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OLD SECOND BANCORP INC - Quarter Report: 2021 September (Form 10-Q)

Table of Contents

I

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For transition period from          to          

Commission File Number 000-10537

Graphic

(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, AuroraIllinois     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         No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  No 

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

Large accelerated filerAccelerated filer

Non-accelerated filerSmaller reporting companyEmerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

Yes         No 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock

OSBC

The Nasdaq Stock Market

As of November 2, 2021, the Registrant has 28,707,737 shares of common stock outstanding at $1.00 par value per share.

Table of Contents

OLD SECOND BANCORP, INC.

Form 10-Q Quarterly Report

Table of Contents

Cautionary Note Regarding Forward-Looking Statements

PART I

Page Number

Item 1.

Financial Statements

5

Item 2.

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

39

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

64

Item 4.

Controls and Procedures

65

PART II

Item 1.

Legal Proceedings

65

Item 1.A.

Risk Factors

66

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

66

Item 3.

Defaults Upon Senior Securities

66

Item 4.

Mine Safety Disclosure

66

Item 5.

Other Information

66

Item 6.

Exhibits

67

Signatures

68

2

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report and other publicly available documents of the Company contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act, including with respect to management’s expectations regarding future plans, strategies and financial performance, including regulatory developments, industry and economic trends, our proposed merger with West Suburban Bancorp. Inc. (“West Suburban”) and other matters.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, can be identified by the inclusion of such qualifications as “expects,” “intends,” “believes,” “may,” “will,” “would,” “could,” “should,” “plan,” “anticipate,” “estimate,” “possible,” “likely” or other indications that the particular statements are not historical facts and refer to future periods. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and may be outside of the Company’s control. Actual events and results may differ materially from those described in such forward-looking statements due to numerous factors, including:

our ability to execute our growth strategy;
the continuing impact of COVID-19 and its variants on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy, and the resulting effect of these items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers;
negative economic conditions that adversely affect the economy, real estate values, the job market and other factors nationally and in our market area, in each case that may affect our liquidity and the performance of our loan portfolio;
challenges retaining or hiring key personnel, including with respect to new lenders in key markets and the resulting negative impact on our ability to increase lending activities;
the possibility that our previously announced merger with West Suburban does not close when expected or at all because stockholder or other conditions to closing are not received or satisfied on a timely basis or at all;
the occurrence of any event, change or other circumstances that could give rise to the right of the Company, West Suburban or both to terminate the Merger Agreement;
the occurrence of any event, change or other circumstances that causes the Board of Governors of the Federal Reserve System or the Office of the Comptroller of the Currency to revoke their approvals of the proposed merger with West Suburban or its subsidiary bank, respectively, or otherwise impose conditions on such approvals that could adversely affect the combined company or the benefits of the transaction;
the possibility that the anticipated benefits of the proposed merger with West Suburban, including anticipated cost savings and strategic gains, are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy, competitive factors in the areas where the Company and West Suburban do business, or as a result of other unexpected factors or events;
the impact of purchase accounting with respect to the proposed merger with West Suburban, or any change in the assumptions used regarding the assets purchased and liabilities assumed to determine their fair value;
diversion of management’s attention from ongoing business operations and opportunities as a result of the proposed merger with West Suburban;
potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the proposed merger with West Suburban;
the outcome of any legal proceedings that may be instituted against the Company or West Suburban as a result of the proposed merger with West Suburban;
the integration of the businesses and operations of the Company and West Suburban, which may take longer than anticipated or be more costly than anticipated or have unanticipated adverse results relating to the Company’s and West Suburban’s existing businesses;
the financial success and viability of the borrowers of our commercial loans;
changes in U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that may affect, among other things, our liquidity and the value of our assets and liabilities;
the transition away from LIBOR to an alternative reference rate;
competitive pressures from other financial service businesses and from nontraditional financial technology (“FinTech”) companies;
any negative perception of our reputation or financial strength;
our ability to raise additional capital on acceptable terms when needed;
our ability to raise cost-effective funding to support business plans when needed;
our ability to use technology to provide products and services that will satisfy customer demands and create efficiencies in operations;
adverse effects on our information technology systems resulting from system failures, human error or cyberattacks;
adverse effects of failures by our vendors to provide agreed upon services in the manner and at the cost agreed, particularly our information technology vendors and those vendors performing a service on the Company’s behalf;
the impact of any claims or legal actions, including any effect on our reputation;
losses incurred in connection with repurchases and indemnification payments related to mortgages;

3

Table of Contents

the soundness of other financial institutions and other counter-party risk;
changes in accounting standards, rules and interpretations and the related impact on our financial statements, including assumptions surrounding the ongoing impact of CECL, which are subject to change based on a number of factors including changes in our macroeconomic forecasts, credit quality, loan composition and other factors;
our ability to receive dividends from our subsidiaries;
a decrease in our regulatory capital ratios;
adverse federal or state tax assessments, or changes in tax laws or policies;
risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;
legislative or regulatory changes, particularly changes in regulation of financial services companies;
increased costs of compliance, heightened regulatory capital requirements and other risks associated with changes in regulation and the current regulatory environment, including  changes as a result of the new presidential administration and Democratic control of Congress;
negative changes in our capital position;
the adverse effects of events beyond our control that may have a destabilizing effect on financial markets and the economy, such as epidemics and pandemics (including COVID-19), war or terrorist activities, essential utility outages, deterioration in the global economy, instability in the credit markets, disruptions in our customers’ supply chains or disruption in transportation;
changes in trade policy and any related tariffs; and
each of the factors and risks under the heading “Risk Factors” in our 2020 Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, the Joint Proxy Statement/Prospectus dated October 21, 2021, filed pursuant to Rule 424(b)(3) on October 25, 2021, relating to our Form S-4 Registration Statement (File No. 333-259964) and in subsequent filings we make with the SEC.

We caution readers that the foregoing list of factors is not exclusive, is not necessarily in order of importance and readers should not place undue reliance on any forward-looking statements.  Because the Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain, there can be no assurances that future actual results will correspond to any forward-looking statements and you should not rely on any forward-looking statements.  Additionally, all statements in this Form 10-Q, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events, except as required by applicable law.

4

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

(unaudited)

September 30, 

December 31, 

    

2021

    

2020

Assets

Cash and due from banks

$

26,705

$

24,306

Interest earning deposits with financial institutions

492,548

305,597

Cash and cash equivalents

519,253

329,903

Securities available-for-sale, at fair value

715,188

496,178

Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock

9,917

9,917

Loans held-for-sale

3,009

12,611

Loans

1,867,942

2,034,851

Less: allowance for credit losses on loans

26,949

33,855

Net loans

1,840,993

2,000,996

Premises and equipment, net

44,120

45,477

Other real estate owned

1,912

2,474

Mortgage servicing rights, at fair value

5,320

4,224

Goodwill and core deposit intangible

20,433

20,781

Bank-owned life insurance ("BOLI")

64,265

63,102

Deferred tax assets, net

7,335

8,121

Other assets

43,387

47,053

Total assets

$

3,275,132

$

3,040,837

Liabilities

Deposits:

Noninterest bearing demand

$

1,037,638

$

909,505

Interest bearing:

Savings, NOW, and money market

1,366,138

1,202,134

Time

310,553

425,434

Total deposits

2,714,329

2,537,073

Securities sold under repurchase agreements

42,962

66,980

Junior subordinated debentures

25,773

25,773

Subordinated debentures

59,190

-

Senior notes

44,454

44,375

Notes payable and other borrowings

20,155

23,393

Other liabilities

47,037

36,156

Total liabilities

2,953,900

2,733,750

Stockholders’ Equity

Common stock

34,957

34,957

Additional paid-in capital

121,074

122,212

Retained earnings

262,513

236,579

Accumulated other comprehensive income

12,249

14,762

Treasury stock

(109,561)

(101,423)

Total stockholders’ equity

321,232

307,087

Total liabilities and stockholders’ equity

$

3,275,132

$

3,040,837

September 30, 2021

December 31, 2020

Common

Common

Stock

    

Stock

Par value

$

1.00

$

1.00

Shares authorized

60,000,000

60,000,000

Shares issued

34,957,384

34,957,384

Shares outstanding

28,707,737

29,328,723

Treasury shares

6,249,647

5,628,661

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except per share data)

(unaudited)

(unaudited)

Three Months Ended September 30, 

Nine Months Ended September 30, 

    

2021

    

2020

    

2021

    

2020

    

Interest and dividend income

Loans, including fees

$

21,315

$

21,980

$

64,337

$

67,924

Loans held-for-sale

39

95

132

241

Securities:

Taxable

1,835

1,458

5,282

5,315

Tax exempt

1,285

1,327

3,851

4,178

Dividends from FHLBC and FRBC stock

114

118

342

366

Interest bearing deposits with financial institutions

203

68

432

185

Total interest and dividend income

24,791

25,046

74,376

78,209

Interest expense

Savings, NOW, and money market deposits

209

299

667

1,319

Time deposits

330

1,084

1,239

4,292

Securities sold under repurchase agreements

15

28

67

167

Other short-term borrowings

-

24

-

167

Junior subordinated debentures

286

285

850

1,932

Subordinated debentures

547

-

1,064

-

Senior notes

673

673

2,019

2,019

Notes payable and other borrowings

113

144

355

439

Total interest expense

2,173

2,537

6,261

10,335

Net interest and dividend income

22,618

22,509

68,115

67,874

(Release of) provision for credit losses

(1,500)

300

(8,000)

10,413

Net interest and dividend income after (release of) provision for credit losses

24,118

22,209

76,115

57,461

Noninterest income

Wealth management

2,372

1,889

6,912

5,793

Service charges on deposits

1,368

1,322

3,784

4,168

Secondary mortgage fees

240

492

834

1,267

Mortgage servicing rights mark to market loss

(282)

(160)

(202)

(2,739)

Mortgage servicing income

572

521

1,646

1,447

Net gain on sales of mortgage loans

2,186

5,246

7,802

12,123

Securities gains (losses), net

244

(1)

246

(25)

Change in cash surrender value of BOLI

406

459

1,163

942

Death benefit realized on BOLI

-

(2)

-

57

Card related income

1,624

1,499

4,737

4,097

Other income

610

420

1,637

1,572

Total noninterest income

9,340

11,685

28,559

28,702

Noninterest expense

Salaries and employee benefits

12,964

12,586

39,366

36,846

Occupancy, furniture and equipment

2,418

2,003

7,188

6,239

Computer and data processing

1,477

1,226

4,079

3,808

FDIC insurance

211

191

604

403

General bank insurance

301

281

854

764

Amortization of core deposit intangible

113

122

348

374

Advertising expense

107

62

262

228

Card related expense

662

566

1,881

1,612

Legal fees

455

169

645

476

Other real estate expense, net

25

125

138

505

Other expense

3,396

2,935

9,903

8,909

Total noninterest expense

22,129

20,266

65,268

60,164

Income before income taxes

11,329

13,628

39,406

25,999

Provision for income taxes

2,917

3,363

10,295

6,221

Net income

$

8,412

$

10,265

$

29,111

$

19,778

Basic earnings per share

$

0.30

$

0.35

$

1.01

$

0.67

Diluted earnings per share

0.29

0.34

0.99

0.65

Dividends declared per share

0.05

0.01

0.11

0.03

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(In thousands)

(unaudited)

(unaudited)

Three Months Ended September 30, 

Nine Months Ended September 30, 

    

2021

    

2020

    

2021

    

2020

Net Income

$

8,412

$

10,265

$

29,111

$

19,778

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

(3,007)

5,812

(4,483)

10,455

Related tax benefit (expense)

841

(1,633)

1,277

(2,932)

Holding (losses) gains, after tax, on available-for-sale securities

(2,166)

4,179

(3,206)

7,523

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

Net realized gains (losses)

244

(1)

246

(25)

Related tax (expense) benefit

(69)

-

(70)

7

Net realized gains (losses) after tax

175

(1)

176

(18)

Other comprehensive (loss) income on available-for-sale securities

(2,341)

4,180

(3,382)

7,541

Changes in fair value of derivatives used for cash flow hedges

218

615

1,207

(1,472)

Related tax (expense) benefit

(62)

(173)

(338)

413

Other comprehensive income (loss) on cash flow hedges

156

442

869

(1,059)

Total other comprehensive (loss) income

(2,185)

4,622

(2,513)

6,482

Total comprehensive income

$

6,227

$

14,887

$

26,598

$

26,260

(unaudited)

(unaudited)

(unaudited)

Accumulated

Accumulated

Total

Unrealized Gain

Unrealized Gain

Accumulated Other

(Loss) on Securities

(Loss) on Derivative

Comprehensive

Available-for -Sale

Instruments

Income/(Loss)

For the Three Months Ended

Balance, June 30, 2020

$

10,188

$

(3,766)

$

6,422

Other comprehensive income, net of tax

4,180

442

4,622

Balance, September 30, 2020

$

14,368

$

(3,324)

$

11,044

Balance, June 30, 2021

$

16,372

$

(1,938)

$

14,434

Other comprehensive (loss) income, net of tax

(2,341)

156

(2,185)

Balance, September 30, 2021

$

14,031

$

(1,782)

$

12,249

For the Nine Months Ended

Balance, December 31, 2019

$

6,827

$

(2,265)

$

4,562

Other comprehensive income (loss), net of tax

7,541

(1,059)

6,482

Balance, September 30, 2020

$

14,368

$

(3,324)

$

11,044

Balance, December 31, 2020

$

17,413

$

(2,651)

$

14,762

Other comprehensive (loss) income, net of tax

(3,382)

869

(2,513)

Balance, September 30, 2021

$

14,031

$

(1,782)

$

12,249

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

Nine Months Ended September 30, 

2021

    

2020

    

Cash flows from operating activities

Net income

$

29,111

$

19,778

Adjustments to reconcile net income to net cash provided by operating activities:

Net premium / discount from amortization on securities

1,736

1,712

Securities (gains) losses, net

(246)

25

(Release of) provision for credit losses

(8,000)

10,413

Originations of loans held-for-sale

(191,679)

(296,388)

Proceeds from sales of loans held-for-sale

207,339

300,045

Net gains on sales of mortgage loans

(7,802)

(12,123)

Mortgage servicing rights mark to market loss

202

2,739

Net discount from accretion on loans

(618)

(841)

Net change in cash surrender value of BOLI

(1,163)

(942)

Net gains on sale of other real estate owned

(40)

(188)

Provision for other real estate owned valuation losses

65

264

Depreciation of fixed assets and amortization of leasehold improvements

2,286

2,075

Amortization of core deposit intangibles

348

374

Change in current income taxes receivable

329

(781)

Deferred tax expense (benefit)

1,796

(693)

Change in accrued interest receivable and other assets

2,973

(19,144)

Amortization of purchase accounting adjustment on notes payable and other borrowings

(3)

25

Amortization of junior subordinated debentures issuance costs

-

643

Amortization of subordinated debentures issuance costs

42

-

Amortization of senior notes issuance costs

79

79

Change in accrued interest payable and other liabilities

12,898

8,060

Stock based compensation

1,113

1,623

Net cash provided by operating activities

50,766

16,755

Cash flows from investing activities

Proceeds from maturities and calls, including pay down of securities available-for-sale

91,931

41,645

Proceeds from sales of securities available-for-sale

35,075

18,006

Purchases of securities available-for-sale

(352,236)

(14,681)

Net change in loans

168,551

(100,370)

Proceeds from claims on BOLI, net of claims receivable

-

483

Proceeds from sales of other real estate owned, net of participations and improvements

607

3,140

Net purchases of premises and equipment

(929)

(2,635)

Net cash used in investing activities

(57,001)

(54,412)

Cash flows from financing activities

Net change in deposits

177,256

352,494

Net change in securities sold under repurchase agreements

(24,018)

10,575

Net change in other short-term borrowings

-

(42,375)

Redemption of junior subordinated debentures

-

(32,604)

Issuance of subordinated debentures, net of issuance costs

59,148

-

Issuance of term note

-

20,000

Repayment of term note

(3,000)

(2,000)

Net change in notes payable and other borrowings, excluding term note

(235)

(229)

Dividends paid on common stock

(3,177)

(893)

Purchase of treasury stock

(10,389)

(4,803)

Net cash provided by financing activities

195,585

300,165

Net change in cash and cash equivalents

189,350

262,508

Cash and cash equivalents at beginning of period

329,903

50,632

Cash and cash equivalents at end of period

$

519,253

$

313,140

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in

Stockholders’ Equity

(In thousands)

Accumulated

Additional

Other

Total

(unaudited)

Common

Paid-In

Retained

Comprehensive

Treasury

Stockholders’

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Stock

    

Equity

For the Three Months Ended

Balance, June 30, 2020

$

34,957

$

121,437

$

218,856

$

6,422

$

(99,156)

$

282,516

Net income

10,265

10,265

Other comprehensive income, net of tax

4,622

4,622

Dividends declared and paid, ($0.01 per share)

(296)

(296)

Stock based compensation

309

309

Purchase of treasury stock from stock repurchase program

(1,148)

(1,148)

Balance, September 30, 2020

$

34,957

$

121,746

$

228,825

$

11,044

$

(100,304)

$

296,268

Balance, June 30, 2021

$

34,957

$

120,572

$

255,536

$

14,434

$

(109,561)

$

315,938

Net income

8,412

8,412

Other comprehensive loss, net of tax

(2,185)

(2,185)

Dividends declared and paid, ($0.05 per share)

(1,435)

(1,435)

Stock based compensation

502

502

Balance, September 30, 2021

$

34,957

$

121,074

$

262,513

$

12,249

$

(109,561)

$

321,232

Accumulated

Additional

Other

Total

Common

Paid-In

Retained

Comprehensive

Treasury

Stockholders’

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Stock

    

Equity

For the Nine Months Ended

Balance, December 31, 2019

$

34,854

$

120,657

$

213,723

$

4,562

$

(95,932)

$

277,864

Adoption of ASU 2016-13 (CECL)

(3,783)

(3,783)

Net income

19,778

19,778

Other comprehensive income, net of tax

6,482

6,482

Dividends declared and paid, ($0.03 per share)

(893)

(893)

Vesting of restricted stock

103

(534)

431

-

Stock based compensation

1,623

1,623

Purchase of treasury stock from taxes withheld on stock awards

(423)

(423)

Purchase of treasury stock from stock repurchase program

(4,380)

(4,380)

Balance, September 30, 2020

$

34,957

$

121,746

$

228,825

$

11,044

$

(100,304)

$

296,268

Balance, December 31, 2020

$

34,957

$

122,212

$

236,579

$

14,762

$

(101,423)

$

307,087

Net income

29,111

29,111

Other comprehensive loss, net of tax

(2,513)

(2,513)

Dividends declared and paid, ($0.11 per share)

(3,177)

(3,177)

Vesting of restricted stock

(2,251)

2,251

-

Stock based compensation

1,113

1,113

Purchase of treasury stock from taxes withheld on stock awards

(577)

(577)

Purchase of treasury stock from stock repurchase program

(9,812)

(9,812)

Balance, September 30, 2021

$

34,957

$

121,074

$

262,513

$

12,249

$

(109,561)

$

321,232

9

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Note 1 – Basis of Presentation and Changes in Significant Accounting Policies

The accounting policies followed in the preparation of the interim consolidated financial statements are consistent with those used in the preparation of the annual financial information.  The interim consolidated financial statements reflect all normal and recurring adjustments that are necessary, in the opinion of management, for a fair statement of results for the interim period presented.  Results for the period ended September 30, 2021, are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.  These interim consolidated financial statements are unaudited and should be read in conjunction with the audited financial statements and notes included in Old Second Bancorp, Inc.’s (the “Company”) annual report on Form 10-K for the year ended December 31, 2020.  Unless otherwise indicated, dollar amounts in the tables contained in the notes to the consolidated financial statements are in thousands.  Certain items in prior periods have been reclassified to conform to the current presentation.

The Company’s consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (“GAAP”) and follow general practices within the banking industry.  Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the consolidated financial statements.  Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts reported in the consolidated financial statements.

Recent Accounting Pronouncements

In June 2016, the Financial Standards Board, or FASB, issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Measurement of Credit Losses on Financial Instruments (Topic 326),” also known as Current Expected Credit Losses, or CECL.  ASU 2016-13 was issued to provide financial statement users with more useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date to enhance the decision making process.  The new methodology reflects expected credit losses based on relevant vintage historical information, supported by reasonable forecasts of projected loss given defaults, which will affect the collectability of the reported amounts.  This new methodology also requires available-for-sale debt securities to have a credit loss recorded through an allowance rather than write-downs through an other than temporary impairment analysis.  In addition, an allowance must be established for the credit risk related to unfunded commitments.  ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and was adopted as of January 1, 2020, by the Company.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” and Note 1 – Summary of Significant Accounting Policies, both found in our Annual Report on Form 10-K for the year ended December 31, 2020 for further discussion of our Allowance for Credit Losses methodology and assessment as a critical accounting policy.

Change in Significant Accounting Policies

Significant accounting policies are presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.  These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.  During the third quarter of 2021, the Company had no changes to significant accounting policies.

10

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Subsequent Events

On October 19, 2021, the Company’s Board of Directors declared a cash dividend of $0.05 per share payable on November 8, 2021, to stockholders of record as of October 29, 2021; dividends of $1.4 million are scheduled to be paid to stockholders on November 8, 2021.

Note 2 – Proposed Merger with West Suburban Bancorp, Inc.

On July 25, 2021, the Company and West Suburban Bancorp, Inc. (“West Suburban”) entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”), under which West Suburban will merge with and into Old Second, with Old Second as the surviving corporation.

The merger is expected to close in December 2021, subject to the satisfaction of customary closing conditions, including approval by the stockholders of the Company and the shareholders of West Suburban. Subject to the terms and conditions of the Merger Agreement, if the merger closes, each West Suburban shareholder will receive 42.413 shares of Company common stock and $271.15 in cash, without interest, for each share of West Suburban common stock owned by the shareholder.

Based on the number of outstanding shares of Company common stock and West Suburban common stock as of September 30, 2021, and based on the exchange ratio of 42.413, it is expected that the Company’s stockholders will hold approximately 64% and West Suburban’s shareholders will hold approximately 36% of the issued and outstanding shares of Company common stock immediately following the closing of the merger.

Note 3 – Securities

Investment Portfolio Management

Our investment portfolio serves the liquidity needs and income objectives of the Company.  While the portfolio serves as an important component of the overall liquidity management at the Bank, portions of the portfolio also serve as income producing assets.  The size and composition of the portfolio reflects liquidity needs, loan demand and interest income objectives.  Portfolio size and composition will be adjusted from time to time.  While a significant portion of the portfolio consists of readily marketable securities to address liquidity, other parts of the portfolio may reflect funds invested pending future loan demand or to maximize interest income without undue interest rate risk.

Investments are comprised of debt securities and non-marketable equity investments.  Securities available-for-sale are carried at fair value.  Unrealized gains and losses, net of tax, on securities available-for-sale are reported as a separate component of equity.  This balance sheet component changes as interest rates and market conditions change.  Unrealized gains and losses are not included in the calculation of regulatory capital.  

Federal Home Loan Bank of Chicago (“FHLBC”) and Federal Reserve Bank of Chicago (“FRBC”) stock are considered nonmarketable equity investments.  FHLBC stock was recorded at $3.7 million at September 30, 2021, and December 31, 2020.  FRBC stock was recorded at $6.2 million at September 30, 2021, and December 31, 2020.  

The following tables summarize the amortized cost and fair value of the securities portfolio at September 30, 2021, and December 31, 2020, and the corresponding amounts of gross unrealized gains and losses:

11

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

September 30, 2021

    

Cost1

    

Gains

    

Losses

Value

Securities available-for-sale

U.S. Treasury

$

4,017

$

53

$

-

$

4,070

U.S. government agencies

33,915

-

(340)

33,575

U.S. government agencies mortgage-backed

17,269

764

(215)

17,818

States and political subdivisions

222,833

16,758

(639)

238,952

Corporate bonds

5,000

-

(8)

4,992

Collateralized mortgage obligations

163,756

1,966

(308)

165,414

Asset-backed securities

187,825

1,646

(133)

189,338

Collateralized loan obligations

61,085

18

(74)

61,029

Total securities available-for-sale

$

695,700

$

21,205

$

(1,717)

$

715,188

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

December 31, 2020

    

Cost1

    

Gains

    

Losses

Value

Securities available-for-sale

U.S. Treasury

$

4,014

$

103

$

-

$

4,117

U.S. government agencies

6,811

-

(154)

6,657

U.S. government agencies mortgage-backed

16,098

1,112

(1)

17,209

States and political subdivisions

229,352

21,269

(1,362)

249,259

Collateralized mortgage obligations

53,999

2,866

(280)

56,585

Asset-backed securities

130,959

1,370

(511)

131,818

Collateralized loan obligations

30,728

15

(210)

30,533

Total securities available-for-sale

$

471,961

$

26,735

$

(2,518)

$

496,178

1 Excludes accrued interest receivable of $2.8 million and $2.7 million at September 30, 2021 and December 31, 2020, respectively, that is recorded in other assets on the consolidated balance sheet.

The fair value, amortized cost and weighted average yield of debt securities at September 30, 2021, by contractual maturity, are listed in the table below.  Securities not due at a single maturity date are shown separately.

Weighted

Amortized

Average

Fair

Securities available-for-sale

    

Cost

    

Yield

    

Value

  

Due in one year or less

$

4,227

1.87

%

$

4,281

Due after one year through five years

36,288

0.79

36,240

Due after five years through ten years

28,159

2.35

29,387

Due after ten years

197,091

3.01

211,681

265,765

2.62

281,589

Mortgage-backed and collateralized mortgage obligations

181,025

1.73

183,232

Asset-backed securities

187,825

1.14

189,338

Collateralized loan obligations

61,085

1.40

61,029

Total securities available-for-sale

$

695,700

1.88

%

$

715,188

At September 30, 2021, the Company’s investments included $154.5 million of asset-backed securities that are backed by student loans originated under the Federal Family Education Loan program (“FFEL”).  Under the FFEL, private lenders made federally guaranteed student loans to parents and students. While the program was modified several times before elimination in 2010, FFEL securities are

12

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

generally guaranteed by the U.S Department of Education (“DOE”) at not less than 97% of the outstanding principal amount of the loans.  The guarantee will reduce to 85% if the DOE receives reimbursement requests in excess of 5% of insured loans; reimbursement will drop to 75% if reimbursement requests exceed 9% of insured loans.  In addition to the DOE guarantee, total added credit enhancement in the form of overcollateralization and/or subordination amounted to $15.6 million, or 10.03% of outstanding principal.

At September 30, 2021, the Company had invested in securities issued from one originator that individually amounted to over 10% of the Company’s stockholders’ equity.  Information regarding this issuer and the value of the securities issued follows:

September 30, 2021

    

Amortized

    

Fair

Issuer

Cost

Value

Towd Point Mortgage Trust

$

32,836

$

34,339

Securities with unrealized losses with no corresponding allowance for credit losses at September 30, 2021 and December 31, 2020, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands except for number of securities):

Less than 12 months

12 months or more

September 30, 2021

in an unrealized loss position

in an unrealized loss position

Total

Number of

Unrealized

Fair

Number of

Unrealized

Fair

Number of

Unrealized

Fair

Securities available-for-sale

    

Securities

   

Losses

   

Value

   

Securities

   

Losses

   

Value

   

Securities

   

Losses

   

Value

U.S. government agencies

2

$

229

$

28,066

4

$

111

$

5,509

6

$

340

$

33,575

U.S. government agencies mortgage-backed

6

215

6,084

-

-

-

6

215

6,084

States and political subdivisions

2

23

1,490

1

616

4,085

3

639

5,575

Corporate bonds

1

8

4,992

-

-

-

1

8

4,992

Collateralized mortgage obligations

7

244

63,495

1

64

7,531

8

308

71,026

Asset-backed securities

5

79

35,048

1

54

3,270

6

133

38,318

Collateralized loan obligations

6

27

20,386

2

47

10,625

8

74

31,011

Total securities available-for-sale

29

$

825

$

159,561

9

$

892

$

31,020

38

$

1,717

$

190,581

Less than 12 months

12 months or more

December 31, 2020

in an unrealized loss position

in an unrealized loss position

Total

Number of

Unrealized

Fair

Number of

Unrealized

Fair

Number of

Unrealized

Fair

Securities available-for-sale

    

Securities

   

Losses

   

Value

   

Securities

   

Losses

   

Value

   

Securities

   

Losses

   

Value

U.S. government agencies

-

$

-

$

-

4

$

154

$

6,657

4

$

154

$

6,657

U.S. government agencies mortgage-backed

1

1

141

-

-

-

1

1

141

States and political subdivisions

-

-

-

1

1,362

3,433

1

1,362

3,433

Collateralized mortgage obligations

4

279

8,142

1

1

146

5

280

8,288

Asset-backed securities

1

2

251

3

509

49,572

4

511

49,823

Collateralized loan obligations

1

31

7,468

4

179

21,477

5

210

28,945

Total securities available-for-sale

7

$

313

$

16,002

13

$

2,205

$

81,285

20

$

2,518

$

97,287

Each quarter we perform an analysis to determine if any of the unrealized losses on securities available-for-sale are comprised of credit losses as compared to unrealized losses due to market interest rate adjustments.  Our assessment includes a review of the unrealized loss for each security issuance held; the financial condition and near-term prospects of the issuer, including external credit ratings and recent downgrades; and our ability and intent to hold the security for a period of time sufficient for a recovery in value.  We also consider the extent to which the securities are issued by the federal government or its agencies, and any guarantee of issued amounts by those agencies.  No credit losses were determined to be present as of September 30, 2021, as there was no credit quality deterioration noted.  Therefore, no provision for credit losses on securities was recognized for the third quarter of 2021.

The following table presents proceeds from sale and net realized gains (losses) on securities available-for-sale for the three and nine months ended September 30, 2021 and 2020:  

13

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

Securities available-for-sale

    

2021

    

2020

    

2021

    

2020

    

Proceeds from sales of securities

$

26,873

$

-

$

35,075

$

18,006

Gross realized gains on securities

$

262

$

-

$

267

$

17

Gross realized losses on securities

 

(18)

 

(1)

 

(21)

 

(42)

Net realized gains (losses)

$

244

$

(1)

$

246

$

(25)

Income tax (expense) benefit on net realized gains (losses)

$

(69)

$

-

$

(70)

$

7

Effective tax rate applied

28.3

%

0.0

%

28.5

%

28.0

%

As of September 30, 2021, securities valued at $353.2 million were pledged to secure deposits and borrowings, and for other purposes, an increase from $335.8 million of securities pledged at year-end 2020.  

Note 4 – Loans and Allowance for Credit Losses on Loans

Major segments of loans were as follows:

    

September 30, 2021

    

December 31, 2020

Commercial 1

$

321,548

$

407,159

Leases

162,444

141,601

Commercial real estate - Investor

535,506

582,042

Commercial real estate - Owner occupied

330,648

333,070

Construction

108,690

98,486

Residential real estate - Investor

45,497

56,137

Residential real estate - Owner occupied

108,343

116,388

Multifamily

160,798

189,040

HELOC

69,651

80,908

HELOC - Purchased

12,370

19,487

Other 2

12,447

10,533

Total loans

1,867,942

2,034,851

Allowance for credit losses on loans

(26,949)

(33,855)

Net loans3

$

1,840,993

$

2,000,996

1 Includes $34.7 million and $74.1 million of Paycheck Protection Program (“PPP”) loans at September 30, 2021 and December 31, 2020, respectively.

2 The “Other” segment includes consumer and overdrafts in this table and in subsequent tables within Note 4 - Loans and Allowance for Credit Losses on Loans.

3 Excludes accrued interest receivable of $6.1 million and $7.0 million at September 30, 2021 and December 31, 2020, respectively, that is recorded in other assets on the consolidated balance sheet.

It is the policy of the Company to review each prospective credit prior to making a loan in order to determine if an adequate level of security or collateral has been obtained.  The type of collateral, when required, will vary from liquid assets to real estate.  The Company seeks to assure access to collateral, in the event of borrower default, through adherence to lending laws, the Company’s lending standards and credit monitoring procedures.  Although the Bank makes loans primarily within its market area, there are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single economic sector.  The real estate related categories listed above represent 73.4% and 72.5% of the portfolio at September 30, 2021, and December 31, 2020, respectively, and include a mix of owner and non-owner occupied, residential, construction and multifamily loans.  

14

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

The following tables represent the activity in the allowance for credit losses for loans, or the ACL, for the three and nine months ended September 30, 2021 and 2020:

Provision for

Beginning

(Release of)

Ending

Allowance for credit losses

   

Balance

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Three months ended September 30, 2021

Commercial

$

2,601

$

82

$

23

$

25

$

2,685

Leases

3,388

(41)

4

-

3,343

Commercial real estate - Investor

10,437

(890)

101

18

9,464

Commercial real estate - Owner occupied

1,086

99

5

7

1,187

Construction

3,048

(175)

-

-

2,873

Residential real estate - Investor

975

(287)

-

7

695

Residential real estate - Owner occupied

1,866

(116)

-

18

1,768

Multifamily

3,266

(121)

183

-

2,962

HELOC

1,604

13

-

28

1,645

HELOC - Purchased

229

(36)

-

-

193

Other

139

19

53

29

134

Ending Balance, September 30, 2021

$

28,639

$

(1,453)

$

369

$

132

$

26,949

Provision for

Beginning

(Release of)

Ending

Allowance for credit losses

   

Balance

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Nine months ended September 30, 2021

Commercial

$

2,812

$

43

$

232

$

62

$

2,685

Leases

3,888

(513)

32

-

3,343

Commercial real estate - Investor

9,205

302

101

58

9,464

Commercial real estate - Owner occupied

2,251

(1,250)

39

225

1,187

Construction

4,054

(1,181)

-

-

2,873

Residential real estate - Investor

1,740

(1,328)

-

283

695

Residential real estate - Owner occupied

2,714

(1,074)

-

128

1,768

Multifamily

3,625

(480)

183

-

2,962

HELOC

1,749

(216)

17

129

1,645

HELOC - Purchased

199

(6)

-

-

193

Other

1,618

(1,483)

108

107

134

Ending Balance, September 30, 2021

$

33,855

$

(7,186)

$

712

$

992

$

26,949

Impact of

Provision for

Beginning

Adopting

(Release of)

Ending

Allowance for credit losses

   

Balance

   

ASC 326

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Three months ended September 30, 2020

Commercial

$

2,292

$

-

$

98

$

5

$

12

$

2,397

Leases

2,012

-

1,965

119

-

3,858

Commercial real estate - Investor

7,725

-

783

-

102

8,610

Commercial real estate - Owner occupied

2,521

-

(535)

145

565

2,406

Construction

4,431

-

406

60

1

4,778

Residential real estate - Investor

2,217

-

(290)

3

18

1,942

Residential real estate - Owner occupied

3,204

-

(508)

-

25

2,721

Multifamily

3,518

-

(301)

-

-

3,217

HELOC

2,255

-

(359)

-

52

1,948

HELOC - Purchased

398

-

(43)

66

-

289

Other

700

-

64

53

41

752

Ending Balance, September 30, 2020

$

31,273

$

-

$

1,280

$

451

$

816

$

32,918

15

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Impact of

Provision for

Allowance for credit losses

Beginning

Adopting

(Release of)

Ending

Nine months ended September 30, 2020

   

Balance

   

ASC 326

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Commercial

$

3,015

$

(292)

$

(250)

$

124

$

48

$

2,397

Leases

1,262

501

2,214

119

-

3,858

Commercial real estate - Investor

6,218

(741)

3,009

15

139

8,610

Commercial real estate - Owner occupied

3,678

(848)

556

1,546

566

2,406

Construction

513

1,334

2,990

60

1

4,778

Residential real estate - Investor

601

740

564

8

45

1,942

Residential real estate - Owner occupied

1,257

1,320

30

43

157

2,721

Multifamily

1,444

1,732

41

-

-

3,217

HELOC

1,161

1,526

(902)

85

248

1,948

HELOC - Purchased

-

-

355

66

-

289

Other

640

607

(433)

192

130

752

Ending Balance, September 30, 2020

$

19,789

$

5,879

$

8,174

$

2,258

$

1,334

$

32,918

The ACL on loans excludes $2.2 million, $3.0 million and $4.0 million of allowance for unfunded commitments, recorded within Other Liabilities, as of September 30, 2021, December 31, 2020 and September 30, 2020, respectively.

The following tables presents the collateral dependent loans and the related ACL allocated by segment of loans as of September 30, 2021 and December 31, 2020:

Accounts

ACL

September 30, 2021

Real Estate

Receivable

Equipment

Other

Total

Allocation

Commercial

$

195

$

-

$

-

$

-

$

195

$

-

Leases

-

-

3,413

546

3,959

661

Commercial real estate - Investor

6,070

-

-

-

6,070

2,290

Commercial real estate - Owner occupied

4,373

-

-

2,523

6,896

7

Construction

4,898

-

-

-

4,898

988

Residential real estate - Investor

998

-

-

-

998

-

Residential real estate - Owner occupied

3,945

-

-

-

3,945

-

Multifamily

1,889

-

-

-

1,889

90

HELOC

700

-

-

-

700

195

HELOC - Purchased

181

-

-

-

181

-

Other

-

-

-

2

2

2

Total

$

23,249

$

-

$

3,413

$

3,071

$

29,733

$

4,233

Accounts

ACL

December 31, 2020

Real Estate

Receivable

Equipment

Other

Total

Allocation

Commercial

$

-

$

1,070

$

-

$

55

$

1,125

$

56

Leases

-

-

2,377

597

2,974

880

Commercial real estate - Investor

4,179

-

-

-

4,179

84

Commercial real estate - Owner occupied

9,726

-

-

-

9,726

195

Construction

1,891

-

-

-

1,891

952

Residential real estate - Investor

928

-

-

-

928

-

Residential real estate - Owner occupied

3,535

-

-

-

3,535

10

Multifamily

3,838

-

-

-

3,838

378

HELOC

1,053

-

-

-

1,053

78

HELOC - Purchased

-

-

-

-

-

-

Other

-

-

-

4

4

4

Total

$

25,150

$

1,070

$

2,377

$

656

$

29,253

$

2,637

16

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Aged analysis of past due loans by segments of loans was as follows:

90 days or

90 Days or

Greater Past

30-59 Days

60-89 Days

Greater Past

Total Past

Due and

September 30, 2021

Past Due

    

Past Due

    

Due

    

Due

    

Current

    

Total Loans

    

Accruing

Commercial

$

778

$

-

$

220

$

998

$

320,550

$

321,548

$

25

Leases

-

-

1,637

1,637

160,807

162,444

-

Commercial real estate - Investor

-

239

30

269

535,237

535,506

30

Commercial real estate - Owner occupied

812

672

2,258

3,742

326,906

330,648

-

Construction

-

-

2,665

2,665

106,025

108,690

-

Residential real estate - Investor

-

-

882

882

44,615

45,497

-

Residential real estate - Owner occupied

-

322

1,853

2,175

106,168

108,343

741

Multifamily

876

32

437

1,345

159,453

160,798

437

HELOC

344

-

77

421

69,230

69,651

-

HELOC - Purchased

-

-

181

181

12,189

12,370

-

Other

1

-

-

1

12,446

12,447

-

Total

$

2,811

$

1,265

$

10,240

$

14,316

$

1,853,626

$

1,867,942

$

1,233

90 days or

90 Days or

Greater Past

30-59 Days

60-89 Days

Greater Past

Total Past

Due and

December 31, 2020 1

Past Due

    

Past Due

    

Due

    

Due

    

Current

    

Total Loans

    

Accruing

Commercial

$

-

$

-

$

52

$

52

$

407,107

$

407,159

$

-

Leases

613

59

316

988

140,613

141,601

163

Commercial real estate - Investor

1,439

-

1,108

2,547

579,495

582,042

-

Commercial real estate - Owner occupied

1,848

958

7,309

10,115

322,955

333,070

-

Construction

1,237

-

-

1,237

97,249

98,486

-

Residential real estate - Investor

1,022

20

484

1,526

54,611

56,137

157

Residential real estate - Owner occupied

859

286

717

1,862

114,526

116,388

114

Multifamily

3,282

467

-

3,749

185,291

189,040

-

HELOC

549

50

206

805

80,103

80,908

-

HELOC - Purchased

47

-

-

47

19,440

19,487

-

Other

20

-

-

20

10,513

10,533

-

Total

$

10,916

$

1,840

$

10,192

$

22,948

$

2,011,903

$

2,034,851

$

434

1 Loans modified under the CARES Act are considered current if they are in compliance with the modified terms.  

There were 506 loans which totaled $237.8 million modified under the CARES Act.  As of September 30, 2021, 12 loans of the original 506 loans deferred, or $8.8 million, had an active deferral request and were in compliance with modified terms; 494 loans which totaled $229.0 million had resumed payments or paid off.  Details of loans in active deferral is below:

September 30, 2021

1st Deferral

2nd Deferral

3rd Deferral

Total

Loans modified under CARES Act, in deferral

$

-

$

6,752

$

2,077

$

8,829

Loans modified under CARES Act, in nonaccrual, within deferral above

-

2,524

2,077

4,601

17

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

The table presents all nonaccrual loans as of September 30, 2021, and December 31, 2020:

Nonaccrual loan detail

    

September 30, 2021

    

December 31, 2020

    

Commercial

$

195

$

1,125

Leases

3,959

2,638

Commercial real estate - Investor

6,070

1,632

Commercial real estate - Owner occupied

6,896

9,262

Construction

2,958

-

Residential real estate - Investor

998

928

Residential real estate - Owner occupied

3,945

3,206

Multifamily

1,618

2,437

HELOC

700

1,052

HELOC - Purchased

181

-

Other

-

-

Total

$

27,520

$

22,280

The Company recognized $243,000 of interest on nonaccrual loans during the three months ended September 30, 2021.

Credit Quality Indicators

The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparison to industry averages, historical payment experience, and current economic trends.  This analysis includes loans with outstanding balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and residential mortgages.  Loans with a classified risk rating are reviewed quarterly regardless of size or loan type.  The Company uses the following definitions for classified risk ratings:

Special Mention.  Loans classified as special mention have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.

Doubtful.  Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Credits that are not covered by the definitions above are pass credits, which are not considered to be adversely rated.

Credit quality indicators by loan segment and loan origination date at September 30, 2021 were as follows:

18

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Revolving

Loans

Converted

Revolving

To Term

    

2021

    

2020

    

2019

    

2018

    

2017

    

Prior

    

Loans

    

Loans

    

Total

Commercial

Pass

$

64,298

$

24,032

$

26,420

$

11,445

$

4,172

$

2,184

$

186,201

$

59

$

318,811

Special Mention

287

357

177

-

-

-

1,449

-

2,270

Substandard

233

200

-

34

-

-

-

-

467

Total commercial

64,818

24,589

26,597

11,479

4,172

2,184

187,650

59

321,548

Leases

Pass

59,361

47,677

$

36,332

10,311

1,752

2,588

-

-

158,021

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

2,918

664

35

806

-

-

4,423

Total leases

59,361

47,677

39,250

10,975

1,787

3,394

-

-

162,444

Commercial real estate - Investor

Pass

109,776

146,497

107,124

62,359

44,644

42,916

2,697

-

516,013

Special Mention

-

-

10,607

-

-

168

-

-

10,775

Substandard

2,107

-

448

185

5,948

30

-

-

8,718

Total commercial real estate - investor

111,883

146,497

118,179

62,544

50,592

43,114

2,697

-

535,506

Commercial real estate - Owner occupied

Pass

85,407

67,186

42,218

41,444

38,798

45,990

2,179

-

323,222

Special Mention

-

-

-

-

215

-

-

-

215

Substandard

-

3,493

1,686

-

1,008

1,024

-

-

7,211

Total commercial real estate - owner occupied

85,407

70,679

43,904

41,444

40,021

47,014

2,179

-

330,648

Construction

Pass

30,362

44,396

16,992

1,671

514

1,258

7,511

-

102,704

Special Mention

-

-

1,088

-

-

-

-

-

1,088

Substandard

174

-

2,784

1,940

-

-

-

-

4,898

Total construction

30,536

44,396

20,864

3,611

514

1,258

7,511

-

108,690

Residential real estate - Investor

Pass

1,877

6,148

10,909

6,383

6,867

10,229

1,930

-

44,343

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

-

156

388

610

-

-

1,154

Total residential real estate - investor

1,877

6,148

10,909

6,539

7,255

10,839

1,930

-

45,497

Residential real estate - Owner occupied

Pass

16,322

16,625

19,433

6,892

11,045

30,816

2,022

-

103,155

Special Mention

253

-

-

-

-

-

-

427

680

Substandard

64

46

-

399

178

3,821

-

-

4,508

Total residential real estate - owner occupied

16,639

16,671

19,433

7,291

11,223

34,637

2,022

427

108,343

Multifamily

Pass

20,071

29,014

28,374

45,325

21,745

6,362

69

-

150,960

Special Mention

-

-

6,901

610

-

-

-

-

7,511

19

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Substandard

-

-

-

1,580

747

-

-

-

2,327

Total multifamily

20,071

29,014

35,275

47,515

22,492

6,362

69

-

160,798

HELOC

Pass

503

1,918

2,018

1,132

1,576

1,023

60,339

-

68,509

Special Mention

-

-

-

-

-

-

108

-

108

Substandard

-

28

-

30

34

259

683

-

1,034

Total HELOC

503

1,946

2,018

1,162

1,610

1,282

61,130

-

69,651

HELOC - Purchased

Pass

-

-

-

-

-

12,189

-

-

12,189

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

-

-

-

181

-

-

181

Total HELOC - purchased

-

-

-

-

-

12,370

-

-

12,370

Other

Pass

3,772

1,490

575

178

112

223

6,095

-

12,445

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

-

2

-

-

-

-

2

Total other

3,772

1,490

575

180

112

223

6,095

-

12,447

Total loans

Pass

391,749

384,983

290,395

187,140

131,225

155,778

269,043

59

1,810,372

Special Mention

540

357

18,773

610

215

168

1,557

427

22,647

Substandard

2,578

3,767

7,836

4,990

8,338

6,731

683

-

34,923

Total loans

$

394,867

$

389,107

$

317,004

$

192,740

$

139,778

$

162,677

$

271,283

$

486

$

1,867,942

Credit quality indicators by loan segment and loan origination date at December 31, 2020, were as follows:

Revolving

Loans

Converted

Revolving

To Term

    

2020

    

2019

    

2018

    

2017

    

2016

    

Prior

    

Loans

    

Loans

    

Total

Commercial

Pass

$

101,796

$

42,294

$

14,519

$

6,265

$

1,825

$

1,691

$

230,388

$

-

$

398,778

Special Mention

5,130

425

68

-

3

-

76

-

5,702

Substandard

273

52

1,524

-

-

-

830

-

2,679

Total commercial

107,199

42,771

16,111

6,265

1,828

1,691

231,294

-

407,159

Leases

Pass

56,605

52,168

16,830

6,545

5,242

651

-

-

138,041

Special Mention

175

163

-

-

-

-

-

-

338

Substandard

-

1,434

798

59

450

481

-

-

3,222

Total leases

56,780

53,765

17,628

6,604

5,692

1,132

-

-

141,601

Commercial real estate - Investor

Pass

173,781

158,677

92,156

66,762

55,963

15,966

1,319

-

564,624

Special Mention

2,394

9,592

220

-

95

-

-

-

12,301

Substandard

2,709

1,126

71

-

340

871

-

-

5,117

Total commercial real estate - investor

178,884

169,395

92,447

66,762

56,398

16,837

1,319

-

582,042

Commercial real estate - Owner occupied

Pass

72,605

52,809

73,719

45,315

50,000

25,507

1,324

-

321,279

20

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Special Mention

604

-

-

-

-

-

-

-

604

Substandard

1,564

2,154

1,780

1,664

501

3,524

-

-

11,187

Total commercial real estate - owner occupied

74,773

54,963

75,499

46,979

50,501

29,031

1,324

-

333,070

Construction

Pass

50,170

24,163

7,203

539

218

1,261

9,702

-

93,256

Special Mention

38

-

-

-

-

-

-

-

38

Substandard

-

3,135

2,057

-

-

-

-

-

5,192

Total construction

50,208

27,298

9,260

539

218

1,261

9,702

-

98,486

Residential real estate - Investor

Pass

9,371

14,194

8,522

7,775

2,431

11,184

1,144

-

54,621

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

349

-

610

-

91

466

-

-

1,516

Total residential real estate - investor

9,720

14,194

9,132

7,775

2,522

11,650

1,144

-

56,137

Residential real estate - Owner occupied

Pass

18,308

23,450

10,808

15,409

10,394

31,325

2,654

-

112,348

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

47

-

412

219

526

2,836

-

-

4,040

Total residential real estate - owner occupied

18,355

23,450

11,220

15,628

10,920

34,161

2,654

-

116,388

Multifamily

Pass

40,671

30,849

44,301

38,133

12,147

7,735

197

-

174,033

Special Mention

-

6,901

-

548

-

-

-

-

7,449

Substandard

69

-

4,254

927

118

2,190

-

-

7,558

Total multifamily

40,740

37,750

48,555

39,608

12,265

9,925

197

-

189,040

HELOC

Pass

2,511

2,174

1,679

2,120

504

803

69,483

-

79,274

Special Mention

-

-

-

-

-

-

94

-

94

Substandard

-

-

86

37

271

91

1,055

-

1,540

Total HELOC

2,511

2,174

1,765

2,157

775

894

70,632

-

80,908

HELOC - Purchased

Pass

-

-

-

-

-

19,487

-

-

19,487

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

-

-

-

-

-

-

-

Total HELOC - purchased

-

-

-

-

-

19,487

-

-

19,487

Other

Pass

1,555

574

569

229

559

341

6,702

-

10,529

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

4

-

-

-

-

-

4

Total other

1,555

574

573

229

559

341

6,702

-

10,533

Total loans

Pass

527,373

401,352

270,306

189,092

139,283

115,951

322,913

-

1,966,270

Special Mention

8,341

17,081

288

548

98

-

170

-

26,526

Substandard

5,011

7,901

11,596

2,906

2,297

10,459

1,885

-

42,055

Total loans

$

540,725

$

426,334

$

282,190

$

192,546

$

141,678

$

126,410

$

324,968

$

-

$

2,034,851

21

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

The Company had $572,000 and $546,000 in residential real estate loans in the process of foreclosure as of September 30, 2021, and December 31, 2020, respectively.  

Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist: (1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties.  Loans are restructured on a case-by-case basis during the loan collection process with modifications generally initiated at the request of the borrower.  These modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications.  The Bank participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an opportunity to refinance into more affordable monthly payments.  Additionally, in accordance with interagency guidance, short-term deferrals granted due to the COVID-19 pandemic are not considered TDRs unless the borrower was experiencing financial difficulty prior to the pandemic.

The specific allocation of the allowance for credit losses for TDRs is determined by calculating the present value of the TDR cash flows by discounting the original payment less an assumption for probability of default at the original note’s issue rate, and adding this amount to the present value of collateral less selling costs.  If the resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance (i.e., specific reserve) as a component of the allowance for credit losses or charges off the impaired balance if it determines that such amount is a confirmed loss.  This method is used consistently for all segments of the portfolio.  The allowance for credit losses also includes an allowance based on a loss migration analysis for each loan category on loans and leases that are not individually evaluated for specific impairment.  All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.

There was no TDR activity for the three and nine months ended September 30, 2021.  

TDRs that were modified during the period are as follows:

TDR Modifications

TDR Modifications

Three Months Ended September 30, 2020

Nine Months Ended September 30, 2020

# of 

Pre-modification 

Post-modification 

# of 

Pre-modification 

Post-modification 

    

contracts

    

recorded investment

    

recorded investment

    

contracts

    

recorded investment

    

recorded investment

  

Troubled debt restructurings

Residential real estate - Owner occupied

HAMP1

1

$

154

$

153

3

$

410

$

404

Total

1

$

154

$

153

3

$

410

$

404

1  HAMP:  Home Affordable Modification Program

TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms.  There was no TDR default activity for the periods ended September 30, 2021, and September 30, 2020, for loans that were restructured within the prior 12 month period.

22

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Note 5 – Other Real Estate Owned

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

Three Months Ended

Nine Months Ended

    

September 30, 

    

September 30, 

  

Other real estate owned

    

2021

    

2020

    

2021

    

2020

Balance at beginning of period

$

1,877

$

5,082

$

2,474

$

5,004

Property additions, net of acquisition adjustments

70

314

70

898

Less:

Proceeds from property disposals, net of participation purchase and of gains/losses

37

2,664

567

2,952

Period valuation (write-up)/write-down

(2)

46

65

264

Balance at end of period

$

1,912

$

2,686

$

1,912

$

2,686

Activity in the valuation allowance was as follows:

    

Three Months Ended

Nine Months Ended

  

    

September 30, 

    

September 30, 

  

    

2021

    

2020

    

2021

    

2020

  

Balance at beginning of period

$

1,296

$

6,464

$

1,643

$

6,712

Provision for unrealized losses

(2)

46

65

264

Reductions taken on sales

(129)

(4,897)

(543)

(5,363)

Balance at end of period

$

1,165

$

1,613

$

1,165

$

1,613

Expenses related to OREO, net of lease revenue includes:

Three Months Ended

Nine Months Ended

September 30, 

    

September 30, 

    

2021

    

2020

    

2021

    

2020

Gain on sales, net

$

(5)

$

(165)

$

(40)

$

(188)

Provision for unrealized losses

(2)

46

65

264

Operating expenses

32

253

117

460

Less:

Lease revenue

-

9

4

31

Net OREO expense

$

25

$

125

$

138

$

505

Note 6 – Deposits

Major classifications of deposits were as follows:

    

September 30, 2021

    

December 31, 2020

  

Noninterest bearing demand

$

1,037,638

$

909,505

Savings

457,900

399,057

NOW accounts

537,547

486,612

Money market accounts

370,691

316,465

Certificates of deposit of less than $100,000

173,595

200,107

Certificates of deposit of $100,000 through $250,000

98,496

164,982

Certificates of deposit of more than $250,000

38,462

60,345

Total deposits

$

2,714,329

$

2,537,073

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Note 7 – Borrowings

The following table is a summary of borrowings as of September 30, 2021, and December 31, 2020.  Junior subordinated debentures are discussed in more detail in Note 8:

    

September 30, 2021

    

December 31, 2020

  

Securities sold under repurchase agreements

$

42,962

$

66,980

Junior subordinated debentures

25,773

25,773

Subordinated debentures

59,190

-

Senior notes

44,454

44,375

Notes payable and other borrowings

20,155

23,393

Total borrowings

$

192,534

$

160,521

The Company enters into deposit sweep transactions where the transaction amounts are secured by pledged securities.  These transactions consistently mature overnight from the transaction date and are governed by sweep repurchase agreements.  All sweep repurchase agreements are treated as financings secured by U.S. government agencies and collateralized mortgage-backed securities and had a carrying amount of $43.0 million at September 30, 2021, and $67.0 million at December 31, 2020.  The fair value of the pledged collateral was $113.8 million at September 30, 2021, and $94.4 million at December 31, 2020.  At September 30, 2021, there were no customers with secured balances exceeding 10% of stockholders’ equity.

The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC.  Total borrowings are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans.  As of September 30, 2021, and December 31, 2020 the Bank had no short-term advances outstanding under the FHLBC.  The Bank also assumed $23.4 million of long-term FHLBC advances with the ABC Bank acquisition in 2018.  At September 30, 2021, one advance remains in long-term status, with a total outstanding balance of $6.2 million, at a 2.83% interest rate, and is scheduled to mature on February 2, 2026.  FHLBC stock held at September 30, 2021 was valued at $3.7 million, and any potential FHLBC advances were collateralized by loans with a principal balance of $553.6 million, which carried a FHLBC-calculated combined collateral value of $402.1 million.  The Company had excess collateral of $269.7 million available to secure borrowings at September 30, 2021.

The Company also had $44.5 million and $44.4 million of senior notes outstanding, net of deferred issuance costs, as of September 30, 2021 and December 31, 2020.  The senior notes were issued in December 2016 with a ten year maturity, and terms include interest payable semiannually at 5.75% for five years.  Beginning December 2021, the senior debt will pay interest at a floating rate, with interest payable quarterly at three month LIBOR plus 385 basis points.  The notes are redeemable, in whole or in part, at the option of the Company, beginning with the interest payment date on December 31, 2021, and on any floating rate interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest.  As of September 30, 2021, and December 31, 2020, unamortized debt issuance costs related to the senior notes were $546,000 and $625,000, respectively, and are included as a reduction of the balance of the senior notes on the Consolidated Balance Sheet.  These deferred issuance costs will be amortized to interest expense over the ten year term of the notes and are included in the Consolidated Statements of Income.

On February 24, 2020, the Company originated a $20.0 million term note, of which $14.0 million is outstanding as of September 30, 2021,  with a correspondent bank related to the Company’s redemption of the 7.80% cumulative trust preferred securities issued by Old Second Capital Trust I and related junior subordinated debentures.  See the discussion in Note 8 – Junior Subordinated Debentures.  The term note was issued for a three year term at one-month LIBOR plus 175 basis points, requires principal and interest payments quarterly, and the balance of this note is included within Notes Payable and Other Borrowings on the Consolidated Balance Sheet.  The Company also has an undrawn line of credit of $20.0 million with a correspondent bank to be used for short-term funding needs; advances under this line can be outstanding up to 360 days from the date of issuance.  This line of credit has not been utilized since early 2019.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

On April 6, 2021, we sold and issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”). The Notes were offered and sold to eligible purchasers in a private offering in reliance on the exemption from the registration requirements of Section 4(a)(2) of the Securities Act of 1933, as amended and the provisions of Regulation D promulgated thereunder. The Company intends to use the net proceeds from the offering for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions.  The Notes bear interest at a fixed annual rate of 3.50%, from and including the date of issuance to but excluding April 15, 2026, payable semi-annually in arrears.  From and including April 15, 2026 to, but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an interest rate per annum equal to Three-Month Term SOFR (as defined in the Note) plus 273 basis points, payable quarterly in arrears.

Note 8 – Junior Subordinated Debentures

On March 2, 2020, the Company redeemed the 7.80% cumulative trust preferred securities issued by Old Second Capital Trust I (“OSBCP”) and related junior subordinated debentures, which totaled $32.6 million.  These debentures were originally issued in 2003 for a term of 30 years at 7.80%, and subject to regulatory approval, were able to be called in whole or in part by the Company after June 30, 2008.  The Company received regulatory approval to redeem the debentures in early 2020, and notified OSBCP stockholders of the redemption in late January 2020.  Cash disbursed for the redemption, including accrued interest on the debentures, totaled $33.0 million, or $10.13 per OSBCP share.  The OSBCP redemption was funded by cash on hand and the $20 million term note discussed in Note 7 – Borrowings.  Upon redemption of the junior subordinated debentures related to OSBCP in March 2020, the Company recognized the remaining unamortized debt issuance costs of $635,000.

The Company issued $25.0 million of cumulative trust preferred securities through a private placement completed by another unconsolidated subsidiary, Old Second Capital Trust II, in April 2007.  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 were fixed at 6.77% through June 15, 2017, and float at 150 basis points over three-month LIBOR thereafter.  Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 4.40% for the quarters ended September 30, 2021 and September 30, 2020.  The Company issued a new $25.8 million subordinated debenture to Old Second Capital Trust II in return for the aggregate net proceeds of this trust preferred offering.  The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.  

The junior subordinated debentures issued by the Company are disclosed on the Consolidated Balance Sheet, and the related interest expense for each issuance is included in the Consolidated Statements of Income.  As of September 30, 2021, and December 31, 2020, the remaining unamortized debt issuance costs related to the junior subordinated debentures were $1,000 and are included as a reduction to the balance of the junior subordinated debentures on the Consolidated Balance Sheet.  The remaining deferred issuance costs on the junior subordinated debentures related to the issuance of Old Second Capital Trust II will be amortized to interest expense over the remainder of the 30-year term of the notes and are included in the Consolidated Statements of Income.

Note 9 – Equity Compensation Plans

The Company’s 2019 Equity Incentive Plan, which authorized 600,000 shares for issuance under the plan, was approved at the May 2019 annual stockholders’ meeting.  Following approval of such plan, no further awards will be granted under any other prior Company equity compensation plan.  At the May 2021 annual stockholders’ meeting, the Company obtained stockholder approval to amend and restate the 2019 Equity Incentive Plan to increase the number of shares of common stock authorized for issuance under the plan by 1,200,000 shares, from 600,000 shares to 1,800,000 shares (the “2019 Plan”).

The 2019 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights (“SARs”).  Awards may be granted to selected directors, officers, employees or eligible service providers under the 2019 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors.  

As of September 30, 2021, 1,418,520 shares remained available for issuance under the 2019 Plan.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Under the 2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, all stock options and SARs then held by the participant will become fully exercisable immediately if, and all stock awards and cash incentive awards will become fully earned and vested immediately if, (i) the 2019 Plan is not an obligation of the successor entity following a change in control or (ii) the 2019 Plan is an obligation of the successor entity following a change in control and the participant incurs a termination of service without cause  or for good reason  following the change in control.  Notwithstanding the immediately preceding sentence, if the vesting of an award is conditioned upon the achievement of performance measures, then such vesting will generally be subject to the following: if, at the time of the change in control, the performance measures are less than 50% attained (pro rata based upon the time of the period through the change in control), the award will become vested and exercisable on a fractional basis with the numerator being equal to the percentage of attainment and the denominator being 50%; and if, at the time of the change in control, the performance measures are at least 50% attained (pro rata based upon the time of the period through the change in control), the award will become fully earned and vested immediately upon the change in control.  Generally, restricted stock and restricted stock units granted under the Plans vest three years from the grant date, but the Compensation Committee of the Company’s Board of Directors has discretionary authority to change some terms including the amount of time until the vest date.  

Awards of restricted stock under the Plans generally entitle holders to voting and dividend rights upon grant and are subject to forfeiture until certain restrictions have lapsed including employment for a specific period.  Awards of restricted stock units under the Plans are also subject to forfeiture until certain restrictions have lapsed including employment for a specific period, but do not entitle holders to voting rights until the restricted period ends and shares are transferred in connection with the units.

There were 224,464 and 137,944 restricted stock units issued under the 2019 Plan during the nine months ended September 30, 2021 and September 30, 2020, respectively. Compensation expense is recognized over the vesting period of the restricted stock units based on the market value of the award on the issue date.  Total compensation cost that has been recorded for the Plan was $1.2 million in the first nine months of 2021 and $1.6 million for the first nine months ended of 2020.

A summary of changes in the Company’s unvested restricted awards for the nine months ended September 30, 2021, is as follows:

September 30, 2021

Weighted

Restricted

Average

Stock Shares

Grant Date

    

and Units

    

Fair Value

Unvested at January 1

532,609

$

13.15

Granted

224,464

11.38

Vested

(191,653)

13.95

Forfeited

(42,111)

14.15

Unvested at September 30

523,309

$

12.01

Total unrecognized compensation cost of restricted awards was $3.1 million as of September 30, 2021, which is expected to be recognized over a weighted-average period of 1.88 years.  

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Note 10 – Earnings Per Share

The earnings per share, both basic and diluted, are as follows:

Three Months Ended September 30, 

Nine Months Ended September 30, 

    

2021

    

2020

    

2021

    

2020

    

Basic earnings per share:

Weighted-average common shares outstanding

28,707,737

29,559,026

28,925,612

29,708,239

Net income

$

8,412

$

10,265

$

29,111

$

19,778

Basic earnings per share

$

0.30

$

0.35

$

1.01

$

0.67

Diluted earnings per share:

Weighted-average common shares outstanding

28,707,737

29,559,026

28,925,612

29,708,239

Dilutive effect of unvested restricted awards 1

522,543

543,275

533,194

553,482

Diluted average common shares outstanding

29,230,280

30,102,301

29,458,806

30,261,721

Net Income

$

8,412

$

10,265

$

29,111

$

19,778

Diluted earnings per share

$

0.29

$

0.34

$

0.99

$

0.65

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

Note 11 Regulatory & Capital Matters

The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighted Bank assets, developed by the Office of the Comptroller of the Currency (the “OCC”) and the other bank regulatory agencies.  In connection with the current risk-based capital regulatory guidelines, the Bank’s Board of Directors has established an internal guideline requiring the Bank to maintain a Tier 1 leverage capital ratio at or above eight percent (8%) and a total risk-based capital ratio at or above twelve percent (12%).  At September 30, 2021, the Bank exceeded those thresholds.

At September 30, 2021, the Bank’s Tier 1 capital leverage ratio was 10.83%, an increase of 9 basis points from December 31, 2020, but is well above the 8.00% objective.  The Bank’s total capital ratio was 16.69%, an increase of 168 basis points from December 31, 2020, and also well above the objective of 12.00%.

Bank holding companies are generally required to maintain minimum levels of capital in accordance with capital guidelines implemented by the Board of Governors of the Federal Reserve System.  The general bank and holding company capital adequacy guidelines are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of September 30, 2021, and December 31, 2020.

In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital requirements for U.S. banking institutions, which went into effect on January 1, 2015. The Basel III Rules are applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” generally holding companies with consolidated assets of less than $3.0 billion. The Company is currently considered a “small bank holding company.”  As we had total assets in excess of $3.0 billion as of June 30, 2021, we will no longer be considered a small bank holding company in March of 2022.  A detailed discussion of the Basel III Rules is included in Part I, Item 1 of the Company’s Form 10-K for the year ended December 31, 2020, under the heading “Supervision and Regulation.”

At September 30, 2021, and December 31, 2020, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Capital levels and industry defined regulatory minimum required levels are as follows:

Minimum Capital

Well Capitalized

Adequacy with Capital

Under Prompt Corrective

Actual

Conservation Buffer, if applicable1

Action Provisions2

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

September 30, 2021

Common equity tier 1 capital to risk weighted assets

Consolidated

$

292,767

12.99

%

$

157,765

7.00

%

N/A

N/A

Old Second Bank

351,663

15.65

157,293

7.00

$

146,058

6.50

%

Total capital to risk weighted assets

Consolidated

401,027

17.80

236,561

10.50

N/A

N/A

Old Second Bank

374,923

16.69

235,871

10.50

224,639

10.00

Tier 1 capital to risk weighted assets

Consolidated

317,767

14.10

191,562

8.50

N/A

N/A

Old Second Bank

351,663

15.65

190,999

8.50

179,764

8.00

Tier 1 capital to average assets

Consolidated

317,767

9.81

129,569

4.00

N/A

N/A

Old Second Bank

351,663

10.83

129,885

4.00

162,356

5.00

December 31, 2020

Common equity tier 1 capital to risk weighted assets

Consolidated

$

277,199

11.94

%

$

162,512

7.00

%

N/A

N/A

Old Second Bank

318,466

13.75

162,128

7.00

$

150,548

6.50

%

Total capital to risk weighted assets

Consolidated

331,178

14.26

243,855

10.50

N/A

N/A

Old Second Bank

347,408

15.00

243,186

10.50

231,605

10.00

Tier 1 capital to risk weighted assets

Consolidated

302,199

13.01

197,440

8.50

N/A

N/A

Old Second Bank

318,466

13.75

196,870

8.50

185,289

8.00

Tier 1 capital to average assets

Consolidated

302,199

10.21

118,393

4.00

N/A

N/A

Old Second Bank

318,466

10.74

118,609

4.00

148,262

5.00

1 Amounts are shown inclusive of a capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes.

2 The prompt corrective action provisions are only applicable at the Bank level. The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized.”

As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopted CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we elected to utilize the five-year CECL transition.  The cumulative amount that is not recognized in regulatory capital, in addition to the $3.8 million

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Day 1 impact of CECL adoption, will be phased in at 25% per year beginning January 1, 2022. As of September 30, 2021, the capital measures of the Company exclude $4.2 million, which is the modified CECL transition adjustment.

Dividend Restrictions

In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be paid by a bank without prior regulatory approval.  Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital requirements described above.  Pursuant to the Basel III rules that came into effect January 1, 2015, and were fully phased in as of January 1, 2019, the Bank must keep a capital conservation buffer of 2.50% above the new regulatory minimum capital requirements, which must consist entirely of Common Equity Tier 1 capital in order to avoid additional limitations on capital distributions and certain other payments.

Stock Repurchase Program

In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase Program”).  The Repurchase Program expired on September 19, 2020, however, on October 20, 2020, the Company received notice of non-objection from the Federal Reserve Bank of Chicago to extend the Repurchase Program through October 20, 2021.  Repurchases by us under the Repurchase Program may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means.  During the third quarter of 2021, we repurchased no shares of our common stock pursuant to the Repurchase Program.  As of September 30, 2021, 1,485,307 shares had been repurchased since the program’s inception, and 9,519 shares remained available for repurchase under the Repurchase Program. The Repurchase Program expired on October 21, 2021.

Note 12 Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  The fair value hierarchy established by the Company also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  Three levels of inputs that may be used to measure fair value are:

Level 1:  Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.

Level 2:  Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3:  Significant unobservable inputs that reflect a company’s own view about the assumptions that market participants would use in pricing an asset or liability.

The majority of securities available-for-sale are valued by external pricing services or dealer market participants and are classified in Level 2 of the fair value hierarchy.  Both market and income valuation approaches are utilized.  Quarterly, the Company evaluates the methodologies used by the external pricing services or dealer market participants to develop the fair values to determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value.  The Company uses the following methods and significant assumptions to estimate fair value:

Government-sponsored agency debt securities are primarily priced using available market information through processes such as benchmark spreads, market valuations of like securities, like securities groupings and matrix pricing.
Other government-sponsored agency securities, MBS and some of the actively traded real estate mortgage investment conduits and collateralized mortgage obligations are priced using available market information including benchmark yields, prepayment speeds, spreads, volatility of similar securities and trade date.
State and political subdivisions are largely grouped by characteristics (e.g., 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.

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Auction rate securities are priced using market spreads, cash flows, prepayment speeds, and loss analytics.  Therefore, the valuations of auction rate asset-backed securities are considered Level 2 valuations.
Asset-backed collateralized loan obligations were priced using data from a pricing matrix supported by our bond accounting service provider and are therefore considered Level 2 valuations.
Annually every security holding is priced by a pricing service independent of the regular and recurring pricing services used.  The independent service provides a measurement to indicate if the price assigned by the regular service is within or outside of a reasonable range.  Management reviews this report and applies judgment in adjusting calculations at year end related to securities pricing.
Residential mortgage loans available 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, e.g., residential mortgage loans with locked interest rates 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 MBS are considered derivatives.  Fair values are estimated based on observable changes in mortgage interest rates including prices for MBS 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 valuation pricing models using an income approach reflecting readily observable market parameters such as interest rate yield curves.
The fair value of impaired loans with specific allocations of the allowance for credit losses is essentially based on recent real estate appraisals or the fair value of the collateralized asset.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are made in the appraisal process by the appraisers to reflect differences between the available comparable sales and income data.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at fair value, less costs to sell.  Fair values are based on third party appraisals of the property, resulting in a Level 3 classification, or an executed pending sales contract.  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

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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

The tables below present the balance of assets and liabilities at September 30, 2021, and December 31, 2020, respectively, measured by the Company at fair value on a recurring basis:

September 30, 2021

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Securities available-for-sale

U.S. Treasury

$

4,070

$

-

$

-

$

4,070

U.S. government agencies

-

33,575

-

33,575

U.S. government agencies mortgage-backed

-

17,818

-

17,818

States and political subdivisions

-

233,392

5,560

238,952

Corporate bonds

-

4,992

-

4,992

Collateralized mortgage obligations

-

165,414

-

165,414

Asset-backed securities

-

189,338

-

189,338

Collateralized loan obligations

-

61,029

-

61,029

Loans held-for-sale

-

3,009

-

3,009

Mortgage servicing rights

-

-

5,320

5,320

Interest rate swap agreements

-

5,292

-

5,292

Mortgage banking derivatives

-

875

-

875

Total

$

4,070

$

714,734

$

10,880

$

729,684

Liabilities:

Interest rate swap agreements, including risk participation agreements

$

-

$

7,798

$

-

$

7,798

Total

$

-

$

7,798

$

-

$

7,798

December 31, 2020

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Securities available-for-sale

U.S. Treasury

$

4,117

$

-

$

-

$

4,117

U.S. government agencies

-

6,657

-

6,657

U.S. government agencies mortgage-backed

-

17,209

-

17,209

States and political subdivisions

-

244,940

4,319

249,259

Collateralized mortgage obligations

-

56,585

-

56,585

Asset-backed securities

-

131,818

-

131,818

Collateralized loan obligations

-

30,533

-

30,533

Loans held-for-sale

-

12,611

-

12,611

Mortgage servicing rights

-

-

4,224

4,224

Interest rate swap agreements

-

9,388

-

9,388

Mortgage banking derivatives

-

840

-

840

Total

$

4,117

$

510,581

$

8,543

$

523,241

Liabilities:

Interest rate swap agreements, including risk participation agreements

$

-

$

13,159

$

-

$

13,159

Total

$

-

$

13,159

$

-

$

13,159

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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

Nine Months Ended September 30, 2021

Securities available-for-sale

States and

Mortgage

Political

Servicing

   

Subdivisions

   

Rights

Beginning balance January 1, 2021

$

4,319

$

4,224

Total gains or losses

Included in earnings

(7)

840

Included in other comprehensive income

812

-

Purchases, issuances, sales, and settlements

Purchases

748

-

Issuances

-

1,298

Settlements

(312)

(1,042)

Ending balance September 30, 2021

$

5,560

$

5,320

Nine Months Ended September 30, 2020

Securities available-for-sale

States and

Mortgage

Political

Servicing

    

Subdivisions

    

Rights

Beginning balance January 1, 2020

$

5,419

$

5,935

Total gains or losses

Included in earnings

(16)

(2,463)

Included in other comprehensive income

(216)

-

Purchases, issuances, sales, and settlements

Purchases

12,900

-

Issuances

-

1,813

Settlements

(13,297)

(275)

Ending balance September 30, 2020

$

4,790

$

5,010

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of September 30, 2021:

Weighted

Measured at fair value

Unobservable

Average

on a recurring basis:

   

Fair Value

   

Valuation Methodology

   

Inputs

   

Range of Input

   

of Inputs

Mortgage servicing rights

$

5,320

Discounted Cash Flow

Discount Rate

11.0 - 15.0%

11.0

%

Prepayment Speed

0.0 - 49.6%

15.5

%

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of December 31, 2020:

Weighted

Measured at fair value

Unobservable

Average

on a recurring basis:

   

Fair Value

   

Valuation Methodology

   

Inputs

   

Range of Input

   

of Inputs

Mortgage servicing rights

$

4,224

Discounted Cash Flow

Discount Rate

11.0 - 15.0%

11.0

%

Prepayment Speed

5.5 - 59.1%

19.5

%

In addition to the above, Level 3 fair value measurement included $5.6 million for state and political subdivisions representing various local municipality securities at September 30, 2021.  These securities were classified as securities available-for-sale, and were valued using a discount based on market spreads of similar assets, but the liquidity premium was an unobservable input.  The state and political subdivisions securities balance in Level 3 fair value at September 30, 2020, was $4.8 million.  These securities were classified as securities available-for-sale, and were valued using a discount based on market spreads of similar assets, but the liquidity premium was an unobservable input.

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

The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP.  These assets consist of individually evaluated (formerly, impaired) loans and OREO.  For assets measured at fair value on a nonrecurring basis at September 30, 2021, and December 31, 2020, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:

September 30, 2021

    

Level 1

    

Level 2

    

Level 3

    

Total

Individually evaluated loans1

$

-

$

-

$

7,187

$

7,187

Other real estate owned, net2

-

-

1,912

1,912

Total

$

-

$

-

$

9,099

$

9,099

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 $11.0 million and a valuation allowance of $3.8 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $1.2 million for the nine months ended September 30, 2021.

2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $1.9 million at September 30, 2021, which is made up of the outstanding balance of $3.1 million, net of a valuation allowance of $1.2 million.

December 31, 2020

    

Level 1

    

Level 2

    

Level 3

    

Total

Individually evaluated loans1

$

-

$

-

$

9,675

$

9,675

Other real estate owned, net2

-

-

2,474

2,474

Total

$

-

$

-

$

12,149

$

12,149

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 $12.3 million and a valuation allowance of $2.6 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $1.4 for the year December 31, 2020.

2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $2.5 million at December 31, 2020, which is made up of the outstanding balance of $4.1 million, net of a valuation allowance of $1.6 million.

The Company has estimated the fair values of these assets based primarily on Level 3 inputs.  OREO and impaired loans are generally valued using the fair value of collateral provided by third party appraisals.  These valuations include assumptions related to cash flow

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

projections, discount rates, and recent comparable sales.  The numerical ranges of unobservable inputs for these valuation assumptions are not meaningful.

Note 13 – Fair Values of Financial Instruments

The estimated fair values approximate carrying amount for all items except those described in the following table.  Securities available-for-sale fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the security.  The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC or another member institution at par.  FHLBC stock is carried at cost and considered a Level 2 fair value.  September 30, 2021 and December 31, 2020, the fair values of loans and leases are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors.  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 volume is not considered material.

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

September 30, 2021

Carrying

Fair

    

Amount

    

Value

    

Level 1

    

Level 2

    

Level 3

Financial assets:

Cash and due from banks

$

26,705

$

26,705

$

26,705

$

-

$

-

Interest earning deposits with financial institutions

492,548

492,548

492,548

-

-

Securities available-for-sale

715,188

715,188

4,070

705,558

5,560

FHLBC and FRBC stock

9,917

9,917

-

9,917

-

Loans held-for-sale

3,009

3,009

-

3,009

-

Net loans

1,840,993

1,849,933

-

-

1,849,933

Mortgage servicing rights

5,320

5,320

-

-

5,320

Interest rate swap agreements

5,292

5,292

-

5,292

-

Interest rate lock commitments and forward contracts

875

875

-

875

-

Interest receivable on securities and loans

8,956

8,956

-

8,956

-

Financial liabilities:

Noninterest bearing deposits

$

1,037,638

$

1,037,638

$

1,037,638

$

-

$

-

Interest bearing deposits

1,676,691

1,677,796

-

1,677,796

-

Securities sold under repurchase agreements

42,962

42,962

-

42,962

-

Junior subordinated debentures

25,773

18,557

-

18,557

-

Subordinated debentures

59,190

60,390

60,390

Senior notes

44,454

44,724

44,724

-

-

Note payable and other borrowings

20,155

20,600

-

20,600

-

Interest rate swap agreements

7,767

7,767

-

7,767

-

Interest payable on deposits and borrowings

1,920

1,920

-

1,920

-

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

December 31, 2020

Carrying

Fair

    

Amount

    

Value

    

Level 1

    

Level 2

    

Level 3

Financial assets:

Cash and due from banks

$

24,306

$

24,306

$

24,306

$

-

$

-

Interest earning deposits with financial institutions

305,597

305,597

305,597

-

-

Securities available-for-sale

496,178

496,178

4,117

487,742

4,319

FHLBC and FRBC stock

9,917

9,917

-

9,917

-

Loans held-for-sale

12,611

12,611

-

12,611

-

Net loans

2,000,996

2,009,773

-

-

2,009,773

Mortgage servicing rights

4,224

4,224

-

-

4,224

Interest rate swap agreements

9,388

9,388

-

9,388

-

Interest rate lock commitments and forward contracts

840

840

-

840

-

Interest receivable on securities and loans

9,698

9,698

-

9,698

-

Financial liabilities:

Noninterest bearing deposits

$

909,505

$

909,505

$

909,505

$

-

$

-

Interest bearing deposits

1,627,568

1,630,109

-

1,630,109

-

Securities sold under repurchase agreements

66,980

66,980

-

66,980

-

Junior subordinated debentures

25,773

14,658

-

14,658

-

Senior notes

44,375

44,600

44,600

-

-

Note payable and other borrowings

23,393

24,043

-

24,043

-

Interest rate swap agreements

13,071

13,071

-

13,071

-

Interest payable on deposits and borrowings

418

418

-

418

-

Note 14 – Derivatives, Hedging Activities and Financial Instruments with Off-Balance Sheet Risk

Risk Management Objective of Using Derivatives

The Company is exposed to certain risk arising from both its business operations and economic conditions.  The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments.  Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s loan portfolio.  

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.  In December of 2019, the Company also executed a loan pool hedge of $50 million to convert variable rate loans to a fixed rate index for a five year term.

For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest income/expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are received on the Company’s variable-rate borrowings.  During the next twelve

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

months, the Company estimates that an additional $189,000 will be reclassified as an increase to interest income and an additional $175,000 will be reclassified as an increase to interest expense.  

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers.  The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies.  Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions.  As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives with financial counterparties are recognized directly in earnings.  

The Company also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards.  The interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans as well as selling forward mortgage-backed securities contracts.  Loan interest rate lock commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Commitments to originate residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue.  Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.

Disclosure of Fair Values of Derivative Instruments on the Balance Sheet

The Company entered into a forward starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017.  This transaction had a notional amount totaling $25.8 million as of September 30, 2021, was designated as a cash flow hedge of certain junior subordinated debentures and was determined to be fully effective during the period presented.  As such, no amount of ineffectiveness has been included in net income.  Therefore, the aggregate fair value of the swap is recorded in other liabilities with changes in fair value recorded in other comprehensive income, net of tax.  The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be considered effective.  The Company expects the hedge to remain fully effective during the remaining term of the swap.  The Bank will pay the counterparty a fixed rate and receive a floating rate based on three month LIBOR.  The trust preferred securities changed from fixed rate to floating rate on June 15, 2017.  The cash flow hedge has a maturity date of June 15, 2037.

In December 2019, the Company also executed a loan pool hedge of $50.0 million to convert variable rate loans to a fixed rate index for a five year term.  This transaction falls under hedge accounting standards and is paired against a pool of the Bank’s LIBOR-based loans. Overall, the new swap only bolsters income in down rate scenarios by a modest degree.  We consider the current level of interest rate risk to be moderate but intend to continue looking for market opportunities to hedge further.  The Bank held $740,000 and $1.4 million of cash collateral related to one correspondent financial institution to cover the loan pool hedge mark to market valuation at September 30, 2021, and December 31, 2020, respectively.

The Bank also has interest rate derivative positions to assist with risk management that are not designated as hedging instruments.  These derivative positions relate to transactions in which the Bank enters an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution.  The Bank had $17.2 million of cash collateral held by one correspondent financial institution to support interest rate swap activity and no investment securities were required to be pledged to any correspondent financial institution at September 30, 2021 and December 31, 2020.  At September 30, 2021, the notional amount of non-hedging interest rate swaps was $167.2 million with a weighted average maturity of 4.1 years.  At December 31, 2020, the notional amount of non-hedging interest rate swaps was $189.1 million with a weighted average maturity of 4.7 years.  The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of September 30, 2021 and December 31, 2020.

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Fair Value of Derivative Instruments

September 30, 2021

No. of Trans.

Notional Amount $

Balance Sheet Location

Fair Value $

Balance Sheet Location

Fair Value $

Derivatives designated as hedging instruments

Interest rate swap agreements

2

75,774

Other Assets

1,567

Other Liabilities

4,042

Total derivatives designated as hedging instruments

1,567

4,042

Derivatives not designated as hedging instruments

Interest rate swaps with commercial loan customers

26

167,218

Other Assets

3,725

Other Liabilities

3,725

Interest rate lock commitments and forward contracts

132

46,753

Other Assets

875

Other Liabilities

-

Other contracts

3

17,297

Other Assets

-

Other Liabilities

31

Total derivatives not designated as hedging instruments

4,600

3,756

December 31, 2020

No. of Trans.

Notional Amount $

Balance Sheet Location

Fair Value $

Balance Sheet Location

Fair Value $

Derivatives designated as hedging instruments

Interest rate swap agreements

2

75,774

Other Assets

2,697

Other Liabilities

6,380

Total derivatives designated as hedging instruments

2,697

6,380

Derivatives not designated as hedging instruments

Interest rate swaps with commercial loan customers

28

189,126

Other Assets

6,691

Other Liabilities

6,691

Interest rate lock commitments and forward contracts

205

84,472

Other Assets

840

Other Liabilities

-

Other contracts

4

26,523

Other Assets

-

Other Liabilities

88

Total derivatives not designated as hedging instruments

7,531

6,779

Disclosure of the Effect of Fair Value and Cash Flow Hedge Accounting

The fair value and cash flow hedge accounting related to derivatives covered under ASC Subtopic 815-20 impacted Accumulated Other Comprehensive Income (“AOCI”) and the Income Statement.  The loss recognized in AOCI on derivatives totaled $1.8 million as of September 30, 2021, and $3.3 million as of September 30, 2020.  The amount of the gain or (loss) reclassified from AOCI to interest income or interest expense on the income statement totaled $40,000 and ($72,000) for the nine months ended September 30, 2021, and September 30, 2020, respectively.  

Credit-risk-related Contingent Features

For derivative transactions involving counterparties who are lending customers of the Company, the derivative credit exposure is managed through the normal credit review and monitoring process, which may include collateralization, financial covenants and/or financial guarantees of affiliated parties.  Agreements with such customers require that losses associated with derivative transactions receive payment priority from any funds recovered should a customer default and ultimate disposition of collateral or guarantees occur.

Credit exposure to broker/dealer counterparties is managed through agreements with each derivative counterparty that require collateralization of fair value gains owed by such counterparties.  Some small degree of credit exposure exists due to timing differences between when a gain may occur and the subsequent point in time that collateral is delivered to secure that gain.  This is monitored by the Company and procedures are in place to minimize this exposure.  Such agreements also require the Company to collateralize counterparties in circumstances wherein the fair value of the derivatives result in loss to the Company.

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Other provisions of such agreements include the definition of certain events that may lead to the declaration of default and/or the early termination of the derivative transaction(s):

If the Company either defaults or is capable of being declared in default on any of its indebtedness (exclusive of deposit obligations), then the Company could also be declared in default on its derivative obligations.
If a merger occurs that materially changes the Company's creditworthiness in an adverse manner.
If certain specified adverse regulatory actions occur, such as the issuance of a Cease and Desist Order, or citations for actions considered Unsafe and Unsound or that may lead to the termination of deposit insurance coverage by the FDIC.

The Bank also issues letters of credit, which are conditional commitments that guarantee the performance of a customer to a third party.  The credit risk involved and collateral obtained in issuing letters of credit are essentially the same as that involved in extending loan commitments to our customers.  In addition to customer related commitments, the Company is responsible for letters of credit commitments that relate to properties held in OREO.  The following table represents the Company’s contractual commitments due to letters of credit as of September 30, 2021, and December 31, 2020.

The following table is a summary of letter of credit commitments:

September 30, 2021

December 31, 2020

    

Fixed

    

Variable

    

Total

    

Fixed

    

Variable

    

Total

  

Letters of credit:

Borrower:

Financial standby

$

329

$

8,446

$

8,775

$

329

$

9,051

$

9,380

Commercial standby

-

-

-

-

-

-

Performance standby

532

6,836

7,368

356

4,517

4,873

861

15,282

16,143

685

13,568

14,253

Non-borrower:

Performance standby

-

67

67

-

67

67

Total letters of credit

$

861

$

15,349

$

16,210

$

685

$

13,635

$

14,320

Unused loan commitments:

$

126,753

$

330,934

$

457,687

$

88,883

$

316,298

$

405,181

As of September 30, 2021, the Company evaluated current market conditions, including the impacts related to COVID-19 and market interest rates during the third quarter of 2021, and based on that analysis under the CECL methodology, the Company determined credit losses related to unfunded commitments totaled $2.2 million.  The decrease in the ACL for unfunded commitments of $47,000 for the third quarter of 2021, compared to the prior quarter end, is primarily related to a decrease in the commercial unfunded commitments funding rate assumptions based on our analysis of the last 12 months of utilization.  The Company will continue to assess the credit risk at least quarterly, and adjust the allowance for unfunded commitments, which is carried within other liabilities on our Consolidated Balance Sheet, as needed, with the appropriate offsetting entry to the provision for credit losses on our Consolidated Statements of Income.

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Table of Contents

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

Overview

The following discussion provides additional information regarding our operations for the three and nine months ended September 30, 2021, compared to the three and nine months ended September 30, 2020, and our financial condition at September 30, 2021, compared to December 31, 2020.  This discussion should be read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our Form 10-K for the year ended December 31, 2020.  The results of operations for the three and nine months ended September 30, 2021, are not necessarily indicative of future results.  Dollar amounts presented in the following tables are in thousands, except per share data, and September 30, 2021 and 2020 amounts are unaudited.

In this report, unless the context suggests otherwise, references to the “Company,” “we,” “us,” and “our” mean the combined business of Old Second Bancorp, Inc. and its subsidiary bank, Old Second National Bank (the “Bank”).

We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” on page 3 of this report.

Business Overview

The Company is a bank holding company headquartered in Aurora, Illinois. Through our wholly-owned subsidiary bank, Old Second National Bank, a national banking organization also headquartered in Aurora, Illinois, we offer a wide range of financial services through our 29 banking centers located in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois.  These banking centers offer access to a full range of traditional retail and commercial banking services including treasury management operations as well as fiduciary and wealth management services.  We focus our business on establishing and maintaining relationships with our clients while maintaining a commitment to provide for the financial services needs of the communities in which we operate.  We emphasize relationships with individual customers as well as small to medium-sized businesses throughout our market area.  We also have extensive wealth management services, which includes a registered investment advisory platform in addition to trust administration and trust services related to personal and corporate trusts and employee benefit plan administration services.

Proposed Merger with West Suburban Bancorp, Inc.

The Company and West Suburban Bancorp, Inc. (“West Suburban”) have entered into an Agreement and Plan of Merger and Reorganization, dated as of July 25, 2021 (the “Merger Agreement”). Under the Merger Agreement, West Suburban will be merged with and into the Company, with the Company continuing as the surviving entity. Immediately following the merger or at such later time as the parties may mutually agree, West Suburban Bank will merge with and into the Bank, with the Bank as the surviving bank. The Merger Agreement was approved by the boards of directors of the Company and West Suburban, and bank regulatory approval was received from the Office of the Comptroller of the Currency on September 30, 2021, and the Federal Reserve Bank of Chicago on October 8, 2021. The merger is subject to stockholder approval of each company and satisfaction of other customary closing conditions. The transaction is anticipated to close in December 2021. The transaction is discussed in more detail in Note 2 to our Consolidated Financial Statements included in this Quarterly Report.

COVID-19

The COVID-19 pandemic and variants of the virus continue to create disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. The impact of the COVID-19 pandemic and its related variants is fluid and continues to evolve, adversely affecting many of our clients. Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and in the United States as a whole. The unprecedented and rapid spread of COVID-19 and its variants and their associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities have resulted and continue to result in less economic activity, and volatility and disruption in financial markets.  In addition, due to the COVID-19 pandemic, market interest rates declined to historic lows. These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, adverse effects on our business, financial condition and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition

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Table of Contents

and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental and private sector initiatives, the effect of the continued rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus and its variants, including any new strains, and the ability for customers and businesses to return to, and remain in, their pre-pandemic routines. In addition, it is reasonably possible that certain significant estimates made in our financial statements could be materially and adversely affected in the near term as a result of these conditions.

Results of Operation and Financial Condition

We continue to monitor the impact of the COVID-19 pandemic on our results of operation and financial condition.  To date, the COVID-19 pandemic has not significantly impacted the health of the overall real estate industry in our markets, which have reflected relative stability over the past three years. In addition, we have not experienced significant incurred losses on loans or received communications from our borrowers that significant losses are imminent. While management does not currently expect the next year to result in the precipitous decline in the value of certain real estate assets similar to the declines seen in 2009 to 2010, our forecast includes assumptions for certain loss scenarios that may occur due to the exhaustion of federal stimulus funds or a decrease in market valuations.  Accordingly, we determined it prudent to increase our allowance for credit losses to $33.9 million as of December 31, 2020, driven by both our adoption of the new CECL methodology and the expected impact of the COVID-19 pandemic and market interest rate reductions in anticipation of continued market risk and uncertainty.  During the first nine months of 2021, unemployment expectations and other market indicators reflected an improving economic outlook, which resulted in a $3.0 million release of our provision for credit losses in the first quarter of 2021, a $3.5 million release of provision for credit losses in the second quarter of 2021, and a $1.5 million release of provision for credit losses in the third quarter of 2021.  The total release of credit losses for the first nine months of 2021 of $8.0 million is comprised of a $7.2 million reserve release on loans and an $813,000 release of expense in our provision for credit losses on unfunded commitments.    

We also adjust our investment securities portfolio to fair value each period end and review for any impairment that would require a provision for credit losses.  At this time, we have determined there is no need for a provision for credit losses related to our investment securities portfolio.  Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments in the future on the securities we hold as well as experience reductions in other comprehensive income.  We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.

As of September 30, 2021 and December 31, 2020, we had $18.6 million of goodwill.  At November 30, 2020, we performed our recurring annual review for any goodwill impairment.  We determined no goodwill impairment existed, however, continued delayed recovery or further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.

Lending Operations and Accommodations to Borrowers

To more fully support our customers during the pandemic, we established client assistance programs, including offering commercial, consumer, and mortgage loan payment deferrals for certain clients.  As of September 30, 2021, we have executed 506 of these deferrals on loan balances of $237.8 million since March 31, 2020.  In accordance with interagency guidance issued in March 2020, these short term deferrals were not considered troubled debt restructurings.  As of September 30, 2021, 494 loans previously in deferral status, representing loan balances of $229.0 million, had resumed payments or paid off, and 12 loans totaling $8.8 million remained in active deferral status, of which $4.6 million were in nonaccrual status.  We also suspended late fees for consumer loans through June 30, 2020, and, although consumer late fees have been reinstated, we will continue to evaluate any late fee suspension based on the borrower’s financial situation and prior payment history.  In addition, we paused new foreclosure and repossession actions through October 3, 2021, and will continue to re-evaluate these activities based on the ongoing COVID-19 pandemic. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time. Future governmental actions may require these and other types of customer-related responses.  

During 2020, as part of the first round of the SBA Paycheck Protection Program (“PPP”), we processed 746 PPP loan applications, representing a total of $136.7 million.  In January through May 2021, we processed an additional 574 PPP loans, totaling $62.3 million, as part of the second round of the program, before the program expired on May 31, 2021.  We started the application process for loan forgiveness for the first round of PPP loans in October 2020, and we continued to receive funds for forgiven loans from both the first and second round of PPP loans during the first nine months of 2021.  As of September 30, 2021, we had 260 loans, which totaled $34.7 million, still outstanding under the PPP program.  We expect the application process for loan forgiveness to continue through the first quarter of 2022, with funds to be received from the SBA for the forgiven loans through March 2022.  We recorded $1.1 million of net

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fee and interest income on PPP loans in the third quarter of 2021, and $2.7 million of net fee and interest income on PPP loans in the first nine months of 2021.  As of September 30, 2021, unearned net fee income on both first and second round PPP loans totaled $1.3 million.  In addition, as of September 30, 2021, we had one loan with a total outstanding balance of $87,500 under the Main Street Lending Program.

Capital and Liquidity

As of September 30, 2021, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by credit losses.

We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic.  For instance, as customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit.  However, to date, due in part to federal government stimulus funds received by our customers, as well as a higher volume of loan paydowns than periods prior to COVID-19, our liquidity has increased.

We have developed new processes to monitor our liquidity on a daily basis, and have run stress testing based on various economic assumptions under stress and severe stress scenarios.  In addition, management continued to communicate as needed throughout 2021 in structured meetings with key staff to ensure all current events related to the COVID-19 pandemic, such as federal government stimulus check receipt, PPP loan fundings and the forgiveness application process, are managed appropriately.

Financial Overview

Our community-focused banking franchise experienced a decrease in total loans in the third quarter of 2021, compared to the year ended December 31, 2020, and a decrease in total loans compared to the third quarter of 2020, but we believe we are positioned for moderate loan growth for the last quarter of 2021 and into 2022, as we continue to serve our customers’ needs in a competitive economic environment.  Given the unprecedented nature of the COVID-19 pandemic and any potential related variants, it is difficult to predict the full impact the pandemic will have on our business.  We are continuing to seek to provide value to our customers and the communities in which we operate, by executing on growth opportunities in our local markets and developing new banking relationships, while ensuring the safety and soundness of our Bank, our customers and our employees during the COVID-19 pandemic.  

The following provides an overview of some of the factors impacting our financial performance for the three month period ended September 30, 2021, compared to the like period ended September 30, 2020:

Net income for the third quarter of 2021 was $8.4 million, or $0.29 per diluted share, compared to $10.3 million, or $0.34 per diluted share, for the third quarter of 2020.  

Net interest and dividend income was $22.6 million for the third quarter of 2021, compared to $22.5 million for the third quarter of 2020.  The increase in 2021 was due to the year over year reduction in interest expense of $364,000 primarily due to the run-off of higher yielding time deposits, partially offset by a decrease in interest and dividend income of $255,000, primarily due to a reduction in interest income on loans, including fees, year over year.  The decrease in interest and fee income on loans was primarily due to a $162.4 million reduction in loan volumes in the third quarter of 2021, compared to the third quarter of 2020.  

The provision for credit losses resulted in a $1.5 million net benefit driven by a reserve release in the third quarter of 2021, consisting of a $1.5 million reserve release related to loans and a $47,000 reserve release related to unfunded commitments, compared to a provision for credit losses of $300,000 recorded in the third quarter of 2020.  We adopted the new current expected credit losses accounting standard, or CECL, effective January 1, 2020, which measures the allowance based on management’s best estimate of lifetime expected credit losses inherent in our lending activities, which resulted in a $5.9 million allowance for credit losses related to loans and a $1.7 million allowance for credit losses related to unfunded commitments as of January 1, 2020.  The provision expense recorded in 2020 was impacted by both our adoption of the new CECL methodology and the expected impact, as of September 30, 2020, of the COVID-19 pandemic on future losses.

Noninterest income was $9.3 million for the third quarter of 2021, compared to $11.7 million for the third quarter of 2020.  The decrease in 2021 was primarily due to a $3.4 million decrease in residential mortgage banking revenue, primarily stemming from a $3.1 million decrease in net gain on sales of mortgage loans.  Partially offsetting this decrease was an increase of $483,000 in wealth management fees, and an increase of $125,000 in card-related income, as customer spending increased due to the easing of COVID-19 restrictions.    

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Noninterest expense was $22.1 million for the third quarter of 2021, compared to $20.3 million for the third quarter of 2020, an increase of $1.9 million, or 9.2%.  The increase in 2021 was primarily due to increases in salaries and employee benefits expense, occupancy, furniture and equipment expense, computer and data processing expense, and legal fees, which included $425,000 of merger-related costs in the third quarter of 2021 stemming from our pending merger of West Suburban.

The provision for income taxes was $2.9 million for the third quarter of 2021, compared to a $3.4 million for the third quarter of 2020.   Pretax income was $11.3 million in the third quarter of 2021, compared to a $13.6 million for the third quarter of 2020.  

Nonaccrual loans increased in the third quarter of 2021 due to the transfer of two credits totaling $7.4 million to nonaccrual, which resulted in nonperforming loans as a percent of total loans of 1.5% as of September 30, 2021, compared to 1.1% as of December 31, 2020, and 1.0% at September 30, 2020.  Classified assets decreased to $36.8 million as of September 30, 2021, which is $7.7 million, or 17.3%, less than December 31, 2020, and $8.5 million, or 18.8%, less than September 30, 2020.  Asset quality metrics continue to remain stable overall, as classified assets decreased 18.8% compared to the year over year period.

Critical Accounting Policies

Our consolidated financial statements are prepared based on the application of accounting policies in accordance with generally accepted accounting principles (“GAAP”) and follow general practices within the banking industry.  These policies require the reliance on estimates and assumptions, which may prove inaccurate or are subject to variations.  These estimates, assumptions, and judgments are based on information available as of the date of the consolidated financial statements.  Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts reported in the consolidated financial statements.  Changes in underlying factors, assumptions, or estimates could have a material impact on our future financial condition and results of operations.  

Of the significant accounting policies used in the preparation of our consolidated financial statements, we have identified certain items as critical accounting policies based on the associated estimates, assumptions, judgments and complexity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2020. There have been no material changes to our critical accounting policies or the estimates made pursuant to those policies during the most recent quarter from those disclosed in our 2020 Annual Report in Form 10-K.  

Non-GAAP Financial Measures

This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the presentation of net interest income and net interest margin on a tax equivalent (“TE”) basis, our adjusted efficiency ratio, our tangible common equity to tangible assets ratio, and our core net interest margin on a TE basis.  Management believes that the presentation of these non-GAAP financial measures (a) provides important supplemental information that contributes to a proper understanding of our operating performance, (b) enables a more complete understanding of factors and trends affecting our business, and (c) allows investors to evaluate our performance in a manner similar to management, the financial services industry, bank stock analysts, and bank regulators. Management uses non-GAAP measures as follows: in the preparation of our operating budgets, monthly financial performance reporting, and in our presentation to investors of our performance.  However, we acknowledge that these non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently.  These disclosures should not be considered an alternative to our GAAP results.  A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented below or alongside the first instance where each non-GAAP financial measure is used.

Results of Operations

Overview

Three months ended September 30, 2021 and 2020

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Our income before taxes was $11.3 million in the third quarter of 2021 compared to $13.6 million in the third quarter of 2020.  This decrease in pretax income was primarily due to a $2.3 million decrease in noninterest income, primarily due to a $3.4 million decline in residential mortgage banking income year over year, and a $1.9 million increase in noninterest expense, primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment expense, computer and data processing expense and legal expense. These decreases to pretax income were partially offset by a $1.5 million release of provision for credit losses expense in the third quarter of 2021, compared to provision for credit losses of $300,000 in the like quarter of 2020.  Our net income was $8.4 million, or $0.29 per diluted share, for the third quarter of 2021, compared to net income of $10.3 million, or $0.34 per diluted share, for the third quarter of 2020.

Net interest and dividend income was $22.6 million in the third quarter of 2021, compared to $22.5 million in the third quarter of 2020.  The $109,000 increase was primarily driven by a $377,000 increase in taxable securities income, as well as a $754,000 decrease in interest expense on time deposits due to higher yielding deposits running off year over year.   Partially offsetting this increase was a $665,000 decrease in loan interest income in the third quarter of 2021, compared to the third quarter of 2020, primarily due to a decrease in interest rates and loan volume reductions.  

Management has remained diligent in reviewing our loan portfolio to analyze and determine if charge-offs are required.  Average loans, including loans held for sale, decreased $159.3 million in the third quarter of 2021, compared to the third quarter of 2020, stemming primarily from $164.3 million of PPP loans forgiven or repaid in the past nine months, and loan paydowns due to growth in our borrowers’ liquidity year over year.

Nine months ended September 30, 2021 and 2020

Our income before taxes was $39.4 million for the nine months ended September 30, 2021, compared to $26.0 million for the nine months ended September 30, 2020.  This $13.4 million increase in pretax income was primarily due to a $8.0 million release of provision for credit losses expense for the nine months ended September 30, 2021, compared to a $10.4 million provision for credit losses for the like period in 2020, due both to our adoption of the new CECL methodology effective January 1, 2020 and the expected impact, as of September 30, 2020, of the COVID-19 pandemic and related market interest rate reductions.  Due to an improved unemployment forecast and our charge-offs recorded to date, our projected credit losses have decreased over the past year, resulting in the reversal in 2021 of a portion of our reserves recorded in 2020.  Our net income was $29.1 million, or $0.99 per diluted share, for the nine months ended September 30, 2021, compared to net income of $19.8 million, or $0.65 per diluted share, for the nine months ended September 30, 2020.  

Net interest and dividend income was $68.1 million for the nine months ended September 30, 2021, compared to $67.9 million for the same period of 2020. While net interest and dividend income remained relatively flat, interest and dividend income decreased $3.8 million year over year, due to the reduction in interest rates and a decline in loan volumes.  This decrease was offset by a reduction in interest expense for the nine months ended September 30, 2021, compared to the like 2020 period, due to the reduction in interest rates on interest-bearing deposits, as well as our redemption of the Old Second Capital Trust I trust preferred securities and related subordinated debentures in the first quarter of 2020, which was partially offset by the issuance of $60.0 million of subordinated debentures in April 2021.  

Net Interest Income

Net interest income, which is our primary source of earnings, is the difference between interest income earned on interest-earning assets, such as loans and investment securities, as well as accretion income on purchased loans, and interest incurred on interest-bearing liabilities, such as deposits and borrowings.  Net interest income depends upon the relative mix of interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and movements in market interest rates.  Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and OREO, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.

Three months ended September 30, 2021 and 2020

Our net interest and dividend income increased by $109,000 to $22.6 million, for the third quarter of 2021, from $22.5 million for the third quarter of 2020.  This increase was primarily attributable to a $754,000 decline in time deposit interest expense due to the decrease in interest rates and volume reductions year over year, and a $377,000 increase in taxable securities income due to an increase of $225.2 million in average taxable securities.  Partially offsetting this increase in net interest and dividend income was a decrease of $665,000 in

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loan interest and fees income, primarily due to a reduction in loan volumes and continuing low interest rates year over year.  Net interest and dividend income for the third quarter of 2021 reflected an increase of $664,000, or 3.0%, compared to the second quarter of 2021.

Average earning assets for the third quarter of 2021 totaled $3.09 billion, reflecting an increase of $32.1 million, or 1.1%, compared to the second quarter of 2021, and an increase of $316.1 million, or 11.4%, compared to the third quarter of 2020.  Average interest earning deposits with financial institutions totaled $523.6 million for the third quarter of 2021, which reflected an increase of $24.0 million compared to the second quarter of 2021, and an increase of $260.4 million compared to the third quarter of 2020.  The yield on average interest earning deposits was 15 basis points for the third quarter of 2021, five basis points more than the third quarter of 2020.  Securities reflected an increase in interest income year over year, due to growth in volumes.  Total average securities for the third quarter of 2021 increased $49.4 million from the second quarter of 2021, and increased $215.0 million from the third quarter of 2020.  The yield on average securities declined to 2.07% for the third quarter of 2021, compared to 2.24% for the second quarter of 2021 and 2.78% for third quarter of 2020.  Total average loans, including loans held-for-sale, totaled $1.89 billion in the third quarter of 2021, which reflected a decrease of $41.3 million compared to the second quarter of 2021, and a decrease of $159.3 million compared to the third quarter of 2020.  The decline in average loan balances year over year was primarily due to a decrease in commercial loans related to PPP loan payoffs, net of originations, and early payoffs on other commercial loans due to higher levels of borrower liquidity.  This decline in loan volumes resulted in a decrease in loan interest and fee income of $665,000 in the year over year period.  For the third quarter of 2021, the yield on average loans increased to 4.48%, compared to 4.33% for the second quarter of 2021, and 4.29% for the third quarter of 2020.  

Average interest bearing liabilities decreased $7.4 million, or 0.4%, in the third quarter of 2021, compared to the second quarter of 2021, but increased $137.7 million compared to the third quarter of 2020.  The year over year increase in average interest bearing liabilities was primarily driven by a $98.9 million increase in interest bearing deposits, and a $59.2 million increase in subordinated debentures.  The cost of interest bearing liabilities for the third quarter of 2021 decreased by two basis points from the second quarter of 2021, and decreased 12 basis points from the third quarter of 2020.  Growth in our average noninterest bearing demand deposits of $136.9 million in the year over year period has assisted us in controlling our cost of funds stemming from average interest bearing deposits and borrowings, which totaled 0.30% for the third quarter of 2021, 0.31% for the second quarter of 2021, and 0.38% for the third quarter of 2020.    

In the second quarter of 2021, we entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers pursuant to which we sold and issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”).  We sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance are intended to be used for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions.  The Notes bear interest at a fixed annual rate of 3.50% through April 14, 2026, payable semi-annually in arrears.  As of April 15, 2026 forward, the interest rate on the Notes will generally reset quarterly to a rate equal to Three-Month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears.  The Notes have a stated maturity of April 15, 2031, and are redeemable, in whole are in part, on April 15, 2026, or any interest payment date thereafter, and at any time upon the occurrence of certain events.

Due to the significant increase in cash and due from banks stemming from federal stimulus funds received and PPP loan forgiveness, we had no average other short-term borrowings, which consist of FHLBC advances, in the third quarter of 2021, compared to minimal average balances in the second quarter of 2021, and $8.2 million in the third quarter of 2020.   As of September 30, 2021, notes payable and other borrowings consisted of one long-term FHLBC advance of $6.2 million, and $14.0 million outstanding on a term note with a correspondent bank originated in the first quarter of 2020.  

Our net interest margin (GAAP) increased three basis points to 2.91% for the third quarter of 2021, compared to 2.88% for the second quarter of 2021, and decreased 32 basis points compared to 3.23% for the third quarter of 2020.  Our net interest margin (TE) increased two basis points to 2.95% for the third quarter of 2021, compared to 2.93% for the second quarter of 2021, and decreased 33 basis points compared to 3.28% for the third quarter of 2020.  Our core net interest margin (TE), a non-GAAP financial measure that excludes the impact of our PPP loans, was 2.85% for the third quarter of 2021, compared to 2.91% for the second quarter of 2021 and 3.34% for the third quarter of 2020. The reductions year over year were due primarily to the lower level of market interest rates over the majority of the past twelve months, the related rate resets on loans and securities during the past year, and the increase in liquidity on the balance sheet.  

Nine months ended September 30, 2021 and 2020

Our net interest and dividend income increased by $241,000, to $68.1 million for the nine months ended September 30, 2021, compared to $67.9 million for the nine months ended September 30, 2020.  This increase was attributable to a $4.1 million decrease in total interest expense, which was materially offset by a $3.8 million decrease in interest and dividend income for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020.  The reduction in market interest rates year over year drove the

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decrease in interest income on loans and securities, as well as the decrease in rates paid on interest bearing deposits, specifically impacting time deposits as both rate and volume declines occurred year over year.  

Average earning assets for the nine months ended September 30, 2021 were $3.02 billion, reflecting an increase of $386.8 million, or 14.7%, compared to the nine months ended September 30, 2020.  The yield on average earning assets for the nine months ended September 30, 2021 was 3.34%, compared to 4.02% for the nine months ended September 30, 2020.  Total average loans, including loans held-for-sale, totaled $1.94 billion for the nine months ended September 30, 2021, which reflected a decrease of $70.9 million, compared to the nine months ended September 30, 2020.  The decline in average loan balances and market interest rate reductions resulted in a $3.7 million decrease in loan interest income for the nine months ended September 30, 2021, compared to the like period in 2020.  For the nine months ended September 30, 2021, yields on average securities decreased by 84 basis points and yields on average loans decreased by nine basis points, each as compared to the nine months ended September 30, 2020, due primarily to the falling interest rate environment and rate resets on those assets. Average interest earning deposits with financial institutions increased $312.8 million in the nine months ended September 30, 2021, compared to the prior year like period, as payoffs related to forgiven PPP loans were received from the Small Business Administration (“SBA”) over the past twelve months, in addition to federal stimulus funds received by certain of our depositors, both of which increased our liquidity.

Average interest bearing liabilities increased $162.9 million, or 9.6%, in the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020.  The increase was primarily due to growth in average interest bearing deposits of $128.4 million due to federal stimulus funds received by certain of our depositors.  In addition, securities sold under repurchase agreements increased $16.0 million, and average subordinated debt increased $38.6 million, due to the $60.0 million of Notes issued in April 2021, as discussed above. Partially offsetting these increases to interest bearing liabilities was a decrease in average other short-term borrowings, which primarily consist of FHLBC advances, of $13.2 million, and a decrease in average junior subordinated debentures of $7.1 million due to the redemption of the trust preferred securities issued by Old Second Capital Trust I and the related $32.6 million of subordinated debentures in March 2020.   The rate on our junior subordinated debentures was 7.85% for the nine months ended September 30, 2020, as $635,000 of deferred issuance costs was expensed upon the redemption in 2020.   Average noninterest bearing deposits increased $185.0 million in the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, primarily due to federal stimulus funds received from certain of our depositors.  The cost of interest bearing liabilities decreased 37 basis points, to 45 basis points, for the nine months ended September 30, 2021, from 82 basis points for the nine months ended September 30, 2020.

Our net interest margin (GAAP) for the nine months ended September 30, 2021 was 3.02% compared to 3.44% for the nine months ended September 30, 2020, reflecting a 42 basis point decrease.  Our net interest margin (TE) for the nine months ended September 30, 2021 was 3.06% compared to 3.50% for the nine months ended September 30, 2020, reflecting a 44 basis point decrease. The decrease in net interest margin for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020, was due primarily to reductions in the market interest rates, a decline of $70.9 million in average loans and loans held for sale, and the growth of our liquidity with an increase in cash and due from banks, which were not yet reinvested into higher yielding assets.  These reductions to the net interest margin were partially offset by reductions in rates paid on deposits, additional securities purchases, and growth in noninterest bearing deposits, which drove down our overall cost of funds.

We continue to observe competitive pressure to maintain reduced interest rates on loans retained at renewal.  While our loan prices are targeted to achieve certain returns on equity, significant competition for commercial and industrial loans as well as commercial real estate loans has put pressure on loan yields, and our stringent underwriting standards limit our ability to make higher-yielding loans.

The following table sets forth certain information relating to our average consolidated balance sheet and reflect the yield on average earning assets and cost of average interest bearing liabilities for the periods indicated.  These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period.  Average balances are derived from daily balances.  For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP TE basis using a marginal rate of 21% in 2021 and 2020 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 Income / Expense and Rates

(Dollars in thousands - unaudited)

Quarters Ended

September 30, 2021

June 30, 2021

September 30, 2020

Average

Income /

Rate

Average

Income /

Rate

Average

Income /

Rate

Balance

Expense

%

Balance

Expense

%

Balance

Expense

%

Assets

Interest earning deposits with financial institutions

$

523,561

$

203

0.15

$

499,555

$

137

0.11

$

263,199

$

68

0.10

Securities:

Taxable

476,935

1,835

1.53

425,785

1,832

1.73

251,760

1,458

2.30

Non-taxable (TE)1

186,515

1,627

3.46

188,281

1,594

3.40

196,648

1,680

3.40

Total securities (TE)1

663,450

3,462

2.07

614,066

3,426

2.24

448,408

3,138

2.78

Dividends from FHLBC and FRBC

9,917

114

4.56

9,917

113

4.57

9,917

118

4.73

Loans and loans held-for-sale1, 2

1,889,696

21,358

4.48

1,930,965

20,857

4.33

2,048,968

22,078

4.29

Total interest earning assets

3,086,624

25,137

3.23

3,054,503

24,533

3.22

2,770,492

25,402

3.65

Cash and due from banks

29,760

-

-

29,985

-

-

31,354

-

-

Allowance for credit losses on loans

(28,639)

-

-

(31,024)

-

-

(31,518)

-

-

Other noninterest bearing assets

185,415

-

-

185,368

-

-

185,228

-

-

Total assets

$

3,273,160

$

3,238,832

$

2,955,556

Liabilities and Stockholders' Equity

NOW accounts

$

534,056

$

96

0.07

$

531,804

$

105

0.08

$

470,474

$

106

0.09

Money market accounts

355,651

66

0.07

330,536

59

0.07

306,763

91

0.12

Savings accounts

451,829

47

0.04

439,104

53

0.05

378,957

102

0.11

Time deposits

331,482

330

0.39

359,635

409

0.46

417,952

1,084

1.03

Interest bearing deposits

1,673,018

539

0.13

1,661,079

626

0.15

1,574,146

1,383

0.35

Securities sold under repurchase agreements

46,339

15

0.13

67,737

21

0.12

54,313

28

0.21

Other short-term borrowings

-

-

-

1

-

-

8,204

24

1.16

Junior subordinated debentures

25,773

286

4.40

25,773

284

4.42

25,773

285

4.40

Subordinated debentures

59,180

547

3.67

56,081

517

3.70

-

-

-

Senior notes

44,441

673

6.01

44,415

673

6.08

44,337

673

6.04

Notes payable and other borrowings

21,171

113

2.12

22,250

119

2.15

25,482

144

2.25

Total interest bearing liabilities

1,869,922

2,173

0.46

1,877,336

2,240

0.48

1,732,255

2,537

0.58

Noninterest bearing deposits

1,029,705

-

-

1,012,163

-

-

892,811

-

-

Other liabilities

53,370

-

-

36,553

-

-

39,589

-

-

Stockholders' equity

320,163

-

-

312,780

-

-

290,901

-

-

Total liabilities and stockholders' equity

$

3,273,160

$

3,238,832

$

2,955,556

Net interest income (GAAP)

$

22,618

$

21,954

$

22,509

Net interest margin (GAAP)

2.91

2.88

3.23

Net interest income (TE)1

$

22,964

$

22,293

$

22,865

Net interest margin (TE)1

2.95

2.93

3.28

Core net interest margin (TE - excluding PPP loans)1

2.85

2.91

3.34

Interest bearing liabilities to earning assets

60.58

%

61.46

%

62.53

%

1Represents a non-GAAP financial measure. See the discussion entitled “Non-GAAP Presentations” below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2021 and 2020.

2 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 50, and includes fees of $1.8 million for the third quarter of 2021, $1.3 million second quarter of 2021, and $975,000 for the third quarter of 2020.  Nonaccrual loans are included in the above-stated average balances.

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Table of Contents

Analysis of Average Balances,

Tax Equivalent Income / Expense and Rates

(Dollars in thousands - unaudited)

Nine Months Ended September 30, 

2021

2020

Average

Income /

Rate

Average

Income /

Rate

Balance

Expense

%

Balance

Expense

%

Assets

Interest earning deposits with financial institutions

$

461,498

$

432

0.13

$

148,660

$

185

0.17

Securities:

Taxable

415,029

5,282

1.70

257,664

5,315

2.76

Non-taxable (TE)1

188,700

4,875

3.45

201,242

5,289

3.51

Total securities (TE)1

603,729

10,157

2.25

458,906

10,604

3.09

Dividends from FHLBC and FRBC

9,917

342

4.61

9,917

366

4.93

Loans and loans held-for-sale 1 , 2

1,944,687

64,480

4.43

2,015,592

68,174

4.52

Total interest earning assets

3,019,831

75,411

3.34

2,633,075

79,329

4.02

Cash and due from banks

29,407

-

-

31,498

-

-

Allowance for credit losses on loans

(31,380)

-

-

(28,601)

-

-

Other noninterest bearing assets

186,083

-

-

181,762

-

-

Total assets

$

3,203,941

$

2,817,734

Liabilities and Stockholders' Equity

NOW accounts

$

520,556

$

295

0.08

$

450,178

$

468

0.14

Money market accounts

338,510

203

0.08

289,219

412

0.19

Savings accounts

434,702

169

0.05

353,737

439

0.17

Time deposits

363,227

1,239

0.46

435,419

4,292

1.32

Interest bearing deposits

1,656,995

1,906

0.15

1,528,553

5,611

0.49

Securities sold under repurchase agreements

65,385

67

0.14

49,358

167

0.45

Other short-term borrowings

-

-

-

13,205

167

1.69

Junior subordinated debentures

25,773

850

4.41

32,889

1,932

7.85

Subordinated debentures

38,637

1,064

3.68

-

-

-

Senior note

44,416

2,019

6.08

44,310

2,019

6.09

Notes payable and other borrowings

22,243

355

2.13

22,277

439

2.63

Total interest bearing liabilities

1,853,449

6,261

0.45

1,690,592

10,335

0.82

Noninterest bearing deposits

993,308

-

-

808,273

-

-

Other liabilities

42,632

-

-

35,911

-

-

Stockholders' equity

314,552

-

-

282,958

-

-

Total liabilities and stockholders' equity

$

3,203,941

$

2,817,734

Net interest income (GAAP)

$

68,115

$

67,874

Net interest margin (GAAP)

3.02

3.44

Net interest income (TE)1

$

69,150

$

68,994

Net interest margin (TE)1

3.06

3.50

Core net interest margin (TE - excluding PPP loans)1

3.02

3.54

Interest bearing liabilities to earning assets

61.38

%

64.21

%

1Represents a non-GAAP financial measure. See the discussion entitled “Non-GAAP Presentations” below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2021 and 2020.

2 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 50, and includes fees of $4.4 million and $2.0 million for the third quarter of 2021 and the third quarter of 2020, respectively.  Nonaccrual loans are included in the above-stated average balances.

47

Table of Contents

Reconciliation of Tax-Equivalent Non-GAAP Financial Measures

Net interest and dividend income (TE) and net interest income (TE) to average interest earning assets are non-GAAP measures that have been adjusted on a TE basis using a marginal rate of 21% for 2021 and 2020 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:

Three Months Ended

Nine Months Ended

September 30, 

June 30, 

September 30, 

September 30, 

Net Interest Margin

    

2021

    

2021

2020

    

2021

2020

Interest income (GAAP)

$

24,791

$

24,194

$

25,046

$

74,376

$

78,209

Taxable-equivalent adjustment:

Loans

4

4

3

11

9

Securities

342

335

353

1,024

1,111

Interest and dividend income (TE)

25,137

24,533

25,402

75,411

79,329

Interest expense (GAAP)

2,173

2,240

2,537

6,261

10,335

Net interest income (TE)

$

22,964

$

22,293

$

22,865

$

69,150

$

68,994

Paycheck Protection Program ("PPP") loan - interest and net fee income

1,138

832

736

2,711

1,339

Net interest income (TE) - excluding PPP loans

$

21,826

$

21,461

$

22,129

$

66,439

$

67,655

Net interest income (GAAP)

$

22,618

$

21,954

$

22,509

$

68,115

$

67,874

Average interest earning assets

$

3,086,624

$

3,054,503

$

2,770,492

$

3,019,831

$

2,633,075

Average PPP loans

$

53,562

$

91,948

$

136,281

$

78,288

$

77,302

Average interest earning assets, excluding PPP loans

$

3,033,062

$

2,962,555

$

2,634,211

$

2,941,543

$

2,555,773

Net interest margin (GAAP)

2.91

%

2.88

%

3.23

%

3.02

%

3.44

%

Net interest margin (TE)

2.95

%

2.93

%

3.28

%

3.06

%

3.50

%

Core net interest margin (TE - excluding PPP loans)

2.85

%

2.91

%

3.34

%

3.02

%

3.54

%

Noninterest Income

Three months ended September 30, 2021 and 2020

The following table details the major components of noninterest income for the periods presented:

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Table of Contents

3rd Quarter 2021

Noninterest Income

Three Months Ended

Percent Change From

(Dollars in thousands)

September 30, 

June 30, 

September 30, 

June 30, 

September 30, 

    

2021

    

2021

    

2020

    

2021

    

2020

 

Wealth management

$

2,372

$

2,389

$

1,889

(0.7)

25.6

Service charges on deposits

1,368

1,221

1,322

12.0

3.5

Residential mortgage banking revenue

Secondary mortgage fees

240

272

492

(11.8)

(51.2)

Mortgage servicing rights mark to market loss

(282)

(1,033)

(160)

(72.7)

76.3

Mortgage servicing income

572

507

521

12.8

9.8

Net gain on sales of mortgage loans

2,186

1,895

5,246

15.4

(58.3)

Total residential mortgage banking revenue

2,716

1,641

6,099

65.5

(55.5)

Securities gains (losses), net

244

2

(1)

N/M

N/M

Change in cash surrender value of BOLI

406

423

459

(4.0)

(11.5)

Death benefit realized on BOLI

-

-

(2)

-

(100.0)

Card related income

1,624

1,666

1,499

(2.5)

8.3

Other income

610

577

420

5.7

45.2

Total noninterest income

$

9,340

$

7,919

$

11,685

17.9

(20.1)

N/M - Not meaningful

Noninterest income increased $1.4 million, or 17.9%, in the third quarter of 2021, compared to the second quarter of 2021, and decreased $2.3 million, or 20.1%, compared to the third quarter of 2020.  The increase from the linked quarter was primarily driven by a $1.1 million increase in residential mortgage banking revenue, primarily attributable to a $751,000 decrease in mark to market losses on mortgage servicing rights (MSRs) stemming from market interest rate changes and a $291,000 increase in net gain on sales of mortgage loans in the third quarter of 2021, compared to the second quarter of 2021.  In addition, increases were noted compared to the linked quarter of $242,000 in securities gains, net, and $147,000 in service charges on deposits.  

The decrease in noninterest income in the third quarter of 2021, compared to the third quarter of 2020, is primarily due to a $3.4 million decrease in residential mortgage banking revenue, which included a $3.1 million decrease in net gain on sales of mortgage loans and a $252,000 decrease in secondary mortgage fees from the 2020 like period.  Partially offsetting these decreases was a $483,000 increase in wealth management income and a $125,000 increase in card related income in the third quarter of 2021, compared to the third quarter of 2020.  The increase in card related income in the third quarter of 2021, compared to both the linked quarter and prior year quarter, resulted from reductions in COVID-19 related restrictions and the resultant increase in consumer spending.  An increase of $245,000 in the third quarter of 2021, compared to the like quarter in 2020, was also noted in securities gains, net, due to securities sold in the third quarter of 2021.

Nine months ended September 30, 2021 and 2020

Noninterest Income

Nine Months Ended

YTD

(Dollars in thousands)

September 30, 

September 30, 

Percent

    

2021

    

2020

    

Change

Wealth management

$

6,912

$

5,793

19.3

Service charges on deposits

3,784

4,168

(9.2)

Residential mortgage banking revenue

Secondary mortgage fees

834

1,267

(34.2)

Mortgage servicing rights mark to market loss

(202)

(2,739)

92.6

Mortgage servicing income

1,646

1,447

13.8

Net gain on sales of mortgage loans

7,802

12,123

(35.6)

Total residential mortgage banking revenue

10,080

12,098

(16.7)

Securities gains (losses) , net

246

(25)

N/M

Change in cash surrender value of BOLI

1,163

942

23.5

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Death benefit realized on BOLI

-

57

(100.0)

Card related income

4,737

4,097

15.6

Other income

1,637

1,572

4.1

Total noninterest income

$

28,559

$

28,702

(0.5)

N/M - Not meaningful

Noninterest income for the nine months ended September 30, 2021 decreased $143,000, or 0.5%, compared to the nine months ended September 30, 2020. This decrease was primarily driven by a $2.0 million decrease in total residential mortgage banking revenue primarily stemming from a $4.3 million decrease in net gain on sales of mortgage loans, partially offset by a $2.5 million decrease in mark to market losses on MSRs.  Wealth management income increased $1.1 million for the nine months ended September 30, 2021, compared to the like period in 2020, primarily due to an increase in customer liquidity and the resultant assets under management.  In addition, card related income increased $640,000 for the nine months ended September 30, 2021, compared to the like period in 2020, as customers are starting to spend more as COVID-19 restrictions ease.  The change in cash surrender value of BOLI also increased by $221,000 for the nine months ended September 30, 2021, compared to the like period in 2020, due to market rate changes and an increase in BOLI asset balances year over year.  Securities gains, net, totaled $246,000, compared to securities losses, net of $25,000 for the like period in 2020, due to sales of $35.1 million during the nine months ended September 30, 2021 compared to sales of $18.0 million in the like period in 2020.

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Table of Contents

Noninterest Expense

Three months ended September 30, 2021 and 2020

The following table details the major components of noninterest expense for the periods presented:

3rd Quarter 2021

Noninterest Expense

Three Months Ended

Percent  Change From

(Dollars in thousands)

September 30, 

June 30, 

September 30, 

June 30, 

September 30, 

    

2021

    

2021

    

2020

    

2021

    

2020

 

Salaries

$

9,630

$

9,435

$

9,731

2.1

(1.0)

Officers incentive

1,212

1,194

968

1.5

25.2

Benefits and other

2,122

2,267

1,887

(6.4)

12.5

Total salaries and employee benefits

12,964

12,896

12,586

0.5

3.0

Occupancy, furniture and equipment expense

2,418

2,303

2,003

5.0

20.7

Computer and data processing

1,477

1,304

1,226

13.3

20.5

FDIC insurance

211

192

191

9.9

10.5

General bank insurance

301

277

281

8.7

7.1

Amortization of core deposit intangible asset

113

115

122

(1.7)

(7.4)

Advertising expense

107

95

62

12.6

72.6

Card related expense

662

626

566

5.8

17.0

Legal fees

455

135

169

237.0

169.2

Other real estate owned expense, net

25

77

125

(67.5)

(80.0)

Other expense

3,396

3,381

2,935

0.4

15.7

Total noninterest expense

$

22,129

$

21,401

$

20,266

3.4

9.2

Efficiency ratio (GAAP)1

68.73

%

68.63

%

58.27

%

Adjusted efficiency ratio (non-GAAP)2

66.46

%

67.64

%

57.47

%

N/M - Not meaningful

1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs.

2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses and merger-related costs, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities and mark to market gains or losses on MSRs, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI.  See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” on page 52 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent.

Noninterest expense for the third quarter of 2021 increased $728,000, or 3.4%, compared to the second quarter of 2021, and increased $1.9 million, or 9.2%, compared to the third quarter of 2020.  The linked quarter increase is primarily attributable to a $195,000 increase in salaries primarily due to a reduction of salary-related loan cost deferrals due to the decrease in PPP loan originations, a $173,000 increase in computer and data processing expense and a $320,000 increase in legal fees attributable to merger-related costs incurred related to our pending merger with West Suburban. In addition, occupancy, furniture and equipment expense increased $115,000 in the third quarter of 2021 compared to the linked quarter due to an increase in planned building maintenance. These increases were partially offset by a decrease in other real estate owned expenses.

The year over year increase in noninterest expense is primarily attributable to a $378,000 increase in salaries and employee benefits in the third quarter of 2021 compared to the third quarter of 2020. Officer incentive compensation increased $244,000 in the third quarter of 2021, compared to the third quarter of 2020, as incentive accruals in 2021 were at a higher rate than the prior year.  Employee benefits expense increased $235,000 in the third quarter of 2021, compared to the third quarter of 2020, due to an increase in employee insurance costs as more employees returned to routine medical appointments, many of which were on hold during the first six months of the COVID-19 pandemic.  We also had increases in the year over year period in occupancy, furniture and equipment of $415,000 due to an increase in planned building repairs, an increase in computer and data processing expense of $251,000, and an increase in legal fees of

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Table of Contents

$286,000, primarily due to merger-related costs incurred.  Finally, other expense increased $461,000 primarily due to growth in management and consulting fees, commercial loan non-legal expense, and company events due to our 150th anniversary celebration during the third quarter of 2021.

Nine months ended September 30, 2021 and 2020

Noninterest Expense

Nine Months Ended

YTD

(Dollars in thousands)

September 30, 

September 30, 

Percent

    

2021

    

2020

    

Change

Salaries

$

28,280

$

28,080

0.7

Officers incentive

4,060

2,894

40.3

Benefits and other

7,026

5,872

19.7

Total salaries and employee benefits

39,366

36,846

6.8

Occupancy, furniture and equipment expense

7,188

6,239

15.2

Computer and data processing

4,079

3,808

7.1

FDIC insurance

604

403

49.9

General bank insurance

854

764

11.8

Amortization of core deposit intangible asset

348

374

(7.0)

Advertising expense

262

228

14.9

Card related expense

1,881

1,612

16.7

Legal fees

645

476

35.5

Other real estate owned expense, net

138

505

(72.7)

Other expense

9,903

8,909

11.2

Total noninterest expense

$

65,268

$

60,164

8.5

Efficiency ratio (GAAP)1

67.04

%

59.71

%

Adjusted efficiency ratio (non-GAAP)2

65.69

%

58.89

%

N/M - Not meaningful

1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs.

2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses and merger-related costs, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities and mark to market gains or losses on MSRs, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI.  See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” on page 52 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent.

Noninterest expense for the nine months ended September 30, 2021, increased $5.1 million, or 8.5%, compared to the nine months ended September 30, 2020, primarily due to an increase in salaries and employee benefits due to annual merit increases in March 2021, as well as payout of officer incentives in early 2021 at a rate higher than that accrued for 2020 performance, and the resultant increase in accruals in 2021 to be paid out in 2022.  In addition, occupancy, furniture and equipment expense increased $949,000, stemming from planned building repairs and maintenance, FDIC insurance increased $201,000 due to assessment credits received in early 2020 not repeated in 2021, card related expense increased $269,000, primarily due to a return to pre-COVID-19 customer spending levels in 2021, and other expense increased $994,000, primarily due an increase in management and consulting fees due to the pending merger with West Suburban, and directors fees due to growth in the number of our directors year over year.  Partially offsetting these increases was a $367,000 decrease in other real estate owned expense, net, as property holdings have decreased $774,000 year over year, due to continued remediation of credits prior to foreclosure, and the COVID-19 foreclosure moratorium in effect during most of 2021.

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Table of Contents

Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures

GAAP

Non-GAAP

Three Months Ended

Three Months Ended

September 30, 

June 30, 

September 30, 

September 30, 

June 30, 

September 30, 

2021

2021

2020

2021

2021

2020

Efficiency Ratio / Adjusted Efficiency Ratio

Noninterest expense

$

22,129

$

21,401

$

20,266

$

22,129

$

21,401

$

20,266

Less amortization of core deposit

113

115

122

113

115

122

Less other real estate expense, net

25

77

125

25

77

125

Less merger related costs

N/A

N/A

N/A

425

-

-

Noninterest expense less adjustments

$

21,991

$

21,209

$

20,019

$

21,566

$

21,209

$

20,019

Net interest income

$

22,618

$

21,954

$

22,509

$

22,618

$

21,954

$

22,509

Taxable-equivalent adjustment:

Loans

N/A

N/A

N/A

4

4

3

Securities

N/A

N/A

N/A

342

335

353

Net interest income including adjustments

22,618

21,954

22,509

22,964

22,293

22,865

Noninterest income

9,340

7,919

11,685

9,340

7,919

11,685

Less death benefit related to BOLI

-

-

(2)

-

-

(2)

Less securities gains (losses), net

244

2

(1)

244

2

(1)

Less MSRs mark to market losses

(282)

(1,033)

(160)

(282)

(1,033)

(160)

Taxable-equivalent adjustment:

Change in cash surrender value of BOLI

N/A

N/A

N/A

108

112

122

Noninterest income (less) / including adjustments

9,378

8,950

11,848

9,486

9,062

11,970

Net interest income including adjustments plus noninterest income (less) / including adjustments

$

31,996

$

30,904

$

34,357

$

32,450

$

31,355

$

34,835

Efficiency ratio / Adjusted efficiency ratio

68.73

%

68.63

%

58.27

%

66.46

%

67.64

%

57.47

%

GAAP

Non-GAAP

Nine Months Ended

Nine Months Ended

September 30, 

September 30, 

September 30, 

September 30, 

2021

2020

2021

2020

Efficiency Ratio / Adjusted Efficiency Ratio

(Dollars in thousands)

Noninterest expense

$

65,268

$

60,164

$

65,268

$

60,164

Less amortization of core deposit

348

374

348

374

Less other real estate expense, net

138

505

138

505

Less merger related costs

N/A

N/A

425

-

Noninterest expense less adjustments

$

64,782

$

59,285

$

64,357

$

59,285

Net interest income

$

68,115

$

67,874

$

68,115

$

67,874

Taxable-equivalent adjustment:

Loans

N/A

N/A

11

9

Securities

N/A

N/A

1,024

1,111

Net interest income including adjustments

68,115

67,874

69,150

68,994

Noninterest income

28,559

28,702

28,559

28,702

Less death benefit related to BOLI

-

57

-

57

Less securities gains (losses), net

246

(25)

246

(25)

Less MSRs mark to market losses

(202)

(2,739)

(202)

(2,739)

Taxable-equivalent adjustment:

Change in cash surrender value of BOLI

N/A

N/A

309

266

Noninterest income (less) / including adjustments

28,515

31,409

28,824

31,675

Net interest income including adjustments plus noninterest income (less) / including adjustments

$

96,630

$

99,283

$

97,974

$

100,669

Efficiency ratio / Adjusted efficiency ratio

67.04

%

59.71

%

65.69

%

58.89

%

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Income Taxes

We recorded income tax expense of $2.9 million for the third quarter of 2021 on $11.3 million of pretax income, compared to income tax expense of $3.2 million on $12.0 million of pretax income in the second quarter of 2021, and income tax expense of $3.4 million on $13.6 million of pretax income in the third quarter of 2020. The effective tax rate was 25.8% for the third quarter of 2021, 26.3% for the second quarter of 2021, and 24.7% for the third quarter of 2020.  

Income tax expense reflected all relevant statutory tax rates and GAAP accounting.  There were no significant changes in our ability to utilize our deferred tax assets during the quarter or nine months ended September 30, 2021.  We had no valuation reserve on the deferred tax assets as of September 30, 2021.

Financial Condition

Total assets increased $234.3 million to $3.28 billion at September 30, 2021, from $3.04 billion at December 31, 2020, due primarily to an increase in cash and cash equivalents of $189.4 million and securities available-for-sale of $219.0 million, partially offset by a reduction in loans of $166.9 million.  We continue to actively assess potential investment opportunities for our excess liquidity. Total deposits were $2.71 billion at September 30, 2021, an increase of $177.3 million from December 31, 2020, primarily due to increases in noninterest bearing demand accounts, savings, money market and NOW accounts due to lower interest rates on time deposits in 2021, and federal stimulus funds received by many depositors.

September 30, 2021

Securities

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

    

2021

    

2020

    

2020

    

2020

    

2020

Securities available-for-sale, at fair value

U.S. Treasuries

$

4,070

$

4,117

$

4,134

(1.1)

(1.5)

U.S. government agencies

33,575

6,657

7,005

404.4

379.3

U.S. government agencies mortgage-backed

17,818

17,209

18,219

3.5

(2.2)

States and political subdivisions

238,952

249,259

249,777

(4.1)

(4.3)

Corporate bonds

4,992

-

-

-

-

Collateralized mortgage obligations

165,414

56,585

57,013

192.3

190.1

Asset-backed securities

189,338

131,818

81,585

43.6

132.1

Collateralized loan obligations

61,029

30,533

30,688

99.9

98.9

Total securities

$

715,188

$

496,178

$

448,421

44.1

59.5

Securities available-for-sale increased $219.0 million as of September 30, 2021, compared to December 31, 2020, and increased $266.8 million compared to September 30, 2020.  Available-for-sale security purchases during the quarter ended September 30, 2021, totaled $189.6 million and consisted of $28.3 million of U.S. government agencies, $73.0 million of collateralized mortgage obligations, $48.3 million of asset-backed securities, and $39.4 million of collateralized loan obligations.  These purchases were partially offset by $23.8 million of calls, maturities and paydowns during the third quarter of 2021, and $26.9 million of security sales, as well as an unrealized mark to market loss adjustment of $3.3 million and net premium amortization of $641,000.  During the third quarter of 2021, $244,000 of security gains, net, were recorded, compared to $1,000 of security losses, net, in the third quarter of 2020.  

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Table of Contents

September 30, 2021

Loans

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2021

2020

2020

2020

    

2020

Commercial

$

321,548

$

407,159

$

436,277

(21.0)

(26.3)

Leases

162,444

141,601

133,676

14.7

21.5

Commercial real estate - Investor

535,506

582,042

548,970

(8.0)

(2.5)

Commercial real estate - Owner occupied

330,648

333,070

335,978

(0.7)

(1.6)

Construction

108,690

98,486

91,856

10.4

18.3

Residential real estate - Investor

45,497

56,137

61,923

(19.0)

(26.5)

Residential real estate - Owner occupied

108,343

116,388

114,283

(6.9)

(5.2)

Multifamily

160,798

189,040

188,398

(14.9)

(14.6)

HELOC

69,651

80,908

85,882

(13.9)

(18.9)

HELOC - Purchased

12,370

19,487

22,312

(36.5)

(44.6)

Other (1)

12,447

10,533

10,772

18.2

15.5

Total loans

$

1,867,942

$

2,034,851

$

2,030,327

(8.2)

(8.0)

1 The “Other” segment includes consumer and overdrafts.

Total loans were $1.87 billion as of September 30, 2021, a decrease of $166.9 million from December 31, 2020.  The decrease in total loans in the first nine months of 2021, compared to December 31, 2020, was due primarily to forgiveness or payoff of 1,060 PPP loans that totaled $164.3 million within commercial loans, as well as reductions in the majority of our loan categories due to paydowns as commercial and consumer liquidity increased primarily due to the receipt of federal stimulus funds and capital expenditures decreased due to the COVID-19 pandemic.  Total loans decreased $162.4 million from September 30, 2020 to September 30, 2021, primarily due to PPP loans forgiven, net of originations, as well as reductions in organic commercial loans due to payoffs related to borrower liquidity. As required by CECL, the balance (or amortized cost basis) of purchased credit deteriorated loans, or PCD loans (discussed below) are carried on a gross basis (rather than net of the associated credit loss estimate), and the expected credit losses for PCD loans are estimated and separately recognized as part of the allowance for credit losses, or ACL.  

The quality of our loan portfolio is impacted not only by our credit decisions but also by the economic health of the communities in which we operate.  Since we are located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial real estate, construction, residential, multifamily, and HELOCs) has been and continues to be a sizeable portion of our portfolio.  These categories comprised 73.4% of the portfolio as of September 30, 2021, compared to 72.5% of the portfolio as of December 31, 2020.  We continue to oversee and seek to manage our loan portfolio in accordance with interagency guidance on risk management.

Asset Quality

Nonperforming loans consist of nonaccrual loans, performing restructured accruing loans and loans 90 days or greater past due.  Remediation work continues in all segments.  Nonperforming loans increased by $5.9 million to $29.0 million at September 30, 2021 from $23.0 million at December 31, 2020.  Purchased credit deteriorated loans, or PCD loans, are purchased loans that, as of the date of acquisition, we determined had experienced a more-than-insignificant deterioration in credit quality since origination.  PCD loans and their related deferred loan costs are included in our nonperforming loan disclosures, if such loans otherwise meet the definition of a nonperforming loan.  Management continues to carefully monitor loans considered to be in a classified status.  Nonperforming loans as a percent of total loans were 1.5% as of September 30, 2021, 1.1% as of December 31, 2020, and 1.0% as of September 30, 2020.  The distribution of our nonperforming loans is shown in the following table.

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Table of Contents

September 30, 2021

Nonperforming Loans

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2021

2020

2020

2020

2020

Commercial

$

220

$

1,125

$

1,605

(80.4)

(86.3)

Leases

3,959

2,801

2,079

41.3

90.4

Commercial real estate - Investor

6,100

1,632

2,021

273.8

201.8

Commercial real estate - Owner occupied

6,896

9,262

8,635

(25.5)

(20.1)

Construction

2,958

-

-

N/M

N/M

Residential real estate - Investor

998

1,085

935

(8.0)

6.7

Residential real estate - Owner occupied

4,885

3,561

3,516

37.2

38.9

Multifamily

2,055

2,437

895

(15.7)

129.6

HELOC

700

1,142

1,140

(38.7)

(38.6)

HELOC - Purchased

181

-

-

N/M

N/M

Other 1

-

-

6

-

(100.0)

Total nonperforming loans

$

28,952

$

23,045

$

20,832

25.6

39.0

N/M - Not meaningful

1 The “Other” segment includes consumer and overdrafts.

The components of our nonperforming assets are shown in the following table.

September 30, 2021

Nonperforming Assets

As of

Percent Change From

(Dollars in Thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

  

2021

  

2020

  

2020

  

2020

2020

Nonaccrual loans

$

27,520

$

22,280

$

20,076

23.5

37.1

Performing troubled debt restructured loans accruing interest

 

199

 

331

 

334

(39.9)

(40.4)

Loans past due 90 days or more and still accruing interest

 

1,233

 

434

 

422

184.1

192.2

Total nonperforming loans

 

28,952

 

23,045

 

20,832

25.6

39.0

Other real estate owned

 

1,912

 

2,474

 

2,686

(22.7)

(28.8)

Total nonperforming assets

$

30,864

$

25,519

$

23,518

20.9

31.2

30-89 days past due loans and still accruing interest

$

2,829

$

11,326

$

5,511

Nonaccrual loans to total loans

1.5

%

1.1

%

1.0

%

Nonperforming loans to total loans

1.5

%

1.1

%

1.0

%

Nonperforming assets to total loans plus OREO

1.7

%

1.3

%

1.2

%

Allowance for credit losses

$

26,949

$

33,855

$

32,918

Allowance for credit losses to total loans

1.4

%

1.7

%

1.6

%

Allowance for credit losses to nonaccrual loans

97.9

%

152.0

%

164.0

%

Loan charge-offs, net of recoveries, for the current quarter, prior linked quarter and year over year quarter are shown in the following table.

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Table of Contents

Loan Charge-offs, Net of Recoveries

Three Months Ended

(Dollars in thousands)

September 30, 

% of

June 30, 

% of

September 30, 

% of

2021

Total1

2021

Total1

2020

Total1

Commercial

$

(2)

(0.8)

$

190

292.3

$

(7)

1.9

Leases

4

1.7

28

43.1

119

(32.6)

Commercial real estate - Investor

83

35.0

(20)

(30.8)

(102)

27.9

Commercial real estate - Owner occupied

(2)

(0.8)

21

32.3

(420)

115.1

Construction

-

-

-

-

59

(16.2)

Residential real estate - Investor

(7)

(3.0)

(10)

(15.4)

(15)

4.1

Residential real estate - Owner occupied

(18)

(7.6)

(61)

(93.8)

(25)

6.8

Multifamily

183

77.2

-

-

-

-

HELOC

(28)

(11.8)

(72)

(110.8)

(52)

14.2

HELOC - Purchased

-

-

-

-

66

(18.1)

Other 2

24

10.1

(11)

(16.9)

12

(3.1)

Net (recoveries) charge-offs

$

237

100.0

$

65

100.0

$

(365)

100.0

1 Represents the percentage of net charge-offs attributable to each category of loans.

2 The “Other” segment includes consumer and overdrafts.

Net charge-offs of $237,000 were recorded for the third quarter of 2021, compared to net charge-offs of $65,000 for the second quarter of 2021, and net recoveries of $365,000 for the third quarter of 2020, reflecting continuing management attention to credit quality and remediation efforts.  The net charge-offs for the third quarter of 2021 were primarily due to one multifamily charge-off.  We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs.

Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard.  Classified assets include both classified loans and OREO.  Loans classified as substandard are inadequately protected by either the current net worth and ability to meet payment obligations of the obligor, or by the collateral pledged to secure the loan, if any.  These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and carry the distinct possibility that we will sustain some loss if deficiencies remain uncorrected.

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Table of Contents

The following table shows classified assets by segment for the following periods.

September 30, 2021

Classified Assets

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2021

2020

2020

2020

2020

Commercial

$

467

$

2,679

$

5,992

(82.6)

(92.2)

Leases

4,423

3,222

3,270

37.3

35.3

Commercial real estate - Investor

8,718

5,117

5,596

70.4

55.8

Commercial real estate - Owner occupied

7,211

11,187

9,658

(35.5)

(25.3)

Construction

4,898

5,192

5,108

(5.7)

(4.1)

Residential real estate - Investor

1,154

1,516

1,526

(23.9)

(24.4)

Residential real estate - Owner occupied

4,508

4,040

3,836

11.6

17.5

Multifamily

2,327

7,558

5,833

(69.2)

(60.1)

HELOC

1,034

1,540

1,566

(32.9)

(34.0)

HELOC - Purchased

181

-

-

N/M

N/M

Other 1

2

4

272

(50.0)

(99.3)

Total classified loans

34,923

42,055

42,657

(17.0)

(18.1)

Other real estate owned

1,912

2,474

2,686

(22.7)

(28.8)

Total classified assets

$

36,835

$

44,529

$

45,343

(17.3)

(18.8)

N/M - Not meaningful

1 The “Other” segment includes consumer and overdrafts.

Total classified loans and classified assets decreased as of September 30, 2021, from the levels at both December 31, 2020 and September 30, 2020, primarily due to continued remediation efforts and the high level of paydowns and payoffs we have experienced due to increased borrower liquidity stemming from federal stimulus funds received by borrowers and other COVID-19 relief funding, such as PPP loans. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the ACL on loans as another measure of overall change in loan related asset quality, which is referred to as the “classified assets ratio.”  The classified assets ratio was 9.73% for the period ended September 30, 2021, compared to 12.64% as of December 31, 2020, and 12.86% as of September 30, 2020.  The decrease in the classified assets ratio for the period ended September 30, 2021, compared to September 30, 2020, is also due to the remediation efforts and borrower liquidity noted above, as well as growth in our capital level over the past year.  

Allowance for Credit Losses on Loans

The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. As of January 1, 2020, we adopted ASU 2016-13, or CECL.

We recorded a net release of $1.5 million in our provision for credit losses due to a reserve release for the third quarter of 2021, comprised of a $1.5 million reserve release related to loans and a $47,000 reserve release related to unfunded commitments.  We recorded a release of $3.5 million in our provision for credit losses for the second quarter of 2021, comprised of a $2.3 million reserve release related to loans and $1.2 million of additional provision expense for credit losses on unfunded commitments, compared to a provision for credit losses recorded in the third quarter of 2020 of $300,000.  In the third quarter of 2021, we determined a reserve release on loans was appropriate, after considering our low level of net charge-offs for the quarter of $237,000, and net recovery position of $280,000 year to date, as well as the impact of changes to our future loss rate assumptions based on a decrease to the unemployment factor projected for the life of the loans over the one year forecast period.   In addition, we recorded a $47,000 release to the provision for credit losses on unfunded commitments in the third quarter of 2021, primarily due to an updated analysis of line utilization rates over the past twelve months, as well as the roll off of prior historical periods with lower losses within the CECL model.  

Management estimates the amount of provision required on a quarterly basis and records the appropriate provision expense, or release of expense, to maintain an adequate reserve for all potential and estimated credit losses on loan, leases and unfunded commitments.  Our ACL on loans to total loans was 1.4% as of September 30, 2021, compared to 1.7% at December 31, 2020.  See Item 7 – Critical Accounting Policies in the Management Discussion and Analysis in our 2020 Annual Report in Form 10-K for discussion of our ACL

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Table of Contents

methodology on loans. Allocations of the ACL may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

Below is a reconciliation of the activity in the allowance for credit losses on loans for the periods indicated (dollars in thousands):

Three Months Ended

Nine Months Ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

2021

2021

2020

2021

2020

Allowance at beginning of period

$

28,639

$

30,967

$

31,273

$

33,855

$

19,789

Charge-offs:

Commercial

23

207

5

232

124

Leases

4

28

119

32

119

Commercial real estate - Investor

101

-

-

101

15

Commercial real estate - Owner occupied

5

31

145

39

1,546

Construction

-

-

60

-

60

Residential real estate - Investor

-

-

3

-

8

Residential real estate - Owner occupied

-

-

-

-

43

Multifamily

183

-

-

183

-

HELOC

-

5

-

17

85

HELOC - Purchased

-

-

66

-

66

Other 1

53

30

53

108

192

Total charge-offs

369

301

451

712

2,258

Recoveries:

Commercial

25

17

12

62

48

Leases

-

-

-

-

-

Commercial real estate - Investor

18

20

102

58

139

Commercial real estate - Owner occupied

7

10

565

225

566

Construction

-

-

1

-

1

Residential real estate - Investor

7

10

18

283

45

Residential real estate - Owner occupied

18

61

25

128

157

Multifamily

-

-

-

-

-

HELOC

28

77

52

129

248

HELOC - Purchased

-

-

-

-

-

Other 1

29

41

41

107

130

Total recoveries

132

236

816

992

1,334

Net charge-offs (recoveries)

237

65

(365)

(280)

924

Adoption of ASC 326

-

-

-

-

5,879

(Release of) provision for credit losses on loans

(1,453)

(2,263)

1,280

(7,186)

8,174

Allowance at end of period

$

26,949

$

28,639

$

32,918

$

26,949

$

32,918

Average total loans (exclusive of loans held-for-sale)

$

1,884,788

$

1,926,105

$

2,035,584

$

1,938,573

$

2,005,253

Net charge-offs / (recoveries) to average loans

0.01

%

0.00

%

(0.02)

%

(0.01)

%

0.05

%

Allowance at period end to average loans

1.43

%

1.49

%

1.62

%

1.39

%

1.64

%

1 The “Other” segment includes consumer and overdrafts.

The coverage ratio of the ACL on loans to nonperforming loans was 93.1% as of September 30, 2021, which was a decrease from the coverage ratio of 123.9% as of June 30, 2021 and a decrease from 158.0% as of September 30, 2020.  When measured as a percentage of average loans, our total ACL on loans was 1.39% for the nine months ended September 30, 2021, and 1.64% for the like period of September 30, 2020  

In management’s judgment, an adequate ACL has been established to encompass the current lifetime expected credit losses at September 30, 2021, and general changes in lending policy, procedures and staffing, as well as other external factors, such as the impacts of the COVID-19 pandemic.  However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession.  Further delayed recovery or further deterioration in market conditions related to COVID-19 and the associated impacts on our customers,

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Table of Contents

changes in business climates and the condition of collateral at the time of default or repossession may revise our current expectations of future credit losses in future reporting periods.

Other Real Estate Owned

As of September 30, 2021, OREO totaled $1.9 million, reflecting a $562,000 reduction from the $2.5 million at December 31, 2020, and a $774,000 reduction from the $2.7 million at September 30, 2020.  There was one property disposal of $37,000 net book value and one transfer to OREO for $70,000 recorded in the third quarter of 2021.  There was one property addition for $314,500 in the third quarter of 2020. There were seven property disposals for a total of $2.7 million in the third quarter of 2020. There were two valuation adjustments which occurred in the third quarter of 2021 for a net write-up of $2,000, compared to $93,000 of OREO valuation write-downs in the fourth quarter of 2020, and $46,250 of valuation write-downs recorded in the third quarter of 2020.

September 30, 2021

OREO

Three Months Ended

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2021

2020

2020

2020

2020

Balance at beginning of period

$

1,877

$

2,686

$

5,082

(30.1)

(63.1)

Property additions, net of acquisition adjustments

70

-

314

-

(77.7)

Less:

Proceeds from property disposals, net of participation purchase and of gains/losses

37

119

2,664

(68.9)

(98.6)

Period valuation (write-up)/write-down

(2)

93

46

(102.2)

(104.3)

Balance at end of period

$

1,912

$

2,474

$

2,686

(22.7)

(28.8)

In management’s judgment, the property valuation allowance as established presents OREO at current estimates of fair value less estimated costs to sell; however, there can be no assurance that additional losses will not be incurred on disposals or upon updates to valuations in the future.  Of note, properties valued in total at $1.1 million, or approximately 56.4% of total OREO at September 30, 2021, have been in OREO for five years or more.  The appropriate regulatory approval has been obtained for any OREO properties held in excess of five years.

OREO Properties by Type

(Dollars in thousands)

September 30, 2021

December 31, 2020

September 30, 2020

Amount

% of Total

Amount

% of Total

Amount

% of Total

Single family residence

$

519

27

%

$

430

17

%

$

450

17

%

Lots (single family and commercial)

1,078

56

%

1,387

57

%

1,461

54

%

Vacant land

315

17

%

352

14

%

351

13

%

Commercial property

-

-

%

305

12

%

424

16

%

Total other real estate owned

$

1,912

100

%

$

2,474

100

%

$

2,686

100

%

Deposits and Borrowings

September 30, 2021

Deposits

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2021

2020

2020

2020

    

2020

Noninterest bearing demand

$

1,037,638

$

909,505

$

889,085

14.1

16.7

Savings

457,900

399,057

382,711

14.7

19.6

NOW accounts

537,547

486,612

492,407

10.5

9.2

Money market accounts

370,691

316,465

310,613

17.1

19.3

Certificates of deposit of less than $100,000

173,595

200,107

208,570

(13.2)

(16.8)

Certificates of deposit of $100,000 through $250,000

98,496

164,982

129,522

(40.3)

(24.0)

Certificates of deposit of more than $250,000

38,462

60,345

66,335

(36.3)

(42.0)

Total deposits

$

2,714,329

$

2,537,073

$

2,479,243

7.0

9.5

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Total deposits were $2.71 billion at September 30, 2021, which reflects a $177.3 million increase from total deposits of $2.54 billion at December 31, 2020, and an increase of $235.1 million from total deposits of $2.48 billion at September 30, 2020.  The increase in deposits at September 30, 2021, compared to both December 31, 2020 and September 30, 2020, was due to increases in noninterest bearing demand, savings, NOW, and money market accounts, with decreases noted in all maturity categories of certificates of deposit.  These total deposit increases in the linked quarter as well as the year over year periods were primarily due to federal stimulus funds received by certain depositors due to the COVID-19 pandemic.  

In addition to deposits, we obtained funding from other sources in all periods presented.  Securities sold under repurchase agreements totaled $43.0 million at September 30, 2021, a $24.0 million, or 35.9%, decrease from $67.0 million at December 31, 2020.   Our notes payable and other borrowings is comprised of one remaining $6.2 million long-term FHLBC advance, which matures on February 2, 2026, and $14.0 million outstanding on a $20.0 million term note originated with a correspondent bank in the first quarter of 2020, to facilitate the redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures, completed on March 2, 2020.  Notes payable and other borrowings of $20.1 million as of September 30, 2021, decreased $3.2 million from December 31, 2020, and decreased $4.3 million from September 30, 2020.  

In the second quarter of 2021, we entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers pursuant to which we sold and issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”).  We sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance are intended to be used for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions.  The Notes bear interest at a fixed annual rate of 3.50% through April 14, 2026, payable semi-annually in arrears.  As of April 15, 2026 forward, the interest rate on the Notes will generally reset quarterly to a rate equal to Three-Month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears.  The Notes have a stated maturity of April 15, 2031, and are redeemable, in whole are in part, on April 15, 2026, or any interest payment date thereafter, and at any time upon the occurrence of certain events.

The Company is indebted on senior notes originated in December 2016, totaling $44.5 million, net of deferred issuance costs, as of September 30, 2021.  These notes mature in December 2026, and include interest payable semi-annually at 5.75% for five years.  Beginning December 2021, the interest becomes payable quarterly at three month LIBOR plus 385 basis points.  The Company is also indebted on $25.8 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust II (“Trust II”).  The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points on June 15, 2017.  Upon conversion to a floating rate, we initiated a cash flow hedge which resulted in the total interest rate paid on this debt of 4.41% as of September 30, 2021, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017, rate reset.  

Capital

As of September 30, 2021, total stockholders’ equity was $321.2 million, which was an increase of $14.1 million from $307.1 million as of December 31, 2020.  This increase is attributable to an increase in retained earnings of $25.9 million, comprised of net income year to date of $29.1 million, less a reduction to retained earnings of $3.2 million for payment of dividends to our common stockholders in the first nine months of 2021. In addition, a decrease to accumulated other comprehensive income of $2.5 million was recorded due to a net decrease in unrealized gains on available-for-sale securities, net of unrealized losses on swaps. Total stockholders’ equity was reduced by an increase of $8.1 million to our treasury stock in the first nine months of 2021, primarily due to repurchases of our common shares pursuant to our stock repurchase program.

In the third quarter of 2019, our Board of Directors authorized a stock repurchase program, under which we were authorized to repurchase up to approximately 1.5 million shares (or approximately 5%) of our outstanding common stock through open market purchases, trading plans established in accordance with U.S. Securities and Exchange Commission rules, privately negotiated transactions, or by other means.  The stock repurchase program expired on September 19, 2020; however, we received a notice of non-objection from the Federal Reserve Bank of Chicago to extend the previously authorized stock repurchase program through October 20, 2021.  The actual means and timing of any repurchases, quantity of purchased shares and prices will be, subject to certain limitations, at the discretion of management and will depend on a number of factors, including, without limitation, market prices of our common stock, general market and economic condition, and applicable legal and regulatory requirements.  These share purchases were funded by our cash on hand.  During the third quarter of 2021, we did not repurchase any shares pursuant to our stock repurchase program.  For the nine months ended September 30, 2021, we repurchased 766,034 shares at a weighted average share price of $12.81 per share.  To date, we have repurchased 1,485,307 shares of our common stock at a weighted average price of $10.31 per share, under our stock repurchase program. As of September 30, 2021, we had substantially completed the stock repurchase program, which expired on October 21, 2021.

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The following table shows the regulatory capital ratios and the current well capitalized regulatory requirements for the Company and the Bank as of the dates indicated:

Minimum Capital

Well Capitalized

Adequacy with

Under Prompt

Capital Conservation

Corrective Action

September 30, 

December 31, 

September 30, 

Buffer, if applicable1

Provisions2

2021

2020

2020

The Company

Common equity tier 1 capital ratio

7.00

%

N/A

12.99

%

11.94

%

11.97

%

Total risk-based capital ratio

10.50

%

N/A

17.80

%

14.26

%

14.33

%

Tier 1 risk-based capital ratio

8.50

%

N/A

14.10

%

13.01

%

13.08

%

Tier 1 leverage ratio

4.00

%

N/A

9.81

%

10.21

%

10.07

%

The Bank

Common equity tier 1 capital ratio

7.00

%

6.50

%

15.65

%

13.75

%

14.24

%

Total risk-based capital ratio

10.50

%

10.00

%

16.69

%

15.00

%

15.49

%

Tier 1 risk-based capital ratio

8.50

%

8.00

%

15.65

%

13.75

%

14.24

%

Tier 1 leverage ratio

4.00

%

5.00

%

10.83

%

10.74

%

10.90

%

1 Amounts are shown inclusive of a capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes.

2 The prompt corrective action provisions are only applicable at the Bank level.

As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopted CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we elected to utilize the five-year CECL transition.  The cumulative amount that is not recognized in regulatory capital, in addition to the $3.8 million Day One impact of CECL adoption, will be phased in at 25% per year beginning January 1, 2022. As of September 30, 2021, the capital measures of the Company exclude $4.2 million, which is the modified CECL transition adjustment.

As of September 30, 2021, the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” and met the now fully phased-in capital conservation buffer requirements.  In addition to the above regulatory ratios, our GAAP common equity to total assets ratio, which is used as a performance measurement for capital analysis and peer comparisons, decreased from 10.10% at December 31, 2020, to 9.81% at September 30, 2021. Our GAAP tangible common equity to tangible assets ratio was 9.24% at September 30, 2021, compared to 9.48% as of December 31, 2020.  Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, decreased from 9.49% at December 31, 2020, to 9.25% at September 30, 2021, due to the growth in total tangible assets.  

In November 2019, the federal banking agencies published final rules to provide an optional simplified measure of capital adequacy for qualifying community banking organizations, which we refer to as the community bank leverage ratio (“CBLR”) framework. Generally, under the CBLR framework, qualifying community banking organizations with total assets of less than $10 billion, and limited amounts of off-balance-sheet exposures and trading assets and liabilities, may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9%. Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of the FDIC’s Prompt Corrective Action framework.  The final rule became effective on January 1, 2020.  We do not have any immediate plans to elect to use the community bank leverage ratio framework, but may make such an election in the future.

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Reconciliation of Tangible Common Equity to Tangible Assets Ratio Non-GAAP Measure

September 30, 2021

December 31, 2020

Tangible common equity

GAAP

Non-GAAP

GAAP

Non-GAAP

(Dollars in thousands)

Total Equity

$

321,232

$

321,232

$

307,087

$

307,087

Less: Goodwill and intangible assets

20,433

20,433

20,781

20,781

Add: Limitation of exclusion of core deposit intangible (80%)

N/A

366

N/A

435

Adjusted goodwill and intangible assets

20,433

20,067

20,781

20,346

Tangible common equity

$

300,799

$

301,165

$

286,306

$

286,741

Tangible assets

Total assets

$

3,275,132

$

3,275,132

$

3,040,837

$

3,040,837

Less: Adjusted goodwill and intangible assets

20,433

20,067

20,781

20,346

Tangible assets

$

3,254,699

$

3,255,065

$

3,020,056

$

3,020,491

Common equity to total assets

9.81

%

9.81

%

10.10

%

10.10

%

Tangible common equity to tangible assets

9.24

%

9.25

%

9.48

%

9.49

%

The non-GAAP intangible asset exclusion reflects the 80% core deposit limitation per Basel III guidelines within risk based capital calculations, and is useful for us when reviewing risk based capital ratios and equity performance metrics.

Liquidity

Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments.  Our liquidity principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds.  We monitor our borrowing capacity at the FHLBC as part of our liquidity management process as supervised by our Asset and Liability Committee (“ALCO”) and reviewed by our Board of Directors.  In addition, due to the potential impacts on our liquidity stemming from the COVID-19 pandemic, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs.  As of September 30, 2021, our cash on hand liquidity totaled $519.3 million, an increase of $189.4 million over cash balances held as of December 31, 2020.  

Net cash inflows from operating activities were $50.8 million during the first nine months of 2021, compared with net cash inflows of $16.8 million in the same period of 2020.  Funds used to originate loans held-for-sale, net of proceeds from sales of loans held-for-sale, were a source of inflows for both the first nine months of 2021 and the like period of 2020.  Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of inflows for the nine months ended September 30, 2021, and outflows for the like period of 2020.  The management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows.  Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process.

Net cash outflows from investing activities were $57.0 million in the nine months ended September 30, 2021, compared to net cash outflows of $54.4 million in the same period in 2020.  In the first nine months of 2021, securities transactions accounted for net outflows of $225.2 million, and the principal change on loans accounted for net inflows of $168.6 million.  In the first nine months of 2020, securities transactions accounted for net inflows of $45.0 million, and net principal on loans funded accounted for net outflows of $100.4 million.  Proceeds from sales of OREO accounted for $608,000 and $3.1 million in investing cash inflows for the nine months ended September 30, 2021 and 2020, respectively.

Net cash inflows from financing activities in the nine months ended September 30, 2021 were $195.6 million, compared with net cash inflows of $300.2 million in the nine months ended September 30, 2020.   Net deposit inflows in the first nine months of 2021 were $177.3 million compared to net deposit inflows of $352.5 million in the first nine months of 2020.  Other short-term borrowings had no net cash outflows in the first nine months of 2021, compared to $42.4 million of outflows in the first nine months of 2020.  Changes in securities sold under repurchase agreements accounted for outflows of $24.0 million and inflows of $10.6 million for the nine months ended September 30, 2021 and 2020, respectively.  The redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures resulted in cash outflows of $32.6 million in the first quarter of 2020, which was partially offset by a $20.0 million term note cash inflow which was originated to partially fund this trust preferred redemption; $14.0 million of this term note

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remains outstanding as of September 30, 2021.  In the second quarter of 2021, we issued $59.1 million of subordinated debentures, net of issuance costs; this cash is anticipated to be used for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases or strategic acquisitions.

Cash and cash equivalents for the nine months ended September 30, 2021, totaled $519.3 million, as compared to $313.1 million as of September 30, 2020.  In addition to cash and cash equivalents on hand or held as deposits with other financial institutions, we rely on funding sources from customer deposits, cash flows from securities available-for-sale and loans, and a line of credit with the FHLBC to meet potential liquidity needs.  These sources of liquidity are immediately available to satisfy any funding requirements due to depositor or borrower demands through the ordinary course of our business.  Additional sources of funding include a $20 million undrawn line of credit held by the Company with a third party financial institution, as well as unpledged securities available-for-sale.    

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

As part of our normal operations, we are subject to interest-rate risk on the assets we invest in (primarily loans and securities) and the liabilities we fund (primarily customer deposits and borrowed funds).  Fluctuations in interest rates may result in changes in the fair market values of our financial instruments, cash flows, and net interest income.  Like most financial institutions, we have an exposure to changes in both short-term and long-term interest rates.

The Federal Reserve has kept the target Fed Funds range of 0% to 0.25% since the first quarter of 2020, the latest Fed Funds Futures implies a rate hike in the third quarter of 2022.  The Fed has been aggressively purchasing assets in the open market since March 2020, increasing its balance sheet to $8.5 trillion by the end of September 2021. Given that inflation has been more persistent than initially thought, the Fed announced that it will start tapering its asset purchases this year and conclude such purchases by the middle of 2022.  We manage interest rate risk within guidelines established by policy which are intended to limit the amount of rate exposure. In practice, we seek to manage our interest rate risk exposure well within our guidelines so that such exposure does not pose a material risk to our future earnings.

We manage various market risks in the normal course of our operations, including credit, liquidity risk, and interest-rate risk.  Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of our business activities and operations.  In addition, since we do not hold a trading portfolio, we are not exposed to significant market risk from trading activities.  Our interest rate risk exposures at September 30, 2021 and December 31, 2020 are outlined in the table below.

Our net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such as LIBOR and prime), and balance sheet growth or contraction.  Our asset-liability committee seeks to manage interest rate risk under a variety of rate environments by structuring our balance sheet and off-balance sheet positions, which includes interest rate swap derivatives as discussed in Note 18 of our consolidated financial statements found in in our Annual Report on Form 10-K for the year ended December 31, 2020.  We seek to monitor and manage interest rate risk within approved policy guidelines and limits.

We use simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by us are incorporated into the simulation model. Earnings at risk are calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a different interest rate environment in order to determine the percentage change. As of September 30, 2021, we had notable amounts of earnings gains (in both dollars and percentage) should interest rates rise.  The projected increases in income across all up rate interest rate shock scenarios as of September 30, 2021 were notably higher than December 31, 2020, primarily due to the increase in Fed Funds from high deposit levels and repricing on short term rates.

The following table summarizes the effect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 0.5%, 1.0%, and 2.0% and no change in the slope of the yield curve.  Due to relatively low current market interest rates, it was not possible to calculate any down rate scenarios because many of the market interest rates would fall below zero in that scenario.

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Analysis of Net Interest Income Sensitivity

(Dollars in thousands)

Analysis of Net Interest Income Sensitivity

Immediate Changes in Rates

    

(2.0)

%

    

(1.0)

%

    

  

(0.5)

%

    

  

0.5

%

    

  

1.0

%

    

  

2.0

%

September 30, 2021

Dollar change

N/M

N/M

N/M

$

5,343

$

10,854

$

22,180

Percent change

N/M

N/M

N/M

6.4

%

12.9

%

26.5

%

December 31, 2020

Dollar change

N/M

N/M

N/M

$

3,405

$

6,879

$

13,145

Percent change

N/M

N/M

N/M

3.9

%

7.8

%

14.9

%

N/M - Not meaningful

The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results.  Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies.  The above results do not take into account any management action to mitigate potential risk.

Effects of Inflation

In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate.  While interest rates are greatly influenced by changes in the inflation rate, they do not change at the same rate or in the same magnitude as the inflation rate.  Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as on changes in monetary and fiscal policies.  A financial institution’s ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in today’s volatile economic environment.  We seek to insulate the Company from interest rate volatility by using our best efforts to ensure that rate sensitive assets and rate sensitive liabilities respond to changes in interest rates in a similar time frame and to a similar degree.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of September 30, 2021.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2021, the Company’s internal controls were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities and Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified.

There were no changes in the Company’s internal controls over financial reporting during the quarter ended September 30, 2021, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

The Company and its subsidiaries, from time to time, are involved in collection suits in the ordinary course of business against its debtors and are defendants in legal actions arising from normal business activities.  Management, after consultation with legal counsel, believes

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that the ultimate liabilities, if any, resulting from these actions will not have a material adverse effect on the financial position of the Bank or on the consolidated financial position of the Company.

Item 1.A.  Risk Factors

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as well as cautionary statements contained in this Quarterly Report, on Form 10-Q, including those under the caption “Cautionary Note Regarding Forward-Looking Statements,” and set forth in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2021.

Except as set forth in Part II, Item 1A of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2021 and filed with the SEC on August 6, 2021, which is incorporated herein by this reference, there have been no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 filed with the SEC on March 8, 2021.

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

Stock Repurchases

In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase Program”).  The Repurchase Program expired on September 19, 2020.  However, on October 20, 2020, the Company received notice of non-objection from the Federal Reserve Bank of Chicago to extend the Repurchase Program through October 20, 2021.  We made no repurchases under the Repurchase Program in the third quarter of 2021. The Repurchase Program expired on October 21, 2021.

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not applicable

Item 5.  Other Information

None.

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Item 6.  Exhibits

Exhibits:

2.1

Agreement and Plan of Merger between Old Second Bancorp, Inc. and West Suburban Bancorp, Inc. dated as of July 25, 2021 (incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on July 26, 2021).

31.1

31.2

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.

101

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at September 30, 2021, and December 31, 2020; (ii) Consolidated Statements of Income for the three months ended September 30, 2021 and 2020; (iii) Consolidated Statements of Stockholders’ Equity for the three months ended September 30, 2021 and 2020; (iv) Consolidated Statements of Cash Flows for the three months ended September 30,  2021 and 2020; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.*

104

Cover Page Interactive Data File (the cover page XBRL tags are embedded within the Inline XBRL document).

* As provided in Rule 406T of Regulation S-T, these interactive data files shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 as amended, or otherwise subject to liability under those sections.

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

OLD SECOND BANCORP, INC.

BY:

/s/ James L. Eccher

James L. Eccher

President and Chief Executive Officer

(principal executive officer)

BY:

/s/ Bradley S. Adams

Bradley S. Adams

Executive Vice President and Chief Financial Officer

(principal financial and accounting officer)

DATE: November 5, 2021

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