Old Second Bancorp (OSBC): A Promising Community Bank Navigating Market Challenges

Published on November 30, 2024 | Ticker: OSBC

Business Overview and History

Old Second Bancorp, Inc. (OSBC) is a bank holding company headquartered in Aurora, Illinois, with a strong presence in the Chicago metropolitan area. Founded in 1871, the company has established itself as a reliable community bank, serving the financial needs of individuals and businesses across its 48 banking centers.

Old Second Bancorp's history can be traced back to 1871, when it was first established as a national banking organization. Over the years, the company has grown and evolved, expanding its footprint and service offerings to meet the needs of its diverse customer base. Through its wholly-owned subsidiary, Old Second National Bank, the company offers a wide range of financial services including commercial and retail banking, wealth management, and treasury management.

In 2016, Old Second Bancorp completed a $45 million senior note issuance, which provided the company with additional capital to fund growth and strategic initiatives. However, in 2023 the company redeemed these senior notes in full.

The company has faced some credit quality challenges in recent years. In late 2021 and through 2022, Old Second began substantially downgrading large amounts of commercial real estate loans, including office and healthcare properties. This led to a significant increase in classified and substandard loans, which peaked at over 7% of the total loan portfolio in early 2023.

To address these credit issues, the company has been proactive in remediating problem loans. By the third quarter of 2024, classified and substandard loans had declined by over 40% from their peak levels. The company recorded net recoveries of $155,000 in Q3 2024, compared to net charge-offs of $5.8 million in the prior quarter and $6.6 million in the year-ago quarter. Management has expressed confidence that they can recover a significant portion of the losses realized in the second half of 2023 through their continued credit remediation efforts.

Old Second Bancorp's operations are organized into three main business segments:

1. Commercial Banking: This segment provides a range of services to small and medium-sized businesses, including commercial and industrial loans, commercial real estate loans, construction loans, and leases. The commercial banking segment is a significant driver of OSBC's loan portfolio and interest income.

2. Retail Banking: This segment offers traditional deposit products like checking, savings, money market, and time deposit accounts to individual customers. It also provides residential mortgage loans, home equity lines of credit, and consumer loans. Retail banking contributes a large portion of OSBC's total deposits, which are a key funding source for its lending activities.

3. Wealth Management: This segment provides trust, investment management, and financial planning services to high net worth individuals, families, and institutions. Services include personal and corporate trust administration, retirement plan services, and investment advisory services. The wealth management business generates fee-based noninterest income for the company.

Financial Performance and Resilience

For the fiscal year ended December 31, 2023, Old Second Bancorp reported net income of $91.73 million, with a net interest margin of 4.66% and a return on assets of 1.60%. The company's total assets stood at $5.72 billion, while its common equity tier 1 capital ratio was a robust 12.32% as of the same period, well above the regulatory minimum requirements. This solid financial performance and strong capital position have allowed Old Second Bancorp to navigate the challenges posed by the COVID-19 pandemic and the ongoing economic volatility with relative resilience.

In the most recent quarter (Q3 2024), Old Second Bancorp reported revenue of $76.07 million and net income of $22.95 million. The company's operating cash flow (OCF) for the quarter was $48.04 million, while free cash flow (FCF) reached $54.79 million. Compared to Q3 2023, revenue increased by 2.5%, while net income decreased by 5.7%. However, OCF and FCF showed significant improvements, increasing by 22.1% and 25.5% respectively.

Diversified Revenue Streams and Operational Efficiency

Old Second Bancorp's revenue streams are well-diversified, with a balanced mix of interest income from its loan portfolio and noninterest income from services such as wealth management, deposit-related fees, and mortgage banking activities. The company has maintained a strong focus on operational efficiency, as evidenced by its adjusted efficiency ratio of 47.66% for the year ended December 31, 2023, which is notably lower than the industry average. In Q3 2024, the efficiency ratio, adjusted to exclude acquisition costs and BOLI death benefits, was 52.31%, slightly improving from 52.68% in the previous quarter.

Risk Management and Asset Quality

The company's commitment to prudent risk management is evident in its approach to credit quality. As of September 30, 2024, Old Second Bancorp's nonperforming loans to total loans ratio stood at 1.30%, a significant improvement from the 1.70% reported at the end of 2023. The company's allowance for credit losses on loans was 1.11% of total loans, reflecting its proactive stance in addressing potential credit risks. This allowance increased from $42.3 million (1.06% of loans) at the end of Q2 2024 to $44.4 million as of September 30, 2024.

Financials

Old Second Bancorp's financial performance has been solid, as evidenced by its reported net income of $91.73 million for the fiscal year ended December 31, 2023. The company's net interest margin of 4.66% and return on assets of 1.60% demonstrate its ability to generate profitable returns. With total assets of $5.72 billion and a common equity tier 1 capital ratio of 12.32%, the bank maintains a strong balance sheet position.

For the fiscal year 2023, Old Second Bancorp reported revenue of $280.99 million, net income of $91.73 million, operating cash flow of $116.40 million, and free cash flow of $104.03 million. In the most recent quarter (Q3 2024), the company's total assets were $5.67 billion, with total loans of $3.99 billion and total deposits of $4.47 billion. The net interest income for Q3 2024 was $60.6 million, while noninterest income was $10.6 million.

Old Second Bancorp's regulatory capital ratios remain well above the well-capitalized thresholds, with a total risk-based capital ratio of 14.45% as of September 30, 2024. The company's net interest margin was 4.64% in Q3 2024, remaining relatively stable compared to 4.63% in Q2 2024 and 4.66% in Q3 2023.

Liquidity

The company's liquidity position appears to be robust, as indicated by its ability to redeem its $45 million senior notes in full in 2023. This action suggests that Old Second Bancorp has sufficient cash resources to meet its financial obligations and fund its operations. The bank's diverse revenue streams, including interest income from loans and noninterest income from various services, contribute to its overall liquidity profile.

As of September 30, 2024, Old Second Bancorp reported a debt-to-equity ratio of 0.64 and cash holdings of $115.77 million. The company also has access to a $30 million undrawn line of credit with a correspondent bank for short-term funding needs. The current ratio and quick ratio both stood at 3.74, indicating a strong ability to meet short-term obligations.

Dividend and Capital Allocation

Old Second Bancorp has a history of returning capital to its shareholders through a consistent dividend policy. In the third quarter of 2024, the company announced a 20% increase in its common dividend, underscoring its confidence in the long-term prospects of the business and its commitment to creating shareholder value. The company's capital allocation strategy also includes a share repurchase program, which provides additional flexibility in managing its capital structure.

Outlook and Growth Opportunities

Looking ahead, Old Second Bancorp is poised to capitalize on the growth opportunities within its market. The company's focus on expanding its commercial lending capabilities, enhancing its wealth management services, and exploring strategic acquisitions positions it well to drive future growth and profitability. However, the company will need to navigate the challenges posed by the volatile interest rate environment, heightened competition, and potential economic headwinds.

Old Second Bancorp expects future provisioning to be in the $2 million range per quarter going forward, absent any significant deterioration. The company is focused on managing liquidity, building capital, and enhancing its commercial loan origination capability for the long-term. Management anticipates mid-single-digit organic loan growth in 2025.

While the net interest margin is expected to trend down modestly for the remainder of the year due to recent rate cuts, the impact is likely to be mitigated by the expected closure of a branch acquisition in early December. The company remains open to inorganic growth opportunities and still has a buyback program in place, as it looks to deploy its growing capital levels.

Conclusion

Old Second Bancorp's long history, strong financial performance, diversified revenue streams, and prudent risk management make it a compelling investment proposition in the community banking space. The company's commitment to enhancing shareholder value, coupled with its strategic initiatives, positions it for continued success in the years to come. As the financial landscape evolves, Old Second Bancorp's adaptability and focus on serving its local communities will be crucial factors in its ability to navigate the market challenges and capitalize on emerging opportunities.

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