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OLD SECOND BANCORP INC - Quarter Report: 2023 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, 2023

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)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock

OSBC

The Nasdaq Stock Market

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

Yes         No 

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

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

Large accelerated 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 

As of November 3, 2023, the Registrant has 44,697,917 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

4

Item 2.

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

37

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

62

Item 4.

Controls and Procedures

63

PART II

Item 1.

Legal Proceedings

64

Item 1.A.

Risk Factors

64

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

64

Item 3.

Defaults Upon Senior Securities

64

Item 4.

Mine Safety Disclosure

64

Item 5.

Other Information

64

Item 6.

Exhibits

65

Signatures

66

2

Table of Contents

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report and other publicly available documents of the Company contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act, including, but not limited to, management’s expectations regarding future plans, strategies and financial performance, including regulatory developments, industry and economic trends and estimates and assumptions underlying accounting policies.  Forward-looking statements are based on our current beliefs, expectations and assumptions and on information currently available and, can be identified by the use of words such as “should,” “anticipate,” “expect,” “estimate,” “intend,” “believe,” “may,” “likely,” “will,” “forecast,” “project,” “looking forward,” “optimistic,” “hopeful,” “potential,” “progress,” “prospect,” “remain,” “continue,” “trend,” “momentum” or the negative thereof as well as other similar words and expressions of the future. Forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict as to timing, extent, likelihood and degree of occurrence, which could cause our actual results to differ materially from those anticipated in or by such statements. Potential risks and uncertainties include, but are not limited to, the following:

our ability to execute our growth strategy;
negative economic conditions, including inflation, which may 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;
our ability to raise cost-effective funding to support business plans when needed;
risks with respect to our ability to successfully expand and integrate businesses and operations that we acquire, as well our ability to identify and complete future mergers or acquisitions;
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;
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 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;
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;
our ability to receive dividends from our subsidiaries;
a decrease in our regulatory capital ratios or negative changes in our capital position;
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;
continued increases in FDIC assessment which will continue to increase our cost of doing business;
risks associated with complex and changing regulatory environments, including, among others, with respect to data privacy, artificial intelligence, information security, climate change or other environmental, social and governance matters, and labor matters, relating to the Company’s operations;
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, war or terrorist activities, such as the war in Ukraine and the Middle East conflict, essential utility outages, deterioration in the global economy, instability in the credit markets, labor shortages, 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 2022 Annual Report on Form 10-K and in subsequent filings we make with the SEC.

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

3

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

(unaudited)

September 30, 

December 31, 

    

2023

    

2022

Assets

Cash and due from banks

$

55,548

$

56,632

Interest earning deposits with financial institutions

53,485

58,545

Cash and cash equivalents

109,033

115,177

Securities available-for-sale, at fair value

1,229,618

1,539,359

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

35,830

20,530

Loans held-for-sale

2,297

491

Loans

4,029,543

3,869,609

Less: allowance for credit losses on loans

51,729

49,480

Net loans

3,977,814

3,820,129

Premises and equipment, net

76,472

72,355

Other real estate owned

407

1,561

Mortgage servicing rights, at fair value

11,461

11,189

Goodwill

86,478

86,478

Core deposit intangible

11,820

13,678

Bank-owned life insurance (“BOLI”)

108,187

106,608

Deferred tax assets, net

44,051

44,750

Other assets

64,688

56,012

Total assets

$

5,758,156

$

5,888,317

Liabilities

Deposits:

Noninterest bearing demand

$

1,862,659

$

2,051,702

Interest bearing:

Savings, NOW, and money market

2,273,671

2,617,100

Time

477,990

441,921

Total deposits

4,614,320

5,110,723

Securities sold under repurchase agreements

25,894

32,156

Other short-term borrowings

435,000

90,000

Junior subordinated debentures

25,773

25,773

Subordinated debentures

59,361

59,297

Senior notes

-

44,585

Notes payable and other borrowings

-

9,000

Other liabilities

65,250

55,642

Total liabilities

5,225,598

5,427,176

Stockholders’ Equity

Common stock

44,705

44,705

Additional paid-in capital

201,553

202,276

Retained earnings

377,320

310,512

Accumulated other comprehensive loss

(90,619)

(93,124)

Treasury stock

(401)

(3,228)

Total stockholders’ equity

532,558

461,141

Total liabilities and stockholders’ equity

$

5,758,156

$

5,888,317

September 30, 2023

December 31, 2022

Common

Common

Stock

    

Stock

Par value

$

1.00

$

1.00

Shares authorized

60,000,000

60,000,000

Shares issued

44,705,150

44,705,150

Shares outstanding

44,684,987

44,582,311

Treasury shares

20,163

122,839

See accompanying notes to consolidated financial statements.

4

Table of Contents

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, 

    

2023

    

2022

    

2023

    

2022

    

Interest and dividend income

Loans, including fees

$

62,665

$

46,614

$

181,436

$

121,209

Loans held-for-sale

29

22

60

111

Securities:

Taxable

8,946

9,116

29,611

21,071

Tax exempt

1,333

1,332

4,007

3,946

Dividends from FHLBC and FRBC stock

597

261

1,273

677

Interest bearing deposits with financial institutions

659

663

1,887

1,714

Total interest and dividend income

74,229

58,008

218,274

148,728

Interest expense

Savings, NOW, and money market deposits

2,558

380

5,449

1,124

Time deposits

1,982

335

3,802

877

Securities sold under repurchase agreements

27

10

43

30

Other short-term borrowings

5,840

44

13,345

44

Junior subordinated debentures

245

285

805

849

Subordinated debentures

547

546

1,639

1,639

Senior notes

-

728

2,408

1,791

Notes payable and other borrowings

-

111

87

309

Total interest expense

11,199

2,439

27,578

6,663

Net interest and dividend income

63,030

55,569

190,696

142,065

Provision for credit losses

3,000

4,500

8,501

5,050

Net interest and dividend income after provision for credit losses

60,030

51,069

182,195

137,015

Noninterest income

Wealth management

2,475

2,280

7,203

7,484

Service charges on deposits

2,504

2,661

7,290

7,063

Secondary mortgage fees

66

81

201

270

Mortgage servicing rights mark to market gain (loss)

281

548

(148)

3,608

Mortgage servicing income

519

514

1,534

1,612

Net gain on sales of mortgage loans

407

449

1,111

1,682

Securities losses, net

(924)

(1)

(4,146)

(34)

Change in cash surrender value of BOLI

919

146

1,579

342

Card related income

2,606

2,653

7,540

8,194

Other income

1,024

2,165

3,286

3,949

Total noninterest income

9,877

11,496

25,450

34,170

Noninterest expense

Salaries and employee benefits

23,115

21,011

67,161

62,310

Occupancy, furniture and equipment

3,506

4,119

10,620

10,864

Computer and data processing

1,922

2,543

4,986

12,817

FDIC insurance

744

659

2,122

1,771

Net teller & bill paying

534

504

1,551

3,245

General bank insurance

300

257

911

923

Amortization of core deposit intangible

616

657

1,858

1,981

Advertising expense

93

83

338

459

Card related expense

1,347

1,453

3,785

3,044

Legal fees

97

212

699

648

Consulting & management fees

549

607

1,859

1,746

Other real estate (income) expense, net

(27)

21

181

96

Other expense

4,627

3,862

12,104

11,585

Total noninterest expense

37,423

35,988

108,175

111,489

Income before income taxes

32,484

26,577

99,470

59,696

Provision for income taxes

8,149

7,054

25,966

15,906

Net income

$

24,335

$

19,523

$

73,504

$

43,790

Basic earnings per share

$

0.55

$

0.43

$

1.65

$

0.98

Diluted earnings per share

0.54

0.43

1.62

0.97

Dividends declared per share

0.05

0.05

0.15

0.15

See accompanying notes to consolidated financial statements.

5

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(unaudited)

(unaudited)

Three Months Ended September 30, 

Nine Months Ended September 30, 

    

2023

    

2022

    

2023

    

2022

Net Income

$

24,335

$

19,523

$

73,504

$

43,790

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

(9,062)

(41,163)

(1,212)

(146,477)

Related tax benefit

2,538

11,526

344

41,014

Holding losses, after tax, on available-for-sale securities

(6,524)

(29,637)

(868)

(105,463)

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

Net realized losses

(924)

(1)

(4,146)

(34)

Related tax benefit

260

1

1,165

10

Net realized losses after tax

(664)

-

(2,981)

(24)

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

(5,860)

(29,637)

2,113

(105,439)

Changes in fair value of derivatives used for cash flow hedges

1,975

(4,868)

560

(2,381)

Related tax (expense) benefit

(548)

1,360

(168)

663

Other comprehensive income (loss) on cash flow hedges

1,427

(3,508)

392

(1,718)

Total other comprehensive (loss) income

(4,433)

(33,145)

2,505

(107,157)

Total comprehensive income (loss)

$

19,902

$

(13,622)

$

76,009

$

(63,367)

Accumulated

Accumulated

Total

Unrealized Gain

Unrealized Gain

Accumulated Other

(Loss) on Securities

(Loss) on Derivative

Comprehensive

(unaudited)

Available-for -Sale

Instruments

Income/(Loss)

For the Three Months Ended

Balance, July 1, 2022

$

(64,663)

$

(581)

$

(65,244)

Other comprehensive loss, net of tax

(29,637)

(3,508)

(33,145)

Balance, September 30, 2022

$

(94,300)

$

(4,089)

$

(98,389)

Balance, July 1, 2023

$

(80,919)

$

(5,267)

$

(86,186)

Other comprehensive (loss) income, net of tax

(5,860)

1,427

(4,433)

Balance, September 30, 2023

$

(86,779)

$

(3,840)

$

(90,619)

For the Nine Months Ended

Balance, January 1, 2022

$

11,139

$

(2,371)

$

8,768

Other comprehensive loss, net of tax

(105,439)

(1,718)

(107,157)

Balance, September 30, 2022

$

(94,300)

$

(4,089)

$

(98,389)

Balance, January 1, 2023

$

(88,892)

$

(4,232)

$

(93,124)

Other comprehensive income, net of tax

2,113

392

2,505

Balance, September 30, 2023

$

(86,779)

$

(3,840)

$

(90,619)

See accompanying notes to consolidated financial statements.

6

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

Nine Months Ended September 30, 

2023

    

2022

    

Cash flows from operating activities

Net income

$

73,504

$

43,790

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

Net premium / discount amortization on securities

2,506

4,259

Securities losses, net

4,146

34

Provision for credit losses

8,501

5,050

Originations of loans held-for-sale

(39,068)

(65,103)

Proceeds from sales of loans held-for-sale

37,962

69,263

Net gains on sales of mortgage loans

(1,111)

(1,682)

Mortgage servicing rights mark to market loss (gain)

148

(3,608)

Net accretion of discount on loans and unfunded commitments

(2,620)

(5,473)

Net change in cash surrender value of BOLI

(1,579)

(342)

Net gains on sale of other real estate owned

(229)

(163)

Provision for other real estate owned valuation losses

269

104

Depreciation of fixed assets and amortization of leasehold improvements

3,246

3,079

Net gains on disposal and transfer of fixed assets

(636)

(1,872)

Amortization of core deposit intangibles

1,858

1,981

Change in current income taxes receivable

1,070

7,279

Deferred tax expense

(289)

(1,854)

Change in accrued interest receivable and other assets

(10,053)

1,036

Accretion of purchase accounting adjustment on time deposits

(1,004)

(1,207)

Change in accrued interest payable and other liabilities

7,991

3,314

Stock based compensation

2,709

2,176

Net cash provided by operating activities

87,321

60,061

Cash flows from investing activities

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

104,471

231,483

Proceeds from sales of securities available-for-sale

205,738

3,303

Purchases of securities available-for-sale

(4,186)

(301,649)

Net purchases of FHLBC/FRBC stock

(15,300)

(6,156)

Net change in loans

(164,252)

(443,628)

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

1,800

941

Proceeds from disposition of premises and equipment

4,460

12,167

Net purchases of premises and equipment

(8,217)

(2,670)

Cash paid for acquisition, net of cash and cash equivalents acquired

-

(146)

Net cash provided by (used in) investing activities

124,514

(506,355)

Cash flows from financing activities

Net change in deposits

(495,399)

(183,666)

Net change in securities sold under repurchase agreements

(6,262)

(14,840)

Net change in other short-term borrowings

345,000

25,000

Repayment of term note

(9,000)

(3,000)

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

-

(6,056)

Repayment of senior notes

(45,000)

-

Dividends paid on common stock

(6,713)

(6,650)

Purchase of treasury stock

(605)

(447)

Net cash used in financing activities

(217,979)

(189,659)

Net change in cash and cash equivalents

(6,144)

(635,953)

Cash and cash equivalents at beginning of period

115,177

752,107

Cash and cash equivalents at end of period

$

109,033

$

116,154

See accompanying notes to consolidated financial statements.

7

Table of Contents

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, July 1, 2022

$

44,705

$

201,282

$

271,831

$

(65,244)

$

(3,670)

$

448,904

Net income

19,523

19,523

Other comprehensive loss, net of tax

(33,145)

(33,145)

Dividends declared on common stock, ($0.05 per share)

(2,228)

(2,228)

Vesting of restricted stock

(304)

304

-

Stock based compensation

722

722

Purchase of treasury stock from taxes withheld on stock awards

(62)

(62)

Balance, September 30, 2022

$

44,705

$

201,700

$

289,126

$

(98,389)

$

(3,428)

$

433,714

Balance, July 1, 2023

$

44,705

$

200,963

$

355,219

$

(86,186)

$

(746)

$

513,955

Net income

24,335

24,335

Other comprehensive loss, net of tax

(4,433)

(4,433)

Dividends declared on common stock, ($0.05 per share)

(2,234)

(2,234)

Vesting of restricted stock

(345)

345

-

Stock based compensation

935

935

Balance, September 30, 2023

$

44,705

$

201,553

$

377,320

$

(90,619)

$

(401)

$

532,558

For the Nine Months Ended

Balance, January 1, 2022

$

44,705

$

202,443

$

252,011

$

8,768

$

(5,900)

$

502,027

Net income

43,790

43,790

Other comprehensive loss, net of tax

(107,157)

(107,157)

Dividends declared on common stock, ($0.15 per share)

(6,675)

(6,675)

Vesting of restricted stock

(2,919)

2,919

-

Stock based compensation

2,176

2,176

Purchase of treasury stock from taxes withheld on stock awards

(447)

(447)

Balance, September 30, 2022

$

44,705

$

201,700

$

289,126

$

(98,389)

$

(3,428)

$

433,714

Balance, January 1, 2023

$

44,705

$

202,276

$

310,512

$

(93,124)

$

(3,228)

$

461,141

Net income

73,504

73,504

Other comprehensive income, net of tax

2,505

2,505

Dividends declared on common stock, ($0.15 per share)

(6,696)

(6,696)

Vesting of restricted stock

(3,432)

3,432

-

Stock based compensation

2,709

2,709

Purchase of treasury stock from taxes withheld on stock awards

(605)

(605)

Balance, September 30, 2023

$

44,705

$

201,553

$

377,320

$

(90,619)

$

(401)

$

532,558

8

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, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023.  These interim consolidated financial statements and accompanying notes are unaudited and should be read in conjunction with the audited financial statements and notes included in Old Second Bancorp, Inc.’s (the “Company”) annual report on Form 10-K for the year ended December 31, 2022.  Unless otherwise indicated, dollar amounts in the tables contained in the notes to the consolidated financial statements are in thousands.  Certain items in prior periods have been reclassified to conform to the current presentation.

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

Recent Accounting Pronouncements

The following is a summary of recent accounting pronouncements that have impacted or could potentially affect the Company:  

ASU 2018-16, ASU 2020-04, ASU 2021-01, and ASU 2022-06 – In October 2018, the Financial Standards Board, or FASB, issued ASU No. 2018-16 “Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting.”  ASU 2018-16 adds the SOFR overnight index swap rate to the list of United States (U.S.) benchmark rates eligible for hedge accounting purposes, which is the fourth rate permissible to be used as a U.S. benchmark rate.  This guidance was effective for annual and interim periods beginning after December 15, 2018, and did not have a material impact on the financial condition or liquidity of the Company. ASU 2020-04 and ASU 2021-01 Reference Rate Reform (Topic 848) were issued on March 12, 2020 and January 7, 2021, respectively, and each provide further guidance on optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships due to the discontinuation of LIBOR.  In addition, on March 5, 2021, the International Swaps and Derivatives Association (“ISDA”) issued a statement with an “Index Cessation Event Announcement,” which confirmed the extension of the cessation of LIBOR-referenced rates from December 31, 2021, to June 30, 2023, for certain rate tenors. ASU 2022-06 further defers the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848.

The Company formed a LIBOR transition team in 2019 and developed a project plan to assess the use of alternative indexes and to seek to ensure all financial instruments that reference LIBOR are identified, quantified, and researched for the LIBOR fallback language available or needed.  The Company completed the ISDA protocol adherence for LIBOR fallback language for all commercial swaps, met with its commercial loan clients to also guide their swap fallback language adherence, and worked to revise all credit documents being issued by Old Second National Bank (the “Bank”) for new loans to ensure appropriate fallback language was included.  We discontinued the use of LIBOR as a reference rate for all consumer loans issued after July 31, 2021, and all commercial loans issued after December 31, 2021, with certain exceptions for those loans that were in the process of funding at the end of 2021. The Company’s systems were updated to handle multiple SOFR-based indexes and we planned accordingly for the transition of existing LIBOR exposures as the final LIBOR cessation date was June 30, 2023.  As of September 30, 2023, the Company’s LIBOR transition processes were determined to be completed and alternative index rates are in place.

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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)

ASU 2022-01 On March 28, 2022, the FASB issued ASU 2022-01 “Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method.”  The goal of this new hedging standard is to better align the economic results of risk management activities with hedge accounting, by allowing multiple layers of a single closed portfolio to be hedged, as compared to the single-layer, or last of layer method, allowed with the adoption of ASU 2017-12.  ASU 2022-01 is effective for public business entities for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years, and was adopted by the Company as of January 1, 2023.  There was no material impact of the pronouncement to the financial statements of the Company.

ASU 2022-02 – On March 31, 2022, the FASB issued ASU 2022-02 “Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.” The amendments eliminate certain troubled debt restructuring (“TDR”) recognition and measurement guidance previously in effect, and consideration of the TDRs similar to other modified loans under CECL is now required.  ASU 2022-02 also requires enhancements to vintage loan disclosures, requiring detail be provided on current-period gross write-offs and disclosure of the amortized cost basis of financing receivables by credit quality indicators and by loan portfolio class of the gross charge-off based on year of origination.  ASU 2022-02 was effective for fiscal years beginning after December 15, 2022, including interim periods within those years, and was adopted prospectively by the Company as of January 1, 2023.  There was no material impact of the pronouncement to the financial statements of the Company.

Change in Significant Accounting Policies

Significant accounting policies are presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.  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 2023, the Company had no changes to significant accounting policies or estimates.

Subsequent Events

On October 17, 2023, our Board of Directors declared a cash dividend of $0.05 per share payable on November 6, 2023, to stockholders of record as of October 27, 2023; dividends of $2.2 million are scheduled to be paid to stockholders on November 6, 2023.

Note 2 – Acquisition

On December 1, 2021, the Company completed its acquisition of West Suburban Bancorp, Inc. (“West Suburban”), a bank holding company, and its wholly owned subsidiary, West Suburban Bank, based in Lombard, Illinois, with operations throughout our existing market footprint.  At closing, the Company acquired $2.94 billion of assets, $1.50 billion of loans, $1.07 billion of securities, and $2.69 billion of deposits, net of fair value adjustments. Under the terms of the merger agreement, each outstanding share of West Suburban common stock was exchanged for 42.413 shares of Company common stock, plus $271.15 of cash. This resulted in merger consideration of $295.2 million, based on the closing price of the Company’s common stock on the date of acquisition, which consisted of 15.7 million shares of the Company’s common stock and $100.7 million of cash.  Goodwill of $67.9 million associated with the acquisition was recorded by the Company, which was the result of expected synergies, operational efficiencies and other factors.  The acquisition of West Suburban was accounted for as a business combination, and none of the $67.9 million of goodwill recorded is expected to be deductible for income tax purposes.

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.

10

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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 $20.9 million at September 30, 2023, and $5.6 million at December 31, 2022.  FRBC stock was recorded at $14.9 million at September 30, 2023 and December 31, 2022.  

The following tables summarize the amortized cost and fair value of the securities portfolio at September 30, 2023, and December 31, 2022, and the corresponding amounts of gross unrealized gains and losses:

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

September 30, 2023

    

Cost1

    

Gains

    

Losses

Value

Securities available-for-sale

U.S. Treasury

$

224,481

$

-

$

(7,704)

$

216,777

U.S. government agencies

60,197

-

(4,376)

55,821

U.S. government agencies mortgage-backed

122,653

-

(18,084)

104,569

States and political subdivisions

240,107

142

(20,149)

220,100

Corporate bonds

5,000

-

(39)

4,961

Collateralized mortgage obligations

450,470

54

(63,845)

386,679

Asset-backed securities

71,241

-

(4,325)

66,916

Collateralized loan obligations

175,995

10

(2,210)

173,795

Total securities available-for-sale

$

1,350,144

$

206

$

(120,732)

$

1,229,618

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

December 31, 2022

    

Cost1

    

Gains

    

Losses

Value

Securities available-for-sale

U.S. Treasury

$

224,054

$

-

$

(11,925)

$

212,129

U.S. government agencies

61,178

-

(5,130)

56,048

U.S. government agencies mortgage-backed

140,588

-

(15,598)

124,990

States and political subdivisions

239,999

363

(14,234)

226,128

Corporate bonds

10,000

-

(378)

9,622

Collateralized mortgage obligations

596,336

1

(62,569)

533,768

Asset-backed securities

210,388

6

(8,466)

201,928

Collateralized loan obligations

180,276

-

(5,530)

174,746

Total securities available-for-sale

$

1,662,819

$

370

$

(123,830)

$

1,539,359

1 Excludes accrued interest receivable of $6.7 million and $6.8 million at September 30, 2023 and December 31, 2022, respectively, that is recorded in other assets on the consolidated balance sheets.

11

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

The fair value, amortized cost and weighted average yield of debt securities at September 30, 2023, 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

$

49,989

0.64

%

$

49,804

Due after one year through five years

253,955

1.17

241,430

Due after five years through ten years

60,975

2.92

53,882

Due after ten years

164,866

3.11

152,543

529,785

1.92

497,659

Mortgage-backed and collateralized mortgage obligations

573,123

2.29

491,248

Asset-backed securities

71,241

4.24

66,916

Collateralized loan obligations

175,995

7.21

173,795

Total securities available-for-sale

$

1,350,144

3.00

%

$

1,229,618

At September 30, 2023, the Company had no securities issued from any one originator, other than the U.S. Government and its agencies, which individually amounted to over 10% of the Company’s stockholders’ equity.

Securities with unrealized losses with no corresponding allowance for credit losses at September 30, 2023 and December 31, 2022, 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, 2023

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. Treasuries

-

$

-

$

-

5

$

7,704

$

216,777

5

$

7,704

$

216,777

U.S. government agencies

-

-

-

9

4,376

55,821

9

4,376

55,821

U.S. government agencies mortgage-backed

-

-

-

128

18,084

104,569

128

18,084

104,569

States and political subdivisions

44

3,232

110,511

30

16,917

104,582

74

20,149

215,093

Corporate bonds

-

-

-

1

39

4,961

1

39

4,961

Collateralized mortgage obligations

2

14

756

146

63,831

379,159

148

63,845

379,915

Asset-backed securities

-

-

-

19

4,325

66,916

19

4,325

66,916

Collateralized loan obligations

-

-

-

33

2,210

170,803

33

2,210

170,803

Total securities available-for-sale

46

$

3,246

$

111,267

371

$

117,486

$

1,103,588

417

$

120,732

$

1,214,855

Less than 12 months

12 months or more

December 31, 2022

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. Treasuries

1

$

1,025

$

24,121

4

$

10,900

$

188,008

5

$

11,925

$

212,129

U.S. government agencies

-

-

-

9

5,130

56,048

9

5,130

56,048

U.S. government agencies mortgage-backed

15

975

11,369

117

14,623

113,621

132

15,598

124,990

States and political subdivisions

45

5,800

128,770

15

8,434

48,877

60

14,234

177,647

Corporate bonds

-

-

-

2

378

9,622

2

378

9,622

Collateralized mortgage obligations

80

12,895

180,624

120

49,674

348,880

200

62,569

529,504

Asset-backed securities

30

3,030

121,915

21

5,436

79,659

51

8,466

201,574

Collateralized loan obligations

23

3,579

112,772

11

1,951

61,974

34

5,530

174,746

Total securities available-for-sale

194

$

27,304

$

579,571

299

$

96,526

$

906,689

493

$

123,830

$

1,486,260

Each quarter, we perform an analysis to determine if any of the unrealized losses on securities available-for-sale are comprised of credit losses as compared to unrealized losses due to market interest rate adjustments.  Our assessment includes a review of the unrealized loss for each security issuance held; the financial condition and near-term prospects of the issuer, including external credit ratings and recent downgrades; and our ability and intent to hold the security for a period of time sufficient for a recovery in value.  We also consider the extent to which the securities are issued by the federal government or its agencies, and any guarantee of issued amounts by those agencies.  The portfolio continues to consist of a mix of fixed and floating-rate, high quality securities, largely rated AA (or better), displaying an overall effective duration of approximately 3.0 years.  No credit losses were determined to be present as of September 30, 2023, as there was no credit quality deterioration noted.  Therefore, no provision for credit losses on securities was recognized for the third quarter of 2023.

12

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 presents net realized losses on securities available-for-sale for three and nine months ended:

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

Securities available-for-sale

    

2023

    

2022

    

2023

    

2022

    

Proceeds from sales of securities

$

65,572

$

-

$

205,738

$

3,303

Gross realized losses on securities

 

(924)

 

(1)

 

(4,146)

 

(34)

Net realized losses

$

(924)

$

(1)

$

(4,146)

$

(34)

Income tax benefit on net realized losses

$

260

$

1

$

1,165

$

10

Effective tax rate applied

28.1

%

N/M

28.1

%

29.4

%

N/M - Not meaningful

As of September 30, 2023, securities valued at $808.7 million were pledged for borrowings, and for other purposes, an increase from $547.8 million of securities pledged at year-end 2022.  

Note 4 – Loans and Allowance for Credit Losses on Loans

Major segments of loans were as follows:

    

September 30, 2023

    

December 31, 2022

Commercial

$

834,877

$

840,964

Leases

354,827

277,385

Commercial real estate – investor

1,047,122

987,635

Commercial real estate – owner occupied

809,050

854,879

Construction

202,546

180,535

Residential real estate – investor

53,762

57,353

Residential real estate – owner occupied

227,446

219,718

Multifamily

372,020

323,691

HELOC

102,055

109,202

Other 1

25,838

18,247

Total loans

4,029,543

3,869,609

Allowance for credit losses on loans

(51,729)

(49,480)

Net loans 2

$

3,977,814

$

3,820,129

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

2 Excludes accrued interest receivable of $19.2 million and $15.9 million at September 30, 2023 and December 31, 2022, respectively, that is recorded in other assets on the consolidated balance sheets.

It is the policy of the Company to review each prospective credit prior to making a loan in order to determine if an adequate level of security or collateral has been obtained.  The type of collateral, when required, will vary from liquid assets to real estate.  The Company seeks to 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 69.8% and 70.6% of the portfolio at September 30, 2023, and December 31, 2022, respectively, and include a mix of owner occupied and non-owner occupied commercial real estate, residential, construction and multifamily loans.  

13

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, 2023 and 2022:

Provision for

Beginning

(Release of)

Ending

Allowance for credit losses

   

Balance

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Three months ended September 30, 2023

Commercial

$

11,532

$

(1,025)

$

20

$

12

$

10,499

Leases

2,690

(193)

-

95

2,592

Commercial real estate – investor

20,031

4,726

6,774

20

18,003

Commercial real estate – owner occupied

12,562

(154)

35

12

12,385

Construction

1,179

(39)

-

100

1,240

Residential real estate – investor

743

(55)

-

3

691

Residential real estate – owner occupied

1,868

(36)

-

25

1,857

Multifamily

2,737

(165)

-

-

2,572

HELOC

1,694

(77)

-

35

1,652

Other

278

30

107

37

238

Total

$

55,314

$

3,012

$

6,936

$

339

$

51,729

Provision for

Beginning

(Release of)

Ending

Allowance for credit losses

   

Balance

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Nine months ended September 30, 2023

Commercial

$

11,968

$

(1,287)

$

427

$

245

$

10,499

Leases

2,865

498

882

111

2,592

Commercial real estate – investor

10,674

14,117

6,845

57

18,003

Commercial real estate – owner occupied

15,001

(2,397)

236

17

12,385

Construction

1,546

(406)

-

100

1,240

Residential real estate – investor

768

(104)

-

27

691

Residential real estate – owner occupied

2,046

(260)

-

71

1,857

Multifamily

2,453

119

-

-

2,572

HELOC

1,806

(242)

-

88

1,652

Other

353

53

301

133

238

Total

$

49,480

$

10,091

$

8,691

$

849

$

51,729

Provision for

Beginning

(Release of)

Ending

Allowance for credit losses

   

Balance

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Three months ended September 30, 2022

Commercial

$

14,114

$

(919)

$

67

$

47

$

13,175

Leases

1,736

(24)

178

-

1,534

Commercial real estate – investor

9,436

256

124

19

9,587

Commercial real estate – owner occupied

11,478

3,618

12

87

15,171

Construction

1,535

9

-

-

1,544

Residential real estate – investor

661

147

-

8

816

Residential real estate – owner occupied

1,869

149

-

113

2,131

Multifamily

2,434

33

-

63

2,530

HELOC

1,542

386

-

35

1,963

Other

583

(128)

103

44

396

Total

$

45,388

$

3,527

$

484

$

416

$

48,847

14

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Provision for

Allowance for credit losses

Beginning

(Release of)

Ending

Nine months ended September 30, 2022

   

Balance

   

Credit Losses

   

Charge-offs

   

Recoveries

   

Balance

Commercial

$

11,751

$

1,488

$

149

$

85

$

13,175

Leases

3,480

(1,768)

178

-

1,534

Commercial real estate – investor

10,795

(664)

604

60

9,587

Commercial real estate – owner occupied

4,913

10,289

133

102

15,171

Construction

3,373

(1,829)

-

-

1,544

Residential real estate – investor

760

33

-

23

816

Residential real estate – owner occupied

2,832

(919)

-

218

2,131

Multifamily

3,675

(1,208)

-

63

2,530

HELOC

2,510

(649)

-

102

1,963

Other

192

404

320

120

396

Total

$

44,281

$

5,177

$

1,384

$

773

$

48,847

At September 30, 2023, our allowance for credit losses (“ACL”) on loans totaled $51.7 million, and our ACL on unfunded commitments, included in other liabilities, totaled $2.9 million including related purchase accounting adjustments.  During the first nine months of 2023, we recorded net provision expense of $8.5 million based on historical loss rate updates driven by higher charge offs in commercial real estate-investor, loan growth of approximately $160.0 million, downward risk rating migration including an increased reserve on loans individually analyzed, and our assessment of estimated future credit losses. The ACL on loans excludes $2.7 million, $4.3 million and $4.4 million of allowance for unfunded commitments as of September 30, 2023, December 31, 2022 and September 30, 2022, respectively, recorded within Other Liabilities.  The total ACL on unfunded commitments listed as of September 30, 2023, December 31, 2022, and September 30, 2022 excludes the purchase accounting adjustment of $149,000, $819,000, and $1.0 million, respectively, recorded due to our acquisition of West Suburban, which is also recorded within Other Liabilities, and is being accreted in interest income over the estimated life of the unused commitments.

Generally, the Bank considers a loan to be collateral dependent when, based on current information and events, it is probable that foreclosure will be initiated. Additionally, the Bank will review all loans meeting the criteria for individual analysis, to determine if repayment or satisfaction of the loan is expected through the sale of collateral. This will generally be the case for credits with high loan-to-values. Exceptions to this policy would include loans with guarantors that have the means and willingness to support the obligation. Non-accruing loans with an outstanding balance of $500,000 or more are assessed on an individual loan level basis. When a financial asset is deemed collateral-dependent, the level of credit loss is measured by the difference between amortized cost of the financial asset and the fair value of collateral adjusted for estimated cost to sell. The Company had $55.8 million and $50.5 million of collateral dependent loans secured by real estate or business assets as of September 30, 2023, and December 31, 2022, respectively.

The following tables present the collateral dependent loans and the related ACL allocated by segment of loans as of September 30, 2023 and December 31, 2022:

Accounts

ACL

September 30, 2023

Real Estate

Receivable

Equipment

Other

Total

Allocation

Commercial

$

849

$

679

$

-

$

-

$

1,528

$

2

Leases

-

-

339

-

339

339

Commercial real estate – investor

26,724

-

-

-

26,724

4,848

Commercial real estate – owner occupied

17,636

-

-

-

17,636

4,201

Construction

7,206

-

-

-

7,206

-

Residential real estate – investor

32

-

-

-

32

-

Residential real estate – owner occupied

1,679

-

-

-

1,679

-

Multifamily

568

-

-

-

568

-

HELOC

39

-

-

-

39

-

Total

$

54,733

$

679

$

339

$

-

$

55,751

$

9,390

15

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Accounts

ACL

December 31, 2022

Real Estate

Receivable

Equipment

Other

Total

Allocation

Commercial

$

883

$

5,915

$

-

$

364

$

7,162

$

569

Leases

-

-

1,248

-

1,248

1,248

Commercial real estate – investor

16,576

-

-

-

16,576

2,875

Commercial real estate – owner occupied

19,188

-

-

2,310

21,498

5,808

Residential real estate – investor

675

-

-

-

675

-

Residential real estate – owner occupied

1,817

-

-

-

1,817

244

Multifamily

1,322

-

-

-

1,322

-

HELOC

180

-

-

-

180

-

Total

$

40,641

$

5,915

$

1,248

$

2,674

$

50,478

$

10,744

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, 2023

Past Due

    

Past Due

    

Due

    

Due

    

Current

    

Total Loans

    

Accruing

Commercial

$

1,829

$

1,874

$

1,052

$

4,755

$

830,122

$

834,877

$

979

Leases

2,502

-

157

2,659

352,168

354,827

-

Commercial real estate – investor

2,205

16,728

16,116

35,049

1,012,073

1,047,122

-

Commercial real estate – owner occupied

15,232

120

1,879

17,231

791,819

809,050

-

Construction

118

200

7,206

7,524

195,022

202,546

-

Residential real estate – investor

252

-

277

529

53,233

53,762

140

Residential real estate – owner occupied

735

419

1,820

2,974

224,472

227,446

-

Multifamily

713

127

-

840

371,180

372,020

-

HELOC

646

88

259

993

101,062

102,055

90

Other

-

-

-

-

25,838

25,838

-

Total

$

24,232

$

19,556

$

28,766

$

72,554

$

3,956,989

$

4,029,543

$

1,209

90 days or

90 Days or

Greater Past

30-59 Days

60-89 Days

Greater Past

Total Past

Due and

December 31, 2022

Past Due

    

Past Due

    

Due

    

Due

    

Current

    

Total Loans

    

Accruing

Commercial

$

3

$

1,012

$

825

$

1,840

$

839,124

$

840,964

$

460

Leases

447

22

614

1,083

276,302

277,385

-

Commercial real estate – investor

3,276

1,276

4,315

8,867

978,768

987,635

-

Commercial real estate – owner occupied

373

113

2,211

2,697

852,182

854,879

173

Construction

14

-

116

130

180,405

180,535

-

Residential real estate – investor

445

-

987

1,432

55,921

57,353

144

Residential real estate – owner occupied

1,191

-

2,232

3,423

216,295

219,718

485

Multifamily

267

361

1,322

1,950

321,741

323,691

-

HELOC

291

90

392

773

108,429

109,202

-

Other

19

-

-

19

18,228

18,247

-

Total

$

6,326

$

2,874

$

13,014

$

22,214

$

3,847,395

$

3,869,609

$

1,262

16

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, 2023, and December 31, 2022:

Nonaccrual loan detail

    

September 30, 2023

    

With no ACL

    

December 31, 2022

    

With no ACL

Commercial

$

2,167

$

2,167

$

7,189

$

6,598

Leases

377

38

1,876

-

Commercial real estate – investor

26,724

11,786

4,346

4,244

Commercial real estate – owner occupied

18,290

3,833

8,050

3,813

Construction

7,206

7,206

251

-

Residential real estate – investor

1,362

1,362

1,528

675

Residential real estate – owner occupied

3,627

3,627

3,713

1,572

Multifamily

1,141

1,141

2,538

1,322

HELOC

1,222

1,222

2,109

180

Other

-

-

2

-

Total

$

62,116

$

32,382

$

31,602

$

18,404

The Company recognized $189,000 and $304,000 of interest on nonaccrual loans during the three months and nine months ended September 30, 2023, respectively.

Credit Quality Indicators

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

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

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

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

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

17

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Credit quality indicators by loan segment and loan origination date at September 30, 2023 were as follows:

  

2023

  

2022

  

2021

  

2020

  

2019

  

Prior

  

Revolving
Loans

  

Revolving
Loans
Converted
To Term
Loans

  

Total

Commercial

Pass

$

215,492

$

187,682

$

41,464

$

13,359

$

10,676

$

4,315

$

311,562

$

1,379

$

785,929

Special Mention

-

500

244

-

51

-

29,855

-

30,650

Substandard

-

79

1,381

2,735

9,689

-

4,414

-

18,298

Total commercial

215,492

188,261

43,089

16,094

20,416

4,315

345,831

1,379

834,877

Leases

Pass

151,691

125,092

$

47,808

17,522

9,545

2,595

-

-

354,253

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

339

-

-

235

-

-

-

574

Total leases

151,691

125,431

47,808

17,522

9,780

2,595

-

-

354,827

Commercial real estate – investor

Pass

176,779

341,597

203,972

111,333

59,770

67,264

8,148

-

968,863

Special Mention

-

12,866

11,267

-

-

-

-

-

24,133

Substandard

10,964

11,787

1,950

7,748

9,278

-

12,399

-

54,126

Total commercial real estate – investor

187,743

366,250

217,189

119,081

69,048

67,264

20,547

-

1,047,122

Commercial real estate – owner occupied

Pass

105,963

139,223

181,543

78,750

54,909

101,396

33,258

-

695,042

Special Mention

1,758

11,722

18,180

26,480

222

354

-

-

58,716

Substandard

-

14,994

19,926

1,142

18,811

419

-

-

55,292

Total commercial real estate – owner occupied

107,721

165,939

219,649

106,372

73,942

102,169

33,258

-

809,050

Construction

Pass

26,529

75,698

56,217

19,531

1,837

1,155

3,699

-

184,666

Special Mention

305

312

-

-

-

-

-

-

617

Substandard

-

7,206

-

10,057

-

-

-

-

17,263

Total construction

26,834

83,216

56,217

29,588

1,837

1,155

3,699

-

202,546

Residential real estate – investor

Pass

3,310

14,560

8,954

6,317

7,116

10,519

1,417

-

52,193

Special Mention

-

-

67

-

-

-

-

-

67

Substandard

-

398

-

-

418

686

-

-

1,502

Total residential real estate – investor

3,310

14,958

9,021

6,317

7,534

11,205

1,417

-

53,762

Residential real estate – owner occupied

Pass

26,371

41,915

41,439

26,544

15,147

71,637

766

-

223,819

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

122

-

90

686

2,729

-

-

3,627

Total residential real estate – owner occupied

26,371

42,037

41,439

26,634

15,833

74,366

766

-

227,446

Multifamily

Pass

69,947

79,689

101,878

57,792

12,391

42,603

382

-

364,682

Special Mention

-

170

3,505

326

1,656

540

-

-

6,197

Substandard

-

887

-

-

-

254

-

-

1,141

Total multifamily

69,947

80,746

105,383

58,118

14,047

43,397

382

-

372,020

HELOC

Pass

1,765

2,760

211

1,443

1,631

2,494

90,317

-

100,621

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

39

27

1

1

-

106

1,260

-

1,434

Total HELOC

1,804

2,787

212

1,444

1,631

2,600

91,577

-

102,055

Other

Pass

4,461

2,068

1,415

223

151

88

17,432

25,838

Special Mention

-

-

-

-

-

-

-

-

Substandard

-

-

-

-

-

-

-

-

Total other

4,461

2,068

1,415

223

151

88

17,432

-

25,838

Total loans

Pass

782,308

1,010,284

684,901

332,814

173,173

304,066

466,981

1,379

3,755,906

Special Mention

2,063

25,570

33,263

26,806

1,929

894

29,855

-

120,380

Substandard

11,003

35,839

23,258

21,773

39,117

4,194

18,073

-

153,257

Total loans

$

795,374

$

1,071,693

$

741,422

$

381,393

$

214,219

$

309,154

$

514,909

$

1,379

$

4,029,543

18

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Credit quality indicators by loan segment and loan origination date at December 31, 2022, were as follows:

  

2022

  

2021

  

2020

  

2019

  

2018

  

Prior

  

Revolving
Loans

  

Revolving
Loans
Converted
To Term
Loans

  

Total

Commercial

Pass

$

225,056

$

70,608

$

21,597

$

12,742

$

6,957

$

2,651

$

447,821

$

-

$

787,432

Special Mention

1,875

272

1,182

2,432

-

-

21,286

-

27,047

Substandard

4,958

2,447

2,981

12,176

7

-

3,916

-

26,485

Total commercial

231,889

73,327

25,760

27,350

6,964

2,651

473,023

-

840,964

Leases

Pass

161,379

64,203

$

26,995

17,653

4,449

830

-

-

275,509

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

1,606

-

-

270

-

-

-

-

1,876

Total leases

162,985

64,203

26,995

17,923

4,449

830

-

-

277,385

Commercial real estate – investor

Pass

416,094

228,686

118,491

63,845

46,935

46,406

7,113

-

927,570

Special Mention

5,349

1,417

5,490

10,206

1,070

9,123

-

-

32,655

Substandard

12,332

2,018

-

10,763

-

2,297

-

-

27,410

Total commercial real estate – investor

433,775

232,121

123,981

84,814

48,005

57,826

7,113

-

987,635

Commercial real estate – owner occupied

Pass

169,703

223,731

105,669

47,351

49,367

86,660

33,745

-

716,226

Special Mention

8,430

22,242

48,184

17,668

231

1,008

-

-

97,763

Substandard

2,546

17,129

1,191

16,962

-

3,062

-

-

40,890

Total commercial real estate – owner occupied

180,679

263,102

155,044

81,981

49,598

90,730

33,745

-

854,879

Construction

Pass

53,058

65,758

39,542

2,390

226

1,408

1,523

-

163,905

Special Mention

-

-

15,297

-

-

-

-

-

15,297

Substandard

1,217

-

-

116

-

-

-

-

1,333

Total construction

54,275

65,758

54,839

2,506

226

1,408

1,523

-

180,535

Residential real estate – investor

Pass

14,737

9,910

6,945

8,585

4,853

9,548

991

-

55,569

Special Mention

-

70

-

-

-

-

-

-

70

Substandard

621

-

-

499

186

408

-

-

1,714

Total residential real estate – investor

15,358

9,980

6,945

9,084

5,039

9,956

991

-

57,353

Residential real estate – owner occupied

Pass

41,885

44,884

28,418

16,146

12,152

70,741

1,638

-

215,864

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

131

267

237

723

131

2,365

-

-

3,854

Total residential real estate – owner occupied

42,016

45,151

28,655

16,869

12,283

73,106

1,638

-

219,718

Multifamily

Pass

76,877

126,257

52,262

13,125

39,703

6,098

329

-

314,651

Special Mention

377

3,683

342

1,684

-

-

-

-

6,086

Substandard

2,100

-

-

-

587

267

-

-

2,954

Total multifamily

79,354

129,940

52,604

14,809

40,290

6,365

329

-

323,691

HELOC

Pass

2,760

517

1,497

1,703

657

2,288

97,258

-

106,680

Special Mention

-

-

-

-

-

-

111

-

111

Substandard

62

1

-

-

67

309

1,972

-

2,411

Total HELOC

2,822

518

1,497

1,703

724

2,597

99,341

-

109,202

Other

Pass

4,195

2,835

432

167

69

111

10,436

-

18,245

Special Mention

-

-

-

-

-

-

-

-

-

Substandard

-

-

1

-

-

-

1

-

2

Total other

4,195

2,835

433

167

69

111

10,437

-

18,247

Total loans

Pass

1,165,744

837,389

401,848

183,707

165,368

226,741

600,854

-

3,581,651

Special Mention

16,031

27,684

70,495

31,990

1,301

10,131

21,397

-

179,029

Substandard

25,573

21,862

4,410

41,509

978

8,708

5,889

-

108,929

Total loans

$

1,207,348

$

886,935

$

476,753

$

257,206

$

167,647

$

245,580

$

628,140

$

-

$

3,869,609

19

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

The gross charge-offs activity by loan type and year of origination for the nine months ended September 30, 2023 were as follows:

Current period gross charge-offs

  

2023

  

2022

  

2021

  

2020

  

2019

  

Prior

  

Revolving
Loans

  

Revolving
Loans
Converted to Term
Loans

  

Total

Commercial

$

-

-

17

364

-

46

$

-

$

-

$

427

Leases

-

870

-

-

12

-

-

-

882

Commercial real estate – investor

-

4,121

71

2,653

-

-

-

-

6,845

Commercial real estate – owner occupied

-

22

178

4

-

32

-

-

236

Construction

-

-

-

-

-

-

-

-

-

Residential real estate – investor

-

-

-

-

-

-

-

-

-

Residential real estate – owner occupied

-

-

-

-

-

-

-

-

-

Multifamily

-

-

-

-

-

-

-

-

-

HELOC

-

-

-

-

-

-

-

-

-

Other

-

3

26

7

-

265

-

-

301

Total

$

-

$

5,016

$

292

$

3,028

$

12

$

343

-

-

$

8,691

The Company had $176,000 and $600,000 in residential real estate loans in the process of foreclosure as of September 30, 2023 and December 31, 2022, respectively.  

As of January 1, 2023, the Company prospectively adopted ASU 2022-02, Topic 326 “Troubled Debt Restructuring (“TDRs”) and Vintage Disclosures”, see Note 1. Fifteen loans, totaling $43.0 million in aggregate, were modified which were experiencing financial difficulty during the nine-month period ending September 30, 2023.  There were no TDR loan modifications for the three months ended September 30, 2022, and there were two TDR loan modifications for an aggregate of $39,000 for the nine months ended September 30, 2022.  TDRs were classified as being in default on a case-by-case basis when they failed to be in compliance with the modified terms.  There were no financial difficulty loans modified in payment default as of September 30, 2023 and was no TDR default activity for the period ended September 30, 2023, for loans that were restructured within the prior 12-month period.

The following table presents the amortized costs basis of loans at September 30, 2023 that were both experiencing financial difficulty and modified during the period ended September 30, 2023 by class and by type of modification.  The percentage of the amortized cost basis of loans that were modified to borrowers in financial distress as compared to amortized costs basis of each class of financing receivable is also presented below.

September 30, 2023

Term Extension

Combination - Term Extension and Interest Rate Reduction

Combination - Term Extension and Payment Delay

Total Loans Modified

% of Total Loan Segment Modified to Total Loan Segment

Commercial

$

1,713

$

979

$

-

$

2,692

0.3%

Commercial real estate – investor

12,755

-

10,608

23,363

2.2%

Commercial real estate – owner occupied

16,218

-

-

16,218

2.0%

Residential real estate – owner occupied

437

-

-

437

0.2%

Multifamily

254

-

-

254

0.1%

HELOC

39

-

-

39

0.0%

Total

$

31,416

$

979

$

10,608

$

43,003

1.1%

20

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 closely monitors the performance of loan modifications to borrowers experiencing financial difficulty. The following table presents the performance of loans that have been modified as of September 30, 2023.

September 30, 2023

30-59 days past due

60-89 Days Past Due

90 Days or Greater Past Due

Total Past Due

Current

Total Loan Modified

Commercial

$

-

$

-

$

979

$

979

$

1,713

$

2,692

Commercial real estate – investor

-

-

-

-

23,363

23,363

Commercial real estate – owner occupied

-

-

-

-

16,218

16,218

Residential real estate – owner occupied

-

-

-

-

437

437

Multifamily

-

-

-

-

254

254

HELOC

-

-

-

-

39

39

Total

$

-

$

-

$

979

$

979

$

42,024

$

43,003

The following table summarizes the financial effect of the loan modifications presented above to borrowers experiencing financial difficulty for the period ended September 30, 2023. The Company had two Commercial real estate – investor loans that had a payment modification, one changed to a single payment at maturity and the other changed from principal and interest to interest only until maturity.

September 30, 2023

Weighted-Average Term Extension (In Months)

Weighted-Average Interest Rate Change

Weighted-Average Delay of Payment (In Months)

Commercial

6.74

5.00

%

-

Commercial real estate – investor

9.81

-

7.17

Commercial real estate – owner occupied

14.00

-

-

Residential real estate – owner occupied

2.00

-

-

Multifamily

16.00

-

-

HELOC

24.00

-

-

Total

11.17

5.00

%

7.17

Note 5 – Deposits

Major classifications of deposits were as follows:

    

September 30, 2023

    

December 31, 2022

  

Noninterest bearing demand

$

1,862,659

$

2,051,702

Savings

1,003,498

1,145,592

NOW accounts

567,997

609,338

Money market accounts

702,176

862,170

Certificates of deposit of less than $100,000

248,272

244,017

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

162,901

157,438

Certificates of deposit of more than $250,000

66,817

40,466

Total deposits

$

4,614,320

$

5,110,723

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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)

Note 6 – Borrowings

The following table is a summary of borrowings as of September 30, 2023 and December 31, 2022.  Junior subordinated debentures are discussed in more detail in Note 7.

    

September 30, 2023

    

December 31, 2022

  

Securities sold under repurchase agreements

$

25,894

$

32,156

Other short-term borrowings

435,000

90,000

Junior subordinated debentures1

25,773

25,773

Subordinated debentures

59,361

59,297

Senior notes

-

44,585

Notes payable and other borrowings

-

9,000

Total borrowings

$

546,028

$

260,811

1 See Note 7: Junior Subordinated Debentures

The Company enters into deposit sweep transactions where the transaction amounts are secured by pledged securities.  These transactions consistently mature overnight from the transaction date and are governed by sweep repurchase agreements.  All sweep repurchase agreements are treated as financings secured by U.S. government agencies and collateralized mortgage-backed securities, and had a carrying amount of $25.9 million at September 30, 2023, and $32.2 million at December 31, 2022.  The fair value of the pledged collateral was $43.8 million at September 30, 2023, and $71.4 million at December 31, 2022.  At September 30, 2023, 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, 2023, the Bank had $435.0 million in short-term advances outstanding under the FHLBC.  There were $90.0 million in short-term advances as of December 31, 2022. FHLBC stock held at September 30, 2023 was valued at $20.9 million, and any potential FHLBC advances were collateralized by loans and securities with a principal balance of $1.47 billion, which carried a FHLBC-calculated combined collateral value of $1.02 billion.  The Company had excess collateral of $581.7 million available to secure borrowings at September 30, 2023.

In the second quarter of 2021, we issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”). The Company used the net proceeds from the offering for general corporate purposes.  The Notes bear interest at a fixed annual rate of 3.50%, from and including the date of issuance to but excluding April 15, 2026, payable semi-annually in arrears.  From and including April 15, 2026 to, but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an interest rate per annum equal to three-month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears. As of September 30, 2023 and December 31, 2022, we had $59.4 million and $59.3 million of subordinated debentures outstanding, net of deferred issuance costs, respectively.

The Company issued senior notes in December 2016 with a ten-year maturity, and terms included interest payable semiannually at 5.75% for five years.  Beginning December 31, 2021, the senior debt began to pay interest at a floating rate, with interest payable quarterly at three month LIBOR plus 385 basis points. The interest rate at June 30, 2023 and December 31, 2022 was 9.39% and 8.62%, respectively. The notes were redeemable, in whole or in part, at the option of the Company, beginning with the interest payment date on December 31, 2021, and on any floating rate interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest.  On June 30, 2023, we redeemed all of the $45.0 million senior notes.  Upon redemption, the related deferred debt issuance costs of $362,000 was also recorded as interest expense, resulting in an effective cost of this debt issuance of 12.85% for the second quarter of 2023.

On February 24, 2020, the Company originated a $20.0 million three-year term note with a correspondent bank. The term note was issued at one-month LIBOR plus 175 basis points, and required principal payments quarterly and interest payments monthly.  This note was included within Notes payable and other borrowings on the Consolidated Balance Sheets, and the remaining $9.0 million balance of the note was paid off on February 24, 2023.  The Company also has an undrawn line of credit of $30.0 million with a correspondent bank to be used for short-term funding needs; advances under this line can be outstanding up to 360 days from the date of issuance.  This line of credit has not been utilized since early 2019.

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 7 – Junior Subordinated Debentures

The Company issued $25.0 million of cumulative trust preferred securities through a private placement completed by an unconsolidated subsidiary, Old Second Capital Trust II, in April 2007.  These trust preferred securities mature in 30 years, but subject to regulatory approval, can be called in whole or in part on a quarterly basis commencing June 15, 2017.  The quarterly cash distributions on the securities were fixed at 6.77% through June 15, 2017, and now have a floating rate of 150 basis points over three-month SOFR.  Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 3.77% and 4.39% for the quarters ended September 30, 2023 and September 30, 2022, respectively.  The Company issued a $25.8 million subordinated debenture to Old Second Capital Trust II in return for the aggregate net proceeds of this trust preferred offering.  The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.  

The junior subordinated debentures issued by the Company are disclosed on the Consolidated Balance Sheets, and the related interest expense for each issuance is included in the Consolidated Statements of Income.  As of September 30, 2023 and December 31, 2022, 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 Sheets.  The remaining deferred issuance costs on the junior subordinated debentures related to the issuance of Old Second Capital Trust II will be amortized to interest expense over the remainder of the 30-year term of the notes and are included in the Consolidated Statements of Income.

Note 8 – Equity Compensation Plans

Stock-based awards are outstanding under the Company’s 2019 Equity Incentive Plan, as amended and restated (the “2019 Plan”).  The 2019 Plan was originally approved at the May 2019 annual stockholders’ meeting and authorized 600,000 shares, and at the May 2021 annual stockholders’ meeting, the Company obtained stockholder approval to increase the number of shares of common stock authorized for issuance under the 2019 Plan by 1,200,000 shares, from 600,000 shares to 1,800,000 shares.  Following the approval of the 2019 Plan, no further awards will be granted under any other prior plan.  

The 2019 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights (“SARs”).  Awards may be granted to selected directors, officers, employees or eligible service providers under the 2019 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors.  As of September 30, 2023, 975,712 shares remained available for issuance under the 2019 Plan.  The Company has granted only restricted stock units under the 2019 Equity Plan.

Generally, restricted stock units granted under the 2019 Plan vest three years from the grant date, but the Compensation Committee of the Company’s Board of Directors has discretionary authority to change the terms of particular awards including the vesting schedule.

Under the 2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, all equity awards then held by the participant will become fully exercisable immediately if, and all stock awards and cash incentive awards will become fully earned and vested immediately if, (i) the 2019 Plan is not an obligation of the successor entity following a change in control or (ii) the 2019 Plan is an obligation of the successor entity following a change in control and the participant incurs a termination of service without cause or for good reason following the change in control.  Notwithstanding the immediately preceding sentence, if the vesting of an award is conditioned upon the achievement of performance measures, then such vesting will generally be subject to the following: if, at the time of the change in control, the performance measures are less than 50% attained (pro rata based upon the time of the period through the change in control), the award will become vested and exercisable on a fractional basis with the numerator being equal to the percentage of attainment and the denominator being 50%; and if, at the time of the change in control, the performance measures are at least 50% attained (pro rata based upon the time of the period through the change in control), the award will become fully earned and vested immediately upon the change in control.

Awards of restricted stock under the 2019 Plan generally entitle holders to voting and dividend rights upon grant and are subject to forfeiture until certain restrictions have lapsed including employment for a specific period.  Awards of restricted stock units under the 2019 Plan are also subject to forfeiture until certain restrictions have lapsed including employment for a specific period, but do not entitle holders to voting rights until the restricted period ends and shares are transferred in connection with the units.

23

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

There were 240,149 and 268,160 restricted stock units issued under the 2019 Plan during the nine months ended September 30, 2023 and September 30, 2022, respectively.  Compensation expense is recognized over the vesting period of the restricted stock units based on the market value of the award on the issue date.  Total compensation cost that has been recorded for the 2019 Plan was $2.7 million for the nine months ended September 30, 2023 and $2.3 million for the nine months ended September 30, 2022.

A summary of changes in the Company’s unvested restricted awards for the nine months ended September 30, 2023, is as follows:

September 30, 2023

Weighted

Restricted

Average

Stock Shares

Grant Date

    

and Units

    

Fair Value

Unvested at January 1

649,210

$

12.84

Granted

240,149

17.02

Vested

(137,534)

12.53

Forfeited

(15,191)

14.25

Unvested at September 30

736,634

$

14.23

Total unrecognized compensation cost of restricted awards was $5.0 million as of September 30, 2023, which is expected to be recognized over a weighted-average period of 1.87 years.  

Note 9 – Earnings Per Share

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

Three Months Ended September 30, 

Nine Months Ended September 30, 

    

2023

    

2022

    

2023

    

2022

    

Basic earnings per share:

Weighted-average common shares outstanding

44,675,489

44,565,626

44,653,451

44,509,072

Net income

$

24,335

$

19,523

$

73,504

$

43,790

Basic earnings per share

$

0.55

$

0.43

$

1.65

$

0.98

Diluted earnings per share:

Weighted-average common shares outstanding

44,675,489

44,565,626

44,653,451

44,509,072

Dilutive effect of unvested restricted awards 1

752,920

655,915

736,767

698,920

Diluted average common shares outstanding

45,428,409

45,221,541

45,390,218

45,207,992

Net Income

$

24,335

$

19,523

$

73,504

$

43,790

Diluted earnings per share

$

0.54

$

0.43

$

1.62

$

0.97

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

24

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Note 10 Regulatory & Capital Matters

The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighted Bank assets, developed by the Office of the Comptroller of the Currency (the “OCC”) and the other bank regulatory agencies.  In connection with the current risk-based capital regulatory guidelines, the Bank’s Board of Directors has established an internal guideline requiring the Bank to maintain a Tier 1 leverage capital ratio at or above eight percent (8%) and a total risk-based capital ratio at or above twelve percent (12%).  At September 30, 2023, the Bank exceeded those thresholds.

At September 30, 2023, the Bank’s Tier 1 capital leverage ratio was 10.43%, an increase of 111 basis points from December 31, 2022, and is above the 8.00% objective.  The Bank’s total capital ratio was 13.57%, an increase of 82 basis points from December 31, 2022, and also above the objective of 12.00%.

Bank holding companies are generally required to maintain minimum levels of capital in accordance with capital guidelines implemented by the Board of Governors of the Federal Reserve System.  The general bank and holding company capital adequacy guidelines are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of September 30, 2023 and December 31, 2022.

The Basel III Rules are applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies”, which are generally holding companies with consolidated assets of less than $3.0 billion.  A detailed discussion of the Basel III Rules is included in Part I, Item 1 of the Company’s Form 10-K for the year ended December 31, 2022, under the heading “Supervision and Regulation.”

At September 30, 2023 and December 31, 2022, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.

25

Table of Contents

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, 2023

Common equity tier 1 capital to risk weighted assets

Consolidated

$

530,368

11.00

%

$

337,507

7.00

%

N/A

N/A

Old Second Bank

601,999

12.49

337,389

7.00

$

313,290

6.50

%

Total capital to risk weighted assets

Consolidated

667,182

13.84

506,171

10.50

N/A

N/A

Old Second Bank

653,813

13.57

505,898

10.50

481,808

10.00

Tier 1 capital to risk weighted assets

Consolidated

555,368

11.52

409,777

8.50

N/A

N/A

Old Second Bank

601,999

12.49

409,687

8.50

385,588

8.00

Tier 1 capital to average assets

Consolidated

555,368

9.62

230,922

4.00

N/A

N/A

Old Second Bank

601,999

10.43

230,872

4.00

288,590

5.00

December 31, 2022

Common equity tier 1 capital to risk weighted assets

Consolidated

$

457,206

9.67

%

$

330,966

7.00

%

N/A

N/A

Old Second Bank

552,404

11.70

330,498

7.00

$

306,891

6.50

%

Total capital to risk weighted assets

Consolidated

592,039

12.52

496,518

10.50

N/A

N/A

Old Second Bank

602,237

12.75

495,960

10.50

472,343

10.00

Tier 1 capital to risk weighted assets

Consolidated

482,206

10.20

401,838

8.50

N/A

N/A

Old Second Bank

552,404

11.70

401,319

8.50

377,712

8.00

Tier 1 capital to average assets

Consolidated

482,206

8.14

236,956

4.00

N/A

N/A

Old Second Bank

552,404

9.32

237,083

4.00

296,354

5.00

1 Amounts are shown inclusive of a capital conservation buffer of 2.50%.

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

As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopted CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we elected to utilize the five-year CECL transition.  As of September 30, 2023, the capital measures of the Company exclude $1.9 million, which is the modified CECL transition adjustment.

26

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Dividend Restrictions

In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be paid by a bank without prior regulatory approval.  Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital requirements described above.  As of September 30, 2023, the Bank had capacity to pay dividends of $70.4 million to the Company without prior regulatory approval.  Pursuant to the Basel III rules, the Bank must keep a capital conservation buffer of 2.50% above the regulatory minimum capital requirements, which must consist entirely of Common Equity Tier 1 capital in order to avoid additional limitations on capital distributions and certain other payments.

Note 11 Fair Value Measurements

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

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

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

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

During the nine-month period ended September 30, 2023, $14.9 million of asset-backed securities and $6.8 million of collateralized mortgage obligations were transferred to Level 2 from Level 3. There were no transfers between levels at September 30, 2022.

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.
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.

27

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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 individually evaluated 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 other real estate owned (“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.

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

The tables below present the balance of assets and liabilities at September 30, 2023 and December 31, 2022, respectively, measured by the Company at fair value on a recurring basis:

September 30, 2023

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Securities available-for-sale

U.S. Treasury

$

216,777

$

-

$

-

$

216,777

U.S. government agencies

-

55,821

-

55,821

U.S. government agencies mortgage-backed

-

104,569

-

104,569

States and political subdivisions

-

206,034

14,066

220,100

Corporate bonds

-

4,961

-

4,961

Collateralized mortgage obligations

-

386,679

-

386,679

Asset-backed securities

-

66,916

-

66,916

Collateralized loan obligations

-

173,795

-

173,795

Loans held-for-sale

-

2,297

-

2,297

Mortgage servicing rights

-

-

11,461

11,461

Interest rate swap agreements, including risk participation agreement

-

9,028

-

9,028

Mortgage banking derivatives

-

37

-

37

Total

$

216,777

$

1,010,137

$

25,527

$

1,252,441

Liabilities:

Interest rate swap agreements, including risk participation agreements

$

-

$

14,293

$

-

$

14,293

Total

$

-

$

14,293

$

-

$

14,293

28

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, 2022

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Securities available-for-sale

U.S. Treasury

$

212,129

$

-

$

-

$

212,129

U.S. government agencies

-

56,048

-

56,048

U.S. government agencies mortgage-backed

-

124,990

-

124,990

States and political subdivisions

-

211,899

14,229

226,128

Corporate bonds

-

9,622

-

9,622

Collateralized mortgage obligations

-

526,998

6,770

533,768

Asset-backed securities

-

186,916

15,012

201,928

Collateralized loan obligations

-

174,746

-

174,746

Loans held-for-sale

-

491

-

491

Mortgage servicing rights

-

-

11,189

11,189

Interest rate swap agreements

-

6,516

-

6,516

Mortgage banking derivatives

-

76

-

76

Total

$

212,129

$

1,298,302

$

47,200

$

1,557,631

Liabilities:

Interest rate swap agreements, including risk participation agreements

$

-

$

12,265

$

-

$

12,265

Total

$

-

$

12,265

$

-

$

12,265

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

Nine Months Ended September 30, 2023

Securities available-for-sale

Collateralized

States and

Mortgage

Asset-backed

Mortgage

Political

Servicing

   

Securities

Obligations

Subdivisions

   

Rights

Beginning balance January 1, 2023

$

15,012

$

6,770

$

14,229

$

11,189

Transfers out of Level 3

(14,885)

(6,764)

-

-

Total gains or losses

Included in earnings

(11)

-

(99)

232

Included in other comprehensive income

226

(6)

(132)

-

Purchases, issuances, sales, and settlements

Purchases

-

-

406

-

Issuances

-

-

-

420

Settlements

(342)

-

(338)

(380)

Ending balance September 30, 2023

$

-

$

-

$

14,066

$

11,461

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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)

Nine Months Ended September 30, 2022

Securities available-for-sale

States and

Mortgage

Political

Servicing

    

Subdivisions

    

Rights

    

Beginning balance January 1, 2022

$

15,236

$

7,097

Total gains or losses

Included in earnings

(98)

4,384

Included in other comprehensive income

(1,333)

-

Purchases, issuances, sales, and settlements

Issuances

519

756

Settlements

(1,015)

(776)

Ending balance September 30, 2022

$

13,309

$

11,461

The following table and commentary present quantitative and qualitative information about Level 3 fair value measurements as of September 30, 2023:

Weighted

Measured at fair value

Significant Unobservable

Average

on a recurring basis:

   

Fair Value

   

Valuation Methodology

   

Inputs

   

Range of Input

   

of Inputs

States and political subdivisions

$

14,066

Discounted Cash Flow

Discount Rate

3.5 – 5.9%

4.3

%

Liquidity Premium

0.3 – 0.5%

0.5

%

Mortgage servicing rights

$

11,461

Discounted Cash Flow

Discount Rate

9.0 – 11.0%

9.0

%

Prepayment Speed

0.0 – 16.4%

6.2

%

The following table and commentary present quantitative and qualitative information about Level 3 fair value measurements as December 31, 2022:

Weighted

Measured at fair value

Significant Unobservable

Average

on a recurring basis:

   

Fair Value

   

Valuation Methodology

   

Inputs

   

Range of Input

   

of Inputs

States and political subdivisions

$

14,229

Discounted Cash Flow

Discount Rate

2.3 – 5.8%

4.4

%

Liquidity Premium

0.3 – 0.5%

0.5

%

Collateralized mortgage obligations

$

6,770

Discounted Cash Flow

Discount Rate

7.0 – 7.0%

7.0

%

Asset-backed securities

$

15,012

Discounted Cash Flow

Discount Rate

6.2 – 6.5%

6.3

%

Mortgage servicing rights

$

11,189

Discounted Cash Flow

Discount Rate

9.0 – 11.0%

9.0

%

Prepayment Speed

3.6 – 27.3%

6.2

%

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

The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP.  These assets consist of individually evaluated loans and OREO.  For assets measured at fair value on a nonrecurring basis at

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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)

September 30, 2023 and December 31, 2022, 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, 2023

    

Level 1

    

Level 2

    

Level 3

    

Total

Individually evaluated loans1

$

-

$

-

$

63,322

$

63,322

Other real estate owned, net2

-

-

407

407

Total

$

-

$

-

$

63,729

$

63,729

1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans, which had a carrying amount of $82.0 million and a valuation allowance of $18.7 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $1.0 million for the nine months ended September 30, 2023.

2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $407,000 at September 30, 2023, which is made up of the outstanding balance of $525,000, and a valuation allowance of $118,000.

December 31, 2022

    

Level 1

    

Level 2

    

Level 3

    

Total

Individually evaluated loans1

$

-

$

-

$

47,700

$

47,700

Other real estate owned, net2

-

-

1,561

1,561

Total

$

-

$

-

$

49,261

$

49,261

1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans, which had a carrying amount of $65.3 million and a valuation allowance of $17.6 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $12.2 million for the year December 31, 2022.

2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $1.6 million at December 31, 2022, which is made up of the outstanding balance of $2.5 million, net of a purchase accounting adjustment of $131,000 and a valuation allowance of $856,000.

The Company has estimated the fair values of these assets based primarily on Level 3 inputs.  OREO and individually evaluated loans are generally valued using the fair value of collateral provided by third party appraisals.  These valuations include assumptions related to cash flow projections, discount rates, and recent comparable sales.  The numerical ranges of unobservable inputs for these valuation assumptions are not meaningful.

Note 12 – Fair Values of Financial Instruments

The estimated fair values approximate carrying amount for all items except those described in the following table.  Securities available-for-sale fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the security.  The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC or another member institution at par. At September 30, 2023 and December 31, 2022, the fair values of loans are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability factors.  The fair value of time deposits was estimated using discounted future cash flows at current rates offered for deposits of similar remaining maturities.  The fair values of borrowings were estimated based on interest rates available to the Company for debt with similar terms and remaining maturities.  The fair value of off balance sheet volume was not considered material.

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

September 30, 2023

Carrying

Fair

    

Amount

    

Value

    

Level 1

    

Level 2

    

Level 3

Financial assets:

Cash and due from banks

$

55,548

$

55,548

$

55,548

$

-

$

-

Interest earning deposits with financial institutions

53,485

53,485

53,485

-

-

Securities available-for-sale

1,229,618

1,229,618

216,777

998,775

14,066

FHLBC and FRBC stock

35,830

35,830

-

35,830

-

Loans held-for-sale

2,297

2,297

-

2,297

-

Net loans

3,977,814

3,855,774

-

-

3,855,774

Mortgage servicing rights

11,641

11,641

-

-

11,641

Interest rate swap agreements

8,980

8,980

-

8,980

-

Interest rate lock commitments and forward contracts

37

37

-

37

-

Interest receivable on securities and loans

25,921

25,921

-

25,921

-

Financial liabilities:

Noninterest bearing deposits

$

1,862,659

$

1,862,659

$

1,862,659

$

-

$

-

Interest bearing deposits

2,751,661

2,738,632

-

2,738,632

-

Securities sold under repurchase agreements

25,894

25,894

-

25,894

-

Other short-term borrowings

435,000

435,000

-

435,000

-

Junior subordinated debentures

25,773

19,072

-

19,072

-

Subordinated debentures

59,361

46,161

-

46,161

-

Senior notes

-

-

-

-

-

Note payable and other borrowings

-

-

-

-

-

Interest rate swap agreements

14,293

14,293

-

14,293

-

Interest payable on deposits and borrowings

3,066

3,066

-

3,066

-

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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, 2022

Carrying

Fair

    

Amount

    

Value

    

Level 1

    

Level 2

    

Level 3

Financial assets:

Cash and due from banks

$

56,632

$

56,632

$

56,632

$

-

$

-

Interest earning deposits with financial institutions

58,545

58,545

58,545

-

-

Securities available-for-sale

1,539,359

1,539,359

212,129

1,291,219

36,011

FHLBC and FRBC stock

20,530

20,530

-

20,530

-

Loans held-for-sale

491

491

-

491

-

Net loans

3,820,129

3,681,387

-

-

3,681,387

Mortgage servicing rights

11,189

11,189

-

-

11,189

Interest rate swap agreements

6,391

6,391

-

6,391

-

Interest rate lock commitments and forward contracts

76

76

-

76

-

Interest receivable on securities and loans

22,661

22,661

-

22,661

-

Financial liabilities:

Noninterest bearing deposits

$

2,051,702

$

2,051,702

$

2,051,702

$

-

$

-

Interest bearing deposits

3,059,021

3,042,740

-

3,042,740

-

Securities sold under repurchase agreements

32,156

32,156

-

32,156

-

Other short-term borrowings

90,000

90,000

-

90,000

-

Junior subordinated debentures

25,773

21,907

-

21,907

-

Subordinated debentures

59,297

52,322

-

52,322

-

Senior notes

44,585

44,248

44,248

-

-

Note payable and other borrowings

9,000

8,984

-

8,984

-

Interest rate swap agreements

12,264

12,264

-

12,264

-

Interest payable on deposits and borrowings

1,657

1,657

-

1,657

-

Note 13 – Derivatives, Hedging Activities and Financial Instruments with Off-Balance Sheet Risk

Risk Management Objective of Using Derivatives

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

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. The aggregate fair value of the swaps is recorded in other assets or other liabilities with changes in fair value recorded in other comprehensive income, net of tax. The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest income or interest expense in the same period(s) during which the hedged transaction affects earnings. Amounts

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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)

reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income or expense as interest payments are received on the variable rate loan pools or paid on the Company’s fixed-rate borrowings.

Interest rate swaps with notional amounts totaling $300.0 million and $250.0 million as of September 30, 2023 and December 31, 2022, respectively, were designated as cash flow hedges of certain variable rate commercial and commercial real estate loan pools. Each of these hedges were executed to pay variable and receive fixed rate cash flows. Each of these hedges was determined to be effective during all periods presented and the Company expects the hedges to remain effective during the remaining terms of the swaps.

An interest rate swap with a notional amount of $25.8 million as of September 30, 2023 and December 31, 2022, is designated as a cash flow hedge of junior subordinated debentures and was executed to pay fixed and receive variable rate cash flows. The hedge was determined to be effective during all periods presented and the Company expects the hedge to remain effective during the remaining terms of the swap.

During the next twelve months, the Company estimates that an additional $7.0 million will be reclassified as an increase to interest income and an additional $708,000 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. The notional amounts of interest rate swaps with its loan customers as of September 30, 2023 and December 31, 2022 were $105.6 million and $110.6 million, respectively. 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 are recognized directly in earnings.

At September 30, 2023 and December 31, 2022, the Company had $9.2 million and $11.2 million of cash collateral pledged with two correspondent financial institutions, respectively. The Company held $8.1 million and $5.3 million of cash pledged from one correspondent financial institution to support the interest rate swap activity during the years presented, respectively. No investment securities were required to be pledged to any correspondent financial institution during 2023 through September 30, 2023, or during 2022. The Company offsets derivative assets and liabilities that are subject to a master netting arrangement.

The Company also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans as well as selling forward mortgage-backed securities contracts. Loan interest rate lock commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The notional amount of these commitments at September 30, 2023 and December 31, 2022 was $7.6 million and $5.3 million, respectively. Commitments to originate residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue. Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.

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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 table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheets as of September 30, 2023 and December 31, 2022.

Fair Value of Derivative Instruments

September 30, 2023

No. of Trans.

Notional Amount $

Balance Sheet Location

Fair Value $

Balance Sheet Location

Fair Value $

Derivatives designated as hedging instruments

Interest rate swap agreements

5

325,774

Other Assets

4,517

Other Liabilities

9,830

Total derivatives designated as hedging instruments

4,517

9,830

Derivatives not designated as hedging instruments

Interest rate swaps with commercial loan customers

17

105,558

Other Assets

4,463

Other Liabilities

4,463

Interest rate lock commitments and forward contracts

28

7,613

Other Assets

37

Other Liabilities

-

Other contracts

4

44,892

Other Assets

48

Other Liabilities

-

Total derivatives not designated as hedging instruments

4,548

4,463

December 31, 2022

No. of Trans.

Notional Amount $

Balance Sheet Location

Fair Value $

Balance Sheet Location

Fair Value $

Derivatives designated as hedging instruments

Interest rate swap agreements

4

275,774

Other Assets

2,737

Other Liabilities

8,610

Total derivatives designated as hedging instruments

2,737

8,610

Derivatives not designated as hedging instruments

Interest rate swaps with commercial loan customers

21

110,647

Other Assets

3,654

Other Liabilities

3,654

Interest rate lock commitments and forward contracts

28

5,298

Other Assets

76

Other Liabilities

-

Other contracts

4

43,699

Other Assets

125

Other Liabilities

1

Total derivatives not designated as hedging instruments

3,855

3,655

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 $3.8 million as of September 30, 2023, and $4.1 million as of September 30, 2022.  The amount of the loss reclassified from AOCI to net interest income on the income statement was $3.9 million for the nine months ended September 30, 2023 and $15,000 of gain for the nine months ended September 30, 2022.  

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.

35

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, 2023, and December 31, 2022.

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

September 30, 2023

December 31, 2022

    

Fixed

    

Variable

    

Total

    

Fixed

    

Variable

    

Total

  

Letters of credit:

Borrower:

Financial standby

$

173

$

16,543

$

16,716

$

3,514

$

15,365

$

18,879

Performance standby

353

15,733

16,086

3,161

13,989

17,150

526

32,276

32,802

6,675

29,354

36,029

Non-borrower:

Performance standby

-

67

67

-

67

67

Total letters of credit

$

526

$

32,343

$

32,869

$

6,675

$

29,421

$

36,096

Unused loan commitments:

$

146,201

$

710,271

$

856,472

$

139,070

$

860,255

$

999,325

As of September 30, 2023, the Company evaluated current market conditions, including any impacts related to market interest rate changes and unused line of credit utilization trends during the second quarter of 2023, and based on that analysis under the CECL methodology, the Company determined credit losses related to unfunded commitments totaled $2.7 million, excluding a $149,000 purchase accounting adjustment on unfunded commitments recorded from our West Suburban acquisition, which is being accreted to interest income over the estimated life of the unused commitments.  The resultant decrease in the ACL for unfunded commitments of $235,000 for the third quarter of 2023, compared to the prior quarter end, is primarily related to a $223,000 decrease by accretion to interest income of the purchase accounting adjustment, as well as adjustments to historical benchmark assumptions, such as the funding rates and the period used to forecast those rates within the ACL calculation, resulting in a $12,000 reduction.  The Company will continue to assess the credit risk at least quarterly, and adjust the allowance for unfunded commitments, which is carried within other liabilities on our Consolidated Balance Sheets, as needed, with the appropriate offsetting entry to the provision for credit losses on our Consolidated Statements of Income.

36

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, 2023, compared to the three and nine months ended September 30, 2022, and our financial condition at September 30, 2023, compared to December 31, 2022.  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, 2022.  The results of operations for the three and nine months ended September 30, 2023, are not necessarily indicative of future results.  Dollar amounts presented in the following tables are in thousands, except per share data, and September 30, 2023 and 2022 amounts are unaudited.

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

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

Business Overview

The Company is a bank holding company headquartered in Aurora, Illinois. Through our wholly-owned subsidiary bank, Old Second National Bank, a national banking organization also headquartered in Aurora, Illinois, we offer a wide range of financial services through our 48 banking centers located in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois.  These banking centers offer access to a full range of traditional retail and commercial banking services including treasury management operations as well as fiduciary and wealth management services.  We focus our business on establishing and maintaining relationships with our clients while maintaining a commitment to provide for the financial services needs of the communities in which we operate.  We emphasize relationships with individual customers as well as small to medium-sized businesses throughout our market area.  We also have extensive wealth management services, which includes a registered investment advisory platform in addition to trust administration and trust services related to personal and corporate trusts and employee benefit plan administration services.

Our results of operations depend generally on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, we are subject to interest rate risk to the degree that our interest-earning assets mature or reprice at different times, or at different speeds, than our interest-bearing liabilities. Our results of operations are also affected by noninterest income, such as service charges, wealth management fees, loan fees, gains from the sale of newly originated loans, gains or losses on investments and certain other noninterest related items. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, professional fees, data processing expenses and provision for credit losses.

 

We are significantly impacted by prevailing economic conditions, including federal monetary and fiscal policies, and federal regulations of financial institutions. Deposit balances are influenced by numerous factors such as competing investments, the level of income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing and the interest rate pricing competition from other lending institutions.

As of September 30, 2023, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession, our reported and regulatory capital ratios could be adversely impacted by credit losses.

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Table of Contents

Merger with West Suburban Bancorp, Inc.

On December 1, 2021, we completed our merger with West Suburban Bancorp, Inc. (“West Suburban”), the holding company for West Suburban Bank.  Under the terms of the merger agreement, each share of West Suburban common stock was converted into 42.413 shares of our common stock and $271.15 in cash. Total cash and stock consideration paid was approximately $295.2 million. With the acquisition of West Suburban, we acquired 34 branches in DuPage, Kane, Kendall and Will counties in Illinois. The transaction is discussed in more detail in Note 2 to our Consolidated Financial Statements included in this report and in Note 2 of our Annual Report in Form 10-K.

Recent Banking Events

There were three significant bank failures in the first five months of 2023, primarily due to the failed banks’ lack of liquidity as depositors sought to withdraw their deposits. Due to rising interest rates, the failed banks were unable to sell investment securities held to meet liquidity needs without realizing substantial losses. As a result of the bank closures during 2023 and in an effort to strengthen public confidence in the banking system and protect depositors, regulators announced that any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law, which could increase the cost of our FDIC insurance assessment. Additionally, the Federal Reserve announced the creation of a new Bank Term Funding Program in an effort to minimize the need for banks to sell securities at a loss in times of stress. We have access but have not received or requested funds from this Program and, though we do have access to the Federal Reserve Discount Window, we have not accessed these funds and have an unused capacity of $18.7 million at September 30, 2023. The future impact of these failures on the economy, financial institutions and their depositors, as well as any governmental regulatory responses or actions resulting from the same, is difficult to predict at this time.

Financial Overview

Net income for the third quarter of 2023 was $24.3 million, or $0.54 per diluted share, compared to $19.5 million, or $0.43 per diluted share, for the third quarter of 2022. The increase was primarily due to growth in our loan portfolio and higher loan and security yields, partially offset by increased funding costs and increased other short-term borrowing, which resulted in growth in net interest income.  Noninterest income decreased in the third quarter of 2023, compared to the like quarter of 2022, as a result of net losses on security sales and a reduction in mortgage banking revenues.  An increase was also noted in noninterest expense for the current quarter, primarily due to higher salaries and employee benefits and $629,000 of liquidation and deconversion costs incurred in the third quarter of 2023 related to the 2022 sale of our Visa credit card portfolio. Also contributing to the increase in net income in the third quarter of 2023, compared to the third quarter of 2022, were acquisition costs, net of gains on branch sales, of $2.0 million incurred in the prior year like quarter, compared to no acquisition related costs or branch sales in the third quarter of 2023.  Adjusted net income, a non-GAAP financial measure that excludes Visa portfolio and land trust portfolio gains on sale, Visa portfolio liquidation and deconversion costs, and any merger related costs, as applicable, was $24.8 million for the third quarter of 2023, compared to $25.6 million for the second quarter of 2023, and $19.6 million for the third quarter of 2022. Adjusted net income was $73.8 million for the nine months ended September 30, 2023, compared to $49.4 million for the nine months ended September 30, 2022. See the discussion entitled “Non-GAAP Financial Measures” on page 40, as well as the table below, which provides a reconciliation of this non-GAAP measure to the most comparable GAAP equivalents.

Quarters Ended

Nine Months Ended

September 30, 

June 30, 

September 30, 

September 30, 

    

2023

    

2023

2022

    

2023

2022

Net Income

Income before income taxes (GAAP)

$

32,484

$

34,973

$

26,577

$

99,470

$

59,696

Pre-tax income adjustments:

Merger-related costs, net of losses/(gains) on branch sales

-

29

1,061

(277)

8,527

Liquidation and deconversion costs on Visa credit card portfolio

629

-

-

629

-

Gains on the sale of Visa credit card and land trust portfolios

-

-

(923)

-

(923)

Adjusted net income before taxes

33,113

35,002

26,715

99,822

67,300

Taxes on adjusted net income

8,307

9,419

7,091

26,051

17,944

Adjusted net income (non-GAAP)

$

24,806

$

25,583

$

19,624

$

73,771

$

49,356

Basic earnings per share (GAAP)

$

0.55

$

0.57

$

0.43

$

1.65

$

0.98

Diluted earnings per share (GAAP)

0.54

0.56

0.43

1.62

0.97

Adjusted basic earnings per share excluding acquisition-related costs (non-GAAP)

0.55

0.58

0.44

1.65

1.11

Adjusted diluted earnings per share excluding acquisition-related costs (non-GAAP)

0.55

0.56

0.43

1.63

1.09

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The following provides an overview of some of the factors impacting our financial performance for the three month period ended September 30, 2023, compared to the like period ended September 30, 2022:

Net interest and dividend income was $63.0 million for the third quarter of 2023, compared to $55.6 million for the third quarter of 2022. Growth in interest and dividend income in the third quarter of 2023 was primarily due to loan growth and higher yields on loans, partially offset by higher funding and borrowing costs, as well as increased other short-term borrowings.

We recorded a net provision for credit losses of $3.0 million in the third quarter of 2023, driven by a $3.0 million increase in the allowance for credit losses on loans based on increased historical loss rates, loan growth, our assessment of nonperforming loan metrics and trends, and estimated future credit losses, net of a reversal of $12,000 in our allowance for unfunded commitments based on an adjustment of historical benchmark assumptions, such as funding rates and the period used to forecast those rates, within the ACL calculation.  We recorded a net provision for credit loss of $4.5 million in the third quarter of 2022.

Noninterest income was $9.9 million for the third quarter of 2023, compared to $11.5 million for the third quarter of 2022.  Contributing to the decrease were security losses of $924,000 due to strategic sales in the third quarter of 2023, compared to losses on the call of securities of $1,000 in the third quarter of 2022.  Also contributing to the reduction in noninterest income was a $1.1 million decrease in other income, primarily due to the gain on sale of both our Visa credit card portfolio and the land trust portfolio in 2022. These decreases were partially offset by an increase of $195,000 in wealth management income and a $773,000 increase in the cash surrender value of BOLI.

Noninterest expense was $37.4 million for the third quarter of 2023, compared to $36.0 million for the third quarter of 2022, an increase of $1.4 million, or 4.0%.  Contributing to the increase in noninterest expense in the third quarter of 2023 was higher salaries and employee benefits, as well as $629,000 of net liquidation and deconversion costs from the 2022 sale of our Visa credit card portfolio. Partially offsetting the increase in noninterest expense was a reduction of occupancy, furniture and equipment and computer and data processing expenses, primarily from acquisition costs, net of gains on branch sales, incurred in the third quarter of 2022 stemming from our West Suburban acquisition in the fourth quarter of 2021.

We had a provision for income tax expense of $8.1 million for the third quarter of 2023, compared to a provision for income tax expense of $7.1 million for the third quarter of 2022. The effective tax rate for these two periods was 25.1% and 26.5%, respectively.

Our community-focused banking franchise experienced growth of $159.9 million in total loans in the first nine months of 2023, compared to the year ended December 31, 2022, and an increase of $160.2 million in total loans compared to the third quarter of 2022.  We believe we are positioned for continued loan growth, though likely at a slower pace, as we continue to serve our customers’ needs in a competitive economic environment. We continue 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 seeking to ensure the safety and soundness of our Bank, our customers, and our employees.

Nonaccrual loans increased $30.5 million as of September 30, 2023, compared to December 31, 2022, primarily due to a few larger credits that moved from substandard accrual to nonaccrual in the first nine months of 2023. There were additions of two office buildings and one health care facility credit as of March 31, 2023, and additions of one medical office development and one office building as of September 30, 2023. The additions are partially offset by three charge offs totaling $6.8 million, recorded in the third quarter of 2023. Nonperforming loans as a percent of total loans was 1.6% as of September 30, 2023, compared to 0.9% as of December 31, 2022, and 1.4% as of September 30, 2022.  Classified assets increased to $153.7 million as of September 30, 2023, which is $43.2 million, or 39.1% more than December 31, 2022, and $38.4 million, or 33.3%, more than September 30, 2022.

Critical Accounting Estimates

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

Of the significant accounting policies used in the preparation of our consolidated financial statements, we have identified certain items as critical accounting policies based on the associated estimates, assumptions, judgments and complexity. See “Management’s Discussion

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and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2022. 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 2022 Annual Report in Form 10-K.

Non-GAAP Financial Measures

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

Results of Operations

Overview

Three months ended September 30, 2023 and 2022

Our income before taxes was $32.5 million in the third quarter of 2023 compared to $26.6 million in the third quarter of 2022.  This increase in pretax income was primarily due to a $7.5 million increase in net interest and dividend income, and a $1.5 million decrease in provision for credit losses. Income before taxes was negatively impacted by a $1.6 million decrease in noninterest income, primarily due to $924,000 of security losses and a $1.1 million decrease in other income in the third quarter of 2023, as well as a $1.4 million increase in noninterest expense. Our net income was $24.3 million, or $0.54 per diluted share, for the third quarter of 2023, compared to net income of $19.5 million, or $0.43 per diluted share, for the third quarter of 2022. The Bank remains well positioned to navigate uncertain macroeconomics; we have mitigated interest rate risk, controlled expenses in an inflationary environment, and actively managed daily liquidity.  Furthermore, we continue to possess strong liquidity metrics and an outsized securities portfolio for funding needs.

Net interest and dividend income was $63.0 million in the third quarter of 2023, compared to $55.6 million in the third quarter of 2022.  The $7.4 million increase was primarily driven by significant growth in our loan portfolio as well as the effect of higher market interest rates on our loan portfolios.  Higher interest income was partially offset by an increase in interest expense in the third quarter of 2023, compared to the third quarter of 2022, primarily due to a rise in deposit interest rates, and an increase in other short-term borrowing expense due to additional FHLB advances. As of June 30, 2023, we redeemed the $45.0 million senior debt issuance that was due in 2026, which resulted in no senior debt interest expense recorded for the third quarter of 2023.

Nine months ended September 30, 2023 and 2022

Our income before taxes was $99.5 million for the nine months ended September 30, 2023 compared to $59.7 million for the nine months ended September 30, 2022.  This increase in pretax income was primarily due to a $48.6 million increase in net interest and dividend income and a $3.3 million decrease in noninterest expenses. These changes were partially offset by a $3.5 million increase in provision for credit losses, and a $8.7 million decrease in noninterest income, mainly due to $4.1 million of security losses recorded in the first nine months of 2023 and a $4.5 million decrease in mortgage banking revenues. Our net income was $73.5 million, or $1.62 per diluted share, for the nine months ended September 30, 2023, compared to net income of $43.8 million, or $0.97 per diluted share, for the same period of 2022.

Net interest and dividend income was $190.7 million for the nine months ended September 30, 2023, compared to $142.1 million for the same period of 2022.  The $48.6 million increase was primarily driven by significant growth in our loan portfolio as well as the effect of higher market interest rates on our loan and securities portfolios.  Higher interest and dividend income was partially offset by an increase in interest expense in the first nine months of 2023, compared to the first nine months of 2022, primarily due to a rise in deposit interest rates, an increase in other short-term borrowing expense due to FHLB advances, and an increase in the rate paid on our senior notes. The senior notes redeemed on June 30, 2023 had an effective cost of 10.95% for the nine months ending September 30, 2023.

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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, 2023 and 2022

The increased yield of 10 basis points on interest earning assets compared to the linked period was driven by higher yields on loan originations than those in the previous period as well as repricing within the existing variable rate portfolios for securities available-for-sale and loans. Changes in the market interest rate environment impact earning assets at varying intervals depending on the repricing timeline of loans, as well as the securities maturity, paydown and purchase activities.

The year over year increase of 136 basis points on interest earning assets was driven by significant increases to benchmark interest rates as well as strong loan growth throughout the period, specifically within the leases, commercial real estate and multifamily portfolios, as these loan segments generally produce the greatest yield. The increases in benchmark interest rates impacted yields on the securities portfolio through the inverse relationship between interest rates and market value coupled with maturities and strategic sales of lower yielding assets, as we work to increase the weighted average yield in the portfolio.

Average balances of interest-bearing deposit accounts have decreased steadily since the third quarter of 2022 through the third quarter of 2023, from $3.23 billion to $2.79 billion, with decreases reflected in all deposit categories excluding time deposits. We have continued to control the cost of funds over the periods reflected, with the rate of overall interest-bearing deposits increasing to 65 basis points for the quarter ended September 30, 2023, from 40 basis points for the quarter ended June 30, 2023, and from nine basis points for the quarter ended September 30, 2022. A 32 basis point increase in the cost of money market funds for the quarter ended September 30, 2023 compared to prior linked quarter, and a 91 basis point increase compared to the prior year like quarter were both due to select deposit account exception pricing, and drove a significant portion of the overall increase.  Average rates paid on time deposits for the quarter ended September 30, 2023 increased by 63 basis points and 140 basis points in the quarter over linked quarter and year over year quarters, respectively, primarily due to CD rate specials we offered.

Borrowing costs decreased in the third quarter of 2023 compared to the second quarter of 2023, primarily due to the redemption of the senior notes as of June 30, 2023, partially offset by an increase in average short-term borrowings of $24.6 million stemming from increased average FHLB advances over the prior quarter. The increase of $421.7 million year over year of average FHLB advances was based on daily liquidity needs. Subordinated and junior subordinated debt interest expense were essentially flat over each of the periods presented. We redeemed all of the $45.0 million senior notes, net of deferred issuance costs, on June 30, 2023, resulting in senior notes having no balance or related interest expense in the third quarter of 2023. In February 2023, we paid off the remaining balance of $9.0 million on the original $20.0 million term note issued in 2020, resulting in notes payable and other borrowings having no balance after that time.

Our net interest margin (GAAP) increased three basis points to 4.64% for the third quarter of 2023 compared to 4.61% for the second quarter of 2023, and increased 71 basis points compared to 3.93% for the third quarter of 2022.  Our net interest margin (TE) increased two basis points to 4.66% for the third quarter of 2023, compared to 4.64% for the second quarter of 2023, and increased 70 basis points compared to 3.96% for the third quarter of 2022.  The increase in the current quarter, compared to the prior quarter, is primarily due to the growth in loan interest income due to the rising interest rate environment, and a decrease in borrowing interest expense due to the redemption of the senior notes in June 2023. The increase in the current quarter, compared to the prior year like quarter, is primarily due to an increase in market interest rates, and the related rate resets on loans and securities during the past year, as well as continuing loan growth relative to a more modest increase in costs of interest-bearing liabilities. See the discussion entitled “Non-GAAP Financial Measures” and the tables on page 45 that provide a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent.

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Table of Contents

Nine months ended September 30, 2023 and 2022

The year over year increase of 187 basis points on interest earning assets was driven by significant increases to benchmark interest rates as well as strong loan growth throughout the period, specifically within the leases, commercial real estate-investor, construction and multi-family portfolios.  The increases in benchmark interest rates impacted yields on the securities portfolio through the inverse relationship between interest rates and market value coupled with maturities and strategic sales of lower yielding assets and timely purchase of higher yielding securities as we work to increase the weighted average yield in the portfolio.  Average securities available-for-sale decreased $367.0 million for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, due to paydowns, changes in market value, and strategic sales.  Due to market interest rate increases year over year, securities available-for-sale interest income was $34.7 million for the nine months ended September 30, 2023, compared to $26.1 million for the like 2022 period, reflecting an increase in yield of 134 basis points.  Average loans, including loans held for sale, increased $438.0 million in the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, primarily driven by the growth in leases, commercial real estate-investor, construction, and multi-family portfolios.  Growth in the loan portfolio, as well as the rising interest rate environment, resulted in $181.5 million of loan interest income in the nine months ended September 30, 2023, compared to $121.3 million in the like 2022 period, reflecting an increase in yield of 152 basis points.

Average balances of interest-bearing deposit accounts have decreased steadily since September 30, 2022 through the nine months ended September 30, 2023, from $3.32 billion to $2.89 billion, with such decreases reflected in all categories. We have continued to control the cost of funds over the periods reflected, with the rate of overall interest-bearing deposits increasing by 35 basis points to 43 basis points from eight basis points as of September 30, 2022. A 61 basis point increase in the cost of money market funds as of September 30, 2023, compared to September 30, 2022, was due to select deposit account exception pricing and drove a significant portion of the overall increase.  Interest expense paid on time deposits also contributed to the increased cost of deposits year over year, as the cost of average time deposits increased 89 basis points to 114 basis points for the nine months ended September 30, 2023, compared to 25 basis points for the nine months ended September 30, 2022, primarily due to CD rate specials we offered.

Borrowing costs increased in the nine months ended September 30, 2023 primarily due to the increase in short term borrowings from higher average FHLB advance growth of $342.5 million since the nine months ended September 30, 2022, based on daily liquidity needs. Subordinated and junior subordinated debt interest expense remained flat over the periods presented. Senior notes interest expense had the most significant interest expense increase, as this issuance referenced three-month LIBOR, and rising market interest rates resulted in a 557 basis point increase to 10.95%, from 5.38% for the nine months ended September 30, 2022. We redeemed these notes on June 30, 2023, which contributed to the significant basis point increase due to the $362,000 in deferred issuance costs that were recognized as interest expense due to the early redemption. In the first quarter of 2023, we paid off the remaining balance of $9.0 million on the original $20.0 million term note issued in 2020, recorded within notes payable and other borrowings.

Our net interest margin (GAAP) increased 135 basis points to 4.66% for the nine months ended September 30, 2023, compared to 3.31% for the nine months ended September 30, 2022.  Our net interest margin (TE) increased 135 basis points to 4.68% for the nine months ended September 30, 2023, compared to 3.33% for the nine months ended September 30, 2022.  The increase in the current period, compared to the prior year like period, is primarily due to an increase in market interest rates, and the related rate resets on loans and securities during the past year, as well as continuing loan growth relative to a more modest increase in the cost of interest-bearing liabilities.

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

The following tables set forth certain information relating to our average consolidated balance sheets and reflect the yield on average earning assets and cost of average interest-bearing liabilities for the periods indicated.  These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period.  Average balances are derived from daily balances.  For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP TE basis using a marginal rate of 21% in 2023 and 2022 to compare returns more appropriately on tax-exempt loans and securities to other earning assets.

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Analysis of Average Balances,

Tax Equivalent Income / Expense and Rates

(Dollars in thousands - unaudited)

Quarters Ended

September 30, 2023

June 30, 2023

September 30, 2022

Average

Income /

Rate

Average

Income /

Rate

Average

Income /

Rate

Balance

Expense

%

Balance

Expense

%

Balance

Expense

%

Assets

Interest earning deposits with financial institutions

$

49,737

$

659

5.26

$

50,309

$

643

5.13

$

131,260

$

663

2.00

Securities:

Taxable

1,125,688

8,946

3.15

1,231,994

9,930

3.23

1,525,258

9,116

2.37

Non-taxable (TE)1

169,523

1,687

3.95

172,670

1,692

3.93

178,090

1,686

3.76

Total securities (TE)1

1,295,211

10,633

3.26

1,404,664

11,622

3.32

1,703,348

10,802

2.52

FHLBC and FRBC Stock

35,954

597

6.59

34,029

396

4.67

19,565

261

5.29

Loans and loans held-for-sale1, 2

4,010,859

62,705

6.20

4,040,202

61,591

6.11

3,753,117

46,642

4.93

Total interest earning assets

5,391,761

74,594

5.49

5,529,204

74,252

5.39

5,607,290

58,368

4.13

Cash and due from banks

57,279

-

-

56,191

-

-

56,265

-

-

Allowance for credit losses on loans

(54,581)

-

-

(53,480)

-

-

(45,449)

-

-

Other noninterest bearing assets

384,059

-

-

379,576

-

-

377,850

-

-

Total assets

$

5,778,518

$

5,911,491

$

5,995,956

Liabilities and Stockholders' Equity

NOW accounts

$

576,138

$

440

0.30

$

600,957

$

312

0.21

$

612,174

$

148

0.10

Money market accounts

720,488

1,767

0.97

762,967

1,245

0.65

967,106

157

0.06

Savings accounts

1,027,987

351

0.14

1,073,172

185

0.07

1,186,001

75

0.03

Time deposits

466,250

1,982

1.69

436,524

1,156

1.06

459,925

335

0.29

Interest bearing deposits

2,790,863

4,540

0.65

2,873,620

2,898

0.40

3,225,206

715

0.09

Securities sold under repurchase agreements

24,945

27

0.43

25,575

7

0.11

33,733

10

0.12

Other short-term borrowings

427,174

5,840

5.42

402,527

5,160

5.14

5,435

44

3.21

Junior subordinated debentures

25,773

245

3.77

25,773

281

4.37

25,773

285

4.39

Subordinated debentures

59,350

547

3.66

59,329

546

3.69

59,265

546

3.66

Senior notes

-

-

-

44,134

1,414

12.85

44,546

728

6.48

Notes payable and other borrowings

-

-

-

-

-

-

10,989

111

4.01

Total interest bearing liabilities

3,328,105

11,199

1.34

3,430,958

10,306

1.20

3,404,947

2,439

0.28

Noninterest bearing deposits

1,867,201

-

-

1,920,448

-

-

2,092,301

-

-

Other liabilities

53,164

-

-

48,434

-

-

34,949

-

-

Stockholders' equity

530,048

-

-

511,651

-

-

463,759

-

-

Total liabilities and stockholders' equity

$

5,778,518

$

5,911,491

$

5,995,956

Net interest income (GAAP)

$

63,030

$

63,580

$

55,569

Net interest margin (GAAP)

4.64

4.61

3.93

Net interest income (TE)1

$

63,395

$

63,946

$

55,929

Net interest margin (TE)1

4.66

4.64

3.96

Interest bearing liabilities to earning assets

61.73

%

62.05

%

60.72

%

1 Represents a non-GAAP financial measure. See the discussion entitled “Reconciliation of Tax-Equivalent Non-GAAP Financial Measures” below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2023 and 2022.

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 45, and includes loan fee expense of $780,000 for the third quarter of 2023, $242,000 for the second quarter of 2023, and $750,000 of loan fee income for the third quarter of 2022.  Nonaccrual loans are included in the above-stated average balances.

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Analysis of Average Balances,

Tax Equivalent Income / Expense and Rates

(Dollars in thousands - unaudited)

Nine Months Ended September 30, 

2023

2022

Average

Income /

Rate

Average

Income /

Rate

Balance

Expense

%

Balance

Expense

%

Assets

Interest earning deposits with financial institutions

$

49,787

$

1,887

5.07

$

395,948

$

1,714

0.58

Securities:

Taxable

1,228,576

29,611

3.22

1,582,549

21,071

1.78

Non-taxable (TE)1

171,825

5,072

3.95

184,842

4,995

3.61

Total securities (TE)1

1,400,401

34,683

3.31

1,767,391

26,066

1.97

Dividends from FHLBC and FRBC

31,670

1,273

5.37

18,888

677

4.79

Loans and loans held-for-sale 1 , 2

3,994,804

181,524

6.08

3,556,798

121,337

4.56

Total interest earning assets

5,476,662

219,367

5.36

5,739,025

149,794

3.49

Cash and due from banks

56,211

-

-

50,918

-

-

Allowance for credit losses on loans

(52,505)

-

-

(44,719)

-

-

Other noninterest bearing assets

382,077

-

-

374,388

-

-

Total assets

$

5,862,445

$

6,119,612

Liabilities and Stockholders' Equity

NOW accounts

$

592,617

$

995

0.22

$

605,578

$

339

0.07

Money market accounts

772,011

3,840

0.67

1,039,717

482

0.06

Savings accounts

1,075,374

614

0.08

1,200,014

303

0.03

Time deposits

445,926

3,802

1.14

474,665

877

0.25

Interest bearing deposits

2,885,928

9,251

0.43

3,319,974

2,001

0.08

Securities sold under repurchase agreements

27,178

43

0.21

35,791

30

0.11

Other short-term borrowings

344,341

13,345

5.18

1,832

44

3.21

Junior subordinated debentures

25,773

805

4.18

25,773

849

4.40

Subordinated debentures

59,329

1,639

3.69

59,244

1,639

3.70

Senior note

29,414

2,408

10.95

44,520

1,791

5.38

Notes payable and other borrowings

1,780

87

6.53

14,338

309

2.88

Total interest bearing liabilities

3,373,743

27,578

1.09

3,501,472

6,663

0.25

Noninterest bearing deposits

1,929,653

-

-

2,101,749

-

-

Other liabilities

50,965

-

-

42,706

-

-

Stockholders' equity

508,084

-

-

473,685

-

-

Total liabilities and stockholders' equity

$

5,862,445

$

6,119,612

Net interest income (GAAP)

$

190,696

$

142,065

Net interest margin (GAAP)

4.66

3.31

Net interest income (TE)1

$

191,789

$

143,131

Net interest margin (TE)1

4.68

3.33

Interest bearing liabilities to earning assets

61.60

%

61.01

%

1 Represents a non-GAAP financial measure. See the discussion entitled “Reconciliation of Tax-Equivalent Non-GAAP Financial Measures” below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2023 and 2022.

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 45, and includes fee expense of $1.8 million and $2.1 million for the nine months ended September 30, 2023 and 2022, respectively.  Nonaccrual loans are included in the above-stated average balances.

44

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 2023 and 2022 to compare returns more appropriately on tax-exempt loans and securities to other earning assets.  The table below provides a reconciliation of each non-GAAP (TE) measure to the GAAP equivalent for the periods indicated:

Three Months Ended

Nine Months Ended

September 30, 

June 30, 

September 30, 

September 30, 

Net Interest Margin

    

2023

    

2023

2022

    

2023

2022

Interest income (GAAP)

$

74,229

$

73,886

$

58,008

$

218,274

$

148,728

Taxable-equivalent adjustment:

Loans

11

11

6

28

17

Securities

354

355

354

1,065

1,049

Interest and dividend income (TE)

74,594

74,252

58,368

219,367

149,794

Interest expense (GAAP)

11,199

10,306

2,439

27,578

6,663

Net interest income (TE)

$

63,395

$

63,946

$

55,929

$

191,789

$

143,131

Net interest income (GAAP)

$

63,030

$

63,580

$

55,569

$

190,696

$

142,065

Average interest earning assets

$

5,391,761

$

5,529,204

$

5,607,290

$

5,476,662

$

5,739,025

Net interest margin (TE)

4.66

%

4.64

%

3.96

%

4.68

%

3.33

%

Net interest margin (GAAP)

4.64

%

4.61

%

3.93

%

4.66

%

3.31

%

Noninterest Income

Three months ended September 30, 2023 and 2022

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

3rd Quarter 2023

Noninterest Income

Three Months Ended

Percent Change From

(Dollars in thousands)

September 30, 

June 30, 

September 30, 

June 30, 

September 30, 

    

2023

    

2023

    

2022

    

2023

    

2022

 

Wealth management

$

2,475

$

2,458

$

2,280

0.7

8.6

Service charges on deposits

2,504

2,362

2,661

6.0

(5.9)

Residential mortgage banking revenue

Secondary mortgage fees

66

76

81

(13.2)

(18.5)

MSRs mark to market gain

281

96

548

192.7

(48.7)

Mortgage servicing income

519

499

514

4.0

1.0

Net gain on sales of mortgage loans

407

398

449

2.3

(9.4)

Total residential mortgage banking revenue

1,273

1,069

1,592

19.1

(20.0)

Securities losses, net

(924)

(1,547)

(1)

40.3

N/M

Change in cash surrender value of BOLI

919

418

146

119.9

529.5

Card related income

2,606

2,690

2,653

(3.1)

(1.8)

Other income

1,024

773

2,165

32.5

(52.7)

Total noninterest income

$

9,877

$

8,223

$

11,496

20.1

(14.1)

N/M - Not meaningful

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Table of Contents

Noninterest income increased $1.7 million, or 20.1%, in the third quarter of 2023, compared to the second quarter of 2023, and decreased $1.6 million, or 14.1%, compared to the third quarter of 2022.  The increase from the second quarter of 2023 was primarily driven by a $204,000 increase in residential mortgage banking revenue, a $623,000 decrease in securities losses, net, based on strategic sales, a $501,000 increase in the cash surrender value of BOLI, and a $251,000 increase in other income primarily due to contract incentives achieved on brokerage activities, as well as various recoveries on prior year sold mortgage claims.  

The decrease in noninterest income of $1.6 million in the third quarter of 2023, compared to the third quarter of 2022, is primarily due to an increase in security losses, net, of $923,000 on strategic sales for the quarter ended September 30, 2023, a decrease of $267,000 on mortgage servicing rights mark to market gains, and a $1.1 million decrease in other income due to a $743,000 pretax gain on a Visa credit card portfolio sale and a $180,000 pretax gain on the sale of a land trust portfolio recorded in the third quarter of 2022. These decreases were partially offset by a $773,000 increase in the cash surrender value of BOLI due to market interest rate changes.

Nine months ended September 30, 2023 and 2022

Noninterest Income

Nine Months Ended

YTD through September 30, 2023

(Dollars in thousands)

September 30, 

September 30, 

Percent

    

2023

    

2022

    

Change

Wealth management

$

7,203

$

7,484

(3.8)

Service charges on deposits

7,290

7,063

3.2

Residential mortgage banking revenue

Secondary mortgage fees

201

270

(25.6)

MSRs mark to market (loss) gain

(148)

3,608

(104.1)

Mortgage servicing income

1,534

1,612

(4.8)

Net gain on sales of mortgage loans

1,111

1,682

(33.9)

Total residential mortgage banking revenue

2,698

7,172

(62.4)

Securities losses, net

(4,146)

(34)

N/M

Change in cash surrender value of BOLI

1,579

342

361.7

Card related income

7,540

8,194

(8.0)

Other income

3,286

3,949

(16.8)

Total noninterest income

$

25,450

$

34,170

(25.5)

N/M - Not meaningful

Noninterest income decreased $8.7 million, or 25.5%, for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022.  This decrease was primarily driven by a $4.5 million decline in mortgage banking revenue, comprised mostly of a $3.8 million decrease in MSRs mark to market gains and a $571,000 decrease in net gain on sales of mortgage loans.  In addition, the current nine month period decreased due to a $4.1 million increase in net losses on the sale of securities for the year over year period. Partially offsetting these decreases was a $227,000 increase in service charges on deposits and a $1.2 million increase in the cash surrender value of BOLI.

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Noninterest Expense

Three months ended September 30, 2023 and 2022

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

3rd Quarter 2023

Noninterest Expense

Three Months Ended

Percent Change From

(Dollars in thousands)

September 30, 

June 30, 

September 30, 

June 30, 

September 30, 

    

2023

    

2023

    

2022

    

2023

    

2022

 

Salaries

$

17,279

$

16,310

$

14,711

5.9

17.5

Officers incentive

2,773

2,397

2,787

15.7

(0.5)

Benefits and other

3,063

3,091

3,513

(0.9)

(12.8)

Total salaries and employee benefits

23,115

21,798

21,011

6.0

10.0

Occupancy, furniture and equipment expense

3,506

3,639

4,119

(3.7)

(14.9)

Computer and data processing

1,922

1,290

2,543

49.0

(24.4)

FDIC insurance

744

794

659

(6.3)

12.9

Net teller & bill paying

534

515

504

3.7

6.0

General bank insurance

300

306

257

(2.0)

16.7

Amortization of core deposit intangible asset

616

618

657

(0.3)

(6.2)

Advertising expense

93

103

83

(9.7)

12.0

Card related expense

1,347

1,222

1,453

10.2

(7.3)

Legal fees

97

283

212

(65.7)

(54.2)

Consulting & management fees

549

520

607

5.6

(9.6)

Other real estate owned expense, net

(27)

(98)

21

72.4

(228.6)

Other expense

4,627

3,840

3,862

20.5

19.8

Total noninterest expense

$

37,423

$

34,830

$

35,988

7.4

4.0

Efficiency ratio (GAAP)1

50.08

%

46.84

%

53.08

%

Adjusted efficiency ratio (non-GAAP)2

48.82

%

46.49

%

51.90

%

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

2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses, and acquisition-related costs, net of gains on branch sales, Visa credit card portfolio liquidation and related deconversion costs, as well as any merger related costs, if applicable, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities, mark to market gains or losses on MSRs, gain on the sale of our Visa credit card and land trust portfolios, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI.  See the discussion entitled “Non-GAAP Financial Measures” above and the table on page 49 that provides a reconciliation of this non-GAAP financial measure to the most comparable GAAP equivalent.

Noninterest expense for the third quarter of 2023 increased $2.6 million, or 7.4%, compared to the second quarter of 2023, and increased $1.4 million, or 4.0%, compared to the third quarter of 2022.  The increase in the third quarter of 2023 compared to the second quarter of 2023 was attributable to a $1.3 million increase in salaries and employee benefits, primarily due to an increase in salaries and the officer incentive accrual.  Also contributing to the increase in the third quarter of 2023 was a $632,000 increase in computer and data processing costs as the second quarter reflects software contract incentives, and a $787,000 increase in other expenses primarily due to $629,000 of liquidation costs recorded from the September 2023 Visa credit card portfolio deconversion, which was sold in the third quarter of 2022 and we continued to service through the third quarter of 2023.  Partially offsetting the increase in noninterest expense in the third quarter

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of 2023 was a $186,000 decrease in legal fees, as the second quarter of 2023 experienced higher legal costs due to senior debt redemption, the proxy filing, and benefit plan reviews.

The year over year increase in noninterest expense is primarily attributable to a $2.1 million increase in salaries and employee benefits, primarily due to an increase in salaries due to higher wage rates and an increase in full-time equivalent employees in the current year. Also contributing to the increase was a $765,000 growth in other expense, which was primarily due to $629,000 of liquidation and deconversion costs recorded on the Visa credit card portfolio liquidation in the third quarter of 2023. Partially offsetting the increase in noninterest expense in the third quarter of 2023, compared to the third quarter of 2022, was a $613,000 decrease in furniture and equipment expenses, a $621,000 decrease in computer and data processing expenses, and a $115,000 decrease in legal fees, all stemming from acquisition related costs that were recorded in the third quarter of 2022.

Nine months ended September 30, 2023 and 2022

Noninterest Expense

Nine Months Ended

YTD through September 30, 2023

(Dollars in thousands)

September 30, 

September 30, 

Percent

    

2023

    

2022

    

Change

Salaries

$

49,676

$

46,304

7.3

Officers incentive

6,997

5,443

28.6

Benefits and other

10,488

10,563

(0.7)

Total salaries and employee benefits

67,161

62,310

7.8

Occupancy, furniture and equipment expense

10,620

10,864

(2.2)

Computer and data processing

4,986

12,817

(61.1)

FDIC insurance

2,122

1,771

19.8

Net teller & bill paying

1,551

3,245

(52.2)

General bank insurance

911

923

(1.3)

Amortization of core deposit intangible asset

1,858

1,981

(6.2)

Advertising expense

338

459

(26.4)

Card related expense

3,785

3,044

24.3

Legal fees

699

648

7.9

Consulting & management fees

1,859

1,746

6.5

Other real estate owned expense, net

181

96

88.5

Other expense

12,104

11,585

4.5

Total noninterest expense

$

108,175

$

111,489

(3.0)

Efficiency ratio (GAAP)1

48.15

%

63.37

%

Adjusted efficiency ratio (non-GAAP)2

47.66

%

58.35

%

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

2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses, and acquisition-related costs, net of gains on branch sales, Visa credit card portfolio liquidation and related deconversion costs, as well as any merger related costs, if applicable, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities, mark to market gains or losses on MSRs, gain on the sale of our Visa credit card and land trust portfolios, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI.  See the discussion entitled “Non-GAAP Financial Measures” above and the table on page 49 that provides a reconciliation of this non-GAAP financial measure to the most comparable GAAP equivalent.

Noninterest expense for the nine months ended September 30, 2023, decreased $3.3 million, or 3.0%, compared to the nine months ended September 30, 2022, primarily due to a $7.8 million decrease in computer and data processing due to acquisition related costs incurred during the nine months ended September 30, 2022 as the result of our acquisition of West Suburban in December 2021. Salaries and employee benefits increased $4.9 million largely from incentives and merit increases effective during the nine months ended September 30, 2023. Net teller & bill paying decreased $1.7 million largely due to acquisition related costs that were incurred during the nine months ended September 30, 2022. In addition, FDIC insurance increased $351,000 due to growth in our asset size, a scheduled increase in rates

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Table of Contents

used by the FDIC for assessments, as well as the absence of assessment credits fully utilized in the nine months ended September 30, 2022. Finally, card related expense increased $741,000 due to the growth in customer transactions and related volume changes.

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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, 

2023

2023

2022

2023

2023

2022

Efficiency Ratio / Adjusted Efficiency Ratio

Noninterest expense

$

37,423

$

34,830

$

35,988

$

37,423

$

34,830

$

35,988

Less amortization of core deposit

616

618

657

616

618

657

Less other real estate (income) expense, net

(27)

(98)

21

(27)

(98)

21

Less acquisition related costs, net of losses/(gains) on branch sales

N/A

N/A

N/A

-

29

1,061

Less liquidation and deconversion costs on Visa credit card portfolio

N/A

N/A

N/A

629

-

-

Noninterest expense less adjustments

$

36,834

$

34,310

$

35,310

$

36,205

$

34,281

$

34,249

Net interest income

$

63,030

$

63,580

$

55,569

$

63,030

$

63,580

$

55,569

Taxable-equivalent adjustment:

Loans

N/A

N/A

N/A

11

11

6

Securities

N/A

N/A

N/A

354

355

354

Net interest income including adjustments

63,030

63,580

55,569

63,395

63,946

55,929

Noninterest income

9,877

8,223

11,496

9,877

8,223

11,496

Less securities losses

(924)

(1,547)

(1)

(924)

(1,547)

(1)

Less MSRs mark to market gains

281

96

548

281

96

548

Less gain on Visa credit card portfolio sale

N/A

N/A

N/A

-

-

743

Less gain on sale of land trust portfolio

N/A

N/A

N/A

-

-

180

Taxable-equivalent adjustment:

Change in cash surrender value of BOLI

N/A

N/A

N/A

245

111

39

Noninterest income (excluding) / including adjustments

10,520

9,674

10,949

10,765

9,785

10,065

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

$

73,550

$

73,254

$

66,518

$

74,160

$

73,731

$

65,994

Efficiency ratio / Adjusted efficiency ratio

50.08

%

46.84

%

53.08

%

48.82

%

46.49

%

51.90

%

N/A - not applicable

GAAP

Non-GAAP

Nine Months Ended

Nine Months Ended

September 30, 

September 30, 

September 30, 

September 30, 

2023

2022

2023

2022

Efficiency Ratio / Adjusted Efficiency Ratio

(Dollars in thousands)

Noninterest expense

$

108,175

$

111,489

$

108,175

$

111,489

Less amortization of core deposit

1,858

1,981

1,858

1,981

Less other real estate expense, net

181

96

181

96

Less acquisition related costs, net of (gains)/losses on branch sales

N/A

N/A

(277)

8,527

Less liquidation and deconversion costs on Visa credit card portfolio

N/A

N/A

629

-

Noninterest expense less adjustments

$

106,136

$

109,412

$

105,784

$

100,885

Net interest income

$

190,696

$

142,065

$

190,696

$

142,065

Taxable-equivalent adjustment:

Loans

N/A

N/A

28

17

Securities

N/A

N/A

1,065

1,049

Net interest income including adjustments

190,696

142,065

191,789

143,131

Noninterest income

25,450

34,170

25,450

34,170

Less securities losses, net

(4,146)

(34)

(4,146)

(34)

Less MSRs mark to market (losses) gains

(148)

3,608

(148)

3,608

Less gain on Visa credit card portfolio sale

N/A

N/A

-

743

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Table of Contents

Less gain on sale of land trust portfolio

N/A

N/A

-

180

Taxable-equivalent adjustment:

Change in cash surrender value of BOLI

N/A

N/A

420

91

Noninterest income (excluding) / including adjustments

29,744

30,596

30,164

29,764

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

$

220,440

$

172,661

$

221,953

$

172,895

Efficiency ratio / Adjusted efficiency ratio

48.15

%

63.37

%

47.66

%

58.35

%

N/A - not applicable

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Table of Contents

Income Taxes

We recorded income tax expense of $8.1 million for the third quarter of 2023 on $32.5 million of pretax income, compared to income tax expense of $9.4 million on $35.0 million of pretax income in the second quarter of 2023, and income tax expense of $7.1 million on $26.6 million of pretax income in the third quarter of 2022. Our effective tax rate was 25.1% in the third quarter of 2023, 26.9% for the second quarter of 2023, and 26.6% for the third quarter of 2022.  The slight reduction in the effective tax rate for the third quarter of 2023 reflects the finalization of the 2022 income tax return, and related adjustments due to state apportionment factor changes and deferred tax allocations within the current period.

We recorded income tax expense of $26.0 million on $99.5 million of pretax income for the nine months ended September 30, 2023, compared to income tax expense of $15.9 million on $59.7 million of pretax income in the like 2022 period. The effective tax rate was 26.1% and 26.7% for the nine months ended September 30, 2023 and 2022, respectively.

Income tax expense reflected all relevant statutory tax rates and GAAP accounting.  There were no significant changes in our ability to utilize our deferred tax assets during the quarter ended September 30, 2023.  We had no valuation reserve on the deferred tax assets as of September 30, 2023.

Financial Condition

Total assets decreased $130.2 million to $5.76 billion at September 30, 2023, from $5.89 billion at December 31, 2022, due primarily to the decrease of $309.7 million in securities available-for-sale.  The decrease in securities available-for-sale was primarily due to strategic sales. These decreases were partially offset by increases in net loans of $157.7 million, FHLB and FRB stock held of $15.3 million, and other assets of $8.7 million. We continue to actively assess potential investment opportunities to utilize our excess liquidity. Total deposits were $4.61 billion at September 30, 2023, a decrease of $496.4 million from December 31, 2022, through a combination of seasonal activity as well as leakage from excess savings stemming from COVID-related government payments and opportunities for alternative investments.

September 30, 2023

Securities

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

    

2023

    

2022

    

2022

    

2022

    

2022

Securities available-for-sale, at fair value

U.S. Treasuries

$

216,777

$

212,129

$

211,097

2.2

2.7

U.S. government agencies

55,821

56,048

55,963

(0.4)

(0.3)

U.S. government agencies mortgage-backed

104,569

124,990

127,626

(16.3)

(18.1)

States and political subdivisions

220,100

226,128

224,259

(2.7)

(1.9)

Corporate bonds

4,961

9,622

9,544

(48.4)

(48.0)

Collateralized mortgage obligations

386,679

533,768

587,846

(27.6)

(34.2)

Asset-backed securities

66,916

201,928

219,587

(66.9)

(69.5)

Collateralized loan obligations

173,795

174,746

173,837

(0.5)

(0.0)

Total securities

$

1,229,618

$

1,539,359

$

1,609,759

(20.1)

(23.6)

Securities available-for-sale decreased $309.7 million as of September 30, 2023 compared to December 31, 2022, and decreased $380.1 million compared to September 30, 2022. The decrease in the portfolio during the third quarter of 2023 was driven by securities sales totaling $65.6 million and paydowns totaling $29.6 million, in addition to growth in unrealized losses of $8.1 million. We continue to

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seek to position the portfolio in higher credit quality, shorter duration securities with an appropriate mix of fixed- and floating-rate exposures.

September 30, 2023

Loans

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2023

2022

2022

2022

    

2022

Commercial

$

834,877

$

840,964

$

888,081

(0.7)

(6.0)

Leases

354,827

277,385

251,603

27.9

41.0

Commercial real estate – investor

1,047,122

987,635

941,910

6.0

11.2

Commercial real estate – owner occupied

809,050

854,879

876,951

(5.4)

(7.7)

Construction

202,546

180,535

176,700

12.2

14.6

Residential real estate – investor

53,762

57,353

59,580

(6.3)

(9.8)

Residential real estate – owner occupied

227,446

219,718

220,969

3.5

2.9

Multifamily

372,020

323,691

322,856

14.9

15.2

HELOC

102,055

109,202

116,108

(6.5)

(12.1)

Other 1

25,838

18,247

14,576

41.6

77.3

Total loans

$

4,029,543

$

3,869,609

$

3,869,334

4.1

4.1

1 The “Other” segment includes consumer loans and overdrafts.

Total loans were $4.03 billion as of September 30, 2023, an increase of $159.9 million from December 31, 2022.  The increase in total loans in the first nine months of 2023, compared to December 31, 2022, was due primarily to growth in loan originations, net of paydowns, within leases of $77.4 million, commercial real estate – investor of $59.5 million and multifamily of $48.3 million offset by net reductions in commercial real estate – owner occupied of $45.8 million from December 31, 2022.  Total loans increased $160.2 million from September 30, 2022 to September 30, 2023, primarily due to growth in loan originations, net of paydowns, within commercial real estate – investor of $105.2 million, leases of $103.2 million and multifamily of $49.2 million, offset by net reductions in commercial real estate – owner occupied of $67.9 million and commercial of $53.2 million.  As required by CECL, the balance (or amortized cost basis) of purchased credit deteriorated loans, or PCD loans (discussed below) is carried on a gross basis (rather than net of the associated credit loss estimate), and the expected credit losses for PCD loans are estimated and separately recognized as part of the allowance for credit losses, or ACL.  

The quality of our loan portfolio is impacted not only by our credit decisions but also by the economic health of the communities in which we operate.  Since we are located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial real estate, construction, residential, multifamily, and HELOCs) has been and continues to be a sizeable portion of our portfolio.  These categories comprised 69.8% of the portfolio as of September 30, 2023, compared to 70.6% of the portfolio as of December 31, 2022.  At September 30, 2023, our outstanding commercial real estate loans and undrawn commercial real estate commitments, excluding owner occupied real estate were equal to 288.9% of our Tier 1 capital plus allowance for credit losses, an increase from 304.2% at December 31, 2022.  We continue to oversee and seek to manage our loan portfolio in accordance with interagency guidance on risk management.

Asset Quality

Nonperforming loans consist of nonaccrual loans and loans 90 days or greater past due.  Prior to January 1, 2023, nonperforming loans also included performing troubled debt restructured loans accruing interest. Nonperforming loans increased by $30.4 million to $63.3 million at September 30, 2023 from $32.9 million at December 31, 2022 and increased $10.4 million from $52.9 million at September 30, 2022. 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 1.6% as of September 30, 2023, 0.9% as of December 31, 2022, and 1.4% as of September 30, 2022.  The distribution of our nonperforming loans is shown in the following table.

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September 30, 2023

Nonperforming Loans

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2023

2022

2022

2022

2022

Commercial

$

3,146

$

7,649

$

8,821

(58.9)

(64.3)

Leases

377

1,876

235

(79.9)

60.4

Commercial real estate – investor

26,724

4,346

17,945

514.9

48.9

Commercial real estate – owner occupied

18,290

8,223

9,581

122.4

90.9

Construction

7,206

251

7,525

N/M

(4.2)

Residential real estate – investor

1,502

1,672

1,380

(10.2)

8.8

Residential real estate – owner occupied

3,627

4,198

3,787

(13.6)

(4.2)

Multifamily

1,141

2,538

1,559

(55.0)

(26.8)

HELOC

1,312

2,158

2,065

(39.2)

(36.5)

Other 1

-

2

2

(100.0)

(100.0)

Total nonperforming loans

$

63,325

$

32,913

$

52,900

92.4

19.7

1 The “Other” segment includes consumer loans and overdrafts.

N/M – Not meaningful.

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

September 30, 2023

Nonperforming Assets

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

  

2023

  

2022

  

2022

  

2022

2022

Nonaccrual loans

$

62,116

$

31,602

$

32,126

96.6

93.4

Performing troubled debt restructured loans accruing interest 1

 

N/A

 

49

 

22

N/A

N/A

Loans past due 90 days or more and still accruing interest

 

1,209

 

1,262

 

20,752

(4.2)

(94.2)

Total nonperforming loans

 

63,325

 

32,913

 

52,900

92.4

19.7

Other real estate owned

 

407

 

1,561

 

1,561

(73.9)

(73.9)

Total nonperforming assets

$

63,732

$

34,474

$

54,461

84.9

17.0

30-89 days past due loans and still accruing interest

$

28,486

$

7,508

$

8,197

Nonaccrual loans to total loans

1.5

%

0.8

%

0.8

%

Nonperforming loans to total loans

1.6

%

0.9

%

1.4

%

Nonperforming assets to total loans plus OREO

1.6

%

0.9

%

1.4

%

Allowance for credit losses

$

51,729

$

49,480

$

48,847

Allowance for credit losses to total loans

1.3

%

1.3

%

1.3

%

Allowance for credit losses to nonaccrual loans

83.3

%

156.6

%

152.1

%

N/A – Not applicable

1 As of January 1, 2023, the Company prospectively adopted ASU 2022-02 Topic 326 “Troubled Debt Restructurings (“TDRs”) and Vintage Disclosures”, which eliminated the need for recognition, measurement and disclosure of TDRs going forward.  See Note 1 for further details of ASU 2022-02 adoption.

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Loan charge-offs, net of recoveries, for the third quarter of 2023, prior linked quarter and year over year quarter are shown in the following table.

Loan Charge–offs, Net of Recoveries

Three Months Ended

(Dollars in thousands)

September 30, 

% of

June 30, 

% of

September 30, 

% of

2023

Total1

2023

Total1

2022

Total1

Commercial

$

8

0.1

$

298

59.0

$

20

29.4

Leases

(95)

(1.4)

(7)

(1.4)

178

261.8

Commercial real estate – investor

6,754

102.4

51

10.1

105

154.4

Commercial real estate – owner occupied

23

0.3

198

39.2

(75)

(110.3)

Construction

(100)

(1.5)

-

-

-

-

Residential real estate – investor

(3)

-

(5)

(1.0)

(8)

(11.8)

Residential real estate – owner occupied

(25)

(0.4)

(36)

(7.1)

(113)

(166.2)

Multifamily

-

-

-

-

(63)

(92.6)

HELOC

(35)

(0.5)

(24)

(4.8)

(35)

(51.5)

Other 2

70

1.0

30

6.0

59

86.8

Net charge–offs

$

6,597

100.0

$

505

100.0

$

68

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 $6.6 million were recorded for the third quarter of 2023, compared to net charge-offs of $505,000 for the second quarter of 2023, and net charge-offs of $68,000 for the third quarter of 2022, reflecting continuing management attention to credit quality and remediation efforts.  The net charge-offs for the third quarter of 2023 were primarily due to charge offs of three commercial real estate-investor loans of $6.8 million in aggregate.  These three commercial real estate-investor credits had a reported reserve allocation of $4.7 million prior to the third quarter of 2023 charge-offs. We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs.  

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

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

September 30, 2023

Classified Assets

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2023

2022

2022

2022

2022

Commercial

$

18,298

$

26,485

$

31,722

(30.9)

(42.3)

Leases

574

1,876

235

(69.4)

144.3

Commercial real estate – investor

54,126

27,410

28,252

97.5

91.6

Commercial real estate – owner occupied

55,292

40,890

42,698

35.2

29.5

Construction

17,263

1,333

1,347

N/M

N/M

Residential real estate – investor

1,502

1,714

1,285

(12.4)

16.9

Residential real estate – owner occupied

3,627

3,854

3,929

(5.9)

(7.7)

Multifamily

1,141

2,954

1,982

(61.4)

(42.4)

HELOC

1,434

2,411

2,278

(40.5)

(37.1)

Other 1

-

2

2

(100.0)

(100.0)

Total classified loans

153,257

108,929

113,730

40.7

34.8

Other real estate owned

407

1,561

1,561

(73.9)

(73.9)

Total classified assets

$

153,664

$

110,490

$

115,291

39.1

33.3

1 The “Other” segment includes consumer loans and overdrafts.

N/M - Not meaningful

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Table of Contents

Total classified loans increased $44.3 million and classified assets increased $43.2 million as of September 30, 2023 from December 31, 2022. The increase since December 31, 2022 is due to the addition of $26.7 million of classified loans in commercial real estate – investor, primarily due to four large credits, two of which are office buildings, one is an assisted living facility during the first six months of 2023, and one office building in the third quarter of 2023. The increase is also due to the growth in construction, primarily due to two large credits. The increase from September 30, 2022 is primarily due to the same loan additions to commercial real estate – investor and construction. 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 23.51% for the period ended September 30, 2023, compared to 18.36% as of December 31, 2022, and 19.23% as of September 30, 2022.  

Allowance for Credit Losses on Loans

The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for credit losses (“ACL”) at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date.

At September 30, 2023, our ACL on loans totaled $51.7 million, and our ACL on unfunded commitments, included in other liabilities, totaled $2.9 million. In the third quarter of 2023, we recorded provision expense on loans of $3.0 million, based on our assessment of nonperforming loan metrics and trends and estimated future credit losses, and a $12,000 reversal of provision on unfunded commitments, primarily due to an adjustment of historical benchmark assumptions, such as funding rates and the period used to forecast those rates, within the ACL calculation.  These adjustments resulted in a $3.0 million net impact to the provision for credit losses for the third quarter of 2023.  

Management estimates the amount of provision required on a quarterly basis and records the appropriate provision expense, or release of expense, to maintain an adequate reserve for all potential and estimated credit losses on loans, leases and unfunded commitments.  The ACL on loans totaled $51.7 million as of September 30, 2023, $49.5 million as of December 31, 2022, and $48.8 million as of September 30, 2022.  Our ACL on loans to total loans was 1.3% as of September 30, 2023, compared to 1.3% as of December 31, 2022 and September 30, 2022.  See Item 7 – Critical Accounting Estimates in the Management Discussion and Analysis in our 2022 Annual Report in Form 10-K for discussion of our ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

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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, 

2023

2023

2022

2023

2022

Allowance at beginning of period

$

55,314

$

53,392

$

45,388

$

49,480

$

44,281

Charge–offs:

Commercial

20

380

67

427

149

Leases

-

-

178

882

178

Commercial real estate – investor

6,774

71

124

6,845

604

Commercial real estate – owner occupied

35

201

12

236

133

Construction

-

-

-

-

-

Residential real estate – investor

-

-

-

-

-

Residential real estate – owner occupied

-

-

-

-

-

Multifamily

-

-

-

-

-

HELOC

-

-

-

-

-

Other 1

107

81

103

301

320

Total charge–offs

6,936

733

484

8,691

1,384

Recoveries:

Commercial

12

82

47

245

85

Leases

95

7

-

111

-

Commercial real estate – investor

20

20

19

57

60

Commercial real estate – owner occupied

12

3

87

17

102

Construction

100

-

-

100

-

Residential real estate – investor

3

5

8

27

23

Residential real estate – owner occupied

25

36

113

71

218

Multifamily

-

-

63

-

63

HELOC

35

24

35

88

102

Other 1

37

51

44

133

120

Total recoveries

339

228

416

849

773

Net charge-offs

6,597

505

68

7,842

611

Provision for credit losses on loans

3,012

2,427

3,527

10,091

5,177

Allowance at end of period

$

51,729

$

55,314

$

48,847

$

51,729

$

48,847

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

$

4,009,218

$

4,039,052

$

3,751,097

$

3,993,600

$

3,552,871

Net charge–offs to average loans

0.65

%

0.05

%

0.01

%

0.26

%

0.02

%

Allowance at period end to average loans

1.29

%

1.37

%

1.30

%

1.30

%

1.37

%

1 The “Other” segment includes consumer loans and overdrafts.

The coverage ratio of the ACL on loans to nonperforming loans was 81.3% as of September 30, 2023, which was a decrease from the coverage ratio of 90.3% as of June 30, 2023 and a decrease from 92.3% as of September 30, 2023.  When measured as a percentage of average loans, our total ACL on loans was 1.29% at September 30, 2023, 1.37% at June 30, 2023, and 1.30% at September 30, 2022.

In management’s judgment, an adequate ACL has been established to encompass the current lifetime expected credit losses at September 30, 2023, and general changes in lending policy, procedures and staffing, as well as other external factors.  However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession.  Continued volatility in the economic environment stemming from the impacts of and response to inflation, potential recession, and the war in Ukraine and the conflict in the Middle East, and the associated effects on our customers, or other factors, such as changes in business climates and the condition of collateral at the time of default or repossession, may revise our current expectations of future credit losses in future reporting periods.

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Deposits and Borrowings

September 30, 2023

Deposits

As of

Percent Change From

(Dollars in thousands)

September 30, 

December 31, 

September 30, 

December 31, 

September 30, 

2023

2022

2022

2022

    

2022

Noninterest bearing demand

$

1,862,659

$

2,051,702

$

2,098,144

(9.2)

(11.2)

Savings

1,003,498

1,145,592

1,164,036

(12.4)

(13.8)

NOW accounts

567,997

609,338

630,747

(6.8)

(9.9)

Money market accounts

702,176

862,170

931,813

(18.6)

(24.6)

Certificates of deposit of less than $100,000

248,272

244,017

258,071

1.7

(3.8)

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

162,901

157,438

148,411

3.5

9.8

Certificates of deposit of more than $250,000

66,817

40,466

50,137

65.1

33.3

Total deposits

$

4,614,320

$

5,110,723

$

5,281,359

(9.7)

(12.6)

Total deposits were $4.61 billion at September 30, 2023, which reflects a $496.4 million decrease from total deposits of $5.11 billion at December 31, 2022, and a decrease of $667.0 million from total deposits of $5.28 billion at September 30, 2022.  The decrease in deposits at September 30, 2023, compared to December 31, 2022, was primarily due to decreases in noninterest-bearing deposits of $189.0 million, money market accounts of $160.0 million and savings accounts of $142.1 million. The decrease in deposits at September 30, 2023, compared to September 30, 2022, was primarily due to decreases in noninterest-bearing deposits of $235.5 million, money market accounts of $229.6 million, and savings accounts of $160.5 million.  Total quarterly average deposits decreased $659.4 million, or 12.4%, in the year over year period, driven by declines in our average demand deposits of $225.1 million, and savings, NOW and money markets combined of $440.7 million. In general, the bulk of the decline in deposits year over year can be characterized as rate sensitive with significant flows and transfers into investing activities, materially offsetting the significant expansion in those same accounts in the immediate aftermath of the pandemic.

The following table presents estimated insured and uninsured deposits at September 30, 2023 and December 31, 2022 by deposit type, as well as the weighted average rates for each year to date ending period.

(Dollars in thousands)

September 30, 2023

December 31, 2022

Total Deposits

Insured Deposits

Uninsured Deposits

Average Rate Paid

Total Deposits

Insured Deposits

Uninsured Deposits

Average Rate Paid

Noninterest bearing demand

$

1,862,659

$

1,202,051

$

660,608

-

%

$

2,051,702

$

1,327,379

$

724,323

-

%

Savings

1,003,498

935,664

67,834

0.08

1,145,592

1,065,153

80,439

0.03

NOW accounts

567,997

409,219

158,778

0.22

609,338

453,799

155,539

0.09

Money market accounts

702,176

490,539

211,637

0.67

862,170

588,923

273,247

0.10

Time deposits

477,990

414,227

63,763

1.14

441,921

381,980

59,941

0.31

Total

$

4,614,320

$

3,451,700

$

1,162,620

0.26

%

$

5,110,723

$

3,817,234

$

1,293,489

0.06

%

Collateralized public funds

$

264,322

$

15,410

$

248,912

$

262,318

$

15,879

$

246,439

Deposits declined 9.7% for the nine months ended September 30, 2023 due to retail and commercial run off.  Total deposit run off year to date has been very granular, and not necessarily attributable to large deposit accounts.  Our deposit retention efforts for commercial clients were more effective due to high touch relationships where we had a larger share of wallet.  The largest reduction in total deposits was from retail customers due to personal and real estate tax payments, real estate transactions, investments, and consumer spending.  In terms of product mix, we observed some migration into time deposits, drawn by CD rate specials.  Overall, our deposit level remains stable and we continue to monitor customer relationships and liquidity levels daily.

In addition to deposits, we used other liquidity sources for our funding needs in all periods presented, such as repurchase agreements and other short-term borrowings with the FHLBC. Securities sold under repurchase agreements totaled $25.9 million at September 30, 2023, a $6.3 million, or 19.5%, decrease from $32.2 million at December 31, 2022. Our excess liquidity on hand during much of 2022 allowed us to fund our short-term liquidity needs with cash on hand. During the third quarter of 2022, we began re-utilizing short-term borrowings from the FHLBC. The outstanding balance of our short-term FHLBC borrowings was $435.0 million as of September 30, 2023, $90.0 million as of December 31, 2022, and $25.0 million as of September 30, 2022.

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We are also indebted on $25.8 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust II (“Trust II”) as of September 30, 2023.  The Trust II issuance converted from fixed to floating rate at three month LIBOR, which is now three month Term SOFR, plus 150 basis points 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 4.18% as of September 30, 2023, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017 rate reset.

In the second quarter of 2021, we entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers pursuant to which we issued $60.0 million in aggregate principal amount of our 3.50% Fixed-to-Floating Rate Subordinated Notes due April 15, 2031 (the “Notes”).  We sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance were used for general corporate purposes. The Notes bear interest at a fixed annual rate of 3.50% through April 14, 2026, payable semi-annually in arrears.  As of April 15, 2026 forward, the interest rate on the Notes will generally reset quarterly to a rate equal to three-month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears.  The Notes have a stated maturity of April 15, 2031, and are redeemable, in whole are in part, on April 15, 2026, or any interest payment date thereafter, and at any time upon the occurrence of certain events. As of September 30, 2023, we had $59.4 million of subordinated debentures outstanding, net of deferred issuance costs.

In December 2016, we completed a $45.0 million senior note issuance. The notes had a ten-year term, and included interest payable semiannually at 5.75% for five years. Beginning December 31, 2021, the interest became payable quarterly at three month LIBOR plus 385 basis points. On June 30, 2023, the senior notes were redeemed in full.  The remaining balance of deferred debt issuance costs of $362,000 related to these senior notes was recognized as interest expense as of June 30, 2023.      

On February 24, 2023, we paid off the remaining $9.0 million balance in notes payable and other borrowings, resulting in no balance in this line item as of September 30, 2023, compared to $9.0 million as of December 31, 2022, and $10.0 million as of September 30, 2022. The balance in notes payable was related to a $20.0 million dollar 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.

Capital

As of September 30, 2023, total stockholders’ equity was $532.6 million, which was an increase of $71.5 million from $461.1 million as of December 31, 2022.  This increase is primarily attributable to an increase in retained earnings of $66.8 million due to net income of $73.5 million in the first nine months of 2023, partially offset by $6.7 million of dividends paid to our common stockholders. In addition, total stockholders’ equity as of September 30, 2023 increased over December 31, 2022, due to a reduction in unrealized net losses on available-for-sale securities, which decreased accumulated other comprehensive loss by $2.5 million in the first nine months of 2023, due to changes in market interest rates.  Total stockholders’ equity as of September 30, 2023 increased $98.8 million compared to September 30, 2022 due to net income year over year and the increase in accumulated other comprehensive loss of $7.8 million year over year.

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

Minimum Capital

Well Capitalized

Adequacy with

Under Prompt

Capital Conservation

Corrective Action

September 30, 

December 31, 

September 30, 

Buffer, if applicable1

Provisions2

2023

2022

2022

The Company

Common equity tier 1 capital ratio

7.00

%

N/A

11.00

%

9.67

%

9.16

%

Total risk-based capital ratio

10.50

%

N/A

13.84

%

12.52

%

11.99

%

Tier 1 risk-based capital ratio

8.50

%

N/A

11.52

%

10.20

%

9.68

%

Tier 1 leverage ratio

4.00

%

N/A

9.62

%

8.14

%

7.70

%

The Bank

Common equity tier 1 capital ratio

7.00

%

6.50

%

12.49

%

11.70

%

11.60

%

Total risk-based capital ratio

10.50

%

10.00

%

13.57

%

12.75

%

12.64

%

Tier 1 risk-based capital ratio

8.50

%

8.00

%

12.49

%

11.70

%

11.60

%

Tier 1 leverage ratio

4.00

%

5.00

%

10.43

%

9.32

%

9.24

%

1 Amounts are shown inclusive of a capital conservation buffer of 2.50%.

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

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As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopted CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we elected to utilize the five-year CECL transition.  As of September 30, 2023, our capital measures exclude $1.9 million, which is the modified CECL transition adjustment.

As of September 30, 2023, the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” and met the capital conservation buffer requirements.  In addition to the above regulatory ratios, our GAAP common equity to total assets ratio, which is used as a performance measurement for capital analysis and peer comparisons, increased from 7.83% at December 31, 2022, to 9.25% at September 30, 2023. Our GAAP tangible common equity to tangible assets ratio was 7.67% at September 30, 2023, compared to 6.24% as of December 31, 2022.  Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, increased from 6.28% at December 31, 2022, to 7.71% at September 30, 2023, primarily due to an increase in tangible common equity in the third quarter of 2023.  The increase in tangible common equity was due to an increase in retained earnings of $66.8 million and an increase in accumulated other comprehensive loss of $2.5 million primarily related to improved unrealized losses on available-for-sale securities stemming from the changes in market interest rates.

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

September 30, 2023

December 31, 2022

Tangible common equity

GAAP

Non-GAAP

GAAP

Non-GAAP

(Dollars in thousands)

Total Equity

$

532,558

$

532,558

$

461,141

$

461,141

Less: Goodwill and intangible assets

98,298

98,298

100,156

100,156

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

N/A

2,364

N/A

2,736

Adjusted goodwill and intangible assets

98,298

95,934

100,156

97,420

Tangible common equity

$

434,260

$

436,624

$

360,985

$

363,721

Tangible assets

Total assets

$

5,758,156

$

5,758,156

$

5,888,317

$

5,888,317

Less: Adjusted goodwill and intangible assets

98,298

95,934

100,156

97,420

Tangible assets

$

5,659,858

$

5,662,222

$

5,788,161

$

5,790,897

Common equity to total assets

9.25

%

9.25

%

7.83

%

7.83

%

Tangible common equity to tangible assets

7.67

%

7.71

%

6.24

%

6.28

%

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

Liquidity

Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments.  Our liquidity principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds. In the third quarter of 2023, we continued to experience moderate loan growth, while deposits have trended down as clients moved balances to pursue higher yields as well as due to seasonal declines.  We managed the change in our funding through borrowing from the Federal Home Loan Bank of Chicago (“FHLBC”) and sales of securities, which resulted in minimal losses and mitigated our interest rate risk profile.  The bank failures in the first five months of 2023 exemplify the potentially serious results of the unexpected inability of insured depository institutions to obtain needed liquidity to satisfy deposit withdrawal requests, including how quickly such requests can accelerate once uninsured depositors lose confidence in an institution’s ability to satisfy its obligations to depositors. We seek to ensure our funding needs are met by maintaining a level of liquidity through asset and liability management. We monitor our borrowing capacity at the FHLBC as part of our liquidity management process as supervised by our Asset and Liability Committee (“ALCO”) and reviewed by our Board of Directors.  In addition, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs.  As of September 30, 2023, our cash on hand liquidity totaled $109.0 million, a decrease of $6.1 million over cash balances held as of December 31, 2022.  

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Net cash inflows from operating activities were $87.3 million during the first nine months of 2023, compared with net cash inflows of $60.1 million in the same period of 2022.  Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, were a source of outflows for the first nine months of 2023 compared to a source of inflows for the like period of 2022.  Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of outflows for the nine months ended September 30, 2023 and source of inflows for the like period of 2022. The management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows.  Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process.

Net cash inflows from investing activities were $124.5 million in the nine months ended September 30, 2023, compared to net cash outflows of $506.4 million in the same period in 2022.  In the first nine months of 2023, securities transactions accounted for net inflows of $306.0 million, and the principal change on loans accounted for net outflows of $164.3 million.  In the first nine months of 2022, securities transactions accounted for net outflows of $66.9 million, and principal on loans funded, net of paydowns, accounted for net outflows of $443.6 million.  

Net cash outflows from financing activities in the nine months ended September 30, 2023, were $218.0 million, compared with net cash outflows of $189.7 million in the nine months ended September 30, 2022.  Net deposit outflows in the first nine months of 2023 were $495.4 million compared to net deposit outflows of $183.7 million in the first nine months of 2022.  Other short-term borrowings had $345.0 million of net cash inflows in the first nine months of 2023, compared to net cash inflows of $25.0 million for other short-term borrowings in the first nine months of 2022.  Changes in securities sold under repurchase agreements accounted for outflows of $6.3 million and outflows of $14.8 million for the nine months ended September 30, 2023 and 2022, respectively.  Dividends paid on our common stock totaled $6.7 million for both the nine months ended September 30, 2023 and 2022.  The purchase of treasury stock in the first nine months of 2023 due to shares acquired with equity award vestings resulted in outflows of $605,000, compared to cash outflows of $447,000 in the first nine months of 2022.

Cash and cash equivalents for the nine months ended September 30, 2023, totaled $109.0 million, as compared to $115.2 million as of December 31, 2022 and $116.2 million as of September 30, 2022.  The decrease in cash and cash equivalents for the nine months ended September 30, 2023 was mainly attributable to loan growth and the payoffs of the remaining balance of the term note and senior notes, as well as deposit outflows, partially offset by security sales and FHLB advances during the first nine months of 2023. The year over year decrease is again driven by loan growth, as well as increased customer use of deposits. In addition to cash and cash equivalents on hand or held as deposits with other financial institutions, we rely on funding sources from customer deposits, cash flows from securities available-for-sale and loans, and a line of credit with the FHLBC to meet potential liquidity needs.  These sources of liquidity are immediately available to satisfy any funding requirements due to depositor or borrower demands through the ordinary course of our business.  Additional sources of funding include a $30.0 million undrawn line of credit held by the Company with a third party financial institution, as well as unpledged securities available-for-sale.    

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

As part of our normal operations, we are subject to interest-rate risk on the assets we invest in (primarily loans and securities) and the liabilities we fund (primarily customer deposits and borrowed funds).  Fluctuations in interest rates may result in changes in the fair market values of our financial instruments, cash flows, and net interest income.  Like most financial institutions, we have an exposure to changes in both short-term and long-term interest rates. A financial institution’s ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in a volatile rate environment.  We mitigate the impact of interest rate volatility to the Bank by managing our rate sensitivity under various scenarios.

During the third quarter of 2023, the Federal Reserve increased rates by 0.25% in July and held rates unchanged at the September FOMC meeting.  The current market expectation is for rates to be unchanged for the remainder of 2023.  The projected level of rate cuts in 2024 have been reduced and moved to later in the year, framing a “higher rates for a longer period” outcome.  The Federal Reserve managed to shrink its balance sheet to $8.0 trillion by September 2023, down from its peak of $8.7 trillion in March 2023.

We manage interest rate risk within guidelines established by policy which are intended to limit the amount of rate exposure.  In practice, we seek to manage our interest rate risk exposure within our guidelines so that such exposure does not pose a material risk to our future earnings.  We manage various market risks in the normal course of our operations, including credit, liquidity risk, and interest-rate risk.  Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of our business activities and operations.  In addition, since we do not hold a trading portfolio, we are not exposed to significant market risk from trading activities.  Our interest rate risk exposures at September 30, 2023 and December 31, 2022 are outlined in the table below.

Our net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such as SOFR and Prime), and balance sheet growth or contraction.  Our asset-liability committee seeks to manage interest rate risk under a variety of rate environments by structuring our on-balance sheet and off-balance sheet positions, which includes interest rate swap derivatives as discussed in Note 19 of our consolidated financial statements found in in our Annual Report on Form 10-K for the year ended December 31, 2022.  We seek to monitor and manage interest rate risk within approved policy guidelines and limits.  Asset and liability modeling and tracking is performed and presented to the Asset-Liability committee and the Board of Directors no less than quarterly. The presentations discuss our current and historical interest rate risk posture, shifts in the balance sheet composition, and the impact of interest rate movements on earnings and equity.  Our current balance sheet is a moderately asset sensitive profile, as our variable rate assets reprice faster than our longer duration, low beta deposit base. Recent market events of failed liquidity management at other banks have been reviewed by the Asset-Liability committee. The committee concluded that we possess a strong liquidity profile and no new liquidity risks were identified.  Prudently, we added new measures to assess liquidity risk and enhanced our reports to segment deposits by insured, uninsured, collateralized deposits; and monitor the bank’s funding sources and uses on a regular basis.

We also have a Risk Committee, chaired by our Chief Risk Officer, which reports no less than quarterly to senior management as well as our Board of Directors regarding compliance with risk tolerance limits, key risk factor changes, both internally and externally, due to portfolio changes as well as market conditions.  Our enterprise risk management framework is governed by this committee, with input being provided by line of business managers, senior management and the Board.

We use simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by us are incorporated into the simulation model. Earnings at risk are calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a different interest rate environment in order to determine the percentage change. As of September 30, 2023, our net interest income profile remained sensitive to earnings gains (in both dollars and percentage) should interest rates rise.  However, we have moved to a less sensitive profile compared to December 31, 2022, due to the impact of interest rate swaps and sales of variable rate securities.

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The following table summarizes the effect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 0.5%, 1.0%, and 2.0%, with no change in the slope of the yield curve.  

Analysis of Net Interest Income Sensitivity

Immediate Changes in Rates

(Dollars in thousands)

    

(2.0)

%

    

(1.0)

%

    

  

(0.5)

%

    

  

0.5

%

    

  

1.0

%

    

  

2.0

%

September 30, 2023

Dollar change

$

(37,003)

$

(18,371)

$

(9,055)

$

9,349

$

18,817

$

36,942

Percent change

(14.6)

%

(7.2)

%

(3.6)

%

3.7

%

7.4

%

14.5

%

December 31, 2022

Dollar change

$

(46,800)

$

(22,963)

$

(11,327)

$

11,278

$

22,593

$

44,482

Percent change

(18.2)

%

(8.9)

%

(4.4)

%

4.4

%

8.8

%

17.3

%

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

Effects of Inflation

In management’s opinion, although changes in interest rates affect our financial condition to a far greater degree than changes in the inflation rate, we monitor both.  The annual US inflation rate for September 2023 was 3.7%, a moderate increase quarter-over-quarter, while Core CPI eased to 4.1%.  Management believes the inflation rate will continue to come down, albeit at a much slower rate than experienced year-to-date as of September 2023.  The downside risks of high inflation put upwards pressure to our expenses, which could impact our profits.  Furthermore, higher costs of living weaken the financial condition of our borrowers which could affect our credit profile.  Overall, we expect the risk of high inflation has been contained with minimal impact to our results.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of September 30, 2023.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2023, 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, 2023, 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.

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Table of Contents

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

The Company and its subsidiaries, from time to time, are involved in collection suits in the ordinary course of business against its debtors and are defendants in legal actions arising from normal business activities.  Management, after consultation with legal counsel, believes that the ultimate liabilities, if any, resulting from these actions will not have a material adverse effect on the financial position of the Bank or on the consolidated financial position of the Company.

Item 1.A.  Risk Factors

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as well as cautionary statements contained in this Quarterly Report, on Form 10-Q, including those under the caption “Cautionary Note Regarding Forward-Looking Statements.”

There have been no material changes to the risk factors previously disclosed in the Company’s (i) Annual Report on Form 10-K for the fiscal year ended December 31, 2022; (ii) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2023; and (iii) Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2023.

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

None.

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

None.

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Table of Contents

Item 6.  Exhibits

Exhibits:

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, 2023 and December 31, 2022; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2023 and 2022; (iii) Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2023 and 2022; (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2023 and 2022; (v) Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2023 and 2022; and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.

104

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

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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

Chairman and Chief Executive Officer

(principal executive officer)

BY:

/s/ Bradley S. Adams

Bradley S. Adams

Executive Vice President,

Chief Operating Officer and Chief Financial Officer

(principal financial and accounting officer)

DATE: November 8, 2023

66