OLD SECOND BANCORP, INC.
ANNUAL REPORT 2019
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
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
For the fiscal year ended December 31, 2019
OR
Commission file number 0-10537
Delaware
(State of Incorporation)
36-3143493
(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
Common Stock, $1.00 par value
Preferred Securities of Old Second Capital Trust I
Trading Symbol(s)
OSBC
OSBCP
Name of each exchange on which registered
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of
this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See
the definitions of ‘‘large accelerated filer,’’ ‘‘accelerated filer,’’ ‘‘smaller reporting company,’’ and ‘‘emerging growth company’’ in Rule 12b–2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial
accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, on June 28, 2019, the last business day of the registrant’s most recently
completed second fiscal quarter, was approximately $374.5 million. The number of shares outstanding of the registrant's common stock, par value $1.00 per share, was 30,019,113 at
March 3, 2020.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain information required by Part III of this Annual Report on Form 10-K is incorporated by reference from the registrant's definitive proxy statement relating to the 2020 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Annual Report on Form 10-
K relates.
EXPLANATORY NOTES
On March 2, 2020, Old Second Bancorp, Inc. redeemed all of the 7.80% cumulative trust preferred securities (NASDAQ: OSBCP) (the
“Trust Securities”) issued by Old Second Capital Trust I (the “Trust”), which are included on the cover page of this Annual Report on
Form 10-K. In connection with the redemption, the Trust Securities were delisted from The Nasdaq Stock Market pursuant to a Form 25
filed with the U.S. Securities and Exchange Commission (the “SEC”). We intend to deregister the Trust Securities under the Securities
Exchange Act of 1934, as amended, pursuant to a Form 15 to be filed with the SEC no later than March 13, 2020. However, as of the
date of this filing, the Trust Securities have not been deregistered and, therefore, are included on the cover page of this Annual Report on
Form 10-K. Because no Trust Securities are issued or outstanding (and we will deregister the Trust Securities), we have not included a
description of the Trust Securities in the Description of Capital Stock included as Exhibit 4.5 to this Annual Report on Form 10-K.
On April 28, 2020, we filed Amendment No. 1 on Form 10-K with the SEC to provide certain information required by Part III of Form
10-K (the “Amended 10-K”), rather than incorporating such information from our definitive proxy statement. We have not included the
Amended 10-K in this Annual Report, as the information included therein is also set forth in our accompanying proxy statement.
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OLD SECOND BANCORP, INC.
Form 10-K
INDEX
PART I
Cautionary Note Regarding Forward-Looking Statements
Item 1
Business
Item 1A
Risk Factors
Item 1B
Unresolved Staff Comments
Item 2
Properties
Item 3
Legal Proceedings
Item 4
Mine Safety Disclosures
PART II
Item 5
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6
Selected Financial Data
Item 7
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A
Quantitative and Qualitative Disclosures about Market Risk
Item 8
Financial Statements and Supplementary Data
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A
Controls and Procedures
Item 9B
Other Information
PART III
Item 10
Directors, Executive Officers, and Corporate Governance
Item 11
Executive Compensation
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13
Certain Relationships and Related Transactions, and Director Independence
Item 14
Principal Accountant Fees and Services
PART IV
Item 15
Exhibits and Financial Statement Schedules
Item 16
Form 10-K Summary
Signatures
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106
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108
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109
109
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report and other publicly available documents of the Company contain forward-looking statements within the meaning of the Private
Securities Litigation Reform Act, including with respect to management’s expectations regarding future plans, strategies and financial
performance, including regulatory developments, industry and economic trends, estimates and assumptions underlying accounting
policies, including management’s initial estimate of the impact of a new credit impairment model, the Current Expected Credit Losses,
or CECL. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management
and on information currently available to management, can be identified by the inclusion of such qualifications as “expects,” “intends,”
“believes,” “may,” “will,” “would,” “could,” “should,” “plan,” “anticipate,” “estimate,” “possible,” “likely” or other indications that the
particular statements are not historical facts and refer to future periods. Because forward-looking statements relate to the future, they are
subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and may be outside of the Company’s
control. Actual events and results may differ materially from those described in such forward-looking statements due to numerous factors,
including:
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negative economic conditions that adversely affect the economy, real estate values, the job market and other factors nationally
and in our market area, in each case that may affect our liquidity and the performance of our loan portfolio;
our ability to achieve anticipated results from any bank acquisition depends on the state of the economic and financial markets
going forward. Specifically, we may incur more credit losses than expected, cost savings may be less than expected, anticipated
strategic gains may be significantly harder or take longer to achieve than expected or may not be achieved in their entirety, and
customer attrition may be greater than expected;
the financial success and viability of the borrowers of our commercial loans;
changes in U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that
may affect, among other things, our liquidity and the value of our assets and liabilities;
competitive pressures from other financial service businesses and from nontraditional financial technology (“FinTech”)
companies;
any negative perception of our reputation or financial strength;
ability to raise additional capital on acceptable terms when needed;
ability to raise cost-effective funding to support business plans when needed:
ability to use technology to provide products and services that will satisfy customer demands and create efficiencies in
operations;
adverse effects on our information technology systems resulting from failures, human error or cyberattacks;
adverse effects of failures by our vendors to provide agreed upon services in the manner and at the cost agreed, particularly our
information technology vendors and those vendors performing a service on the Company’s behalf;
the impact of any claims or legal actions, including any effect on our reputation;
losses incurred in connection with repurchases and indemnification payments related to mortgages;
the soundness of other financial institutions and other counter-party risk;
changes in accounting standards, rules and interpretations and the impact on our financial statements , including revisions to
management’s initial estimates and assumptions surrounding the impact of CECL, which are subject to change based on a
number of factors including changes in our macroeconomic forecasts, credit quality, our loan composition and other factors;
our ability to receive dividends from our subsidiaries;
a decrease in our regulatory capital ratios;
adverse federal or state tax assessments;
risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;
legislative or regulatory changes, particularly changes in regulation of financial services companies;
increased costs of compliance, heightened regulatory capital requirements and other risks associated with changes in regulation
and the current regulatory environment, including the Dodd-Frank Act;
negative changes in our capital position;
the timing of actions by or on behalf of the property trustee of the Trust Securities (defined below);
the adverse effects of events such as outbreaks of contagious disease (such as the novel coronavirus), war or terrorist activities,
or essential utility outages, including deterioration in the global economy, instability in credit markets and disruptions in our
customers’ supply chains and transportation;
changes in trade policy and any related tariffs; and
each of the factors and risks under the heading “Risk Factors” in our 2019 Annual Report on Form 10-K and in subsequent
filings we make with the SEC.
Because the Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain, there can be no
assurances that future actual results will correspond to any forward-looking statements and you should not rely on any forward-looking
statements. Additionally, all statements in this Form 10-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, except as required
by applicable law.
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Item 1. Business
General
PART I
Old Second Bancorp, Inc. is a corporation organized under the laws of the State of Delaware in 1981 that serves as the bank holding
company for its wholly-owned subsidiary bank, Old Second National Bank. Old Second National Bank (the “Bank”) is a national banking
association headquartered in Aurora, Illinois, that operates through 29 banking centers located in Cook, DeKalb, DuPage, Kane, Kendall,
LaSalle and Will counties in Illinois.
In this report, unless the context suggests otherwise, references to the “Company” refer to Old Second Bancorp, Inc. and references to
“we,” “us,” and “our” mean the combined business of the Company, the Bank and its wholly-owned subsidiaries.
We conduct a full service community banking and trust business through the Bank and its wholly-owned subsidiaries:
• Old Second Affordable Housing Fund, L.L.C., which was formed for the purpose of providing down payment assistance for
home ownership to qualified individuals;
• Station I, LLC, which is wholly-owned by the Bank to hold property acquired by the Bank through foreclosure or in the ordinary
course of collecting a debt previously contracted with borrowers; and
• River Street Advisors, LLC, a wholly-owned subsidiary of the Bank, which was formed in May 2010 to provide investment
advisory/management services.
Intercompany transactions and balances are eliminated in consolidation.
We are a full-service banking business offering a broad range of deposit products, trust and wealth management services, and lending
services, including demand, NOW, money market, savings, time deposit and individual retirement accounts; commercial, industrial,
consumer and real estate lending, including installment loans, agricultural loans, lines of credit and overdraft checking; safe deposit
operations, 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, money orders, cashiers’ checks and foreign currency, direct deposit, discount brokerage, debit cards, credit
cards, and other special services. Our lending activities include making commercial and consumer loans, primarily on a secured basis.
Commercial lending focuses on business, capital, construction, inventory and real estate lending. Installment lending includes direct and
indirect loans to consumers and commercial customers.
We also offer 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, foreign and domestic wire transfers, vault services for currency and coin, and
checking accounts. Additionally, we provide 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. We also originate residential
mortgages, offering a wide range of mortgage products including conventional, government, and jumbo loans. We also handle secondary
marketing of those mortgages.
We evaluate our operations as one operating segment, which is community banking. Financial information concerning our operations can
be found in the financial statements in this annual report.
Merger with Greater Chicago Financial Corp.
On April 20, 2018, we completed our acquisition of Greater Chicago Financial Corp., and its wholly-owned bank subsidiary, ABC Bank.
In connection with the merger, Greater Chicago Financial Corp. merged with and into the Company, with the Company as the surviving
company in the merger. Immediately following the merger, ABC Bank, an Illinois state-chartered bank and wholly-owned subsidiary of
Greater Chicago Financial Corp., merged with and into the Bank, with the Bank as the surviving bank. With the acquisition of ABC
Bank, we acquired four branches in the Chicago, Illinois, metropolitan area. ABC Bank had total assets with a fair value of $336.9
million as of April 20, 2018, including $227.6 million of loans, net of purchase accounting adjustments.
Market Area
Our main office is located at 37 South River Street, Aurora, Illinois 60507. The city of Aurora is located in northeastern Illinois,
approximately 40 miles west of Chicago. The Bank operates primarily in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle, and Will
counties in Illinois, and it has developed a strong presence in these counties. The Bank offers its services to retail, commercial, industrial,
and public entity customers in the Aurora, North Aurora, Batavia, St. Charles, Burlington, Elburn, Elgin, Kaneville, Sugar Grove, Lisle,
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Joliet, Yorkville, Plano, Wasco, Ottawa, Oswego, Sycamore, Frankfort, Chicago, Bensenville, and Chicago Heights communities and
surrounding areas through its 29 banking locations that are located primarily west and south of the Chicago metropolitan area.
Lending Activities
We provide a broad range of commercial and retail lending services to corporations, partnerships, individuals and government agencies.
We actively market our services to qualified borrowers, and our lending officers actively solicit the business of new borrowers entering
our market areas as well as long-standing members of the local business community. We have established lending policies that include
a number of underwriting factors to be considered in making a loan, including location, amortization, loan to value ratio, cash flow,
pricing, documentation and the credit history of the borrower. In 2019, we originated approximately $790.2 million in loans, and our
total loan portfolio grew $33.8 million due to organic originations, net of paydowns. We originated approximately $222.7 million of
residential mortgage loans in 2019, which includes originations of loans held for sale of $164.7 million. Proceeds from the sales of
residential mortgage loans to third parties were $168.5 million in 2019.
Our loan portfolio is comprised primarily of loans in the areas of commercial real estate, residential real estate, general commercial,
construction real estate, leases, and consumer lending. As of December 31, 2019, commercial real estate loans represented approximately
45.0% (43.5% at year-end 2018) of our loan portfolio, residential mortgages represented approximately 20.6% (21.6% at year-end 2018),
general commercial loans represented approximately 17.3% (16.7% at year-end 2018), home equity lines of credit represented 6.4%
(7.4% at year-end 2018), construction lending represented approximately 3.6% (5.7% at year-end 2018), leases represented approximately
6.2% (4.2% at year-end 2018), and consumer and other lending represented less than 1.0% (less than 1.0% at year-end 2018). It is our
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.
Commercial Loans. We continue to focus on identifying commercial and industrial prospects in our new business pipeline with favorable
results in 2019. As noted above, we are an active commercial lender in the Chicago metropolitan area, with primary markets in the city
of Chicago, as well as west and south of Chicago. In 2019, we enhanced our commercial lending team with new hires specializing in
health care and professional services, bringing additional expertise to our developing presence in the Chicago metropolitan market.
Commercial lending is comprised of revolving lines of credit for working capital, lending for capital expenditures on manufacturing
equipment and lending to small business manufacturers, service companies, medical and dental entities as well as specialty contractors.
We also have commercial and industrial loans to customers 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, we often obtain 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 term loans range principally from one to
seven years with the majority falling in the one to five year range. Interest rates on commercial loans are a mixture of fixed and variable
rates, with these rates often tied to the prime rate, a spread over the FHLB Chicago index rate, or LIBOR.
Repayment of commercial loans is largely dependent upon the cash flows generated by the operations of the commercial borrower. Our
underwriting procedures identify the sources of those cash flows and seek to match the repayment terms of the commercial loans to those
sources. Secondary repayment sources are typically found in collateralization and guarantor support.
Lease Financing Receivables. We continued growth of our lease portfolio in 2019 primarily with organic lease originations. The
collateral for lease financing receivables primarily includes manufacturing and transportation equipment, and lease terms typically range
from one to seven years, with the majority falling in the one to five year range. Growth in this portfolio reflects management’s efforts to
diversify lending product offerings, and lessen our commercial real estate loan concentration.
Commercial Real Estate Loans. While management has been actively working to reduce our concentration in real estate loans, a large
portion of the loan portfolio continues to be comprised of commercial real estate loans. As of December 31, 2019, approximately $328.1
million, or 37.9% (43.6%, at year-end 2018) of the total commercial real estate loan portfolio of $865.6 million consisted of loans to
borrowers secured by owner occupied property. A primary repayment risk for owner occupied commercial real estate loans is a reduction
of or discontinuance of cash flows from underlying operations; for non-owner occupied loans, cash flow disruptions may occur with the
loss of a tenant or rental income reductions. Repayment could also be influenced by economic events, which may or may not be under
the control of the borrower, or changes in 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, and 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. We seek 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 our borrowers. In most cases, we have collateralized these loans and/or have 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 value of the real estate and
enforceability of personal and corporate guarantees if any exist.
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Construction Loans. Our construction and development portfolio decreased from $108.4 million at December 31, 2018, to $69.6 million
at December 31, 2019, due to a reduction in seasonal demand and completion of several projects that were reclassified to commercial
real estate or sold. We use underwriting and construction loan guidelines to determine whether to issue loans on build-to-suit or build
out arrangements 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 “as-is” and “prospective” 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 12 to 24 months, with extensions as
needed. The Bank disburses loan proceeds in increments as construction progresses and as inspections warrant.
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. Therefore, development lending
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, loan advances are limited to the lesser of the cost to complete or “prospective” value determined
by the appraisal, therefore there is the possibility of an unforeseen event affecting the value and/or costs of the project. Development
loans are primarily used for multi-family developments, where the leasing of units is tied to local demand and rental rates, and commercial
developments, where the success of the project is tied to the demand for commercial space, cap rates and leasing rates. If the borrower
defaults prior to completion of the project, we may be required to fund additional amounts so that another developer can complete the
project. We are 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 local demand for commercial buildings and multi-family housing
shift. We address 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 by project type and obligor.
Residential Real Estate Loans. Residential first mortgage loans and second mortgages are included in this category. First mortgage
loans may include fixed rate loans that are generally sold to investors. We are a direct seller to the Federal National Mortgage Association
(“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and to several large financial institutions. We retain servicing rights
for mortgages sold to FNMA and FHLMC. The retention of such servicing rights is a source of noninterest income and also allows us
an opportunity to have regular contact with mortgage customers and can help to solidify our community involvement. Other loans that
are not sold include adjustable rate mortgages, lot loans, and construction loans that are held in our portfolio. Loans sold to other investors,
such as Federal Housing Administration (“FHA”), and the Veterans Administration (“VA”), are sold with servicing released. We
experienced growth in residential mortgage purchase activity in 2019, with interest rates falling in 2019 reflecting an increase in volume
and mixture of both refinance and purchase financing opportunities.
Home Equity Lines of Credit. Our home equity lines of credit, or HELOCs, consist of originated as well as purchased HELOCs. We
experienced a decline in our home equity lending in 2019, as HELOC payoffs were accelerated on both the organic and purchased
portfolios held. No HELOC portfolio purchases were made in 2019; in 2018, we executed two portfolio purchases from a third party
which totaled $41.6 million. We purchased these HELOCs at a 4.25% premium, and the average annualized yield on the total purchased
HELOC portfolio in 2019 was 5.60%, net of the premium accretion.
Consumer Loans. We also provide many types of consumer loans including primarily motor vehicle, home improvement and signature
loans. 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.
Competition
Our market area is highly competitive and our business activities require us to compete with many other financial institutions. 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 Chicago area or actively compete for customers within our market area. We also face 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, including nontraditional financial technology companies or FinTech
companies. Many of our nonbank competitors which are not subject to the same extensive federal regulations that govern bank holding
companies and banks, such as the Company and the Bank, may have certain competitive advantages.
We compete for loans principally through the quality of our client service and our responsiveness to client needs in addition to competing
on interest rates and loan fees. Management believes that our long-standing presence in the community and personal one-on-one service
philosophy enhances our ability to compete favorably in attracting and retaining individual and business customers. We actively solicit
deposit-related clients and compete for deposits by offering personal attention, competitive interest rates, and professional services made
available through experienced bankers and multiple delivery channels that fit the needs of our market. In wealth management and trust
services, we compete with a variety of custodial banks as well as a diverse group of investment managers.
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We believe the financial services industry will likely continue to become more competitive as further technological advances enable more
financial institutions to provide expanded financial services without having a physical presence in our market.
Employees
At December 31, 2019, we employed 535 full-time equivalent employees.
Available Information
We maintain a corporate website at https://www.oldsecond.com. We make available free of charge on or through our 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 our policies, committee charters and
other investor information including our Code of Business Conduct and Ethics are available on our website. No information contained
on our website is intended to be included as part of, or incorporated by reference into, this Annual Report on Form 10-K. The Company’s
reports, proxy and informational statements and other information regarding the Company are also available free of charge on the SEC’s
website (https://www.sec.gov). We will also provide copies of our filings free of charge upon written request to: Investor Relations, Old
Second Bancorp, Inc., 37 South River Street, Aurora, Illinois 60507.
SUPERVISION AND REGULATION
General
FDIC-insured institutions, their holding companies and their affiliates, are extensively regulated under federal and state law. As a result,
our growth and earnings performance may be affected not only by management decisions and general economic conditions, but also by
the requirements of federal and state statutes and by the regulations and policies of various bank regulatory 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 the Consumer Financial Protection Bureau (the “CFPB”). Furthermore, taxation
laws administered by the Internal Revenue Service (the “IRS”) and state taxing authorities, accounting rules developed by the Financial
Accounting Standards Board (“FASB”), securities laws administered by the Securities and Exchange Commission (the “SEC”) and state
securities authorities, and anti-money laundering laws enforced by the U.S. Department of the Treasury (“Treasury”) have an impact on
our business. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to our operations and
results.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of FDIC-
insured institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and
depositors of banks, rather than stockholders. These laws, and the regulations of the bank regulatory agencies issued under them, affect,
among other things, the scope of our business, the kinds and amounts of investments we may make, reserve requirements, required capital
levels relative to assets, the nature and amount of collateral for loans, the establishment of branches, our ability to merge, consolidate and
acquire, dealings with our insiders and affiliates and our payment of dividends. We have experienced heightened regulatory requirements
and scrutiny following the global financial crisis, and as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(the “Dodd-Frank Act”). Although the reforms primarily targeted systemically important financial service providers, their influence
filtered down in varying degrees to community banks over time, and the reforms have caused our compliance and risk management
processes, and the costs thereof, to increase.
This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by 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 certain 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. These statutes and regulations are subject to change, and additional statutes, regulations, and corresponding
guidance may be adopted. We are unable to predict these future changes or the effects, if any, that these changes could have on our
business, revenues, and results of operations.
Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their
business, FDIC-insured institutions are generally required to hold more capital than other businesses, which directly affects our earnings
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capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and
banks, its role became 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 that are meaningfully more stringent than those in place previously.
Basel III Capital Standards. Regulatory capital rules adopted in July 2013 and fully-phased in as of January 1, 2019, which we refer to
as the Basel III rules or Basel III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules
apply to all national and state banks and savings and loan associations regardless of size and bank holding companies and savings and
loan holding companies other than “small bank holding companies,” generally holding companies with consolidated assets of less than
$3 billion. The Company is currently considered a “small bank holding company.” More stringent requirements are imposed on
“advanced approaches” banking organizations which are organizations with $250 billion or more in total consolidated assets, $10 billion
or more in total foreign exposures, or that have opted into the Basel III capital regime.
Specifically, the Bank is required to maintain the following minimum capital levels:
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•
•
•
a common equity Tier 1 (“CET1”), risk-based capital ratio of 4.5%;
a Tier 1 risk-based capital ratio of 6%;
a total risk-based capital ratio of 8%; and
a leverage ratio of 4%.
Under Basel III, Tier 1 capital includes two components: CET1 capital and additional Tier 1 capital. The highest form of capital, CET1
capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, otherwise
referred to as AOCI, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily
comprised of noncumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities (as discussed
below). Tier 2 capital generally includes the allowance for loan losses up to 1.25% of risk-weighted assets, qualifying preferred stock,
subordinated debt and qualifying tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial
institution. Cumulative perpetual preferred stock is included only in Tier 2 capital, except that the Basel III rules permit bank holding
companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual
preferred stock issued before May 19, 2010 in Tier 1 Capital (but not in CET1 capital), subject to certain restrictions. AOCI is
presumptively included in CET1 capital and often would operate to reduce this category of capital. When implemented, Basel III provided
a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of
AOCI. We made this opt-out election and, as a result, retained our pre-existing treatment for AOCI.
In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, under Basel III, a banking
organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must
consist solely of CET1 capital, but the buffer applies to all three risk-based measurements (CET1, Tier 1 capital and total capital). The
2.5% capital conservation buffer was phased in incrementally over time, and became fully effective for us on January 1, 2019, resulting
in the following effective minimum capital plus capital conservation buffer ratios: (i) a CET1 capital ratio of 7.0%, (ii) a Tier 1 risk-based
capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%.
On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the
upcoming implementation of a new credit impairment model, the Current Expected Credit Loss, or CECL model, an accounting standard
under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking
organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020
capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. We are finalizing the analysis
of the impact CECL adoption will have on our financial statements. We currently expect to recognize an overall increase in our allowance
for loans and leases, which will be renamed the allowance for credit losses (“ACL”) in future periods, of approximately $4.0 million to
$6.0 million. In addition, we have established a reserve for unfunded commitments of approximately $1.5 million to $2.5 million.
Approximately $2.5 million of the increase to the ACL results from the transfer of the non-accretable purchase accounting adjustments
on our purchase credit impaired loans. As a result of the adoption of this new standard on January 1, 2020, we expect a reduction to
retained earnings of approximately $3.0 million to $5.0 million. The initial impact estimated by management and in subsequent reporting
periods is highly dependent on credit quality, macroeconomic forecasts and conditions, as well as the composition of our loans and
available-for-sale securities portfolio. The ultimate ACL and retained earnings transition adjustment may fall outside of management’s
current estimates due to a material change in management’s macroeconomic forecast, loan composition and other management
adjustments used in calculating the ACL upon the adoption of CECL.
In November 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain
banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect on January
1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets
and meet other qualifying criteria, including a leverage ratio of greater than 9%, off-balance-sheet exposures of 25% or less of total
consolidated assets, and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed “qualifying community
banking organizations” and are eligible to opt into the “community bank leverage ratio framework.” A qualifying community banking
organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of greater than 9% is
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considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III rules and, if
applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt
corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community banking
organization that temporarily fails to meet any of the qualifying criteria, including the greater-than 9% leverage capital ratio requirement,
is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater than 8%. A
banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must
comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We do not have
any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.
Well-Capitalized Requirements. The ratios described above are minimum standards in order for banking organizations to be considered
“adequately capitalized.” Bank regulatory agencies uniformly encourage banks to hold more capital and 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, roll-over or renew brokered deposits. Higher capital levels could 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.
Under the capital regulations of the OCC, in order to be well-capitalized, a banking organization must maintain:
• A CET1 ratio to risk-weighted assets of 6.5% or more;
• A ratio of Tier 1 Capital to total risk-weighted assets of 8%;
• A ratio of Total Capital to total risk-weighted assets of 10%; and
• A leverage ratio of Tier 1 Capital to total adjusted average quarterly assets of 5% or greater.
Effective with the March 31, 2020 Call Report, qualifying community banking organizations that elect to use the new community bank
leverage ratio framework and that maintain a leverage ratio of greater than 9% will be considered to have satisfied the risk-based and
leverage capital requirements to be deemed well-capitalized.
It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer
discussed above.
As of December 31, 2019, the Bank was well-capitalized, as defined by OCC regulations. As of December 31, 2019, the Company had
regulatory capital in excess of the Federal Reserve’s requirements and met the Basel III Rule requirements to be well-capitalized.
Prompt Corrective Action. An FDIC-insured institution’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 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 sell itself; (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.
Regulation and Supervision of the Company
General. The Company, as the sole stockholder of the Bank, is a bank holding company. As a bank holding company, the Company is
registered with, and subject to regulation, supervision and enforcement by, the Federal Reserve under the Bank Holding Company Act,
as amended (the “BHCA”). The Company is legally obligated to act as a source of financial and managerial 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 and is required to file with the Federal Reserve periodic reports of the
Company’s operations and such additional information regarding the Company and the Bank as the Federal Reserve may require.
Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The
BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition
by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration
limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the
United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the
aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the
state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions or their holding
10
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 examiners must rate them well-managed in order to effect interstate mergers or acquisitions. For
a discussion of the capital requirements, see “Regulatory Emphasis on Capital” above.
The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of 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 services. The BHCA does not place territorial restrictions on the domestic activities of nonbank
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 FDIC-insured institutions or the financial system generally. The Company has not elected to operate as a financial
holding company.
The BHCA prohibits a company from, directly or indirectly, acquiring 25% or more (5% if the acquirer is a bank holding company) of
any class of our voting stock or obtaining the ability to control in any manner the election of a majority of our directors or otherwise
directing the management or policies of the Bank without prior application to and the approval of the Federal Reserve. Moreover, under
the Change in Bank Control Act, any person or group of persons acting in concert who intends to acquire 10% or more of any class of
our voting stock or otherwise obtain control over us would be required to provide prior notice to and obtain the non-objection of the OCC.
Capital Requirements. The Federal Reserve imposes certain capital requirements on a bank holding company under the BHCA, including
a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the
same as those that apply to the Bank and are described above under “Regulatory Emphasis on Capital.” However, because the Company
currently qualifies as a small bank holding company, these capital requirements do not currently apply to the Company. Subject to certain
restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid
from the Bank to the Company. Our ability to pay dividends depends on, among other things, the Bank’s ability to pay dividends to us,
which is subject to regulatory restrictions as described below in “Regulation and Supervision of the Bank—Dividend Payments.” We
are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to
compliance with federal and state securities laws.
Dividend Payments. The Company’s ability to pay dividends to its stockholders may be affected by both general corporate law
considerations and policies of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, the Company is
subject to the limitations of the Delaware General Corporation Law (the “DGCL”). The DGCL allows the Company to pay dividends
only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such surplus,
out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.
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 stockholders if: (i) the company's net income available to stockholders for the past four quarters, net of
dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is
inconsistent with the company's capital needs and overall current and prospective financial condition; or (iii) the company will not meet,
or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers
over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or
violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and
bank holding companies. In addition, under the Basel III Rule, financial institutions that seek to pay dividends will have to maintain the
2.5% capital conservation buffer. See “Regulatory Emphasis on Capital – Basel III Capital Standards” above.
Incentive Compensation. There have been a number of developments in recent years focused on incentive compensation plans sponsored
by bank holding companies and banks, reflecting recognition by the bank regulatory agencies and Congress that flawed incentive
compensation practices in the financial industry were one of many factors contributing to the global financial crisis. Layered on top of
that are the abuses in the headlines dealing with product cross-selling incentive plans. The result is interagency guidance on sound
incentive compensation practices and proposed rulemaking by the agencies required under Section 956 of the Dodd-Frank Act.
The interagency guidance recognized three core principles; effective incentive plans are required to: (i) provide employees incentives
that appropriately balance risk and reward; (ii) be compatible with effective controls and risk-management; and (iii) be supported by
strong corporate governance, including active and effective oversight by the organization’s board of directors. Much of the guidance
addresses large banking organizations and, because of the size and complexity of their operations, the regulators expect those
organizations to maintain systematic and formalized policies, procedures, and systems for ensuring that the incentive compensation
arrangements for all executive and non-executive employees covered by this guidance are identified and reviewed, and appropriately
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balance risks and rewards. Smaller banking organizations like the Company that use incentive compensation arrangements are expected
to be less extensive, formalized, and detailed than those of the larger banks.
Section 956 of the Dodd-Frank Act required the banking agencies, the National Credit Union Administration, the SEC and the Federal
Housing Finance Agency to jointly prescribe regulations that prohibit types of incentive-based compensation that encourage inappropriate
risk taking and to disclose certain information regarding such plans. On June 10, 2016, the agencies released an updated proposed rule
for comment. Section 956 will only apply to banking organizations with assets of greater than $1 billion. The Company has consolidated
assets greater than $1 billion and less than $50 billion and the Company is considered a Level 3 banking organization under the proposed
rules. The proposed rules contain mostly general principles and reporting requirements for Level 3 institutions so there are no specific
prescriptions or limits, deferral requirements or claw-back mandates. Risk management and controls are required, as is board or committee
level approval and oversight. No final rule has been issued yet.
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 bank borrowings and changes in reserve requirements against
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.
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 reporting, proxy solicitation, insider trading and other
restrictions and requirements of the SEC under the Exchange Act.
Corporate Governance. The Dodd-Frank Act addressed many investor protection, corporate governance and executive compensation
matters that affect most U.S. publicly traded companies. The Dodd-Frank Act (i) grants stockholders of U.S. publicly traded companies
an advisory vote on executive compensation and so-called “golden parachute” payments, (ii) enhances independence requirements for
compensation committee members, (iii) requires the SEC to adopt rules directing national securities exchanges to establish listing
standards requiring all listed companies to adopt incentive-based compensation clawback policies for executive officers, and (iv) provides
the SEC with authority to adopt proxy access rules that would allow stockholders of publicly traded companies to nominate candidates
for election as a director and have those nominees included in a company’s proxy materials. The SEC has completed the bulk (although
not all) of the rulemaking necessary to implement these provisions.
Regulation and Supervision of 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, currently
$250,000 per insured depositor category, 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 chartering authority for national banks. The FDIC,
as administrator of the DIF, also has regulatory authority over the Bank.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the
FDIC. Effective July 1, 2016, the FDIC changed its pricing system for banks under $10 billion, so that minimum and maximum initial
base assessment rates are based on supervisory ratings. The initial base assessment rates currently range from three basis points to
30 basis points. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if needed, increases or decreases
the assessment rates, following notice and comment on proposed rulemaking.
The assessment base against which an FDIC-insured institution’s deposit insurance premiums paid to the DIF are calculated based on its
average consolidated total assets less its average tangible equity. This method shifts the burden of deposit insurance premiums toward
those large depository institutions that rely on funding sources other than U.S. deposits.
The reserve ratio is the DIF balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum 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 FDIC-insured institutions when the reserve ratio exceeds certain thresholds. The reserve ratio reached
1.36% on September 30, 2018. Because the reserve ratio has reached 1.35%, two deposit insurance assessment changes occurred under
FDIC regulations: (1) surcharges on insured depository institutions with total consolidated assets of $10 billion or more (large
institutions) ceased; and (2) banks with assets of less than $10 billion, such as us, received assessment credits for the portion of their
assessments that contributed to the growth in the reserve ratio from between 1.15% and 1.35%, which were applied when the reserve
ratio was at or above 1.38%. These assessment credits started with the June 30, 2019 assessment invoiced in September 2019 and will
run off by March 31, 2020.
FICO Assessments. In addition to paying basic deposit insurance assessments, the FDIC collects Financing Corporation (“FICO”)
assessments to pay interest on FICO bonds. FICO bonds were issued in the late 1980’s to recapitalize the (former) Federal Savings &
Loan Insurance Corporation. The last of the remaining FICO bonds matured in September 2019. Our final FICO assessment was
collected on March 31, 2019.
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 considers the Bank’s size and its supervisory condition. During the year ended
December 31, 2019, the Bank paid supervisory assessments to the OCC totaling $471,000.
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Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital
requirements, see “Regulatory Emphasis on Capital” above.
Liquidity Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets
are those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions must
have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. Because the global financial crisis was
in part a liquidity crisis, Basel III also includes a liquidity framework that requires FDIC-insured institutions to measure their liquidity
against specific liquidity tests. One test, referred to as the Liquidity Coverage Ratio (“LCR”), is designed to ensure that the banking
entity has an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets
into cash to meet liquidity needs for a 30-calendar day liquidity stress scenario. The other test, known as the Net Stable Funding Ratio
(“NSFR”) is designed to promote more medium and long-term funding of the assets and activities of FDIC-insured institutions over a
one-year horizon. These tests provide an incentive for banks and holding companies to increase their holdings in Treasury securities and
other sovereign debt as a component of assets, increase the use of long-term debt as a funding source and rely on stable funding like core
deposits (in lieu of brokered deposits).
In addition to liquidity guidelines already in place, the federal bank regulatory agencies implemented the Basel III LCR in 2014 and have
proposed the NSFR. While the LCR only applies to the largest banking organizations in the country, as will the NSFR, certain elements
are expected to filter down to all FDIC-insured institutions. The Company has adopted a modified version of the LCR as a part of
measuring the liquidity at the Bank. The Company has no plans to adopt the NSFR and has not received regulatory guidance indicating
a requirement to do so.
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 FDIC-insured
institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations,
and an FDIC-insured institution generally is prohibited from paying any dividends if, following payment thereof, the institution would
be undercapitalized. As described above, the Bank exceeded its capital requirements under applicable guidelines as of December 31,
2019. Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the payment of dividends by the Bank if
it determines such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule, institutions that seek
the freedom to pay dividends will have to maintain the 2.5% capital conservation buffer. See “Regulatory Emphasis on Capital” above.
Affiliate and Insider Transactions. The Bank is subject to certain 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, 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 stockholders of the Company and to “related interests” of such directors,
officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person who is a director
or officer of the Company or the Bank, or a principal stockholder of the Company, may obtain credit from banks with which the Bank
maintains a correspondent relationship.
On December 27, 2019, the federal banking agencies issued an interagency statement explaining that such agencies will provide
temporary relief from enforcement action against banks or asset managers, which become principal stockholders of banks, with respect
to certain extensions of credit by banks that otherwise would violate Regulation O, provided the asset managers and banks satisfy certain
conditions designed to ensure that there is a lack of control by the asset manager over the bank. This temporary relief will apply while
the Federal Reserve, in consultation with the other federal banking agencies, considers whether to amend Regulation O.
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 FDIC-insured 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 FDIC-insured institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining
compliance. If an FDIC-insured 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 FDIC-insured institution’s
rate of growth, require the FDIC-insured institution to increase its capital, restrict the rates the institution pays on deposits or require the
institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by
the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal bank regulatory agencies,
including cease and desist orders and civil money penalty assessments.
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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 FDIC-insured 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. New products and services, third-party risk and cybersecurity are critical sources of operational risk that FDIC-insured
institutions are expected to address in the current environment. 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.
The Dodd-Frank Act permits well-capitalized and well-managed banks to establish new interstate branches or acquire individual branches
of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) without 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.
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 determined by the FHLBC.
Transaction Account Reserves. Federal Reserve regulations require FDIC-insured institutions to maintain reserves against their
transaction accounts (primarily NOW and regular checking accounts). For 2019, the first $16.3 million of otherwise reservable balances
are exempt from reserves and have a zero percent reserve requirement; for transaction accounts aggregating more than $16.3 million to
$124.2 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $124.2 million,
the reserve requirement is 3% up to $124.2 million plus 10% of the aggregate amount of total transaction accounts in excess of
$124.2 million. These reserve requirements are subject to annual adjustment by the Federal Reserve.
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. The Bank received an overall “outstanding” rating on its most recent CRA performance evaluation.
In December 2019, the OCC and the FDIC proposed changes to the regulations implementing the CRA, which, if adopted will result in
changes to the current CRA framework. The Federal Reserve Board did not join the proposal.
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 FDIC-insured 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 FDIC-
insured institutions and law enforcement authorities. Bank regulators routinely examine institutions for compliance with these obligations,
and this area has become a particular focus of the regulators in recent years. In addition, the regulators are required to consider compliance
in connection with the regulatory review of certain applications. In recent years, regulators have expressed concern over banking
institutions’ compliance with anti-money laundering requirements and, in some cases, have delayed approval of their expansionary
proposals. The regulators and other governmental authorities have been active in imposing “cease and desist” orders and significant
money penalty sanctions against institutions found to be in violation of the anti-money laundering regulations.
Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any
one industry or segment. A concentration in commercial real estate is one example of regulatory concern. 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) non-owner occupied commercial
14
real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land
development loans exceeding 100% of 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. On December 18, 2015, the federal banking agencies issued a statement
to reinforce prudent risk-management practices related to CRE lending, having observed substantial growth in many CRE asset and
lending markets, increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE underwriting standards.
The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management
practices to identify, measure, monitor, and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must
maintain capital commensurate with the level and nature of their CRE concentration risk.
Based on the Bank’s loan portfolio as of December 31, 2019, concentrations in commercial real estate did not exceed the 300% guideline
for non-owner occupied commercial real estate loans, or the 100% guideline for construction and development loans.
Financial Privacy and Cybersecurity. Under privacy protection provisions of the Gramm-Leach-Bliley Act of 1999 and related
regulations, we are limited in our ability to disclose non-public information about consumers to nonaffiliated third parties. These limitations
require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal
information to a nonaffiliated third party. Federal banking agencies have adopted guidelines for establishing information security
standards and cybersecurity programs for implementing safeguards under the supervision of the board of directors. These guidelines,
along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the
use of third parties in the provision of financial services.
Consumer Protection Regulations. The activities of the Bank are subject to a variety of statutes and regulations designed to protect
consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning
interest rates. The loan operations of the Bank are also subject to federal laws applicable to credit transactions, such as:
•
•
•
•
•
•
the Truth-In-Lending Act (“TILA”) and Regulation Z, governing disclosures of credit and servicing terms to
consumer borrowers and including substantial new requirements for mortgage lending and servicing, as mandated
by the Dodd-Frank Act;
the Home Mortgage Disclosure Act of 1975 and Regulation C, requiring financial institutions to provide information
to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help
meet the housing needs of the communities they serve;
the Equal Credit Opportunity Act and Regulation B, prohibiting discrimination on the basis of race, color, religion,
or other prohibited factors in extending credit;
the Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act and Regulation
V, as well as the rules and regulations of the FDIC governing the use and provision of information to credit reporting
agencies, certain identity theft protections and certain credit and other disclosures;
the Fair Debt Collection Practices Act and Regulation F, governing the manner in which consumer debts may be
collected by collection agencies; and
the Real Estate Settlement Procedures Act and Regulation X, which governs aspects of the settlement process for
residential mortgage loans.
The deposit operations of the Bank are also subject to federal laws, such as:
•
•
•
•
the FDIA, which, among other things, limits the amount of deposit insurance available per insured depositor category
to $250,000 and imposes other limits on deposit-taking;
the Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial
records and prescribes procedures for complying with administrative subpoenas of financial records;
the Electronic Funds Transfer Act and Regulation E, which governs automatic deposits to and withdrawals from
deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other
electronic banking services; and
the Truth in Savings Act and Regulation DD, which requires depository institutions to provide disclosures so that
consumers can make meaningful comparisons about depository institutions and accounts.
The Consumer Financial Protection Bureau (the “CFPB”) is an independent regulatory authority housed within the Federal Reserve.
The CFPB has broad authority to regulate the offering and provision of consumer financial products. The CFPB has the authority to
supervise and examine depository institutions with more than $10 billion in assets for compliance with federal consumer laws. The
authority to supervise and examine depository institutions with $10 billion or less in assets, such as the Bank, for compliance with
federal consumer laws remains largely with those institutions’ primary regulators. However, the CFPB may participate in examinations
of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary
regulators. As such, the CFPB may participate in examinations of the Bank.
The CFPB has issued a number of significant rules that impact nearly every aspect of the lifecycle of a residential mortgage loan. These
rules implement Dodd-Frank Act amendments to the Equal Credit Opportunity Act, TILA and the Real Estate Settlement Procedures
15
Act (“RESPA”). Among other things, the rules adopted by the CFPB require banks to: (i) develop and implement procedures to ensure
compliance with a “reasonable ability-to-repay” test; (ii) implement new or revised disclosures, policies and procedures for originating
and servicing mortgages, including, but not limited to, pre-loan counseling, early intervention with delinquent borrowers and specific
loss mitigation procedures for loans secured by a borrower’s principal residence, and mortgage origination disclosures, which integrate
existing requirements under TILA and RESPA; (iii) comply with additional restrictions on mortgage loan originator hiring and
compensation; and (iv) comply with new disclosure requirements and standards for appraisals and certain financial products.
Bank regulators take into account compliance with consumer protection laws when considering approval of any proposed expansionary
proposals.
Item 1A. Risk Factors
RISK FACTORS
There are risks, many beyond our control, which could cause our results to differ significantly from management’s expectations. Some
of these risk factors are described below. Any factor described in this Annual Report on Form 10-K could, by itself or together with one
or more other factors, adversely affect our business, results of operations and/or financial condition. Additional risks and uncertainties
not currently known to us or that we currently consider to not be material also may materially and adversely affect us. In assessing these
risks, you should also refer to other information disclosed in our SEC filings, including the financial statements and notes thereto. 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 Our Business
Our business may be adversely affected by economic conditions.
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans
and the value of collateral securing those loans, as well as demand for loans and other products and services we offer and whose success
we rely on to drive our growth, is highly dependent upon the business environment in the primary markets where we operate and in the
United States as a whole. Unfavorable market conditions can result in a deterioration in the credit quality of our borrowers and the
demand for our products and services, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions
for loan losses, adverse asset values of the collateral securing our loans and an overall material adverse effect on the quality of our loan
portfolio. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or
investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or
interest rates; high unemployment; natural disasters; epidemics or pandemics; or a combination of these or other factors.
During 2019, the U.S. economy has continued to grow across a wide range of industries and regions in the United States. However, there
are continuing concerns related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to address
that debt, depressed oil prices, the U.S.-China trade disputes and related tariffs and the consequences of unexpected geopolitical evens,
such as outbreaks of contagious disease (such as the novel coronavirus) or acts of war or terrorism, that may have a destabilizing effect
on the global economy and financial markets. There can be no assurance that current economic conditions will continue or improve, and
economic conditions could worsen. Economic pressure on consumers and uncertainty regarding continuing economic improvement may
result in changes in consumer and business spending, borrowing and saving habits. A return of recessionary conditions and/or other
negative developments in the domestic or international credit markets may significantly affect the markets in which we do business, the
value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes
and high unemployment or underemployment may also result in higher than expected loan delinquencies, increases in our levels of
nonperforming and classified assets and a decline in demand for our products and services. These negative events may cause us to incur
losses and may adversely affect our capital, liquidity and financial condition.
We may not be able to implement our growth strategy or manage costs effectively, resulting in lower earnings or profitability.
There can be no assurance that we will be able to continue to grow and to be profitable in future periods, or, if profitable, that our overall
earnings will remain consistent or increase in the future. Our strategy is focused on organic growth, supplemented by opportunistic
acquisitions, such as our acquisition of ABC Bank. Our growth requires that we increase our loans and deposits while managing risks by
following prudent loan underwriting standards without increasing interest rate risk or compressing our net interest margin, maintaining
more than adequate capital and liquidity levels at all times, hiring and retaining qualified employees and successfully implementing
strategic projects and initiatives. Even if we are able to increase our interest income, our earnings may nonetheless be reduced by increased
expenses, such as additional employee compensation or other general and administrative expenses and increased interest expense on any
liabilities incurred or deposits solicited to fund increases in assets. Additionally, if our competitors extend credit on terms we find to pose
excessive risks, or at interest rates which we believe do not warrant the credit exposure, we may not be able to maintain our lending volume
and could experience deteriorating financial performance. Our inability to manage our growth successfully or to continue to expand into
new markets could have a material adverse effect on our business, financial condition or results of operations.
16
Nonperforming assets take significant time to resolve, adversely affect our results of operations and financial condition and could
result in further losses in the future.
Our nonperforming loans (which consist of nonaccrual loans, loans past due 90 days or more still accruing interest and restructured loans
still accruing interest) and our nonperforming assets (which include nonperforming loans plus OREO) are reflected in the table below at
December 31. We do not consider our purchased credit impaired loans, or PCI loans to be nonperforming assets as long as their cash
flows and the timing of such cash flows continue to be estimable and probable of collection, because we recognize interest income on
these loans through accretion of the difference between the carrying value of these loans and the present value of expected future cash
flows. As a result, management has excluded PCI loans from nonperforming assets in the table below.
Nonperforming loans
OREO
Total nonperforming assets
2019
15,849 $
5,004
20,853 $
$
$
2018
16,341
7,175
23,516
% Change
(3.0)
(30.3)
(11.3)
Our nonperforming assets adversely affect our net income in various ways. For example, we do not accrue interest income on nonaccrual
loans and OREO may have expenses in excess of any lease revenues collected, thereby adversely affecting our net income, return on
assets and return on equity. Our loan administration costs also increase because of our nonperforming assets. The resolution of
nonperforming assets requires significant time commitments from management, which can be detrimental to the performance of their
other responsibilities. There is no assurance that we will not experience increases in nonperforming assets in the future, or that our
nonperforming assets will not result in losses in the future.
Our loan portfolio is concentrated heavily in commercial and residential real estate loans, including exposure to construction
loans, which involve risks specific to real estate values and the real estate markets in general.
Our loan portfolio generally reflects the profile of the communities in which we operate. Because we operate in areas that saw rapid
historical growth, real estate lending of all types is a significant portion of our loan portfolio. Total real estate lending, excluding PCI
loans, was $1.46 billion, or approximately 75.4%, of our loan portfolio at December 31, 2019, compared to $1.48 billion, or
approximately 77.9%, at December 31, 2018. Given that the primary (if not only) source of collateral on these loans is real estate, adverse
developments affecting real estate values in our market area could increase the credit risk associated with our real estate loan portfolio.
In addition, with respect to commercial real estate loans, the banking regulators are examining commercial real estate lending activity
with greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting,
internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and
capital levels as a result of commercial real estate lending growth and exposures. At December 31, 2019, our outstanding commercial
real estate loans, including owner occupied real estate, and undrawn commercial real estate commitments were equal to 257.6% of our
Tier 1 capital plus allowance for loan and lease losses, which is under our policy limit and regulatory guidance of 300%. If our regulators
require us to maintain higher levels of capital than we would otherwise be expected to maintain, this could limit our ability to leverage
our capital and have a material adverse effect on our business, financial condition, results of operations and prospects.
Real estate market volatility and future changes in disposition strategies could result in net proceeds that differ significantly from
our fair value appraisals of loan collateral and OREO and could negatively impact our operating performance.
Many of our nonperforming real estate loans are collateral-dependent, meaning the repayment of the loan is largely dependent upon the
value of the property securing the loan and the borrower’s ability to refinance, recapitalize or sell the property. For collateral-dependent
loans, we estimate the value of the loan based on the appraised value of the underlying collateral less costs to sell. Our OREO portfolio
essentially 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. Some property in OREO reflects property formerly utilized as a bank premise or land that was acquired
with the expectation that a bank premise would be established at the location. In some cases, the market for such properties has been
significantly depressed, and we have been unable to sell them at prices or within timeframes that we deem acceptable. OREO is recorded
at the fair value of the property when acquired, 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. In response to market conditions and other economic factors, we may utilize alternative sale strategies other than orderly
disposition as part of our OREO disposition strategy, such as immediate liquidation sales. In this event, as a result of the significant
judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from
such sales transactions could differ significantly from appraisals, comparable sales and other estimates used to determine the fair value
of our OREO properties.
If we fail to effectively manage credit risk, our business and financial condition will suffer.
17
We must effectively manage credit risk. As a lender, we are exposed to the risk that our borrowers will be unable to repay their loans
according to their original contractual terms, and that the collateral securing repayment of their loans, if any, may not be sufficient to ensure
repayment. In addition, there are risks inherent in making any loan, including risks relating to proper loan underwriting, risks resulting from
changes in economic and industry conditions and risks inherent in dealing with individual borrowers, including the risk that a borrower may
not provide information to us about its business in a timely manner, and/or may present inaccurate or incomplete information to us, and risks
relating to the value of collateral. In order to manage credit risk successfully, we must, among other things, maintain disciplined and prudent
underwriting standards and ensure that our lenders follow those standards. The weakening of these standards for any reason, such as an
attempt to attract higher yielding loans, a lack of discipline or diligence by our employees in underwriting and monitoring loans, the inability
of our employees to adequately adapt policies and procedures to changes in economic or any other conditions affecting borrowers and the
quality of our loan portfolio, may result in loan defaults, foreclosures and additional charge-offs and may necessitate that we significantly
increase our allowance for loan and lease losses, each of which could adversely affect our net income. As a result, our inability to successfully
manage credit risk could have a material adverse effect on our business, financial condition or results of operations.
Our allowance for loan and lease losses, or ALLL, and fair value adjustments with respect to acquired loans, may be insufficient
to absorb potential losses in our loan portfolio, which may adversely affect our business, financial condition and results of
operations.
Our success depends significantly on the quality of our assets, particularly loans. Like other financial institutions, we are exposed to the
risk that our borrowers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be
insufficient to fully compensate us for the outstanding balance of the loan plus the costs to dispose of the collateral. As a result, we may
experience significant loan and lease losses that may have a material adverse effect on our operating results and financial condition.
We maintain an ALLL at a level we believe is adequate to absorb estimated losses inherent in our existing loan portfolio. The level of
the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; credit loss experience; current
loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio.
We may be required to make significant increases in the provision for loan and lease losses and to charge-off additional loans in the
future.
Determination of the ALLL 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 2019, 2018 and 2017 included an amount
reserved for other not specifically identified risk factors. New information regarding existing loans, identification of additional problem
loans, and other factors, both within and outside of our control, may require an increase in the ALLL. In addition, bank regulatory
agencies periodically review our allowance and may require an increase in the provision for loan and lease losses or the recognition of
additional loan charge-offs, based on judgments different from those of management. If charge-offs in future periods exceed the ALLL,
we will need additional provisions to increase the allowance. Any increases in the ALLL will result in a decrease in net income and
capital and may have a material adverse effect on our financial condition and results of operations.
The application of the purchase method of accounting in our acquisition of ABC Bank and any future acquisitions will impact our ALLL.
Under the purchase method of accounting, all acquired loans are recorded in our consolidated financial statements at their estimated fair
value at the time of acquisition and any related ALLL is eliminated because credit quality, among other factors, is considered in the
determination of fair value. To the extent that our estimates of fair value are too high, we will incur losses associated with the acquired
loans.
New accounting standards could require us to increase our allowance for loan and lease losses and may have a material adverse
effect on our financial condition and results of operations.
The measure of our ALLL is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards
Board, or FASB, recently issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become
applicable to us for interim and annual reporting periods beginning January 1, 2020. Under the CECL model, we will be required to
present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net
amount expected to be collected. The measurement of expected credit losses will be recorded to the allowance for credit losses (“ACL”),
and is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable
forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first
added to our balance sheet, with adjustments related to this credit assessment recorded to the ACL, and periodic measurements will occur
thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is
probable a loss has been incurred. Accordingly, with the adoption of the CECL model on January 1, 2020, we expect an overall increase
in our ACL for loans and leases of approximately $4.0 million to $6.0 million. Approximately $2.5 million of the increase to the ACL
(formerly allowance for loan and lease losses) as of the CECL adoption date will be due to the transfer of the non-accretable purchase
accounting adjustments on our purchased credit impaired loans. As a result of the adoption of this new standard on January 1, 2020, we
expect a reduction to retained earnings of approximately $3.0 million to $5.0 million. Moreover, the ongoing use of the CECL model
may create more volatility in the level of our ACL. If we are required to materially increase our level of ACL for any reason, such
increase could adversely affect our business, financial condition and results of operations.
18
Our business is geographically concentrated in several counties in Illinois, which makes our business highly susceptible to
downturns in these local economies.
Unlike larger financial institutions that are more geographically diversified, our banking franchise is concentrated in Aurora, Illinois, and
its surrounding communities, as well as Cook County. The city of Aurora is located in northeastern Illinois, approximately 40 miles west
of Chicago. We operate primarily in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois, and, as a result, our
financial condition, results of operations and cash flows are subject to changes and fluctuations in the economic conditions in those
areas. The local economic conditions in these areas have a significant impact on our commercial real estate, construction and residential
real estate loans, the ability of borrowers to repay these loans, and the value of the collateral securing these loans. Adverse changes in
the economic conditions in the United States in general, or in our primary markets in Illinois and the State of Illinois in general, could
negatively affect our financial condition, results of operations and profitability. While economic conditions in Illinois, along with the
U.S. and worldwide, have improved since the end of the economic recession, a return of recessionary conditions could result in the
following consequences, any of which could have a material adverse effect on our business:
•
•
•
•
loan delinquencies may increase;
problem assets and foreclosures may increase;
demand for our products and services may decline; and
collateral for loans that we make, especially real estate, may decline in value, in turn reducing a customer’s borrowing
power, and reducing the value of assets and collateral associated with the our loans.
In addition, the State of Illinois continues to experience severe fiscal challenges. Payment lapses by the State of Illinois to its vendors
and government sponsored entities may have negative effects on our primary market area. To the extent that these issues, or any future
state tax increases, impact the economic vitality of the businesses operating in Illinois, encourage businesses to leave the state or
discourage new employers to start or move businesses to Illinois, they could have a material adverse effect on our financial condition and
results of operations.
We operate in a highly competitive industry and market area and may face severe competitive disadvantages.
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and have
more financial resources. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms,
other financial service businesses, including investment advisory and wealth management firms, mutual fund companies, and securities
brokerage and investment banking firms, as well as super-regional, national and international financial institutions that operate offices in
our primary market areas and elsewhere. Local competitors continue to expand their presence in the western suburbs of Chicago,
including the communities that surround Aurora, Illinois, and these competitors may be better positioned than us to compete for loans,
acquisitions and personnel. As customers’ preferences and expectations continue to evolve, technology has lowered barriers to entry and
made it possible for banks to expand their geographic reach by providing services over the Internet and for non-banks to offer products
and services traditionally provided by banks, such as business and consumer lending, automatic transfer and automatic payment systems.
There has also been significant advancement in the exchange of digital assets (“cryptocurrency”) that could materially impact the financial
services industry in the future. Because of this rapidly changing technology, our future success will depend in part on our ability to
address our customers’ needs by using technology. Customer loyalty can be easily influenced by a competitor’s new products, especially
offerings that could provide cost savings or a higher return to the customer. Moreover, the financial services industry could become even
more competitive as a result of legislative and regulatory changes, and many large scale competitors can leverage economies of scale to
offer better pricing for products and services compared to what we can offer.
We compete with these institutions in attracting deposits and assets under management, processing payment transactions, and in making
loans. We may not be able to compete successfully with other financial institutions in our markets, particularly with larger financial
institutions operating in our markets that have significantly greater resources than us and offer financial products and services that we are
unable to offer, putting us at a disadvantage in competing with them for loans and deposits and wealth management clients, and we may
have to pay higher interest rates to attract deposits, accept lower yields on loans to attract loans and pay higher wages for new employees,
resulting in lower net interest margin and reduced profitability. In addition, competitors that are not depository institutions are generally
not subject to the extensive regulations that apply to us. If we are unable to compete effectively with those banking or other financial
services businesses, we could find it more difficult to attract new and retain existing clients and our net interest margin, net interest
income and wealth management fees could decline, which would adversely affect our results of operations and could cause us to incur
losses in the future.
In addition, our ability to successfully attract and retain wealth management clients is dependent on our ability to compete with
competitors’ investment products, level of investment performance, client services and marketing and distribution capabilities. If we are
not successful in attracting new and retaining existing clients, our business, financial condition, results of operations and prospects may
be materially and adversely affected.
19
Failure to keep pace with technological change could adversely affect our business.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new
technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better
serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using
technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our
operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able
to effectively implement new technology-driven products and services or be successful in marketing these products and services to our
customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material
adverse impact on our business, financial condition and results of operations.
We face a risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations and
corresponding enforcement proceedings.
The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001, or the “PATRIOT Act,” and other laws and regulations require financial institutions, among our other duties, to
institute and maintain effective anti-money laundering programs and to file suspicious activity and currency transaction reports as
appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank
Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in
coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug
Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by
the Office of Foreign Assets Control. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act
and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and
systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would be subject to
liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory
approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our
business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money
laundering and terrorist financing could also have serious reputational consequences for us.
Our strategic growth plans contemplate additional organic growth and potential growth through additional mergers and
acquisitions, which exposes us to additional risks.
Our strategic growth plans include organic growth and growth through additional mergers and acquisitions. To the extent that we are
unable to increase loans through organic loan growth, or to identify and consummate attractive acquisitions, we may be unable to
successfully implement our growth strategy, which could materially and adversely affect our financial condition and earnings.
We routinely evaluate opportunities to acquire additional financial institutions or branches or to open new branches. As a result, we
regularly engage in discussions or negotiations that, if they were to result in a transaction, could have a material effect on our operating
results and financial condition, including short- and long-term liquidity. Our merger and acquisition activities could be material and
could require us to use a substantial amount of common stock, cash, other liquid assets, and/or incur debt. In addition, if goodwill
recorded in connection with our prior or potential future acquisitions were determined to be impaired, then we would be required to
recognize a charge against our earnings, which could materially and adversely affect our results of operations during the period in which
the impairment was recognized. Moreover, these types of expansions involve various risks, including:
Management of Growth. We may be unable to successfully:
• maintain loan quality in the context of significant loan growth;
•
•
•
•
identify and expand into suitable markets;
obtain regulatory and other approvals necessary to consummate mergers, acquisitions or other expansion activities, or
regulatory approvals may be delayed, impeded, or conditioned due to existing or new regulatory issues surrounding
us, the target institution or the proposed combined entity as a result of, among other things, issues related to anti-
money laundering/Bank Secrecy Act compliance, fair lending laws, fair housing laws, consumer protection laws,
unfair, deceptive or abusive acts or practices regulations, or the Community Reinvestment Act;
retain employees and customers of the Company or the businesses that we acquire or merge with;
attract sufficient deposits and capital to fund anticipated loan growth;
• maintain adequate common equity and regulatory capital;
•
avoid diversion or disruption of our management and existing operations as well as those of the acquired or merged
institution;
• maintain adequate management personnel and systems to oversee such growth;
• maintain adequate internal audit, risk management, loan review and compliance functions; and
20
•
implement additional policies, procedures and operating systems required to support such growth.
Operating Results. There is no assurance that existing branches or future branches will maintain or achieve deposit levels, loan balances
or other operating results necessary to avoid losses or produce profits. Our growth may entail an increase in overhead expenses as we
add new branches and staff. There are considerable costs involved in opening branches, and new branches generally do not generate
sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, any new branches we
establish can be expected to negatively impact our earnings for some period of time until they reach certain economies of scale. Our
historical results may not be indicative of future results or results that may be achieved, particularly if we continue to expand.
Failure to successfully address these and other issues related to our expansion could have a material adverse effect on our business,
financial condition and results of operations, including short-term and long-term liquidity, and could adversely affect our ability to
successfully implement our business strategy.
We may be exposed to difficulties in combining the operations of acquired or merged businesses into our own operations, which
may prevent us from achieving the expected benefits from our merger and acquisition activities.
We may not be able to fully achieve the strategic objectives and operating efficiencies that we anticipate in our merger and acquisition
activities. Inherent uncertainties exist in integrating the operations of an acquired or merged business. We may lose our customers or the
customers of acquired or merged entities as a result of an acquisition. We may also lose key personnel from the acquired entity as a result
of an acquisition. We may not discover all known and unknown factors when examining a company for acquisition or merger during the
due diligence period. These factors could produce unintended and unexpected consequences for us. Undiscovered factors as a result of
an acquisition or merger could bring civil, criminal, and financial liabilities against us, our management, and the management of those
entities we acquire or merge with. In addition, if difficulties arise with respect to the integration process, the economic benefits expected
to result from acquisitions and mergers might not occur. Failure to successfully integrate businesses that we acquire or merge with could
have an adverse effect on our profitability, return on equity, return on assets, or our ability to implement our strategy, any of which in
turn could have a material adverse effect on our business, financial condition and results of operations. These factors could contribute to
our not achieving the expected benefits from our mergers and acquisitions within desired time frames, if at all.
Uncertainty relating to the London Inter-bank Offered Rate, or LIBOR, calculation process and potential phasing out of LIBOR
may adversely affect us.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it
intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021.
The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is
impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or
whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to
what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the
value of LIBOR-based securities and variable rate loans, or other securities or financial arrangements, given LIBOR’s role in determining
market interest rates globally. The Federal Reserve Board, in conjunction with the Alternative Reference Rates Committee, a steering
committee comprised of large U.S. financial institutions, is considering replacing the U.S. dollar LIBOR with a new index calculated by
short-term repurchase agreements, backed by Treasury securities (“SOFR”). SOFR is observed and backward looking, which stands in
contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert
judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does
not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to
correlate with the funding costs of financial institutions. Whether or not SOFR attains traction as a LIBOR replacement tool remains in
question, although some transactions using SOFR have been completed in 2019, and the future of LIBOR remains uncertain as this time.
Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect
LIBOR rates and the value of LIBOR-based loans, and securities in our portfolio. If LIBOR rates are no longer available, and we are
required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may
experience significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over
the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.
Changes in U.S. trade policies and other factors beyond our control, including the imposition of tariffs and retaliatory tariffs and
the impacts of epidemics or pandemics, may adversely impact our business, financial condition and results of operations.
There have been changes and discussions with respect to U.S. trade policies, legislation, treaties and tariffs, including trade policies and
tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by such countries.
Tariffs and retaliatory tariffs have been imposed, and additional tariffs and retaliation tariffs have been proposed. Such tariffs, retaliatory
tariffs or other trade restrictions on products and materials that our customers import or export could cause the prices of our customers’
products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues,
financial results and ability to service debt; which, in turn, could adversely affect our financial condition and results of operations. In
addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate our
business, results of operations and financial condition could be materially and adversely impacted in the future. It remains unclear what
the U.S. Administration or foreign governments will or will not do with respect to tariffs already imposed, additional tariffs that may be
imposed, or international trade agreements and policies. On January 26, 2020, President Trump signed a new trade deal between the
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United States, Canada and Mexico to replace the North American Free Trade Agreement. The full impact of this agreement on us, our
customers and on the economic conditions in our primary banking markets is currently unknown. In addition, the novel coronavirus and
concerns regarding the extent to which it may spread have affected, and may increasingly affect, international trade (including supply
chains and export levels), travel, employee productivity and other economic activities. A trade war or other governmental action related
to tariffs or international trade agreements or policies as well as coronavirus or other potential epidemics or pandemics, have the potential
to negatively impact our and/or our customers’ costs, demand for our customers’ products, and/or the U.S. economy or certain sectors
thereof and, thus, adversely affect our business, financial condition, and results of operations.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to
do so may materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our
business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core
values: being an integral part of the communities we serve; delivering superior service to our customers; and caring about our customers
and associates. Damage to our reputation could undermine the confidence of our current and potential clients in our ability to provide
financial services. Such damage could also impair the confidence of our counterparties and business partners, and ultimately affect our
ability to effect transactions. Maintenance of our reputation depends not only on our success in maintaining our core values and
controlling and mitigating the various risks described herein, but also on our success in identifying and appropriately addressing issues
that may arise in areas such as potential conflicts of interest, anti-money laundering, client personal information and privacy issues,
record-keeping, regulatory investigations and any litigation that may arise from the failure or perceived failure of us to comply with legal
and regulatory requirements. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and,
therefore, our operating results may be materially adversely affected. Further, negative public opinion can expose us to litigation and
regulatory action as we seek to implement our growth strategy, which could adversely affect our business, financial condition and results
of operations.
We are subject to interest rate risk, and a change in interest rates could have a negative effect on our net income.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that
are beyond our control, including general economic conditions, our competition and policies of various governmental and regulatory
agencies, particularly the Federal Reserve. Changes in monetary policy could influence our earnings. When interest-bearing liabilities
mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase in interest rates could reduce
net interest income. Similarly, when interest-earning assets mature or reprice more quickly, or to a greater degree than interest-bearing
liabilities, falling interest rates could reduce net interest income. Additionally, an increase in the general level of interest rates may also,
among other things, adversely affect our current borrowers’ ability to repay variable rate loans, the demand for loans and our ability to
originate loans and decrease loan prepayment rates. Conversely, a decrease in the general level of interest rates, among other things, may
lead to increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits.
Accordingly, changes in the general level of market interest rates may adversely affect our net yield on interest-earning assets, loan
origination volume and our overall results. Although management believes it has implemented effective asset and liability management
strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged
change in market interest rates could have a material adverse effect on our financial condition and results of operations.
Our business needs and future growth may require us to raise additional capital, but that capital may not be available or may be
dilutive.
We may need to raise additional capital, in the form of debt or equity securities, in the future to have sufficient capital resources to meet
our commitments and fund our business needs and future growth, particularly if the quality of our assets or earnings were to deteriorate
significantly. In addition, the Company and the Bank are each required by federal regulatory authorities to maintain adequate levels of
capital to support their operations.
Our ability to raise capital will depend on, among other things, conditions in the capital markets, which are outside of our control, and
our financial performance. Accordingly, we cannot provide assurance that such capital will be available on terms acceptable to us or at
all. Any occurrence that limits our access to capital, may adversely affect our capital costs and our ability to raise capital and, in turn,
our liquidity. Further, if we need to raise capital in the future we may have to do so when many other financial institutions are also
seeking to raise capital and would then have to compete with those institutions for investors. Any inability to raise capital on acceptable
terms when needed could have a material adverse effect on our business, financial condition and results of operations and could be
dilutive to both tangible book value and our share price.
In addition, an inability to raise capital when needed may subject us to increased regulatory supervision and the imposition of restrictions
on our growth and business. These restrictions could negatively affect our ability to operate or further expand our operations through
loan growth, acquisitions or the establishment of additional branches. These restrictions may also result in increases in operating expenses
and reductions in revenues that could have a material adverse effect on our financial condition, results of operations and share price.
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We 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. We seek
to ensure that our funding needs are met by maintaining an appropriate level of liquidity through asset and liability management. In
2019, the Bank continued to secure liquidity under the advance program provided under terms offered by the FHLBC. If we are unable
to obtain funds when needed, it could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to maintain a strong core deposit base or access other low-cost funding sources.
We rely on bank deposits to be a low cost and stable source of funding. In addition, our future growth will largely depend on our ability
to maintain and grow a strong deposit base. If we are unable to continue to attract and retain core deposits, to obtain third party financing
on favorable terms, or to have access to interbank or other liquidity sources, we may not be able to grow our assets as quickly. We
compete with banks and other financial services companies for deposits. If our competitors raise the rates they pay on deposits in response
to interest rate changes initiated by the FRBC Open Market Committee or for other reasons of their choice, our funding costs may
increase, either because we raise our rates to avoid losing deposits or because we lose deposits and must rely on more expensive sources
of funding. Higher funding costs could reduce our net interest margin and net interest income. Any decline in available funding could
adversely affect our ability to continue to implement our business strategy which could have a material adverse effect on our liquidity,
business, financial condition and results of operations.
Our estimate of fair values for our investments may not be realizable if we were to sell these securities today.
Our available-for-sale securities are carried at fair value.
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. Recent market disruptions and the resulting
fluctuations in fair value have made the valuation process even more difficult and subjective. If the valuations are incorrect, it could
harm our financial results and financial condition.
We may be materially and adversely affected by the highly regulated environment in which we operate.
We are 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 our stockholders. Compliance with
banking regulations is costly and these regulations affect our lending practices, capital structure, investment practices, mergers and
acquisitions, dividend policy, and growth, among other things.
The Company and the Bank also undergo periodic examinations by their regulators, who have extensive discretion and authority to
prevent or remedy unsafe or unsound practices or violations of law. Failure to comply with applicable laws, regulations or policies could
also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written
supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could
restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous
to us or our stockholders and could have a material adverse effect on our business, financial condition and results of operations.
A more detailed description of the primary federal banking laws and regulations that affect the Company and the Bank is included in this
Form 10-K under the section captioned “Supervision and Regulation” in Item 1. Since the economic recession, federal and state banking
laws and regulations, as well as interpretations and implementations of these laws and regulations, have undergone substantial review
and change. In particular, the Dodd-Frank Act drastically revised the laws and regulations under which we operate. The burden of
regulatory compliance has increased under the Dodd-Frank Act and has increased our costs of doing business and, as a result, may create
an advantage for our competitors who may not be subject to similar legislative and regulatory requirements. Regulations and laws may
be modified at any time, and new legislation may be enacted that will affect us. Any future changes in federal and state laws and
regulations, as well as the interpretation and implementation of such laws and regulations, could affect us in substantial and unpredictable
ways, including those listed above or other ways that could have a material adverse effect on our business, financial condition or results
of operations.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of
operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve.
An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the
Federal Reserve to implement these objectives are open market purchases and sales of U.S. government securities, adjustments of the
discount rate and changes in banks’ reserve requirements against bank deposits. These instruments are used in varying combinations to
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influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest
rates charged on loans or paid on deposits.
The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks
in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and
results of operations cannot be predicted.
Our accounting estimates and risk management processes and controls rely on analytical and forecasting techniques and models
and assumptions, which may not accurately predict future events.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our
management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with
GAAP and reflect management’s judgment of the most appropriate manner in which to report our financial condition and results. In
some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be
reasonable under the circumstances, yet which may result in our reporting materially different results than would have been reported
under a different alternative.
Certain accounting policies are critical to presenting our financial condition and results of operations. They require management to make
difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different
conditions or using different assumptions or estimates. These critical accounting policies include the allowance for loan and lease losses,
fair value methodologies, accounting for business combinations, and loans acquired in business combinations. Because of the uncertainty
of estimates involved in these matters, we may be required to significantly increase the ALLL (or the ACL under CECL) or sustain loan
losses that are significantly higher than the reserve provided, reduce the carrying value of an asset measured at fair value, or significantly
increase liabilities measured at fair value. Any of these could have a material adverse effect on our business, financial condition or results
of operations. See “Management's Discussion and Analysis of Financial Condition and Results of Operations.”
Our internal controls, disclosure controls, processes and procedures, and corporate governance policies and procedures are 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 our controls, processes and procedures or failure to comply with regulations related to controls, processes and
procedures could necessitate changes in those controls, processes and procedures, which may increase our compliance costs, divert
management attention from our business or subject us to regulatory actions and increased regulatory scrutiny. Any of these could have
a material adverse effect on our business, financial condition or results of operations.
Our deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our
future earnings.
The FDIC insures deposits at FDIC-insured depository institutions, such as the Bank, up to $250,000 per insured depositor category. The
amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based
assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the
institution poses to its regulators. As a result of recent FDIC assessment charges, banks are now assessed deposit insurance premiums
based on the bank’s average consolidated total assets less the sum of its average tangible equity, and the FDIC has modified certain risk-
based adjustments, which increase or decrease a bank’s overall assessment rate. In addition to ordinary assessments described above, the
FDIC has the ability to impose special assessments in certain instances. We are generally unable to control the amount of premiums that
we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay higher
FDIC premiums than the recent levels. Any future additional assessments, increases or required prepayments in FDIC insurance
premiums could reduce our profitability, may limit our ability to pursue certain business opportunities or otherwise negatively impact
our operations.
We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.
Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose
nondiscriminatory lending requirements on financial institutions. The Department of Justice, the Consumer Financial Protection Bureau
and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to
challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance
under the fair lending laws and regulations could adversely impact our rating under the Community Reinvestment Act and result in a
wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of
restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation,
business, financial condition and results of operations.
New lines of business, products, product enhancements or services may subject us to additional risks.
From time to time, we may implement new lines of business or offer new products, and product enhancements as well as new services
within our existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances
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in which the markets are not fully developed. In implementing, developing or marketing new lines of business, products, product
enhancements or services, we may invest significant time and resources, although we may not assign the appropriate level of resources
or expertise necessary to make these new lines of business, products, product enhancements or services successful or to realize their
expected benefits. Further, initial timetables for the introduction and development of new lines of business, products, product
enhancements or services may not be achieved, and price and profitability targets may not prove feasible. The introduction of such new
products requires continued innovative efforts on the part of our management and may require significant time and resources as well as
ongoing support and investment. External factors, such as compliance with regulations, competitive alternatives and shifting market
preferences, may also affect the ultimate implementation of a new line of business or offerings of new products, product enhancements
or services. Furthermore, any new line of business, product, product enhancement or service or system conversion could have a
significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development
and implementation of new lines of business or offerings of new products, product enhancements or services could have a material
adverse effect on our business, financial condition or results of operations.
We could be subject to changes in tax laws, regulations, and interpretations or challenges to our income tax provision.
We compute our income tax provision based on enacted tax rates in the jurisdictions in which we operate. Any change in enacted tax
laws, rules or regulatory or judicial interpretations, or any change in the pronouncements relating to accounting for income taxes could
adversely affect our effective tax rate, tax payments and results of operations. The taxing authorities in the jurisdictions in which we
operate may challenge our tax positions, which could increase our effective tax rate and harm our financial position and results of
operations. We are subject to audit and review by U.S. federal and state tax authorities. Any adverse outcome of such a review or audit
could have a negative effect on our financial position and results of operations.
In addition, deferred tax assets are reported as assets on our balance sheet and represent the decrease in taxes expected to be paid in the
future because of net operating losses (“NOLs”) and tax credit carryforwards and because of future reversals of temporary differences in
the bases of assets and liabilities as measured by enacted tax laws and their bases as reported in the financial statements. As of December
31, 2019, we had net deferred tax assets of $11.5 million, which included no remaining federal net operating loss carryforward.
Realization of deferred tax assets is dependent upon the generation of sufficient future taxable income during the periods in which existing
deferred tax assets are expected to become deductible for income tax purposes. Changes in enacted tax laws, such as adoption of a lower
income tax rate in any of the jurisdictions in which we operate, could impact our ability to obtain the future tax benefits represented by
our deferred tax assets. Our deferred tax asset may be further reduced in the future if estimates of future income or our tax planning
strategies do not support the amount of the deferred tax asset. Charges to establish a valuation allowance with respect to our deferred tax
asset could have a material adverse effect on our financial condition and results of operations.
In addition, the determination of our provision for income taxes and other liabilities requires significant judgment by management.
Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial
statements and could have a material adverse effect on our financial results in the period or periods for which such determination is made.
We could become subject to claims and litigation pertaining to our fiduciary responsibility.
Some of the services we provide, such as wealth management services through River Street Advisors, LLC, require us to act as fiduciaries
for our customers and others. Customers make claims and on occasion take legal action pertaining to our performance of our fiduciary
responsibilities. Whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or
unfounded, if such claims and legal action are not resolved in a manner favorable to us, they may result in significant financial liability
and/or adversely affect the market perception of us and our 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 our business, which, in turn, could
have a material adverse impact on our financial condition and results of operations.
Our trust and wealth management business may be negatively impacted by changes in economic and market conditions and
clients may seek legal remedies for investment performance.
Our trust and wealth management business may be negatively impacted by changes in general economic and market conditions because
the performance of this businesses is directly affected by conditions in the financial and securities markets. The financial markets and
businesses operating in the securities industry are highly volatile (meaning that performance results can vary greatly within short periods
of time) and are directly affected by, among other factors, domestic and foreign economic conditions and general trends in business and
finance, and by the threat, as well as the occurrence of global conflicts, all of which are beyond our control. We cannot assure you that
broad market performance will be favorable in the future. Declines in the financial markets or a lack of sustained growth may result in a
decline in the performance of our wealth management business and may adversely affect the market value and performance of the
investment securities that we manage, which could lead to reductions in our wealth management fees, because they are based primarily
on the market value of the securities we manage, and could lead some of our clients to reduce their assets under management by us or
seek legal remedies for investment performance. If any of these events occur, the financial performance of our wealth management
business could be materially and adversely affected.
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We depend on our executive officers and other key employees, and our ability to attract additional key personnel, to continue the
implementation of our long-term business strategy, and we could be harmed by the unexpected loss of their services.
We believe that our continued growth and future success will depend in large part on the skills of our executive officers and other key
employees and our ability to motivate and retain these individuals, as well as our ability to attract, motivate and retain highly qualified
senior and middle management and other skilled employees. Our business is primarily relationship-driven in that many of our key
personnel have extensive customer or asset management relationships. Loss of key personnel with such relationships may lead to the
loss of business if the customers were to follow that employee to a competitor or if asset management expertise was not replaced in a
timely manner. Competition for employees is intense, and the process of locating key personnel with the combination of skills and
attributes required to execute our business strategy may be lengthy. We may not be successful in retaining key personnel, and the
unexpected loss of services of one or more of our key personnel could have a material adverse effect on our business because of their
skill, knowledge of our primary markets, years of industry experience and the difficulty of promptly finding qualified replacement
personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire
qualified persons on terms acceptable to the Company, or at all, which could have a material adverse effect on our business, financial
condition, results of operation and future prospects.
If we are unable to offer our key management personnel long-term incentive compensation, including options, restricted stock,
and restricted stock units, as part of their total compensation package, we may have difficulty retaining such personnel, which
would adversely affect our operations and financial performance.
We have historically granted equity awards, including restricted stock units and stock options, to key management personnel as part of a
competitive compensation package. Our ability to grant equity compensation awards as a part of our total compensation package has
been vital to attracting, retaining and aligning stockholder interest with a talented management team in a highly competitive marketplace.
In the future, we may seek stockholder approval to adopt new equity compensation plans so that we may issue additional equity awards
to management in order for the equity component of our compensation packages to remain competitive in the industry. Stockholder
advisory groups have implemented guidelines and issued voting recommendations related to how much equity companies should be able
to grant to employees. These advisors influence certain shareholder votes regarding approval of a company’s request for approval of new
equity compensation plans. The factors used to formulate these guidelines and voting recommendations include the volatility of a
company’s share price and are influenced by broader macro-economic conditions that can change year to year. The variables used by
stockholder advisory groups to formulate equity plan recommendations may limit our ability to obtain approval to adopt new equity plans
in the future. If we are limited in our ability to grant equity compensation awards, we would need to explore offering other compelling
alternatives to supplement our compensation, including long-term cash compensation plans or significantly increased short-term cash
compensation, in order to continue to attract and retain key management personnel. If we used these alternatives to long-term equity
awards, our compensation costs could increase and our financial performance could be adversely affected. If we are unable to offer key
management personnel long-term incentive compensation, including stock options, restricted stock or restricted stock units, as part of
their total compensation package, we may have difficulty attracting and retaining such personnel, which would adversely affect our
operations and financial performance.
Our information systems may experience an interruption or breach in security and cyber-attacks, all of which could have a
material adverse effect on our business.
internal and outsourced
technologies, communications, and
to conduct our
We rely heavily on
business. Additionally, in the normal course of business, we collect, process and retain sensitive and confidential information regarding
our customers. As our reliance on technology has increased, so have the potential risks of a technology-related operation interruption
(such as disruptions in our customer relationship management, general ledger, deposit, loan, or other systems) or the occurrence of a
cyber-attack (such as unauthorized access to our systems). These risks have increased for all financial institutions as new technologies
have emerged, including the use of the Internet and the expansion of telecommunications technologies (including mobile devices) to
conduct financial and other business transactions, and as the sophistication of organized criminals, perpetrators of fraud, hackers, terrorists
and others have increased.
information systems
In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have
engaged in attacks against large financial institutions, particularly denial of service attacks that are designed to disrupt key business
services, such as customer-facing web sites. We operate in an industry where otherwise effective preventive measures against security
breaches become vulnerable as breach strategies change frequently and cyber-attacks can originate from a wide variety of sources. It is
possible that a cyber incident, such as a security breach, may be undetected for a period of time. However, applying guidance from the
Federal Financial Institutions Examination Council, we have identified security risks and employ risk mitigation controls. Following a
layered security approach, we have analyzed and will continue to analyze security related to device specific considerations, user access
topics, transaction-processing and network integrity. We expect that we will spend additional time and will incur additional costs going
forward to modify and enhance protective measures and that effort and spending will continue to be required to investigate and remediate
any information security vulnerabilities.
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We also face risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that
typically involve the transmission of sensitive information regarding our customers through various third parties, including merchant-
acquiring banks, payment processors, payment card networks and their processors. Some of these parties have in the past been the target
of security breaches and cyber-attacks. Because these third parties and related environments such as the point-of-sale are not under our
direct control, future security breaches or cyber-attacks affecting any of these third parties could impact us and in some cases we may
have exposure and suffer losses for breaches or attacks. We offer our customers protection against fraud and attendant losses for
unauthorized use of debit cards in order to stay competitive in the market place. Offering such protection exposes us to potential losses
which, in the event of a data breach at one or more retailers of considerable magnitude, may adversely affect our business, financial
condition, and results of operation. Further cyber-attacks or other breaches in the future, whether affecting us or others, could intensify
consumer concern and regulatory focus and result in reduced use of payment cards and increased costs, all of which could have a material
adverse effect on our business. To the extent we are involved in any future cyber-attacks or other breaches, our reputation could be
affected which may have a material adverse effect on our business, financial condition or results of operations.
We depend on outside third parties for the processing and handling of our records and data.
We rely on software developed by third party vendors to process various Company transactions. In some cases, we have contracted with
third parties to run their proprietary software on our behalf at a location under the control of the third party. These systems include, but
are not limited to, core data processing, payroll, wealth management record keeping, and securities portfolio management. While we
perform a review of controls instituted by the vendor over these programs in accordance with industry standards and institute our own
user controls, we must rely on the continued maintenance of the performance controls by these outside parties, including safeguards over
the security of customer data. In addition, we create backup copies of key processing output daily in the event of a failure on the part of
any of these systems. Nonetheless, we may incur a temporary disruption in our ability to conduct our business or process our transactions,
or incur damage to our reputation if a third party vendor fails to adequately maintain internal controls or institute necessary changes to
systems. A disruption or breach of security may ultimately have a material adverse effect on our financial condition and results of
operations.
Our use of third party vendors and our other ongoing third party business relationships are subject to increasing regulatory
requirements and attention.
We regularly use third party vendors as part of our business. We also have substantial ongoing business relationships with other third
parties. These types of third party relationships are subject to increasingly demanding regulatory requirements and attention by our
federal bank regulators. Recent regulation requires us to enhance our due diligence, ongoing monitoring and control over our third party
vendors and other ongoing third party business relationships. We expect that our regulators will hold us responsible for deficiencies in
our oversight and control of our third party relationships and in the performance of the parties with which we have these relationships.
As a result, if our regulators conclude that we have not exercised adequate oversight and control over our third party vendors or other
ongoing third party business relationships or that such third parties have not performed appropriately, we could be subject to enforcement
actions, including civil money penalties or other administrative or judicial penalties or fines as well as requirements for customer
remediation, any of which could have a material adverse effect our business, financial condition or results of operations.
27
We are at risk of increased losses from fraud.
Criminals committing fraud increasingly are using more sophisticated techniques and in some cases are part of larger criminal rings,
which allow them to be more effective.
The fraudulent activity has taken many forms, ranging from check fraud, mechanical devices attached to ATMs, social engineering and
phishing attacks to obtain personal information or impersonation of our clients through the use of falsified or stolen credentials.
Additionally, an individual or business entity may properly identify themselves, particularly when banking online, yet seek to establish a
business relationship for the purpose of perpetrating fraud. Further, in addition to fraud committed against us, we may suffer losses as a
result of fraudulent activity committed against third parties. Increased deployment of technologies, such as chip card technology, defray
and reduce aspects of fraud; however, criminals are turning to other sources to steal personally identifiable information, such as
unaffiliated healthcare providers and government entities, in order to impersonate the consumer to commit fraud. Many of these data
compromises are widely reported in the media. Further, as a result of the increased sophistication of fraud activity, we have increased
our spending on systems and controls to detect and prevent fraud. This will result in continued ongoing investments in the future.
We are defendants in a variety of litigation and other actions.
Currently, there are certain other legal proceedings pending against the Company and our 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 not have a material adverse effect on us or our consolidated financial
statements. However, if actual results differ from management’s expectations, it could have a material adverse effect on our financial
condition, results of operations, or cash flows.
From time to time we are, or may become, involved in suits, legal proceedings, information-gatherings, investigations and
proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.
Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, the subject
of information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank
regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to
significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions,
restrictions on the way we conduct our business or reputational harm.
28
Risks Associated with the Company’s Common Stock
Our future ability to pay dividends is subject to restrictions.
We currently conduct substantially all of our operations through our subsidiaries, and a significant part of our income is attributable to
dividends from the Bank. We principally rely on the profitability of the Bank to conduct operations and satisfy obligations. As is the
case with all financial institutions, the profitability of the Bank is subject to the fluctuating cost and availability of money, changes in
interest rates, and in economic conditions in general.
Holders of our common stock are only entitled to receive such cash dividends as our board of directors may declare out of funds legally
available for such payments. Any declaration and payment of dividends on common stock will depend upon our earnings and financial
condition, liquidity and capital requirements, the general economic and regulatory climate, our ability to service any equity or debt
obligations senior to the common stock, and other factors deemed relevant by the board of directors. Furthermore, consistent with our
business plans, growth initiatives, capital availability, projected liquidity needs, and other factors, we have made, and will continue to
make, capital management decisions and policies that could adversely impact the amount of dividends, if any, paid to our stockholders.
Although we currently expect to continue to pay quarterly dividends, any future determination relating to our dividend policy will be
made by our board of directors and will depend on a number of factors. We are subject to certain restrictions on the payment of cash
dividends as a result of banking laws, regulations and policies. Finally, our ability to pay dividends to our stockholders depends on our
receipt of dividends from the Bank, which is also subject to restrictions on dividends as a result of banking laws, regulations and policies.
See Part II, Item 5.“Dividend Policy.”
The trading volumes in our common stock may not provide adequate liquidity for investors.
Shares of our common stock are listed on the NASDAQ Global Select Market; however, the average daily trading volume in our 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 we have no control. Given the current daily average trading volume of our common stock, significant sales of our common
stock in a brief period of time, or the expectation of these sales, could cause a significant decline in the price of our common stock.
The trading price of our common stock may be subject to continued significant fluctuations and volatility.
The market price of our common stock could be subject to significant fluctuations due to, among other things:
•
actual or anticipated quarterly fluctuations in our operating and financial results, particularly if such results vary from
the expectations of management, securities analysts and investors, including with respect to further loan and lease losses
we may incur;
announcements regarding significant transactions in which we may engage;
•
• market assessments regarding such transactions;
•
•
•
•
•
changes or perceived changes in our operations or business prospects;
legislative or regulatory changes affecting our industry generally or our businesses and operations;
a weakening of general market and economic conditions, particularly with respect to economic conditions in Illinois;
the operating and share price performance of companies that investors consider to be comparable to us;
future offerings by us of debt, preferred stock or trust preferred securities, each of which would be senior to our common
stock upon liquidation and for purposes of dividend distributions;
actions of our current stockholders, including future sales of common stock by existing stockholders and our 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.
•
•
As a result, the market price of our common stock may continue to be subject to similar market fluctuations that may or may not be
related to our operating performance or prospects. Increased volatility could result in a decline in the market price of our common stock.
Shares of our common stock are subject to dilution, which could cause our common stock price to decline.
We are generally not restricted from issuing additional shares of our common stock up to the number of shares authorized in our Certificate
of Incorporation. We may issue additional shares of our common stock (or securities convertible into common stock) in the future for a
number of reasons, including to finance our operations and business strategy (including mergers and acquisitions), to adjust our ratio of
debt to equity, to address regulatory capital concerns, or to satisfy our obligations upon the exercise of outstanding options. We may
issue equity securities in transactions that generate cash proceeds, transactions that free up regulatory capital but do not immediately
29
generate or preserve substantial amounts of cash, and transactions that generate regulatory or balance sheet capital only and do not
generate or preserve cash. If we choose to raise capital by selling shares of our common stock or securities convertible into common
stock for any reason, the issuance would have a dilutive effect on the holders of our common stock and could have a material negative
effect on the market price of our common stock.
Certain banking laws and our governing documents 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 us,
even if doing so would be perceived to be beneficial to our stockholders. In addition, we have a classified board of directors, and our
Certificate of Incorporation requires the approval of certain business combinations by at least 75% of our outstanding shares of common
stock. The combination of these laws, the board structure and the business combination provision in our Certificate of Incorporation may
inhibit certain business combinations, including a non-negotiated merger or other business combination, which, in turn, could adversely
affect the market price of our common stock.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We conduct our business primarily at 29 banking locations in various communities throughout the greater western and southern Chicago
metropolitan area. The principal business office of the Company is located at 37 South River Street, Aurora, Illinois. We own 26 of our
properties and lease three of our locations. Our three leased locations are under agreement through March 31, 2020, March 1, 2022, and
June 30, 2030. 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.
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.
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
Our common stock trades on the NASDAQ Global Select Market under the symbol “OSBC.” As of December 31, 2019, we had
833 stockholders of record for our common stock. The following table sets forth the high and low trading prices of our common stock
on the NASDAQ Global Select Market, and information about declared dividends during each quarter for 2019 and 2018.
First quarter
Second quarter
Third quarter
Fourth quarter
Dividend Policy
2019
2018
High Low Dividend High Low Dividend
$
14.80
13.64
13.60
13.77
$
12.01
11.43
11.24
11.72
$
0.01
0.01
0.01
0.01
$
15.00
15.60
16.30
15.61
$ 13.10
13.45
14.35
11.32
$
0.01
0.01
0.01
0.01
The Company’s stockholders are entitled to receive dividends when, as and if declared by the board of directors out of funds legally
available therefor. The Company’s ability to pay dividends to stockholders is largely dependent upon the dividends it receives from the
Bank; however, certain regulatory restrictions and the terms of its debt and equity securities, limit the amount of cash dividends it may
pay. See “Supervision and Regulation—Regulation and Supervision of the Bank.”
Although we currently expect to continue to pay quarterly dividends, any future determination relating to our dividend policy will be
made by our board of directors and will depend on a number of factors, including: (1) our historic and projected financial condition,
30
liquidity and results of operations, (2) our capital levels and needs, (3) tax considerations, (4) any acquisitions or potential acquisitions
that we may examine, (5) statutory and regulatory prohibitions and other limitations, (6) the terms of any credit agreements or other
borrowing arrangements that restrict our ability to pay cash dividends, (7) general economic conditions and (8) other factors deemed
relevant by our board of directors. We are not obligated to pay dividends on our common stock and are subject to restrictions on paying
dividends on our common stock.
As a Delaware corporation, we are subject to certain restrictions on dividends under the DGCL. Generally, a Delaware corporation may
only pay dividends either out of surplus or out of the current or the immediately preceding year’s net profits. Surplus is defined as the
excess, if any, at any given time, of the total assets of a corporation over its total liabilities and statutory capital. The value of a
corporation’s assets can be measured in a number of ways and may not necessarily equal their book value.
In addition, we are subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies.
See “Supervision and Regulation—Regulation and Supervision of the Company.”
Stock Repurchases
In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase
Program”). Repurchases by us under the Repurchase Program may be made from time to time through open market purchases, trading
plans established in accordance with SEC rules, privately negotiated transactions, or by other means.
The actual means and timing of any repurchases, quantity of purchased shares and prices will be, subject to certain limitations, at the
discretion of management and will depend on a number of factors, including, without limitation, market prices of our common stock,
general market and economic conditions, and applicable legal and regulatory requirements. Repurchases under the Repurchase Program
may be initiated, discontinued, suspended or restarted at any time; provided that repurchases under the Repurchase Program after
September 19, 2020 would require Federal Reserve non-objection or approval. We are not obligated to repurchase any shares under the
Repurchase Program.
Total
Number of
Shares
Purchased
Average
Price Paid
per Share
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
— $
—
—
— $
—
—
—
—
—
—
—
—
Maximum Number
of Shares that May
Yet Be
Purchased Under
the Plans or Programs
1,494,826
1,494,826
1,494,826
1,494,826
(Dollars in thousands, except for per share
amounts)
October 1, 2019 - October 31, 2019
November 1, 2019 - November 30, 2019
December 1, 2019 - December 31, 2019
Total
Recent Sales of Unregistered Securities
None.
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,
Shareholder Relations Department
37 South River Street
Aurora, Illinois 60507
(630) 906-2303
scantrell@oldsecond.com
31
Stockholder Return Performance Graph. The following graph indicates, for the period commencing December 31, 2014, and ending
December 31, 2019, a comparison of cumulative total returns for the Company, S&P 500 and the SNL U.S. Bank NASDAQ. The
information assumes that $100 was invested at the closing price at December 31, 2014, in the common stock of the Company and each index
and that all dividends were reinvested.
Index
Old Second Bancorp, Inc.
S&P 500
SNL U.S. Bank NASDAQ
Period Ending
12/31/2014 12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019
100.00
100.00
100.00
146.00
101.38
107.95
206.59
113.51
149.68
256.06
138.29
157.58
244.55
132.23
132.82
254.17
173.86
166.75
32
Item 6. Selected Financial Data
Balance sheet items at year-end
Total assets
Total earning assets
Average assets
Loans, gross
Allowance for loan and lease losses
Deposits
Securities sold under agreement to repurchase
Other short-term borrowings
Junior subordinated debentures
Senior notes
Subordinated debt
Notes payable and other borrowings
Stockholders’ equity
Results of operations for the year ended
Interest and dividend income
Interest expense
Net interest and dividend income
Provision (release) for loan and lease losses
Noninterest income
Noninterest expense
Income before taxes
Provision for income taxes
Net income
Preferred stock dividends and accretion
Net income available to common stockholders
Performance ratio
Return on average total assets
Return on average equity
Average equity to average assets
Dividend payout ratio
Per share data
Basic earnings
Diluted earnings
Common book value per share
Weighted average diluted shares outstanding
Weighted average basic shares outstanding
Shares outstanding at year-end
Old Second Bancorp, Inc. and Subsidiaries
Financial Highlights
(Dollars in thousands, except per share data)
2019
2018
2017
2016
2015
$
2,635,545
2,444,974
2,623,443
1,930,812
19,789
2,126,749
48,693
48,500
57,734
44,270
-
6,673
277,864
$
$
115,594
18,835
96,759
1,600
35,800
79,102
51,857
12,402
39,455
-
39,455
$
$
$
2,676,003
2,471,328
2,547,806
1,897,027
19,006
2,116,673
46,632
149,500
57,686
44,158
-
15,379
229,081
107,617
16,678
90,939
1,228
31,353
77,128
43,936
9,924
34,012
-
34,012
$
$
$
2,383,429
2,191,685
2,318,798
1,617,622
17,461
1,922,925
29,918
115,000
57,639
44,058
-
-
200,350
87,505
12,626
74,879
1,800
30,372
69,149
34,302
19,164
15,138
-
15,138
$
$
$
2,251,188
2,037,012
2,142,748
1,478,809
16,158
1,866,785
25,715
70,000
57,591
43,998
-
-
175,210
73,379
9,938
63,441
750
28,574
66,761
24,504
8,820
15,684
-
15,684
$
$
$
2,077,028
1,862,257
2,065,122
1,133,715
16,223
1,759,086
34,070
15,000
57,543
-
45,000
500
155,929
68,164
9,076
59,088
(4,400)
29,294
68,421
24,361
8,976
15,385
1,873
13,512
1.50 %
1.33 %
15.37
9.78
3.03
16.08
8.30
3.51
0.65 %
7.89
8.28
7.84
0.73 %
9.43
7.76
5.66
0.74 %
8.87
8.40
7.84
$
1.32
1.30
9.28
30,416,348
29,891,046
29,931,809
$
1.14
1.12
7.70
30,308,935
29,728,308
29,763,078
$
0.51
0.50
6.76
30,038,417
29,600,702
29,627,086
$
0.53
0.53
5.93
29,838,931
29,532,510
29,556,216
$
0.46
0.46
5.29
29,730,074
29,476,821
29,483,429
Loan quality ratios
Allowance for loan and lease losses to total loans
at end of the year
Provision (release) for loan and lease losses to total loans
Net loans charged-off (recovered) to average total loans
Nonaccrual loans to total loans at end of the year
Nonperforming assets to total assets at end of the year
Allowance for loan and lease losses to nonaccrual loans
1.02 %
0.08 %
0.04 %
0.64 %
0.79 %
159.18 %
1.00 %
0.06 %
(0.02) %
0.72 %
0.88 %
138.32 %
1.08 %
0.11 %
0.03 %
0.89 %
1.01 %
121.36 %
1.09 %
0.05 %
0.07 %
1.03 %
1.24 %
105.73 %
1.43 %
(0.39) %
0.09 %
1.27 %
1.63 %
112.75 %
33
Old Second Bancorp, Inc.
Quarterly Financial Information
(Dollars in thousands, except per share data, unaudited)
Interest income
Interest expense
Net interest income
Loan loss (release) reserve
Securities gains, net
Income before taxes
Net income (loss)
Basic earnings (losses) per share
Diluted earnings (losses) per share
Dividends paid per share
4th
$ 27,668
4,479
23,189
150
35
12,453
9,536
0.32
0.31
0.01
2019
3rd
$ 29,444
4,664
24,780
550
3,463
16,209
12,173
0.41
0.40
0.01
2nd
$ 29,586
4,832
24,754
450
986
12,321
9,278
0.31
0.31
0.01
1st
$ 28,896
4,860
24,036
450
27
10,874
8,468
0.28
0.28
0.01
4th
$ 29,038
4,698
24,340
500
-
11,565
8,620
0.29
0.28
0.01
2018
3rd
$ 28,176
4,436
23,740
-
13
12,843
9,642
0.32
0.32
0.01
2nd
$ 27,261
4,019
23,242
1,450
312
8,038
6,261
0.21
0.21
0.01
1st
$ 23,142
3,526
19,616
(722)
35
11,489
9,489
0.32
0.31
0.01
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion provides additional information regarding our operations for the twelve-month periods ending
December 31, 2019, 2018 and 2017, and financial condition at December 31, 2019 and 2018 and should be read in conjunction with our
consolidated financial statements and the related notes. Historical results of operations and the percentage relationships among any
amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments
regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties.
Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our
cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this annual report.
Business overview
We provide a wide range of financial services through our 29 banking locations located in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle
and Will counties in Illinois. These banking centers offer access to a full range of traditional retail and commercial banking services
including treasury management operations as well as fiduciary and wealth management services. We focus our business on establishing
and maintaining relationships with our clients while maintaining a commitment to providing for the financial services needs of the
communities in which we operate through our retail branch network. We emphasize relationships with individual customers as well as
small to medium-sized businesses throughout our market area. Our market area includes a mix of commercial and industrial, real estate,
and consumer related lending opportunities, and provides a stable, loyal core deposit base. We also offer extensive wealth management
services, which 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.
Our primary deposit products are checking, NOW, money market, savings, and certificate of deposit accounts, and our primary lending
products are commercial mortgages, leases, construction lending, commercial loans, residential mortgages, and consumer loans. Many
of our 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.
The health of the overall real estate industry in our markets continued to improve in 2019. While the precipitous decline in the value of
certain real estate assets slowed in the latter part of 2010, continued difficult market conditions through 2015 generated smaller declines
in values of real estate and associated asset types. Overall stable market conditions over the past three years are reflected in the financials
presented for the reporting period that ended December 31, 2019.
On April 20, 2018, we closed on our acquisition of Greater Chicago Financial Corp. (“GCFC”), and its wholly-owned subsidiary, ABC
Bank. As a result of this transaction, we acquired $227.6 million of loans, net of fair value adjustments, and $248.5 million of deposits,
net of fair value adjustments. The purchase resulted in us increasing our presence in the near west Chicago area and metropolitan Chicago,
as four branches were acquired with a retail and commercial client mix of loans and deposits.
Financial overview
In 2019, we recorded net income of $39.5 million, or $1.30 per fully diluted share, which compares with $34.0 million, or $1.12 per fully
diluted share, in 2018, and $15.1 million, or $0.50 per fully diluted share, in 2017. Our basic earnings per share for the periods presented
were $1.32 in 2019, $1.14 in 2018, and $0.51 in 2017. Our 2019 net income increased primarily due to the expansion of our net interest
34
margin driven by loans we acquired in 2018 as well as organic loan growth and improved operating leverage. Our 2018 net income was
also favorably impacted by expansion in our net interest margin due to our ABC Bank acquisition and rising interest rates, which more
than offset the merger and acquisition related costs incurred. Our 2017 net income was negatively impacted by a nonrecurring income
tax expense of $9.5 million recorded in the fourth quarter of 2017 due to the “Tax Cuts and Jobs Act,” signed into law in late 2017, which
reduced the federal income tax rate and decreased our deferred tax asset. Our 2017 net income was favorably impacted by a nonrecurring
income tax credit of $1.6 million recorded in July 2017 due to a State of Illinois tax rate increase, which increased the deferred tax asset
by a like amount. In addition, we recorded provision for loan and lease losses in 2019 of $1.6 million, compared to $1.2 million in 2018
and $1.8 million in 2017. Net loan charge-offs were $817,000 in 2019, compared to net loan recoveries of $317,000 in 2018, and net
loan charge-offs of $497,000 in 2017.
Net interest and dividend income increased $5.8 million, or 6.4%, for 2019 compared to 2018. Average loans, including loans held-for-
sale, increased $118.9 million, or 6.7%, in 2019 compared to 2018. We had organic loan growth in our commercial, leases, and
commercial real estate loan portfolios in 2019 compared to 2018. Average interest bearing deposits decreased $17.1 million, or 1.2%,
for 2019 compared to 2018, while average deposit rates increased 12 basis points. The increase in rates was primarily due to the rising
interest rate environment through the first half of 2019, which impacted all interest-bearing deposit categories. Average noninterest
bearing deposits increased by $41.6 million, or 6.8%, from 2018 to 2019, as a result of commercial demand deposit growth which
correlated with our commercial, leases, and commercial real estate loan growth.
Net interest and dividend income increased $16.1 million, or 21.4%, for 2018, compared to 2017. Average loans, including loans held-
for-sale, increased $241.3 million, or 15.7%, in 2018 compared to 2017. The ABC Bank acquisition in the second quarter of 2018 and
two select HELOC loan purchases in the first and fourth quarters of 2018 contributed to the full year 2018 average loan growth over 2017
average loans. We also had organic loan growth in all areas of our loan portfolios in 2018 compared to 2017. Average interest bearing
deposits increased $123.1 million, or 9.1%, while average rates increased 16 basis points. This increase in rates was primarily due to the
rising interest rate environment in 2018, impacting interest rates on all interest-bearing deposit categories. Average noninterest bearing
deposits increased by $61.0 million, or 11.1%, from 2017 to 2018, a result of commercial demand deposit growth which correlated with
our commercial, construction and commercial real estate loan growth.
In 2018 and 2019, we continued to reposition our balance sheet to provide appropriate funding for loan growth and branch acquisition
needs, to further reduce asset quality risk, and grow deposits organically as a less expensive funding source. In 2019, our available-for-
sale securities portfolio decreased $56.6 million, compared to year end 2018, primarily from sales in the third quarter of 2019 due to
interest rate reductions and the tightening of credit spreads, which resulted in a $1.2 million decrease to interest income for 2019 compared
to 2018. The securities portfolio composition did not change materially in 2018 compared to 2017, and higher yields on our securities
resulted in a $1.8 million increase to interest income for 2018 compared to 2017. In 2017, we repositioned our available-for sale securities
portfolio into higher-yielding state and political subdivisions from mortgage-backed securities (“MBS”) and collateralized mortgage
obligations (“CMOs”) as market conditions made securities issued by federal agencies less attractive. Market conditions also increased
the value of our collateralized loan obligations (“CLOs”), which led many holdings to be called during 2017 and reduced the size of the
CLO portfolio significantly. Net securities gains of $4.5 million were recorded in 2019, compared to $360,000 in 2018, and $474,000 in
2017, related to sales and calls during those years. Average interest bearing liabilities decreased to $1.69 billion in 2019 from
$1.71 billion in 2018, as funding needs in 2019 were also met by an increase in average noninterest bearing deposits year over year.
Management also continued to emphasize credit quality and maintained our capital ratios with continued strong liquidity. In 2019, we
experienced loan growth of $33.8 million, or 1.8%, over 2018. The growth was driven by an active commercial lending team in new and
existing markets, and the continued development of a lease lending team. Asset quality levels have remained steady over the last few
years in comparison to total loans, as nonperforming assets, excluding PCI loans (which we do not consider to be nonperforming assets),
decreased to $20.9 million for 2019, compared to $23.5 million for 2018 and $24.0 million for 2017. We also continued to take steps to
reduce operating expenses and increase net income. A decline in other real estate owned holdings resulted in a minimal increase of
$27,000 in net other real estate owned expenses for 2019 compared to 2018, and a decline of $1.8 million in 2018 compared to 2017. As
we focused on reducing all noninterest expenses, we were able to maintain our profitable wealth management business and secondary
residential real estate originations and sales as important sources of noninterest income.
Critical accounting policies
Our consolidated financial statements are prepared based on the application of accounting policies in accordance with generally accepted
accounting principles (“GAAP”) and follow general practices within the banking industry. These policies require the reliance on
estimates, assumptions and judgements, which may prove inaccurate or are subject to variations. Changes in underlying factors,
estimates, assumptions or judgements could have a material impact on our future financial condition and results of operations.
Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater
possibility of producing results that could be materially different than originally reported. We have identified the determination of the
allowance for loan and lease losses, fair value methodologies, accounting for business combinations and accounting for loans acquired
in a business combination to be the accounting areas that require the most subjective or complex judgments and, as such, could be most
subject to revision as new or additional information becomes available or circumstances change, including overall changes in the
35
economic climate and/or market interest rates. Therefore, we consider these policies, discussed below, to be critical accounting estimates
and discuss them directly with the Audit Committee of our board of directors.
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. Recent accounting pronouncements and
standards that have impacted or could potentially affect us are also discussed in Note 1 of the consolidated financial statements.
Allowance for loan and lease losses
The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable credit losses inherent in the loan and
lease portfolio. Determination of the ALLL 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, portfolio growth and concentration
risk, management and staffing changes, and other credit market factors.
The ALLL methodology consists of (i) specific reserves established for probable losses on individual loans or leases for which the
recorded investment in the loan or lease exceeds the present value of expected future cash flows or the net realizable value of the
underlying collateral, if collateral dependent, (ii) an allowance based on an analysis that uses historical credit loss experience for each
loan or lease category, and (iii) the impact of other internal and external qualitative and credit market factors as assessed by management
through detailed review of loans, allowance analysis and credit discussions.
The ALLL is a valuation allowance for losses, increased by the provision for loan and lease 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 or leases, but the entire allowance is available for
losses inherent in the loan and lease portfolio.
Management incorporated methodology changes in the ALLL calculation in 2017, 2018 and 2019 to further refine the process. These
methodology changes are described in the “Allowance for Loan and Lease Losses” section of this “Management Discussion and Analysis
of Financial Condition and Results of Operations.” As a result of management’s analysis of the adequacy of the ALLL, a loan and lease
loss provision was recorded in 2019, 2018 and 2017.
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 were $18.0 million at December 31, 2019, $20.4 million at December 31, 2018, and
$20.1 million at December 31, 2017. In addition, a discussion of the factors driving changes in the amount of the ALLL is included in
the “Allowances for Loan and Lease Losses” section that follows.
Fair Value
The use of fair values is required in determining the carrying values of certain assets and liabilities, as well as for specific disclosures.
Fair value is an estimate of the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most
advantageous market for the asset or liability in an orderly transaction (i.e., not a forced transaction, such as a liquidation or distressed
sale) between market participants at the measurement date and is based on the assumptions market participants would use when pricing
an asset or liability.
In determining the fair value of financial instruments, market prices of the same or similar instruments are used whenever such prices are
available. If observable market prices are unavailable or impracticable to obtain, we are required to make judgments about assumptions
market participants would use in estimating the fair value of the financial instrument. Fair value is estimated using modeling techniques
and incorporates assumptions about interest rates, duration, prepayment speeds, risks inherent in a particular valuation technique and the
risk of nonperformance. These assumptions are inherently subjective as they require material estimates, all of which may be susceptible
to significant change. In 2018, we adopted ASU 2016-01, which, among other topics addressed, required business entities to use the exit
price notion, as defined in ASC 820, for the measurement of the fair value of financial instruments. Adoption of this standard resulted
in our use of an exit price rather than an entrance price to determine the fair value of loans and deposits not already measured at fair value
on a non-recurring basis in the consolidated balance sheet disclosures; see Note 19 “Fair Value of Financial Instruments” for further
information regarding the valuation processes.
Note 18, “Fair Value Measurements,” to the consolidated financial statements includes information about the extent to which fair value
is used to measure assets and liabilities and the valuation methodologies and key inputs used.
36
Accounting for Business Combinations
We account for transactions that meet the definition of a purchase business combination by recording the assets acquired and liabilities
assumed at their fair value on the acquisition date. Determining the fair value of assets acquired, including identified intangible assets,
and liabilities assumed often involves estimates based on third-party valuations, such as appraisals, or internal valuations based on
discounted cash flow analysis or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, discount
rates, multiples of earnings or other relevant factors. In addition, the determination of the useful lives over which an intangible asset will
be amortized is subjective. If the fair value of the assets acquired exceeds the purchase price plus the fair value of the liabilities assumed,
a bargain purchase gain is recognized. Conversely, if the purchase price plus the fair value of the liabilities assumed exceeds the fair
value of the assets acquired, goodwill is recognized.
Loans Acquired in Business Combinations
We record purchased loans at fair value at the date of acquisition based on a discounted cash flow methodology that considers various
factors, including the type of loan and related collateral, classification status, whether the loan has a fixed or variable interest rate, its
term and whether or not the loan was amortizing, and our assessment of risk inherent in the cash flow estimates. These cash flow
evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. Purchased
loans are segregated into two categories upon purchase: (1) loans purchased without evidence of deteriorated credit quality since
origination, referred to as purchased non-credit impaired (“non-PCI”) loans, and (2) loans purchased with evidence of deteriorated credit
quality since origination for which it is probable that all contractually required payments will not be collected, referred to as purchased
credit impaired (“PCI”) loans.
We account for and evaluate PCI loans for impairment in accordance with the provisions of ASC 310-30. We estimate the cash flows
expected to be collected on purchased loans based upon the expected remaining life of the loans, which includes the effects of estimated
prepayments. Cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to
significant change. We will perform re-estimations of cash flows on our PCI loan portfolio on a quarterly basis. Any decline in expected
cash flows as a result of these re-estimations, due in any part to a change in credit, is deemed credit impairment, and recorded as provision
for loan and lease losses during the period. Any decline in expected cash flows due only to changes in expected timing of cash flows is
recognized prospectively as a decrease in yield on the loan and any improvement in expected cash flows, once any previously recorded
impairment is recaptured, is recognized prospectively as an adjustment to the yield on the loan.
Non-PCI loans outside the scope of ASC 310-30 are accounted for under ASC 310-20. For non-PCI loans, credit discounts representing
the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest
income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is
similar to organic loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses.
Non-GAAP Financial Measures
This annual report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include
the presentation of net interest income and net interest income to interest earning assets on a tax equivalent (“TE”) basis and our tangible
common equity to tangible assets ratio. Management believes that the presentation of these non-GAAP financial measures (a) provides
important supplemental information that contributes to a proper understanding of our operating performance, (b) enables a more complete
understanding of factor and trends affecting our business, and (c) allows investors to evaluate our performance in a manner similar to
management, the financial services industry, bank stock analysts, and bank regulators. Management uses non-GAAP measures as follows:
in the preparation of our operating budgets, monthly financial performance reporting, and in our presentation to investors of our
performance. However, we acknowledge that these non-GAAP financial measures have a number of limitations. Limitations associated
with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these
measures and that different companies might calculate these measures differently. These disclosures should not be considered an
alternative to our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial
measures is presented below or alongside the first instance where each non-GAAP financial measure is used.
Results of operations
Net interest income
Net interest income, which is our primary source of earnings, is the difference between interest income earned on interest-earning assets,
such as loans and investment securities, as well as accretion income on purchased loans, and interest incurred on interest-bearing
liabilities, such as deposits and borrowings. Net interest income depends upon the relative mix of interest-earning assets and interest-
bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and
movements in market interest rates. Our net interest income can be significantly influenced by a variety of factors, including overall loan
demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and PCI loans, 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
37
sheet growth or contraction. Our asset and liability committee (“ALCO”) seeks to manage interest rate risk under a variety of rate
environments by structuring our balance sheet and off-balance sheet positions. This process is discussed in more detail in the section
entitled “Interest rate risk” in “Quantitative and Qualitative Disclosures about Market Rate Risk.”
Our net interest income increased $5.8 million, or 6.4%, to $96.8 million for 2019, from $90.9 million for 2018. The increase in 2019
was primarily driven by a full year impact of our acquisition of ABC Bank, and was partially offset by increases in interest expense. Our
net interest margin was 3.98% for the year ended 2019, compared to 3.87% for the year ended 2018, an increase of 11 basis points. Our
net interest margin on a taxable equivalent (TE) basis, which is net interest income divided by total interest-earning assets, was 4.06%
for the year ended 2019, compared to 3.96% for the year ended 2018, an increase of ten basis points. The growth in our net interest
margin was due to higher loan volumes in 2019, coupled with $2.1 million of discount accretion on loans acquired in our ABC Bank
acquisition in 2018 and Talmer branch purchase in late 2016. The increase in interest expense in 2019 compared to 2018 was due
primarily to higher rates paid on all interest bearing deposits, as well as additional short-term funding needs, which increased due to our
loan growth and was financed by FHLBC borrowings, which reprice daily.
Our net interest income increased $16.1 million, or 21.4%, to $90.9 million for 2018, from $74.9 million for 2017. The increase in
interest and dividend income in 2018 was primarily driven by our acquisition of ABC Bank, and was partially offset by increases in
interest expense. Our net interest margin on a taxable equivalent basis was 3.78% for the year ended 2018, compared to 3.54% for the
year ended 2017, an increase of 33 basis points. Our net interest margin (TE) basis was 3.96% for the year ended 2018, compared to
3.70% for the year ended 2017, an increase of 26 basis points. The growth in our net interest margin was due to higher loan volumes in
2018, coupled with $2.7 million of discount accretion on loans acquired in our ABC Bank acquisition in 2018 and Talmer branch purchase
in late 2016, and higher yielding municipal securities held for the full year 2018. The increase in interest expense in 2018 compared to
2017 was due primarily to higher rates paid on time deposits, as well as additional short-term funding needs, which increased due to our
loan growth and was financed by FHLBC borrowings, which reprice daily.
Our average earning assets increased $81.5 million, or 3.5%, to $2.43 billion in 2019, from $2.35 billion in 2018. The increase was
primarily attributable to a full year of average impact of our April 2018 acquisition of ABC Bank, as well as organic commercial, lease
financing, and commercial real estate loan growth. Our average earning assets increased $238.2 million, or 11.3%, to $2.35 billion in
2018, from $2.11 billion in 2017. The increase was primarily attributable to our ABC Bank acquisition, organic commercial, lease
financing, commercial real estate, and construction loan growth and our purchase of two HELOC portfolios, totaling $41.6 million from
a third party.
Our average interest bearing liabilities decreased $17.3 million, or 1.0%, from $1.71 billion in 2018 to $1.69 billion in 2019, due primarily
to a reduction in average NOW, money market, savings and time deposits, as well as growth in commercial demand deposit accounts
commensurate with growth in our commercial loan clients, and a modest increase in short-term borrowings used to fund loan growth.
Our average interest bearing liabilities increased $153.7 million, or 9.9%, from $1.56 billion in 2017 to $1.71 billion in 2018, due
primarily to the ABC Bank acquisition in the second quarter of 2018, as well as growth in commercial deposit accounts corresponding
with growth in commercial loan clients, and an increase in short-term borrowings used to fund loan growth.
The following table sets forth certain information relating to our average consolidated balance sheets and reflects the yield on average
interest earning assets and cost of average interest bearing liabilities for the years indicated obtained by dividing the related interest by
the average balance of assets or liabilities. Average balances are derived from daily balances.
38
Assets
Interest earning deposits with financial institutions $
Securities:
Taxable
Non-taxable (TE)1
Total securities (TE)1
Dividends from FHLBC and FRBC
Loans and loans held-for-sale 1 , 2
Total interest earning assets
Cash and due from banks
Allowance for loan and lease losses
Other noninterest bearing assets
Total assets
Liabilities and Stockholders' Equity
NOW accounts
Money market accounts
Savings accounts
Time deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Senior notes
Notes payable and other borrowings
Total interest bearing liabilities
Noninterest bearing deposits
Other liabilities
Stockholders' equity
Total liabilities and stockholders' equity
Net interest income (GAAP)
Net interest margin (GAAP)
Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates
(Dollars in thousands - unaudited)
Average
Balance
2019
Income / Rate
%
Expense
Average
Balance
2018
Income / Rate Average
Balance
Expense
%
2017
Income / Rate
Expense %
21,783 $
459
2.11 $
17,540 $
334
1.90 $
12,224
$
134
1.08
253,260
249,976
503,236
10,730
1,897,909
9,256
9,399
18,655
602
97,866
2,433,658 117,582
-
-
-
34,027
(19,548)
175,306
$ 2,623,443
268,791
3.65
277,555
3.76
546,346
3.71
5.61
9,305
5.16 1,778,996
4.83
-
-
-
9,577
10,558
20,135
469
88,922
2,352,187 109,860
-
-
-
34,021
(18,930)
180,528
$ 2,547,806
347,712
3.56
208,142
3.80
555,854
3.69
5.04
8,127
5.00 1,537,742
2,113,947
4.67
33,738
-
(16,390)
-
187,503
-
$ 2,318,798
10,202
9,137
19,339
370
70,950
90,793
-
-
-
2.93
4.39
3.48
4.55
4.55
4.25
-
-
-
$ 432,028 $
289,745
308,847
431,377
1,461,997
43,698
73,757
57,710
44,212
12,008
1,693,382
650,400
22,984
256,677
$ 2,623,443
1,386
1,086
488
6,736
9,696
577
1,755
3,724
2,699
384
18,835
-
-
-
0.32 $ 436,702 $
0.37
0.16
1.56
0.66
1.32
2.38
6.45
6.10
3.20
1.11
-
-
-
307,259
291,611
443,520
1,479,092
44,122
71,041
57,663
44,109
14,696
1,710,723
608,762
16,742
211,579
978
843
335
5,829
7,985
462
1,429
3,716
2,688
398
16,678
-
-
-
$ 2,547,806
0.22 $ 425,435
278,826
0.27
261,974
0.11
389,771
1.31
1,356,006
0.54
31,478
1.05
67,959
2.01
57,615
6.44
44,010
6.09
-
2.71
1,557,068
0.97
547,719
-
22,131
-
191,880
-
$ 2,318,798
$
424
349
177
4,227
5,177
17
741
4,002
2,689
-
12,626
-
-
-
$ 96,759
$ 90,939
$ 74,879
3.98
3.87
0.10
0.13
0.07
1.08
0.38
0.05
1.08
6.95
6.11
-
0.81
-
-
-
3.54
3.70
Net interest income (TE)1
Net interest margin (TE)1
Interest bearing liabilities to earning assets
$ 98,747
$ 93,182
$ 78,167
69.58 %
72.73 %
73.66 %
4.06
3.96
1 Tax equivalent basis is calculated using a marginal tax rate of 21% in 2019 and 2018 and 35% in 2017. See the discussion entitled
“Non-GAAP Presentations” below and the table on page 40 that provides a reconciliation of each non-GAAP measure to the most
comparable GAAP equivalent.
2 Interest income from loans is shown tax equivalent basis, which is a non-GAAP financial measure, discussed below, and includes fees
of $1.1 million for both 2019 and 2018, and $2.4 million for 2017, respectively. Nonaccrual loans are included in the above stated
average balances.
39
For purposes of discussion, net interest income and net interest income to interest earning assets have been adjusted to a non-GAAP tax
equivalent (“TE”) basis 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:
(Dollars in thousands)
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)
Average interest earning assets
Net interest income to total interest earning assets (GAAP)
Net interest income to total interest earning assets (TE)
$
$
$
$
2019
Effect of Tax Equivalent Adjustment
2018
2017
115,594
14
1,974
117,582
18,835
98,747
96,759
2,433,658
$
$
$
$
3.98 %
4.06 %
107,617
26
2,217
109,860
16,678
93,182
90,939
2,352,187
$
$
$
$
3.87 %
3.96 %
87,505
90
3,198
90,793
12,626
78,167
74,879
2,113,947
3.54 %
3.70 %
The following table allocates the changes in net interest income to changes in either average balances or average rates for interest earning
assets and interest bearing liabilities. Interest income is measured on a tax-equivalent basis using a 21% marginal rate for 2019 and 2018,
and a 35% marginal rate for 2017. Interest income not yet received on nonaccrual loans is reversed upon transfer to nonaccrual status;
future receipt of interest income is a reduction to principal while in nonaccrual status.
Analysis of Year-to-Year Changes in Net Interest Income1
(Dollars in thousands)
Interest and dividend income
Interest earning deposits
Securities:
Taxable
Tax-exempt
Dividends from FHLBC and FRBC
Loans and loans held-for-sale
Total interest and dividend income
Interest expense
NOW accounts
Money market accounts
Savings accounts
Time deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Senior notes
Notes payable and other borrowings
Total interest expense
Net interest and dividend income
2019 Compared to 2018
Change Due to
Average
Balance
Average
Rate
Total
Change
2018 Compared to 2017
Change Due to
Average
Balance
Average
Rate
Total
Change
$
87
$
38
$
125 $
73
$
127
$
200
(579)
(1,038)
76
6,071
4,617
(10)
(45)
21
(154)
(4)
56
3
6
(1,216)
(1,343)
5,960
$
258
(121)
57
2,873
3,105
418
288
132
1,061
119
270
5
5
1,202
3,500
(395)
(321)
(1,159)
133
8,944
7,722
(11,252)
2,369
57
11,045
2,292
10,627
(948)
42
6,927
16,775
(625)
1,421
99
17,972
19,067
408
243
153
907
115
326
8
11
(14)
2,157
5,565 $
12
39
22
632
10
34
3
6
-
758
1,534
542
455
136
970
435
654
(289)
(7)
398
3,294
$ 13,481
554
494
158
1,602
445
688
(286)
(1)
398
4,052
15,015
$
$
$
1 The changes in net interest income are created by changes in both interest rates and volumes. In the table above, volume variances
are computed using the change in volume multiplied by previous year’s rate. Rate variances are computed using the change in rate
multiplied by the previous year’s volume. The change in interest due to both rate and volume has been allocated between factors in
proportion to the relationship of absolute dollar amounts of the change in each.
Provision for loan and lease losses
We recorded a provision for loan and lease losses in 2019 of $1.6 million, compared to $1.2 million in 2018 and $1.8 million in 2017.
For additional discussion of the loan and lease loss provision and allowance, see the section below “Allowance for Loan and Lease
Losses” in Item 7. Management’s Discussion and Analysis of Financial Condition.
40
Noninterest income
(Dollars in thousands)
Trust income
Service charges on deposits
Residential mortgage banking revenue
Secondary mortgage fees
Mortgage servicing rights mark to market loss
Mortgage servicing income
Net gain on sales of mortgage loans
Total residential mortgage banking revenue
Securities gains (losses), net
Increase in cash surrender value of BOLI
Death benefit realized on bank-owned life insurance
Debit card interchange income
Gains on disposal and transfer of fixed assets
Other income
Total noninterest income
$
N/M - Not meaningful
Noninterest Income for the Twelve Months
ending December 31,
2018
2019
2017
$
6,655 $
7,715
6,417 $
7,328
6,203
6,720
Percent Change From
2019-2018 2018-2017
3.4
9.0
3.7
5.3
772
(2,662)
1,881
5,112
5,103
4,511
1,415
872
4,177
32
5,320
35,800 $
696
(734)
1,939
3,791
5,692
360
984
1,026
4,420
-
5,126
31,353 $
776
(802)
1,778
4,803
6,555
474
1,432
-
4,200
10
4,778
30,372
10.9
(262.7)
(3.0)
34.8
(10.3)
N/M
43.8
(15.0)
(5.5)
100.0
3.8
14.2
(10.3)
8.5
9.1
(21.1)
(13.2)
(24.1)
(31.3)
100.0
5.2
(100.0)
7.3
3.2
Our total noninterest income increased $4.4 million to $35.8 million in 2019, compared to $31.4 million in 2018. We continued to
implement our strategy to grow trust income and service charges on deposits, subject to applicable bank regulations. Trust income
increased $238,000 in 2019 from 2018, due primarily to growth in agent fees, IRA management fees, and management emphasis on
advisory fee growth. Average assets under management by our wealth management department totaled $1.21 billion for 2019, reflecting
growth of $33.0 million, or 2.8%, from $1.18 billion for 2018. Service charges on deposits increased $387,000 in 2019 from 2018 due
primarily to growth in commercial demand related account fees, as a result of increases in commercial demand deposit balances
commensurate with management’s focus on growing commercial loans. Residential mortgage banking revenue declined $589,000 in
2019 from 2018, due primarily to a rising interest rate environment in the first half of 2019 and the negative impact of the rate changes
to mortgage servicing rights, which were partially offset by an increase of $30.8 million in mortgage loans originated for sale in 2019.
Security gains, net, of $4.5 million were recorded in 2019, relating to security sales of $191.3 million, compared to security gains, net, of
$360,000 in 2018 related to $94.7 million of securities sales in 2018. We recorded a death benefit of $872,000 on bank owned life
insurance, or BOLI, in 2019, in addition to the $431,000 increase in cash surrender value of BOLI compared to 2018. Debit card
interchange income decreased due to a reversal of $250,000 recorded in 2018 related to an accrual for a debit card rewards program that
was discontinued in late 2018. Finally, other income increased $226,000 in 2019 compared to 2018 due to an increase in ATM
interchange fees and an incentive recorded related to a new debit card vendor contract.
Our total noninterest income increased $981,000, to $31.4 million in 2018, compared to $30.4 million in 2017. Trust income increased
$214,000 in 2018 from 2017, due primarily to growth in agent fees, IRA management fees, and management emphasis on advisory fee
growth. Average assets under management by our wealth management department totaled $1.18 billion for 2018, reflecting growth of
$72.4 million, or 6.5%, from $1.11 billion for 2017. Service charges on deposits increased $608,000 in 2018 from 2017 due primarily to
growth in commercial demand related account fees, as a result of increases in commercial demand deposit balances commensurate with
management’s focus on growing commercial loans. Residential mortgage banking revenue declined $863,000 in 2018 from 2017, due
primarily to a rising interest rate environment and the negative impact of the rate changes to mortgage servicing rights, as well as a
reduction of $12.9 million in mortgage loans originated for sale in 2018. Securities gains were $360,000 for 2018, relating to security
sales of $94.7 million, compared to security gains, net, of $474,000 in 2017 related primarily to $232.5 million of securities sales in 2017.
We recorded a death benefit of $1.0 million on BOLI in 2018, which was partially offset by a reduction in the increase in cash surrender
value of BOLI compared to 2017. An increase was reflected in debit card interchange income due to a reversal of $250,000 related to an
accrual for a debit card rewards program that was discontinued in late 2018. Finally, other income increased $348,000 in 2018 compared
to 2017 due to an increase in ATM transaction fees and miscellaneous recoveries, primarily related to a reversal of property tax accruals
taken in prior years on nonperforming loans.
41
Noninterest expense
(Dollars in thousands)
Salaries
Officers incentive
Benefits and other
Total salaries and employee benefits
Occupancy, furniture and equipment
Computer and data processing
FDIC insurance
General bank insurance
Amortization of core deposit intangible
Advertising expense
Debit card interchange expense
Legal fees
Other real estate owned expense, net
Other expense
Total noninterest expense
N/M - Not meaningful
Noninterest Expense for the Twelve Months
ending December 31,
2018
2019
2017
$
$
36,413 $
3,378
7,078
46,869
8,289
5,631
176
1,002
539
1,225
977
675
423
13,296
79,102 $
34,031 $
3,131
6,999
44,161
6,915
6,745
653
1,040
387
1,567
940
835
396
13,489
77,128 $
31,096
2,637
6,347
40,080
5,951
4,387
658
1,031
96
1,505
1,329
650
2,165
11,297
69,149
Percent Change From
2019-2018 2018-2017
9.4
18.7
10.3
10.2
16.2
53.7
(0.8)
0.9
N/M
4.1
(29.3)
28.5
(81.7)
19.4
11.5
7.0
7.9
1.1
6.1
19.9
(16.5)
(73.0)
(3.7)
39.3
(21.8)
3.9
(19.2)
6.8
(1.4)
2.6
Our total noninterest expense increased by $2.0 million, or 2.6%, in 2019 compared to 2018. The increase was primarily attributable to
a full year of costs related to our acquisition of ABC Bank in the second quarter of 2018, which increased salaries and employee benefits,
and occupancy, furniture and equipment expense. In addition to the acquisition-related expense, as part of our strategic plan, we also
made significant improvements, repairs and maintenance in 2019 on our various bank locations. Computer and data processing and legal
fees decreased in 2019 compared to 2018, as the 2018 expenses included acquisition related costs. FDIC insurance expense decreased
$477,000, or 73.0%, in 2019 from 2018 due to assessment credits received in 2019 after the FDIC reached its required reserve ratio; see
“Supervision and Regulation Deposit Insurance” for further discussion of these assessment credits. Amortization of core deposit
intangibles increased $152,000, or 39.0%, in 2019, reflecting a full year of expense of the ABC Bank acquired deposit premium.
Advertising expense decreased in 2019, as we are assessing our marketing strategy and opportunities for future promotion of our 150th
anniversary in 2021. Our other real estate owned expenses, net, increased marginally by $27,000 due to continued low levels of other
real estate held, and reductions in valuation reserves taken in 2019.
Our total noninterest expense increased by $8.0 million, or 11.5%, in 2018 compared to 2017. The increase was primarily attributable to
our acquisition of ABC Bank in the second quarter of 2018, which resulted in aggregate merger and acquisition related costs of
$3.5 million in 2018. In addition, growth in our employees and branches from the ABC Bank acquisition has contributed to increased
salaries and employee benefits and occupancy, furniture and equipment expense in 2018. Total salaries and employee benefits increased
10.2% in 2018 compared to 2017, occupancy, furniture and equipment costs increased 16.2% in 2018 compared to 2017, and computer
and data processing costs increased 53.7%, due primarily to the data conversion and contract exit costs related to the acquisition. Our
other real estate owned expenses, net, decreased $1.8 million in 2018 compared to 2017, as a result of decreases in maintenance costs
due to the reduction in our other real estate owned balances, a decrease in valuation reserves taken in 2018, and an increase in gains on
sales of properties held in 2018. Other expense reflected an increase of $2.2 million in 2018 over 2017 primarily due to ABC Bank
acquisition-related costs of $582,000, an increase in consulting costs of $300,000 related to third party stress testing, various operational
reviews, and preparation for the implementation of CECL, and a loss incurred related to a mortgage escrow reimbursement payable to a
loan customer of $240,000.
Our number of full-time equivalent employees was 535 as of December 31, 2019, compared to 518 as of December 31, 2018 and 450 as
of December 31, 2017. Staffing levels increased in 2019 primarily due to the continued growth of our commercial lending and compliance
staff. The increase in staffing levels from 2017 to 2018 of 68 employees was primarily driven by our ABC Bank acquisition. Management
continues to be diligent in controlling the hiring of additional personnel, even as positions become open, as we seek to efficiently utilize
our current staff and control expenses.
42
Income taxes
Our provision for income taxes includes both federal and state income tax expense (benefit). An analysis of the provision for income
taxes for the three years ended December 31, 2019, is detailed in Note 12 of the consolidated financial statements and our income tax
accounting policies are described in Note 1 to the consolidated financial statements.
Our income tax expense totaled $12.4 million for 2019, compared to an income tax expense of $9.9 million for 2018 and $19.2 million
for 2017. Income tax expense reflected all relevant statutory tax rates and GAAP accounting. Our effective tax rate was 23.9% for 2019,
22.6% for 2018 and 55.9% for 2017. Any changes in tax rates will be recorded in the period enacted.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, which resulted in a reduction in the Federal income tax rate from
35% to 21%, thereby decreasing our deferred tax asset by $9.5 million and increasing our income tax expense. In addition, in July 2017,
the State of Illinois enacted a tax rate change which resulted in us recording a $1.6 million increase to the deferred tax asset and an income
tax credit.
On September 2, 2015, the Company and the Bank, as rights agent, entered into a Second Amendment to Amended and Restated Rights
Agreement and Tax Benefits Preservation Plan, which amended the Amended and Restated Rights Agreement and Tax Benefits
Preservation Plan, dated as of September 12, 2012 (as amended, the “Tax Benefits Plan”). This amendment was submitted and approved
by our stockholders at our 2016 annual meeting, which extended the final expiration date of the Tax Benefits Plan from September 12,
2015, to September 12, 2018. The Tax Benefits Plan expired on September 12, 2018, and our board of directors determined not to extend
it.
The determination of whether we will be able to realize our 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 both current and future economic and business conditions. Management considered both positive and
negative evidence regarding our ability to ultimately realize the deferred tax assets, which is largely dependent on our ability to derive
benefits based on future taxable income. For all periods presented, management determined that the realization of the deferred tax asset
was “more likely than not” as required by GAAP.
Financial condition
General
Our total assets were $2.63 billion at December 31, 2019, a decrease of $40.5 million, or 1.5%, from December 31, 2018. Our loans
increased by $33.8 million, or 1.8%, to $1.93 billion for the year ended December 31, 2019, compared to 2018. We experienced organic
loan growth in 2019, primarily in our commercial, leases and commercial real estate loan portfolios. Total securities decreased by $56.6
million, or 10.5%, for the year ended December 31, 2019. Our portfolio mix remained static overall, but we were able to benefit from
tight credit spreads and executed sales, primarily in the third quarter of 2019 when interest rates started to fall, recording pretax security
gains, net, of $4.5 million for 2019. In 2019, management continued to emphasize the stabilization of our balance sheet and credit quality
in all lending decisions. We also continued to experience a high level of competition for loans in our target markets. The balance of our
other real estate owned decreased to $5.0 million as of December 31, 2019, from $7.2 million as of December 31, 2018.
Our total liabilities were $2.36 billion at December 31, 2019, a decrease of $89.2 million, or 3.7%, from December 31, 2018. Total
deposits increased by $10.0 million, or 0.5%, to $2.13 billion for the year ended December 31, 2019, compared to $2.12 billion for the
year ended December 31, 2018, primarily due to commercial demand deposit growth commensurate with our commercial loan growth.
Management continued to fund new lending with deposit growth, short term borrowings from the Federal Home Loan Bank of Chicago
(the “FHLBC”), securities sold under repurchase agreements, long-term FHLBC borrowings acquired with the ABC Bank acquisition
which are recorded within notes payable and other borrowings, and security sales.
At December 31, 2019, total stockholders’ equity was $277.9 million, compared to $229.1 million at December 31, 2018.
Investments
As shown below, we experienced minimal changes in the overall composition of our securities portfolio from 2017 to 2019. However,
the size of the portfolio decreased in 2019 compared to 2018 primarily due to security sales, which generated $191.3 million of proceeds
in 2019.
43
(Dollars in thousands)
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 loan obligations
Total securities available-for-sale
2019
2018
2017
Amortized Fair
Cost
Value
% of Amortized Fair
Value
Cost
Total
% of Amortized Fair
Value
Cost
Total
% of
Total
$
4,010
8,502
16,164
240,399
-
57,059
82,114
66,898
$ 475,146
$
4,036
8,337
16,588
249,175
-
57,984
81,844
66,684
$ 484,648
4,006
0.8 $
11,112
1.7
14,407
3.4
277,112
51.4
-
0.0
66,494
12.0
108,574
16.9
65,162
13.8
100.0 $ 546,867
$
3,923
10,951
14,075
274,067
-
64,429
109,514
64,289
$ 541,248
0.7
2.0
2.6
50.6
0.0
11.9
20.3
11.9
100.0
$
4,002
13,062
12,372
272,240
823
66,892
113,983
54,271
$ 537,645
$
3,947
13,061
12,214
278,092
833
65,939
112,932
54,421
$ 541,439
0.7
2.4
2.3
51.4
0.1
12.2
20.9
10.0
100.0
Our investment portfolio serves as both an important source of liquidity and as a source of income. Accordingly, the size and composition
of the portfolio reflects our liquidity needs, loan demand and interest income objectives. We will adjust the size and composition of the
portfolio 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.
Our total securities as of December 31, 2019, reflected a net decrease of $56.6 million, or 10.5%, from December 31, 2018. Security
sales were executed in 2019 to take advantage of the tightening credit spreads in the falling interest rate environment, with the reduction
occurring primarily in states and political subdivisions, collateralized mortgage obligations (“CMOs”), and asset-backed securities. In
addition, net paydowns and calls totaled $41.8 million in 2019, primarily due to the falling interest rate environment. We recorded net
securities gains of $4.5 million in 2019 related to sales and calls during the year.
Our total securities as of December 31, 2018, reflected a net decrease of $191,000, or 0.04%, from December 31, 2017. Portfolio activity
in 2018 was minimal, with the most notable change being the reduction of collateralized loan obligations (“CLOs”) due to call options
exercised by select issuers. The stability of the portfolio composition in 2018 reflected the tight credit spreads that persisted through
much of 2018, with an associated lack of relative value among investment sectors. We recorded net securities gains of $360,000 in 2018
related to sales and calls during the year.
In 2017, market conditions made mortgage-backed securities (“MBS”) and CMOs issued by federal agencies less attractive, while
issuances of states and political subdivisions became more attractive. As a result, we liquidated select CMOs, mortgage-backed securities,
corporate bonds and asset-backed securities (“ABS”) to allow for portfolio repositioning in favor of high-quality state and municipal
securities. We executed purchases totaling $270.2 million in this security type during 2017 due to favorable pricing in the rising interest
rate environment. These portfolio increases were more than offset by reductions in holdings of ABS and CMOs; these reductions were
comprised of sales of $146.9 million and paydowns of $13.0 million. We recorded net securities gains of $474,000 in 2017 related to
sales and calls during the year.
Some of our holdings of U.S. government agency MBS and CMOs are issuances of government-sponsored enterprises, such as Fannie
Mae and Freddie Mac, which are not backed by the full faith and credit of the U.S. government. Some holdings of MBS and CMOs are
issued by Ginnie Mae, which does carry the full faith and credit of the U.S. government. We also hold some MBS and CMOs that were
not issued by U.S. government agencies and are typically credit-enhanced via over-collateralization and/or subordination. Holdings of
ABS were largely comprised of securities backed by student loans issued under the U.S. Department of Education’s (“DOE”) FFEL
program, which generally provides a minimum 97% U.S. DOE guarantee of principal. These ABS securities also have added credit
enhancement through over-collateralization and/or subordination. The majority of holdings issued by states and political subdivisions
are general obligation or revenue bonds that have S&P or Moody’s ratings of AA- or higher. Other state and political subdivision
issuances are unrated and generally consist of smaller investment amounts that involve issuers in our markets. The credit quality of these
issuers is monitored and none have been identified as posing a material risk of loss. We also hold collateralized loan obligation (“CLOs”)
securities that are generally backed by a pool of debt issued by multiple middle-sized and large businesses. Our CLO S&P or Moody’s
ratings distribution consists of 58% rated A, 26% rated AA and 14% rated AAA. CLO credit enhancement is achieved through over-
collateralization and/or subordination.
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, 2019. Securities not due at a single maturity date are shown only in the total column.
44
(Dollars in thousands)
Securities available-for-sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Mortgage-backed securities and collateralized
mortgage obligations
Asset-backed securities
Collateralized loan obligations
Securities Portfolio Maturity and Yields
After One But
Within One Year Within Five Years Within Ten Years
Amount Yield Amount Yield Amount Yield Amount
After Five But
After Ten Years
Total
Yield Amount
Yield
$
-
-
-
-
510 2.03 %
510 2.03
$ 4,036 1.85 % $
-
-
2,375 2.56
6,411 2.11
-
-
$
-
-
-
$
8,337 2.80 %
-
5,076 3.49 %
5,076 3.49
241,214 3.02
249,551 3.02
4,036 1.85 %
8,337 2.80
249,175 3.03
261,548 3.00
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
81,844
74,572 3.28
2.99
66,684 4.28
Total securities available-for-sale
$
510 2.03 % $ 6,411 2.11 % $ 5,076 3.49 % $ 249,551 3.02 % $ 484,648 3.22 %
As of December 31, 2019, net unrealized gains on available-for-sale securities totaled $9.5 million, which offset by deferred income taxes
resulted in an overall decrease to equity capital of $6.8 million. As of December 31, 2018, net unrealized losses on available-for-sale
securities totaled $5.6 million, which offset by deferred income taxes resulted in an overall increase to equity capital of $4.0 million.
At December 31, 2019, there were two issuers of ABS and CMOs where the book value of our holdings were greater than 10% of our
stockholders’ equity, as follows:
(Dollars in thousands)
Issuer
GCO Education Loan Funding Corp
Towd Point Mortgage Trust
December 31, 2019
Fair
Value
Amortized
Cost
27,873
33,551
$
$
27,470
34,322
We had no securities held-to-maturity in 2019, 2018, or 2017. In the second quarter of 2016, we transferred our portfolio to available-
for-sale to allow for portfolio restructuring and to fund loan growth. Due to the transfer to available-for-sale in 2016, we were precluded
from holding any securities as held-to-maturity for a two year period after the date of transfer; that two year limitation expired in the
second quarter of 2018.
Loans
The following table presents the composition of the loan portfolio at December 31 for the year indicated:
Loan Portfolio
(Dollars in thousands)
Commercial
Leases
Real estate - commercial
Real estate - construction
Real estate - residential
HELOC
Other1
Total loans, excluding deferred loans
costs and PCI loans
Net deferred loans costs
Total loans, excluding PCI loans
PCI loans, net of purchase accounting
adjustments
Total Loans
$
2019
332,842
119,751
865,599
69,617
396,901
123,457
12,258
% of
Total
17.2 $
6.2
44.8
3.6
20.6
6.4
0.7
$
2018
314,323
78,806
820,941
108,390
407,068
140,442
14,439
% of
Total
16.6
4.2
43.3
5.7
21.5
7.4
0.6
$
2017
272,851
68,325
750,991
85,162
313,397
112,833
13,383
% of
Total
16.9
4.2
46.4
5.3
19.4
7.0
0.8
$
2016
228,113
55,451
736,247
64,720
276,226
101,625
15,210
% of
Total
15.4
3.7
49.8
4.4
18.7
6.9
1.0
2015
115,603
25,712
605,721
19,806
245,475
105,532
14,829
% of
Total
10.2
2.3
53.4
1.7
21.7
9.3
1.3
1,920,425
1,786
1,922,211
99.5
0.1
99.6
1,884,409
1,653
1,886,062
99.3
0.1
99.4
1,616,942 100.0
0.0
680
1,617,622 100.0
99.9
1,477,592
1,217
0.1
1,478,809 100.0
99.9
1,132,678
0.1
1,037
1,133,715 100.0
8,601
0.6
$ 1,930,812 100.0 $ 1,897,027 100.0
10,965
0.4
0.0
$ 1,617,622 100.0
-
0.0
$ 1,478,809 100.0
-
0.0
$ 1,133,715 100.0
-
1 The “Other” class includes consumer loans and overdrafts.
Our total loans were $1.93 billion as of December 31, 2019, an increase of $33.8 million from $1.90 billion as of December 31, 2018.
Our loan growth in 2019 was driven by organic loan growth in commercial, leases, and commercial real estate loans, partially offset by
reductions in construction, residential real estate, HELOC, and other loans. Total loan originations of $790.2 million were recorded in
2019, which were largely offset by accelerated paydowns experienced in 2019. No loan purchases were recorded in 2019, as all growth
was originated by our commercial, residential and retail teams’ ongoing sales efforts. We strive to serve customers in and around our
geographic locations and continue to seek opportunities in our primary lending markets; however, our markets remain very competitive
for new loan business.
45
Our total loans were $1.90 billion as of December 31, 2018, an increase of $279.4 million from $1.62 billion as of December 31, 2017.
Our loan growth in 2018 was driven by our ABC Bank acquisition of $227.6 million of loans, net of purchase accounting adjustments,
as well as organic loan and lease financing growth and two HELOC purchases from a third party of $41.6 million in 2018. In 2018, we
continued our focus on identifying commercial and industrial loan prospects that conform to our loan policies, and we increased
commercial loans by $41.5 million in 2018 compared to 2017. We also purchased $17.1 million in leases from a third-party originator
in 2017, and organic loan growth increased commercial loans by $44.7 million in 2017 compared to 2016.
We worked diligently to build loan origination pipelines in a competitive marketplace during the past four years, as evidenced by our
loan growth of 1.8% in 2019, 17.3% in 2018, 9.4% in 2017 and 30.4% in 2016. Management continues to emphasize loan portfolio
quality, which was evidenced by the improved nonperforming loan metrics discussed in the “Asset Quality” section below. As a result,
net loan charge-offs of $817,000 were recorded in 2019, net loan recoveries of $317,000 were recorded in 2018, and $497,000 of net loan
charge-offs were recorded in 2017.
The quality of our loan portfolio is in large part a reflection of the economic health of the communities in which we operate. Our local
economies have displayed improved economic conditions in the past five years, as reflected in our loan growth and declines in classified
assets, as discussed in the “Asset Quality” section below. Real estate lending categories comprised the largest group in the portfolio for
all years presented. In addition, our lending exposure is diversified across our commercial, leasing, real estate-commercial, real estate-
residential and real estate-construction loan portfolios, with total loan portfolio growth increasing in each of the five years presented. We
remain committed to overseeing and managing our loan portfolio to avoid unnecessarily high credit concentrations in accordance with
the general interagency guidance on risk management. Consistent with those commitments, management monitors our asset
diversification and anticipates that the percentage of real estate lending in relation to the overall portfolio will decrease in the future.
The following table sets forth the remaining contractual maturities for loan categories at December 31, 2019:
Maturity and Rate Sensitivity of Loans to Changes in Interest Rate
(Dollars in thousands)
Commercial
Leases
Real estate - commercial
Real estate - construction
Real estate - residential
HELOC
Other1
Total2
One Year
or Less
$ 163,372
2,647
113,425
37,591
45,039
2,733
4,241
$ 369,048
Over 1 Year
Through 5 Years
Fixed
Rate
$
63,992
110,486
389,224
12,604
150,497
2,388
3,184
$ 732,375
Floating
$
Rate
77,609
674
170,321
14,777
43,584
16,798
4,843
$ 328,606
Over 5 Years
Fixed
Rate
$
8,574
6,789
59,047
2,469
13,142
42,124
-
$ 132,145
Floating
$
Rate
19,834
-
136,269
2,383
150,738
59,414
-
368,638
$
Total
333,381
120,596
868,286
69,824
403,000
123,457
12,268
1,930,812
$
$
1 The “Other” class includes consumer loans and overdrafts; column one includes demand notes.
2 The “Total” is inclusive of PCI loans, net of purchase accounting adjustments of $8.6 million within the appropriate loan category.
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 75.4% and 77.9% of the portfolio at December 31, 2019 and 2018,
respectively. We had no concentration of loans exceeding 10% of total loans that were not otherwise disclosed as a category of loans at
December 31, 2019.
Our ALLL was $19.8 million at year-end 2019, compared to $19.0 million at year-end 2018, and $17.5 million at year-end 2017. One
measure of the adequacy of the ALLL is the ratio of the allowance to total loans. The ALLL as a percentage of total loans was 1.0% as
of December 31, 2019 and December 31, 2018. 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. Excluding the balances
of the loans acquired from our ABC Bank acquisition and Talmer branch purchase, the ratio of ALLL to total loans as of year-end 2019
was 1.06%. The loans acquired in the ABC Bank acquisition and Talmer branch purchase are carried at contractual loan values less a
fair market value adjustment as of the date of each acquisition. As of December 31, 2019, this acquisition adjustment totaled $817,000
for non-PCI loans.
Commercial real estate values have generally stabilized in the greater metro Chicago area with increased competition for the financing
investor and multifamily transactions. While we continue to adhere to rigorous underwriting standards, we could experience increased
levels of delinquencies, problem loans and losses in future periods if an economic recession or politically triggered economic instability
develops.
46
Asset Quality
Nonperforming loans consist of nonaccrual loans, performing restructured accruing loans and loans 90 days or more past due but still
accruing. Management believes recovery in the overall commercial real estate segment is evident but could be stifled by macroeconomic
events. Negative changes in the economy could increase our nonperforming loans. Total nonperforming loans were $15.8 million at
December 31, 2019, a decrease from $16.3 million at December 31, 2018. As noted above in the Loans Acquired in Business
Combinations section, we do not consider our PCI loans to be nonperforming assets as long as their cash flows and the timing of such
cash flows continue to be estimable and probable of collection, because we recognize interest income on these loans through accretion
of the difference between the carrying value of these loans and the present value of expected future cash flows. As a result, management
has excluded PCI loans from our presentation of nonperforming assets. Other positive trends included continued stability within
nonaccrual loan and past due loan levels in 2019 compared to 2018 and 2017. Nonaccrual loans, excluding PCI loans, totaled $12.4
million at December 31, 2019, a decrease of $1.3 million from year end 2018 Total past due loans, including accruing and nonaccrual
loans, totaled $25.7 million at year end 2019, a $7.3 million increase from year end 2018, resulting in the rate of past dues to total loans
increasing to 1.33% at year-end 2019 compared to 0.97% at year-end 2018, and 0.96% at year-end 2017. Refer to Note 5, “Loans”, in
our consolidated financial statements, below, for further detail of past due loans by classification for 2019 and 2018.
Risk Elements
The following table sets forth the amounts of nonperforming assets at December 31 for the years indicated:
(Dollars in thousands)
Nonaccrual loans
Performing troubled debt restructured loans accruing interest
Loans past due 90 days or more and still accruing interest
Total nonperforming loans
Other real estate owned
Total nonperforming assets
2019
12,432 $
872
2,545
15,849
5,004
20,853 $
2018
13,741 $
1,683
917
16,341
7,175
23,516 $
2017
14,388 $
988
248
15,624
8,371
23,995 $
2016
15,283 $
718
-
16,001
11,916
27,917 $
2015
14,389
165
65
14,619
19,141
33,760
$
$
PCI loans, net of purchase accounting adjustments
$
8,601 $
10,965 $
- $
- $
-
Other real estate owned ("OREO") as % of nonperforming assets, excluding
PCI loans
24.0 %
30.5 %
34.9 %
42.7 %
56.7 %
Accrual of interest is discontinued on a loan when principal or interest is 90 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 $347,000, $335,000 and $47,000 was recorded and
collected during 2019, 2018 and 2017, respectively, on loans that subsequently went to nonaccrual status by year-end. Interest income,
which would have been recognized during 2019, 2018 and 2017, had these loans been on an accrual basis throughout the year, was
approximately $1.3 million, $952,000 and $781,000, respectively. There were approximately $4.5 million and $5.3 million in
restructured residential mortgage loans that were still accruing interest based upon their prior performance history at December 31, 2019
and 2018, respectively. Additionally, the nonaccrual loans above include $3.4 million and $2.2 million in restructured loans for the years
ending December 31, 2019 and 2018.
47
(Dollars in thousands)
Commercial
Leases
Real estate - commercial, nonfarm
Real estate - commercial, farm
Real estate - construction
Real estate - residential:
Investor
Multi-Family
Owner occupied
HELOC
Other(1)
Total classified loans, excluding PCI loans
PCI loans, net of purchase accounting adjustments
Total classified loans, including PCI loans
Other real estate owned
Total classified assets
Classified Assets
Classified assets as of December 31,
2017
2018
2019
$
$
11,688 $
329
11,672
1,210
262
1,390
503
3,631
1,969
359
33,013
8,601
41,614
5,004
46,618 $
137 $
-
22,661
1,222
2,610
1,216
979
4,524
1,889
31
35,269
10,965
46,234
7,175
53,409 $
Percent Change From
2019-2018 2018-2017
N/M
(100.0)
212.0
(50.8)
594.1
N/M
N/M
(48.5)
(1.0)
(90.0)
-
825
7,262
2,486
376
448
4,723
5,266
1,899
20
23,305
-
23,305
8,371
31,676
14.3
(48.6)
(19.7)
4.2
N/M
(6.4)
(21.6)
(10.0)
(30.3)
(12.7)
171.4
(79.3)
(14.1)
(0.5)
55.0
51.3
N/M
98.4
(14.3)
68.6
N/M - Not meaningful
1 The “Other” class includes consumer loans and overdrafts.
Classified loans, excluding PCI loans, include nonaccrual, performing troubled debt restructurings and all other loans considered
substandard. Classified assets include both classified loans and OREO. Both total classified loans and total classified assets decreased
in 2019 compared to 2018, but increased in 2018 from 2017. Classified loans, excluding PCI loans, decreased primarily due to
remediation of select credits which were downgraded in our commercial and real estate – commercial, nonfarm portfolios. Classified
assets, which includes classified loans and OREO, was favorably impacted by the decrease of our OREO portfolio, which declined
$2.2 million in 2019 from 2018, and $1.2 million in 2018 from 2017. Management monitors a ratio of classified assets to the sum of
Bank Tier 1 capital and the allowance for loan and lease losses, which is referred to as the “classified assets ratio.” Our classified assets
ratio decreased to 11.11% at December 31, 2019, compared to a modest increase to 13.49% at December 31, 2018, from 11.87% at
December 31, 2017.
Potential Problem Loans
We utilize 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 we 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 5 to the Consolidated Financial Statements, as listed in the credit quality indicators
discussion.
Allowance for Loan and Lease Losses
Our ALLL methodology is designed to produce reasonable estimates of loan and lease losses as of the financial statement date(s) and
incorporates management’s 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. Analysis is prepared in accordance with guidelines established by the SEC, the Federal Financial Institutions
Examination Council, the American Institute of Certified Public Accountants Audit and Accounting Guide for Depository and Lending
Institutions, and banking industry practices. The total ALLL was $19.8 million as of December 31, 2019.
In accordance with accounting guidance for business combinations, there was no allowance for loan or lease losses brought forward on
any acquired loans in our acquisition of ABC Bank in 2018 or our Talmer branch purchase in 2016. For non-PCI loans, credit discounts
representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to
48
interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit
discount is similar to organic loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses. The
aggregate non-PCI loans related to our acquisition of ABC Bank and the Talmer branch purchase totaled $183.8 million as of December
31, 2019, net of $817,000 of purchase accounting adjustments. In management’s judgment, an adequate allowance for estimated losses
has been established for inherent losses at December 31, 2019, and general changes in lending policy, procedures and staffing, as well as
other external factors. However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based
on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession.
We recorded $11.4 million of PCI loans in our acquisition of ABC Bank, which totaled $8.6 million, net of purchase accounting
adjustments, including $4.0 million of credit discounts, as of December 31, 2019. We will perform re-estimations of cash flows on our
PCI loan portfolio on a quarterly basis. Any decline in expected cash flows as a result of these re-estimations, due in any part to a change
in credit, is deemed credit impairment, and is recorded as provision for loan and lease losses during the period. Any decline in expected
cash flows due only to changes in expected timing of cash flows is recognized prospectively as a decrease in yield on the loan and any
improvement in expected cash flows, once any previously recorded impairment is recaptured, is recognized prospectively as an
adjustment to the yield on the loan.
Our ALLL 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 our loan portfolio. The components of the ALLL 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 of the consolidated financial statements, “Summary of
Significant Accounting Policies” for further detail.
The historical loss experience component 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-offs on TDRs. We perform a loss migration analysis quarterly, and the
loss factors are updated based on actual experience.
Management takes into consideration many internal and external qualitative factors when estimating the additional adjustment for
management factors, including 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.
credit policies and procedures, such as underwriting standards and collection, charge-off, and recovery practices.
the experience, ability, and depth of credit management and other relevant staff.
the quality of the Company’s loan review system and board of directors’ oversight.
the value of the underlying collateral for collateral-dependent loans.
the national and local economy that affect the collectability of various segments of the portfolio.
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.
Management conducts an annual review of all Home Equity Lines of Credit (“HELOC”) by looking at credit scores. When we are
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 analysis of these factors involves a high degree of judgment by management. Because of the imprecision surrounding these factors,
we estimate a range of inherent losses and maintain a general allowance that is not allocated to a specific category. As of
December 31, 2019, the unallocated allowance decreased to $503,000, from the unallocated balance of $537,000 as of
December 31, 2018. Changes in the ALLL are detailed in Note 6 in the consolidated financial statements of this annual report.
Our ALLL methodology is periodically reviewed by our independent accountants and banking regulators, and select methodology
changes were made in 2017, 2018 and 2019.
We refined our ALLL methodology in 2017, with implementation of management factor classifications for newer loan portfolios, such
as our purchase of home equity lines of credit (“HELOCs”) in 2017 and the expanded business development company loan portfolio, as
these portfolios have not been outstanding long enough to be sufficiently seasoned. In addition, we revised the risk weightings for the
historical loss factors to allocate an increase in the loss factor applied in the earliest quarter, and a like reduction of the loss factor in the
most recent quarter, as management believes the lower charge-off levels in the more recent quarters will likely not continue long-term.
We refined our ALLL methodology again in 2018, as we determined that a minimum threshold of two basis points should be used for
those quarters within the historical losses calculation with minimal or no losses incurred, to ensure some loss expectation was being
49
applied. In addition, a base line for reserves was set for economic conditions (.25%), past due and classified loans (.05%), loan portfolio/
concentrations (.05%), general (.05%) and external factors (.05%). These factors are evaluated quarterly by the Bank’s ALLL
Committee and the ASC 450 percentages are adjusted according to the overall bias in the individual factors (up, down or neutral).
In the first quarter of 2018, these baseline levels were modified to establish floors and ceilings for each management factor ranging from
five to 50 basis points, depending on the factor. We believe these floors and ceilings will allow management to evaluate changes to
factors within prescribed guidelines and to remain consistent with factor determination in a stressed scenario, as a ceiling could be applied.
We continued to enhance our ALLL methodology in 2019, with loan portfolio volume changes supporting revisions to the management
factor related to portfolio volumes and concentrations. Lease portfolio growth of $40.9 million and a decline in the construction portfolio
of $38.8 million in 2019 supported an increase in the management factor due to the changes in the volume and concentrations of five
basis points for leases, and a decrease of ten basis points for construction loans, respectively. In addition, due to the falling interest rate
environment, the management factors for variable rate commercial loans and HELOCs were reduced to become more commensurate with
fixed rate commercial loan and HELOC products. Finally, as the purchased HELOC portfolio and the business development loans have
been analyzed with a separate management factor for two years within the ALLL calculation, and there have been minimal HELOC
charge-offs and no business development losses to date, these management factors were each reduced by five basis points for the
December 31, 2019 calculation.
Summary of Loan Loss Experience
The following table summarizes, for the years indicated, activity in the ALLL, 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:
Analysis of Allowance for Loan and Lease Losses
(Dollars in thousands)
Average total loans (exclusive of loans held-for-sale)
Allowance at beginning of year
Charge-offs:
Commercial
Leases
Real estate - commercial
Real estate - construction
Real estate - residential
HELOC
Other1
Total charge-offs
Recoveries:
Commercial
Leases
Real estate - commercial
Real estate - construction
Real estate - residential
HELOC
Other1
Total recoveries
Net charge-offs / (recoveries)
Provision (release) for loan and lease losses
Allowance at end of year
2019
2017
$ 1,894,745 $ 1,776,230 $ 1,534,673 $ 1,214,804 $ 1,144,618
21,637
16,223
17,461
19,006
16,158
2015
2018
2016
109
49
1,019
9
118
338
409
2,051
41
13
1,548
(16)
(45)
147
409
2,097
25
215
309
23
1,347
386
1
2,306
95
23
1,633
23
450
622
344
3,190
74
-
684
1
103
172
200
1,234
817
1,600
19,789 $
157
-
447
35
1,146
364
265
2,414
(317)
1,228
19,006 $
30
-
161
377
980
243
18
1,809
497
1,800
17,461 $
32
5
640
96
486
845
271
2,375
815
750
16,158 $
$
993
-
1,653
2
665
974
483
4,770
451
-
1,595
276
579
496
359
3,756
1,014
(4,400)
16,223
Net charge-offs / (recoveries) to average loans
Allowance at year end to average loans
0.04 %
1.04 %
(0.02) %
1.07 %
0.03 %
1.14 %
0.07 %
1.33 %
0.09 %
1.42 %
1 The “Other” class includes consumer loans and overdrafts.
We had net loan charge-offs of $817,000 in 2019 and net loan recoveries of $317,000 in 2018, compared to net charge-offs of $497,000
in 2017. The provision for loan and lease losses is based upon management’s estimate of losses inherent in the loan and lease portfolio
and its evaluation of the adequacy of the ALLL. Factors which influence management’s judgment in estimating loan and lease losses are
the composition of the portfolio, past loss experience, loan delinquencies, nonperforming loans, national and local economic conditions,
and other credit risk considerations that, in management’s judgment, deserve evaluation in estimating loan and lease losses.
50
The following table shows our allocation of the ALLL by loan type at December 31 for the years indicated, and, for each category of
loans, the percent of total loans represented by that category:
Allocation of the Allowance for Loan and Lease Losses
2019
Loan Type
to Total
2018
Loan Type
to Total
2017
Loan Type
to Total
2016
Loan Type
to Total
2015
Loan Type
to Total
(Dollars in thousands)
Commercial
Leases
Real estate - commercial
Real estate - construction
Real estate - residential
HELOC
Other1
Total
Amount Loans
$ 3,015
1,262
11,175
513
2,015
1,172
637
$ 19,789
Amount Loans
Amount Loans
Amount Loans
Amount Loans
734
17.2 % $ 2,832
6.2
45.0
3.6
20.8
6.4
0.8
10,470
969
1,931
1,449
621
100.0 % $ 19,006
16.6 % $ 2,453
4.2
43.5
5.8
21.8
7.4
0.7
692
9,522
923
1,846
1,446
579
100.0 % $ 17,461
16.9 % $ 1,629
4.2
46.4
5.3
19.4
7.0
0.8
633
9,547
389
2,178
1,331
451
100.0 % $ 16,158
-
15.4 % $ 2,096
3.8
49.8
4.4
18.7
6.9
1.0
9,013
265
724
2,050
2,075
100.0 % $ 16,223
12.5 %
-
53.4
1.7
21.7
9.3
1.4
100.0 %
1 The “Other” class includes consumer loans, overdrafts and the unallocated allowance balance for each year presented.
The ALLL is a valuation allowance, which increased by the provision for loan and lease losses of $1.6 million, $1.2 million and
$1.8 million in 2019, 2018 and 2017, respectively, adjusted for 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 ALLL. 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 ALLL. 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. Management believes it has established an adequate estimated allowance for probable loan and lease 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 Board of Directors and Audit Committee. Although management believes the ALLL 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 and
lease losses or that regulators, in reviewing the loan portfolio, would not request us to materially adjust our ALLL at the time of their
examination.
Our coverage ratio of ALLL to nonperforming loans, excluding PCI loans, was 124.9% as of December 31, 2019, which reflects an
increase from 116.3% as of December 31, 2018. A modest decrease of $492,000, or 3.0%, in nonperforming loans in 2019, and an
increase of $783,000 in the allowance for loan and lease losses from year-end 2018 to year-end 2019 drove the increase. Following
established methodology, management updated the estimated specific allocations each quarter after receiving more recent appraisal
valuations or information on cash flow trends related to the impaired credits. Allocations for general risk and management risk factors
as of December 31, 2019, increased by $556,000 from December 31, 2018 while the overall loan balances subject to the allowance
increased by approximately $40.2 million at December 31, 2019. Management determined the estimated amount to include in the ALLL
based on 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.
Management reviews the estimate of the management risk factors including higher risk loan pools rated as special mention and problem
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 our 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 potential valuation impact would result from that
migration. Management has also observed that many stresses in those credits were generally attributable to cyclical economic events that
continued to show signs of stabilization in 2019.
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 ALLL. Based on these assessments, management determined that a provision for loan
and lease losses of $1.6 million, $1.2 million and $1.8 million was required for 2019, 2018 and 2017, respectively. When measured as a
percentage of average loans outstanding, the total ALLL decreased from 1.1% of total loans as of December 31, 2017 and December 31,
2018, to 1.0% of total loans at December 31, 2019. In management’s judgment, an adequate allowance for estimated losses has been
51
established for potential incurred losses at December 31, 2019; however, there can be no assurance that actual losses will not exceed the
estimated amounts in the future.
Other Real Estate Owned
Other real estate owned (“OREO”) decreased to $5.0 million as of December 31, 2019, compared to $7.2 million as of
December 31, 2018, reflecting a $2.2 million decline. Of the 20 properties we held as of year-end 2019, the largest net book value
property was comprised of two adjoining vacant commercial parcels carried at $1.9 million. Reductions in our OREO balance during
2019 included the sale of eleven properties resulting in proceeds of $2.5 million. Net gains on the sale of OREO properties during 2019
totaled $264,000, compared to net gains on sale of $792,000 recorded in 2018 and $474,000 in 2017. The trend of year over year
reductions in valuation adjustments continued but at decreasing levels in 2017 through 2019.
(Dollars in thousands)
Single family residence
Lots (single family and commercial)
Vacant land
Commercial property
Total OREO properties
OREO Properties by Type as of December 31,
2018
2017
2019
$
$
174 $
3,945
41
844
5,004 $
1,137 $
4,310
470
1,258
7,175 $
900
5,329
479
1,663
8,371
Percent Change From
2019-2018
(84.7)
(8.5)
(91.3)
(32.9)
(30.3)
2018-2017
26.3
(19.1)
(1.9)
(24.4)
(14.3)
Other real estate assets acquired in settlement of loans are recorded at the fair value of the property when acquired, less estimated costs
to sell, establishing a new cost basis. The OREO valuation reserve for the year ended 2019 was $6.7 million, which was 57.3% of gross
OREO, net of participations, at year-end 2019. This compares to $8.0 million, or 52.8%, of gross OREO, net of participations, at year-
end 2018.
Deposits
We grew total deposits by $10.1 million, or 0.5%, to a total of $2.13 billion at year-end 2019 compared to year-end 2018. Total deposits
grew by $193.7 million, or 10.1%, from $1.92 billion at year-end 2017 to $2.12 billion at year-end 2018 primarily due to our ABC Bank
acquisition, in which we assumed $248.5 million of additional deposits, net of purchase accounting adjustments. We had $249,000 in
brokered certificates of deposit as of December 31, 2019, compared to $16.5 million in brokered certificates of deposit as of
December 31, 2018 due to scheduled runoff of brokered deposits acquired with the ABC Bank acquisition. Deposits held by senior
officers and directors, including their related interests, totaled $2.9 million and $1.6 million as of December 31, 2019 and 2018.
YTD Average Balances and Interest Rates
2018
Average Rate Average Rate Average Rate
2017
2019
(Dollars in thousands)
Noninterest bearing demand
Interest bearing:
NOW and money market
Savings
Time
Total deposits
Balance
%
Balance
%
Balance
%
$
650,400
- $
608,762
- $
547,719
-
721,773
308,847
431,377
0.34
0.16
1.56
743,961
291,611
443,520
$
2,112,397
$
2,087,854
0.24
0.11
1.31
$
704,261
261,974
389,771
0.11
0.07
1.08
1,903,725
The following table sets forth the amounts and maturities of time deposits of $100,000 or more at December 31 of the year indicated:
Maturities of Time Deposits of $100,000 or More
(Dollars in thousands)
3 months or less
Over 3 months through 6 months
Over 6 months through 12 months
Over 12 months
$
$
2019
54,234
56,362
72,119
31,376
214,091
$
$
2018
58,036
46,452
48,932
72,974
226,394
52
Borrowings
In addition to deposits, other liquidity sources were utilized for our funding needs in 2019, such as repurchase agreements and other
short-term borrowings with the FHLBC. Our 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-
backed loans. We primarily use these borrowings as a source of short-term funding, and short-term borrowing levels with the FHLBC
decreased by $101.0 million in 2019 compared to 2018, to end at $48.5 million outstanding as of December 31, 2019, compared to $145.5
million outstanding as of December 31, 2018. We also recorded long-term FHLBC borrowings stemming from the ABC Bank acquisition
in April 2018 of $23.4 million, net of purchase accounting adjustments. These borrowings were issued at favorable rates compared to
the current overnight borrowing rate, and mature over the next seven years. The balance of these borrowings in long-term status totaled
$6.7 million as of December 31, 2019. In addition, an unused line of credit of $20.0 million is available with a third-party bank and is
used for the Company’s operating needs at the holding company level; this line of credit renews every February and must be repaid within
360 days, if drawn. This line of credit had an outstanding balance of $4.0 million as of year-end 2018, but was repaid in January 2019
and has not been used since that time.
Short-term and Long-term Borrowings
2019
2018
2017
(Dollars in thousands)
At period-end:
Securities sold under repurchase agreements $
Other short-term borrowings
Junior subordinated debentures(1)
Senior notes(1)
Notes payable and other borrowings
Total borrowed funds
$
Amount
48,693
48,500
57,734
44,270
6,673
205,870
Weighted
Average
Rate %
1.19 $
1.78
6.37
5.84
2.83
3.79 $
Amount
46,632
149,500
57,686
44,158
15,379
313,355
Weighted
Average
Rate %
1.28 $
2.50
6.36
5.86
2.42
3.50 $
Amount
29,918
115,000
57,639
44,058
-
246,615
Average for the year-to-date period:
Securities sold under repurchase agreements $
Other short-term borrowings
Junior subordinated debentures
Senior notes
Notes payable and other borrowings
Total borrowed funds
$
Maximum amount outstanding at the end of
any month-end during the period:
Securities sold under repurchase agreements $
Other short-term borrowings
Junior subordinated debentures
Senior notes
Notes payable and other borrowings
43,698
73,757
57,710
44,212
12,008
231,385
54,166
120,000
57,734
44,270
15,363
1.32 $
2.38
6.45
6.10
3.20
3.95 $
44,122
71,041
57,663
44,109
14,696
231,631
1.05 $
2.01
6.44
6.09
2.71
3.75 $
31,478
67,959
57,615
44,010
-
201,062
$
54,037
149,500
57,686
44,158
26,037
$
36,361
125,000
57,639
44,058
-
Weighted
Average
Rate %
0.44
1.42
6.34
5.87
-
3.25
0.05
1.09
6.95
6.11
-
3.71
1 Period end rates listed for long term borrowings are stated rates per contract, and do not include adjustments for deferred issuance
costs.
There were no other categories of short-term borrowings that had an average balance greater than 30% of our stockholders’ equity as of
December 31, 2019, 2018 and 2017.
The junior subordinated debentures included two issuances of trust preferred securities by our subsidiaries, Old Second Capital Trust I
(“Trust I”) which totaled $31.6 million as of December 31, 2019, and Old Second Capital Trust II (“Trust II”), which totaled $25.0 million
as of December 31, 2019. On March 2, 2020, we redeemed all of the subordinated debentures due June 30, 2033 relating to the
outstanding 7.80% cumulative trust preferred securities (NASDAQ: OSBCP) (the “Trust Securities”) issued by Trust I. Also on March
2, 2020, we redeemed all of the outstanding Trust Securities at a redemption price of $10.00 per Trust Security, which reflects 100% of
the liquidation amount, plus accrued and unpaid distributions through the redemption date. In connection with the redemption, the Trust
Securities were delisted from The Nasdaq Stock Market. See Note 11: Junior Subordinated Debentures for further discussion of the
Capital Trusts I and II.
53
In December 2016, we completed the retirement of $45.0 million of subordinated debt with the proceeds of a $45.0 million senior notes
issuance and cash on hand. The senior notes mature in ten years, and terms include interest payable semiannually at 5.75% for five years.
Beginning December 2021, the senior debt will pay interest at a floating rate, with interest payable quarterly at three month LIBOR plus
385 basis points. As of December 31, 2019, we had $44.3 million of senior debt outstanding, net of deferred issuance costs. At
December 31, 2019, we were in compliance with all of the financial covenants contained within the senior debt agreement.
Capital
As of December 31, 2019, we had total stockholders’ equity of $277.9 million, an increase of $48.8 million, or 21.3%, from
$229.1 million as of December 31, 2018. This increase was largely attributable to net income of $39.5 million in 2019, and a favorable
fair value adjustment on securities available for sale, within accumulated other comprehensive income. At December 31, 2018,
accumulated other comprehensive income, net of deferred taxes, was $4.6 million, compared to a $4.1 million accumulated other
comprehensive loss, net of tax, as of year-end 2018. Equity in 2019 was reduced for the payment of dividends to common stockholders,
which totaled $1.2 million for the year. Our total stockholders’ equity increased in 2018, ending at $229.1 million, compared to $200.4
million at year end 2017, due primarily to net income of $34.0 million in 2018.
We issued $31.6 million of cumulative trust preferred securities through our consolidated subsidiary, Trust I, in July 2003. As noted
above, we redeemed all of the outstanding Trust Securities on March 2, 2020, at a redemption price of $10.00 per Trust Security, which
reflects 100% of the liquidation amount, plus accrued and unpaid distributions through the redemption date.
We issued an additional $25.8 million of cumulative trust preferred securities through a private placement completed by a second
unconsolidated subsidiary, Trust II, in April 2007. These trust preferred securities also mature in 30 years, but subject to regulatory
approval, can also now be called in whole or in part. The quarterly cash distributions on the securities were fixed at 6.77% through
June 15, 2017, and converted to a floating rate at 150 basis points over the three-month LIBOR rate thereafter. We entered into a forward
starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017. This transaction had a notional amount totaling
$25.8 million as of December 31, 2015, and was designated as a cash flow hedge of certain junior subordinated debentures and continues
to be fully effective during the period presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the
aggregate fair value of the swap is recorded in other liabilities with changes in fair value recorded in other comprehensive income, net of
tax. The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge
no longer be considered effective. We expect the hedge to remain fully effective during the remaining term of the swap. We will pay
the counterparty a fixed rate and receive a floating rate based on three month LIBOR. Management concluded that it would be
advantageous to enter into this transaction given that our trust preferred securities issued in 2007 changed from a fixed to floating rate on
June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.
We are currently paying interest on all trust preferred securities as that interest comes due. As of December 31, 2019, and December 31,
2018, total trust preferred proceeds of $56.6 million qualified as Tier 1 regulatory capital at the bank holding company level.
In January 2009, we issued and sold (i) 73,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B 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 U.S. Treasury. The total
liquidation value of the Series B Stock and the warrant was $73.0 million at issuance. As of December 31, 2015, the Series B Stock was
fully redeemed. The warrant had a carrying value of $4.8 million and is included within additional paid-in capital as of December 31,
2018 and 2017. On January 16, 2019, the warrant was fully exercised; see further disclosures in Note 14, Earnings Per Share, in our
consolidated financial statements.
In the third quarter of 2019, our Board of Directors authorized the repurchase of up to 1,494,826 shares of our common stock. We may
engage in repurchases under the Repurchase Program from time to time through open market purchases, trading plans established in
accordance with SEC rules, privately negotiated transactions, or by other means. The actual means and timing of any repurchases,
quantity of purchased shares and prices will be, subject to certain limitations, at the discretion of management and will depend on a
number of factors, including, without limitation, market prices of our common stock, general market and economic conditions, and
applicable legal and regulatory requirements. Repurchases under the Repurchase Program may be initiated, discontinued, suspended or
restarted at any time; provided that repurchases under the Repurchase Program after September 19, 2020 would require Federal Reserve
non-objection or approval. We are not obligated to repurchase any shares under the Repurchase Program, and we did not engage in any
repurchases under the Repurchase Program in 2019.
We withheld 49,959 shares for $667,000 to satisfy stock award tax withholding obligations in 2019, which increased treasury stock; this
increase was offset by issuances of 38,614 shares for nonqualified stock option exercises and RSU vestings, which totaled $526,000, and
the exercise of stock warrants of 45,836 shares, which totaled $313,000. The net impact was a reduction to treasury stock of 34,491
shares, to 4,921,948 shares totaling $95.9 million as of December 31, 2019. We withheld 35,508 shares for $506,000 to satisfy tax
withholding obligations in 2018, and issued 77,717 shares for nonqualified stock option exercises and RSU vestings for $858,000 in
2018, resulting in a decrease in treasury stock to 4,956,439 shares and $96.1 million as of December 31, 2018. The decrease in treasury
stock increased stockholders’ equity, and also decreased earnings per share by increasing the number of shares outstanding. There were
4,500 stock options exercised in 2019 and in 2018; no stock options remain outstanding as of December 31, 2019.
54
Regulatory capital rules adopted in July 2013 and fully-phased in as of January 1, 2019, which we refer to as the Basel III rules or Basel
III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state
banks and savings associations regardless of size and bank holding companies and savings and loan holding companies other than “small
bank holding companies” which are generally holding companies with consolidated assets of less than $3 billion. In order to avoid
restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a
“capital conservation buffer” on top of our minimum risk-based capital requirements. This buffer must consist solely of CET1, but the
buffer applies to all three measurements (CET1, Tier 1 capital and total capital). The capital conservation buffer consists of an additional
amount of common equity equal to 2.5% of risk-weighted assets.
The following table shows the regulatory capital ratios and the current minimum and well capitalized regulatory requirements at the dates
indicated:
Minimum Capital
Adequacy with
Capital Conservation
Buffer, if applicable1
Well Capitalized
Under Prompt
Corrective Action December 31, December 31, December 31,
Provisions2
2019
2018
2017
The Company
Common equity tier 1 capital ratio
Total risk-based capital ratio
Tier 1 risk-based capital ratio
Tier 1 leverage ratio
The Bank
Common equity tier 1 capital ratio
Total risk-based capital ratio
Tier 1 risk-based capital ratio
Tier 1 leverage ratio
7.00 %
10.50 %
8.50 %
4.00 %
7.00 %
10.50 %
8.50 %
4.00 %
N/A
N/A
N/A
N/A
6.50 %
10.00 %
8.00 %
5.00 %
11.14 %
14.53 %
13.65 %
11.93 %
14.35 %
15.23 %
14.35 %
12.50 %
9.29 %
12.63 %
11.78 %
10.08 %
13.29 %
14.14 %
13.29 %
11.36 %
9.25 %
12.93 %
12.03 %
10.08 %
12.88 %
13.78 %
12.88 %
10.79 %
1
Amounts are shown inclusive of a capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company
Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at
the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank
level). Although the minimum regulatory capital requirements are not applicable to the Company or the Tier 1 Leverage ratio, we
calculate these ratios for our own planning and monitoring purposes.
2 Prompt corrective action provisions are only applicable at the Bank level.
The Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” at December 31, 2019,
pursuant to the capital requirements in effect at that time. All ratios conform to the regulatory calculation requirements in effect as of the
date noted.
55
In addition to the above regulatory ratios, our common equity to total assets ratio increased from 8.56% to 10.54%, while our tangible
common equity to tangible assets ratio (non-GAAP), increased from 7.83% at December 31, 2018 to 9.83% at December 31, 2019.
Management considers this non-GAAP measure a valuable performance measurement for capital analysis. The following table provides
a reconciliation of the GAAP tangible common equity to tangible assets ratio to the non-GAAP ratio for the periods indicated:
(Dollars in thousands)
Tangible common equity
Total Equity
$
Less: Goodwill and intangible assets
Add: Limitation of exclusion of core deposit intangible (80%)
Adjusted goodwill and intangible assets
Tangible common equity
Tangible assets
Total assets
Less: Adjusted goodwill and intangible assets
Tangible assets
$
$
$
December 31, 2019
December 31, 2018
GAAP
Non-GAAP
GAAP
Non-GAAP
277,864
21,275
N/A
21,275
256,589
$
$
277,864
21,275
534
20,741
257,123
$
$
229,081
21,814
N/A
21,814
207,267
$
$
229,081
21,814
642
21,172
207,909
2,635,545
21,275
2,614,270
$ 2,635,545
20,741
$ 2,614,804
$ 2,676,003
21,814
$ 2,654,189
$ 2,676,003
21,172
$ 2,654,831
Common equity to total assets
Tangible common equity to tangible assets
10.54 %
9.81 %
10.54 %
9.83 %
8.56 %
7.81 %
8.56 %
7.83 %
The non-GAAP intangible asset exclusion reflects the 80% core deposit limitation per Basel III guidelines within risk based capital
calculations, and is useful for the Company when reviewing risk based capital ratios and equity performance metrics.
Liquidity
Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customer’s credit needs, and to meet maturing
obligations and existing commitments. Our liquidity 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 our ability
to borrow funds. In addition, the Company’s liquidity depends on the Bank’s ability to pay dividends, which is subject to certain
regulatory requirements. See “Supervision and Regulation Dividend Payments.” We continually monitor our cash position and
borrowing capacity as well as perform stress tests of contingency funding no less frequently than quarterly as part of our liquidity
management process. Stress testing of liquidity for contingency funding purposes includes 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 monthly and our Board of Directors quarterly. Cash and cash equivalents at the end of 2019
totaled $50.6 million, compared to $55.2 million as of December 31, 2018, and $55.8 million as of December 31, 2017.
Net cash inflows from operating activities were $52.6 million during 2019, compared with inflows of $54.9 million in 2018 and inflows
of $37.1 million in 2017. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, was a source of
inflows for 2019. Interest received, net of interest paid, combined with changes in other assets and liabilities were a source of inflows.
Management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash
flows in 2019. Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible as part of our
balance sheet management process.
Net cash inflows from investing activities were $42.2 million in 2019, compared to net cash outflows of $25.8 million in 2018 and net
cash outflows of $132.5 million in 2017. Loan growth in 2019 resulted in $34.4 million of net outflows, compared to $52.7 million of
net outflows in 2018 and net outflows of $141.7 million in 2017. The ABC Bank acquisition in April 2018 resulted in net cash outflows
of $35.7 million in 2018. In 2019, securities transactions accounted for net inflows of $77.0 million, and proceeds from the sales of
OREO assets accounted for inflows of $2.8 million. In 2018, securities transactions accounted for net inflows of $58.5 million, whereas
proceeds from the sale of OREO assets accounted for inflows of $4.8 million. In 2017, securities transactions accounted for net inflows
of $4.1 million, and proceeds from the sale of OREO assets accounted for inflows of $6.1 million.
Net cash outflows from financing activities in 2019 were $99.5 million compared with net cash outflows of $29.7 million in 2018, while
2017 had net cash inflows of $103.9 million. Significant cash inflows from financing activities in 2019 included increases of
$10.1 million in deposits and decreases of $101.0 million in other short-term borrowings from the FHLBC. Significant cash outflows
from financing activities in 2018 included decreases of $54.7 million in deposits excluding deposits acquired with the ABC Bank
acquisition, and inflows of $23.6 million in other short-term borrowings from the FHLBC. In 2017, net increases in cash inflows from
financing activities included deposit growth of $56.1 million and growth in short-term borrowings from the FHLBC of $45.0 million.
56
Contractual Obligations
We have various financial obligations that may require future cash payments. The following table presents, as of December 31, 2019,
significant fixed and determinable contractual obligations to third parties by payment date:
(Dollars in thousands)
Deposits without a stated maturity
Certificates of deposit
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Senior notes
Notes payable and other borrowings
Purchase obligations
Automatic teller machine leases
Operating leases
Nonqualified voluntary deferred compensation plan
Total
$
$
Over
One to
Three to
Within
One Year Three Years Five Years Five Years Total
-
$
$ 1,685,080
17,556
354,394
-
48,693
-
48,500
-
-
-
-
-
-
4,542
4,459
9
47
1,230
450
104
48
23,441
$ 2,141,671
-
-
-
-
57,734
44,270
6,673
1,633
-
3,940
2,767
$ 117,017
$ 1,685,080
441,669
48,693
48,500
57,734
44,270
6,673
16,723
67
6,972
3,023
$ 2,359,404
-
69,719
-
-
-
-
-
6,089
11
1,352
104
77,275
$
$
Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on us
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. We routinely enter 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, we have made an effort to estimate such payments, where
applicable. Additionally, where necessary, all data reflects reasonable management estimates as to certain purchase obligations as of
December 31, 2019. Management has used the information available to make the estimations necessary to value the related purchase
obligations.
Commitments, Contingent Liabilities, and Off-balance sheet arrangements
Derivative contracts, which include contracts under which we either receive cash from, or pay cash to, counterparties reflecting changes
in interest rates are carried at fair value on our Consolidated Balance Sheet as disclosed in Note 20 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, 2019, 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 and assets under custody are held in fiduciary or custodial capacity for clients. In accordance with GAAP,
these assets are not included on our 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 15 of the Notes to Consolidated Financial Statements provided in Part II, Item 8, “Financial Statements and Supplementary Data.”
The following table details the amounts and expected maturities of significant commitments to extend credit as of December 31, 2019:
(Dollars in thousands)
Commercial secured by real estate
Revolving open end residential
Other unused loan commitments, including commercial and
industrial
Financial standby letters of credit (borrowers)
Performance standby letters of credit (borrowers)
Performance standby letters of credit (others)
Total
Within One to
One Year Three Years Five Years Five Years
$ 27,343
5,291
Three to Over
$
715
103,168
$
1,729
17,910
52,173
12,158
$
Total
$
81,960
138,527
151,007
9,839
6,773
67
$ 200,320
50,689
102
10
-
115,132
3,271
10
-
-
22,920
6,014
-
-
-
$ 109,897
210,981
9,951
6,783
67
$ 448,269
$
$
57
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As part of our normal operations, we are subject to interest-rate risk on the assets we invest in (primarily loans and securities) and the
liabilities we fund (primarily customer deposits and borrowed funds). Fluctuations in interest rates may result in changes in the fair
market values our financial instruments, cash flows, and net interest income. Like most financial institutions, we have an exposure to
changes in both short-term and long-term interest rates.
In October 2019, the Federal Reserve dropped short-term interest rates by 0.25%. As a result, the Federal Funds rate and the Bank's prime
rate dropped by 0.25% during the quarter to 1.75% and 4.75%, respectively. In December 2019 and January 2020, the Federal Reserve
voted to keep short-term interest rates unchanged. The general market consensus is that the Federal Reserve will keep its key interest
rates unchanged for the next several months. Generally, Federal Reserve actions have not had a significant impact on long-term rates.
We manage interest rate risk within guidelines established by policy which are intended to limit the amount of rate exposure. In practice,
we seek to manage our interest rate risk exposure well within our guidelines so that such exposure does not pose a material risk to our
future earnings.
We manage various market risks in the normal course of our operations, including credit, liquidity risk, and interest-rate risk. Other types
of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of our business
activities and operations. In addition, since we do not hold a trading portfolio, we are not exposed to significant market risk from trading
activities. Our interest rate risk exposures at December 31, 2019 and December 31, 2018 are outlined in the table below.
Our net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and
actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and
securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition,
a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such
as LIBOR and prime), and balance sheet growth or contraction. Our asset-liability committee seeks to manage interest rate risk under a
variety of rate environments by structuring our balance sheet and off-balance sheet positions, which includes interest rate swap derivatives
as discussed in Note 20 of our consolidated financial statements included in this annual report. We seek to monitor and manage interest
rate risk within approved policy guidelines and limits.
We use simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing
characteristics, and embedded options of the assets and liabilities held by us are incorporated into the simulation model. Earnings at risk
are calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a different interest
rate environment in order to determine the percentage change. As of December 31, 2018, we had modest amounts of earnings gains (in
both dollars and percentage) should interest rates rise, and limited earnings reductions should interest rates fall. The changes in income
across the various interest rate scenarios as of December 2019 were similar compared to those of December 2018. The general balance
sheet composition, both assets and liabilities, did not change appreciably during 2019, which resulted in minimal change to our interest
rate risk profile. In December 2019, we executed a five-year $50 million receive fixed interest rate swap to hedge against declining
interest rates. This transaction falls under hedge accounting standards and is paired against a pool the Bank’s Libor-based loans. Overall,
the new swap only bolsters income in down rate scenarios by a modest degree. Management considers the current level of interest rate
risk to be moderate but intends to continue looking for market opportunities for further hedging opportunities.
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. Due to relatively low current market interest rates, it was not
possible to calculate a decrease of 2% because many of the market interest rates would fall below zero in that scenario.
(Dollars in thousands)
December 31, 2019
Dollar change
Percent change
December 31, 2018
Dollar change
Percent change
Analysis of Net Interest Income Sensitivity
Immediate Changes in Rates
(2.0) %
(1.0) %
(0.5) %
0.5 %
1.0 %
2.0 %
N/A
N/A
$
(6,229)
$
(2,670)
$
(6.6) %
(2.8) %
993
1.1 %
$ 2,016
$ 3,856
2.1 %
4.1 %
$
(12,303)
$
(5,356)
$
(2,062)
$ 1,084
$ 2,145
$ 4,178
(12.2) %
(5.3) %
(2.1) %
1.1 %
2.1 %
4.2 %
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.
58
Effects of Inflation
In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than
changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not change at the same
rate or in the same magnitude as the inflation rate. Rather, interest rate volatility is based on changes in the expected rate of inflation, as
well as on changes in monetary and fiscal policies. A financial institution’s ability to be relatively unaffected by changes in interest rates
is a good indicator of its capability to perform in today’s volatile economic environment. We seek to insulate the Company from interest
rate volatility by using our best efforts to ensure that rate sensitive assets and rate sensitive liabilities respond to changes in interest rates
in a similar time frame and to a similar degree.
59
Item 8. Financial Statements and Supplementary Data
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2019 and 2018
(In thousands, except per share data)
Assets
Cash and due from banks
Interest earning deposits with financial institutions
Cash and cash equivalents
Securities available-for-sale, at fair value
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock
Loans held-for-sale
Loans
Less: allowance for loan and lease losses
Net loans
Premises and equipment, net
Other real estate owned
Mortgage servicing rights, net
Goodwill and core deposit intangible
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
Senior notes
Notes payable and other borrowings
Other liabilities
Total liabilities
Stockholders’ Equity
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Treasury stock
Total stockholders’ equity
Total liabilities and stockholders’ equity
Par value
Shares authorized
Shares issued
Shares outstanding
Treasury shares
See accompanying notes to consolidated financial statements.
60
December 31,
December 31,
2019
2018
$
$
$
$
34,096
16,536
50,632
484,648
9,917
3,061
1,930,812
19,789
1,911,023
44,354
5,004
5,935
21,275
61,763
11,459
26,474
2,635,545
$
$
38,599
16,636
55,235
541,248
13,433
2,984
1,897,027
19,006
1,878,021
42,439
7,175
7,357
21,814
61,544
21,280
23,473
2,676,003
669,795
$
618,830
1,015,285
441,669
2,126,749
48,693
48,500
57,734
44,270
6,673
25,062
2,357,681
34,854
120,657
213,723
4,562
(95,932)
277,864
2,635,545
$
1,040,668
457,175
2,116,673
46,632
149,500
57,686
44,158
15,379
16,894
2,446,922
34,720
119,081
175,463
(4,079)
(96,104)
229,081
2,676,003
December 31, 2019
Common
Stock
December 31, 2018
Common
Stock
$
$
1.00
60,000,000
34,853,757
29,931,809
4,921,948
1.00
60,000,000
34,719,517
29,763,078
4,956,439
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
Years Ended December 31, 2019, 2018 and 2017
(In thousands, except per share data)
Year Ended December 31,
2018
2019
2017
$
97,719 $
133
88,769 $
127
9,256
7,425
602
459
115,594
2,960
6,736
577
1,755
3,724
2,699
384
18,835
96,759
1,600
95,159
6,655
7,715
772
(2,662)
1,881
5,112
4,511
1,415
872
4,177
32
5,320
35,800
9,577
8,341
469
334
107,617
2,156
5,829
462
1,429
3,716
2,688
398
16,678
90,939
1,228
89,711
6,417
7,328
696
(734)
1,939
3,791
360
984
1,026
4,420
-
5,126
31,353
46,869
8,289
5,631
176
1,002
539
1,225
977
675
423
13,296
79,102
51,857
12,402
39,455 $
1.32 $
1.30
0.04
44,161
6,915
6,745
653
1,040
387
1,567
940
835
396
13,489
77,128
43,936
9,924
34,012 $
1.14 $
1.12
0.04
$
$
70,737
123
10,202
5,939
370
134
87,505
950
4,227
17
741
4,002
2,689
-
12,626
74,879
1,800
73,079
6,203
6,720
776
(802)
1,778
4,803
474
1,432
-
4,200
10
4,778
30,372
40,080
5,951
4,387
658
1,031
96
1,505
1,329
650
2,165
11,297
69,149
34,302
19,164
15,138
0.51
0.50
0.04
Interest and dividend income
Loans, including fees
Loans held-for-sale
Securities:
Taxable
Tax exempt
Dividends from FHLBC and FRBC stock
Interest bearing deposits with financial institutions
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
Senior notes
Notes payable and other borrowings
Total interest expense
Net interest and dividend income
Provision for loan and lease losses
Net interest and dividend income after provision for loan and lease losses
Noninterest income
Trust income
Service charges on deposits
Secondary mortgage fees
Mortgage servicing rights mark to market loss
Mortgage servicing income
Net gain on sales of mortgage loans
Securities gains, net
Increase in cash surrender value of BOLI
Death benefit realized on BOLI
Debit card interchange income
Gains on disposal and transfer of fixed assets, net
Other income
Total noninterest income
Noninterest expense
Salaries and employee benefits
Occupancy, furniture and equipment
Computer and data processing
FDIC insurance
General bank insurance
Amortization of core deposit intangible
Advertising expense
Debit card interchange expense
Legal fees
Other real estate expense, net
Other expense
Total noninterest expense
Income before income taxes
Provision for income taxes
Net income
Basic earnings per share
Diluted earnings per share
Dividends declared per share
See accompanying notes to consolidated financial statements.
61
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2019, 2018 and 2017
(In thousands)
Net Income
$
Unrealized holding gains (losses) on available-for-sale securities arising during the period
Related tax (expense) benefit
Holding gains (losses) after tax on available-for-sale securities
Less: Reclassification adjustment for the net gains realized during the period
Net realized gains
Related tax expense
Net realized gains after tax
Other comprehensive income (loss) on available-for-sale securities
Changes in fair value of derivatives used for cash flow hedges
Related tax benefit (expense)
Other comprehensive (loss) income on cash flow hedges
Year Ended December 31,
2018
34,012 $
2019
39,455 $
2017
15,138
19,630
(5,521)
14,109
4,511
(1,267)
3,244
10,865
(3,092)
868
(2,224)
(9,053)
2,554
(6,499)
360
(100)
260
(6,759)
1,230
(348)
882
17,863
(7,183)
10,680
474
(198)
276
10,404
(293)
130
(163)
Total other comprehensive income (loss)
Total comprehensive income
8,641
48,096 $
(5,877)
28,135 $
10,241
25,379
$
Balance, December 31, 2016
Other comprehensive income (loss), net of tax
Balance, December 31, 2017
Balance, December 31, 2017
Reclassification of stranded tax effects
Other comprehensive (loss) income, net of tax
Balance, December 31, 2018
Balance, December 31, 2018
Other comprehensive income (loss), net of tax
Balance, December 31, 2019
$
$
$
$
$
$
See accompanying notes to consolidated financial statements.
Accumulated
Unrealized Gain
(Loss) on Securities
Available-for -Sale
Accumulated
Unrealized Gain
(Loss) on Derivative
Instruments
Total
Accumulated Other
Comprehensive
Income/(Loss)
(8,165)
10,404
2,239
2,239
482
(6,759)
(4,038)
(4,038)
10,865
6,827
$
$
$
$
$
$
(597)
(163)
(760)
(760)
(163)
882
(41)
(41)
(2,224)
(2,265)
$
$
$
$
$
$
(8,762)
10,241
1,479
1,479
319
(5,877)
(4,079)
(4,079)
8,641
4,562
62
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2019, 2018 and 2017
(In thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium / discount from amortization on securities
Securities gains, net
Provision for loan and lease losses
Originations of loans held-for-sale
Proceeds from sales of loans held-for-sale
Net gains on sales of mortgage loans
Mortgage servicing rights mark to market loss
Net discount / premium from accretion on loans
Increase in cash surrender value of BOLI
Net gains on sale of other real estate owned
Provision for other real estate owned valuation losses
Depreciation of fixed assets and amortization of leasehold improvements
Net (gains) on disposal and transfer of fixed assets
Amortization of core deposit intangible
Change in current income taxes receivable
Provision for deferred tax expense
Net deferred tax expense due to DTA revaluation
Change in accrued interest receivable and other assets
Accretion of purchase accounting adjustment on time deposits
Amortization of purchase accounting adjustment on notes payable and other borrowings
Amortization of junior subordinated debentures issuance costs
Amortization of senior notes issuance costs
Change in accrued interest payable and other liabilities
Stock based compensation
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
Net proceeds from sales of FHLBC stock
Net disbursements from purchases of FRB stock
Net change in loans, excluding acquisition
Proceeds from claims on BOLI
Improvements in other real estate owned
Proceeds from sales of other real estate owned, net of participation purchase
Proceeds from disposition of fixed assets
Net purchases of premises and equipment
Cash paid for acquisition, net of cash and cash equivalents retained
Net cash provided by (used in) investing activities
Cash flows from financing activities
Net change in deposits, excluding acquisition
Net change in securities sold under repurchase agreements
Net change in other short-term borrowings
Payment of senior note issuance costs
Net change in notes payable and other borrowings
Proceeds from exercise of stock options
Dividends paid on common stock
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
$
63
Year Ended December 31,
2019
2018
2017
$
39,455
$
34,012 $
15,138
2,726
(4,511)
1,600
(164,696)
168,472
(5,112)
2,662
(1,025)
(1,415)
(264)
519
2,462
(32)
539
1,546
6,436
-
(6,318)
(38)
92
48
112
6,863
2,516
52,637
41,752
191,298
(159,544)
3,516
-
(34,440)
1,196
-
2,779
32
(4,377)
-
42,212
10,114
2,061
(101,000)
-
(8,798)
32
(1,195)
(666)
(99,452)
(4,603)
55,235
50,632
2,969
(360)
1,228
(133,930)
137,622
(3,791)
734
(1,703)
(984)
(792)
581
2,423
-
387
1,678
9,840
-
1,218
(100)
81
47
100
1,390
2,257
54,907
40,641
94,663
(75,044)
(295)
(1,421)
(52,706)
1,204
(59)
4,782
-
(1,895)
(35,711)
(25,841)
1,881
(474)
1,800
(146,867)
151,289
(4,803)
802
(1,328)
(1,432)
(474)
1,708
2,306
(10)
96
(2,519)
13,662
7,909
(4,492)
-
-
48
102
1,582
1,181
37,105
117,389
232,462
(343,470)
(2,250)
-
(141,683)
-
-
6,107
13
(1,055)
-
(132,487)
(54,650)
11,091
23,625
-
(8,069)
33
(1,189)
(505)
(29,664)
(598)
55,833
55,235 $
56,140
4,203
45,000
(42)
-
-
(1,184)
(236)
103,881
8,499
47,334
55,833
$
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows – Continued
Years Ended December 31, 2019, 2018 and 2017
Supplemental cash flow information
Income taxes paid, net
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
See accompanying notes to consolidated financial statements.
$
Year Ended December 31,
2019
2018
2017
4,425 $
9,686
9,073
863
-
20 $
7,644
8,323
2,915
-
430
5,145
7,362
3,701
95
64
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended December 31, 2019, 2018 and 2017
(In thousands)
Common
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Treasury
Stock
Total
Stockholders’
Equity
Balance, December 31, 2016
Net income
Other comprehensive income, net of tax
Dividends declared and paid, ($0.04 per share)
Tax effect from vesting of restricted stock
Stock based compensation
Purchase of treasury stock
Balance, December 31, 2017
Balance, December 31, 2017
Net income
Other comprehensive loss, net of tax
Dividends declared and paid, ($0.04 per share)
Vesting of restricted stock
Reclassification of stranded tax effects
Stock option exercised
Stock based compensation
Purchase of treasury stock
Balance, December 31, 2018
Balance, December 31, 2018
Net income
Other comprehensive income, net of tax
Dividends declared and paid, ($0.04 per share)
Vesting of restricted stock
Stock option exercised
Stock warrants exercised
Stock based compensation
Purchase of treasury stock
Balance, December 31, 2019
$
34,534 $
116,653 $
129,005 $
15,138
(1,184)
(8,762) $
(96,220) $
10,241
92
(92)
1,181
$
34,626 $
117,742 $
142,959 $
1,479 $
(236)
(96,456) $
1,479 $
(96,456) $
$
34,626 $
117,742 $
91
3
(926)
8
2,257
142,959 $
34,012
(1,189)
(319)
(5,877)
319
$
34,720 $
119,081 $
175,463 $
(4,079) $
835
22
(505)
(96,104) $
$
34,720 $
119,081 $
175,463 $
39,455
(1,195)
(4,079) $
(96,104) $
8,641
132
2
(634)
7
(313)
2,516
$
34,854 $
120,657 $
213,723 $
4,562 $
502
23
313
(666)
(95,932) $
175,210
15,138
10,241
(1,184)
-
1,181
(236)
200,350
200,350
34,012
(5,877)
(1,189)
-
-
33
2,257
(505)
229,081
229,081
39,455
8,641
(1,195)
-
32
-
2,516
(666)
277,864
See accompanying notes to consolidated financial statements.
65
Old Second Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2019, 2018 and 2017
(Table amounts in thousands, except per share data)
Note 1: Summary of Significant Accounting Policies
Nature of Operations - Old Second Bancorp, Inc. (the “Company”) is a corporation organized under the laws of the State of Delaware
in 1981 that serves as the bank holding company for its wholly-owned subsidiary bank, Old Second National Bank. Old Second National
Bank (the “Bank”) is a national banking association headquartered in Aurora, Illinois, that operates through 29 banking centers located
in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois. The Bank is a full-service banking business, offering a
broad range of deposit products, trust and wealth management services, and lending services, including commercial, residential and
consumer loans. We also offer a full complement of electronic banking services, such as online and mobile banking and corporate cash
management products.
The consolidated financial statements of the Company include the financial statements of the Bank and its wholly-owned subsidiaries,
River Street Advisors, LLC, an investment advisory/management service company, Old Second Affordable Housing Fund, L.L.C., which
provides down payment assistance for home ownership to qualified individuals, and Station I, LLC, which holds property acquired by
the Bank through foreclosure or in the ordinary course of collecting a debt previously contracted with borrowers. The Company uses the
accrual basis of accounting for financial reporting purposes. Certain amounts in prior year financial statements have been reclassified to
conform to the 2019 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.
Segment Reporting – An operating segment is a component of a business entity that engages in business activity from which it may earn
revenues and/or incur expenses. It has operating results that are reviewed regularly by the entity’s chief operating decision maker in
order to make decisions about resource allocation and performance assessment, and the segment has discrete financial information
available for this assessment. As of December 31, 2019, the Company had one operating segment, which is community banking.
Therefore, segment reporting is not required.
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. The classification of cash and cash equivalents includes those assets held
in the form of cash or liquid instruments with an original maturity of 90 days or less.
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 (loss). Unrealized gains
and losses are not included in the calculation of regulatory capital.
Securities held-to-maturity are carried at amortized cost and the discount or premium created at acquisition or in the transfer from
available-for-sale is accreted or amortized to the maturity or expected payoff date but not an earlier call.
Discounts are accreted into interest income over the estimated life of the related security and premiums are amortized into income to the
earlier of the call date or estimated life of the related security using the level yield method.
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 Income. 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 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
66
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 (“FRBC”). 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. FRBC stock is redeemable at par, and therefore fair 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
and costs. Loans purchased as a result of a business combination are recorded at estimated fair value on the acquisition date, with no
carryover of the related allowance for loan and lease losses recorded by the acquiree at the time of purchase. These loans are segregated
into two classifications upon purchase:
1) purchased non-credit impaired (“non-PCI”) loans, accounted for in accordance with FASB ASC Subtopic 310-20
“Nonrefundable Fees and Costs” (“ASC 310-20”), as these loans do not have evidence of credit deterioration since
origination. The premiums and discounts created when ASC 310-20 loans are recorded at their fair values at acquisition
are recorded to income over the remaining life of the loan as an adjustment to the related loan’s yield; and
2) purchased credit impaired (“PCI”) loans, accounted for under FASB ASC Subtopic 310-30, “Loans and Debt Securities
Acquired with Deteriorated Credit Quality” (“ASC 310-30”) as they display signs of credit deterioration since origination.
Interest income, through accretion of the difference between the carrying value of the loans and the expected cash flows, is
recognized on the acquired loans accounted for under ASC 310-30.
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 amortized over the life of the related loans or commitments as a yield adjustment.
The acquisition adjustment discount related to purchased loans is accreted into interest income over the contractual life of each loan, or
is generally taken into income immediately upon payoff or renewal of the loan. 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 Cook, DeKalb, DuPage,
Kane, Kendall, LaSalle and Will counties in Illinois. These banking centers surround or are within 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 Loans – Such credits typically comprise working capital loans, loans for physical asset expansion, asset acquisition loans
and other commercial and industrial 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.
Lease Financing Receivables – Lease financing receivables are subject to underwriting standards and processes similar to commercial
loans. These loans are often secured by equipment or transportation assets, and 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.
Real Estate - Commercial Loans – Real estate - commercial 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.
67
Real Estate - Construction Loans – The Company defines real estate - construction loans as loans where the loan proceeds are controlled
by the Company and used exclusively for the improvement or development 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.
Real Estate - Residential 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.
Home Equity Lines of Credit (“HELOCs”) – These are lines of credit that are extended to refinance 1-4 family residential dwellings,
or to finance the borrower’s needs and collateralized by the borrower’s residence. These lines may be fixed or variable in nature, and the
home serving as collateral may also have a first lien outstanding.
Consumer Loans – Consumer loans include loans extended primarily for consumer and household purposes. These also include
overdrafts and other items not captured by the definitions above.
Nonaccrual Loans – Generally, commercial and consumer loans, as well as 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. Generally, 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, consumer and real estate loans 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 outstanding.
Troubled Debt Restructurings (“TDRs”) – A restructuring of debt is considered a TDR 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 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 TDRs are 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
impaired are classified as nonaccrual and are exclusive of smaller homogeneous loans, such as HELOCs, 1-4 family mortgages, and
consumer loans.
90-Days or Greater Past Due Loans – 90-days or greater 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 and Lease Losses (“ALLL”) – The ALLL is 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 ALLL
is inherently subjective since it requires significant estimates and management 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 ALLL is dependent upon a variety of
factors beyond the Company’s direct control, including the performance of the loan portfolio, consideration of current economic trends,
changes in interest rates and property values, the amounts and timing of expected future cash flows on impaired loans, estimated losses
on pools of homogeneous loans based on an analysis that uses historical loss experience, portfolio growth and concentration risk,
68
management and staffing changes, the interpretation of loan risk classifications by regulatory authorities and other credit market factors.
While each component of the ALLL is determined separately, the entire balance is available for the entire loan portfolio.
Loans deemed to be uncollectible are charged-off against the ALLL while recoveries of amounts previously charged-off are credited to
the ALLL. Approved releases from previously established loan loss reserves authorized under our ALLL methodology also reduce the
ALLL. Additions to the ALLL are established through the provision for loan and lease losses charged to expense.
The ALLL methodology consists of (i) specific reserves established for probable losses on individual loans for which the recorded
investment in the loan exceeds the present value of expected future cash flows or the net realizable value of the underlying collateral, if
collateral dependent, (ii) a general reserve based on a historical loss analysis that uses credit loss experience for the prior 20 quarters for
each loan category, and (iii) the impact of other internal and external qualitative and credit market factors as assessed by management
through detailed loan review, ALLL analysis and credit discussions.
The Company refined its ALLL methodology in 2017, with implementation of management factor classifications for newer loan
portfolios, such as the Company’s purchase of home equity lines of credit (“HELOCs”) in 2017 and the expanded business development
company loan portfolio, as these portfolios had not been outstanding long enough to be sufficiently seasoned. In addition, the Company
revised the risk weightings for the historical loss factors to allocate an increase in the loss factor applied in the earliest quarter, and a like
reduction of the loss factor in the most recent quarter, as management believed the lower charge-off levels in the more recent quarters
will likely not continue long-term.
The Company refined its ALLL methodology again in 2018, as the Company determined that a minimum threshold of two basis points
should be used for those quarters within the historical loss calculation with minimal or no losses incurred. In addition, a base line for
reserves was set for economic conditions, past due and classified loans, loan portfolio/ concentrations, general and external factors. These
factors are evaluated quarterly by the Bank’s ALLL Committee and the ASC 450 percentages are adjusted according to the overall
bias in the individual factors (up, down or neutral). In the first quarter of 2018, these baseline levels were modified to establish floors
and ceilings for each management factor. The establishment of floors and ceilings for management factors will allow management to
evaluate changes to factors within prescribed guidelines and to remain consistent with factor determination in a stressed scenario, as a
ceiling could be applied.
The Company continued to enhance its ALLL methodology in 2019, with loan portfolio volume changes supporting revisions to the
management factor related to portfolio volumes and concentrations. Lease portfolio growth of $40.9 million in 2019 supported an
increase in the management factor related to the changes in the volume and concentrations for leases, and a decline in the construction
portfolio of $38.8 million supported a decrease in the same management factor for construction loans. In addition, due to the falling
interest rate environment, the management factors for variable rate commercial loans and HELOCs were reduced to become more
commensurate with fixed rate commercial loan and HELOC products. Finally, as the purchased HELOC portfolio and the business
development loans have been analyzed with a separate management factor for two years within the ALLL calculation, and there have
been minimal HELOC charge-offs and no business development losses to date, these management factors were each reduced for the
December 31, 2019 calculation.
These modifications to the Company’s ALLL methodology are intended to more accurately reflect all portfolio risk, and resulted in a
consistent balance for the overall unallocated component of the allowance over the past three years. The unallocated component of the
allowance was $503,000 as of December 31, 2019, compared to $537,000 as of December 31, 2018 and $542,000 as of
December 31, 2017. All calculations conform to GAAP.
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
or 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 Income. Maintenance and repairs are charged to operating expenses as incurred,
while improvements that conform to definitions of tangible property improvements are capitalized and depreciated over the estimated
remaining life.
Other Real Estate Owned (“OREO”) – Real estate assets acquired in settlement of loans are recorded at the fair value of the property
when acquired, less estimated costs to sell, establishing a new cost basis. Physical possession of residential real estate property
collateralizing a consumer mortgage loan occurs when legal title is obtained upon foreclosure or when the borrower conveys all interest
in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Any deficiency
between the net book value and fair value at the foreclosure or deed in lieu date is charged to the ALLL. Any reduction in OREO carrying
value within 90 days of transfer to OREO would be charged to the ALLL. If the fair value of the property when acquired, less estimated
costs to sell, is greater than the net book value of the loan, a gain on transfer is recorded. If a determination is made more than 90 days
after the transfer to OREO that the fair value for the OREO property has declined, an OREO valuation allowance is established for the
decrease between the recorded value and the updated fair value less costs to sell. Such declines are included in other noninterest expense
69
in the Consolidated Statements of Income. A subsequent reversal of an OREO valuation adjustment can occur, but the resultant carrying
value cannot exceed the cost basis established at transfer of the loan to OREO. Operating costs after acquisition are also expensed.
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 $723.4 million and $711.1 million at December 31, 2019, and
2018, 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 effect recorded in net gains on sales of mortgage loans in the Consolidated
Statements of Income. 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.
Servicing fee income, which is included in the Consolidated Statements of Income as mortgage servicing income, 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 mortgage 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 these changes in mortgage
servicing rights mark to market in the Consolidated Statements of Income. The fair values of mortgage servicing rights are subject to
significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
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
Balance Sheets at their cash surrender value (“CSV”) or the amount that could be realized. The change in CSV is recorded as an increase
in cash surrender value of bank-owned life insurance in the Consolidated Statements of Income in noninterest income. In addition,
insurance proceeds received, net of the original premium investment, are recorded as death benefit realized on bank-owned life insurance
in the Consolidated Statements of Income in noninterest income.
Goodwill and Core Deposit Intangible – Goodwill is the excess of an acquisition’s purchase price over the fair value of identified net
assets acquired in an acquisition. Goodwill is not deemed to have definitive life span, and therefore is not amortized, but is subject to
annual review for impairment. The annual review performed is qualitative in nature, and factors reviewed include macroeconomic data,
industry specific data, current market conditions, and the Company’s overall financial performance. Based on management’s annual
review of goodwill as of December 31, 2019, no goodwill impairment was noted.
The core deposit intangible (“CDI”) is being amortized on an accelerated method over a ten year estimated useful life. In 2018, CDI of
$3.1 million was recorded stemming from the ABC Bank acquisition, which is discussed further in Note 2. As of December 31, 2019,
$2.3 million of the ABC Bank CDI remained, which is in addition to the $366,000 of CDI remaining from the Talmer branch purchase.
Total CDI amortization expense of $539,000, $387,000 and $96,000 was recorded in 2019, 2018 and 2017, respectively. The expected
future annual amortization expense for each of the next five years is approximately $494,000, $459,000, $421,000, $379,000, and
$331,000.
Debt Issuance Costs – Costs associated with the issuance of debt are presented in the Consolidated Balance Sheet as a direct reduction
from the carrying value of that debt liability. The deferred issuance costs are amortized over the life the related debt instrument, and
included within the debt’s interest expense.
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 are such matters that will have a material effect on the financial statements.
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 included as a component of noninterest income in the
Consolidated Statements of Income.
Advertising Costs – All advertising costs incurred by the Company are expensed in the period in which they are incurred.
70
Equity 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, which utilizes
assumptions for expected volatilities based on the previous five-year historical volatilities of the Company's common stock. Historical
data is used to estimate option exercise rates and post-vesting termination behavior, and 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 grant. The market price of the Company’s common stock at the
date of grant is used for restricted stock awards, which include restricted stock units. 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 Consolidated Statement of Income. 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 a credit to income tax expense.
Income Taxes – The Company files income tax returns in the U.S. federal jurisdiction, and in the states of Illinois, Indiana and Wisconsin.
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. Any change in tax rates will be recorded in the period in which the law is enacted.
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.
As of December 31, 2019 and 2018, the Company evaluated tax positions taken for filings with the Internal Revenue Service and all state
jurisdictions in which it operates. The Company believes that income tax filing positions will be sustained under examination and does not
anticipate any adjustments that would result in a material adverse effect on the Company’s financial condition, results of operations, or cash
flows. Accordingly, the Company has not recorded any reserves or related accruals for interest and penalties for uncertain tax positions at
December 31, 2019 and 2018. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service from
2016 to 2018, the state of Illinois from 2016 to 2018, and the states of Wisconsin and Indiana from 2009 to 2018.
Earnings Per Common Share (“EPS”) – Basic EPS is computed by dividing net income applicable to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income applicable to
common stockholders by the weighted-average number of common shares outstanding plus the number of additional common shares that
would have been outstanding if the dilutive potential shares had been issued. The Company’s potential common shares represent shares
issuable under its long-term incentive compensation plans and under the common stock warrant originally issued to preferred stockholders.
Such common stock equivalents are computed based on the treasury stock method using the average market price for the period.
Treasury Stock – Treasury stock acquired is recorded at cost and is carried as a reduction of stockholders’ equity in the Consolidated
Balance Sheets. 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 the 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 net gains
on sales of loans in the Consolidated Statements of Income.
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. The Company records all
derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of
the derivative and whether the Company has elected to designate a derivative as a hedging relationship and apply hedge accounting. A
further consideration involves a determination on whether the hedging relationship has satisfied the criteria necessary to apply hedge
accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm
commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Hedge accounting generally
provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the
fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged
forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge
certain risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
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 is deferred and reported as a component of accumulated
other comprehensive income, which is a component of stockholders’ equity, until such time the hedged transaction affects earnings. For
71
derivative instruments not accounted for as hedges, changes in fair value are recognized in noninterest income/expense. Counterparty
risk with loan customers is managed through loan covenant agreements and, as such, does not have a significant impact on the fair value
of the swaps. Counterparty risk with other banks is managed through bilateral collateralization agreements. Deferred gains and losses
from derivatives not accounted for as hedges and 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 – Comprehensive income is the total of reported earnings for 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 in the Consolidated
Statements of Comprehensive Income: (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) the effective portion of a derivative
used to hedge cash flows.
Recent Accounting Pronouncements – The following is a summary of recent accounting pronouncements that have impacted or could
potentially affect the Company:
In February 2016, the FASB issued ASU No. 2016-02 “Leases (Topic 842).” This ASU was issued to increase transparency and
comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about
leasing arrangements. One key revision from prior guidance was to include operating leases within assets and liabilities recorded; another
revision was to create a new model to follow for sale-leaseback transactions. The impact of this pronouncement primarily affected
lessees, as virtually all of their assets will be recognized on the balance sheet, by recording a right of use asset and lease liability. This
pronouncement is effective for fiscal years beginning after December 15, 2018. In July 2018, the FASB issued ASU No. 2018-11,
“Leases (Topic 842): Targeted Improvements” which provided additional guidance on the transition method, including application as a
cumulative-effect adjustment to equity and practical expedients to use when accounting for lease components. The Company adopted
this standard as of January 1, 2019, and recorded right of use assets of $817,000 with a like lease liability, recorded to other assets and
other liabilities, respectively. As of December 31, 2019, the right of use assets and lessee lease liability both totaled $3.3 million. The
Company also recorded leases receivable related to lessor leases of $174,000 as of January 1, 2019, which is within other assets, with a
like entry to lease liabilities for the lessor position, recorded within other liabilities. These tenant leases receivable balances and lessor
lease liabilities both totaled $77,000 as of December 31, 2019. There was no impact to equity for the adoption of this standard on a
modified retrospective basis.
In June 2016, the FASB issued ASU No. 2016-13 “Measurement of Credit Losses on Financial Instruments (Topic 326)”, also known
as Current Expected Credit Losses, or “CECL”. ASU 2016-13 was issued to provide financial statement users with more useful
information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity
at each reporting date to enhance the decision making process. The new methodology to be used should reflect expected credit losses
based on relevant vintage historical information, supported by reasonable forecasts of projected loss given defaults, which will affect the
collectability of the reported amounts. This new methodology will also require available-for-sale debt securities to have a credit loss
recorded through an allowance rather than write-downs through an other than temporary impairment analysis. In addition, an allowance
will be established for the credit risk related to unfunded commitments. ASU 2016-13 is effective for financial statements issued for
fiscal years beginning after December 15, 2019, and was adopted as of January 1, 2020, by the Company.
Upon issuance of ASU 2016-13, the Company set up a CECL committee, with the goal of establishing a timeline for CECL data
collection, implementation, parallel runs, testing, and model validation. The Company has implemented a software solution provided by
a third party vendor to assist in the determination of the allowance for credit losses (“ACL”), and the third party validation process was
completed in the fourth quarter of 2019. The Company has accumulated historical data by loan pools and collateral classifications. All
historical data, model assumptions and calculation parameters were analyzed by the third party validation team, and management has
made enhancements to the software model used based on their recommendations.
Our approach for estimating expected life-time credit losses for loans includes the following components:
• An initial forecast period of one year for all portfolio segments and off-balance-sheet credit exposures. This period reflects
management’s expectation of losses based on forward-looking economic scenarios over that time.
• A historical reversion loss forecast period covering the remaining contractual life, adjusted for prepayments, by portfolio
segment based on the historical loss rate of loans within those segments.
• The initial loss forecast period and historical reversion loss rate is based on economic conditions at the measurement date.
• We primarily utilized the static pool and migration analysis methods to estimate credit losses. Such methods would obtain
estimated life-time credit losses using the conceptual components described above.
Based on our portfolio composition at December 31, 2019, and the current economic environment, we expect an overall increase in our
ACL for loans and leases of approximately $4.0 to $6.0 million. In addition, a reserve for unfunded commitments has been established
of approximately $1.5 to $2.5 million. Approximately $2.5 million of the increase to the ACL results from the transfer of the non-
accretable purchase accounting adjustments on purchase credit impaired loans. As a result of the adoption of this new standard on January
1, 2020, we expect a reduction to retained earnings of approximately $3.0 to $5.0 million. The initial impact estimated by management
72
and subsequent reporting periods is highly dependent on credit quality, macroeconomic forecasts and conditions, as well as the
composition of our loans and available-for-sale securities portfolio. The ultimate ACL and retained earnings transition adjustment may
fall outside of management’s estimated increase due to a material change in management’s macroeconomic forecast, loan composition
and other management adjustments used in calculating the ACL upon the adoption of CECL.
The Company is finalizing internal control processes and disclosure documentation related to adoption of this standard, which will be
completed prior to the end of the first quarter of 2020.
In October 2018 the FASB issued ASU No. 2018-16 “Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight
Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting.” ASU 2018-16 adds the
SOFR overnight index swap rate to the list of United States (U.S.) benchmark rates eligible for hedge accounting purposes, which is the
fourth rate permissible to be used as a U.S. benchmark rate. This guidance is effective for annual and interim periods beginning after
December 15, 2018, and we do not expect this guidance to have a material impact on the financial condition or liquidity of the Company.
Subsequent Events
On January 21, 2020, the Company’s Board of Directors declared a cash dividend of $0.01 per share payable on February 10, 2020, to
stockholders of record as of January 31, 2020.
On January 28, 2020, the Company issued a redemption notice with respect to its 7.80% subordinated debentures due June 30, 2033 (the
“Subordinated Debentures”) relating to the outstanding 7.80% cumulative trust preferred securities (NASDAQ: OSBCP) (the “Trust
Securities”) issued by Old Second Capital Trust I (“Trust I”), which are guaranteed on a subordinated basis by the Company. An
aggregate principal amount of Subordinated Debentures of $32,604,000 was redeemed on March 2, 2020, plus accrued and unpaid interest
through the redemption date. Also on March 2, 2020 all of the outstanding Trust Securities were redeemed at a redemption price of
$10.00 per Trust Security, which reflects 100% of the liquidation amount, plus accrued and unpaid distributions through the redemption
date. In connection with the redemption, the Trust Securities were delisted from The Nasdaq Stock Market.
Note 2: Acquisitions
Greater Chicago Financial Corp. and ABC Bank Acquisition
On April 20, 2018, the Company acquired Greater Chicago Financial Corp. (“GCFC”) and its wholly-owned subsidiary, ABC Bank,
which operated four branches in the Chicago metro area. In addition to the acquisition price of $41.1 million, the Company retired the
convertible and nonconvertible debentures held by GCFC upon acquisition, which totaled $6.6 million, including interest due. The
purchase and the retirement of the debentures was funded with the Company’s cash on hand, and all GCFC common stock was retired
and cancelled simultaneous with the close of the transaction. The Company acquired $227.6 million of loans, net of purchase accounting
adjustments, and $248.5 million of deposits, net of purchase accounting adjustments for time deposits. Purchase accounting adjustments
recorded include a loan valuation mark of $11.2 million, a core deposit intangible of $3.1 million, a fixed asset valuation adjustment of
$1.5 million, and goodwill of $10.2 million. In addition, a deferred tax asset of $3.5 million was recorded as of the date of acquisition
based on analysis of the fair value of assets acquired, less liabilities assumed. None of the $10.2 million recorded as goodwill is expected
to be deductible for tax purposes. Acquisition related costs incurred by the Company for the year ended December 31, 2018, totaled $3.5
million, pre-tax, and included $1.1 million of salaries and employee benefits related expenses, and $1.8 million of data processing,
computer and ATM related conversion costs. Acquisition costs incurred for the year ending December 31, 2017, related to the merger
with GCFC were $65,000, and were expensed as incurred.
73
The assets and liabilities associated with the acquisition of GCFC were recorded in the Consolidated Balance Sheets at their estimated
fair values as of the acquisition date. In many cases the determination of these fair values required management to make estimates about
discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. The following
table shows the estimated fair value of the assets acquired and liabilities assumed as of April 20, 2018.
All amounts have been accounted for under the acquisition method of accounting.
GCFC/ABC Bank Acquisition Summary
As of Date of Acquisition
Assets
Cash and due from banks
Interest bearing deposits with financial institutions
Securities available-for-sale, at fair value
Federal funds sold
FHLBC stock
Loans
Premises and equipment
Other real estate owned
Goodwill and core deposit intangible
Deferred tax assets, net
Other assets
Total assets
Liabilities
Noninterest bearing demand
Savings, NOW and money market
Time
Total deposits
Securities sold under repurchase agreements
Other short-term borrowings
Notes payable and other borrowings
Other liabilities
Total liabilities
Cash consideration paid
Total Liabilities Assumed and Cash Consideration Paid for Acquisition
April 20, 2018
6,669
500
72,091
4,300
1,549
227,594
5,339
401
13,280
3,459
1,767
336,949
58,005
91,494
98,999
248,498
5,623
10,875
23,367
1,406
289,769
47,180
336,949
$
$
$
$
Loans acquired in the GCFC acquisition were initially recorded at fair value with no separate allowance for loan losses. The Company
reviewed the loans at acquisition to determine which loans should be considered PCI loans, defining impaired loans as those that were
either not accruing interest or exhibited credit risk factors consistent with nonperforming loans at the acquisition date, or non-PCI loans,
as addressed in the Company’s significant accounting policies.
The following table represents the acquired loans as of date of acquisition and as of December 31, 2019:
ABC Bank Acquired Loans
Fair Value
Contractually required principal and interest payments
Best estimate of contractual cash flows not expected to be collected
Best estimate of contractual cash flows expected to be collected
$
Talmer Bank and Trust Branch Purchase
April 20, 2018
Non-PCI
PCI
11,360 $
19,447
6,537
12,910
216,234 $
220,308
2,511
217,797
December 31, 2019
PCI
Non-PCI
8,601 $
13,254
3,970
9,284
126,482
127,630
500
127,130
On October 28, 2016, the Bank completed the acquisition of the Chicago branch of Talmer Bank and Trust, the banking subsidiary of
Talmer Bancorp, Inc. (“Talmer”). As a result of this transaction, the Bank acquired $221.0 million of loans, net of fair value adjustment,
and $48.9 million of deposits. The purchase resulted in the Company establishing a metropolitan Chicago office presence with a strong
commercial client focus, and retention of an experienced lending team. The acquisition was funded with security sales and cash on hand,
and was recorded applying the acquisition method of accounting. Net assets acquired totaled $181.5 million. Acquisition expenses
incurred in 2016 related to the Talmer branch purchase totaled $269,000 as of December 31, 2016; all material acquisition costs identified
were paid or accrued as of year-end 2016.
74
Note 3: Cash and Due from Banks
The Bank is required to maintain reserve balances with the FRBC. As of December 31, 2019 and 2018, the required reserve balance was
$12.4 million and $10.8 million, 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.
Note 4: Securities
Investment Portfolio Management
The following table summarizes the amortized cost and fair value of the securities portfolio at December 31, and the corresponding
amounts of gross unrealized gains and losses were as follows:
2019
Securities available-for-sale
U.S. Treasury
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total securities available-for-sale
2018
Securities available-for-sale
U.S. Treasury
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total securities available-for-sale
Gross
Gross
Amortized
Unrealized
Unrealized
Cost
Gains
Losses
Fair
Value
$
$
4,010 $
8,502
16,164
240,399
57,059
82,114
66,898
475,146 $
26 $
-
443
11,207
963
617
29
13,285 $
- $
(165)
(19)
(2,431)
(38)
(887)
(243)
(3,783) $
4,036
8,337
16,588
249,175
57,984
81,844
66,684
484,648
Amortized
Cost
Gross
Gross
Unrealized
Unrealized
Gains
Losses
$
$
4,006 $
11,112
14,407
277,112
66,494
108,574
65,162
546,867 $
- $
-
45
1,916
79
1,165
24
3,229 $
(83) $
(161)
(377)
(4,961)
(2,144)
(225)
(897)
(8,848) $
Fair
Value
3,923
10,951
14,075
274,067
64,429
109,514
64,289
541,248
Nonmarketable equity investments include FHLBC stock and FRBC stock. FHLBC stock was $3.7 million and $7.2 million at
December 31, 2019 and December 31, 2018, respectively. FRBC stock was $6.2 million at December 31, 2019 and December 31, 2018.
Our FHLBC stock is necessary to maintain access to FHLBC advances.
Securities valued at $320.8 million as of December 31, 2019, an increase from $318.4 million at year-end 2018 were pledged to secure
deposits and borrowings, and for other purposes.
75
The fair value, amortized cost and weighted average yield of debt securities at December 31, 2019, by contractual maturity, were as
follows in the table below. Securities not due at a single maturity date 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
Mortgage-backed and collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total securities available-for-sale
Amortized
Cost
Weighted
Average
Yield
$
$
509
6,297
4,727
241,378
252,911
73,223
82,114
66,898
475,146
2.03 %
2.11
3.49
3.02
3.00
3.28
2.99
4.28
3.22 %
$
$
Fair
Value
510
6,411
5,076
249,551
261,548
74,572
81,844
66,684
484,648
At December 31, 2019, the Company’s investments include asset-backed securities totaling $54.9 million that are backed by student
loans originated under the Federal Family Education Loan program (“FFEL”). Under the FFEL, private lenders made federally
guaranteed student loans to parents and students. While the program was modified several times before elimination in 2010, FFEL
securities are generally guaranteed by the U.S. Department of Education (“DOE”) at not less than 97% of the principal amount of the
loans. The guarantee will reduce to 85% if the DOE receives reimbursement requests in excess of 5% of insured loans; reimbursement
will drop to 75% if reimbursement requests exceed 9% of insured loans. As of December 31, 2019, the likelihood of the decrease in the
government guarantee was minimal as the average rate of reimbursement for 2019 was less than 1.0%.
The Company has accumulated the securities of the following two different originators that individually amount to over 10% of the
Company’s stockholders equity. The amortized cost and fair value of securities related to these two issuers are as follows:
Issuer
GCO Education Loan Funding Corp
Towd Point Mortgage Trust
December 31, 2019
Fair
Value
Amortized
Cost
27,873
33,551
$
$
27,470
34,322
Securities with unrealized losses at December 31, aggregated by investment category and length of time that individual securities have
been in a continuous unrealized loss position, were as follows:
2019
Securities available-for-sale
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total securities available-for-sale
2018
Securities available-for-sale
U.S. Treasuries
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total securities available-for-sale
Less than 12 months
in an unrealized loss position
Fair
Value
Number of Unrealized
Securities Losses
12 months or more
in an unrealized loss position
Fair
Value
- $
3
6
2
4
4
19 $
- $
10
1,665
26
839
62
-
3,018
41,043
9,054
54,540
21,927
2,602 $ 129,582
Number of Unrealized
Securities Losses
4 $
2
2
2
1
4
15 $
165 $
9
766
12
48
181
1,181 $
165 $
Fair
Value
Number of Unrealized
Securities Losses
4 $
5
8
4
5
8
34 $
19
2,431
38
887
243
8,337
3,861
47,636
10,263
57,778
46,947
3,783 $ 174,822
8,337
843
6,593
1,209
3,238
25,020
45,240
Total
Less than 12 months
in an unrealized loss position
Fair
12 months or more
in an unrealized loss position
Fair
Number of Unrealized
$
Number of Unrealized
Securities Losses
-
-
100
3
-
-
126
4
309
2
-
-
7
721
16 $
$
Value Securities Losses
83
$
61
377
4,835
1,835
225
176
-
7,385
-
17,713
15,211
-
46,547
1,256 $ 86,856
Value Securities Losses
83
$
161
377
4,961
2,144
225
897
3,923
3,566
11,439
110,326
43,687
16,473
7,824
7,592 $ 197,238
1
1
11
33
10
4
1
61 $
1
4
11
37
12
4
8
77 $
$
Fair
Value
3,923
$
10,951
11,439
128,039
58,898
16,473
54,371
8,848 $ 284,094
Number of Unrealized
Total
Recognition of other-than-temporary impairment was not necessary in the years ended December 31, 2019, 2018 or 2017. The changes
in fair value related primarily to interest rate fluctuations. The Company’s review of other-than-temporary impairment confirmed no
credit quality deterioration.
76
The following table presents net realized gains (losses) on securities available-for-sale for the years ended:
Years ended December 31,
Securities available-for-sale
Proceeds from sales of securities
Gross realized gains on securities
Gross realized losses on securities
Net realized gains
Income tax expense on net realized gains
Effective tax rate applied
Note 5: Loans
Major classifications of loans were as follows as of December 31, were as follows:
Commercial
Leases
Real estate - commercial
Real estate - construction
Real estate - residential
HELOC
Other 1
Total loans, excluding deferred loan costs and PCI loans
Net deferred loan costs
Total loans, excluding PCI loans
PCI loans, net of purchase accounting adjustments
Total loans
1 The “Other” class includes consumer loans and overdrafts.
2017
2019
2018
$ 191,298 $ 94,663 $ 232,462
2,367
(1,893)
474
(198)
41.8 %
5,521
(1,010)
4,511 $
(1,267) $
28.1 %
369
(9)
360 $
(100) $
27.8 %
$
$
2019
2018
332,842
119,751
865,599
69,617
396,901
123,457
12,258
1,920,425
1,786
1,922,211
8,601
1,930,812
$
$
314,323
78,806
820,941
108,390
407,068
140,442
14,439
1,884,409
1,653
1,886,062
10,965
1,897,027
$
$
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 75.4% and 77.9% of the portfolio at December 31, 2019, and
December 31, 2018, respectively.
77
Aged analysis of past due loans by class of loans as of December 31, were as follows:
2019
Commercial
Leases
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
Multi-family
Owner occupied
HELOC
Other 1
Total, excluding PCI loans
$
PCI loans, net of purchase accounting adjustments
261
Total
$
9,379 $
90 Days or
Greater Past Total Past
Due
2,103 $
81
Due
4,299 $
443
Current
Nonaccrual Total Loans
328,399 $
118,979
144 $
329
332,842 $
119,751
Recorded
Investment
90 days or
Greater Past
Due and
Accruing
2,132
128
-
-
343
-
-
-
-
-
-
-
-
-
-
18
-
2,411
852
1,064
-
-
232
-
-
-
26
146,323
173,346
317,923
146,483
52,930
17,160
5,300
12,379
37,571
14,248
792
4,388
549
-
1,146
-
-
-
-
93
149,526
178,586
319,536
146,483
54,076
17,392
5,300
12,379
37,571
14,367
266
1,710
4,801
803
28
70,051
187,995
128,650
121,110
13,997
788
68
2,572
1,544
19
71,105
189,773
136,023
123,457
14,044
2,545 $ 16,935 $ 1,892,844 $ 12,432 $ 1,922,211 $
-
261
5,377
2,963
8,601
2,545 $ 17,196 $ 1,898,221 $ 15,395 $ 1,930,812 $
-
-
348
-
-
-
-
-
-
-
-
-
-
20
-
2,628
-
2,628
60-89 Days
Past Due
30-59 Days
Past Due
$
1,271 $
362
1,725
512
626
-
-
232
-
-
-
26
141
10
3,450
735
28
9,118 $
925 $
-
686
340
95
-
-
-
-
-
-
-
125
1,700
1,351
50
-
5,272 $
-
5,272 $
2018
Commercial
Leases
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
Multi-family
Owner occupied
HELOC
Other 1
Total, excluding PCI loans
PCI loans, net of purchase accounting adjustments
Total
30-59 Days
Past Due
$
58 $
90 Days or
60-89 Days Greater Past Total Past
Due
Past Due
Due
Current
- $
-
352 $
-
410 $
-
313,913 $
78,806
Recorded
Investment
90 days or
Greater Past
Due and
Nonaccrual Total Loans Accruing
361
-
314,323 $
78,806
- $
-
-
1,768
826
2,832
-
-
-
-
266
-
-
801
545
1,241
775
53
9,165 $
1,452
$ 10,617 $
$
-
135
203
-
620
-
-
-
-
-
156
-
705
-
5
1,824 $
-
1,824 $
33
-
-
-
-
-
-
-
350
-
-
179
-
-
3
1,801
961
3,035
-
620
-
-
266
350
-
160,892
192,426
286,115
106,036
45,968
13,778
5,102
2,478
55,060
45,028
1,579
395
4,236
3,099
-
-
-
-
-
106
164,272
193,782
293,386
109,135
46,588
13,778
5,102
2,744
55,410
45,134
957
724
1,946
775
61
69,148
195,504
135,360
138,801
16,000
353
-
3,076
866
31
70,458
196,228
140,382
140,442
16,092
917 $ 11,906 $ 1,860,415 $ 13,741 $ 1,886,062 $
-
1,452
7,248
2,265
10,965
917 $ 13,358 $ 1,867,663 $ 16,006 $ 1,897,027 $
36
-
-
-
-
-
-
-
355
-
-
180
-
-
3
935
-
935
1 The “Other” class includes consumer loans, overdrafts and net deferred 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 balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and
residential mortgages. Loans with a classified risk rating are reviewed quarterly regardless of size or loan type. The Company uses the
following definitions for classified risk ratings:
78
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.
Credit Quality Indicators by class of loans as of December 31, were as follows:
2019
Commercial
Leases
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
Multi-Family
Owner occupied
HELOC
Other 1
Total, excluding PCI loans
$
PCI loans, net of purchase accounting adjustments
Total
$
$
Pass
307,948
119,045
144,292
171,444
315,340
142,958
52,342
15,155
5,300
12,379
37,571
14,105
Special
Mention
$
13,206
377
Substandard2
11,688
329
$
$
Doubtful
$
-
-
2,967
2,663
416
3,525
588
1,027
-
-
-
-
-
1,710
134
12
-
26,625
261
26,886
$
$
2,267
4,479
3,780
-
1,146
1,210
-
-
-
262
1,390
503
3,631
1,969
359
33,013
7,767
40,780
$
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
Total
332,842
119,751
149,526
178,586
319,536
146,483
54,076
17,392
5,300
12,379
37,571
14,367
71,105
189,773
136,023
123,457
14,044
$ 1,922,211
8,601
$ 1,930,812
69,715
187,560
132,258
121,476
13,685
1,862,573
573
1,863,146
$
$
79
2018
Commercial
Leases
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
Multi-Family
Owner occupied
HELOC
Other 1
Total, excluding PCI loans
$
PCI loans, net of purchase accounting adjustments
Total
$
$
Pass
305,993
78,806
157,334
186,218
284,818
104,526
44,805
11,307
5,102
2,744
55,410
42,524
Special
Mention
$
8,193
-
1,660
3,429
202
1,510
-
1,249
-
-
-
-
69,242
195,249
135,858
138,553
16,061
1,834,550
907
1,835,457
$
$
-
-
-
-
-
16,243
2,906
19,149
$
$
Substandard2
137
-
$
$
Doubtful
$
-
-
Total
314,323
78,806
164,272
193,782
293,386
109,135
46,588
13,778
5,102
2,744
55,410
45,134
70,458
196,228
140,382
140,442
16,092
$ 1,886,062
10,965
$ 1,897,027
5,278
4,135
8,366
3,099
1,783
1,222
-
-
-
2,610
1,216
979
4,524
1,889
31
35,269
7,152
42,421
$
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
1 The “Other” class includes consumer, overdrafts and net deferred costs.
2 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.
The Company had $831,000 and $448,000 in consumer mortgage loans in the process of foreclosure as of December 31, 2019 and
December 31, 2018, respectively.
80
Impaired loans, which include nonaccrual loans and troubled debt restructurings, by class of loan as of December 31, were as follows:
2019
Unpaid
Recorded
Principal
Investment Balance
Unpaid
Related
Principal
Recorded
Allowance Investment Balance
Related
Allowance
2018
$
- $
70
- $
73
- $
-
- $
-
- $
-
With no related allowance recorded
Commercial
Leases
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
Multi-Family
Owner occupied
HELOC
Other 1
Total impaired loans with no recorded allowance
With an allowance recorded
Commercial
Leases
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
Multi-Family
Owner occupied
HELOC
Other 1
Total impaired loans with a recorded allowance
Total impaired loans, excluding PCI loans $
PCI loans, net of purchase accounting adjustments
Total impaired loans
$
861
1,573
444
-
1,146
-
-
-
-
93
872
68
2,924
1,394
2
9,447
144
259
106
2,815
159
-
-
-
-
-
-
-
915
2,069
471
-
1,183
-
-
-
-
132
1,022
68
4,415
1,866
3
12,217
147
259
106
2,815
170
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
93
100
1
815
14
-
-
-
-
-
-
-
1,659
395
1,138
-
-
-
-
-
-
49
353
-
3,359
884
7
7,844
-
-
396
-
3,098
3,099
-
-
-
-
-
57
1,782
530
1,159
-
-
-
-
-
-
73
459
-
4,882
1,003
7
9,895
-
-
396
-
4,038
3,575
-
-
-
-
-
58
787
-
3,249
1,034
17
8,570
18,017 $
2,624
20,641 $
787
-
3,251
1,035
19
8,589
20,806 $
4,686
25,492 $
10
-
40
56
6
1,135
1,135 $
77
1,212 $
808
-
3,676
1,357
24
12,515
20,359 $
-
20,359 $
808
-
3,679
1,357
25
13,936
23,831 $
-
23,831 $
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
3
-
97
139
-
-
-
-
-
1
4
-
46
49
13
352
352
-
352
1 The “Other” class includes consumer loans and overdraft.
81
Average recorded investment and interest income recognized on impaired loans by class of loan for the years ending December 31,
were as follows:
Year Ended
December 31, 2019
Year Ended
December 31, 2018
Year Ended
December 31, 2017
Average
Recorded
Interest
Income
Average
Recorded
Interest
Income
Average
Recorded
Interest
Income
Investment Recognized
Investment Recognized
Investment Recognized
$
$
-
35
- $
-
$
-
89
- $
-
120
272
$
With no related allowance recorded
Commercial
Lease
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
Multi-Family
Owner occupied
HELOC
Other 1
Total impaired loans with no recorded allowance
With an allowance recorded
Commercial
Leases
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
Multi-Family
Owner occupied
HELOC
Other 1
Total impaired loans with a recorded allowance
Total impaired loans, excluding PCI loans
PCI loans, net of purchase accounting
adjustments
Total impaired loans
$
$
1,260
984
791
-
573
-
-
-
-
71
613
34
3,141
1,139
5
8,646
72
129
251
1,408
1,628
1,550
-
-
-
-
-
28
6
-
-
-
-
-
-
-
-
-
8
-
43
5
-
62
-
-
13
-
4
-
-
-
-
-
-
-
1,057
369
1,150
-
541
-
-
-
-
125
362
2,362
4,283
1,005
7
11,350
-
-
198
-
1,549
1,549
-
-
-
-
-
29
8
-
-
-
-
-
-
-
-
-
-
-
39
1
-
48
-
-
29
-
-
-
-
-
-
-
-
-
1,168
364
1,453
507
1,130
-
-
-
37
204
1,106
2,362
7,516
1,804
4
18,047
-
-
-
-
123
-
-
-
-
-
-
-
798
-
3,462
1,196
20
10,542
19,188
1,312
20,500
$
$
44
-
156
52
-
269
331 $
818
-
3,560
1,171
12
8,886
20,236
132
463 $
-
20,236
$
$
43
-
150
56
-
278
326 $
414
-
2,123
493
-
3,153
21,200
-
326 $
-
21,200
$
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
44
1
-
45
-
-
-
-
-
-
-
-
-
-
-
-
43
-
123
35
-
201
246
-
246
1 The “Other” class includes consumer loans and overdrafts.
Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist:
(1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-by-
case basis during the loan collection process with modifications generally initiated at the request of the borrower. These modifications
may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank participates in the
U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying
homeowners an opportunity to refinance into more affordable monthly payments.
82
The specific allocation of the ALLL on a TDR is determined by either discounting the 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 ALLL 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.
Loans that were modified during the period are summarized as follows:
Troubled debt restructurings
Real estate - commercial
Owner occupied general purpose
Deferral1
Non-owner occupied general purpose
Other2
Retail properties
Other2
Real estate - residential
Owner occupied
HAMP3
HELOC
Other2
Total
Troubled debt restructurings
Real estate - commercial
Owner occupied general purpose
Other2
Owner occupied special purpose
Other2
Real estate - construction
All other
HAMP3
Real estate - residential
Owner occupied
HAMP3
Other2
HELOC
HAMP3
Rate4
Other2
Total
1 Deferral: Refers to the deferral of principal
2 Other: Change of terms from bankruptcy court
3 HAMP: Home Affordable Modification Program
4 Rate: Refers to interest rate reduction
TDR Modifications
Year Ended December 31, 2019
# of
contracts
Pre-modification
recorded investment
Post-modification
recorded investment
1 $
421 $
1
1
3
1
7 $
58
1,159
399
39
2,076 $
418
54
1,146
293
38
1,949
TDR Modifications
Year Ended December 31, 2018
# of
contracts
Pre-modification
recorded investment
Post-modification
recorded investment
396
46
56
443
29
115
24
600
1,709
1 $
427 $
110
58
502
34
117
24
622
1,894 $
1
1
4
1
3
1
9
21 $
83
TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. There were
$39,000 of HELOC TDRs that defaulted during year 2019 and none during year 2018.
The Bank had no commitments to borrowers whose loans were classified as impaired at December 31, 2019.
The following table details the accretable discount on all of the Company’s purchased loans, both non-PCI loans and PCI loans as of
December 31 were as follows:
Beginning balance, January 1, 2019
Accretion
Charge-offs
Transfer
Ending balance, December 31, 2019
Beginning balance, January 1, 2018
Purchases
Accretion
Transfer
Ending balance, December 31, 2018
Accretable
Discount -
Non-PCI
Loans
Accretable
Discount -
PCI Loans
Non-
Accretable
Discount -
PCI Loans
$
$
1,867
(1,050)
-
-
817
$
$
1,099
(413)
(170)
6
522
$
$
5,969
(606)
(1,387)
(6)
3,970
$
$
Total
8,935
(2,069)
(1,557)
-
5,309
Accretable
Discount -
Non-PCI
Loans
$
$
835
3,182
(1,777)
(373)
1,867
Accretable
Discount -
PCI Loans
-
1,551
(424)
(28)
1,099
$
$
Non-
Accretable
Discount -
PCI Loans
-
6,536
(434)
(133)
5,969
$
$
Total
835
11,269
(2,635)
(534)
8,935
$
$
Loans to principal officers, directors, and their affiliates, which are made in the ordinary course of business, as of December 31, were as
follows:
Beginning balance
New loans
Repayments and other reductions
Change in related party status
Ending balance
Note 6: Allowance for Loan and Lease losses
2019
1,417
635
(1,025)
(64)
963
$
$
2018
1,524
89
(196)
-
1,417
$
$
Changes in the ALLL by segment of loans based on method of impairment for the year ended December 31, 2019, were as follows:
Allowance for loan and lease losses:
Beginning balance
Charge-offs
Recoveries
Provision (Release)
Ending balance
$
Commercial Leases
734
$
49
-
577
1,262
2,832
109
74
218
3,015
$
$
$
$
Real Estate Real Estate Real Estate
Commercial Construction Residential HELOC Other1 Total
1,931
118
103
99
2,015
1,449
338
172
(111)
$
1,172
969
9
1
(448)
$
513
10,470
1,019
684
1,040
11,175
621
409
200
225
637
19,006
2,051
1,234
1,600
19,789
$
$
$
$
$
$
$
$
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
Ending balance: Acquired and accounted for ASC 310-30
Total ending allowance balance
Loans:
Ending balance: Individually evaluated for Impairment
Ending balance: Collectively evaluated for impairment
Ending balance: Acquired and accounted for ASC 310-30
Total ending loans balance
$
$
$
$
93
2,922
-
3,015
$
$
100
1,162
-
1,262
144
332,698
-
$
329
119,422
-
$
$
$
$
$
$
830
10,285
60
11,175
7,104
858,495
3,420
$
$
$
-
513
-
513
93
69,524
600
50
1,965
-
2,015
$
$
56
1,116
-
1,172
$
$
6
614
17
637
$
$
1,135
18,577
77
19,789
7,900
389,001
4,581
$
2,428
121,029
-
$
19
14,025
-
$
18,017
1,904,194
8,601
332,842
$ 119,751
$
869,019
$
70,217
$ 401,482
$ 123,457
$ 14,044
$ 1,930,812
84
Changes in the ALLL by segment of loans based on method of impairment for the year ended December 31, 2018, were as follows:
Real Estate Real Estate Real Estate
Allowance for loan and lease losses:
Beginning balance
Charge-offs
Recoveries
Provision (Release)
Ending balance
$
Commercial Leases Commercial Construction Residential HELOC Other1 Total
923
$
$
(16)
35
(5)
$
1,446
147
364
(214)
$
1,449
9,522
1,548
447
2,049
10,470
1,146
(1,106)
$
1,931
2,453
41
157
263
2,832
692
13
-
55
734
579
409
265
186
621
17,461
2,097
2,414
1,228
19,006
$
(45)
1,846
969
$
$
$
$
$
$
$
$
$
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
Ending balance: Acquired and accounted for ASC 310-30
Total ending allowance balance
$
$
-
2,832
-
2,832
$
$
-
734
-
734
Loans:
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
Ending balance: Acquired and accounted for ASC 310-30
Total ending loan balance
$
$
-
314,323
-
314,323
$
-
78,806
-
$ 78,806
$
$
$
$
239
10,231
-
10,470
9,785
811,156
4,182
825,123
$
$
$
$
1
968
-
969
$
$
50
1,881
-
1,931
$
$
49
1,400
-
1,449
$
$
13
608
-
621
$
$
352
18,654
-
19,006
106
108,284
745
109,135
$
8,196
398,872
6,038
$ 413,106
$
2,241
138,201
-
$ 140,442
$
31
16,061
-
$ 16,092
$
20,359
1,865,703
10,965
$ 1,897,027
Changes in the ALLL by segment of loans based on method of impairment for the year ended December 31, 2017, were as follows:
Allowance for loan and lease losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
$
Commercial Leases
633
$
215
-
274
692
1,629
25
30
819
2,453
$
$
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
Total ending allowance balance
$
$
-
2,453
2,453
$
$
-
692
692
Loans:
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
Total ending loan balance
$
$
-
272,851
272,851
$
178
68,147
$ 68,325
9,547
309
161
123
9,522
-
9,522
9,522
3,041
747,950
750,991
$
$
$
$
$
$
$
$
$
$
Real Estate Real Estate Real Estate
Commercial Construction Residential HELOC Other1
$
$
$
$
$
389
23
377
180
923
-
923
923
$
$
$
2,178
1,347
980
35
1,846
53
1,793
1,846
$
$
$
1,331
386
243
258
1,446
91
1,355
1,446
$
$
$
451 $
1
18
111
579 $
Total
16,158
2,306
1,809
1,800
17,461
- $
579
579 $
144
17,317
17,461
201
84,961
85,162
$
14,575
298,822
$ 313,397
$
2,110
110,723
$ 112,833
$
7 $
20,112
14,056 1,597,510
$ 14,063 $ 1,617,622
1 The “Other” class includes consumer loans, overdrafts and net deferred costs.
Note 7: Other Real Estate Owned
Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation reserve, for the periods presented are
itemized in the following table.
Other real estate owned
Balance at beginning of period
Property additions, net of acquisition adjustments
Property improvements
Less:
Proceeds from property disposals, net of participation purchase and of
gains/losses
Period valuation adjustments
Other adjustments
Balance at end of period
Years Ended
December 31,
2018
$
$
8,371
3,316
59
3,990
581
-
7,175
2019
7,175
872
-
2,515
519
9
5,004
$
$
2017
11,916
3,796
-
5,633
1,708
-
8,371
$
$
85
Activity in the valuation allowance was as follows:
Balance at beginning of period
Provision for unrealized losses
Reductions taken on sales
Balance at end of period
Expenses related to OREO, net of lease revenue includes:
Gain on sales, net
Provision for unrealized losses
Operating expenses
Less:
Lease revenue
Net OREO expense
Note 8: Premises and Equipment
Premises and equipment at December 31, were as follows:
Twelve Months Ended
December 31,
2018
2019
8,027
519
(1,834)
6,712
$
$
8,208
581
(762)
8,027
$
$
2017
9,982
1,708
(3,482)
8,208
Twelve Months Ended
December 31,
2018
2017
2019
(264)
519
173
5
423
$
$
(792)
581
649
42
396
$
$
(474)
1,708
1,227
296
2,165
$
$
$
$
2019
2018
Land
Buildings
Leasehold improvements
Furniture and equipment
$
Total Premises and Equipment
$
Cost
18,501
43,457
2,314
47,696
111,968
$
Accumulated
Depreciation/ Net Book
Amortization Value
-
24,912
399
42,303
67,614
18,501 $
18,545
1,915
5,393
44,354 $
$
$
$
$
Accumulated
Depreciation/ Net Book
Amortization Value
-
23,913
246
41,247
65,406
18,501
19,463
464
4,011
42,439
$
$
$
Cost
18,501
43,376
710
45,258
107,845
Note 9: Deposits
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 through $250,000
Certificates of deposit of more than $250,000
Total deposits
$
$
2019
669,795 $
307,015
425,792
282,478
227,578
151,279
62,812
2,126,749 $
2018
618,830
304,400
425,878
310,390
230,781
159,953
66,441
2,116,673
86
The Company had $31.4 million and $30.4 million in brokered certificates of deposit as of December 31, 2019 and 2018, respectively.
Deposits held by senior officers and directors, including their related interests, totaled $2.9 million and $1.6 million as of
December 31, 2019 and 2018, respectively.
At December 31, scheduled maturities of time deposits were as follows:
2020
2021
2022
2023
2024
Total time deposits
Note 10: Borrowings
The following table is a summary of borrowings as of December 31, were as follows:
Securities sold under repurchase agreements
Other short-term borrowings 1
Junior subordinated debentures 2
Senior notes
Notes payable and other borrowings
Total borrowings
$
$
354,394
51,594
18,125
9,948
7,608
441,669
2019
2018
48,693
48,500
57,734
44,270
6,673
205,870
$
$
46,632
149,500
57,686
44,158
15,379
313,355
$
$
1 Includes short-term FHLBC advances and the outstanding portion of an operating line of credit.
2 See Note 11: Junior Subordinated Debentures, below.
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, collateralized mortgage obligations, mortgage-
backed securities and/or highly-rated issues of State and political subdivisions, and had a carrying amount of $48.7 million and
$46.6 million at December 31, 2019 and 2018, respectively. The fair value of the pledged collateral was $70.7 million and $72.8 million
at December 31, 2019 and December 31, 2018, respectively. At December 31, 2019, there were no customers with secured balances
exceeding 10% of stockholders’ equity.
Total FHLBC advances are generally limited to the lower of 35% of total assets and the amount of acceptable collateral adjusted for
applicable funding percentages as determined by the FHLBC. As of December 31, 2019, the Bank had outstanding advances in the
amount of $48.5 million with a weighted average interest rate of 1.78%. As of December 31, 2018, the Bank had outstanding advances
in the amount of $149.5 million with a weighted average interest rate of 2.50%. As of December 31, 2019, FHLBC stock owned by the
Bank was valued at $3.7 million, the fair value of securities pledged to the FHLBC was $54.6 million, and the principal balance of loans
pledged was $644.5 million. In 2018, the Bank assumed $23.4 million of long-term FHLBC advances with the ABC acquisition. At
December 31, 2019, these advances have a total outstanding balance of $6.7 million and are scheduled to mature over the next 6.25 years
with an interest rate of 2.83%. At December 31, 2018, these advances have a total outstanding balance of $15.3 million and were
scheduled to mature over the next 7.25 years with interest rates ranging between 1.40% to 2.83%. Based on the total amount of securities
and loans pledged, the Bank had total borrowing capacity of $491.7 million. Adjusting for the outstanding advances and letters of credit,
the Bank had a remaining funding availability of $327.3 million on December 31, 2019.
The Company also has $44.3 million of senior notes outstanding, net of deferred issuance costs, as of December 31, 2019 and
$44.2 million as of December 31, 2018. The senior notes were issued in 2016, had an original maturity of ten years, and terms include
interest payable semiannually at 5.75% for five years. Beginning December 31, 2021, the senior debt will pay interest at a floating rate,
with interest payable quarterly at three month LIBOR plus 385 basis points. The notes are redeemable, in whole or in part, at the option
of the Company, beginning with the interest payment date on December 31, 2021, and on any floating rate interest payment date thereafter,
at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest. As of December 31, 2019 and
2018, unamortized debt issuance costs related to the senior notes were $730,000 and $842,000, respectively, and are included as a
reduction of the balance of the senior notes on the Consolidated Balance Sheets. These deferred issuance costs will be amortized to
interest expense over the ten year term of the notes and included in the Consolidated Statements of Income.
87
Scheduled maturities and weighted average rates of borrowings for the years ended December 31, were as follows:
2019
Weighted
Average
2018
Weighted
Average
2019
2020
2021
2022
2023
2024
Thereafter
Total borrowings
Note 11: Junior Subordinated Debentures
Balance Rate
$
Balance Rate
N/A
97,193
-
-
-
-
108,677
$ 205,870
$ 196,132
N/A
1.85 %
8,500
-
-
-
-
-
-
-
-
6.11
108,723
4.10 % $ 313,355
1.78 %
2.05
-
-
-
-
6.07
3.28 %
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 after
June 30, 2008, and can be exercised by the Company from time to time thereafter. When not in deferral, 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 Old Second Capital
Trust I 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.
On January 28, 2020, the Company issued a redemption notice with respect to its 7.80% subordinated debentures due June 30, 2033 (the
“Subordinated Debentures”) relating to the outstanding 7.80% cumulative trust preferred securities (NASDAQ: OSBCP) (the “Trust
Securities”) issued by Old Second Capital Trust I (“Trust I”), which are guaranteed on a subordinated basis by the Company. An
aggregate principal amount of Subordinated Debentures of $32,604,000 was redeemed on March 2, 2020, plus accrued and unpaid interest
through the redemption date. Also on March 2, 2020, all of the outstanding Trust Securities were redeemed on at a redemption price of
$10.00 per Trust Security, which reflects 100% of the liquidation amount, plus accrued and unpaid distributions through the redemption
date. In connection with the redemption, the Trust Securities were delisted from The Nasdaq Stock Market.
The Company sold 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. 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 Trust II issuance converted from fixed to float rate at three month LIBOR plus 150 basis points on June 16, 2017;
as of December 31, 2019, the rate effective for the Trust II issuance was 4.40%. Upon conversion to a floating rate, a cash flow hedge
was initiated which resulted in the total interest rate period on the debt of 4.37% as of December 31, 2018, compared to the rate paid
prior to June 15, 2017 of 6.77%. The Company issued a new $25.8 million subordinated debenture to the Old Second Capital Trust II in
return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the debenture are
equivalent to the cash distribution basis on the trust preferred securities. Both of the debentures issued by the Company are disclosed on
the Consolidated Balance Sheets as junior subordinated debentures and the related interest expense for each issuance is included in the
Consolidated Statements of Income. As of December 31, 2019 and 2018, unamortized debt issuance costs related to the junior
subordinated debentures were $644,000 and $692,000 respectively, and are included as a reduction to the balance of the junior
subordinated debentures on the Consolidated Balance Sheets.
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 continue to accrue. Also during a deferral
period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock. As of
December 31, 2019, the Company is current on the payments due on these securities.
88
Note 12: Income Taxes
Income tax expense (recovery) for the years ending December 31, were as follows:
Current federal
Current state
Deferred federal
Deferred state
Recovery due to State of Illinois tax rate change
Expense due to enactment of federal tax reform
Total income tax expenses
2019
2018
2017
$
$
4,815 $
1,151
3,177
3,259
-
-
12,402 $
- $
84
6,226
3,614
-
-
9,924 $
(2,407)
-
11,724
1,938
(1,566)
9,475
19,164
The following were the components of the deferred tax assets and liabilities as of December 31:
Allowance for loan and lease losses
Deferred compensation
Goodwill amortization/impairment
Stock based compensation
Business combination adjustments
OREO write-downs
Federal net operating loss (“NOL”) carryforward
State NOL carryforward
Other assets
Total deferred tax assets
Accumulated depreciation on premises and equipment
Mortgage servicing rights
Amortization of core deposit intangible
State tax benefits
Other liabilities
Total deferred tax liabilities
Net deferred tax asset before adjustments related to other comprehensive income
Tax effect of adjustments related to other comprehensive (loss) income
Net deferred tax asset
2019
2018
6,082
907
3,456
1,622
1,547
1,931
340
326
2,270
18,481
(746)
(1,779)
(144)
(927)
(1,637)
(5,233)
13,248
(1,789)
11,459
$
$
5,803
665
4,698
1,377
2,532
2,337
2,199
4,034
1,401
25,046
(443)
(2,210)
(130)
(1,839)
(741)
(5,363)
19,683
1,597
21,280
$
$
On December 22, 2017, H.R.1, commonly known as the Tax Cuts and Jobs Act (the “Act”), was signed into law. Among other things,
the Act reduced the corporate federal tax rate from 35% to 21% effective January 1, 2018. As a result, the Company was required to
remeasure, through income tax expense, deferred tax assets and liabilities using the enacted rate at which these items are expected to
recover or settle. The re-measurement of the Company’s net deferred tax asset resulted in additional income tax expense of approximately
$9.5 million for the year ended December 31, 2017. The Company also re-measured the net deferred tax asset as a result of the Illinois
income tax increase effective as of July 1, 2017. This resulted in a tax benefit of approximately $1.6 million for the year ended December
31, 2017.
At December 31, 2019, the Company no longer has federal net operating loss carryforward. The Company had a $1.9 million state net
operating loss carryforward which begins to expire in 2025. In addition, the Company had $1.6 million of recognized built-in loss
carryforward, which is limited to $945,000 per year under IRC Section 382.
89
The components of the provision for deferred income tax expense for the years ending December 31, were as follows:
Provision for loan and lease losses
Deferred compensation
Amortization of core deposit intangible
Stock based compensation
Business combination adjustments
OREO write-downs
Federal net operating loss carryforward
State net operating loss carryforward
Deferred tax credit
Depreciation
Mortgage servicing rights
Goodwill amortization/impairment
State tax benefits
Other, net
Total deferred tax expense
2019
2018
2017
(279) $
(242)
14
(245)
985
406
1,859
3,708
-
303
(431)
1,242
(912)
28
6,436 $
(426) $
(15)
957
(511)
927
48
5,041
2,986
-
59
124
1,389
(550)
(189)
9,840 $
1,680
85
574
80
-
2,725
12,122
715
2,058
(297)
(674)
4,040
(1,738)
201
21,571
$
$
Effective tax rates differ from federal statutory rates applied to financial statement income for the years ended December 31, 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
Stock based compensation
Impact of Federal tax rate change
Impact of Illinois tax rate change
Other, net
Total tax at effective tax rate
2019
2018
2017
$
$
10,890
(1,409)
(480)
3,496
(207)
-
-
112
12,402
$
$
9,227
(1,600)
(422)
2,927
(305)
-
-
97
9,924
$
$
11,817
(1,976)
(501)
1,775
-
9,475
(1,566)
140
19,164
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. No significant negative evidence was noted.
Note 13: Equity Compensation Plans
Stock-based awards are outstanding under the Company’s 2008 Equity Incentive Plan (the “2008 Plan”), the Company’s 2014 Equity
Incentive Plan, as amended (the “2014 Plan”), and the Company’s 2019 Equity Incentive Plan (the “2019 Plan” and together with the
2008 Plan and the 2014 Plan, the “Plans”). The 2019 Plan was approved at the May 2019 annual stockholders’ meeting and the number
of authorized shares under the 2019 Plan is fixed at 600,000. Following approval of the 2014 Plan, no further awards will be granted
under the 2008 Plan or any other prior Company equity compensation plan, and following the approval of the 2019 Plan, no further
awards will be granted under the 2014 Plan. The 2019 Plan authorizes the granting of qualified stock options, non-qualified stock options,
restricted stock, restricted stock units, and stock appreciation rights (“SARs”). Awards may be granted to selected directors, officers,
employees or eligible service providers under the 2019 Plan at the discretion of the Compensation Committee of the Company’s Board
of Directors. As of December 31, 2019, 447,781 shares remained available for issuance under the 2019 Plan.
The Company granted 16,500 stock options in 2009 under the 2008 Equity Incentive Plan, and there are no remaining outstanding stock
options as of December 31, 2019. No stock options were granted in 2009 through 2019. There were 4,500 stock options exercised during
2019 and 2018, and no stock options exercised during 2017. At December 31, 2019, the Company had no unrecognized compensation
cost related to unvested stock options as all stock options have fully vested.
90
A summary of stock option activity in the Plans for the year ending December 31, 2019, is as follows:
Beginning outstanding
Canceled
Exercised
Expired
Ending outstanding
Shares
4,500
-
(4,500)
-
-
Weighted-
Average
Remaining
Contractual
Weighted
Average
Exercise
per Price Term (years) Intrinsic Value
25
-
(27)
-
-
7.49
-
7.49
-
-
0.1
-
-
-
-
Aggregate
$
$
$
$
Exercisable at end of period
-
$
-
-
$
A summary of stock option activity as of each year is as follows:
Intrinsic value of options exercised
Cash received from option exercises
Tax benefit realized from option exercises
Weighted average fair value of options granted
2019
2018
2017
$
27 $
32
5
-
27 $
33
5
-
-
-
-
-
-
Generally, restricted stock and restricted stock units granted under the Plans vest three years from the grant date, but the Compensation
Committee of the Company’s Board of Directors has discretionary authority to change some terms including the amount of time until the
vest date.
Under the 2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, all stock options and
SARs then held by the participant will become fully exercisable immediately if, and all stock awards and cash incentive awards will
become fully earned and vested immediately if, (i) the 2019 Plan is not an obligation of the successor entity following a change in control
or (ii) the 2019 Plan is an obligation of the successor entity following a change in control and the participant incurs a termination of
service without cause or for good reason following the change in control. Notwithstanding the immediately preceding sentence, if the
vesting of an award is conditioned upon the achievement of performance measures, then such vesting will generally be subject to the
following: if, at the time of the change in control, the performance measures are less than 50% attained (pro rata based upon the time of
the period through the change in control), the award will become vested and exercisable on a fractional basis with the numerator being
equal to the percentage of attainment and the denominator being 50%; and if, at the time of the change in control, the performance
measures are at least 50% attained (pro rata based upon the time of the period through the change in control), the award will become fully
earned and vested immediately upon the change in control.
The Company granted restricted stock under its equity compensation plans beginning in 2005 and it began granting restricted stock units
in February 2009. Awards of restricted stock under the Plans generally entitle holders to voting and dividend rights upon grant and are
subject to forfeiture until certain restrictions have lapsed including employment for a specific period. Awards of restricted stock units
under the Plans are also subject to forfeiture until certain restrictions have lapsed including employment for a specific period, but do not
entitle holders to voting rights until the restricted period ends and shares are transferred in connection with the units.
Total compensation cost that has been charged for the 2019 and 2014 Plan was $2.5 million, $2.3 million and $1.2 million the years
ending December 31, 2019, 2018 and 2017 respectively.
There were 171,356 restricted stock units granted during the year ending December 31, 2019. There were 254,281 restricted stock units
granted the year ending December 31, 2018. Compensation expense is recognized over the vesting period of the restricted stock unit
based on the market value of the award on the issue date.
91
A summary of changes in the Company’s unvested restricted awards for the year ending December 31, is as follows:
Unvested at January 1
Granted
Vested
Forfeited
Unvested at December 31
2019
Weighted
Average
Grant Date
Fair Value
Restricted
Stock Shares
and Units
552,281
171,356
(168,354)
-
555,283
$
$
11.30
12.75
7.68
-
12.85
Total unrecognized compensation cost of restricted stock unit awards was $3.0 million as of December 31, 2019, which is expected to be
recognized over a weighted-average period of 1.83 years.
Note 14: Earnings Per Share
The earnings per share, both basic and diluted, are included below as of December 31, (in thousands except for per share data):
2019
2018
2017
Basic earnings per share:
Weighted-average common shares outstanding
Net income
Basic earnings per share
Diluted earnings per share:
Weighted-average common shares outstanding
Dilutive effect of unvested restricted awards 1
Dilutive effect of stock options and warrants
Diluted average common shares outstanding
Net Income
Diluted earnings per share
29,891,046
$
$
39,455 $
1.32 $
29,728,308 29,600,702
15,138
0.51
34,012 $
1.14 $
29,891,046
525,302
-
30,416,348
$
$
39,455 $
1.30 $
532,692
47,935
29,728,308 29,600,702
435,142
2,573
30,308,935 30,038,417
15,138
0.50
34,012 $
1.12 $
Number of antidilutive options and warrants excluded from the diluted earnings per
share calculation
-
-
815,339
1 Includes the common stock equivalents for restricted share rights that are dilutive.
The above earnings per share calculation did not include a warrant for 815,339 shares of common stock that was outstanding as of
December 31, 2017, because the warrant was anti-dilutive at an exercise price of $13.43. Of note, the warrant was sold at auction by the
Treasury in June 2013 to a third party investor. On January 16, 2019, the warrant for 815,339 common shares of the Company’s stock
was exercised in a cashless transaction. This warrant was issued in January 2009 at an exercise price of $13.43 per share, and expired on
January 16, 2019. As of the date of exercise, the Company’s closing market price was $14.23 per share, resulting in 45,836 shares being
issued. These shares were issued from treasury stock held by the Company, and resulted in a $313,000 reduction of treasury stock in
January 2019.
Note 15: Commitments
In the normal course of business, there are outstanding commitments that are not reflected in the Consolidated 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.
92
The following table is a summary of financial instrument commitments as of December 31, were as follows:
Letters of credit:
Borrower:
Financial standby
Commercial standby
Performance standby
Non-borrower:
Performance standby
Total letters of credit
Fixed
Variable Total
Fixed
Variable Total
2019
2018
$
$
339
-
571
910
$
9,612
-
6,212
15,824
$
9,951
-
6,783
16,734
$
327
-
532
859
$
7,158
397
6,381
13,936
$
7,485
397
6,913
14,795
-
910
67
15,891
$
67
16,801
$
$
-
859
67
14,003
$
67
14,862
$
Unused loan commitments:
$ 111,348
$ 320,120
$ 431,468
$ 89,303
$ 297,785
$ 387,088
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 automatic teller machines (ATMs). The Company also receives rental income on certain
leased properties. As of December 31, 2019, aggregate future minimum rental income to be received under noncancelable leases totaled
$42,000. Total facility net operating lease expense or revenue recorded under all operating leases was a net expense of $248,000,
$180,000 and $64,000 in 2019, 2018 and 2017, respectively. Total ATM lease expense, including the costs related to servicing those
ATM’s, was $916,000, $979,000 and $679,000 in 2019, 2018 and 2017, respectively, with growth in expense in 2018 forward due to the
ATMs obtained with the acquisition of ABC Bank.
The following table below is the estimated aggregate minimum annual rental commitments at December 31, 2019:
Rental commitment
Legal proceedings
2020
2021
2022
2023
2024
$
496
$
742
$
621
$
612
$
628
2025
and thereafter
3,940
$
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 16: Regulatory & Capital Matters
The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighted Bank
assets, developed by the Office of the Comptroller of the Currency (the “OCC”) and the other bank regulatory agencies. In connection
with the current economic environment, the Bank’s current level of nonperforming assets and the risk-based capital guidelines, the Bank’s
board of directors’ guidelines are for the Bank to maintain a Tier 1 leverage capital ratio at or above eight percent (8%) and a total risk-
based capital ratio at or above twelve percent (12%). The Bank currently exceeds those thresholds.
Bank holding companies are required to maintain minimum levels of capital in accordance with capital guidelines implemented by the
Board of Governors of the Federal Reserve System. The general bank and holding company capital adequacy guidelines in force as of
the periods reported are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of December 31, 2019,
and December 31, 2018.
In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital
requirements for U.S. banking institutions, which went into effect on January 1, 2015. A detailed discussion of the Basel III Rules is
included in Part I, Item 1 of the under the heading “Supervision and Regulation.”
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. The capital ratios
below are calculated pursuant to the capital requirements in effect for the periods reported below.
93
Capital levels and industry defined regulatory minimum required levels at December 31, were as follows:
2019
Common equity tier 1 capital to risk
weighted assets
Consolidated
Old Second Bank
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
2018
Common equity tier 1 capital to risk
weighted assets
Consolidated
Old Second Bank
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
Minimum Capital
Adequacy with Capital
Conservation Buffer, if applicable1
Well Capitalized
Under Prompt Corrective
Action Provisions2
Actual
Amount Ratio Amount
Ratio
Amount Ratio
$ 251,477
322,496
11.14 % $
14.35
158,020
157,315
7.000 %
7.000
N/A
$ 146,078
N/A
6.50 %
327,886
342,280
14.53
15.23
236,944
235,978
10.500
10.500
N/A
224,741
N/A
10.00
308,102
322,496
13.65
14.35
191,858
191,026
8.500
8.500
308,102
322,496
11.93
12.50
103,303
103,199
4.00
4.00
N/A
179,789
N/A
128,998
N/A
8.00
N/A
5.00
$ 207,597
295,599
9.29 % $
13.29
142,458
141,794
6.375 %
6.375
N/A
$ 144,574
N/A
6.50 %
282,126
314,600
12.63
14.14
263,125
295,599
11.78
13.29
263,125
295,599
10.08
11.36
220,585
219,708
175,901
175,157
104,415
104,084
9.875
9.875
7.875
7.875
4.00
4.00
N/A
222,489
N/A
10.00
N/A
177,938
N/A
130,105
N/A
8.00
N/A
5.00
1
As of December 31, 2019, amounts are shown inclusive of a capital conservation buffer of 2.50%; as compared to 1.875% at
December 31, 2018. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the
minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised
by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital
requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes.
2
The prompt corrective action provisions are only applicable at the Bank level. The Bank exceeded the general minimum regulatory
requirements to be considered “well capitalized.”
Dividend Restrictions
In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be
paid by a Bank without prior regulatory approval. Under these regulations, the amount of dividends that may be paid in any calendar
year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital requirements
described above. Pursuant to the Basel III rules that were fully phased-in at January 1, 2019, the Bank must keep a capital conservation
buffer of 2.5% on all risk-based capital requirements in order to avoid additional limitations on capital distributions.
94
Note 17: 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, were as follows:
Forward contracts:
Notional amount
Fair value
Rate lock commitments:
Notional amount
Fair value
2019
2018
$
$
13,500
(15)
10,167
265
$
$
9,315
(50)
8,815
209
Fair values were estimated based on changes in mortgage interest rates from the date of the commitments. The Company sold
$164.7 million in loans to investors receiving proceeds of $168.5 million and resulting in a gain on sale of $5.1 million for the year ended
December 31, 2019. Sales to investors included $122.4 million, or 74.4%, to FNMA and $18.7 million, or 11.4%, to FHLMC for the
year ended December 31, 2019. No other individual investor was sold more than 10% of the total loans sold.
Note 18: Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal
or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The fair value hierarchy established by the Company also requires an entity to maximize the use of observable inputs and minimize the
use of unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair value are:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access
as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted
prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own view about the assumptions that market participants
would use in pricing an asset or liability.
Transfers between levels are deemed to have occurred at the end of the reporting period. At December 31, 2019 and 2018, there were no
transfers between levels.
The majority of securities are valued by external pricing services or dealer market participants and are classified in Level 2 of the fair
value hierarchy. Both market and income valuation approaches are utilized. Quarterly, the Company evaluates the methodologies used
by the external pricing services or dealer market participants to develop the fair values to determine whether the results of the valuations
are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value. The Company uses
the following methods and significant assumptions to estimate fair value:
• Government-sponsored agency debt securities are primarily priced using available market information through processes such
as benchmark spreads, market valuations of like securities, like securities groupings and matrix pricing.
• Other government-sponsored agency securities, MBS and some of the actively traded real estate mortgage investment conduits
and collateralized mortgage obligations are priced using available market information including benchmark yields, prepayment
speeds, spreads, volatility of similar securities and trade date.
• State and political subdivisions are largely grouped by characteristics (e.g., geographical data and source of revenue in trade
dissemination systems). Because some securities are not traded daily and due to other grouping limitations, active market quotes
are often obtained using benchmarking for like securities.
• Beginning March 31, 2015, auction rate asset backed securities are priced using market spreads, cash flows, prepayment speeds,
and loss analytics. This process supports the transfer to Level 2 valuations.
• Annually every security holding is priced by a pricing service independent of the regular and recurring pricing services used.
The independent service provides a measurement to indicate if the price assigned by the regular service is within or outside of a
reasonable range. Management reviews this report and applies judgment in adjusting calculations at year end related to securities
pricing.
95
• Residential mortgage loans available for sale in the secondary market are carried at fair market value. The fair value of loans
held-for-sale is determined using quoted secondary market prices.
• Lending related commitments to fund certain residential mortgage loans, e.g. residential mortgage loans with locked interest
rates to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party
investors as well as forward commitments for future delivery of MBS are considered derivatives. Fair values are estimated
based on observable changes in mortgage interest rates including prices for MBS from the date of the commitment and do not
typically involve significant judgments by management.
• The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net
servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net
servicing income to derive the resultant value. The Company is able to compare the valuation model inputs, such as the discount
rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates to widely available published industry
data for reasonableness.
Interest rate swap positions, both assets and liabilities, are based on valuation pricing models using an income approach reflecting
readily observable market parameters such as interest rate yield curves.
•
• The fair value of impaired loans with specific allocations of the ALLL is essentially based on recent real estate appraisals or the
fair value of the collateralized asset. These appraisals may utilize a single valuation approach or a combination of approaches
including comparable sales and the income approach. Adjustments are made in the appraisal process by the appraisers to reflect
differences between the available comparable sales and income data. Such adjustments are usually significant and typically
result in a Level 3 classification of the inputs for determining fair value.
• Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at 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.
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The tables below present the balance of assets and liabilities at December 31, measured by the Company at fair value on a recurring basis
are as follows:
Assets:
Securities available-for-sale
U.S. Treasury
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Loans held-for-sale
Mortgage servicing rights
Interest rate swap agreements
Mortgage banking derivatives
Total
Level 1
Level 2
Level 3
Total
2019
$
4,036 $
-
-
-
-
-
-
-
-
-
-
- $
8,337
16,588
243,756
57,984
81,844
66,684
3,061
-
2,771
250
$
4,036 $ 481,275 $
- $
-
-
5,419
-
-
-
-
5,935
-
-
4,036
8,337
16,588
249,175
57,984
81,844
66,684
3,061
5,935
2,771
250
11,354 $ 496,665
Liabilities:
Interest rate swap agreements, including risk participation agreements
Total
$
$
- $
- $
5,974 $
5,974 $
- $
- $
5,974
5,974
96
Assets:
Securities available-for-sale
U.S. Treasury
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Loans held-for-sale
Mortgage servicing rights
Interest rate swap agreements
Mortgage banking derivatives
Total
Level 1
December 31, 2018
Level 3
Level 2
Total
$
3,923 $
-
-
-
-
-
-
-
-
-
-
- $
10,951
14,075
265,902
64,429
109,514
64,289
2,984
-
672
159
$
3,923 $ 532,975 $
- $
-
-
8,165
-
-
-
-
7,357
-
-
3,923
10,951
14,075
274,067
64,429
109,514
64,289
2,984
7,357
672
159
15,522 $ 552,420
Liabilities:
Interest rate swap agreements, including risk participation agreements
Total
$
$
- $
- $
756 $
756 $
- $
- $
756
756
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are as follows:
Year Ended December 31, 2019
Securities available-for-sale
States and
Political
Collateralized
Mortgage
Obligation
Subdivisions
Mortgage
Servicing
Rights
Beginning balance January 1, 2019
Total gains or losses
Included in earnings
Included in other comprehensive income
Purchases, issuances, sales, and settlements
Purchases
Issuances
Settlements
Ending balance December 31, 2019
$
$
-
-
-
-
-
-
-
$
8,165
$
7,357
(32)
726
17,938
-
(21,378)
5,419
$
$
(1,953)
-
-
1,240
(709)
5,935
Year Ended December 31, 2018
Securities available-for-sale
States and
Political
Collateralized
Mortgage
Obligation
Subdivisions
Beginning balance January 1, 2018
Transfers out of Level 3
Total gains or losses
Included in earnings
Included in other comprehensive income
Purchases, issuances, sales, and settlements
Purchases
Issuances
Settlements
Ending balance December 31, 2018
$
$
2,268
(1,308)
$
14,261
-
$
35
40
-
(746)
-
-
(1,035)
-
$
22,046
-
(27,396)
8,165
$
97
Mortgage
Servicing
Rights
6,944
-
(181)
-
-
1,146
(552)
7,357
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of
December 31, 2019:
Measured at fair value
on a recurring basis:
Fair Value
Valuation Methodology
Mortgage servicing rights
$
5,935
Discounted Cash Flow
Unobservable
Inputs
Range of Input
Weighted
Average
of Inputs
Discount Rate
Prepayment Speed
10.0% - 58.8%
0.0 - 69.0%
10.1 %
14.1 %
The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of
December 31, 2018:
Measured at fair value
on a recurring basis:
Fair Value
Valuation Methodology
Mortgage servicing rights
$
7,357
Discounted Cash Flow
Unobservable
Inputs
Range of Input
Weighted
Average
of Inputs
Discount Rate
Prepayment Speed
10.0 - 229.7%
7.0 - 68.9%
10.2 %
9.6 %
In addition to the above, Level 3 fair value measurement included $5.4 million for state and political subdivisions representing various
local municipality securities at December 31, 2019. Level 3 fair value measurement included $8.2 million on the state and political
subdivisions line at December 31, 2018. Given the small dollar amount and size of the municipality issuances involved, this is categorized
as Level 3 based on the payment stream received by the Company from the municipalities. 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 at December 31,
the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related
assets:
2019
Impaired loans1
Other real estate owned, net2
Total
$
Level 1 Level 2
-
-
-
$
$
$
-
-
-
Level 3 Total
$
7,435
5,004
$ 12,439
$
7,435
5,004
$ 12,439
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 $8.6 million and a valuation allowance of $1.2 million, resulting
in an increase of specific allocations within the provision for loan and lease losses of $783,000 for the year ending December 31, 2019.
2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $5.0 million, which is
made up of the outstanding balance of $12.6 million, net of a valuation allowance of $6.7 million and participations of $937,000, at
December 31, 2019.
2018
Impaired loans1
Other real estate owned, net2
Total
$
Level 1 Level 2
-
-
-
$
$
$
Level 3 Total
-
-
-
$ 12,163
7,175
$ 19,338
$ 12,163
7,175
$ 19,338
1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of
collateral for collateral-dependent loans, had a carrying amount of $12.5 million, and a valuation allowance of 352,000, resulting in
an increase of specific allocations within the provision for loan and lease losses of $208,000 for the year ending December 31, 2018.
2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $7.2 million, which is
made up of the outstanding balance of $16.1 million, net of a valuation allowance of $8.0 million and participations of $900,000, at
December 31, 2018.
98
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.
Note 19: Fair Value of Financial Instruments
The estimated fair values approximate carrying amount for all items except those described in the following table. Securities available-
for-sale fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the
security. The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC
or another member institution at par. FHLBC stock is carried at cost and considered a Level 2 fair value. For December 31, 2019 and
2018, the fair values of loans and leases are estimated on an exit price basis incorporating discounts for credit, liquidity and marketability
factors. The fair value of time deposits is estimated using discounted future cash flows at current rates offered for deposits of similar
remaining maturities. The fair values of borrowings were estimated based on interest rates available to the Company for debt with similar
terms and remaining maturities. The fair value of off balance sheet volume is not considered material. The fair value of mortgage banking
derivatives is discussed in Note 17: Mortgage Banking Derivatives, above.
The carrying amount and estimated fair values of financial instruments at December 31, were as follows:
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
December 31, 2019
Financial assets:
Cash and due from banks
Interest bearing deposits with financial institutions
Securities available-for-sale
FHLBC and FRBC stock
Loans held-for-sale
Net loans
Accrued interest receivable
$
34,096
16,536
484,648
9,917
3,061
1,911,023
9,697
$
34,096
16,536
484,648
9,917
3,061
1,915,531
9,697
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Senior notes
Note payable and other borrowings
Interest rate swap agreements
Borrowing interest payable
Deposit interest payable
$
669,795
1,456,954
48,693
48,500
57,734
44,270
6,673
3,101
96
983
$
669,795
1,457,832
48,693
48,500
51,188
46,269
7,003
3,101
96
983
$
$
$
$
34,096
16,536
4,036
-
-
-
-
669,795
-
-
-
33,614
46,269
-
-
-
-
-
-
475,193
9,917
3,061
-
9,697
$
-
-
5,419
-
-
1,915,531
-
$
-
1,457,832
48,693
48,500
17,574
-
7,003
3,101
96
983
-
-
-
-
-
-
-
-
-
-
99
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
2018
Financial assets:
$
Cash and due from banks
Interest bearing deposits with financial institutions
Securities available-for-sale
FHLBC and FRBC stock
Loans held-for-sale
Net loans
Accrued interest receivable
38,599
16,636
541,248
13,433
2,984
1,878,021
10,940
$
38,599
16,636
541,248
13,433
2,984
1,867,594
10,940
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Senior notes
Note payable and other borrowings
Interest rate swap agreements
Borrowing interest payable
Deposit interest payable
$
618,830
1,497,843
46,632
149,500
57,686
44,158
15,379
58
281
973
$
618,830
1,495,614
46,632
149,500
47,625
45,008
15,364
58
281
973
$
$
$
$
38,599
16,636
3,923
-
-
-
-
618,830
-
-
-
32,989
45,008
-
-
-
-
-
-
529,160
13,433
2,984
-
10,940
$
-
-
8,165
-
-
1,867,594
-
$
-
1,495,614
46,632
149,500
14,636
-
15,364
58
281
973
-
-
-
-
-
-
-
-
-
-
Note 20: Financial Instruments with Off-Balance Sheet Risk and Derivative Transactions
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally
manages its exposures to a wide variety of business and operational risks through management of its core business activities. The
Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and
duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative
financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and
uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to
manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected
cash payments principally related to the Company’s loan portfolio.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest
rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management
strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange
for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Prior
to 2019, such derivatives were used to hedge the variable cash flows associated with existing variable-rate borrowings. In December of
2019, the Company also executed a loan pool hedge of $50 million to convert variable rate loans to a fixed rate index for a five year term.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in
Accumulated Other Comprehensive Income and subsequently reclassified into interest income or interest expense in the same period(s)
during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to
derivatives will be reclassified to interest income or expense as interest payments are received on the variable rate loan pool or the
Company’s variable-rate borrowings. During the next twelve months, the Company estimates that an additional $17,000 will be
reclassified as a decrease to interest income and an additional $274,000 will be reclassified as an increase to interest expense.
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The
Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those
interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the
Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program
do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting
derivatives are recognized directly in earnings.
100
The Company also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards.
The interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans
as well as selling forward mortgage-backed securities contracts. Loan interest rate lock commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to originate
residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are
considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue. Fair values are estimated
based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.
Disclosure of Fair Values of Derivative Instruments on the Balance Sheet
The Company entered into a forward starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017. This
transaction had a notional amount totaling $25.8 million as of December 31, 2019 and 2018, was designated as a cash flow hedge of
certain junior subordinated debentures and was determined to be fully effective during the period presented. As such, no amount of
ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other liabilities with
changes in fair value recorded in other comprehensive income, net of tax. The amount included in other comprehensive income would
be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. We expect the hedge to remain
fully effective during the remaining term of the swap. The Bank will pay the counterparty a fixed rate and receive a floating rate based
on three month LIBOR. The trust preferred securities changed from fixed rate to floating rate in June 15, 2017. The cash flow hedge
has a maturity date of June 15, 2037.
In December of 2019, the Company also executed a loan pool hedge of $50.0 million to convert variable rate loans to a fixed rate index
for a five year term. This transaction falls under hedge accounting standards and is paired against a pool the Bank’s Libor-based loans.
Overall, the new swap only bolsters income in down rate scenarios by a modest degree. We consider the current level of interest rate
risk to be moderate but intend to continue looking for market opportunities for further hedging opportunities.
The Bank also has interest rate derivative positions to assist with risk management that are not designated as hedging instruments. These
derivative positions relate to transactions in which the Bank enters an interest rate swap with a client while at the same time entering into
an offsetting interest rate swap with another financial institution. The Bank had $114,000 of cash collateral pledged with one
correspondent financial institution to support interest rate swap activity at December 31, 2019; $11.0 million of investment securities
were required to be pledged to two correspondent financial institutions. The Bank had $260,000 of cash collateral pledged with one
correspondent financial institution to support interest rate swap activity at December 31, 2018; no investment securities were required to
be pledged. At December 31, 2019, the notional amount of non-hedging interest rate swaps was $177.9 million with a weighted average
maturity of 5.9 years. At December 31, 2018, the notional amount of non-hedging interest rate swaps was $188.9 million with a weighted
average maturity of 6.6 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.
101
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance
Sheets as of December 31, were as follows:
Fair Value of Derivative Instruments
Derivatives designated as hedging instruments
Interest rate swaps
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers
Interest rate lock commitments and forward contracts
Other contracts
Total derivatives not designated as hedging instruments
Derivatives designated as hedging instruments
Interest rate swaps
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers
Interest rate lock commitments and forward contracts
Other contracts
Total derivatives not designated as hedging instruments
No. of
Trans.
Notional
Amount $
Balance Sheet
Location
2
75,774 Other Assets
2019
Fair
Value
$
-
-
Balance Sheet
Location
Other Liabilities
Fair
Value
$
3,150
3,150
25
87
4
177,872 Other Assets
23,667 Other Assets
28,176 Other Assets
2,920 Other Liabilities
Other Liabilities
Other Liabilities
250
-
3,170
2,920
-
53
2,973
2018
No. of
Trans.
Notional
Amount $
Balance Sheet
Location
1
25,774 Other Assets
Fair
Value
$
-
-
Balance Sheet
Location
Fair
Value
$
Other Liabilities
25
63
3
188,931 Other Assets
18,130 Other Assets
18,155 Other Assets
672 Other Liabilities
Other Liabilities
159
Other Liabilities
-
831
58
58
672
-
26
698
Disclosure of the Effect of Fair Value and Cash Flow Hedge Accounting
The fair value and cash flow hedge accounting related to derivatives covered under ASC Subtopic 815-20 impacted Accumulated Other
Comprehensive Income (“AOCI”) and the Income Statement. The loss recognized in AOCI on derivatives totaled $3.1 million as of
December 31, 2019, and a gain in AOCI of $1.2 million as of December 31, 2018. The amount of the loss reclassified from AOCI to
interest income or interest expense on the income statement totaled $50,000 and $168,000 for the years ended December 31, 2019, and
December 31, 2018, respectively.
Credit-risk-related Contingent Features
For derivative transactions involving counterparties who are lending customers of the Company, the derivative credit exposure is managed
through the normal credit review and monitoring process, which may include collateralization, financial covenants and/or financial
guarantees of affiliated parties. Agreements with such customers require that losses associated with derivative transactions receive
payment priority from any funds recovered should a customer default and ultimate disposition of collateral or guarantees occur.
Credit exposure to broker/dealer counterparties is managed through agreements with each derivative counterparty that require
collateralization of fair value gains owed by such counterparties. Some small degree of credit exposure exists due to timing differences
between when a gain may occur and the subsequent point in time that collateral is delivered to secure that gain. This is monitored by the
Company and procedures are in place to minimize this exposure. Such agreements also require the Company to collateralize
counterparties in circumstances wherein the fair value of the derivatives result in loss to the Company.
Other provisions of such agreements define certain events that may lead to the declaration of default and/or the early termination of the
derivative transaction(s), including the following:
•
•
•
if the Company either defaults or is capable of being declared in default on any of its indebtedness (exclusive of deposit
obligations);
if a merger occurs that materially changes the Company's creditworthiness in an adverse manner; or
If certain specified adverse regulatory actions occur, such as the issuance of a Cease and Desist Order, or citations for actions
considered Unsafe and Unsound or that may lead to the termination of deposit insurance coverage by the Federal Deposit
Insurance Corporation.
102
Note 21: Preferred Stock
The Series B preferred stock was issued as part of the Treasury’s Troubled Asset Relief Program and Capital Purchase Program in 2009.
Concurrent with issuing the Series B preferred stock in 2009, 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 recorded the warrant 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.
In 2014 and 2015, the Company completed redemption of all 73,000 shares of Series B preferred stock issued in 2009. As of
December 31, 2018, the only remaining component of the 2009 issuance was the warrant outstanding for 815,339 shares, valued at $4.8
million and carried within stockholders’ equity. Preferred stock of 300,000 shares is authorized but unissued as of December 31, 2019
and 2018. On January 16, 2019, the warrant was exercised; see further disclosures in Note 14: Earnings Per Share, above.
Note 22: Parent Company Condensed Financial Information
Condensed Balance Sheets for the years ended December 31, were as follows:
2019
2018
26,562 $
352,703
3,981
383,246 $
9,039
315,252
12,997
337,288
- $
57,734
44,270
3,378
277,864
383,246 $
4,000
57,686
44,158
2,363
229,081
337,288
$
$
$
$
2019
2018
2017
$
20,000 $
109
20,109
30,000 $
106
30,106
-
114
114
3,724
2,700
13
4,025
10,462
9,647
(3,187)
12,834
26,621
39,455 $
3,716
2,688
98
4,208
10,710
19,396
(3,355)
22,751
11,261
34,012 $
4,002
2,689
-
2,639
9,330
(9,216)
(16)
(9,200)
24,338
15,138
Assets
Noninterest bearing deposit with bank subsidiary
Investment in subsidiaries
Other assets
Total assets
Liabilities and Stockholders’ Equity
Other short term borrowings
Junior subordinated debentures
Senior notes
Other liabilities
Stockholders’ equity
Total liabilities and stockholders' equity
Condensed Statements of Income for the years ended December 31 were as follows:
Operating Income
Cash dividends received from subsidiaries
Other income
Total operating income
Operating Expenses
Junior subordinated debentures
Senior notes
Other interest expense
Other expenses
Total operating expense
Income (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 available to common stockholders
$
103
Condensed Statements of Cash Flows for the years ended December 31, were as follows:
Cash Flows from Operating Activities
Net Income
Adjustments to reconcile net income to net cash from operating activities:
Equity in undistributed net income of subsidiaries
Provision for deferred tax expense (benefit)
Net deferred tax expense due to DTA revaluation
Change in taxes payable
Change in other assets
Stock-based compensation
Other, net
Net cash provided by (used in) operating activities
2019
2018
2017
$
39,455
$
34,012
$
15,138
(26,621)
4,186
-
3,896
-
2,516
(80)
23,352
(11,261)
6,697
-
(1,211)
97
2,257
172
30,763
(24,338)
6,397
3,908
(4,797)
74
1,181
(15)
(2,452)
Cash Flows from Investing Activities
Cash paid for acquisition, net of cash and cash equivalents retained
Net cash used in investing activities
-
-
(47,074)
(47,074)
-
-
Cash Flows from Financing Activities
Net change in other short-term borrowings
Dividend paid on common stock
Purchases of treasury stock
Payment of senior note issuance costs
Proceeds from exercise of stock option
Net cash (used in) provided by 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
Note 23: Employee Benefit Plans
(4,000)
(1,195)
(666)
-
32
(5,829)
17,523
9,039
26,562
4,000
(1,189)
(505)
-
33
2,339
(13,972)
23,011
9,039
$
$
-
(1,184)
(236)
(42)
-
(1,462)
(3,914)
26,925
23,011
$
Old Second Bancorp, Inc. Employees 401(k) Savings Plan and Trust
The Company sponsors a qualified, tax-exempt defined contribution plan (the “401(k) 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, 2019, and 2018, a discretionary match equal to 100% of the first 3% and 50% of the next 2% was made to participants of
the 401(k) Plan. For the year ended December 31, 2017, the Company made a discretionary match equal to 100% of the first 3%
contributed by participants of the 401(k) Plan. Participants are 100% vested in the discretionary matching contributions. Participants
can choose between several different investment options under the 401(k) Plan, including shares of the Company’s common stock. An
additional component of the 401(k) Plan arrangement allows the Company to make annual discretionary profit sharing contributions
based on the Company’s profitability in a given year, and on each participant’s annual compensation. The Company elected not to make
a discretionary profit sharing contribution for the years end December 31, 2019, 2018 and 2017.
The total expense relating to the 401(k) Plan was approximately $1.1 million in both 2019 and 2018 and $785,000 in 2017.
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. Company obligations under
this arrangement as of December 31, 2019 totaled $3.0 million and totaled $2.2 for both December 31, 2018 and 2017, and are included
in other liabilities.
104
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Old Second Bancorp, Inc. and Subsidiaries
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Old Second Bancorp, Inc. and Subsidiaries (the “Company”) as of
December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively referred to as the “financial
statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the
Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year
period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited the Company’s internal control over financial reporting as of December 31, 2019, in accordance with the standards
of the Public Company Accounting Oversight Board (United States) (“PCAOB”), based on criteria established in Internal Control-
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our report
dated March 6, 2020, expresses an unqualified opinion.
Basis for Opinion
The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on the Company’s
financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent
with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities
and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our
audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or
fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding
the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits
provide a reasonable basis for our opinion.
/s/ Plante & Moran PLLC
We have served as the Company’s auditor since 2010.
Chicago, Illinois
March 6, 2020
105
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
(the “Exchange Act”), as of December 31, 2019. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that as of December 31, 2019, 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 Exchange Act 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, 2019, that have
materially affected or are reasonably likely to materially 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 Exchange Act. 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, 2019, management assessed the effectiveness of the Company’s internal control over financial reporting based on
the framework established in the “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, 2019, 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 into 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, 2019.
106
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Old Second Bancorp, Inc. and Subsidiaries
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting as of December 31, 2019, of Old Second Bancorp, Inc. and Subsidiaries
(the “Company”), based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the “COSO framework”). In our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2019, based on criteria established in the COSO framework.
We also have audited the accompanying consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related
consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2019, in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Our report dated March 6, 2020, expresses an unqualified opinion.
Basis for Opinion
The Company's 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 the Company's internal control over financial reporting based
on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company
in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission
and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. 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 of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing
the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the
assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
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.
/s/ Plante & Moran PLLC
We have served as the Company’s auditor since 2010.
Chicago, Illinois
March 6, 2020
107
Item 9B. Other Information
None.
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The Company incorporates by reference the information required by Item 10 that is contained in the Proxy Statement for the 2020 Annual
Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019, on form DEF 14A (the “Proxy Statement”),
under the following captions:
•
•
•
“Proposal 1—Election of Directors,” including “—Director Experience” and “—Biographical Information for Executive
Officers;”
“Corporate Governance and the Board of Directors—Code of Business Conduct and Ethics;” and
“Corporate Governance and the Board of Directors —Committees of the Board of Directors—Audit Committee.”
There have been no material changes to the procedures by which security holders may recommend nominees to our Board of Directors.
Item 11. Executive Compensation
The Company incorporates by reference the information required by Item 11 that is contained in our Proxy Statement under the
following captions:
•
•
•
•
•
“Compensation Discussion and Analysis;”
“Compensation Committee Report;”
“Executive Compensation;”
“Director Compensation;” and
“Corporate Governance and the Board of Directors—Compensation Committee Interlocks and Insider Participation.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information 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. Equity compensation includes options,
warrants, rights and restricted stock units which may be granted from time to time. As of December 31, 2019, the below equity awards
were outstanding:
Equity Compensation Plan Information
Plan category
Number of securities Weighted-average
to be issued upon the
exercise price of
Number of
exercise of outstanding outstanding options securities remaining
available for future
options and restricted
issuance
stock units
and restricted
stock units
Equity compensation plans approved by security holders1
Equity compensation plans not approved by security holders
Total
555,283
-
555,283
$
$
12.85
-
12.85
447,781
-
447,781
1 Reflects the outstanding awards under our 2019 Equity Incentive Plan and our 2014 Equity Incentive Plan, as well as the total remaining
share reserve under our 2019 Equity Incentive Plan.
The Company incorporates by reference the other information that is required by this Item 12 that is contained in our Proxy Statement
under the caption “Security Ownership of Certain Beneficial Owners and Management.”
Item 13. Certain Relationships and Related Transactions, and Director Independence
The Company incorporates by reference the information that is required by this Item 13 that is contained in our Proxy Statement under
the captions “Corporate Governance and the Board of Directors - Director Independence” and “ - Certain Relationships and Related Party
Transactions.”
108
Item 14. Principal Accountant Fees and Services
The Company incorporates by reference the information required by this Item 14 that is contained in our Proxy Statement under the
caption “Ratification of our Independent Public Accountants.”
PART IV
Item 15. Exhibits and Financial Statement Schedules
(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.
Item 16. Form 10-K Summary
Not Applicable.
Exhibits:
EXHIBIT
NO.
EXHIBIT INDEX
Description of Exhibits
3.1
3.2
3.3
3.4
4.1
4.2
4.3
4.4
Restated Certificate of Incorporation of Old Second Bancorp, Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Annual
Report on Form 10-K filed on March 11, 2016.
Amendment to Old Second Bancorp, Inc.’s Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 of the
Company’s Current Report on Form 8-K filed on May 22, 2019).
Certificate of Elimination Eliminating References to Series A Junior Participating Preferred Stock From the Restated Certificate of
Incorporation, as Amended, of Old Second Bancorp. Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report
on Form 8-K filed on June 5, 2019).
Bylaws of Old Second Bancorp, Inc., as amended and restated through August 20, 2019 (incorporated by reference to Exhibit 3.1 of
the Company’s Current Report on Form 8-K filed on August 21, 2019).
Specimen Common Stock Certificate of Old Second Bancorp, Inc. (incorporated by reference to Exhibit 4.1 of the Company’s
Registration Statement on Form S-1 filed on January 17, 2014).
Indenture, dated as of December 15, 2016, between the Company and Wells Fargo Bank, National Association (incorporated by
reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed on December 15, 2016).
First Supplemental Indenture, dated as of December 15, 2016, between the Company and Wells Fargo Bank National Association
(incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed on December 15, 2016).
Form of 5.750% Fixed-to-Floating Rate Senior Notes Due 2026 (incorporated by reference to Exhibit 5.1 of the Company’s Current
Report on Form 8-K filed on December 15, 2016).
109
4.5
10.1
10.2
Description of Capital Stock.
Form of Indenture relating to trust preferred securities (incorporated by reference to Exhibit 4.1 to the Company’s Registration
Statement on Form S-3 filed on May 20, 2003).
Indenture between Old Second Bancorp, Inc. as issuer, and Wells Fargo Bank, National Association, as Trustee, dated as of April 30,
2007 (incorporated by reference to Exhibit 99(b)(2) of the Company’s Amendment No. 1 to Schedule TO filed on May 2, 2007).
10.3*
Old Second Bancorp, Inc. 2008 Equity Incentive Plan (incorporated by reference to Appendix A to the Company’s Proxy Statement
on Form DEF 14A filed on March 17, 2008).
10.4*
Employment Agreement, dated September 16, 2014, by and among Old Second Bancorp, Inc. and James L. Eccher (incorporated by
reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on September 18, 2014).
10.5*
Old Second Bancorp, Inc. Amended and Restated Voluntary Deferred Compensation Plan for Executives dated September 1, 2008.
10.6*
Old Second Bancorp, Inc. Amended and Restated Voluntary Deferred Compensation Plan for Directors dated September 1, 2008.
10.7*
2008 Equity Incentive Plan Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Current
Report on Form 8-K filed on February 23, 2009).
10.8*
2008 Equity Incentive Plan Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.2 of the Company’s
Current Report on Form 8-K filed on February 23, 2009).
10.9*
2008 Equity Incentive Plan Incentive Stock Option (incorporated by reference to Exhibit 10.3 of the Company’s Current Report on
Form 8-K filed on February 23, 2009).
10.10*
2008 Equity Incentive Plan Non-Qualified Stock Option (incorporated by reference to Exhibit 10.4 of the Company’s Current Report
on Form 8-K filed on February 23, 2009).
10.11*
10.12*
10.13*
10.14*
10.15*
10.16*
10.17*
Restated Old Second Bancorp, Inc. 2014 Equity Incentive Plan (restated to combine the 2014 Equity Incentive Plan included as
Appendix A to the Company’s Proxy Statement filed on Form DEFA filed on April 21, 2014, and the First Amendment thereto and to
correct a scrivener’s error in such First Amendment included as Appendix A to the Company’s Proxy Statement filed on Form DEF14A
filed on April 12, 2016) (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q filed on
November 7, 2018).
Offer Letter, dated August 1, 2016, between Old Second National Bank and Gary Collins incorporated by reference to Exhibit 10.1
of the Company’s Quarterly Report on Form 10-Q filed on November 8, 2016.
2014 Equity Incentive Plan Restricted Stock Award Agreement (incorporated by reference to Exhibit 4.3 of the Company’s
Registration Statement on Form S-8 filed on June 24, 2014).
2014 Equity Incentive Plan Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 4.4 of the Company’s
Registration Statement on Form S-8 filed on June 24, 2014).
Old Second Bancorp, Inc. 2002 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.1 of the Company’s Registration
Statement on Form S-8 filed on September 12, 2006).
Offer letter, dated April 3, 2017, between the Company and Bradley Adams (incorporated by reference to Exhibit 10.1 of the
Company’s Quarterly Report on Form 10-Q filed on August 7, 2017).
Revised Compensation and Benefits Assurance Agreement, dated as of April 25, 2017, between the Company and Gary Collins
(incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on April 28, 2017).
110
10.18*
10.19*
10.20*
10.21*
10.22*
Compensation and Benefits Assurance Agreement, dated May 2, 2017, between the Company and Bradley Adams (incorporated by
reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q filed on August 7, 2017).
First Amendment of Old Second Bancorp, Inc. Employment Agreement with James Eccher dated as of September 1, 2017
(incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on September 1, 2017).
Form of Compensation and Benefits Assurance Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Current Report
on Form 8-K filed on September 1, 2017). Pursuant to Instruction 2 of Item 601, one form of Compensation and Benefits Assurance
Agreement has been filed which has been executed by each of the following executive officers: Keith Gottschalk and Donald Pilmer.
Executive Annual Incentive Plan dated February 19, 2018 (incorporated by reference to Exhibit 10.1 of the Company’s Current Report
on Form 8-K filed on February 23, 2018).
Form of Performance-Based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Current
Report on Form 8-K filed on April 18, 2018).
10.23*
Form of Director Performance-Based Restricted Stock Agreement (incorporated by reference to Exhibit 10.2 of the Company’s
Quarterly Report on Form 10-Q filed on August 7, 2018).
10.24*
Old Second Bancorp, Inc. 2019 Equity Incentive Plan (incorporated by reference to Appendix A to the Company’s definitive proxy
statement for the Annual Meeting filed with the SEC on April 19, 2019).
10.25*
Form of Time Vesting Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 4.8 to the Company’s
Registration Statement on Form S-8 filed on May 29, 2019).
10.26*
Form of Director Time Vesting Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 4.9 to the Company’s
Registration Statement on Form S-8 filed on May 29, 2019).
21.1
A list of all subsidiaries of the Company.
23.1
Consent of Plante & Moran, PLLC.
24.1
Power of Attorney (contained herein as part of the signature pages).
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
32.2
101
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.
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.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets December 31, 2019, and
December 31, 2018; (ii) Consolidated Statements of Income Years Ended December 31, 2019, 2018 and 2017; (iii) Consolidated
Statements of Comprehensive Income Years Ended December 31, 2019, 2018 and 2017; (iv) Consolidated Statements of Cash Flows
Years Ended December 31, 2019, 2018 and 2017; (v) Changes in Stockholders’ Equity Years Ended December 31, 2019, 2018 and
2017; and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.
*Management contract or compensatory plan or arrangement.
111
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
SIGNATURES
OLD SECOND BANCORP, INC.
BY:
/s/ James L. Eccher
James L. Eccher
President and Chief Executive Officer
DATE: March 06, 2020
112
SIGNATURES (Continued)
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James L. Eccher,
his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead,
in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and
agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises,
as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent,
or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of Section 13 or 15(d) 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 L. Eccher
James L. Eccher
/s/ Bradley S. Adams
Bradley S. Adams
/s/ Gary Collins
Gary Collins
/s/ Edward Bonifas
Edward Bonifas
/s/ Barry Finn
Barry Finn
/s/ William Kane
William Kane
/s/ John Ladowicz
John Ladowicz
/s/ Hugh McLean
Hugh McLean
/s/ Duane Suits
Duane Suits
/s/ James F. Tapscott
James F. Tapscott
/s/ Patti Temple Rocks
Patti Temple Rocks
Chairman of the Board, Director
March 06, 2020
President and Chief Executive Officer,
Director Old Second Bancorp and
Old Second National Bank (principal executive
officer)
March 06, 2020
Executive Vice President and
Chief Financial Officer
(principal financial and accounting officer)
March 06, 2020
Vice Chairman of the Board, Director
March 06, 2020
Director
Director
Director
Director
Director
Director
Director
Director
113
March 06, 2020
March 06, 2020
March 06, 2020
March 06, 2020
March 06, 2020
March 06, 2020
March 06, 2020
March 06, 2020
Old Second Bancorp, Inc. and
Old Second National Bank Directors
William Skoglund
Chairman
Old Second Bancorp, Inc. &
Old Second National Bank
James Eccher
President & CEO
Old Second Bancorp, Inc. &
Old Second National Bank
Gary Collins
Vice Chairman
Old Second Bancorp, Inc. &
Old Second National Bank
Edward Bonifas
Executive Vice President
Alarm Detection Systems, Inc.
Barry Finn
Retired, President & CEO
Rush-Copley Medical Center
William Kane
General Partner
The Label Printers, Inc.
John Ladowicz
Former Chairman & CEO
HeritageBanc Inc. & Heritage Bank
Hugh McLean
Partner, Rock Island Capital, LLC
Former Regional President of Talmer
Bancorp, Inc.
Duane Suits
Retired Partner, Sikich LLP
James Tapscott
Retired Partner, McGladrey LLP
Patti Temple Rocks
Senior Partner, Head of Client Impact
ICF Next
Old Second Bancorp, Inc. and
Old Second National Bank Executive Officers
James Eccher
President & CEO
Old Second Bancorp, Inc. &
Old Second National Bank
Gary Collins
Vice Chairman
Old Second Bancorp, Inc. &
Old Second National Bank
Bradley Adams
Executive Vice President,
Chief Financial Officer
Old Second Bancorp, Inc. &
Old Second National Bank
Member FDIC
Donald Pilmer
Executive Vice President,
Chief Lending Officer
Old Second Bancorp, Inc. &
Old Second National Bank
Keith Gottschalk
Executive Vice President,
Digital Banking Services
Old Second Bancorp, Inc. &
Old Second National Bank
114
90
MCHENRY
23
Huntley
Crystal
Lake
14
Lake-in-the-Hills
Algonquin
Carpenters-
Lake
Zurich
22
94
45
Genoa
23
Hampshire
72
Pingree
Grove
Sleepy
Hollow
47
20
Elgin
Burlington
59
Hoffman
Estates
90
Arlington
Heights
94
294
Sycamore
DeKalb
KANE
Wasco
Maple
Park
38
Elburn
Geneva
25
88
Kaneville
Batavia
31
N. Aurora
Sugar Grove
Big Rock
Aurora
30
Montgomery
DEKALB
Hinckley
30
23
Sandwich
Schaumburg
290
Bensenville
St. Charles
23
W. Chicago
20
290
Carol
Stream
355
Winfield
DUPAGE
Wheaton
COOK
Oak Park
290
45
20
294
Chicago
56
Warrenville
Downers
Grove
Oak
Brook
Lisle
34
Naperville
Bolingbrook
55
Plano
34
Yorkville
Oswego
30
59
Romeoville
53
Lockport
KENDALL
47
Plainfield
WILL
Joliet
90
94
57
94
94
94 80
Oak
Lawn
45
Orland
Park
71
LASALLE
23
Ottawa
Morris
80
Shorewood
Minooka
55
30
80
Mokena
New
Lenox
Frankfort
Chicago
Heights
57
71
GRUNDY
45
Peotone
Old Second National Bank
37 S. River St., Aurora
555 Redwood Dr., Aurora
1350 N. Farnsworth Ave., Aurora
1230 N. Orchard Road, Aurora
4080 Fox Valley Ctr. Dr., Aurora
1991 W. Wilson St., Batavia
2 S. York Road, Bensenville
194 S. Main St., Burlington
9443 S. Ashland Ave., Chicago
6400 W. North Avenue, Chicago
1301 W. Taylor Street, Chicago
333 W. Wacker Dr., Ste. 1010, Chicago
195 W. Joe Orr Rd., Chicago Heights
749 N. Main St., Elburn
3290 Rt. 20, Elgin
20201 S. LaGrange Rd., Frankfort
850 Essington Rd., Joliet
2S101 Harter Rd., Kaneville
3101 Ogden Ave., Lisle
200 W. John St., North 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
115
Member FDIC
Old Second Bancorp, Inc.
37 South River Street, Aurora, IL 60506-4173 • www.oldsecond.com • 1-877-866-0202