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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

Form 10-K

 

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

 

For the fiscal year ended December 31, 2009

 

OR

 

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

 

For the transition period from             to             

 

Commission file number  0-10537

 

OLD SECOND BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

37 South River Street, Aurora, Illinois 60507

(Address of principal executive offices, including Zip Code)

 

(630) 892-0202

(Registrant’s telephone number, including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class		Name of each exchange on which registered
Common Stock, $1.00 par value		The Nasdaq Stock Market
Preferred Securities of Old Second Capital Trust I		The Nasdaq Stock Market

 

Securities registered pursuant to Section 12(g) of the Act:

 

Preferred Share Purchase Rights

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o  No x

 

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 x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by Reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).Yes o  No x

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, on June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $75.1 million.  The number of shares outstanding of the registrant’s common stock, par value $1.00 per share, was 13,939,833 at March 11, 2010.

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s Annual Report for the fiscal year ended December 31, 2009 are incorporated by reference into Parts I, II and IV.

Portions of the Company’s Proxy Statement for the 2010 Annual Meeting of Stockholders are incorporated by reference into Part III.

 

 

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OLD SECOND BANCORP, INC.

Form 10-K

 

INDEX

 

PART I
Item 1		Business
Item 1A		Risk Factors
Item 1B		Unresolved Staff Comments
Item 2		Properties
Item 3		Legal Proceedings
Item 4		Reserved
PART II
Item 5		Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6		Selected Financial Data
Item 7		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A		Quantitative and Qualitative Disclosures about Market Risk
Item 8		Financial Statements and Supplementary Data
Item 9		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A		Controls and Procedures
Item 9B		Other Information
PART III
Item 10		Directors, Executive Officers, and Corporate Governance
Item 11		Executive Compensation
Item 12		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13		Certain Relationships and Related Transactions, and Director Independence
Item 14		Principal Accountant Fees and Services
PART IV
Item 15		Exhibits and Financial Statement Schedules
		Signatures

 

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PART I

 

Item 1.  Business

 

General

 

Old Second Bancorp, Inc. (the “Company” or the “Registrant”) was organized under the laws of Delaware on September 8, 1981. It is a registered bank holding company under the Bank Holding Company Act of 1956 (the “BHCA”). The Company’s office is located at 37 South River Street, Aurora, Illinois 60507.

 

The Company conducts a full service community banking and trust business through its wholly owned subsidiaries, which are together referred to as the “Company”:

 

·                  Old Second National Bank (the “Bank”).

·                  Old Second Capital Trust I, which was formed for the exclusive purpose of issuing trust preferred securities in an offering that was completed in July 2003.

·                  Old Second Capital Trust II, which was formed for the exclusive purpose of issuing trust preferred securities in an offering that was completed in April 2007.

·                  Old Second Affordable Housing Fund, L.L.C., which was formed for the purpose of providing down payment assistance for home ownership to qualified individuals.

·                  Station I, LLC, a wholly owned subsidiary of Old Second National Bank, which was formed in August 2008 to hold property acquired by the Bank through foreclosure or in the ordinary course of collecting a debt previously contracted.

 

Inter-company transactions and balances are eliminated in consolidation. The Company provided financial services through its thirty banking locations and one commercial loan production office located in Kane, Kendall, DeKalb, DuPage, LaSalle, Will and southwestern Cook counties in Illinois as of December 31, 2009.  The Company expanded its franchise into Cook County and the desirable, higher growth markets of the south Chicago suburbs by adding additional retail locations through acquisition in February 2008.  That transaction allowed the Company to fill in its footprint surrounding the Chicago metropolitan area.

 

Business of the Company and its Subsidiaries

 

The Bank’s full service banking businesses includes the customary consumer and commercial products and services that banks provide including demand, NOW, money market, savings, time deposit, individual retirement and Keogh deposit accounts; commercial, industrial, consumer and real estate lending, including installment loans, student loans, agricultural loans, lines of credit and overdraft checking; safe deposit operations; trust services; wealth management services, and an extensive variety of additional services tailored to the needs of individual customers, such as the acquisition of U.S. Treasury notes and bonds, the sale of traveler’s checks, money orders, cashier’s checks and foreign currency, direct deposit, discount brokerage, debit cards, credit cards, and other special services. The Bank also offers a full complement of electronic banking services such as Internet banking and corporate cash management including remote deposit capture. Commercial and consumer loans are made to corporations, partnerships and individuals, primarily on a secured basis. Commercial lending focuses on business, capital, construction, inventory and real estate lending. Installment lending includes direct and indirect loans to consumers and commercial customers.  Additionally, the Bank provides a wide range of trust, investment, agency, and custodial services for individual, corporate, and not-for-profit clients. These services include the administration of estates and personal trusts, as well as the management of investment accounts for individuals, employee benefit plans, and charitable foundations.  The Bank also originates residential mortgages, offering a wide range of products including conventional, government, and jumbo loans. Secondary marketing of those mortgages is handled at the Bank.

 

Operating segments are components of a business about which separate financial information is available and that are evaluated regularly by the Company’s management in deciding how to allocate resources and assess performance.  Public companies are required to report certain financial information about operating segments.  The Company’s chief operating decision maker evaluates the operations of the Company as one operating segment, Community Banking.  As a result, disclosure of separate segment information is not required.  The Company offers the products and services described above to its external customers as part of its customary banking business.

 

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Market Area

 

The Bank is the principal operating subsidiary of Old Second Bancorp, Inc.  The Bank’s primary market area is Aurora, Illinois, its surrounding communities as well as southwestern Cook county.  The city of Aurora is located in northeastern Illinois, approximately 40 miles west of Chicago.  Aurora is strategically situated on U.S. Interstate 88 and is centrally located near our banking offices in Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois.  Based upon most recent estimates, these counties together represent a market of more than 2.4 million people.  Likewise, the city of Aurora has a reported population of over 170,000 residents.  The Bank expanded its footprint in the Chicago metropolitan area in 2008 when it acquired a presence in the southern suburbs of Chicago to compliment its presence in the western and northwestern suburbs.

 

Lending Activities

 

In 2009, the Company received an investment from the U.S. Department of Treasury through the Capital Purchase Program.  The Company is committed to using these funds to enable the Bank to continue to make loans to qualified borrowers in its market areas.  In 2009, the Bank originated approximately $737.5 million in loans, which included residential mortgage loans of just over $481.2 million that were subsequently sold to investors.

 

General.  The Bank provides a broad range of commercial and retail lending services to corporations, partnerships, individuals and government agencies.  The Bank actively markets its services to qualified borrowers.  Lending officers actively solicit the business of new borrowers entering our market areas as well as long-standing members of the local business community.  The Bank has established lending policies that include a number of underwriting factors to be considered in making a loan, including location, amortization, loan to value ratio, cash flow, pricing, documentation and the credit history of the borrower.  The Bank’s loan portfolios are comprised primarily of loans in the areas of commercial real estate, residential real estate, construction, general commercial and consumer lending.  As of December 31, 2009, residential mortgages made up approximately 31% of its loan portfolio, commercial real estate loans comprised approximately 45%, construction lending comprised approximately 13%, general commercial loans comprised approximately 10%, and consumer and other lending comprised less than 1%.  It is the Bank’s policy to comply at all times with the various consumer protection laws and regulations including, but not limited to, the Equal Credit Opportunity Act, the Fair Housing Act, the Community Reinvestment Act, the Truth in Lending Act, and the Home Mortgage Disclosure Act.  The Bank does not discriminate in application procedures, loan availability, pricing, structure, or terms on the basis of race, color, religion, national origin, sex, marital status, familial status, handicap, age (provided the applicant has the legal capacity to enter into a binding contract), whether income is derived from public assistance, whether a borrower resides or his property is located in a low- or moderate-income area, or whether a right was exercised under the Consumer Credit Protection Act. The Bank strives to offer all of their credit services throughout their primary market area, including low- and moderate-income areas.

 

Commercial Loans.  As noted above, the Bank is an active commercial lender.  The areas of emphasis include loans to wholesalers, manufacturers, building contractors, developers, business services companies and retailers.  The Bank provides a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment and other purposes.  Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate.  In addition, the Bank may take personal guarantees to help assure repayment.  Loans may be made on an unsecured basis if warranted by the overall financial condition of the borrower.  Commercial lines of credit are generally for one year and have floating rates.  Commercial term loans range from one to seven years with the majority falling in the three to five year range with rates fixed for the duration of the loan.  There was a slight increase in the percentage of the portfolio attributed to commercial loans in 2009.  This trend reflects increased demand for working capital and equipment financing as well as a decision by management to diversify the loan portfolio composition.  Repayment of commercial loans is largely dependent upon the cash flows generated by the operations of the commercial enterprise.  The Bank’s underwriting procedures identify the sources of those cash flows and seek to match the repayment terms of the commercial loans to the sources.  Secondary repayment sources are typically found in collateralization and guarantor support.

 

Commercial Real Estate Loans.  A large portion of the loan portfolio is comprised of commercial real estate loans.  At December 31, 2009 approximately $427.1 million, or 46.2%, of the total commercial real estate loan portfolio of $925.0 million was to owner occupied borrowers.  A primary repayment risk for a commercial real estate loan is interruption or discontinuance of cash flows from operations.  Such cash flows are usually derived from rent in the case of

 

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nonowner occupied commercial properties, and repayment could also be influenced by economic events, which may or may not be under the control of the borrower, or changes in governmental regulations that negatively impact the future cash flow and market values of the affected properties.  Repayment risk can also arise from general downward shifts in the valuations of classes of properties over a given geographic area such as the price adjustments that have been observed beginning in 2008.  Property valuations could continue to be affected by changes in demand and other economic factors, which could further influence cash flows associated with the borrower and/or the property.  The Bank mitigates these risks through staying apprised of market conditions and by maintaining underwriting practices that provide for adequate cash flow margins and multiple repayment sources as well as remaining in regular contact with the borrowers.  In most cases, the Bank has collateralized these loans and/or has taken personal guarantees to help assure repayment.  Commercial real estate loans are primarily made based on the identified cash flow of the borrower and/or the property at origination and secondarily on the underlying real estate acting as collateral.  Additional credit support is provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the real estate and enforcement of a personal guarantee, if any exists.

 

Construction Loans.  The Bank originates loans to finance the construction of residential and commercial properties located in its market area.  The Bank uses underwriting and construction loan guidelines for financing where reputable contractors are involved.  Construction loans are structured most often to be converted to permanent loans at the end of the construction phase or, infrequently, to be paid off upon receiving financing from another financial institution.  Construction loans are generally limited to locally known markets and construction lending is typically based upon cost supplemented by information based on the appraised value of the property, as determined by an independent appraiser, and an analysis of the potential marketability and profitability of the project, and identification of a cash flow source to service the permanent loan, or verification of a refinancing source.  Construction loans generally have terms of up to 12 months, with extensions as needed.  The Bank disburses loan proceeds in increments as construction progresses and as inspections warrant.

 

Construction loans have traditionally afforded the Bank the opportunity to increase the interest rate sensitivity of their loan portfolio and to receive yields higher than those obtainable on ARM loans secured by existing residential properties.  These higher yields corresponded to the higher risks management estimated to be associated with construction lending.

 

Construction development loans involve additional risks and few new development loans are being sought in the current economic environment.  Development lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest.  This involves more risk than other lending because it is based on future estimates of value and economic circumstances.  While appraisals are required prior to funding, and advances are limited to the value determined by the appraisal, there is the possibility of an unforeseen event affecting the value and/or costs of the project.  Development loans are primarily used for single-family developments, where the sale of lots and houses are tied to customer preferences and interest rates.  If the borrower defaults prior to completion of the project, the Bank may be required to fund additional amounts so that another developer can complete the project.  The Bank is located in an area where a large amount of development activity has occurred as rural and semi-rural areas were being suburbanized.  This type of growth presents some economic risks should a sustained shift occur in the local demand for housing as has occurred in conjunction with the current economic turmoil.  The Bank has attempted to address these risks by closely monitoring local real estate activity, developing and strengthening underwriting procedures, closely monitoring construction projects, and by limiting the amount of construction development lending.  Activity in this sector slowed considerably with the downward economic trends in real estate and other markets that was experienced in 2008 and continued in 2009.  With the current rates of unemployment and downward valuations in this and other real estate sectors, the Company anticipates that both demand and lending activity will continue to be flat in 2010.

 

Residential Real Estate Loans.  Residential first mortgage loans, second mortgages, and home equity line of credit mortgages are included in this category.  First mortgage loans may include fixed rate loans that are generally sold to investors.  The Bank is a direct seller to Federal National Mortgage Association (“FNMA”), Chase Manhattan Bank, Bank of America, and to other investors and periodically retains servicing rights for sold mortgages.  Management believes that selling of mortgage servicing can provide the Company with a relatively steady source of income.  The periodic retention of such servicing rights also allows the Bank an opportunity to have regular contact with mortgage customers and can help to solidify community involvement.  Other loans that are not sold include adjustable rate mortgages, lot loans, and constructions loans that are held in portfolio by the Bank.

 

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Consumer Loans.  The Bank also provides many types of consumer loans including motor vehicle, home improvement, home equity, signature loans and small personal credit lines. Consumer loans typically have shorter terms and lower balances with higher yields as compared to other loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances.  Home equity lending has continued to slow in the past year but is still a significant portion of the Bank’s business and the largest share of consumer loans.

 

Competition

 

The market area is highly competitive and the Bank’s lines of business and activities require us to compete with many other companies.  A number of these financial institutions are affiliated with large bank holding companies headquartered outside of our principal market area as well as other institutions that are based in Aurora’s surrounding communities and in Chicago, Illinois.  All of these financial institutions operate banking offices in the greater Aurora area or actively compete for customers within the Company’s market area. The Bank also faces competition from finance companies, insurance companies, credit unions, mortgage companies, securities brokerage firms, United States Government securities, money market funds, loan production offices and other providers of financial services.  Many of our non-bank competitors are not subject to the same extensive Federal regulations that govern bank holding companies and banks. Such non-bank competitors may, as a result, have certain advantages over us in providing some services.

 

The Bank competes for loans principally through the range and quality of the client service and responsiveness to client needs that it provides, in addition to competing on interest rates and loan fees.  Management believes that its long-standing presence in the community and personal one-on-one service philosophy enhances its ability to compete favorably in attracting and retaining individual and business customers.  The Bank actively solicits deposit-related clients and competes for deposits by offering personal attention, competitive interest rates, and professional services made available through practiced bankers and multiple delivery channels that fit the needs of its market.

 

The Bank is subject to vigorous competition from other banks and savings and loan associations, as well as credit unions and other financial institutions in the area.  Within the Aurora banking market, which geographically covers the southern two-thirds of Kane County and the northern one-third of Kendall County, there were 27 other financial institutions with a total of 68 branches as of mid 2009.  The Bank operated 30 offices located in the seven counties of Kane, Kendall, LaSalle, Will, DeKalb, DuPage and southwestern Cook as of December 31, 2009.  The Bank is the deposit market leader in Kane and Kendall counties where it has a concentrated number of branches, facing competition with over 46 different financial institutions representing in excess of 226 branches.  The Bank’s branches in the remaining counties face many of these same competitors as well as competition from additional local institutions.  Competition for residential mortgage lending also includes a number of mortgage brokerage operations as well as traditional banks, thrifts and credit unions.  The Bank’s wealth management division includes traditional trust services as well as investment advisory, brokerage, and employee benefit administration services.  This diverse array of products and services allows us to compete against other larger banks as well as specialized brokerage companies.  The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services without having a physical presence in our market.  These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.

 

Employees

 

At December 31, 2009, the Company employed 572 full-time equivalent employees.  The Company places a high priority on staff development, which involves extensive training, including customer service training.  New employees are selected on the basis of both technical skills and customer service capabilities.  None of the Company’s employees are covered by a collective bargaining agreement with the Company.  The Company offers a variety of employee benefits and management considers its employee relations to be excellent.

 

Internet

 

The Company maintains a corporate web site at http://www.oldsecond.com.  The Company makes available free of charge on or through its web site the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission.  Many of the Company’s policies, committee charters and other investor information including our Code of Business Conduct and Ethics, are available on the web site.  The Company will also provide copies of its filings free of charge upon written request to: J. Douglas Cheatham, Executive Vice President and Chief Financial Officer, Old Second Bancorp, Inc., 37 South River Street, Aurora, Illinois 60507.

 

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SUPERVISION AND REGULATION

 

General

 

Financial institutions, their holding companies, and their affiliates are extensively regulated under federal and state law.  As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”).  Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the “SEC”) and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.

 

Federal   and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of the Company and its subsidiaries and is intended primarily for the protection of FDIC-insured deposits and depositors of the Bank, rather than shareholders.  In addition to this generally applicable regulatory framework, turmoil in the credit markets in recent years has prompted the enactment of unprecedented legislation that has allowed the U.S. Treasury to make equity capital available to qualifying financial institutions to help restore confidence and stability in the U.S. financial markets, which imposes additional requirements on institutions in which the U.S. Treasury Department invests.

 

The following is a summary of the material elements of the regulatory framework that currently applies to the Company and its subsidiaries.  It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described.  Additionally, in response to the global financial crisis that began in 2007, various legislative and regulatory proposals have been issued addressing, among other things, the restructuring of the federal bank regulatory system, more stringent regulation of consumer products such as mortgages and credit cards, and safe and sound compensation practices.  At this time, the Company is unable to determine whether any of these proposals will be adopted as proposed.  As such, the following is qualified in its entirety by reference to applicable law.  Any change in statutes, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries.

 

The Company

 

General.  The Company, as the sole shareholder of the Bank, is a bank holding company.  As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not otherwise do so.  Under the BHCA, the Company is subject to periodic examination by the Federal Reserve.  The Company is required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require.

 

Acquisitions, Activities and Change in Control.  The primary purpose of a bank holding company is to control and manage banks.  The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company.  Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.

 

The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than

 

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5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries.  This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking . . . as to be a proper incident thereto.”  This authority would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation of a thrift, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.

 

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.  The Company has elected (and the Federal Reserve has accepted the Company’s election) to operate as a financial holding company.

 

Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator.  “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership

 

Capital Requirements.  Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines.  If capital levels fall below the minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

 

The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets.  The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%.  The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others.  For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus Tier 2 capital, which consists of other non-permanent capital items such as certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.

 

The risk-based and leverage standards described above are minimum regulatory requirements. In connection with the current environment and the Bank’s level of nonperforming assets, which are higher than its historical averages however, management instituted a capital plan to maintain the Bank’s Tier 1 capital to average assets at above 8.75% and its total capital to risk weighted assets at above 11.25%.  Higher capital levels could be required by the regulators to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.  Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels.  As of December 31, 2009, the Company had regulatory capital in excess of the Federal Reserve’s minimum requirements as well as its own capital plan.

 

Emergency Economic Stabilization Act of 2008.  Events in the U.S. and global financial markets over the past several years, including deterioration of the worldwide credit markets, have created significant challenges for financial institutions throughout the country.  In response to this crisis affecting the U.S. banking system and financial markets, on October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the “EESA”).  The EESA authorized the Secretary of the United States Department of Treasury (“Treasury”) to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system.  Financial institutions

 

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participating in certain of the programs established under the EESA are required to adopt Treasury’s standards for executive compensation and corporate governance.

 

The TARP Capital Purchase Program.  On October 14, 2008, Treasury announced that it would provide Tier 1 capital (in the form of perpetual preferred stock) to eligible financial institutions.  This program, known as the TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion authorized by the EESA to Treasury for the purchase of senior preferred shares from qualifying financial institutions (the “CPP Preferred Stock”).  Under the program, eligible institutions were able to sell equity interests to the Treasury in amounts equal to between 1% and 3% of the institution’s risk-weighted assets.  The CPP Preferred Stock is non-voting and pays dividends at the rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum.  In conjunction with the purchase of the CPP Preferred Stock, the Treasury received warrants to purchase common stock from the participating public institutions with an aggregate market price equal to 15% of the preferred stock investment.  Participating financial institutions are required to adopt Treasury’s standards for executive compensation and corporate governance for the period during which Treasury holds equity issued under the CPP.  These requirements are discussed in more detail in the Compensation Discussion and Analysis section in the Company’s proxy statement, which is incorporated by reference in this Form 10-K.

 

Pursuant to the CPP, on January 16, 2009, the Company entered into a Letter Agreement with Treasury, pursuant to which the Company issued (i) 73,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B and (ii) a warrant to purchase 815,339 shares of the Company’s common stock for an aggregate purchase price of $73.0 million in cash.  The Company’s federal regulators and the Treasury’s Office of the Inspector General maintain significant oversight over the Company as a participating institution, to evaluate how it is using the capital provided and to ensure that it strengthens its efforts to help its borrowers avoid foreclosure, which is one of the core aspects of the EESA.

 

Dividend Payments.  The Company’s ability to pay dividends to its stockholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies.  As a Delaware corporation, the Company is subject to the limitations of the Delaware General Corporation Law (the “DGCL”). The DGCL allows the Company to pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or, if the Company has no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.  Additionally, as a bank holding company, the Company’s ability to declare and pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends.  The Federal Reserve guidelines generally require the Company to review the effects of the cash payment of dividends on common stock and other Tier 1 capital instruments (i.e., perpetual preferred stock and trust preferred securities) in light of our earnings, capital adequacy and financial condition.  In addition, as a matter of policy, the Federal Reserve has indicated that bank holding companies should not pay dividends on common stock (or make distributions on trust preferred securities) using funds from the CPP.  As a general matter, the Federal Reserve indicates that the board of directors of a bank holding company should eliminate, defer or significantly reduce the dividends if:  (i) the company’s net income available to stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.  The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.  Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.

 

Furthermore, with respect to the Company’s participation in the CPP, the terms of the CPP Preferred Stock provide that no dividends on any common or preferred stock that ranks equal to or junior to the CPP Preferred Stock may be paid unless and until all accrued and unpaid dividends for all past dividend periods on the CPP Preferred Stock have been fully paid.

 

Federal Securities Regulation.  The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

 

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The Bank

 

General.  Old Second National Bank (the “Bank”) is a national bank chartered by the OCC under the National Bank Act. The deposit accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (the “DIF”) to the maximum extent provided under federal law and FDIC regulations.  The Bank is also a member of the Federal Reserve System.  The Bank is subject to the examination, supervision, reporting and enforcement requirements of the OCC, the chartering authority for national banks.  The FDIC, as administrator of the DIF, also has regulatory authority over the Bank.

 

Deposit Insurance.  As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification.  An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators.  Under the regulations of the FDIC, as presently in effect, insurance assessments range from 0.07% to 0.78% of total deposits, depending on an institution’s risk classification, its levels of unsecured debt and secured liabilities, and, in certain cases, its level of brokered deposits.

 

Furthermore, as a result of the increased volume of bank failures in 2008 and 2009, on May 22, 2009, the FDIC approved a final rule imposing a special assessment on all depository institutions whose deposits are insured by the FDIC.  This one-time special assessment was imposed on institutions in the second quarter, and was collected on September 30, 2009.  Pursuant to the final rule, the FDIC imposed on the Bank a special assessment in the amount of $1.2 million, which was due and payable on September 30, 2009.

 

On November 12, 2009, the FDIC adopted a final rule that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012.  On December 31, 2009, the Bank paid the FDIC $20.1 million in prepaid assessments.  An institution’s prepaid assessments were calculated based on the institution’s actual September 30, 2009, assessment base, adjusted quarterly by an estimated five percent annual growth rate through the end of 2012.  The FDIC also used the institution’s total base assessment rate in effect on September 30, 2009, increasing it by an annualized three basis points beginning in 2011.  The FDIC will begin to offset prepaid assessments on March 30, 2010, representing payment of the regular quarterly risk-based deposit insurance assessment for the fourth quarter of 2009.  Any prepaid assessment not exhausted after collection of the amount due on June 30, 2013, will be returned to the institution.

 

FDIC Temporary Liquidity Guarantee Program.  In conjunction with Treasury’s actions to address the credit and liquidity crisis in financial markets, on October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program.  One component of the Temporary Liquidity Guarantee Program is the Transaction Account Guarantee Program, which temporarily provides participating institutions with unlimited deposit insurance coverage for non-interest bearing and certain low-interest bearing transaction accounts maintained at FDIC-insured institutions.  All institutions that did not opt out of the Transaction Account Guarantee Program were subject to a 10 basis point per annum assessment on amounts in excess of $250,000 in covered transaction accounts through December 31, 2009.  On August 26, 2009, the FDIC extended the Transaction Account Guarantee Program for an additional six months through June 30, 2010.  Beginning January 1, 2010, the assessment levels increased to 15 basis points, 20 basis points or 25 basis points per annum, based on the risk category to which an institution is assigned for purposes of the risk-based premium system.  The Bank did not opt out of the six-month extension of the Transaction Account Guarantee Program.  As a result, the Bank, like every other FDIC-insured depository institution in the United States that did not opt out of the Transaction Account Guarantee Program, is incurring fees on amounts in excess of $250,000 in covered transaction accounts.

 

FICO Assessments.  The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Federal Savings and Loan Insurance Corporation Recapitalization Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation.  FICO issued 30-year non-callable bonds of approximately $8.2 billion that mature by 2019.  Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations.  These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2009, the FICO assessment rate was approximately 0.01% of deposits.

 

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Supervisory Assessments.  National banks are required to pay supervisory assessments to the OCC to fund the operations of the agency.  The amount of the assessment paid to the OCC is calculated using a formula that takes into account the bank’s size and its supervisory condition (as determined by the composite rating assigned to the bank as a result of its most recent OCC examination).  During the year ended December 31, 2009, the Bank paid supervisory assessments to the OCC totaling $504,000.

 

Capital Requirements.  Banks are generally required to maintain capital levels in excess of other businesses.  The OCC has established the following minimum capital standards for national banks, such as the Bank: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%.  In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.

 

The capital requirements described above are minimum regulatory requirements.  In connection with the current environment and the Bank’s level of nonperforming assets, which are higher than its historical averages however, management instituted a capital plan to maintain the Bank’s Tier 1 capital to average assets at above 8.75% and its total capital to risk weighted assets at above 11.25%.  Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions.  For example, OCC regulations provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.

 

Further, federal law and regulations provide various incentives for financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.”  Under the OCC regulations, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.

 

Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions.  The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation.  Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.

 

As of December 31, 2009, the Bank exceeded its minimum regulatory capital requirements under applicable capital adequacy guidelines and its own capital plan.

 

Dividend Payments.  The primary source of funds for the Company is dividends from the Bank.  Under the National Bank Act, the Bank may pay dividends out of its undivided profits in such amounts and at such times as its board of directors deems prudent.  Without prior OCC approval, however, the Bank may not pay dividends in any calendar year that, in the aggregate, exceed its year-to-date net income plus its retained net income for the two preceding years.

 

The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized.  As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2009.  However, because of the significant net loss that we incurred in 2009 and our current capital ratios, as of December 31, 2009, the

 

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Bank was unable to pay dividends to the Company.  Furthermore, the OCC may prohibit the payment of dividends by the Bank if it determines such payment would constitute an unsafe or unsound practice.

 

Insider Transactions.  The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its subsidiaries, on investments in the stock or other securities of the Company and its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans made by the Bank.  Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company and to “related interests” of such directors, officers and principal stockholders.  In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which the Bank maintains correspondent relationships.

 

Safety and Soundness Standards.  The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions.  The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

 

In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals.  If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

 

Branching Authority.  National banks headquartered in Illinois, such as the Bank, have the authority to establish branches anywhere in the State of Illinois, subject to OCC approval.

 

Federal law permits national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger.  The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion.

 

Financial Subsidiaries.  Under Federal law and OCC regulations, national banks are authorized to engage, through “financial subsidiaries,” in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except: (i) insurance underwriting; (ii) real estate development or real estate investment activities (unless otherwise permitted by law); (iii) insurance company portfolio investments; and (iv) merchant banking.  The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from capital the bank’s outstanding investments in financial subsidiaries).  The Bank has not applied for approval to establish any financial subsidiaries.

 

Federal Reserve System.  Federal Reserve regulations, as presently in effect, require depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $55.2 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $55.2 million, the reserve requirement is $1.335 million plus 10% of the aggregate amount of total transaction accounts in excess of $55.2 million.  The first $10.7 million of otherwise reservable balances are exempted from the reserve requirements.  These reserve requirements are subject to annual adjustment by the Federal Reserve.  The Bank is in compliance with the foregoing requirements.

 

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GUIDE 3 STATISTICAL DATA REQUIREMENTS

 

The statistical data required by Guide 3 of the Guides for Preparation and Filing of Reports and Registration Statements under the Securities Exchange Act of 1934 is set forth in the following pages.  This data should be read in conjunction with the consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as set forth in the 2009 Annual Report incorporated herein by reference (attached hereto as Exhibit 13.1).  All dollars in the tables are expressed in thousands.

 

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The following table sets forth certain information relating to the Company’s average consolidated balance sheets and reflects the yield on average earning assets and cost of average liabilities for the years indicated.  Dividing the related interest by the average balance of assets or liabilities derives rates.  Average balances are derived from daily balances. 

 

ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

Years ended December 31, 2009 ,2008 and 2007

 

		2009								2008								2007
		Average Balance			Interest			Rate		Average Balance			Interest			Rate		Average Balance			Interest			Rate
ASSETS
Interest bearing deposits		$	16,928		$	39		0.23	%	$	1,310		$	44		3.30	%	$	1,438		$	51		3.50	%
Federal funds sold		15,060			17			0.11		10,032			146			1.43		6,248			317			5.00
Securities:
Taxable		193,952			8,526			4.40		326,542			15,745			4.82		356,040			17,095			4.80
Non-taxable (tax equivalent)		135,644			8,046			5.93		151,408			9,134			6.03		147,875			8,842			5.98
Total securities		329,596			16,572			5.03		477,950			24,879			5.21		503,915			25,937			5.15
Dividends from FRB and FHLB stock		13,044			225			1.72		10,816			83			0.77		8,902			239			2.68
Loans and loans held-for-sale (1)		2,224,759			118,818			5.27		2,192,540			136,187			6.11		1,835,121			132,486			7.12
Total interest earning assets		2,599,387			135,671			5.16		2,692,648			161,339			5.91		2,355,624			159,030			6.67
Cash and due from banks		42,935			—			—		49,916			—			—		49,775			—			—
Allowance for loan losses		(57,976		)	—			—		(22,058		)	—			—		(16,648		)	—			—
Other noninterest-bearing assets		228,875			—			—		200,085			—			—		126,989			—			—
Total assets		$	2,813,221							$	2,920,591							$	2,515,740
LIABILITIES AND STOCKHOLDERS’ EQUITY
NOW accounts		$	361,806		1,287			0.36		$	291,274		2,699			0.93		$	250,984		4,345			1.73
Money market accounts		439,325			4,334			0.99		554,358			11,194			2.02		499,647			19,264			3.86
Savings accounts		152,671			838			0.55		110,426			620			0.56		102,659			882			0.86
Time deposits		1,092,598			32,886			3.01		1,085,924			42,046			3.87		985,861			48,525			4.92
Total interest bearing deposits		2,046,400			39,345			1.92		2,041,982			56,559			2.77		1,839,151			73,016			3.97
Securities sold under repurchase agreements		29,782			140			0.47		45,183			837			1.85		53,323			2,391			4.48
Federal funds purchased		15,938			78			0.48		45,420			1,372			2.97		58,777			3,115			5.23
Other short-term borrowings		44,734			296			0.65		137,800			2,593			1.85		76,600			3,967			5.11
Junior subordinated debentures		58,378			4,287			7.34		58,295			4,281			7.34		48,996			3,629			7.41
Subordinated debt		45,000			1,245			2.73		40,451			1,831			4.45		—			—			—
Notes payable and other borrowings		4,966			122			2.42		23,988			940			3.85		16,338			1,025			6.19
Total interest bearing liabilities		2,245,198			45,513			2.03		2,393,119			68,413			2.85		2,093,185			87,143			4.16
Noninterest bearing deposits		314,436			—			—		312,943			—			—		257,090			—			—
Accrued interest and other liabilities		18,682			—			—		18,419			—			—		16,813			—			—
Stockholders’ equity		234,905			—			—		196,110			—			—		148,652			—			—
Total liabilities and stockholders’ equity		$	2,813,221							$	2,920,591							$	2,515,740
Net interest income (tax equivalent)					$	90,158							$	92,926							$	71,887
Net interest income (tax equivalent) to total earning assets								3.47	%							3.45	%							3.05	%
Interest bearing liabilities to earnings assets		86.37		%						88.88		%						88.86		%

 

(1)          Interest income from loans  is shown tax equivalent as discussed below and includes fees of $3,329,000, $4,006,000 and  $3,725,000 for 2009, 2008 and 2007, respectively.  Nonaccrual loans are included in the above stated average balances.

 

Notes:  For purposes of discussion, net interest income and net interest income to earning assets have been adjusted to a non-GAAP tax equivalent (“TE”) basis using a marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets.  The table below provides a reconciliation of each non-GAAP TE measure to the GAAP equivalent:

 

		Effect of Tax Equivalent Adjustment
		2009			2008			2007
Interest income (GAAP)		$	132,650		$	157,927		$	155,741
Taxable equivalent adjustment - loans		205			215			194
Taxable equivalent adjustment - securities		2,816			3,197			3,095
Interest income (TE)		135,671			161,339			159,030
Less: interest expense (GAAP)		45,513			68,413			87,143
Net interest income (TE)		$	90,158		$	92,926		$	71,887
Net interest and income (GAAP)		$	87,137		$	89,514		$	68,598
Net interest income to total interest earning assets		3.35		%	3.32		%	2.91		%
Net interest income to total interest earning assets (TE)		3.47		%	3.45		%	3.05		%

 

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The following table allocates the changes in net interest income to changes in either average balances or average rates for earnings assets and interest bearing liabilities.  The changes in interest due to both volume and rate have been allocated proportionately to the change due to balance and due to rate.  Interest income is measured on a tax-equivalent basis using a 35% rate as per the note to the analysis of averages balance table on page 14.

 

		2009 Compared to 2008									2008 Compared to 2007
		Change Due to									Change Due to
		Average			Average			Total			Average			Average			Total
		Balance			Rate			Change			Balance			Rate			Change
EARNING ASSETS/INTEREST INCOME
Interest bearing deposits		$	(5	)	$	—		$	(5	)	$	(4	)	$	(3	)	$	(7	)
Federal funds sold		154			(283		)	(129		)	956			(1,127		)	(171		)
Securities:
Taxable		(5,929		)	(1,290		)	(7,219		)	(1,423		)	73			(1,350		)
Tax-exempt		(937		)	(151		)	(1,088		)	213			79			292
Dividends from FRB and FHLB Stock		20			122			142			67			(223		)	(156		)
Loans and loans held-for-sale		2,072			(19,441		)	(17,369		)	13,657			(9,956		)	3,701
TOTAL EARNING ASSETS		(4,625		)	(21,043		)	(25,668		)	13,466			(11,157		)	2,309
INTEREST BEARING LIABILITIES/ INTEREST EXPENSE
NOW accounts		914			(2,326		)	(1,412		)	869			(2,515		)	(1,646		)
Money market accounts		(1,980		)	(4,880		)	(6,860		)	2,409			(10,479		)	(8,070		)
Savings accounts		232			(14		)	218			73			(335		)	(262		)
Time deposits		260			(9,420		)	(9,160		)	5,879			(12,358		)	(6,479		)
Securities sold under repurchase agreements		(219		)	(478		)	(697		)	(321		)	(1,233		)	(1,554		)
Federal funds purchased		(565		)	(729		)	(1,294		)	(601		)	(1,142		)	(1,743		)
Other short-term borrowings		(1,173		)	(1,124		)	(2,297		)	(6,805		)	5,431			(1,374		)
Junior subordinated debentures		6			0			6			683			(31		)	652
Subordinated debt		240			(826		)	(586		)	1,831			—			1,831
Notes payable and other borrowings		(556		)	(262		)	(818		)	(437		)	352			(85		)
INTEREST BEARING LIABILITIES		(2,841		)	(20,059		)	(22,900		)	3,580			(22,310		)	(18,730		)
NET INTEREST INCOME		$	(1,784	)	$	(984	)	$	(2,768	)	$	9,886		$	11,153		$	21,039

 

The following table presents the composition of the securities portfolio by major category as of December 31, of each year indicated:

 

SECURITIES PORTFOLIO COMPOSITION

 

		2009						2008						2007
		Amortized			Fair			Amortized			Fair			Amortized			Fair
		Cost			Value			Cost			Value			Cost			Value
SECURITIES AVAILABLE FOR SALE
U.S. Treasury		$	1,499		$	1,523		$	1,496		$	1,568		$	10,018		$	10,150
U.S. government agencies		84,265			84,452			95,290			96,355			209,799			210,551
U.S. government agency mortgage-backed		41,175			42,800			86,062			87,250			95,839			96,875
States and political subdivisions		81,801			83,338			150,313			151,593			158,862			159,758
Collateralized mortgage obligations		22,246			23,151			58,684			59,270			73,518			73,941
Collateralized debt obligations		17,834			10,883			17,834			10,267			9,507			9,532
Equity securities		99			94			99			83			52			52
		$	248,919		$	246,241		$	409,778		$	406,386		$	557,595		$	560,859

 

The Company’s holdings of U.S. government agency and U.S. government agency mortgage-backed securities are comprised of government-sponsored enterprises, such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which are not backed by the full faith and credit of the United States government.

 

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SECURITIES AVAILABLE FOR SALE MATURITY AND YIELDS

 

The following table presents the expected maturities or call dates and weighted average yield (non tax equivalent) of securities by major category as of December 31, 2009:

 

							After One But					After Five But
		Within One Year					Within Five Years					Within Ten Years					After Ten Years					Total
		Amount			Yield		Amount			Yield		Amount			Yield		Amount			Yield		Amount			Yield
U.S. Treasury		$	1,523		3.79	%	$	—		0.00	%	$	—		—		$	—		—		$	1,523		3.79	%
U.S. government agencies		36,374			0.34	%	23,833			0.97	%	15,096			4.09	%	9,149			5.55	%	84,452			1.74	%
States and political subdivisions		3,018			3.30	%	10,257			4.18	%	37,346			4.10	%	32,717			4.24	%	83,338			4.13	%
		40,915			0.68	%	34,090			1.91	%	52,442			4.09	%	41,866			4.52	%	169,313			2.93	%
Mortgage-backed securities and collateralized mortgage obligations																						65,951			5.13	%
Collateralized debt obligations																						10,883			1.60	%
Equity securities																						94			0.08	%
		$	40,915		3.48	%	$	34,090		3.79	%	$	52,442		4.44	%	$	41,866		4.58	%	$	246,241		4.59	%

 

As of December 31, 2009, net unrealized losses of $2,678,000, offset by deferred income taxes of $1,073,000, resulted in a decrease in equity capital of $1,605,000.  As of December 31, 2008, net unrealized gains of $3,392,000, offset by deferred income taxes of $1,364,000, resulted in a decrease in equity capital of $2,028,000.  At year-end 2009 and 2008, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of shareholders’ equity.

 

LOAN PORTFOLIO

 

The following table presents the composition of the loan portfolio at December 31, for the years indicated:

 

		2009			2008			2007			2006			2005
Commercial and industrial		$	206,779		$	243,272		$	196,392		$	174,964		$	168,052
Real estate - commercial		925,013			928,747			660,608			624,289			592,814
Real estate - construction		273,719			373,371			371,436			354,518			357,997
Real estate - residential		642,335			700,595			633,682			586,393			550,027
Installment		10,447			19,972			20,356			16,556			25,539
Overdraft		830			761			714			551			1,039
Lease Financing Receivables		3,703			4,396			7,922			6,641			8,914
Gross loans		2,062,826			2,271,114			1,891,110			1,763,912			1,704,382
Allowance for loan losses		(64,540		)	(41,271		)	(16,835		)	(16,193		)	(15,329		)
Loans, net		$	1,998,286		$	2,229,843		$	1,874,275		$	1,747,719		$	1,689,053

 

The above loan total includes net unearned and deferred loan fees and costs.

 

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MATURITY AND RATE SENSITIVITY OF LOANS

 

The following table sets forth the remaining contractual maturities for certain loan categories at December 31, 2009:

 

					Over 1 Year
					Through 5 Years						Over 5 Years
		One Year			Fixed			Floating			Fixed			Floating
		or Less			Rate			Rate			Rate			Rate			Total
Commercial and industrial		$	127,963		$	51,013		$	14,985		$	12,674		$	144		$	206,779
Real estate - commercial		206,935			506,384			107,049			80,450			24,195			925,013
Real estate - construction		168,397			77,276			23,479			2,606			1,961			273,719
Real estate - residential		65,692			140,741			87,566			43,325			305,011			642,335
Installment		2,603			5,275			2,518			51			—			10,447
Overdraft		830			—			—			—			—			830
Lease financing receivables		170			3,380			—			153			—			3,703
Total		$	572,590		$	784,069		$	235,597		$	139,259		$	331,311		$	2,062,826

 

The Company had no concentration of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans at December 31, 2009.

 

NONPERFORMING ASSETS

 

The following table sets forth the amounts of nonperforming assets at December 31, of the years indicated:

 

		2009			2008			2007			2006			2005
Nonaccrual loans		$	174,978		$	106,510		$	5,346		$	1,632		$	3,845
Restructured loans		14,171
Loans past due 90 days or more and still accruing interest		561			2,119			625			583			2,752
Total nonperforming loans		189,710			108,629			5,971			2,215			6,597
Other real estate owned		40,200			15,212			—			48			251
Receivable from foreclosed loan participation		1,505			—			—			—			—
Total nonperforming assets		$	231,415		$	123,841		$	5,971		$	2,263		$	6,848

 

Accrual of interest is discontinued on a loan when principal or interest is ninety days or more past due, unless the loan is well secured and in the process of collection.  When a loan is placed on nonaccrual status, interest previously accrued but not collected in the current period is reversed against current period interest income. Interest accrued in prior years but not collected is charged against the allowance for loan losses. Interest income of approximately $3,898,000, $4,064,000, and $179,000 was recorded during 2009, 2008, and 2007, respectively on loans in nonaccrual status at year-end.  Interest income, which would have been recognized during 2009, 2008, and 2007, had these loans been on an accrual basis throughout the year, was approximately $13,189,000, $7,714,000, and $480,000, respectively.  As of December 31, 2009, there was $14,171,000 in restructured residential mortgage loans that were still accruing interest based upon their prior performance history.  There were no accruing troubled debt restructurings prior to December 31, 2009.  Additionally, the non-accrual loans above includes $31,593,000 in restructured loans for the period ending December 31, 2009.

 

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