.6 million, partially offset by net increases in leases of $138.0 million. As required by CECL, the balance (or amortized cost basis) of purchased credit deteriorated loans, or PCD loans (discussed below) is 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 allowance for credit losses, or 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 68.0% of the portfolio as of June 30, 2024, compared to 68.8% of the portfolio as of December 31, 2023. At June 30, 2024, our outstanding commercial real estate loans and undrawn commercial real estate commitments, excluding owner occupied real estate, were equal to 259.7% of our Tier 1 capital plus allowance for credit losses, a decrease from 286.9% at December 31, 2023. 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 and loans 90 days or greater past due. Nonperforming loans decreased by $21.9 million to $46.9 million at June 30, 2024 from $68.8 million at December 31, 2023, and decreased $14.4 million from $61.2 million at June 30, 2023. Purchased credit deteriorated loans, or PCD loans, are purchased loans that, as of the date of acquisition, we 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. Management continues to carefully monitor loans considered to be in a classified status. Nonperforming loans as a percent of total loans were 1.2% as of June 30, 2024, 1.7% as of December 31, 2023, and 1.5% as of June 30, 2023. The distribution of our nonperforming loans is shown in the following table.
Nonperforming Loans
2,025
31.1
71.9
758
(55.6)
(62.5)
31,613
(39.9)
(68.5)
22,091
18,857
(36.8)
17.2
116
(19.9)
1,445
(11.4)
3,660
(15.6)
(29.0)
(21.4)
17.1
869
1,251
2,049
(30.5)
(57.6)
Total nonperforming loans
46,866
68,779
61,233
(31.9)
(23.5)
The components of our nonperforming assets are shown in the following table.
Nonperforming Assets
Nonaccrual loans
60,925
(37.9)
(31.1)
Loans past due 90 days or more and still accruing interest
308
310.5
35.1
809.3
Total nonperforming assets
53,786
73,902
61,994
(27.2)
(13.2)
30-89 days past due loans and still accruing interest
16,728
13,668
12,449
Nonaccrual loans to total loans
1.1
1.7
Nonperforming loans to total loans
1.2
Nonperforming assets to total loans plus OREO
1.4
1.8
Allowance for credit losses to total loans
Allowance for credit losses to nonaccrual loans
100.7
65.5
90.8
54
Loan charge-offs, net of recoveries, for the second quarter of 2024, prior linked quarter and year over year quarter are shown in the following table.
Loan Charge–offs, Net of Recoveries
% of
Total1
(19)
(0.3)
(58)
298
59.0
(1.1)
(7)
4,560
78.7
10.1
1,162
20.1
3,868
104.7
198
39.2
(3)
(0.1)
(2)
(9)
(0.2)
(36)
(0.5)
(24)
(4.8)
Other 2
0.7
0.6
Net charge–offs
5,794
3,695
505
1 Represents the percentage of net charge-offs attributable to each category of loans.
2 The “Other” segment includes consumer and overdrafts.
Net charge-offs of $5.8 million were recorded for the second quarter of 2024, compared to net charge-offs of $3.7 million for the first quarter of 2024, and net charge-offs of $505,000 for the second quarter of 2023, reflecting continuing management attention to credit quality and remediation efforts. The net charge-offs for the second quarter of 2024 were primarily due to three commercial real estate – investor charge offs totaling $4.6 million and a $1.3 million charge off of a commercial real estate – owner occupied loan. The commercial real estate – owner occupied credit had a reported reserve allocation of $1.2 million prior to the second quarter of 2024 charge-off. We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs.
Classified loans include nonaccrual loans 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
22,245
127.5
(13.9)
974
(65.3)
(70.8)
57,041
(15.7)
(35.2)
38,495
25.7
(66.5)
1,714
0.9
(21.6)
(15.0)
(25.3)
283.7
471.8
2,152
(38.4)
Total classified loans
127,588
(7.8)
Total classified assets
129,325
137,907
128,349
(6.2)
0.8
N/M - Not meaningful
55
Total classified loans and classified assets decreased $10.4 million and $8.6 million as of June 30, 2024, from December 31, 2023, respectively. The decrease since December 31, 2023, is due to outflows of $40.3 million which consisted of $11.9 million loans paid off, $9.8 million charged off, $8.7 million of classified loans upgraded, $6.5 million of principal reductions through payments, and $3.4 million that transferred to OREO. The outflows are offset by the additions of $29.9 million, the majority of which consisted of five relationships totaling $28.2 million. Commercial loans were the majority of the additions, consisting of twelve loans totaling $18.6 million. The increase from June 30, 2023 is primarily due to additions to commercial real estate – owner occupied. 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 18.98% for the period ended June 30, 2024, compared to 21.66% as of December 31, 2023, and 20.46% as of June 30, 2023.
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 allowance for credit losses (“ACL”) at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date.
At June 30, 2024, our ACL on loans totaled $42.3 million, and our ACL on unfunded commitments, included in other liabilities, totaled $2.5 million. In the second quarter of 2024, we recorded provision expense on loans of $4.0 million, based on historical loss rates, our assessment of nonperforming loan metrics and trends, downward risk rating migrations, and estimated future credit losses, and a $199,000 reversal of provision on unfunded commitments, primarily due to an adjustment of historical benchmark assumptions, such as funding rates and the period used to forecast those rates, within the ACL calculation. These adjustments resulted in a $3.8 million net impact to the provision for credit losses for the second quarter of 2024.
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 loans, leases and unfunded commitments. The ACL on loans totaled $42.3 million as of June 30, 2024, $44.3 million as of December 31, 2023, and $55.3 million as of June 30, 2023. Our ACL on loans to total loans was 1.1% as of June 30, 2024, and December 31, 2023, and 1.4% as of June 30, 2023. See Item 7 – Critical Accounting Estimates in the Management Discussion and Analysis in our 2023 Annual Report in Form 10-K 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.
56
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
Charge–offs:
3,887
Total charge–offs
3,988
Recoveries:
Total recoveries
293
Net charge-offs
9,489
Provision for credit losses on loans
3,544
Allowance at end of period
Average total loans (exclusive of loans held–for–sale)
3,957,454
4,018,631
4,039,052
3,988,043
3,985,662
Net charge–offs to average loans
0.59
0.37
0.06
Allowance at period end to average loans
1.07
1.37
1.39
The coverage ratio of the ACL on loans to nonperforming loans was 90.2% as of June 30, 2024, which was an increase from the coverage ratio of 67.8% as of March 31, 2024, and a slight decrease from 90.3% as of June 30, 2023. When measured as a percentage of quarter to date average loans, our total ACL on loans was 1.07% at June 30, 2024, 1.10% at March 31, 2024, and 1.37% at June 30, 2023.
In management’s judgment, an adequate ACL has been established to encompass the current lifetime expected credit losses at June 30, 2024, and general changes in lending policy, procedures and staffing, as well as other external factors. However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession. Continued volatility in the economic environment stemming from the impacts of and response to inflation, potential recession, and the war in Ukraine and the conflict in the Middle East, and the associated effects on our customers, or other factors, such as 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.
57
Other Real Estate Owned
As of June 30, 2024, OREO totaled $6.9 million, reflecting an increase of $1.8 million from $5.1 million at December 31, 2023, and an increase of $6.2 million from $761,000 at June 30, 2023. There were two property additions totaling $3.4 million and one disposal totaling $1.6 million in the OREO portfolio during the second quarter of 2024. No valuation adjustments occurred in the second quarter of 2024, the fourth quarter of 2023, or the second quarter of 2023.
OREO
308.2
4,894
(30.8)
Proceeds from property disposals, net of participation purchase and of gains/losses
178
793.8
134.3
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.
OREO Properties by Type
% of Total
Single family residence
Lots (single family and commercial)
Vacant land
197
Multi-family
Commercial property
6,723
97
4,926
Total other real estate owned
Deposits and Borrowings
Deposits
1,897,694
(5.8)
1,050,453
586,121
(4.9)
731,459
(5.0)
240,848
14.3
26.3
148,070
23.8
50.7
62,937
66.0
4,717,582
58
Total deposits were $4.52 billion at June 30, 2024, which reflects a $49.0 million decrease from total deposits of $4.57 billion at December 31, 2023, and a decrease of $195.9 million from total deposits of $4.72 billion at June 30, 2023. The decrease in deposits at June 30, 2024, compared to December 31, 2023, was primarily due to decreases in non-interest bearing deposits of $106.4 million, savings accounts of $62.5 million, and NOW accounts of $7.9 million, partially offset by an increase of $23.9 million in money market accounts, and $103.9 million in time deposits. The decrease in deposits at June 30, 2024, compared to June 30, 2023, was primarily due to decreases in non-interest bearing deposits of $169.2 million, savings accounts of $141.6 million, NOW accounts of $28.7 million, and money market accounts of $36.3 million, partially offset by an increase in time deposits of $180.0 million. Total quarterly average deposits decreased $217.9 million, or 4.6%, in the year over year period, driven by declines in our average demand deposits of $150.9 million, and savings, NOW and money markets combined of $241.2 million. In general, the bulk of the decline in deposits year over year can be characterized as rate sensitive with significant flows and transfers into investing activities.
The following table presents estimated insured and uninsured deposits at June 30, 2024, and December 31, 2023 by deposit type, as well as the weighted average rates for each year to date ending period.
Total Deposits
Insured Deposits
Uninsured Deposits
Average Rate Paid
1,129,090
599,397
1,137,089
697,802
853,603
55,223
905,163
66,171
391,902
165,567
414,005
151,370
462,474
232,657
473,006
198,234
0.80
537,328
94,487
452,000
75,906
1.45
3,374,397
1,147,331
0.76
3,381,263
1,189,483
Collateralized public funds
253,790
16,673
237,117
247,202
15,211
231,991
Deposits declined 1.1% for the six months ended June 30, 2024, as a result of seasonal flows and overall stabilization. Balances continue to migrate into money market accounts and time deposits, as customers seek higher interest rates. Additionally, competitive pricing remains aggressive in our market which has increased the rates paid on deposits.
In addition to deposits, we used other liquidity sources for our funding needs in all periods presented, such as repurchase agreements and other short-term borrowings with the FHLBC. Securities sold under repurchase agreements totaled $46.5 million at June 30, 2024, a $20.1 million, or 75.8%, increase from $26.5 million at December 31, 2023, and an increase of $15.0 million, or 47.6%, from June 30, 2023. The outstanding balance of our short-term FHLBC borrowings was $330.0 million as of June 30, 2024, $405.0 million as of December 31, 2023, and $485.0 million as of June 30, 2023.
We are also indebted on $25.8 million of junior subordinated debentures, net of deferred issuance costs, as of June 30, 2024, 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, which is now three month Term SOFR, plus 150 basis points beginning 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 4.43% as of June 30, 2024, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017, rate reset.
In the second quarter of 2021, we entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers pursuant to which we issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”). We sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance were used for general corporate purposes. The Notes bear interest at a fixed annual rate of 3.50% through April 14, 2026, payable semi-annually in arrears. As of April 15, 2026, forward, the interest rate on the Notes will generally reset quarterly to a rate equal to three-month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears. The Notes have a stated maturity of April 15, 2031, and are redeemable, in whole are in part, on April 15, 2026, or any interest payment date thereafter, and at any time upon the occurrence of certain events. As of June 30, 2024, we had $59.4 million of subordinated debentures outstanding, net of deferred issuance costs.
In December 2016, we completed a $45.0 million senior note issuance. The notes had a ten-year term, and included interest payable semiannually at 5.75% for five years. Beginning December 31, 2021, the interest became payable quarterly at three month LIBOR plus 385 basis points. On June 30, 2023, the senior notes were redeemed in full. The remaining balance of deferred debt issuance costs of $362,000 related to these senior notes was recognized as interest expense as of June 30, 2023.
On February 24, 2023, we paid off the remaining $9.0 million balance in notes payable and other borrowings, resulting in no balance in this line item as of June 30, 2024, December 31, 2023, and June 30, 2023. The balance in notes payable was related to 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.
As of June 30, 2024, total stockholders’ equity was $619.3 million, which was an increase of $42.1 million from $577.3 million as of December 31, 2023. This increase was largely attributable to net income of $43.2 million in the first six months of 2024, partially offset by $4.5 million of dividends paid to our common stockholders. In addition, total stockholders’ equity as of June 30, 2024, increased over December 31, 2023, due to a reduction in unrealized net losses on available-for-sale securities, which contributed to the overall decrease in accumulated other comprehensive loss of $2.0 million in the first six months of 2024, due to changes in market interest rates. Total stockholders’ equity as of June 30, 2024, increased $105.4 million compared to June 30, 2023 due to net income year over year and the decrease in accumulated other comprehensive loss of $25.4 million year over year.
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
10.29
Total risk-based capital ratio
13.16
Tier 1 risk-based capital ratio
10.80
Tier 1 leverage ratio
8.96
The Bank
11.70
12.83
9.70
2 The prompt corrective action provisions are only applicable at the Bank level.
N/A - Not applicable
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. As of June 30, 2024, our capital measures listed above include $951,000, which is the modified CECL transition adjustment.
As of June 30, 2024, the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” and met the 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, increased from 10.09% at December 31, 2023, to 10.94% at June 30, 2024. Our GAAP tangible common equity to tangible assets ratio was 9.39% at June 30, 2024, compared to 8.53% as of December 31, 2023. Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, increased from 8.56% at December 31, 2023, to 9.43% at June 30, 2024, primarily due to an increase in tangible common equity in the second quarter of 2024. The increase in tangible common equity was primarily due to an increase in retained earnings of $38.7 million.
Reconciliation of Tangible Common Equity to Tangible Assets Ratio Non-GAAP Measure
Tangible common equity
Total Equity
Less: Goodwill and intangible assets
96,541
97,695
Add: Limitation of exclusion of core deposit intangible (80%)
2,014
2,243
Adjusted goodwill and intangible assets
94,527
95,452
522,794
524,808
479,586
481,829
Tangible assets
Less: Adjusted goodwill and intangible assets
5,566,159
5,568,173
5,625,104
5,627,347
Common equity to total assets
10.94
10.09
Tangible common equity to tangible assets
9.39
9.43
8.53
8.56
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. In the second quarter of 2024, we experienced a decrease in loans and deposits. We managed the change in our funding through a reduction in average borrowings from the Federal Home Loan Bank of Chicago (“FHLBC”) in the current year to date period, compared to the prior year like period, which resulted in a minimal interest expense impact to our interest rate risk profile. The bank failures that occurred in 2023 exemplify the potentially serious results of the unexpected inability of insured depository institutions to obtain needed liquidity to satisfy deposit withdrawal requests, including how quickly such requests can accelerate once uninsured depositors lose confidence in an institution’s ability to satisfy its obligations to depositors. We seek to ensure our funding needs are met by maintaining a level of liquidity through asset and liability management. 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, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs. As of June 30, 2024, our cash on hand liquidity totaled $120.9 million, an increase of $20.7 million over cash balances held as of December 31, 2023.
Net cash inflows from operating activities were $59.0 million during the first six months of 2024, compared with net cash inflows of $5.6 million in the same period of 2023. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, were a source of outflows for the first six months of 2024 and 2023. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of inflows for the six months ended June 30, 2024, and a source of outflows for the like period of 2023. 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 inflows from investing activities were $70.8 million in the six months ended June 30, 2024, compared to net cash inflows of $49.0 million in the same period in 2023. In the first six months of 2024, securities transactions accounted for net inflows of $19.2 million, and the principal change on loans accounted for net inflows of $54.0 million. In the first six months of 2023, securities transactions accounted for net inflows of $210.0 million, and principal on loans funded, net of paydowns, accounted for net outflows of $144.0 million.
61
Net cash outflows from financing activities in the six months ended June 30, 2024, were $109.1 million, compared with net cash outflows of $57.1 million in the six months ended June 30, 2023. Net deposit outflows in the first six months of 2024 were $48.9 million compared to net deposit outflows of $392.4 million in the first six months of 2023. Other short-term borrowings had $75.0 million of net cash outflows in the first six months of 2024, compared to net cash inflows of $395.0 million for other short-term borrowings in the first six months of 2023. Changes in securities sold under repurchase agreements accounted for inflows of $20.1 million and outflows of $624,000 for the six months ended June 30, 2024 and 2023, respectively. Dividends paid on our common stock totaled $4.5 million for both the six months ended June 30, 2024 and 2023. The purchase of treasury stock in the first six months of 2024 due to shares acquired with equity award vestings resulted in outflows of $791,000, compared to cash outflows of $605,000 in the first six months of 2023 related to shares acquired from equity award vestings.
Cash and cash equivalents for the six months ended June 30, 2024, totaled $120.9 million, as compared to $100.1 million as of December 31, 2023, and $112.6 million as of June 30, 2023. The increase in cash and cash equivalents for the six months ended June 30, 2024 was mainly attributable to the decrease in our loan and securities portfolios, partially offset by the decrease in customer deposits and other short-term borrowings during the first six months of 2024. The year over year cash and cash equivalents increase is driven by the decline in loans and securities, partially offset by decreased customer use of deposits and a reduction in other short-term borrowings. 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 available include a $30.0 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. A financial institution’s ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in a volatile rate environment. We mitigate the impact of interest rate volatility to the Bank by managing our rate sensitivity under various scenarios.
The Federal Reserve Board (“FRB”) continues to hold rates unchanged through the second quarter of 2024, this was widely expected among market participants. The outlook of multiple rate cuts by market participants has come back into the picture for the second half of 2024. The softer labor market and broader disinflationary trends are conditions that the FRB looks for when evaluating lowering rates.
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 within our guidelines so that such exposure does not pose a material risk to our future earnings. We 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 June 30, 2024 and December 31, 2023, 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 SOFR 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 on-balance sheet and off-balance sheet positions, which includes interest rate swap derivatives as discussed in Note 19 of our consolidated financial statements found in our Annual Report on Form 10-K for the year ended December 31, 2023. We seek to monitor and manage interest rate risk within approved policy guidelines and limits. Asset and liability modeling and tracking is performed and presented to the asset-liability committee and the Board of Directors no less than quarterly. The presentations discuss our current and historical interest rate risk posture, shifts in the balance sheet composition, and the impact of interest rate movements on earnings and equity. Our current balance sheet is a moderately asset sensitive profile, as our variable rate assets reprice faster than our longer duration, low beta deposit base. The market events of failed liquidity management at other banks have been discussed and reviewed by the asset-liability committee. The committee concluded that we continue to have a strong liquidity position and no new liquidity risks were identified. Prudently, we added new measures to assess liquidity risk and enhanced our reports to segment deposits by insured, uninsured, collateralized deposits; and monitor the bank’s funding sources and uses on a regular basis.
We also have a Risk Committee, chaired by our Chief Risk Officer, which reports no less than quarterly to senior management as well as our Board of Directors regarding compliance with risk tolerance limits, key risk factor changes, both internally and externally, due to portfolio changes as well as market conditions. Our enterprise risk management framework is governed by this committee, with input being provided by line of business managers, senior management and the Board.
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 June 30, 2024, our net interest income profile remained sensitive to earnings gains, in both dollars and percentage, should interest rates rise. Our profile is less asset sensitive compared to December 31, 2023, due to shortening of term deposits and updates made to modeling of swap cashflows.
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%, 1.0%, and 2.0%, with no change in the slope of the yield curve.
Analysis of Net Interest Income Sensitivity
Immediate Changes in Rates
(2.0)
Dollar change
(34,147)
(16,994)
(8,367)
8,395
16,916
31,899
Percent change
(13.4)
(6.7)
(3.3)
3.3
12.5
(36,337)
(18,117)
(8,982)
9,354
18,818
36,453
(14.7)
(7.3)
(3.6)
3.8
14.7
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, balance sheet composition 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 additional management action to mitigate potential risk.
Effects of Inflation
In management’s opinion, although changes in interest rates affect our financial condition to a far greater degree than changes in the inflation rate, we monitor both. The annual U.S. inflation rate for June 2024 was 3.0%, down from 3.5% quarter-over-quarter, while Core CPI eased to 3.3%. Inflationary pressures have subsided and are expected to continue trending down. The downside risks of high inflation put upwards pressure to our expenses, which could impact our profits. Furthermore, higher costs of living weaken the financial condition of our borrowers which could affect our credit profile. Inflation is moderating at a comfortable level and has minimal direct impact to our results.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of June 30, 2024. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of June 30, 2024, the Company’s internal controls were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities and Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified.
There were no changes in the Company’s internal controls over financial reporting during the quarter ended June 30, 2024, 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, 2023, 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.”
There have been no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Stock Repurchases
In December 2023, our board of directors authorized the repurchase of up to 2,234,896 shares of our common stock (the “Repurchase Program”). The Company received notice of non-objection in January 2024 from the Federal Reserve Bank of Chicago for the Repurchase Program. Under the Repurchase Program, repurchases may be made through December 31, 2024, will not exceed $17.50 per share, and the aggregate value of share repurchases will not exceed $39.1 million. We may make repurchases under the Repurchase Program 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 December 31, 2024, 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 June 30, 2024.
Total Number of
Maximum Number
Shares Purchased
of Shares that May
as Part of Publicly
Yet Be
Shares
Price Paid
Announced Plans
Purchased Under
Purchased (a)
per Share (b)
or Programs (c)1
the Plans or Programs (d)
April 1, 2024 - April 30, 2024
2,234,896
May 1, 2024 - May 31, 2024
June 1, 2024 - June 30, 2024
1 We announced our Repurchase Program, which will expire on December 31, 2024, unless further extended as described above, in our Current Report on Form 8-K filed on January 3, 2024, and 2,234,896 shares remained available for repurchase under the Repurchase Program as of June 30, 2024.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
Trading Plans
During the three months ended June 30, 2024, no director or “officer” of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or a “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.
Item 6. Exhibits
Exhibits:
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.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at June 30, 2024 and December 31, 2023; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2024 and 2023; (iii) Consolidated Statements of Comprehensive Income (Loss) for the three and months ended June 30, 2024 and 2023; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2024 and 2023; (v) Consolidated Statements of Stockholders’ Equity for the three and six months ended June 30, 2024 and 2023; and (vi) 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).
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
Chairman and Chief Executive Officer
(principal executive officer)
/s/ Bradley S. Adams
Bradley S. Adams
Executive Vice President,
Chief Operating Officer and Chief Financial Officer
(principal financial and accounting officer)
DATE: August 8, 2024