CMYCMMYCYCMYKAR_Cover_2013_OL.pdf 1 3/12/14 9:35 AM0247_Cov.indd 13/14/14 2:29 PM UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to ____________
Commission file number 0-10537
OLD SECOND BANCORP, INC._______
(Exact name of registrant as specified in its charter)
Delaware 36-3143493____
(State of Incorporation) (IRS Employer Identification Number)
37 South River Street, Aurora, Illinois 60507____
(Address of principal executive offices, including zip code)
(630) 892-0202________
(Registrant's telephone number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of each exchange on which registered
Common Stock, $1.00 par value
Preferred Securities of Old Second Capital Trust I
The Nasdaq Stock Market
The Nasdaq Stock Market
Securities registered pursuant to Section 12(g) of the Act:
Preferred Share Purchase Rights
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.
Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Exchange Act.
Yes
No
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 and posted on its corporate Website, if
any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during
the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements
incorporated by Reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer
or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
(Do not check if smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes
No
1
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, on
June 30, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was
approximately $70.1 million. The number of shares outstanding of the registrant's common stock, par value $1.00
per share, was 13,923,843 at February 20, 2014.
2
OLD SECOND BANCORP, INC.
Form 10-K
INDEX
PART I
Item 1
Business
Item 1A
Risk Factors
Item 1B
Unresolved Staff Comments
Item 2
Item 3
Item 4
PART II
Item 5
Item 6
Item 7
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Selected Financial Data
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 7A
Quantitative and Qualitative Disclosures about Market Risk
Item 8
Item 9
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
Item 9A
Controls and Procedures
Item 9B
Other Information
PART III
Item 10
Directors, Executive Officers, and Corporate Governance
Item 11
Executive Compensation
Item 12
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
Page
4
32
46
46
47
47
48
51
52
70
73
124
124
127
127
132
150
Item 13
Certain Relationships and Related Transactions, and Director Independence
152
Item 14
Principal Accountant Fees and Services
PART IV
Item 15
Exhibits and Financial Statement Schedules
Signatures
153
153
154
3
PART I
Item 1. Business
General
Old Second Bancorp, Inc. (the "Company" or the "Registrant") was organized under the laws of Delaware
on September 8, 1981. It is a registered bank holding company under the Bank Holding Company Act of
1956 (the "BHCA"). The Company's office is located at 37 South River Street, Aurora, Illinois 60507.
The Company conducts a full service community banking and trust business through the following
wholly owned subsidiaries, which together with the Registrant are referred to as the “Company”:
(cid:120) Old Second National Bank (the “Bank”).
(cid:120) Old Second Capital Trust I, which was formed for the exclusive purpose of issuing trust preferred
securities in an offering that was completed in July 2003.
(cid:120) Old Second Capital Trust II, which was formed for the exclusive purpose of issuing trust preferred
securities in an offering that was completed in April 2007.
(cid:120) Old Second Affordable Housing Fund, L.L.C., which was formed for the purpose of providing
down payment assistance for home ownership to qualified individuals.
(cid:120) A series of limited liability companies wholly owned by the Bank and formed between 2008 and
2012 to hold property acquired by the Bank through foreclosure or in the ordinary course of
collecting a debt previously contracted with borrowers.
(cid:120) River Street Advisors, LLC, a wholly-owned subsidiary of the Bank, which was formed in May
2010 to provide investment advisory/management services.
Inter-company transactions and balances are eliminated in consolidation.
The Company provides financial services through its 27 banking locations that are located primarily in
Aurora, Illinois, and its surrounding communities and throughout the Chicago metropolitan area. These
locations included retail offices located in Kane, Kendall, DeKalb, DuPage, LaSalle, Will and
southwestern Cook counties in Illinois as of December 31, 2013. The Company expanded its franchise
from long standing offices in the western suburbs into Cook County and traditionally growing southern
Chicago suburbs with an acquisition in February 2008.
Business of the Company and its Subsidiaries
The Bank’s full service banking businesses include the customary consumer and commercial products
and services that banks provide including demand, NOW, money market, savings, time deposit,
individual retirement and Keogh deposit accounts; commercial, industrial, consumer and real estate
lending, including installment loans, student loans, agricultural loans, lines of credit and overdraft
checking; safe deposit operations; trust services; wealth management services, and an extensive variety of
additional services tailored to the needs of individual customers, such as the acquisition of U.S. Treasury
notes and bonds, the sale of traveler's checks, money orders, cashiers’ checks and foreign currency, direct
deposit, discount brokerage, debit cards, credit cards, and other special services. The Bank also offers a
full complement of electronic banking services such as online and mobile banking and corporate cash
management products including remote deposit capture, mobile deposit capture, investment sweep
accounts, zero balance accounts, automated tax payments, ATM access, telephone banking, lockbox
accounts, automated clearing house transactions, account reconciliation, controlled disbursement, detail
and general information reporting, wire transfers, vault services for currency and coin, and checking
accounts. Commercial and consumer loans are made to corporations, partnerships and individuals,
primarily on a secured basis. Commercial lending focuses on business, capital, construction, inventory
and real estate lending. Installment lending includes direct and indirect loans to consumers and
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commercial customers. Additionally, the Bank provides a wide range of wealth management, investment,
agency, and custodial services for individual, corporate, and not-for-profit clients. These services include
the administration of estates and personal trusts, as well as the management of investment accounts for
individuals, employee benefit plans, and charitable foundations. The Bank also originates residential
mortgages, offering a wide range of mortgage products including conventional, government, and jumbo
loans. Secondary marketing of those mortgages is also handled at the Bank.
Operating segments are components of a business about which separate financial information is available
and that are evaluated regularly by the Company’s management in deciding how to allocate resources and
assess performance. Public companies are required to report certain financial information about operating
segments. The Company’s management evaluates the operations of the Company as one operating
segment, i.e. community banking. As a result, disclosure of separate segment information is not required.
The Company offers the products and services described above to its external customers as part of its
customary banking business.
Market Area
The Company’s primary market area is Aurora, Illinois and its surrounding communities. The city of
Aurora is located in northeastern Illinois, approximately 40 miles west of Chicago. The Bank operates
primarily in Kane, Kendall, DeKalb, DuPage, LaSalle, Will and southwestern Cook counties in Illinois,
and it has developed a strong presence in these counties. Based on 2012 estimates from the United States
Census Bureau, these counties, excluding Cook County, represent a market of more than 2.4 million
people, and the city of Aurora itself has a population of approximately 200,000 residents. In addition, in
2008, the Company added an office in southwestern Cook County, which has an estimated population of
5.2 million people. The Bank offers its services to retail, commercial, industrial, and public entity
customers in the Aurora, North Aurora, Batavia, St. Charles, Burlington, Elburn, Elgin, Maple Park,
Kaneville, Sugar Grove, Naperville, Lisle, Joliet, Yorkville, Plano, Wasco, Ottawa, Oswego, Sycamore,
New Lenox, Frankfort, and Chicago Heights communities and surrounding areas.
Lending Activities
The Bank provides a broad range of commercial and retail lending services to corporations, partnerships,
individuals and government agencies. The Bank actively markets its services to qualified borrowers.
Lending officers actively solicit the business of new borrowers entering our market areas as well as long-
standing members of the local business community. The Bank has established and updated lending
policies that include a number of underwriting factors to be considered in making a loan, including
location, amortization, loan to value ratio, cash flow, pricing, documentation and the credit history of the
borrower. In 2013, the Bank originated approximately $409.4 million in loans. Also in 2013, residential
mortgage loans of just over $185.4 million (some of which were originated in 2012) were sold to
investors. The Bank’s loan portfolios are comprised primarily of loans in the areas of commercial real
estate, residential real estate, construction, general commercial and consumer lending. As of December
31, 2013, residential mortgages made up approximately 35% of the Bank’s loan portfolio, commercial
real estate loans comprised approximately 51%, construction lending comprised approximately 3%,
general commercial loans comprised approximately 9%, and consumer and other lending comprised less
than 2%. It is the Bank’s policy to comply at all times with the various consumer protection laws and
regulations including, but not limited to, the Equal Credit Opportunity Act, the Fair Housing Act, the
Community Reinvestment Act, the Truth in Lending Act, and the Home Mortgage Disclosure Act. The
Bank does not discriminate in application procedures, loan availability, pricing, structure, or terms on the
basis of race, color, religion, national origin, sex, marital status, familial status, handicap, age (provided
the applicant has the legal capacity to enter into a binding contract), whether income is derived from
public assistance, whether a borrower resides, or his property is located, in a low- or moderate-income
area, or whether a right was exercised under the Consumer Credit Protection Act. The Bank strives to
offer all of its credit services throughout its market area, including low- and moderate-income areas.
5
Commercial Loans. The Bank continues to focus on growing commercial and industrial prospects in the
new business pipeline with positive results, mostly occurring in fourth quarter. As noted above, the Bank
is an active commercial lender, primarily located west and south of the Chicago metropolitan area and
active in other parts of the Chicago and Aurora metropolitan areas. Commercial lending reflects
revolving lines of credit for working capital, lending for capital expenditures on manufacturing equipment
and lending to small business manufactures, service companies, medical and dental entities as well as
specialty contractors. The Bank also has commercial and industrial loans to customers with over $50
million in revenue in food product manufacturing, food process and packing, machinery tooling
manufacturing as well as service and technology companies. Collateral for these loans generally includes
accounts receivable, inventory, equipment and real estate. In addition, the Bank may take personal
guarantees to help assure repayment. Loans may be made on an unsecured basis if warranted by the
overall financial condition of the borrower. Commercial lines of credit are predominantly for a one to
two year term and have floating rates. Commercial term loans range principally from one to eight years
with the majority falling in the one to five year range. Interest rates are primarily fixed although some
have interest rates tied to the prime rate or LIBOR. While management would like to continue to
diversify the loan portfolio, overall demand for working capital and equipment financing continued to be
muted in the Bank’s primary market area in 2013.
Repayment of commercial loans is largely dependent upon the cash flows generated by the operations of
the commercial enterprise. The Bank’s underwriting procedures identify the sources of those cash flows
and seek to match the repayment terms of the commercial loans to the sources. Secondary repayment
sources are typically found in collateralization and guarantor support.
Commercial Real Estate Loans. While management has been actively working to reduce the Bank’s
concentrations in real estate loans, including commercial real estate loans, a large portion of the loan
portfolio continues to be comprised of commercial real estate loans. As of December 31, 2013,
approximately $294.4 million, or 52.5%, of the total commercial real estate loan portfolio of $560.2
million was to borrowers who secured the loan with owner occupied property. A primary repayment risk
for a commercial real estate loan is interruption or discontinuance of cash flows from operations. Such
cash flows are usually derived from rent in the case of nonowner occupied commercial properties.
Repayment could also be influenced by economic events, which may or may not be under the control of
the borrower, or changes in governmental regulations that negatively impact the future cash flow and
market values of the affected properties. Repayment risk can also arise from general downward shifts in
the valuations of classes of properties over a given geographic area such as the ongoing but diminished
price adjustments that have been observed by the Company beginning in 2008. Property valuations could
continue to be affected by changes in demand and other economic factors, which could further influence
cash flows associated with the borrower and/or the property. The Bank attempts to mitigate these risks by
staying apprised of market conditions and by maintaining underwriting practices that provide for adequate
cash flow margins and multiple repayment sources as well as remaining in regular contact with the
borrowers. In most cases, the Bank has collateralized these loans and/or has taken personal guarantees to
help assure repayment. Commercial real estate loans are primarily made based on the identified cash
flow of the borrower and/or the property at origination and secondarily on the underlying real estate
acting as collateral. Additional credit support is provided by the borrower for most of these loans and the
probability of repayment is based on the liquidation of the real estate and enforcement of a personal
guarantee, if any exists.
Construction Loans. The Bank’s construction and development lending and related risks have
greatly diminished from prior periods. The construction and development portfolio no longer dominates
the Bank’s commercial real estate portfolio. While outside data sources report a considerable rise in
national homebuilder activity, the Bank’s construction lending is very limited in the current economic
environment. Loans in this category decreased from $42.2 million at December 31, 2012, to $29.4
million at December 31, 2013. The Bank uses underwriting and construction loan guidelines to determine
6
whether to issue loans to reputable contractors on build-to-suit or build out of existing borrower
properties.
Construction loans are structured most often to be converted to permanent loans at the end of the
construction phase or, infrequently, to be paid off upon receiving financing from another financial
institution. Construction loans are generally limited to our local market area. Lending decisions have
been based on the appraised value of the property as determined by an independent appraiser, an analysis
of the potential marketability and profitability of the project and identification of a cash flow source to
service the permanent loan or verification of a refinancing source. Construction loans generally have
terms of up to 12 months, with extensions as needed. The Bank disburses loan proceeds in increments as
construction progresses and as inspections warrant.
Construction development loans involve additional risks. Development lending often involves the
disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate
project rather than the ability of the borrower or guarantor to repay principal and interest. This generally
involves more risk than other lending because it is based on future estimates of value and economic
circumstances. While appraisals are required prior to funding, and loan advances are limited to the value
determined by the appraisal, there is the possibility of an unforeseen event affecting the value and/or costs
of the project. Development loans are primarily used for single-family developments, where the sale of
lots and houses are tied to customer preferences and interest rates. If the borrower defaults prior to
completion of the project, the Bank may be required to fund additional amounts so that another developer
can complete the project. The Bank is located in an area where a large amount of development activity
has occurred as rural and semi-rural areas are being suburbanized. This type of growth presents some
economic risks should the shift in local demand for housing that occurred in conjunction with stressed
economic conditions become permanent. The Bank addresses these risks by closely monitoring local real
estate activity, adhering to proper underwriting procedures, closely monitoring construction projects, and
limiting the amount of construction development lending.
Activity in this sector slowed considerably with the downward economic trends in real estate and other
markets that the Company and the U.S. economy have experienced since 2008.
Residential Real Estate Loans. Residential first mortgage loans, second mortgages, and home equity line
of credit mortgages are included in this category. First mortgage loans may include fixed rate loans that
are generally sold to investors. The Bank is a direct seller to the Federal National Mortgage Association
(“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and to several large financial
institutions. The Bank periodically retains servicing rights for sold mortgages. The periodic retention of
such servicing rights also allows the Bank an opportunity to have regular contact with mortgage
customers and can help to solidify community involvement. Other loans that are not sold include
adjustable rate mortgages, lot loans, and constructions loans that are held in portfolio by the Bank. In
light of lower residential property prices, residential mortgage purchase activity has reflected a moderate
level of activity as purchasers initiate a purchase transaction at a near market bottom price while locking
in a comparatively low mortgage rate. Home equity lending has continued to slow in the past year but is
still a meaningful portion of the Bank’s business.
Consumer Loans. The Bank also provides many types of consumer loans including motor vehicle, home
improvement, signature loans and small personal credit lines. Consumer loans typically have shorter
terms and lower balances with higher yields as compared to other loans but generally carry higher risks of
default. Consumer loan collections are dependent on the borrower’s continuing financial stability and thus
are more likely to be affected by adverse personal circumstances.
7
Competition
The Company’s market area is highly competitive, and the Bank’s business and activities require us to
compete with many other companies. A number of these financial institutions are affiliated with large
bank holding companies headquartered outside of our principal market area as well as other institutions
that are based in Aurora's surrounding communities and in Chicago, Illinois. All of these financial
institutions operate banking offices in the greater Aurora area or actively compete for customers within
the Company's market area. The Bank also faces competition from finance companies, insurance
companies, credit unions, mortgage companies, securities brokerage firms, money market funds, loan
production offices and other providers of financial services. Many of our nonbank competitors are not
subject to the same extensive federal regulations that govern bank holding companies and banks, such as
the Company and may, as a result, have certain competitive advantages.
The Bank competes for loans principally through the quality of its client service and its responsiveness to
client needs in addition to competing on interest rates and loan fees. Management believes that its long-
standing presence in the community and personal one-on-one service philosophy enhances its ability to
compete favorably in attracting and retaining individual and business customers. The Bank actively
solicits deposit-related clients and competes for deposits by offering personal attention, competitive
interest rates, and professional services made available through practiced bankers and multiple delivery
channels that fit the needs of its market.
The Bank operated 27 branches in the seven counties of Kane, Kendall, LaSalle, Will, DeKalb, DuPage,
and southwestern Cook County as of December 31, 2013. As of June 30, 2013, the Bank was a deposit
market leader in Kane and Kendall Counties, the Bank faced competition from 196 bank branches
representing 42 different financial institutions (including us) according to the June 30, 2013, Federal
Deposit Insurance Corporation (“FDIC”) share of deposit data. The Bank’s branches in the remaining
counties in which it operates face many of these same competitors as well as competition from other non-
FDIC insured credit unions and financial service firms. The financial services industry will continue to
become more competitive as further technological advances enable more companies to provide expanded
financial services without having a physical presence in our market.
Employees
At December 31, 2013, the Company employed 492 full-time equivalent employees. The Company
places a high priority on staff development, which involves extensive training, including customer service
training. New employees are selected on the basis of both technical skills and customer service
capabilities. None of the Company's employees are covered by collective bargaining agreements.
Internet
The Company maintains a corporate website at www.oldsecond.com. The Company makes available free
of charge on or through its website the Annual Report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a)
or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files
such material with, or furnishes it to, the Securities and Exchange Commission (the “SEC”). Many of the
Company’s policies, committee charters and other investor information including our Code of Business
Conduct and Ethics, are available on the Company’s website. The Company’s reports, proxy and
informational statements and other information regarding the Company are available free of charge on the
SEC’s website (www.sec.gov). The Company will also provide copies of its filings free of charge upon
written request to: J. Douglas Cheatham, Executive Vice President and Chief Financial Officer, Old
Second Bancorp, Inc., 37 South River Street, Aurora, Illinois 60507.
8
Forward-Looking Statements: This report may contain forward-looking statements. Forward-looking
statements are identifiable by the inclusion of such qualifications as expects, intends, believes, may, likely
or other indications that the particular statements are not based upon facts but are rather based upon the
Company’s beliefs as of the date of this release. Actual events and results may differ significantly from
those described in such forward-looking statements, due to changes in the economy, interest rates or other
factors. Additionally, all statements in this Form 10-K, 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.
9
SUPERVISION AND REGULATION
General
Financial institutions, their holding companies and their affiliates are extensively regulated under federal
and state law. As a result, the growth and earnings performance of the Company may be affected not
only by management decisions and general economic conditions, but also by requirements of federal and
state statutes and by the regulations and policies of various bank regulatory agencies, including the
Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve
System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”) and Consumer
Financial Protection Bureau (the “CFPB”). Furthermore, taxation laws administered by the Internal
Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting
Standards Board (the “FASB”) and securities laws administered by the Securities and Exchange
Commission (the “SEC”) and state securities authorities have an impact on the business of the Company.
The effect of these statutes, regulations, regulatory policies and accounting rules are significant to the
operations and results of the Company and the Bank, and the nature and extent of future legislative,
regulatory or other changes affecting financial institutions are impossible to predict with any certainty.
Federal and state banking laws impose a comprehensive system of supervision, regulation and
enforcement on the operations of financial institutions, their holding companies and affiliates that is
intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than
shareholders. These federal and state laws, and the regulations of the bank regulatory agencies issued
under them, affect, among other things, the scope of business, the kinds and amounts of investments
banks may make, reserve requirements, capital levels relative to operations, the nature and amount of
collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings
with insiders and affiliates and the payment of dividends. Moreover, turmoil in the credit markets in
recent years prompted the enactment of unprecedented legislation that has allowed the U.S. Department
of the Treasury (the “Treasury”) to make equity capital available to qualifying financial institutions to
help restore confidence and stability in the U.S. financial markets, which imposes additional requirements
on institutions in which the Treasury has an investment.
This supervisory and regulatory framework subjects banks and bank holding companies to regular
examination by their respective regulatory agencies, which results in examination reports and ratings that
are not publicly available and that can impact the conduct and growth of their business.
These examinations consider not only compliance with applicable laws and regulations, but also capital
levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other
factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on
the operations of a regulated entity where the agencies determine, among other things, that such
operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with
laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework
applicable to the Company and the Bank. It does not describe all of the statutes, regulations and
regulatory policies that apply, nor does it restate all of the requirements of those that are described.
The descriptions are qualified in their entirety by reference to the particular statutory and regulatory
provision.
Financial Regulatory Reform
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection
Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act represents a sweeping reform of the U.S.
supervisory and regulatory framework applicable to financial institutions and capital markets in the wake
of the global financial crisis, certain aspects of which are described below in more detail. In particular,
and among other things, the Dodd-Frank Act: (i) created a Financial Stability Oversight Council as part of
a regulatory structure for identifying emerging systemic risks and improving interagency cooperation; (ii)
created the CFPB, which is authorized to regulate providers of consumer credit, savings, payment and
10
other consumer financial products and services; (iii) narrowed the scope of federal preemption of state
consumer laws enjoyed by national banks and federal savings associations and expanded the authority of
state attorneys general to bring actions to enforce federal consumer protection legislation; (iv) imposed
more stringent capital requirements on bank holding companies and subjected certain activities, including
interstate mergers and acquisitions, to heightened capital conditions; (v) with respect to mortgage lending,
(a) significantly expanded requirements applicable to loans secured by 1-4 family residential real
property, (b) imposed strict rules on mortgage servicing, and (c) required the originator of a securitized
loan, or the sponsor of a securitization, to retain at least 5% of the credit risk of securitized exposures
unless the underlying exposures are qualified residential mortgages or meet certain underwriting
standards; (vi) repealed the prohibition on the payment of interest on business checking accounts; (vii)
restricted the interchange fees payable on debit card transactions for issuers with $10 billion in assets or
greater; (viii) in the so-called “Volcker Rule”, subject to numerous exceptions, prohibited depository
institutions and affiliates from certain investments in, and sponsorship of, hedge funds and private equity
funds and from engaging in proprietary trading; (ix) provided for enhanced regulation of advisers to
private funds and of the derivatives markets; enhanced oversight of credit rating agencies; and (x)
prohibited banking agency requirements tied to credit ratings. These statutory changes shifted the
regulatory framework for financial institutions, impacted the way in which they do business and have the
potential to constrain revenues.
Numerous provisions of the Dodd-Frank Act are required to be implemented through rulemaking by the
appropriate federal regulatory agencies. Many of the required regulations have been issued and others
have been released for public comment, but there remain a number that have yet to be released in any
form. Furthermore, while the reforms primarily target systemically important financial service providers,
their influence is expected to filter down in varying degrees to smaller institutions over time. Management
of the Company and the Bank will continue to evaluate the effect of the Dodd-Frank Act changes;
however, in many respects, the ultimate impact of the Dodd-Frank Act will not be fully known for years,
and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes,
will not have a negative impact on the results of operations and financial condition of the Company and
the Bank.
The Increasing Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a financial institution available to absorb losses. Because of
the risks attendant to their business, depository institutions are generally required to hold more capital
than other businesses, which directly affects earnings capabilities. While capital has historically been one
of the key measures of the financial health of both bank holding companies and banks, its role is
becoming fundamentally more important in the wake of the global financial crisis, as the banking
regulators recognized that the amount and quality of capital held by banks prior to the crisis was
insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and
Basel III, discussed below, establish strengthened capital standards for banks and bank holding
companies, require more capital to be held in the form of common stock and disallow certain funds from
being included in capital determinations. Once fully implemented, these standards will represent
regulatory capital requirements that are meaningfully more stringent than those in place historically.
The Company and Bank Required Capital Levels. Bank holding companies have historically had to
comply with less stringent capital standards than their bank subsidiaries and were able to raise capital
with hybrid instruments such as trust preferred securities. The Dodd-Frank Act mandated the
Federal Reserve to establish minimum capital levels for bank holding companies on a consolidated basis
that are as stringent as those required for insured depository institutions. As a consequence, the
components of holding company permanent capital known as “Tier 1 Capital” are being restricted to
capital instruments that are considered to be Tier 1 Capital for insured depository institutions. A result of
this change is that the proceeds of hybrid instruments, such as trust preferred securities, are being
excluded from Tier 1 Capital unless such securities were issued prior to May 19, 2010 by bank holding
companies with less than $15 billion of assets. Because the Company has assets of less than $15 billion, it
is able to maintain its trust preferred proceeds, subject to certain restrictions, as Tier 1 Capital but will
11
have to comply with new capital mandates in other respects and will not be able to raise Tier 1 Capital in
the future through the issuance of trust preferred securities.
Under current federal regulations, the Bank is subject to the following minimum capital standards:
(cid:120) A leverage requirement, consisting of a minimum ratio of Tier 1 Capital to total adjusted book
assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all
others;
(cid:120) A risk-based capital requirement, consisting of a minimum ratio of Total Capital to total risk-
weighted assets of 8% and a minimum ratio of Tier 1 Capital to total risk-weighted assets of 4%;
(cid:120) For this purpose, “Tier 1 Capital” consists primarily of common stock, noncumulative perpetual
preferred stock and related surplus less intangible assets (other than certain loan servicing rights
and purchased credit card relationships). Total Capital consists primarily of Tier 1 Capital plus
“Tier 2 Capital,” which includes other non-permanent capital items, such as certain other debt and
equity instruments that do not qualify as Tier 1 Capital, and a portion of the Bank’s allowance for
loan and lease losses; and
(cid:120) Further, risk-weighted assets for the purposes of the risk-weighted ratio calculations are balance
sheet assets and off-balance sheet exposures to which required risk-weightings of 0% to 100% are
applied.
The capital standards described above are minimum requirements and will be increased under Basel III,
as discussed below. Bank regulatory agencies are uniformly encouraging banks and bank holding
companies to be “well-capitalized” and, to that end, federal law and regulations provide various
incentives for banking organizations to maintain regulatory capital at levels in excess of minimum
regulatory requirements. For example, a banking organization that is “well-capitalized” may: (i) qualify
for exemptions from prior notice or application requirements otherwise applicable to certain types of
activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept
brokered deposits. Under the capital regulations of the OCC and Federal Reserve, in order to be
“well-capitalized,” a banking organization, under current federal regulations, must maintain:
(cid:120) A leverage ratio of Tier 1 Capital to total assets of 5% or greater;
(cid:120) A ratio of Tier 1 Capital to total risk-weighted assets of 6% or greater; and
(cid:120) A ratio of Total Capital to total risk-weighted assets of 10% or greater.
The OCC and Federal Reserve guidelines also provide that banks and bank holding companies
experiencing internal growth or making acquisitions will be expected to maintain capital positions
substantially above the minimum supervisory levels without significant reliance on intangible assets.
Furthermore, the guidelines indicate that the agencies will continue to consider a “tangible Tier 1 leverage
ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activities.
Higher capital levels may also be required if warranted by the particular circumstances or risk profiles of
individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that
additional capital may be required to take adequate account of, among other things, interest rate risk, or
the risks posed by concentrations of credit, nontraditional activities or securities trading activities.
Further, any banking organization experiencing or anticipating significant growth would be expected to
maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets),
well above the minimum levels.
Prompt Corrective Action. A banking organization’s capital plays an important role in connection with
regulatory enforcement as well. Federal law provides the federal banking regulators with broad power to
take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the
regulators’ powers depends on whether the institution in question is “adequately capitalized,”
“undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as
defined by regulation. Depending upon the capital category to which an institution is assigned, the
12
regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan;
(ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue
additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions
between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on
deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive
officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from
correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the
payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the
institution.
As of December 31, 2013, the Bank exceeded its minimum regulatory capital requirements under OCC
capital adequacy guidelines. As of December 31, 2013, the Bank exceeded the heightened regulatory
capital ratios to which it had agreed. As of December 31, 2013, the Company had regulatory capital in
excess of the Federal Reserve’s requirements and met the Dodd-Frank Act requirements.
The Basel International Capital Accords. The current risk-based capital guidelines described above,
which apply to the Bank and are being phased in for the Company, are based upon the 1988 capital accord
known as “Basel I” adopted by the international Basel Committee on Banking Supervision, a committee
of central banks and bank supervisors, as implemented by the U.S. federal banking regulators on an
interagency basis. In 2008, the banking agencies collaboratively began to phase-in capital standards based
on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally
defined for United States’ purposes as having total assets of $250 billion or more, or consolidated foreign
exposures of $10 billion or more). Basel II emphasized internal assessment of credit, market and
operational risk, as well as supervisory assessment and market discipline in determining minimum capital
requirements.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the
Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital
requirements for banking organizations around the world, known as Basel III, to address deficiencies
recognized in connection with the global financial crisis. Basel III was intended to be effective globally
on January 1, 2013, with phase-in of certain elements continuing until January 1, 2019, and it is currently
effective in many countries.
United States Implementation of Basel III. After an extended rulemaking process that included a
prolonged comment period, in July 2013, the U.S. federal banking agencies approved the implementation
of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules
effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to capital
requirements historically, which were in the form of guidelines, Basel III was released in the form of
regulations by each of the agencies. The Basel III Rule is applicable to all U.S. banks that are subject to
minimum capital requirements, including federal and state banks and savings and loan associations, as
well as to bank and savings and loan holding companies other than “small bank holding companies”
(generally bank holding companies with consolidated assets of less than $500 million).
The Basel III Rule not only increases most of the required minimum capital ratios, but it introduces the
concept of Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus
(net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests subject to certain
regulatory adjustments. The Basel III Rule also expanded the definition of capital as in effect currently
by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1
Capital (Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that
now qualify as Tier 1 Capital will not qualify, or their qualifications will change. For example,
cumulative preferred stock and certain hybrid capital instruments, including trust preferred securities, will
no longer qualify as Tier 1 Capital of any kind, with the exception, subject to certain restrictions, of such
instruments issued before May 10, 2010, by bank holding companies with total consolidated assets of less
than $15 billion as of December 31, 2009. For those institutions, trust preferred securities and other
nonqualifying capital instruments currently included in consolidated Tier 1 Capital are permanently
13
grandfathered under the Basel III Rule, subject to certain restrictions. Noncumulative perpetual preferred
stock, which now qualifies as simple Tier 1 Capital, will not qualify as Common Equity Tier 1 Capital,
but will qualify as Additional Tier 1 Capital. The Basel III Rule also constrains the inclusion of minority
interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from
Common Equity Tier 1 Capital in the event such assets exceed a certain percentage of a bank’s
Common Equity Tier 1 Capital.
The Basel III Rule requires:
(cid:120) A new required ratio of minimum Common Equity Tier 1 equal to 4.5% of risk-weighted
assets;
(cid:120) An increase in the minimum required amount of Tier 1 Capital from the current level of 4%
of total assets to 6% of risk-weighted assets;
(cid:120) A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2)
at 8% of risk-weighted assets; and
(cid:120) A minimum leverage ratio of Tier 1 Capital to total assets equal to 4% in all circumstances.
In addition, institutions that seek the freedom to make capital distributions (including for dividends and
repurchases of stock) and pay discretionary bonuses to executive officers without restriction must also
maintain 2.5% in Common Equity Tier 1 attributable to a capital conservation buffer to be phased in over
three years beginning in 2016. The purpose of the conservation buffer is to ensure that banks maintain a
buffer of capital that can be used to absorb losses during periods of financial and economic stress.
Factoring in the fully phased-in conservation buffer increases the minimum ratios depicted above to 7%
for Common Equity Tier 1, 8.5% for Tier 1 Capital and 10.5% for Total Capital. The required leverage
ratio is not impacted by the conservation buffer.
The Basel III Rule maintained the general structure of the current prompt corrective action framework,
while incorporating the increased requirements. The prompt corrective action guidelines were also revised
to add the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution
under the new regime, a bank and holding company must maintain a Common Equity Tier 1 Capital ratio
of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more; and a
leverage ratio of 5% or more. It is possible under the Basel III Rule to be well-capitalized while
remaining out of compliance with the capital conservation buffer discussed above.
The Basel III Rule revises a number of the risk weightings (or their methodologies) for bank assets that
are used to determine the capital ratios. For nearly every class of assets, the Basel III Rule requires a more
complex, detailed and calibrated assessment of credit risk and calculation of risk weightings. While Basel
III would have changed the risk-weighting for residential mortgage loans based on loan-to-value ratios
and certain product and underwriting characteristics, there was concern in the United States that the
proposed methodology for risk weighting residential mortgage exposures and the higher risk weightings
for certain types of mortgage products would increase costs to consumers and reduce their access to
mortgage credit. As a result, the Basel III Rule did not effect this change, and banks will continue to apply
a risk weight of 50% or 100% to their exposure from residential mortgages, with the risk weighting
depending on, among other things, whether the mortgage was a prudently underwritten first lien
mortgage.
Furthermore, there was significant concern noted by the financial industry in connection with the Basel III
rulemaking as to the proposed treatment of accumulated other comprehensive income (“AOCI”). Basel III
requires unrealized gains and losses on available-for-sale securities to flow through to regulatory capital
as opposed to the current treatment, which neutralizes such effects. Recognizing the problem for
community banks, the U.S. bank regulatory agencies adopted the Basel III Rule with a one-time election
for smaller institutions like the Company and the Bank to opt out of including most elements of AOCI in
regulatory capital. This opt-out, which must be made in the first quarter of 2015, would exclude from
regulatory capital both unrealized gains and losses on available-for-sale debt securities and accumulated
14
net gains and losses on cash-flow hedges and amounts attributable to defined benefit post-retirement
plans. The Company is currently evaluating whether it will make the opt-out election.
Generally, financial institutions (except for large, internationally active financial institutions) become
subject to the new rules on January 1, 2015. However, there will be separate phase-in/phase-out periods
the capital conservation buffer; (ii) regulatory capital adjustments and deductions;
for: (i)
(iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules. The phase-
in periods commence on January 1, 2016 and extend until 2019.
The Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank
holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve
under the Bank Holding Company Act of 1956, as amended (the “BHCA”). In accordance with Federal
Reserve policy, and as now codified by the Dodd-Frank Act, the Company is legally obligated to act as a
source of financial strength to the Bank and to commit resources to support the Bank in circumstances
where the Company might not otherwise do so. Under the BHCA, the Company is subject to periodic
examination by the Federal Reserve. The Company is required to file with the Federal Reserve periodic
reports of the Company’s operations and such additional information regarding the Company and its
subsidiaries as the Federal Reserve may require.
Enforcement Action. On July 22, 2011, the Company entered into a Written Agreement with the Federal
Reserve Bank of Chicago (the “Reserve Bank”) that was terminated on January 17, 2014 (the “Written
Agreement”). Under the terms of the Written Agreement, the Company was required to, among other
things: (i) fully utilize its financial and managerial resources to serve as a source of strength to the Bank;
(ii) obtain the written approval of the Reserve Bank (and in certain cases, the Federal Reserve) prior to the
declaration or payment of any dividends, the acceptance of dividends or any other form of capital
distribution from the Bank, and the payment of principal, interest, or other sums on subordinated
debentures or trust preferred securities; (iii) obtain the written approval of the Reserve Bank prior to
incurring, increasing, or guaranteeing any debt, or repurchasing or redeeming any stock; (iv) develop,
submit to the Reserve Bank, and implement a capital plan, and notify the Reserve Bank if any of the
Company’s quarterly capital ratios fell below the minimum ratios set forth in the approved capital plan,
along with a written plan to increase any applicable capital ratio to or above the approved minimum level;
and (v) for each calendar year that the Written Agreement was in effect, submit to the Reserve Bank
annual cash flow projections. The Company was also required to submit certain reports to the Reserve
Bank with respect to the foregoing requirements. Although the Written Agreement has been terminated,
the Company expects that it will continue to seek approval from the Reserve Bank prior to paying any
dividends on its capital stock and incurring any additional indebtedness.
Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to
control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for
any merger involving a bank holding company or any acquisition by a bank holding company of another
bank or bank holding company. Subject to certain conditions (including deposit concentration limits
established by the BHCA and the Dodd-Frank Act), the Federal Reserve may allow a bank holding
company to acquire banks located in any state of the United States. In approving interstate acquisitions,
the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount
of deposits that may be held by the acquiring bank holding company and its insured depository institution
affiliates in the state in which the target bank is located (provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies) and state laws that require that the
target bank have been in existence for a minimum period of time (not to exceed five years) before being
acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act,
bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers
or acquisitions. For a discussion of the capital requirements, see “The Increasing Regulatory Emphasis
on Capital” above.
The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of
15
more than 5% of the voting shares of any company that is not a bank and from engaging in any business
other than that of banking, managing and controlling banks or furnishing services to banks and their
subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception
allows bank holding companies to engage in, and to own shares of companies engaged in, certain
businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking
... as to be a proper incident thereto.” This authority would permit the Company to engage in a variety of
banking-related businesses, including the ownership and operation of a savings association, or any entity
engaged in consumer finance, equipment leasing, the operation of a computer service bureau
(including software development) and mortgage banking and brokerage. The BHCA generally does not
place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding
companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA
and elect to operate as financial holding companies may engage in, or own shares in companies engaged
in, a wider range of nonbanking activities, including securities and insurance underwriting and sales,
merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of
the Treasury, determines by regulation or order is financial in nature or incidental to any such financial
activity or that the Federal Reserve determines by order to be complementary to any such financial
activity and does not pose a substantial risk to the safety or soundness of depository institutions or the
financial system generally. The Company does not currently operate as a financial holding company.
Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured
depository institution or its holding company without prior notice to the appropriate federal bank
regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the
outstanding voting securities of a bank or bank holding company, but may arise under certain
circumstances between 10% and 24.99% ownership.
Capital Requirements. Bank holding companies are required to maintain capital in accordance with
Federal Reserve capital adequacy requirements, as affected by the Dodd-Frank Act and Basel III. For a
discussion of capital requirements, see “—The Increasing Regulatory Emphasis on Capital” above.
U.S. Government Investment in Bank Holding Companies. Events in the United States and global
financial markets leading up to the global financial crisis, including deterioration of the worldwide credit
markets, created significant challenges for financial institutions throughout the country beginning in 2008.
In response to this crisis affecting the U.S. banking system and financial markets, on October 3, 2008,
the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act
of 2008 (the “EESA”). The EESA authorized the Secretary of the Treasury to implement various
temporary emergency programs designed to strengthen the capital positions of financial institutions and
stimulate the availability of credit within the U.S. financial system. Financial institutions participating in
certain of the programs established under the EESA are required to adopt the Treasury’s standards for
executive compensation and corporate governance.
On October 14, 2008, the Treasury announced that it would provide Tier 1 capital (in the form of
perpetual preferred stock and common stock warrants) to eligible financial institutions. This program,
known as the TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion
authorized by the EESA to the Treasury for the purchase of senior preferred shares from qualifying
financial institutions (the “CPP Preferred Stock”). Under the program, eligible institutions were able to
sell equity interests to the Treasury in amounts equal to between 1% and 3% of the institution’s risk-
weighted assets. The CPP Preferred Stock is non-voting and pays dividends at the rate of 5% per annum
for the first five years and thereafter at a rate of 9% per annum. In conjunction with the purchase of the
CPP Preferred Stock, the Treasury received warrants to purchase common stock from the participating
public institutions with an aggregate market price equal to 15% of the preferred stock investment.
Participating financial institutions were required to adopt the Treasury’s standards for executive
compensation and corporate governance for the period during which the Treasury holds equity issued
under the CPP. These requirements are discussed in more detail in item 11 of this Form 10-K.
16
Pursuant to the CPP, on January 16, 2009, the Company entered into a Letter Agreement with the
Treasury, pursuant to which the Company issued (i) 73,000 shares of the Company’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”) and (ii) a warrant to
purchase 815,339 shares of the Company’s common stock for an aggregate purchase price of $73.0
million in cash. During the fourth quarter of 2012, the Treasury announced the continuation of individual
auctions of the CPP Preferred Stock and informed the Company that its Series B Preferred Stock would
be auctioned. Auctions for the Company’s Series B Preferred Stock were held in the first quarter of 2013.
As a result of the auctions, all of the shares of the Company’s Series B Preferred Stock were sold to third
parties, including certain of the Company’s directors. The warrant to purchase 815,339 shares of the
Company’s common stock was also sold to a third party in a separate auction.
Dividend Payments. The Company’s ability to pay dividends to its shareholders may be affected by both
general corporate law considerations and policies of the Federal Reserve applicable to bank holding
companies. As a Delaware corporation, the Company is subject to the limitations of the Delaware
General Corporation Law (the “DGCL”). The DGCL allows the Company to pay dividends only out of its
surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has
no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding
company should eliminate, defer or significantly reduce dividends to shareholders if: (i) the company’s
net income available to shareholders for the past four quarters, net of dividends previously paid during
that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is
inconsistent with the company’s capital needs and overall current and prospective financial condition; or
(iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy
ratios. The Federal Reserve also possesses enforcement powers over bank holding companies and their
non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or
violations of applicable statutes and regulations. Among these powers is the ability to proscribe the
payment of dividends by banks and bank holding companies. Although the Written Agreement has been
terminated, the Company expects that it will continue to seek approval from the Reserve Bank prior to
paying any dividends on its capital stock and incurring any additional indebtedness.
Furthermore, the Company’s ability to pay dividends on its common stock is restricted by the terms of
certain of its other securities. For example, under the terms of certain of the Company’s junior
subordinated debentures, it may not pay dividends on its capital stock unless all accrued and unpaid
interest payments on the subordinated debentures have been fully paid. On August 31, 2010, the
Company announced that it had elected to begin deferring the interest payments due on the junior
subordinated debentures described above, as well as the dividend payments due on the CPP Preferred
Stock, and therefore may not pay common stock dividends until such time as these deferred payments
have been made in full.
Federal Securities Regulation. The Company’s common stock is registered with the SEC under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, the Company is
subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the
SEC under the Exchange Act.
Corporate Governance. The Dodd-Frank Act addresses many investor protection, corporate governance
and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-
Frank Act increased shareholder influence over boards of directors by requiring companies to give
shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments,
and authorizing the SEC to promulgate rules that would allow shareholders to nominate and solicit voters
for their own candidates using a company’s proxy materials. The legislation also directed the Federal
Reserve to promulgate rules prohibiting excessive compensation paid to executives of bank holding
companies, regardless of whether such companies are publicly traded.
17
The Bank
General. The Bank is a national bank, chartered by the OCC under the National Bank Act. The deposit
accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (the “DIF”) to the maximum extent
provided under federal law and FDIC regulations, and the Bank is a member of the Federal Reserve
System. As a national bank, the Bank is subject to the examination, supervision, reporting and enforcement
requirements of the OCC. The FDIC, as administrator of the DIF, also has regulatory authority over the
Bank.
Enforcement Action. On May 16, 2011, the Bank entered into a Consent Order with the OCC that was
terminated on October 17, 2013 (the “Consent Order”). Under the terms of the Consent Order, the Bank
was required to, among other things: (i) adopt and adhere to a three-year written strategic plan that
established objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet
mix, off-balance sheet activities, liability structure, capital adequacy, reduction in nonperforming assets
and its product development; (ii) adopt and maintain a capital plan; (iii) by September 30, 2011, achieve
and thereafter maintain a total risk-based capital ratio of at least 11.25% and a Tier 1 capital ratio of at
least 8.75%; (iv) seek approval of the OCC prior to paying any dividends on its capital stock; (v) develop
a program to reduce the Bank’s credit risk; (vi) obtain or update appraisals on certain loans secured by
real estate; (vii) implement processes to ensure that real estate valuations conform to applicable standards;
(viii) take certain actions related to credit and collateral exceptions; (ix) reaffirm the Bank’s liquidity risk
management program; and (x) appoint a compliance committee of the Bank’s board of directors to help
ensure the Bank’s compliance with the Consent Order. The Bank was also required to submit certain
reports to the OCC with respect to the foregoing requirements. Even though the Consent Order has been
terminated, the Bank is still subject to the risk-based capital regulatory guidelines, which include the
methodology for calculating the risk-weighting of the Bank’s assets, developed by the OCC and the other
bank regulatory agencies. In connection with the current economic environment, the Bank’s current level
of nonperforming assets and the risk-based capital guidelines, the Bank’s board of directors has
determined the Bank should maintain a Tier 1 leverage ratio at or above eight percent (8%) and a total
risk-based capital ratio at or above twelve percent (12%). The Bank currently exceeds these thresholds.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance
premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby
FDIC-insured depository
their risk
classification. An institution’s risk classification is assigned based on its capital levels and the level of
supervisory concern the institution poses to the regulators.
insurance premiums at rates based on
institutions pay
Amendments to the Federal Deposit Insurance Act also revised the assessment base against which an
insured depository institution’s deposit insurance premiums paid to the DIF are calculated. Under the
amendments, the assessment base is no longer the institution’s deposit base, but rather its average
consolidated total assets less its average tangible equity. This may shift the burden of deposit insurance
premiums toward those large depository institutions that rely on funding sources other than U.S.
deposits. Additionally, the Dodd-Frank Act made changes to the minimum designated reserve ratio of the
DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and
eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio
exceeds certain thresholds. The FDIC is given until September 3, 2020 to meet the 1.35% reserve ratio
target. Several of these provisions could increase the Bank’s FDIC deposit insurance premiums.
The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks to
$250,000 per insured depositor.
FICO Assessments. The Financing Corporation (“FICO”) is a mixed-ownership governmental
the
corporation chartered by
Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of
the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of
approximately $8.1 billion that mature in 2017 through 2019. FICO’s authority to issue bonds ended on
December 12, 1991. Since 1996, federal legislation has required that all FDIC-insured depository
former Federal Home Loan Bank Board pursuant
the
to
18
institutions pay assessments to cover interest payments on FICO’s outstanding obligations. These FICO
assessments are in addition to amounts assessed by the FDIC for deposit insurance. The FICO assessment
rate is adjusted quarterly and for the fourth quarter of 2013 was approximately 0.0064%, which reflects
the changes from an assessment base computed on deposits to an assessment base computed on assets as
required by the Dodd-Frank Act.
Supervisory Assessments. National banks are required to pay supervisory assessments to the OCC to fund
the operations of the OCC. The amount of the assessment is calculated using a formula that takes into
account the bank’s size and its supervisory condition. During the year ended December 31, 2013, the Bank
paid supervisory assessments to the OCC totaling $809,000.
Capital Requirements. Banks are generally required to maintain capital levels in excess of other
businesses. For a discussion of capital requirements, see “—The Increasing Regulatory Emphasis on
Capital” above.
Dividend Payments. The primary source of funds for the Company is dividends from the Bank. Under
the National Bank Act, a national bank may pay dividends out of its undivided profits in such amounts and
at such times as the bank’s board of directors deems prudent. Without prior OCC approval, however, a
national bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s year-to-
date net income plus the bank’s retained net income for the two preceding years.
The payment of dividends by any financial institution is affected by the requirement to maintain adequate
capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution
generally is prohibited from paying any dividends if, following payment thereof, the institution would be
undercapitalized. As described above, the Bank exceeded its minimum capital requirements under
applicable guidelines as of December 31, 2013.
Insider Transactions. The Bank is subject to restrictions imposed by federal law on “covered
transactions” between the Bank and its “affiliates.” The Company is an affiliate of the Bank for purposes
of these restrictions, and covered transactions subject to the restrictions include extensions of credit to the
Company, investments in the stock or other securities of the Company and the acceptance of the stock or
other securities of the Company as collateral for loans made by the Bank. The Dodd-Frank Act enhanced
the requirements for certain transactions with affiliates as of July 21, 2011, including an expansion of the
definition of “covered transactions” and an increase in the amount of time for which collateral
requirements regarding covered transactions must be maintained.
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its
directors and officers, to directors and officers of the Company and its subsidiaries, to principal
shareholders of the Company and to “related interests” of such directors, officers and principal
shareholders. In addition, federal law and regulations may affect the terms upon which any person who is
a director or officer of the Company or the Bank, or a principal shareholder of the Company, may obtain
credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted
guidelines that establish operational and managerial standards to promote the safety and soundness of
federally insured depository institutions. The guidelines set forth standards for internal controls,
information systems, internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each
institution is responsible for establishing its own procedures to achieve those goals. If an institution fails
to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator
may require the institution to submit a plan for achieving and maintaining compliance. If an institution
fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance
plan that has been accepted by its primary federal regulator, the regulator is required to issue an order
directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured,
the regulator may restrict the institution’s rate of growth, require the institution to increase its capital,
19
restrict the rates the institution pays on deposits or require the institution to take any action the regulator
deems appropriate under the circumstances. Noncompliance with the standards established by the safety
and soundness guidelines may also constitute grounds for other enforcement action by the federal banking
regulators, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of
sound risk management processes and strong internal controls when evaluating the activities of the
institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe
and sound banking activities and has become even more important as new technologies, product
innovation, and the size and speed of financial transactions have changed the nature of banking
markets. The agencies have identified a spectrum of risks facing a banking institution including, but not
limited to, credit, market, liquidity, operational, legal, and reputational risk. In particular, recent
regulatory pronouncements have focused on operational risk, which arises from the potential that
inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen
catastrophes will result in unexpected losses. The Bank is expected to have active board and senior
management oversight; adequate policies, procedures, and limits; adequate risk measurement, monitoring,
and management information systems; and comprehensive internal controls.
Branching Authority. National banks headquartered in Illinois, such as the Bank, have the same branching
rights in Illinois as banks chartered under Illinois law, subject to OCC approval. Illinois law grants Illinois-
chartered banks the authority to establish branches anywhere in the State of Illinois, subject to receipt of all
required regulatory approvals.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory
approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the
merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to
the merger. The establishment of new interstate branches or the acquisition of individual branches of a
bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically
been permitted only in those states the laws of which expressly authorize such expansion. However, the
Dodd-Frank Act permits well-capitalized and well-managed banks to establish new branches across state
lines without these impediments.
Financial Subsidiaries. Under federal law and OCC regulations, national banks are authorized to engage,
through “financial subsidiaries,” in any activity that is permissible for a financial holding company and any
activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial
in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate
development or real estate investment activities (unless otherwise permitted by law), (iii) insurance
company portfolio investments and (iv) merchant banking. The authority of a national bank to invest in a
financial subsidiary is subject to a number of conditions, including, among other things, requirements that
the bank must be well-managed and well-capitalized (after deducting from capital the bank’s outstanding
investments in financial subsidiaries). The Bank has not applied for approval to establish any financial
subsidiaries.
Transaction Account Reserves. Federal Reserve regulations require depository institutions to maintain
reserves against their transaction accounts (primarily NOW and regular checking accounts). For 2014:
the first $13.3 million of otherwise reservable balances are exempt from the reserve requirements; for
transaction accounts aggregating more than $13.3 million to $89.0 million, the reserve requirement is 3%
of total transaction accounts; and for net transaction accounts in excess of $89.0 million, the reserve
requirement is $2,271,000 plus 10% of the aggregate amount of total transaction accounts in excess of
$89.0 million. These reserve requirements are subject to annual adjustment by the Federal Reserve. The
Bank is in compliance with the foregoing requirements.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Chicago
(the “FHLBC”), which serves as a central credit facility for its members. The FHLBC is funded primarily
from proceeds from the sale of obligations of the FHLBC system. It makes loans to member banks in the
form of FHLBC advances. All advances from the FHLBC are required to be fully collateralized as
20
determined by the FHLBC.
Community Reinvestment Act Requirements. The Community Reinvestment Act requires the Bank to
have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of
its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly
assess the Bank’s record of meeting the credit needs of its communities. Applications for additional
acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its Community
Reinvestment Act requirements.
Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) is designed to deny terrorists
and criminals the ability to obtain access to the U.S. financial system and has significant implications for
depository institutions, brokers, dealers and other businesses involved in the transfer of money. The
Patriot Act mandates financial services companies to have policies and procedures with respect to
measures designed to address any or all of the following matters: (i) customer identification programs; (ii)
money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and
currency transactions; (v) currency crimes; and (vi) cooperation between financial institutions and law
enforcement authorities.
Commercial Real Estate Guidance. The interagency Concentrations in Commercial Real Estate
Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria,
including the following numerical indicators, to assist bank examiners in identifying banks with
potentially significant commercial real estate loan concentrations that may warrant greater supervisory
scrutiny: (i) commercial real estate loans exceeding 300% of risk-based capital and increasing 50% or
more in the preceding three years; or (ii) construction and land development loans exceeding 100% of
risk-based capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending
activities, but rather guides institutions in developing risk management practices and levels of capital that
are commensurate with the level and nature of their commercial real estate concentrations. Based on the
Bank’s current loan portfolio, the Bank does not exceed these guidelines.
Consumer Financial Services
There are numerous developments in federal and state laws regarding consumer financial products and
services that impact the Bank’s business. Importantly, the current structure of federal consumer protection
regulation applicable to all providers of consumer financial products and services changed significantly
on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection
laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply
to all providers of consumer products and services, including the Bank, as well as the authority to prohibit
“unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority
over providers with more than $10 billion in assets. Banks and savings institutions with $10 billion or less
in assets, like the Bank, will continue to be examined by their applicable bank regulators. Below are
additional recent regulatory developments relating to consumer mortgage lending activities. The
Company does not currently expect these provisions to have a significant impact on Bank operations;
however, additional compliance resources will be needed to monitor changes.
Ability-to-Repay Requirement and Qualified Mortgage Rule. The Dodd-Frank Act contains additional
provisions that affect consumer mortgage lending. First, it significantly expands underwriting
requirements applicable to loans secured by 1-4 family residential real property and augments federal law
combating predatory lending practices. In addition to numerous new disclosure requirements, the
Dodd-Frank Act imposes new standards for mortgage loan originations on all lenders, including banks
and savings associations, in an effort to strongly encourage lenders to verify a borrower’s ability to repay,
while also establishing a presumption of compliance for certain “qualified mortgages.” In addition, the
Dodd-Frank Act generally requires lenders or securitizers to retain an economic interest in the credit risk
relating to loans that the lender sells, and other asset-backed securities that the securitizer issues, if the
loans have not complied with the ability-to-repay standards. The risk retention requirement generally will
be 5%, but could be increased or decreased by regulation.
21
On January 10, 2013, the CFPB issued a final rule, effective January 10, 2014, that implements the Dodd-
Frank Act’s ability-to-repay requirements and clarifies the presumption of compliance for “qualified
mortgages.” In assessing a borrower’s ability to repay a mortgage-related obligation, lenders generally
must consider eight underwriting factors: (i) current or reasonably expected income or assets; (ii) current
employment status; (iii) monthly payment on the subject transaction; (iv) monthly payment on any
simultaneous loan; (v) monthly payment for all mortgage-related obligations; (vi) current debt
obligations, alimony, and child support; (vii) monthly debt-to-income ratio or residual income; and
(viii) credit history. The final rule also includes guidance regarding the application of, and methodology
for evaluating, these factors.
Further, the final rule also clarifies that qualified mortgages do not include “no-doc” loans and loans with
negative amortization, interest-only payments, balloon payments, terms in excess of 30 years, or points
and fees paid by the borrower that exceed 3% of the loan amount, subject to certain exceptions. In
addition, for qualified mortgages, the monthly payment must be calculated on the highest payment that
will occur in the first five years of the loan, and the borrower’s total debt-to-income ratio generally may
not be more than 43%. The final rule also provides that certain mortgages that satisfy the general product
feature requirements for qualified mortgages and that also satisfy the underwriting requirements of
Fannie Mae and Freddie Mac (while they operate under federal conservatorship or receivership) or the
U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of
Agriculture or Rural Housing Service are also considered to be qualified mortgages. This second
category of qualified mortgages will phase out as the aforementioned federal agencies issue their own
rules regarding qualified mortgages, the conservatorship of Fannie Mae and Freddie Mac ends, and, in
any event, after seven years.
As set forth in the Dodd-Frank Act, subprime (or higher-priced) mortgage loans are subject to the ability-
to-repay requirement, and the final rule provides for a rebuttable presumption of lender compliance for
those loans. The final rule also applies the ability-to-repay requirement to prime loans, while also
providing a conclusive presumption of compliance (i.e., a safe harbor) for prime loans that are also
qualified mortgages. Additionally, the final rule generally prohibits prepayment penalties (subject to
certain exceptions) and sets forth a 3-year record retention period with respect to documenting and
demonstrating the ability-to-repay requirement and other provisions.
Changes to Mortgage Loan Originator Compensation. Effective April 2, 2011, previously existing
regulations concerning the compensation of mortgage loan originators were amended. As a result of these
amendments, mortgage loan originators may not receive compensation based on a mortgage transaction’s
terms or conditions other than the amount of credit extended under the mortgage loan. Further, the new
standards limit the total points and fees that a bank and/or a broker may charge on conforming and jumbo
loans to 3% of the total loan amount. Mortgage loan originators may receive compensation from a
consumer or from a lender, but not both. These rules contain requirements designed to prohibit mortgage
loan originators from “steering” consumers to loans that provide mortgage loan originators with greater
compensation. In addition, the rules contain other requirements concerning recordkeeping.
Foreclosure and Loan Modifications. Federal and state laws further impact foreclosures and loan
modifications, with many of such laws having the effect of delaying or impeding the foreclosure process
on real estate secured loans in default. Mortgages on commercial property can be modified, such as by
reducing the principal amount of the loan or the interest rate, or by extending the term of the loan, through
plans confirmed under Chapter 11 of the Bankruptcy Code. In recent years, legislation has been
introduced in the U.S. Congress that would amend the Bankruptcy Code to permit the modification of
mortgages secured by residences, although at this time the enactment of such legislation is not presently
proposed. The scope, duration and terms of potential future legislation with similar effect continue to be
discussed. The Company cannot predict whether any such legislation will be passed or the impact, if any,
it would have on the Company’s business.
Servicing. On January 17, 2013, the CFPB announced rules to implement certain provisions of the Dodd-
Frank Act relating to mortgage servicing. The new servicing rules require servicers to meet certain
22
benchmarks for loan servicing and customer service in general. Servicers must provide periodic billing
statements and certain required notices and acknowledgments, promptly credit borrowers’ accounts for
payments received and promptly investigate complaints by borrowers and are required to take additional
steps before purchasing insurance to protect the lender’s interest in the property. The new servicing rules
also call for additional notice, review and timing requirements with respect to delinquent borrowers,
including early intervention, ongoing access to servicer personnel and specific loss mitigation and
foreclosure procedures. The rules provide for an exemption from most of these requirements for “small
servicers.” A small servicer is defined as a loan servicer that services 5,000 or fewer mortgage loans and
services only mortgage loans that they or an affiliate originated or own. The new servicing rules took
effect on January 10, 2014. Bank management is continuing to evaluate the full impact of these rules and
their impact on mortgage servicing operations.
Additional Constraints on the Company and Bank
Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating
results of financial or bank holding companies and their subsidiaries. Among the tools available to the
Federal Reserve to affect the money supply are open market transactions in U.S. government securities,
changes in the discount rate on member bank borrowings and changes in reserve requirements against
member bank deposits. These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect interest rates charged on
loans or paid on deposits.
The Volcker Rule. In addition to other implications of the Dodd-Frank Act discussed above, the act
amends the BHC Act to require the federal regulatory agencies to adopt rules that prohibit banks and their
affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered
investment companies (defined as hedge funds and private equity funds). This statutory provision is
commonly called the “Volcker Rule.” On December 10, 2013, the federal regulatory agencies issued final
rules to implement the prohibitions required by the Volcker Rule. Thereafter, in reaction to industry
concern over the adverse impact to community banks of the treatment of certain collateralized debt
instruments in the final rule, the federal regulatory agencies approved an interim final rule to permit
banking entities to retain interests in collateralized debt obligations backed primarily by trust preferred
securities (“TruPS CDOs”) from the investment prohibitions contained in the final rule. Under the interim
final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking
entities under $15 billion in assets if the following qualifications are met:
(cid:120) The TruPS CDO was established, and the interest was issued, before May 19, 2010;
(cid:120) The banking entity reasonably believes that the offering proceeds received by the TruPS CDO
were invested primarily in qualifying TruPS collateral; and
(cid:120) The banking entity's interest in the TruPS CDO was acquired on or before December 10, 2013.
Although the Volcker Rule has significant implications for many large financial institutions, the
Company sold its TruPS CDOs in December of 2013, and, consequently, the Company does not believe
that the Volcker Rule will have a material effect on the operations of the Company or the Bank going
forward. The Company may incur costs if it is required to adopt additional policies and systems to ensure
compliance with the Volcker Rule, but any such costs are not expected to be material. Until the
application of the final rules is fully understood, the precise financial impact of the rule on the Company,
the Bank, its customers or the financial industry more generally, cannot be determined.
GUIDE 3 STATISTICAL DATA REQUIREMENTS
The statistical data required by Guide 3 of the Guides for Preparation and Filing of Reports and
Registration Statements under the Securities Exchange Act of 1934 is set forth in the following pages.
This data should be read in conjunction with the consolidated financial statements, related notes and
"Management's Discussion and Analysis of Financial Condition and Results of Operations" as set forth in
Part II Items 7 and 8. All dollars in the tables are expressed in thousands.
23
I.
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rate and Interest
Differential.
The following table sets forth certain information relating to the Company's average consolidated balance
sheets and reflects the yield on average earning assets and cost of average liabilities for the years
indicated. Dividing the related interest by the average balance of assets or liabilities derives rates.
Average balances are derived from daily balances.
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
Years ended December 31, 2013, 2012 and 2011
Average
Balance
2013
Interest
365
360
Rate
Average
Balance
2012
Interest
366
360
Rate
Average
Balance
2011
Interest
365
360
Rate
$
43,801
-
$
108
-
0.24%
-
$
48,820
-
$
119
-
0.24%
-
$
92,830
533
$
230
1
0.24%
0.19
586,188
14,616
600,804
10,629
1,106,447
1,761,681
26,871
(35,504)
209,640
1,962,688
$
$
290,998
318,343
226,404
493,855
1,329,600
23,313
15,849
58,378
45,000
500
1,472,640
362,871
36,063
91,114
11,692
904
12,596
304
56,417
69,425
-
-
-
1.99
6.19
2.10
2.86
5.03
3.90
-
-
-
395,225
10,350
405,575
12,294
1,270,162
1,736,851
26,197
(45,047)
232,624
1,950,625
$
7,212
640
7,852
305
67,110
75,386
-
-
-
1.82
6.18
1.94
2.48
5.20
4.28
-
-
-
161,986
13,220
175,206
13,963
1,535,054
1,817,586
27,402
(69,471)
239,947
2,015,464
$
3,989
749
4,738
290
80,513
85,772
-
-
-
$
255
443
161
6,774
7,633
3
25
5,298
811
16
13,786
-
-
-
0.09
0.14
0.07
1.37
0.57
0.01
0.16
9.08
1.78
3.16
0.94
-
-
-
$
274,299
314,363
211,632
552,489
1,352,783
4,826
12,268
58,378
45,000
500
1,473,755
377,624
27,285
71,961
$
270
576
216
8,809
9,871
2
17
4,925
903
17
15,735
-
-
-
0.10
0.18
0.10
1.59
0.73
0.04
0.14
8.44
1.97
3.34
1.07
-
-
-
$
264,470
295,212
191,857
701,189
1,452,728
1,957
2,742
58,378
45,000
500
1,561,305
354,196
20,238
79,725
$
422
835
322
14,478
16,057
1
-
4,577
822
16
21,473
-
-
-
2.46
5.67
2.70
2.08
5.17
4.66
-
-
-
0.16
0.28
0.17
2.06
1.11
0.05
-
7.84
1.80
3.16
1.37
-
-
-
ASSETS
Interest bearing deposits
Federal funds sold
Securities:
Taxable
Non-taxable (tax equivalent)
Total securities
Dividends from FRB and FHLB stock
Loans and loans held-for-sale 1
Total interest earning assets
Cash and due from banks
Allowance for loan losses
Other noninterest-bearing assets
Total assets
LIABILITIES AND
STOCKHOLDERS' EQUITY
NOW accounts
Money market accounts
Savings accounts
Time deposits
Total interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Total interest bearing liabilities
Noninterest bearing deposits
Accrued interest and other liabilities
Stockholders' equity
Total liabilities and
stockholders' equity
$
1,962,688
$
1,950,625
$
2,015,464
Net interest income (tax equivalent)
Net interest income (tax equivalent)
to total earning assets
Interest bearing liabilities to
earnings assets
$
55,639
$
59,651
$
64,299
3.16%
3.43%
3.54%
83.59%
84.85%
85.90%
1. Interest income from loans is shown tax equivalent as discussed below and includes fees of $2,547, $2,111 and $2,194 for 2013, 2012 and 2011, respectively.
Nonaccrual loans are included in the above stated average balances.
Notes: For purposes of discussion, net interest income and net interest income to earning assets have been adjusted to a non-GAAP tax equivalent ("TE") basis
using a marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets. The table below provides a
reconciliation of each non-GAAP TE measure to the GAAP equivalent:
2013
Effect of Tax Equivalent Adjustment
2012
2011
Interest income (GAAP)
Taxable equivalent adjustment - loans
Taxable equivalent adjustment - securities
Interest income (TE )
Less: interest expense (GAAP)
Net interest income (TE)
Net interest income (GAAP)
Net interest income to total interest earning assets
Net interest income to total interest earning assets (TE)
$
$
$
69,040
68
317
69,425
13,786
55,639
55,254
3.14%
3.16%
24
$
$
$
75,081
81
224
75,386
15,735
59,651
59,346
3.42%
3.43%
$
$
$
85,423
87
262
85,772
21,473
64,299
63,950
3.52%
3.54%
The following table allocates the changes in net interest income to changes in either average balances or
average rates for earnings assets and interest bearing liabilities. The changes in interest due to both
volume and rate have been allocated proportionately to the change due to balance and due to rate. Interest
income is measured on a tax-equivalent basis using a 35% rate as per the note to the analysis of averages
balance table on the preceding page.
ANALYSIS OF YEAR-TO-YEAR CHANGES IN NET INTEREST INCOME
EARNING ASSETS/INTEREST INCOME
Interest bearing deposits
Federal funds sold
Securities:
Taxable
Tax-exempt
Dividends from FRB and FHLB Stock
Loans and loans held-for-sale
TOTAL EARNING ASSETS
INTEREST BEARING LIABILITIES/
INTEREST EXPENSE
NOW accounts
Money market accounts
Savings accounts
Time deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
INTEREST BEARING LIABILITIES
NET INTEREST INCOME
2013 Compared to 2012
2012 Compared to 2011
Change Due to
Average
Balance
Average
Rate
Total
Change
Change Due to
Average
Balance
Average
Rate
Total
Change
$
(13)
-
$
2
-
$
(11)
-
$
(107)
-
$
(4)
(1)
$
(111)
(1)
3,756
264
8
(8,550)
(4,535)
19
7
16
(878)
1
5
-
-
-
(830)
(3,705)
$
724
0
(9)
(2,143)
(1,426)
4,480
264
(1)
(10,693)
(5,961)
3,930
(188)
(24)
(13,771)
(10,160)
(707)
79
39
368
(226)
3,223
(109)
15
(13,403)
(10,386)
(34)
(140)
(71)
(1,157)
-
3
373
(92)
(1)
(1,119)
(307)
$
(15)
(133)
(55)
(2,035)
1
8
373
(92)
(1)
(1,949)
(4,012)
$
16
58
38
(2,733)
1
-
-
-
-
(2,620)
(7,540)
$
(168)
(317)
(144)
(2,936)
-
17
348
81
1
(3,118)
2,892
$
(152)
(259)
(106)
(5,669)
1
17
348
81
1
(5,738)
(4,648)
$
25
II.
Investment Portfolio
The following table presents the composition of the securities portfolio by major category as of December
31 of each year indicated:
Securities Portfolio Composition
2013
2012
2011
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Securities Available-For-Sale
U.S. Treasury
U.S. government agencies
U.S. government agency mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized debt obligations
Total Securities Available-For-Sale
Held-To-Maturity
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total Held-To-Maturity
$
$
$
$
$
$
1,549
1,738
-
16,382
15,733
66,766
274,118
-
376,286
1,544
1,672
-
16,794
15,102
63,876
273,203
-
372,191
1,500
49,848
127,716
14,639
36,355
168,795
165,347
17,941
582,141
1,507
49,850
128,738
15,855
36,886
169,600
167,493
9,957
579,886
1,501
43,112
152,473
12,152
32,357
25,616
28,755
17,892
313,858
1,524
43,398
154,007
13,809
31,389
25,122
28,341
9,974
307,564
$
$
$
$
$
$
$
35,268
221,303
256,571
$
$
35,240
219,088
254,328
$
$
-
-
$
-
$
-
-
$
-
$
-
-
$
-
$
-
-
$
-
The Company’s holdings of U.S. government agency and U.S. government agency mortgage-backed
securities are comprised of government-sponsored enterprises, such as Fannie Mae, Freddie Mac and the
FHLB, which are not backed by the full faith and credit of the U.S. government.
Securities Portfolio Maturity and Yields
The following table presents the expected maturities or call dates and weighted average yield (nontax
equivalent) of securities by major category as of December 31, 2013:
After One But
After Five But
Securities Available-For-Sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Mortgage-backed securities and
collateralized mortgage obligations
Asset-backed securities
Within One Year
Yield
Amount
Within Five Years Within Ten Years
Yield
Amount
Amount
Yield
After Ten Years
Yield
Amount
Total
Amount
-
$
-
485
300
785
-
-
4.45%
2.17%
3.58%
$
1,544
-
3,479
-
5,023
0.40%
-
4.70%
-
3.38%
$
-
1,672
7,331
13,646
22,649
-
3.14%
3.33%
3.19%
3.23%
-
$
-
5,499
1,156
6,655
-
0.00%
4.37%
4.41%
4.38%
$
1,544
1,672
16,794
15,102
35,112
Yield
0.40%
3.14%
3.98%
3.26%
3.48%
2.53%
1.70%
2.01%
63,876
273,203
372,191
$
Total Securities Available-For-Sale
$
785
3.58%
$
5,023
3.38%
$
22,649
3.23%
$
6,655
4.38%
Held-To-Maturity
Mortgage-backed securities and
collateralized mortgage obligations
Total Held-To-Maturity
$
-
0.00%
$
-
0.00%
$
-
0.00%
$
-
0.00%
256,571
256,571
$
3.06%
3.06%
26
As of December 31, 2013, net unrealized losses on available-for-sale securities and net losses not accreted
on securities transferred from available-for-sale to held-to-maturity in the year of $11,965,000, offset by
deferred income taxes of $4,927,000 results in an overall reduction to equity capital of $7,038,000. As of
December 31, 2012, net unrealized losses of $2,255,000, offset by deferred income taxes of $928,000,
results in an overall reduction to equity capital of $1,327,000. At December 31, 2013, there were four
issuers where the book value of the Company’s holdings were greater than 10% of stockholders’ equity.
Issuers of Securities with an aggregate book value greater than 10% of stockholders equity at December
31, 2013.
Issuer
December 31, 2013
Book
Fair
Value
Value
Access Group
Northstar Education Finance
GCO Education Loan Funding Corp
Credit Suisse
$
24,220
95,320
39,664
28,872
$
24,962
96,327
38,085
26,319
III.
Loan Portfolio
Types of Loans
The following table presents the composition of the loan portfolio at December 31 for the years indicated:
2013
2012
2011
2010
2009
$
$
$
$
$
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease Financing Receivables
Other
Gross loans
Allowance for loan losses
Loans, net
95,211
560,233
29,351
389,931
3,040
628
10,069
12,793
1,101,256
(27,281)
1,073,975
87,136
579,687
42,167
414,141
3,414
994
6,060
16,451
1,150,050
(38,597)
1,111,453
98,241
704,415
70,919
477,196
4,172
457
2,087
11,498
1,368,985
(51,997)
1,316,988
173,718
821,101
129,601
556,609
5,587
739
2,774
N/A
1,690,129
(76,308)
1,613,821
206,779
925,013
273,719
642,335
10,447
830
3,703
N/A
2,062,826
(64,540)
1,998,286
$
$
$
$
$
The above loan totals include deferred loan fees and costs.
27
Maturity and Rate Sensitivity Of Loans to Changes in Interest Rates
The following table sets forth the remaining contractual maturities for certain loan categories at December
31, 2013:
Over 1 Year
Through 5 Years
Over 5 Years
One Year
or Less
Fixed
Rate
Floating
Rate
Fixed
Rate
Floating
Rate
Total
$
$
$
$
$
$
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease financing receivables
Other
Total
36,900
84,479
10,252
45,170
353
628
35
822
178,639
20,968
302,273
16,168
62,844
1,134
-
9,961
6,848
420,196
25,552
32,681
840
73,287
1,413
-
-
4,751
138,524
9,572
109,658
326
45,092
67
-
73
372
165,160
2,219
31,142
1,765
163,538
73
-
-
-
198,737
95,211
560,233
29,351
389,931
3,040
628
10,069
12,793
1,101,256
$
$
$
$
$
$
The above loan total includes deferred loan fees and costs; column one includes demand notes.
While 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 represented 89.0% and 90.1% of
the portfolio at December 31, 2013, and 2012, respectively. The Company had no concentration of loans
exceeding 10% of total loans, which were not otherwise disclosed as a category of loans at December 31,
2013.
Risk Elements
The following table sets forth the amounts of nonperforming assets at December 31, of the years
indicated:
Nonaccrual loans
Nonperforming Troubled debt restructured loans
accruing interest
Loans past due 90 days or more
and still accruing interest
Total nonperforming loans
Other real estate owned
Receivable from foreclosed loan participation
Receivable from swap terminations
Total nonperforming assets
2013
38,911
$
2012
77,519
$
2011
126,786
$
2010
212,225
$
2009
174,978
$
796
4,987
11,839
15,637
14,171
87
39,794
41,537
-
-
81,331
$
89
82,595
72,423
-
-
155,018
$
318
138,943
93,290
-
-
232,233
$
1,013
228,875
75,613
-
3,520
308,008
$
561
189,710
40,200
1,505
-
231,415
$
OREO as % of nonperforming assets
51.1%
46.7%
40.2%
24.5%
17.4%
Accrual of interest is discontinued on a loan when principal or interest is ninety days or more past due,
unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual
status, interest previously accrued but not collected in the current period is reversed against current period
interest income. Interest income of approximately $333,000 and $813,000 was recorded and collected
during 2013 and 2012, respectively, on loans that subsequently went to nonaccrual status by year-end.
Interest income, which would have been recognized during 2013 and 2012, had these loans been on an
accrual basis throughout the year, was approximately $2,953,000 and $6,488,000, respectively. As of
December 31, 2013, and 2012, there were $4,837,000 and $5,441,000 respectively in restructured
residential mortgage loans that were still accruing interest based upon their prior performance history.
Additionally, the nonaccrual loans above include $5,567,000 and $11,505,000 in restructured loans for
the period ending December 31, 2013, and 2012, respectively.
28
Potential Problem Loans
The Company utilizes an internal asset classification system as a means of reporting problem and
potential problem assets. At the scheduled board of directors meetings of the Bank, loan listings are
presented, which show significant loan relationships listed as “Special Mention,” “Substandard,” and
“Doubtful.” Loans classified as Substandard include those that have a well-defined weakness or
weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility
that the institution will sustain some loss if the deficiencies are not corrected. Assets classified as
Doubtful have all the weaknesses inherent as those classified 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. Assets that do not currently expose us to
sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses
that deserve management’s close attention, are deemed to be Special Mention.
Management defines potential problem loans as performing loans rated Substandard, that do not meet the
definition of a nonperforming loan. These potential problem loans carry a higher probability of default
and require additional attention by management. A more detailed description of these loans can be found
in Note 4 to the Financial Statements.
IV.
Summary of Loan Loss Experience
Analysis of Allowance For Loan Losses
The following table summarizes, for the years indicated, activity in the allowance for loan losses,
including amounts charged-off, amounts of recoveries, additions to the allowance charged to operating
expense, and the ratio of net charge-offs to average loans outstanding:
Average total loans (exclusive of loans held-for-sale)
2013
1,102,197
$
2012
1,263,172
$
2011
1,527,311
$
2010
1,900,604
$
2009
2,206,189
$
Allowance at beginning of year
Charge-offs:
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer and other loans
Total charge-offs
Recoveries:
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer and other loans
Total recoveries
Net charge-offs
Provision for loan losses
Allowance at end of year
38,597
316
2,985
1,014
6,293
597
11,205
51,997
344
13,508
4,969
8,406
638
27,865
76,308
366
19,576
10,430
10,229
568
41,169
64,540
2,247
29,665
39,321
13,216
560
85,009
41,271
3,493
4,148
60,173
6,238
926
74,978
119
5,325
1,266
1,221
508
8,439
2,766
(8,550)
27,281
$
115
3,576
3,420
583
487
8,181
19,684
6,284
38,597
$
173
3,947
1,262
1,807
782
7,971
33,198
8,887
51,997
$
320
900
3,674
1,799
416
7,109
77,900
89,668
76,308
$
22
-
1,123
47
340
1,532
73,446
96,715
64,540
$
Net charge-offs to average loans
Allowance at year end to average loans
0.25%
2.48%
1.56%
3.06%
2.17%
3.40%
4.10%
4.01%
3.33%
2.93%
The provision for loan losses is based upon management's estimate of losses inherent in the portfolio and
its evaluation of the adequacy of the allowance for loan losses. Factors which influence management's
judgment in estimating loan losses are the composition of the portfolio, past loss experience, loan
delinquencies, nonperforming loans and other credit risk considerations that, in management's judgment,
deserve evaluation in estimating loan losses. The Company has consistently followed GAAP and
regulatory guidance in all calculation methodologies with no significant criticism of those methodologies
from outside third party evaluations.
29
Allocation of the Allowance For Loan Losses
The following table shows the Company's allocation of the allowance for loan losses by types of loans
and the amount of unallocated allowance at December 31 of the years indicated:
2013
2012
2011
2010
2009
Loan Type
to Total
Loans
Amount
Loan Type
to Total
Loans
Amount
Loan Type
to Total
Loans
Amount
Loan Type
to Total
Loans
Amount
Loan Type
to Total
Loans
Amount
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Lease financing receivables
Unallocated
Total
$
$
$
$
$
2,250
16,763
1,980
2,837
1,439
-
2,012
27,281
8.6%
50.9%
2.7%
35.4%
0.3%
0.9%
1.2%
100.0%
4,517
20,100
3,837
4,535
1,178
-
4,430
38,597
7.6%
50.4%
3.7%
36.0%
0.3%
0.1%
1.9%
100.0%
5,070
30,770
7,937
6,335
884
-
1,001
51,997
7.2%
51.5%
5.2%
34.9%
0.3%
0.1%
0.8%
100.0%
6,764
42,242
18,344
6,999
880
-
1,079
76,308
10.3%
48.5%
7.7%
33.0%
0.3%
0.2%
-
100.0%
4,547
24,598
29,895
3,770
703
-
1,027
64,540
$
$
$
$
$
10.0%
44.8%
13.3%
31.2%
0.5%
0.2%
-
100.0%
The allowance for loan losses is a valuation allowance for loan losses, increased by the provision for loan
losses and decreased by both loan loss reserve releases ($8.6 million loan loss reserve release in 2013)
and charge-offs less recoveries. Allocations of the allowance may be made for specific loans, but the
entire allowance is available for losses inherent in the loan portfolio. In addition, the OCC, as part of
their examination process, periodically reviews the allowance for loan losses. Regulators can require
management to record adjustments to the allowance level based upon their assessment of the information
available to them at the time of examination. The OCC, in conjunction with the other federal banking
agencies, has adopted an interagency policy statement on the allowance for loan losses. The policy
statement provides guidance for financial institutions on both the responsibilities of management for the
assessment and establishment of adequate allowances and guidance for banking agency examiners to use
in determining the adequacy of general valuation guidelines. Generally, the policy statement
recommends that (1) institutions have effective systems and controls to identify, monitor and address
asset quality problems; (2) management has analyzed all significant factors that affect the collectability of
the portfolio in a reasonable manner; and (3) management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement and that the Company is in
full compliance with the policy statement. Management believes it has established an adequate estimated
allowance for probable loan losses. Management reviews its process quarterly as evidenced by an
extensive and detailed loan review process, makes changes as needed, and reports those results at
meetings of our Audit Committee. Although management believes the allowance for loan losses is
sufficient to cover probable losses inherent in the loan portfolio, there can be no assurance that the
allowance will prove sufficient to cover actual loan losses. However, there can be no assurance that
regulators, in reviewing the loan portfolio, would not request us to materially adjust our allowance for
loan losses at the time of their examination.
V.
Deposits
The following table sets forth the amount and maturities of deposits of $100,000 or more at December 31 of
the years indicated:
2013
2012
3 months or less
Over 3 months through 6 months
Over 6 months through 12 months
Over 12 months
30
$
$
24,415
21,137
77,718
60,824
184,094
20,701
15,594
52,609
103,044
191,948
$
$
YTD Average Balances and Interest Rates
Noninterest bearing demand
Interest bearing:
NOW and money market
Savings
Time
Total deposits
2013
Average
Balance
$
362,871
609,341
226,404
493,855
1,692,471
$
2012
Average
Balance
-
$
377,624
Rate
0.12%
0.07%
1.37%
588,662
211,632
552,489
1,730,407
$
Rate
-
0.14%
0.10%
1.59%
VI.
Return on Equity and Assets
The following table presents selected financial ratios as of December 31 for the years indicated:
Return on average total assets
Return on average equity
Average equity to average assets
Dividend payout ratio
VII.
Short-Term Borrowings
2013
4.18%
90.09%
4.64%
0.00%
2012
0.00%
(0.10%)
3.69%
0.00%
There were no categories of short-term borrowings having an average balance greater than 30% of the
Company’s stockholders’ equity as of December 31, 2013.
31
Item 1.A. Risk Factors
RISK FACTORS
The material risks that management believes affect the Company are described below. Before making an
investment decision with respect to any of the Company's securities, you should carefully consider the
risks as described below, together with all of the information included herein. The risks described below
are not the only risks the Company faces. Additional risks not presently known or currently deemed
immaterial also may have a material adverse effect on the Company's results of operations and financial
condition. If any of the following risks actually occur, the Company's results of operations and financial
condition could suffer, possibly materially. The risks discussed below also include forward-looking
statements, and actual results may differ substantially from those discussed or implied in these forward-
looking statements.
Risks Relating to the Company’s Business
The Company has incurred net losses in the past and cannot ensure that the Company will not
incur further net losses in the future.
Although the Company reported net income of $82.1 million for 2013, the Company incurred a net loss of
$72,000 for 2012 and $6.5 million for 2011 as well as a net loss of $108.6 million for 2010. Despite a
general improvement in the overall economy and the real estate market, the economic environment
remains challenging and the stability of the real estate market is uncertain, and the Company cannot
ensure it will not incur future losses. Any future losses may affect its ability to meet its expenses or raise
additional capital and may delay the time in which the Company can resume dividend payments on its
common stock. In addition, future losses may cause the Company to re-establish a valuation allowance
against its deferred tax assets. Furthermore, any future losses would likely cause a decline in its holding
company regulatory capital ratios, which could materially and adversely affect its financial condition,
liquidity and results of operations.
Nonperforming assets take significant time to resolve, adversely affect the Company’s results of
operations and financial condition and could result in further losses in the future.
At December 31, 2013, its nonperforming loans (which consist of nonaccrual loans and loans past due
90 days or more, still accruing interest and restructured loans still accruing interest) and its nonperforming
assets (which include nonperforming loans plus OREO) are reflected in the table below (in millions):
Nonperforming loans
OREO
Nonperforming assets
12/31/2013
39.8
$
41.5
81.3
$
12/31/2012 % Change
(51.8)%
$
(42.7)%
(47.5)%
82.6
72.4
155.0
$
The Company’s nonperforming assets adversely affect its net income in various ways. For example, the
Company does not accrue interest income on nonaccrual loans and OREO may have expenses in excess
of lease revenues collected, thereby adversely affecting its income and returns on assets and equity. The
Company’s loan administration costs also increase because of its nonperforming assets. The resolution of
nonperforming assets requires significant time commitments from management, which can be detrimental
to the performance of their other responsibilities. While the Company has made significant progress in
reducing its nonperforming assets, there is no assurance that it will not experience increases in
nonperforming assets in the future, or that its nonperforming assets will not result in further losses in the
future.
32
The Company’s loan portfolio is concentrated heavily in commercial and residential real estate
loans, including construction loans, which involve risks specific to real estate values and the real
estate markets in general, all of which have been experiencing significant weakness.
The Company’s loan portfolio generally reflects the profile of the communities in which the Company
operates. Because the Company operates in areas that saw rapid growth between 2000 and 2007, real
estate lending of all types is a significant portion of its loan portfolio. Total real estate lending is still,
excluding deferred fees, at $979.8 million, or approximately 89.0% of the Company’s December 31,
2013, loan portfolio. Given that the primary (if not only) source of collateral on these loans is real estate,
additional adverse developments affecting real estate values in its market area could increase the credit
risk associated with the Company’s real estate loan portfolio.
The effects of ongoing real estate challenges, combined with the ongoing correction in commercial and
residential real estate market prices and reduced levels of home sales, have adversely affected the
Company’s real estate loan portfolio and have the potential to further adversely affect such portfolio in
several ways, each of which could further adversely impact its financial condition and results of
operations.
Real estate market volatility and future changes in disposition strategies could result in net
proceeds that differ significantly from fair value appraisals of loan collateral and OREO and could
negatively impact the Company's operating performance.
Many of the Company's nonperforming real estate loans are collateral-dependent, meaning the repayment
of the loan is largely dependent upon the successful operation of the property securing the loan. For
collateral-dependent loans, the Company estimates the value of the loan based on appraised value of the
underlying collateral less costs to sell. The Company's OREO portfolio consists of properties acquired
through foreclosure or deed in lieu of foreclosure in partial or total satisfaction of certain loans as a result
of borrower defaults. OREO is recorded at the lower of the recorded investment in the loans for which
property served as collateral or estimated fair value, less estimated selling costs. In determining the value
of OREO properties and loan collateral, an orderly disposition of the property is generally assumed.
Significant judgment is required in estimating the fair value of property, and the period of time within
which such estimates can be considered current is significantly shortened during periods of market
volatility.
A return of recessionary conditions could result in increases in the Company’s level of
nonperforming loans and/or reduced demand for the Company’s products and services, which
could lead to lower revenue, higher loan losses and lower earnings.
A return of recessionary conditions and/or continued negative developments in the domestic and
international credit markets may significantly affect the markets in which the Company does business, the
value of its loans and investments and its ongoing operations, costs and profitability. Declines in real
estate values and sales volumes and increased unemployment or underemployment levels may result in
higher than expected loan delinquencies, increases in the Company’s levels of nonperforming and
classified assets and a decline in demand for its products and services. These negative events may cause
the Company to incur losses and may adversely affect its capital, liquidity and financial condition.
The Company's allowance for loan losses may be insufficient to absorb potential losses in the
Company’s loan portfolio.
The Company maintains an allowance for loan losses at a level the Company believes adequate to absorb
estimated losses inherent in its existing loan portfolio. The level of the allowance reflects management's
continuing evaluation of industry concentrations; specific credit risks; credit loss experience; current loan
33
portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent
in the current loan portfolio.
Determination of the allowance is inherently subjective since it requires significant estimates and
management judgment of credit risks and future trends, all of which may undergo material changes. For
example, the final allowance for December 31, 2012, and December 31, 2013, included an amount
reserved for other not specifically identified risk factors. Although improving, continued difficult
economic conditions affecting borrowers, new information regarding existing loans, identification of
additional problem loans, and other factors, both within and outside of the Company's control, may
require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically
review the Company's allowance and may require an increase in the provision for loan losses or the
recognition of additional loan charge-offs, based on judgments different from those of management. In
addition, if charge-offs in future periods exceed the allowance for loan losses, the Company will need
additional provisions to increase the allowance. Any increases in the allowance will result in a decrease in
net income and capital and may have a material adverse effect on the Company's financial condition and
results of operations.
While the Company had a loan loss reserve release in 2013, its provision for loan losses has been
elevated during the last several years and the Bank may be required to make increases in the
provision for loan losses and to charge-off additional loans in the future.
For the years ended December 31, 2013, and 2012, the Company recorded a loan loss reserve release of
$8.6 million and a provision for loan losses of $6.3 million, respectively. The Company also recorded net
loan charge-offs of $2.8 million and $19.7 million for the years ended December 31, 2013, and 2012,
respectively. The Company’s nonperforming assets totaled $81.3 million, or 4.1% of total assets, at
December 31, 2013. Additionally, classified assets were $103.8 million at December 31, 2013. If the
economy and/or the real estate market continue to weaken, more of the Company’s classified assets may
become nonperforming and the Company may be required to take additional provisions to increase its
allowance for loan losses for these assets as the value of the collateral may be insufficient to pay any
remaining net loan balance, which could have a negative effect on its results of operations. The Company
maintains an allowance for loan losses to provide for loans in its portfolio that may not be repaid in their
entirety. The Company believes that its allowance for loan losses is maintained at a level adequate to
absorb probable losses inherent in its loan portfolio as of the corresponding balance sheet date. However,
the Company’s allowance for loan losses may not be sufficient to cover actual loan losses and future
provisions for loan losses could materially adversely affect its operating results.
The size of the Company’s loan portfolio has declined in recent periods, and, if the Company is
unable to return to loan growth, its profitability may be adversely affected.
Since December 31, 2010, the Company’s gross loans held for investment have declined by 34.8% while
its total assets have declined by 5.6%. During this period, the Company was managing its balance sheet
composition to manage its capital levels and position the Bank to meet and exceed its targeted capital
levels. Management's efforts have reduced the Company’s nonperforming assets by 73.6% over this same
period. Among other things, the Company’s current strategic plan calls for continued reductions in the
amount of its nonperforming assets and returning to growth in its loan portfolio to improve its net interest
margin and profitability. The Company’s ability to increase profitability in accordance with this plan will
depend on a variety of factors, including its ability to originate attractive new lending relationships. While
the Company believes it has the management resources and lending staff in place to successfully achieve
its strategic plan, if the Company is unable to increase the size of its loan portfolio, its strategic plan may
not be successful and its profitability may be adversely affected.
The Company’s business is concentrated in and dependent upon the welfare of several counties in
34
Illinois specifically and the State of Illinois generally.
The Company’s primary market area is Aurora, Illinois, and surrounding communities as well as
southwestern Cook County. The city of Aurora is located in northeastern Illinois, approximately 40 miles
west of Chicago. The Bank operates primarily in Kane, Kendall, DeKalb, DuPage, LaSalle, Will and
southwestern Cook counties in Illinois, and, as a result, the Company’s financial condition, results of
operations and cash flows are subject to changes and fluctuations in the economic conditions in those
areas. The Company has developed a strong presence in the communities it serves, with a particular
concentration in Aurora, Illinois, and surrounding communities.
The communities that the Company serves grew rapidly over the past decade, and the Company intends to
continue concentrating its business efforts in these communities. The Company’s future success is
largely dependent upon the overall economic health of these communities. However, since late 2007, the
U.S. economy has generally experienced difficult economic conditions, and the State of Illinois’ financial
condition continues to be among the most troubled of any state in the United States with both
unemployment rates and foreclosure rates among the ten worst in the United States. Weak economic
conditions are characterized by, among other indicators, deflation, unemployment, fluctuations in debt
and equity capital markets, increased delinquencies on mortgage, commercial and consumer loans,
residential and commercial real estate price declines and lower home sales and commercial activity. All
of those factors are generally detrimental to the Company’s business. If the overall economic conditions
fail to significantly improve or decline further, particularly within the Company’s primary market areas,
the Company could experience a lack of demand for its products and services, an increase in loan
delinquencies and defaults and high or increased levels of problem assets and foreclosures. Moreover,
because of the Company’s geographic concentration, it is less able than other regional or national
financial institutions to diversify its credit risks across multiple markets.
Similarly, the Company has credit exposure to entities or in industries that could be impacted by the
continued financial difficulties at the state level. Exposure to health care, construction and social services
organizations has been reviewed to evaluate credit impact from a possible reorganization of state
finances. Credit downgrades, partial charge-offs and specific reserves could develop in this exposure
with resulting impact on the Company’s financial condition if the State of Illinois encounters more severe
payment issuance capabilities.
The repeal of federal prohibitions on payment of interest on business demand deposits could
increase the Company’s interest expense and have a material adverse effect on the Company.
All federal prohibitions on the ability of financial institutions to pay interest on business demand deposit
accounts were repealed as part of the Dodd-Frank Act. As a result, some financial institutions have
commenced offering interest on these demand deposits to compete for customers. If competitive
pressures require the Company to pay interest on these demand deposits to attract and retain business
customers, the Company’s interest expense would increase and its net interest margin would decrease.
This could have a material adverse effect on the Company. Further, the effect of the repeal of the
prohibition could be more significant in a higher interest rate environment as business customers would
have a greater incentive to seek interest on demand deposits.
The Company operates in a highly competitive industry and market area and may not be able to
continue to effectively compete.
The Company faces substantial competition in all areas of its operations from a variety of different
competitors, many of which are larger and may have more financial resources. The Company’s
competitors primarily include national and regional banks as well as community banks within the markets
the Company serves. The Company also faces competition from savings and loan associations, credit
35
unions, personal loan and finance companies, retail and discount stockbrokers, investment advisors,
mutual funds, insurance companies, and other financial intermediaries. For example, in Kane and
Kendall counties, the Bank faced competition from 196 bank branches representing 42 different financial
institutions (including the Company) according to the June 30, 2013, FDIC share of deposit data. The
financial services industry could become even more competitive as a result of legislative and regulatory
changes. Banks, securities firms, and insurance companies can merge under the umbrella of a financial
holding company, which can offer the wide spectrum of financial services to many customer segments.
Many large scale competitors can leverage economies of scale and be able to offer better pricing for
products and services compared to what the Company can offer.
The Company’s ability to compete successfully depends on developing and maintaining long-term
customer relationships, offering community banking services with features and pricing in line with
customer interests and expectations, consistently achieving outstanding levels of customer service and
adapting to many and frequent changes in banking as well as local or regional economies. Failure to
excel in these areas could significantly weaken the Company's competitive position, which could
adversely affect the Company's growth and profitability. These weaknesses could have a significant
negative impact on the Company's business, financial condition, and results of operations.
The Company is a community bank and its ability to maintain its reputation is critical to the
success of its business and the failure to do so may materially adversely affect its performance.
The Company is a community bank, and its reputation is one of the most valuable components of its
business. As such, the Company strives to conduct its business in a manner that enhances its reputation.
This is done, in part, by recruiting, hiring and retaining employees who share the Company’s core values:
being an integral part of the communities the Company serves; delivering superior service to the
Company’s customers; and caring about the Company’s customers and associates. If the Company’s
reputation is negatively affected, by the actions of its employees or otherwise, its business and operating
results may be adversely affected.
The Company is subject to interest rate risk, and a change in interest rates could have a negative
effect on its net income.
The Company's earnings and cash flows are largely dependent upon the Company’s net interest income.
Interest rates are highly sensitive to many factors that are beyond the Company's control, including
general economic conditions, the Company’s competition and policies of various governmental and
regulatory agencies, particularly the Federal Reserve. Changes in monetary policy, including changes in
interest rates, could influence the amount of interest the Company earns on loans and securities and the
amount of interest it incurs on deposits and borrowings. Such changes could also affect the Company's
ability to originate loans and obtain deposits as well as the average duration of the Company's securities
portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the
interest rates received on loans and other investments, the Company's net interest income, and therefore
earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates
received on loans and other investments fall more quickly than the interest rates paid on deposits and
other borrowings.
Although management believes it has implemented effective asset and liability management strategies to
reduce the potential effects of changes in interest rates on the Company's results of operations, any
substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on
the Company's financial condition and results of operations.
Monetary policies and regulations of the Federal Reserve could adversely affect the Company’s
business, financial condition and results of operations.
36
The policies of the Federal Reserve also have a significant impact on the Company. Among other things,
the Federal Reserve’s monetary policies directly and indirectly influence the rate of interest earned on
loans and paid on borrowings and interest-bearing deposits, and can also affect the value of financial
instruments the Company holds and the ability of borrowers to repay their loans, which could have a
material adverse effect on the Company.
If the Company fails to maintain sufficient capital, whether due to losses, an inability to raise
additional capital or otherwise, its financial condition, liquidity and results of operations, as well as
its ability to maintain regulatory compliance, would be adversely affected.
The Company and the Bank must meet minimum regulatory capital requirements and maintain sufficient
liquidity. The Company also faces significant capital and other regulatory requirements as a financial
institution. The Company’s ability to raise additional capital, when and if needed, will depend on
conditions in the economy and capital markets, and a number of other factors – including investor
perceptions regarding the Company, banking industry and market condition, and governmental activities
– many of which are outside the Company’s control, and on the Company’s financial condition and
performance. Accordingly, the Company cannot assure you that it will be able to raise additional capital
if needed or on terms acceptable to the Company. If the Company fails to meet these capital and other
regulatory requirements, its financial condition, liquidity and results of operations could be materially and
adversely affected.
The Company could experience an unexpected inability to obtain needed liquidity.
Liquidity measures the ability to meet current and future cash flow needs as they become due. The
liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible
outflows in deposits, and to take advantage of interest rate market opportunities and is essential to a
financial institution's business. The ability of a financial institution to meet its current financial
obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to
alternative sources of funds. The Company seeks to ensure that its funding needs are met by maintaining
an appropriate level of liquidity through asset and liability management. If the Company becomes unable
to obtain funds when needed, it could have a material adverse effect on its business, financial condition
and results of operations.
Loss of customer deposits due to increased competition could increase the Company's funding
costs.
The Company relies on bank deposits to be a low cost and stable source of funding. The Company
competes with banks and other financial services companies for deposits. If the Company's competitors
raise the rates they pay on deposits, the Company's funding costs may increase, either because the
Company raises its rates to avoid losing deposits or because the Company loses deposits and must rely on
more expensive sources of funding. Higher funding costs could reduce the Company's net interest margin
and net interest income and could have a material adverse effect on the Company's financial condition
and results of operations.
The Company depends on the accuracy and completeness of information about customers and
counterparties.
The Company may rely on information furnished by or on behalf of customers and counterparties in
deciding whether to extend credit or enter into other transactions. This information could include
financial statements, credit reports, and other financial information. The Company may also rely on
representations of those customers, counterparties, or other third parties, such as independent auditors, as
to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial
37
statements, credit reports, or other financial information could have a material adverse impact on the
Company's business, financial condition, and results of operations.
The Company's estimate of fair values for its investments may not be realizable if it were to sell
these securities today.
The Company's available-for-sale securities are carried at fair value. Accounting standards require the
Company to categorize these securities according to a fair value hierarchy. As of December 31, 2013,
approximately 0.4% of the Company's available-for-sale securities were categorized in Level 1 of the fair
value hierarchy (meaning that the fair values were based on quoted market prices). Approximately, 58%
of the Company's available-for-sale securities were categorized in Level 2 of the fair value hierarchy.
The remaining securities were categorized as Level 3 (meaning that their fair values were determined by
inputs that are unobservable in the market and therefore require a greater degree of management
judgment). The Company’s held-to-maturity securities are carried at amortized cost.
The determination of fair value for securities categorized in Level 3 involves significant judgment due to
the complexity of the factors contributing to the valuation, many of which are not readily observable in
the market. The market disruptions since 2007 and the resulting fluctuations in fair value have made the
valuation process even more difficult and subjective.
The Company may be materially and adversely affected by the highly regulated environment in
which the Company operates.
The Company is subject to extensive federal and state regulation, supervision and examination. Banking
regulations are primarily intended to protect depositors' funds, FDIC funds, customers and the banking
system as a whole, rather than the Company’s stockholders. These regulations affect the Company’s
lending practices, capital structure, investment practices, dividend policy, and growth, among other
things.
As a bank holding company, the Company is subject to extensive regulation and supervision and undergo
periodic examinations by its regulators, who have extensive discretion and authority to prevent or remedy
unsafe or unsound practices or violations of law by banks and bank holding companies. Failure to
comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil
monetary penalties, and/or damage to the Company’s reputation, which could have a material adverse
effect on the Company. Although the Company has policies and procedures designed to mitigate the risk
of any such violations, there can be no assurance that such violations will not occur.
Although a more detailed description of the primary federal and state banking laws and regulations that
affect the Company are described in this Form 10-K under the section captioned "Supervision and
Regulation" in Item 1. These laws, regulations, rules, standards, policies and interpretations are
constantly evolving and may change significantly over time. For example, on July 21, 2010, the Dodd-
Frank Act was signed into law, which significantly changed the regulation of financial institutions and the
financial services industry. The Dodd-Frank Act, together with the regulations to be developed
thereunder, includes provisions affecting large and small financial institutions alike, including several
provisions that affect how community banks, thrifts and small bank and thrift holding companies will be
regulated. In addition, the Federal Reserve, in recent years, has adopted numerous new regulations
addressing banks' overdraft and mortgage lending practices. Further, the CFPB was recently established,
with broad powers to supervise and enforce consumer protection laws, and additional consumer
protection legislation and regulatory activity is anticipated in the near future.
In addition, in July 2013, the U.S. federal banking authorities approved the implementation of the Basel
III Rules. The Basel III Rules are applicable to all U.S. banks that are subject to minimum capital
38
requirements as well as to bank and saving and loan holding companies, other than "small bank holding
companies" (generally bank holding companies with consolidated assets of less than $500 million). The
Basel III Rules not only increase most of the required minimum regulatory capital ratios, they introduce a
new Common Equity Tier 1 Capital ratio and the concept of a capital conservation buffer. The Basel III
Rules also expand the current definition of capital by establishing additional criteria that capital
instruments must meet to be considered Additional Tier 1 Capital (i.e., Tier 1 Capital in addition to
Common Equity) and Tier 2 Capital. A number of instruments that now generally qualify as Tier 1
Capital will not qualify or their qualifications will change when the Basel III Rules are fully implemented.
However, the Basel III Rules permit banking organizations with less than $15 billion in assets to retain,
through a one-time election, the existing treatment for accumulated other comprehensive income. The
Basel III Rules have maintained the general structure of the current prompt corrective action thresholds
while incorporating the increased requirements, including the Common Equity Tier 1 Capital ratio. In
order to be a "well-capitalized" depository institution under the new regime, an institution must maintain
a Common Equity Tier 1 Capital ratio of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total
Capital ratio of 10% or more; and a leverage ratio of 5% or more. Institutions must also maintain a capital
conservation buffer consisting of Common Equity Tier 1 Capital. Generally, financial institutions will
become subject to the Basel III Rules on January 1, 2015 with a phase-in period through 2019 for many of
the changes.
These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to
laws applicable to the financial industry, may impact the profitability of the Company’s business
activities and may change certain of its business practices, including its ability to offer new products,
obtain financing, attract deposits, make loans and achieve satisfactory interest spreads and could expose
the Company to additional costs, including increased compliance costs. These changes also may require
the Company to invest significant management attention and resources to make any necessary changes to
operations in order to comply and could therefore also materially and adversely affect its business,
financial condition and results of operations.
It is possible that the Company may have to re-establish a valuation allowance with respect to its
deferred tax assets, which could negatively affect the Company’s ability to utilize its deferred tax
assets in the future.
In the third quarter of 2013, the Company reported net income of $72.9 million, which included a
$70.0 million benefit from the reversal of the vast majority of its valuation allowance against its deferred
tax assets. Deferred tax assets represent the tax effect of the difference between the book and tax basis of
the Company’s assets and liabilities and are assessed periodically by management to determine if they are
realizable. Factors in management's determination of whether the deferred tax assets are realizable
include the Company’s performance, including the ability to generate taxable net income. If, based on
available information, it is more likely than not that the deferred tax assets will not be realized in any
subsequent period, then a valuation allowance must be established with a corresponding charge to income
tax expense. Consequently, although the Company reversed the vast majority of the valuation allowance
against its deferred tax assets in the third quarter of 2013, future facts and circumstances may require the
Company to re-establish a valuation allowance. Charges to re-establish a valuation allowance with respect
to the Company’s deferred tax assets could have a material adverse effect on its financial condition and
results of operations.
The Company and its subsidiaries may not be able to realize the benefit of the remaining deferred
tax assets.
The Company records deferred tax assets and liabilities for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to
39
apply to taxable income in years in which those temporary differences are expected to be recovered or
settled. The deferred tax assets can be recognized in future periods dependent upon a number of factors,
including the ability to realize the asset through carrybacks or carryforwards to taxable income in prior or
future years, the future reversal of existing taxable temporary differences, future taxable income, and the
possible application of future tax planning strategies. While a significant portion of the Company’s
previously fully reserved deferred tax assets were recovered in 2013, the remaining deferred tax assets
may not be recoverable resulting in an adverse impact on the Company’s earnings and stockholders’
equity.
The Company and its subsidiaries could become subject to claims and litigation pertaining to the
Company’s or the Bank’s fiduciary responsibility.
From time to time, customers make claims and take legal action pertaining to the Company's performance
of its fiduciary responsibilities. Whether customer claims and legal action related to the Company's
performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal action are
not resolved in a manner favorable to the Company, they may result in significant financial liability
and/or adversely affect the market perception of the Company and its products and services as well as
impact customer demand for those products and services. Any financial liability or reputational damage
could have a material adverse effect on the Company's business, which, in turn, could have a material
adverse impact on its financial condition and results of operations.
The Company and its subsidiaries are subject to changes in accounting principles, policies, or
guidelines.
The Company's financial performance is impacted by accounting principles, policies, and guidelines.
Some of these policies require the use of estimates and assumptions that may affect the value of the
Company's assets or liabilities and financial results. Some of the Company's accounting policies are
critical because they require management to make difficult, subjective, and complex judgments about
matters that are inherently uncertain and because it is likely that materially different amounts would be
reported under different conditions or using different assumptions. If such estimates or assumptions
underlying the Company's financial statements are incorrect, it may experience material losses.
From time to time, the FASB and the SEC change the financial accounting and reporting standards or the
interpretation of those standards that govern the preparation of the Company's external financial
statements. These changes are beyond the Company's control, can be difficult to predict, and could
materially impact how the Company reports its results of operations and financial condition.
Changes in these standards are continuously occurring, and given the current economic environment,
more drastic changes may occur. The implementation of such changes could have a material adverse
effect on the Company's financial condition and results of operations.
The Company is a bank holding company and the sources of funds available to the Company to
meet its obligations are limited.
The Company is a bank holding company, and its operations are primarily conducted by the Bank, which
is subject to significant federal and state regulation. Cash available to pay dividend and interest
obligations, expenses and to meet debt service requirements is derived primarily from dividends received
from the Bank. The Company has not received dividends from the Bank since 2010 and future dividend
payments by the Bank to the Company will require generation of future earnings by the Bank and are
subject to certain regulatory guidelines and approval requirements. If the Bank is unable to pay dividends
to the Company, the Company may not have the resources or cash flow to meet all of its obligations.
40
The Company's controls and procedures may fail or be circumvented.
Management regularly reviews and updates the Company's loan underwriting and monitoring process,
internal controls, disclosure controls and procedures, and corporate governance policies and procedures.
Any system of controls, however well designed and operated, is based in part on certain assumptions and
can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any
failure or circumvention of the Company's controls and procedures or failure to comply with regulations
related to controls and procedures could have a material adverse effect on the Company's business,
financial condition, and results of operations.
Loss of key employees may disrupt relationships with certain customers.
The Company's business is primarily relationship-driven in that many of its key employees have
extensive customer relationships. Loss of key employees with such customer relationships may lead to
the loss of business if the customers were to follow that employee to a competitor. While the Company
believes its relationships with its key personnel are strong, it cannot guarantee that all of its key personnel
will remain with the organization. Loss of such key personnel, should they enter into an employment
relationship with one of the Company's competitors, could result in the loss of some of its customers,
which could have a negative impact on the company's business, financial condition, and results of
operations.
The Company's information systems may experience an interruption or breach in security.
The Company relies heavily on internal and outsourced technologies, communications, and information
systems to conduct its business. As the Company's reliance on technology has increased, so have the
potential risks of a technology-related operation interruption (such as disruptions in the Company's
customer relationship management, general ledger, deposit, loan, or other systems) or the occurrence of a
cyber-incident (such as unauthorized access to the Company's systems). Cyber-incidents can result from
deliberate attacks or unintentional events, including (i) gaining unauthorized access to automated systems
for purposes of misappropriating assets or sensitive information, corrupting data or causing operational
disruptions, (ii) causing denial of service attacks on websites, or (iii) intelligence gathering and social
engineering aim at obtaining information. Applying guidance from FFIEC, the Company has identified
security risks and employs risk mitigation controls. Following a layered security approach, this program
has analyzed and will continue to analyze security related to device specific considerations, user access
topics, transaction-processing and network integrity. Additionally, the Company has instituted a
comprehensive Vendor Management Program that allows the Company to expand its control over how
and where Company information assets are stored.
Management believes that a strong foundational security structure has been established but can make no
assurances that such structure will be sufficient to prevent cyber-incidents. The Company will continue to
work with state and federal cybercrime organizations to stay abreast of continuously evolving threats. An
annual risk assessment of information technology has been and will be prepared by the Company’s
information technology group for presentation to the Company’s board of directors. The Company also
assessed vendors who may store any of our data externally, and the Company believes such outside
vendors have established sufficient security procedures. Last, the Company has established and will
continue to develop a security awareness program for its customers as well as all Company employees.
The occurrence of an operational interruption or a deficiency in the cyber-security of the Company's
technology systems (internal or outsourced) could negatively impact the Company's financial condition or
results of operations.
The Company is dependent upon outside third parties for the processing and handling of Company
records and data.
41
The Company relies on software developed by third party vendors to process various Company
transactions. In some cases, the Company has contracted with third parties to run their proprietary
software on behalf of the Company. These systems include, but are not limited to, general ledger, payroll,
wealth management record keeping, and securities portfolio management. While the Company performs
a review of controls instituted by the vendor over these programs in accordance with industry standards
and institutes its own user controls, the Company must rely on the continued maintenance of the
performance controls by the outside party, including safeguards over the security of customer data. In
addition, the Company backups of key processing output daily in the event of a failure on the part of any
of these systems. Nonetheless, the Company may incur a temporary disruption in its ability to conduct its
business or process its transactions, or incur damage to its reputation if the third party vendor fails to
adequately maintain internal controls or institute necessary changes to systems. Such disruption or breach
of security may have a material adverse effect on the Company's financial condition and results of
operations.
The Company and its subsidiaries are defendants in a variety of litigation and other actions.
Currently, there are certain other legal proceedings pending against the Company and its subsidiaries in
the ordinary course of business. While the outcome of any legal proceeding is inherently uncertain, based
on information currently available, the Company's management believes that any liabilities arising from
pending legal matters would have a material adverse effect on the Bank or on the consolidated financial
statements of the Company. However, if actual results differ from management's expectations, it could
have a material adverse effect on the Company's financial condition, results of operations, or cash flows.
Risks Associated with the Company's Common Stock
The Company has not established a minimum dividend payment level, and it cannot ensure its
ability to pay dividends in the future.
The Written Agreement with the Federal Reserve included restrictions on the Company’s payment of
dividends on its common stock. Although the Written Agreement was terminated in January 2014, the
Company expects that it will continue to seek approval from the Reserve Bank prior to paying any
dividends on its common stock.
In addition, the Federal Reserve has issued Federal Reserve Supervision and Regulation Letter SR-09-4,
which requires bank holding companies to inform and consult with Federal Reserve supervisory staff
prior to declaring and paying a dividend that exceeds earnings for the period for which the dividend is
being paid. Under this regulation, if the Company experiences losses in a series of consecutive quarters,
it may be required to inform and consult with the Federal Reserve supervisory staff prior to declaring or
paying any dividends. In this event, there can be no assurance that the Company's regulators will approve
the payment of such dividends. In addition, as a Delaware corporation, the Company is subject to the
limitations of the Delaware General Corporation Law (the “DGCL”). The DGCL allows the Company to
pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the
DGCL) or, if the Company has no such surplus, out of its net profits for the fiscal year in which the
dividend is declared and/or the preceding fiscal year.
Holders of the Company’s common stock are also only entitled to receive such dividends as the
Company’s board of directors may declare out of funds legally available for such payments. The
Company is currently prohibited from paying any cash dividends, and even when such prohibitions end,
there are restrictions on its ability to make cash dividends that will likely continue to materially limit its
ability to pay cash dividends and cannot make assurances of when it may pay cash dividends in the future.
Finally, the Company is also currently deferring the regularly scheduled quarterly payments on its
42
outstanding trust preferred securities and its outstanding shares of Series B Preferred Stock and is
prohibited from paying any cash dividends on its common stock until all unpaid dividends and
distributions on such senior securities have been paid in full.
The Company has deferred interest payments on its junior subordinated debentures and dividends
on the Series B Preferred Stock, and the failure to resume payments may adversely affect the
Company and the stockholders.
In the third quarter of 2010, the Company elected to defer regularly scheduled interest payments on $58.4
million of junior subordinated debentures related to the trust preferred securities issued by its two
statutory trust subsidiaries, Old Second Capital Trust I and Old Second Capital Trust II (collectively, the
“Trust Preferred Securities”). Because of the deferral on the junior subordinated debentures, the trusts
have deferred regularly scheduled dividends on the Trust Preferred Securities. The total accumulated
interest on the junior subordinated debentures including compounded interest from July 1, 2010 on the
deferred payments totaled $17.0 million at December 31, 2013.
On August 31, 2010, the Company also announced that it elected to defer quarterly cash dividends on its
Series B Preferred Stock. Dividend payments on the Series B Preferred Stock may be deferred without
default but the dividends are cumulative. The dividend rate on the Series B Preferred Stock is 5% per
annum through February 2014 and 9% per annum thereafter. In addition, following Treasury's auction of
the Series B Preferred Stock in the first quarter of 2013, the Company elected to stop accruing the
dividend on the Series B Preferred Stock. Given the discount reflected in the results of the auction, the
Company believed that the Company would likely be able to repurchase the Series B Preferred Stock at a
price less than the face amount of the Series B Preferred Stock plus unpaid dividends. Although the
Company has stopped accruing the dividend, dividends on the Series B Preferred Stock have continued to
accumulate and the Company can make no assurances that it will not be required to pay all unpaid
dividends on the Series B Preferred Stock. As of December 31, 2013, the accumulated and unpaid
Series B Preferred Stock dividends totaled $13.3 million.
The Company is allowed to defer payments of interest for 20 quarterly periods on the Trust Preferred
Securities without default or penalty, but such amounts will continue to accumulate. Also during the
deferral period, the Company generally may not pay cash dividends on or repurchase its common stock or
preferred stock, including the Series B Preferred Stock. The terms of the Series B Preferred Stock also
prevent the Company from paying cash dividends on or repurchasing its common stock while Series B
Preferred Stock dividends are in arrears.
The holders of the Company’s debt have rights that are senior to those of its stockholders.
The Company currently has a $45.5 million credit facility with a correspondent lender, which includes
$45.0 million of subordinated debt and $500,000 in term debt. As of December 31, 2013, the $45.0
million in principal of subordinated debt and the $500,000 in principal of term debt were
outstanding. The term debt and subordinated debt mature on March 31, 2018. The term debt portion of
the senior debt is secured by all of the capital stock of the Bank. As of December 31, 2013, the Company
was out of compliance with the financial covenant in the agreement governing the credit facility regarding
the level of nonperforming loans to the Bank's Tier 1 capital and, as a result, were in default on the
$500,000 in term debt currently outstanding under the senior debt portion of the credit facility. As a result
of the Company’s default under the term debt, it is possible that its lender could seek to accelerate the
$500,000 outstanding on the term debt and, if the Company is unable to pay such amount, seek to recover
on its secured interest in the capital stock of the Bank. In addition, as of December 31, 2013, the
Company also had $58.4 million in junior subordinated debentures related to the Trust Preferred
Securities outstanding. Payments of the principal and interest on the Trust Preferred Securities are
conditionally guaranteed by the Company to the extent the trusts have funds available for such
43
obligations.
The rights of the holders of the Company’s senior debt, subordinated debt and junior subordinated
debentures are senior to the shares of its common stock and preferred stock. As a result, the Company
must make payments on its senior debt, subordinated debt and junior subordinated debentures (and the
related Trust Preferred Securities) before any dividends can be paid on its common stock or preferred
stock and, in the event of its bankruptcy, dissolution or liquidation, the holders of the Company’s senior
debt, subordinated debt and junior subordinated debentures must be satisfied before any distributions can
be made to its common stockholders.
The holders of the Company’s preferred stock have rights that are senior to those of its common
stockholders.
In January 2009, the Company issued and sold 73,000 shares of Series B Preferred Stock, which ranks
senior to its common stock in the payment of dividends and on liquidation, to the Treasury in connection
with the CCP (together with the warrant to acquire 815,339 shares of the Company’s common stock) for
$73.0 million. During the first quarter of 2013, Treasury sold all of Series B Preferred Stock to third
party investors, including certain of the Company’s directors, in a public auction. In the event of the
Company’s bankruptcy, dissolution, or liquidation, the holders of the Series B Preferred Stock will
receive distributions of its available assets prior to the holders of its common stock but after the holders of
its senior debt, subordinated debt and junior subordinated debentures.
The trading volumes in the Company's common stock may not provide adequate liquidity for
investors.
Shares of the Company’s common stock are listed on The Nasdaq Global Select Market (“Nasdaq”);
however, the average daily trading volume in its common stock is less than that of most larger financial
services companies. A public trading market having the desired characteristics of depth, liquidity and
orderliness depends on the presence in the marketplace of a sufficient number of willing buyers and
sellers of the common stock at any given time. This presence depends on the individual decisions of
investors and general economic and market conditions over which the Company has no control. A capital
offering is likely to positively impact the liquidity in the Company’s common stock; however, the
Company cannot be sure this expectation will materialize. Given the current daily average trading volume
of the Company’s common stock, if there is no change in liquidity as a result of this offering, significant
sales of the Company’s common stock in a brief period of time, or the expectation of these sales, could
cause a significant decline in the price of the Company’s stock.
The trading price of the Company’s common stock may be subject to continued significant
fluctuations and volatility.
The market price of the Company’s common stock could be subject to significant fluctuations due to,
among other things:
∙
∙
actual or anticipated quarterly fluctuations in its operating and financial results,
particularly if such results vary from the expectations of management, securities analysts
and investors, including with respect to further loan losses the Company may incur;
announcements regarding significant transactions in which the Company may engage,
including this offering;
∙ market assessments regarding such transactions, including the timing, terms and
likelihood of success of this offering;
changes or perceived changes in its operations or business prospects;
∙
44
∙
∙
∙
∙
∙
∙
legislative or regulatory changes affecting its industry generally or its businesses and
operations;
the failure of general market and economic conditions to stabilize and recover,
particularly with respect to economic conditions in Illinois, and the pace of any such
stabilization and recovery;
the operating and share price performance of companies that investors consider to be
comparable to the Company;
future offerings by the Company of debt, preferred stock or trust preferred securities,
each of which would be senior to its common stock upon liquidation and for purposes of
dividend distributions;
actions of its current shareholders, including future sales of common stock by existing
shareholders and its directors and executive officers; and
other changes in U.S. or global financial markets, economies and market conditions, such
as interest or foreign exchange rates, stock, commodity, credit or asset valuations or
volatility.
Stock markets in general, and the Company’s common stock in particular, have experienced significant
volatility since 2007 and continue to experience significant price and volume volatility. As a result, the
market price of the Company’s common stock may continue to be subject to similar market fluctuations
that may or may not be related to its operating performance or prospects. Increased volatility could result
in a decline in the market price of the Company’s common stock.
Holders of the Series B Preferred Stock have certain voting rights that may adversely affect the
Company’s common stock holders, and the holders of the Series B Preferred Stock may have
interests different from the Company’s common shareholders.
As a consequence of missing the sixth dividend payment on the Series B Preferred Stock, Treasury had
the right to appoint two directors to the Company’s board of directors until all unpaid dividends have
been paid. Treasury exercised its right and appointed one director, Mr. Duane Suits, to the Company’s
board of directors during the fourth quarter of 2012. In addition to holding a seat on the board of
directors, the holders of the Series B Preferred Stock have limited voting rights, except as required by law
or to the extent such rights are waived. For as long as shares of the Series B Preferred Stock are
outstanding, in addition to any other vote or consent of the shareholders required by law or the
Company’s certificate of incorporation, the vote or consent of holders of at least 662/3% of the shares of
the Series B Preferred Stock outstanding is required for any authorization or issuance of shares ranking
senior to the Series B Preferred Stock; any amendments to the rights of the Series B Preferred Stock that
adversely affect the rights, privileges or voting power of the Series B Preferred Stock; or initiation and
completion of any merger, share exchange or similar transaction unless the shares of Series B Preferred
Stock remain outstanding, or, if the Company is not the surviving entity in such transaction, are converted
into or exchanged for preferred securities of the surviving entity that have the same rights, preferences,
privileges and voting power of the Series B Preferred Stock. The holders of the Series B Preferred Stock
may have different interests from the holders of the Company’s common stock and could vote to block
the forgoing transactions, even when considered desirable by, or in the best interests of, the holders of the
Company’s common stock.
Any future offerings of debt, preferred stock or other securities, each of which would be senior to
the Company’s common stock upon liquidation and for purposes of dividend distributions, and any
future equity offerings may adversely affect the market price of the Company’s common stock.
The Company may attempt to increase its capital resources, or the Company or the Bank, could be forced
by federal and state bank regulators to raise additional capital by making additional offerings of debt or
preferred equity securities, including medium-term notes, senior or subordinated notes and preferred
45
stock. Upon liquidation, holders of the Company’s debt securities and preferred stock and lenders with
respect to other borrowings will receive distributions of the Company’s available assets prior to the
holders of the outstanding shares of common stock. Additional equity offerings, including an offering in
the Company’s common stock, may dilute the holdings of its existing shareholders or reduce the market
price of its common stock, or both. Holders of the Company’s common stock are not entitled to
preemptive rights or other protections against dilution.
The Company’s board of directors is authorized to issue one or more classes or series of preferred stock
from time to time without any action on the part of its shareholders. The Company’s board of directors
also has the power, without shareholder approval, to set the terms of any such classes or series of
preferred stock that may be issued, including voting rights, dividend rights and preferences over its
common stock with respect to dividends or upon the Company’s dissolution, winding-up and liquidation
and other terms. Therefore, if the Company issues preferred stock in the future that has a preference over
its common stock with respect to the payment of dividends or upon its liquidation, dissolution or winding
up, or if the Company issues preferred stock with voting rights that dilute the voting power of its common
stock, the rights of holders of the Company’s common stock or the market price of the Company’s
common stock could be adversely affected.
Certain banking laws and the Company’s Rights Plan may have an anti-takeover effect.
Certain federal banking laws, including regulatory approval requirements, could make it more difficult for
a third party to acquire the Company, even if doing so would be perceived to be beneficial to the
Company’s shareholders. In addition, the Company’s Amended and Restated Rights Plan and Tax
Benefits Preservation Plan (the “Rights Plan”) is intended to discourage any person from acquiring 5% or
more of the Company’s outstanding stock (with certain limited exceptions). The combination of these
provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could
adversely affect the market price of the Company’s common stock.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
We conduct our business at 27 retail banking center locations. We own 25 and lease 2 of our banking
center locations. The two leased locations are leased through March 2015 and August 2016. We believe
that all of our properties and equipment are well maintained, in good operating condition and adequate for
all of our present and anticipated needs.
Set forth below is information relating to each of our offices as of December 31, 2013. The total net book
value of our premises and equipment (including land and land improvements, buildings, furniture and
equipment, and buildings and leasehold improvements) at December 31, 2013, was $46.0 million.
Principal Business Office:
37 South River Street, Aurora, Illinois
Banking Office Locations:
Cook County
195 West Joe Orr Road, Chicago Heights, Illinois
DeKalb County
1810 DeKalb Avenue, Sycamore, Illinois
46
1100 South County Line Road, Maple Park, Illinois
DuPage County
4080 Fox Valley Center Drive, Aurora, Illinois
3101 Ogden Road, Lisle, Illinois
Kane County
1991 West Wilson Street, Batavia, Illinois
555 Redwood Drive, Aurora, Illinois
200 West John Street, North Aurora, Illinois
1350 North Farnsworth Avenue, Aurora, Illinois
Cross Street and State Route 47, Sugar Grove, Illinois
801 South Kirk Road, Saint Charles, Illinois
1230 North Orchard Road, Aurora, Illinois
1078 East Wilson Street, Batavia, Illinois
1000 South Mclean Boulevard, Elgin, Illinois (1)
3290 U.S. Highway 20 and Nesler Road, Elgin, Illinois
749 North Main Street, Elburn, Illinois
40W422 IL Route 64, Wasco, Illinois
194 South Main Street, Burlington, Illinois
2S101 Harter Road, Kaneville, Illinois (1)
Kendall County
1200 Douglas Road, Oswego, Illinois
26 West Countryside Parkway, Yorkville, Illinois
7050 Burroughs Avenue, Plano, Illinois
La Salle County
323 East Norris Drive, Ottawa, Illinois
Will County
850 Essington Road, Joliet, Illinois
20201 South Lagrange Road, Frankfort, Illinois
951 East Lincoln Highway, New Lennox, Illinois
(1) Leased facility
Item 3. Legal Proceedings
The Company and its subsidiaries have, from time to time, collection suits and other actions that arise in
the ordinary course of business against its borrowers 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 4. Mine Safety Disclosures
Not applicable
47
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
Market for the Company’s Common Stock
The Company’s common stock trades on The Nasdaq Global Select Market under the symbol “OSBC”. As
of December 31, 2013, the Company had 1,011 stockholders of record of its common stock. The following
table sets forth the range of prices during each quarter for 2013 and 2012.
First quarter
Second quarter
Third quarter
Fourth quarter
High
$3.75
6.07
6.92
5.94
2013
Low
$1.20
3.13
5.32
4.16
Dividend
High
$0.00
0.00
0.00
0.00
$1.98
1.93
1.75
1.65
2012
Low
$1.15
1.15
1.28
1.10
Dividend
$0.00
0.00
0.00
0.00
The Company incorporates by reference the information contained Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations under the caption “Capital”.
The Company also incorporates by reference the information contained under the "Notes to Consolidated
Financial Statements Note 15: Regulatory & Capital Matters”.
The Company did not pay any dividends in 2012 or 2013 as set forth in the table above. The Company’s
shareholders are entitled to receive dividends when, as and if declared by the board of directors out of
funds legally available therefore. The Company’s ability to pay dividends to shareholders is largely
dependent upon the dividends it receives from the Bank, certain regulatory restrictions and the terms of its
debt and equity securities, and the Bank is subject to regulatory limitations on the amount of cash
dividends it may pay.
As of December 31, 2013, we had $58.4 million of junior subordinated debentures held by two statutory
business trusts that we control. We have the right to defer interest payments on the junior subordinated
debentures, which were approximately $5.3 million in the year ended December 31, 2013, for a period of
up to 20 consecutive quarters, and we elected to begin such a deferral period in August 2010. All
deferred interest must be paid before we may pay dividends on our capital stock. Therefore, we will not
be able to pay dividends on our common stock until all deferred interest on these debentures has been
paid in full. The total amount of such deferred interest as of December 31, 2013, was $17.0 million.
Furthermore, as with the debentures discussed above, the Company is prohibited from paying dividends
on its common stock unless it has fully paid all accrued dividends on its Series B Preferred Stock. In
August 2010, the Company also announced the payment deferral of dividends on such preferred stock and
must also fully pay all accrued and unpaid dividends on the Series B Preferred Stock before it may
reinstate the payment of dividends on the common stock.
Finally, the Written Agreement between the Company and the Reserve Bank prohibited the Company
from paying dividends without prior regulatory approval. Although the Written Agreement was
terminated, the Company expects that it will continue to seek approval from the Reserve Bank prior to
paying any dividends on its common stock.
48
Form 10-K and Other Information
Transfer Agent/Stockholder Services
Inquiries related to stockholders records, stock transfers, changes of ownership, change of address and
dividend payments should be sent to the transfer agent at the following address:
Old Second Bancorp, Inc.
c/o Shirley Cantrell,
Executive Administrative Department
37 River Street
Aurora, Illinois 60506-4172
(630) 906-2303
scantrell@oldsecond.com
Stockholder Return Performance Graph. The following graph indicates, for the period commencing
December 31, 2008 and ending December 31, 2013, a comparison of cumulative total returns for the
Company, the Nasdaq Bank Index and the S&P 500. The information assumes that $100 was invested at
the closing price at December 31, 2008 in the common stock of the Company and each index and that all
dividends were reinvested.
5-Year Performance Comparison
Old Second Bancorp, Inc.
NASDAQ Bank
S&P 500
300
250
200
150
100
50
0
e
u
l
a
V
x
e
d
n
I
12/31/08
12/31/09
12/31/10
12/31/11
12/31/12
12/31/13
Index
12/31/08
12/31/09
12/31/10
12/31/11
12/31/12
12/31/13
Old Second Bancorp, Inc.
NASDAQ Bank
S&P 500
100.00
100.00
100.00
60.31
83.70
14.95
95.55
11.43
85.52
126.46
145.51
148.59
10.73
101.50
172.37
40.63
143.84
228.19
Period Ending
Purchases of Equity Securities By the Issuer and Affiliated Purchasers
There were purchases of 88,877 shares made by or on behalf of the Company of shares of its common
stock during the year ended December 31, 2013, primarily for the payment of taxes relating to the vesting
of stock awards. During 2013 there were 178,943 shares recaptured on shares previously awarded to
certain officers after the Treasury’s auction of the Old Second Bancorp Series B Preferred Stock.
49
The following table shows certain information relating to purchases or recapture of common stock for the
twelve months ended December 31, 2013:
Period
January 1 - January 31, 2013
February 1 - February 28, 2013
March 1 - March 31, 2013
September 1 - September 30, 2013
Total
number
of shares
acquired
14,010
59,065
178,943
15,802
Average
price paid
per share
1.45
$
2.79
3.18
5.83
Total
267,820
$
3.16
Total number of
shares purchased
as part of a
publicly
announced plan
Remaining
number of shares
authorized for
purchase under
the plan
-
-
-
-
-
-
-
-
-
50
Item 6. Selected Financial Data
Old Second Bancorp, Inc. and Subsidiaries
Financial Highlights
(In thousands, except share data)
Balance sheet items at year-end
Total assets
Total earning assets
Average assets
Loans, gross
Allowance for loan losses
Deposits
Securities sold under agreement
to repurchase
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Note payable
Stockholders' equity
Results of operations for the year ended
Interest and dividend income
Interest expense
Net interest and dividend income
(Release) provision for loan losses
Noninterest income
Noninterest expense
Income (loss) before taxes
(Benefit) provision for income taxes
Net income (loss)
Preferred stock dividends and accretion
Net income (loss) available to common stockholders
Loan quality ratios
Allowance for loan losses to total loans at end of year
Provision for loan losses to total loans
Net loans charged-off to average total loans
Nonaccrual loans to total loans at end of year
Nonperforming assets to total assets at end of year
Allowance for loan losses to nonaccrual loans
Per share data
Basic earnings (loss)
Diluted earnings (loss)
Dividends declared
Common book value per share
2013
2012
2011
2010
2009
$
2,004,034
1,758,582
1,962,688
1,101,256
27,281
1,682,128
$
2,045,799
1,834,995
1,950,625
1,150,050
38,597
1,717,219
$
1,941,418
1,751,662
2,015,464
1,368,985
51,997
1,740,781
$
2,123,921
1,933,296
2,426,356
1,690,129
76,308
1,908,528
$
2,596,657
2,359,740
2,813,221
2,062,826
64,540
2,206,277
22,560
5,000
58,378
45,000
500
147,692
17,875
100,000
58,378
45,000
500
72,552
901
-
58,378
45,000
500
74,002
2,018
4,141
58,378
45,000
500
83,958
18,374
54,998
58,378
45,000
500
197,208
69,040
13,786
55,254
(8,550)
31,183
83,144
11,843
(70,242)
82,085
5,258
76,827
$
75,081
15,735
59,346
6,284
37,219
90,353
(72)
-
(72)
4,987
(5,059)
$
85,423
21,473
63,950
8,887
31,062
92,623
(6,498)
-
(6,498)
4,730
(11,228)
$
106,681
28,068
78,613
89,668
42,536
98,262
(66,781)
41,868
(108,649)
4,538
(113,187)
$
132,650
45,513
87,137
96,715
41,761
143,344
(111,161)
(45,573)
(65,588)
4,281
(69,869)
$
2.48%
-0.78%
0.25%
3.53%
4.06%
70.11%
3.36%
0.55%
1.56%
6.74%
7.58%
49.79%
3.80%
0.65%
2.17%
9.26%
11.96%
41.01%
4.51%
5.31%
4.10%
12.56%
14.50%
35.96%
3.13%
4.69%
3.33%
8.48%
8.91%
36.88%
$
5.45
5.45
-
5.37
$
(0.36)
(0.36)
-
0.05
$
(0.79)
(0.79)
-
0.22
$
(8.03)
(8.03)
0.02
1.01
$
(5.04)
(5.04)
0.10
9.27
Weighted average diluted shares outstanding
Weighted average basic shares outstanding
Shares outstanding at year-end
14,106,033
13,939,919
13,917,108
14,207,252
14,074,188
14,084,328
14,220,822
14,019,920
14,034,991
14,104,228
13,918,309
13,911,475
13,912,916
13,815,965
13,823,917
51
The following represents unaudited quarterly financial information for the periods indicated:
Interest income
Interest expense
Net interest income
(Release) provision for loan losses
Securities (losses) gains, net
(Loss) Income before taxes
Net income (loss)
Basic (loss) earnings per share
Diluted (loss) earnings per share
Dividends paid per share
2013
2012
$
4th
16,894
3,219
13,675
(2,500)
(4,103)
(32)
213
(0.08)
(0.08)
-
$
3rd
17,724
3,435
14,289
(1,750)
(7)
2,927
72,924
5.08
5.08
-
$
2nd
16,932
3,544
13,388
(1,800)
745
3,477
3,477
0.15
0.15
-
$
1st
17,490
3,588
13,902
(2,500)
1,453
5,471
5,471
0.30
0.30
-
$
4th
17,562
3,645
13,917
-
269
1,524
1,524
0.02
0.02
-
$
3rd
18,333
3,698
14,635
-
513
120
120
(0.08)
(0.08)
-
$
2nd
19,736
4,046
15,690
200
692
1,252
1,252
0.00
0.00
-
$
1st
19,450
4,346
15,104
6,084
101
(2,968)
(2,968)
(0.30)
(0.30)
-
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion provides additional information regarding the Company's operations for the
twelve-month periods ending December 31, 2013, and 2012 and financial condition at December 31,
2013, and 2012. This discussion should be read in conjunction with “Selected Financial Data” and the
Company's consolidated financial statements and the accompanying notes thereto included or
incorporated by reference elsewhere in this document.
The Company provides a wide range of financial services through its 27 branch locations located in Kane,
Kendall, DeKalb, DuPage, LaSalle, Will and southwestern Cook 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. The Company focuses its
business upon establishing and maintaining relationships with its clients while maintaining a commitment to
providing for the financial services needs of the communities in which it operates through its retail branch
network. The Company emphasizes relationships with individual customers as well as small to medium-
sized businesses throughout our market area. The Company’s market area includes a mix of commercial
and industrial, real estate, and consumer related lending opportunities, and provides a stable core deposit
base. The Company also has extensive wealth management services, which now include a registered
investment advisory platform in addition to trust administration and trust services related to personal and
corporate trusts, including employee benefit plan administration services.
The health of the overall real estate market has improved in the Company’s market area. While the
precipitous decline in the value of certain real estate assets slowed in the latter part of 2010, continued
market sluggishness resulted in smaller declines in the values of real estate and associated asset types
during the reporting period that ended December 31, 2013. The availability of ready local markets for
real estate, while improved in 2013, remained limited and continued to affect the ability of many
borrowers to pay on their obligations. The Company’s net income for 2013 as measured under generally
accepted accounting principles (“GAAP”) was $82.1 million, largely from tax related benefits. The
Company recorded a net loss of $72,000 for the year of 2012 as measured under GAAP.
The Company recorded income tax expense totaling $41.9 million in 2010 as it established a valuation
reserve on substantially all of its deferred tax assets. In 2011 and 2012, management determined that the
realization of the deferred tax assets was not more likely than not and maintained a valuation allowance
on substantially all of its net deferred tax assets. The Company, in making this tax valuation estimate
considered forecasts of future income, available tax planning strategies, and assessments of the current
and future economic and business conditions. In 2013, the Company’s management reevaluated these
conditions and whether there was support for a change in the valuation allowance against its deferred tax
52
assets. The 2013 evaluation concluded in the third quarter and management determined that, after
comprehensive review of both positive and negative considerations, it was now more likely than not that
the deferred tax assets could be realized. A significant portion of the valuation allowance against deferred
tax assets consequently was reversed. A discussion related to the realizability of tax benefits and related
items is included in our results of operations that follows as well as in Notes 1 and 11 of the consolidated
financial statements included in this annual report.
The Company sold certain collateralized debt obligations (“CDOs”) in the fourth quarter of 2013 at a pre-
tax loss of $4.1 million. The CDOs were originally purchased by the Bank in late 2007 and mid-
2008. Credit ratings on these securities, which were issued by prominent rating agencies were upgraded
between December 31, 2012, and September 30, 2013. The Company sold these securities following the
December 2013 announcements of the implementation of Section 619 of the Dodd – Frank Wall Street
Reform and Consumer Protection Act, commonly referred to as the Volcker Rule. As originally released,
the Volcker Rule required banking entities to divest investments in these types of CDOs by July 2015. As
a result of the regulatory uncertainty and the possibility that the Company would not be allowed to hold
the CDOs to maturity, the Company determined that the best course of action was to liquidate the CDOs.
These securities were carried at an unrealized loss of $6.1 million as of September 30, 2013, and were
sold in December 2013 at a pre-tax loss of $4.1 million, contributing $1.2 million net of tax to tangible
capital in the fourth quarter of 2013.
In 2013, the Bank continued to reposition its balance sheet to reduce asset quality risk and maintain its
capital ratios with continued strong liquidity. The Company also continued to take steps to cut operating
expenses and increase net earnings. In this environment, the Company significantly reduced problem
loans and nonperforming assets. Reduced other real estate owned holdings resulted in lower property
valuation and maintenance expenses. As the Company focused on reducing expenses, it was able to
maintain its profitable wealth management business and extensive residential real estate business as
important sources of the noninterest income.
The Company’s primary deposit products are checking, NOW, money market, savings, and certificate of
deposit accounts, and the Company’s primary lending products are commercial mortgages, construction
lending, commercial loans, residential mortgages and consumer loans. Major portions of the Company’s
loans are secured by various forms of collateral including real estate, business assets, and consumer property
although borrower cash flow is the primary source of repayment at the time of loan origination.
For 2013, the Company recorded net income of $82.1 million, or $5.45 per diluted share, which compares
with a net loss of $72,000 or $0.36 diluted loss per share in 2012. The basic income per share was $5.45 in
2013 and the basic loss per share was $0.36 in 2012. The Company recorded an $8.6 million release of
reserves for loan losses in 2013, compared to $6.3 million provision for reserves in 2012 which was a
decrease of $14.9 million. The Company recorded a release of reserve for loan losses of $2.5 million in the
fourth quarter of 2013. Net charge-offs were $2.8 million during 2013, including a net recovery of
$234,000 in the fourth quarter. Net charge-offs were $19.7 million in 2012 which included $1.7 million in
the fourth quarter. The net income available to common stockholders was $76.8 million for the year ended
December 31, 2013, with a net loss available to common stockholders of $5.1 million for the year ended
December 31, 2012.
Net interest and dividend income decreased $4.1 million, or 6.9%, from $59.3 million for the year ended
2012 to $55.3 million for the year ended 2013. Average earning assets increased $24.8 million, or 1.4%,
from $1.74 billion in 2012 to $1.76 billion in 2013, as management continued to focus on asset quality
and capital management. Average loans, including loans held-for-sale during the year, decreased $163.7
million, in part, from a continued low level of qualified borrower demand within the Company’s market
areas, combined with charge-off activity. Average interest bearing liabilities decreased $1.1 million, or
0.08%, to $1.47 billion in 2012 and 2013, as the need for funding remained low with the stabilization in
assets.
53
Application of critical accounting policies
The Company’s consolidated financial statements are prepared in accordance with 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.
Significant accounting policies are presented in Note 1 of the financial statements included in this annual
report. These policies, along with the disclosures presented in the other financial statement notes and in this
discussion, provide information on how significant assets and liabilities are valued in the financial
statements and how those values are determined.
Management firmly believes that the Company’s accounting policies with respect to the allowance for loan
losses is an accounting area requiring subjective or complex judgments very important to the Company’s
financial position and results of operations. Therefore, the allowance policy is one of the Company’s most
critical accounting policies. The allowance for loan losses represents management’s estimate of probable
credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is
considered a critical accounting estimate because it requires significant judgment. The amounts of
estimated losses on pools of homogeneous loans are based on historical loss experience, consideration of
current economic trends and conditions, as well as estimated collateral valuations, all of which may be
susceptible to significant change. As a result of management’s analysis of the adequacy of the allowance
for loan losses, loan loss reserve releases were recorded during the year ended December 31, 2013.
The loan portfolio represents the largest asset class on the consolidated balance sheets. The allowance for
loan losses is a valuation allowance for loan losses, increased by the provision for loan losses and decreased
by both loan loss reserve releases and charge-offs less recoveries. Management estimates the allowance
balance required using an assessment of various risk factors including, but not limited to, past loan loss
experience, known and inherent risks in the portfolio, information about specific borrower situations,
estimated collateral values, volume trends in delinquencies, nonaccruals, economic conditions, and other
credit market considerations. Allocations of the allowance may be made for specific loans, but the entire
allowance is available for losses inherent in the loan portfolio.
A loan is considered impaired when it is probable that not all contractual principal or interest due will be
received according to the original terms of the loan agreement. Management defines the measured value of
an impaired loan based upon the present value of the future cash flows, discounted at the loan’s original
effective interest rate, or the fair value reflecting costs to sell the underlying collateral, if the loan is
collateral dependent. Impaired loans at December 31, 2013, and 2012, were $46.6 million and $89.0
million, respectively. In addition, a discussion of the factors driving changes in the amount of the allowance
for loan losses is included in the Allowances for Loan Losses section that follows.
The Company recognizes expense for federal and state income taxes currently payable as well as deferred
federal and state taxes, estimated future tax effects of temporary differences between the tax basis of
assets and liabilities and amounts reported in the consolidated balance sheets, as well as loss
carryforwards and tax credit carryforwards. The Company maintained deferred tax assets for deductible
temporary differences, the largest of which related to the goodwill amortization/impairment. For income
tax return purposes this relates to Section 197 goodwill amortization and goodwill impairment charges.
Realization of deferred tax assets is dependent upon generating sufficient taxable income in either the
carryforward or carryback periods to cover net operating losses generated by the reversal of temporary
differences.
54
A valuation allowance was provided in the past by way of a charge to income tax expense when it was
determined that it was more likely than not that some or all of the deferred tax asset would not be
realized. That determination reflected management’s evaluation of both positive and negative evidence,
including recent Company profits, the forecasts of future income, applicable tax planning strategies, and
assessments of current and future economic and business conditions. Examples of positive evidence that
it was more likely than not that some or all of the deferred tax asset would be realized included the
existence, if any, of taxes paid in available carry-back years, positive credit quality trends, improving
economic or business conditions and the likelihood that taxable income will be generated in future
periods. Examples of negative evidence included a cumulative loss and less than robust tax planning
opportunities, as well as improving but still sluggish trends in real estate conditions in our primary market
areas. In 2013, management determined that realization of a significant portion of the deferred tax asset
was more likely than not, and accordingly, reversed a significant portion of the previously established
valuation allowance. At September 30, 2013, management concluded that internal projections and
positive evidence were sufficient under GAAP to overcome the offsetting negative evidence. In addition,
general uncertainty surrounding future economic and business conditions has diminished so that the
likelihood of volatility in future earnings is similarly diminished. Accrual of income taxes payable and
the remaining portion of the valuation allowances against deferred tax assets are estimates subject to
change based upon the outcome of future events.
Future issuances or sales of common stock or other equity securities could also result in an “ownership
change” as defined for U.S. federal income tax purposes. If an ownership change were to occur, the
Company could realize a loss of a portion of its U.S. federal and state deferred tax assets, including
certain built-in losses that have not been recognized for tax purposes, as a result of the operation of
Section 382 of the Internal Revenue Code of 1986, as amended. The amount of the permanent loss would
be determined by the annual limitation period and the carryforward period (generally up to 20 years for
federal net operating losses) and any resulting loss could have a material adverse effect on the results of
operations and financial condition. On September 12, 2012, the Company and the Bank, as rights agent,
entered into the Rights Plan which is designed to protect the Company’s deferred tax assets against an
unsolicited ownership change.
Income tax returns are also subject to audit by the Internal Revenue Service (the “IRS”) and state taxing
authorities. Income tax expense for current and prior periods is subject to adjustment based upon the
outcome of such audits. All audit work by the IRS has been completed through and including 2011. The
Company believes it has adequately accrued for all probable income taxes payable. The Company is
under examination by the State of Illinois for the tax years 2008 and 2009.
Another of the Company’s critical accounting policies relates to the fair value measurement of various
nonfinancial and financial instruments including investment securities, valuation of OREO, derivative
instruments and the expanded fair value measurement disclosures that are related to Accounting Standards
Codification (“ASC”) 820-10 in detail in Notes 1 and 17 to the consolidated financial statements included in
this annual report.
Results of operations
Net interest income
Net interest income decreased $4.1 million, from $59.3 million for the year ended December 31, 2012, to
$55.3 million for the year ended December 31, 2013. Average earning assets increased $24.8 million, or
1.4%, from $1.74 billion for the year ended December 31, 2012, to $1.76 billion for the year ended
December 31, 2013, as a result of growth in investment securities. Management continued to emphasize
asset quality in marketable securities purchases as new loan originations continued to be limited despite
the increased loan growth late in the year. Management continues to develop loan pipelines that can be
expected to generate future loan originations and loan growth. Average loans, including loans held-for-
55
sale, decreased $163.7 million from December 31, 2012, to December 31, 2013.
At $13.7 million, net interest income for the fourth quarter of 2013 was down from the $14.3 million
recorded in the third quarter. Except for loan growth late in the fourth quarter, the trends discussed above
for the year generally continued in the fourth quarter. The decline from the third quarter is largely
attributable to interest income recognized in the third quarter on loans returning to performing status after
a period of nonaccrual that did not reoccur in the fourth quarter as well as reduced loan-related fees. The
net interest margin was 3.13% for the fourth quarter of 2013 compared to 3.17% for the fourth quarter of
2012.
At $55.3 million, net interest income for the year ended December 31, 2013, was similarly down from the
$59.3 million recorded for the year ended December 31, 2012. The year over year decline is driven by a
sizable decrease in average balance for higher yielding loan earning assets over the period only partially
offset by a sizable increase in average balance for lower yielding investment securities in the same period.
The Company's 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. The Company's asset and liability committee (“ALCO”) seeks
to manage interest rate risk under a variety of rate environments by structuring the Company's balance
sheet and off-balance sheet positions. This process is discussed in more detail in the interest rate risk
section.
Asset Quality
Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans
90 days or greater past due but still accruing. The largest decrease in the nonperforming loans since
December 31, 2012, was in the real estate-commercial, nonfarm segment as this segment’s upgrades and
migration of these loans to OREO was greater than the migration of loans to nonperforming status. Total
nonperforming loans were $39.8 million at December 31, 2013, from $82.6 million at December 31,
2012.
Net recoveries of $234,000 for the fourth quarter of 2013 reflect charge-offs of $1.9 million against
previously established specific reserves on nonaccrual loans deemed uncollectible offset by recoveries of
$2.1 million. Charge-off activity improved for the year ended December 31, 2013, compared to the same
period in 2012 and in the fourth quarter compared to the third quarter of 2013, reflecting an improved
economy in our target markets and past work done on loan quality improvement.
56
The following table shows classified loans by segment for the following periods.
(in thousands)
Real estate-construction
Real estate-residential:
Investor
Owner occupied
Revolving and junior liens
Real estate-commercial, nonfarm
Real estate-commercial, farm
Commercial
Other
Classified loans as of
December 31, 2013
Dollar Change From
December 31,
2013
$
3,024
September 30, December 31, September 30, December 31,
2013
$
6,236
2012
2013
2012
$
14,140
$
(3,212)
$
(11,116)
9,750
7,699
3,971
37,297
-
481
1
62,223
$
10,642
7,292
3,675
40,832
-
264
1
68,942
$
12,007
12,946
5,694
67,851
2,517
1,063
26
116,244
$
(892)
407
296
(3,535)
-
217
-
(6,719)
$
(2,257)
(5,247)
(1,723)
(30,554)
(2,517)
(582)
(25)
(54,021)
$
Classified loans include nonaccrual, performing troubled debt restructurings and all other loans
considered Substandard. All three components are down since December 31, 2012. Classified assets
include both classified loans and OREO. Management monitors a ratio of classified assets to the sum of
Bank Tier 1 capital and the allowance for loan loss reserve. This ratio reflects another measure of overall
improvement in loan related asset quality. The decline in both classified loans and OREO as well as
improved Bank Tier 1 capital in the fourth quarter again strengthened this ratio.
Other positive trends included continued reduction in nonaccrual loans. The December 31, 2013,
nonaccrual total of $38.9 million reflects a trend of reduced nonaccrual loans that has been seen since
January 2011. Similarly, total past due loans, including nonaccrual loans, of $28.5 million for year end
2013 is the most recent decreased total for this metric in a trend of reductions seen since November 2011.
Both results reflect aggressive portfolio management process and diligent follow up by individual
relationship managers on specific credits.
Summarizing numerous encouraging developments, the classified asset ratio showed a positive change
from 49.76% at September 30, 2013, to 43.44% at December 31, 2013, after standing at 82.94% at
December 31, 2012.
Allowance for Loan Losses
The bank’s allowance for loan losses methodology reasonably estimates loan and lease losses as of the
financial statement date(s) and incorporates management’s current judgments about the credit quality of
the loan portfolio through a disciplined and consistently applied methodology. The methodology follows
GAAP including, but not limited to, guidance included in Accounting Standards Codification (“ASC”)
310 and ASC 450, formally known as FAS 114 and FAS 5, respectively. Analysis is prepared in
accordance with guidelines established by the SEC, the Federal Financial Institutions Examination
Council, the American Institution of Certified Public Accountants Audit and Accounting Guide for Banks
and Savings Institutions, and banking industry practices. Methodology is periodically reviewed by the
bank’s independent accountants and banking regulators. No significant methodology changes were made
in 2013. Only minor changes in the risk evaluation factors for commercial loans and commercial real
estate credits were made in 2013.
The coverage ratio of the allowance for loan losses to nonperforming loans was 68.6% as of December
31, 2013, which reflects an increase from 46.7% as of December 31, 2012. A decrease of $42.8 million,
or 51.8%, in nonperforming loans in 2013 drove the overall coverage ratio change. Following established
methodology, management updated the estimated specific allocations in the fourth quarter after receiving
57
more recent appraisal valuations or information on cash flow trends related to the impaired credits.
General allocations decreased by $7.5 million from December 31, 2012, as the overall loan balances
subject to general factors decreased at December 31, 2013. Management determined the estimated
amount to include in the allowance for loan losses based upon a number of factors, including an
evaluation of credit market circumstances, loan growth or contraction, the quality and composition of the
loan portfolio and loan loss experience. The latter item was also weighted more heavily based upon
recent loss experience.
Management reviews the performance of the higher risk loan pool within commercial real estate loans,
and adjusts the population and the related loss factors taking into account adverse market trends including
collateral valuation as well as its assessments of the credits in that pool. Changes are identified in the
Company’s comprehensive loan review process and made in the related risk factors when needed with a
formal affirmation at each quarter end. Those assessments capture management’s estimate of the
potential for adverse migration to an impaired status as well as its estimation of what the potential
valuation impact from that migration would be if it were to occur. The amount of assets subject to this
pool factor decreased by $5.4 million, or 24.0%, at December 31, 2013, as compared to December 31,
2012. Also, compared to December 31, 2012, management increased the loss factor assigned to this pool
by 4.4% based on risk characteristics of the remaining credits. Management has also observed that many
stresses in those credits were generally attributable to cyclical economic events that are showing some
signs of stabilization. Those signs included a reduction in loan migration to watch status, as well as some
stabilization in values of certain properties.
Management conducts a full annual review of all Home Equity Lines of Credit (“HELOC”) by looking at
credit scores and collateral values. When the Company is notified of a foreclosure on a first mortgage,
the HELOC loan is moved to nonaccrual and a decision is made if the loan is collectible. Loan balances
are actively charged-off in the absence of sufficient equity unless the borrower reaffirms or notifies us of
an intention to reaffirm.
The above changes in estimates were made by management to be consistent with observable trends on
asset quality within loan portfolio segments (as discussed in the Asset Quality section above) and in
conjunction with market conditions and credit review administration activities. Several environmental
factors are also evaluated monthly when appropriate with formal affirmation each quarter end and are
included in the assessment of the adequacy of the allowance for loan losses. Further and importantly,
significant improvement was seen in 2013 net charge-offs and nonperforming loans. Net charge-offs of
$19.7 million in 2012 declined by 85.9% to $2.8 million in 2013. Nonperforming loans of $82.6 million
at year end 2012 declined 51.8% to $39.8 million at December 31, 2013. Based on this assessment
management determined that an overall improvement in loan asset quality justified a $2.5 million loan
loss reserve release in the fourth quarter and a total loan loss reserve release of $8.6 million for the year.
When measured as a percentage of loans outstanding, the total allowance for loan losses decreased from
3.4% of total loans as of December 31, 2012, to 2.5% of total loans at December 31, 2013. In
management’s judgment, an adequate allowance for estimated losses has been established for inherent
losses at December 31, 2013; however, there can be no assurance that actual losses will not exceed the
estimated amounts in the future.
The allowance for loan losses consists of three components: (i) specific allocations established for losses
resulting from an analysis developed through reviews of individual impaired loans for which the recorded
investment in the loan exceeds the measured value of the loan; (ii) reserves based on historical loss
experience for each loan category; and (iii) reserves based on general current economic conditions as well as
specific economic and other factors believed to be relevant to the Company’s loan portfolio. The
components of the allowance for loan losses represent an estimation performed pursuant to ASC Topic 450,
“Contingencies”, and ASC Topic 310, “Receivables” including “Accounting by Creditors for Impairment of
a Loan – Income Recognition and Disclosures”. See Note 1 on Summary of Significant Accounting
Policies for further detail.
58
The analysis of these factors involves a high degree of judgment by management. Because of the
imprecision surrounding these factors, the Company estimates a range of inherent losses and maintains a
general allowance that is not allocated to a specific category. At December 31, 2013, the general allowance
not allocated to a specific category was $2.0 million down from $4.4 million at December 31, 2012.
Changes in the allowance for loan losses are detailed in Note 5 on the consolidated financial statements of
this report.
Noninterest income
(in thousands)
Noninterest income
Trust income
Service charges on deposits
Residential mortgage revenue
Securities gains (losses), net
Loss on sale of CDOs
Total Securities (losses) gains, net
Increase in cash surrender value of bank-owned life insurance
Death benefit realized on bank-owned life insurance
Debit card interchange income
Other income
Total noninterest income
Three Months Ended
December 31, 2013
Dollar Change From
December 31, September 30, December 31, September 30, December 31,
2012
2012
2013
2013
2013
$
$
$
$
$
1,673
1,877
1,858
14
(4,117)
(4,103)
405
-
893
1,263
3,866
1,494
1,904
1,232
(7)
-
(7)
419
6
873
1,549
7,470
1,438
1,976
3,605
269
-
269
362
-
886
803
9,339
179
(27)
626
21
(4,117)
(4,096)
(14)
(6)
20
(286)
(3,604)
235
(99)
(1,747)
(255)
(4,117)
(4,372)
43
-
7
460
(5,473)
$
$
$
$
$
Noninterest income declined in the fourth quarter of 2013 from the third quarter reflecting the $4.1
million loss on the sale of certain CDOs. Operationally, residential mortgage revenue increased in the
fourth quarter of 2013 from the third quarter of 2013 along with an improvement in trust income. The
Company’s results in other categories except for other noninterest income remain flat or slightly better.
Other noninterest income decreased in the fourth quarter from the third quarter due to recognition in the
third quarter income of a forfeited purchase deposit from a loan sale where the purchaser did not complete
the sale as contractually required.
The Company had a 4.9% increase in trust income year over year while many noninterest income
categories remained flat or down year over year. Reflecting residential mortgage market conditions, year
over year improvement in mortgage servicing gain net of changes in fair value was offset by sharply
reduced fees and gains on sales. Notably, the other noninterest income category increased year over year
on items like the first quarter clawback of restricted stock and the third quarter purchase deposit forfeiture
discussed above.
59
Noninterest expense
(in thousands)
Noninterest expense
Salaries
Bonus
Benefits and other
Total salaries and employee benefits
Occupancy expense, net
Furniture and equipment expense
FDIC insurance
General bank insurance
Amortization of core deposit intangible assets
Advertising expense
Debit card interchange expense
Legal fees
OREO valuation expense
Other OREO expense, net
Other expense
Total noninterest expense
Three Months Ended
December 31, 2013
Dollar Change From
December 31, September 30, December 31, September 30, December 31,
2012
2013
2013
2013
2012
$
$
$
$
$
7,141
686
1,353
9,180
1,245
990
981
489
525
384
361
642
1,756
48
3,472
20,073
7,010
903
1,386
9,299
1,266
1,026
987
489
524
347
366
615
1,961
583
3,119
20,582
7,084
(92)
1,162
8,154
1,157
1,198
973
846
537
327
365
961
4,284
(280)
3,210
21,732
131
(217)
(33)
(119)
(21)
(36)
(6)
-
1
37
(5)
27
(205)
(535)
353
(509)
57
778
191
1,026
88
(208)
8
(357)
(12)
57
(4)
(319)
(2,528)
328
262
(1,659)
$
$
$
$
$
All categories of noninterest expense were essentially flat to down in the fourth quarter from the third
quarter of 2013, except for other expense. A modest amount was reserved in the fourth quarter other
expense for expenses related to the debit card security compromise at TargetTM stores. An additional
amount was recorded in the quarter for possible expenses related to an ongoing dispute.
All categories were flat to down year over year except salaries and benefits covering board approved
bonus programs, amortization of intangibles and other expenses. Other expense for the year includes the
fourth quarter items discussed above as well as increased expenses for items related to marketing or
public relations, recruitment expense and expense for required property appraisals in 2013. The Company
also realized reduced 2013 yearly expenses on a late 2012 general insurance renewal at lower cost and
effective management of legal expenses in 2013.
Year over year expense related to OREO properties decreased sharply in 2013 as the Company had fewer
OREO properties with related operating expenses and valuation expense adjustments were more
moderate. These factors also were significant in a similar decrease in 2013 from 2012 when considering
other real estate expense, net as shown on the Consolidated Statement of Operations in Item 8. The most
significant factor in the year over year decrease in other real estate expense net of revenue is the full year
expense reduction of $8.1 million on valuation expense adjustments or provision for unrealized losses.
Similarly, operating expenses on OREO properties were down $2.3 million in 2013 from 2012. However,
with fewer properties year over year, lease revenue from OREO is also down $2.2 million. Similarly,
while real estate sales markets have shown moderate improvement year over year, property sales
generated a reduced level of net gain on sales in 2013 compared to net gains realized on sales in 2012.
As of December 31, 2013, there were certain legal proceedings against the Company and its subsidiaries
that arose in the ordinary course of business. The Company does not believe that liabilities, individually
or in the aggregate, arising from these proceedings, if any, would have a material adverse effect on the
consolidated financial condition of the Company as of December 31, 2013.
Income taxes
The Company recorded a tax benefit of $70.2 million on $11.8 million pre-tax income for the year
60
2013. The tax benefit was composed of $134,000 in current income tax expense and $3.8 million in
deferred income tax expense offset by a $74.1 million reversal of the deferred tax valuation allowance
reserve. The valuation allowance against the Company’s deferred tax assets was first established as of
December 31, 2010. Under GAAP, income tax benefits and the related tax assets are only allowed to be
recognized if they will “more likely than not” be fully realized.
On September 12, 2012, the Company and the Bank, as rights agent, entered into the Rights Plan. The
Rights Plan amends the Rights Agreement, dated September 17, 2002. The purpose of the Rights Plan is
to protect the Company’s deferred tax asset against an unsolicited ownership change, which could
significantly limit the Company’s ability to utilize its deferred tax assets. The Rights Plan was ratified by
the Company’s stockholders at the Company’s 2013 annual meeting.
The determination of being able to realize the deferred tax assets is highly subjective and dependent upon
judgment concerning management’s evaluation of both positive and negative evidence, including forecasts
of future income, available tax planning strategies, and assessments of the current and future economic and
business conditions. Management considered both positive and negative evidence regarding the Company’s
ability to ultimately realize the deferred tax assets, which is largely dependent upon the ability to derive
benefits based upon future taxable income. As of September 30, 2013, management determined that the
realization of most of the deferred tax asset was “more likely than not” as required by accounting principles
and reversed a significant portion of an established valuation allowance to reflect this judgment. The
remaining valuation allowance is for a portion of the state net operating loss carryforward the Company
could possibly use, but does not meet the threshold of “more likely than not” at September 30, 2013 and
December 31, 2013.
The Company considered the federal and state net operating loss carryforwards separately when
determining if a valuation allowance was required. After considering tax-planning strategies, the Company
reserved a portion of the state net operating loss carryfoward management did not anticipate using by
December 31, 2016 based on forecasts made at September 30, 2013. While the state net operating loss
carryfoward does not begin to expire until 2021, management acknowledges that forecasts are inherently
subjective and only periods in the foreseeable future should be considered when determining if net deferred
tax assets will be utilized. In each future accounting period, the Company’s management will reevaluate
whether the current conditions in conjunction with positive and negative evidence support a change in the
valuation allowance against the Company’s deferred tax assets. Any such subsequent reduction in the
estimated valuation allowance would lower the amount of income tax expense recognized in the Company’s
consolidated statements of operations in future periods.
The positive evidence considered included the following: (1) the current quarter results reflect the
Company’s sixth consecutive quarter of pre-tax earnings (2) reduced nonperforming assets for the eleventh
consecutive quarter (3) strongly encouraging indications from OCC on the removal of the Consent Order
subsequently confirmed with the removal of the Consent Order effective October 17, 2013. Negative
evidence considered included the decrease in the Company’s net interest margin and reduced noninterest
income, primarily from decreased mortgage banking income. The only tax planning strategy considered
was selling the Company’s bank-owned life insurance which would result in immediate taxable income of
approximately $11.4 million if it were to be sold effective September 30, 2013. While the Company does
not anticipate completing this sale, management would consider the sale in the event a deferred tax asset
was close to expiration.
Financial condition
General
Total assets decreased $41.8 million, or 2.0%, from December 31, 2012, to close at $2.00 billion as of
December 31, 2013. Loans decreased by $48.8 million, or 4.2%, to $1.10 billion over the course of 2013
as management continued to emphasize balance sheet stabilization and credit quality while demand from
61
qualified borrowers remained limited. At the same time, loan charge-off activity reduced balances and
collateral that previously secured loans moved to OREO. In total, OREO assets decreased $30.9 million,
or 42.6%, for the year ended December 31, 2013, compared to December 31, 2012, as sale activity and
valuation writedowns exceeded new properties added. Offsetting these reductions, total securities
increased by $48.9 million, or 8.4%, for the year ended December 31, 2013, reflecting continued
management emphasis on securities investments in the absence of qualified loan demand. Management
continued to maintain available-for-sale securities and held-to-maturity securities in the fourth quarter
consistent with the Company’s past practice of utilizing available liquid funds supplemented by short
term borrowings from the Federal Home Loan Bank of Chicago (the “FHLBC”). For the year ended
December 31, 2013, large dollar purchases were made in collateralized mortgage backed securities and
asset-backed securities (many backed by student loan assets) totaling $266.6 million, and $302.6 million,
respectively. At December 31, 2013, the largest changes by loan type included decreases in commercial
real estate, real estate construction, and residential real estate loans of $19.5 million, $12.8 million and
$24.3 million, or 3.4%, 30.4%, and 5.9%, respectively.
In response to the pending implementation of the Volker Rule, the Company sold CDOs at a before tax
loss of $4.1 million. The CDOs were originally purchased by the Bank in late 2007 and mid-2008. These
securities were carried at an unrealized loss of $6.1 million as of September 30, 2013, and were sold in
December 2013 at a pre-tax loss of $4.1 million, contributing $1.2 million net of tax to tangible capital in
the fourth quarter of 2013.
Investments
As shown below, net investments purchases during 2013 changed the composition of the Company’s
securities portfolio as total loans, except for modest improvement from September 30, 2013, to December
31, 2013, continued to decline.
(in thousands)
Securities available-for-sale, at fair value
U.S. Treasury
U.S. government agencies
U.S. government agency mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized debt obligations
Total securities available-for-sale
Securities held-to-maturity, at amortized cost
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total securities held-to-maturity
As of
September 30, December 31,
December 31, 2013
Dollar Change From
September 30, December 31,
2013
2012
2013
2012
December 31,
2013
$
$
$
$
$
1,507
49,850
128,738
15,855
36,886
169,600
167,493
9,957
579,886
(4)
(21)
-
(3,047)
(7,098)
15,751
4,219
(11,087)
(1,287)
37
(48,178)
(128,738)
939
(21,784)
(105,724)
105,710
(9,957)
(207,695)
1,544
1,672
-
16,794
15,102
63,876
273,203
-
372,191
35,268
221,303
256,571
1,548
1,693
-
19,841
22,200
48,125
268,984
11,087
373,478
35,241
222,860
258,101
$
$
$
$
$
$
$
$
$
-
$
-
$
-
$
$
27
(1,557)
(1,530)
35,268
221,303
256,571
$
$
Total secutities
$
628,762
$
631,579
$
579,886
$
(2,817)
$
48,876
The Company’s total securities show a net decrease of $2.8 million since September 30, 2013, with all
categories declining except total (including available-for-sale and held-to-maturity) collateralized
mortgage obligations and asset-backed securities, which were up $14.2 million and $4.2 million in the
period. Securities held with the intent to hold to maturity were established in the third quarter in response
to increases in overall market interest rates. Management decisions on securities to be classified as held-
to-maturity were made based on the characteristics of individual securities. At December 31, 2013, the
total securities portfolio was $48.9 million higher when compared to December 31, 2012, reflecting both
slow to develop loan opportunities and investment decisions made by management under supervision of
62
the Company’s ALCO process.
Of note, in response to the pending implementation of the Volker Rule, the Company sold certain CDOs
in December 2013 at a before tax loss of $4.1 million. Because these securities were carried at an
unrealized loss of $6.1 million as of September 30, 2013 and sold at a before tax loss of $4.1 million, the
sales contributed $1.2 million net of tax to 2013 tangible capital.
Loans
(in thousands)
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease financing receivables
Other
Net deferred loan costs and (fees)
Major Classification of Loans as of
December 31,
2013
September 30, December 31,
2013
2012
$
$
$
December 31, 2013
Dollar Change From
September 30, December 31,
2013
$
2012
$
94,736
560,233
29,351
390,201
2,760
628
10,069
12,793
1,100,771
485
1,101,256
86,822
554,874
30,996
376,859
2,570
544
11,204
13,236
1,077,105
535
1,077,640
86,941
579,687
42,167
414,543
3,101
994
6,060
16,451
1,149,944
106
1,150,050
7,914
5,359
(1,645)
13,342
190
84
(1,135)
(443)
23,666
(50)
23,616
7,795
(19,454)
(12,816)
(24,342)
(341)
(366)
4,009
(3,658)
(49,173)
379
(48,794)
$
$
$
$
$
Fourth quarter loan production provided a positive close to 2013 and an increase in loans outstanding
from the third quarter. This loan production reflects extensive work done earlier in the year to build
business origination pipelines. Significant new business was realized during the quarter in the multi–
family, commercial real estate (both owner occupied and nonowner occupied) and commercial &
industrial classifications. Management found the multi–family segment to have stabilized, and while not
yet as strong as was found in 2012, reflecting an overall segment recovery. Other commercial real estate
credits were realized in the fourth quarter on relationships in our targeted customer and geographic
markets, in one instance via a participation in a transaction originated by a larger Illinois based financial
institution. Similarly, significant new commercial & industrial lending was realized in the quarter to
businesses that conform to the Company’s profile of customers we seek. Additionally, we strive to serve
customers near our geographical locations in communities served by the Company. The Company
continues to seek opportunities in its primary lending markets that will develop additional relationship
banking customers; however, markets remain very competitive for new loan business.
Total loans were $1.10 billion as of December 31, 2013, a decrease of $48.8 million, or 4.2%, from $1.15
billion as of December 31, 2012. While the Company worked diligently to rebuild and build loan
origination pipelines during 2013, the lack of demand from qualified borrowers, including borrower
reluctance to drawdown on existing credit lines through the year, as well as the competitive landscape,
hindered growth in the loan portfolio. As discussed in the Asset Quality section above, management
continued to emphasize loan portfolio quality in 2013 and, as a result, $2.8 million of net loan charge-offs
were recorded in 2013 down from $19.7 million in 2012.
The quality of the loan portfolio is in large part a reflection of the economic health of the communities in
which the Company operates. The local economies have been affected by the difficult economic
conditions that have been experienced nationwide. The less than vibrant economic conditions continue to
affect business regions served in particular and financial markets generally. Real estate related activity,
including valuations and transactions, while improved from past severe conditions, continues to be less
than expansive. Because the Company is located in a growth corridor with significant open space and
63
undeveloped real estate, real estate lending (including commercial, residential, and construction) has been
and continues to be a sizable portion of the portfolio. During 2013, new negotiating strategies were
employed in addressing maturing real estate facilities and both additional collateral and guarantor support
were taken. Credit structuring has taken a more proactive approach to harness the benefit of stronger
borrower assets to support lowering loan risk profiles and improve loan quality ratings.
Real estate lending categories comprised 89.0% of the portfolio as of December 31, 2013, compared to
90.1% of the portfolio as of December 31, 2012. The commercial loan portfolio increased $7.8 million,
or 9.0%, to $94.7 million at December 31, 2013, from $86.9 million at December 31, 2012. The
Company remains committed to overseeing and managing its loan portfolio to avoid unnecessarily high
credit concentrations in accordance with the general interagency guidance on risk management.
Consistent with those commitments, management updated its asset diversification plan and policy and
anticipates that the percentage of real estate lending to the overall portfolio will decrease in the future.
Consumer loans, overdrafts, and lease financing receivables also increased $3.3 million, or 32.5% in the
aggregate, to $13.5 million at December 31, 2013, from $10.2 million at December 31, 2012.
The allowance for loan losses was $27.3 million and $38.6 million at year end 2013 and 2012, respectively.
One measure of the adequacy of the allowance for loan losses is the ratio of the allowance to total loans.
The allowance for loan losses as a percentage of total loans was 2.5% as of December 31, 2013, compared
to 3.4% as of December 31, 2012. In management's judgment, an adequate allowance for estimated losses
has been established; however, there can be no assurance that losses will not exceed the estimated amounts
in the future.
Management remains cautious about the current tepid recovery in the overall economic environment.
Furthermore, the sustained difficulties in the real estate market, while showing signs of improvement, could
continue to adversely affect collateral values. These events may adversely affect cash flows generally for
both commercial and individual borrowers, and, as a result, the Company could continue to experience
reduced but undesirable levels of problem assets, delinquencies, and losses on loans in future periods.
Other Real Estate Owned
OREO decreased $7.5 million from $49.1 million at September 30, 2013, to $41.5 million at December
31, 2013. OREO activity (property additions, disposals) as well as period valuation adjustments recorded
in the fourth quarter of 2013 is specified below. Overall, a net gain on sale of $781,000 was realized in
the fourth quarter up from $608,000 in the third quarter. A similar reduction in overall holdings at
December 31, 2013, from December 31, 2012, is also shown below. The year over year data show
continued valuation adjustments but at a lower level in 2013 compared to 2012. Also, 2013 property
disposals outweighed 2013 property additions to OREO by over $22.5 million.
(in thousands)
Beginning balance
Property additions
Development improvements
Less:
Property disposals
Period valuation adjustments
Other real estate owned
Three Months Ended
December 31,
2013
2012
$
49,066
4,998
13
$
88,093
5,177
55
Year to Date
December 31,
2013
2012
$
72,423
19,194
73
$
93,290
32,121
701
10,784
1,756
41,537
$
16,337
4,565
72,423
$
41,712
8,441
41,537
$
36,854
16,835
72,423
$
The OREO valuation reserve ended 2013 at $22.3 million, which was 34.9% of gross OREO at
December 31, 2013. The valuation reserve represented 33.4% and 30.3% of gross OREO at September
64
30, 2013, and December 31, 2012, respectively. In management's judgment, an adequate property
valuation allowance has been established to present OREO at current estimates of fair value less costs to
sell; however, there can be no assurance that additional losses will not be incurred on dispositions or
updates to valuation in the future.
OREO Properties by Type
(in thousands)
Single family residence
Lots (single family and
commercial)
Vacant land
Multi-family
Commercial property
Total OREO properties
December 31, 2013
Amount % of Total
11%
$
4,658
September 30, 2013
Amount % of Total
13%
$
6,585
December 31, 2012
Amount % of Total
15%
$
10,624
15,020
3,135
1,783
16,941
41,537
$
36%
8%
4%
41%
100%
18,993
3,135
2,194
18,159
49,066
$
39%
6%
5%
37%
100%
26,473
6,745
4,372
24,209
72,423
$
37%
9%
6%
33%
100%
As shown above, OREO holdings decreased year over year across all property types.
Deposits & Borrowings
The Company saw a modest $35.1 million decline in total deposits during 2013 from $1.72 billion at
December 31, 2012. Overall total deposits were essentially flat during the fourth quarter. In both periods
slowly developing loan activity and availability of other liquidity sources reduced the need for deposit
funding. Market interest rates decreased generally and the average cost of interest bearing deposits
decreased from 0.73% in the year ended December 31, 2012, to 0.57%, or 16 basis points, in the same
period of 2013. Similarly, the average total cost of interest bearing liabilities decreased 13 basis points
from 1.07% in the year ended December 31, 2012, to 0.94% in the same period of 2013.
The Company’s most significant borrowing relationship continued to be the $45.5 million credit facility
with Bank of America. The credit facility was originally composed of a $30.5 million senior debt facility,
which included $500,000 in term debt, and $45.0 million of subordinated debt. The Company has
remaining debt of $500,000 in principal outstanding in term debt, and $45.0 million in principal
outstanding in subordinated debt under that facility at the end of December 31, 2013, and December 31,
2012. The term debt is secured by all of the outstanding capital stock of the Bank. The subordinated debt
and term debt portion of the senior debt facility mature on March 31, 2018. At December 31, 2013, the
Company was out of compliance with one of the financial covenants contained within the credit
agreement. The Company has made all required interest payments on the outstanding principal amounts
on a timely basis. Pursuant to the Written Agreement, the Company was required to receive the Reserve
Bank’s approval prior to making any interest payment on the subordinated debt. In January 2014, the
Reserve Bank notified the Company that the Written Agreement was terminated.
Prior to 2013, the Company had been out of compliance with two of the financial covenants of the Bank
of America credit facility. The agreement provides that noncompliance is an event of default and as the
result of the Company's failure to comply with a financial covenant, the lender may (i) terminate all
commitments to extend further credit, (ii) increase the interest rate on the revolving line of the term debt
by 200 basis points, (iii) declare the senior debt immediately due and payable and (iv) exercise all of its
rights and remedies at law, in equity and/or pursuant to any or all collateral documents, including
foreclosing on the collateral. Because the subordinated debt is treated as Tier 2 capital for regulatory
capital purposes, the senior debt agreement does not provide the lender with any rights of acceleration or
other remedies with regard to the subordinated debt upon an event of default caused by the Company's
65
failure to comply with a financial covenant.
The Company's borrowings at the FHLBC require the Bank to be a member and invest in the stock of the
FHLBC and 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 December 31, 2013, the Bank took an advance of $5.0 million at
0.13% interest on the FHLBC stock valued at $5.5 million. This advance matured on January 3, 2014 and
was replaced with short term FHLBC advances that matured in January 2014.
Capital
As of December 31, 2013, total stockholders’ equity was $147.7 million, which was an increase of $75.1
million, or 103.6%, from $72.6 million as of December 31, 2012. This increase was driven primarily by
the reversal of the valuation allowance on a significant portion of the Company’s net deferred tax assets,
made possible by recent profits and an evaluation of all available evidence, both for and against reversing
the valuation allowance. Unrealized loss on securities available-for-sale net of deferred taxes was $1.3
million at December 31, 2012, and $7.0 million (including unamortized losses and gains not accreted on
securities transferred from available-for-sale to held-to-maturity in the year) at December 31, 2013,
causing a reduction in stockholders’ equity of $5.7 million. Additionally, total stockholders’ equity
benefited by the Company not declaring and accruing a dividend in 2013 on its Series B Stock.
In January 2009, the Company issued and sold (i) 73,000 shares of Series B Preferred Stock and (ii) a
warrant to purchase 815,339 shares of its common stock at an exercise price of $13.43 per share to the
Treasury through the CPP. The total liquidation value of the Series B Stock and the warrant is $73.0
million.
All of the Series B Stock held by Treasury was sold to third parties, including certain of the Company’s
directors, in public auctions that were completed in the first quarter of 2013. The warrant was also sold at
a subsequent auction to a third party. At December 31, 2012, the Company carried $71.9 million of
Series B Stock in total stockholders’ equity. At December 31, 2013, the Company carried $72.9 million
of Series B Stock in total stockholders’ equity.
At December 31, 2013, the Bank’s Tier 1 capital leverage ratio was 10.97%, up 130 basis points from
December 31, 2012. The Bank’s total capital ratio was 18.04%, up 318 basis points from December 31,
2012. The Company’s regulatory capital ratios of total capital to risk weighted assets, Tier 1 capital to
risk weighted assets and Tier 1 capital to average assets increased to 15.88%, 10.65% and 6.96%,
respectively, compared to 13.62%, 6.81% and 4.85%, respectively, at December 31, 2012. The
Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized”
at December 31, 2013.
As discussed in the section entitled “Supervision and Regulation,” on May 16, 2011 the Bank entered into
the Consent Order with the OCC that was terminated on October 17, 2013. In addition, in July 2011 the
Company entered into the Written Agreement with the Reserve Bank designed to maintain the financial
soundness of the Company. In January 2014, the Reserve Bank terminated the Written Agreement.
Although the Written Agreement was terminated, the Company expects that it will continue to seek
approval from the Reserve Bank prior to paying any dividends on its common stock and incurring any
additional indebtedness.
As discussed in greater detail in the section entitled “Supervision and Regulation,” in July 2013, the U.S.
federal banking authorities approved the implementation of the Basel III Rules. The Basel III Rules are
applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and
savings and loan holding companies. The Basel III Rules not only increase selected minimum regulatory
capital ratios, but also introduce a new Common Equity Tier 1 capital ratio and the concept of a capital
conservation buffer. The Basel III Rules also revise the criteria that certain instruments must meet to
66
qualify as Tier 1 or Tier 2 capital. A number of instruments that now qualify as Tier 1 capital will not
qualify under the Basel III rules. The Basel III Rules also permit smaller banking organizations to retain,
through a one-time election, the existing treatment of accumulated other comprehensive income. The
Basel III Rules have maintained the general structure of the current prompt corrective action framework
while incorporating the increased requirements. The Basel III Rules also revise prompt corrective action
guidelines to add the Common Equity Tier 1 capital ratio. Generally, the new Basel III Rules become
effective on January 1, 2015, although parts of the Basel III Rules will be phased in through 2019.
Management is reviewing the new rules to assess their impact on the Company.
At December 31, 2013, the Company, on a consolidated basis, exceeded the minimum thresholds to be
considered “adequately capitalized” under current regulatory defined capital ratios. The Company and
the Bank are subject to regulatory capital requirements administered by federal banking agencies.
Generally, if adequately capitalized, regulatory approval is not required to accept brokered deposits. In
addition to the above regulatory ratios, the Company’s non-GAAP tangible common equity to tangible
assets increased to 3.67% at December 31, 2013, compared to (0.13)% at December 31, 2012, largely
attributable to increased capital resulting from the reversal of the valuation allowance on a significant
portion of net deferred tax assets, made possible by recent profits and an evaluation of all available
positive and negative evidence. The Tier 1 common equity to risk weighted assets increased to 0.77% at
December 31, 2013, compared to (0.12)% at December 31, 2012.
The Company completed the sale of $32.6 million of cumulative trust preferred securities by its subsidiary,
Old Second Capital Trust I in July 2003. These trust preferred securities remain outstanding for a 30-year
term, but subject to regulatory approval, they can be called in whole or in part at the Company’s discretion
after an initial five-year period, which has since passed. The Company does not currently intend on seeking
regulatory approval to call these securities. Dividends are payable quarterly at an annual rate of 7.80% and
are included in interest expense in the consolidated financial statements even when deferred. Likewise, the
Company issued an additional $25.0 million of cumulative trust preferred securities through a private
placement completed by a second unconsolidated subsidiary, Old Second Capital Trust II in April 2007.
These trust preferred securities also mature in 30 years, but subject to the aforementioned regulatory
approval, can be called in whole or in part in 2017. When not in deferral the quarterly cash distributions on
the securities are fixed at 6.766% through June 15, 2017 and float at 150 basis points over the three-month
LIBOR rate thereafter. As of December 31, 2013, trust preferred proceeds of $51.6 million qualified as Tier
1 regulatory capital and $5.0 million qualified as Tier 2 regulatory capital. As of December 31, 2012, trust
preferred proceeds of $24.6 million qualified as Tier 1 regulatory capital and $32.0 million qualified as Tier
2 regulatory capital. Additionally, the $45.0 million in subordinated debt that was obtained to finance the
February 2008 acquisition qualified as Tier 2 regulatory capital as of December 31, 2013, and December 31,
2012.
As announced and implemented in the third quarter of 2010, the Company elected to defer regularly
scheduled interest payments on $58.4 million of junior subordinated debentures related to the trust
preferred securities issued by its two statutory trust subsidiaries, Old Second Capital Trust I and Old
Second Capital Trust II (collectively the “Trust Preferred Securities”). Because of the deferral on the
subordinated debentures, the trusts will defer regularly scheduled dividends on their Trust Preferred
Securities. The total accumulated interest on the Trust Preferred Securities including compounded
interest from July 1, 2010, on the deferred payments totaled $17.0 million at December 31, 2013. Under
the terms of the junior subordinated debentures, the Company is allowed to defer payments of interest for
20 quarterly periods on the Trust Preferred Securities without default or penalty, but such amounts will
continue to accrue. Also during the deferral period, the Company generally may not pay cash dividends
on or repurchase its common stock or preferred stock, including the Series B Preferred Stock.
Under the terms of the Series B Preferred Stock, the Company is required to pay dividends on a quarterly
basis at a rate of 5% per year for the first five years, after which the dividend rate automatically increases
to 9%. Dividend payments on the Series B Preferred Stock may be deferred without default, but the
67
dividend is cumulative, and, if the Company fails to pay dividends for an aggregate of six quarters,
whether or not consecutive, the holder will have the right to appoint representatives to the Company’s
board of directors. A new director, Mr. Duane Suits, was appointed by the Treasury to join the board
during the fourth quarter of 2012. Following Treasury’s sale of the Series B Preferred Stock at auction in
the first quarter of 2013, this ability to appoint a director transferred to the new holders of the Series B
Preferred Stock, who re-elected Mr. Suits at the Company’s 2013 annual meeting. The dividend
payments on the Series B Preferred Stock have been deferred since November 15, 2010, and while in
deferral these dividends are compounded quarterly. The accumulated unpaid Series B Preferred Stock
dividends totaled $13.3 million at December 31, 2013. At December 31, 2012, the Company carried
$71.9 million of Series B Stock in total stockholders’ equity. At December 31, 2013, the Company
carried $72.9 million of Series B Stock in total stockholders’ equity.
As a result of the completed auctions, the Company’s Board elected to stop accruing the dividend on the
Series B Stock in first quarter of 2013. Previously, the Company had accrued the dividend on the Series
B Stock quarterly throughout the deferral period. Given the discount reflected in the results of the
auction, the Board believed that the Company would likely be able to repurchase the Series B Stock in the
future at a price less than the face amount of the Series B Stock plus accrued and unpaid dividends.
Therefore, under GAAP, the Company did not fully accrue the dividend on the Series B Stock in the first
quarter of 2013 and did not accrue for it in subsequent quarters. The Company will evaluate whether
accruing dividends on the Series B Stock is appropriate in future periods. Pursuant to the terms of the
Series B Stock, the dividends paid on the Series B Stock will increase from 5% to 9% in February 2014.
The Company purchased or recaptured 267,820 shares of common stock in 2013, resulting in an increase in
treasury stock to 4,912,626 shares as of December 31, 2013. The purchase or recapture of these shares
increased treasury stock by $847,000 or 0.9% to $95.8 million at December 31, 2013. The Company had
repurchased 51,939 shares in 2012, resulting in an increase in treasury stock to 4,644,806 shares as of
December 31, 2012. The repurchase of these shares increased treasury stock by $63,000, or 0.07%, to $95.0
million at December 31, 2012. Treasury stock repurchased decreases stockholders’ equity, but also
increases earnings per share by reducing the number of shares outstanding. No options were exercised in
the years ended December 31, 2013, and 2012. Return on average equity was 90.09% and (0.10)% in 2013
and 2012, respectively.
Bank regulatory agencies have adopted capital standards by which all banks and bank holding companies
are evaluated. Those agencies define the basis for these calculations including the prescribed
methodology for the calculation of the amount of risk-weighted assets. The risk based capital guidelines
were designed to make regulatory capital requirements more sensitive to differences in risk profiles
among banks. In addition to the regulatory capital ratios disclosed above, information regarding capital
levels and minimum required levels can be found in Note 15 of the consolidated financial statements.
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance sheet
arrangements
The Company has various financial obligations that may require future cash payments. The following
table presents, as of December 31, 2013, significant fixed and determinable contractual obligations (all
dollars in thousands) to third parties by payment date:
68
Deposits without a stated maturity
Certificates of deposit
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Purchase obligations
Automatic teller machines ("ATM's") leases
Operating leases
Nonqualified voluntary deferred compensation plan
Total
Within
One Year
$
1,209,689
313,231
22,560
5,000
-
-
-
2,410
33
96
66
1,553,085
$
One to
Three Years
$
-
111,441
-
-
-
-
-
1,988
32
147
629
114,237
$
Three to
Five Years
-
$
47,767
-
-
-
45,000
500
-
9
-
101
93,377
$
Over
Five Years
-
$
-
-
-
58,378
-
-
-
-
-
984
59,362
$
Total
1,209,689
472,439
22,560
5,000
58,378
45,000
500
4,398
74
243
1,780
1,820,061
$
$
Purchase obligations represent obligations under agreements to purchase goods or services that are
enforceable and legally binding on the Company and that specify all significant terms, including: fixed or
minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate
timing of the transaction. The purchase obligation amounts presented above primarily relate to certain
contractual payments for services provided for information technology, capital expenditures, and the
outsourcing of certain operational activities. The Company routinely enters into contracts for services.
These contracts may require payment for services to be provided in the future and may also contain
penalty clauses for early termination. In this disclosure, the Company has have made an effort to estimate
such payments, where applicable. Additionally, where necessary, all data reflects reasonable estimates as
to certain purchase obligations as of December 31, 2013. Management has used the information available
to make the estimations necessary to value the related purchase obligations.
Derivative contracts, which include contracts under which the Company either receives cash from, or
pays cash to, counterparties reflecting changes in interest rates are carried at fair value on the consolidated
balance sheet as disclosed in Note 18 of the Notes to the Consolidated Financial Statements provided in
Part II, Item 8, “Financial Statements and Supplementary Data”. Because the fair value of derivative
contracts changes daily as market interest rates change, the derivative assets and liabilities recorded on the
balance sheet at December 31, 2013, do not necessarily represent the amounts that may ultimately be
paid. As a result, these assets and liabilities are not included in the table of contractual obligations
presented above.
Assets under management are held in the investment advisory company. In addition, assets under
management and assets under custody are held in fiduciary or custodial capacity for clients. In
accordance with GAAP, these assets are not included on the Company’s balance sheet.
Financial instruments with off-balance sheet risk address the financing needs of our clients. These
instruments include commitments to extend credit as well as performance, standby and commercial letters
of credit. Further discussion of these commitments is included in Note 14 of the Notes to Consolidated
Financial Statements provided in Part II, Item 8, “Financial Statements and Supplementary Data.”
69
The following table details the amounts and expected maturities of significant commitments to extend
credit as of December 31, 2013:
Within
One Year
One to
Three Years
Three to
Five Years
Over
Five Years
Total
Commitment to extend credit:
Commercial secured by real estate
Revolving open end residential
Other
Financial standby letters of credit (borrowers)
Performance standby letters of credit (borrowers)
Commercial letters of credit (borrowers)
Performance standby letters of credit (others)
Total
$
$
$
$
$
7,957
12,654
99,611
3,856
4,106
51
867
129,102
2,950
24,092
27,038
5
197
-
-
54,282
2,390
30,968
241
35
-
-
-
33,634
2,112
34,745
1,504
-
-
-
-
38,361
15,409
102,459
128,394
3,896
4,303
51
867
255,379
$
$
$
$
$
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Liquidity and market risk
Liquidity is the Company’s ability to fund operations, to meet depositor withdrawals, to provide for
customer’s credit needs, and to meet maturing obligations and existing commitments. The liquidity of the
Company principally depends on cash flows from net operating activities, including pledging
requirements, investment in, and both maturity and repayment of assets, changes in balances of deposits
and borrowings, and its ability to borrow funds. The Company continually monitors its cash position and
borrowing capacity as well as performs monthly stress tests of contingency funding as part of its liquidity
management process. In the first quarter of 2011, management expanded the methodology for stress
testing of liquidity for contingency funding purposes to include tests that outline scenarios for specifically
identified liquidity risk events, which are then aggregated into a Bank-wide assessment of liquidity risk
stress levels. The outcomes of these tests are reviewed by management and the Company’s Board of
Directors monthly.
Net cash inflows from operating activities were $35.3 million during 2013, compared with $43.3 million in
2012. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, was a
source of inflow for 2013 and 2012. Interest received, net of interest paid, combined with changes in
provision for loan losses, and other assets and liabilities were a source of inflow for 2013 and 2012. The
Company did not record an income tax benefit for the year ended December 31, 2012, despite a $72,000
pre-tax loss during the year, due to the establishment of a valuation allowance against the Company’s
deferred tax assets established as of December 31, 2010. Management of investing and financing activities,
as well as market conditions, determines the level and the stability of net interest cash flows. Management’s
policy is to mitigate the impact of changes in market interest rates to the extent possible as part of the
balance sheet management process.
Net cash inflows from investing activities were $9.6 million in 2013, compared to net cash outflow of $59.1
million in 2012. In 2013, securities transactions accounted for a net outflow of $53.7 million, net principal
received on loans accounted for net inflows of $21.5 million, and proceeds from the sales of OREO assets
accounted for inflows of $43.7 million. In 2012, securities transactions accounted for a net outflow of
$264.8 million, and net principal received on loans accounted for net inflows of $167.5 million whereas
proceeds from the sale of OREO assets accounted for inflows of $39.1 million.
Net cash outflows from financing activities in 2013, were $125.7 million compared with net cash inflows of
$93.3 million in 2012. Significant cash outflows from financing activities in 2013 included reductions of
$35.1 million in deposits and $95.0 million in other short-term borrowings. Net increase in securities sold
under repurchase agreements were $4.7 million during 2013. Significant cash inflows from financing
70
activity in 2012 included an increase in securities sold under repurchase agreements of $17.0 million and an
increase in other short term borrowings of $100.0 million, offset by decreases in deposits of $23.6 million.
Interest rate risk
As part of its normal operations, the Company is subject to interest-rate risk on the assets it invests in
(primarily loans and securities) and the liabilities it funds (primarily customer deposits and borrowed
funds), as well as its ability to manage such risk. Fluctuations in interest rates may result in changes in
the fair market values of the Company's financial instruments, cash flows, and net interest income. Like
most financial institutions, the Company has an exposure to changes in both short-term and long-term
interest rates.
The Company manages various market risks in its normal course of operations, including credit, liquidity
risk, and interest-rate risk. Other types of market risk, such as foreign currency exchange risk and
commodity price risk, do not arise in the normal course of the Company's business activities and
operations. In addition, since the Company does not hold a trading portfolio, it is not exposed to
significant market risk from trading activities. The changes in the Company's interest rate risk exposures
at December 31, 2013, and December 31, 2012, are outlined in the table below.
Like most financial institutions, the Company's net income can be significantly influenced by a variety of
external factors, including: overall economic conditions, policies and actions of regulatory authorities,
the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and
securities other than those that are assumed, early withdrawal of deposits, exercise of call options on
borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of
the yield-curve, changes in historical relationships between indices (such as LIBOR and prime), and
balance sheet growth or contraction. The Company's ALCO seeks to manage interest rate risk under a
variety of rate environments by structuring the Company's balance sheet and off-balance sheet positions,
which includes interest rate swap derivatives as discussed in Note 18 of the financial statements included
in this annual report. The risk is monitored and managed within approved policy limits.
The Company utilizes simulation analysis to quantify the impact of various rate scenarios on net interest
income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities
held by the Company are incorporated into the simulation model. Earnings at risk is calculated by
comparing the net interest income of a stable interest rate environment to the net interest income of a
different interest rate environment in order to determine the percentage change. Due to the significant
declines in interest rates that occurred during the first half of 2012, and the historically low interest rates
that have continued through 2013, it is no longer possible to calculate valid interest rate scenarios that
represent declines of 0.5% or more. Consequently, net interest income sensitivity is currently only
calculated for interest rate increases. Compared to December 31, 2012, the Company would have less
earnings gains (in dollars) if interest rates should rise. This decline in rising-rate benefit reflects the
Company’s emphasis on increasing loan originations, some of which may be fixed rate, and funding the
added loans through sales of securities which are predominantly variable rate. Such activity over time
will further erode the benefit from rising interest rates. Federal Funds rates and the Bank's prime rate
were stable throughout the year at 0.25% and 3.25%, respectively.
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%, and 2% and no change in the slope of the
yield curve. The -2% -1% and -0.5% sections of the table do not show model changes for those
magnitudes of decrease due to the historically low interest rate environment over the relevant time
periods:
71
Analysis of Net Interest Income Sensitivity
Immediate Changes in Rates
December 31, 2013
Dollar change
Percent change
December 31, 2012
Dollar change
Percent change
-2.0%
-1.0%
-0.5%
0.5%
1.0%
2.0%
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$
70
+0.1%
$
249
+0.4%
$
1,190
+2.1%
$
538
+1.1%
$
1,164
+2.3%
$
2,511
+4.9%
The amounts and assumptions used in the simulation model should not be viewed as indicative of
expected actual results. Actual results will differ from simulated results due to timing, magnitude and
frequency of interest rate changes as well as changes in market conditions and management strategies.
The above results do not take into account any management action to mitigate potential risk.
Effects of Inflation
In management's opinion, changes in interest rates affect the financial condition of a financial institution
to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by
changes in the inflation rate, they do not change at the same rate or in the same magnitude as the inflation
rate. Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as on
changes in monetary and fiscal policies. A financial institution's ability to be relatively unaffected by
changes in interest rates is a good indicator of its capability to perform in today's volatile economic
environment. The Company seeks to insulate itself from interest rate volatility by ensuring that rate
sensitive assets and rate sensitive liabilities respond to changes in interest rates in a similar time frame
and to a similar degree.
72
Item 8. Financial Statements and Supplementary Data
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2013 and 2012
(In thousands, except share data)
2013
2012
Assets
Cash and due from banks
Interest bearing deposits with financial institutions
Cash and cash equivalents
Securities available-for-sale, at fair value
Securities held-to-maturity, at amortized cost
Federal Home Loan Bank and Federal Reserve Bank stock
Loans held-for-sale
Loans
Less: allowance for loan losses
Net loans
Premises and equipment, net
Other real estate owned
Mortgage servicing rights, net
Core deposit intangible, net
Bank-owned life insurance (BOLI)
Deferred tax assets, net
Other assets
Total assets
Liabilities
Deposits:
Noninterest bearing demand
Interest bearing:
Savings, NOW, and money market
Time
Total deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Other liabilities
Total liabilities
Stockholders' Equity
Preferred stock
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
33,210
14,450
47,660
372,191
256,571
10,292
3,822
1,101,256
27,281
1,073,975
46,005
41,537
5,807
1,177
55,410
75,303
14,284
2,004,034
44,221
84,286
128,507
579,886
-
11,202
9,571
1,150,050
38,597
1,111,453
47,002
72,423
4,116
3,276
54,203
928
23,232
2,045,799
$
$
$
373,389
$
379,451
836,300
472,439
1,682,128
22,560
5,000
58,378
45,000
500
42,776
1,856,342
826,976
510,792
1,717,219
17,875
100,000
58,378
45,000
500
34,275
1,973,247
72,942
18,830
66,212
92,549
(7,038)
(95,803)
147,692
2,004,034
$
71,869
18,729
66,189
12,048
(1,327)
(94,956)
72,552
2,045,799
$
Par value
Liquidation value
Shares authorized
Shares issued
Shares outstanding
Treasury shares
December 31, 2013
December 31, 2012
Preferred
Stock
1
$
1,000
300,000
73,000
73,000
-
Common
Stock
$
1
n/a
60,000,000
18,829,734
13,917,108
4,912,626
Preferred
Stock
1
$
1,000
300,000
73,000
73,000
-
Common
Stock
$
1
n/a
60,000,000
18,729,134
14,084,328
4,644,806
See accompanying notes to consolidated financial statements.
73
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 2013 and 2012
(In thousands, except share data)
Interest and dividend income
Loans, including fees
Loans held-for-sale
Securities:
Taxable
Tax-exempt
Dividends from Federal Reserve Bank and Federal Home Loan Bank stock
Interest bearing deposits
Total interest and dividend income
Interest expense
Savings, NOW and money market deposits
Time deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Total interest expense
Net interest and dividend income
(Release) provision for loan losses
Net interest and dividend income after provision for loan losses
Noninterest income
Trust income
Service charges on deposits
Secondary mortgage fees
Mortgage servicing gain (loss), net of changes in fair value
Net gain on sales of mortgage loans
Securities (losses) gains, net
Increase in cash surrender value of bank-owned life insurance
Death benefit realized on bank-owned life insurance
Debit card interchange income
Other income
Total noninterest income
Noninterest expense
Salaries and employee benefits
Occupancy expense, net
Furniture and equipment expense
FDIC insurance
General bank insurance
Amortization of core deposit
Advertising expense
Debit card interchange expense
Legal fees
Other real estate expense, net
Other expense
Total noninterest expense
Income (loss) before income taxes
(Benefit) provision for income taxes
Net income (loss)
2013
2012
$
56,193
156
$
66,769
260
11,692
587
304
108
69,040
859
6,774
3
25
5,298
811
16
13,786
55,254
(8,550)
63,804
6,339
7,256
821
1,913
5,627
(1,912)
1,603
381
3,458
5,697
31,183
36,688
5,032
4,264
4,027
2,318
2,099
1,225
1,433
2,066
10,747
13,245
83,144
11,843
(70,242)
82,085
7,212
416
305
119
75,081
1,062
8,809
2
17
4,925
903
17
15,735
59,346
6,284
53,062
6,041
7,682
1,307
(289)
10,688
1,575
1,608
-
3,547
5,060
37,219
34,989
4,841
4,614
4,031
3,384
1,402
1,309
1,548
3,176
18,663
12,396
90,353
(72)
-
(72)
Preferred stock dividends and accretion of discount
Net income (loss) available to common stockholders
Basic earnings (loss) per share
Diluted earnings (loss) per share
Dividends declared per share
See accompanying notes to consolidated financial statements.
5,258
76,827
$
4,987
(5,059)
$
$
5.45
5.45
-
$
(0.36)
(0.36)
-
74
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(In thousands, except share data)
Net income (loss)
Total unrealized holding (losses) gains on available-for-sale
securities arising during the period
Related tax benefit (expense)
Holding (losses) gains after tax
Less: Reclassification adjustment for the net gains and
losses realized during the period
Net realized (losses) gains
Income tax benefit (expense) on net realized gains
Net realized (losses) gains after tax
Other comprehensive (loss) income on available-for-sale securities
Twelve Months Ended
December 31,
2013
$
82,085
2012
$
(72)
(11,965)
4,924
(7,041)
(1,912)
784
(1,128)
(5,913)
5,614
(2,305)
3,309
1,575
(641)
934
2,375
Accretion of net unrealized holding gains on held-to-maturity
transferred from available-for-sale securities
Related tax expense
Other comprehensive income on held-to-maturity securities
Total other comprehensive (loss) income
Total comprehensive income
343
(141)
202
(5,711)
76,374
$
-
-
-
2,375
2,303
$
See accompanying notes to consolidated financial statements.
75
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2013 and 2012
(In thousands)
Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization of leasehold improvement
Change in market value of mortgage servicing rights
(Release) provision for loan losses
Gain on recapture of restricted stock
Provision for deferred tax benefit
Originations of loans held-for-sale
Proceeds from sales of loans held-for-sale
Net gain on sales of mortgage loans
Change in current income taxes (payable) receivable
Increase in cash surrender value of bank-owned life insurance
Death claim on bank owned life insurance
Change in accrued interest receivable and other assets
Change in accrued interest payable and other liabilities
Net discount (accretion)/premium amortization on securities
Securities losses (gains), net
Amortization of core deposit, net
Stock based compensation
Net gain on sale of other real estate owned
Provision for other real estate owned losses
Net gain on disposal of fixed assets
Loss on transfer of premises to other real estate owned
Net cash provided by operating activities
Cash flows from investing activities
Proceeds from maturities and calls including pay down
of securities available-for-sale
Proceeds from sales of securities available-for-sale
Purchases of securities available-for-sale
Proceeds from maturities and calls including pay down
of securities held-to-maturity
Purchases of securities held-to-maturity
Proceeds from sales of Federal Home Loan Bank stock
Net change in loans
Improvements in other real estate owned
Proceeds from sales of other real estate owned
Proceeds from disposition of fixed assets
Net purchases of premises and equipment
Net cash provided by (used in) investing activities
Cash flows from financing activities
Net change in deposits
Net change in securities sold under repurchase agreements
Net change in other short-term borrowings
Purchase of treasury stock
Net cash (used in) provided by financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
76
2013
2012
$
82,085
$
(72)
2,794
(260)
(8,550)
(612)
(70,376)
(181,497)
191,019
(5,627)
(132)
(1,603)
396
8,764
8,877
(528)
1,912
2,099
167
(1,956)
8,293
(9)
-
35,256
40,028
533,302
(609,033)
2,444
(21,382)
910
21,505
(73)
43,668
10
(1,798)
9,581
(35,091)
4,685
(95,000)
(278)
3,074
1,575
6,284
-
-
(291,559)
303,561
(10,688)
815
(1,608)
-
8,381
8,119
943
(1,575)
1,402
291
(2,198)
16,385
(609)
782
43,303
79,642
223,860
(571,153)
-
-
2,848
167,490
(701)
39,052
917
(1,049)
(59,094)
(23,562)
16,974
100,000
(63)
(125,684)
(80,847)
128,507
47,660
$
93,349
77,558
50,949
128,507
$
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows - Continued
(In thousands)
Supplemental cash flow information
Income taxes paid (received)
Interest paid for deposits
Interest paid for borrowings
Non-cash transfer of loans to other real estate owned
Non-cash transfer of premises to other real estate owned
Non-cash transfer of loans to securities available-for-sale
Non-cash transfer of securities available-for-sale to securities held-to-maturity
Change in dividends accrued not paid
Accretion on preferred stock warrants
Fair value difference on recapture of restricted stock
See accompanying notes to consolidated financial statements.
Years Ended
December 31,
2013
$
266
7,868
864
19,194
-
5,329
237,154
511
1,073
43
2012
$
(815)
10,592
930
31,761
360
-
-
3,981
1,006
-
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in
Stockholders' Equity
(In thousands, except share data)
Common
Stock
18,628
$
Preferred
Stock
$
70,863
Additional
Paid-In
Capital
$
65,999
Retained
Earnings
17,107
$
(72)
Accumulated
Other
Comprehensive
Income (Loss)
$
(3,702)
2,375
Total
Treasury Stockholders'
Stock
(94,893)
$
Equity
$
74,002
(72)
101
(101)
291
(63)
$
18,729
1,006
71,869
$
$
66,189
$
18,729
$
71,869
$
66,189
(4,987)
12,048
$
$
12,048
82,085
$
(1,327)
$
(94,956)
$
(1,327)
$
(94,956)
101
(101)
(43)
167
(5,711)
(569)
(278)
$
18,830
1,073
72,942
$
$
66,212
(1,584)
92,549
$
$
(7,038)
$
(95,803)
2,375
-
291
(63)
(3,981)
72,552
$
$
72,552
82,085
(5,711)
-
(612)
167
(278)
(511)
147,692
$
Balance, December 31, 2011
Net loss
Change in net unrealized gain on securities
available-for-sale net of $1,664 tax effect
Change in restricted stock
Stock based compensation
Purchase of treasury stock
Preferred dividends declared and accrued
(5% per preferred share)
Balance, December 31, 2012
Balance, December 31, 2012
Net income
Change in net unrealized loss on securities
net of $3,998 tax effect
Change in restricted stock
Recapture of restricted stock
Stock based compensation
Purchase of treasury stock
Preferred stock accretion and
declared dividends
Balance, December 31, 2013
See accompanying notes to consolidated financial statements.
77
Old Second Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(Table amounts in thousands, except per share data)
Note 1: Summary of Significant Accounting Policies
The Company uses the accrual basis of accounting for financial reporting purposes. Certain
reclassifications were made to prior year amounts to conform to the current year presentation.
Use of Estimates – The preparation of consolidated financial statements in conformity with generally
accepted accounting principles (“GAAP”) and following general practices within the banking industry
requires management to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Although these estimates and assumptions
are based on the best available information, actual results could differ from those estimates.
Principles of Consolidation – The accompanying consolidated financial statements include the accounts
and results of operations of the Company and its subsidiaries after elimination of all significant
intercompany accounts and transactions. Assets held in a fiduciary or agency capacity are not assets of
the Company or its subsidiaries and are not included in the consolidated financial statements.
Cash and Cash Equivalents – For purposes of the Consolidated Statements of Cash Flows, management
has defined cash and cash equivalents to include cash and due from banks, interest-bearing deposits in
other banks, and other short-term investments, such as federal funds sold and securities purchased under
agreements to resell.
Securities – Securities are classified as available-for-sale or held-to-maturity at the time of purchase or
transfer.
Securities that are classified as available-for-sale are carried at fair value. Unrealized gains and losses,
net of related deferred income taxes, are recorded in stockholders' equity as a separate component of
accumulated other comprehensive income.
Securities held-to-maturity are carried at amortized cost and the discount or premium created in the
transfer from available-for-sale is accreted or amortized to the maturity or expected payoff date but not an
earlier call. The Company reclassified certain securities, chosen by management, to held-to-maturity
effective September 1, 2013. No new purchases were made in the held-to-maturity classification during
the fourth quarter.
The historical cost of debt securities is adjusted for amortization of premiums and accretion of discounts
over the estimated life of the security, using the level yield method. Amortization of premium and
accretion of discount are included in interest income from the related security.
Purchases and sales of securities are recognized on a trade date basis. Realized securities gains or losses
are reported in securities gains, net in the Consolidated Statements of Operations. The cost of securities
sold is based on the specific identification method. On a quarterly basis, the Company makes an
assessment (at the individual security level) to determine whether there have been any events or
circumstances indicating that a security with an unrealized loss is other-than-temporarily impaired
(“OTTI”). In evaluating OTTI, the Company considers many factors, including the severity and duration
of the impairment; the financial condition and near-term prospects of the issuer, which for debt securities
considers external credit ratings and recent downgrades; its ability and intent to hold the security for a
78
period of time sufficient for a recovery in value; and the likelihood that it will be required to sell the
security before a recovery in value, which may be at maturity. The amount of the impairment related to
other factors is recognized in other comprehensive income (loss) unless management intends to sell the
security or believes it is more likely than not that it will be required to sell the security prior to full
recovery.
Federal Home Loan Bank and Federal Reserve Bank Stock – The Company owns the stock of the
Federal Home Loan Bank of Chicago (“FHLBC”) and the Federal Reserve Bank of Chicago (“Reserve
Bank”). Both of these entities require the Bank to invest in their nonmarketable stock as a condition of
membership. The FHLBC is a governmental sponsored entity. The Bank continues to utilize the various
products and services of the FHLBC and management considers this stock to be a long-term investment.
FHLBC members are required to own a certain amount of stock based on the level of borrowings and
other factors, and may invest in additional amounts. FHLBC stock is carried at cost, classified as a
restricted security, and periodically evaluated for impairment based on ultimate recovery of par value.
The Company’s ability to redeem the shares owned is dependent on the redemption practices of the
FHLBC. The Company records dividends in income on the ex-dividend date. Reserve Bank stock is
redeemable at par, therefore, market value equals cost.
Loans Held-for-Sale – The Bank originates residential mortgage loans, which consist of loan products
eligible for sale to the secondary market. Residential mortgage loans eligible for sale in the secondary
market are carried at fair market value. The fair value of loans held-for-sale is determined using quoted
secondary market prices on similar loans.
Loans – Loans held-for-investment are carried at the principal amount outstanding, including certain net
deferred loan origination fees. Interest income on loans is accrued based on principal amounts
outstanding. Loan and lease origination fees, commitment fees, and certain direct loan origination costs
are deferred, and the net amount is amortized over the life of the related loans or commitments as a yield
adjustment. Fees related to standby letters of credit, whose ultimate exercise is remote, are amortized into
fee income over the estimated life of the commitment. Other credit-related fees are recognized as fee
income when earned.
Concentration of Credit Risk – Most of the Company’s business activity is with customers located
within Kane, Kendall, DeKalb, DuPage, LaSalle, Will and southwestern Cook counties in Illinois. These
banking centers surround the Chicago metropolitan area. Therefore, the Company’s exposure to credit
risk is significantly affected by changes in the economy in that market area since the Bank generally
makes loans within its market. There are no significant concentrations of loans where the customers’
ability to honor loan terms is dependent upon a single economic sector.
Commercial and Industrial Loans – Such credits typically comprise working capital loans, loans for
physical asset expansion, asset acquisition loans and other business loans. Loans to closely held
businesses will generally be guaranteed in full or for a meaningful amount by the businesses’ major
owners. Commercial loans are made based primarily on the historical and projected cash flow of the
borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of
borrowers, however, may not behave as forecasted and collateral securing loans may fluctuate in value
due to economic or individual performance factors. Minimum standards and underwriting guidelines
have been established for all commercial loan types.
Commercial Real Estate Loans – Commercial real estate loans are subject to underwriting standards and
processes similar to commercial and industrial loans. These are loans secured by mortgages on real estate
collateral. Commercial real estate loans are viewed primarily as cash flow loans and the repayment of
these loans is largely dependent on the successful operation of the property. Loan performance may be
adversely affected by factors impacting the general economy or conditions specific to the real estate
market such as geographic location and/or property type.
79
Residential Real Estate Loans – These are loans that are extended to purchase or refinance 1 – 4 family
residential dwellings, or to purchase or refinance vacant lots intended for the construction of a 1 – 4
family home. Residential real estate loans are considered homogenous in nature. Homes may be the
primary or secondary residence of the borrower or may be investment properties of the borrower.
Real Estate Construction & Development Loans – The Company defines construction loans as loans
where the loan proceeds are controlled by the Company and used exclusively for the improvement of real
estate in which the Company holds a mortgage. Due to the inherent risk in this type of loan, they are
subject to other industry specific policy guidelines outlined in the Company’s Credit Risk Policy and are
monitored closely.
Consumer Loans – Consumer loans include loans extended primarily for consumer and household
purposes although they may include very small business loans for the purchase of vehicles and equipment
to a single-owner enterprise and could include business purpose lines of credit if made under the terms of
a small business product whose features and underwriting criteria are specified in advance by the Loan
Committee. These also include overdrafts and other items not captured by the definitions above.
Nonaccrual loans – Generally, commercial loans and loans secured by real estate are placed on
nonaccrual status (i) when either principal or interest payments become 90 days or more past due based
on contractual terms unless the loan is sufficiently collateralized such that full repayment of both
principal and interest is expected and is in the process of collection within a reasonable period or (ii)
when an individual analysis of a borrower’s creditworthiness indicates a credit should be placed on
nonaccrual status whether or not the loan is 90 days or more past due. When a loan is placed on
nonaccrual status, unpaid interest credited to income is reversed. After the loan is placed on nonaccrual,
all debt service payments are applied to the principal on the loan. Nonaccrual loans are returned to
accrual status when the financial position of the borrower and other relevant factors indicate there is no
longer doubt that the Company will collect all principal and interest due.
Commercial loans and loans secured by real estate are generally charged-off when deemed uncollectible.
A loss is recorded at that time if the net realizable value can be quantified and it is less than the associated
principal and interest outstanding.
Troubled Debt Restructurings (“TDRs”) – A restructuring of debt is considered a TDRs when (i) the
borrower is experiencing financial difficulties and (ii) the creditor grants a concession, such as
forgiveness of principal, reduction of the interest rate, changes in payments, or extension of the maturity,
that it would not otherwise consider. Loans are not classified as TDRs when the modification is short-
term or results in only an insignificant delay or shortfall in the payments to be received. The Company’s
TDRs are determined on a case-by-case basis in connection with ongoing loan collection processes.
The Company does not accrue interest on any TDRs unless it believes collection of all principal and
interest under the modified terms is reasonably assured. For a TDRs to accrue interest, the borrower must
demonstrate both some level of past performance and the capacity to perform under the modified terms.
Generally, six months of consecutive payment performance by the borrower under the restructured terms
is required before a TDRs is returned to accrual status. However, the period could vary depending on the
individual facts and circumstances of the loan. An evaluation of the borrower’s current creditworthiness
is used to assess whether the borrower has the capacity to repay the loan under the modified terms. This
evaluation includes an estimate of expected cash flows, evidence of strong financial position, and
estimates of the value of collateral, if applicable.
Impaired Loans – Impaired loans consist of nonaccrual loans and TDRs (both accruing and on
nonaccrual). A loan is considered impaired when it is probable that the Company will be unable to
collect all contractual principal and interest due according to the terms of the loan agreement based on
current information and events. With the exception of TDRs still accruing interest, loans deemed to be
80
impaired are classified as nonaccrual and are exclusive of smaller homogeneous loans, such as home
equity, 1-4 family mortgages, and consumer loans. When a loan is designated as impaired, any
subsequent principal and interest payments received are applied to the principal on the loan.
90-Days or Greater Past Due Loans – 90-days or more past due loans are loans with principal or
interest payments three months or more past due, but that still accrue interest. The Company continues to
accrue interest if it determines these loans are sufficiently collateralized and the process of collection will
conclude within a reasonable time period.
Allowance for Loan Losses – The allowance for loan losses is comprised of the allowance for loan
losses calculated according to GAAP standards and is maintained by management at a level believed
adequate to absorb estimated losses inherent in the existing loan portfolio. Determination of the
allowance for loan losses is inherently subjective since it requires significant estimates and management
judgment, including the amounts and timing of expected future cash flows on impaired loans, estimated
losses on pools of homogeneous loans based on a migration analysis that uses historical loss experience,
consideration of current economic trends, and other credit market factors.
Loans deemed to be uncollectible are charged-off against the allowance for loan losses while recoveries
of amounts previously charged-off are credited to the allowance for loan losses. Approved releases from
previously established loan loss reserves authorized under our allowance methodology also reduce the
allowance for loan losses. Additions to the allowance for loan losses are established through the
provision for loan losses charged to expense. The amount charged to operating expense depends on a
number of factors, including historic loan growth, changes in the composition of the loan portfolio, net
charge-off levels, and the Company’s assessment of the allowance for loan losses based on the
methodology discussed below. The Company had no major methodology changes in 2013 and only
minor changes in two management factors included in the methodology calculations.
The allowance for loan losses methodology consists of (i) specific reserves established for probable losses
on individual loans for which the recorded investment in the loan exceeds the value of the loan, (ii) an
allowance based on a loss migration analysis that uses historical credit loss experience for each loan
category, and (iii) the impact as assessed by management in detailed loan review sessions of other internal
and external qualitative and credit market factors.
The specific reserves component of the allowance for loan losses is based on a periodic analysis of
impaired loans exceeding a fixed dollar amount. This analysis follows GAAP standards for collateral
based loans.
An additional component of the allowance for loan losses is based on actual loss experience for a rolling
20-quarter period and the related internal risk rating and category of loans charged-off, including any
charge-off on TDRs. The loss migration analysis is performed quarterly, and the loss factors are updated
based on actual experience.
Management takes into consideration many internal and external qualitative factors when estimating an
additional adjustment for management factors, including:
(cid:120) Changes in the composition of the loan portfolio, trends in the volume and terms of loans, and
trends in delinquent and nonaccrual loans that could indicate that historical trends do not reflect
current conditions.
(cid:120) Changes in credit policies and procedures, such as underwriting standards and collection, charge-
off, and recovery practices.
(cid:120) Changes in the experience, ability, and depth of credit management and other relevant staff.
(cid:120) Changes in the quality of the Company’s loan review system and board of directors’ oversight.
(cid:120) Changes in the value of the underlying collateral for collateral-dependent loans.
81
(cid:120) Changes in the national and local economy that affect the collectability of various segments of the
portfolio.
(cid:120) Changes in other external factors, such as competition and legal or regulatory requirements are
considered when determining the level of estimated loss in various segments of the portfolio.
The establishment of the allowance for loan losses involves a high degree of judgment and includes a
level of imprecision given the difficulty of identifying and assessing the factors impacting loan repayment
and estimating the timing and amount of losses. While management utilizes its best judgment and
information available, the ultimate adequacy of the allowance for loan losses is dependent upon a variety
of factors beyond the Company’s direct control, including the performance of its loan portfolio, the
economy, changes in interest rates and property values, and the interpretation of loan risk classifications
by regulatory authorities. While each component of the allowance for loan losses is determined
separately, the entire balance is available for the entire loan portfolio.
Mortgage Servicing Rights – The Bank is also involved in the business of servicing mortgage loans.
Servicing activities include collecting principal, interest, and escrow payments from borrowers, making tax
and insurance payments on behalf of the borrowers, monitoring delinquencies, executing foreclosure
proceedings, and accounting for and remitting principal and interest payments to the investors. Mortgage
servicing rights represent the right to a stream of cash flows and an obligation to perform specified
residential mortgage servicing activities.
Mortgage loans that the Company is servicing for others aggregated to $591.5 million and $552.0 million
at December 31, 2013, and 2012, respectively. Mortgage loans that the Company is servicing for others
are not included in the consolidated balance sheets. Fees received in connection with servicing loans for
others are recognized as earned. Loan servicing costs are charged to expense as incurred.
Servicing rights are recognized separately as assets when they are acquired through sales of loans and
servicing rights are retained. Servicing rights are initially recorded at fair value with the income
statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable
mortgage servicing contracts, when available, or alternatively, is based on a valuation model that
calculates the present value of estimated future net servicing income. The valuation model incorporates
assumptions that market participants would use in estimating future net servicing income, such as the cost
to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment
speeds and default rates and losses. The Company compares the valuation model inputs and results to
published industry data in order to validate the model results and assumptions.
Servicing fee income, which is included on the Consolidated Statements of Operations as mortgage
servicing income, net of fair value changes, is recorded for fees earned for servicing loans. The fees are
based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded
as income when earned.
Under the fair value measurement method, the Company measures servicing rights at fair value at each
reporting date, reports changes in fair value of servicing assets in earnings in the period in which the
changes occur, and includes mortgage servicing rights in mortgage servicing income, net of fair value
changes, on the Consolidated Statements of Operations. The fair values of servicing rights are subject to
significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates
and losses.
Other Real Estate Owned (“OREO”) – Real estate assets acquired in settlement of loans are recorded at
fair value when acquired, less estimated costs to sell, establishing a new cost basis. Any deficiency
between the net book value and fair value at the foreclosure or deed in lieu date is charged to the
allowance for loan losses. If fair value declines after acquisition, a valuation allowance is established for
the decrease between the recorded value and the updated fair value less costs to sell. Such declines are
82
included in other noninterest expense. A subsequent reversal of an OREO valuation adjustment can
occur, but the resultant carrying value cannot exceed the cost basis established at transfer to OREO.
OREO properties are valued at the lower of cost or estimated market less costs subsequent to acquisition.
Operating costs after acquisition are also expensed.
Premises and Equipment – Premises, furniture, equipment, and leasehold improvements are stated at
cost less accumulated depreciation and amortization. Depreciation expense is determined by the straight-
line method over the estimated useful lives of the assets. Leasehold improvements are amortized on a
straight-line basis over the shorter of the life of the asset or the lease term including anticipated renewals.
Rates of depreciation are generally based on the following useful lives: buildings, 25 to 40 years; building
improvements, 3 to 15 years but longer under limited circumstances; and furniture and equipment, 3 to
10 years. Gains and losses on dispositions are included in other noninterest income in the Consolidated
Statements of Operations. Maintenance and repairs are charged to operating expenses as incurred, while
improvements that extend the useful life of assets are capitalized and depreciated over the estimated
remaining life.
Bank-Owned Life Insurance ("BOLI") – BOLI represents life insurance policies on the lives of certain
Company employees (both current and former) for which the Company is the sole owner and beneficiary.
These policies are recorded as an asset on the Consolidated Statements of Financial Condition at their
cash surrender value (“CSV”) or the amount that could be realized. The change in CSV and insurance
proceeds received are recorded as BOLI income in the Consolidated Statements of Operations in
noninterest income.
Core Deposit Intangible Assets – The core deposit intangible (“CDI”) is amortized over its useful
life. The CDI was initially measured at fair value and is amortized on an accelerated method over their
estimated useful life of twelve years. It is also evaluated for impairment and impairment, if needed,
would be recorded to earnings.
Impairment testing is performed using a two-step process. The first step of the impairment review uses an
undiscounted cash flow approach to determine if the core deposit intangible is recoverable. If the results
of the undiscounted cash flow indicate the CDI is recoverable, the second step of the impairment test is
not required. If necessary, the second step of the impairment test compares the implied fair value of the
deposits with the carrying amount of the deposits. The implied fair value of deposits is determined using
a discounted cash flow approach. An impairment loss would be recognized if the carrying amount of the
reported CDI exceeded the carrying value less the implied fair value of the deposits.
The annual impairment analysis, completed as of November 30, 2012, indicated the core deposit
intangible was not impaired as the Company passed the first step of the impairment test. However, during
2012 management determined that the fair value of the intangible asset had declined largely due to a
significant reduction in the cost of funds compared to the alternative funds rate used in the impairment
analysis. Expecting these circumstances to continue throughout 2012 and beyond, management believed
the useful life of the core deposit intangible has decreased. Management increased the amortization
expense for the year ended December 31, 2012, by $622,000. The Company’s November 30, 2013
annual impairment analysis indicated the core deposit intangible was not impaired. The carrying value of
the intangible asset decreased from $3.3 million at December 31, 2012, to $1.2 million at December 31,
2013. Further, estimated future amortization expense as of December 31, 2013, indicates that the asset
will be fully amortized by December 31, 2014.
Loss Contingencies – Loss contingencies, including claims and legal actions arising in the ordinary
course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or
range of loss can be reasonably estimated. Management does not believe there now are such matters that
will have a material effect on the financial statements.
83
Wealth Management – Assets held in a fiduciary or agency capacity for customers are not included in
the consolidated financial statements as they are not assets of the Company or its subsidiaries. Fee
income is recognized on a cash basis and is included as a component of noninterest income in the
Consolidated Statements of Operations.
Advertising Costs – All advertising costs incurred by the Company are expensed in the period in which
they are incurred.
Long-term Incentive Plan – Compensation cost is recognized for stock options and restricted stock
awards issued to employees based upon the fair value of the awards at the date of grant. A binomial
model is utilized to estimate the fair value of stock options, while the market price of the Company’s
common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized
over the required service period, generally defined as the vesting period. Once the award is settled, the
Company would determine whether the cumulative tax deduction exceeded the cumulative compensation
cost recognized in the income statement. The cumulative tax deduction would include both the
deductions from the dividends and the deduction from the exercise or vesting of the award. If the tax
benefit received from the cumulative deductions exceeds the tax effect of the recognized cumulative
compensation cost, the excess would be recognized as an increase to additional paid-in capital.
Income Taxes – The Company files income tax returns in the U.S. federal jurisdiction and in Illinois.
The provision for income taxes is based on income in the consolidated financial statements, rather than
amounts reported on the Company's income tax return. Income tax expense is the total of the current year
income tax due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates that are
expected to apply to taxable income in years in which those temporary differences are expected to be
recovered or settled. A full valuation allowance was previously established for the deferred tax assets
excluding an asset associated with a net unrealized gain or loss on available-for-sale investment
securities. At September 30, 2013, the Company reversed a significant portion of the valuation allowance
after an analysis of both positive and negative evidence concerning the likelihood of deferred tax asset
recognition under GAAP. Due to the implicit recovery of the book basis of the underlying securities
along with management’s intent and ability to hold the securities to recovery or maturity, no valuation
allowance on this specific deferred tax asset has been established.
The Company is under examination by the State of Illinois for the tax years 2008 and 2009. The
Company conducts a regular assessment of uncertain tax positions and will establish reserves for tax
related interest and penalties with those amounts reflected in income tax expense. The Company did not
have any material amounts accrued for interest and penalties at either December 31, 2013, or December
31, 2012.
Earnings Per Common Share ("EPS") – Basic EPS is computed by dividing net income applicable to
common shares by the weighted-average number of common shares outstanding for the period. The basic
EPS computation excludes the dilutive effect of all common stock equivalents. Diluted EPS is computed
by dividing net income applicable to common shares by the weighted-average number of common shares
outstanding plus all potential common shares. Diluted EPS reflects the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or converted into common stock.
The Company's potential common shares represent shares issuable under its long-term incentive
compensation plans and under the common stock warrant issued to Treasury through the CPP and
subsequently sold to a third party at auction. Such common stock equivalents are computed based on the
treasury stock method using the average market price for the period.
84
Treasury Stock – Treasury stock acquired is recorded at cost and is carried as a reduction of
stockholders' equity in the Consolidated Statements of Financial Condition. Treasury stock issued is
valued based on the "last in, first out" inventory method. The difference between the consideration
received upon issuance and the carrying value is charged or credited to additional paid-in capital.
Mortgage Banking Derivatives – As part of ongoing residential mortgage business, the Company enters
into mortgage banking derivatives such as forward contracts and interest rate lock commitments. The
derivatives and loans held-for-sale are carried at fair value with the changes in fair value recorded in current
earnings. The net gain or loss on mortgage banking derivatives is included in gain on sale of loans.
Derivative Financial Instruments – The Company occasionally enters into derivative financial
instruments as part of its interest rate risk management strategies. These derivative financial instruments
consist primarily of interest rate swaps. Under accounting guidance all derivative instruments are
recorded on the balance sheet, in either other assets or other liabilities, at fair value. The accounting for
the gain or loss resulting from changes in fair value depends on the intended use of the derivative. For a
derivative used to hedge changes in fair value of a recognized asset or liability, or an unrecognized firm
commitment, the gain or loss on the derivative will be recognized in earnings, together with the offsetting
loss or gain on the hedged item. This results in an earnings impact only to the extent that the hedge is not
completely effective in achieving offsetting changes in fair value. If it is determined that the derivative
instrument is not highly effective as a hedge, hedge accounting is discontinued, and the adjustment to fair
value of the derivative instrument is recorded in earnings. For a derivative used to hedge changes in cash
flows associated with forecasted transactions, the gain or loss on the effective portion of the derivative are
deferred and reported as a component of accumulated other comprehensive income, which is a component
of shareholders’ equity, until such time the hedged transaction affects earnings. For derivative
instruments not accounted for as hedges, changes in fair value are recognized in noninterest
income/expense. Counterparty risk with correspondent banks is considered through loan covenant
agreements and, as such, does not have a significant impact on the fair value of the swaps. The credit
valuation reserve recorded on customer interest rate swap positions was determined based upon
management’s estimate of the amount of credit risk exposure, including available collateral protection
and/or by utilizing an estimate related to a probability of default as indicated in the Bank credit policy.
Deferred gains and losses from derivatives that are terminated are amortized over the shorter of the
original remaining term of the derivative or the remaining life of the underlying asset or liability.
Comprehensive Income (Loss) – Comprehensive income (loss) is the total of reported earnings all other
revenues, expenses, gains, and losses that are not reported in earnings under GAAP. The Company
includes the following items, net of tax, in other comprehensive income (loss) in the Consolidated
Statements of Comprehensive Income (Loss): (i) changes in unrealized gains or losses on securities
available-for-sale, (ii) changes in unrealized gains or losses on securities held-to-maturity established
upon transfer from securities available-for-sale, and (iii) changes in the fair value of derivatives
designated under cash flow hedges (when applicable).
New Accounting Pronouncements: In February 2013, the Financial Accounting Standards Board
(“FASB”) issued Accounting Standards Update (ASU) No. 2013-02 “Comprehensive Income (Topic 220)
— Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02
requires an entity to provide information about the amounts reclassified out of accumulated other
comprehensive income by component. In addition, an entity is required to present, either on the face of
the statement where net income is presented or in the notes, significant amounts reclassified out of
accumulated other comprehensive income by the respective line items of net income but only if the
amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same
reporting period. The impact of ASU 2013-02 on the Company’s consolidated financial statements is
reflected in the consolidated statement of comprehensive income (loss) and has been reflected in the
Company’s financial statements since January 1, 2013.
85
Note 2: Cash and Due from Banks
The Bank is required to maintain reserve balances with the Reserve Bank. In accordance with the Reserve
Bank requirements, the average reserve balances were $8.5 million and $8.4 million, for the years ending
December 31, 2013, and 2012, respectively.
The nature of the Company's business requires that it maintain amounts with other banks and federal funds
which, at times, may exceed federally insured limits. Management monitors these correspondent
relationships, and the Company has not experienced any losses in such accounts. The Bank also has a $4.4
million pledge requirement, met with cash, to a correspondent bank as it relates to credit card processing
services.
Note 3: Securities
Investment Portfolio Management
Our investment portfolio serves the liquidity and income needs of the Company. While the portfolio
serves as an important component of the overall liquidity management at the Bank, portions of the
portfolio will also serve as income producing assets. The size of the portfolio reflects liquidity needs,
loan demand and interest income objectives.
Portfolio size and composition may be adjusted from time to time. While a significant portion of the
portfolio consists of readily marketable securities to address liquidity, other parts of the portfolio may
reflect funds invested pending future loan demand or to maximize interest income without undue interest
rate risk.
Investments are comprised of debt securities and non-marketable equity investments. Until the third
quarter of 2013, all debt securities had been classified as available-for-sale. 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.
As of September 1, 2013, securities with a fair value of $237.2 million, a cost basis of $245.4 million,
with an August 31, 2013, unrealized loss of $8.2 million, were transferred from available-for-sale to held-
to-maturity. In addition, new held-to-maturity securities purchases were made during September 2013.
Specifically, two purchases were made of securities issued by the Government National Mortgage
Association. In accordance with GAAP, the Company has the positive intent and ability to hold the
securities to maturity. Securities held-to-maturity are carried at amortized cost and the discount or
premium created in the transfer is accreted or amortized to the maturity or expected payoff date but not an
earlier call. The Company has followed and will follow GAAP accounting on all securities holdings.
Nonmarketable equity investments include FHLBC stock and Reserve Bank stock. FHLBC stock was
recorded at a value of $5.5 million at December 31, 2013, a decrease of $910,000 from December 31,
2012. Reserve Bank stock was recorded at $4.8 million at December 31, 2013, which was unchanged
from December 31, 2012. Our FHLBC stock is necessary to maintain our continued access to FHLBC
advances. In late 2011, management at the Bank evaluated the October 17, 2011, FHLBC Capital Plan
and determined the best overall course for the Bank was to accept the stock conversion as of January 1,
2012. Subsequently, during the first half of 2012 management redeemed excess FHLBC stock held by
the Bank reducing the value of FHLBC stock held by the Bank to $6.4 million at December 31, 2012.
The following table summarizes the amortized cost and fair value of securities at December 31, 2013, and
2012 and the corresponding amounts of gross unrealized gains and losses:
86
December 31, 2013:
Securities Available-for-Sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate Bonds
Collateralized mortgage obligations
Asset-backed securities
Total Securities Available-for-Sale
Securities Held-to-Maturity
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total Securities Held-to-Maturity
December 31, 2012:
Securities Available-for-Sale
U.S. Treasury
U.S. government agencies
U.S. government agency mortgage-backed
States and political subdivisions
Corporate Bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized debt obligations
Total Securities Available-for-Sale
Amortized
Cost
Gross
Gross
Unrealized Unrealized
Gains
Losses
Fair
Value
$
1,549
1,738
16,382
15,733
66,766
274,118
376,286
$
$
35,268
221,303
256,571
$
$
-
-
629
17
256
2,168
3,070
$
$
$
45
643
688
$
$
(5)
(66)
(217)
(648)
(3,146)
(3,083)
(7,165)
1,544
1,672
16,794
15,102
63,876
273,203
372,191
$
$
$
(73)
(2,858)
(2,931)
$
$
35,240
219,088
254,328
$
$
1,500
49,848
127,716
14,639
36,355
168,795
165,347
17,941
582,141
$
$
7
122
1,605
1,216
586
1,895
2,468
-
7,899
$
$
-
(120)
(583)
-
(55)
(1,090)
(322)
(7,984)
(10,154)
$
$
1,507
49,850
128,738
15,855
36,886
169,600
167,493
9,957
579,886
$
During the twelve months ended December 31, 2013, we added $48.9 million to the total securities
portfolio (net of payoffs, maturities, sales, calls, amortization and accretion). This change is largely found
in the collateralized mortgage obligations and asset-backed securities components.
Securities valued at $266.7 million as of December 31, 2013, (up from $210.1 million at year-end 2012)
were pledged to secure deposits and for other purposes.
The fair value, amortized cost and weighted average yield of debt securities at December 31, 2013, by
contractual maturity, were as set forth below. Securities not due at a single maturity date, mortgage-
backed securities, collateralized mortgage obligations and asset-backed securities are shown separately.
Securities Available-for-Sale
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Collateralized mortgage obligations
Asset-backed
Amortized
Cost
$
773
4,725
23,161
6,743
35,402
66,766
274,118
376,286
$
Weighted
Average
Yield
3.58%
3.38%
3.23%
4.38%
3.48%
2.53%
1.70%
2.01%
Fair
Value
$
785
5,023
22,649
6,655
35,112
63,876
273,203
372,191
$
Securities Held-to-Maturity
Mortgage-backed and collateralized mortgage obligations
$
256,571
3.06%
$
254,328
At December 31, 2013, the Company’s investments include asset-backed securities that are backed by
87
student loans originated under the Federal Family Education Loan program (“FFEL”). Under the FFEL,
private lenders made federally guaranteed student loans to parents and students. While the program was
modified several times before elimination in 2010, not less than 97% of the original principal amount of
the loans made under FFEL were guaranteed by the U.S. Department of Education. A number of major
student loan originators packaged loans and sold them as asset-backed securities. The Company has
accumulated the securities of the following three different originators that individually amount to over
10% of the Company’s stockholders equity. Information regarding these three issuers and the value of
the securities issued follows:
Issuer
December 31, 2013
Fair
Value
Amortized
Cost
Access Group
Northstar Education Finance
GCO Education Loan Funding Corp
$
24,220
95,320
39,664
$
24,962
96,327
38,085
The Company has also invested over ten percent of the Company’s stockholders equity in mortgage-
backed securities issued by Credit Suisse Mortgage Trust, a trust formed by Credit Suisse Mortgage
Corporation. The securities held by the Company are backed by residential mortgage loans that were not
eligible for securitization by the U.S. Government or any of its agencies. As of December 31, 2013, the
book value of the securities issued by Credit Suisse Mortgage Corporation was $28.9 million and the
market value of such securities was $26.3 million and are rated “AAA” by Standard & Poor’s. The
“AAA” rating is supported by other bonds in the issuance structure that are subordinate to the securities
purchased by the Company, meaning that the subordinate bonds will absorb losses to principal before any
loss can impact the Company’s securities.
Securities with unrealized losses at December 31, 2013, and 2012 aggregated by investment category and
length of time that individual securities have been in a continuous unrealized loss position, are as follows:
2013
Securities Available-for-Sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Securities Held-to-Maturity
Collateralized mortgage obligations
Asset-backed securities
2012
Securities Available-for-Sale
U.S. government agencies
U.S. government agency mortgage-backed
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized debt obligations
Number of
Securities
Less than 12 months
in an unrealized loss position
Unrealized
Losses
5
$
-
217
429
3,146
2,836
6,633
1
-
6
4
5
11
27
$
$
Fair
Value
$
1,544
-
4,625
10,493
54,021
99,466
170,149
6
19
25
$
73
2,858
2,931
$
$
19,134
156,632
175,766
$
Less than 12 months
in an unrealized loss position
Unrealized
Losses
$
$
Fair
Value
Number of
Securities
4
12
4
6
6
-
32
120
583
55
1,060
322
-
2,140
17,039
53,184
9,724
37,778
37,488
-
155,213
$
$
Greater than 12 months
in an unrealized loss position
Number of
Securities
-
1
-
2
-
2
5
-
-
-
Unrealized
Losses
-
$
66
-
219
-
247
532
$
Fair
Value
-
$
1,672
-
2,796
-
6,368
10,836
$
$
-
-
$
-
$
-
-
$
-
Greater than 12 months
in an unrealized loss position
Number of
Securities
-
-
-
1
-
2
3
Unrealized
Losses
-
$
-
-
30
-
7,984
8,014
$
Fair
Value
-
$
-
-
2,343
-
9,957
12,300
$
Number of
Securities
1
1
6
6
5
13
32
6
19
25
Number of
Securities
4
12
4
7
6
2
35
88
Total
Unrealized
Losses
5
$
66
217
648
3,146
3,083
7,165
$
$
73
2,858
2,931
$
Total
Unrealized
Losses
$
120
583
55
1,090
322
7,984
10,154
Fair
Value
$
1,544
1,672
4,625
13,289
54,021
105,834
180,985
$
$
19,134
156,632
175,766
$
Fair
Value
$
17,039
53,184
9,724
40,121
37,488
9,957
167,513
$
$
In determining when OTTI exists for debt securities, management considers many factors, including: (1)
the length of time and the extent to which the fair value has been less than cost, (2) the financial condition
and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic
conditions, and (4) whether the Company has the intent to sell the debt security, or more likely than not
will be required to sell the debt security, before its anticipated recovery. The assessment of whether an
OTTI decline exists involves a high degree of subjectivity and judgment and is based on the information
available to management at a point in time.
Years ended December 31,
Proceeds from sales of securities
Gross realized gains on securities
Gross realized losses on securities
Securities (losses) gains, net
Income tax (benefit) expense on net realized (losses) gains
$
2013
533,302
5,376
(7,288)
(1,912)
(784)
$
$
$
2012
223,860
1,937
(362)
1,575
641
$
$
Note 4: Loans
Major classifications of loans at December 31 were as follows:
2013
2012
$
$
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease financing receivables
Other
Net deferred loan fees and costs
94,736
560,233
29,351
390,201
2,760
628
10,069
12,793
1,100,771
485
1,101,256
86,941
579,687
42,167
414,543
3,101
994
6,060
16,451
1,149,944
106
1,150,050
$
$
It is the policy of the Company to review each prospective credit in order to determine if an adequate level
of security or collateral was obtained prior to making a loan. The type of collateral, when required, will
vary from liquid assets to real estate. The Company's access to collateral, in the event of borrower default,
is generally protected through adherence to state lending laws, the Company's lending standards and credit
monitoring procedures. The Bank generally makes loans within its market area. There are no significant
concentrations of loans where the customers' ability to honor loan terms is dependent upon a single
economic sector, although the real estate related categories listed above represent 89.0% and 90.1% of the
portfolio at December 31, 2013, and December 31, 2012, respectively.
89
Aged analysis of past due loans by class of loans as of December 31, 2013, and December 31, 2012, were as
follows:
December 31, 2013
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Consumer
All other1
December 31, 2012
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Consumer
All other1
30-59 Days
Past Due
$
-
60-89 Days
Past Due
$
-
90 Days or
Greater Past
Due
$
-
Total Past
Due
$
-
Current
$
104,778
Nonaccrual
$
27
Total Loans
$
104,805
290
511
218
-
-
-
-
-
-
32
581
4,414
650
5
526
-
-
-
-
-
-
-
-
-
171
308
76
-
-
-
-
-
-
-
-
-
-
-
-
87
-
-
816
511
218
-
-
-
-
-
-
32
752
4,809
726
5
117,938
164,277
132,331
73,325
34,034
16,419
3,515
4,436
11,235
7,404
140,926
106,184
121,013
2,755
3,180
7,671
5,708
661
3,144
-
168
209
1,913
439
6,615
5,967
3,209
-
121,934
172,459
138,257
73,986
37,178
16,419
3,683
4,645
13,148
7,875
148,293
116,960
124,948
2,760
Recorded
Investment
90 days or
Greater Past
Due and
Accruing
$
-
-
-
-
-
-
-
-
-
-
-
-
87
-
-
-
6,701
$
-
1,081
$
-
87
$
-
7,869
$
13,906
1,054,476
$
-
38,911
$
13,906
1,101,256
$
-
87
$
30-59 Days
Past Due
$
159
60-89 Days
Past Due
$
-
90 Days or
Greater Past
Due
$
-
Total Past
Due
$
159
Current
$
92,080
Nonaccrual
$
762
Total Loans
$
93,001
1,580
172
-
-
-
-
-
-
-
300
276
3,151
888
3
50
-
1,046
4,304
-
-
-
-
-
215
164
375
203
-
-
-
-
-
-
-
-
-
-
68
-
21
-
-
1,630
172
1,046
4,304
-
-
-
-
-
583
440
3,547
1,091
3
119,994
149,439
128,817
69,299
37,732
23,372
4,469
2,747
10,755
14,360
140,141
110,735
134,990
3,075
5,487
11,433
13,436
477
10,532
2,517
1,855
254
6,587
557
9,910
9,918
3,771
23
127,111
161,044
143,299
74,080
48,264
25,889
6,324
3,001
17,342
15,500
150,491
124,200
139,852
3,101
Recorded
Investment
90 days or
Greater Past
Due and
Accruing
$
-
-
-
-
-
-
-
-
-
-
68
-
21
-
-
-
6,529
$
-
6,357
$
-
89
$
-
12,975
$
17,551
1,059,556
$
-
77,519
$
17,551
1,150,050
$
-
89
$
1. The “All other” class includes overdrafts and net deferred loan fees and costs.
Credit Quality Indicators:
The Company categorizes loans into credit risk categories based on current financial information, overall
debt service coverage, comparison against industry averages, historical payment experience, and current
economic trends. This analysis includes loans with outstanding loans 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:
90
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 institution will sustain some loss if the
deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as
substandard, with the added characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions, and values, highly questionable and
improbable.
Credits that are not covered by the definitions above are pass credits, which are not considered to be
adversely rated. Loans listed as not rated have outstanding loans or commitments less than $50,000 or are
included in groups of homogeneous loans.
91
Credit Quality Indicators by class of loans as of December 31, 2013, and December 31, 2012, were as
follows:
December 31, 2013
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail Properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior leins
Consumer
All other
Total
December 31, 2012
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail Properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior leins
Consumer
All other
Total
Pass
Special
Mention
$
96,371
$
7,953
Substandard 1
$
481
Doubtful
$
-
Total Loans
$
104,805
105,683
162,586
122,844
59,674
30,059
16,419
1,745
4,436
7,674
7,109
9,048
1,968
1,826
9,840
2,989
-
1,770
-
3,561
32
7,203
7,905
13,587
4,472
4,130
-
168
209
1,913
734
-
-
-
-
-
-
-
-
-
-
121,934
172,459
138,257
73,986
37,178
16,419
3,683
4,645
13,148
7,875
135,136
109,261
120,589
2,759
13,906
996,251
$
3,407
-
388
-
-
42,782
$
9,750
7,699
3,971
1
-
62,223
$
-
-
-
-
-
$
-
148,293
116,960
124,948
2,760
13,906
1,101,256
$
Pass
Special
Mention
$
88,071
$
3,867
Substandard 1
$
1,063
Doubtful
$
-
Total Loans
$
93,001
113,118
134,152
105,192
68,682
32,715
21,262
1,318
2,747
7,122
14,607
2,995
9,036
14,273
3,911
1,873
2,110
2,196
-
-
37
10,998
17,856
23,834
1,487
13,676
2,517
2,810
254
10,220
856
-
-
-
-
-
-
-
-
-
-
127,111
161,044
143,299
74,080
48,264
25,889
6,324
3,001
17,342
15,500
123,876
110,858
133,992
3,075
17,331
978,118
$
14,608
396
166
-
220
55,688
$
12,007
12,946
5,694
26
-
116,244
$
-
-
-
-
-
$
-
150,491
124,200
139,852
3,101
17,551
1,150,050
$
1 The substandard credit quality indicator includes both potential problem loans that are
currently performing and nonperforming loans
92
Impaired loans by class of loan as of December 31, 2013, were as follows:
With no related allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with no recorded allowance
With an allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with a recorded allowance
Total impaired loans
Year to date
December 31, 2013
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Inte rest
Income
Recognized
$
27
$
34
$
-
$
112
$
-
2,543
3,371
5,428
661
3,144
-
2,016
209
738
4
5,984
9,179
1,771
-
35,075
-
730
4,300
939
-
-
-
168
-
1,175
436
3,006
4,117
6,709
919
3,811
-
2,016
308
742
35
8,338
10,451
2,313
-
42,799
-
792
4,702
1,030
-
-
-
604
-
1,808
468
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
264
759
129
-
-
-
76
-
17
262
3,508
5,275
9,892
569
5,962
1,259
3,085
232
1,501
41
5,576
9,284
1,570
11
47,877
283
872
4,277
1,859
-
876
-
97
-
2,748
458
3
-
75
-
-
-
97
-
-
-
-
209
6
-
390
-
-
-
-
-
-
-
-
-
-
-
684
1,565
1,498
-
11,495
$ 46,570
913
1,831
1,848
-
13,996
$ 56,795
160
170
558
-
2,395
$ 2,395
2,713
3,737
1,981
-
19,901
$ 67,778
-
-
-
-
-
$ 390
93
Impaired loans by class of loan as of December 31, 2012, were as follows:
With no related allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with no recorded allowance
With an allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with a recorded allowance
Total impaired loans
Year to date
December 31, 2012
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Ave rage
Recorded
Investment
Inte rest
Income
Recognized
$
196
$
229
$
-
$
354
$
-
4,473
7,180
14,356
477
8,780
2,517
4,155
254
2,265
78
5,168
9,389
1,368
23
60,679
566
1,014
4,253
2,779
-
1,752
-
26
-
4,322
479
5,021
8,486
17,381
634
15,323
2,517
4,729
308
3,451
168
6,979
11,002
1,689
23
77,940
619
1,057
6,200
3,906
-
1,812
-
75
-
6,613
649
-
-
-
-
-
-
-
-
-
-
-
-
-
-
458
230
712
204
-
1,102
-
3
-
757
353
4,616
9,893
11,329
928
6,683
1,798
7,413
1,140
5,907
2,193
4,075
10,635
1,428
11
68,403
610
4,499
4,106
5,588
217
6,531
248
1,115
-
4,495
430
-
-
270
-
-
-
119
-
-
-
-
249
4
-
642
-
-
-
-
-
-
-
-
-
-
-
4,742
5,909
2,464
-
28,306
$ 88,985
5,954
6,923
2,625
-
36,433
$ 114,373
477
1,089
874
-
6,259
$ 6,259
8,514
7,141
1,908
-
45,402
$ 113,805
-
40
-
-
40
$ 682
TDRs are loans for which the contractual terms have been modified and both of these conditions exist: (1)
there is a concession of principal or interest and (2) the borrower is experiencing financial difficulties.
Loans are restructured on a case-by-case basis during the loan collection process with modifications
generally initiated at the request of the borrower. These modifications may include reduction in interest
rates, extension of term, deferrals of principal, and other modifications. The Bank does participate in the
Treasury’s Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an
opportunity to refinance into more affordable monthly payments.
The specific allocation of the allowance for loan losses on TDRs is determined by discounting the
94
modified cash flows at the original effective rate of the loan before modification or is based on the
underlying collateral value less costs to sell, if repayment of the loan is collateral-dependent. If the
resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance
(i.e. specific reserve) as a component of the allowance for loan losses or charges off the impaired balance
if it determines that such amount is a confirmed loss. This method is used consistently for all segments of
the portfolio. The allowance for loan losses also includes an allowance based on a loss migration analysis
for each loan category for loans that are not individually evaluated for specific impairment. All loans
charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.
TDRs that were modified during the period are summarized as follows:
Troubled debt restructurings
Real estate - commercial
Deferral1
Real estate - residential
Investor
Other2
Owner occupied
Deferral1
Troubled debt restructurings
Real estate - commercial
Deferral1
Interest3
Other2
Real estate - construction
Interest3
Real estate - residential
Investor
Other2
Owner occupied
Deferral1
Bifurcate4
Other2
Revolving and junior liens
HAMP5
TDR Modifications
Twelve months ended December 31, 2013
# of
contracts
Pre-modification
recorded investment
Post-modification
recorded investment
1
1
1
3
$
610
$
433
54
54
$
137
801
$
136
623
TDR Modifications
Twelve months ended December 31, 2012
# of
contracts
Pre-modification
recorded investment
Post-modification
recorded investment
3
1
1
1
1
2
1
2
$
1,772
$
1,369
2,921
105
460
174
513
337
214
2,685
102
412
174
145
87
147
1
13
$
117
6,613
$
61
5,182
1 Deferral: Refers to the deferral of principal
2 Other: Change of terms from bankruptcy court
3 Interest: Refers to change of interest rate
4 Bifurcate: Refers to an “A/B” restructure separated into two notes, charging off the entire B portion of
the note.
5 HAMP: Home Affordable Modification Program
95
TDRs are classified as being in default on a case-by-case when they fail to be in compliance with the
modified terms. The following table presents TDRs that defaulted during the periods shown and were
restructured within the 12-month period prior to default:
TDR Default Activity
TDR Default Activity
Troubled debt restructurings that
Subsequently Defaulted
Real estate - commercial
Twelve Months ending December 31, 2013 Twelve Months ending December 31, 2012
Pre-modification outstanding
recorded investment
Pre-modification outstanding
recorded investment
# of
contracts
# of
contracts
Owner occupied special purpose
1
$
610
-
$
-
Real estate - construction
Commercial speculative
Real estate - residential
Investor
Owner occupied
-
1
2
4
-
1
460
$
155
312
1,077
-
-
1
$
-
-
460
The Bank had no commitments to borrowers whose loans were classified as impaired at
December 31, 2013.
Loans to principal officers, directors, and their affiliates, which are made in the ordinary course of
business, were as follows at December 31:
2013
2012
Beginning balance
New loans
Repayments and other reductions
Change in related party status
Ending balance
$
$
3,586
27,616
(24,831)
43
6,414
4,318
13,486
(14,118)
(100)
3,586
$
$
No loans to principal officers, directors, and their affiliates were past due greater than 90 days at either
December 31, 2013, or December 31, 2012.
96
Note 5: Allowance for Loan Losses
Changes in the allowance for loan losses by segment of loans based on method of impairment as of and for
the year ending December 31, 2013, were as follows:
Commercial
Real Estate
Commercial1
Real Estate
Construction
Real Estate
Residential
Consumer
Unallocated
Total
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Ending balance: Individually
evaluated for impairment
Ending balance: Collectively
evaluated for impairment
Loans:
Ending balance
Ending balance: Individually
evaluated for impairment
Ending balance: Collectively
evaluated for impairment
$
$
$
$
$
$
$
4,517
316
119
(2,070)
2,250
20,100
2,985
5,325
(5,677)
16,763
3,837
1,014
1,266
(2,109)
1,980
4,535
6,293
1,221
3,374
2,837
1,178
597
508
350
1,439
4,430
-
-
(2,418)
2,012
38,597
11,205
8,439
(8,550)
27,281
$
$
$
$
$
$
$
$
-
$
1,152
$
355
$
888
$
-
$
-
$
2,395
$
2,250
$
15,611
$
1,625
$
1,949
$
1,439
$
2,012
$
24,886
$
104,805
$
560,233
$
29,351
$
390,201
$
2,760
$
13,906
$
1,101,256
$
27
$
21,116
$
4,746
$
20,681
$
-
$
-
$
46,570
$
104,778
$
539,117
$
24,605
$
369,520
$
2,760
$
13,906
$
1,054,686
1 As of December 31, 2013, this segment consisted of performing loans that included a higher risk pool of
loans rated as substandard that totaled $17.2 million. The amount of general allocation that was estimated
for that portion of these performing substandard rated loans was $2.1 million at December 31, 2013.
The Company’s allowance for loan loss is calculated in accordance with GAAP and relevant supervisory
guidance. All management estimates were made in light of observable trends within loan portfolio
segments, market conditions and established credit review administration practices.
Changes in the allowance for loan losses by segment of loans based on method of impairment as of and for
the year ending December 31, 2012, were as follows:
Commercial
Real Estate
Commercial1
Real Estate
Construction
Real Estate
Residential
Consumer
Unallocated
Total
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Ending balance: Individually
evaluated for impairment
Ending balance: Collectively
evaluated for impairment
Loans:
Ending balance
Ending balance: Individually
evaluated for impairment
Ending balance: Collectively
evaluated for impairment
$
$
$
$
$
$
$
5,070
344
115
(324)
4,517
30,770
13,508
3,576
(738)
20,100
7,937
4,969
3,420
(2,551)
3,837
6,335
8,406
583
6,023
4,535
884
638
487
445
1,178
1,001
-
-
3,429
4,430
51,997
27,865
8,181
6,284
38,597
$
$
$
$
$
$
$
$
458
$
2,248
$
1,113
$
2,440
$
-
$
-
$
6,259
$
4,059
$
17,852
$
2,724
$
2,095
$
1,178
$
4,430
$
32,338
$
93,001
$
579,687
$
42,167
$
414,543
$
3,101
$
17,551
$
1,150,050
$
762
$
47,581
$
11,579
$
29,040
$
23
$
-
$
88,985
$
92,239
$
532,106
$
30,588
$
385,503
$
3,078
$
17,551
$
1,061,065
97
1 As of December 31, 2012, this segment consisted of performing loans that included a higher risk pool of
loans rated as substandard that totaled $22.7 million. The amount of general allocation that was estimated
for that portion of these performing substandard rated loans was $1.8 million at December 31, 2012.
Note 6: Other Real Estate Owned
Details related to the activity in the net OREO portfolio for the periods presented is itemized in the
following table:
Twelve Months Ended
December 31,
Other real estate owned
Beginning balance
Property additions
Development improvements
Less:
Property Disposals, net of gains/losses
Period valuation adjustments
Other real estate owned
$
2013
72,423
19,194
73
41,712
8,441
41,537
$
$
2012
93,290
32,121
701
36,854
16,835
72,423
$
Activity in the valuation allowance was as follows:
2013
2012
Balance at beginning of year
Provision for unrealized losses
Reductions taken on sales
Other adjustments
Balance at end of year
Expenses related to foreclosed assets includes:
Gain on sales, net
Provision for unrealized losses
Operating expenses
Less:
Lease revenue
$
$
31,454
8,293
(17,389)
(74)
22,284
23,462
16,385
(8,843)
450
31,454
$
$
2013
2012
$
(1,956)
8,293
5,705
$
(2,198)
16,385
7,973
1,295
10,747
$
3,497
18,663
$
98
Note 7: Premises and Equipment
Premises and equipment at December 31 were as follows:
2013
Accumulated
Depreciation/
Amortization
-
$
20,714
72
36,579
57,365
$
$
Cost
17,474
45,903
74
39,919
103,370
$
Land
Buildings
Leasehold improvements
Furniture and equipment
Note 8: Deposits
Net Book
Value
$
$
17,474
25,189
2
3,340
46,005
$
$
Cost
17,474
45,759
74
38,681
101,988
2012
Accumulated
Depreciation/
Amortization
-
$
19,574
72
35,340
54,986
$
Net Book
Value
$
17,474
26,185
2
3,341
47,002
$
Major classifications of deposits at December 31 were as follows:
Noninterest bearing demand
Savings
NOW accounts
Money market accounts
Certificates of deposit of less than $100,000
Certificates of deposit of $100,000 or more
$
$
2013
373,389
228,589
297,852
309,859
288,345
184,094
1,682,128
2012
379,451
216,305
286,860
323,811
318,844
191,948
1,717,219
$
$
The Company had no brokered certificates of deposit as of December 31, 2013, and 2012. Deposits held
by senior officers and directors, including their related interests, totaled $3.4 million and $2.1 million,
respectively, as of December 31, 2013, and 2012.
At December 31, 2013, scheduled maturities of time deposits were as follows:
2014
2015
2016
2017
2018
Total
$
$
313,231
87,359
24,082
15,066
32,701
472,439
The following table sets forth the amount and maturities of deposits of $100,000 or more at December 31:
2013
2012
3 months or less
Over 3 months through 6 months
Over 6 months through 12 months
Over 12 months
$
$
24,415
21,137
77,718
60,824
184,094
20,701
15,594
52,609
103,044
191,948
$
$
99
Note 9: Borrowings
Borrowings at December 31 are as follows:
Securities sold under repurchase agreements
FHLBC advances1
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
2013
2012
$
$
22,560
5,000
58,378
45,000
500
131,438
17,875
100,000
58,378
45,000
500
221,753
$
$
1Included in other short-term borrowing on the balance sheet.
The Company enters into deposit sweep transactions where the transaction amounts are secured by
pledged securities. These transactions consistently mature within 1 to 90 days 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 $22.6 million at December 31, 2013, and $17.9 million at December 31, 2012. The
fair value of the pledged collateral was $39.2 million and $26.0 million at December 31, 2013 and
December 31, 2012, respectively. At year end 2013, there were no customers with secured balances
exceeding 10% of stockholders’ equity.
The following table is a summary of additional information related to repurchase agreements:
2012
$
$
2013
Average daily balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year-end
23,313
0.01%
30,510
0.01%
4,826
0.04%
17,875
0.05%
$
$
The Company's borrowings at the FHLBC require the Bank to be a member and invest in the stock of the
FHLBC and the Company’s total borrowings from the FHLBC are generally limited to the lower of 35%
of the Company’s total assets or 60% of the book value of certain mortgage loans. As of December 31,
2013, the Bank had taken an advance of $5.0 million at 0.13% interest on the FHLBC stock valued at
$5.5 million. This advance matured on January 2, 2014 and was replaced with short term FHLBC
advances that matured in January 2014. Additional drawdowns and repayments of FHLBC advances
have been and will be conducted in the normal course of Company business. Previous borrowing
capacity at the Reserve Bank that was not used at either December 31, 2013, or December 31, 2012, was
dropped by the Company in October 2013, as management determined that it was not needed given
current and prospective liquidity projections.
One of the Company's most significant borrowing relationships continued to be the $45.5 million credit
facility with a correspondent bank. That credit began in January 2008 and was originally composed of a
$30.5 million senior debt facility, which included $500,000 in term debt, and $45.0 million of
subordinated debt. The subordinated debt and the term debt portion of the senior debt facility mature on
March 31, 2018. The interest rate on the senior debt facility resets quarterly and at the Company’s option,
is based on, either the lender's prime rate or three-month LIBOR plus 90 basis points. The interest rate on
the subordinated debt resets quarterly, and is equal to three-month LIBOR plus 150 basis points. The
Company had no principal outstanding balance on the senior line of credit when it matured and the senior
line of credit has been terminated. The Company had $500,000 in principal outstanding in term debt and
$45.0 million in principal outstanding in subordinated debt at the end of both December 31, 2012, and
December 31, 2013. The term debt is secured by all of the outstanding capital stock of the Bank. The
100
Company has made all required interest payments on the outstanding principal amounts on a timely basis.
Pursuant to the Written Agreement (the “Written Agreement”) the Company entered into with the
Reserve Bank, the Company was required to receive the Reserve Bank’s approval prior to making any
interest payments on the subordinated debt. In January 2014 the Reserve Bank notified the Company that
the Written Agreement was terminated.
The credit facility agreement contains usual and customary provisions regarding acceleration of the senior
debt upon the occurrence of an event of default by the Company under the senior debt agreement. The
senior debt agreement also contains certain customary representations and warranties and financial
covenants. At December 31, 2013, the Company was out of compliance with one of the financial
covenants contained within the credit agreement. Prior to 2013, the Company had been out of compliance
with two of the financial covenants. The agreement provides that noncompliance is an event of default
and as the result of the Company's failure to comply with a financial covenant, the lender may (i)
terminate all commitments to extend further credit, (ii) increase the interest rate on the revolving line of
the term debt by 200 basis points, (iii) declare the senior debt immediately due and payable and (iv)
exercise all of its rights and remedies at law, in equity and/or pursuant to any or all collateral documents,
including foreclosing on the collateral. The total outstanding principal amount of the senior debt is the
$500,000 in term debt. Because the subordinated debt is treated as Tier 2 capital for regulatory capital
purposes, the senior debt agreement does not provide the lender with any rights of acceleration or other
remedies with regard to the subordinated debt upon an event of default caused by the Company's failure
to comply with a financial covenant.
Scheduled maturities and weighted average rates of borrowings for the years ended December 31,
were as follows:
2013
2012
Weighted
Average
Rate
Weighted
Average
Rate
Balance
Balance
$
$
2014
2015
2016
2017
2018
Thereafter
Total
27,560
-
-
-
45,500
58,378
131,438
0.02%
-
-
-
1.76%
7.35%
3.88%
117,875
-
-
-
-
103,878
221,753
0.12%
-
-
-
-
4.95%
2.38%
$
$
Note 10: Junior Subordinated Debentures
The Company completed the sale of $27.5 million of cumulative trust preferred securities by its
unconsolidated subsidiary, Old Second Capital Trust I in June 2003. An additional $4.1 million of
cumulative trust preferred securities were sold in July 2003. The costs associated with the issuance of the
cumulative trust preferred securities are being amortized over 30 years. The trust preferred securities may
remain outstanding for a 30-year term but, subject to regulatory approval, can be called in whole or in part
by the Company. The stated call period commenced on June 30, 2008 and can be exercised by the
Company from time to time thereafter. When not in deferral, cash distributions on the securities are
payable quarterly at an annual rate of 7.80%. The Company issued a new $32.6 million subordinated
debenture to the trust in return for the aggregate net proceeds of this trust preferred offering. The interest
rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust
preferred securities.
101
The Company issued an additional $25.0 million of cumulative trust preferred securities through a private
placement completed by an additional unconsolidated subsidiary, Old Second Capital Trust II, in April
2007. Although nominal in amount, the costs associated with that issuance are being amortized over 30
years. These trust preferred securities also mature in 30 years, but subject to the aforementioned
regulatory approval, can be called in whole or in part on a quarterly basis commencing June 15, 2017.
The quarterly cash distributions on the securities are fixed at 6.77% through June 15, 2017 and float at
150 basis points over three-month LIBOR thereafter. The Company issued a new $25.8 million
subordinated debenture to the trust in return for the aggregate net proceeds of this trust preferred offering.
The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on
the trust preferred securities.
Under the terms of the subordinated debentures issued to each of Old Second Capital Trust I and II, the
Company is allowed to defer payments of interest for 20 quarterly periods without default or penalty, but
such amounts will continue to accrue. Also during the deferral period, the Company generally may not
pay cash dividends on or repurchase its common stock or preferred stock, including the Series B Fixed
Rate Cumulative Perpetual Preferred Stock (the “Series B Preferred Stock”) as discussed in Note 20. In
August of 2010, the Company elected to defer regularly scheduled interest payments on the $58.4 million
of junior subordinated debentures. Because of the deferral on the subordinated debentures, the trusts will
defer regularly scheduled dividends on the trust preferred securities. Both of the debentures issued by the
Company are recorded on the Consolidated Balance Sheets as junior subordinated debentures and the
related interest expense for each issuance is included in the Consolidated Statements of Operations. The
total accumulated unpaid interest on the junior subordinated debentures including compounded interest
from July 1, 2010, on the deferred payments totaled $17.0 million and $11.7 million at December 31,
2013, and December 31, 2012, respectively.
Note 11: Income Taxes
Income tax expense (benefit) for the year ended December 31 was as follows:
2013
$
105
29
2,780
989
(74,145)
(70,242)
$
2012
-
$
-
(302)
(436)
738
$
-
Current federal
Current state
Deferred federal
Deferred state
Change in valuation allowance
102
The following were the components of the deferred tax assets and liabilities as of December 31:
Allowance for loan losses
Deferred compensation
Amortization of core deposit asset
Goodwill amortization/impairment
Stock option expense
OREO write downs
Federal net operating loss ("NOL") carryforward
State net operating loss ("NOL") carryforward
Deferred tax credit
Other assets
Total deferred tax assets
Accumulated depreciation on premises and equipment
Accretion on securities
Mortgage servicing rights
State tax benefits
Other liabilities
Total deferred tax liabilities
Net deferred tax asset before valuation allowance
Tax benefit on net unrealized losses on securities
Valuation allowance
Net deferred tax asset
$
2013
12,725
788
1,656
15,252
583
10,041
28,023
11,847
1,444
1,166
83,525
(1,035)
(8)
(2,571)
(6,994)
(178)
(10,786)
72,739
4,927
(2,363)
75,303
$
$
2012
18,236
679
965
16,796
785
16,632
20,736
10,186
1,444
585
87,044
(1,063)
(122)
(1,819)
(7,315)
(217)
(10,536)
76,508
928
(76,508)
928
$
At December 31, 2013, the Company had $80.1 million federal net operation loss (“NOL”) carryforward
of which, $25.3 million expires in 2030, $31.4 million expires in 2031, $8.6 million expires in 2032 and
$14.8 million expires in 2033. The Company had $124.7 million state NOL carryforward of which, $29.4
million expires in 2021, and $95.3 million expires in 2025. In addition, the Company had $1.4 million in
alternative minimum tax credit that can be carried forward indefinitely.
The components of the provision for deferred income tax expense (benefit) were as follows:
Provision for loan losses
Deferred Compensation
Amortization of core deposit asset
Stock option expense
OREO write downs
Federal net operating loss carryforward
State net operating loss carryforward
Depreciation
Net premiums and discounts on securities
Mortgage servicing rights
Goodwill amortization/impairment
State tax benefits
Change in valuation allowance
Other, net
Total deferred tax benefit
2012
$
6,125
(51)
(382)
326
(6,538)
(926)
(446)
(202)
85
281
1,526
114
738
(650)
$
-
2013
$
5,511
(109)
(691)
202
6,591
(7,287)
(1,661)
(28)
(114)
752
1,544
(321)
(74,145)
(620)
(70,376)
$
103
Effective tax rates differ from federal statutory rates applied to financial statement loss due to the following:
Tax at statutory federal income tax rate
Nontaxable interest income, net
of disallowed interest deduction
BOLI income
State income taxes, net of federal benefit
Change in valuation allowance
Deficiency from restricted stock
Other, net
Tax at effective tax rate
2013
$
4,145
2012
$
(25)
(245)
(694)
662
(74,145)
10
25
(70,242)
$
(192)
(563)
(53)
738
299
(204)
$
-
The Company recorded a tax benefit of $70.2 million on $11.8 million pre-tax income for the year 2013. The tax
benefit was composed of $134,000 in current income tax expense and $3.8 million in deferred income tax expense
offset by a $74.1 million reversal of the deferred tax valuation allowance reserve. The Company evaluated
positive and negative evidence in order to determine if it was more likely than not that the deferred tax
asset would be recovered through future income. Significant positive evidence evaluated included recent
and projected earnings, significantly improved asset quality and an improved capital position. Negative
evidence identified included a reduction in net interest margin as a result of the current rate environment,
and historic runoff of loans. After evaluating all of the evidence, the Company believes it will more
likely than not utilize the net deferred tax assets and reversed a significant portion of the valuation reserve
on the net deferred tax asset in the third quarter of 2013.
Note 12: Long-Term Incentive Plan
The Long-Term Incentive Plan (the "Incentive Plan") authorizes the issuance of up to 1,908,332 shares of
the Company's common stock, including the granting of qualified stock options, nonqualified stock
options, restricted stock, restricted stock units, and stock appreciation rights. Total shares issuable under
the plan were 45,368 at December 31, 2013. Stock based awards may be granted to selected directors,
officers or employees at the discretion of the board of directors.
The Company’s board of directors has discretionary authority to establish or change some terms, on a grant-
by-grant basis, including the amount of time until the awards vest. Awards under the Incentive Plan become
fully vested upon a merger or change in control of the Company.
Total compensation cost that has been charged against income for those plans was $167,000 and
$291,000, in 2013 and 2012, respectively.
The fair value of each option award is estimated on the date of grant using a closed form option valuation
(binomial) model that uses the assumptions noted in the table below. Expected volatilities are based on
the previous five-year historical volatilities of the Company’s common stock. The Company uses
historical data to estimate option exercise and post-vesting termination behavior. The expected term of
options granted is based on historical data and represents the period of time that options granted are
expected to be outstanding, which takes into account that the options are not transferable. The risk-free
interest rate for the expected term of the option is based on the Treasury yield curve in effect at the time
of the grant.
There were no stock options exercised during 2013 or 2012. The Company did not grant any options of
the Company’s common stock during either of those periods. All stock options, when granted, are for a
term of ten years. There was no unrecognized compensation cost related to nonvested stock options
104
granted under the Incentive Plan as of December 31, 2013, or 2012.
A summary of stock option activity in the Incentive Plan is as follows for the year ended
December 31, 2013:
Weighted
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term (Years)
Aggregate
Intrinsic
Value
Beginning outstanding
Canceled
Expired
Ending outstanding
Shares
409,500
(8,000)
(76,000)
325,500
$
$
28.75
30.81
25.08
29.56
Exercisable at end of year
325,500
$
29.56
2.5
2.5
$
-
$
-
Under the incentive plan, restricted stock was granted beginning in 2005 and the grant of restricted units
began in February 2009. Restricted stock has voting rights and both of these restricted awards have
dividend rights, and are subject to forfeiture until certain restrictions have lapsed including employment
for a specific period. Both restricted stock and restricted units are redeemable in common stock when
they vest. There were 155,500 of restricted units issued in 2013 and 60,000 of restricted awards issued in
2012. There were no restricted units issued in 2012 and no restricted awards were issued in 2013.
Compensation expense is recognized over the vesting period of the restricted award based on the market
value of the award at issue date.
A summary of changes in the Company’s nonvested restricted awards are as follows for the year ended
December 31, 2013:
December 31, 2013
Nonvested at January 1
Granted
Vested
Forfeited
Recaptured after Series B auction
Nonvested at December 31
Restricted
Stock Shares
and Units
327,920
155,500
(241,920)
(11,000)
(45,000)
185,500
Weighted
Average
Grant Date
Fair Value
$
2.21
3.28
2.50
2.47
1.25
2.95
$
As of December 31, 2013, there was $342,000 of total unrecognized compensation cost related to
nonvested restricted awards granted under the Plan. The cost is expected to be recognized over a
weighted-average period of 2.22 years. There were 241,920 and 144,976 shares that vested during the
years ended December 31, 2013, and 2012, respectively.
105
Note 13: Earnings (Loss) per Share
Basic earnings (loss) per share:
Weighted-average common shares outstanding
Weighted-average common shares less stock based awards
Weighted-average common shares stock based awards
Net earnings (loss) from Operations
Dividends on preferred shares
Net earnings (loss) available to common stockholders
Common stock dividends
Un-vested share-based payment awards
Undistributed earnings (loss)
Basic earnings (loss) per share common undistributed earnings (loss)
Basic earnings (loss) per share of common stock
2013
2012
$
$
13,939,919
13,896,893
209,140
82,085
5,258
76,827
-
-
76,827
5.45
5.45
14,074,188
13,876,129
331,123
(72)
4,987
(5,059)
-
-
(5,059)
(0.36)
(0.36)
$
$
Weighted-average common shares outstanding
Dilutive effect of nonvested restricted awards
Diluted average common shares outstanding
Net earnings (loss) available to common stockholders
13,939,919
166,114
14,106,033
76,827
$
14,074,188
133,064
14,207,252
(5,059)
$
Diluted earnings (loss) per share
$
5.45
$
(0.36)
Number of antidilutive options excluded
from the diluted earnings (loss) per share calculation
1,140,839
1,224,839
The above earnings (loss) per share calculation did not include 815,339 in a common stock warrant that
was outstanding as of December 31, 2013 and 2012.
Note 14: Commitments
In the normal course of business, there are outstanding commitments that are not reflected in the financial
statements. Commitments include financial instruments that involve, to varying degrees, elements of
credit, interest rate, and liquidity risk. In management's opinion, these do not represent unusual risks and
management does not anticipate significant losses as a result of these transactions. The Company uses the
same credit policies in making commitments and conditional obligations for borrowers as it does for on-
balance sheet instruments.
106
The following table is a summary of financial instrument commitments (in thousands):
Letters of credit:
Borrower:
Financial standby
Commercial standby
Performance standby
Nonborrower:
Performance standby
Total letters of credit
December 31, 2013
Variable
Fixed
Total
Fixed
December 31, 2012
Variable
Total
$
10
-
1,580
1,590
$
3,886
51
2,723
6,660
$
3,896
51
4,303
8,250
5
$
-
1,630
1,635
$
3,378
51
4,217
7,646
$
3,383
51
5,847
9,281
-
-
1,590
$
867
867
7,527
$
867
867
9,117
$
240
240
1,875
$
1,125
1,125
8,771
$
1,365
1,365
10,646
$
Unused loan commitments:
$
60,681
$
185,581
$
246,262
$
58,330
$
195,290
$
253,620
The Bank occupies facilities under long-term operating leases, some of which include provisions for future
rent increases. In addition, the Company leases space at sites that house ATM's. As of December 31, 2013,
the estimated aggregate minimum annual rental commitments under these leases totaled $129,000 in 2014,
$112,000 in 2015, $67,000 in 2016, and $9,000 in 2017 and each year thereafter. The Company also
receives rental income on certain leased properties. As of December 31, 2013, aggregate future minimum
rental income to be received under noncancelable leases totaled $291,000. Total facility net operating lease
revenue/expense recorded under all operating leases was $64,000 of revenue in 2013, and $50,000 of
revenue in 2012. Total ATM lease expense, including the costs related to servicing those ATM's, was
$830,000 in 2013 and $941,000 in 2012.
Legal proceedings
The Company and its subsidiaries, from time to time, pursue collection suits and other actions that arise in
the ordinary course of business against their borrowers 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 based on all known
information at this time.
Note 15: Regulatory & Capital Matters
On May 16, 2011, the Bank, a wholly-owned subsidiary of the Company, entered into a Stipulation and
Consent to the Issuance of a Consent Order (the “Consent Order”) with the Office of the Comptroller of
the Currency (“OCC”). Pursuant to the Consent Order, the Bank took certain actions and operated in
compliance with the Consent Order’s provisions during its terms. On October 17, 2013, the OCC
terminated the Consent Order.
Even though the Consent Order has been terminated, the Bank is still subject to the risk-based capital
regulatory guidelines, which include the methodology for calculating the risk-weighting of the Bank’s
assets, developed by the OCC and the other bank regulatory agencies. In connection with the current
economic environment, the Bank’s current level of nonperforming assets and the risk-based capital
guidelines, the Bank’s board of directors has determined that the Bank should maintain a Tier 1 leverage
107
capital ratio at or above eight percent (8%) and a total risk-based capital ratio at or above twelve percent
(12%). The Bank currently exceeds those thresholds.
The Bank exceeded both board of directors’ capital ratio objectives. At December 31, 2013, the Bank’s
Tier 1 capital leverage ratio was 10.97%, up 130 basis points from December 31, 2012, and 297 basis
points above the 8.00% objective. The Bank’s total capital ratio was 18.04%, up 318 basis points from
December 31, 2012, and 604 basis points above the objective of 12.00%.
On July 22, 2011, the Company entered into a Written Agreement with the Reserve Bank designed to
maintain the financial soundness of the Company. Pursuant to the Written Agreement, the Company took
certain actions and operated in compliance with the Written Agreement’s provisions during its term. On
January 17, 2014, the Reserve Bank terminated the Written Agreement.
Under the terms of the now terminated Written Agreement, the Company was required to, among other
things: (i) serve as a source of strength to the Bank, including ensuring that the Bank complies with the
Consent Order it entered into with the OCC on May 16, 2011; (ii) refrain from declaring or paying any
dividend, or taking dividends or other payments representing a reduction in the Bank’s capital, each
without the prior written consent of the Federal Reserve and the Director of the Division of Banking
Supervision and Regulation of the Federal Reserve (the “Director”); (iii) refrain, along with its nonbank
subsidiaries, from making any distributions on subordinated debentures or trust preferred securities
without the prior written consent of the Federal Reserve and the Director; (iv) refrain, along with its
nonbank subsidiaries, from incurring, increasing or guaranteeing any debt, and from purchasing or
redeeming any shares of its capital stock, each without the prior written consent of the Federal Reserve;
(v) provide the Federal Reserve with a written plan to maintain sufficient capital at the Company on a
consolidated basis; (vi) provide the Federal Reserve with a projection of the Company’s planned sources
and uses of cash; (vii) comply with certain regulatory notice provisions pertaining to the appointment of
any new director or senior executive officer, or the changing of responsibilities of any senior executive
officer; and (viii) comply with certain regulatory restrictions on indemnification and severance payments.
The Company was required to submit and has submitted certain reports to the Federal Reserve with
respect to the foregoing requirements. Although the Written Agreement has been terminated, the
Company expects that it will continue to seek approval from the Reserve Bank prior to paying any
dividends on its capital stock and incurring any additional indebtedness.
Bank holding companies are required to maintain minimum levels of capital in accordance with Federal
Reserve Capital guidelines. The general bank and holding company capital adequacy guidelines are
described in the accompanying table, as are the capital ratios of the Company and the Bank, as of
December 31, 2013, and December 31, 2012. These ratios are calculated on a consistent basis with the
ratios disclosed in the most recent filings with the regulatory agencies.
At December 31, 2013, the Company, on a consolidated basis, exceeded the minimum thresholds to be
considered “adequately capitalized” under regulatory defined capital ratios and exceeded the heightened
capital requirements set forth in the now terminated Consent Order. The Company and the Bank are
subject to regulatory capital requirements administered by federal banking agencies.
108
Capital levels and industry defined regulatory minimum required levels:
2013
Total capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to average assets
Consolidated
Old Second Bank
2012
Total capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to average assets
Consolidated
Old Second Bank
Actual
at year-end
Amount
Ratio
Minimum Required
for Capital
Adequacy Purposes
Amount
Ratio
Minimum Required
to be Well
Capitalized 1
Amount
Ratio
$
200,139
227,467
15.88%
18.04
$
100,826
100,872
8.00%
8.00
N/A
126,090
$
N/A
10.00
134,199
211,568
10.65
16.78
134,199
211,568
6.96
10.97
50,403
50,433
77,126
77,144
4.00
4.00
4.00
4.00
N/A
75,650
N/A
96,430
N/A
6.00
N/A
5.00
$
189,465
206,496
13.62%
14.86
$
111,286
111,169
8.00%
8.00
N/A
138,961
$
N/A
10.00
94,816
188,873
6.81
13.59
94,816
188,873
4.85
9.67
55,692
55,592
78,199
78,127
4.00
4.00
4.00
4.00
N/A
83,388
N/A
97,659
N/A
6.00
N/A
5.00
1 The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized”.
The Company’s credit facility with Bank of America includes $45.0 million in subordinated debt. That
debt obligation continues to qualify as Tier 2 regulatory capital. In addition, the trust preferred securities
continue to qualify as Tier 1 regulatory capital, and the Company treats the maximum amount of this
security type allowable under regulatory guidelines as Tier 1 capital. As of December 31, 2013, trust
preferred proceeds of $51.6 million qualified as Tier 1 regulatory capital and $5.0 million qualified as
Tier 2 regulatory capital. As of December 31, 2012, trust preferred proceeds of $24.6 million qualified as
Tier 1 regulatory capital and $32.0 million qualified as Tier 2 regulatory capital. All of the Series B
Preferred Stock qualified as Tier 1 regulatory capital as of December 31, 2013 and 2012.
Dividend Restrictions and Deferrals: In addition to the above requirements, banking regulations and
capital guidelines generally limit the amount of dividends that may be paid by a bank without prior
regulatory approval. Under these regulations, the amount of dividends that may be paid in any calendar
year is limited to the current year’s profits, combined with the retained profit of the previous two years,
subject to the capital requirements described above.
As discussed in Notes 1 and 10, as of December 31, 2013, the Company had $58.4 million of junior
subordinated debentures held by two statutory business trusts that it controls. The Company has the right
to defer interest payments, which were approximately $5.3 million in the year ended December 31, 2013,
on the debentures for a period of up to 20 consecutive quarters, and elected to begin such a deferral period
in August 2010. However, all deferred interest must be paid before the Company may pay dividends on
its capital stock. Therefore, the Company will not be able to pay dividends on its common stock until all
deferred interest on these debentures has been paid in full. The total amount of such deferred and unpaid
109
interest as of December 31, 2013, was $17.0 million.
Furthermore, as with the debentures discussed above, the Company is prohibited from paying dividends
on its common stock unless it has fully paid all accrued and unpaid dividends on its Series B Preferred
Stock. In August 2010, the Company also announced the deferral of dividends on such preferred stock.
Therefore, in addition to paying all the accumulated and unpaid distributions on the debentures set forth
above, the Company must also fully pay all accrued and unpaid dividends on the Series B Preferred Stock
before it may reinstate the payment of dividends on the common stock. The total amount of such deferred
and unpaid Series B Preferred Stock dividends as of December 31, 2013, was $13.3 million.
Further detail on the subordinated debentures, the Series B Preferred Stock and the deferral of interest and
dividends thereon is described in Notes 10 and 20 of this report.
Note 16: Mortgage Banking Derivatives
Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and
forward commitments for the future delivery of mortgage loans to third party investors are considered
derivatives. It is the Company’s practice to sell mortgage-backed securities (“MBS”) contracts for the
future delivery to economically hedge the effect of changes in interest rates resulting from its
commitments to fund the loans. These contracts are also derivatives and collectively with the forward
commitments for the future delivery of mortgage loans are considered forward contracts. These mortgage
banking derivatives are not designated in hedge relationships using the accepted accounting for derivative
instruments and hedging activities at December 31 (dollars in thousands).
Forward contracts:
Notional amount
Fair value
Change in fair value
Rate lock commitments:
Notional amount
Fair value
Change in fair value
2013
2012
$
11,500
178
126
$
28,000
1,393
(85)
$
9,178
504
189
$
20,855
1,488
652
Fair values were estimated based on changes in mortgage interest rates from the date of the
commitments. Changes in the fair values of these mortgage banking derivatives are included in net gains
on sales of loans. The Company sold $185.4 million in loans to investors receiving proceeds of $191.0
million and resulting in a gain on sale of $5.6 million for the year ended December 31, 2013. Sales to
investors included $126.3 million or 68.2% to Federal National Mortgage Association, $29.3 million, or
15.8% to Wells Fargo and $18.9 million or 10.2% to Federal Home Loan Mortgage Corporation for the
year ended December 31, 2013. No other individual investor was sold more than 10% of the total loans
sold.
Periodic changes in value of both forward MBS contracts and rate lock commitments are reported in
current period earnings as net gain on sale of mortgage loans. Net gain recognized in earnings for the
years ended December 31, 2013, and 2012 were $315,000 and $567,000, respectively.
Note 17: 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
110
transaction between market participants on the measurement date. The fair value hierarchy established by
the Company also requires an entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair
value are:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the
Company has the ability to access as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar
assets or liabilities, quoted prices in markets that are not active, and other inputs that are
observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own view about the
assumptions that market participants would use in pricing an asset or liability.
Transfers between levels are deemed to have occurred at the end of the reporting period. For the
years ended December 31, 2013, and 2012 there were no significant transfers between levels.
Except for certain CDOs sold by the Company in December 2013 and auction rate asset-backed
securities, all securities (available-for-sale and held-to-maturity) 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:
(cid:120) Government-sponsored agency debt securities are primarily priced using available market
information through processes such as benchmark curves, market valuations of like securities,
sector groupings and matrix pricing.
(cid:120) Other government-sponsored agency securities, MBS, real estate mortgage investment conduits
and collateralized mortgage obligations and non auction rate asset-backed securities are priced
using available market information including benchmark yields, prepayment speeds, spreads,
volatility of similar securities and trade date.
(cid:120) 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,
(cid:120) Prior to their sale in December 2013, certain CDOs held by the Company were collateralized by
trust preferred security issuances of other financial institutions. These CDOs were valued
utilizing a discounted cash flow analysis. To reflect an appropriate fair value measurement,
management included a risk premium adjustment to provide an estimate of the amount that a
market participant would demand because of uncertainty in cash flows in the discounted cash
flow analysis. Changes in unobservable inputs such as future cash flows, prepayment speeds and
market rates may result in a significantly higher or lower fair value measurement. Due to the
significant amount of unobservable inputs for the security and limited market activity, these
securities were considered Level 3 valuations.
(cid:120) During 2013, asset-backed auction rate securities were acquired and priced using data from dealer
market participants until December 31, 2013. At December 31, 2013, the Company utilized
pricing data from a nationally recognized valuation firm providing specialized securities
valuation services. Therefore, the valuation of auction rate asset-backed securities are considered
Level 3 valuations
111
(cid:120) Residential mortgage loans eligible for sale in the secondary market are carried at fair market
value. The fair value of loans held-for-sale is determined using quoted secondary market prices.
(cid:120) Lending related commitments to fund certain residential mortgage loans, e.g. residential mortgage
loans with locked in 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.
(cid:120) 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.
(cid:120)
(cid:120) Both the credit valuation reserve on current interest rate swap positions and on receivables related
to unwound customer interest rate swap positions were determined based upon management’s
estimate of the amount of credit risk exposure, including by available collateral protection and/or
by utilizing an estimate related to a probability of default as indicated in the Bank credit policy.
Such adjustments would result in a Level 3 classification.
(cid:120) The fair value of impaired loans with specific allocations of the allowance for loan losses is
essentially based on recent real estate appraisals. These appraisals may utilize a single valuation
approach or a combination of approaches including comparable sales and the income approach.
Adjustments are 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.
(cid:120) Nonrecurring adjustments to certain commercial and residential real estate properties classified as
OREO are measured at the lower of carrying amount or fair value, less costs to sell. Fair values
are based on third party appraisals of the property, resulting in a Level 3 classification. In cases
where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is
recognized.
112
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The tables below present the balance of assets and liabilities at December 31, 2013, and December 31,
2012, respectively, which are measured by the Company at fair value on a recurring basis:
Assets:
Investment securities available-for-sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Loans held-for-sale
Mortgage servicing rights
Other assets (Interest rate swap agreements
net of swap credit valuation)
Other assets (Mortgage banking derivatives)
Total
Liabilities:
Other liabilities (Interest rate swap agreements)
Total
Assets:
Investment securities available-for-sale
U.S. Treasury
U.S. government agencies
U.S. government agency mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized debt obligations
Loans held-for-sale
Mortgage servicing rights
Other assets (Interest rate swap agreements
net of swap credit valuation)
Other assets (Mortgage banking derivatives)
Total
Level 1
Level 2
Level 3
Total
December 31, 2013
$
1,544
-
-
-
-
-
-
$
-
1,672
16,669
15,102
63,876
119,066
3,822
-
-
$
-
125
-
-
154,137
-
5,807
$
1,544
1,672
16,794
15,102
63,876
273,203
3,822
5,807
-
-
1,544
$
229
315
220,751
$
(6)
-
160,063
$
223
315
382,358
$
-
$
$
-
$
$
229
229
$
-
$
-
$
$
229
229
Level 1
Level 2
Level 3
Total
December 31, 2012
$
1,507
-
-
-
-
-
-
-
-
$
-
49,850
128,738
15,723
36,886
169,600
167,493
-
9,571
-
-
$
-
-
132
-
-
-
9,957
-
4,116
$
1,507
49,850
128,738
15,855
36,886
169,600
167,493
9,957
9,571
4,116
-
-
1,507
$
1,349
567
579,777
$
(47)
-
14,158
$
1,302
567
595,442
$
$
$
1,349
5
1,354
-
$
-
$
-
$
$
1,349
5
1,354
Liabilities:
Other liabilities (Interest rate swap agreements)
Other liabilities (Interest rate lock commitments to borrowers)
Total
-
$
-
$
-
113
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis using significant
unobservable inputs are summarized as follows:
Beginning balance January 1, 2013
Transfers into Level 3
Transfers out of Level 3
Total gains or losses
Included in earnings (or changes in net assets)
Included in other comprehensive income
Purchases, issuances, sales, and settlements
Purchases
Issuances
Settlements
Sales
Ending balance December 31, 2013
Year Ended December 31, 2013
Investment securities available-for- sale
Collateralized
Debt
Obligations
9,957
$
-
-
Asset-backed
-
$
-
-
States and
Political
Subdivisons
132
$
-
-
Mortgage
Servicing
Rights
$
4,116
-
-
Rate
Swap
Valuation
(47)
$
-
-
(3,903)
7,984
808
1,414
-
-
260
-
41
-
-
-
(1,016)
(13,022)
$
-
172,454
-
-
(20,539)
154,137
$
-
-
(7)
-
125
$
-
1,431
-
-
5,807
$
-
-
-
-
(6)
$
Year Ended December 31, 2012
Investment securities
available-for-sale
Collateralized
Debt
Obligations
9,974
$
-
-
States and
Political
Subdivisons
$
138
-
-
Mortgage
Servicing
Rights
Interest Rate
Swap
Valuation
$
3,487
-
-
$
(80)
-
-
172
(66)
-
-
(1,575)
-
33
-
-
-
(123)
-
9,957
$
-
-
(6)
-
132
$
-
2,204
-
-
4,116
$
-
-
-
-
(47)
$
Beginning balance January 1, 2012
Transfers into Level 3
Transfers out of Level 3
Total gains or losses
Included in earnings (or changes in net assets)
Included in other comprehensive income
Purchases, issuances, sales, and settlements
Purchases
Issuances
Settlements
Sales
Ending balance December 31, 2012
The following table and commentary presents quantitative (dollars in thousands) and qualitative
information about Level 3 fair value measurements as of December 31, 2013:
Measured at fair value
on a recurring basis:
Mortgage Servicing rights
Fair Value Valuation Methodology
Discounted Cash Flow
$
5,807
Unobservable Inputs
Discount Rate
Prepayment Speed
Range of Input
10.2%
9.7%
Weighted
Average
of Inputs
10.2%
9.7%
Interest Rate Swap Valuation
(6)
Management estimate
of credit risk exposure
Probability of Default
5%-20%
12.5%
Asset-backed securities
154,137
Discounted Cash Flow
with comparable
transaction yields
Credit Risk Premium
Liquidity Discount
1.1%-1.5%
4.5%-5.1%
1.2%
4.9%
114
The following table and commentary presents quantitative (dollars in thousands) and qualitative
information about Level 3 fair value measurements as of December 31, 2012:
Measured at fair value
on a recurring basis:
Collateralized Debt Obligations
Fair Value Valuation Methodology
Discounted Cash Flow
$
9,957
Unobservable
Inputs
Discount Rate
Prepayment %
Default range
Range of Input
Libor + 6%-7%
0%-76%
3.1%-100%
Mortgage Servicing rights
4,116
Discounted Cash Flow
Discount Rate
Prepayment Speed
Interest Rate Swap Valuation
(47)
Management estimate
of credit risk exposure
Probability of
Default
10.5%
15.8%
2%-31%
Weighted
Average
of Inputs
6.4%
16.4%
19.1%
10.5%
15.8%
17.9%
The $125,000 on the State and political subdivisions line at December 31, 2013, represents a security
from a small, local municipality. This is categorized as a Level 3 security based on the payment stream
received by the Company from the municipality. That payment stream is otherwise an unobservable
input.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:
The Company may be required, from time to time, to measure certain other assets at fair value on a
nonrecurring basis in accordance with GAAP. These assets consist of, impaired loans and OREO. For
assets measured at fair value on a nonrecurring basis on hand at December 31, 2013, and December 31,
2012, respectively, the following tables provide the level of valuation assumptions used to determine each
valuation and the carrying value of the related assets:
Impaired loans1
Other real estate owned, net2
Total
Level 1
December 31, 2013
Level 3
Level 2
Total
$
-
$
-
$
9,103
$
9,103
-
$
-
-
$
-
41,537
50,640
$
41,537
50,640
$
1 Represents carrying value and related write-downs of loans for which adjustments are substantially
based on the appraised value of collateral for collateral-dependent loans, had a carrying amount of $11.5
million, with a valuation allowance of $2.4 million, resulting in a decrease of specific allocations within
the provision for loan losses of $3.9 million for the year ending December 31, 2013. The carrying value
of loans fully charged-off is zero.
2 OREO is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of
$41.5 million, which is made up of the outstanding balance of $65.9 million, net of a valuation allowance
of $22.3 million and participations of $2.1 million, at December 31, 2013, resulting in a charge to expense
of $8.3 million for the year ended December 31, 2013.
The Company also has assets that under certain conditions are subject to measurement at fair value on a
nonrecurring basis. These assets include OREO and impaired loans. The Company has estimated the fair
values of these assets based primarily on Level 3 inputs. OREO and impaired loans are generally valued
using the fair value of collateral provided by third party appraisals. These valuations include assumptions
related to cash flow projections, discount rates, and recent comparable sales. The numerical range of
unobservable inputs for these valuation assumptions are not meaningful.
115
Impaired loans1
Other real estate owned, net2
Total
Level 1
December 31, 2012
Level 3
Level 2
Total
$
-
$
-
$
21,543
$
21,543
-
$
-
-
$
-
72,423
93,966
$
72,423
93,966
$
1 Represents carrying value and related write-downs of loans for which adjustments are substantially
based on the appraised value of collateral for collateral-dependent loans, had a carrying amount of $27.8
million, with a valuation allowance of $6.3 million, resulting in a decrease of specific allocations within
the provision for loan losses of $6.8 million for the year ending December 31, 2012. The carrying value
of loans fully charged-off is zero.
2 OREO is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of
$72.4 million, which is made up of the outstanding balance of $109.7 million, net of a valuation
allowance of $31.4 million and participations of $5.9 million, at December 31, 2012, resulting in a charge
to expense of $16.4 million for the year ended December 31, 2012.
Note 18: Financial Instruments with Off-Balance Sheet Risk and Derivative Transactions
To meet the financing needs of its customers, the Bank, as a subsidiary of the Company, is a party to
various financial instruments with off-balance-sheet risk in the normal course of business. These off-
balance-sheet financial instruments include commitments to originate and sell loans as well as financial
standby, performance standby and commercial letters of credit. The instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated
balance sheet. The Bank’s exposure to credit loss in the event of nonperformance by the other party to
the financial instruments for loan commitments and letters of credit are represented by the dollar amount
of those instruments. Management generally uses the same credit policies and collateral requirements in
making commitments and conditional obligations as it does for on-balance-sheet instruments.
Interest Rate Swaps
The Company also has interest rate derivative positions to assist with risk management that are not
designated as hedging instruments. These derivative positions relate to transactions in which the Bank
enters into an interest rate swap with a client while at the same time entering into an offsetting interest
rate swap with another financial institution. Due to financial covenant violations relating to
nonperforming assets, the Bank had $3.1 million in investment securities pledged to support interest rate
swap activity with three correspondent financial institutions at December 31, 2013. The Bank had $7.4
million in investment securities pledged to support interest rate swap activity with a correspondent
financial institution at December 31, 2012. In connection with each transaction, the Bank agreed to pay
interest to the client on a notional amount at a variable interest rate and receive interest from the client on
the same notional amount at a fixed interest rate. At the same time, the Bank agreed to pay another
financial institution the same fixed interest rate on the same notional amount and receive the same
variable interest rate on the same notional amount. The transaction allows the client to effectively convert
a variable rate loan to a fixed rate loan and is also part of the Company’s interest rate risk management
strategy. Because the Bank acts as an intermediary for the client, changes in the fair value of the
underlying derivative contracts offset each other and do not generally impact the results of operations.
Fair value measurements include an assessment of credit risk related to the client’s ability to perform on
their contract position, however, and valuation estimates related to that exposure are discussed in Note 17
above. At December 31, 2013, the notional amount of nonhedging interest rate swaps was $51.9 million
with a weighted average maturity of 1.5 years. At December 31, 2012, the notional amount of
nonhedging interest rate swaps was $82.1 million with a weighted average maturity of 1.3 years. The
116
Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.
The Bank also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan
underwriting standards. The interest rate risk associated with these loan interest rate lock commitments is
managed by entering into contracts for future deliveries of loans as well as selling forward mortgage-
backed securities contracts. Loan interest rate lock commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. Commitments to originate residential mortgage loans held-for-sale and forward
commitments to sell residential mortgage loans or forward MBS contracts are considered derivative
instruments and changes in the fair value are recorded to mortgage banking income. Fair values are
estimated based on observable changes in mortgage interest rates including mortgage-backed securities
prices from the date of the commitment.
The following table presents derivatives not designated as hedging instruments as of December 31, 2013,
and periodic changes in the values of the interest rate swaps and the risk participation agreement contract
are reported in other noninterest income. Periodic changes in the value of the forward contracts related to
mortgage loan origination are reported in the net gain on sales of mortgage loans.
Asset Derivatives
Liability Derivatives
Notional or
Contractual
Amount
Balance Sheet
Location
Fair Value
Balance Sheet
Location
Fair Value
Interest rate swap contracts net of
credit valuation
Commitments1
Forward contracts2
Total
$
51,877
Other Assets
$
223
Other Liabilities
$
229
206,965
Other Assets
315
N/A
11,500
N/A
-
Other Liabilities
-
-
$
538
$
229
1Includes unused loan commitments and interest rate lock commitments.
2Includes forward MBS contracts.
The following table presents derivatives not designated as hedging instruments as of December 31, 2012.
Asset Derivatives
Liability Derivatives
Notional or
Contractual
Amount
Balance Sheet
Location
Fair Value
Balance Sheet
Location
Fair Value
Interest rate swap contracts net of
credit valuation
Commitments1
Forward contracts2
Total
$
82,097
Other Assets
$
1,302
Other Liabilities
$
1,349
226,135
Other Assets
567
N/A
28,000
N/A
-
Other Liabilities
-
5
$
1,869
$
1,354
1Includes unused loan commitments, interest rate lock commitments, and forward rate lock.
2Includes forward mortgage backed securities and forward loan contracts.
117
Note 19: Fair Values of Financial Instruments
The estimated fair values of financial instruments approximate carrying amount for all items except those
described in the following table. Investment security fair values are based upon market prices or dealer
quotes, and if no such information is available, on the rate and term of the security. The fair value of the
CDOs included in investment securities, as of December 31, 2012, and subsequently sold in December
2013, includes a risk premium adjustment to provide an estimate of the amount that a market participant
would demand because of uncertainty in cash flows and the methods for determining fair value of securities
as discussed in detail in Note 17. 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. During the year
ended December 31, 2013, and 2012, we participated in multiple redemptions with the FHLBC and using
the redemption values as the carrying value, FHLBC stock has been transferred to a Level 2 fair value as of
December 31, 2012. Fair values of loans were estimated for portfolios of loans with similar financial
characteristics, such as type and fixed or variable interest rate terms. Cash flows were discounted using
current rates at which similar loans would be made to borrowers with similar ratings and for similar
maturities. The fair value of time deposits is estimated using discounted future cash flows at current rates
offered for deposits of similar remaining maturities. The fair values of borrowings were estimated based on
interest rates available to the Company for debt with similar terms and remaining maturities. The fair value
of off-balance sheet items is not considered material. The fair value of mortgage banking derivatives is
discussed above in Note 16.
The carrying amount and estimated fair values of financial instruments were as follows:
Financial assets:
Cash and due from banks
Interest bearing deposits with financial institutions
Securities available-for-sale
Securities held-to-maturity
FHLBC and FRB Stock
Bank-owned life insurance
Loans held for sale
Loans, net
Accrued interest receivable
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debenture
Note payable and other borrowings
Borrowing interest payable
Deposit interest payable
December 31, 2013
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
$
33,210
14,450
372,191
256,571
10,292
55,410
3,822
1,073,975
4,248
$
373,389
1,308,739
22,560
5,000
58,378
45,000
500
17,037
762
$
33,210
14,450
372,191
254,328
10,292
55,410
3,822
1,072,837
4,248
$
373,389
1,312,476
22,560
5,000
67,053
39,896
423
17,037
762
$
33,210
14,450
1,544
-
-
-
-
-
$
373,389
-
-
-
39,777
-
-
10,122
-
-
$
-
216,385
254,328
10,292
55,410
3,822
-
4,248
-
$
1,312,476
22,560
5,000
27,276
39,896
423
6,915
762
-
$
-
154,262
-
-
-
1,072,837
-
-
$
-
-
-
-
-
-
-
118
December 31, 2012
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
$
44,221
84,286
579,886
11,202
54,203
9,571
1,111,453
5,252
$
379,451
1,337,768
17,875
100,000
58,378
45,000
500
11,740
1,006
$
44,221
84,286
579,886
11,202
54,203
9,571
1,118,711
5,252
$
379,451
1,347,603
17,875
100,000
38,308
28,206
302
11,740
1,006
$
44,221
84,286
1,507
-
-
-
-
-
$
379,451
-
-
-
22,725
-
-
6,946
-
-
$
-
568,290
11,202
54,203
9,571
-
5,252
-
$
1,347,603
17,875
100,000
15,583
28,206
302
4,794
1,006
-
$
-
10,089
-
-
-
1,118,711
-
-
$
-
-
-
-
-
-
-
Financial assets:
Cash and due from banks
Interest bearing deposits with financial institutions
Securities available-for-sale
FHLBC and FRB Stock
Bank-owned life insurance
Loans held for sale
Loans, net
Accrued interest receivable
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debenture
Note payable and other borrowings
Borrowing interest payable
Deposit interest payable
Note 20: Preferred Stock
The Series B Preferred Stock was issued to Treasury as part of the Treasury’s Troubled Asset Relief
Program and Capital Purchase Program (the “CPP”). The Series B Preferred Stock qualifies as Tier 1
capital and pays cumulative dividends on the liquidation preference amount on a quarterly basis at a rate
of 5% per annum for the first five years, and 9% per annum thereafter effective in February 2014.
Concurrent with issuing the Series B Preferred Stock, the Company issued to the Treasury a ten year
warrant to purchase 815,339 shares of the Company's common stock at an exercise price of $13.43 per
share.
The Company allocated the $73 million in proceeds received from the Treasury in the first quarter of
2009 between the Series B Preferred Stock and the warrant that was issued. The warrant was classified as
equity, and the allocation was based on their relative fair values in accordance with accounting guidance.
The fair value was determined for both the Series B Preferred Stock and the warrant as part of the
allocation process in the amounts of $68.2 million and $4.8 million, respectively.
As discussed in Note 15, on August 31, 2010, the Company announced that it would begin deferring
quarterly cash dividends on its outstanding Series B Preferred Stock. Further, as discussed in Note 10 and
Note 15, the Company has elected to defer interest payments on certain of its subordinated debentures.
However, if the Company fails to pay dividends for an aggregate of six quarters on the Series B Preferred
Stock, whether or not consecutive, the holders have the right to appoint representatives to the Company’s
board of directors. As the Company elected to defer dividends for more than six quarters, a new director
was appointed by the Treasury to join the board during the fourth quarter of 2012. The terms of the
Series B Preferred Stock also prevent the Company from paying cash dividends or generally repurchasing
its common stock while Series B Preferred Stock dividends are in arrears. The total amount of unpaid
and deferred Series B Preferred Stock dividends as of December 31, 2013, was $13.3 million.
All of the Series B Preferred Stock held by Treasury was sold to third parties, including certain of our
119
directors, in auctions that were completed in the first quarter of 2013. The warrant was also sold at a
subsequent auction to a third party. Upon completion by Treasury of the auction, the Company’s board
affirmed the director appointed by Treasury to ongoing board membership, and the Series B director was
elected by the holders of the Series B Preferred Stock at the Company’s 2013 annual meeting. At
December 31, 2012, the Company carried $71.9 million of Series B Preferred Stock in total stockholders’
equity. At December 31, 2013, the Company carried $72.9 million of Series B Preferred Stock in total
stockholders’ equity.
As a result of the completed auctions, the Company’s Board elected to stop accruing the dividend on the
Series B Preferred Stock in the first quarter 2013. Previously, the Company had accrued the dividend on
the Series B Preferred Stock quarterly throughout the deferral period. Given the discount reflected in the
results of the auction, the board believes that the Company will likely be able to repurchase the Series B
Preferred Stock in the future at a price less than the face amount of the Series B Preferred Stock and the
accrued and unpaid dividends. Therefore, the Company did not fully accrue the dividend on the Series B
Preferred Stock in the first quarter and did not accrue for it in subsequent quarters. The Company will
continue to evaluate whether accruing dividends on the Series B Preferred Stock is appropriate in future
periods.
Note 21: Parent Company Condensed Financial Information
Condensed Balance Sheets as of December 31 were as follows:
2013
2012
Assets
Noninterest bearing deposit with bank subsidiary
Investment in subsidiaries
Other assets
Liabilities and Stockholders' Equity
Junior subordinated debentures
Subordinated debt
Other liabilities
Stockholders' equity
$
$
$
$
$
$
2,071
258,588
18,766
279,425
58,378
45,000
28,355
147,692
279,425
3,554
192,988
1,712
198,254
58,378
45,000
22,324
72,552
198,254
$
$
120
Condensed Statements of Operations for the years ended December 31 were as follows:
Operating Income
Cash dividends received from subsidiaries
Interest income
Other income
Operating Expenses
Junior subordinated debentures interest expense
Subordinated debt interest expense
Other interest expense
Other expenses
Loss before income taxes and equity in
undistributed net income of subsidiaries
Income tax benefit
Income (loss) before equity in undistributed
net income of subsidiaries
Equity in undistributed net income of subsidiaries
Net income (loss)
Preferred stock dividends and accretion of discount
Net income (loss) available to common stockholders
2013
2012
$
-
-
772
772
$
-
-
189
189
5,298
811
16
1,006
7,131
4,925
903
17
971
6,816
(6,359)
(17,133)
(6,627)
-
10,774
71,311
82,085
5,258
76,827
$
(6,627)
6,555
(72)
4,987
(5,059)
$
Condensed Statements of Cash Flows for the years ended December 31 were as follows:
Cash Flows from Operating Activities
Net Income (loss)
Adjustments to reconcile net income (loss) to net
cash from operating activities:
Equity in undistributed net income of subsidiaries
Deferred income taxes
Change in taxes payable
Change in other assets
Gain on recapture of restricted stock
Stock-based compensation
Other, net
Net cash used in operating activities
Cash Flows from Investing Activities
Net cash provided by investing activities
Cash Flows from Financing Activities
Purchases of treasury stock
Net cash used in financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
121
2013
2012
$
82,085
$
(72)
(71,311)
(16,786)
14
(264)
(612)
167
5,502
(1,205)
(6,555)
-
2,445
(100)
-
291
3,293
(698)
-
-
(278)
(278)
(1,483)
3,554
2,071
$
(63)
(63)
(761)
4,315
3,554
$
Note 22: Stockholders’ Rights Plan
On September 12, 2012, the Company and the Bank, as rights agent, entered into the Amended and Restated
Rights Plan and Tax Benefits Preservation Plan (the “Rights Plan”). The Rights Plan amended the Rights
Agreement, dated September 17, 2002. The purpose of the Rights Plan is to protect the Company’s deferred
tax asset against an unsolicited ownership change, which could significantly limit the Company’s ability to
utilize its deferred tax assets. The Rights Plan was ratified by the Company’s stockholders at the
Company’s 2013 annual meeting. For a description of the Rights Plan, please refer to the Company’s Form
8-A, filed September 13, 2012.
Note 23: Employee Benefit Plans
Old Second Bancorp, Inc. Employees 401(k) Savings Plan and Trust
The Company sponsors a qualified, tax-exempt defined contribution plan (the “Plan”) qualifying under
section 401(k) of the Internal Revenue Code. Virtually all employees are eligible to participate after
meeting certain age and service requirements. Eligible employees are permitted to contribute up to a dollar
limit set by law of their compensation to the 401(k) plan. For the years ended December 31, 2013 and 2012,
a discretionary match equal to 100% of the first 2% of the participant’s compensation was contributed to
participants of the Plan. Participants are 100% vested in the discretionary matching contributions. The
profit sharing portion of the 401(k) plan arrangement provides an annual discretionary contribution to the
retirement account of each employee based in part on the Company’s profitability in a given year, and on
each participant’s annual compensation. Participants can choose between several different investment
options under the 401(k) plan, including shares of the Company’s common stock.
The total expense relating to the 401(k) plan was approximately $468,000 and $441,000 in 2013 and 2012,
respectively.
Old Second Bancorp, Inc. Voluntary Deferred Compensation Plan for Executives
The Company sponsors an executive deferred compensation plan, which is a means by which certain
executives may voluntarily defer a portion of their salary or bonus. This plan is an unfunded, nonqualified
deferred compensation arrangement.
this arrangement as of
December 31, 2013, and 2012 were $1.8 million and $1.5 million, respectively, and are included in other
liabilities.
Company obligations under
122
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Old Second Bancorp, Inc. and Subsidiaries
Aurora, Illinois
We have audited the accompanying consolidated balance sheets of Old Second Bancorp, Inc. and
Subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations,
comprehensive income (loss), stockholders’ equity and cash flows for the years then ended. The
Company’s management is responsible for these financial statements. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material misstatement. Our audits included
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management and evaluating the
overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of Old Second Bancorp, Inc. and Subsidiaries as of December 31, 2013 and
2012, and the results of its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), Old Second Bancorp, Inc. and Subsidiaries’ internal control over financial reporting
as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our
report dated February 26, 2014, expressed an unqualified opinion thereon.
Chicago, Illinois
February 26, 2014
123
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. 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 December 31, 2013. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of December 31,
2013, the Company’s disclosure controls and procedures are effective to ensure that information required to
be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and
forms and such information is accumulated and communicated to the issuer's management, including its
principal executive and principal financial officers as appropriate to allow timely decisions regarding
required disclosure.
There were no changes in the Company’s internal control over financial reporting during the quarter ended
December 31, 2013, that have materially affected or are reasonably likely to affect, the Company’s internal
control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control
over financial reporting, as defined in Rule 13a–15(f) under the Securities Exchange Act of 1934. The
Company’s internal control over financial reporting is a process designed under the supervision of the
Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of the Company’s financial statements for external
reporting purposes in accordance with U.S. generally accepted accounting principles.
As of December 31, 2013, management assessed the effectiveness of the Company’s internal control over
financial reporting based on the framework established in the 1992 “Internal Control - Integrated
Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on this evaluation, management has determined that the Company’s internal control over financial
reporting was effective as of December 31, 2013, based on the criteria specified.
Plante & Moran PLLC, the independent registered public accounting firm that audited the consolidated
financial statements of the Company incorporated by reference to this Annual Report on Form 10-K, has
issued an attestation report, included herein, on the Company’s internal control over financial reporting as of
December 31, 2013.
124
Report of Independent Registered Public Accounting Firm
To the Audit Committee
Old Second Bancorp, Inc. and Subsidiaries
Aurora, Illinois
We have audited Old Second Bancorp, Inc. and Subsidiaries’ internal control over financial reporting as
of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (referred
to as (“COSO”). Old Second Bancorp, Inc. and Subsidiaries’ management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying “Management’s Report on Internal Control
Over Financial Reporting.” Our responsibility is to express an opinion on Old Second Bancorp, Inc. and
Subsidiaries’ internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Old Second Bancorp, Inc. and Subsidiaries maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2013, based on criteria established in Internal
Control - Integrated Framework issued by COSO.
125
To the Audit Committee
Old Second Bancorp, Inc. and Subsidiaries
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheet of Old Second Bancorp, Inc. and Subsidiaries as of
December 31, 2013, and the related consolidated statements of operations, comprehensive income (loss),
changes in stockholders’ equity and cash flows for the year then ended, and our report dated February 26,
2014, expressed an unqualified opinion on those financial statements.
Chicago, Illinois
February 26, 2014
126
Item 9B. Other Information
None
PART III
Item 10.
Directors, Executive Officers and Corporate Governance
Directors, Executive Officers, Promoters and Control Persons
The Company’s board of directors is divided into three classes, approximately equal in number, which are
elected by the Company’s common stockholders (the “Common Stock Directors”), and one class that is
elected by the holders of the Company’s Series B Preferred Stock (the “Class B Directors”). Each of the
Company’s directors has been duly elected by the Company’s shareholders at the applicable annual meeting
of shareholders. The Common Stock Directors were elected at the 2013 annual meeting following such
directors’ nomination by the Company’s Nominating and Corporate Governance Committee, and the Class
B Director, Duane Suits, was elected to the board at the 2013 annual meeting.
Treasury, as the holder of the Series B Preferred Stock, had the right to appoint two directors to the
Company’s board following the Company’s deferral of the dividend payments on the Series B Preferred
Stock for an aggregate of six quarters and partially exercised this right in 2012 with the appointment of Mr.
Suits to the board. In November 2012, Mr. Suit’s appointment was approved by the unanimous written
consent of the board. Following Treasury’s sale of the Series B Preferred Stock at auction in the first
quarter of 2013, Mr. Suits was elected a Class B Director by the current holders of the Series B Preferred
Stock at the 2013 annual meeting. In addition to Mr. Suits, the current holders of the Series B Preferred
Stock have the right to appoint a second Class B Director. Set forth below is information concerning the
Company’s directors, including their age, year first elected or appointed as a director and business
experience during the previous five years. None of the directors serve on the boards of any other publicly
traded companies besides the Company
DIRECTORS
Common Stock Directors
Name
(Term expires 2014)
Barry Finn ......................
(Age 54)
William Kane ................
(Age 62)
John Ladowicz ...............
(Age 61)
Served as
Director Since
2004
Principal Occupation
President and Chief Executive Officer, Rush-Copley
Medical Center (2002-present), Chief Operating
Officer and Chief Financial Officer, Rush-Copley
Medical Center (1996-2002).
1999
Partner, Label Printers, Inc., a printing company.
2008
Former Chairman and Chief Executive Officer of
HeritageBanc, Inc. and Heritage Bank (1996-2008).
127
Served as
Director Since
Principal Occupation
Name
(Term expires 2015)
J. Douglas Cheatham .....
(Age 57)
2003
James Eccher ..................
(Age 48)
2006
Gerald Palmer .................
(Age 68)
James Carl Schmitz ........
(Age 65)
1998
1999
Executive Vice President and Chief Financial
Officer, Old Second Bancorp, Inc. (2007-present),
Secretary, Old Second Bancorp, Inc. (2010-present),
Sr. Vice President, Chief Financial Officer, Chief
Accounting Officer and Assistant Secretary, Old
Second Bancorp, Inc. (2003-2007).
Executive Vice President and Chief Operating
Officer, Old Second Bancorp, Inc. (2007-present),
President and Chief Executive Officer, Old Second
National Bank (2003-present), Sr. Vice President and
Branch Director, Old Second National Bank (1999-
2003), President and Chief Executive Officer of
Bank of Sugar Grove (1995-1999).
Retired Vice President/General Manager, Caterpillar,
Inc., a construction equipment manufacturer.
Tax Consultant (1999-present), Director of Taxes with
H. B. Fuller Company (1998), tax specialist with
KPMG LLP (1999).
Name
(Term Expires 2016)
Edward Bonifas ..............
(Age 54)
William Meyer ..............
(Age 66)
William B. Skoglund .....
(Age 63)
Served as
Director Since
Principal Occupation
2000
1995
1992
Vice President, Alarm Detection Systems, Inc.,
producer and installer of alarm systems, closed circuit
video systems and card access control systems.
President, William F. Meyer Co., a wholesale
plumbing supply company.
Chairman and Chief Executive Officer of Old Second
Bancorp, Inc. and Chairman of Old Second National
Bank.
128
Class B Directors
Name
(term expires 2014)
Duane Suits ....................
(Age 64)
Served as
Director Since
2012
Principal Occupation
Retired Partner, Sikich LLC, financial service
firm, and Independent Financial Services Provider
(2004-present)
All Common Stock Directors will hold office for the terms indicated, or until their earlier death,
resignation, removal or disqualification and until their respective successors are duly elected and
qualified. The Class B Director will hold office for a one-year term, until his earlier death, resignation,
removal or disqualification and until his respective successor is duly elected and qualified. The Class B
Directorship will terminate if the Company either pays all accumulated but unpaid interest on, or redeems
in full, the Series B Preferred Stock.
There are no arrangements or understandings between any of the nominees, directors or executive officers
and any other person pursuant to which any of the Company’s nominees, directors or executive officers
have been selected for their respective positions. No nominee, member of the board of directors or
executive officer is related to any other nominee, member of the board of directors or executive officer.
Director Qualifications
The Company has established minimum criteria that the Company believes each director should possess
to be an effective member of the Company’s board. The particular experience, qualifications, attributes
or skills that led the board to conclude that each member is qualified to serve on the board and any
committee he or she serves on is as follows:
Mr. Bonifas: The Company considers Mr. Bonifas to be qualified for service on the board, the Audit
Committee and the Compensation Committee due to his skills and expertise acquired as a leader of a
successful business and his prominence in the community.
Mr. Cheatham: The Company considers Mr. Cheatham to be qualified for service on the board due to
his experience in the financial services industry and the familiarity with Old Second’s operations he has
acquired as Chief Financial Officer of the Company.
Mr. Eccher: The Company considers Mr. Eccher to be qualified for service on the board due to his
experience in the financial services industry and the familiarity with the Company’s operations he has
acquired as the Chief Operating Officer of the Company and President of the Bank.
Mr. Finn: The Company considers Mr. Finn to be qualified for service on the board and the Nominating
and Corporate Governance Committee and the Audit Committee due to his business and financial
expertise acquired as an executive at a successful local medical center, as well as his prominence in the
community.
Mr. Kane: The Company considers Mr. Kane to be qualified for service on the board and the
Compensation Committee due to his experience as a partner at a successful local business, his general
experience in business and his prominence in the community.
Mr. Ladowicz: The Company considers Mr. Ladowicz to be qualified for service on the board, the Audit
Committee and the Nominating and Corporate Governance Committee due to his previous experience as a
129
chief executive officer in the financial services industry, as well as his extensive knowledge of the market
areas the Company entered through the acquisition of HeritageBanc, Inc. in 2008.
Mr. Meyer: The Company considers Mr. Meyer to be qualified for service on the board, the
Compensation Committee and the Nominating and Corporate Governance Committee due to his skills
and expertise acquired as president of a well-established local business and his prominence in the local
business community.
Mr. Palmer: The Company considers Mr. Palmer to be qualified for service on the board, the
Compensation Committee and the Nominating and Corporate Governance Committee due to his skills
and expertise acquired as vice president of a successful publicly traded company, his experience in the
industrial manufacturing industry and his knowledge of the business community in the markets the
Company serves.
Mr. Schmitz: The Company considers Mr. Schmitz to be qualified for service on the board and the Audit
Committee due to his skills and expertise in tax consulting and his familiarity with the Company’s local
market areas.
Mr. Skoglund: The Company considers Mr. Skoglund to be qualified for service on the board due to his
skills and experience in the financial services industry and the intimate familiarity with the Company’s
operations he has acquired as the Chief Executive Officer of the Company.
Mr. Suits: Pursuant to the terms of the Company’s outstanding Series B Preferred Stock, Treasury
appointed Mr. Suits to the Company’s board as a Class B Director in 2012. Mr. Suits’ appointment was
approved by the unanimous written consent of the board on November 20, 2012. Mr. Suits was also
appointed to the Audit Committee. Following Treasury’s sale of the Series B Preferred Stock at auction,
Mr. Suits was elected by the holders of the Series B Preferred Stock at the 2013 annual meeting.
Although holders of the Company’s common stock are not entitled to vote for the election of Mr. Suits to
the Company’s board of directors, the Company considers Mr. Suits to be qualified for service due to his
skills and experience in the financial services industry and his familiarity with the Company’s operations.
Security 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires that the Company’s directors, executive officers and ten
percent stockholders file reports of ownership and changes in ownership with the Securities and Exchange
Commission. Such persons are also required to furnish us with copies of all Section 16(a) forms they file.
No person failed to comply with the filing requirements of Section 16(a) during 2013 and there are no late
filings to report. Based solely on its review of the copies of Section 16(a) forms received from its
directors and executive officers and written representations that no other reports were required, the
Company believes that all Section 16(a) reports applicable to its directors and officers during 2013 were
filed, with two exceptions. Messrs. Skoglund and Eccher each filed one late form all of which all related
to the grant and forfeiture of certain restricted stock awards in April 2013.
Corporate Governance
Currently, the board of directors is made up of eleven directors of which ten are Common Stock
Directors, who are elected by the holders of the Company’s common stock every three years to serve
staggered terms, and one is a Class B Director, who is elected annually by the holders of the Company’s
Series B Preferred Stock. Under the terms of the Series B Preferred Stock, the Series B Preferred
Stockholders also have the right to appoint a second Class B Director.
Generally, the board oversees the Company’s business and monitors the performance of the Company’s
management. In accordance with the Company’s corporate governance procedures, the board does not
130
involve itself in the day-to-day operations of the Company, which is monitored by the Company’s
executive officers and management. The Company’s directors fulfill their duties and responsibilities by
attending regular meetings of the board and through committee membership, which is discussed below.
The board has determined that all of the Company’s directors are "independent" as defined by the Nasdaq
Stock Market, with the exception of Messrs. Skoglund, Cheatham and Eccher, each of whom is an
executive officer.
The Company’s board of directors believes that it is important to encourage the highest level of corporate
ethics and responsibility. Among other things, the board adopted a Code of Business Conduct and Ethics,
which applies to all of the Company’s directors, officers and employees, as well as a procedure for
allowing employees to anonymously report any problems they may detect with respect to the Company’s
financial reporting. The Code of Business Conduct and Ethics, as well as other information pertaining to
the Company’s committees, corporate governance and reporting with the Securities and Exchange
Commission, can be found on the Company’s website at www.oldsecond.com.
The board of directors has standing Audit, Nominating and Corporate Governance and Compensation
Committees, each of which is made up solely of directors who are deemed to be "independent" under the
rules of Nasdaq. Nasdaq's independence rules include certain instances that will preclude a director from
being deemed independent and the board reviews those requirements each year to determine a director's
status as an independent director.
Audit Committee
The Audit Committee assists the board in carrying out its oversight responsibilities for the Company’s
financial reporting process, audit process and internal controls. The Audit Committee is solely responsible
for the pre-approval of all audit and non-audit services to be provided by the Company’s independent
registered public accounting firm and exercises its authority to do so in accordance with a policy that it
has adopted. Additionally, the Audit Committee reviews and approves all related party transactions
between the Company and related parties in accordance with Nasdaq's rules and regulations.
The members of the Company’s Audit Committee during 2013 were Messrs. Finn, (who served as
Chairman), Bonifas, Ladowicz, Schmitz and Suits, each of whom is deemed to be an independent director
under Nasdaq's rules. The Company expects that these members will continue to serve on the committee
in 2014. Mr. Finn was appointed as chairman of the Audit Committee in 2008. Mr. Schmitz will serve as
chairman of the Audit Committee at any meeting Mr. Finn is unable to attend or if Mr. Finn is otherwise
unable to carry out the duties of Audit Committee chairman. The Audit Committee met six times in 2013.
The board has designated Mr. Finn, who is currently President and Chief Executive Officer of Rush-
Copley Medical Center and previously served as its Chief Operating Officer and Chief Financial Officer,
as the “audit committee financial expert,” as such term is defined by the regulations of the SEC. The
board's determination was based upon Mr. Finn's level of knowledge and experience regarding financial
matters and his experience overseeing and managing the audit of an organization, which he has gained
both from his formal education and from his professional experience as the Chief Financial Officer of a
regional hospital organization. The board believes that each of the other members of the Audit Committee
possesses knowledge and experience sufficient to understand the complexities of the financial statements
of the Company. Mr. Finn, or another member of the Audit Committee, met on a quarterly basis during
2013 with the Company’s independent registered public accounting firm.
The Audit Committee's duties, responsibilities and functions are further described in its charter, which is
available on the Company’s website at www.oldsecond.com. A copy of the audit committee's charter can
be requested by sending a written request to the Corporate Secretary at 37 South River Street, Aurora,
Illinois 60506, or by sending an e-mail requesting same to corporatesecretary@oldsecond.com.
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Item 11.
Executive Compensation
COMPENSATION DISCUSSION AND ANALYSIS
Introduction
This Compensation Discussion and Analysis describes our compensation philosophy and policies for
2013 and 2014 as applicable to the executive officers named in the Summary Compensation Table set
forth below. This section explains the structure and rationale associated with each material element of
our named executive officers compensation, and it provides important context for the more detailed
disclosure tables and specific compensation amounts provided following the section. It is important to
note that the Company and the Bank share an executive management team, the members of which are
compensated by the Bank rather than the Company. The compensation packages of the named executive
officers are determined and approved by our Compensation Committee based upon their performances
and roles for both the Company and the Bank.
The Compensation Committee has overall responsibility for evaluating the compensation plans, policies
and programs relating to our executive officers. Further, as required by the rules established by Treasury,
guidance issued by the Federal Reserve and other financial institution regulatory agencies, and the SEC’s
guidance regarding risk associated with compensation arrangements (each as described more fully
below), the Compensation Committee is also responsible for a more expansive risk review with respect to
most of the compensation plans, policies and programs maintained for our employees. The
Compensation Committee relies upon the input of management, particularly Mr. Skoglund, when carrying
out its responsibilities in establishing executive compensation. Management provides the Compensation
Committee with evaluations as to employee performance, guidance on establishing performance targets
and objectives and recommends salary levels and equity awards. The Compensation Committee also
consults with management on matters that are relative to executive compensation and benefit plans where
board or stockholder action is expected, including the adoption of new plans or the amendment of existing
plans. Finally, the Compensation Committee consults with our management, specifically the Bank’s
Chief Risk Officer, in completing the risk review with respect to employee compensation plans. No
executive officer participates in any recommendation or decision regarding his or her own compensation.
The Compensation Committee’s charter gives it the authority to delegate its responsibility to members or
subcommittees of the Compensation Committee. Also, the charter gives the Compensation Committee
the authority to hire outside consultants to further its objectives and responsibilities. In prior years, the
Compensation Committee has retained ChaseCompGroup LLC on a bi-annual basis to provide services in
connection with a review and analysis of compensation paid to our named executive officers and board of
directors. In keeping with the Compensation Committee’s historical philosophy of comparing our
compensation with that of the local marketplace every other year, the Compensation Committee did not
retain a consultant during 2013 but will likely do so during 2014. In addition, during 2014 the
Compensation Committee engaged the services of Towers-Watson to perform a review and analysis of
our existing equity incentive plan.
During 2013, the Compensation Committee convened in January, February and November. Mr. Palmer,
Chairman of the Compensation Committee, also met as needed with internal staff members, to compile
compensation information for this Form 10-K. The Compensation Committee also met in February 2014
to approve salaries, incentive plans and performance metrics for 2014.
Participation in the CPP
We continued as a participant in the CPP through the time of the Treasury’s auction sale of our Series B
Preferred Stock and related warrant during the first quarter of 2013. As such, for the period of time from
January 1, 2013 through March 11, 2013 (the “2013 CPP Period”), the Company and the Bank, and
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certain employees of both, continued to be subject to the CPP compensation-related limitations and
restrictions. The CPP compensation limitations and restrictions included the following:
(cid:120) Except in limited circumstances, our five most highly compensated employees (as determined on
an annual basis) were prohibited from receiving cash bonus payments during the 2013 CPP
Period. Messrs. Skoglund, Cheatham and Eccher were subject to this prohibition during the 2013
CPP Period.
(cid:120) Except in limited circumstances, our named executive officers and our next five most highly
compensated employees (each as determined on an annual basis) were prohibited during the 2013
CPP Period from receiving any severance payments upon a termination of employment or any
payments triggered by the occurrence of a change in control.
(cid:120) Our named executive officers and next 20 most highly compensated employees were subject to a
“clawback” of incentive compensation if that compensation was based on materially inaccurate
financial statements or performance metrics. Further, no one in this group of employees could
have received any tax gross-up payment during the 2013 CPP Period.
(cid:120) We were limited to an annual deduction of $500,000 with respect to the compensation paid to
each of our named executive officers.
In addition to the specific CPP limitations and restrictions described above, the CPP rules and regulations
have required the Compensation Committee to undertake a semi-annual risk assessment with respect to
certain of the compensation plans, programs and arrangements maintained by us, regardless of whether
the individual employee(s) covered by the plan, program or arrangement is a named executive officer.
The risk assessments were performed by the Bank’s Chief Risk Officer and the Compensation
Committee. The Bank’s Chief Risk Officer and the Compensation Committee review all compensation
plans and arrangements to ensure that risks are identified and mitigated. The intent of these risk
assessments is to minimize the opportunity that any employee will be incentivized to take unacceptable
risks in order to maximize his or her compensation under such plans and arrangements. Following the
end of the 2013 CPP Period, we were no longer subject to the CPP compensation limitations and
restrictions.
Regulatory Impact on Compensation
As a publicly-traded financial institution, we and the Bank must contend with several often overlapping
layers of regulations, in addition to the CPP compensation-related limitations and restrictions, when
considering and implementing compensation-related decisions. These regulations are primarily intended
to focus attention on the risks that often go hand-in-hand with compensation programs designed to
incentivize the achievement of better than average performance. We and the Compensation Committee
strive to incorporate the broad principles of these regulations into the compensation decisions made with
respect to our named executive officers and other employees.
Under its long-standing Interagency Guidelines Establishing Standards for Safety and Soundness, the
FDIC has long held that excessive compensation is prohibited as an unsafe and unsound practice. In
describing a framework within which to make a determination as to whether compensation is to be
considered excessive, the FDIC has indicated that financial institutions should consider whether aggregate
cash amounts paid, or noncash benefits provided, to employees are unreasonable or disproportionate to
the services performed by an employee. The FDIC encourages financial institutions to review an
employee's compensation history and to consider internal pay equity, and, as appropriate, to consider
benchmarking compensation to peer groups. Finally, the FDIC provides that, in order to give proper
context, such an assessment must be made in light of the institution's overall financial condition.
In addition to the Safety and Soundness standards, the Compensation Committee must also take into
account the joint agency Guidance on Sound Incentive Compensation Policies. Various financial
institution regulatory agencies worked together to issue the Guidance, which is intended to serve as a
133
compliment to the Safety and Soundness standards. The Guidance sets forth a framework for assessing
and mitigating risk associated with incentive compensation plans, programs and arrangements maintained
by financial institutions. The Guidance is narrower in scope than the Safety and Soundness standards
because it applies only to senior executive officers and those other individuals who, either alone or as a
group, could pose a material risk to an institution. With respect to such individuals, the Guidance is
intended to focus an institution's attention on balanced risk-taking incentives, compatibility of incentives
with effective controls and risk management, and a focus on general principles of strong corporate
governance in establishing, reviewing and maintaining incentive compensation programs.
The Compensation Committee, with the assistance of its advisors and our management, continues to
monitor the status of compensation-related rules and regulations expected to be finalized or issued under
the Dodd-Frank Act. While the Compensation Committee believes its own risk assessment procedures
are effective, the Compensation Committee is prepared to implement any additional steps that may be
deemed necessary to fully comply with such rules and regulations when finally finalized or issued. The
Compensation Committee does note, however, that the proposed risk assessment rules issued under the
Dodd-Frank Act nearly mirror the Safety and Soundness standards and the framework of the Guidance.
As such, the Compensation Committee already adheres, in many respects, with the proposed rules and
regulations under the Dodd-Frank Act.
Finally, in addition to the foregoing, as a publicly-traded corporation, we are also subject to the SEC's
rules regarding risk assessment. Those rules require a publicly-traded company to determine whether any
of its existing incentive compensation plans, programs or arrangements create risks that are reasonably
likely to have a material adverse effect on the company.
The Compensation Committee continues to believe in and practice a sensible approach to balancing risk-
taking and rewarding reasonable, but not necessarily easily attainable, goals and this has always been a
component of its overall assessment of the compensation plans, programs and arrangements it has put in
place for our named executive officers. In this regard, the Compensation Committee has regularly
revisited the components of the frameworks set forth in the Safety and Soundness standards and the
Guidance as an effective tool for conducting its own assessment of the balance between risk and reward
built into our compensation programs for named executive officers. The Compensation Committee
believes we have adequate policies and procedures in place to balance and control any risk-taking that
may be incentivized by the employee compensation plans. The Compensation Committee further
believes that such policies and procedures will work to limit the risk that any employee would manipulate
reporting earnings in an effort to enhance his or her compensation.
Impact of Prior Say-on-Pay Votes on Compensation Decisions
At our 2013 Annual Meeting, approximately 95% of stockholders present and entitled to vote approved
the non-binding advisory proposal on the compensation of certain executive officers. We, our board and
the Compensation Committee pay careful attention to communications received from stockholders
regarding executive compensation, including the non-binding advisory vote. We considered the positive
result of the 2013 advisory vote on executive compensation but not for specific 2013 compensation
decisions. Based on this consideration and the other factors described in this Compensation Discussion &
Analysis, the Compensation Committee did not alter the policies or structure for named executives’
compensation for 2013.
Financial and Operational Performance
In 2013, we continued our emphasis on returning to sustained profitability and growth as its primary
objectives. Specific accomplishments in 2013 that directly impacted those objectives include:
(cid:120) Reduction in classified assets by 45%;
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(cid:120) Net income of $11.8 million highlighted by lower credit costs, loan loss reserve releases and
lower insurance costs; and
(cid:120) Balance sheet stability allowing renewed focus on commercial loan relationship generation.
Accordingly, our executive compensation, particularly metrics for the organization’s short-term incentive
plans, focused on the following goals and accountabilities: our and the Bank’s net income growth;
specific profit center performance; asset-credit quality risk; reduction in classified assets; and cost savings
initiatives. These metrics were prudently designed to contain and minimize risk while at the same time
emphasizing growth and profitability.
Compensation Philosophy and Objectives
Our philosophy is intended to align the interests of management with those of our stockholders without
creating undue risk to us. The executive compensation program is designed in a manner which the
Compensation Committee believes does not provide our executives with incentives to engage in business
activities or other behavior that would threaten our value or the investments of our stockholders.
The executive compensation program is intended to accomplish the following objectives:
align the interests of our named executive officers with those of our stockholders;
(cid:120)
(cid:120) maintain a corporate environment which encourages stability and a long-term focus for both us
and our management;
(cid:120) maintain a program which:
o clearly motivates personnel to perform and succeed according to our current goals;
o
o does not create undue risk to us; and
retains key personnel critical to our long-term success; and
(cid:120)
ensure that management:
o
fulfills its oversight responsibility to its constituents which include stockholders,
customers, employees, the community and government regulatory agencies;
o conforms its business conduct to the highest ethical standards;
o
remains free from any influences that could impair or appear to impair the objectivity and
impartiality of its judgments or treatment of our constituents; and
o continues to avoid any conflict between its responsibilities to us and each individual’s
personal interests.
Compensation Components
General. In recent years, the Compensation Committee has been required to reevaluate the components
of our compensation program because of the continuing impact of the CPP executive compensation rules.
Historically, we have included four major components in our named executive officers’ compensation
program: (i) base salary, (ii) annual cash bonus, (iii) equity awards and (iv) additional benefits.
However, until recently, the Compensation Committee was unable to rely on annual cash bonuses as a
component for some of our named executive officers because of the impact of the CPP compensation
limitations and restrictions. As such, for our named executive officers, the Compensation Committee has
focused primarily on base salary, equity awards permitted under the CPP rules, and additional benefits.
This began to change somewhat during 2013 with our exit from the CPP when cash incentive bonuses
again became a possibility for our named executive officers.
The Compensation Committee’s decisions regarding each of the components for the named executive
officers are based in part on the Compensation Committee’s subjective judgment and take into account
qualitative and quantitative factors, as are discussed below. In reviewing an executive officer’s
compensation, the Compensation Committee considers and evaluates all components of the officer’s total
compensation package. This involves reviewing base salary, bonus, incentive stock awards, perquisites,
135
participation in our non-qualified executive plans, participation in our 401(k) plan and any other
payments, awards or benefits that an officer earns (to the extent each is permitted under the CPP
compensation limitations and restrictions). Additionally, the Compensation Committee takes into
consideration any amounts an executive officer is entitled to upon retirement, termination or a change-in-
control event, including the impact of the CPP compensation limitations and restrictions on these
amounts. In this regard, in establishing compensation for 2013 and 2014, the Compensation Committee
utilized tally sheets summarizing these aggregated amounts.
Base Compensation - Salary. The Compensation Committee believes that base compensation should
offer security to each executive sufficient to maintain a stable management team and environment.
Because of the need to provide stability, salaries make up the largest portion of the executives’
compensation. In establishing a senior executive officer’s initial base salary the Compensation
Committee considers, among other things, the executive’s level of responsibility, prior experience,
breadth of knowledge, the competitive salary practices at peer companies, internal performance
objectives, education, internal pay equity, potential bonus and equity awards, level of benefits and
perquisites and the tax deductibility of base salary.
The Compensation Committee reviews salaries of the named executive officers on an annual basis. As
with all of its decisions regarding compensation levels, when reviewing salaries the Compensation
Committee considers the levels of all aspects and components of the officer’s compensation, including the
individual’s potential bonus and equity awards as well as the level of benefits and perquisites offered. All
of these factors are considered on a subjective basis in the aggregate, and none of the factors is accorded a
specific weight.
Cash Incentive Awards - Bonus. The executive compensation restrictions contained in the CPP rules
prohibited us from paying or accruing cash bonuses on behalf of the top five most highly paid employees
(as determined on an annual basis) during the 2013 CPP Period. Messrs. Skoglund, Cheatham and Eccher
were subject to the bonus prohibition during the 2013 CPP Period, but were eligible to receive cash
bonuses with respect to any part of 2013 following the 2013 CPP Period.
In anticipation of our possible exit from the CPP during 2013, the Compensation Committee adopted a
non-equity incentive compensation plan for our named executive officers. The 2013 plan established a
structure under which Messrs. Skoglund, Cheatham and Eccher would be eligible for cash bonus
payments if our performance during 2013 met or exceeded certain performance goals; provided that, the
Compensation Committee ultimately had discretion to determine the amount of any bonuses awarded.
Any such bonus payments were contingent upon our exit from the CPP and were required to be prorated
to reflect the period of time during 2013 that we continued to be a participant in the CPP.
The 2013 bonus plan was designed to provide an incentive to achieve corporate financial goals while
considering the mitigation of any risks which may affect our overall financial performance. Generally
speaking, thresholds and targets are set so that improvement in a performance metric is necessary in order
to receive any or all of the bonus payout with respect to that metric.
In setting the performance metrics, Mr. Skoglund provided recommendations with respect to members of
management other than himself to the Compensation Committee. The Compensation Committee then,
outside the presence of Mr. Skoglund, considers factors applicable to Mr. Skoglund’s annual bonus.
In 2013, pursuant to our bonus plan, Mr. Skoglund was potentially eligible for an annual bonus equal to
51.25% of his salary, or $258,761. Mr. Eccher was potentially eligible for an annual bonus equal to 45%
of his salary, or $146,250, and Mr. Cheatham was potentially eligible for an annual bonus equal to 40%
of his salary, or $100,800. Based on our performance during 2013 and the adjustment required under the
CPP rules, Messrs. Skoglund and Eccher earned 81% of their bonuses, and Mr. Cheatham earned 61% of
his bonus
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The components designated by the Compensation Committee and the target percentage of salary that the
named executive officers were eligible to earn for 2013 performance and resulting actual bonus received,
were as follows:
Named Executive
Officer
William B. Skoglund
J. Douglas Cheatham
James Eccher
Company
Income Growth
25%
20%
20%
Bank Capital
Ratio
10%
5%
10%
Asset/Credit
Quality
10%
---
10%
Cost Savings
---
10%
---
TTotal
45%
35%
40%
In October 2013, our named executive officers also received payment of bonus amounts that were earned
during 2008 but could not be paid until after each executive was no longer subject to the bonus
restrictions applicable under the CPP. Mr. Skoglund received a payment of $235,669, Mr. Cheatham
received a payment of $93,094 and Mr. Eccher received a payment of $122,119. These payments were
not factored into our bonus decisions with respect to 2013.
Company Income Growth. The Compensation Committee believes that our growth, as measured by
reference to our net income, is an appropriate measure because it focuses on our financial performance,
which in turn reflects stockholder value. Each named executive officer has a portion of his bonus tied to
this metric. The Compensation Committee applied the following scale to determine how much of the
target percentage any named executive officer would receive based on our net income:
Net Income
$2.0 million
$3.0 million
$4.0 million
$5.0 million
Amount of Target
Percentage
50%
75%
100%
125%
Our 2013 net income exceeded $5.0 million, and, therefore, the named executive officers earned 125% of
this component.
Capital Ratios. The Compensation Committee believes that our and the Bank’s capital ratios are another
way in which we can measure our return to sustained profitability. As such, each of our named executive
officers has a portion of his bonus tied to this metric. Provided that we maintained at the Bank during
2013 a Tier 1 capital leverage capital ratio of 10% or better and a total capital ratio of 14% or better, our
named executive officers would earn 100% of the bonus attributable to this metric. If we fell below either
level, our executives would receive no bonus with respect to this metric.
The Bank’s leverage capital ratio was 10.97% and its total capital ratio was 18.04% as of December 31,
2013. Therefore, the named executive officers earned 100% of this component.
Asset/Credit Quality. With respect to Messrs. Skoglund and Eccher, because classified assets were a
difficult issue for the company to navigate the last several years, the Compensation Committee believes
incentivizing them to focus on our asset/credit quality will further ensure that we are working toward
sustainable growth and profitability. As such, the Compensation Committee determined that a bonus
component for them would appropriately be tied to our classified asset ratio. If the ratio remained at
61.90% or lower, each of Messrs. Skoglund and Eccher would be entitled to 100% of their bonus with
respect to this metric. If the ratio exceeded 61.90%, then no bonus would be earned with respect to our
asset/credit quality.
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Our classified asset ratio was 43.44% at December 31, 2013, thus entitling Messrs. Skoglund and Eccher
to 100% of the bonus associated with this component.
Cost Savings. The Compensation Committee believes that expense control and efficiency of operations is
a goal we must continually strive for in order to provide for the best financial return for our shareholders.
Further, the Compensation Committee believes that Mr. Cheatham is the person best situated to impact
our efforts in this regard. As such, the Compensation Committee deemed a bonus component in 2013 tied
to cost savings as measured by total non-interest expense at the Company level to be merited. If our total
non-interest expense was less than $84,200,000, Mr. Cheatham would earn 100% of the bonus with
respect to this component. No bonus would be earned if our total non-interest expense was not below that
level.
Although we reported non-interest expense of $83,144,000, the Compensation Committee determined
that Mr. Cheatham was not eligible for a bonus with respect to this component because the reported non-
interest expense reflects an adjustment that was not anticipated at the time performance metrics were
established.
Long-Term Incentive Awards - Equity Awards. Our board and the Compensation Committee believe in
senior management ownership of our common stock as an effective means to align the interests of senior
management with those of the stockholders. In addition, because the CPP rules prohibited the payment of
cash bonuses to our named executive officers, the Compensation Committee has in recent years placed a
greater focus on equity awards, which were permitted under the CPP rules. Our current long-term
incentive plan (the “Incentive Plan”), which was approved by stockholders at the 2008 annual meeting, is
intended to promote equity ownership in the Company by the directors and selected officers and
employees, focus the management team on increasing value to stockholders, increase their proprietary
interest in the success of the Company and encourage them to remain in the employ of the Company or its
subsidiaries for a long period of time. The current equity incentive plan authorizes the issuance of up to
575,000 shares of our common stock, including the granting of qualified stock options, non-qualified
stock options, restricted stock, restricted stock units and stock appreciation rights.
All awards are at the discretion of the Compensation Committee and are generally subjective in nature. In
determining the number of equity awards to be granted to executive officers, the Compensation
Committee considers individual and corporate performance and whether the respective goals were
obtained, the person’s position and ability to affect profits and stockholder value, as well as the level of
awards granted to individuals with similar positions at our peer organizations. Because of the nature of
equity awards, the Compensation Committee also evaluates the prior awards of stock options and
restricted stock and takes into account the overall wealth accumulation of a given executive officer
through such awards.
Pursuant to a formal equity compensation policy, all equity grants are finalized in the beginning of each
calendar year. This allows for a more complete review of the full prior year when making equity awards
as well as coordinating the granting of equity awards to a time when there is less likelihood of there being
existing material, non-public information, as the grants will normally be made after the public release of
our financial information for the prior year.
Over the last few years, because of our participation in CPP, the Compensation Committee has made
most equity awards in the form of restricted stock or restricted stock units. The CPP rules limited our
ability to grant to our named executive officers equity awards other than restricted stock or restricted
stock units. The CPP rules also dictated the terms and conditions of those awards. In 2013, the
Compensation Committee granted restricted stock that complied with the CPP rules to the named
executive officers. The Compensation Committee believes that restricted stock is an appropriate
138
employee retention tool because it aligns our executive officers’ interests with those of our stockholders.
The awards subject to the CPP rules have a two-year vesting period.
The Compensation Committee did not make a new equity award to our named executive officers in early
2014 but retains the discretion to do so later in the year if it determines that circumstances warrant such
award.
When considering our past equity awards that were made subject to the CPP rules, it is important to note
that Treasury auctioned our Series B Preferred Stock and related warrant in early 2013. As a result, our
named executive officers were required to forfeit 75% of each outstanding equity award that was granted
pursuant to the CPP rules. For our named executive officers, this resulted in a forfeiture of 75% of each
of the equity awards, even if previously vested, made to such officer during 2009, 2010, 2011 and 2012.
All Other Compensation. We provide general and customary benefit programs to executive officers and
other employees. Benefits offered to executives are intended to serve a different purpose than base salary,
bonus and equity awards. While the benefits offered are competitive with the marketplace and help
attract and retain executives, the benefits also provide financial security for employees for retirement as
well as in the event of illness, disability or death. The benefits we offer to executive officers are generally
those offered to other employees with some variation to promote tax efficiency and replacement of
benefit opportunities lost to regulatory limits although there are some additional perquisites that may only
be offered to executive officers. Because of the nature of the benefits offered, the Compensation
Committee normally does not adjust the level of benefits offered on a year-to-year basis. We will
continue to offer benefits, the amount of which shall be determined from time-to-time in the sole
discretion of the Compensation Committee, provided that such benefits are not in the future determined to
be limited or prohibited by the CPP rules.
The following table summarizes the benefits and perquisites we do and do not provide as well as
identifies those employees that may be eligible to receive them:
Health Plans:
Life & Disability Insurance ..........................
Medical/Dental/Vision Plans ........................
Retirement Plans:
401(k) Plan/Profit-Sharing ............................
Deferred Compensation Plan ........................
Perquisites:
Automobile Allowance .................................
Country Club Membership ...........................
Executive
Officers
Other
Officers/Mgrs.
Full-Time
Employees
X
X
X
X
X
X
X
X
X
X
X
X
X
Not Offered
Not Offered
Not Offered
Not Offered
Not Offered
Old Second Bancorp, Inc. Employees 401(k) Savings Plan and Trust. We sponsor a tax-qualified
401(k) savings plan and trust qualifying under Section 401(k) of the Internal Revenue Code. Virtually all
employees are eligible to participate after meeting certain age and service requirements. Eligible
employees are permitted to contribute up to a dollar limit set by law. Since we terminated our defined-
benefit plan as of the end of 2005, the 401(k) plan became the primary retirement vehicle we provide to
our officers and employees. Participants can choose between several different investment options under
the 401(k) plan, including shares of our common stock.
During 2013, we provided a matching contribution on elective deferrals to eligible participants in an
amount equal to 2% of each participant’s salary. There is also a profit-sharing portion of the 401(k) plan
139
which provides for an annual discretionary contribution to the retirement account of each employee based
in part on our profitability in a given year and on each participant’s annual compensation. The
contribution amount granted each year is on a discretionary basis and there is no set formula used by the
Compensation Committee. No discretionary contribution was provided to employees based on our 2013
financial performance.
Old Second Bancorp, Inc. Amended and Restated Voluntary Deferred Compensation Plan for
Executives. We sponsor an executive deferred compensation plan, which provides a means for certain
executives to voluntarily defer all or a portion of their salary and/or bonus, if any, without regard to the
statutory limitations applicable to tax-qualified plans, such as our 401(k) plan. The deferred
compensation plan provides for participant deferrals, company matching contributions and discretionary
employer profit-sharing contributions. A company matching contribution is credited to the plan on behalf
of a participant when the participant elects to defer the maximum amount permitted under the 401(k) plan
(including catch-up contributions, if applicable) and keeps that level of deferral for the entire plan year.
The company matching contribution is an amount up to 3%, provided at least a 6% deferral was met, of
the participant’s combined base salary and bonuses, less any matching contribution paid to the 401(k)
plan on the participant’s behalf. The determination of whether a profit-sharing contribution is made and
in what amount is entirely at the Compensation Committee’s discretion and there is no set formula. We
suspended the matching contribution under the plan while we were a participant in CPP. Participants are
permitted to make hypothetical investments in publicly-traded mutual funds that are held in an insurance
company separate account with respect to the deferrals and our contributions credited to their accounts
under the plan. Participants may elect to receive their plan balance in a lump sum or in installments.
Participants may make a withdrawal from the plan during their employment in the event of hardship as
approved by the plan’s administrator. The plan is administered through an independent service provider.
Other Perquisites. It is our belief that perquisites for executive officers should be very limited in scope
and value. Due to this philosophy, we have generally provided very nominal benefits to executives that
are not available to full-time employees, and we plan to continue this approach in the future. We do
provide country club memberships to certain executives and managers in the ordinary course of business
to give them the opportunity to bring in and recruit new business opportunities. These individuals are
eligible to use the club membership for their own personal use. Additionally, we provide each of Mr.
Skoglund and Mr. Eccher with an automobile allowance to enable them to visit our banking locations on a
regular basis as well as to call on our customers. We have disclosed the value of all perquisites to named
executive officers in the Summary Compensation Table even if they fall below the disclosure thresholds
under the SEC rules. We will continue to offer perquisites, the amount of which shall be determined from
time-to-time in the sole discretion of the Compensation Committee.
Compensation Decisions
This section describes the decisions made by the Compensation Committee with respect to the
compensation for the named executive officers for 2013 and 2014.
The following is a brief summary of the Compensation Committee’s compensation decisions for 2013
and 2014:
(cid:120)
(cid:120)
for 2013, minimal merit increases in base salary were granted to our named executive officers in
keeping with the conservative compensation guidelines established for the organization;
for 2014, merit increases in base salary ranging from 3% to 11.5% were granted to our named
executive officers;
(cid:120) $388,334 cash bonus payments were earned or awarded to our named executive officers with
respect to 2013 performance; and
(cid:120) benefits and perquisites remained substantially similar in 2013 compared to prior years and we
expect that will continue through 2014.
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Base Salary. We annually review the base salaries of the named executive officers to determine whether
or not they will be adjusted, as described above. The salaries for 2013, determined by the Compensation
Committee at the beginning of 2013, are set forth in the Summary Compensation Table below. In
determining these salary levels, we generally considered the following:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
the compensation philosophy and guiding principles described above;
the general economic factors in the financial industry beyond our control and the financial
performance of the Company compared to our peers;
the experience and industry knowledge of our named executive officers and the quality and
effectiveness of their leadership;
all of the components of executive compensation, including base salary, bonus, stock options,
retirement and death benefits, as well as benefits and perquisites; and
internal pay equity among our executives.
In early 2014, the Compensation Committee determined the base salaries for the executive directors for
2014. The base salaries for 2013 and 2014 are as follows:
Name
William B.
Skoglund...................
J. Douglas
Cheatham ..................
Position
2013
2014
Chairman, Chief Executive Officer of the
Company
$504,900
$530,000
Chief Financial Officer of the Company
$252,000
$260,000
James Eccher ............
Chief Executive Officer of the National Bank
$325,000
$362,500
In determining the base salaries for 2014, we considered the same general factors discussed above
including the continuing general slowdown in the economy and growth of our earnings, return on average
assets and overall assets.
Bonus. Based on our named executive officers’ achievement of the goals for earning a cash bonus
established by the Compensation Committee, we awarded cash bonuses as set forth below:
Named Executive Officer
Bonus Earned in 2013
William B. Skoglund
J. Douglas Cheatham
James Eccher
$209,079
$61,085
$118,170
Because of our exit from the CPP in 2013, the Compensation Committee has again established for 2014
an incentive bonus program intended to focus our named executive officers on important performance
measures.
Equity Awards. The Compensation Committee typically acts to award equity grants at the beginning of
each year, specifically in the months of January and February. The Compensation Committee did not
make equity award grants to our named executive officers in 2013 and not yet done so in 2014 although it
retains the discretion to do so later in the year if economic conditions and our performance warrant such
grants.
141
All Other Compensation. While the Compensation Committee reviews and monitors the level of other
compensation offered to the named executive officers, the Compensation Committee typically does not
adjust the level of benefits offered on an annual basis. The Compensation Committee does consider the
benefits and perquisites offered to the named executive officers in its evaluation of the total compensation
received by each. The perquisites received by the named executive officers in 2013 are reported in the
Summary Compensation Table below. The benefits offered in 2013 to the named executive officers are
expected to continue for 2014.
COMPENSATION COMMITTEE REPORT
The Compensation Committee has reviewed and discussed the foregoing Compensation Discussion and
Analysis with management. Based on the Compensation Committee’s review and discussion with
management, the Compensation Committee has recommended to our board of directors that the
Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the year
ended December 31, 2013.
Section 111(b)(2)(A) of the Emergency Economic Stabilization Act requires the Compensation
Committee to conduct, in conjunction with the Bank’s Chief Risk Officer, a review of the incentive
compensation arrangements in place between the Company and its employees. In February 2013, the
Bank’s Chief Risk Officer presented his comprehensive risk assessment of the organization’s
compensation plans to the Compensation Committee. Because of the CPP auction in early 2013, the
second semi-annual risk assessment was not required. However, our management and the Compensation
Committee have determined that it is appropriate for the Bank’s Chief Risk Officer to continue to conduct
his risk assessments on an annual basis.
The Compensation Committee certifies that, at least once during the 2013 CPP Period (a) it reviewed with
the Bank’s Chief Risk Officer the senior executive officer (“SEO”) compensation plans and has made all
reasonable efforts to ensure that these plans do not encourage SEOs to take unnecessary and excessive
risks that threaten the value of the Company; (b) it reviewed with the Bank’s Chief Risk Officer the
employee compensation plans and has made reasonable efforts to limit any unnecessary risks these plans
pose to the Company; and (c) it reviewed the employee compensation plans to eliminate any features of
these plans that would encourage the manipulation of reported earnings of the Company to enhance the
compensation of any employee ((a), (b) and (c) being collectively referred to as the “CPP Risk
Assessment”).
In the course of conducting its CPP Risk Assessment, the Compensation Committee considered the
overall business and risk environment confronting the Company and how the SEO compensation plans
and employee compensation plans serve to motivate employee behavior when operating within that
environment. In particular, the Compensation Committee’s CPP Risk Assessment focused on the
following compensation plans (* denotes plans in which SEOs participate):
(cid:120) Amended and Restated Voluntary Deferred
(cid:120) Officers Incentive Plan*
Compensation Plan for Executives*
(cid:120) Base Salary*
(cid:120) Residential Lending Commission Plan
(cid:120) Compensation and Benefits Assurance
(cid:120) Residential Lending Override Plan
Agreements*
(cid:120) Customer Service/Support Center Plan
(cid:120) Retail Banking Plan
(cid:120) Employees 401(k) Savings Plan and Trust*
(cid:120) Special Recognition Awards Program
(cid:120) 2008 Equity Incentive Plan*
(cid:120) Wealth Management Commission Plan
142
(cid:120) Loan Administration Plan
With the exception of individual bonus goals designated under the Officers Incentive Plan, the Company
does not maintain any compensation plans in which only SEOs participate. For purposes of this
discussion, references to “SEO compensation plans” mean the portion of an employee plan in which the
SEOs participate.
With respect to the SEO compensation plans, the Compensation Committee believes that such plans do
not encourage the Company’s SEOs to take unnecessary or excessive risks that could harm the value of
the Company. The Compensation Committee believes this to be true because, as is more fully described
in the Compensation Discussion and Analysis, the Compensation Committee strives to provide a balanced
aggregate compensation package to the Company’s SEOs that serves to incentivize the Company’s SEOs
to manage the business of the Company in a way that will result in Company-wide financial success and
value growth for the Company’s stockholders.
The Compensation Committee believes it is appropriate for the Company’s executives to focus certain of
their efforts on near-term goals that have importance to the Company; however, the Compensation
Committee also acknowledges that near-term focus should not be to the detriment of a focus on the long-
term health and success of the Company. In practice, providing base salary to any employee provides the
most immediate reward for job performance. The Compensation Committee engages in an annual
process, as is described in the Compensation Discussion and Analysis, to set base salary. The
Compensation Committee believes its process for establishing base salary is relatively free from risk to
the Company, as the Compensation Committee does not typically make significant adjustments to base
salary based on a single year’s performance. The Compensation Committee believes it is appropriate to
reward the Company’s executives’ focus on near-term goals, when such goals correspond to the overall
Company or operating division goals and direction set by the Company’s board of directors. To reward
the executives for such focus, the Compensation Committee maintains an annual cash incentive plan (i.e.,
Officers Incentive Plan) for the Company’s executives. In establishing the annual cash incentive plan, the
Compensation Committee tries to provide an adequate level of incentive for the achievement of
Company, operating division and individual goals, while also limiting the maximum amount that may be
earned so that executives do not feel the need to strive for attainment of unreasonable or unrealistic levels
of performance. In this way, the Compensation Committee believes the design of the annual cash
incentive plan does not encourage the Company’s executives to take unnecessary or excessive risks that
could harm the value of the Company.
The other incentive compensation elements offered to the Company’s SEOs, with the exception of
perquisites, are intended to reward performance over the long-term or are intended to focus the
Company’s executives’ attention on the long-term performance of the Company. The Compensation
Committee feels there is little, if any, risk associated with the Company’s Employees 401(k) Savings Plan
and Trust as it is a tax-qualified retirement plan that is subject to and maintained in accordance with the
mandates of the Internal Revenue Code and the Employee Retirement Income Security Act. The
Compensation Committee believes the Company’s 2008 Equity Incentive Plan helps to tie the Company’s
executives’ interest more closely to those of the Company’s stockholders by giving them an equity
interest in the Company. The Compensation Committee feels this equity interest in the Company
promotes a long-term focus among the Company’s executives on the financial success of the Company.
Finally, the Compensation Committee believes the deferred compensation arrangements (i.e., Amended
and Restated Voluntary Deferred Compensation Plan for Executives, Compensation and Benefits
Assurance Agreements) in place with respect to the Company’s SEOs encourage the Company’s
executives to consider the long-term health of the Company because, pursuant to the Internal Revenue
Code and applicable guidance, those arrangements must be unfunded, unsecured promises to pay a benefit
in the future. In the case of the Company’s insolvency, the executives participating in those arrangements
would be treated as general unsecured creditors, which encourages the executives to ensure a healthy
organization remains after their tenures are concluded.
143
With respect to the employee compensation plans, the CPP Risk Assessment has not resulted in a
determination by the Compensation Committee that changes were necessary to bring such plans into
compliance with the CPP rules. The Compensation Committee believes the Company has adequate
policies and procedures in place to balance and control any risk-taking that may be incentivized by the
employee compensation plans. The Compensation Committee further believes that such policies and
procedures will work to limit the risk that any employee would manipulate reporting earnings in an effort
to enhance his or her compensation.
Submitted by:
Mr. Gerald Palmer, Chairman
Mr. Edward Bonifas
Mr. William Kane
Mr. William Meyer
Members of the Compensation Committee
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth information concerning the compensation of our Chief Executive Officer,
Chief Financial Officer and our next most highly compensated executive officer:
Name and
principal position
(a)
Year
(b)
Salary
(c)
Bonus(1)
(d)
Stock
awards(2)
(e)
All other
compensation(3)
(i)
William B. Skoglund .................
Chairman and Chief Executive
Officer - Old Second;
Chairman of Old Second
National Bank
J. Douglas Cheatham .................
Chief Financial Officer
2013
2012(4)
2011
$ 504,900
495,000
495,000
$209,079
---
---
$98,400
25,000
37,450
$30,004
26,855
27,280
2013
2012(4)
2011
$ 252,000
247,000
247,000
$61,085
---
---
$65,600
25,000
37,450
$19,119
15,945
16,470
James Eccher .............................
Chief Executive Officer – Old
Second National Bank
2013
2012(4)
2011
$ 325,000
319,000
304,500
$118,170
---
---
$82,000
25,000
37,450
$30,004
26,855
27,280
Total ($)
(j)
$842,383
546,855
559,730
$397,804
287,945
300,920
$555,174
370,855
369,230
(1)
In October 2013, our named executive officers also received payment of bonus amounts that were earned
during 2008 but could not be paid until after each executive was no longer subject to the bonus restrictions
applicable under the CPP. Mr. Skoglund received a payment of $235,669, Mr. Cheatham received a payment of
$93,094 and Mr. Eccher received a payment of $122,119.
The amounts represent the grant date fair value for equity awards in accordance with ASC 718 -
(2)
“Compensation-Stock Compensation.” A discussion of the assumptions used in calculating the values may be
found in the notes to our audited financial statements included in our annual report to stockholders.
(3)
The 2013 amounts set forth in column (i) include the following:
144
Mr. Skoglund
401(k) match .............................................
Life insurance ............................................
Automobile allowance ..............................
Country club dues .....................................
Total
$ 5,100
690
10,800
13,414
$30,004
Mr.
Cheatham
$ 5,023
682
---
13,414
$19,119
Mr. Eccher
$5,100
690
10,800
13,414
$30,004
The amounts reflected in the “All Other Compensation” and “Total” columns for 2012 were incorrectly
(4)
calculated and have been adjusted by $975 when compared to our prior disclosure of these amounts.
Grants of Plan-Based Awards
Name
William B. Skoglund ...................................................
Restricted Stock Award
Grant date
4/16/13
All Other
Stock
Awards;
Number
of Shares
of Stock
or Units(1)
30,000
Grant Date
Fair Value
of Stock and
Option
Awards(2)
$98,400
J. Douglas Cheatham ...................................................
Restricted Stock Award
4/16/13
20,000
$65,600
James Eccher ...............................................................
Restricted Stock Award
4/16/13
25,000
$82,000
(1)
(2)
The amounts represent shares of restricted stock. The restricted stock will vest 100% on the third
anniversary of the grant date.
The grant date fair value is based on the closing price of our stock on April 16, 2013, which was
$3.28 per share. With respect to the amounts reflected for 2012 and 2011, it should be noted that
75% of those awards were forfeited due to Treasury’s auction of our Series B Preferred Stock and
related warrant.
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth information concerning the outstanding equity awards at December 31,
2013 held by the individuals named in the Summary Compensation Table:
Option Awards
Number of
securities
underlying
unexercised
options
(#)
Exercisable(1)
Number of
securities
underlying
unexercised
options (#)
Unexercisable(1)
Option
exercise
Price
($)
Option
expiration
date
Stock Awards
Number of
shares or
units of
stock that
have not
vested
(#)(2)
Market
value of
shares or
units of
stock that
have not
vested
($)(3)
Name
145
(a)
William B.
Skoglund
J. Douglas
Cheatham
James Eccher
(c)
(b)
32,000
32,000
32,000
40,000
12,000
12,000
12,000
15,000
12,000
12,000
12,000
20,000
(e)
32.59
31.34
29.20
27.75
32.59
31.34
29.20
27.75
32.59
31.34
29.20
27.75
(f)
12/21/2014
12/20/2015
12/19/2016
12/18/2017
12/21/2014
12/20/2015
12/19/2016
12/18/2017
12/21/2014
12/20/2015
12/19/2016
12/18/2017
(g)
(h)
35,000
$ 161,700
25,000
$ 115,500
30,000
$ 138,600
(1)
(2)
All options granted prior to December 31, 2005 vested on that date. Options granted on
December 19, 2006 and December 18, 2007 vested in three equal installments on the first three
anniversaries of the grant date.
Each award of restricted stock granted to Messrs. Skoglund, Cheatham and Eccher will vest in
full on the second anniversary of each date of grant. Includes 25% of the awards made in 2012
that were not forfeited due to Treasury’s auction of our Series B Preferred Stock and related
warrant. (3)
Based upon the December 31, 2013 closing price of $4.62 per share of common
stock.
Nonqualified Deferred Compensation
Name
Executive
contributions
in last FY
($)
Registrant
contributions
in last FY
($)
Aggregate
earnings
in last FY
($)
Aggregate
withdrawals/
distributions
($)
Aggregate
balance at
last FYE
($)
William B. Skoglund ........ $
J. Douglas Cheatham ........
James Eccher .....................
---
---
---
$
---
---
---
$ 118,694
$ ---
$ 624,771
25,567
22,533
---
---
112,544
103,272
We sponsor an executive deferred compensation plan, which is described in the Compensation Discussion
and Analysis above, and a director deferred compensation plan, which is described below following the
Directors Compensation Table. The plans provide a means by which certain executives and directors may
voluntarily defer all or a portion of their compensation. The plans are funded by participant deferrals and,
in the case of the executive plan, company matching contributions and discretionary employer profit
sharing contributions. Participants are permitted to make hypothetical investments in publicly-traded
mutual funds that are held in an insurance company separate account, with respect to their deferrals and
our contributions, credited to their accounts under the plan. The deferrals to the director plan are credited
146
earnings based on our stock price. Participants may elect to receive their plan balance in a lump sum or in
installments. Participants are permitted, in the discretion of the administrator, to make a withdrawal from
the plan during their employment in the event of hardship.
Potential Payments Upon Termination or Change in Control
Each of Messrs. Skoglund, Cheatham and Eccher entered into Compensation and Benefits Assurance
Agreements with us (each, an “Assurance Agreement”), which provide for payments and benefits to a
terminating executive following a change in control. In addition, our Cash Incentive Plan provides for
termination related benefits. Other than the benefits provided by the Assurance Agreements and pursuant
to the Cash Incentive Plan, none of our named executive officers will be entitled to any payments or
benefits as a result of the occurrence of a change in control or as a result of a termination of employment
in connection with a change in control. It should be noted that pursuant to regulations applicable to us, we
would have to confer with our regulators before making any payment under the Assurance Agreements
for a termination deemed to occur on December 31, 2013.
Assurance Agreements. Other than as is provided in the Assurance Agreements, and except as is
provided in accordance with the terms of our equity incentive plan and our cash incentive plan for
executive officers, no named executive officer will be entitled to any payments or benefits as a result of
the occurrence of a change in control or as a result of a termination of employment in connection with a
change in control. The Assurance Agreements have an initial term of one-year and, unless earlier
terminated by either party, will automatically renew for successive one-year periods. Upon the
occurrence of a change in control, the terms of the Assurance Agreements shall automatically renew for a
two-year period (three-year period, in the case of Mr. Skoglund) and terminate following such extended
period. The Assurance Agreements provide that, in the case of: (i) a termination of employment by us
without “cause” within six months prior to, or 24 months (36 months, in the case of Mr. Skoglund)
immediately following, a change in control, (ii) a termination of employment by an executive for “good
reason” within 24 months (36 months, in the case of Mr. Skoglund) following a change in control or (iii)
a material breach by us (or any successor) of a provision of the Assurance Agreement, an executive
officer will be entitled to:
(cid:120) Payment, in a single lump sum, of accrued base salary, accrued vacation pay, unreimbursed
business expenses and all other items earned by or owed to the executive through and including
the date of termination.
(cid:120) Payment, in a single lump sum, of a severance benefit equal to two times (three times, in the case
of Mr. Skoglund) the sum of (i) the greater of the executive’s annual rate of base salary in effect
upon the date of termination or the executive’s annual rate of base salary in effect immediately
prior to the occurrence of the change in control and (ii) the average of the annual cash bonus paid
to the executive (including any portion of such bonus, payment of which the executive elected to
defer) for the three calendar years immediately preceding the year in which the termination
occurs. For a termination as of December 31, 2013, our named executive officers would have
been entitled to the following payment amounts: Mr. Skoglund - $1,514,700; Mr. Cheatham -
$504,000; and Mr. Eccher - $650,000.
Immediate 100% vesting of all stock options and any other awards which have been provided to
the executive by us under any of its incentive compensation plans. As of December 31, 2013, the
fair market value of unvested restricted stock and restricted units held by our named executive
officers was as follows: Mr. Skoglund - $161,700; Mr. Cheatham - $115,500; and Mr. Eccher -
$138,600.
(cid:120)
(cid:120) At the exact same cost to the executive, and at the same coverage level as in effect as of the
executive’s termination, a continuation of the executive’s (and the executive’s eligible
dependents’) health insurance coverage for 24 months (36 months, in the case of Mr. Skoglund)
from the date of termination. In the event that the executive (and/or his dependents, if any)
becomes covered under the terms of any other health insurance coverage of a subsequent
147
employer which does not contain any exclusion or limitation with respect to any preexisting
condition of the executive or the executive’s eligible dependents, coverage under our plans will
cease for the executive (and/or his dependents, if any). The monthly amount, based on rates in
effect as of December 31, 2013, to be paid by us on behalf of our named executive officers was as
follows: Mr. Skoglund - $660.90; Mr. Cheatham - $1,094.48; and Mr. Eccher - $1,010.96.
(cid:120) At our expense, standard outplacement services for a period of up to one year from the date of
executive’s termination. The maximum amount to be paid by us for such outplacement services
is limited to $20,000.
(cid:120) Where, upon the occurrence of a change in control, an executive is subject to certain excise taxes
under Section 280G of the Internal Revenue Code, we will reimburse the executive for those
excise taxes as well as any income and excise taxes payable by the executive as a result of any
reimbursements for the 280G excise taxes. While circumstances could exist under which excise
tax gross-up payments would be due to the executive officers, we do not believe that any
payments made to any of the named executive officers as a result of a termination of employment
in connection with a change in control occurring on December 31, 2013 would result in the
imposition of an excise tax under the Internal Revenue Code.
In exchange for the payments and benefits provided under the Assurance Agreements, the executive
officers agree to be bound by a 24 month (36 month, in the case of Mr. Skoglund) restrictive covenant.
The restrictive covenant will prohibit the executive officers from using, attempting to use, disclosing or
otherwise making known to any person or entity (other than our board of directors) confidential or
proprietary knowledge or information which the executive officers may acquire in the course of their
employment.
The Assurance Agreements define certain relevant terms, generally, as follows:
(cid:120)
(cid:120)
(cid:120)
“Cause” means the occurrence of any one or more of the following: (i) a demonstrably willful and
deliberate act or failure to act by the executive (other than as a result of incapacity due to physical
or mental illness) which is committed in bad faith, without reasonable belief that such action or
inaction is in the best interests of us, which causes actual material financial injury to us, or any of
its subsidiaries, and which action or inaction is not remedied within fifteen business days of
written notice from us or the subsidiary for which the executive works; or (ii) the executive’s
conviction for committing an act of fraud, embezzlement, theft or any other act constituting a
felony involving moral turpitude which causes material harm, financial or otherwise, to us or any
of our subsidiaries.
“Good reason” means the occurrence of any one or more of the following within the 24-month
period (36-month period, in the case of Mr. Skoglund) following the change in control: (i) a
material reduction or alteration in the nature or status of authorities, duties or responsibilities
from those in effect as of 90 days prior to the change in control; (ii) moving the executive’s
principal office more than 25 miles from its location immediately prior to the change in control;
(iii) a material reduction of the executive’s base salary and/or other benefits; and, (iv) a material
breach by us or a successor, of any term of the Assurance Agreement, including any failure by us
to ensure assumption of the Assurance Agreement by a successor or any failure of a successor
company to assume and agree to perform our entire obligations under the Assurance Agreement.
“Change in control” means (i) any person, company or other entity, other than an employee
benefit plan or subsidiary company of us, becoming the beneficial owner, either directly or
indirectly, of 33% or more of our stock; (ii) during any two consecutive years, a change in a
majority of the members of our board of directors; or (iii) consummation of a merger or
consolidation where our stockholders before the merger or consolidation do not own more than
67% of the resulting entity, a complete liquidation or our dissolution or a sale or other disposition
of substantially all of our assets.
148
In exchange for the payments and benefits provided under the Assurance Agreements, the executive
officers agree to be bound by confidentiality, non-competition and non-disclosure provisions.
Except for payments and benefits provided by the Assurance Agreements, all other payments and benefits
provided to any NEO upon termination of his or her employment are the same as the payments and
benefits provided to our other eligible employees.
Retirement, Death and Disability. Generally speaking, a termination of employment due to retirement,
death or disability does not entitle the named executive officers to any payments or benefits that are not
available to other employees. Following a termination due to death or disability, an employee (or his or
her estate) shall be entitled to the following:
(cid:120) Upon a termination due to death or disability, all unvested stock options shall become
immediately 100% vested and an employee or beneficiary shall have a period of twelve months
following such termination during which to exercise his or her vested stock options.
(cid:120) Any unvested restricted stock or restricted stock units outstanding at the time of an employee’s
termination due to death or disability shall become immediately 100% vested upon such
termination.
Also, it should be noted that, pursuant to existing agreements, as of the time of a termination of
employment due to retirement, all unvested stock options shall become immediately 100% vested.
Acceleration of Vesting Upon a Change in Control. All employees, including the named executive
officers, who receive equity awards under our equity incentive plan will immediately vest in any unvested
equity awards held by such employees upon the occurrence of a change in control.
DIRECTOR COMPENSATION
Each of our directors also serves as a director of the Bank. In 2013 each non-employee director received
$1,000 for every board meeting and $500 for every committee meeting attended if there were no other
bank-level meetings held that day. Non-employee directors of the Bank received a $13,000 annual
retainer. Due to increased responsibilities associated with mandates from Sarbanes-Oxley, the Lead
Director and Compensation Committee Chairman, Mr. Palmer, received an $18,000 retainer in 2013 and
the Audit Committee Chairman, Mr. Finn, received a $20,000 annual retainer in 2013, due to increased
meetings and increased time spent on behalf of the Audit Committee. Messrs. Skoglund, Eccher and
Cheatham, as our executive officers, did not receive any board fees for their service on our board, nor did
they receive board fees for their service on the board of the Bank. The following table sets forth the fees
earned by each non-employee director and senior director in 2013:
Name
Edward Bonifas ................................................................
Barry Finn ........................................................................
William Kane ...................................................................
John Ladowicz .................................................................
William Meyer .................................................................
Gerald Palmer ..................................................................
James C. Schmitz .............................................................
Fees earned
or paid in
cash
($)(1)
$46,500
51,000
38,000
47,000
38,500
46,500
46,500
Total
($)
$46,500
51,000
38,000
47,000
38,500
46,500
46,500
(1) We maintain the Old Second Bancorp, Inc. Amended and Restated Voluntary
Deferred Compensation Plan for Directors under which directors are permitted to
149
defer receipt of their directors’ fees. The directors who participate in the plan are
permitted to make hypothetical investments in publicly-traded funds that are held
in an insurance company separate account, with respect to the contributions
credited to their plan accounts. We may, but are not required to, contribute the
deferred fees into a trust, which may hold our stock. The plan is a nonqualified
deferred compensation plan and the directors have no interest in the trust. The
deferred fees and any earnings thereon are our unsecured obligations. Any
shares held in the trust are treated as treasury shares and may not be voted on any
matter presented to stockholders. We do not pay any above-market interest on
the compensation or fees deferred by the directors.
Compensation Committee Interlocks and Insider Participation
The members of the Compensation Committee in 2013 were Messrs. Bonifas, Kane, Meyer and Palmer
(who served as Chairman), each of whom is an “independent” director as defined by Nasdaq, an “outside”
director pursuant to Section 162(m) of the Internal Revenue Code and a “non-employee” director under
Section 16 of the Securities Exchange Act of 1934. We expect that these members will continue to serve
on the committee in 2014.
Item 12.
Stockholder Matters
Security Ownership of Certain Beneficial Owners and Management and Related
The following table sets forth certain information with respect to the beneficial ownership of the
Company’s common stock at December 31, 2013, by each person known by us to be the beneficial owner
of more than 5% of the outstanding common stock, by each director, by each executive officer named in
the Summary Compensation Table (which can be found in Item 11 of this Form 10-K), and by all
directors and executive officers of the Company as a group. Beneficial ownership has been determined
for this purpose in accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”), under which a person is deemed to be the beneficial owner of securities if he or she
has or shares voting power or investment power with respect to such securities or has the right to acquire
beneficial ownership of securities within 60 days of December 31, 2013. Unless otherwise noted, the
address of each 5% stockholder is 37 South River Street, Aurora, Illinois 60506.
Name of Individual and Number of Persons in Group
5% Stockholders:
Old Second Bancorp, Inc.(2) ....................................................
Profit Sharing Plan & Trust
Dimensional Fund Advisors LP(3) ...........................................
Palisades West, Building One
6300 Bee Cave Road
Austin, Texas 78746
Amount and
Nature of
Beneficial
Ownership(1)
1,424,989
935,463
Percent
of Class
10.2%
6.7%
150
Name of Individual and
Number of Persons in Group
Directors:
Edward Bonifas(10) ................
J. Douglas Cheatham(5) ........
James Eccher(6) .....................
Barry Finn(10) ........................
William Kane(10) ...................
John Ladowicz(7) ...................
William Meyer(10) .................
Gerald Palmer(10) ..................
J. Carl Schmitz(8)(10) ..............
William B. Skoglund(9) .........
Duane Suits ...........................
34,326
126,652
117,656
25,296
53,296
314,727
93,314
61,962
59,496
247,284
4,700
All directors and executive
officers as a group (11 persons)
1,151,965
* Less than 1%.
Common
Stock
Percent of
Class of
Common Stock
Series B
Preferred Stock(4)
Percent of Class
of Series B
Preferred Stock
*
*
*
*
*
2.3%
*
*
*
1.8%
*
8.3%
284
*
120
*
*
283
*
567
200
*
56
*
*
*
*
*
*
*
*
*
*
*
1,510
2.1%
(1)
Includes ownership of shares of our common stock by spouse (even though any beneficial interest is
disclaimed) and in our profit sharing plan and trust and our salary savings plan.
(2)
In addition, as of December 31, 2013, Old Second National Bank held in its trust department, in
various fiduciary capacities (other than as trustee of our profit sharing plan and trust), 810,201 shares
of our common stock. Old Second had full investment power with respect to 244,480 shares and
shared investment power with respect to 58,166 shares.
(3) As reported on a Schedule 13G/A filed on February 11, 2013.
(4) Certain of our directors purchased shares of our Series B Preferred Stock from Treasury in the first
quarter of 2013.
(5) Includes 51,000 shares issuable pursuant to options held by Mr. Cheatham as well as 5,000 shares of
restricted stock, plus an additional 20,000 shares of restricted stock granted in February of 2013.
Also includes 4,192 shares held in our profit sharing plan and trust, 36,058 shares held in our 401(k)
plan, and 10,402 shares held in Mr. Cheatham’s name alone. The shares of restricted stock granted to
Mr. Cheatham are subject to two-year cliff vesting, and therefore the 20,000 shares granted in
February of 2012 will fully vest in 2014.
(6) Includes 56,000 shares issuable pursuant to options held by Mr. Eccher, as well as 5,000 shares of
restricted stock in addition to 25,000 shares of restricted stock granted in February of 2013. Also
includes 1,960 shares held in our profit sharing plan and trust, 6,242 shares held in our 401(k) plan,
50 in his name alone, 148 held with his spouse, and 23,256 shares held in brokerage. The shares of
restricted stock granted to Mr. Eccher are subject to two-year cliff vesting, and therefore the 20,000
shares granted in February of 2012 will fully vest in 2014.
(7) Includes 268,181 shares held in our 401(k) plan.
(8) Mr. Schmitz has voting control of 50,000 shares held in the J. C. Schmitz Revocable Trust.
(9) Includes 136,000 shares issuable pursuant to options held by Mr. Skoglund, as well as 5,000 shares of
restricted stock plus an additional 30,000 shares of restricted stock granted in February of 2013. The
total also includes 47,038 shares held in our profit sharing plan and trust, 14,206 shares held in our
401(k) plan, and 15,040 shares held in Mr. Skoglund’s name alone. The shares of restricted stock
151
granted to Mr. Skoglund are subject to two-year cliff vesting, and therefore the 20,000 shares granted
in February of 2012 will fully vest in 2014.
(10) Each director, with the exception of Mr. Cheatham, Mr. Eccher, Mr. Skoglund and Mr. Ladowicz,
holds a total of 7,500 options from grants of 1,500 shares in each of 2005-2009, as well as 596
restricted stock units for 2009. Mr. Ladowicz was appointed to the board on February 8, 2008 and
was awarded options in February of 2009 of 1,500 shares, along with the other Board members, as
well as 596 restricted stock units. In addition, in January of 2010, all non-employee directors were
given 1,200 restricted stock units. All options vest in three equal installments on the first three
anniversaries of the grant date and the exercisable portion is included in these totals. The 596
restricted stock units are subject to cliff vesting and fully vested in 2012. The 1,200 restricted stock
units granted to all non-employee directors are subject to cliff vesting and fully vested in 2013.
The table below sets forth the following information as of December 31, 2013 for (i) all equity
compensation plans previously approved by the Company’s stockholders and (ii) all equity compensation
plans not previously approved by the Company’s stockholders:
(a) the number of securities to be issued upon the exercise of outstanding options, warrants and
rights;
(b) the weighted-average exercise price of such outstanding options, warrants and rights;
(c) other than securities to be issued upon the exercise of such outstanding options, warrants and
rights, the number of securities remaining available for future issuance under the plans.
EQUITY COMPENSATION PLAN INFORMATION
Plan category
Equity compensation plans approved
by security holders
Equity compensation plans not
approved by security holders
Total
Number of securities
to be issued upon the
exercise of
outstanding options
Weighted-
average exercise
price of
outstanding
options
Number of
securities remaining
available for future
issuance
325,500
$
29.56
-
325,500
-
$
29.56
45,368
-
45,368
Security holders approved 100,000 shares in 1994, 250,000 shares in 2002 and 575,000 shares in 2008 to
be issued upon the exercise of options. Subsequent stock splits are reflected in the table above.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The board has determined that all of the Company’s directors are "independent" as defined by the Nasdaq
Stock Market, with the exception of Messrs. Skoglund, Cheatham and Eccher, each of whom is an
executive officer. During its review of director independence, the board considered Mr. Finn's roles as
President and Chief Executive Officer of Rush-Copley Medical Center and Mr. Skoglund's position as the
Vice Chairman of Rush-Copley's board of directors. The board determined that this does not preclude a
finding that Mr. Finn is independent under Nasdaq's rules because Mr. Skoglund does not serve on Rush-
152
Copley's compensation committee and has recused himself from any discussions or votes that involve
Mr. Finn's salary. The board also reviewed certain transactions between Alarm Detection Systems, Inc.
and the Company. Mr. Bonifas is a Vice President of Alarm Detection Systems, Inc. The board
determined that Mr. Bonifas qualified as an independent director because the amounts paid to Alarm
Detection Systems by the Company were less than 5% of Alarm Detection System’s gross revenues for
2013.
Item 14. Principal Accountant Fees and Services
At the 2013 annual meeting of the Company, the Company’s shareholders ratified the appointment of
Plante & Moran, PLLC, as the Company’s independent registered public accounting firm for the year
ending December 31, 2013. The Company expects to appointment Plante & Moran, PLLC, as its
independent registered public accounting firm for the year ending December 31, 2014, and to seek its
shareholders ratification of that appointment at the 2014 annual meeting.
Audit Fees. The aggregate fees and expenses paid to Plante & Moran PLLC in connection with the
audit of the Company’s annual financial statements and the related securities filings were $421,929
for 2013 and $281,563 for 2012.
Audit Related Fees. Audit related fees paid to Plante & Moran PLLC were $62,500 for 2013 and
were $94,411 for 2012.
Tax Fees. There were no amounts for tax related services billed by Plante & Moran, PLLC for
2013 or 2012.
All Other Fees. All other fees paid to Plante & Moran PLLC were $23,500 for 2013, and there
were no aggregate fees or pre-approved expenses billed by Plante & Moran, PLLC for all other
services rendered to us for 2012.
The Audit Committee of the Company’s board of directors is solely responsible for the pre-approval
of all audit and non-audit services to be provided by the independent accountants and the Audit
Committee exercises its authority to do so in accordance with the Audit Committee policy that it has
adopted. All services provided by Plante & Moran, PLLC were approved pursuant to the pre-
approval policy. The pre-approval policy is available on our website at www.oldsecond.com.
Item 15. Exhibits and Financial Statement Schedules
PART IV
(1) Index to Financial Statements: See Part II--Item 8. Financial Statements and Supplementary
Data.
(2) Financial Statement Schedules
All financial statement schedules as required by Item 8 of Form 10-K have been omitted because
the information requested is either not applicable or has been included in the consolidated financial
statements or notes thereto.
(3) Exhibits: See Exhibit Index.
153
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
OLD SECOND BANCORP, INC.
BY:
/s/ William B. Skoglund
William B. Skoglund
Chairman of the Board,
President and Chief Executive
Officer
(principal executive officer)
BY:
/s/ J. Douglas Cheatham
J. Douglas Cheatham
Executive Vice-President and
Chief Financial Officer,
(principal
financial
accounting officer)
and
DATE: February 26, 2014
154
SIGNATURES (Continued)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ William B. Skoglund
William B. Skoglund
/s/ James Eccher
James Eccher
/s/ J. Douglas Cheatham
J. Douglas Cheatham
/s/ Edward Bonifas
Edward Bonifas
/s/ Barry Finn
Barry Finn
/s/ William Kane
William Kane
/s/ John Ladowicz
John Ladowicz
/s/ William Meyer
William Meyer
/s/ Gerald Palmer
Gerald Palmer
/s/ James Carl Schmitz
James Carl Schmitz
/s/ Duane Suits
Duane Suits
Chairman of the Board, Director
President and Chief Executive Officer
February 26, 2014
President and Chief Executive Officer
Old Second National Bank
February 26, 2014
Executive Vice President and
Chief Financial Officer, Director
February 26, 2014
February 26, 2014
February 26, 2014
February 26, 2014
February 26, 2014
February 26, 2014
February 26, 2014
February 26, 2014
February 26, 2014
Director
Director
Director
Director
Director
Director
Director
Director
155
EXHIBIT
NO.
EXHIBIT INDEX
Description of Exhibits
3.1
Restated Certificate of Incorporation of Old Second Bancorp, Inc. (incorporated herein by
reference to Exhibit 3.1 to Form S-3 filed by Old Second Bancorp, Inc., on May 13, 2010.
3.2
Bylaws of Old Second Bancorp, Inc. (incorporated herein by reference to Exhibit 3.2 of the
Form S-4 filed by Old Second Bancorp, Inc., on December 19, 2007).
4.1
4.2
Amended and Restated Rights Agreement and Tax Benefits Preservation Plan, dated
September 12, 2012 (incorporated herein by reference to Exhibit 99.1 of Form 8-K filed by
Old Second Bancorp, Inc., September 13, 2012).
Form of Stock Certificate for Series B Fixed Rate Cumulative Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K filed by Old Second
Bancorp, Inc. on January 16, 2009).
4.3
Warrant to Purchase Shares of Common Stock, dated January 16, 2009 (incorporated herein
by reference to Exhibit 4.2 of the Company’s Form 8-K filed on January 16, 2009).
10.1
Form of Compensation and Benefits Assurance Agreements for the executive officers (filed
as Exhibit 10.1 to the Company's Form 10-Q filed on November 8, 2006 and incorporated
herein by reference).
10.2
Old Second Bancorp, Inc. Employees 401 (k) Savings Plan and Trust (filed with the
Company’s Form S-8 filed on June 9, 2000 and incorporated herein by reference).
10.3
Form of Indenture relating to trust preferred securities (filed as Exhibit 4.1 to the Company’s
registration statement on the Company’s Form S-3 filed on May 20, 2003 and incorporated
herein by reference).
10.4
Indenture between Old Second Bancorp, Inc. as issuer, and Wells Fargo Bank, National
Association, as Trustee, dated as of April 30, 2007 (filed as exhibit 99 (b) (2) to the
Company’s Amendment No. 1 to Schedule TO filed on May 2, 2007 and incorporated herein
by reference and incorporated herein by reference).
10.5
Old Second Bancorp, Inc. 2008 Long Term Incentive Plan (filed as Appendix A to the
Company’s Form DEF14A filed on March 17, 2008 and incorporated herein by reference).
156
10.6 Compensation and Benefits Assurance Agreement for Mr. Eccher (filed as Exhibit 10.1 to
the Company’s Form 8-K filed on February 10, 2005 and incorporated herein by reference).
10.7
Amended and Restated Voluntary Deferred Compensation Plan for Executives and Directors
(filed as an Exhibit to the Company’s Form 8-K filed on March 28, 2005 and incorporated
herein by reference).
10.8
Amendment to the Old Second Bancorp, Inc. Supplemental Executive and Retirement Plan
(filed as Exhibit 10.1 to the Company’s Form 8-K filed on October 24, 2005 and
incorporated herein by reference).
10.9
Form of Amended Stock Option Award Agreement (filed as Exhibit 10.1 to the Company’s
Form 8-K filed on December 21, 2005 and incorporated herein by reference).
10.10
Loan and Subordinated Debenture Purchase Agreement, dated January 31, 2008, between
LaSalle Bank National Association (now Bank of America) and Old Second Bancorp, Inc.
(filed as Exhibit 10.11 to the Company’s Form 10-K filed on March 17, 2008 and
incorporated herein by reference).
10.11
Agreed Upon Terms and Procedures, dated January 31, 2008, between LaSalle Bank
National Association (now Bank of America) and Old Second Bancorp, Inc. (filed as
Exhibit 10.12 to the Company’s Form 10-K filed on March 17, 2008 and incorporated
herein by reference).
10.12
Letter Agreement, dated January 16, 2009, by and between Old Second Bancorp, Inc., and
the United States Department of the Treasury, which includes the Securities Purchase
Agreement – Standard Terms with respect to the issuance and sale of the Series B Preferred
Stock and the Warrant (filed as Exhibit 10.1 to the Company’s Form 8-K filed on January
16, 2009 and incorporated herein by reference).
10.13
2008 Equity Incentive Plan Restricted Stock Award Agreement (filed as Exhibit 10.1 to the
Company’s Form 8-K filed on February 23, 2009 and incorporated herein by reference).
10.14
2008 Equity Incentive Plan Restricted Stock Unit Award Agreement (filed as Exhibit 10.2 to
the Company’s Form 8-K filed on February 23, 2009 and incorporated herein by reference).
10.15
2008 Equity Incentive Plan Incentive Stock Option (filed as Exhibit 10.3 to the Company’s
Form 8-K filed on February 23, 2009 and incorporated herein by reference).
10.16
2008 Equity Incentive Plan Incentive Non-Qualified Stock Option (filed as Exhibit 10.4 to
the Company’s Form 8-K filed on February 23, 2009 and incorporated herein by reference).
157
10.17
Written Agreement by and between Old Second Bancorp, Inc. and the Federal Reserve Bank
of Chicago, dated July 22, 2011 (filed as Exhibit 10.1 to the Company’s Form 10-Q filed on
August 9, 2011 and incorporated herein by reference).
21.1
A list of all subsidiaries of the Company (filed herewith).
23.1
Consent of Plante & Moran, PLLC (filed herewith).
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2
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 (filed herewith).
99.1
Certification of Chief Executive Officer pursuant to Section III(b) of the Emergency
Economic Stabilization Act of 2008.
99.2
Certification of Chief Financial Officer pursuant to Section III(b) of the Emergency
Economic Stabilization Act of 2008.
101
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) consolidated balance sheets
at December 31, 2013, and December 31, 2012; (ii) consolidated statements of operations for
year ended December 31, 2013, and December 31, 2012; (iii) consolidated statements of
stockholders’ equity for the twelve months ended December 31, 2013, and December 31,
2012; (iv) consolidated statements of cash flows for the twelve months ended December 31,
2013, and December 31, 2012; and (v) Notes to consolidated financial statements, tagged as
blocks of text and in detail.
158
SUMMARY OF FEES FOR BOARD OF DIRECTORS
Each director of Old Second Bancorp, Inc. also serves as a director of Old Second National Bank,
and may serve on boards of its other subsidiaries. In 2013, nonemployee directors received $1,000 for
every board meeting attended and $500 for each committee meeting attended. Nonemployee directors of
Old Second National Bank received a $13,000 annual retainer and Mr. Palmer who also serves as
committee chair of the Compensation or Nominating Committee received an $18,000 annual retainer and
Mr. Finn, as the Audit Committee financial expert, received a $20,000 retainer in 2013.
Nonemployee directors of Old Second National Bank are also eligible to receive options and
restricted stock awards pursuant to the Old Second Bancorp, Inc. 2008 Long Term Incentive Plan. The
Company also maintains the Old Second Bancorp Directors Fee Deferral Plan, under which directors are
permitted to defer receipt of their directors’ fees. The plan is unqualified and the directors have no
interest in the trust. The deferred fees and any earnings thereon are unsecured obligations of Old Second
National Bank.
159
LIST OF SUBSIDIARIES
Exhibit 21.1
Subsidiaries of the Company
Incorporated Under Laws of Percent Owned by the Company
Old Second National Bank
United States
100%
Old Second Capital Trust I
State of Delaware
100% of the common stock
Old Second Capital Trust II
State of Delaware
100% of the common stock
Old Second Affordable
Housing Fund, L.L.C.
State of Illinois
Owned by Old Second National Bank
Station I, LLC
State of Illinois
Owned by Old Second National Bank
Station II, LLC
State of Illinois
Owned by Old Second National Bank
Station III, LLC
State of Illinois
Owned by Old Second National Bank
Station IV, LLC
State of Illinois
Owned by Old Second National Bank
Station V, LLC
State of Illinois
Owned by Old Second National Bank
Station VI, LLC
State of Illinois
Owned by Old Second National Bank
Station VII, LLC
State of Illinois
Owned by Old Second National Bank
River Street Advisors, LLC
State of Illinois
Owned by Old Second National Bank
160
Exhibit 23.1
Consent of Independent Registered
Public Accounting Firm
We have issued our report dated February 26, 2014, with respect to the consolidated financial statements
(which are included in the 2013 Annual Report to Stockholders, attached as an exhibit to the Annual Report
on Form 10-K) and internal control over financial reporting included in the Annual Report of Old Second
Bancorp, Inc. on Form 10-K for the year ended December 31, 2013. We hereby consent to the
incorporation by reference of said reports in the Registration Statements of Old Second Bancorp, Inc. on
Form S-8 (File No. 333-38914, effective June 9, 2000; File No. 333-137261, effective September 12, 2006;
File No. 333-137262, effective September 12, 2006; and File No. 333-151794, effective June 20, 2008) and
Form S-3 (File No. 333-31049, effective August 6, 1997; File No. 333-105421, effective June 25, 2003; File
No. 333-158715, effective April 23, 2009; and File No. 333-166806, effective May 26, 2010).
/s/ Plante & Moran, PLLC
Chicago, Illinois
February 26, 2014
161
Exhibit 31.1
I, William B. Skoglund, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Old Second Bancorp, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by
this report;
Based on my knowledge, the financial statements, and other financial information included in
this report, fairly present in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))
and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
Designed such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting
principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such
evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant’s auditors and the audit
committee of registrant’s board of directors (or persons performing the equivalent functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize, and report financial information; and
Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant’s internal control over financial reporting.
Dated: February 26, 2014
/s/ William B. Skoglund
William B. Skoglund
President and Chief Executive Officer
162
Exhibit 31.2
I, J. Douglas Cheatham, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Old Second Bancorp, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by
this report;
Based on my knowledge, the financial statements, and other financial information included in
this report, fairly present in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))
and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f) for the registrant and have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
Designed such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting
principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such
evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant’s auditors and the audit
committee of registrant’s board of directors (or persons performing the equivalent functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize, and report financial information; and
Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant’s internal control over financial reporting.
Dated: February 26, 2014
/s/ J. Douglas Cheatham
____
J. Douglas Cheatham
Chief Financial Officer
163
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Old Second Bancorp, Inc. (the “Company”) on Form 10-K for the
period ending December 31, 2013, as filed with the Securities and Exchange Commission on the date hereof
(the “Report), I, William B Skoglund, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities
Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial
condition and result of operations of the Company.
/s/ William B. Skoglund
William B. Skoglund
President and Chief Executive Officer
Dated: February 26, 2014
164
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2
In connection with the Annual Report of Old Second Bancorp, Inc. (the “Company”) on Form 10-K for the
period ending December 31, 2013, as filed with the Securities and Exchange Commission on the date hereof
(the “Report), I, J. Douglas Cheatham, Chief Financial Officer, certify, pursuant to 18 U.S.C. § 1350, as
adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities
Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial
condition and result of operations of the Company.
/s/ J. Douglas Cheatham
J. Douglas Cheatham
Executive Vice-President and Chief Financial Officer
Dated: February 26, 2014
165
Exhibit 99.1
Old Second Bancorp, Inc.
Certification of the Principal Executive Officer
Pursuant to Section 111(b) EESA
Fiscal Year Ended December 31, 2012
I, William B. Skoglund, the President and Chief Executive Officer of Old Second Bancorp, Inc. (“Old
Second”), certify, based on my knowledge, that:
(i)
The compensation committee of Old Second has discussed, reviewed, and evaluated with
senior risk officers at least every six months during any part of the most recently completed fiscal year
that was a TARP period, senior executive officer (SEO) compensation plans and employee compensation
plans and the risks these plans pose to Old Second;
(ii)
The compensation committee of Old Second has identified and limited during any part of
the most recently completed fiscal year that was a TARP period any features of the SEO compensation
plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of Old
Second and has identified any features of the employee compensation plans that pose risks to Old Second
and has limited those features to ensure that Old Second is not unnecessarily exposed to risks;
(iii)
The compensation committee has reviewed, at least every six months during any part of
the most recently completed fiscal year that was a TARP period, the terms of each employee
compensation plan and identified any features of the plan that could encourage the manipulation of
reported earnings of Old Second to enhance the compensation of an employee, and has limited such
features;
(iv)
The compensation committee of Old Second will certify to the reviews of the SEO
compensation plans and employee compensation plans required under (i) and (iii) above;
(v)
The compensation committee of Old Second will provide a narrative description of how
it limited during any part of the most recently completed fiscal year that was a TARP period the features
in (A) SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could
threaten the value of Old Second; (B) Employee compensation plans that unnecessarily expose Old
Second to risks; and (C) Employee compensation plans that would encourage the manipulation of
reported earnings of Old Second to enhance the compensation of an employee;
(vi)
Old Second has required that bonus payments to SEOs or any of the next twenty most
highly compensated employees, as defined in the regulations and guidance established under section 111
of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most
recently completed fiscal year that was a TARP period if the bonus payments were based on materially
inaccurate financial statements or any other materially inaccurate performance metric criteria;
(vii) Old Second has prohibited any golden parachute payment, as defined in the regulations
and guidance established under section 111 of EESA, to a SEO or any of the next five most highly
compensated employees during any part of the most recently completed fiscal year that was a TARP
period;
(viii) Old Second has limited bonus payments to its applicable employees in accordance with
section 111 of EESA and the regulations and guidance established thereunder during any part of the most
recently completed fiscal year that was a TARP period;
166
(ix)
Old Second and its employees have complied with the excessive or luxury expenditures
policy, as defined in the regulations and guidance established under section 111 of EESA, during any part
of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the
policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an
executive officer with a similar level of responsibility were properly approved;
(x)
Old Second will permit a non-binding shareholder resolution in compliance with any
applicable Federal securities rules and regulations on the disclosures provided under the Federal securities
laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal
year that was a TARP period;
(xi)
Old Second will disclose the amount, nature, and justification for the offering, during any
part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in
the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000
for any employee who is subject to the bonus payment limitations identified in paragraph (viii);
(xii) Old Second will disclose whether Old Second, the board of directors of Old Second, or
the compensation committee of Old Second has engaged during any part of the most recently completed
fiscal year that was a TARP period a compensation consultant; and the services the compensation
consultant or any affiliate of the compensation consultant provided during this period;
(xiii) Old Second has prohibited the payment of any gross-ups, as defined in the regulations
and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly
compensated employees during any part of the most recently completed fiscal year that was a TARP
period;
(xiv) Old Second has substantially complied with all other requirements related to employee
compensation that are provided in the agreement between Old Second and Treasury, including any
amendments;
(xv) Old Second has submitted to Treasury a complete and accurate list of the SEOs and the
twenty next most highly compensated employees for the current fiscal year, with the non-SEOs ranked in
descending order of level of annual compensation, and with the name, title, and employer of each SEO
and most highly compensated employee identified; and
(xvi)
I understand that a knowing and willful false or fraudulent statement made in connection
with this certification may be punished by fine, imprisonment, or both. (See, for example 18 U.S.C.
1001.)
By: _/s/ William B. Skoglund
William B. Skoglund
President and Chief Executive Officer
Old Second Bancorp, Inc.
Dated: February 26, 2014
167
Exhibit 99.2
Old Second Bancorp, Inc.
Certification of the Principal Financial Officer
Pursuant to Section 111(b) EESA
Fiscal Year Ended December 31, 2012
I, J. Douglas Cheatham, the Executive Vice President and Chief Financial Officer of Old Second Bancorp, Inc. (“Old
Second”), certify, based on my knowledge, that:
(i)
The compensation committee of Old Second has discussed, reviewed, and evaluated with senior risk
officers at least every six months during any part of the most recently completed fiscal year that was a TARP period,
senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to
Old Second;
(ii)
The compensation committee of Old Second has identified and limited during any part of the most
recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs
to take unnecessary and excessive risks that could threaten the value of Old Second and has identified any features of the
employee compensation plans that pose risks to Old Second and has limited those features to ensure that Old Second is
not unnecessarily exposed to risks;
(iii)
The compensation committee has reviewed, at least every six months during any part of the most recently
completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features
of the plan that could encourage the manipulation of reported earnings of Old Second to enhance the compensation of an
employee, and has limited such features;
(iv)
The compensation committee of Old Second will certify to the reviews of the SEO compensation plans
and employee compensation plans required under (i) and (iii) above;
(v)
The compensation committee of Old Second will provide a narrative description of how it limited during
any part of the most recently completed fiscal year that was a TARP period the features in (A) SEO compensation plans
that could lead SEOs to take unnecessary and excessive risks that could threaten the value of Old Second; (B) Employee
compensation plans that unnecessarily expose Old Second to risks; and (C) Employee compensation plans that would
encourage the manipulation of reported earnings of Old Second to enhance the compensation of an employee;
(vi)
Old Second has required that bonus payments to SEOs or any of the next twenty most highly
compensated employees, as defined in the regulations and guidance established under section 111 of EESA (bonus
payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year
that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other
materially inaccurate performance metric criteria;
(vii) Old Second has prohibited any golden parachute payment, as defined in the regulations and guidance
established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any
part of the most recently completed fiscal year that was a TARP period;
(viii) Old Second has limited bonus payments to its applicable employees in accordance with section 111 of
EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year
that was a TARP period;
(ix)
Old Second and its employees have complied with the excessive or luxury expenditures policy, as defined
in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed
fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of
directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were
properly approved;
168
(x)
Old Second will permit a non-binding shareholder resolution in compliance with any applicable Federal
securities rules and regulations on the disclosures provided under the Federal securities laws related to SEO compensation
paid or accrued during any part of the most recently completed fiscal year that was a TARP period;
(xi)
Old Second will disclose the amount, nature, and justification for the offering, during any part of the most
recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance
established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus
payment limitations identified in paragraph (viii);
(xii) Old Second will disclose whether Old Second, the board of directors of Old Second, or the compensation
committee of Old Second has engaged during any part of the most recently completed fiscal year that was a TARP period
a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant
provided during this period;
(xiii) Old Second has prohibited the payment of any gross-ups, as defined in the regulations and guidance
established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any
part of the most recently completed fiscal year that was a TARP period;
(xiv) Old Second has substantially complied with all other requirements related to employee compensation that
are provided in the agreement between Old Second and Treasury, including any amendments;
(xv) Old Second has submitted to Treasury a complete and accurate list of the SEOs and the twenty next most
highly compensated employees for the current fiscal year, with the non-SEOs ranked in descending order of level of
annual compensation, and with the name, title, and employer of each SEO and most highly compensated employee
identified; and
(xvi)
I understand that a knowing and willful false or fraudulent statement made in connection with this
certification may be punished by fine, imprisonment, or both. (See, for example 18 U.S.C. 1001.)
By:
/s/ J. Douglas Cheatham
J. Douglas Cheatham
Executive Vice President and Chief Financial Officer
Old Second Bancorp, Inc.
Dated: February 26, 2014
169
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170
Old Second Bancorp, Inc. and
Old Second National Bank Directors
William Skoglund
Chairman, President & CEO,
Old Second Bancorp, Inc. &
Chairman, Old Second National Bank
James Eccher
EVP & COO, Old Second Bancorp, Inc. &
President & CEO,
Old Second National Bank
J. Douglas Cheatham
Executive Vice President & Chief Financial Officer,
Old Second Bancorp, Inc.
Edward Bonifas
Vice President, Alarm Detection Systems, Inc.
Barry Finn
President & CEO, Rush-Copley
Medical Center
William Kane
General Partner,
The Label Printers, Inc.
John Ladowicz
Former Chairman & CEO,
HeritageBanc Inc. & Heritage Bank
William Meyer
President, William F. Meyer Company
Gerald Palmer
Retired, Vice President & General Manager, Caterpillar, Inc.
James Schmitz
Tax Consultant
Duane Suits
Retired Partner, Sikich LLP
Directors Emeriti
Walter Alexander, President, Alexander Lumber Company
James Benson, Retired Chairman of the Board,
Old Second Bancorp, Inc. and Old Second National Bank
Marvin Fagel, Retired, Aurora Packing Company
and New City Packing Company
Jesse Maberry, Retired, Aurora Bearing Company
Edward Schmitt, Retired, Schmitt McDonalds
Townsend Way, Jr., Retired, Richards - Wilcox Mfg. Co.
Member FDIC
171
Genoa
23
Hampshire
Burlington
72
Pingree
Grove
Sleepy
Hollow
47
20
Elgin
Sycamore
De
DeKalb
KANE
Wasco
Maple Park
38
DDDDDEKAL
DEKALB
Hinckley
30
23
Elburn
88
Geneva
25
Kaneville
Batavia
31
N. Aurora
Sugar Grove
Big Rock
Aurora
30
Montgomery
59
Hoffman
Estates
90
Arlington
Heights
94
294
Schaumburg
290
COOK
Oak Park
290
45
20
294
St. Charles
64
W. Chicago
20
290
Carol
Stream
355
Winfield
DUPAGE
Wheaton
56
Warrenville
Downers
Grove
Oak
Brook
Lisle
34
Naperville
Bolingbrook
55
Plano
34
Yorkville
Oswego
30
59
Sandwich
KENDALL
Plainfield
47
Romeoville
53
Lockport
WILL
Joliet
90
94
94
57
Oak
Lawn
45
Orland
Park
71
LASALLE
23
Ottawa
Morris
80
Shorewood
Minooka
55
30
80
Mokena
New
Lenox
Frankfort
Chicago
Heights
57
71
45
Peotone
Old Second National Bank
37 S. River St., Aurora
555 Redwood Dr., Aurora
1350 N. Farnswor th Ave., Aurora
1230 N. Orchard Road, Aurora
4080 Fox Valley Ctr. Dr., Aurora
1991 W. Wilson St., Batavia
1078 E. Wilson St., Batavia
194 S. Main St., Burlington
195 W. Joe Orr Rd., Chicago Heights
749 N. Main St., Elburn
1000 S. McLean Blvd., Elgin
3290 Rt. 20, Elgin
20201 S. LaGrange Rd., Frankfor t
850 Essington Rd., Joliet
2S101 Har ter Rd., Kaneville
3101 Ogden Ave., Lisle
1100 S. County Line Rd., Maple Park
951 E. Lincoln Hwy., New Lenox
200 W. John St., Nor th Aurora
1200 Douglas Rd., Oswego
323 E. Norris Dr., Ottawa
7050 Burroughs Ave., Plano
801 S. Kirk Road, St. Charles
Route 47 @ Cross St., Sugar Grove
1810 DeKalb Ave., Sycamore
40W422 Route 64, Wasco
26 W. Countryside Pkwy., Yorkville
420 S. Bridge St., Yorkville
172
Member FDIC
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