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 September 30, 2022
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 November 4, 2022, the Registrant has 44,573,958 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
4
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
39
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
62
Item 4.
Controls and Procedures
63
PART II
Legal Proceedings
Item 1.A.
Risk Factors
64
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosure
Item 5.
Other Information
Item 6.
Exhibits
65
Signatures
66
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,” “seeks to,” “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:
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.
3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)
September 30,
December 31,
2022
2021
Assets
Cash and due from banks
$
64,903
38,565
Interest earning deposits with financial institutions
51,251
713,542
Cash and cash equivalents
116,154
752,107
Securities available-for-sale, at fair value
1,609,759
1,693,632
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock
19,413
13,257
Loans held-for-sale
1,297
4,737
Loans
3,869,334
3,420,804
Less: allowance for credit losses on loans
48,847
44,281
Net loans
3,820,487
3,376,523
Premises and equipment, net
77,301
88,005
Other real estate owned
1,561
2,356
Mortgage servicing rights, at fair value
11,461
7,097
Goodwill
86,478
86,332
Core deposit intangible
14,323
16,304
Bank-owned life insurance ("BOLI")
105,642
105,300
Deferred tax assets, net
49,620
6,100
Other assets
54,209
60,439
Total assets
5,967,705
6,212,189
Liabilities
Deposits:
Noninterest bearing demand
2,098,144
2,093,494
Interest bearing:
Savings, NOW, and money market
2,726,596
2,868,928
Time
456,619
503,810
Total deposits
5,281,359
5,466,232
Securities sold under repurchase agreements
35,497
50,337
Other short-term borrowings
25,000
-
Junior subordinated debentures
25,773
Subordinated debentures
59,275
59,212
Senior notes
44,559
44,480
Notes payable and other borrowings
10,000
19,074
Other liabilities
52,528
45,054
Total liabilities
5,533,991
5,710,162
Stockholders’ Equity
Common stock
44,705
Additional paid-in capital
201,700
202,443
Retained earnings
289,126
252,011
Accumulated other comprehensive (loss) income
(98,389)
8,768
Treasury stock
(3,428)
(5,900)
Total stockholders’ equity
433,714
502,027
Total liabilities and stockholders’ equity
September 30, 2022
December 31, 2021
Common
Stock
Par value
1.00
Shares authorized
60,000,000
Shares issued
44,705,150
Shares outstanding
44,572,544
44,461,045
Treasury shares
132,606
244,105
See accompanying notes to consolidated financial statements.
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
Interest and dividend income
Loans, including fees
46,614
21,315
121,209
64,337
22
111
132
Securities:
Taxable
9,116
1,854
21,071
5,301
Tax exempt
1,332
1,266
3,946
3,832
Dividends from FHLBC and FRBC stock
261
114
677
342
Interest bearing deposits with financial institutions
663
203
1,714
432
Total interest and dividend income
58,008
24,791
148,728
74,376
Interest expense
Savings, NOW, and money market deposits
380
209
1,124
667
Time deposits
335
330
877
1,239
10
15
30
67
44
285
286
849
850
546
547
1,639
1,064
728
673
1,791
2,019
113
309
355
Total interest expense
2,439
2,173
6,663
6,261
Net interest and dividend income
55,569
22,618
142,065
68,115
Provision for (release of) credit losses
4,500
(1,500)
5,050
(8,000)
Net interest and dividend income after provision for (release of) credit losses
51,069
24,118
137,015
76,115
Noninterest income
Wealth management
2,280
2,372
7,484
6,912
Service charges on deposits
2,661
1,368
7,063
3,784
Secondary mortgage fees
81
240
270
834
Mortgage servicing rights mark to market gain (loss)
548
(282)
3,608
(202)
Mortgage servicing income
514
572
1,612
1,646
Net gain on sales of mortgage loans
449
2,186
1,682
7,802
Securities (losses) gains, net
(1)
244
(34)
246
Change in cash surrender value of BOLI
146
406
1,163
Card related income
2,653
1,624
8,194
Other income
2,165
610
3,949
1,637
Total noninterest income
11,496
9,340
34,170
28,559
Noninterest expense
Salaries and employee benefits
21,011
12,964
62,310
39,366
Occupancy, furniture and equipment
4,119
2,418
10,864
7,188
Computer and data processing
2,543
1,477
12,817
4,079
FDIC insurance
659
211
1,771
604
General bank insurance
257
301
923
854
Amortization of core deposit intangible
657
1,981
348
Advertising expense
83
107
459
262
Card related expense
1,453
662
3,044
1,881
Legal fees
212
455
648
645
Consulting & management fees
607
248
1,746
914
Other real estate expense, net
25
97
138
Other expense
4,365
3,148
14,829
8,989
Total noninterest expense
35,988
22,129
111,489
65,268
Income before income taxes
26,577
11,329
59,696
39,406
Provision for income taxes
7,054
2,917
15,906
10,295
Net income
19,523
8,412
43,790
29,111
Basic earnings per share
0.43
0.30
0.98
1.01
Diluted earnings per share
0.29
0.97
0.99
Dividends declared per share
0.05
0.15
0.11
5
Consolidated Statements of Comprehensive (Loss) Income
(In thousands)
Net Income
Unrealized holding losses on available-for-sale securities arising during the period
(41,163)
(3,007)
(146,477)
(4,483)
Related tax benefit
11,526
841
41,014
1,277
Holding losses, after tax, on available-for-sale securities
(29,637)
(2,166)
(105,463)
(3,206)
Less: Reclassification adjustment for the net (losses) gains realized during the period
Net realized (losses) gains
Related tax benefit (expense)
1
(69)
(70)
Net realized gains (losses) after tax
175
(24)
176
Other comprehensive loss on available-for-sale securities
(2,341)
(105,439)
(3,382)
Changes in fair value of derivatives used for cash flow hedges
(4,868)
218
(2,381)
1,207
1,360
(62)
(338)
Other comprehensive (loss) income on cash flow hedges
(3,508)
156
(1,718)
869
Total other comprehensive loss
(33,145)
(2,185)
(107,157)
(2,513)
Total comprehensive (loss) income
(13,622)
6,227
(63,367)
26,598
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, June 30, 2021
16,372
(1,938)
14,434
Other comprehensive (loss) income, net of tax
Balance, September 30, 2021
14,031
(1,782)
12,249
Balance, June 30, 2022
(64,663)
(581)
(65,244)
Other comprehensive loss, net of tax
Balance, September 30, 2022
(94,300)
(4,089)
For the Nine Months Ended
Balance, December 31, 2020
17,413
(2,651)
14,762
Balance, December 31, 2021
11,139
(2,371)
6
Consolidated Statements of Cash Flows
(Unaudited)
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium / discount amortization on securities
4,259
1,736
Securities losses (gains), net
34
(246)
Originations of loans held-for-sale
(65,103)
(191,679)
Proceeds from sales of loans held-for-sale
69,263
207,339
Net gains on sales of mortgage loans
(1,682)
(7,802)
Mortgage servicing rights mark to market (gain) loss
(3,608)
202
Net accretion of discount on loans and unfunded commitments
(5,473)
(618)
Net change in cash surrender value of BOLI
(342)
(1,163)
Net gains on sale of other real estate owned
(163)
(40)
Provision for other real estate owned valuation losses
104
Depreciation of fixed assets and amortization of leasehold improvements
3,079
2,286
Net gains on disposal and transfer of fixed assets
(1,872)
Amortization of core deposit intangibles
Change in current income taxes receivable
7,279
329
Deferred tax (benefit) expense
(1,854)
1,796
Change in accrued interest receivable and other assets
1,036
2,973
Accretion of purchase accounting adjustment on time deposits
(1,207)
Change in accrued interest payable and other liabilities
3,314
13,016
Stock based compensation
2,176
1,113
Net cash provided by operating activities
60,061
50,766
Cash flows from investing activities
Proceeds from maturities and calls, including pay down of securities available-for-sale
231,483
91,931
Proceeds from sales of securities available-for-sale
3,303
35,075
Purchases of securities available-for-sale
(301,649)
(352,236)
Proceeds from sales of FHLBC/FRBC stock
2,561
Purchases of FHLBC/FRBC stock
(8,717)
Net change in loans
(443,628)
168,551
Proceeds from sales of other real estate owned, net of participations and improvements
941
Proceeds from disposition of premises and equipment
12,167
Net purchases of premises and equipment
(2,670)
(929)
Cash paid for acquisition, net of cash and cash equivalents acquired
(146)
Net cash used in investing activities
(506,355)
(57,001)
Cash flows from financing activities
Net change in deposits
(183,666)
177,256
Net change in securities sold under repurchase agreements
(14,840)
(24,018)
Net change in other short-term borrowings
Issuance of subordinated debentures, net of issuance costs
59,148
Repayment of term note
(3,000)
Net change in notes payable and other borrowings, excluding term note
(6,056)
(235)
Dividends paid on common stock
(6,650)
(3,177)
Purchase of treasury stock
(447)
(10,389)
Net cash (used in) provided by financing activities
(189,659)
195,585
Net change in cash and cash equivalents
(635,953)
189,350
Cash and cash equivalents at beginning of period
329,903
Cash and cash equivalents at end of period
519,253
7
Consolidated Statements of Changes in
Additional
Other
Paid-In
Retained
Treasury
Stockholders’
Capital
Earnings
Income (Loss)
Equity
34,957
120,572
255,536
(109,561)
315,938
Dividends declared and paid, ($0.05 per share)
(1,435)
502
121,074
262,513
321,232
201,282
271,831
(3,670)
448,904
(2,228)
Vesting of restricted stock
(304)
304
722
Purchase of treasury stock from taxes withheld on stock awards
122,212
236,579
(101,423)
307,087
Dividends declared and paid, ($0.11 per share)
(2,251)
2,251
(577)
Purchase of treasury stock from stock repurchase program
(9,812)
Dividends declared and paid, ($0.15 per share)
(6,675)
(2,919)
2,919
8
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 September 30, 2022, are not necessarily indicative of the results that may be expected for the year ending December 31, 2022. These interim consolidated financial statements are unaudited and should be read in conjunction with the audited financial statements and notes included in Old Second Bancorp, Inc.’s (the “Company”) annual report on Form 10-K for the year ended December 31, 2021. 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.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” and Note 1 – Summary of Significant Accounting Policies, both found in our Annual Report on Form 10-K for the year ended December 31, 2021, for further discussion of our Allowance for Credit Losses methodology, which now implements Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Measurement of Credit Losses on Financial Instruments (Topic 326),” also known as Current Expected Credit Losses, or CECL. ASU 2016-13, which is considered a critical accounting estimate, is effective for financial statements issued for fiscal years beginning after December 15, 2019, and was adopted as of January 1, 2020, by the Company.
Recent Accounting Pronouncements
The following is a summary of recent accounting pronouncements that have impacted or could potentially affect the Company:
ASU 2018-16, ASU 2020-04 and ASU 2021-01 – In October 2018, the Financial Standards Board, or FASB, issued ASU No. 2018-16 “Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting.” ASU 2018-16 adds the SOFR overnight index swap rate to the list of United States (U.S.) benchmark rates eligible for hedge accounting purposes, which is the fourth rate permissible to be used as a U.S. benchmark rate. This guidance is effective for annual and interim periods beginning after December 15, 2018, and we do not expect this guidance to have a material impact on the financial condition or liquidity of the Company. ASU 2020-04 and ASU 2021-01 Reference Rate Reform (Topic 848) were issued on March 12, 2020 and January 7, 2021, respectively, and each provide further guidance on optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships due to the discontinuation of LIBOR. In addition, on March 5, 2021, the International Swaps and Derivatives Association (“ISDA”) issued a statement with an “Index Cessation Event Announcement,” which confirmed the extension of the cessation of LIBOR-referenced rates from December 31, 2021, to June 30, 2023, for certain rate tenors.
The Company formed a LIBOR transition team in 2019, and has developed a project plan to assess the use of alternative indexes and to seek to ensure all financial instruments that reference LIBOR are identified, quantified, and researched for the LIBOR fallback language available or needed. The Company has completed the ISDA protocol adherence for LIBOR fallback language for all commercial swaps, has met with its commercial loan clients to also guide their swap fallback language adherence, and worked to revise all credit documents being issued by Old Second National Bank (the “Bank”) for new loans to ensure appropriate fallback language is included. We have discontinued the use of LIBOR as a reference rate for all consumer loans issued after July 31, 2021, and all commercial loans issued after December 31, 2021, with certain exceptions for those loans that were in the process of funding at the end of 2021. The Company’s systems have been updated to handle multiple SOFR-based indexes and we continue to meet regularly to plan for the transition of existing LIBOR exposures prior to the final LIBOR cessation date of June 30, 2023.
9
ASU 2022-01 – On March 28, 2022, the FASB issued ASU 2022-01 “Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method.” ASU 2022-01 is effective for public business entities for fiscal years beginning after December 15, 2022, and also interim periods within those fiscal years. Early adoption is permitted if an entity has adopted ASU No. 2017-12 concurrently or prior. The goal of this new hedging standard is to better align the economic results of risk management activities with hedge accounting, by allowing multiple layers of a single closed portfolio to be hedged, as compared to the single-layer, or last of layer method, allowed with the adoption of ASU 2017-12.
The Company is currently reviewing ASU 2022-01 for the impact to derivative measurement and disclosures, and will assess any revisions needed for reporting purposes in the next quarter. We anticipate adopting ASU 2022-01 no later than January 1, 2023. We do not expect a material impact upon adoption.
ASU 2022-02 – On March 31, 2022, the FASB issued ASU 2022-02 “Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 is effective for any entities that have adopted CECL, and is effective for fiscal years beginning after December 15, 2022, including interim periods within those years. The amendments eliminate certain troubled debt restructuring (“TDR”) recognition and measurement guidance previously in effect, and consideration of the TDRs similar to other modified loans under CECL is now required. ASU 2022-02 also requires enhancements to vintage loan disclosures, requiring detail be provided on current-period gross write-offs and disclosure of the amortized cost basis of financing receivables by credit quality indicators and by loan portfolio class of the gross charge-off based on year of origination.
The Company is currently reviewing ASU 2022-02 for the impact to TDR recognition, measurement and disclosures, and will assess any revisions needed for reporting purposes in the next quarter. We anticipate adopting ASU 2022-02 as of January 1, 2023.
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, 2021. 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 third quarter of 2022, the Company had no changes to significant accounting policies or estimates.
Subsequent Events
On October 18, 2022, our Board of Directors declared a cash dividend of $0.05 per share payable on November 7, 2022, to stockholders of record as of October 28, 2022; dividends of $2.2 million are scheduled to be paid to stockholders on November 7, 2022.
Note 2 – Acquisition
On December 1, 2021, the Company completed its acquisition of West Suburban Bancorp, Inc. (“West Suburban”), a bank holding company, and its wholly owned subsidiary, West Suburban Bank, based in Lombard, Illinois, with operations throughout our existing market footprint. This acquisition brought increased scale and new markets to the Company, and provided new product offerings and line of business opportunities. At closing, the Company acquired $2.94 billion of assets, $1.50 billion of loans, $1.07 billion of securities, and $2.69 billion of deposits, net of fair value adjustments. Under the terms of the merger agreement, each outstanding share of West Suburban common stock was exchanged for 42.413 shares of Company common stock, plus $271.15 of cash. This resulted in merger consideration of $295.2 million, based on the closing price of the Company’s common stock on the date of acquisition, which consisted of 15.7 million shares of the Company’s common stock and $100.7 million of cash. Goodwill of $67.9 million associated with the acquisition was recorded by the Company, which was the result of expected synergies, operational efficiencies and other factors.
The acquisition of West Suburban was accounted for as a business combination. We recorded the estimate of fair value based on initial valuations available at December 1, 2021. The determination of estimated fair value required management to make assumptions related to discount rates, expected future cash flows, market conditions and other future events that are often subjective in nature and may require adjustments. Estimated fair values which are subject to adjustment for up to one year after December 1, 2021 are considered final as of September 30, 2022. Adjustments and reclasses between deferred tax assets and current taxes receivable, which is reported within other
assets, were identified during the quarter ended September 30, 2022 based on further analysis after West Suburban Bank tax filings were made. Deferred tax assets increased $3.7 million, which was offset by a decrease in current taxes receivable of $3.9 million, which resulted in an increase to goodwill of $146,000. None of the $67.9 million of goodwill recorded is expected to be deductible for income tax purposes.
The following table provides the preliminary purchase price allocation as of the December 1, 2021 closing date of the merger for the estimated fair value of the assets acquired and liabilities assumed, as recorded by the Company.
West Suburban Acquisition Summary
As of Date of Acquisition
December 1, 2021
16,794
232,880
Securities available-for-sale and held-to maturity, at fair value
1,067,517
FHLBC stock
3,340
Loans, net of allowance for credit losses Day One PCD loan adjustment
1,500,974
Premises and equipment
47,456
5,552
14,772
Deferred tax assets
5,819
48,838
2,943,942
1,070,980
Savings, NOW and money market
1,408,051
215,205
2,694,236
Reserve for unfunded commitments
1,787
20,629
2,716,652
Cash consideration paid
100,679
Stock issued for acquisition
194,484
Total Liabilities Assumed and Cash and Stock Consideration Paid for Acquisition
3,011,815
67,873
Expenses related to the West Suburban acquisition totaled $650,000 and $9.5 million for the three month and nine month periods ended September 30, 2022 respectively, and $13.2 million during the year ended December 31, 2021, and are reported within noninterest expense based on the line items impacted, which are primarily salaries and employee benefits, occupancy, furniture and equipment, computer and data processing, legal fees, and other expense in the Consolidated Statements of Income.
11
Purchased loans and leases that reflect a more-than-insignificant deterioration of credit from origination are considered purchased credit deteriorated (“PCD”) loans. For PCD loans, the initial estimate of expected credit losses was recognized in the allowance for credit losses (“ACL”) on the date of acquisition using the same methodology as other loans and leases held-for-investment. The following table provides a summary of loans purchased as part of the West Suburban acquisition which were individually evaluated and determined to be PCD loans at acquisition.
As of
West Suburban Acquired PCD Loans
Par value of acquired loans
108,241
Allowance for credit losses
(12,075)
Non-credit discount
(1,723)
Purchase price of PCD loans at acquisition
94,443
The following table presents the carrying amount of all acquired loans as of September 30, 2022 and December 31, 2021, including loans that, as of the acquisition date, had not experienced a more-than-insignificant deterioration in credit quality since origination (“non-PCD loans”):
Acquired Loan Detail
As of September 30, 2022
As of December 31, 2021
PCD
Non-PCD
West Suburban acquired loans
77,548
1,171,877
1,249,425
102,409
1,418,752
1,521,161
ABC Bank acquired loans
2,114
44,082
46,196
4,547
64,236
68,783
Talmer Bank acquired loans
16,048
45,858
Total acquired loans net book value
79,662
1,232,007
1,311,669
106,956
1,528,846
1,635,802
Accretion recorded on acquired loans year to date
782
4,121
4,903
401
565
966
Accretion recorded on acquired unfunded commitments year to date
670
74
Note 3 – Securities
Investment Portfolio Management
Our investment portfolio serves the liquidity needs and income objectives of the Company. While the portfolio serves as an important component of the overall liquidity management at the Bank, portions of the portfolio also serve as income producing assets. The size and composition of the portfolio reflects liquidity needs, loan demand and interest income objectives. Portfolio size and composition will be adjusted from time to time. While a significant portion of the portfolio consists of readily marketable securities to address liquidity, other parts of the portfolio may reflect funds invested pending future loan demand or to maximize interest income without undue interest rate risk.
Investments are comprised of debt securities and non-marketable equity investments. Securities available-for-sale are carried at fair value. Unrealized gains and losses, net of tax, on securities available-for-sale are reported as a separate component of equity. This balance sheet component changes as interest rates and market conditions change. Unrealized gains and losses are not included in the calculation of regulatory capital.
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 $4.5 million at September 30, 2022, and $7.1 million at December 31, 2021. FRBC stock was recorded at $14.9 million at September 30, 2022, and $6.2 million at December 31, 2021.
The following tables summarize the amortized cost and fair value of the securities portfolio at September 30, 2022, and December 31, 2021, and the corresponding amounts of gross unrealized gains and losses:
12
Gross
Amortized
Unrealized
Fair
Cost1
Gains
Losses
Value
Securities available-for-sale
U.S. Treasury
223,910
(12,813)
211,097
U.S. government agencies
61,364
(5,401)
55,963
U.S. government agencies mortgage-backed
145,857
(18,231)
127,626
States and political subdivisions
243,515
(19,257)
224,259
Corporate bonds
(456)
9,544
Collateralized mortgage obligations
648,044
(60,203)
587,846
Asset-backed securities
227,130
23
(7,566)
219,587
Collateralized loan obligations
180,910
(7,073)
173,837
Total securities available-for-sale
1,740,730
29
(131,000)
202,251
125
(37)
202,339
62,587
(699)
61,888
172,016
856
(570)
172,302
241,937
16,344
(672)
257,609
(113)
9,887
673,238
2,014
(2,285)
672,967
236,293
1,245
(661)
236,877
79,838
(78)
79,763
1,678,160
20,587
(5,115)
1 Excludes accrued interest receivable of $6.3 million and $4.3 million at September 30, 2022 and December 31, 2021, respectively, that is recorded in other assets on the consolidated balance sheet.
The fair value, amortized cost and weighted average yield of debt securities at September 30, 2022, 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
8,816
1.10
%
8,617
Due after one year through five years
303,411
1.05
284,480
Due after five years through ten years
44,313
2.63
39,593
Due after ten years
182,249
3.02
168,173
538,789
1.85
500,863
Mortgage-backed and collateralized mortgage obligations
793,901
2.22
715,472
3.39
4.64
2.51
At September 30, 2022, the Company’s investments included $167.0 million of asset-backed securities that are backed by student loans originated under the Federal Family Education Loan program (“FFEL”). Under the FFEL, private lenders made federally guaranteed student loans to parents and students. While the program was modified several times before elimination in 2010, FFEL securities are
13
generally guaranteed by the U.S Department of Education (“DOE”) at not less than 97% of the outstanding principal amount of the loans. The guarantee will reduce to 85% if the DOE receives reimbursement requests in excess of 5% of insured loans; reimbursement will drop to 75% if reimbursement requests exceed 9% of insured loans. In addition to the DOE guarantee, total added credit enhancement in the form of overcollateralization and/or subordination amounted to $20.3 million, or 9.29%, of outstanding principal.
At September 30, 2022, 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 September 30, 2022 and December 31, 2021, 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
12,813
1,987
27,188
3,414
28,775
5,401
126
16,766
122,905
1,465
4,721
18,231
79
18,155
219,497
1,102
4,510
82
19,257
224,007
4,715
170
4,829
456
205
48,552
505,601
11,651
77,102
220
60,203
582,703
6,553
196,221
1,013
11,524
50
7,566
207,745
26
5,735
134,712
1,338
39,125
7,073
488
110,847
1,421,936
46
20,153
170,586
534
131,000
1,592,522
37
49,719
592
56,879
5,008
699
61,887
505
78,711
1,663
570
80,374
55
8,430
617
4,051
672
12,481
133
2,285
381,658
20
608
103,819
53
3,276
661
107,095
35
45,132
43
10,628
78
55,760
241
4,230
734,235
885
24,626
252
5,115
758,861
Each quarter we perform an analysis to determine if any of the unrealized losses on securities available-for-sale are comprised of credit losses as compared to unrealized losses due to market interest rate adjustments. Our assessment includes a review of the unrealized loss for each security issuance held; the financial condition and near-term prospects of the issuer, including external credit ratings and recent downgrades; and our ability and intent to hold the security for a period of time sufficient for a recovery in value. We also consider the extent to which the securities are issued by the federal government or its agencies, and any guarantee of issued amounts by those agencies. No credit losses were determined to be present as of September 30, 2022, as there was no credit quality deterioration noted. Therefore, no provision for credit losses on securities was recognized for the third quarter of 2022.
14
Three Months Ended
Nine Months Ended
Proceeds from sales of securities
26,873
Gross realized gains on securities
267
Gross realized losses on securities 1
(18)
(21)
Income tax benefit (expense) on net realized (losses) gains
Effective tax rate applied
N/M
28.3
29.4
28.5
1 The Company received proceeds of $7.5 million from the call of available for sale investment securities for the nine months ended September 30, 2022. A loss of $1,000 was recorded on the call of securities during the third quarter of 2022.
N/M - Not meaningful
As of September 30, 2022, securities valued at $578.5 million were pledged to secure deposits and borrowings, and for other purposes, an increase from $501.3 million of securities pledged at year-end 2021.
Note 4 – Loans and Allowance for Credit Losses on Loans
Major segments of loans were as follows:
Commercial 1
888,081
771,474
Leases
251,603
176,031
Commercial real estate – investor
941,910
799,928
Commercial real estate – owner occupied
876,951
731,845
Construction
176,700
206,132
Residential real estate – investor
59,580
63,399
Residential real estate – owner occupied
220,969
213,248
Multifamily
322,856
309,164
HELOC
116,108
126,290
Other 2
14,576
23,293
Total loans
Allowance for credit losses on loans
(48,847)
(44,281)
Net loans 3
1 Includes $2.4 million and $38.4 million of Paycheck Protection Program (“PPP”) loans at September 30, 2022 and December 31, 2021, respectively.
2 The “Other” segment includes consumer and overdrafts in this table and in subsequent tables within Note 4 - Loans and Allowance for Credit Losses on Loans.
3 Excludes accrued interest receivable of $13.7 million and $9.2 million at September 30, 2022 and December 31, 2021, respectively, that is recorded in other assets on the consolidated balance sheet.
It is the policy of the Company to review each prospective credit prior to making a loan in order to determine if an adequate level of security or collateral has been obtained. The type of collateral, when required, will vary from liquid assets to real estate. The Company seeks to assure access to collateral, in the event of borrower default, through adherence to lending laws, the Company’s lending standards and credit monitoring procedures. Although the Bank makes loans primarily within its market area, there are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single economic sector. The real estate related categories
listed above represent 70.2% and 71.6% of the portfolio at September 30, 2022, and December 31, 2021, 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 nine months ended September 30, 2022 and 2021:
(Release of)
Beginning
Provision for
Ending
Balance
Credit Losses
Charge-offs
Recoveries
Three months ended September 30, 2022
Commercial
14,114
(919)
47
13,175
178
1,534
9,436
256
124
19
9,587
11,478
3,618
87
15,171
1,535
1,544
147
816
1,869
149
2,131
2,434
33
2,530
1,542
386
1,963
583
(128)
103
396
45,388
3,527
484
416
Nine months ended September 30, 2022
11,751
1,488
85
3,480
(1,768)
10,795
(664)
60
4,913
10,289
102
3,373
(1,829)
760
2,832
3,675
(1,208)
2,510
(649)
192
404
320
120
5,177
1,384
773
Three months ended September 30, 2021
2,601
2,685
3,388
(41)
3,343
9,003
(799)
101
18
8,121
2,520
3,048
(175)
2,873
975
(287)
695
1,866
(116)
1,768
3,266
(121)
183
2,962
1,833
(23)
28
1,838
139
134
28,639
(1,453)
369
26,949
16
Nine months ended September 30, 2021
2,812
232
3,888
(513)
32
7,899
265
58
3,557
(1,213)
225
4,054
(1,181)
1,740
(1,328)
283
2,714
(1,074)
128
3,625
(480)
1,948
(222)
17
129
1,618
(1,483)
108
33,855
(7,186)
712
992
The ACL on loans excludes $4.4 million, $4.5 million and $2.2 million of allowance for unfunded commitments as of September 30, 2022, December 31, 2021 and September 30, 2021, respectively, recorded within Other Liabilities. The total ACL on unfunded commitments listed as of September 30, 2022 and December 31, 2021 excludes the purchase accounting adjustment of $1.0 million and $1.7 million, respectively, recorded due to our acquisition of West Suburban, which is also recorded within Other Liabilities, and is being accreted in interest income over the estimated life of the unused commitments.
The following tables presents the collateral dependent loans and the related ACL allocated by segment of loans as of September 30, 2022 and December 31, 2021:
Accounts
ACL
Real Estate
Receivable
Equipment
Allocation
895
8,748
1,090
10,737
1,821
17,389
2,891
20,667
2,379
23,046
6,033
675
1,773
190
42,261
1,825
3,469
56,303
10,636
1,986
9,901
11,887
2,677
3,249
3,754
811
5,693
9,147
2,490
11,637
362
2,104
925
4,271
276
1,845
75
1,006
26,977
3,002
43,129
5,387
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
1,228
1,012
1,153
3,393
884,688
602
187
250,747
1,457
17,945
19,402
922,508
12,833
723
3,091
3,814
873,137
314
7,380
7,694
169,006
457
68
1,040
1,565
58,015
644
424
2,451
3,519
217,450
235
1,023
1,695
321,161
635
630
1,265
114,843
21
41
14,535
5,659
3,156
34,429
43,244
3,826,090
20,752
December 31, 2021 1
3,407
1,413
1,828
6,648
764,826
1,396
1,571
1,696
174,335
1,107
1,374
798,554
2,324
500
4,848
7,672
724,173
1,594
205,278
395
470
792
1,657
61,742
1,994
591
3,077
5,662
207,586
1,046
308,118
193
398
614
125,676
119
23,174
9,342
4,356
13,644
27,342
3,393,462
3,110
1 Loans modified under the CARES Act were considered current if they were in compliance with the modified terms.
The table presents all nonaccrual loans as of September 30, 2022, and December 31, 2021:
Nonaccrual loan detail
With no ACL
8,821
5,449
11,894
9,217
2,943
5,112
2,018
5,694
9,581
7,035
11,205
145
160
1,097
876
3,552
3,304
4,898
4,622
1,559
1,573
2,022
1,042
852
32,126
22,866
41,531
37,145
The Company recognized $142,000 of interest on nonaccrual loans during the nine months ended September 30, 2022.
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 September 30, 2022 were as follows:
2020
2019
2018
Prior
Revolving Loans
Revolving Loans Converted To Term Loans
Pass
170,428
77,354
23,879
14,671
8,502
5,253
527,792
473
828,352
Special Mention
3,030
3,137
1,274
2,528
18,038
28,007
Substandard
5,407
2,976
3,214
7,217
31,722
Total commercial
178,865
83,467
28,367
30,032
8,517
5,313
553,047
122,629
69,757
30,415
21,531
5,628
1,408
251,368
93
142
Total leases
30,508
21,673
335,320
238,901
148,301
65,813
49,805
60,056
6,960
905,156
5,353
3,149
23,140
3,094
28,252
Total commercial real estate – investor
340,673
240,919
88,953
66,299
164,067
241,671
103,552
48,982
51,399
100,087
33,753
743,511
8,429
8,600
53,299
19,102
1,068
90,742
2,625
17,316
1,135
18,309
3,313
42,698
Total commercial real estate – owner occupied
175,121
267,587
157,986
86,393
51,643
104,468
27,377
77,625
44,138
2,460
2,886
1,435
2,560
158,481
5,181
10,226
16,872
1,232
115
1,347
Total construction
28,609
79,090
49,319
12,801
13,481
10,482
7,079
9,508
5,246
11,285
1,214
58,295
499
189
422
1,285
Total residential real estate – investor
13,656
10,007
5,435
11,707
36,688
45,430
29,163
16,407
12,421
74,772
216,446
594
272
239
725
3,929
Total residential real estate – owner occupied
46,296
29,402
17,132
12,553
77,333
71,830
108,581
53,862
15,559
56,411
7,538
155
314,037
6,837
1,095
279
1,982
Total multifamily
72,925
22,396
57,019
7,817
1,909
517
1,512
1,728
2,616
104,776
113,719
70
210
1,935
2,278
Total HELOC
1,972
731
2,826
106,822
2,892
3,102
501
166
57
122
7,734
14,574
Total other
503
946,621
873,420
442,402
196,825
193,016
264,572
686,455
628
3,603,939
16,812
13,796
59,754
38,693
4,217
18,149
151,665
10,597
22,582
4,683
55,763
1,014
9,939
9,152
113,730
974,030
909,798
506,839
291,281
194,274
278,728
713,756
Credit quality indicators by loan segment and loan origination date at December 31, 2021, were as follows:
2017
192,258
50,638
38,614
28,177
5,176
10,945
408,394
734,232
84
694
3,708
4,530
9,498
4,048
14,121
326
4,644
32,712
201,800
54,770
53,429
28,503
11,020
416,746
83,402
44,129
32,259
8,950
1,170
2,367
172,277
2,834
623
297
35,093
9,573
2,664
245,346
175,218
118,697
85,049
64,810
55,523
18,602
763,245
15,466
10,550
26,016
2,238
2,378
451
181
3,612
1,807
10,667
263,050
177,596
129,698
85,230
68,422
57,330
290,225
155,353
90,325
60,915
54,236
59,887
2,522
713,463
2,953
8,318
942
1,686
1,251
3,232
15,429
298,543
156,295
94,964
55,487
63,119
88,620
65,629
37,169
2,727
477
1,193
1,143
196,958
2,138
4,932
7,070
1,944
88,780
67,767
42,101
4,671
13,371
9,758
13,084
6,392
7,059
10,602
1,868
62,134
121
144
197
385
418
13,492
9,902
6,589
7,444
48,009
31,912
20,990
13,304
30,562
60,661
2,052
207,490
322
1,219
3,193
5,099
48,990
32,095
20,996
14,523
30,738
63,854
109,175
71,748
39,293
61,190
11,399
7,117
299,986
6,900
433
1,543
302
109,608
46,193
62,733
11,701
907
2,091
805
1,667
12,315
104,843
124,759
376
1,018
1,423
822
1,679
12,691
105,969
8,659
1,099
437
254
1,414
4,214
7,206
23,283
1,079,972
607,575
392,999
267,763
177,970
224,824
546,694
3,297,827
16,169
2,222
26,029
3,816
48,236
21,090
7,698
19,098
6,057
5,738
9,398
74,741
1,117,231
617,495
438,126
273,820
183,708
234,222
556,172
The Company had $659,000 and $488,000 in residential real estate loans in the process of foreclosure as of September 30, 2022, and December 31, 2021, respectively.
Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist: (1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-by-case basis during the loan collection process with modifications generally initiated at the request of the borrower. These modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an opportunity to refinance into more affordable monthly payments. Additionally, in accordance with interagency guidance, short-term deferrals granted due to the COVID-19 pandemic were not considered TDRs, if modified prior to January 1, 2022, unless the borrower was experiencing financial difficulty prior to the pandemic.
The specific allocation of the allowance for credit losses for TDRs is determined by calculating the present value of the TDR cash flows by discounting the original payment less an assumption for probability of default at the original note’s issue rate, and adding this amount to the present value of collateral less selling costs. If the resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance (i.e., specific reserve) as a component of the allowance for credit losses or charges off the impaired balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. The allowance for credit losses also includes an allowance based on a loss migration analysis for each loan category on loans and leases that are not individually evaluated for specific impairment. All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.
There were no TDR loan modifications for the three months ended September 30, 2022 and two TDR loan modifications for an aggregate of $39,000 for the nine months ended September 30, 2022. There was no TDR activity for the three and nine months ended September 30, 2021. TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. There was no TDR default activity for the periods ended September 30, 2022, and September 30, 2021, for loans that were restructured within the prior 12 month period.
Note 5 – Other Real Estate Owned
Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation allowance, for the periods presented are itemized in the following tables:
Balance at beginning of period
1,877
2,474
Property additions, net of acquisition adjustments
Less:
Proceeds from property disposals, net of participation purchase and of gains/losses
778
567
Period valuation (write-up)/write-down
(2)
Balance at end of period
1,912
Activity in the valuation allowance was as follows:
920
1,296
1,179
1,643
(Release of) provision for unrealized losses
Reductions taken on sales
(64)
(129)
(427)
(543)
1,165
Expenses related to OREO, net of lease revenue includes:
Gain on sales, net
(33)
(5)
Operating expenses
159
117
Lease revenue
Net OREO expense
96
Note 6 – Deposits
Major classifications of deposits were as follows:
Savings
1,164,036
1,178,575
NOW accounts
630,747
587,381
Money market accounts
931,813
1,102,972
Certificates of deposit of less than $100,000
258,071
296,298
Certificates of deposit of $100,000 through $250,000
148,411
138,794
Certificates of deposit of more than $250,000
50,137
68,718
Note 7 – Borrowings
The following table is a summary of borrowings as of September 30, 2022, and December 31, 2021. Junior subordinated debentures are discussed in more detail in Note 8:
Total borrowings
200,104
198,876
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 $35.5 million at September 30, 2022, and $50.3 million at December 31, 2021. The fair value of the pledged collateral was $72.4 million at September 30, 2022, and $113.0 million at December 31, 2021. At September 30, 2022, 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 September 30, 2022, the Bank had $25.0 million in short-term advances outstanding under the FHLBC. There were no short-term advances as of December 31, 2021. The Bank assumed $23.4 million of long-term FHLBC advances with our ABC Bank acquisition in 2018. The remaining balance of $5.9 million was paid off in full during the second quarter of 2022. FHLB stock held at September 30, 2022 was valued at $4.5 million, and any potential FHLBC advances were collateralized by loans with a principal balance of $861.1 million, which carried a FHLBC-calculated combined collateral value of $576.7 million. The Company had excess collateral of $536.7 million available to secure borrowings at September 30, 2022.
The Company also had $44.6 million and $44.5 million of senior notes outstanding, net of deferred issuance costs, as of September 30, 2022 and December 31, 2021, respectively. The senior notes were issued in December 2016 with a ten year maturity, and terms include interest payable semiannually at 5.75% for five years. Beginning December 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 are redeemable, in whole or in part, at the option of the Company, beginning with the interest payment date on December 31, 2021, and on any floating rate interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest. As
24
of September 30, 2022, and December 31, 2021, unamortized debt issuance costs related to the senior notes were $441,000 and $520,000, respectively, and are included as a reduction of the balance of the senior notes on the Consolidated Balance Sheet. These deferred issuance costs will be amortized to interest expense over the ten year term of the notes and are included in the Consolidated Statements of Income.
On February 24, 2020, the Company originated a $20.0 million term note, of which $10.0 million is outstanding as of September 30, 2022, with a correspondent bank. The term note was issued for a three year term at one-month LIBOR plus 175 basis points, requires principal payments quarterly and interest payments monthly, and the balance of this note is included within Notes Payable and Other Borrowings on the Consolidated Balance Sheet. The Company also has an undrawn line of credit of $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.
In the second quarter of 2021, we sold and issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”). The Notes were offered and sold to eligible purchasers in a private offering in reliance on the exemption from the registration requirements of Section 4(a)(2) of the Securities Act of 1933, as amended and the provisions of Regulation D promulgated thereunder. The Company intends to use the net proceeds from the offering for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions. The Notes bear interest at a fixed annual rate of 3.50%, from and including the date of issuance to but excluding April 15, 2026, payable semi-annually in arrears. From and including April 15, 2026 to, but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an interest rate per annum equal to Three-Month Term SOFR (as defined in the Note) plus 273 basis points, payable quarterly in arrears. As of September 30, 2022, we had $59.3 million of subordinated debentures outstanding, net of deferred issuance costs.
Note 8 – 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 LIBOR. Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 4.39% and 4.40% for the quarters ended September 30, 2022 and September 30, 2021, respectively. The Company issued a new $25.8 million subordinated debenture to Old Second Capital Trust II in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.
The junior subordinated debentures issued by the Company are disclosed on the Consolidated Balance Sheet, and the related interest expense for each issuance is included in the Consolidated Statements of Income. As of September 30, 2022, and December 31, 2021, the remaining unamortized debt issuance costs related to the junior subordinated debentures were $1,000 and are included as a reduction to the balance of the junior subordinated debentures on the Consolidated Balance Sheet. The remaining deferred issuance costs on the junior subordinated debentures related to the issuance of Old Second Capital Trust II will be amortized to interest expense over the remainder of the 30-year term of the notes and are included in the Consolidated Statements of Income.
Note 9 – 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 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 September 30, 2022, 1,176,903 shares remained available for issuance under the 2019 Plan.
Under the 2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, all stock options and SARs then held by the participant will become fully exercisable immediately if, and all stock awards and cash incentive awards will become fully earned and vested immediately if, (i) the 2019 Plan is not an obligation of the successor entity following a change in control or (ii) the 2019 Plan is an obligation of the successor entity following a change in control and the participant incurs a termination of service without cause or for good reason following the change in control. Notwithstanding the immediately preceding sentence, if the vesting of an award is conditioned upon the achievement of performance measures, then such vesting will generally be subject to the following: if, at the time of the change in control, the performance measures are less than 50% attained (pro rata based upon the time of the period through the change in control), the award will become vested and exercisable on a fractional basis with the numerator being equal to the percentage of attainment and the denominator being 50%; and if, at the time of the change in control, the performance measures are at least 50% attained (pro rata based upon the time of the period through the change in control), the award will become fully earned and vested immediately upon the change in control.
Awards of restricted stock units 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 Generally, restricted stock and restricted stock units granted under the Plan vest three years from the grant date, but the Compensation Committee of the Company’s Board of Directors has discretionary authority to change some terms including the amount of time until the vest date.
There were 268,160 and 222,464 restricted stock units issued under the 2019 Plan during the nine months ended September 30, 2022 and September 30, 2021, 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 in the first nine months of 2022 and $1.2 million for the first nine months ended of 2021.
A summary of changes in the Company’s unvested restricted awards for the nine months ended September 30, 2022, is as follows:
Restricted
Stock Shares
Grant Date
and Units
Fair Value
Unvested at January 1
540,306
12.04
Granted
268,160
14.25
Vested
(143,437)
12.75
Forfeited
(17,144)
12.49
Unvested at September 30
647,885
12.79
Total unrecognized compensation cost of restricted awards was $4.5 million as of September 30, 2022, which is expected to be recognized over a weighted-average period of 2.01 years.
Note 10 – Earnings Per Share
The earnings per share, both basic and diluted, are as follows:
Basic earnings per share:
Weighted-average common shares outstanding
44,565,626
28,707,737
44,509,072
28,925,612
Diluted earnings per share:
Dilutive effect of unvested restricted awards 1
655,915
522,543
698,920
533,194
Diluted average common shares outstanding
45,221,541
29,230,280
45,207,992
29,458,806
1 Includes the common stock equivalents for restricted share rights that are dilutive.
Note 11 – 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 September 30, 2022, the Bank exceeded those thresholds.
At September 30, 2022, the Bank’s Tier 1 capital leverage ratio was 9.24%, a decrease of 34 basis points from December 31, 2021, but is above the 8.00% objective. The Bank’s total capital ratio was 12.64%, a decrease of 82 basis points from December 31, 2021, but 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 September 30, 2022, and December 31, 2021.
In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital requirements for U.S. banking institutions, which went into effect on January 1, 2015. The Basel III Rules are applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies”, 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, 2021, under the heading “Supervision and Regulation.”
At September 30, 2022 and December 31, 2021, 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
434,155
9.16
331,778
7.00
N/A
Old Second Bank
550,635
11.60
332,280
308,545
6.50
Total capital to risk weighted assets
568,429
11.99
497,790
10.50
599,909
12.64
498,342
474,612
10.00
Tier 1 capital to risk weighted assets
459,155
9.68
403,184
8.50
403,483
379,748
8.00
Tier 1 capital to average assets
7.70
238,522
4.00
9.24
238,370
297,963
5.00
394,421
9.46
291,855
514,992
12.41
290,487
269,738
522,932
12.55
437,513
558,503
13.46
435,682
414,935
419,421
10.06
354,382
352,734
331,985
7.81
214,812
9.58
215,028
268,785
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 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 September 30, 2022, the capital measures of the Company exclude $2.9 million, which is the modified CECL transition adjustment.
Dividend Restrictions
In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be paid by a bank without prior regulatory approval. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital requirements described above. As of September 30, 2022, the Bank had capacity to pay dividends of $17.7 million to the Company without prior regulatory approval. Pursuant to the Basel III rules that came into effect January 1, 2015, and were fully phased in as of January 1, 2019, the Bank must keep a capital conservation buffer of 2.50% above the 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 12 – 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.
Transfers between levels are deemed to have occurred at the end of the reporting period. At September 30, 2022 and 2021, there were no transfers between levels.
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 September 30, 2022, and December 31, 2021, respectively, measured by the Company at fair value on a recurring basis:
Level 1
Level 2
Level 3
Assets:
210,950
13,309
Mortgage servicing rights
Interest rate swap agreements, including risk participation agreement
6,624
Mortgage banking derivatives
188
1,393,462
24,770
1,629,329
Liabilities:
Interest rate swap agreements, including risk participation agreements
12,278
242,373
15,236
Interest rate swap agreements
3,494
508
1,484,796
22,333
1,709,468
6,809
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are as follows:
Nine Months Ended September 30, 2022
States and
Mortgage
Political
Servicing
Subdivisions
Rights
Beginning balance January 1, 2022
Total gains or losses
Included in earnings
(98)
4,384
Included in other comprehensive loss
(1,333)
Purchases, issuances, sales, and settlements
Purchases
Issuances
519
756
Settlements
(1,015)
(776)
Ending balance September 30, 2022
31
Nine Months Ended September 30, 2021
Beginning balance January 1, 2021
4,319
4,224
(7)
840
Included in other comprehensive income
812
748
1,298
(312)
(1,042)
Ending balance September 30, 2021
5,560
5,320
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of September 30, 2022:
Measured at fair value
Significant Unobservable
on a recurring basis:
Valuation Methodology
Inputs
Range of Input
of Inputs
Discounted Cash Flow
Discount Rate
2.9 - 5.4%
4.8
Liquidity Premium
0.4 - 1.3%
0.5
9.0 - 11.0%
9.0
Prepayment Speed
0.0 - 12.8%
6.1
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of December 31, 2021:
0.6 - 3.5%
2.8
0.3 - 2.4%
0.6
11.0 - 15.0%
11.0
0.0 - 36.6%
11.9
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:
The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP. These assets consist of individually evaluated (formerly, impaired) loans and OREO. For assets measured at fair value on a nonrecurring basis at September 30, 2022, and December 31, 2021, 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
51,354
Other real estate owned, net2
52,915
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 $68.1 million and a valuation allowance of $16.7 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $11.3 million for the nine months ended September 30, 2022.
2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $1.6 million at September 30, 2022, which is made up of the outstanding balance of $2.5 million, net of a purchase accounting adjustment of $131,000 and a valuation allowance of $856,000.
13,138
15,494
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 $18.5 million and a valuation allowance of $5.4 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $2.7 million for the year December 31, 2021.
2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $2.4 million at December 31, 2021, which is made up of the outstanding balance of $3.7 million, net of a purchase accounting adjustment of $131,000 and a valuation allowance of $1.2 million.
The Company has estimated the fair values of these assets based primarily on Level 3 inputs. OREO and impaired loans are generally valued using the fair value of collateral provided by third party appraisals. These valuations include assumptions related to cash flow projections, discount rates, and recent comparable sales. The numerical ranges of unobservable inputs for these valuation assumptions are not meaningful.
Note 13 – Fair Values of Financial Instruments
The estimated fair values approximate carrying amount for all items except those described in the following table. Securities available-for-sale fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the security. The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC or another member institution at par. FHLBC stock is carried at cost and considered a Level 2 fair value. The fair value of loans and leases at September 30, 2022 and December 31, 2021, was 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:
1,385,353
FHLBC and FRBC stock
3,694,682
6,602
Interest rate lock commitments and forward contracts
Interest receivable on securities and loans
20,133
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
3,183,215
3,166,428
21,650
51,985
44,469
Note payable and other borrowings
9,970
12,277
Interest payable on deposits and borrowings
2,067
1,476,057
3,407,596
13,431
3,372,738
3,375,930
50,377
18,557
60,111
19,411
6,788
1,706
Note 14 – Derivatives, Hedging Activities and Financial Instruments with Off-Balance Sheet Risk
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s loan portfolio.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. In December of 2019, the Company also executed a loan pool hedge of $50 million to convert variable rate loans to a fixed rate index for a five year term. In August of 2022, the Company also executed two loan pool hedges of $100 million each to convert variable rate loans to a fixed rate index for a three year term.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest income/expense in the same period(s) during
which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are received on the Company’s variable-rate borrowings. During the next twelve months, the Company estimates that an additional $3.5 million will be reclassified as a decrease to interest income and an additional $401,000 will be reclassified as a decrease to interest expense.
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives with financial counterparties are recognized directly in earnings.
The Company also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans as well as selling forward mortgage-backed securities contracts. Loan interest rate lock commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to originate residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue. Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.
Disclosure of Fair Values of Derivative Instruments on the Balance Sheet
The Company entered into a forward starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017. This transaction had a notional amount totaling $25.8 million as of September 30, 2022, was designated as a cash flow hedge of certain junior subordinated debentures and was determined to be fully effective during the period presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other liabilities with changes in fair value recorded in other comprehensive income, net of tax. The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. The Company expects the hedge to remain fully effective during the remaining term of the swap. The Bank will pay the counterparty a fixed rate and receive a floating rate based on three month LIBOR. The trust preferred securities changed from fixed rate to floating rate on June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.
In December 2019, the Company also executed a loan pool hedge of $50.0 million to convert variable rate loans to a fixed rate index for a five year term. This transaction falls under hedge accounting standards and is paired against a pool of the Bank’s LIBOR-based loans. In August 2022, the Company also executed two loan pool hedges of $100.0 million each to convert variable rate loans to a fixed rate index for a three year term. This transaction falls under hedge accounting standards and is paired against a pool of the Bank’s SOFR-based loans. Overall, the new swap only bolsters income in down rate scenarios by a modest degree. We consider the current level of interest rate risk to be moderate but intend to continue looking for market opportunities to hedge further.
The Bank also has interest rate derivative positions to assist with risk management that are not designated as hedging instruments. These derivative positions relate to transactions in which the Bank enters an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. The Bank held $5.0 million of cash collateral and $180,000 of cash collateral related to one correspondent financial institution to cover the loan pool hedge mark to market valuation at September 30, 2022 and December 31, 2021, respectively. The Bank had $9.8 million of cash collateral at two correspondent financial institutions to support interest rate swap activity and $17.2 million of cash collateral held by one correspondent financial institution to support interest rate swap activity. No investment securities were required to be pledged to any correspondent financial institution at September 30, 2022 and December 31, 2021, respectively. At September 30, 2022, the notional amount of non-hedging interest rate swaps was $114.5 million with a weighted average maturity of 5.6 years. At December 31, 2021, the notional amount of non-hedging interest rate swaps was $165.0 million with a weighted average maturity of 3.9 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.
36
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of September 30, 2022 and December 31, 2021.
Fair Value of Derivative Instruments
No. of Trans.
Notional Amount $
Balance Sheet Location
Fair Value $
Derivatives designated as hedging instruments
275,774
Other Assets
2,687
Other Liabilities
8,362
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers
114,511
3,915
15,552
Other contracts
28,526
Total derivatives not designated as hedging instruments
4,125
3,916
75,774
808
4,102
165,005
2,686
34,414
17,173
3,194
2,707
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 $4.1 million as of September 30, 2022, and $1.8 million as of September 30, 2021. The amount of the gain reclassified from AOCI to interest income on the income statement was $15,000 and $40,000 for the nine months ended September 30, 2022 and September 30, 2021, respectively.
Credit-risk-related Contingent Features
For derivative transactions involving counterparties who are lending customers of the Company, the derivative credit exposure is managed through the normal credit review and monitoring process, which may include collateralization, financial covenants and/or financial guarantees of affiliated parties. Agreements with such customers require that losses associated with derivative transactions receive payment priority from any funds recovered should a customer default and ultimate disposition of collateral or guarantees occur.
Credit exposure to broker/dealer counterparties is managed through agreements with each derivative counterparty that require collateralization of fair value gains owed by such counterparties. Some small degree of credit exposure exists due to timing differences between when a gain may occur and the subsequent point in time that collateral is delivered to secure that gain. This is monitored by the Company and procedures are in place to minimize this exposure. Such agreements also require the Company to collateralize counterparties in circumstances wherein the fair value of the derivatives result in loss to the Company.
Other provisions of such agreements include the definition of certain events that may lead to the declaration of default and/or the early termination of the derivative transaction(s):
The Bank also issues letters of credit, which are conditional commitments that guarantee the performance of a customer to a third party. The credit risk involved and collateral obtained in issuing letters of credit are essentially the same as that involved in extending loan commitments to our customers. In addition to customer related commitments, the Company is responsible for letters of credit commitments that relate to properties held in OREO. The following table represents the Company’s contractual commitments due to letters of credit as of September 30, 2022, and December 31, 2021.
The following table is a summary of letter of credit commitments:
Fixed
Variable
Letters of credit:
Borrower:
Financial standby
3,424
15,000
18,424
384
17,474
17,858
Commercial standby
Performance standby
3,947
10,799
14,746
14,907
15,363
7,371
25,799
33,170
32,381
33,221
Non-borrower:
Total letters of credit
25,866
33,237
32,448
33,288
Unused loan commitments:
197,499
779,515
977,014
84,225
895,665
979,890
As of September 30, 2022, the Company evaluated current market conditions, including any impacts related to COVID-19, market interest rate changes, and unused line of credit utilization trends during the third quarter of 2022, and based on that analysis under the CECL methodology, the Company determined credit losses related to unfunded commitments totaled $4.4 million, excluding a $1.0 million purchase accounting adjustment on unfunded commitments recorded from our West Suburban acquisition, which is being accreted to interest income over the estimated life of the unused commitments. The resultant increase in the ACL for unfunded commitments of $749,000 for the third quarter of 2022, compared to the prior quarter end, is primarily related to a $973,000 increase in the commercial unfunded commitments funding rate assumptions based on our analysis of the last 12 months of utilization, decreased by accretion of $224,000 to interest income of the purchase accounting adjustment. The Company will continue to assess the credit risk at least quarterly, and adjust the allowance for unfunded commitments, which is carried within other liabilities on our Consolidated Balance Sheet, as needed, with the appropriate offsetting entry to the provision for credit losses on our Consolidated Statements of Income.
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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 nine months ended September 30, 2022, compared to the three and nine months ended September 30, 2021, and our financial condition at September 30, 2022, compared to December 31, 2021. 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, 2021. The results of operations for the three and nine months ended September 30, 2022, are not necessarily indicative of future results. Dollar amounts presented in the following tables are in thousands, except per share data, and September 30, 2022 and 2021 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 51 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.
Merger with West Suburban Bancorp, Inc.
On December 1, 2021, we completed our merger with West Suburban Bancorp, Inc. (“West Suburban”), the holding company for West Suburban Bank. Under the terms of the merger agreement, each share of West Suburban common stock was converted into 42.413 shares of our common stock and $271.15 in cash. Total cash and stock consideration paid was approximately $295.2 million. With the acquisition of West Suburban, we acquired 34 branches in DuPage, Kane, Kendall and Will counties in Illinois. The transaction is discussed in more detail in Note 2 to our Consolidated Financial Statements included in this report.
As we continue to consolidate operations, nine branches designated as held for sale with a net book value of $5.8 million are reported within fixed assets at September 30, 2022. During the nine months ended September 30, 2022, we sold nine branches, resulting in $977,000 of net gains on sale, after closing costs.
COVID-19 Update
Our historically careful underwriting practices and diverse loan portfolio has helped minimize the adverse impact of the pandemic on the Company. In addition, the combination of the vaccine rollout, government stimulus payments, and reduced spending during the pandemic are likely contributing factors mitigating the impact of the pandemic on our business, financial condition, results of operations, and our customers as of September 30, 2022. While the vaccine remains readily available, the longer term macro-economic effects on global supply chains, inflation, labor shortages and wage increases continue to impact many industries. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including a resurgence of COVID-19 cases, hospitalizations and deaths leading to additional government imposed restrictions; refusals to receive the vaccine or any boosters along with concerns related to new strains of the virus; supply chain issues remaining unresolved longer than anticipated; labor shortages and wage increases continuing to impact many industries; consumer confidence and spending falls; and rising geopolitical tensions. Given the ongoing and dynamic nature of the circumstances surrounding the pandemic, it is difficult to predict its future adverse financial impact to the Company.
Results of Operation and Financial Condition
We continue to monitor the impact of the COVID-19 pandemic on our results of operations and financial condition. For the year ended December 31, 2020, we determined it prudent to increase our allowance for credit losses to $33.9 million, driven by both our adoption of the Current Expected Credit Losses (“CECL”) methodology and the expected impact of the COVID-19 pandemic and market interest rate reductions in anticipation of continued market risk and uncertainty. In 2021, due to the lack of significant net charge-offs projected with the 2020 forecast, and a more favorable forecast for the estimated life of loans, we reversed $9.5 million of our legacy allowance for credit losses, but recorded $12.1 million of Day One credit marks to the allowance for credit losses, as well as $12.2 million of Day Two adjustments on non-purchase credit deteriorated life of loan loss estimates, each stemming from the West Suburban acquisition. During the first nine months of 2022, we recorded $5.2 million of provision for credit losses on loans primarily due to loan growth as well as our assessment of loan metrics and nonperforming loan trends. In addition, we also recorded a reduction of $126,000 in our allowance for credit losses on unfunded commitments, primarily due to a review of credit line utilization rates. These adjustments resulted in a net provision for credit losses expense of $5.1 million for the September 30, 2022 year to date period.
We also adjust our investment securities portfolio to fair value each period end and review for any impairment that would require a provision for credit losses. At this time, we have determined there is no need for a provision for credit losses related to our investment securities portfolio. Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments in the future on the securities we hold as well as experience reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.
As of September 30, 2022 and December 31, 2021, we had $86.5 million and $86.3 million of goodwill, respectively. This reflected a $146,000 increase from the prior quarter and prior year-end as a deferred tax asset and current taxes receivable analysis was performed after the filing of West Suburban Bank related tax returns, with the resultant reclassifications impacting goodwill. At November 30, 2021, we performed our recurring annual review for any goodwill impairment. We determined no goodwill impairment existed, however, further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.
Lending Operations and Accommodations to Borrowers
To more fully support our customers during the pandemic, we established client assistance programs, including offering commercial, consumer, and mortgage loan payment deferrals for certain clients. During 2020 and 2021, we executed 509 of these deferrals on loan balances of $242.7 million. As of September 30, 2022, all COVID-related loan deferrals had resumed payments or paid off.
During 2020 and 2021, as part of the SBA Paycheck Protection Program (“PPP”), we processed 1,320 PPP loan applications, representing a total of $199.0 million, and we acquired $20.8 million PPP loans from our acquisition of West Suburban. We started the application process for loan forgiveness for PPP loans in October 2020, and we continued to receive funds for forgiven loans from both the first and second round of PPP loans through September 2022. As of September 30, 2022, we had 19 loans, which totaled $2.4 million, still outstanding under the PPP program. We expect the application process for loan forgiveness to continue through the fourth quarter of 2022, with funds to be received from the SBA for the forgiven loans through the remainder of 2022.
Capital and Liquidity
As of September 30, 2022, 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.
We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic. For instance, as customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit. However, to date, due in part to federal government stimulus funds received by our customers, as well as a higher volume of loan paydowns than periods prior to COVID-19, our liquidity has increased.
Financial Overview
Net income for the third quarter of 2022 was $19.5 million, or $0.43 per diluted share, compared to $8.4 million, or $0.29 per diluted share, for the third quarter of 2021. The increase was primarily due to our acquisition of West Suburban, which resulted in growth in net interest income and noninterest income, partially offset by higher noninterest expense, which included $1.1 million in acquisition-related
40
costs net of losses on sales of branches in the third quarter of 2022. Adjusted net income, a non-GAAP financial measure that excludes merger-related costs, net of gains/(losses) on branch sales, and gains on the sale of a Visa credit card portfolio and a land trust portfolio, was $19.6 million for the third quarter of 2022. See the discussion entitled “Non-GAAP Financial Measures” on page 42, as well as the table below, which provides a reconciliation of this non-GAAP measure to the most comparable GAAP equivalents.
Quarters Ended
June 30,
Income before income taxes (GAAP)
16,676
Pre-tax income adjustments:
Merger-related costs, net of gains/losses on branch sales
1,061
Gains on the sale of Visa credit card and land trust portfolios
(923)
Adjusted net income before taxes
26,715
18,807
Taxes on adjusted net income
7,091
4,995
Adjusted net income (non-GAAP)
19,624
13,812
Basic earnings per share (GAAP)
0.28
Diluted earnings per share (GAAP)
0.27
Adjusted basic earnings per share excluding acquisition-related costs (non-GAAP)
0.44
0.31
Adjusted diluted earnings per share excluding acquisition-related costs (non-GAAP)
The following provides an overview of some of the factors impacting our financial performance for the three month period ended September 30, 2022, compared to the like period ended September 30, 2021:
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, 2021. 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 2021 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 to investors of our performance. However, we acknowledge that these non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered an alternative to our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented below or alongside the first instance where each non-GAAP financial measure is used.
Results of Operations
Three months ended September 30, 2022 and 2021
Our income before taxes was $26.6 million in the third quarter of 2022 compared to $11.3 million in the third quarter of 2021. This increase in pretax income was primarily due to a $33.0 million increase in interest and dividend income, and a $2.2 million increase in noninterest income, primarily due to the addition of West Suburban loans, securities and fee income in the third quarter of 2022. These increases were partially offset by a $13.9 million increase in noninterest expense, primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment expense, computer and data processing expense, other expense, and amortization of core deposit intangible. The majority of these increases were due to the inclusion of operating costs of the legacy West Suburban staff and branches, as well as $650,000 of West Suburban acquisition-related costs in the third quarter of 2022, primarily within management and consulting and other expenses. Our net income was $19.5 million, or $0.43 per diluted share, for the third quarter of 2022, compared to net income of $8.4 million, or $0.29 per diluted share, for the third quarter of 2021.
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Net interest and dividend income was $55.6 million in the third quarter of 2022, compared to $22.6 million in the third quarter of 2021. The $33.0 million increase was primarily driven by growth in most interest and dividend income categories due to West Suburban related loan and securities income being reflected. In addition we experienced an increase in interest expense in the third quarter of 2022, compared to the third quarter of 2021, primarily due to a rise in deposit interest rates and increased balances from West Suburban, an increase in other short-term borrowings due to an FHLB advance, and an increase in the rate paid on our senior notes during the third quarter of 2022, as the interest rate payable on these notes became floating as of January 1, 2022, at three month LIBOR plus 385 basis points, compared to the prior 5.75% fixed rate.
Average loans, including loans held for sale, increased $1.86 billion in the third quarter of 2022, compared to the third quarter of 2021, primarily from $1.50 billion of average loans acquired in our acquisition of West Suburban. Also contributing to the increase was $244.3 million in average loan growth during the third quarter of 2022, less PPP loans forgiven or repaid and loan paydowns.
Nine months ended September 30, 2022 and 2021
Our income before taxes was $59.7 million for the nine months ended September 30, 2022 compared to $39.4 million for the nine months ended September 30, 2021. This increase in pretax income was primarily due to a $74.0 million increase in interest and dividend income, and a $5.6 million increase in noninterest income, as West Suburban loan, security and fee income are included in the nine months ended September 30, 2022. These increases were partially offset by a $46.2 million increase in noninterest expense, primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment expense, computer and data processing expense, other expense, and amortization of core deposit intangible. The majority of these increases were due to the inclusion of operating costs of the legacy West Suburban staff and branches, as well as $9.5 million of West Suburban acquisition-related costs in the first nine months of 2022, primarily within computer and data processing. Our net income was $43.8 million, or $0.97 per diluted share, for the nine months ended September 30, 2022, compared to net income of $29.1 million, or $0.99 per diluted share, for the same period of 2021.
Net interest and dividend income was $142.1 million for the nine months ended September 30, 2022, compared to $68.1 million for the same period of 2021. The $74.0 million increase was primarily driven by growth in most interest and dividend income categories due to West Suburban related loan and securities income being reflected. This increase was partially offset by a $402,000 increase in interest expense for the nine months ended September 30, 2022, compared to the same period of 2021, primarily due to three full periods of interest expense on the April 2021 issuance of subordinated debt in 2022, as well as higher average balances of deposits from the West Suburban acquisition, partially offset by a decrease in outstanding balances of notes payable and a decrease in the rate paid on our senior notes during 2022, as the interest rate payable on these notes became floating as of January 1, 2022, at three month LIBOR plus 385 basis points, compared to the prior 5.75% fixed rate.
Net Interest Income
Net interest income, which is our primary source of earnings, is the difference between interest income earned on interest-earning assets, such as loans and investment securities, as well as accretion income on purchased loans, and interest incurred on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends upon the relative mix of interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and movements in market interest rates. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and OREO, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Our net interest and dividend income increased by $33.0 million to $55.6 million, for the third quarter of 2022, from $22.6 million for the third quarter of 2021. This increase was primarily attributable to a $33.2 million increase in total interest and dividend income due to the acquisition of West Suburban in December 2021. In addition we experienced an increase in interest expense in the third quarter of 2022, compared to the third quarter of 2021, primarily due to increased balances from West Suburban, increased other short-term borrowings expense due to an FHLB advance, and an increase in the rate paid on our senior notes during 2022, as the interest rate payable on these notes became floating as of January 1, 2022, at three month LIBOR plus 385 basis points, compared to the prior 5.75% fixed rate.
Average earning assets for the third quarter of 2022 totaled $5.61 billion, a decrease of $141.5 million, or 2.5%, compared to the second quarter of 2022, and an increase of $2.52 billion, or 81.7%, compared to the third quarter of 2021. Average interest earning deposits with
financial institutions totaled $131.3 million for the third quarter of 2022, a decrease of $295.6 million, compared to the second quarter of 2022, and a decrease of $392.3 million compared to the third quarter of 2021. The yield on average interest earning deposits was 200 basis points for the third quarter of 2022, an increase of 127 basis points from the second quarter of 2022, and an increase of 185 basis points from the third quarter of 2021. Interest income on securities increased year over year, primarily due to growth in volumes and higher interest rates. Total average securities for the third quarter of 2022 decreased $88.8 million from the second quarter of 2022, and increased $1.04 billion from the third quarter of 2021. The increase in our average securities year over year was primarily due to the $1.07 billion in securities acquired in our acquisition of West Suburban. The yield on average securities increased to 2.52% for the third quarter of 2022, compared to 1.89% for the second quarter of 2022 and increased from 2.07% for the third quarter of 2021. Total average loans, including loans held-for-sale, totaled $3.75 billion in the third quarter of 2022, an increase of $244.3 million from the second quarter of 2022, and an increase of $1.86 billion from the third quarter of 2021. The rise in average loan balances year over year was primarily due to the $1.50 billion loan portfolio acquired in our acquisition of West Suburban, as well as loan growth of $244.3 million in the third quarter of 2022. This rise in loan volumes resulted in an increase in loan interest and fee income of $25.3 million in the year over year period. For the third quarter of 2022, the yield on average loans increased to 4.93%, compared to 4.37% for the second quarter of 2022, and 4.48% for the third quarter of 2021.
Average interest bearing liabilities decreased $113.1 million, or 3.2%, in the third quarter of 2022, compared to the second quarter of 2022, and increased $1.54 billion compared to the third quarter of 2021. The year over year increase was primarily driven by a $1.55 billion increase in interest bearing deposits primarily due to our acquisition of West Suburban, as well as continued deposit activity of our legacy customers, offset by a $12.6 million decrease in securities sold under repurchase agreements and a $10.2 million decrease in notes payable and other borrowings. The linked quarter decrease was primarily the result of maturing higher cost time deposits and declines in money market accounts. The cost of interest bearing liabilities for the third quarter of 2022 increased four basis points from the linked period, and decreased 18 basis points from the third quarter of 2021. Growth in our average noninterest bearing demand deposits of $1.06 billion in the year over year period has assisted us in controlling our cost of funds stemming from average interest bearing deposits and borrowings, which totaled 0.18% for the third quarter of 2022, 0.15% for the second quarter of 2022, and 0.30% for the third quarter of 2021.
Due to the significant increase in interest earning deposits with financial institutions in 2020 and 2021 stemming from federal stimulus funds received and PPP loan forgiveness, we had no average other short-term borrowings in the first and second quarters of 2022 or the third quarter of 2021, which typically consist of FHLBC advances. In the third quarter of 2022, we had an average other short-term borrowing balance of $5.4 million due to a $25.0 million FHLB advance. As of September 30, 2022, notes payable and other borrowings had an average balance of $11.0 million, which consists of $10.0 million outstanding on a term note with a correspondent bank originated in the first quarter of 2020.
Our net interest margin (GAAP) increased 77 basis points to 3.93% for the third quarter of 2022, compared to 3.16% for the second quarter of 2022, and increased 102 basis points compared to 2.91% for the third quarter of 2021. Our net interest margin (TE) increased 78 basis points to 3.96% for the third quarter of 2022, compared to 3.18% for the second quarter of 2022, and increased 101 basis points compared to 2.95% for the third quarter of 2021. The increase in the year over year was due primarily to the increasing market interest rates over the majority of the past twelve months, the related rate resets on loans and securities during the past year, and the elevated liquidity on our balance sheet.
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.
Our net interest and dividend income increased by $74.0 million, to $142.1 million for the nine months ended September 30, 2022, compared to $68.1 million for the nine months ended September 30, 2021. This increase was attributable to a $74.4 million increase in total interest income primarily from the acquisition of West Suburban as well as general loan growth, partially offset by a $402,000 increase in interest expense for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. Increased balances on interest earning assets related to the West Suburban acquisition drove the increase in net interest income, along with increased yields on earning assets and the reduction in the cost of interest bearing deposits, despite the increased average balance of subordinated debt.
Average earning assets for the nine months ended September 30, 2022 were $5.74 billion, an increase of $2.72 billion, or 90.0%, compared to the nine months ended September 30, 2021. The yield on average earning assets for the nine months ended September 30, 2022 was 3.49%, compared to 3.34% for the nine months ended September 30, 2021. Total average loans, including loans held-for-sale,
totaled $3.56 billion for the nine months ended September 30, 2022, an increase of $1.61 billion, compared to the nine months ended September 30, 2021. The increase in average loan balances, coupled with increases in market interest rates, resulted in a $56.9 million increase in loan interest income for the nine months ended September 30, 2022, compared to the like period in 2021. For the nine months ended September 30, 2022, yields on average securities decreased by 28 basis points and yields on average loans increased by 13 basis points, each as compared to the nine months ended September 30, 2021, due primarily to the addition of the lower yielding legacy West Suburban securities and loan portfolios in late 2021, as well as the timing of rate resets on loans and securities as interest rates began to rise in 2022, compared to 2021. Average interest earning deposits with financial institutions decreased $65.6 million in the nine months ended September 30, 2022, compared to the prior year like period driven primarily by the acquisition of West Suburban, as well as the use of cash for loan growth and the decrease in customer deposits.
Average interest bearing liabilities increased $1.65 billion, or 88.8%, in the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. The increase was primarily due to the acquisition of West Suburban in late 2021 resulting in an increase of $2.27 billion of interest earning deposits. In addition, average subordinated debt increased $20.6 million, due to the $60.0 million subordinated note issuance on April 6, 2021, as discussed below. Partially offsetting this increase was a $7.9 million decrease in average notes payable and other borrowings. Average noninterest bearing deposits increased $1.11 billion in the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021, due to the acquisition of West Suburban, as well as remaining federal stimulus funds received from our depositors. The cost of interest bearing liabilities decreased 20 basis points, to 25 basis points, for the nine months ended September 30, 2022, from 45 basis points for the nine months ended September 30, 2021.
In the second quarter of 2021, we entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers pursuant to which we sold and issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”). We sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance are intended to be used for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions. 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.
Our net interest margin (GAAP) for the nine months ended September 30, 2022 was 3.31% compared to 3.02% for the nine months ended September 30, 2021, reflecting an increase of 29 basis points. Our net interest margin (TE) for the nine months ended September 30, 2022 was 3.33% compared to 3.06% for the nine months ended September 30, 2021, an increase of 27 basis points. The increase in net interest margin for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, was primarily due to the market interest rate increases in 2022, as well as full periods reflecting West Suburban loan and securities income. These increases to the net interest margin were partially offset by reductions in rates paid on deposits, and growth in noninterest bearing deposits, which drove down our overall cost of funds.
The following tables set forth certain information relating to our average consolidated balance sheet and reflect the yield on average earning assets and cost of average interest bearing liabilities for the periods indicated. These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP TE basis using a marginal rate of 21% in 2022 and 2021 to compare returns more appropriately on tax-exempt loans and securities to other earning assets.
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Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates
(Dollars in thousands - unaudited)
June 30, 2022
September 30, 2021
Income /
Rate
Expense
131,260
2.00
426,820
0.73
523,561
1,525,258
2.37
1,610,713
6,786
1.69
476,935
1.54
Non-taxable (TE)1
178,090
3.76
181,386
1,642
3.63
186,515
1,603
3.42
Total securities (TE)1
1,703,348
10,802
2.52
1,792,099
8,428
1.89
663,450
3,457
2.07
Dividends from FHLBC and FRBC
19,565
5.29
20,994
263
5.02
9,917
4.56
Loans and loans held-for-sale1, 2
3,753,117
46,642
4.93
3,508,856
38,267
4.37
1,889,696
21,358
4.48
Total interest earning assets
5,607,290
58,368
4.13
5,748,769
47,740
3.33
3,086,624
25,132
3.23
56,265
53,371
29,760
(45,449)
(44,354)
(28,639)
Other noninterest bearing assets
377,850
374,309
185,415
5,995,956
6,132,095
3,273,160
Liabilities and Stockholders' Equity
612,174
148
0.10
604,176
0.07
534,056
967,106
157
0.06
1,054,552
355,651
Savings accounts
1,186,001
0.03
1,213,133
90
451,829
0.04
459,925
469,009
0.23
331,482
0.39
3,225,206
715
0.09
3,340,870
612
1,673,018
539
0.13
33,733
0.12
34,496
46,339
3.21
4.39
284
4.42
4.40
59,265
3.66
59,244
3.70
59,180
3.67
44,546
6.48
44,520
578
5.21
44,441
6.01
10,989
4.01
13,103
95
2.91
21,171
2.12
Total interest bearing liabilities
3,404,947
3,518,006
2,125
0.24
1,869,922
0.46
2,092,301
2,120,428
1,029,705
34,949
32,636
53,370
Stockholders' equity
463,759
461,025
320,163
Total liabilities and stockholders' equity
Net interest income (GAAP)
45,264
Net interest margin (GAAP)
3.93
3.16
Net interest income (TE)1
55,929
45,615
22,964
Net interest margin (TE)1
3.96
3.18
2.95
Interest bearing liabilities to earning assets
60.72
61.20
60.58
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 2022 and 2021.
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 48, and includes fees of $750,000 for the third quarter of 2022, $588,000 second quarter of 2022, and $1.8 million for the third quarter of 2021. Nonaccrual loans are included in the above-stated average balances.
395,948
0.58
461,498
1,582,549
1.78
415,029
1.71
184,842
3.61
188,700
4,851
3.44
1,767,391
26,066
1.97
603,729
10,152
2.25
18,888
4.79
4.61
Loans and loans held-for-sale 1 , 2
3,556,798
121,337
1,944,687
64,480
4.43
5,739,025
149,794
3.49
3,019,831
75,406
3.34
50,918
29,407
(44,719)
(31,380)
374,388
186,083
6,119,612
3,203,941
603,345
339
0.08
520,556
295
1,039,717
481
338,510
1,200,018
434,702
169
474,665
0.25
363,227
3,317,745
2,001
1,656,995
1,906
35,791
65,385
0.14
1,832
4.41
38,637
3.68
Senior note
5.38
44,416
6.08
14,338
2.88
22,243
2.13
3,499,243
1,853,449
0.45
2,103,978
993,308
42,706
42,632
473,685
314,552
3.31
143,131
69,145
3.06
60.97
61.38
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 48, and includes fees of $2.1 million and $4.4 million for the nine months ended September 30, 2022 and 2021, respectively. Nonaccrual loans are included in the above-stated average balances.
Reconciliation of Tax-Equivalent Non-GAAP Financial Measures
Net interest and dividend income (TE) and net interest income (TE) to average interest earning assets are non-GAAP measures that have been adjusted on a TE basis using a marginal rate of 21% for 2022 and 2021 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)
47,389
Taxable-equivalent adjustment:
354
345
337
1,049
1,019
Interest and dividend income (TE)
Interest expense (GAAP)
Net interest income (TE)
22,959
Average interest earning assets
Net interest margin (TE)
Noninterest Income
The following table details the major components of noninterest income for the periods presented:
3rd Quarter 2022
Percent Change From
(Dollars in thousands)
2,506
(9.0)
(3.9)
2,328
14.3
94.5
Residential mortgage banking revenue
62.0
(66.3)
MSRs mark to market gain (loss)
568.3
(294.3)
579
(11.2)
(10.1)
Net gain (loss) on sales of mortgage loans
(262)
(271.4)
(79.5)
Total residential mortgage banking revenue
1,592
2,716
254.6
(41.4)
72
102.8
(64.0)
2,965
(10.5)
63.4
924
134.3
254.9
9,211
24.8
23.1
Noninterest income increased $2.3 million, or 24.8%, in the third quarter of 2022, compared to the second quarter of 2022, and increased $2.2 million, or 23.1%, compared to the third quarter of 2021. The increase from the second quarter was primarily driven by $1.1 million of growth in residential mortgage banking revenue that is attributable to an increase in mark to market gain on MSRs of $466,000, as
48
well as a $449,000 net gain on the sale of mortgage loans, compared to a net loss of $262,000 on the sale of mortgage loans in the second quarter of 2022. The variance in mortgage banking is derived from the changing rate environment experienced during the second and third quarters and the resultant negative impact on interest rate lock commitments during the second quarter, as well as further increases in the fair value of mortgage servicing rights during the third quarter. Increases were also noted in service charges on deposits of $333,000, and in other income of $1.2 million primarily due to a $743,000 gain on a Visa credit card portfolio sale and a $180,000 gain on the sale of a land trust portfolio, as compared to the linked quarter. These increases in noninterest income in the third quarter of 2022, compared to the second quarter of 2022, were partially offset by a $226,000 decrease in wealth management fees, and a $312,000 decrease in card related income.
The increase in noninterest income of $2.2 million in the third quarter of 2022, compared to the third quarter of 2021, is primarily due to an increase of $1.3 million in services charges of deposits, an increase of $1.0 million of card related income, and gains on the sale of the Visa credit card portfolio and the land trust portfolio reported in other income. These gains were partially offset by a $1.1 million decline in residential mortgage banking revenue due to increases in interest rates effecting the mortgage banking volumes and related derivative, offset by an increase in the fair value of mortgage servicing rights, and a $260,000 decline in the cash surrender value of BOLI.
YTD through September 30, 2022
Percent
Change
8.3
86.7
(67.6)
(2.1)
(78.4)
7,172
10,080
(28.8)
(113.8)
(70.6)
73.0
141.2
19.6
Noninterest income increased $5.6 million, or 19.6%, for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. This increase was primarily driven by a $3.5 million increase in card related income, a $3.3 million increase in service charges on deposits, a $572,000 increase in wealth management fees, and a $2.3 million increase in other income, each stemming from the inclusion of West Suburban related activity in our results for the nine months ended September 30, 2022. Partially offsetting these increases was a $2.9 million decline in mortgage banking revenue year over year, comprised primarily of a $6.1 million decrease in net gain on sales of mortgage loans, partially offset by a $3.8 million mark to market gain on MSRs, both due to the increasing interest rate environment, and a $821,000 decline in the cash surrender value of BOLI.
49
Noninterest Expense
The following table details the major components of noninterest expense for the periods presented:
Salaries
14,711
15,995
9,630
(8.0)
52.8
Officers incentive
2,787
1,662
1,212
67.7
130.0
Benefits and other
3,513
2,122
(4.4)
65.6
Total salaries and employee benefits
21,332
(1.5)
62.1
Occupancy, furniture and equipment expense
3,046
35.2
70.3
4,006
(36.5)
72.2
702
(6.1)
212.3
351
(26.8)
(14.6)
Amortization of core deposit intangible asset
(0.3)
481.4
194
(57.2)
(22.4)
1,057
37.5
119.5
179
18.4
(53.4)
523
16.1
144.8
Other real estate owned expense, net
(74.7)
(12.0)
5,113
38.7
37,249
(3.4)
62.6
Efficiency ratio (GAAP)1
53.08
67.07
68.73
Adjusted efficiency ratio (non-GAAP)2
51.90
62.73
66.47
1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs.
2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses and merger-related costs, net of gain 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, mark to market gains or losses on MSRs, and nonrecurring gains on the sale of Visa credit card and land trust portfolios, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI. See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” starting on page 52 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent.
Noninterest expense for the third quarter of 2022 decreased $1.3 million, or 3.4%, compared to the second quarter of 2022, and increased $13.9 million, or 62.6%, compared to the third quarter of 2021. The decrease in the third quarter of 2022 compared to the second quarter was primarily attributable to $650,000 of West Suburban acquisition-related costs for the third quarter of 2022 compared to $3.3 million for the second quarter of 2022. Acquisition-related costs in the third quarter of 2022 included $90,000 in data processing expense, compared to $1.7 million in the second quarter of 2022, primarily due to acquisition-related core system conversion costs. Partially offsetting the decrease in noninterest expense was an increase in occupancy, furniture and equipment costs of $1.1 million in the third quarter of 2022, compared to the prior quarter, due to net losses on branch sales during the quarter. Finally, our card related expense increased in the third quarter of 2022, compared to the second quarter, due to growth in customer transactions and related volume charges.
The year over year increase of $13.9 million in noninterest expense is primarily attributable to an $8.0 million increase in salaries and employee benefits, a $1.7 million increase in occupancy, furniture and equipment, a $1.1 million increase in computer and data processing expense, and a $1.2 million increase in other expense. Officers incentive compensation increased $1.6 million in the third quarter of 2022, compared to the third quarter of 2021, as incentive accruals increased in the current year due to the acquisition of West Suburban, as well as growth in our commercial lending team. Employee benefits expense increased $1.4 million in the third quarter of 2022, compared to the third quarter of 2021, due to increases stemming from additional employees from our acquisition of West Suburban. The increase in occupancy, furniture and equipment expense year over year was due to the addition of 34 West Suburban branches in late 2021. The $1.1
million increase in computer and data processing expense was primarily due to core system conversion costs relating to the West Suburban acquisition. Finally, the increase in other expense was due primarily to growth in bill payment services, consulting fees and commercial loan related costs, primarily due to acquisition-related costs in the third quarter of 2022.
46,304
28,280
63.7
5,443
4,060
34.1
10,563
7,026
50.3
58.3
51.1
214.2
193.2
8.1
469.3
75.2
61.8
91.0
(29.7)
65.0
70.8
63.37
67.04
58.76
65.69
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 merger-related costs, net of gain 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, mark to market gains or losses on MSRs, and nonrecurring gains on the sale of Visa credit card and land trust portfolios, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI. See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” starting on page 52 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent
Noninterest expense for the nine months ended September 30, 2022, increased $46.2 million, or 70.8%, compared to the nine months ended September 30, 2021, primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment, computer and data processing, and other expenses, which increases primarily resulted from our acquisition of West Suburban in December 2021. Salaries and employee benefits increased $22.9 million largely from the additional employees from West Suburban. Occupancy, furniture and equipment increased $3.7 million, or 51.1%, due to additional facilities acquired with our acquisition of West Suburban, net of gains from the sale of overlapping branches. Computer and data processing increased $8.7 million, or 214.2%, primarily related to costs of operating multiple systems prior to conversion as well as data conversion costs. Other expense increased $5.8 million, or 65.0%, primarily from a $2.9 million increase to special services expense and a $1.3 million increase in miscellaneous expenses, due to acquisition-related costs. In addition, FDIC insurance increased $1.2 million due to our increased asset size, as well as the absence of assessment credits fully utilized in the 2021 year to date period. Amortization of core deposit intangible increased $1.6 million for the nine months ended September 30, 2022, compared to the prior year like period, due to the West Suburban acquisition. Finally, consulting and management fees increased $832,000 due to $760,000 of acquisition-related costs and general ledger reclassifications in the first nine months of 2022.
51
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 acquisition related costs, net of gain on branch sales
2,132
425
Noninterest expense less adjustments
35,309
36,503
21,991
34,248
34,371
21,566
Net interest income
Net interest income including adjustments
Less securities (losses) gains
Less MSRs mark to market gain (loss)
Less gain on Visa credit card portfolio sale
743
Less gain on sale of land trust portfolio
180
Noninterest income (less) / including adjustments
10,949
9,162
9,378
10,065
9,181
9,486
Net interest income including adjustments plus noninterest income (less) / including adjustments
66,518
54,426
31,996
65,994
54,796
32,445
Efficiency ratio / Adjusted efficiency ratio
Income Taxes
We recorded income tax expense of $7.1 million for the third quarter of 2022 on $26.6 million of pretax income, compared to income tax expense of $4.4 million on $16.7 million of pretax income in the second quarter of 2022, and income tax expense of $2.9 million on $11.3 million of pretax income in the third quarter of 2021. Our effective tax rate was 26.5% in the third quarter of 2022, 26.6% for the second quarter of 2022, and 25.8% for the third quarter of 2021.
We recorded income tax expense of $15.9 million on $59.7 million of pretax income for the nine months ended September 30, 2022, compared to income tax expense of $10.3 million on $39.4 million of pretax income in the like 2021 period. The effective tax rate was 26.7% and 26.1% for the third quarter of 2022 and the third quarter of 2021, respectively.
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 or nine months ended September 30, 2022. We had no valuation reserve on the deferred tax assets as of September 30, 2022.
Financial Condition
Total assets decreased $244.5 million to $5.97 billion at September 30, 2022, from $6.21 billion at December 31, 2021, due primarily to a net decrease in cash and cash equivalents of $636.0 million, offset by increases of $444.0 million in net loans and $43.5 million in deferred tax assets. The decrease in cash and cash equivalents was primarily due to the use of cash for loan growth, as well as the decrease in customer deposits of $184.9 million. We continue to actively assess potential investment opportunities to utilize our excess liquidity. Total deposits were $5.28 billion at September 30, 2022, a decrease of $184.9 million from December 31, 2021, primarily due to seasonal decreases of municipal deposits, and to a lesser extent declines in interest bearing demand accounts, savings, money market, NOW, and time deposits in 2022.
52
4,070
4.3
33,575
(9.6)
66.7
17,818
(25.9)
616.3
238,952
(12.9)
4,992
(3.5)
91.2
165,414
(12.6)
255.4
189,338
(7.3)
16.0
61,029
117.9
184.8
Total securities
715,188
(5.0)
125.1
Securities available-for-sale decreased $83.9 million as of September 30, 2022, compared to December 31, 2021, and increased $894.6 million compared to September 30, 2021. The decrease in the portfolio during 2022 was driven by $234.8 million in principal reductions from calls, maturities and mortgage related prepayments, as well as an unrealized mark to market loss adjustment of $146.4 million, which were partially offset by the purchase of $301.6 million across a variety of sectors. We continue to seek to position the portfolio in higher credit quality, shorter duration securities with an appropriate mix of fixed- and floating-rate exposures. The increase in the securities portfolio in the year over year period was primarily due to the securities acquired in the acquisition of West Suburban. There were no securities sales during the third quarter of 2022.
321,548
15.1
176.2
162,444
42.9
54.9
420,853
17.7
123.8
445,301
19.8
96.9
108,690
(14.3)
45,497
(6.0)
31.0
108,343
3.6
104.0
160,798
4.4
100.8
82,021
(8.1)
41.6
Other 1
12,447
(37.4)
17.1
1,867,942
13.1
107.1
1 The “Other” segment includes consumer and overdrafts.
Total loans were $3.87 billion as of September 30, 2022, an increase of $448.5 million from December 31, 2021. The increase in total loans in the first nine months of 2022, compared to December 31, 2021, was due primarily to growth in loan originations within commercial real estate – investor, which increased by $142.0 million, commercial real estate – owner occupied, which increased by $145.1 million, commercial, which increased by $116.6 million, and leases, which increased by $75.6 million from December 31, 2021. Total loans increased $2.00 billion from September 30, 2021 to September 30, 2022, primarily due to the loan portfolio acquired from West Suburban. 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 70.2% of the portfolio as of September 30, 2022, compared to 71.6% of the portfolio as of
December 31, 2021. We continue to oversee and seek to manage our loan portfolio in accordance with interagency guidance on risk management.
Asset Quality
Nonperforming loans consist of nonaccrual loans, performing restructured accruing loans and loans 90 days or greater past due. Remediation work continues in all segments. Nonperforming loans increased by $8.2 million to $52.9 million at September 30, 2022 from $44.7 million at December 31, 2021. 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 1.4% as of September 30, 2022, 1.3% as of December 31, 2021, and 1.5% as of September 30, 2021. The distribution of our nonperforming loans is shown in the following table.
Nonperforming Loans
13,291
(33.6)
3,959
(93.7)
(94.1)
215.2
194.2
13,231
6,896
(27.6)
38.9
7,525
2,958
154.4
1,380
899
998
53.5
38.3
3,787
5,019
4,885
(24.5)
(22.5)
2,055
(0.9)
(24.1)
2,065
881
98.2
134.4
Total nonperforming loans
52,900
44,666
28,952
82.7
54
The components of our nonperforming assets are shown in the following table.
Nonperforming Assets
(Dollars in Thousands)
Nonaccrual loans
27,520
(22.6)
16.7
Performing troubled debt restructured loans accruing interest
199
(88.9)
Loans past due 90 days or more and still accruing interest
1,233
567.3
(33.7)
(18.4)
Total nonperforming assets
54,461
47,022
30,864
15.8
76.5
30-89 days past due loans and still accruing interest
8,197
10,745
2,829
Nonaccrual loans to total loans
0.8
1.2
1.5
Nonperforming loans to total loans
1.4
1.3
Nonperforming assets to total loans plus OREO
1.7
Allowance for credit losses to total loans
Allowance for credit losses to nonaccrual loans
152.1
106.6
97.9
Loan charge-offs, net of recoveries, for the current quarter, prior linked quarter and year over year quarter are shown in the following table.
Loan Charge–offs, Net of Recoveries
% of
Total1
17.6
(0.8)
261.80
105
90.0
35.0
(75)
(110.3)
(2.8)
(8)
(11.8)
(2.0)
(3.0)
(166.2)
(22)
(8.8)
(7.6)
(63)
(92.6)
77.2
(35)
(51.5)
(31)
(12.4)
(28)
59
86.8
10.1
Net charge–offs
100.0
250
237
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 $68,000 were recorded for the third quarter of 2022, compared to net charge-offs of $250,000 for the second quarter of 2022, and net charge-offs of $237,000 for the third quarter of 2021, reflecting continuing management attention to credit quality and remediation efforts. The net charge-offs for the third quarter of 2022 were primarily due to one lease charge off for $178,000 and one commercial real estate – investor charge off for $94,000. We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs.
Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. Classified assets include both classified loans and OREO. Loans classified as substandard are inadequately protected by either the current net worth and ability to meet payment obligations of the obligor, or by the collateral pledged to secure the loan, if any. These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and carry the distinct possibility that we will sustain some loss if deficiencies remain uncorrected.
The following table shows classified assets by segment for the following periods.
Classified Assets
467
4,423
(94.7)
8,718
164.9
224.1
7,211
176.7
492.1
(36.0)
(72.5)
1,154
1.6
11.4
4,508
(22.9)
(12.8)
2,327
(13.0)
(14.8)
1,215
60.1
87.5
(80.0)
Total classified loans
34,923
52.2
225.7
Total classified assets
115,291
77,097
36,835
49.5
213.0
Total classified loans and classified assets increased $38.2 million as of September 30, 2022, from the levels at December 31, 2021. The increase is due to the addition of commercial real estate – investor loans totaling $19.7 million and two commercial real estate – owner occupied loans totaling $32.0 million in the second quarter. The increase from September 30, 2021 is primarily due to the $15.4 million addition of the West Suburban loan portfolio in late 2021. 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 19.23% for the period ended September 30, 2022, compared to 13.79% as of December 31, 2021, and 9.73% as of September 30, 2021. The increase in the classified assets ratio for the period ended September 30, 2022, compared to September 30, 2021, is also due to the acquisition of West Suburban.
Allowance for Credit Losses on Loans
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. As of January 1, 2020, we adopted ASU 2016-13, or CECL.
At September 30, 2022, our allowance for credit losses, or ACL, on loans totaled $48.8 million, and our ACL on unfunded commitments, included in other liabilities, totaled $4.4 million. In the third quarter of 2022, we recorded provision expense on loans of $3.5 million, based on our assessment of nonperforming loan metrics and trends and estimated future credit losses, and a $973,000 increase in our reserve on unfunded commitments, primarily due to an updated analysis of line utilization rates over the past twelve months, as well as the roll off of prior historical periods with lower losses within the CECL model. These two entries resulted in a $4.5 million net impact to the provision for credit losses for the third quarter of 2022.
The ACL on loans totaled $45.4 million as of June 30, 2022, $44.3 as of December 31, 2021, and $26.9 million as of September 30, 2021. The ACL on loans increased in late 2021 due to the impact of the West Suburban acquisition Day One credit mark of $12.1 million, the Day Two non-PCD loan adjustment to ACL of $12.2 million, less a reversal of $2.3 million related to our legacy loan portfolio and net charge-offs of $4.7 million for the fourth quarter. The ACL for loans was reduced in the third quarter of 2021 due to a $1.5 million release of the provision for credit losses.
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. Our ACL on loans to total loans was 1.3% as of September 30, 2022, and December 31, 2021. See Item 7 – Critical Accounting Estimates in the Management Discussion and Analysis in our 2021 Annual Report in Form 10-K for discussion of our ACL methodology on loans.
56
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.
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
44,308
Charge–offs:
243
91
Total charge–offs
Recoveries:
Total recoveries
136
Net charge-offs (recoveries)
611
(280)
Provision for (release of) credit losses on loans
1,330
Allowance at end of period
Average total loans (exclusive of loans held–for–sale)
3,751,097
3,505,806
1,884,788
3,552,871
1,938,573
Net charge–offs / (recoveries) to average loans
0.01
0.02
(0.02)
Allowance at period end to average loans
1.30
1.29
1.43
1.37
1.39
The coverage ratio of the ACL on loans to nonperforming loans was 92.3% as of September 30, 2022, which was a decrease from the coverage ratio of 107.8% as of June 30, 2022 and a decrease from 93.1% as of September 30, 2021. When measured as a percentage of average loans, our total ACL on loans was 1.37% for the nine months ended 2022 and 1.39% for the like period of September 30, 2021
In management’s judgment, an adequate ACL has been established to encompass the current lifetime expected credit losses at September 30, 2022, and general changes in lending policy, procedures and staffing, as well as other external factors, such as the impacts of the COVID-19 pandemic. However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession. Continued volatility in the economic environment stemming from the impacts of and response to inflation and the war in Ukraine, 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.
Other Real Estate Owned
As of September 30, 2022, OREO totaled $1.6 million, reflecting a $795,000 decrease from the $2.4 million at December 31, 2021, and a $351,000 decrease from the $1.9 million at September 30, 2021. In the third quarter of 2022, we disposed of one property totaling $62,000 in net book value, which resulted in a gain on sale of OREO of $33,000 and had no transfers to OREO. In the fourth quarter of 2021, we acquired three OREO properties in our acquisition of West Suburban, with a total fair value of $5.6 million, and we sold two of these properties in December, which had a net book value of $5.2 million. In the third quarter of 2022, we recorded no OREO valuation reserve adjustments, compared to $14,000 of valuation reserve adjustments recorded in the fourth quarter of 2021, and $2,000 of valuation reserve adjustments recorded in the third quarter of 2021.
OREO
1,623
(15.1)
(13.5)
5,678
(100.0)
5,220
(98.8)
67.6
Period valuation write-down
In management’s judgment, the property valuation allowance as established presents OREO at current estimates of fair value less estimated costs to sell; however, there can be no assurance that additional losses will not be incurred on disposals or upon updates to valuations in the future. Of note, properties valued in total at $928,000, or approximately 59.5% of total OREO at September 30, 2022, have been in OREO for five years or more. The appropriate regulatory approval has been obtained for any OREO properties held in excess of five years.
OREO Properties by Type
% of Total
Single family residence
0
Lots (single family and commercial)
1,261
1,411
1,078
Vacant land
300
315
Total other real estate owned
100
Deposits and Borrowings
Deposits
1,037,638
0.2
102.2
457,900
(1.2)
154.2
537,547
7.4
17.3
370,691
(15.5)
151.4
173,595
48.7
98,496
6.9
50.7
38,462
(27.0)
30.4
2,714,329
94.6
Total deposits were $5.28 billion at September 30, 2022, which reflects a $184.9 million decrease from total deposits of $5.47 billion at December 31, 2021, and an increase of $2.57 billion from total deposits of $2.71 billion at September 30, 2021. The decrease in deposits at September 30, 2022, compared to December 31, 2021, was primarily due to decreases in savings of $14.5 million, money market
accounts of $171.2 million and time deposits of $47.2 million partially offset by increases in demand and NOW accounts of $48.0 million. The increase in deposits at September 30, 2022, compared to September 30, 2021 was primarily due to an increase of $2.69 billion of deposits from the West Suburban acquisition.
In addition to deposits, we obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled $35.5 million at September 30, 2022, a $14.8 million, or 29.5%, decrease from $50.3 million at December 31, 2021. Our notes payable and other borrowings is comprised of $10.0 million outstanding on a $20.0 million term note originated with a correspondent bank in the first quarter of 2020, to facilitate the redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures, completed on March 2, 2020. Notes payable and other borrowings of $10.0 million as of September 30, 2022, decreased $9.1 million from December 31, 2021, and decreased $10.2 million from September 30, 2021.
We are indebted on senior notes originated in December 2016, totaling $44.6 million, net of deferred issuance costs, as of September 30, 2022. These notes mature in December 2026, and included interest payable semi-annually at 5.75% for five years. Beginning December 31, 2021, the interest became payable quarterly at three month LIBOR plus 385 basis points. We are also indebted on $25.8 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust II (“Trust II”). The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points on June 15, 2017. Upon conversion to a floating rate, we initiated a cash flow hedge which resulted in the total interest rate paid on this debt of 4.39% as of September 30, 2022, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017 rate reset.
As of September 30, 2022, total stockholders’ equity was $433.7 million, which was a decrease of $68.3 million from $502.0 million as of December 31, 2021. This decrease is primarily attributable to a decrease in accumulated other comprehensive income of $107.2 million in the first nine months of 2022 due to a net decrease in unrealized gains on available-for-sale securities, net of unrealized losses on swaps, due to the increase in market interest rates, as well as a reduction to retained earnings of $6.7 million for payment of dividends to our common stockholders in the first nine months of 2022. Partially offsetting this decrease was $43.8 million of net income for the nine months ended September 30, 2022. Total stockholders’ equity as of September 30, 2022, increased $112.5 million compared to September 30, 2021, primarily due to the West Suburban acquisition in late 2021 and the resultant additional common stock issued, as well as net income year over year, less the reduction in accumulated other comprehensive income of $110.6 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
12.99
Total risk-based capital ratio
17.80
Tier 1 risk-based capital ratio
14.10
Tier 1 leverage ratio
9.81
The Bank
15.65
16.69
10.83
2 The prompt corrective action provisions are only applicable at the Bank level.
As of September 30, 2022, the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” and met the now fully phased-in capital conservation buffer requirements. In addition to the above regulatory ratios, our GAAP common equity to total assets ratio, which is used as a performance measurement for capital analysis and peer comparisons, decreased from 8.08% at December 31, 2021, to 7.27% at September 30, 2022. Our GAAP tangible common equity to tangible assets ratio was 5.67% at September 30, 2022, compared to 6.54% as of December 31, 2021. Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, decreased from 6.59% at December 31, 2021, to 5.72% at September 30, 2022, primarily due to a decline in tangible common equity in the nine months ended September 30, 2022. The decline in tangible common equity was due to a decrease in accumulated other comprehensive income of $107.2 million primarily related to unrealized losses on available-for-sale securities stemming from the increase in market interest rates. The non-GAAP tangible common equity to tangible assets ratio was also negatively impacted by growth in total tangible assets in the third quarter of 2022.
Reconciliation of Tangible Common Equity to Tangible Assets Ratio Non-GAAP Measure
Tangible common equity
Total Equity
Less: Goodwill and intangible assets
100,801
102,636
Add: Limitation of exclusion of core deposit intangible (80%)
2,865
3,261
Adjusted goodwill and intangible assets
97,936
99,375
332,913
335,778
399,391
402,652
Tangible assets
Less: Adjusted goodwill and intangible assets
5,866,904
5,869,769
6,109,553
6,112,814
Common equity to total assets
7.27
8.08
Tangible common equity to tangible assets
5.67
5.72
6.54
6.59
The non-GAAP intangible asset exclusion reflects the 80% core deposit limitation per Basel III guidelines within risk based capital calculations, and is useful for us when reviewing risk based capital ratios and equity performance metrics.
Liquidity
Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments. Our liquidity principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds. We monitor our borrowing capacity at the FHLBC as part of our liquidity management process as supervised by our Asset and Liability Committee (“ALCO”) and reviewed by our Board of Directors. In addition, due to the potential impacts on our liquidity stemming from the COVID-19 pandemic, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs. As of September 30, 2022, our cash on hand liquidity totaled $116.2 million, a decrease of $636.0 million over cash balances held as of December 31, 2021.
Net cash inflows from operating activities were $60.1 million during the first nine months of 2022, compared with net cash inflows of $50.8 million in the same period of 2021. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, were a source of inflows for the first nine months of 2022 though to a lesser extent than the like period of 2021. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of inflows for the nine months ended September 30, 2022 and also for the like period of 2021. The management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows. Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process.
Net cash outflows from investing activities were $506.4 million in the nine months ended September 30, 2022, compared to net cash outflows of $57.0 million in the same period in 2021. In the first nine months of 2022, securities transactions accounted for net outflows of $66.9 million, and the principal change on loans accounted for net outflows of $443.6 million. In the first nine months of 2021, securities transactions accounted for net outflows of $225.2 million, and net principal on loans funded accounted for net inflows of $168.6 million. Proceeds from sales of OREO accounted for $941,000 and $607,000 in investing cash inflows for the nine months ended September 30, 2022 and 2021, respectively.
Net cash outflows from financing activities in the nine months ended September 30, 2022, were $189.7 million, compared with net cash inflows of $195.6 million in the nine months ended September 30, 2021. Net deposit outflows in the first nine months of 2022 were $183.7 million compared to net deposit inflows of $177.3 million in the first nine months of 2021. Other short-term borrowings had $25.0 million of net cash inflows in the first nine months of 2022, compared to no cash inflows or outflows in the first nine months of 2021. Changes in securities sold under repurchase agreements accounted for outflows of $14.8 million and outflows of $24.0 million for the nine months ended September 30, 2022 and 2021, respectively. Dividends paid on our common stock totaled $6.7 million in the nine months ended September 30, 2022, compared to dividends paid of $3.2 million for the like 2021 period, as the per common share dividend was increased to five cents per share in the second quarter of 2021. The purchase of treasury stock in the first nine months of 2022 due
61
to shares acquired with restricted stock award vestings resulted in outflows of $447,000, compared to cash outflows of $10.4 million in the first nine months of 2021.
Cash and cash equivalents for the nine months ended September 30, 2022, totaled $116.2 million, as compared to $519.3 million as of September 30, 2021. In addition to cash and cash equivalents on hand or held as deposits with other financial institutions, we rely on funding sources from customer deposits, cash flows from securities available-for-sale and loans, and a line of credit with the FHLBC to meet potential liquidity needs. These sources of liquidity are immediately available to satisfy any funding requirements due to depositor or borrower demands through the ordinary course of our business. Additional sources of funding include a $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.
The Federal Reserve has continued its pace of rate hikes and raised the federal funds target rate by another 0.75% in September 2022. The current market expectation is a federal funds target rate of 4.50% by the end of the year, however the outlook on rates have been constantly changing as new economic measures are published. The Federal Reserve has been slow in shrinking its balance sheet, which decreased from $9.0 trillion in March 2022 to $8.8 trillion in September 2022. We manage interest rate risk within guidelines established by policy 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 September 30, 2022 and December 31, 2021 are outlined in the table below.
Our net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such as LIBOR and prime), and balance sheet growth or contraction. Our asset-liability committee seeks to manage interest rate risk under a variety of rate environments by structuring our 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 in our Annual Report on Form 10-K for the year ended December 31, 2021. We seek to monitor and manage interest rate risk within approved policy guidelines and limits.
We use simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by us are incorporated into the simulation model. Earnings at risk are calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a different interest rate environment in order to determine the percentage change. As of September 30, 2022, our net interest income profile remained sensitive to earnings gains (in both dollars and percentage) should interest rates rise. However, we have a lower sensitivity profile relative to December 31, 2021 from interest rate swaps and mix changes in loans.
The following table summarizes the effect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 0.5%, 1.0%, and 2.0%, with no change in the slope of the yield curve. Due to relatively low market interest rates, it was not possible to calculate any down rate scenarios for December 31, 2021 results because many of the market interest rates would fall below zero in that scenario.
Analysis of Net Interest Income Sensitivity
Immediate Changes in Rates
(1.0)
(0.5)
1.0
2.0
Dollar change
(46,160)
(22,306)
(10,791)
10,567
21,073
40,937
Percent change
(19.5)
(9.4)
(4.5)
4.5
8.9
13,404
27,689
54,007
9.4
19.5
38.0
The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies. The above results do not take into account any management action to mitigate potential risk.
Effects of Inflation
In management’s opinion, changes in interest rates affect our financial condition to a far greater degree than changes in the inflation rate; however, we monitor both. The annual US inflation rate was 8.2% in September 2022, a slight reduction from its peak of 9.1% in June 2022. Management believes the inflation rate will be elevated in the near term, which is expected to be favorable for the Bank. In general, we anticipate that higher inflation will increase borrowers’ needs for credit as a result of GDP growth. In addition, as interest rates are expected to rise to combat inflation, we also expect our net interest margin to be favorably impacted. The downside risks of high inflation puts upwards pressure to our expenses, which could impact profits. Furthermore, higher costs of living weaken the financial condition of our borrowers which could affect our credit profile. A financial institution’s ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in today’s volatile economic environment. We seek to mitigate the impact of interest rate volatility on the Bank by seeking to ensure that rate sensitive assets and rate sensitive liabilities respond to changes in interest rates in a similar time frame and to a similar degree. Overall, we expect the effects of higher inflation to be beneficial to us in the near term.
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 September 30, 2022. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2022, 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 September 30, 2022, 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, 2021, 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, 2021 filed with the SEC on March 10, 2022.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Exhibits:
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at September 30, 2022 and December 31, 2021; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2022 and 2021; (iii) Consolidated Statements of Comprehensive (Loss) Income for the three and nine months ended September 30, 2022 and 2021; (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2022 and 2021; (v) Consolidated Statements of Stockholder’s Equity for the three and nine months ended September 30, 2022 and 2021; and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.
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
President and Chief Executive Officer
(principal executive officer)
/s/ Bradley S. Adams
Bradley S. Adams
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)
DATE: November 8, 2022