OLD SECOND BANCORP, INC. Overview
The following discussion provides additional information regarding our operations for the three and nine months endedSeptember 30, 2022 , compared to the three and nine months endedSeptember 30, 2021 , and our financial condition atSeptember 30, 2022 , compared toDecember 31, 2021 . This discussion should be read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our Form 10-K for the year endedDecember 31, 2021 . The results of operations for the three and nine months endedSeptember 30, 2022 , are not necessarily indicative of future results. Dollar amounts presented in the following tables are in thousands, except per share data, andSeptember 30, 2022 and 2021 amounts are unaudited.
In this report, unless the context suggests otherwise, references to the
"Company," "we," "us," and "our" mean the combined business of
We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the "Cautionary Note Regarding Forward-Looking Statements" on page 3 of this report.
Business Overview
The Company is a bank holding company headquartered inAurora, Illinois . Through our wholly-owned subsidiary bank,Old Second National Bank , a national banking organization also headquartered inAurora, Illinois , we offer a wide range of financial services through our 51 banking centers located inCook ,DeKalb ,DuPage ,Kane ,Kendall ,LaSalle andWill counties inIllinois . These banking centers offer access to a full range of traditional retail and commercial banking services including treasury management operations as well as fiduciary and wealth management services. We focus our business on establishing and maintaining relationships with our clients while maintaining a commitment to provide for the financial services needs of the communities in which we operate.
We emphasize relationships with individual customers as well as small to medium-sized businesses throughout our market area. We also have extensive wealth management services, which includes a registered investment advisory platform in addition to trust administration and trust services related to personal and corporate trusts and employee benefit plan administration services.
Merger with
OnDecember 1, 2021 , we completed our merger withWest Suburban Bancorp, Inc. ("West Suburban"), the holding company forWest Suburban Bank . Under the terms of the merger agreement, each share of West Suburban common stock was converted into 42.413 shares of our common stock and$271.15 in cash. Total cash and stock consideration paid was approximately$295.2 million . With the acquisition of West Suburban, we acquired 34 branches inDuPage ,Kane ,Kendall andWill counties inIllinois . The transaction is discussed in more detail in Note 2 to our Consolidated Financial Statements included in this report. As we continue to consolidate operations, nine branches designated as held for sale with a net book value of$5.8 million are reported within fixed assets atSeptember 30, 2022 . During the nine months endedSeptember 30, 2022 , we sold nine branches, resulting in$977,000 of net gains on sale, after closing costs.
COVID-19 Update
Our historically careful underwriting practices and diverse loan portfolio has helped minimize the adverse impact of the pandemic on the Company. In addition, the combination of the vaccine rollout, government stimulus payments, and reduced spending during the pandemic are likely contributing factors mitigating the impact of the pandemic on our business, financial condition, results of operations, and our customers as ofSeptember 30, 2022 . While the vaccine remains readily available, the longer term macro-economic effects on global supply chains, inflation, labor shortages and wage increases continue to impact many industries. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including a resurgence of COVID-19 cases, hospitalizations and deaths leading to additional government imposed restrictions; refusals to receive the vaccine or any boosters along with concerns related to new strains of the virus; supply chain issues remaining unresolved longer than anticipated; labor shortages and wage increases continuing to impact many industries; consumer confidence and spending falls; and rising geopolitical tensions. Given the ongoing and dynamic nature of the circumstances surrounding the pandemic, it is difficult to predict its future adverse financial impact to the Company. 39
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Results of Operation and Financial Condition
We continue to monitor the impact of the COVID-19 pandemic on our results of operations and financial condition. For the year endedDecember 31, 2020 , we determined it prudent to increase our allowance for credit losses to$33.9 million , driven by both our adoption of the Current Expected Credit Losses ("CECL") methodology and the expected impact of the COVID-19 pandemic and market interest rate reductions in anticipation of continued market risk and uncertainty. In 2021, due to the lack of significant net charge-offs projected with the 2020 forecast, and a more favorable forecast for the estimated life of loans, we reversed$9.5 million of our legacy allowance for credit losses, but recorded$12.1 million ofDay One credit marks to the allowance for credit losses, as well as$12.2 million ofDay Two adjustments on non-purchase credit deteriorated life of loan loss estimates, each stemming from the West Suburban acquisition. During the first nine months of 2022, we recorded$5.2 million of provision for credit losses on loans primarily due to loan growth as well as our assessment of loan metrics and nonperforming loan trends. In addition, we also recorded a reduction of$126,000 in our allowance for credit losses on unfunded commitments, primarily due to a review of credit line utilization rates. These adjustments resulted in a net provision for credit losses expense of$5.1 million for theSeptember 30, 2022 year to date period.
We also adjust our investment securities portfolio to fair value each period end and review for any impairment that would require a provision for credit losses.
At this time, we have determined there is no need for a provision for credit losses related to our investment securities portfolio. Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments in the future on the securities we hold as well as experience reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.
As ofSeptember 30, 2022 andDecember 31, 2021 , we had$86.5 million and$86.3 million of goodwill, respectively. This reflected a$146,000 increase from the prior quarter and prior year-end as a deferred tax asset and current taxes receivable analysis was performed after the filing ofWest Suburban Bank related tax returns, with the resultant reclassifications impacting goodwill. AtNovember 30, 2021 , we performed our recurring annual review for any goodwill impairment. We determined no goodwill impairment existed, however, further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.
Lending Operations and Accommodations to Borrowers
To more fully support our customers during the pandemic, we established client assistance programs, including offering commercial, consumer, and mortgage loan payment deferrals for certain clients. During 2020 and 2021, we executed 509 of these deferrals on loan balances of$242.7 million . As ofSeptember 30, 2022 , all COVID-related loan deferrals had resumed payments or paid off. During 2020 and 2021, as part of the SBA Paycheck Protection Program ("PPP"), we processed 1,320 PPP loan applications, representing a total of$199.0 million , and we acquired$20.8 million PPP loans from our acquisition of West Suburban. We started the application process for loan forgiveness for PPP loans inOctober 2020 , and we continued to receive funds for forgiven loans from both the first and second round of PPP loans throughSeptember 2022 . As ofSeptember 30, 2022 , we had 19 loans, which totaled$2.4 million , still outstanding under the PPP program. We expect the application process for loan forgiveness to continue through the fourth quarter of 2022, with funds to be received from the SBA for the forgiven loans through the remainder of 2022.
Capital and Liquidity
As ofSeptember 30, 2022 , all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession, our reported and regulatory capital ratios could be adversely impacted by credit losses. We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic. For instance, as customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit. However, to date, due in part to federal government stimulus funds received by our customers, as well as a higher volume of loan paydowns than periods prior to COVID-19, our liquidity has increased.
Financial Overview
Net income for the third quarter of 2022 was
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costs net of losses on sales of branches in the third quarter of 2022. Adjusted net income, a non-GAAP financial measure that excludes merger-related costs, net of gains/(losses) on branch sales, and gains on the sale of aVisa credit card portfolio and a land trust portfolio, was$19.6 million for the third quarter of 2022. See the discussion entitled "Non-GAAP Financial Measures" on page 42, as well as the table below, which provides a reconciliation of this non-GAAP measure to the most comparable GAAP equivalents. Quarters Ended September 30, June 30, September 30, 2022 2022 2021 Net Income
Income before income taxes (GAAP)
1,061 2,131 -
Gains on the sale of Visa credit card and land trust portfolios (923) - -
Adjusted net income before taxes 26,715 18,807 11,329
Taxes on adjusted net income 7,091 4,995 2,917
Adjusted net income (non-GAAP) Basic earnings per share (GAAP)
$ 0.43
0.43 0.27 0.29
Adjusted basic earnings per share excluding acquisition-related costs (non-GAAP)
0.44 0.31 0.30
Adjusted diluted earnings per share excluding acquisition-related costs (non-GAAP)
0.43 0.31 0.29
The following provides an overview of some of the factors impacting our
financial performance for the three month period ended
Net interest and dividend income was
2022, compared to
? interest and dividend income in the third quarter of 2022 was primarily due to
our acquisition of West Suburban resulting in additional loan and securities
income.
We recorded a net provision for credit losses of
quarter of 2022, driven by a
? losses on loans due to loan growth in the portfolio, coupled with an increase
of
million release of provision expense in the third quarter of 2021.
Noninterest income was
23.1%. Contributing to the increase was growth in service charges on deposits
? and card related income resulting primarily from the West Suburban acquisition
and resultant additional fee income. These increases were partially offset by
a decrease of
million in the third quarter 2021 to
Noninterest expense was
to
or 62.6%. Contributing to the increase was growth in salaries and employee
benefits and occupancy, furniture and equipment expenses in the third quarter
of 2022, primarily stemming from the additional employees and branches due to
? the West Suburban acquisition. In addition, we recorded
acquisition-related costs in the third quarter of 2022, primarily from
of management consulting expense and
Suburban acquisition. The
timing of a loan documentation storage project of
interchange fees of
We had a provision for income tax expense of
of 2022, compared to a provision for income tax expense of
? third quarter of 2021. The increase in tax expense for the third quarter of
2022 was due to an increase in pre-tax income, compared to the year over year
quarter.
Our community-focused banking franchise experienced growth of
total loans at
2021, and an increase of
quarter of 2021, as we acquired
? acquisition. We believe we are positioned for continued loan growth as we
continue to serve our customers' needs in a competitive economic environment.
We are continuing to seek to provide value to our customers and the communities
in which we operate, by executing on growth opportunities in our local markets
and
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developing new banking relationships, while seeking to ensure the safety and
soundness of our Bank, our customers, and our employees.
Nonaccrual loans decreased
nine months of 2022. Nonperforming loans as a percent of total loans was 1.4%
? as of
2021, and
West Suburban acquisition in late 2021.
Critical Accounting Estimates
Our consolidated financial statements are prepared based on the application of
accounting policies in accordance with generally accepted accounting principles
("GAAP") and follow general practices within the banking industry. These
policies require the reliance on estimates and assumptions, which may prove
inaccurate or are subject to variations. These estimates, assumptions, and
judgments are based on information available as of the date of the consolidated
financial statements. Future changes in information may affect these estimates,
assumptions, and judgments, which, in turn, may affect amounts reported in the
consolidated financial statements. Changes in underlying factors, assumptions,
or estimates could have a material impact on our future financial condition and
results of operations.
Of the significant accounting policies used in the preparation of our
consolidated financial statements, we have identified certain items as critical
accounting policies based on the associated estimates, assumptions, judgments
and complexity. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Critical Accounting Estimates" in our Annual Report on
Form 10-K for the year ended December 31, 2021 . There have been no material
changes to our critical accounting policies or the estimates made pursuant to
those policies during the most recent quarter from those disclosed in our 2021
Annual Report in Form 10-K.
Non-GAAP Financial Measures
This report contains references to financial measures that are not defined in
GAAP. Such non-GAAP financial measures include the presentation of net interest
income and net interest margin on a tax equivalent ("TE") basis, adjusted net
income, adjusted basic and diluted earnings per share, our adjusted efficiency
ratio, and our tangible common equity to tangible assets ratio. Management
believes that the presentation of these non-GAAP financial measures (a) provides
important supplemental information that contributes to a proper understanding of
our operating performance, (b) enables a more complete understanding of factors
and trends affecting our business, and (c) allows investors to evaluate our
performance in a manner similar to management, the financial services industry,
bank stock analysts, and bank regulators. Management uses non-GAAP measures as
follows: in the preparation of our operating budgets, monthly financial
performance reporting, and in our presentation 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
Overview
Three months ended
Our income before taxes was$26.6 million in the third quarter of 2022 compared to$11.3 million in the third quarter of 2021. This increase in pretax income was primarily due to a$33.0 million increase in interest and dividend income, and a$2.2 million increase in noninterest income, primarily due to the addition of West Suburban loans, securities and fee income in the third quarter of 2022. These increases were partially offset by a$13.9 million increase in noninterest expense, primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment expense, computer and data processing expense, other expense, and amortization of core deposit intangible. The majority of these increases were due to the inclusion of operating costs of the legacy West Suburban staff and branches, as well as$650,000 of West Suburban acquisition-related costs in the third quarter of 2022, primarily within management and consulting and other expenses. Our net income was$19.5 million , or$0.43 per diluted share, for the third quarter of 2022, compared to net income of$8.4 million , or$0.29 per diluted share, for the third quarter of 2021. 42 Table of Contents
Net interest and dividend income was$55.6 million in the third quarter of 2022, compared to$22.6 million in the third quarter of 2021. The$33.0 million increase was primarily driven by growth in most interest and dividend income categories due to West Suburban related loan and securities income being reflected. In addition we experienced an increase in interest expense in the third quarter of 2022, compared to the third quarter of 2021, primarily due to a rise in deposit interest rates and increased balances from West Suburban, an increase in other short-term borrowings due to an FHLB advance, and an increase in the rate paid on our senior notes during the third quarter of 2022, as the interest rate payable on these notes became floating as ofJanuary 1, 2022 , at three month LIBOR plus 385 basis points, compared to the prior 5.75% fixed rate. Average loans, including loans held for sale, increased$1.86 billion in the third quarter of 2022, compared to the third quarter of 2021, primarily from$1.50 billion of average loans acquired in our acquisition of West Suburban. Also contributing to the increase was$244.3 million in average loan growth during the third quarter of 2022, less PPP loans forgiven or repaid and loan paydowns.
Nine months ended
Our income before taxes was
This increase in pretax income was primarily due to a$74.0 million increase in interest and dividend income, and a$5.6 million increase in noninterest income, as West Suburban loan, security and fee income are included in the nine months endedSeptember 30, 2022 . These increases were partially offset by a$46.2 million increase in noninterest expense, primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment expense, computer and data processing expense, other expense, and amortization of core deposit intangible. The majority of these increases were due to the inclusion of operating costs of the legacy West Suburban staff and branches, as well as$9.5 million of West Suburban acquisition-related costs in the first nine months of 2022, primarily within computer and data processing. Our net income was$43.8 million , or$0.97 per diluted share, for the nine months endedSeptember 30, 2022 , compared to net income of$29.1 million , or$0.99 per diluted share, for the same period of 2021. Net interest and dividend income was$142.1 million for the nine months endedSeptember 30, 2022 , compared to$68.1 million for the same period of 2021. The$74.0 million increase was primarily driven by growth in most interest and dividend income categories due to West Suburban related loan and securities income being reflected. This increase was partially offset by a$402,000 increase in interest expense for the nine months endedSeptember 30, 2022 , compared to the same period of 2021, primarily due to three full periods of interest expense on theApril 2021 issuance of subordinated debt in 2022, as well as higher average balances of deposits from the West Suburban acquisition, partially offset by a decrease in outstanding balances of notes payable and a decrease in the rate paid on our senior notes during 2022, as the interest rate payable on these notes became floating as ofJanuary 1, 2022 , at three month LIBOR plus 385 basis points, compared to the prior 5.75% fixed rate.
Net Interest Income
Net interest income, which is our primary source of earnings, is the difference between interest income earned on interest-earning assets, such as loans and investment securities, as well as accretion income on purchased loans, and interest incurred on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends upon the relative mix of interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and movements in market interest rates. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and OREO, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Three months ended
Our net interest and dividend income increased by$33.0 million to$55.6 million , for the third quarter of 2022, from$22.6 million for the third quarter of 2021. This increase was primarily attributable to a$33.2 million increase in total interest and dividend income due to the acquisition of West Suburban inDecember 2021 . In addition we experienced an increase in interest expense in the third quarter of 2022, compared to the third quarter of 2021, primarily due to increased balances from West Suburban, increased other short-term borrowings expense due to an FHLB advance, and an increase in the rate paid on our senior notes during 2022, as the interest rate payable on these notes became floating as ofJanuary 1, 2022 , at three month LIBOR plus 385 basis points, compared to the prior 5.75% fixed rate. Average earning assets for the third quarter of 2022 totaled$5.61 billion , a decrease of$141.5 million , or 2.5%, compared to the second quarter of 2022, and an increase of$2.52 billion , or 81.7%, compared to the third quarter of 2021.
Average interest earning deposits with
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financial institutions totaled$131.3 million for the third quarter of 2022, a decrease of$295.6 million , compared to the second quarter of 2022, and a decrease of$392.3 million compared to the third quarter of 2021. The yield on average interest earning deposits was 200 basis points for the third quarter of 2022, an increase of 127 basis points from the second quarter of 2022, and an increase of 185 basis points from the third quarter of 2021. Interest income on securities increased year over year, primarily due to growth in volumes and higher interest rates. Total average securities for the third quarter of 2022 decreased$88.8 million from the second quarter of 2022, and increased$1.04 billion from the third quarter of 2021. The increase in our average securities year over year was primarily due to the$1.07 billion in securities acquired in our acquisition of West Suburban. The yield on average securities increased to 2.52% for the third quarter of 2022, compared to 1.89% for the second quarter of 2022 and increased from 2.07% for the third quarter of 2021. Total average loans, including loans held-for-sale, totaled$3.75 billion in the third quarter of 2022, an increase of$244.3 million from the second quarter of 2022, and an increase of$1.86 billion from the third quarter of 2021. The rise in average loan balances year over year was primarily due to the$1.50 billion loan portfolio acquired in our acquisition of West Suburban, as well as loan growth of$244.3 million in the third quarter of 2022. This rise in loan volumes resulted in an increase in loan interest and fee income of$25.3 million in the year over year period. For the third quarter of 2022, the yield on average loans increased to 4.93%, compared to 4.37% for the second quarter of 2022, and 4.48% for the third quarter of 2021. Average interest bearing liabilities decreased$113.1 million , or 3.2%, in the third quarter of 2022, compared to the second quarter of 2022, and increased$1.54 billion compared to the third quarter of 2021. The year over year increase was primarily driven by a$1.55 billion increase in interest bearing deposits primarily due to our acquisition of West Suburban, as well as continued deposit activity of our legacy customers, offset by a$12.6 million decrease in securities sold under repurchase agreements and a$10.2 million decrease in notes payable and other borrowings. The linked quarter decrease was primarily the result of maturing higher cost time deposits and declines in money market accounts. The cost of interest bearing liabilities for the third quarter of 2022 increased four basis points from the linked period, and decreased 18 basis points from the third quarter of 2021. Growth in our average noninterest bearing demand deposits of$1.06 billion in the year over year period has assisted us in controlling our cost of funds stemming from average interest bearing deposits and borrowings, which totaled 0.18% for the third quarter of 2022, 0.15% for the second quarter of 2022, and 0.30% for the third quarter of 2021. Due to the significant increase in interest earning deposits with financial institutions in 2020 and 2021 stemming from federal stimulus funds received and PPP loan forgiveness, we had no average other short-term borrowings in the first and second quarters of 2022 or the third quarter of 2021, which typically consist of FHLBC advances. In the third quarter of 2022, we had an average other short-term borrowing balance of$5.4 million due to a$25.0 million FHLB advance. As ofSeptember 30, 2022 , notes payable and other borrowings had an average balance of$11.0 million , which consists of$10.0 million outstanding on a term note with a correspondent bank originated in the first quarter of 2020. Our net interest margin (GAAP) increased 77 basis points to 3.93% for the third quarter of 2022, compared to 3.16% for the second quarter of 2022, and increased 102 basis points compared to 2.91% for the third quarter of 2021. Our net interest margin (TE) increased 78 basis points to 3.96% for the third quarter of 2022, compared to 3.18% for the second quarter of 2022, and increased 101 basis points compared to 2.95% for the third quarter of 2021. The increase in the year over year was due primarily to the increasing market interest rates over the majority of the past twelve months, the related rate resets on loans and securities during the past year, and the elevated liquidity on our balance sheet. We continue to observe competitive pressure to maintain reduced interest rates on loans retained at renewal. While our loan prices are targeted to achieve certain returns on equity, significant competition for commercial and industrial loans as well as commercial real estate loans has put pressure on loan yields, and our stringent underwriting standards limit our ability to make higher-yielding loans.
Nine months ended
Our net interest and dividend income increased by$74.0 million , to$142.1 million for the nine months endedSeptember 30, 2022 , compared to$68.1 million for the nine months endedSeptember 30, 2021 . This increase was attributable to a$74.4 million increase in total interest income primarily from the acquisition of West Suburban as well as general loan growth, partially offset by a$402,000 increase in interest expense for the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 . Increased balances on interest earning assets related to the West Suburban acquisition drove the increase in net interest income, along with increased yields on earning assets and the reduction in the cost of interest bearing deposits, despite the increased average balance of subordinated debt. Average earning assets for the nine months endedSeptember 30, 2022 were$5.74 billion , an increase of$2.72 billion , or 90.0%, compared to the nine months endedSeptember 30, 2021 . The yield on average earning assets for the nine months endedSeptember 30, 2022 was 3.49%, compared to 3.34% for the nine months endedSeptember 30, 2021 . Total average loans, including loans held-for-sale, 44 Table of Contents totaled$3.56 billion for the nine months endedSeptember 30, 2022 , an increase of$1.61 billion , compared to the nine months endedSeptember 30, 2021 . The increase in average loan balances, coupled with increases in market interest rates, resulted in a$56.9 million increase in loan interest income for the nine months endedSeptember 30, 2022 , compared to the like period in 2021. For the nine months endedSeptember 30, 2022 , yields on average securities decreased by 28 basis points and yields on average loans increased by 13 basis points, each as compared to the nine months endedSeptember 30, 2021 , due primarily to the addition of the lower yielding legacy West Suburban securities and loan portfolios in late 2021, as well as the timing of rate resets on loans and securities as interest rates began to rise in 2022, compared to 2021. Average interest earning deposits with financial institutions decreased$65.6 million in the nine months endedSeptember 30, 2022 , compared to the prior year like period driven primarily by the acquisition of West Suburban, as well as the use of cash for loan growth and the decrease in customer deposits. Average interest bearing liabilities increased$1.65 billion , or 88.8%, in the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 . The increase was primarily due to the acquisition of West Suburban in late 2021 resulting in an increase of$2.27 billion of interest earning deposits. In addition, average subordinated debt increased$20.6 million , due to the$60.0 million subordinated note issuance onApril 6, 2021 , as discussed below. Partially offsetting this increase was a$7.9 million decrease in average notes payable and other borrowings. Average noninterest bearing deposits increased$1.11 billion in the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 , due to the acquisition of West Suburban, as well as remaining federal stimulus funds received from our depositors. The cost of interest bearing liabilities decreased 20 basis points, to 25 basis points, for the nine months endedSeptember 30, 2022 , from 45 basis points for the nine months endedSeptember 30, 2021 .
In the second quarter of 2021, we entered into Subordinated Note Purchase
Agreements with certain qualified institutional buyers pursuant to which we sold
and issued
We
sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance are intended to be used for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions. The Notes bear interest at a fixed annual rate of 3.50% throughApril 14, 2026 , payable semi-annually in arrears. As ofApril 15, 2026 forward, the interest rate on the Notes will generally reset quarterly to a rate equal to Three-Month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears. The Notes have a stated maturity ofApril 15, 2031 , and are redeemable, in whole are in part, onApril 15, 2026 , or any interest payment date thereafter, and at any time upon the occurrence of certain events. Our net interest margin (GAAP) for the nine months endedSeptember 30, 2022 was 3.31% compared to 3.02% for the nine months endedSeptember 30, 2021 , reflecting an increase of 29 basis points. Our net interest margin (TE) for the nine months endedSeptember 30, 2022 was 3.33% compared to 3.06% for the nine months endedSeptember 30, 2021 , an increase of 27 basis points. The increase in net interest margin for the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 , was primarily due to the market interest rate increases in 2022, as well as full periods reflecting West Suburban loan and securities income. These increases to the net interest margin were partially offset by reductions in rates paid on deposits, and growth in noninterest bearing deposits, which drove down our overall cost of funds. The following tables set forth certain information relating to our average consolidated balance sheet and reflect the yield on average earning assets and cost of average interest bearing liabilities for the periods indicated. These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP TE basis using a marginal rate of 21% in 2022 and 2021 to compare returns more appropriately on tax-exempt loans and securities to other earning assets. 45 Table of Contents Analysis of Average Balances, Tax Equivalent Income / Expense and Rates (Dollars in thousands - unaudited) Quarters Ended September 30, 2022 June 30, 2022 September 30, 2021 Average Income
/ Rate Average Income / Rate Average Income /
Rate
Balance Expense % Balance Expense % Balance Expense %
Assets
Interest earning deposits with financial institutions $ 131,260 $ 663 2.00 $ 426,820 $ 782 0.73 $ 523,561 $ 203 0.15
Securities:
Taxable 1,525,258
9,116 2.37 1,610,713 6,786 1.69 476,935 1,854 1.54 Non-taxable (TE)1
178,090 1,686 3.76 181,386 1,642 3.63 186,515 1,603 3.42 Total securities (TE)1
1,703,348
10,802 2.52 1,792,099 8,428 1.89 663,450 3,457 2.07
Dividends from FHLBC and
19,565 261 5.29 20,994 263 5.02 9,917 114 4.56
Loans and loans held-for-sale1, 2 3,753,117
46,642 4.93 3,508,856 38,267 4.37 1,889,696 21,358 4.48 Total interest earning assets
5,607,290 58,368 4.13 5,748,769 47,740 3.33 3,086,624 25,132 3.23 Cash and due from banks
56,265 - - 53,371 - - 29,760 - -
Allowance for credit losses on loans (45,449) - - (44,354) - - (28,639) -
-
Other noninterest bearing assets 377,850
- - 374,309 - - 185,415 - - Total assets$ 5,995,956 $ 6,132,095 $ 3,273,160 Liabilities and Stockholders' Equity NOW accounts$ 612,174 $ 148 0.10$ 604,176 $ 102 0.07$ 534,056 $ 96 0.07 Money market accounts 967,106 157 0.06 1,054,552 155 0.06 355,651 66 0.07 Savings accounts 1,186,001 75 0.03 1,213,133 90 0.03 451,829 47 0.04 Time deposits 459,925 335 0.29 469,009 265 0.23 331,482 330 0.39 Interest bearing deposits 3,225,206 715 0.09 3,340,870 612 0.07 1,673,018 539 0.13
Securities sold under repurchase agreements 33,733
10 0.12 34,496 9 0.10 46,339 15 0.13 Other short-term borrowings 5,435 44 3.21 - - - - - - Junior subordinated debentures 25,773 285 4.39 25,773 284 4.42 25,773 286 4.40 Subordinated debentures 59,265 546 3.66 59,244 547 3.70 59,180 547 3.67 Senior notes 44,546 728 6.48 44,520 578 5.21 44,441 673 6.01 Notes payable and other borrowings 10,989 111 4.01 13,103 95 2.91 21,171 113
2.12
Total interest bearing liabilities 3,404,947 2,439 0.28 3,518,006 2,125 0.24 1,869,922 2,173 0.46 Noninterest bearing deposits 2,092,301 - - 2,120,428 - - 1,029,705 - - Other liabilities 34,949 - - 32,636 - - 53,370 - - Stockholders' equity 463,759 - - 461,025 - - 320,163 - -
Total liabilities and stockholders' equity$ 5,995,956
$ 6,132,095 $ 3,273,160 Net interest income (GAAP)$ 55,569 $ 45,264 $ 22,618 Net interest margin (GAAP) 3.93 3.16 2.91 Net interest income (TE)1$ 55,929 $ 45,615 $ 22,964 Net interest margin (TE)1 3.96 3.18 2.95
Interest bearing liabilities to earning assets 60.72 % 61.20 % 60.58 % 1Represents a non-GAAP financial measure. See the discussion entitled "Reconciliation of Tax-Equivalent Non-GAAP Financial Measures" below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2022 and 2021. 2 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 48, and includes fees of$750,000 for the third quarter of 2022,$588,000 second quarter of 2022, and$1.8 million for the third quarter of 2021. Nonaccrual loans are included in the above-stated average balances. 46 Table of Contents Analysis of Average Balances, Tax Equivalent Income / Expense and Rates (Dollars in thousands - unaudited)
Nine Months Ended
2022 2021
Average Income / Rate Average Income / Rate
Balance Expense % Balance Expense %
Assets
Interest earning deposits with financial institutions $ 395,948 $ 1,714 0.58 $ 461,498 $ 432 0.13
Securities:
Taxable 1,582,549 21,071 1.78 415,029 5,301 1.71
Non-taxable (TE)1 184,842 4,995 3.61 188,700 4,851 3.44
Total securities (TE)1 1,767,391
26,066 1.97 603,729 10,152 2.25
Dividends from FHLBC and
18,888 677 4.79 9,917 342 4.61
Loans and loans held-for-sale 1 , 2 3,556,798 121,337 4.56 1,944,687 64,480 4.43 Total interest earning assets
5,739,025 149,794 3.49 3,019,831 75,406 3.34 Cash and due from banks
50,918 - - 29,407 - -
Allowance for credit losses on loans (44,719) - - (31,380) - -
Other noninterest bearing assets 374,388 - - 186,083 - -
Total assets $ 6,119,612 $ 3,203,941
Liabilities and Stockholders' Equity
NOW accounts $ 603,345 $ 339 0.08 $ 520,556 $ 295 0.08
Money market accounts 1,039,717 481 0.06 338,510 203 0.08
Savings accounts 1,200,018 304 0.03 434,702 169 0.05
Time deposits 474,665 877 0.25 363,227 1,239 0.46
Interest bearing deposits 3,317,745 2,001 0.08 1,656,995 1,906 0.15
Securities sold under repurchase agreements 35,791 30 0.11 65,385 67 0.14
Other short-term borrowings 1,832 44 3.21 - - -
Junior subordinated debentures 25,773 849 4.40 25,773 850 4.41
Subordinated debentures 59,244 1,639 3.70 38,637 1,064 3.68
Senior note 44,520 1,791 5.38 44,416 2,019 6.08
Notes payable and other borrowings 14,338 309 2.88 22,243 355 2.13
Total interest bearing liabilities 3,499,243 6,663 0.25 1,853,449 6,261 0.45
Noninterest bearing deposits 2,103,978 - - 993,308 - -
Other liabilities 42,706 - - 42,632 - -
Stockholders' equity 473,685 - - 314,552 - -Total liabilities and stockholders' equity$ 6,119,612
$ 3,203,941 Net interest income (GAAP)$ 142,065 $ 68,115 Net interest margin (GAAP) 3.31 3.02 Net interest income (TE)1$ 143,131 $ 69,145 Net interest margin (TE)1 3.33 3.06
Interest bearing liabilities to earning assets 60.97 % 61.38 % 1Represents a non-GAAP financial measure. See the discussion entitled "Reconciliation of Tax-Equivalent Non-GAAP Financial Measures" below that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent. Tax equivalent basis is calculated using a marginal tax rate of 21% in 2022 and 2021. 2 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 48, and includes fees of$2.1 million and$4.4 million for the nine months endedSeptember 30, 2022 and 2021, respectively. Nonaccrual loans are included in the above-stated average balances. 47 Table of Contents
Reconciliation of Tax-Equivalent Non-GAAP Financial Measures
Net interest and dividend income (TE) and net interest income (TE) to average
interest earning assets are non-GAAP measures that have been adjusted on a TE
basis using a marginal rate of 21% for 2022 and 2021 to compare returns more
appropriately on tax-exempt loans and securities to other earning assets. The
table below provides a reconciliation of each non-GAAP (TE) measure to the GAAP
equivalent for the periods indicated:
Three Months Ended Nine Months Ended
September 30, June 30, September 30, September 30,
Net Interest Margin 2022 2022 2021 2022 2021
Interest income (GAAP) $ 58,008 $ 47,389 $ 24,791 $ 148,728 $ 74,376
Taxable-equivalent adjustment:
Loans 6 6 4 17 11
Securities 354 345 337 1,049 1,019
Interest and dividend income (TE) 58,368 47,740
25,132 149,794 75,406
Interest expense (GAAP) 2,439 2,125 2,173 6,663 6,261
Net interest income (TE) $ 55,929 $ 45,615 $ 22,959 $ 143,131 $ 69,145
Net interest income (GAAP) $ 55,569 $ 45,264 $ 22,618 $ 142,065 $ 68,115 Average interest earning assets$ 5,607,290 $ 5,748,769 $ 3,086,624 $ 5,739,025 $ 3,019,831 Net interest margin (GAAP) 3.93 % 3.16 % 2.91 % 3.31 % 3.02 % Net interest margin (TE) 3.96 % 3.18 %
2.95 % 3.33 % 3.06 %
Noninterest Income
Three months ended
The following table details the major components of noninterest income for the
periods presented:
3rd Quarter 2022
Noninterest Income Three Months Ended Percent Change From
(Dollars in thousands) September 30, June 30, September 30, June 30, September 30,
2022 2022 2021 2022 2021
Wealth management $ 2,280 $ 2,506 $ 2,372 (9.0) (3.9)
Service charges on deposits 2,661 2,328 1,368 14.3 94.5
Residential mortgage banking revenue
Secondary mortgage fees 81 50 240 62.0 (66.3)
MSRs mark to market gain (loss) 548 82 (282) 568.3 (294.3)
Mortgage servicing income 514 579 572 (11.2) (10.1)
Net gain (loss) on sales of mortgage loans 449 (262) 2,186 (271.4) (79.5)
Total residential mortgage banking revenue 1,592 449 2,716 254.6 (41.4)
Securities (losses) gains, net (1) (33) 244 N/M N/M
Change in cash surrender value of BOLI 146 72 406 102.8 (64.0)
Card related income 2,653 2,965 1,624 (10.5) 63.4
Other income 2,165 924 610 134.3 254.9
Total noninterest income $ 11,496 $ 9,211 $ 9,340 24.8 23.1
N/M - Not meaningful
Noninterest income increased $2.3 million , or 24.8%, in the third quarter of
2022, compared to the second quarter of 2022, and increased $2.2 million , or
23.1%, compared to the third quarter of 2021. The increase from the second
quarter was primarily driven by $1.1 million of growth in residential mortgage
banking revenue that is attributable to an increase in mark to market gainon MSRs of$466,000 , as 48 Table of Contents well as a$449,000 net gain on the sale of mortgage loans, compared to a net loss of$262,000 on the sale of mortgage loans in the second quarter of 2022. The variance in mortgage banking is derived from the changing rate environment experienced during the second and third quarters and the resultant negative impact on interest rate lock commitments during the second quarter, as well as further increases in the fair value of mortgage servicing rights during the third quarter. Increases were also noted in service charges on deposits of$333,000 , and in other income of$1.2 million primarily due to a$743,000 gain on aVisa credit card portfolio sale and a$180,000 gain on the sale of a land trust portfolio, as compared to the linked quarter. These increases in noninterest income in the third quarter of 2022, compared to the second quarter of 2022, were partially offset by a$226,000 decrease in wealth management fees, and a$312,000 decrease in card related income. The increase in noninterest income of$2.2 million in the third quarter of 2022, compared to the third quarter of 2021, is primarily due to an increase of$1.3 million in services charges of deposits, an increase of$1.0 million of card related income, and gains on the sale of theVisa credit card portfolio and the land trust portfolio reported in other income. These gains were partially offset by a$1.1 million decline in residential mortgage banking revenue due to increases in interest rates effecting the mortgage banking volumes and related derivative, offset by an increase in the fair value of mortgage servicing rights, and a$260,000 decline in the cash surrender value of BOLI.
Nine months ended
YTD through
September
Noninterest Income Nine Months Ended 30, 2022
(Dollars in thousands) September 30, September 30, Percent
2022 2021 Change
Wealth management $ 7,484 $ 6,912 8.3
Service charges on deposits 7,063 3,784 86.7
Residential mortgage banking revenue
Secondary mortgage fees 270 834 (67.6)
MSRs mark to market gain (loss) 3,608 (202) N/M
Mortgage servicing income 1,612 1,646 (2.1)
Net gain on sales of mortgage loans 1,682 7,802 (78.4)
Total residential mortgage banking revenue 7,172 10,080 (28.8)
Securities (losses) gains, net (34) 246 (113.8)
Change in cash surrender value of BOLI 342 1,163 (70.6) Card related income 8,194 4,737 73.0 Other income 3,949 1,637 141.2 Total noninterest income $ 34,170$ 28,559 19.6 N/M - Not meaningful Noninterest income increased$5.6 million , or 19.6%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . This increase was primarily driven by a$3.5 million increase in card related income, a$3.3 million increase in service charges on deposits, a$572,000 increase in wealth management fees, and a$2.3 million increase in other income, each stemming from the inclusion of West Suburban related activity in our results for the nine months endedSeptember 30, 2022 . Partially offsetting these increases was a$2.9 million decline in mortgage banking revenue year over year, comprised primarily of a$6.1 million decrease in net gain on sales of mortgage loans, partially offset by a$3.8 million mark to market gain on MSRs, both due to the increasing interest rate environment, and a$821,000 decline in the cash surrender value of BOLI. 49 Table of Contents Noninterest Expense
Three months ended
The following table details the major components of noninterest expense for the
periods presented:
3rd Quarter 2022
Noninterest Expense Three Months Ended Percent Change From
(Dollars in thousands) September 30, June 30, September 30, June 30, September 30,
2022 2022 2021 2022 2021
Salaries $ 14,711 $ 15,995 $ 9,630 (8.0) 52.8
Officers incentive 2,787 1,662 1,212 67.7 130.0
Benefits and other 3,513 3,675 2,122 (4.4) 65.6
Total salaries and employee benefits 21,011 21,332 12,964 (1.5) 62.1
Occupancy, furniture and equipment expense 4,119 3,046 2,418 35.2 70.3
Computer and data processing 2,543 4,006 1,477 (36.5) 72.2
FDIC insurance 659 702 211 (6.1) 212.3
General bank insurance 257 351 301 (26.8) (14.6)Amortization of core deposit intangible asset 657
659 113 (0.3) 481.4 Advertising expense 83 194 107 (57.2) (22.4) Card related expense 1,453 1,057 662 37.5 119.5 Legal fees 212 179 455 18.4 (53.4) Consulting & management fees 607 523 248 16.1 144.8 Other real estate owned expense, net 22
87 25 (74.7) (12.0) Other expense 4,365 5,113 3,148 (14.6) 38.7 Total noninterest expense$ 35,988 $ 37,249 $ 22,129 (3.4) 62.6 Efficiency ratio (GAAP)1 53.08 % 67.07 % 68.73 % Adjusted efficiency ratio (non-GAAP)2 51.90 % 62.73 % 66.47 % 1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs. 2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses and merger-related costs, net of gain on branch sales, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities, mark to market gains or losses on MSRs, and nonrecurring gains on the sale ofVisa credit card and land trust portfolios, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI. See the section entitled "Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures" starting on page 52 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent. Noninterest expense for the third quarter of 2022 decreased$1.3 million , or 3.4%, compared to the second quarter of 2022, and increased$13.9 million , or 62.6%, compared to the third quarter of 2021. The decrease in the third quarter of 2022 compared to the second quarter was primarily attributable to$650,000 of West Suburban acquisition-related costs for the third quarter of 2022 compared to$3.3 million for the second quarter of 2022. Acquisition-related costs in the third quarter of 2022 included$90,000 in data processing expense, compared to$1.7 million in the second quarter of 2022, primarily due to acquisition-related core system conversion costs. Partially offsetting the decrease in noninterest expense was an increase in occupancy, furniture and equipment costs of$1.1 million in the third quarter of 2022, compared to the prior quarter, due to net losses on branch sales during the quarter. Finally, our card related expense increased in the third quarter of 2022, compared to the second quarter, due to growth in customer transactions and related volume charges. The year over year increase of$13.9 million in noninterest expense is primarily attributable to an$8.0 million increase in salaries and employee benefits, a$1.7 million increase in occupancy, furniture and equipment, a$1.1 million increase in computer and data processing expense, and a$1.2 million increase in other expense. Officers incentive compensation increased$1.6 million in the third quarter of 2022, compared to the third quarter of 2021, as incentive accruals increased in the current year due to the acquisition of West Suburban, as well as growth in our commercial lending team. Employee benefits expense increased$1.4 million in the third quarter of 2022, compared to the third quarter of 2021, due to increases stemming from additional employees from our acquisition of West Suburban. The increase in occupancy, furniture and equipment expense year over year was due to the addition of 34 West Suburban branches
in late 2021. The$1.1 50 Table of Contents
million increase in computer and data processing expense was primarily due to core system conversion costs relating to the West Suburban acquisition.
Finally, the increase in other expense was due primarily to growth in bill payment services, consulting fees and commercial loan related costs, primarily due to acquisition-related costs in the third quarter of 2022.
Nine months ended
YTD through
September 30,
Noninterest Expense Nine Months Ended 2022
(Dollars in thousands) September 30, September 30, Percent
2022 2021 Change
Salaries $ 46,304 $ 28,280 63.7
Officers incentive 5,443 4,060 34.1
Benefits and other 10,563 7,026 50.3Total salaries and employee benefits 62,310 39,366 58.3 Occupancy, furniture and equipment expense 10,864
7,188 51.1 Computer and data processing 12,817 4,079 214.2 FDIC insurance 1,771 604 193.2 General bank insurance 923 854 8.1
Amortization of core deposit intangible asset 1,981
348 469.3
Advertising expense 459 262 75.2
Card related expense 3,044 1,881 61.8
Legal fees 648 645 0.5
Consulting & management fees 1,746 914 91.0Other real estate owned expense, net 97
138 (29.7)
Other expense 14,829 8,989 65.0
Total noninterest expense $ 111,489 $ 65,268 70.8
Efficiency ratio (GAAP)1 63.37 % 67.04 %Adjusted efficiency ratio (non-GAAP)2 58.76 %
65.69 %
1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs. 2 The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits, OREO expenses and merger-related costs, net of gain on branch sales, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains or losses on securities, mark to market gains or losses on MSRs, and nonrecurring gains on the sale ofVisa credit card and land trust portfolios, and includes a tax equivalent adjustment on the change in cash surrender value of BOLI. See the section entitled "Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures" starting on page 52 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent Noninterest expense for the nine months endedSeptember 30, 2022 , increased$46.2 million , or 70.8%, compared to the nine months endedSeptember 30, 2021 , primarily due to an increase in salaries and employee benefits, occupancy, furniture and equipment, computer and data processing, and other expenses, which increases primarily resulted from our acquisition of West Suburban inDecember 2021 . Salaries and employee benefits increased$22.9 million largely from the additional employees from West Suburban. Occupancy, furniture and equipment increased$3.7 million , or 51.1%, due to additional facilities acquired with our acquisition of West Suburban, net of gains from the sale of overlapping branches. Computer and data processing increased$8.7 million , or 214.2%, primarily related to costs of operating multiple systems prior to conversion as well as data conversion costs. Other expense increased$5.8 million , or 65.0%, primarily from a$2.9 million increase to special services expense and a$1.3 million increase in miscellaneous expenses, due to acquisition-related costs. In addition,FDIC insurance increased$1.2 million due to our increased asset size, as well as the absence of assessment credits fully utilized in the 2021 year to date period. Amortization of core deposit intangible increased$1.6 million for the nine months endedSeptember 30, 2022 , compared to the prior year like period, due to the West Suburban acquisition. Finally, consulting and management fees increased$832,000 due to$760,000 of acquisition-related costs and general ledger reclassifications in the first nine months of 2022. 51
Table of Contents
Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures
GAAP Non-GAAP
Three Months Ended Three Months Ended
September 30, June 30, September 30, September 30, June 30, September 30,
2022 2022 2021 2022 2022 2021
Efficiency Ratio / Adjusted Efficiency Ratio
Noninterest expense $
35,988
657 659 113 657 659 113 Less other real estate expense, net 22 87 25 22 87 25 Less acquisition related costs, net of gain on branch sales N/A N/A N/A 1,061 2,132 425 Noninterest expense less adjustments$ 35,309 $ 36,503 $ 21,991 $ 34,248 $ 34,371 $ 21,566 Net interest income$ 55,569 $ 45,264 $ 22,618 $ 55,569 $ 45,264 $ 22,618 Taxable-equivalent adjustment: Loans N/A N/A N/A 6 6 4 Securities N/A N/A N/A 354 345 337 Net interest income including adjustments 55,569 45,264 22,618 55,929 45,615 22,959 Noninterest income 11,496 9,211 9,340 11,496 9,211 9,340 Less securities (losses) gains (1) (33) 244 (1) (33) 244 Less MSRs mark to market gain (loss) 548 82 (282) 548 82 (282) Less gain on Visa credit card portfolio sale N/A N/A N/A 743 - - Less gain on sale of land trust portfolio N/A N/A N/A 180 - - Taxable-equivalent adjustment: Change in cash surrender value of BOLI N/A N/A N/A 39 19 108 Noninterest income (less) / including adjustments 10,949 9,162 9,378 10,065 9,181 9,486
Net interest income including adjustments plus noninterest income (less) / including adjustments
$
66,518
53.08 % 67.07 % 68.73 % 51.90 % 62.73 % 66.47 % Income Taxes We recorded income tax expense of$7.1 million for the third quarter of 2022 on$26.6 million of pretax income, compared to income tax expense of$4.4 million on$16.7 million of pretax income in the second quarter of 2022, and income tax expense of$2.9 million on$11.3 million of pretax income in the third quarter of 2021. Our effective tax rate was 26.5% in the third quarter of 2022, 26.6% for the second quarter of 2022, and 25.8% for the third quarter of 2021.
We recorded income tax expense of
Income tax expense reflected all relevant statutory tax rates and GAAP
accounting. There were no significant changes in our ability to utilize our
deferred tax assets during the quarter or nine months ended
We had no valuation reserve on the deferred tax assets as of
Financial Condition
Total assets decreased$244.5 million to$5.97 billion atSeptember 30, 2022 , from$6.21 billion atDecember 31, 2021 , due primarily to a net decrease in cash and cash equivalents of$636.0 million , offset by increases of$444.0 million in net loans and$43.5 million in deferred tax assets. The decrease in cash and cash equivalents was primarily due to the use of cash for loan growth, as well as the decrease in customer deposits of$184.9 million . We continue to actively assess potential investment opportunities to utilize our excess liquidity. Total deposits were$5.28 billion atSeptember 30, 2022 , a decrease of$184.9 million fromDecember 31, 2021 , primarily due to seasonal decreases of municipal deposits, and to a lesser extent declines in interest bearing demand accounts, savings, money market, NOW, and time deposits in 2022. 52 Table of Contents September 30, 2022 Securities As of Percent Change From (Dollars in thousands) September 30,
2022 2021 2021 2021 2021
Securities available-for-sale, at fair value
U.S. Treasuries $ 211,097 $ 202,339 $ 4,070 4.3 N/M
U.S. government agencies 55,963 61,888 33,575 (9.6) 66.7
U.S. government agencies mortgage-backed 127,626 172,302 17,818 (25.9) 616.3
States and political subdivisions 224,259 257,609 238,952 (12.9) (6.1)
Corporate bonds 9,544 9,887 4,992 (3.5) 91.2
Collateralized mortgage obligations 587,846 672,967 165,414 (12.6) 255.4
Asset-backed securities 219,587 236,877 189,338 (7.3) 16.0
Collateralized loan obligations 173,837 79,763 61,029 117.9 184.8 Total securities$ 1,609,759 $ 1,693,632 $ 715,188 (5.0) 125.1
N/M - Not meaningful
Securities available-for-sale decreased$83.9 million as ofSeptember 30, 2022 , compared toDecember 31, 2021 , and increased$894.6 million compared toSeptember 30, 2021 . The decrease in the portfolio during 2022 was driven by$234.8 million in principal reductions from calls, maturities and mortgage related prepayments, as well as an unrealized mark to market loss adjustment of$146.4 million , which were partially offset by the purchase of$301.6 million across a variety of sectors. We continue to seek to position the portfolio in higher credit quality, shorter duration securities with an appropriate mix of fixed- and floating-rate exposures. The increase in the securities portfolio in the year over year period was primarily due to the securities acquired in the acquisition of West Suburban. There were no securities sales during the third quarter of 2022. September 30, 2022 Loans As of Percent Change From (Dollars in thousands) September 30, December 31, September 30, December 31, September 30, 2022 2021 2021 2021 2021 Commercial$ 888,081 $ 771,474 $ 321,548 15.1 176.2 Leases 251,603 176,031 162,444 42.9 54.9 Commercial real estate - investor 941,910 799,928 420,853 17.7 123.8 Commercial real estate - owner occupied 876,951 731,845 445,301 19.8 96.9 Construction 176,700 206,132 108,690 (14.3) 62.6 Residential real estate - investor 59,580 63,399 45,497 (6.0) 31.0 Residential real estate - owner occupied 220,969 213,248 108,343 3.6 104.0 Multifamily 322,856 309,164 160,798 4.4 100.8 HELOC 116,108 126,290 82,021 (8.1) 41.6 Other 1 14,576 23,293 12,447 (37.4) 17.1 Total loans$ 3,869,334 $ 3,420,804 $ 1,867,942 13.1 107.1
1 The "Other" segment includes consumer and overdrafts.
Total loans were$3.87 billion as ofSeptember 30, 2022 , an increase of$448.5 million fromDecember 31, 2021 . The increase in total loans in the first nine months of 2022, compared toDecember 31, 2021 , was due primarily to growth in loan originations within commercial real estate - investor, which increased by$142.0 million , commercial real estate - owner occupied, which increased by$145.1 million , commercial, which increased by$116.6 million , and leases, which increased by$75.6 million fromDecember 31, 2021 . Total loans increased$2.00 billion fromSeptember 30, 2021 toSeptember 30, 2022 , primarily due to the loan portfolio acquired from West Suburban. As required by CECL, the balance (or amortized cost basis) of purchased credit deteriorated loans, or PCD loans (discussed below) is carried on a gross basis (rather than net of the associated credit loss estimate), and the expected credit losses for PCD loans are estimated and separately recognized as part of the allowance for credit losses, or ACL. The quality of our loan portfolio is impacted not only by our credit decisions but also by the economic health of the communities in which we operate. Since we are located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial real estate, construction, residential, multifamily, and HELOCs) has been and continues to be a sizeable portion of our portfolio. These categories comprised 70.2% of the portfolio as ofSeptember 30, 2022 , compared to 71.6% of the portfolio as of 53
Table of Contents
Asset Quality
Nonperforming loans consist of nonaccrual loans, performing restructured
accruing loans and loans 90 days or greater past due. Remediation work
continues in all segments. Nonperforming loans increased by
Purchased credit deteriorated loans, or PCD loans, are purchased loans that, as of the date of acquisition, we determined had experienced a more-than-insignificant deterioration in credit quality since origination. PCD loans and their related deferred loan costs are included in our nonperforming loan disclosures, if such loans otherwise meet the definition of a nonperforming loan. Management continues to carefully monitor loans considered to be in a classified status. Nonperforming loans as a percent of total loans were 1.4% as ofSeptember 30, 2022 , 1.3% as ofDecember 31, 2021 , and 1.5% as ofSeptember 30, 2021 . The distribution of our nonperforming loans is shown in the following table. September 30, 2022 Nonperforming Loans As of Percent Change From
(Dollars in thousands) September 30, December 31,
September 30, December 31, September 30,
2022 2021 2021 2021 2021
Commercial $ 8,821 $ 13,291 $ 220 (33.6) N/M
Leases 235 3,754 3,959 (93.7) (94.1)Commercial real estate - investor 17,945 5,694 6,100 215.2 194.2 Commercial real estate - owner occupied 9,581 13,231 6,896 (27.6) 38.9 Construction 7,525 160 2,958 N/M 154.4 Residential real estate - investor 1,380 899 998 53.5 38.3 Residential real estate - owner occupied 3,787 5,019
4,885 (24.5) (22.5)
Multifamily 1,559 1,573 2,055 (0.9) (24.1)
HELOC 2,065 1,042 881 98.2 134.4
Other 1 2 3 - - N/M
Total nonperforming loans $ 52,900 $ 44,666 $ 28,952 18.4 82.7
N/M - Not meaningful
1 The "Other" segment includes consumer and overdrafts.
54
Table of Contents
The components of our nonperforming assets are shown in the following table.
September 30, 2022
Nonperforming Assets As of Percent Change From
(Dollars in Thousands) September 30,
December 31, September 30, December 31, September 30,
2022 2021 2021 2021 2021
Nonaccrual loans $ 32,126 $ 41,531 $ 27,520 (22.6) 16.7
Performing troubled debt restructured loans
accruing interest 22 25 199 (12.0) (88.9)
Loans past due 90 days or more and still
accruing interest 20,752 3,110 1,233 567.3 N/M
Total nonperforming loans 52,900 44,666 28,952 18.4 82.7
Other real estate owned 1,561 2,356 1,912 (33.7) (18.4)
Total nonperforming assets $ 54,461 $ 47,022 $ 30,864 15.8 76.5
30-89 days past due loans and still accruing
interest $ 8,197 $ 10,745 $ 2,829
Nonaccrual loans to total loans 0.8 % 1.2 % 1.5 %
Nonperforming loans to total loans 1.4 % 1.3 % 1.5 %
Nonperforming assets to total loans plus OREO 1.4 % 1.4 % 1.7 %
Allowance for credit losses $ 48,847 $ 44,281 $ 26,949
Allowance for credit losses to total loans 1.3 % 1.3 % 1.4 %
Allowance for credit losses to nonaccrual loans 152.1 % 106.6 % 97.9 %
N/M - Not meaningful
Loan charge-offs, net of recoveries, for the current quarter, prior linked quarter and year over year quarter are shown in the following table.
Loan Charge-offs, Net of Recoveries Three Months Ended
(Dollars in thousands) September 30, % of June 30, % of September 30, % of
2022 Total1 2022 Total1 2021 Total1
Commercial $ 20 29.4 $ 44 17.6 $ (2) (0.8)
Leases 178 261.80 - - 4 1.7Commercial real estate - investor 105 154.4 225 90.0 83 35.0 Commercial real estate - owner occupied (75) (110.3) (7) (2.8) (2) (0.8) Residential real estate - investor (8) (11.8) (5) (2.0) (7) (3.0) Residential real estate - owner occupied (113) (166.2)
(22) (8.8) (18) (7.6) Multifamily (63) (92.6) - - 183 77.2 HELOC (35) (51.5) (31) (12.4) (28) (11.8) Other 2 59 86.8 46 18.4 24 10.1 Net charge-offs $ 68 100.0$ 250 100.0 $ 237 100.0
1 Represents the percentage of net charge-offs attributable to each category of loans.
2 The "Other" segment includes consumer and overdrafts.
Net charge-offs of$68,000 were recorded for the third quarter of 2022, compared to net charge-offs of$250,000 for the second quarter of 2022, and net charge-offs of$237,000 for the third quarter of 2021, reflecting continuing management attention to credit quality and remediation efforts. The net charge-offs for the third quarter of 2022 were primarily due to one lease charge off for$178,000 and one commercial real estate - investor charge off for$94,000 . We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs. Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. Classified assets include both classified loans and OREO. Loans classified as substandard are inadequately protected by either the current net worth and ability to meet payment obligations of the obligor, or by the collateral pledged to secure the loan, if any. These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and carry the distinct possibility that we will sustain some loss if deficiencies remain uncorrected. 55
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The following table shows classified assets by segment for the following
periods.
September 30, 2022
Classified Assets As of Percent Change From
(Dollars in thousands) September 30, December 31,
September 30, December 31, September 30,
2022 2021 2021 2021 2021
Commercial $ 31,722 $ 32,712 $ 467 (3.0) N/M
Leases 235 3,754 4,423 (93.7) (94.7)Commercial real estate - investor 28,252 10,667 8,718 164.9 224.1 Commercial real estate - owner occupied 42,698 15,429 7,211 176.7 492.1 Construction 1,347 2,104 4,898 (36.0) (72.5) Residential real estate - investor 1,285 1,265 1,154 1.6 11.4 Residential real estate - owner occupied 3,929 5,099
4,508 (22.9) (12.8)
Multifamily 1,982 2,278 2,327 (13.0) (14.8)
HELOC 2,278 1,423 1,215 60.1 87.5
Other 1 2 10 2 (80.0) -
Total classified loans 113,730 74,741 34,923 52.2 225.7
Other real estate owned 1,561 2,356 1,912 (33.7) (18.4)
Total classified assets $ 115,291 $ 77,097 $ 36,835 49.5 213.0
N/M - Not meaningful
1 The "Other" segment includes consumer and overdrafts.
Total classified loans and classified assets increased$38.2 million as ofSeptember 30, 2022 , from the levels atDecember 31, 2021 . The increase is due to the addition of commercial real estate - investor loans totaling$19.7 million and two commercial real estate - owner occupied loans totaling$32.0 million in the second quarter. The increase fromSeptember 30, 2021 is primarily due to the$15.4 million addition of the West Suburban loan portfolio in late 2021. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the ACL on loans as another measure of overall change in loan related asset quality, which is referred to as the "classified assets ratio."
The classified assets ratio was 19.23% for the period ended
The increase in the classified assets ratio for the period ended
Allowance for Credit Losses on Loans
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management's assessment of expected losses in the loan portfolio at the balance sheet date. As ofJanuary 1, 2020 , we adopted ASU 2016-13, or CECL. AtSeptember 30, 2022 , our allowance for credit losses, or ACL, on loans totaled$48.8 million , and our ACL on unfunded commitments, included in other liabilities, totaled$4.4 million . In the third quarter of 2022, we recorded provision expense on loans of$3.5 million , based on our assessment of nonperforming loan metrics and trends and estimated future credit losses, and a$973,000 increase in our reserve on unfunded commitments, primarily due to an updated analysis of line utilization rates over the past twelve months, as well as the roll off of prior historical periods with lower losses within the CECL model. These two entries resulted in a$4.5 million net impact to the provision for credit losses for the third quarter of 2022. The ACL on loans totaled$45.4 million as ofJune 30, 2022 ,$44.3 as ofDecember 31, 2021 , and$26.9 million as ofSeptember 30, 2021 . The ACL on loans increased in late 2021 due to the impact of the West Suburban acquisitionDay One credit mark of$12.1 million , the Day Two non-PCD loan adjustment to ACL of$12.2 million , less a reversal of$2.3 million related to our legacy loan portfolio and net charge-offs of$4.7 million for the fourth quarter. The ACL for loans was reduced in the third quarter of 2021 due to a$1.5 million release of the provision for credit losses. Management estimates the amount of provision required on a quarterly basis and records the appropriate provision expense, or release of expense, to maintain an adequate reserve for all potential and estimated credit losses on loans, leases and unfunded commitments. Our ACL on loans to total loans was 1.3% as ofSeptember 30, 2022 , andDecember 31, 2021 . See Item 7 - Critical Accounting Estimates in the Management Discussion and Analysis in our 2021 Annual Report in Form 10-K for discussion of our ACL methodology on loans. 56
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Allocations of the ACL may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.
Below is a reconciliation of the activity in the allowance for credit losses on loans for the periods indicated (dollars in thousands):
Three Months Ended Nine Months Ended
September 30, June 30, September 30, September 30, September 30,
2022 2022 2021 2022 2021Allowance at beginning of period$ 45,388 $
44,308$ 28,639 $ 44,281 $ 33,855 Charge-offs: Commercial 67 52 23 149 232 Leases 178 - 4 178 32
Commercial real estate - investor 124 243 101 604 101 Commercial real estate - owner occupied 12 - 5 133 39 Construction - - - - - Residential real estate - investor - - - - - Residential real estate - owner occupied -
- - - -
Multifamily - - 183 - 183
HELOC - - - - 17
Other 1 103 91 53 320 108
Total charge-offs 484 386 369 1,384 712
Recoveries:
Commercial 47 8 25 85 62
Leases - - - - -Commercial real estate - investor 19 18 18 60 58 Commercial real estate - owner occupied 87 7 7 102 225 Construction - - - - - Residential real estate - investor 8 5 7 23 283 Residential real estate - owner occupied 113
22 18 218 128
Multifamily 63 - - 63 -
HELOC 35 31 28 102 129
Other 1 44 45 29 120 107
Total recoveries 416 136 132 773 992
Net charge-offs (recoveries) 68 250 237 611 (280)Provision for (release of) credit losses on loans 3,527 1,330 (1,453) 5,177 (7,186) Allowance at end of period$ 48,847 $
45,388
Average total loans (exclusive of loans held-for-sale)
0.01 % 0.03 % 0.05 % 0.02 % (0.02) %
Allowance at period end to average loans 1.30 % 1.29 % 1.43 % 1.37 % 1.39 %
1 The "Other" segment includes consumer and overdrafts.
The coverage ratio of the ACL on loans to nonperforming loans was 92.3% as ofSeptember 30, 2022 , which was a decrease from the coverage ratio of 107.8% as ofJune 30, 2022 and a decrease from 93.1% as ofSeptember 30, 2021 . When measured as a percentage of average loans, our total ACL on loans was 1.37% for the nine months ended 2022 and 1.39% for the like period ofSeptember 30, 2021 In management's judgment, an adequate ACL has been established to encompass the current lifetime expected credit losses atSeptember 30, 2022 , and general changes in lending policy, procedures and staffing, as well as other external factors, such as the impacts of the COVID-19 pandemic. However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession. Continued volatility in the economic environment stemming from the impacts of and response to inflation and the war inUkraine , and the associated effects on our customers, or other factors, such as changes in business climates and the condition of collateral at the time of default or repossession, may revise our current expectations of future credit losses in future reporting periods. 57 Table of Contents Other Real Estate Owned
As ofSeptember 30, 2022 , OREO totaled$1.6 million , reflecting a$795,000 decrease from the$2.4 million atDecember 31, 2021 , and a$351,000 decrease from the$1.9 million atSeptember 30, 2021 . In the third quarter of 2022, we disposed of one property totaling$62,000 in net book value, which resulted in a gain on sale of OREO of$33,000 and had no transfers to OREO. In the fourth quarter of 2021, we acquired three OREO properties in our acquisition of West Suburban, with a total fair value of$5.6 million , and we sold two of these properties in December, which had a net book value of$5.2 million . In the third quarter of 2022, we recorded no OREO valuation reserve adjustments, compared to$14,000 of valuation reserve adjustments recorded in the fourth quarter of 2021, and$2,000 of valuation reserve adjustments recorded in the third quarter of 2021. September 30, 2022 OREO Three Months Ended Percent Change From (Dollars in thousands) September 30,
2022 2021 2021 2021 2021
Balance at beginning of period $ 1,623 $ 1,912 $ 1,877 (15.1) (13.5)
Property additions, net of acquisition adjustments - 5,678 70 (100.0) (100.0)
Less:
Proceeds from property disposals, net of participation purchase and of gains/losses 62 5,220 37 (98.8) 67.6 Period valuation write-down - 14 (2) (100.0) (100.0) Balance at end of period $ 1,561 $ 2,356 $ 1,912 (33.7) (18.4) In management's judgment, the property valuation allowance as established presents OREO at current estimates of fair value less estimated costs to sell; however, there can be no assurance that additional losses will not be incurred on disposals or upon updates to valuations in the future. Of note, properties valued in total at$928,000 , or approximately 59.5% of total OREO atSeptember 30, 2022 , have been in OREO for five years or more. The appropriate regulatory approval has been obtained for any OREO properties held in excess of five years.OREO Properties by Type (Dollars in thousands) September 30, 2022 December 31, 2021 September 30, 2021 Amount % of Total Amount % of Total Amount % of Total Single family residence $ - 0 % $ 645 27 % $ 519 27 %
Lots (single family and commercial) 1,261
81 % 1,411 60 % 1,078 56 % Vacant land 300 19 % 300 13 % 315 17 % Total other real estate owned$ 1,561 100 %$ 2,356 100 %$ 1,912 100 % Deposits and Borrowings September 30, 2022 Deposits As of Percent Change From (Dollars in thousands) September 30, December 31,
2022 2021 2021 2021 2021
Noninterest bearing demand $ 2,098,144 $ 2,093,494 $ 1,037,638 0.2 102.2 Savings 1,164,036 1,178,575 457,900 (1.2) 154.2 NOW accounts 630,747 587,381 537,547 7.4 17.3 Money market accounts 931,813 1,102,972 370,691 (15.5) 151.4 Certificates of deposit of less than$100,000 258,071 296,298 173,595 (12.9) 48.7 Certificates of deposit of$100,000 through$250,000 148,411 138,794 98,496 6.9 50.7 Certificates of deposit of more than$250,000 50,137 68,718 38,462 (27.0) 30.4 Total deposits$ 5,281,359 $ 5,466,232 $ 2,714,329 (3.4) 94.6 Total deposits were$5.28 billion atSeptember 30, 2022 , which reflects a$184.9 million decrease from total deposits of$5.47 billion atDecember 31, 2021 , and an increase of$2.57 billion from total deposits of$2.71 billion atSeptember 30, 2021 . The decrease in deposits atSeptember 30, 2022 , compared toDecember 31, 2021 , was primarily due to decreases in savings of$14.5 million , money market 58 Table of Contents accounts of$171.2 million and time deposits of$47.2 million partially offset by increases in demand and NOW accounts of$48.0 million . The increase in deposits atSeptember 30, 2022 , compared toSeptember 30, 2021 was primarily due to an increase of$2.69 billion of deposits from the West Suburban acquisition. In addition to deposits, we obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled$35.5 million atSeptember 30, 2022 , a$14.8 million , or 29.5%, decrease from$50.3 million at December 31, 2021. Our notes payable and other borrowings is comprised of$10.0 million outstanding on a$20.0 million term note originated with a correspondent bank in the first quarter of 2020, to facilitate the redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures, completed onMarch 2, 2020 . Notes payable and other borrowings of$10.0 million as ofSeptember 30, 2022 , decreased$9.1 million fromDecember 31, 2021 , and decreased$10.2 million fromSeptember 30, 2021 .
In the second quarter of 2021, we entered into Subordinated Note Purchase
Agreements with certain qualified institutional buyers pursuant to which we sold
and issued
We
sold the Notes to eligible purchasers in a private offering, and the proceeds of this issuance are intended to be used for general corporate purposes, which may include, without limitation, the redemption of existing senior debt, common stock repurchases and strategic acquisitions. The Notes bear interest at a fixed annual rate of 3.50% throughApril 14, 2026 , payable semi-annually in arrears. As ofApril 15, 2026 forward, the interest rate on the Notes will generally reset quarterly to a rate equal to Three-Month Term SOFR (as defined by the Note) plus 273 basis points, payable quarterly in arrears. The Notes have a stated maturity ofApril 15, 2031 , and are redeemable, in whole are in part, onApril 15, 2026 , or any interest payment date thereafter, and at any time upon the occurrence of certain events. We are indebted on senior notes originated inDecember 2016 , totaling$44.6 million , net of deferred issuance costs, as ofSeptember 30, 2022 . These notes mature inDecember 2026 , and included interest payable semi-annually at 5.75% for five years. BeginningDecember 31, 2021 , the interest became payable quarterly at three month LIBOR plus 385 basis points. We are also indebted on$25.8 million , net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust II ("Trust II"). The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points onJune 15, 2017 . Upon conversion to a floating rate, we initiated a cash flow hedge which resulted in the total interest rate paid on this debt of 4.39% as ofSeptember 30, 2022 , as compared to 6.77%, which was the rate paid during the period prior to theJune 15, 2017 rate reset.
Capital
As ofSeptember 30, 2022 , total stockholders' equity was$433.7 million , which was a decrease of$68.3 million from$502.0 million as ofDecember 31, 2021 . This decrease is primarily attributable to a decrease in accumulated other comprehensive income of$107.2 million in the first nine months of 2022 due to a net decrease in unrealized gains on available-for-sale securities, net of unrealized losses on swaps, due to the increase in market interest rates, as well as a reduction to retained earnings of$6.7 million for payment of dividends to our common stockholders in the first nine months of 2022. Partially offsetting this decrease was$43.8 million of net income for the nine months endedSeptember 30, 2022 . Total stockholders' equity as ofSeptember 30, 2022 , increased$112.5 million compared toSeptember 30, 2021 , primarily due to the West Suburban acquisition in late 2021 and the resultant additional common stock issued, as well as net income year over year, less the reduction in accumulated other comprehensive income of$110.6 million year over year. 59
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The following table shows the regulatory capital ratios and the current well capitalized regulatory requirements for the Company and the Bank as of the
dates
indicated:
Minimum Capital Well Capitalized
Adequacy with Under Prompt
Capital Conservation Corrective Action September 30, December 31, September 30,
Buffer, if applicable1 Provisions2 2022 2021 2021
The CompanyCommon equity tier 1 capital ratio 7.00 % N/A 9.16 % 9.46 % 12.99 % Total risk-based capital ratio 10.50 % N/A 11.99 % 12.55 % 17.80 % Tier 1 risk-based capital ratio 8.50 % N/A
9.68 % 10.06 % 14.10 %
Tier 1 leverage ratio 4.00 % N/A 7.70 % 7.81 % 9.81 %
The BankCommon equity tier 1 capital ratio 7.00 % 6.50
% 11.60 % 12.41 % 15.65 % Total risk-based capital ratio
10.50 % 10.00 % 12.64 % 13.46 % 16.69 % Tier 1 risk-based capital ratio
8.50 % 8.00 % 11.60 % 12.41 % 15.65 %
Tier 1 leverage ratio 4.00 % 5.00 % 9.24 % 9.58 % 10.83 %
1 Amounts are shown inclusive of a capital conservation buffer of 2.50%.
2 The prompt corrective action provisions are only applicable at the Bank level.
As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020,U.S. federal regulatory authorities issued an interim final rule that provided banking organizations that adopted CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL onJanuary 1, 2020 , we elected to utilize the five-year CECL transition. As ofSeptember 30, 2022 , the capital measures of the Company exclude$2.9 million , which is the modified CECL transition adjustment. As ofSeptember 30, 2022 , the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed "well capitalized" and met the now fully phased-in capital conservation buffer requirements. In addition to the above regulatory ratios, our GAAP common equity to total assets ratio, which is used as a performance measurement for capital analysis and peer comparisons, decreased from 8.08% atDecember 31, 2021 , to 7.27% atSeptember 30, 2022 . Our GAAP tangible common equity to tangible assets ratio was 5.67% atSeptember 30, 2022 , compared to 6.54% as ofDecember 31, 2021 . Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, decreased from 6.59% atDecember 31, 2021 , to 5.72% atSeptember 30, 2022 , primarily due to a decline in tangible common equity in the nine months endedSeptember 30, 2022 . The decline in tangible common equity was due to a decrease in accumulated other comprehensive income of$107.2 million primarily related to unrealized losses on available-for-sale securities stemming from the increase in market interest rates. The non-GAAP tangible common equity to tangible assets ratio was also negatively impacted by growth in total tangible assets in the third quarter
of
2022.
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Reconciliation of Tangible Common Equity to Tangible Assets Ratio Non-GAAP Measure
September 30, 2022 December 31, 2021
Tangible common equity GAAP Non-GAAP GAAP Non-GAAP
(Dollars in thousands)
Total Equity $ 433,714 $ 433,714 $ 502,027 $ 502,027
Less: Goodwill and intangible assets 100,801 100,801 102,636 102,636
Add: Limitation of exclusion of core deposit intangible (80%) N/A 2,865 N/A 3,261
Adjusted goodwill and intangible assets 100,801
97,936 102,636 99,375
Tangible common equity $ 332,913 $ 335,778 $ 399,391 $ 402,652
Tangible assets
Total assets $ 5,967,705 $ 5,967,705 $ 6,212,189 $ 6,212,189 Less: Adjusted goodwill and intangible assets 100,801
97,936 102,636 99,375
Tangible assets $ 5,866,904 $ 5,869,769 $ 6,109,553 $ 6,112,814
Common equity to total assets 7.27 % 7.27 % 8.08 % 8.08 %Tangible common equity to tangible assets 5.67 %
5.72 % 6.54 % 6.59 %
The non-GAAP intangible asset exclusion reflects the 80% core deposit limitation per Basel III guidelines within risk based capital calculations, and is useful for us when reviewing risk based capital ratios and equity performance metrics.
Liquidity
Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customers' credit needs, and to meet maturing obligations and existing commitments. Our liquidity principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds. We monitor our borrowing capacity at the FHLBC as part of our liquidity management process as supervised by ourAsset and Liability Committee ("ALCO") and reviewed by our Board of Directors. In addition, due to the potential impacts on our liquidity stemming from the COVID-19 pandemic, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs. As ofSeptember 30, 2022 , our cash on hand liquidity totaled$116.2 million , a decrease of$636.0 million over cash balances held as ofDecember 31, 2021 . Net cash inflows from operating activities were$60.1 million during the first nine months of 2022, compared with net cash inflows of$50.8 million in the same period of 2021. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, were a source of inflows for the first nine months of 2022 though to a lesser extent than the like period of 2021. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of inflows for the nine months endedSeptember 30, 2022 and also for the like period of 2021. The management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows. Management's policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process. Net cash outflows from investing activities were$506.4 million in the nine months endedSeptember 30, 2022 , compared to net cash outflows of$57.0 million in the same period in 2021. In the first nine months of 2022, securities transactions accounted for net outflows of$66.9 million , and the principal change on loans accounted for net outflows of$443.6 million . In the first nine months of 2021, securities transactions accounted for net outflows of$225.2 million , and net principal on loans funded accounted for net inflows of$168.6 million . Proceeds from sales of OREO accounted for$941,000 and$607,000 in investing cash inflows for the nine months endedSeptember 30, 2022 and 2021, respectively. Net cash outflows from financing activities in the nine months endedSeptember 30, 2022 , were$189.7 million , compared with net cash inflows of$195.6 million in the nine months endedSeptember 30, 2021 . Net deposit outflows in the first nine months of 2022 were$183.7 million compared to net deposit inflows of$177.3 million in the first nine months of 2021. Other short-term borrowings had$25.0 million of net cash inflows in the first nine months of 2022, compared to no cash inflows or outflows in the first nine months of 2021. Changes in securities sold under repurchase agreements accounted for outflows of$14.8 million and outflows of$24.0 million for the nine months endedSeptember 30, 2022 and 2021, respectively. Dividends paid on our common stock totaled$6.7 million in the nine months endedSeptember 30, 2022 , compared to dividends paid of$3.2 million for the like 2021 period, as the per common share dividend was increased tofive cents per share in the second quarter of 2021. The purchase of treasury stock in the first nine months of 2022 due 61
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to shares acquired with restricted stock award vestings resulted in outflows of$447,000 , compared to cash outflows of$10.4 million in the first nine months of 2021. Cash and cash equivalents for the nine months endedSeptember 30, 2022 , totaled$116.2 million , as compared to$519.3 million as ofSeptember 30, 2021 . In addition to cash and cash equivalents on hand or held as deposits with other financial institutions, we rely on funding sources from customer deposits, cash flows from securities available-for-sale and loans, and a line of credit with the FHLBC to meet potential liquidity needs. These sources of liquidity are immediately available to satisfy any funding requirements due to depositor or borrower demands through the ordinary course of our business. Additional sources of funding include a$30.0 million undrawn line of credit held by the Company with a third party financial institution, as well as unpledged securities available-for-sale.
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