8-K: Old Second Bancorp Reports Lower Q4 2023 Earnings Amidst Increased Credit Loss Provisions

Old Second Bancorp's fourth-quarter 2023 net income decreased to $18.2 million, or $0.40 per diluted share, compared to the previous quarter and the same period last year, primarily due to increased provisions for credit losses.

Summary

• Old Second Bancorp reported a net income of $18.2 million, or $0.40 per diluted share, for the fourth quarter of 2023.
• This is a decrease from $24.3 million, or $0.54 per diluted share, in the third quarter of 2023, and $23.6 million, or $0.52 per diluted share, in the fourth quarter of 2022.
• The decrease in net income was primarily due to a $5.0 million increase in provision for credit losses, a $1.3 million increase in interest expense, and a $1.1 million decrease in noninterest income compared to the third quarter of 2023.
• Compared to the fourth quarter of 2022, the decrease was mainly due to a $6.5 million increase in provision for credit losses and a $2.9 million decrease in net interest income.
• Net interest and dividend income was $61.2 million for the fourth quarter of 2023, a decrease of $1.8 million from the previous quarter and $2.9 million from the same quarter last year.
• The company recorded a net provision for credit losses of $8.0 million in the fourth quarter of 2023, compared to $3.0 million in the third quarter of 2023, and $1.5 million in the fourth quarter of 2022.
• Noninterest income was $8.7 million for the fourth quarter of 2023, a decrease of $1.1 million from the third quarter of 2023.
• Noninterest expense was $37.0 million for the fourth quarter of 2023, a decrease of $397,000 from the third quarter of 2023.
• Total loans increased to $4.04 billion at December 31, 2023, up from $4.03 billion at September 30, 2023, and $3.87 billion at December 31, 2022.
• Nonperforming loans totaled $68.8 million at December 31, 2023, up from $63.3 million at September 30, 2023, and $32.9 million at December 31, 2022.
• The company's tangible common equity to tangible assets ratio increased to 8.53%.

Sentiment

Score: 4

Explanation: The sentiment is moderately negative due to decreased earnings, increased credit loss provisions, and rising non-performing loans, although management expresses optimism about future performance and the company's capital position is improving.

Positives

• The company's tangible common equity to tangible assets ratio increased by 86 basis points to 8.53%.
• Noninterest expense decreased by $397,000 compared to the previous quarter.
• The total of substandard and criticized loans are at their lowest levels since June 2022.
• The loan portfolio, excluding office CRE and healthcare, has remained well behaved.
• Net interest margin trends are stable.
• Income statement efficiency remains at record levels.
• The unrealized mark to market loss on securities decreased to $84.2 million as of December 31, 2023, compared to $120.5 million as of September 30, 2023.

Negatives

• Net income decreased by $6.1 million compared to the third quarter of 2023.
• The provision for credit losses increased by $5.0 million compared to the previous quarter.
• Net interest income decreased by $1.8 million compared to the previous quarter.
• Noninterest income decreased by $1.1 million compared to the previous quarter.
• Nonperforming loans increased to 1.7% of total loans.
• The company recorded a $1.2 million litigation reserve related to prior years overdraft fee compliance.
• There was a $1.3 million expense related to the fair value of mortgage servicing rights.

Risks

• The company is facing challenges with commercial real estate loans due to higher interest rates, declining appraisal values, and cash flow pressures.
• There is an increase in nonperforming loans, driven by downgrades in office-related loans and assisted living properties.
• The company's economic view is more cautious than consensus market forecasts.
• Rising interest rates are impacting the cost of interest-bearing liabilities.
• There is a decrease in average balances of interest-bearing deposit accounts.

Future Outlook

Management is optimistic that the fourth quarter of 2023 will mark an inflection point in asset quality trends, barring a significant recession, and expects to deliver another strong year in 2024. The company is focused on assessing and monitoring risks within the loan portfolio and optimizing the earning asset mix to reduce overall sensitivity to interest rates.

Management Comments

• Profitability at Old Second remains exceptionally strong and balance sheet strengthening continues with our tangible common equity to tangible assets ratio increasing by 86 basis points linked quarter to 8.53%.
• We believe we are being proactive in addressing commercial real estate loans facing deterioration from higher interest rates, declining appraisal values and cash flow pressures.
• Importantly, the total of substandard and criticized loans are now at their lowest levels since June 2022 as we have seen previously identified loans work toward resolution and the pace of downgrades has improved dramatically.
• The loan portfolio, exclusive of office CRE and healthcare, has remained well behaved and we remain confident in our credit quality overall.
• Absent a significant recession, I am optimistic that this quarter will mark the inflection point in our asset quality trends as we have seen the bulk of our loan portfolio reprice and transition into the current interest rate environment.
• Our focus therefore remains on assessing and monitoring risks within the loan portfolio and optimizing the earning asset mix in order to reduce our overall sensitivity to interest rates.
• Net interest margin trends are stable and income statement efficiency remains at record levels.
• Marginal spreads in deposit and lending markets remain exceptionally tight but balance sheet flexibility and the expectation for continuing record efficiency gives me confidence we are well positioned to deliver another strong year in 2024.

Industry Context

The results reflect the broader challenges faced by the banking industry, including rising interest rates impacting net interest margins and increased credit loss provisions due to economic uncertainty and potential commercial real estate loan issues. The company's focus on managing credit risk and optimizing its asset mix aligns with industry best practices in the current environment.

Comparison to Industry Standards

• Old Second's net interest margin (NIM) of 4.62% is within the range of regional banks, but the decrease from the previous quarter indicates pressure from rising interest rates, similar to trends seen at other institutions like First Midwest Bancorp (now part of Old National Bancorp) and Wintrust Financial.
• The increase in provision for credit losses to $8.0 million is a significant jump, reflecting concerns about asset quality, particularly in commercial real estate, which is a common theme among banks with exposure to this sector, such as Associated Banc-Corp and MB Financial (now part of Fifth Third Bank).
• The company's efficiency ratio of 50.82% is competitive, indicating good cost management, which is a key focus for banks in the current environment, similar to efforts by companies like Huntington Bancshares and KeyCorp.
• The increase in nonperforming loans to 1.7% of total loans is a concern, and while not as high as some banks with more exposure to troubled sectors, it is a trend that needs to be monitored closely, similar to the challenges faced by banks like Comerica and Regions Financial.
• The increase in tangible common equity to tangible assets ratio to 8.53% is a positive sign, indicating improved capital strength, which is a key metric for investors and regulators, and is comparable to the capital ratios of well-capitalized regional banks like UMB Financial and Cullen/Frost Bankers.

Legal Proceedings

• The company recorded a $1.2 million litigation reserve related to prior years overdraft fee compliance.

Stakeholder Impact

• Shareholders will see a decrease in earnings per share and may be concerned about the increase in credit loss provisions.
• Employees may be affected by any cost-cutting measures taken to address the decreased profitability.
• Customers may be impacted by changes in lending practices or fees.
• Creditors may be concerned about the increase in nonperforming loans.

Next Steps

• The company will host a conference call on January 25, 2024, to discuss the fourth quarter 2023 financial results.
• Management will continue to assess and monitor risks within the loan portfolio.
• Management will focus on optimizing the earning asset mix to reduce overall sensitivity to interest rates.

Key Dates

Keywords

net income, credit losses, nonperforming loans, interest income, interest expense, loan portfolio, tangible equity, financial results, banking, commercial real estate