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OLD SECOND BANCORP INC - Quarter Report: 2011 March (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2011

 

OR

 

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

 

For transition period from                to                

 

Commission File Number 0 -10537

 

OLD SECOND BANCORP, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

36-3143493

(State or other jurisdiction

 

(I.R.S. Employer Identification Number)

of incorporation or organization)

 

 

 

37 South River Street, Aurora, Illinois

 

60507

(Address of principal executive offices)

 

(Zip Code)

 

(630) 892-0202

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes 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 whether 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 Act.  (check one):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(do not check if a smaller reporting company)

 

 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of May 5, 2011, the Registrant had outstanding 14,034,991 shares of common stock, $1.00 par value per share.

 

 

 



Table of Contents

 

OLD SECOND BANCORP, INC.

 

Form 10-Q Quarterly Report

 

Table of Contents

 

 

 

Page
Number

 

 

 

PART I

 

 

 

Item 1.

Financial Statements

3

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

38

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

56

Item 4.

Controls and Procedures

57

 

 

 

PART II

 

 

 

Item 1.

Legal Proceedings

59

Item 1.A.

Risk Factors

59

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

Item 3.

Defaults Upon Senior Securities

59

Item 4.

Removed and Reserved

59

Item 5.

Other Information

59

Item 6.

Exhibits

59

 

 

 

 

Signatures

60

 

2



Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

 

 

 

(Unaudited)

 

 

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

35,905

 

$

28,584

 

Interest bearing deposits with financial institutions

 

137,556

 

69,492

 

Federal funds sold

 

988

 

682

 

Cash and cash equivalents

 

174,449

 

98,758

 

Securities available-for-sale

 

142,225

 

148,647

 

Federal Home Loan Bank and Federal Reserve Bank stock

 

14,050

 

13,691

 

Loans held-for-sale

 

3,189

 

10,655

 

Loans

 

1,601,761

 

1,690,129

 

Less: allowance for loan losses

 

73,128

 

76,308

 

Net loans

 

1,528,633

 

1,613,821

 

Premises and equipment, net

 

53,650

 

54,640

 

Other real estate owned

 

85,570

 

75,613

 

Mortgage servicing rights, net

 

4,330

 

3,897

 

Core deposit and other intangible assets, net

 

5,296

 

5,525

 

Bank-owned life insurance (BOLI)

 

51,429

 

50,966

 

Other assets

 

52,585

 

47,708

 

Total assets

 

$

2,115,406

 

$

2,123,921

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest bearing demand

 

$

371,940

 

$

330,846

 

Interest bearing:

 

 

 

 

 

Savings, NOW, and money market

 

762,539

 

782,116

 

Time

 

767,870

 

795,566

 

Total deposits

 

1,902,349

 

1,908,528

 

Securities sold under repurchase agreements

 

1,878

 

2,018

 

Other short-term borrowings

 

4,579

 

4,141

 

Junior subordinated debentures

 

58,378

 

58,378

 

Subordinated debt

 

45,000

 

45,000

 

Notes payable and other borrowings

 

500

 

500

 

Other liabilities

 

22,536

 

21,398

 

Total liabilities

 

2,035,220

 

2,039,963

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Preferred stock, ($1.00 par value; authorized 300,000 shares at March 31, 2011; series B, 5% cumulative perpetual, 73,000 shares issued and outstanding at March 31, 2011 and December 31, 2010, $1,000.00 liquidation value)

 

70,151

 

69,921

 

Common stock, $1.00 par value; authorized 60,000,000 shares; issued 18,627,858 at March 31, 2011 and 18,466,538 at December 31, 2010; outstanding 14,034,991 at March 31, 2011 and 13,911,475 at December 31, 2010

 

18,628

 

18,467

 

Additional paid-in capital

 

65,286

 

65,209

 

Retained earnings

 

24,056

 

28,335

 

Accumulated other comprehensive loss

 

(3,042

)

(3,130

)

Treasury stock, at cost, 4,592,867 shares at March 31, 2011 and 4,555,063 shares at December 31, 2010

 

(94,893

)

(94,844

)

Total stockholders’ equity

 

80,186

 

83,958

 

Total liabilities and stockholders’ equity

 

$

2,115,406

 

$

2,123,921

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands, except share data)

 

 

 

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Interest and dividend income

 

 

 

 

 

Loans, including fees

 

$

20,869

 

$

26,632

 

Loans held-for-sale

 

51

 

72

 

Securities:

 

 

 

 

 

Taxable

 

878

 

1,238

 

Tax-exempt

 

142

 

745

 

Dividends from Federal Reserve Bank and Federal Home Loan Bank stock

 

69

 

56

 

Interest bearing deposits with financial institutions

 

70

 

16

 

Total interest and dividend income

 

22,079

 

28,759

 

Interest expense

 

 

 

 

 

Savings, NOW, and money market deposits

 

576

 

1,385

 

Time deposits

 

3,993

 

5,097

 

Securities sold under repurchase agreements

 

 

10

 

Other short-term borrowings

 

 

18

 

Junior subordinated debentures

 

1,113

 

1,072

 

Subordinated debt

 

203

 

195

 

Notes payable and other borrowings

 

4

 

1

 

Total interest expense

 

5,889

 

7,778

 

Net interest and dividend income

 

16,190

 

20,981

 

Provision for loan losses

 

4,000

 

19,220

 

Net interest and dividend income after provision for loan losses

 

12,190

 

1,761

 

Noninterest income

 

 

 

 

 

Trust income

 

1,784

 

1,657

 

Service charges on deposits

 

1,817

 

2,018

 

Secondary mortgage fees

 

227

 

223

 

Mortgage servicing income

 

370

 

163

 

Net gain on sales of mortgage loans

 

1,236

 

1,157

 

Securities gains (losses), net

 

139

 

(2

)

Increase in cash surrender value of bank-owned life insurance

 

463

 

429

 

Debit card interchange income

 

700

 

663

 

Lease revenue from other real estate owned

 

520

 

518

 

Net gain on sale of other real estate owned

 

234

 

151

 

Other income

 

1,798

 

1,290

 

Total noninterest income

 

9,288

 

8,267

 

Noninterest expense

 

 

 

 

 

Salaries and employee benefits

 

8,929

 

9,025

 

Occupancy expense, net

 

1,345

 

1,525

 

Furniture and equipment expense

 

1,460

 

1,639

 

FDIC insurance

 

1,739

 

1,428

 

General bank insurance

 

825

 

140

 

Amortization of core deposit and other intangible assets

 

229

 

282

 

Advertising expense

 

233

 

256

 

Debit card interchange expense

 

373

 

310

 

Legal fees

 

943

 

559

 

Other real estate expense

 

5,314

 

6,428

 

Other expense

 

3,208

 

3,157

 

Total noninterest expense

 

24,598

 

24,749

 

Loss before income taxes

 

(3,120

)

(14,721

)

Benefit for income taxes

 

 

(6,167

)

Net loss

 

(3,120

)

(8,554

)

Preferred stock dividends and accretion of discount

 

1,159

 

1,128

 

Net loss available to common shareholders

 

$

(4,279

)

$

(9,682

)

 

 

 

 

 

 

Share and per share information:

 

 

 

 

 

Ending number of shares

 

14,034,991

 

13,939,833

 

Average number of shares

 

13,973,870

 

13,916,650

 

Diluted average number of shares

 

14,213,701

 

14,197,223

 

Basic loss per share

 

$

(0.30

)

$

(0.69

)

Diluted loss per share

 

(0.30

)

(0.69

)

Dividends paid per share

 

 

0.01

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

 

 

 

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Cash flows from operating activities

 

 

 

 

 

Net loss

 

$

(3,120

)

$

(8,554

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation

 

1,083

 

1,177

 

Amortization of leasehold improvement

 

1

 

127

 

Change in market value on mortgage servicing rights

 

(62

)

 

Provision for loan losses

 

4,000

 

19,220

 

Provision for deferred tax expense

 

 

(2,232

)

Originations of loans held-for-sale

 

(48,517

)

(58,731

)

Proceeds from sales of loans held-for-sale

 

56,889

 

62,235

 

Net gain on sales of mortgage loans

 

(1,236

)

(1,157

)

Change in current income taxes payable

 

 

(249

)

Increase in cash surrender value of bank-owned life insurance

 

(463

)

(429

)

Change in accrued interest receivable and other assets

 

(5,157

)

(77

)

Change in accrued interest payable and other liabilities

 

513

 

619

 

Net premium amortization on securities

 

65

 

141

 

Securities (gains) losses, net

 

(139

)

2

 

Amortization of core deposit and other intangible assets

 

229

 

282

 

Stock based compensation

 

238

 

6

 

Net gain on sale of other real estate owned

 

(234

)

(151

)

Write-down of other real estate owned

 

2,393

 

5,091

 

Net cash provided by operating activities

 

6,483

 

17,320

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from maturities and pre-refunds including pay down of securities available-for-sale

 

4,764

 

21,143

 

Proceeds from sales of securities available-for-sale

 

3,755

 

2,000

 

Purchases of securities available-for-sale

 

(2,000

)

(5,000

)

Purchases of Federal Reserve Bank and Federal Home Loan Bank stock

 

(359

)

 

Net change in loans

 

61,737

 

68,940

 

Investment in other real estate owned

 

(2,022

)

(10

)

Proceeds from sales of other real estate owned

 

9,357

 

4,253

 

Net purchases of premises and equipment

 

(94

)

(192

)

Net cash provided by investing activities

 

75,138

 

91,134

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Net change in deposits

 

(6,179

)

(41,815

)

Net change in securities sold under repurchase agreements

 

(140

)

2,945

 

Net change in other short-term borrowings

 

438

 

(50,608

)

Dividends paid

 

 

(1,052

)

Purchase of treasury stock

 

(49

)

(40

)

Net cash used in financing activities

 

(5,930

)

(90,570

)

Net change in cash and cash equivalents

 

75,691

 

17,884

 

Cash and cash equivalents at beginning of period

 

98,758

 

79,796

 

Cash and cash equivalents at end of period

 

$

174,449

 

$

97,680

 

 

5


 


Table of Contents

 

(In thousands)

 

 

 

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Supplemental cash flow information

 

 

 

 

 

Income taxes received

 

$

 

$

(3,460

)

Interest paid for deposits

 

4,893

 

6,838

 

Interest paid for borrowings

 

1,320

 

1,319

 

Non-cash transfer of loans to other real estate

 

19,451

 

18,838

 

Change in dividends declared not paid

 

929

 

(454

)

Accretion on preferred stock warrants

 

230

 

215

 

 

See accompanying notes to consolidated financial statements.

 

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in

Stockholders’ Equity

(In thousands, except share data)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Total

 

 

 

Common

 

Preferred

 

Paid-In

 

Retained

 

Comprehensive

 

Treasury

 

Stockholders’

 

 

 

Stock

 

Stock

 

Capital

 

Earnings

 

Loss

 

Stock

 

Equity

 

Balance, December 31, 2009

 

$

18,373

 

$

69,039

 

$

64,431

 

$

141,774

 

$

(1,605

)

$

(94,804

)

$

197,208

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

(8,554

)

 

 

 

 

(8,554

)

Change in net unrealized loss on securities available-for-sale, net of $191 tax effect

 

 

 

 

 

 

 

 

 

(311

)

 

 

(311

)

Total comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(8,865

)

Dividends Declared, $.01 per share

 

 

 

 

 

 

 

(141

)

 

 

 

 

(141

)

Change in restricted stock

 

122

 

 

 

(122

)

 

 

 

 

 

 

 

Tax effect from vesting of restricted stock

 

 

 

 

 

(225

)

 

 

 

 

 

 

(225

)

Stock based compensation

 

 

 

 

 

231

 

 

 

 

 

 

 

231

 

Purchase of treasury stock

 

 

 

 

 

 

 

 

 

 

 

(40

)

(40

)

Preferred dividends declared (5% per preferred share)

 

 

 

215

 

 

 

(672

)

 

 

 

 

(457

)

Adoption of mark to market of mortgage servicing rights

 

 

 

 

 

 

 

29

 

 

 

 

 

29

 

Balance, March 31, 2010

 

$

18,495

 

$

69,254

 

$

64,315

 

$

132,436

 

$

(1,916

)

$

(94,844

)

$

187,740

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2010

 

$

18,467

 

$

69,921

 

$

65,209

 

$

28,335

 

$

(3,130

)

$

(94,844

)

$

 83,958

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

(3,120

)

 

 

 

 

(3,120

)

Change in net unrealized loss on securities available-for-sale, net of $65 tax effect

 

 

 

 

 

 

 

 

 

88

 

 

 

88

 

Total comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(3,032

)

Change in restricted stock

 

161

 

 

 

(161

)

 

 

 

 

 

 

 

Stock based compensation

 

 

 

 

 

238

 

 

 

 

 

 

 

238

 

Purchase of treasury stock

 

 

 

 

 

 

 

 

 

 

 

(49

)

(49

)

Preferred dividends declared (5% per preferred share)

 

 

 

230

 

 

 

(1,159

)

 

 

 

 

(929

)

Balance, March 31, 2011

 

$

18,628

 

$

70,151

 

$

65,286

 

$

24,056

 

$

(3,042

)

$

(94,893

)

$

80,186

 

 

6



Table of Contents

 

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Table amounts in thousands, except per share data, unaudited)

 

Note 1 — Summary of Significant Accounting Policies

 

The accounting policies followed in the preparation of the interim financial statements are consistent with those used in the preparation of the annual financial information.  The interim financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim period presented.  Results for the period ended March 31, 2011, are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.  These interim financial statements 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, 2010.  Unless otherwise indicated, amounts in the tables contained in the notes 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 accounting principles generally accepted in the United States 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 financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the financial statements.  Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts reported in the financial statements.

 

All 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, 2010.  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 financial statements and how those values are determined.

 

In January 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-01 “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (Topic 310)”.  The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring.  ASU 2011-01 was effective upon issuance.  The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods beginning on or after June 15, 2011.  Management does not expect this standard to have a material impact on the Company’s financial statements.

 

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.”  Because of inconsistencies in practice and the increased volume of debt modifications, ASU No. 2011-02, amends FASB Accounting Standard Codification (“ASC”) 310-40, “Receivables - Troubled Debt Restructurings by Creditors”, to provide additional clarifying guidance in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring qualifies as a troubled debt restructuring.  The effective date is for the first interim or annual period beginning on or after June 15, 2011, to be applied retrospectively to restructurings taking place on or after the beginning of the fiscal year of adoption.  The impact of ASU 2011-02 on the Company’s disclosures will be reflected in Note 3 - Loans.  Management does not expect this standard to have a material impact on the Company’s financial statements.

 

7



Table of Contents

 

Note 2 — Securities

 

Securities available-for-sale are summarized as follows:

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

March 31, 2011:

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

1,501

 

$

15

 

$

 

$

1,516

 

U.S. government agencies

 

38,054

 

103

 

(658

)

37,499

 

U.S. government agency mortgage-backed

 

72,497

 

1,062

 

(280

)

73,279

 

States and political subdivisions

 

17,431

 

823

 

(127

)

18,127

 

Collateralized debt obligations

 

17,864

 

 

(6,112

)

11,752

 

Equity securities

 

49

 

5

 

(2

)

52

 

 

 

$

147,396

 

$

2,008

 

$

(7,179

)

$

142,225

 

December 31, 2010:

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

1,501

 

$

20

 

$

 

$

1,521

 

U.S. government agencies

 

37,810

 

117

 

(501

)

37,426

 

U.S. government agency mortgage-backed

 

75,257

 

1,475

 

(1

)

76,731

 

States and political subdivisions

 

17,538

 

579

 

(263

)

17,854

 

Collateralized mortgage obligations

 

3,817

 

179

 

 

3,996

 

Collateralized debt obligations

 

17,869

 

 

(6,796

)

11,073

 

Equity securities

 

49

 

4

 

(7

)

46

 

 

 

$

153,841

 

$

2,374

 

$

(7,568

)

$

148,647

 

 

The fair value, amortized cost and weighted average yield of debt securities at March 31, 2011, by contractual maturity, were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, collateralized debt obligations and equity securities are shown separately:

 

 

 

 

 

Weighted

 

 

 

 

 

Amortized

 

Average

 

Fair

 

 

 

Cost

 

Yield

 

Value

 

Due in one year or less

 

$

4,337

 

3.03

%

$

4,363

 

Due after one year through five years

 

4,170

 

2.67

%

4,327

 

Due after five years through ten years

 

41,624

 

3.30

%

41,290

 

Due after ten years

 

6,855

 

4.73

%

7,162

 

 

 

$

56,986

 

3.41

%

$

57,142

 

Mortgage-backed securities

 

72,497

 

3.30

%

73,279

 

Collateralized debt obligations

 

17,864

 

1.65

%

11,752

 

Equity securities

 

49

 

0.16

%

52

 

 

 

$

147,396

 

3.14

%

$

142,225

 

 

The fair value, amortized cost and weighted average yield of debt securities at December 31, 2010 by contractual maturity, were as follows.  Securities not due at a single maturity date, primarily mortgage-backed securities, collateralized mortgage obligations, collateralized debt obligations and equity securities are shown separately:

 

8



Table of Contents

 

 

 

 

 

Weighted

 

 

 

 

 

Amortized

 

Average

 

Fair

 

 

 

Cost

 

Yield

 

Value

 

Due in one year or less

 

$

6,103

 

2.34

%

$

6,128

 

Due after one year through five years

 

4,240

 

2.69

%

4,421

 

Due after five years through ten years

 

39,627

 

3.19

%

39,419

 

Due after ten years

 

6,879

 

4.73

%

6,833

 

 

 

$

56,849

 

3.25

%

$

56,801

 

Mortgage-backed and collateralized mortgage obligations

 

79,074

 

3.53

%

80,727

 

Collateralized debt obligations

 

17,869

 

1.62

%

11,073

 

Equity securities

 

49

 

0.16

%

46

 

 

 

$

153,841

 

3.20

%

$

148,647

 

 

At March 31, 2011, and December 31, 2010, there were no securities of any one issuer with a fair market value, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

Securities with unrealized losses at March 31, 2011, and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

 

 

 

Less than 12 months

 

Greater than 12 months

 

 

 

 

 

in an unrealized loss position

 

in an unrealized loss position

 

Total

 

 

 

Number of

 

Unrealized

 

Fair

 

Number of

 

Unrealized

 

Fair

 

Number of

 

Unrealized

 

Fair

 

March 31, 2011

 

Securities

 

Losses

 

Value

 

Securities

 

Losses

 

Value

 

Securities

 

Losses

 

Value

 

U.S. government agencies

 

5

 

$

658

 

$

24,408

 

 

$

 

$

 

5

 

$

658

 

$

24,408

 

U.S. government agency mortgage-backed

 

6

 

280

 

33,522

 

 

 

 

6

 

280

 

33,522

 

States and political subdivisions

 

2

 

72

 

1,078

 

1

 

55

 

559

 

3

 

127

 

1,637

 

Collateralized debt obligations

 

 

 

 

2

 

6,112

 

11,752

 

2

 

6,112

 

11,752

 

Equity securities

 

1

 

2

 

45

 

 

 

 

1

 

2

 

45

 

 

 

14

 

$

1,012

 

$

59,053

 

3

 

$

6,167

 

$

12,311

 

17

 

$

7,179

 

$

71,364

 

 

 

 

Less than 12 months

 

Greater than 12 months

 

 

 

 

 

in an unrealized loss position

 

in an unrealized loss position

 

Total

 

 

 

Number of

 

Unrealized

 

Fair

 

Number of

 

Unrealized

 

Fair

 

Number of

 

Unrealized

 

Fair

 

December 31, 2010

 

Securities

 

Losses

 

Value

 

Securities

 

Losses

 

Value

 

Securities

 

Losses

 

Value

 

U.S. government agencies

 

6

 

$

501

 

$

26,309

 

 

$

 

$

 

6

 

$

501

 

$

26,309

 

U.S. government agency mortgage-backed

 

1

 

1

 

462

 

 

 

 

1

 

1

 

462

 

States and political subdivisions

 

3

 

182

 

3,323

 

1

 

81

 

533

 

4

 

263

 

3,856

 

Collateralized debt obligations

 

 

 

 

2

 

6,796

 

11,073

 

2

 

6,796

 

11,073

 

Equity securities

 

 

 

 

1

 

7

 

41

 

1

 

7

 

41

 

 

 

10

 

$

684

 

$

30,094

 

4

 

$

6,884

 

$

11,647

 

14

 

$

7,568

 

$

41,741

 

 

The total number of security positions in the investment portfolio in an unrealized loss position at March 31, 2011, and December 31, 2010, was seventeen and fourteen, respectively.  Recognition of other-than-temporary impairment was not necessary in the quarter ended March 31, 2011, or the year ended December 31, 2010.  The changes in fair values related primarily to interest rate fluctuations and other market factors and were generally not related to credit quality deterioration, although the amount of deferrals and defaults in the pooled collateralized debt obligations increased in the period from December 31, 2010 to March 31, 2011.  An increase in interest rates will generally cause a decrease in the fair value of individual securities while a decrease in interest rates typically results in an increase in fair value.  In addition to the impact of rate changes upon pricing, uncertainty in the financial markets in the periods presented has resulted in reduced liquidity for certain investments, particularly the collateralized debt obligations (“CDO”), which also impacted market pricing for the periods presented.  In the case of the CDO fair value measurement, management included a risk premium adjustment as of March 31, 2011, to reflect an estimated amount that a market participant would demand because of uncertainty in cash flows.  Management made that adjustment because the level of market activity for the CDO securities has continued to decrease and information on orderly transaction sales were not generally available.  Accordingly, management designated these securities as level 3 securities at June 30, 2009 as described in

 

9



Table of Contents

 

Note 16 of this quarterly report and maintained that designation as of March 31, 2011.  Management did not have the intent to sell the above securities and it is more likely than not the Company will not sell the securities before recovery of its cost basis.

 

Below is additional information as it relates to the collateralized debt obligation, Trapeza 2007-13A, which is secured by a pool of trust preferred securities issued by trusts sponsored by multiple financial institutions.  This collateralized debt obligation was rated AAA at the time of purchase by the Company.

 

 

 

 

 

 

 

Gross

 

S&P

 

Number of

 

Issuance

 

Issuance

 

 

 

Amortized

 

Fair

 

Unrealized

 

Credit

 

Banks in

 

Deferrals & Defaults

 

Excess Subordination

 

 

 

Cost

 

Value

 

Loss

 

Rating (1)

 

Issuance

 

Amount

 

Collateral %

 

Amount

 

Collateral %

 

March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Class A1

 

$

9,213

 

$

5,952

 

$

(3,261

)

CCC+

 

63

 

$

218,750

 

29.2

%

$

172,173

 

23.0

%

Class A2A

 

8,651

 

5,800

 

(2,851

)

CCC-

 

63

 

218,750

 

29.2

%

75,173

 

10.0

%

 

 

$

17,864

 

$

11,752

 

$

(6,112

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Class A1

 

$

9,241

 

$

5,916

 

$

(3,325

)

CCC+

 

63

 

$

213,750

 

28.5

%

$

175,928

 

23.5

%

Class A2A

 

8,628

 

5,157

 

(3,471

)

CCC-

 

63

 

213,750

 

28.5

%

78,928

 

10.5

%

 

 

$

17,869

 

$

11,073

 

$

(6,796

)

 

 

 

 

 

 

 

 

 

 

 

 

 


(1) Moody’s credit rating for class A1 and A2A were Baa2 and Ba2, respectively, as of March 31, 2011, and December 31, 2010.  The Fitch ratings for class A1 and A2A were BBB and B, respectively, as of March 31, 2011, and December 31, 2010

 

The model assumptions used to estimate fair value in the table above included estimated collateral default rates of 3.2%, 0.9%, and 0.7% in years 1, 2, and 3, respectively.  Additionally, the estimated discount rates were Libor plus 5.25% for the A1 tranche and Libor plus 6.75% for the A2A tranche.

 

In addition to other equity securities, which are recorded at estimated fair value, the Bank owns the stock of the Federal Reserve Bank of Chicago (“FRB”) and the Federal Home Loan Bank of Chicago (“FHLBC”).  Both of these entities require the Bank to invest in their non-marketable stock as a condition of membership.  The value of the stock in each of those entities was recorded at cost in the amounts of $4.8 million and $9.3 million at March 31, 2011, and $4.4 million and $9.3 million at December 31, 2010, respectively.  The FHLBC is a governmental sponsored entity that has been under a regulatory order for a prolonged period that generally requires approval prior to redeeming or paying dividends on their common stock.  The FHLBC declared and paid a dividend in the first quarter of 2011.  The Bank continues to periodically utilize the various products and services of the FHLBC and management considers this stock to be a long-term investment.  FHLBC members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts.  FHLBC stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value.

 

10


 


Table of Contents

 

Note 3 — Loans

 

Major classifications of loans were as follows:

 

 

 

March 31, 2011

 

December 31, 2010

 

Commercial (1)

 

$

164,594

 

$

173,884

 

Real estate - commercial

 

794,251

 

821,101

 

Real estate - construction

 

104,630

 

129,601

 

Real estate - residential

 

531,311

 

557,635

 

Consumer

 

4,753

 

5,104

 

Overdraft

 

372

 

739

 

Lease financing receivables

 

2,397

 

2,774

 

 

 

$

1,602,308

 

$

1,690,838

 

Net deferred loan fees and costs

 

(547

)

(709

)

 

 

$

1,601,761

 

$

1,690,129

 

 


(1)                    Includes $24.9 million and $24.3 million as of March 31, 2011 and December 31, 2011, respectively in loans with different credit quality indicators.

 

It is the policy of the Company to review each prospective credit in order to determine an adequate level of security or collateral to obtain prior to making a loan.  The type of collateral, when required, will vary from liquid assets to real estate.  The Company’s access to collateral, in the event of borrower default, is assured through adherence to state lending laws and the Company’s lending standards and credit monitoring procedures.  The Bank generally makes loans 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, although the real estate related categories listed above represent 89.3% and 89.2% of the portfolio at March 31, 2011, and December 31, 2010, respectively.  The Company is committed to overseeing and managing its loan portfolio to reduce its real estate credit concentrations in accordance with the requirements of the Memorandum of Understanding (“MOU”) between the Bank and the Office of the Comptroller of the Currency (the “OCC”).  Consistent with that commitment, management has updated its asset diversification plan and policy and anticipates that the percentage of real estate lending to the overall portfolio will decrease in the future as a result of that process.  Regulatory matters are discussed in more detail in Note 15 of the consolidated financial statements included in this report.

 

11



Table of Contents

 

Aged analysis of past due loans by class of loans were as follows:

 

March 31, 2011

 

 

 

30-59 Days
Past Due

 

60-89 Days
Past Due

 

90 Days or
Greater Past
Due

 

Total Past
Due

 

Current

 

Nonaccrual

 

Total
Financing
Receivables

 

Recorded
Investment
90 days or
Greater Past
Due and
Accruing

 

Commercial

 

$

429

 

$

 

$

75

 

$

504

 

$

138,375

 

$

3,019

 

$

141,898

 

$

75

 

Real estate - commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied general purpose

 

206

 

20

 

 

226

 

152,697

 

15,132

 

168,055

 

 

Owner occupied special purpose

 

1,505

 

117

 

 

1,622

 

186,818

 

24,348

 

212,788

 

 

Non-owner occupied general purpose

 

 

 

 

 

156,668

 

17,490

 

174,158

 

 

Non-owner occupied special purpose

 

 

 

 

 

103,958

 

9,608

 

113,566

 

 

Strip malls

 

 

 

 

 

61,488

 

22,664

 

84,152

 

 

Farm

 

 

 

 

 

40,338

 

1,194

 

41,532

 

 

Real estate - construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Homebuilder

 

 

 

 

 

10,468

 

24,044

 

34,512

 

 

Land

 

 

 

267

 

267

 

11,727

 

10,176

 

22,170

 

267

 

Commercial speculative

 

 

 

 

 

12,123

 

14,179

 

26,302

 

 

All other

 

49

 

 

 

49

 

16,355

 

5,242

 

21,646

 

 

Real estate - residential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investor

 

2,243

 

 

 

2,243

 

193,470

 

14,726

 

210,439

 

 

Owner occupied

 

6,424

 

 

 

6,424

 

130,876

 

15,041

 

152,341

 

 

Revolving and junior liens

 

893

 

161

 

 

1,054

 

165,588

 

1,889

 

168,531

 

 

Consumer

 

24

 

115

 

 

139

 

4,455

 

5

 

4,599

 

 

All other

 

 

 

 

 

25,072

 

 

25,072

 

 

 

 

$

11,773

 

$

413

 

$

342

 

$

12,528

 

$

1,410,476

 

$

178,757

 

$

1,601,761

 

$

342

 

 

December 31, 2010

 

 

 

30-59 Days
Past Due

 

60-89 Days
Past Due

 

90 Days or
Greater Past
Due

 

Total Past
Due

 

Current

 

Nonaccrual

 

Total
Financing
Receivables

 

Recorded
Investment
90 days or
Greater Past
Due and
Accruing

 

Commercial

 

$

375

 

$

391

 

$

216

 

$

982

 

$

147,676

 

$

3,668

 

$

152,326

 

$

216

 

Real estate - commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied general purpose

 

1,156

 

2

 

 

1,158

 

158,189

 

18,610

 

177,957

 

 

Owner occupied special purpose

 

897

 

 

328

 

1,225

 

181,845

 

25,987

 

209,057

 

328

 

Non-owner occupied general purpose

 

884

 

499

 

 

1,383

 

148,406

 

25,623

 

175,412

 

 

Non-owner occupied special purpose

 

 

 

 

 

104,791

 

11,612

 

116,403

 

 

Strip malls

 

 

 

 

 

74,564

 

24,374

 

98,938

 

 

Farm

 

148

 

999

 

 

1,147

 

41,446

 

741

 

43,334

 

 

Real estate - construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Homebuilder

 

217

 

 

 

217

 

14,676

 

22,001

 

36,894

 

 

Land

 

 

586

 

 

586

 

12,324

 

20,617

 

33,527

 

 

Commercial speculative

 

 

 

 

 

21,603

 

14,881

 

36,484

 

 

All other

 

65

 

73

 

 

138

 

16,545

 

6,013

 

22,696

 

 

Real estate - residential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investor

 

2,221

 

 

469

 

2,690

 

200,011

 

21,223

 

223,924

 

469

 

Owner occupied

 

4,450

 

656

 

 

5,106

 

139,457

 

15,309

 

159,872

 

 

Revolving and junior liens

 

284

 

6

 

 

290

 

171,990

 

1,559

 

173,839

 

 

Consumer

 

9

 

2

 

 

11

 

4,931

 

7

 

4,949

 

 

All other

 

 

 

 

 

24,517

 

 

24,517

 

 

 

 

$

10,706

 

$

3,214

 

$

1,013

 

$

14,933

 

$

1,462,971

 

$

212,225

 

$

1,690,129

 

$

1,013

 

 

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

Credit Quality Indicators:

 

The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparisons against industry averages, historical payment experience, and current economic trends, among other factors.  The Company examines each loan and loan relationship with an outstanding balance or commitment greater than $50,000, excluding homogeneous loans such as HELOC’s 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:

 

12



Table of Contents

 

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 or of the institution’s credit position 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 institution will sustain some loss if the deficiencies are not corrected.

 

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.

 

13



Table of Contents

 

Credit Quality Indicators by class of loans were as follows:

 

March 31, 2011

 

 

 

Pass

 

Special
Mention

 

Substandard (1)

 

Doubtfull

 

Total

 

Commercial

 

$

120,798

 

$

3,616

 

$

17,484

 

$

 

$

141,898

 

Real estate - commercial

 

 

 

 

 

 

 

 

 

 

 

Owner occupied general purpose

 

121,800

 

8,099

 

38,156

 

 

168,055

 

Owner occupied special purpose

 

146,161

 

12,640

 

53,987

 

 

212,788

 

Non-owner occupied general purpose

 

122,276

 

13,496

 

38,386

 

 

174,158

 

Non-owner occupied special purpose

 

90,976

 

 

22,590

 

 

113,566

 

Strip malls

 

35,186

 

11,654

 

37,313

 

 

84,153

 

Farm

 

28,752

 

 

12,780

 

 

41,532

 

Real estate - construction

 

 

 

 

 

 

 

 

 

 

 

Homebuilder

 

7,361

 

2,204

 

24,947

 

 

34,512

 

Land

 

7,804

 

3,036

 

11,330

 

 

22,170

 

Commercial speculative

 

6,578

 

567

 

19,157

 

 

26,302

 

All other

 

14,334

 

307

 

7,004

 

 

21,645

 

Real estate - residential

 

 

 

 

 

 

 

 

 

 

 

Investor

 

153,904

 

17,793

 

38,743

 

 

210,440

 

Owner occupied

 

127,716

 

432

 

24,193

 

 

152,341

 

Revolving and junior leins

 

162,803

 

947

 

4,781

 

 

168,531

 

Consumer

 

4,583

 

 

15

 

 

4,598

 

All other

 

24,937

 

135

 

 

 

25,072

 

Total

 

$

1,175,969

 

$

74,926

 

$

350,866

 

$

 

$

1,601,761

 

 

December 31, 2010

 

 

 

Pass

 

Special
Mention

 

Substandard (1)

 

Doubtfull

 

Total

 

Commercial

 

$

130,564

 

$

4,122

 

$

17,640

 

$

 

$

152,326

 

Real estate - commercial

 

 

 

 

 

 

 

 

 

 

 

Owner occupied general purpose

 

127,527

 

6,633

 

43,797

 

 

177,957

 

Owner occupied special purpose

 

143,165

 

9,762

 

56,130

 

 

209,057

 

Non-owner occupied general purpose

 

126,316

 

5,414

 

43,682

 

 

175,412

 

Non-owner occupied special purpose

 

91,737

 

 

24,666

 

 

116,403

 

Strip malls

 

48,661

 

8,304

 

41,973

 

 

98,938

 

Farm

 

30,812

 

 

12,522

 

 

43,334

 

Real estate - construction

 

 

 

 

 

 

 

 

 

 

 

Homebuilder

 

6,470

 

2,780

 

27,644

 

 

36,894

 

Land

 

9,327

 

3,036

 

21,164

 

 

33,527

 

Commercial speculative

 

15,937

 

567

 

19,980

 

 

36,484

 

All other

 

15,024

 

 

7,672

 

 

22,696

 

Real estate - residential

 

 

 

 

 

 

 

 

 

 

 

Investor

 

166,465

 

15,487

 

41,972

 

 

223,924

 

Owner occupied

 

132,833

 

545

 

26,494

 

 

159,872

 

Revolving and junior leins

 

168,596

 

599

 

4,644

 

 

173,839

 

Consumer

 

4,793

 

62

 

94

 

 

4,949

 

All other

 

24,376

 

141

 

 

 

24,517

 

Total

 

$

1,242,603

 

$

57,452

 

$

390,074

 

$

 

$

1,690,129

 

 


(1) The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans

 

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Table of Contents

 

Impaired loans by class of loan as of March 31, 2011, were as follows:

 

 

 

 

 

 

 

 

 

Quarter Ended

 

 

 

 

 

 

 

 

 

March 31, 2011

 

 

 

Recorded
Investment

 

Unpaid
Principal
Balance

 

Related
Allowance

 

Average
Recorded
Investment

 

Interest
Income
Recognized

 

With no related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

2,307

 

$

2,646

 

$

 

$

1,169

 

$

 

Commercial real estate

 

 

 

 

 

 

 

 

 

 

 

Owner occupied general purpose

 

10,741

 

16,548

 

 

8,623

 

 

Owner occupied special purpose

 

20,602

 

27,522

 

 

15,658

 

 

Non-owner occupied general purpose

 

9,753

 

10,795

 

 

10,385

 

32

 

Non-owner occupied special purpose

 

1,846

 

1,850

 

 

2,796

 

5

 

Strip malls

 

5,023

 

5,037

 

 

7,635

 

 

Farm

 

1,194

 

1,316

 

 

968

 

 

Construction

 

 

 

 

 

 

 

 

 

 

 

Homebuilder

 

15,978

 

26,659

 

 

18,194

 

29

 

Land

 

4,264

 

15,479

 

 

6,918

 

 

Commercial speculative

 

4,794

 

17,270

 

 

7,252

 

 

All other

 

5,177

 

7,225

 

 

5,413

 

 

Residential

 

 

 

 

 

 

 

 

 

 

 

Investor

 

4,268

 

4,895

 

 

8,238

 

 

Owner occupied

 

14,207

 

15,583

 

 

14,716

 

78

 

Revolving and junior leins

 

1,038

 

1,153

 

 

1,006

 

 

Consumer

 

5

 

6

 

 

 

6

 

 

Total impaired loans with no recorded allowance

 

101,197

 

153,984

 

 

108,977

 

144

 

With an allowance recorded

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

712

 

776

 

671

 

2,174

 

 

Commercial real estate

 

 

 

 

 

 

 

 

 

 

 

Owner occupied general purpose

 

4,391

 

4,693

 

1,657

 

8,248

 

 

Owner occupied special purpose

 

3,746

 

3,996

 

725

 

9,510

 

 

Non-owner occupied general purpose

 

10,423

 

13,119

 

4,161

 

12,515

 

 

Non-owner occupied special purpose

 

8,209

 

8,617

 

1,402

 

8,262

 

 

Strip malls

 

17,640

 

19,879

 

1,988

 

15,884

 

 

Farm

 

 

 

 

 

 

Construction

 

 

 

 

 

 

 

 

 

 

 

Homebuilder

 

10,285

 

15,170

 

2,613

 

8,189

 

 

Land

 

5,912

 

5,972

 

872

 

8,479

 

 

Commercial speculative

 

9,385

 

17,042

 

1,758

 

7,278

 

 

All other

 

66

 

200

 

17

 

216

 

 

Residential

 

 

 

 

 

 

 

 

 

 

 

Investor

 

10,972

 

12,058

 

2,282

 

10,252

 

5

 

Owner occupied

 

8,877

 

9,613

 

1,445

 

9,568

 

34

 

Revolving and junior leins

 

851

 

860

 

418

 

718

 

 

Consumer

 

 

 

 

 

 

Total impaired loans with a recorded allowance

 

91,469

 

111,995

 

20,009

 

101,293

 

39

 

Total impaired loans

 

$

192,666

 

$

265,979

 

$

20,009

 

$

210,270

 

$

183

 

 

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Table of Contents

 

Impaired loans by class of loan as of December 31, 2010 were as follows:

 

 

 

Recorded
Investment

 

Unpaid
Principal
Balance

 

Related
Allowance

 

With no related allowance recorded

 

 

 

 

 

 

 

Commercial

 

$

31

 

$

994

 

$

 

Commercial real estate

 

 

 

 

 

 

 

Owner occupied general purpose

 

6,505

 

7,238

 

 

Owner occupied special purpose

 

10,713

 

12,935

 

 

Non-owner occupied general purpose

 

11,017

 

15,030

 

 

Non-owner occupied special purpose

 

3,745

 

6,621

 

 

Strip malls

 

10,247

 

15,354

 

 

Farm

 

741

 

862

 

 

Construction

 

 

 

 

 

 

 

Homebuilder

 

20,409

 

34,569

 

 

Land

 

9,572

 

20,234

 

 

Commercial speculative

 

9,710

 

26,650

 

 

All other

 

5,648

 

8,227

 

 

Residential

 

 

 

 

 

 

 

Investor

 

12,207

 

16,750

 

 

Owner occupied

 

15,224

 

16,749

 

 

Revolving and junior leins

 

973

 

1,010

 

 

Consumer

 

7

 

14

 

 

 

Total impaired loans with no recorded allowance

 

116,749

 

183,237

 

 

With an allowance recorded

 

 

 

 

 

 

 

Commercial

 

3,635

 

3,671

 

1,349

 

Commercial real estate

 

 

 

 

 

 

 

Owner occupied general purpose

 

12,105

 

14,912

 

1,742

 

Owner occupied special purpose

 

15,274

 

18,886

 

3,933

 

Non-owner occupied general purpose

 

14,606

 

16,946

 

6,063

 

Non-owner occupied special purpose

 

8,315

 

8,615

 

1,560

 

Strip malls

 

14,127

 

15,215

 

1,769

 

Farm

 

 

 

 

Construction

 

 

 

 

 

 

 

Homebuilder

 

6,093

 

9,291

 

1,020

 

Land

 

11,045

 

11,523

 

978

 

Commercial speculative

 

5,171

 

8,363

 

1,674

 

All other

 

366

 

502

 

25

 

Residential

 

 

 

 

 

 

 

Investor

 

9,532

 

10,441

 

1,520

 

Owner occupied

 

10,259

 

10,589

 

1,096

 

Revolving and junior leins

 

585

 

664

 

258

 

Consumer

 

 

 

 

Total impaired loans with a recorded allowance

 

111,113

 

129,618

 

22,987

 

Total impaired loans

 

$

227,862

 

$

312,855

 

$

22,987

 

 

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Note 4 — Allowance for Loan Losses

 

Changes in the allowance for loan losses by segment of loans for the three months ending March 31 are summarized as follows:

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Allowance at beginning of year

 

$

76,308

 

$

64,540

 

Charge-offs:

 

 

 

 

 

Commercial

 

145

 

1,231

 

Real estate - commercial

 

5,694

 

3,536

 

Real estate - construction

 

1,970

 

11,534

 

Real estate - residential

 

1,164

 

2,268

 

Consumer other loans

 

114

 

97

 

Total charge-offs

 

9,087

 

18,666

 

Recoveries:

 

 

 

 

 

Commercial

 

32

 

164

 

Real estate - commercial

 

577

 

 

Real estate - construction

 

15

 

1,387

 

Real estate - residential

 

1,168

 

79

 

Consumer other loans

 

115

 

89

 

Total recoveries

 

1,907

 

1,719

 

Net charge-offs

 

7,180

 

16,947

 

Provision for loan losses

 

4,000

 

19,220

 

Allowance at end of year

 

$

73,128

 

$

66,813

 

 

Changes in the allowance for loan losses by segment of loans based on method of impairment for the quarter ended March 31, 2011, were as follows:

 

 

 

Commercial

 

Real Estate
Commercial(1)

 

Real Estate
Construction

 

Real Estate
Residential

 

Consumer

 

Unallocated

 

Total

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

6,764

 

$

42,242

 

$

18,344

 

$

6,999

 

$

880

 

$

1,079

 

$

76,308

 

Charge-offs

 

145

 

5,694

 

1,970

 

1,164

 

114

 

 

9,087

 

Recoveries

 

32

 

577

 

15

 

1,168

 

115

 

 

1,907

 

Provision

 

(1,041

)

6,709

 

(3,058

)

1,407

 

(19

)

2

 

4,000

 

Ending balance

 

$

5,610

 

$

43,834

 

$

13,331

 

$

8,410

 

$

862

 

$

1,081

 

$

73,128

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance: Individually evaluated for impairment

 

$

671

 

$

9,933

 

$

5,260

 

$

4,145

 

$

 

$

 

$

20,009

 

Ending balance: Collectively evaluated for impairment

 

$

4,939

 

$

33,901

 

$

8,071

 

$

4,265

 

$

862

 

$

1,081

 

$

53,119

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing receivables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance

 

$

141,898

 

$

794,251

 

$

104,630

 

$

531,311

 

$

4,599

 

$

25,072

 

$

1,601,761

 

Ending balance: Individually evaluated for impairment

 

$

3,019

 

$

93,568

 

$

55,861

 

$

40,213

 

$

5

 

$

 

$

192,666

 

Ending balance: Collectively evaluated for impairment

 

$

138,879

 

$

700,683

 

$

48,769

 

$

491,098

 

$

4,594

 

$

25,072

 

$

1,409,095

 

 


(1) As of March 31, 2011, this segment consisted of performing loans that included a higher risk pool of loans rated as substandard that totaled $119.3 million.  The amount of general allocation that was estimated for that portion of these performing substandard rated loans was $19.1 million at March 31, 2011.

 

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Note 5: Other Real Estate Owned

 

Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation reserve, for the periods presented are itemized in the following table:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Balance at beginning of period

 

$

75,613

 

$

40,200

 

Property additions

 

19,451

 

18,838

 

Development improvements

 

2,022

 

10

 

Less:

 

 

 

 

 

Property disposals

 

9,123

 

4,102

 

Period valuation adjustments

 

2,393

 

5,091

 

Balance at end of period

 

$

85,570

 

$

49,855

 

 

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Activity in the valuation allowance was as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Balance at beginning of period

 

$

22,220

 

$

5,668

 

Provision for unrealized losses

 

2,325

 

5,091

 

Write-downs taken on sales

 

(2,730

)

(1,183

)

Other adjustments

 

68

 

 

Balance at end of period

 

$

21,883

 

$

9,576

 

 

Expenses related to foreclosed assets, net of lease revenue includes:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Gain on sales, net

 

$

(234

)

$

(151

)

Provision for unrealized losses

 

2,325

 

5,091

 

Operating expenses

 

2,989

 

1,337

 

Less:

 

 

 

 

 

Lease revenue

 

520

 

518

 

 

 

$

4,560

 

$

5,759

 

 

Note 6 —Intangible Assets

 

Management performed a periodic review of the core deposit and other intangible assets for impairment.  Based upon these reviews, management determined there was no impairment of the core deposit and other intangible assets as of March 31, 2011.  No assurance can be given that future impairment tests will not result in a charge to earnings.

 

The following table presents the estimated future amortization expense for core deposit and other intangibles as of March 31, 2011, for periods ended December 31 (in thousands):

 

 

 

Amount

 

2011 (Nine months ended December 31, 2011)

 

$

618

 

2012

 

780

 

2013

 

732

 

2014

 

679

 

2015

 

623

 

Thereafter

 

1,864

 

Total

 

$

5,296

 

 

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Table of Contents

 

Note 7 — Mortgage Servicing Rights

 

Changes in capitalized mortgage servicing rights as of March 31, are summarized as follows:

 

 

 

2011

 

2010

 

Balance at beginning of period

 

$

3,897

 

$

2,470

 

Fair value adjustment

 

 

9

 

Additions

 

371

 

417

 

Mark to market

 

62

 

(75

)

Balance at end of period

 

4,330

 

2,821

 

 

 

 

 

 

 

Changes in the valuation allowance for  servicing assets were as follows:

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(20

)

Fair value adjustment

 

 

20

 

Provisions for impairment

 

 

 

Recovery credited to expense

 

 

 

Balance at end of period

 

 

 

Net balance

 

$

4,330

 

$

2,821

 

 

The Company adopted ASC Topic 860-50-35 using the fair value measurement method for all servicing rights as of January 1, 2010, and the initial impact of adoption was an increase to beginning retained earnings of $29,000.  Management believed that the fair value method of accounting would better allow management to mitigate interest rate risk.  Servicing rights are recognized separately when they are acquired through sales of loans.  When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in net gain on sales of loans.  Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.  Additional disclosure related to fair value of mortgage servicing rights is found in Note 16.

 

Under the fair value measurement method, the Company measures servicing rights at fair value at each reporting date and reports changes in fair value of servicing assets in earnings in the period in which the changes occur, and are included with net gain on sales of mortgage loans on the income statement.  The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

 

Note 8 — Deposits

 

Major classifications of deposits were as follows:

 

 

 

March 31, 2011

 

December 31, 2010

 

Noninterest bearing demand

 

$

371,940

 

$

330,846

 

Savings

 

193,141

 

180,127

 

NOW accounts

 

266,103

 

304,287

 

Money market accounts

 

303,295

 

297,702

 

Certificates of deposit of less than $100,000

 

475,209

 

491,234

 

Certificates of deposit of $100,000 or more

 

292,661

 

304,332

 

 

 

$

1,902,349

 

$

1,908,528

 

 

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Table of Contents

 

Note 9 — Borrowings

 

The following table is a summary of borrowings as of March 31, 2011, and December 31, 2010, and junior subordinated debentures are discussed in detail in Note 10:

 

 

 

March 31, 2011

 

December 31, 2010

 

Securities sold under repurchase agreements

 

$

1,878

 

$

2,018

 

Treasury tax and loan

 

4,579

 

4,141

 

Junior subordinated debentures

 

58,378

 

58,378

 

Subordinated debt

 

45,000

 

45,000

 

Notes payable and other borrowings

 

500

 

500

 

 

 

$

110,335

 

$

110,037

 

 

The Company enters into sales of securities under agreements to repurchase (repurchase agreements) which generally mature within 1 to 90 days from the transaction date.  These repurchase agreements are treated as financings and were secured by securities with a carrying amount of $3.3 and $3.7 million at March 31, 2011, and December 31, 2010, respectively.  The securities sold under agreements to repurchase consisted of U.S. government agencies and mortgage-backed securities during the two-year reporting period.

 

The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC and are generally limited to the lesser of 35% of total assets or 60% of the book value of certain mortgage loans.  As of March 31, 2011, there were no advances on the FHLBC stock of $9.3 million and collateralized loan balance of $60.0 million.  At December 31, 2010, there were also no advances on the FHLBC stock of $9.3 million and loans totaling $29.3 million.  The Company has also established borrowing capacity at the FRB that was not used at either March 31, 2011, or December 31, 2010.  The Company currently has $77.7 million of borrowing capacity at the FRB at the current secondary rate of 1.25%.

 

The Bank is a Treasury Tax & Loan (“TT&L”) depository for the FRB and, as such, accepts TT&L deposits.  The Company is allowed to hold these deposits for the FRB until they are called.  The interest rate is the federal funds rate less 25 basis points.  Securities with a face value greater than or equal to the amount borrowed are pledged as a condition of borrowing TT&L deposits.  As of March 31, 2011, and December 31, 2010, TT&L deposits were $4.6 million and $4.1 million, respectively.

 

One of the Company’s most significant borrowing relationships continued to be the $45.5 million credit facility with LaSalle Bank National Association (now Bank of America).  That credit facility, which began in January 2008, was originally comprised of a $30.5 million senior debt facility, which included a $30.0 million revolving line that matured on March 31, 2010, and $500,000 in term debt, as well as $45.0 million of subordinated debt.  The subordinated debt and the term debt portions of the senior debt facility mature on March 31, 2018.  The interest rate on the senior debt facility resets quarterly and at the Company’s option, based on the Lender’s prime rate or three-month LIBOR plus 90 basis points.  The interest rate on the subordinated debt resets quarterly, and is equal to three-month LIBOR plus 150 basis points.  The proceeds of the $45.0 million of subordinated debt were used to finance the 2008 acquisition of Heritage Bank, including transaction costs.  The Company had no principal outstanding balance on the Bank of America senior line of credit when it matured, but did have $500,000 in principal outstanding in term debt and $45.0 million in principal outstanding in subordinated debt at the end of both December 31, 2010 and March 31, 2011.  The term debt is secured by all of the outstanding capital stock of the Bank.  The Company has made all required interest payments on the outstanding principal amounts on a timely basis.

 

The credit facility agreement contains usual and customary provisions regarding acceleration of the senior debt upon the occurrence of an event of default by the Company under the agreement, as

 

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Table of Contents

 

described therein.  The agreement also contains certain customary representations and warranties and financial and negative covenants.  At March 31, 2011, the Company continued to be out of compliance with two of the financial covenants contained within the credit agreement.  The agreement provides that upon an event of default as the result of the Company’s failure to comply with a financial covenant, the lender may (i) terminate all commitments to extend further credit, (ii) increase the interest rate on the revolving line and the term debt (together the “Senior Debt”) by 200 basis points, (iii) declare the Senior Debt immediately due and payable and (iv) exercise all of its rights and remedies at law, in equity and/or pursuant to any or all collateral documents, including foreclosing on the collateral.  The total outstanding principal amount of the Senior Debt is the $500,000 in term debt.  Because the subordinated debt is treated as Tier 2 capital for regulatory capital purposes, the agreement does not provide the lender with any rights of acceleration or other remedies with regard to the subordinated debt upon an event of default caused by the Company’s failure to comply with a financial covenant.  In November 2009, the lender provided notice to the Company that it was invoking the default rate, thereby increasing the rate on the term debt by 200 basis points retroactive to July 30, 2009.  This action by the lender resulted in nominal additional interest expense as it only applies to the $500,000 of outstanding term debt.

 

Note 10 — Junior Subordinated Debentures

 

The Company completed the sale of $27.5 million of cumulative trust preferred securities by its unconsolidated subsidiary, Old Second Capital Trust I in June 2003.  An additional $4.1 million of cumulative trust preferred securities was sold in July 2003.  The costs associated with the issuance of the cumulative trust preferred securities are being amortized over 30 years.  The trust preferred securities may remain outstanding for a 30-year term but, subject to regulatory approval, can be called in whole or in part by the Company.  The stated call period commenced on June 30, 2008 and can be exercised by the Company from time to time hereafter.  When not in deferral, cash distributions on the securities are payable quarterly at an annual rate of 7.80%.  The Company issued a new $32.6 million subordinated debenture to the trust 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 Company issued an additional $25.0 million of cumulative trust preferred securities through a private placement completed by an additional unconsolidated subsidiary, Old Second Capital Trust II, in April 2007.  Although nominal in amount, the costs associated with that issuance are being amortized over 30 years.  These trust preferred securities also mature in 30 years, but subject to the aforementioned regulatory approval, can be called in whole or in part on a quarterly basis commencing June 15, 2017.  The quarterly cash distributions on the securities are fixed at 6.77% through June 15, 2017 and float at 150 basis points over three-month LIBOR thereafter.  The Company issued a new $25.8 million subordinated debenture to the trust 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 proceeds from this trust preferred offering were used to finance the common stock tender offer in May 2007.

 

Under the terms of the subordinated debentures issued to each of Old Second Capital Trust I and II, the Company is allowed to defer payments of interest for 20 quarterly periods without default or penalty, but such amounts will continue to accrue.  Also during the deferral period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock, including the TARP Preferred Stock as discussed in Note 19.  In August of 2010, the Company elected to defer regularly scheduled interest payments on the $58.4 million of junior subordinated debentures.  Because of the deferral on the subordinated debentures, the trusts will defer regularly scheduled dividends on the trust preferred securities.  Both of the debentures issued by the Company are recorded on the Consolidated Balance Sheets as junior subordinated debentures and the related interest expense for each issuance is included in the Consolidated Statements of Operations.  The total accumulated unpaid interest on the junior subordinated debentures including compounded interest from July 1, 2010 on the deferred payments total $3.4 million at March 31, 2011.

 

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Note 11: Long-Term Incentive Plan

 

The Long-Term Incentive Plan (the “Incentive Plan”) authorizes the issuance of up to 1,908,332 shares of the Company’s common stock, including the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights.  Total shares issuable under the plan were 15,911 at March 31, 2011.  Stock based awards may be granted to selected directors and officers or employees at the discretion of the board of directors.  There were no stock options granted in the first quarter of 2011 or 2010.  All stock options are granted for a term of ten years.

 

Vesting of stock options granted in 2004 and prior years was accelerated to immediately vest all options as of December 20, 2005.  Options granted in 2005 were immediately vested and options granted subsequent to 2006 vest over three years.  Generally, restricted stock and restricted stock units vest three years from the grant date, but the Company’s Board of Directors have discretionary authority to change some terms including the amount of time until vest date.  Awards under the Incentive Plan become fully vested upon a merger or change in control of the Company.

 

Total compensation cost that has been charged for those plans was $238,000 in the first quarter of 2011 and $231,000 in the first quarter of 2010.  The total income tax benefit was $81,000 in the first quarter of 2010.

 

There were no stock options exercised during the first quarter of 2011 or 2010 and the Company did not grant any options of the Company’s common stock during either of those periods.  Total unrecognized compensation cost related to nonvested stock options granted under the Incentive Plan is $6,000 as of March 31, 2011, and is expected to be recognized over a weighted-average period of 0.83 years.  Total unrecognized compensation cost related to nonvested stock options granted under the Incentive Plan was $140,000 as of March 31, 2010, and was expected to be recognized over a weighted-average period of 0.67 years.

 

A summary of stock option activity in the Incentive Plan as of each quarter is as follows:

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

Weighted

 

Average

 

 

 

 

 

 

 

Average

 

Remaining

 

Aggregate

 

 

 

 

 

Exercise

 

Contractual

 

Intrinsic

 

March 31, 2011

 

Shares

 

Price

 

Term (years)

 

Value

 

Beginning outstanding

 

614,832

 

$

25.81

 

 

 

 

 

Canceled

 

(14,000

)

28.84

 

 

 

 

 

Ending outstanding

 

600,832

 

$

25.74

 

3.9

 

$

 

 

 

 

 

 

 

 

 

 

 

Exercisable at end of quarter

 

596,832

 

$

25.86

 

3.8

 

$

 

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

Weighted

 

Average

 

 

 

 

 

 

 

Average

 

Remaining

 

Aggregate

 

 

 

 

 

Exercise

 

Contractual

 

Intrinsic

 

March 31, 2010

 

Shares

 

Price

 

Term

 

Value

 

Beginning outstanding

 

683,666

 

$

24.29

 

 

 

 

 

Ending outstanding

 

683,666

 

$

24.29

 

4.5

 

$

 

 

 

 

 

 

 

 

 

 

 

Exercisable at end of quarter

 

644,668

 

$

24.37

 

4.3

 

$

 

 

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A summary of changes in the Company’s nonvested options in the Incentive Plan is as follows:

 

 

 

2011

 

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Grant Date

 

 

 

Shares

 

Fair Value

 

Nonvested at January 1

 

8,000

 

$

2.01

 

Vested

 

(4,000

)

2.01

 

Nonvested at March 31

 

4,000

 

2.01

 

 

Under the incentive plan, restricted stock was granted beginning in 2005 and the grant of restricted units began in February 2009.  Both of these restricted awards have voting and dividend rights and are subject to forfeiture until certain restrictions have lapsed including employment for a specific period.  Both restricted stock and restricted units were granted in 2010 and both are redeemable in common stock at the time of vesting.  There were 141,320 restricted awards issued during the first quarter of 2011 and 341,200 restricted awards issued during the first quarter of 2010.  Compensation expense is recognized over the vesting period of the restricted award based on the market value of the award at issue date.

 

A summary of changes in the Company’s non-vested restricted awards is as follows:

 

 

 

March 31, 2011

 

March 31, 2010

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

Average

 

 

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Shares

 

Fair Value

 

Shares

 

Fair Value

 

Nonvested at January 1

 

464,298

 

$

6.76

 

179,178

 

$

12.95

 

Granted

 

141,320

 

1.06

 

211,200

 

7.00

 

Vested

 

(98,770

)

10.71

 

(21,663

)

29.20

 

Forfeited

 

(38,938

)

4.54

 

 

 

Nonvested at March 31

 

467,910

 

$

4.39

 

368,715

 

$

8.59

 

 

Total unrecognized compensation cost of restricted awards is $1.3 million as of March 31, 2011, which is expected to be recognized over a weighted-average period of 1.33 years.  Total unrecognized compensation cost of restricted awards was $2.2 million as of March 31, 2010, which was expected to be recognized over a weighted-average period of 3.16 years.

 

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Note 12 —Loss Per Share

 

Loss per share is included below as of March 31 (in thousands except for share data):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Basic loss per share:

 

 

 

 

 

Weighted-average common shares outstanding

 

13,973,870

 

13,916,650

 

Weighted-average common shares less stock based awards

 

13,769,856

 

13,707,907

 

Weighted-average common shares stock based awards

 

443,845

 

366,368

 

Net loss

 

$

(3,120

)

$

(8,554

)

Dividends on preferred shares

 

1,159

 

1,128

 

Net loss available to common shareholders

 

(4,279

)

(9,682

)

Common stock dividends

 

 

(137

)

Nonvested share-based payment awards

 

 

(4

)

Undistributed loss

 

(4,279

)

(9,823

)

Basic loss per share common undistributed earnings

 

(0.30

)

(0.70

)

Basic loss per share common distributed earnings

 

 

0.01

 

Basic loss per share

 

$

(0.30

)

$

(0.69

)

Diluted loss per share:

 

 

 

 

 

Weighted-average common shares outstanding

 

13,973,870

 

13,916,650

 

Dilutive effect of restricted shares(1)

 

239,831

 

280,573

 

Dilutive effect of stock options

 

 

 

Diluted average common shares outstanding

 

14,213,701

 

14,197,223

 

Net loss available to common stockholders

 

$

(4,279

)

$

(9,682

)

Diluted loss per share

 

$

(0.30

)

$

(0.69

)

 

 

 

 

 

 

Number of antidilutive options excluded from the diluted loss per share calculation

 

1,416,171

 

1,577,000

 

 


(1) Includes the common stock equivalents for restricted share rights that are dilutive.

 

The above (loss) earnings per share calculation did not include 815,339 common stock warrants that were outstanding as of March 31, 2011.

 

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Note 13 — Other Comprehensive Income (Loss)

 

The following table summarizes the related income tax effect for the components of Other Comprehensive Income (Loss) as of March 31:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Net loss available to common stockholders

 

$

(4,279

)

$

(9,682

)

 

 

 

 

 

 

Unrealized holding gains (losses) on available-for-sale securities arising during the period

 

 

 

 

 

U.S. Treasury

 

$

(5

)

$

(13

)

U.S. government agencies

 

(171

)

14

 

U.S. government agency mortgage-backed

 

(692

)

172

 

States and political subdivisions

 

380

 

(159

)

Collateralized mortgage obligations

 

(40

)

(89

)

Collateralized debt obligations

 

684

 

(426

)

Equity securities

 

6

 

(3

)

Total unrealized holding gains (losses) on available-for-sale securities arising during the period

 

$

162

 

$

(504

)

Related tax benefit

 

8

(1)

192

 

Holding income (losses) after tax

 

170

 

(312

)

 

 

 

 

 

 

Less: Reclassification adjustment for the net gains and losses realized during the period

 

 

 

 

 

Realized gains (losses) by security type:

 

 

 

 

 

U.S. government agencies

 

$

 

$

(2

)

Collateralized mortgage obligations

 

139

 

 

Net realized gain (losses)

 

139

 

(2

)

Income tax (expense) benefit on net realized gains

 

(57

)

1

 

Net realized gain (losses) after tax

 

82

 

(1

)

Total other comprehensive income (loss)

 

$

88

 

$

(311

)

 


(1) Tax benefit was recorded due to the change in state statutory income tax rates, net of unrealized gains in the investment portfolio.

 

Note 14 — Retirement Plans

 

The Company maintains tax-qualified contributory and non-contributory profit sharing plans covering substantially all full-time and regular part-time employees.  The expense of these plans was $161,000 and $228,000 in the first three months of 2011 and 2010, respectively.  The Company eliminated the profit sharing contribution and lowered the amount of the 401(K) match beginning in second quarter of 2009.

 

Note 15 - Regulatory & Capital Matters

 

On October 20, 2009, the Bank entered into a MOU with the OCC, in which the Bank agreed, among other things, to: (i) implement a variety of programs and policies to reduce its level of credit risk, including a policy to address certain concentrations of credit; and (ii) limit its amount of brokered deposits to 4.50% of total deposits, unless the prior written consent of the OCC is granted to exceed such level.  In addition to the MOU, the Bank also agreed with the OCC to maintain regulatory capital ratios at levels in excess of the general minimums required to be considered “well capitalized” under applicable OCC regulations.  Specifically, the Bank’s Board of Directors agreed to achieve a minimum Tier 1 capital to adjusted total assets ratio of 8.75% and a minimum total risk-based capital to total risk-weighted assets

 

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ratio of 11.25% by December 31, 2009, and to maintain such minimum ratios thereafter.  The Bank achieved these heightened regulatory capital ratios by December 31, 2009 and remained in compliance with them through March 31, 2010.  However, at March 31, 2011, these regulatory capital ratios were 8.64% and 11.97%, respectively, and therefore the Bank was not in compliance with the required ratio of Tier 1 capital to adjusted total assets.  As a result of the Bank’s continuing financial difficulties and heightened levels of nonperforming loans, as well as the Bank’s failure to be in full compliance with the agreed-upon capital ratios management expects that the OCC will replace the current MOU with a formal regulatory enforcement action.

 

The Company, on a consolidated basis, is considered adequately capitalized under regulatory defined capital ratios at March 31, 2011.  While the Bank exceeded the general minimum regulatory requirements to be considered “well capitalized”, it was not in full compliance with heightened capital ratios that it has agreed to maintain with the OCC.

 

The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies.  Those agencies define the basis for these calculations including the prescribed methodology for the calculation of the amount of risk-weighted assets.  The risk based capital guidelines were designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks.  The guidelines assess balance sheet and off-balance sheet exposures, and lessen disincentives for holding liquid assets.  Under the regulations, assets and off-balance sheet items are assigned to risk categories, each with appropriate weights.  The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.  Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors, and regulators can lower classifications in certain areas and/or require additional capital above adequacy guidelines.  Failure to meet various capital requirements can initiate regulatory action that could have a direct material adverse effect on the financial statements.  The prompt corrective action regulations provide five classifications for banks, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition.  Generally, if adequately capitalized, regulatory approval is not required to accept brokered deposits, however, the Bank is limited in the amount of brokered deposits that it can hold pursuant to the MOU.  If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.  Management can also hold higher capital levels consistent with customized risk assessments.

 

Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve Capital guidelines.  The general bank and holding company capital adequacy guidelines are described in the accompanying table, as are the capital ratios of the Company and the Bank, as of March 31, 2011, and December 31, 2010.  These ratios are calculated on a consistent basis with the ratios disclosed in the most recent filings with the regulatory agencies.

 

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Capital levels and industry defined regulatory minimum required levels:

 

 

 

 

 

 

 

Minimum Required

 

Minimum Required

 

 

 

 

 

 

 

for Capital

 

to Be Well

 

 

 

Actual

 

Adequacy Purposes

 

Capitalized (1)

 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

March 31, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital to risk weighted assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

198,980

 

11.65

%

$

136,639

 

8.00

%

N/A

 

N/A

 

Old Second National Bank

 

204,871

 

11.97

 

136,923

 

8.00

 

$

171,154

 

10.00

%

Tier 1 capital to risk weighted assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

103,113

 

6.04

 

68,287

 

4.00

 

N/A

 

N/A

 

Old Second National Bank

 

182,843

 

10.68

 

68,481

 

4.00

 

102,721

 

6.00

 

Tier 1 capital to average assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

103,113

 

4.88

 

84,519

 

4.00

 

N/A

 

N/A

 

Old Second National Bank

 

182,843

 

8.64

 

84,650

 

4.00

 

105,812

 

5.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital to risk weighted assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

203,602

 

11.46

%

$

142,131

 

8.00

%

N/A

 

N/A

 

Old Second National Bank

 

207,007

 

11.63

 

142,395

 

8.00

 

$

177,994

 

10.00

%

Tier 1 capital to risk weighted assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

108,138

 

6.09

 

71,027

 

4.00

 

N/A

 

N/A

 

Old Second National Bank

 

184,098

 

10.34

 

71,218

 

4.00

 

106,827

 

6.00

 

Tier 1 capital to average assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

108,138

 

4.74

 

91,256

 

4.00

 

N/A

 

N/A

 

Old Second National Bank

 

184,098

 

8.10

 

90,913

 

4.00

 

113,641

 

5.00

 

 


(1)          While the Bank exceeded the general minimum regulatory requirements to be considered “well capitalized,” it was not in full compliance with the heightened capital ratios that it has agreed to maintain with the OCC.

 

The Company’s credit facility with Bank of America includes $45.0 million in subordinated debt.  That debt obligation continues to qualify as Tier 2 regulatory capital.  In addition, the trust preferred securities continue to qualify as Tier 1 regulatory capital, and the Company treats the maximum amount of this security type allowable under regulatory guidelines as Tier 1 capital.  As of March 31, 2011, Trust preferred proceeds of $27.7 million qualified as Tier 1 regulatory capital and $28.9 million qualified as Tier 2 regulatory capital.  As of December 31, 2010, Trust preferred proceeds of $29.0 million qualified as Tier 1 regulatory capital and $27.6 million qualified as Tier 2 regulatory capital.

 

Dividend Restrictions and Deferrals

 

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 a result of the December 31, 2009 operating loss, funds were no longer available for the payment of dividends by the Bank to the Company and this restriction continued at March 31, 2011.

 

As discussed in Note 10, as of March 31, 2011, the Company had $58.4 million of junior subordinated debentures held by two statutory business trusts that it controls.  The Company has the right to defer interest payments, which are approximately $4.3 million each year, on the debentures for a period of up to 20 consecutive quarters, and elected to begin such a deferral period in August 2010.  However, all deferred interest must be paid before the Company may pay dividends on its capital stock.  Therefore, the Company will not be able to pay dividends on its common stock until all deferred interest on these

 

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debentures has been paid in full.  The total amount of such deferred and unpaid interest as of March 31, 2011, was $3.4 million.

 

Furthermore, as with the debentures discussed above, the Company is prohibited from paying dividends on its common stock unless it has fully paid all accrued dividends on its Series B Fixed Rate Cumulative Perpetual Preferred Stock.  In August 2010, it also began to defer the payment of dividends on such preferred stock.  Therefore, in addition to paying all the accrued and unpaid distributions on the debentures set forth above, the Company must also fully pay the Treasury all accrued and unpaid dividends on the senior preferred stock before it may reinstate the payment of dividends on the common stock.  The total amount deferred preferred stock dividends as of March 31, 2011, was $2.3 million.  Moreover, even should all accrued payments be paid in full, the Company may not increase the dividends payable on its common stock beyond the level that it had most recently declared prior to Treasury’s investment until January of 2012 without the consent of Treasury, provided Treasury still holds the preferred stock.

 

Further detail on the subordinated debentures, the Series B Fixed Rate Cumulative Perpetual Preferred Stock and the deferral of interest and dividends thereon is described in Notes 10 and 19.

 

Note 16 — Fair Value Option and 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 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:

 

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 assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

The Company uses the following methods and significant assumptions to estimate fair value:

 

·                  Securities available-for-sale are valued primarily by a third party pricing agent and both the market and income valuation approaches are implemented using the following types of inputs:

 

·                  U.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.

·                  Government-sponsored agency debt securities are primarily priced using available market information through processes such as benchmark curves, market valuations of like securities, sector groupings and matrix pricing.

 

·                  Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs are primarily priced using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.

·                  Other inactive government-sponsored agency securities are primarily priced using consensus pricing and dealer quotes.

·                  State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems.  Because some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities and could be valued with level 3 measurements.

 

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·                  Collateralized debt obligations are collateralized by trust preferred security issuances of other financial institutions.  Uncertainty in the financial markets in the periods presented has resulted in reduced liquidity for these investment securities, which continued to affect market pricing in the period presented.  To reflect an appropriate fair value measurement, management included a risk premium adjustment to provide an estimate of the amount that a market participant would demand because of uncertainty in cash flows in the discounted cash flow analysis.  Management initially made that adjustment to Level 3 valuation at June 30, 2009 because the level of market activity for CDO securities continued to decrease and information on orderly sale transactions were not generally available.

·                  Marketable equity securities are priced using available market information.

·                  Residential mortgage loans eligible for sale in the secondary market are carried at fair market value.  The fair value of loans held for sale is determined using quoted secondary market prices.

·                  Lending related commitments to fund certain residential mortgage loans (interest rate locks) to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party investors as well as forward commitments for future delivery of mortgage-backed securities are considered derivatives.  Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment and do not typically involve significant judgments by management.

·                  The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income.  The valuation model incorporates assumptions that market participants would use in estimating future net servicing income to derive the resultant value.  The Company is able to compare the valuation model inputs, such as the discount rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates  to widely available published industry data for reasonableness.

·                  Interest rate swap positions, both assets and liabilities, are based on a valuation pricing models using an income approach based upon readily observable market parameters such as interest rate yield curves.

·                  Both the credit valuation reserve on current interest rate swap positions and on receivables related to unwound customer interest rate swap positions was determined based upon management’s estimate of the amount of credit risk exposure, including available collateral protection and/or by utilizing an estimate related to a probability of default as indicated in the Bank credit policy.  Such adjustments would result in a Level 3 classification.

·                  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

·                  Other Real Estate Owned:  Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at the lower of carrying amount or fair value, less costs to sell.  Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification.  In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

 

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Table of Contents

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis:

 

The tables below present the balance of assets and liabilities at March 31, 2011, and December 31, 2010, respectively, which are measured by the Company at fair value on a recurring basis:

 

 

 

March 31, 2011

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

1,516

 

$

 

$

 

$

1,516

 

U.S. government agencies

 

 

37,499

 

 

37,499

 

U.S. government agency mortgage-backed

 

 

73,279

 

 

73,279

 

States and political subdivisions

 

 

18,127

 

 

18,127

 

Collateralized debt obligations

 

 

 

11,752

 

11,752

 

Equity securities

 

45

 

 

7

 

52

 

Loans held-for-sale

 

 

3,189

 

 

3,189

 

Mortgage servicing rights

 

 

 

4,330

 

4,330

 

Other assets (Interest rate swap agreements net of swap credit valuation)

 

 

2,925

 

(96

)

2,829

 

Other assets (Forward loan commitments to investors)

 

 

8

 

 

8

 

Other assets (Forward MBS)

 

 

60

 

 

60

 

Total

 

$

1,561

 

$

135,087

 

$

15,993

 

$

152,641

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Other liabilities (Interest rate swap agreements)

 

$

 

$

2,925

 

$

 

$

2,925

 

Other liabilities (Interest rate lock commitments to borrowers)

 

 

34

 

 

34

 

Other liabilities (Risk Participation Agreement)

 

 

 

40

 

40

 

Total

 

$

 

$

2,959

 

$

40

 

$

2,999

 

 

 

 

December 31, 2010

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

1,521

 

$

 

$

 

$

1,521

 

U.S. government agencies

 

9,988

 

27,438

 

 

37,426

 

U.S. government agency mortgage-backed

 

4,054

 

72,677

 

 

76,731

 

States and political subdivisions

 

 

14,854

 

3,000

 

17,854

 

Collateralized mortgage obligations

 

 

3,996

 

 

3,996

 

Collateralized debt obligations

 

 

 

11,073

 

11,073

 

Equity securities

 

40

 

 

6

 

46

 

Loans held-for-sale

 

 

10,655

 

 

10,655

 

Mortgage servicing rights

 

 

 

3,897

 

3,897

 

Other assets (Interest rate swap agreements net of swap credit valuation)

 

 

3,499

 

(108

)

3,391

 

Other assets (Forward loan commitments to investors)

 

 

(2

)

 

(2

)

Other assets (Forward MBS)

 

 

505

 

 

505

 

Total

 

$

15,603

 

$

133,622

 

$

17,868

 

$

167,093

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Other liabilities (Interest rate swap agreements)

 

$

 

$

3,499

 

$

 

$

3,499

 

Other liabilities (Interest rate lock commitments to borrowers)

 

 

(17

)

 

(17

)

Other liabilities (Risk Participation Agreement)

 

 

 

38

 

38

 

Total

 

$

 

$

3,482

 

$

38

 

$

3,520

 

 

At December 31, 2010, $10.0 million in United States government agencies and $4.1 million in United States government agency mortgage backed securities were reported in level 1 at their quoted price, as they were purchased within 30 days of year-end.  Subsequently, these securities are included in level 2.  Additionally, at December 31, 2010, $3.0 million in state and political subdivision securities were included in level 3 as they had no observable market price and are now included in level 2 at March 31, 2011.

 

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Table of Contents

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs are summarized as follows:

 

 

 

March 31, 2011

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

Equity Securities

 

Collateralized
Debt
Obligations

 

States and
Political
Subdivisons

 

Mortgage
Servicing
Rights

 

Interest Rate
Swap
Valuation

 

Risk
Participation

Agreement

 

Beginning balance January 1, 2011

 

$

6

 

$

11,073

 

$

3,000

 

$

3,897

 

$

(108

)

$

(38

)

Transfers into Level 3

 

 

 

 

 

 

 

Transfers out of Level 3

 

 

 

(3,000

)

 

 

 

Total gains or losses

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in earnings (or changes in net assets)

 

 

28

 

 

62

 

12

 

(2

)

Included in other comprehensive income

 

1

 

684

 

 

 

 

 

Purchases, issuances, sales, and settlements

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 

 

 

 

 

Issuances

 

 

 

 

371

 

 

 

Settlements

 

 

(33

)

 

 

 

 

Expirations

 

 

 

 

 

 

 

Ending balance March 31, 2011

 

$

7

 

$

11,752

 

$

 

$

4,330

 

$

(96

)

$

(40

)

 

 

 

December 31, 2010

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

Equity Securities

 

Collateralized
Debt
Obligations

 

States and
Political
Subdivisons

 

Mortgage
Servicing
Rights

 

Interest Rate
Swap
Valuation

 

Risk
Participation
Agreement

 

Beginning balance January 1, 2010

 

$

53

 

$

10,883

 

$

 

$

 

$

(285

)

$

(31

)

Transfers into Level 3

 

 

 

3,000

 

2,821

 

 

 

Transfers out of Level 3

 

(50

)

 

 

 

 

 

Total gains or losses

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in earnings (or changes in net assets)

 

 

149

 

 

(794

)

177

 

(7

)

Included in other comprehensive income

 

3

 

155

 

 

 

 

 

Purchases, issuances, sales, and settlements

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 

 

 

 

 

Issuances

 

 

 

 

1,938

 

 

 

Settlements

 

 

(114

)

 

(68

)

 

 

Expirations

 

 

 

 

 

 

 

Ending balance December 31, 2010

 

$

6

 

$

11,073

 

$

3,000

 

$

3,897

 

$

(108

)

$

(38

)

 

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 impaired loans and other real estate owned.  For assets measured at fair value on a nonrecurring basis on hand at March 31, 2011, and December 31, 2010, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:

 

 

 

March 31, 2011

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Impaired loans(1)

 

$

 

$

 

$

76,526

 

$

76,526

 

Other real estate owned, net(2)

 

 

 

85,570

 

85,570

 

Total

 

$

 

$

 

$

162,096

 

$

162,096

 

 


(1)   Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans, had a carrying amount of $100.9 million, with a valuation allowance of $20.0 million, resulting in a decrease of specific allocations within the provision for loan losses of $2.7 million for the quarter ending March 31, 2011.  The carrying value of loans fully charged off is zero.

 

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(2)   OREO is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $85.6 million, which is made up of the outstanding balance of $107.5 million, net of a valuation allowance of $21.9 million, at March 31, 2011, resulting in a charge to expense of $2.3 million for the quarter ended March 31, 2011.

 

 

 

December 31, 2010

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Impaired loans(1)

 

$

 

$

 

$

95,141

 

$

95,141

 

Other real estate owned, net(2)

 

 

 

75,613

 

75,613

 

Total

 

$

 

$

 

$

170,754

 

$

170,754

 

 


(1)   Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans, had a carrying amount of $118.0 million, with a valuation allowance of $22.9 million, resulting in a increase of specific allocations within the provision for loan losses of $4.3 million for the year ending December 31, 2010.  The carrying value of loans fully charged off is zero.

 

(2)   OREO is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $75.6 million, which is made up of the outstanding balance of $97.8 million, net of a valuation allowance of $22.2 million, at December 31, 2010, resulting in a charge to expense of $20.7 million for the year ended December 31, 2010.

 

Note 17 — Financial Instruments with Off-Balance Sheet Risk and Derivative Transactions

 

To meet the financing needs of its customers, the Bank, as a subsidiary of the Company, is a party to various financial instruments with off-balance-sheet risk in the normal course of business.  These off-balance-sheet financial instruments include commitments to originate and sell loans as well as financial standby, performance standby and commercial letters of credit.  The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.  The Bank’s credit exposure for loan commitments and letters of credit are represented by the dollar amount of those instruments.  Management generally uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments.

 

Interest Rate Swaps

 

The Company 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 into an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution.  Due to financial covenant violations relating to nonperforming loans, the Bank had $10.8 million in investment securities pledged to support interest rate swap activity with two correspondent financial institutions at March 31, 2011.  The Bank had $7.2 million in investment securities pledged to support interest rate swap activity with a correspondent financial institution at December 31, 2010.  In connection with each transaction, the Bank agrees to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate.  At the same time, the Bank agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount.  The transaction allows the client to effectively convert a variable rate loan to a fixed rate loan and is part of the Company’s interest rate risk management strategy.  Because the Bank acts as an intermediary for the client, changes in the fair value of the underlying derivative contracts offset each other and do not generally affect the results of operations.  Fair value measurements include

 

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Table of Contents

 

an assessment of credit risk related to the client’s ability to perform on their contract position, however, and valuation estimates related to that exposure are discussed in Note 16 above.  Management also reported $3.5 million in additional receivables as of December 31, 2010, which have been categorized as nonperforming but were estimated to have no loss exposure, was reduced to $722,000 as of March 31, 2011.  At March 31, 2011, the notional amount of non-hedging interest rate swaps was $130.3 million with a weighted average maturity of 2.87 years.  At December 31, 2010, the notional amount of non-hedging interest rate swaps was $131.4 million with a weighted average maturity of 3.12 years.  The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.

 

The Bank 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 by entering into 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 income.  Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.

 

As of March 31, 2011, the Bank was party to one risk participation agreement (“RPA”) in a swap transaction with a correspondent bank for which it received a participation payment.  As a participant in the RPA agreement, the Bank is not a party to the swap transaction, but it does act as a financial guarantor of 26.49% of the close out value of the swap should the counterparty to the swap transaction default or otherwise fail to perform its payment obligation, which ends June 27, 2011.  The Bank estimates the market value of the RPA monthly and includes the estimated change in value in its quarterly operating results.  The maximum theoretical upper limit of dollar exposure of the credit risk of the underlying swap is approximately $63,000 and is derived by assuming interest rates reached an effective rate of 0.0%.  The estimated market value of the RPA at March 31, 2011, was approximately $40,000.

 

The following table presents derivatives not designated as hedging instruments as of March 31, 2011, and periodic changes in the values of the interest rate swaps and the risk participation agreement contract are reported in other noninterest income.  Periodic changes in the value of the forward contracts related to mortgage loan origination are reported in the net gain on sales of mortgage loans.

 

 

 

Notional or

 

Asset Derivaties

 

Liability Derivatives

 

 

 

Contractual
Amount

 

Balance Sheet
Location

 

Fair Value

 

Balance Sheet
Location

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts net of credit valuation

 

$

130,270

 

Other Assets

 

$

2,829

 

Other Liabilities

 

$

2,925

 

Commitments(1)

 

246,104

 

Other Assets

 

68

 

N/A

 

 

Forward contracts(2)

 

19,566

 

N/A

 

 

Other Liabilities

 

34

 

Risk participation agreements

 

7,000

 

N/A

 

 

Other Liabilities

 

40

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

$

2,897

 

 

 

$

2,999

 

 


(1) Includes unused loan commitments and interest rate lock commitments.

(2) Includes forward MBS contracts and forward loan contracts.

 

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Table of Contents

 

The following table presents derivatives not designated as hedging instruments as of December 31, 2010.

 

 

 

Notional or

 

Asset Derivaties

 

Liability Derivatives

 

 

 

Contractual
Amount

 

Balance Sheet
Location

 

Fair Value

 

Balance Sheet
Location

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts net of credit valuation

 

$

131,399

 

Other Assets

 

$

3,391

 

Other Liabilities

 

$

3,499

 

Commitments(1)

 

281,753

 

Other Assets

 

503

 

N/A

 

 

Forward contracts(2)

 

39,673

 

N/A

 

 

Other Liabilities

 

(17

)

Risk participation agreements

 

7,000

 

N/A

 

 

Other Liabilities

 

38

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

$

3,894

 

 

 

$

3,520

 

 


(1)  Includes unused loan commitments, interest rate lock commitments, and forward rate lock.

(2)  Includes forward mortgage backed securities and forward loan contracts.

 

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 is essentially the same as that involved in extending loan commitments to our customers.

 

In addition to customer related commitments, the Company is responsible for letters of credit commitments that relate to properties held in OREO. The following table represents the Company’s contractual commitments due to letters of credit as of March 31, 2011, and December 31, 2010.

 

 

 

March 31, 2011

 

December 31, 2010

 

Commitments to extend credit: borrowers

 

 

 

 

 

Financial standby letters of credit

 

$

14,311

 

$

16,258

 

Performance standby letters of credit

 

11,600

 

12,670

 

Commercial letters of credit

 

8,936

 

9,137

 

Total letters of credit: borrowers

 

34,847

 

38,065

 

 

 

 

 

 

 

Commitments to extend credit: other

 

 

 

 

 

Financial standby letters of credit

 

550

 

 

Performance standby letters of credit

 

1,503

 

2,521

 

Commercial letters of credit

 

 

201

 

Total letters of credit: other

 

2,053

 

2,722

 

 

 

 

 

 

 

Total letters of credit

 

 

 

 

 

Financial standby letters of credit

 

14,861

 

16,258

 

Performance standby letters of credit

 

13,103

 

15,191

 

Commercial letters of credit

 

8,936

 

9,338

 

Total letters of credit

 

$

36,900

 

$

40,787

 

 

Note 18 — Fair Values of Financial Instruments

 

The estimated fair values approximate carrying amount for all items except those described in the following table.  Investment security 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 fair value of the collateralized debt obligations included in investment securities include a risk premium adjustment to provide an estimate of the amount that a market participant would demand because of uncertainty in cash flows and

 

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Table of Contents

 

the methods for determining fair value of securities are discussed in detail in Note 16.  It is not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions on transferability.  Fair values of loans were estimated for portfolios of loans with similar financial characteristics, such as type and fixed or variable interest rate terms.  Cash flows were discounted using current rates at which similar loans would be made to borrowers with similar ratings and for similar maturities.  The fair value of time deposits is estimated using discounted future cash flows at current rates offered for deposits of similar remaining maturities.  The fair values of borrowings were estimated based on interest rates available to the Company for debt with similar terms and remaining maturities.  The fair value of off-balance sheet items is not considered material.

 

The carrying amount and estimated fair values of financial instruments were as follows:

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash, due from banks and federal funds sold

 

$

36,893

 

$

36,893

 

$

29,266

 

$

29,266

 

Interest bearing deposits with financial institutions

 

137,556

 

137,556

 

69,492

 

69,492

 

Securities available-for-sale

 

142,225

 

142,225

 

148,647

 

148,647

 

FHLB and FRB stock

 

14,050

 

14,050

 

13,691

 

13,691

 

Loans, net and loans held-for-sale

 

1,531,822

 

1,527,746

 

1,624,476

 

1,624,068

 

Interest rate swap agreements net of swap valuation

 

2,829

 

2,829

 

3,391

 

3,391

 

Forward loan commitments to investors

 

68

 

68

 

503

 

503

 

Accrued interest receivable

 

6,523

 

6,523

 

6,452

 

6,452

 

 

 

$

1,871,966

 

$

1,867,890

 

$

1,895,918

 

$

1,895,510

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Deposits

 

$

1,902,349

 

$

1,916,572

 

$

1,908,528

 

$

1,920,572

 

Securities sold under repurchase agreements

 

1,878

 

1,878

 

2,018

 

2,018

 

Other short-term borrowings

 

4,579

 

4,578

 

4,141

 

4,140

 

Junior subordinated debentures

 

58,378

 

42,302

 

58,378

 

45,011

 

Subordinated debt

 

45,000

 

43,319

 

45,000

 

43,957

 

Notes payable and other borrowings

 

500

 

481

 

500

 

489

 

Interest rate swap agreements

 

2,925

 

2,925

 

3,499

 

3,499

 

Interest rate lock commitments to borrowers

 

34

 

34

 

(17

)

(17

)

Risk participation agreements

 

40

 

40

 

38

 

38

 

Accrued interest payable

 

2,088

 

2,088

 

2,412

 

2,412

 

 

 

$

2,017,771

 

$

2,014,217

 

$

2,024,497

 

$

2,022,119

 

 

Note 19 — Preferred Stock

 

The Series B Fixed Rate Cumulative Perpetual Preferred Stock was issued as part of the TARP Capital Purchase Program implemented by the Treasury.  The Series B Preferred Stock qualified as Tier 1 capital and pays cumulative dividends on the liquidation preference amount on a quarterly basis at a rate of 5% per annum for the first five years, and 9% per annum thereafter.  Concurrent with issuing the Series B Preferred Stock, the Company issued to the Treasury a ten year warrant to purchase 815,339 shares of the Company’s Common Stock at an exercise price of $13.43 per share.

 

The American Recovery and Reinvestment Act of 2009, which was enacted on February 17, 2009, permits the Company to redeem the Series B Preferred Stock at any time by repaying the Treasury, without penalty and without the requirement to raise new capital, subject to the Treasury’s consultation with the Company’s appropriate regulatory agency.

 

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Table of Contents

 

Subsequent to the Company’s receipt of the $73.0 million in proceeds from the Treasury in the first quarter of 2009, the proceeds were allocated between the preferred stock and warrants that were issued.  The warrants were classified as equity, and the allocation was based on their relative fair values in accordance with accounting guidance.  The fair value was determined for both the preferred stock and the warrants as part of the allocation process in the amounts of $68.2 million and $4.8 million, respectively.

 

The fair value of the preferred stock was determined by using ASC Topic 820, “Fair Value Measurements and Disclosures” concepts, using a discounted cash flow approach.  Upon review of economic conditions and events that gave rise to the TARP initiative, a discount rate of 15% was selected to reflect management’s estimate of a current market rate for the Company.  Factors such as the creditworthiness of the Company, its standing as a public company, and the unique economic environment particularly as it related to financial institutions and the Treasury program were considered, as was the ability of the Company to access capital.  A final factor was management’s belief that the initial stated preferred stock dividend rate (5%) was below market, which also drove the decision to select the higher discount rate of 15%.

 

As discussed in Note15, in August 2010 the Company suspended quarterly cash dividends on its outstanding Series B Fixed Rate Cumulative Perpetual Preferred Stock.  Further, as discussed in Note 10, the Company has elected to defer interest payments on certain of its subordinated debentures.  During the period in which preferred stock dividends are deferred, such dividends will continue to accrue and, if the Company fails to pay dividends for an aggregate of six quarters, whether or not consecutive, the holder will have the right to appoint representatives to the Company’s board of directors.  The terms of the TARP Preferred Stock also prevent the Company from paying cash dividends or generally repurchasing its common stock while TARP Preferred Stock dividends are in arrears.  The total amount of such unpaid deferred dividends as of March 31, 2011, was $2.3 million.

 

Pursuant to the terms of the TARP Capital Purchase Program, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its common stock will be subject to restrictions, including a restriction against increasing dividends from the immediately preceding quarter prior to issuance.  The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also will be restricted.  These restrictions will terminate on the earlier of (a) the third anniversary of the date of issuance of the preferred stock and (b) the date on which the preferred stock has been redeemed in whole or the Treasury has transferred all of the preferred stock to third parties, except that, after the third anniversary of the date of issuance of the preferred stock, if the preferred stock remains outstanding at such time, the Company may not increase its common dividends per share without obtaining consent of the Treasury.

 

The TARP Capital Purchase Program also subjects the Company to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (the “EESA”). In this connection, as a condition to the closing of the transaction, the Company’s Senior Executive Officers (as defined in the purchase agreement) (the “Senior Executive Officers”), (i) voluntarily waived any claim against the U.S. Treasury or the Company for any changes to such officer’s compensation or benefits that are required to comply with the regulation issued by the U.S. Treasury under the TARP Capital Purchase Program and acknowledged that the regulation may require modification of the compensation, bonus, incentive and other benefit plans, arrangements and policies and agreements as they relate to the period the U.S. Treasury owns the preferred stock of the Company; and (ii) entered into a letter with the Company amending the benefit plans with respect to such Senior Executive Officers as may be necessary, during the period that the Treasury owns the preferred stock of the Company, as necessary to comply with Section 111(b) of the EESA.

 

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Table of Contents

 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

Old Second Bancorp, Inc. (the “Company”) is a financial services company with its main headquarters located in Aurora, Illinois.  The Company is the holding company of Old Second National Bank (the “Bank”), a national banking organization headquartered in Aurora, Illinois and provides commercial and retail banking services, as well as a full complement of trust and wealth management services.  The Company has offices located in Cook, Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois.  The following management’s discussion and analysis is presented to provide information concerning our financial condition as of March 31, 2011, as compared to December 31, 2010, and the results of operations for the three months ended March 31, 2011 and 2010.  This discussion and analysis should be read in conjunction with our consolidated financial statements and the financial and statistical data appearing elsewhere in this report and our 2010 Annual Report.

 

The loan portfolio quality is generally reflective of the economic status of the communities in which the Company operates, and the Company recorded a $4.0 million provision for loan losses and a net loss of $3.1 million, prior to preferred stock dividends and accretion, in the first quarter of 2011. The ongoing weakness in the financial system and economy, particularly as it relates to the credit and real estate markets continues to affect directly some borrowers’ ability to repay their loans as well as the general level of property valuations.  While this economic weakness is reflected in the operating results, management remains vigilant in analyzing the loan portfolio quality, estimating loan loss provision and making decisions to charge-off loans.  Management also remains focused on the capital planning process and continues to assess capital alternatives to help ensure capital strength is sustained to best situate the Company to pursue lending and market opportunities that may become available with an economic recovery.

 

Results of Operations

 

The net loss for the first quarter of 2011 was $.30 per diluted share on $3.1 million of net loss.  This compares to net loss of $.69 per diluted share, on $8.6 million of net loss, for the first quarter of 2010.  The decreases in interest expense, the provision for loan losses and other real estate expenses were greater than decreases in earning assets combined with increases to general bank insurance.  The Company recorded a $4.0 million provision for loan losses and net charge-offs totaled $7.2 million in the first quarter of 2011.  This compared to a provision for loan losses of $19.2 million and net charge-offs totaling $16.9 million in the first quarter of 2010.  The net loss available to common stockholders was $4.3 million for the first quarter of 2011 after preferred stock dividends and accretion of $1.2 million.  This compared to net loss available to common stockholders of $9.7 million for the first quarter of 2010 after preferred stock dividends and accretion of $1.1 million.

 

Net Interest Income

 

Net interest income decreased from $21.0 million for the quarter ended March 31, 2010 to $16.2 million for the quarter ended March 31, 2011.  The decline in net interest income was directly related to a decline in average earning assets offset in part by a general decrease in deposit interest rates, particularly on time certificates of deposits.  Average earning assets decreased $368.4 million, or 16.0%, from $2.30 billion in the first quarter of 2010, to $1.93 billion in the first quarter of March 2011.  The decrease in assets is due, in part, to the Company’s strategy to reduce the overall asset size.  This strategy is intended to allow the Bank to focus on its asset quality and maintaining its capital ratios.  Loan growth was limited throughout 2010 and the first quarter of 2011.  Consequently, average loans, including loans held for sale, decreased $371.8 million.  This decline was also due, in part, to a lower level of qualified borrower demand within the Bank’s market, combined with charge-off activity.  The level of average earning assets was also affected by transfers of loans to other real estate owned (“OREO”) and net charge-offs.  Average OREO increased $34.1 million during the first quarter of March 31, 2011, compared to the same period in 2010, as collateral from loans was converted.  Net charge-offs

 

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also decreased average loans, but the pace of this activity in 2011 decreased by $9.8 million compared to the first quarter of 2010.

 

Management has pursued a strategy of deleveraging the balance sheet in order to strengthen capital ratios. The balance sheet deleveraging has been accompanied by significant reductions in deposits that previously provided funding for loan growth and a larger securities portfolio.  Management maintained an emphasis on relationship banking throughout this period of asset reduction, focusing on customers with multiple accounts rather than single-service customers that may be associated with a higher cost of funding.  As a result, there was a decrease in average interest bearing liabilities of $351.0 million, or 17.5%, in the quarter ended March 31, 2011, compared to the same period in 2010.  The quarterly net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, decreased from 3.78% in the first quarter of 2010 to 3.42% in the first quarter of 2011.  The average tax-equivalent yield on earning assets decreased 49 basis points from 5.09% in the first quarter of 2010 to 4.60% in the first quarter of 2011.  At the same time, however, the cost of funds on interest bearing liabilities decreased from 1.57% to 1.44%, or 13 basis points, helping to offset that decrease.

 

Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios.  This includes tax-equivalent net interest income (including its individual components) and net interest margin (including its individual components) to total average interest earning assets.  Management believes that these measures and ratios provide users of the financial information with a more accurate view of the performance of the interest earning assets and interest bearing liabilities and of the Company’s operating efficiency for comparison purposes.  Other financial holding companies may define or calculate these measures and ratios differently.  See the tables and notes below for supplemental data and the corresponding reconciliations to GAAP financial measures for the three-month periods ended March 31, 2011 and 2010.

 

The following tables set forth certain information relating to the Company’s average consolidated balance sheets and reflect the yield on average earning assets and cost of average liabilities for the periods indicated.  Dividing the related interest by the average balance of assets or liabilities derives rates.  Average balances are derived from daily balances.  For purposes of discussion, net interest income and net interest income to total earning assets on the following tables 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.

 

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ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

Three Months ended March 31,  2011 and 2010

(Dollar amounts in thousands - unaudited)

 

 

 

2011

 

2010

 

 

 

Average

 

 

 

 

 

Average

 

 

 

 

 

 

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits

 

$

113,100

 

$

70

 

0.25

%

$

30,551

 

$

16

 

0.21

%

Federal funds sold

 

1,465

 

 

 

1,440

 

 

 

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

128,174

 

878

 

2.74

 

147,768

 

1,238

 

3.35

 

Non-taxable (tax equivalent)

 

14,976

 

219

 

5.85

 

75,246

 

1,146

 

6.09

 

Total securities

 

143,150

 

1,097

 

3.07

 

223,014

 

2,384

 

4.28

 

Dividends from FRB and FHLB stock

 

13,698

 

69

 

2.01

 

13,044

 

56

 

1.72

 

Loans and loans held-for-sale (1)

 

1,656,531

 

20,933

 

5.05

 

2,028,319

 

26,744

 

5.27

 

Total interest earning assets

 

1,927,944

 

22,169

 

4.60

 

2,296,368

 

29,200

 

5.09

 

Cash and due from banks

 

34,882

 

 

 

36,868

 

 

 

Allowance for loan losses

 

(78,812

)

 

 

(67,504

)

 

 

Other noninterest bearing assets

 

238,261

 

 

 

264,210

 

 

 

Total assets

 

$

2,122,275

 

 

 

 

 

$

2,529,942

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW accounts

 

$

272,092

 

$

139

 

0.21

%

$

410,086

 

$

346

 

0.34

%

Money market accounts

 

303,604

 

319

 

0.43

 

392,821

 

816

 

0.84

 

Savings accounts

 

184,861

 

118

 

0.26

 

183,331

 

223

 

0.49

 

Time deposits

 

785,937

 

3,993

 

2.06

 

885,795

 

5,097

 

2.33

 

Interest bearing deposits

 

1,546,494

 

4,569

 

1.20

 

1,872,033

 

6,482

 

1.40

 

Securities sold under repurchase agreements

 

1,754

 

 

 

19,736

 

10

 

0.21

 

Other short-term borrowings

 

3,036

 

 

 

10,509

 

18

 

0.69

 

Junior subordinated debentures

 

58,378

 

1,113

 

7.63

 

58,378

 

1,072

 

7.35

 

Subordinated debt

 

45,000

 

203

 

1.80

 

45,000

 

195

 

1.73

 

Notes payable and other borrowings

 

500

 

4

 

3.20

 

500

 

1

 

0.80

 

Total interest bearing liabilities

 

1,655,162

 

5,889

 

1.44

 

2,006,156

 

7,778

 

1.57

 

Noninterest bearing deposits

 

366,109

 

 

 

308,926

 

 

 

Other liabilities

 

19,460

 

 

 

17,031

 

 

 

Stockholders’ equity

 

81,544

 

 

 

197,829

 

 

 

Total liabilities and stockholders’ equity

 

$

2,122,275

 

 

 

 

 

$

2,529,942

 

 

 

 

 

Net interest income (tax equivalent)

 

 

 

$

16,280

 

 

 

 

 

$

21,422

 

 

 

Net interest income (tax equivalent) to total earning assets

 

 

 

 

 

3.42

%

 

 

 

 

3.78

%

Interest bearing liabilities to earning assets

 

85.85

%

 

 

 

 

87.36

%

 

 

 

 

 


(1)          Interest income from loans is shown on a TE basis as discussed below and includes fees of $525,000 and $683,000 for the first quarter of 2011 and 2010, respectively.  Nonaccrual loans are included in the above-stated average balances.

 

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Table of Contents

 

As indicated previously, net interest income and net interest income to earning assets have been adjusted to a non-GAAP 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 for the periods indicated:

 

 

 

Effect of Tax Equivalent Adjustment

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Interest income (GAAP)

 

$

22,079

 

$

28,759

 

Taxable equivalent adjustment - loans

 

13

 

40

 

Taxable equivalent adjustment - securities

 

77

 

401

 

Interest income (TE)

 

22,169

 

29,200

 

Less: interest expense (GAAP)

 

5,889

 

7,778

 

Net interest income (TE)

 

$

16,280

 

$

21,422

 

Net interest and income (GAAP)

 

$

16,190

 

$

20,981

 

Net interest income to total interest earning assets

 

3.41

%

3.71

%

Net interest income to total interest earning assets (TE)

 

3.42

%

3.78

%

 

Provision for Loan Losses

 

The Company recorded a $4.0 million provision for loan losses in the first quarter of 2011 compared to a $19.2 million provision in the first quarter of 2010 and a $14.0 million provision for loan losses in the fourth quarter of 2010.  Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio.  Nonperforming loans decreased significantly from $228.9 million at December 31, 2010, to $193.0 million at March 31, 2011, which is similar to the $192.7 million at March 31, 2010.  In the first quarter of 2011 and the fourth quarter of 2010, the Company recorded net loan charge-offs of $7.2 million and $5.9 million, respectively.  In the first quarter of 2010, the Company had net charge-offs of $16.9 million.

 

Management closely monitors portfolio quality and when available information indicates that specific loans or portions of loans are uncollectible, management charges off those amounts to reduce the outstanding loan balance.  While this reduces specific allocation estimates in the allowance for loan losses, it simultaneously reduces the estimated remaining risk of loss.  The distribution of the Company’s gross charge-off activity for the periods indicated is detailed in the first table below and the remaining nonperforming loans at March 31, 2011 are included in the table immediately following (in thousands):

 

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Table of Contents

 

 

 

Three Months Ended

 

Loan Charge-offs, Gross

 

March 31,

 

(in thousands)

 

2011

 

2010

 

Real Estate-construction

 

 

 

 

 

Homebuilder

 

$

505

 

$

6,775

 

Land

 

1,431

 

809

 

Commercial speculative

 

 

3,735

 

All other

 

34

 

215

 

Total real estate - construction

 

1,970

 

11,534

 

Real estate-residential

 

 

 

 

 

Investor

 

126

 

614

 

Owner occupied

 

856

 

1,318

 

Revolving and junior liens

 

182

 

336

 

Total real estate-residential

 

1,164

 

2,268

 

Real estate-commercial, nonfarm

 

 

 

 

 

Owner general purpose

 

2,659

 

506

 

Owner special purpose

 

1,321

 

78

 

Non owner general purpose

 

183

 

196

 

Non owner special purpose

 

761

 

231

 

Strip malls

 

770

 

2,525

 

Total real estate - commercial, nonfarm

 

5,694

 

3,536

 

Real estate-commercial, farm

 

 

 

Commercial

 

145

 

1,231

 

Other

 

114

 

97

 

 

 

$

9,087

 

$

18,666

 

 

The distribution of the Company’s nonperforming loans as of March 31, 2011 is included in the chart below (in thousands):

 

 

 

 

 

90 days

 

 

 

 

 

 

 

 

 

 

 

 

 

or More

 

Restructured

 

Total Non-

 

% Non-

 

 

 

Nonperforming loans

 

Nonaccrual

 

Past Due

 

Loans

 

performing

 

performing

 

Specific

 

as of March 31, 2011

 

Total(1)

 

and Accruing

 

(Accruing)

 

Loans

 

Loans

 

Allocation

 

Real estate - construction

 

$

53,641

 

$

267

 

$

2,220

 

$

56,128

 

29.1

%

$

5,260

 

Real estate - residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

Investor

 

14,726

 

 

514

 

15,240

 

7.9

%

2,282

 

Owner occupied

 

15,041

 

 

8,043

 

23,084

 

12.0

%

1,445

 

Revolving and junior liens

 

1,889

 

 

 

1,889

 

1.0

%

418

 

Real estate - commercial, nonfarm

 

89,242

 

 

3,132

 

92,374

 

47.9

%

9,933

 

Real estate - commercial, farm

 

1,194

 

 

 

1,194

 

0.6

%

 

Commercial

 

3,019

 

75

 

 

3,094

 

1.5

%

671

 

Other

 

5

 

 

 

5

 

0.0

%

 

 

 

$

178,757

 

$

342

 

$

13,909

 

$

193,008

 

100.0

%

$

20,009

 

 


(1) Nonaccrual loans included $28.4 million in restructured loans, including $6.5 million in real estate construction, $7.8 million in commercial real estate nonfarm,  $8.2 million in real estate - residential investor, and $5.9 million in real estate - owner occupied.

 

Commercial Real Estate

 

Commercial Real Estate Nonfarm (“CRE”) remained the largest component of nonperforming loans at $92.4 million, or 47.9% of total nonperforming loans.  This compares to $107.0 million and 46.7% at December 31, 2010, and $48.0 million and 24.9% at March 31, 2010.  The class components of the CRE segment at March 31, 2011 were as follows (dollars in thousands):

 

42


 


Table of Contents

 

 

 

Nonaccrual

 

90 Days
or More

 

Restructured
Loans

 

Total Non
performing

 

% Non
Performing

 

Specific

 

Real Estate - Commercial Nonfarm

 

Total

 

Past Due

 

(Accruing)

 

Loans

 

CRE Loans

 

Allocation

 

Owner occupied general purpose

 

$

15,132

 

$

 

$

 

$

15,132

 

16.4

%

$

1,657

 

Owner occupied special purpose

 

24,348

 

 

 

24,348

 

26.4

%

725

 

Non-owner occupied general purpose

 

17,490

 

 

2,686

 

20,176

 

21.8

%

4,161

 

Non-owner occupied special purpose

 

9,608

 

 

446

 

10,054

 

10.9

%

1,402

 

Retail properties

 

22,664

 

 

 

22,664

 

24.5

%

1,988

 

 

 

$

89,242

 

$

 

$

3,132

 

$

92,374

 

100.0

%

$

9,933

 

 

Portfolio loans secured by retail property, primarily strip malls, have been experiencing the most financial stress.  This class accounted for 11.2% of all CRE loans and 24.5% of all nonperforming CRE loans at March 31, 2011.  Almost 26.9% of total retail CRE loans are nonperforming, with $22.7 million of credit exposure at March 31, 2011.  First quarter 2011 charge-offs in the retail segment totaled $770,000 and management estimated the remaining specific allocation for nonperforming loans of $2.0 million was sufficient coverage for the remaining loss exposure at March 31, 2011.  However, there can be no guarantee that actual losses in this category will not exceed such amount.  Retail properties accounted for 13.5% of the first quarter 2011 charge-offs in CRE.

 

The owner occupied special purpose category comprised the largest component of nonperforming CRE.  At $212.8 million, this special purpose class represented 28.3% of all CRE loans.  With $24.3 million of these loans nonperforming at year end, these loans accounted for 26.4% of total nonperforming CRE.  Special purpose owner occupied credits include loans collateralized by property types such as gas stations, health and fitness centers, golf courses, restaurants, and medical office buildings.  Charge-offs in the first quarter of 2011 totaled $1.3 million in this loan class and management estimated that the specific allocation of $725,000 million was sufficient coverage for the remaining loss exposure at March 31, 2011.  However, there can be no guarantee that actual losses in this category will not exceed such amount.

 

Non-owner occupied, general purpose loans include credits that are collateralized by office, warehouse, and industrial properties and represented 23.1% of total CRE loans, and 21.8% of nonperforming CRE loans at the end of the first quarter of 2011.  First quarter 2011 charge-offs in this category were $183,000 and management estimated that $4.2 million of specific allocation was sufficient coverage for the remaining loss exposure at March 31, 2011.  However, there can be no guarantee that actual losses in this category will not exceed such amount.

 

As of March 31, 2011, owner occupied general purpose loans comprised 22.3% of CRE, and 16.4% of nonperforming CRE loans.  Charge-offs totaled $2.7 million in the first quarter of 2011, and management estimated that specific allocations of $1.7 million were sufficient coverage for the remaining loss exposure at March 31, 2011.  However, there can be no guarantee that actual losses in this category will not exceed such amount.

 

Non-owner occupied, special purpose loans represented 15.1% of the CRE portfolio, and 10.9% of nonperforming CRE loans at the end of the first quarter of 2011.  In the first quarter, a charge-off of $761,000 was recorded, and management estimated that a specific allocation of $1.4 million was sufficient coverage for the remaining loss exposure at March 31, 2011.  However, there can be no guarantee that actual losses in this category will not exceed such amount.

 

In addition to the specific allocations detailed above, in accordance with GAAP, in the second quarter of 2009 management created a higher risk commercial real estate pool loss factor for certain CRE loans to be directionally consistent with observable trends within the loan portfolio segments and with continued deteriorating market conditions.  These loans typically have a deficiency in cash flow coverage from the property securing the credit, but other supporting factors such as liquidity, guarantor capacity, sufficient global cash flow coverage or cooperation from the borrower is evident to support the credit.  These deficiencies in cash flow coverage are typically attributable to vacancy that is expected to be temporary or reduced operating income from the owner-occupant due to cyclical impacts from the

 

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Table of Contents

 

recession.  The pool also includes cases where the property securing the credit has adequate cash flow coverage, but the borrower has other economic stress indicators to warrant heightened risk treatment.  Management estimated additional reserves of $6.8 million in the first quarter of 2011, based upon the amount of loans within this pool at March 31, 2011.  The combination of reduced specific loan loss allocations and increased general allocation from the high risk pool resulted in an additional $1.7 million of estimated loss coverage in the first quarter of 2011.

 

Construction and Development

 

At March 31, 2011, nonperforming construction and development (“C & D”) loans totaled $56.1 million, or 29.1% of total nonperforming loans.  This is a decrease from $68.0 million at December 31, 2010.  In the first quarter of 2011, the bank effectively executed a $10.0 million loan sale on a large single borrower that contributed to the 17.5% reduction in nonperforming C & D loans. The loan sale was executed at the remaining book value of the loan, after charge-offs of $846,000 in the first quarter of 2011 and 478,000 in the third quarter of 2010.  Of the $104.6 million of total C & D loans in the portfolio, 53.6% of all construction loans were nonperforming as of March 31, 2011, as compared to 39.7% at March 31, 2010, and 52.5% at December 31, 2010.  Total C & D charge-offs for the first quarter of 2011 were $2.0 million, as compared to $3.6 million in the fourth quarter 2010.  Following that charge-off activity, management estimated that specific allocations of $5.3 million were sufficient coverage for the remaining loss exposure in this segment at March 31, 2011.  However, there can be no guarantee that actual losses in this category will not exceed such amount.  The majority of the Bank’s C & D loans are located in suburban Chicago markets, predominantly in the far western and southwestern suburbs.  The Bank’s loan exposure to credits secured by builder home inventory is down 54.4% from a year ago.

 

Management closely monitors the performing loans that have been rated as “watch” or “substandard” but accruing.  While some additional adverse migration is still possible, management believes that much of the remaining performing C & D borrowers have demonstrated sufficient operating strength through an extended period of weak construction to avoid classification as an impaired credit.  As a result, management believes future losses in the construction segment will continue to trend downward.  In addition to reviewing the operating performance of the borrowers when reviewing allowance estimates, management also continues to update underlying collateral valuation estimates to reflect the aggregate estimated credit exposure.  While management observed some continuation in the decreasing trend in collateral valuation, it has also observed that the rate of property valuation decline has generally slowed.

 

In addition to specific allocations detailed above, management created a higher risk C & D pool loss factor estimate for developers in accordance with GAAP at the end of 2008.  That pool was designed to capture general losses in the portfolio attributable to the construction segment, because of the emerging market risks identified by management in the economic cycle.  Because no similar event had been experienced in the Company’s recent history, management estimated that the historical loss portion of the allowance calculation would not capture the probability of additional loss in that pool segment.  While that estimate was appropriate at that point in the cycle, the volume of credits in that pool steadily diminished and the estimated losses were recognized as described above.  Management also monitored borrower operating results and other characteristics, including the collateral composition of the credits subject to this factor.  On the latter point management observed this profile changed from 2009, where the majority was homebuilder lot inventory loans with greater loss exposure, to the third quarter of 2010, where the majority of the borrowers had buildings that were nearly finished and management estimated a lesser loss exposure.  Management noted the above improving trends and eliminated the special pool factor for construction as of September 30, 2010, in accordance with GAAP. Further, management’s estimated historical loss factor for construction required $7.2 million in reserves at March 31, 2011 and $13.0 million in reserves at December 31, 2010, whereas that factor called for virtually no reserves at the end of 2008.

 

The following table illustrates management’s change in C & D estimates of provision for loan loss on a quarterly basis (in millions):

 

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Table of Contents

 

 

 

Portfolio

 

Specific
Allocation

 

General
Allocation

 

December 31, 2010

 

$

129.6

 

$

3.7

 

$

14.6

 

March 31, 2011

 

104.6

 

5.3

 

8.1

 

 

Residential Real Estate

 

Nonperforming 1-4 family residential mortgages to consumers totaled $23.1 million, or 12.0% of the nonperforming loan total as of March 31, 2011.  This segment totaled $25.5 million in nonperforming loans at December 31, 2010, compared to $27.4 million at March 31, 2010.  While Kendall, Kane and Will counties experienced high rates of foreclosure in both 2009 and 2010, the Bank has experienced relatively stable nonperforming totals.  Of the nonperforming loans in this category, $8.0 million, or 34.8%, are to homeowners enrolled in the Bank’s foreclosure avoidance program and are classified as restructured at March 31, 2011.  The typical concessions granted in these cases were small and temporary rate reductions and a reduced monthly payment.  The usual profile of these borrowers includes a decrease in household income resulting from a change or loss of employment.  It has been management’s experience that these borrowers typically resume normal performance on their obligations when their earnings situation improves.  The remaining nonperforming loans in the 1-4 family residential category are in nonaccrual status and most cases are in various stages of foreclosure.  The Bank did not offer subprime mortgage products to its customers and management believes that the deterioration in this segment relates primarily to the high rate of unemployment in our market area.  In addition, a significant portion of these nonperforming loans were supported by private mortgage insurance, and, at March 31, 2011, management estimated that a specific allocation of $1.4 million was adequate loss coverage following the $856,000 of charge-offs that occurred during the quarter.  However, there can be no guarantee that actual losses in this category will not exceed such amount.  At March 31, 2011, there were no loans that were greater than 90 days past due and were still accruing interest in this portfolio segment.  Additionally, at March 31, 2011, loans 30 to 89 days past due and still accruing totaled $6.4 million, which was an increase from $5.1 million at December 31, 2010, but an improvement from $9.6 million at March 31, 2010.

 

Nonperforming residential investor loans consist of multi-family and 1-4 family properties and totaled $15.2 million, or 7.9% of the nonperforming loans total.  This was a decrease from $22.2 million at December 31, 2010, and a decrease from $24.9 million at March 31, 2010.  Following the first quarter charge-off of $126,000, management estimated that a total specific allocation of $2.3 million would be sufficient loss reserves at March 31, 2011 for the remaining risk in this category.  Management also noted that the remaining loss exposure was centered in loans collateralized by first mortgages on 1-4 family investor loans that total $12.1 million of this category.  However, there can be no guarantee that actual losses in this category will not exceed such amount.  The remaining nonperforming multi-family loans totaled $3.1 million.  Management observed the typical profile of the nonperforming multi-family investor was where the property has decreased net operating income, due to both higher vacancy and higher past due collection rates.  Those trends have generally stabilized in the portfolio and many multi-family borrowers were reporting improved cash flow from operations as of March 31, 2011, compared to March 31, 2010.

 

Other

 

The remaining nonperforming credits included $3.1 million in commercial and industrial loans, $1.9 million in consumer home equity and second mortgage loans and $1.2 million in farmland and agricultural loans.  At March 31, 2011, management estimated that a total specific allocation of $671,000 on the commercial and industrial portfolio would be sufficient loss coverage for the remaining risk in those nonperforming credits, and that $418,000 was sufficient loss coverage for the consumer loan segment.  However, there can be no guarantee that actual losses in this category will not exceed such amount.  These estimated amounts were following charge-offs in the first quarter of 2011 of $145,000 in commercial and industrial loans, and $182,000 in consumer home equity loans.

 

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Other Troubled Loans

 

Loans that were classified as performing but 30 to 89 days past due and still accruing interest decreased to $12.2 million at March 31, 2011 from $44.0 million at March 31, 2010 and $13.9 million at December 31, 2010.  At March 31, 2011, loans 30 to 89 days past due consisted of $6.4 million in 1-4 family consumer mortgages, $1.8 million in commercial real estate credits, $2.2 million in residential investor credits, $49,000 in construction and development, $429,000 in commercial and industrial loans, $139,000 in consumer installment loans and $1.1 million in home equity loans.  Troubled debt restructurings (“TDR”) in accrual status total $13.9 million, which was a decrease from $15.6 million on a linked quarter basis.  Accruing TDRs included $8.0 million in consumer mortgages in the foreclosure avoidance program discussed previously, $2.2 million in restructured residential lot inventory loans to builders, $514,000 in 1-4 family investor mortgages, and $3.1 million in non-owner occupied commercial real estate.

 

Nonaccrual TDR loans totaled $28.4 million as of March 31, 2011.  These credits, which have not demonstrated a sustained period of financial performance, include the following:

 

·                  Investor mortgages on 1-4 properties totaling $6.7 million, with $6.3 million of that amount attributable to one relationship.  That borrower was enrolled in a forbearance program that included financial concessions in March 2009, with an interim plan to stabilize performance.  The borrower performed acceptably under the interim agreement for one year, but the borrower became uncooperative in the process of completing the formal restructuring plan in early 2010 and management is now pursuing a liquidation strategy.

 

·                  Consumer residential mortgages in the amount of $5.9 million with either borrowers who fell past due under normal terms and then enrolled in the foreclosure avoidance program, or credits that were previously enrolled in that program, but have now moved into foreclosure or other workout status.  Based on our limited foreclosure program experience to date, management estimates that approximately 50% of these credits will eventually return to performing status and the remainder will become foreclosures.

 

·                  A $3.6 million loan on a retail strip mall property that was placed in forbearance in early 2009, and then restructured in early 2010.  The credit has performed acceptably under the modified terms, but credit characteristics were too weak to merit a return to accrual status and the owner/guarantor is attempting to negotiate a short sale or deed in lieu arrangement.

 

·                  TDR loans totaling $5.6 million that were made to homebuilders and developers and collateralized by lots and land.  These were primarily builder loans that failed to perform under modified terms and are in the process of foreclosure and deed-in-lieu arrangements.  The original modifications in these cases were generally designed to encourage the borrowers to achieve an orderly sale of the collateral in liquidation, but have not been successful.

 

·                  A $1.6 million credit that is secured by an office building and the terms of the credit were modified by Chapter 11 bankruptcy reorganization.  The effect of the modified terms would produce a very small concession.  Management is not confident the entire amount allowed by the court is collectible and has estimated a larger impairment charge based upon a collateral-dependent analysis, although the borrower is performing according to these modified terms.  A more formal post-bankruptcy restructuring is being considered and such an event may allow a portion of this credit to return to performing status in 2011.

 

Management estimated the quarterly value of TDRs in liquidation status on a collateral dependency basis, and believed that specific allocation estimates at March 31, 2011 were sufficient coverage for the remaining loss exposure in this category.

 

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The coverage ratio of the allowance for loan losses to nonperforming loans was 37.9% as of March 31, 2011, which was an increase from 33.3% as of December 31, 2010.  The linked quarter increase in this ratio was largely driven by a $35.9 million, or 15.7%, reduction in nonperforming loans.  Management updated the estimated specific allocations in the first quarter after receiving more recent appraisal collateral valuations or information on cash flow trends related to the impaired credits.  The estimated general allocations decreased by $202,000 as the overall loan balances subject to general factors decreased at March 31, 2011, even though the pooled commercial real estate segment increased and somewhat offset that decline.  Management determined the estimated amount to provide in the allowance for loan losses based upon a number of factors, including loan growth or contraction, the quality and composition of the loan portfolio and loan loss experience.  The latter item was also weighted more heavily based upon recent increased loss experience.  Management created a higher risk construction and development pool for developers and estimated a higher qualitative loss factor at the end of 2008, and as discussed previously in the construction loan section of this narrative, that pool was determined to no longer be necessary as of September 30, 2010.  This change was made because of diminished migration potential, the more favorable credit characteristics of the remaining construction portfolio, and higher historical loss factors that management now estimates to be adequate coverage for the remaining risk of loss in the construction portfolio.

 

Management also created a higher risk pool within commercial real estate loans and assigned a higher qualitative risk factor for those segments of that portfolio in the second quarter of 2009.  Management regularly reviews the performance of that pool and adjusts the population and the related loss factors taking into account adverse market trends including collateral valuation as well as its assessments of the credits in that pool.  Those assessments capture management’s estimate of the potential for adverse migration to an impaired status as well as its estimation of what the potential valuation impact from that migration would be if it were to occur.  Management slightly decreased the quantity of assets subject to this pool factor by 2.6% in the first quarter.  Management increased the loss factor by 6% assigned to this pool based on its observations of weakness in some CRE sectors.  Management also observed that stresses in those credits were attributable to cyclical economic events that were showing some signs of stabilization.  Those signs included a reduction in loan migration to watch status, as well as a decrease in 30 to 89 day past due loans and some stabilization in values of certain properties.

 

The above changes in estimates were made by management to be consistent with observable trends within loan portfolio segments and in conjunction with market conditions and credit review administration activities.  These environmental factors are evaluated on an ongoing basis and are included in the assessment of the adequacy of the allowance for loan losses.  When measured as a percentage of loans outstanding, the total allowance for loan losses increased from 4.51% of total loans as of December 31, 2010, to 4.57% of total loans at March 31, 2011.  In management’s judgment, an adequate allowance for estimated losses has been established; however, there can be no assurance that actual losses will not exceed the estimated amounts in the future.

 

As discussed above, nonperforming loans include loans in nonaccrual status, troubled debt restructurings, and loans past due ninety days or more and still accruing interest.  The comparative nonperforming loan totals and related disclosures for the period ended March 31, 2011 and December 31, 2010 were as follows (in thousands):

 

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March 31, 2011

 

December 31, 2010

 

Nonaccrual loans (including restructured)

 

$

178,757

 

$

212,225

 

Accruing restructured loans

 

13,909

 

15,637

 

Interest income recorded on nonaccrual loans

 

62

 

4,382

 

Interest income which would have been accrued on nonaccrual loans

 

3,391

 

17,234

 

Loans 90 days or more past due and still accruing interest

 

342

 

1,013

 

 

The Bank had no commitments to any borrower whose loans were classified as impaired at March 31, 2011 or December 31, 2010.  Additional details and discussion related to interest rate swap derivatives and commitments is found in Note 17 to the financial statements provided in this form 10-Q.

 

Other Real Estate

 

Other real estate owned (“OREO”) increased $10.0 million from $75.6 million at December 31, 2010, to $85.6 million at March 31, 2011.  In the first quarter of 2011, management successfully converted collateral securing problem loans to properties ready for disposition in the amount of $19.5 million.  Additionally $2.0 million in development improvements were added to OREO in the first quarter.  First quarter additions were offset by $2.4 million in valuation adjustments and $9.1 million in dispositions which generated a net gain on sale of $234,000.  The Bank added 40 properties to OREO during the first quarter, which brought the total OREO holdings to 245 properties.  These OREO properties consisted of different types, including 109 single-family residences, with an estimated realizable market value of $8.5 million, 49 non-farm, nonresidential properties, with an estimated value of $42.6 million, a number of residential and commercial lots with an estimated realizable market value of $22.5 million, and 12 parcels of vacant acreage suitable for either farming or development with an estimated value of $11.9 million.  Details related to the activity in the OREO portfolio for the periods presented are itemized in the following table (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

Beginning balance

 

$

75,613

 

$

40,200

 

Property additions

 

19,451

 

18,838

 

Development improvements

 

2,022

 

10

 

Less:

 

 

 

 

 

Property disposals

 

9,123

 

4,102

 

Period valuation adjustments

 

2,393

 

5,091

 

Other real estate owned

 

$

85,570

 

$

49,855

 

 

When measured as a percentage of other real estate properties owned, the OREO valuation reserve decreased to $21.9 million, which is 20.4% of gross OREO at March 31, 2011.  The valuation reserve represented 22.7% of gross OREO at December 31, 2010.  In management’s judgment, an adequate property valuation allowance has been established; however, there can be no assurance that actual valuation losses will not exceed the estimated amounts in the future.

 

Noninterest Income

 

Noninterest income increased $1.0 million, or 12.4%, to $9.3 million during the first quarter of 2011, compared to $8.3 million during the same period in 2010.  Trust income increased by $127,000, or 7.7%, for the first quarter of 2011.  The increase in revenue was primarily due to an increase in estate settlement activity and investment advisory fees, partially offset by a reduction in personal trust income.  Service charge income from deposit accounts decreased for the quarter primarily due to decreases in

 

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overdraft fees, which have declined industry wide in keeping with recent regulatory changes.  Total mortgage banking income in the first quarter of 2011, including net gain on sales of mortgage loans, secondary market fees, and servicing income, was $1.8 million, an increase of $290,000, or 18.8%, from the first quarter of 2010. The increase was primarily the result of a $79,000 increase in gains on sales of mortgage loans and a $207,000 increase in servicing income.

 

Realized gains on securities totaled $139,000 in the quarter ended March 31, 2011 compared to a $2,000 realized loss for the same period in the prior year.  Bank owned life insurance (“BOLI”) income increased by $34,000, or 7.9%, in the first quarter of 2011 compared to the same period in 2010, as the underlying investment performance was stronger in 2011.  Debit card interchange income increased $37,000 for the quarter as the volume of consumer card activity remained strong in the first quarter.  Lease revenue received from OREO properties increased $2,000 in the quarter ended March 31, 2011, compared to the prior year.  The Bank had a net gain of $234,000 on disposal of OREO in the first quarter of 2011, which was an increase of $83,000 from the same period in 2010.  Other noninterest income increased $508,000 for the first quarter ended March 31, 2011, compared to the same period in 2010, largely due to miscellaneous income, including prior year interest from loans removed from nonaccrual status, as well as an increase in ATM surcharge and transaction-related fees.

 

Noninterest Expense

 

Noninterest expense was $24.6 million during the first quarter of 2011, a decrease of $151,000, from $24.7 million in the first quarter of 2010. Increases for the quarter were in legal fees, FDIC insurance, general bank insurance, debit card interchange expense and other expenses.  These were more than offset by reductions in OREO expenses as well as salaries and occupancy related expenses.  Salaries and benefits expense decreased by $96,000, or 1.1%, in the first quarter of 2011 compared to same period in 2010.  These reductions in salaries and benefits expense resulted primarily from a decrease in salary expense, partially offset by an increase in group medical expenses.  The number of full time equivalent employees decreased to 505 for the first quarter of 2011, compared to 548 at the same time last year.

 

Occupancy expense decreased $180,000, or 11.8%, from the first quarter of 2010 to the first quarter of 2011.  Furniture and fixture expenses also decreased by $179,000 in the first quarter ended March 31, 2011, as compared to the same period in the prior year.  In the first quarter of 2010, the Company closed three branches where there was an overlap in service area.  As a result of these closures, management has been able to realize lower costs in both the occupancy and furniture and fixtures categories.

 

Federal Deposit Insurance Corporation (“FDIC”) costs increased $311,000, or 21.8%, for the quarter ended March 31, 2011 as compared to the prior year.  As previously announced, the Board of Directors of the FDIC voted to propose a comprehensive, long-range plan for deposit insurance fund management in response to changes to the FDIC’s authority to manage the Deposit Insurance Fund contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act.  As part of the fund management plan, the Board adopted a new Restoration Plan to ensure that the fund reserve ratio reaches 1.4% percent by September 30, 2020, as required.  That Restoration Plan also foregoes the uniform 3 basis point assessment rate increase previously scheduled to go into effect January 1, 2011, and keeps the current rate schedule in effect.

 

General bank insurance increased $685,000 for the first quarter of 2011 when compared to the same period in 2010.  First quarter of 2011 advertising expense decreased by $23,000, or 9.0%, when compared to the same period in 2010.  Legal fees increased $384,000 in a quarterly comparison, and were primarily related to loan workouts and the Company’s ongoing review of its capital initiatives and alternatives.

 

OREO expense decreased $1.1 million, or 17.3%, from $6.4 million in the quarter ended March 31, 2010, to $5.3 million for the same period in 2011.  The decrease for the quarter was primarily due to a decrease in valuation expense of $2.8 million, or 54.3%, when compared to the same period in the prior

 

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year. This decrease was partially offset by increases to OREO real estate taxes and other expenses incurred in administering OREO.  Other expense increased $51,000, or 1.6%, in the first quarter of 2011 when compared to the same period in 2010.

 

Income Taxes

 

The Company did not record an income tax benefit for the first quarter of 2011, despite a $3.1 million pre-tax loss during that period, due to the establishment of a valuation allowance against the Company’s deferred tax assets established as of December 31, 2010.  Under generally accepted accounting principles, income tax benefits and the related tax assets are only allowed to be recognized if they will “more likely than not” be fully realized.  As a result, as of March 31, 2011 the net amount of the Company’s deferred tax assets related to operations has been reduced to zero.  An income tax benefit of $6.2 million was recorded in the first quarter of 2010.  The Company’s taxable book loss significantly decreased in the first quarter of 2011 compared to the same period in 2010, primarily due to the results of our operations.  The Company’s effective tax rate for the quarter ending March 31, 2011, was 0% as compared to 41.9% for the same period in 2010.  The income tax benefit for 2010 resulted, in large part, from the higher levels of loan loss provision and other real estate related expenditures.

 

The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future income, available tax planning strategies, and assessments of the current and future economic and business conditions.  Management considered both positive and negative evidence regarding the ultimate realizability of the deferred tax assets, which is largely dependent upon the ability to derive benefits based upon future taxable income.  Management determined that realization of the deferred tax asset was not “more likely than not” as required by accounting principles and established a valuation allowance at December 31, 2010 to reflect this judgment.  A deferred tax asset of $2.1 million related to accumulated other comprehensive loss resulting from the net unrealized loss on available-for-sale securities remains at both March 31, 2011, and December 31, 2010.  An increase in rates will generally cause a decrease in the fair value of individual securities and results in changes in unrealized loss on available-for-sale securities, while a decrease in rates generally causes an increase in fair value at a point in time.  In addition to the impact of rate changes upon pricing, uncertainty in the financial markets can cause reduced liquidity for certain investments and those changes are discussed in detail in Note 2 to the consolidated financial statements.  Management has both the ability and intent to retain an investment in available-for-sale securities.  In each future accounting period, the Company’s management will reevaluate whether the current conditions in conjunction with positive and negative evidence support a change in the valuation allowance against its deferred tax assets.  Any such subsequent reduction in the estimated valuation allowance would lower the amount of income tax expense recognized in the Company’s consolidated statements of operations in future periods.

 

Financial Condition

 

Assets

 

Total assets decreased $8.5 million, or 0.4%, from December 31, 2010 to close at $2.12 billion as of March 31, 2011.  Loans decreased by $88.4 million, or 5.2%, as management continued to emphasize capital management and credit quality and overall demand from qualified borrowers continued to decline.  At the same time, loan charge-off activity reduced balances and collateral that previously secured loans moved to OREO.  As a result, the latter asset category increased $10.0 million, or 13.2%, for the quarter ended March 31, 2011.  Available-for-sale securities decreased by $6.4 million for the quarter ended March 31, 2011.  At the same time, net cash equivalents increased despite a general balance sheet deleveraging.

 

The core deposit and other intangible assets related to the Heritage Bank acquisition in February 2008 and were $8.9 million at acquisition as compared to $5.3 million as of March 31, 2011.

 

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Management performed an annual review of the core deposit and other intangible assets as of December 31, 2010.  Based upon that review and ongoing quarterly monitoring, management determined there was no impairment of other intangible assets as of March 31, 2011.  No assurance can be given that future impairment tests will not result in a charge to earnings.

 

Loans

 

Total loans were $1.60 billion as of March 31, 2011, a decrease of $88.4 million from $1.69 billion as of December 31, 2010.  The decrease was primarily attributable to declining demand from qualified borrowers, but also included loan charge-offs, net of recoveries, of $7.2 million in the first quarter of 2011.  The largest changes by loan type included decreases in commercial real estate, real estate construction and residential real estate loans of $26.9 million, $25.0 million and $26.3 million, or 3.3%, 19.3% and 4.7%, respectively.  Management intends to make future reductions to portfolio concentrations in real estate in keeping with the requirements of the MOU between the Bank and the OCC, as previously disclosed.

 

The loan portfolio generally reflects the profile of the communities in which the Company operates, and the local economy has been affected by the overall decline in economic conditions that has been experienced nationwide.  The adverse economic conditions continue to affect financial markets generally, and real estate related activity, including valuations and transactions, have been distressed.  Because the Company is located in a growth corridor with significant open space, real estate lending (including commercial, residential, and construction) has been and continues to be a sizeable portion of the portfolio.  These categories comprised 89.3% of the portfolio as of March 31, 2011 compared to 89.2% of the portfolio as of December 31, 2010.  The Company remains committed to overseeing and managing its loan portfolio to attempt to avoid unnecessarily high credit concentrations in accordance with its MOU with the OCC as well as general interagency guidance on risk management.  Consistent with those commitments, management updated its asset diversification plan and policy, and anticipates that the percentage of real estate lending to the overall portfolio will continue to decrease in the future as result of that process.     Commercial and industrial and installment loans also decreased $9.3 million, or 5.3%, and $352,000, or 7.0%, respectively, from December 31, 2010 to March 31, 2011.  Almost all of these decreases were attributable to decreased demand from qualified borrowers, although there was $145,000 in commercial and industrial loans that were charged off in the first quarter of 2011.

 

Securities

 

Securities available-for-sale totaled $142.2 million as of March 31, 2011, a decrease of $6.4 million, or 4.3%, from $148.6 million as of December 31, 2010.  The largest category decrease was in collateralized mortgage obligations (“CMO”) followed close behind by a decrease in the United States government agency mortgage backed securities.  CMOs decreased $4.0 million, or 100.0%, whereas the United States government agency mortgage backed securities decreased $3.5 million, or 4.5% in the first quarter of 2011.  The decrease in CMOs was primarily due to the sale of securities, whereas the decreases in agency mortgage backed securities were attributable to the receipt of pass-through payments.

 

The net unrealized losses, net of deferred tax benefit, in the portfolio decreased by $88,000 from $3.1 million as of December 31, 2010 to $3.0 million as of March 31, 2011.  Additional information related to securities available-for-sale is found in Note 2.

 

Deposits and Borrowings

 

Total deposits decreased $6.2 million, or 0.3%, during the quarter ended March 31, 2011, to close at $1.90 billion.  The deposit segments that declined the most in this period were time certificates of deposits, which declined $27.7 million, or 3.5%, followed by interest bearing saving, NOW and money markets, which in the aggregate decreased $19.6 million, or 2.5%.  The decrease in time deposits occurred primarily due to management’s pricing strategy that required customers to have a core deposit relationship with the Bank to receive a higher rate on time deposits.  The Bank continues to comply with

 

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the brokered deposit guidelines contained within its MOU with the OCC.  NOW accounts decreased by $38.2 million, from $304.3 million to $266.1 million, during the quarter ended March 31, 2011.  At the same time, noninterest bearing demand deposits increased by $41.1 million, or 12.4%, and savings and money market deposits increased by $13.0 million, or 7.2%, and $5.6 million, or 1.9%, respectively.  Market interest rates decreased generally and the average cost of interest bearing deposits decreased from 1.40% in the first quarter of 2010 to 1.20%, or 20 basis points, in the first quarter of 2011.  Similarly, the average total cost of interest bearing liabilities decreased 13 basis points from 1.57% in the first quarter of 2010 to 1.44% in the first quarter of 2011.

 

One of the Company’s most significant borrowing relationships continued to be the $45.5 million credit facility with LaSalle Bank National Association (now Bank of America).  That credit facility, which began in January 2008, was originally comprised of a $30.5 million senior debt facility, which included a $30.0 million revolving line that matured on March 31, 2010, and $500,000 in term debt as well as $45.0 million of subordinated debt.  The Company had no principal outstanding balance on the Bank of America senior line of credit when it matured, but did have $500,000 in principal outstanding in term debt and $45.0 million in principal outstanding in subordinated debt at the end of both December 31, 2010 and March 31, 2011.  The term debt is secured by all of the outstanding capital stock of the Bank.  The Company has made all required interest payments on the outstanding principal amounts on a timely basis.

 

The credit facility agreement contains usual and customary provisions regarding acceleration of the senior debt upon the occurrence of an event of default by the Company under the agreement, as described therein.  The agreement also contains certain customary representations and warranties and financial and negative covenants.  At March 31, 2011, the Company continued to be out of compliance with two of the financial covenants contained within the credit agreement.  The agreement provides that upon an event of default as the result of the Company’s failure to comply with a financial covenant, the lender may (i) terminate all commitments to extend further credit, (ii) increase the interest rate on the revolving line of the term debt (together the “Senior Debt”) by 200 basis points, (iii) declare the Senior Debt immediately due and payable and (iv) exercise all of its rights and remedies at law, in equity and/or pursuant to any or all collateral documents, including foreclosing on the collateral.  The total outstanding principal amount of the Senior Debt is the $500,000 in term debt.  Because the subordinated debt is treated as Tier 2 capital for regulatory capital purposes, the Agreement does not provide the lender with any rights of acceleration or other remedies with regard to the Subordinated Debt upon an event of default caused by the Company’s failure to comply with a financial covenant.  In November 2009, the lender provided notice to the Company that it was invoking the default rate, thereby increasing the rate on the term debt by 200 basis points retroactive to July 30, 2009.  This action by the lender resulted in nominal additional interest expense as it only applies to the $500,000 of outstanding term debt.

 

The Company increased its other short-term borrowings $438,000, or 10.6%, from December 31, 2010.  This increase is related to Treasury Tax & Loan (“TT&L”) deposits.  The Bank is a TT&L depository for the FRB and, as such, accepts TT&L deposits.  The Company is allowed to hold these deposits for the FRB until they are called.

 

Capital

 

As of March 31, 2011, total stockholders’ equity was $80.2 million, which was a decrease of $3.8 million, or 4.5%, from $84.0 million as of December 31, 2010.  This decrease was primarily attributable to the net loss from operations in the first quarter of 2011.  As of March 31, 2011, the Company’s regulatory ratios of total capital to risk-weighted assets, Tier 1 capital to risk-weighted assets and Tier 1 leverage decreased to 11.65%, 6.04%, and 4.88%, respectively, compared to 11.46%, 6.09%, and 4.74%, respectively, at December 31, 2010.  The Company, on a consolidated basis, exceeds the minimum ratios to be deemed “adequately capitalized” under regulatory defined capital ratios at March 31, 2011.  The same capital ratios at the Bank were 11.97%, 10.68%, and 8.64%, respectively, at March 31, 2011 compared to 11.63%, 10.34%, and 8.10%, at December 31, 2010.  While the Bank’s ratios increased and

 

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exceeded the general minimum regulatory requirements to be considered “well capitalized”, it still was not in compliance with the heightened capital ratios that it has agreed to maintain pursuant to an understanding with the OCC. Specifically, the Bank’s Board of Directors agreed to meet by December 31, 2009, and thereafter maintain, a total risk-based capital ratio of at least 11.25%, and a Tier 1 capital ratio of at least 8.75%.  The Bank achieved these heightened regulatory capital ratios by December 31, 2009 and remained in compliance through March 31, 2010. As disclosed above, the Bank was in compliance with the heightened total capital to risk-weighted assets ratio at March 31, 2011, but not the heightened Tier 1 leverage ratio, due to net losses that have been incurred since the first quarter of 2010.  As a result of the Bank’s continuing financial difficulties and heightened levels of nonperforming loans as well as the Bank’s failure to be in full compliance with the agreed-upon capital ratios, management expects that the OCC will replace the current MOU with a formal regulatory enforcement action.

 

In addition to the above regulatory ratios, the Company’s non-GAAP tangible common equity to tangible assets and the Tier 1 common equity to risk-weighted assets also decreased to 0.22% and 0.31%, respectively, at March 31, 2011, compared to 0.40% and 0.52%, respectively, at December 31, 2010.

 

As previously announced, the Company has elected to defer regularly scheduled interest payments on $58.4 million of junior subordinated debentures related to the trust preferred securities issued by its two statutory trust subsidiaries, Old Second Capital Trust I and Old Second Capital Trust II.  Because of the deferral on the subordinated debentures, the trusts will defer regularly scheduled dividends on their trust preferred securities.  The total accumulated interest on the junior subordinated debentures including compounded interest from July 1, 2010 on the deferred payments totaled $3.4 million at March 31, 2011.

 

The Company has also suspended quarterly cash dividends on its outstanding Fixed Rate Cumulative Perpetual Preferred Stock, Series B, issued to the U.S. Department of the Treasury in connection with the Company’s participation in the TARP Capital Purchase Program as well as suspending dividends on its outstanding common stock.  The dividends have been deferred since November 15, 2010, and while in deferral these dividends are compounded quarterly.  The accumulated TARP preferred stock dividends totaled $2.3 million at March 31, 2011.

 

Under the terms of the subordinated debentures, the Company is allowed to defer payments of interest for 20 quarterly periods without default or penalty, but such amounts will continue to accrue. Also during the deferral period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock, including the TARP preferred stock. Under the terms of the TARP preferred stock, the Company is required to pay dividends on a quarterly basis at a rate of 5% per year for the first five years, after which the dividend rate automatically increases to 9%. Dividend payments on the TARP preferred stock may be deferred without default, but the dividend is cumulative and therefore will continue to accrue and, if the Company fails to pay dividends for an aggregate of six quarters, whether or not consecutive, the holder will have the right to appoint representatives to the Company’s board of directors. The terms of the TARP preferred stock also prevent the Company from paying cash dividends on or repurchasing its common stock while TARP preferred stock dividends are in arrears.

 

In addition to the above regulatory ratios, the non-GAAP tangible common equity to tangible assets and the Tier 1 common equity to risk-weighted assets also decreased to 0.22% and 0.31%, respectively, at March 31, 2011 as compared to 0.40% and 0.52%, respectively, at December 31, 2010.  Management also discloses these non-GAAP ratios to be consistent with industry practice and the table below provides an enumeration of the components of each those non-GAAP equity ratios disclosed above to the most comparable GAAP equivalent.

 

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(unaudited)

 

(unaudited)

 

 

 

As of March 31,

 

December 31,

 

 

 

2011

 

2010

 

2010

 

 

 

(dollars in thousands)

 

Tier 1 capital

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

80,186

 

$

187,740

 

$

83,958

 

Tier 1 adjustments:

 

 

 

 

 

 

 

Trust preferred securities

 

27,743

 

56,625

 

29,029

 

Cumulative other comprehensive income

 

3,042

 

1,916

 

3,130

 

Disallowed intangible assets

 

(5,296

)

(6,372

)

(5,525

)

Disallowed deferred tax assets

 

(2,129

)

(44,221

)

(2,064

)

Other

 

(433

)

(282

)

(390

)

Tier 1 capital

 

$

103,113

 

$

195,406

 

$

108,138

 

 

 

 

 

 

 

 

 

Total regulatory capital

 

 

 

 

 

 

 

Tier 1 capital

 

$

103,113

 

$

195,406

 

$

108,138

 

Tier 2 additions:

 

 

 

 

 

 

 

Allowable portion of allowance for loan losses

 

21,992

 

26,292

 

22,875

 

Additional trust preferred securities disallowed for tier 1 captial

 

28,882

 

 

27,596

 

Subordinated debt

 

45,000

 

45,000

 

45,000

 

Other Tier 2 capital components

 

(7

)

(8

)

(7

)

Total regulatory capital

 

$

198,980

 

$

266,690

 

$

203,602

 

 

 

 

 

 

 

 

 

Tangible common equity

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

80,186

 

$

187,740

 

$

83,958

 

Less:  Preferred equity

 

70,151

 

69,254

 

69,921

 

Intangible assets

 

5,296

 

6,372

 

5,525

 

Tangible common equity

 

$

4,739

 

$

112,114

 

$

8,512

 

 

 

 

 

 

 

 

 

Tier 1 common equity

 

 

 

 

 

 

 

Tangible common equity

 

$

4,739

 

$

112,114

 

$

8,512

 

Tier 1 adjustments:

 

 

 

 

 

 

 

Cumulative other comprehensive income

 

3,042

 

1,916

 

3,130

 

Other

 

(2,562

)

(44,503

)

(2,454

)

Tier 1 common equity

 

$

5,219

 

$

69,527

 

$

9,188

 

 

 

 

 

 

 

 

 

Tangible assets

 

 

 

 

 

 

 

Total assets

 

$

2,115,406

 

$

2,497,685

 

$

2,123,921

 

Less: 

 

 

 

 

 

 

 

Intangible assets

 

5,296

 

6,372

 

5,525

 

Tangible assets

 

$

2,110,110

 

$

2,491,313

 

$

2,118,396

 

 

 

 

 

 

 

 

 

Total risk-weighted assets

 

 

 

 

 

 

 

On balance sheet

 

$

1,659,385

 

$

1,995,403

 

$

1,723,519

 

Off balance sheet

 

48,806

 

67,424

 

53,051

 

Total risk-weighted assets

 

$

1,708,191

 

$

2,062,827

 

$

1,776,570

 

 

 

 

 

 

 

 

 

Average assets

 

 

 

 

 

 

 

Total quarterly average assets for leverage

 

$

2,114,417

 

$

2,479,067

 

$

2,281,579

 

 

In addition, management believes the presentation of other financial measures such as core earnings, which excludes taxes, provisions for loan losses, income and expenses associated with other real estate owned, and other nonrecurring items as detailed immediately below, provides useful supplemental information that is helpful in understanding our financial results.  Management considers this information useful since certain items such as provisions for loan losses and other real estate owned activities in the current credit cycle are well above historic levels.  These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

 

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Table of Contents

 

 

 

As of and for the

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

 

 

(dollars in thousands)

 

 

 

(unaudited)

 

Core earnings

 

 

 

 

 

Pre-tax loss

 

$

(3,120

)

$

(14,721

)

Excluding impact of:

 

 

 

 

 

Other real estate owned, net of income

 

4,560

 

5,759

 

Provision for loan losses

 

4,000

 

19,220

 

Core Earnings

 

$

5,440

 

$

10,258

 

 

 

 

 

 

 

Earnings per core diluted share

 

 

 

 

 

Average diluted number of shares

 

14,213,701

 

14,197,223

 

Core diluted earnings per share

 

$

0.38

 

$

0.72

 

 

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Table of Contents

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

Liquidity and Market Risk

 

Liquidity is the Company’s ability to fund operations, to meet depositor withdrawals, to provide for customer’s credit needs, and to meet maturing obligations and existing commitments.  The liquidity of the Company principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and its ability to borrow funds.  The Company monitors borrowing capacity at correspondent banks as well as the Federal Home Loan Bank and Federal Reserve Banks of Chicago as part of its liquidity management process.  Additionally, the $73.0 million cash proceeds from the Treasury discussed above is a source of liquidity that became available to the Company in January 2009.

 

Net cash inflows from operating activities were $6.5 million during the first quarter of 2011, compared with net cash inflows of $17.3 million in the same period in 2010.  Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, continued to be a source of inflow for both of the first quarters of 2011 and 2010.  Interest received, net of interest paid, combined with changes in other assets and liabilities were a source of outflow for 2011 versus an inflow for 2010.  Management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows.  Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process.

 

Net cash inflows from investing activities were $75.1 million in the first quarter of 2011, compared to $91.1 million in the same period in 2010.  In 2011, securities transactions accounted for a net inflow of $6.2 million, and net principal received on loans accounted for net inflows of $61.7 million.  In 2010, securities transactions accounted for a net inflow of $18.1 million, and net principal received on loans accounted for net inflows of $68.9 million.  Proceeds from sales of OREO accounted for $9.4 million and $4.3 million in investing cash inflows for the first quarters of 2011 and 2010 respectively.  Investing cash outflows for investment in OREO were $2.0 million in the first quarter of 2011 as compared to $10,000 in the same period in 2010.

 

Net cash outflows from financing activities in the first quarter of 2011, were $5.9 million compared with $91.0 million in the first quarter of 2010.  Consistent with the Company’s previously disclosed deposit strategy, a financing outflow continued in the first quarter of 2011 for a net deposit outflow of $6.2 million compared to a net deposit outflow of $41.8 million in the first quarter of 2010.  Other short term borrowings had a net cash inflow of $438,000 related to TT&L deposits in the first quarter of 2011, whereas the first quarter of 2010 had a significant cash outflow in other short-term borrowings of $50.6 million, which primarily consisted of Federal Home Loan Bank advances.  Changes in securities sold under repurchase agreements accounted for $140,000 in net outflows and $2.9 million in net inflows, respectively, in the first quarters of 2011 and 2010.

 

Interest Rate Risk

 

As part of its normal operations, the Company is subject to interest-rate risk on the assets it invests in (primarily loans and securities) and the liabilities it funds with (primarily customer deposits and borrowed funds), as well as its ability to manage such risk.  Fluctuations in interest rates may result in changes in the fair market values of the Company’s financial instruments, cash flows, and net interest income.  Like most financial institutions, the Company has an exposure to changes in both short-term and long-term interest rates.

 

The Company manages various market risks in its normal course of 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 the Company’s business activities and operations.  In addition, since the Company does not hold a trading portfolio, it is not exposed to significant market risk from trading activities.  The Company’s interest rate risk exposures from March

 

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Table of Contents

 

31, 2011 and December 31, 2010 are outlined in the table below.

 

Like most financial institutions, the Company’s 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.  The Company’s ALCO seeks to manage interest rate risk under a variety of rate environments by structuring the Company’s balance sheet and off-balance sheet positions, which includes interest rate swap derivatives as discussed in Note 17 of the financial statements included in this quarterly report.  The risk is monitored and managed within approved policy limits.

 

The Company utilizes simulation analysis to quantify the impact of various rate scenarios on net interest income.  Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by the Company are incorporated into the simulation model.  Earnings at risk is 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.  The Company’s earnings at risk exposure at March 31, 2011 versus that at December 31, 2010 was largely unchanged, with slightly greater rising rate benefit in the scenarios with rate increases of 1% or more.  Federal Funds rates and the Bank’s prime rate were stable throughout 2010 and the first quarter of 2011 at 0.25% and 3.25%, respectively.

 

The following table summarizes the affect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 0.5%, 1%, and 2% and no change in the slope of the yield curve.  The 2% and 1% sections of the table do not show model changes for those magnitudes of decrease due to the low interest rate environment over the relevant time periods:

 

Analysis of Net Interest Income Sensitivity

 

 

 

Immediate Changes in Rates

 

 

 

-2.0%

 

-1.0%

 

-0.5%

 

0.5%

 

1.0%

 

2.0%

 

March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollar change

 

N/A

 

N/A

 

$

208

 

$

460

 

$

1,005

 

$

2,520

 

Percent change

 

N/A

 

N/A

 

-0.3

%

+0.7

%

+1.6

%

+4.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Dollar change

 

N/A

 

N/A

 

$

202

 

$

500

 

$

981

 

$

2,087

 

Percent change

 

N/A

 

N/A

 

+0.3

%

+0.7

%

+1.4

%

+3.0

%

 

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.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of March 31, 2011.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2011, 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.

 

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Table of Contents

 

There were no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to affect, the Company’s internal control over financial reporting.

 

Forward-looking Statements

 

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.  Additionally, all statements in this document, 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.

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries, are detailed in the “Risk Factors” section included under Item 1A.  of Part I of the Company’s Form 10-K.  In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

 

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Table of Contents

 

PART II - OTHER INFORMATION

 

Item 1.    Legal Proceedings

 

On February 17, 2011, a former employee filed a purported class action complaint in the U.S. District Court for the Northern District of Illinois on behalf of participants and beneficiaries of the Old Second Bancorp, Inc. Employees’ 401(k) Savings Plan and Trust alleging that the Company, the Bank, the Employee Benefits Committee of Old Second Bancorp, Inc. and certain of the Company’s officers and employees violated certain disclosure requirements and fiduciary duties established under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). The complaint seeks equitable and as-of-yet unquantified monetary relief.  The Company believes that it, its affiliates and its officers and employees have acted, and continue to act, in compliance with ERISA law with respect to these matters, and they intend to vigorously defend the allegations of the complaint.

 

In addition to the matter described above, the Company and its subsidiaries have, from time to time, 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

 

There have been no material changes from the risk factors set forth in Part I, Item 1.A. “Risk Factors,” of the Company’s Form 10-K for the year ended December 31, 2010.  Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.    Defaults Upon Senior Securities

 

None.

 

Item 4.    Removed and Reserved

 

Item 5.    Other Information

 

None.

 

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.

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

 

OLD SECOND BANCORP, INC.

 

 

 

 

 

 

 

 

 

 

BY:

/s/ William B. Skoglund

 

 

 

William B. Skoglund

 

 

 

 

 

 

 

Chairman of the Board, Director

 

 

 

President and Chief Executive Officer
(principal executive officer)

 

 

 

 

 

 

 

 

 

 

BY:

/s/ J. Douglas Cheatham

 

 

 

J. Douglas Cheatham

 

 

 

 

 

 

 

Executive Vice-President and

 

 

 

Chief Financial Officer, Director

 

 

 

(principal financial and accounting
officer)

 

 

 

 

 

 

 

 

DATE: May 10, 2011

 

 

 

 

60