SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to               

Commission file number   0-10537

 

OLD SECOND BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

37 South River Street, Aurora, Illinois 60506

(Address of principal executive offices, including Zip Code)

 

(630) 892-0202

(Registrant’s telephone number, including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $1.00 par value

(Title of Class)

Preferred Securities of Old Second Capital Trust I

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o              No ý

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange

Act.                                                                                                                                                                                                                                                                                            Yes o            No ý

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

YES  ý         NO  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by Reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

YES  o         NO  ý

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, on June 30, 2005, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $393 million*. The number of shares outstanding of the registrant’s common stock, par value $1.00 per share, was 13,520,073 at February 15, 2006.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s 2005 Annual Report are incorporated by reference into Parts I, II and IV.

Portions of the Company’s Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Part III.

 

*                                         Based on the last reported price of an actual transaction in registrant’s common stock on June 30, 2005 and reports of beneficial ownership filed by directors and executive officers of registrant and by beneficial owners of more than 5% of the outstanding shares of common stock of registrant; however, such determination of shares owned by affiliates does not constitute an admission of affiliate status or beneficial interest in shares of registrant’s common stock.

 

 

OLD SECOND BANCORP, INC.

Form 10-K

 

INDEX

 

PART I
Item 1	Business
Item 1A	Risk Factors
Item 1B	Unresolved staff comments
Item 2	Properties
Item 3	Legal Proceedings
Item 4	Submission of Matters to a Vote of Security Holders
PART II
Item 5	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6	Selected Financial Data
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A	Quantitative and Qualitative Disclosures about Market Risk
Item 8	Financial Statements and Supplementary Data
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A	Controls and Procedures
Item 9B	Other Information
PART III
Item 10	Directors and Executive Officers of the Registrant
Item 11	Executive Compensation
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13	Certain Relationships and Related Transactions
Item 14	Principal Accounting Fees and Services
PART IV
Item 15	Exhibits and Financial Statement Schedules
	Signatures

 

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PART I

 

Item 1. Business

 

General

 

Old Second Bancorp, Inc. (the “Company” or the “Registrant”) was organized under the laws of Delaware on September 8, 1981. It is a registered bank holding company under the Bank Holding Company Act of 1956 (the “BHCA”). The Company’s office is located at 37 South River Street, Aurora, Illinois 60506.

 

The Company conducts a full service community banking and trust business through its wholly owned subsidiaries, which are together referred to as the “Company”.

 

•                  The Old Second National Bank of Aurora (“Old Second Bank”)

•                  Old Second Bank-Yorkville

•                  Old Second Bank-Kane County

•                  Old Second Financial, Inc., which provides insurance agency services.

•                  Old Second Mortgage Company, which is a wholly owned subsidiary of Old Second Bank.

•                  Old Second Capital Trust I, a Delaware business trust, which was formed for the exclusive purpose of issuing trust-preferred securities in a transaction completed in July 2003.

•                  Old Second Affordable Housing Fund, L.L.C. for the purpose of providing down payment assistance for home ownership to qualified individuals.

 

The banking subsidiaries are referred to herein as the “Banks.”   Inter-company transactions and balances are eliminated in consolidation.

 

The Company provides financial services through its twenty-seven banking locations and three mortgage banking offices located in Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois. Old Second Mortgage provides mortgage-banking services and Old Second Bank also engages in trust operations.

 

Business of the Company and its Subsidiaries

 

The Banks’ full service banking businesses include the customary consumer and commercial products and services which banks provide. The following services are included: demand, savings, time deposit, individual retirement and Keogh deposit accounts; commercial, industrial, consumer and real estate lending, including installment loans, student loans, farm loans, lines of credit and overdraft checking; safe deposit operations; trust services; and an extensive variety of additional services tailored to the needs of individual customers, such as the acquisition of U.S. Treasury notes and bonds, the sale of traveler’s checks, money orders, cashier’s checks and foreign currency, direct deposit, discount brokerage, debit cards, credit cards, and other special services. Commercial and consumer loans are made to corporations, partnerships and individuals, primarily on a secured basis. Commercial lending focuses on business, capital, construction, inventory and real estate lending. Installment lending includes direct and indirect loans to consumers and commercial customers.

 

Old Second Mortgage Company originates residential mortgages and handles the secondary marketing of those mortgages. Old Second Mortgage Company is a mortgage banking organization offering a wide range of products including conventional, government, jumbo and sub prime loans with operations centralized at its home office location in St. Charles, Illinois. Old Second Mortgage Company has offices in Sycamore, Wheaton and St. Charles, Illinois. As of December 31, 2005, Old Second Mortgage Company employed 26 operations employees and 24 loan origination employees.

 

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Market Area

 

Old Second Bank’s primary market area is Aurora, Illinois, and its surrounding communities. The city of Aurora is located in northeastern Illinois, approximately 40 miles west of Chicago. Aurora is strategically situated on U.S. Interstate 88 and is centrally located near our banking subsidiaries in Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois. Based upon 2003 estimates, these counties together represent a market of more than 2.2 million people. The city of Aurora has a current reported population of approximately 175,000 residents.

 

Lending Activities

 

General. The Banks provide a broad range of commercial and retail lending services to corporations, partnerships, individuals and government agencies. The Banks actively market their services to qualified borrowers. Lending officers actively solicit the business of new borrowers entering our market areas as well as long-standing members of the local business community. The Banks have established lending policies that include a number of underwriting factors to be considered in making a loan, including location, amortization, loan to value ratio, cash flow, pricing, documentation and the credit history of the borrower. The Banks’ loan portfolios are comprised primarily of loans in the areas of commercial real estate, residential real estate, construction, general commercial and consumer lending. As of December 31, 2005, residential mortgages made up approximately 32% of its loan portfolio, commercial real estate loans comprised approximately 35%, construction lending comprised approximately 21%, general commercial loans comprised approximately 10% and consumer lending comprised 2%. It is the Bank’s policy to comply at all times with the various consumer protection laws and regulations including, but not limited to, the Equal Credit Opportunity Act, the Fair Housing Act, the Community Reinvestment Act, the Truth in Lending Act, and the Home Mortgage Disclosure Act. The Banks do not discriminate in application procedures, loan availability, pricing, structure, or terms on the basis of race, color, religion, national origin, sex, marital status, familial status, handicap, age (providing the applicant has the legal capacity to enter into a binding contract), whether income is derived from public assistance, whether a borrower resides or his property is located in a low- or moderate-income area, or whether a right was exercised under the Consumer Credit Protection Act. The Banks strive to offer all of their credit services throughout their primary market area, including low- and moderate-income areas.

 

Commercial Loans. As noted above, the Banks are active commercial lenders. The areas of emphasis include: loans to wholesalers, manufacturers, building contractors, developers, business services companies and retailers. The Banks provide a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment and other purposes. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. In addition, the Banks may take personal guarantees to help assure repayment. Loans may be made on an unsecured basis if warranted by the overall financial condition of the borrower. Commercial lines of credit are generally for 1 year and have floating rates. Commercial term loans range from 1 to 7 years with the majority falling in the 3 to 5 year range with rates fixed for the duration of the loan. A recent trend has seen a decrease in the percentage of the portfolio attributed to commercial loans. This trend reflects decreased demand for working capital and equipment financing over the course of the last few years. Repayment of commercial loans is largely dependent upon the cash flows generated by the operations of the commercial enterprise. The Banks’ underwriting procedures identify the sources of those cash flows and seek to match the repayment terms of the commercial loans to the sources. Secondary repayment sources are typically found in collateralization and guarantor support.

 

Commercial Real Estate Loans. A large portion of the loan portfolio is comprised of commercial real estate loans. The primary repayment risk for a commercial real estate loan is interruption or discontinuance of cash flows, usually derived from rent, and caused by economic events, which may or may not be under the control of the borrower, or changes in governmental regulations that negatively impact the future cash flow and market values of the affected properties. Repayment risk can also arise from systemic downward shifts in the valuations of classes of properties over a given geographic area, and caused by changes in demand and other economic factors. The Banks mitigate these risks through staying apprised of market conditions and by maintaining underwriting practices that provide for adequate cashflow margins and multiple repayment sources. In most cases, the Banks have collateralized these loans and/or taken personal guarantees to help assure repayment. The commercial real estate loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying real estate acting as collateral. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the real estate and enforcement of a personal guarantee, if any exists.

 

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Construction Loans. The Banks originate loans to finance the construction of residential and commercial properties located in the Company’s market area. The Banks use underwriting and construction loan guidelines for financing where reputable contractors are involved. Construction loans are structured most often to be converted to permanent loans at the end of the construction phase or, infrequently, to be paid off upon receiving financing from another financial institution. Construction loans are based on the appraised value of the property, as determined by an independent appraiser, and an analysis of the potential marketability and profitability of the project, and identification of a cashflow source to service the permanent loan, or verification of a refinancing source. Construction loans generally have terms of up to 12 months, with extensions as needed. The Banks disburse loan proceeds in increments as construction progresses and as inspections warrant.

 

Construction loans afford the Banks the opportunity to increase the interest rate sensitivity of their loan portfolio and to receive yields higher than those obtainable on ARM loans secured by existing residential properties. These higher yields correspond to the higher risks associated with construction lending.

 

Construction development loans involve additional risks. Development lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. This involves more risk than other lending because it is based on future estimates of value and economic circumstances. While appraisals are required prior to funding, and advances are limited to the value determined by the appraisal, there is the possibility of an unseen event affecting the value of the project. Development loans are primarily used for single-family developments, where the sale of lots and houses are tied to the customer preferences and interest rates. If the borrower defaults prior to completion of the project, the Bank may be required to fund additional amounts so that another developer can complete the project. The Banks are located in an area where a large amount of development activity is taking place, as rural and semi-rural areas are being suburbanized. This growth is both unprecedented and not likely to occur again once the area has been fully developed, and therefore extends a one-time opportunity as well as some economic risks should a sudden shift occur in the local demand for housing. The Banks have attempted to address these risks by closely monitoring local real estate activity, strong underwriting procedures, construction monitoring, and by limiting the amount of construction development lending.

 

Residential Real Estate Loans. Residential first mortgage loans made by the organization are primarily originated by Old Second Mortgage Company. Second mortgages and home equity line of credit mortgages are included in this category and are primarily originated by the banks. The majority of loans originated by Old Second Mortgage Company are fixed rate loans that are sold to investors. Beginning in the fourth quarter of 2004, Old Second Mortgage Company became a direct seller to FNMA, and retained servicing rights for those sold mortgages. Management believes that the retention of mortgage servicing provides the Company, on a consolidated basis, with a relatively steady source of fee income as compared to fees generated solely from mortgage origination operations. Moreover, the retention of such servicing rights allows the Banks to continue to have regular contact with mortgage customers and solidifies our involvement with the community. Other loans originated by Old Second Mortgage Company that are not sold to FNMA primarily include adjustable rate mortgages, lot loans, and constructions loans that are purchased for portfolio by the banks.

 

Consumer Loans. The Banks also provide many types of consumer loans including motor vehicle, home improvement, home equity, signature loans and small personal credit lines. Consumer loans typically have shorter terms and lower balances with higher yields as compared to our other loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Home equity lending is a rapidly growing segment of the Banks’ business and the largest share of consumer loans, having replaced indirect automobile financing over the course of the last few years. The Banks have scaled back indirect auto financing in response to lower profit potential caused by low rates and continual incentive financing programs offered by dealers.

 

Competition

 

The Company’s market area is highly competitive. Many financial institutions based in Aurora’s surrounding communities and in Chicago, Illinois, operate banking offices in the greater Aurora area or actively compete for customers within the Company’s market area. The Company also faces competition from finance companies, insurance companies, mortgage companies, securities brokerage firms, money market funds, loan production offices and other providers of financial services.

 

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The Company competes for loans principally through the range and quality of the services it provides, interest rates and loan fees. Management believes that its long-standing presence in the community and personal service philosophy enhances its ability to compete favorably in attracting and retaining individual and business customers. The Company actively solicits deposit-related clients and competes for deposits by offering customers personal attention, professional service and competitive interest rates.

 

The Banks are subject to vigorous competition from other banks and savings and loan associations, as well as credit unions and other financial institutions in the area. Within the Aurora banking market, which geographically covers the southern two-thirds of Kane County and the northern one-third of Kendall County, there are in excess of 20 other financial institutions. Within the Old Second Bank-Yorkville market, which includes portions of Kane and LaSalle counties and all of Kendall County, there are approximately 10 other banks or banking facilities and several savings and loan associations. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.

 

Old Second Mortgage Company faces vigorous competition in its retail operations. Competition for its retail products is principally based on location, convenience, service, quality, reputation and price. Within its retail mortgage banking market, there are approximately four large banks, two national mortgage bankers, and a number of small or mid-sized brokerage operations.

 

Employees

 

At December 31, 2005, the Company employed 548 full-time equivalent employees. The Company places a high priority on staff development, which involves extensive training, including customer service training. New employees are selected on the basis of both technical skills and customer service capabilities. None of the Company’s employees are covered by a collective bargaining agreement with the Company. The Company offers a variety of employee benefits and management considers its employee relations to be excellent.

 

Internet

 

The Company maintains a corporate web site at http://www.o2bancorp.com. The Company makes available free of charge on or through its web site the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnish it to, the Securities and Exchange Commission. Many of the Company’s policies, committee charters and other investor information including our Code of Conduct, are available on the web site. The Company will also provide copies of its filings free of charge upon written request to: J. Douglas Cheatham, Senior Vice President and Chief Financial Officer, Old Second Bancorp, Inc., 37 South River Street, Aurora, Illinois 60506-4172.

 

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SUPERVISION AND REGULATION

 

General

 

Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Illinois Department of Financial and Professional Regulation (the ”DFPR”), the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the ”Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the ”SEC”) and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.

 

Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of the Company and its subsidiaries and is intended primarily for the protection of the FDIC-insured deposits and depositors of the Banks, rather than shareholders.

 

The following is a summary of the material elements of the regulatory framework that applies to the Company and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. As such, the following is qualified in its entirety by reference to applicable law. Any change in statutes, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries.

 

The Company

 

General. The Company, as the sole shareholder of the Banks, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the BHCA. In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Banks and to commit resources to support the Banks in circumstances where the Company might not otherwise do so. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is also required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require.

 

Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.

 

The BHCA generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking ... as to be a proper incident thereto.”  This authority would permit the Company to engage in a variety of banking-related businesses,

 

7

 

including the operation of a thrift, consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies

 

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The Company has elected (and the Federal Reserve has accepted the Company’s election) to operate as a financial holding company.

 

Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances at 10% ownership.

 

Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital levels fall below the minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

 

The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.

 

The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 2005, the Company had regulatory capital in excess of the Federal Reserve’s minimum requirements.

 

Dividend Payments. The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, the Company is subject to the limitations of the Delaware General Corporation Law (the ”DGCL”). The DGCL allows the Company to pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Additionally, policies of the Federal Reserve caution that a bank holding company should not pay cash dividends that exceed its net income or that can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.

 

Federal Securities Regulation. The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the ”Exchange Act”). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

 

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The Banks

 

General. Old Second Bank-Yorkville and Old Second Bank-Kane County (the ”State Banks”) are Illinois-chartered banks, the deposit accounts of which are insured by the FDIC’s Bank Insurance Fund (“BIF”). The State Banks are also members of the Federal Reserve System (“member banks”). As Illinois-chartered, FDIC-insured member banks, the State Banks are subject to the examination, supervision, reporting and enforcement requirements of the DFPR, as the chartering authority for Illinois banks, the Federal Reserve, as the primary federal regulator of member banks, and the FDIC, as administrator of the BIF.

 

The Old Second National Bank of Aurora (the “National Bank”) is a national bank chartered by the OCC under the National Bank Act. The deposit accounts of the National Bank are insured by the BIF, and the National Bank is a member of the Federal Reserve System. The National Bank is subject to the examination, supervision, reporting and enforcement requirements of the OCC, the chartering authority for national banks. The FDIC, as administrator of the BIF, also has regulatory authority over the National Bank.

 

Deposit Insurance. As FDIC-insured institutions, the Banks are required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their respective levels of capital and results of supervisory evaluations. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.

 

During the year ended December 31, 2005, BIF assessments ranged from 0% of deposits to 0.27% of deposits. For the semi-annual assessment period beginning January 1, 2006, BIF assessment rates will continue to range from 0% of deposits to 0.27% of deposits.

 

FICO Assessments.  Since 1987, a portion of the deposit insurance assessments paid by members of the FDIC’s Savings Association Insurance Fund (“SAIF”) has been used to cover interest payments due on the outstanding obligations of the Financing Corporation (“FICO”). FICO was created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the SAIF’s predecessor insurance fund. As a result of federal legislation enacted in 1996, beginning as of January 1, 1997, both SAIF members and BIF members became subject to assessments to cover the interest payments on outstanding FICO obligations until the final maturity of such obligations in 2019. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2005, the FICO assessment rate for BIF and SAIF members was approximately 0.01% of deposits.

 

Supervisory Assessments. All Illinois banks and national banks are required to pay supervisory assessments to the DFPR and the OCC, respectively, to fund the operations of those agencies. The amount of the assessment paid by an Illinois bank to the DFPR is calculated on the basis of the institution’s total assets, including consolidated subsidiaries, as reported to the DFPR. In the case of a national bank, the amount of the assessment paid to the OCC is calculated using a formula that takes into account the bank’s size and its supervisory condition (as determined by the composite rating assigned to the bank as a result of its most recent OCC examination). During the year ended December 31, 2005, the State Banks paid supervisory assessments to the DFPR totaling $97,709 and the National Bank paid supervisory assessments to the OCC totaling $293,947.

 

Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. The federal bank regulatory agencies have established the following minimum capital standards for insured state and national banks, such as the Banks: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.

 

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The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, regulations of the Federal Reserve and the OCC provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.

 

Further, federal law and regulations provide various incentives for financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.” Under the regulations of the Federal Reserve and the OCC, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.

 

Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.

 

As of December 31, 2005: (i) none of the Banks was subject to a directive from its primary federal regulator to increase its capital to an amount in excess of the minimum regulatory capital requirements; (ii) each of the Banks exceeded its minimum regulatory capital requirements under applicable capital adequacy guidelines; and (iii) each of the Banks was “well-capitalized,” as defined by applicable regulations.

 

Liability of Commonly Controlled Institutions. Under federal law, institutions insured by the FDIC may be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of commonly controlled FDIC-insured depository institutions or any assistance provided by the FDIC to commonly controlled FDIC-insured depository institutions in danger of default. Because the Company controls each of the Banks, the Banks are commonly controlled for purposes of these provisions of federal law.

 

Dividend Payments. The primary source of funds for the Company is dividends from the Banks. Under the Illinois Banking Act, the State Banks generally may not pay dividends in excess of their net profits. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such as the State Banks. Generally, member banks may pay dividends out of their undivided profits, in such amounts and at such times as each bank’s board of directors deems prudent. Without prior Federal Reserve approval, however, state member banks may not pay dividends in any calendar year that, in the aggregate, exceed their calendar year-to-date net income plus their retained net income for the two preceding calendar years.

 

Under the National Bank Act, the National Bank may pay dividends out of its undivided profits in such amounts and at such times as its board of directors deems prudent. Without prior OCC approval, however, the National Bank may not pay dividends in any calendar year that, in the aggregate, exceed its year-to-date net income plus its retained net income for the two preceding years.

 

The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, each of the Banks exceeded its minimum capital requirements under applicable guidelines as of December 31, 2005.

 

10

 

As of December 31, 2005, approximately $74 million was available to be paid as dividends by the Banks. Notwithstanding the availability of funds for dividends, however, the Federal Reserve (in the case of the State Banks) and the OCC (in the case of the National Bank) may prohibit the payment of any dividends if the agency determines such payment would constitute an unsafe or unsound practice.

 

Insider Transactions. The Banks are subject to certain restrictions imposed by federal law on extensions of credit to the Company and its subsidiaries, on investments in the stock or other securities of the Company and its subsidiaries and the acceptance of the stock or other securities of the Company or it subsidiaries as collateral for loans made by the Banks. Certain limitations and reporting requirements are also placed on extensions of credit by the Banks to their directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or one of its subsidiaries or a principal shareholder of the Company may obtain credit from banks with which the Banks maintain correspondent relationships.

 

Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

 

In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

 

Branching Authority. Illinois banks, such as the State Banks, have the authority under Illinois law to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals. National banks headquartered in Illinois, such as the National Bank, have the same branching rights in Illinois as banks chartered under Illinois law, subject to OCC approval.

 

Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion.

 

State Bank Investments and Activities. The State Banks generally are permitted to make investments and engage in activities directly or through subsidiaries as authorized by Illinois law. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the State Banks.

 

Financial Subsidiaries. Under Federal law and OCC regulations, national banks are authorized to engage, through “financial subsidiaries,” in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise

 

11

 

permitted by law), (iii) insurance company portfolio investments and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from capital the bank’s outstanding investments in financial subsidiaries). Federal law also provides that state banks may invest in financial subsidiaries (assuming they have the requisite investment authority under applicable state law), subject to substantially the same conditions that apply to national bank investments in financial subsidiaries. None of the Banks has applied for approval to establish any financial subsidiaries.

 

Federal Reserve System. Federal Reserve regulations, as presently in effect, require depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $48.3 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $48.3 million, the reserve requirement is $1.215 million plus 10% of the aggregate amount of total transaction accounts in excess of $48.3 million. The first $7.8 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Banks are in compliance with the foregoing requirements.

 

Recent Regulatory Developments

 

On February 8, 2006, President Bush signed the Federal Deposit Insurance Reform Act of 2005 (“FDIRA”) into law as part of the Deficit Reduction Act of 2005. On February 15, 2006, President Bush signed into law the technical and conforming amendments designed to implement FDIRA. FDIRA provides for legislative reforms to modernize the federal deposit insurance system.

 

Among other things, FDIRA: (i) merges the BIF and the SAIF of the FDIC into a new Deposit Insurance Fund (the ”DIF”); (ii) allows the FDIC, after March 31, 2010, to increase deposit insurance coverage by an adjustment for inflation and requires the  FDIC’s Board of Directors, not later than April 1, 2010 and every five years thereafter, to consider whether such an increase is warranted; (iii) increases the deposit insurance limit for certain employee benefit plan deposits from $100,000 to $250,000, subject to adjustments for inflation after March 31, 2010, and provides for pass-through insurance coverage for such deposits; (iv) increases the deposit insurance limit for certain retirement account deposits from $100,000 to $250,000, subject to adjustments for inflation after March 31, 2010; (v) allows the FDIC’s Board of Directors to set deposit insurance premium assessments in any amount the Board of Directors deems necessary or appropriate, after taking into account various factors specified in FDIRA; (vi) replaces the fixed designated reserve ratio of 1.25% with a reserve ratio range of 1.15%-1.50%, with the specific reserve ratio to be determined annually by the FDIC by regulation; (vii) permits the FDIC to revise the risk-based assessment system by regulation; (viii) requires the FDIC, at the end of any year in which the reserve ratio of the DIF exceeds 1.50% of estimated insured deposits, to declare a dividend payable to insured depository institutions in an amount equal to 100% of the amount held by the DIF in excess of the amount necessary to maintain the DIF’s reserve ratio at 1.50% of estimated insured deposits or to declare a dividend equal to 50% of the amount in excess of the amount necessary to maintain the reserve ratio at 1.35% if the reserve ratio is between 1.35%-1.50% of  estimated insured deposits; and (ix) provides a one-time credit based upon the assessment base of the institution on December 31, 1996 to each insured depository institution that was in existence as of December 31, 1996 and paid a deposit insurance assessment prior to that date (or a successor to any such institution).

 

The merger of the BIF and the SAIF will take effect no later than July 1, 2006, while the remaining provisions are not effective until the FDIC issues final regulations. FDIRA requires the FDIC to issue final regulations no later than 270 days after enactment: (i) designating a reserve ratio; (ii) implementing increases in deposit insurance coverage; (iii) implementing the dividend requirement; (iv) implementing the one-time assessment credit; and (v) providing for assessments in accordance with FDIRA.

 

The statistical data required by Guide 3 of the Guides for Preparation and Filing of Reports and Registration Statements under the Securities Exchange Act of 1934 is set forth in the following pages. This data should be read in conjunction with the consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as set forth in the 2005 Annual Report incorporated herein by reference (attached hereto as Exhibit 13). All dollars in the tables are expressed in thousands.

 

12

 

The following table sets forth certain information relating to the Company’s average consolidated balance sheets and reflects the yield on average earning assets and cost of average liabilities for the years indicated. Dividing the related interest by the average balance of assets or liabilities derives rates. Average balances are derived from daily balances.

 

ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

Years ended December 31, 2005, 2004, and 2003

 

		2005								2004								2003
		Average								Average								Average
		Balance			Interest			Rate		Balance			Interest			Rate		Balance			Interest			Rate
ASSETS
Interest bearing deposits		$	361		$	3		0.83	%	$	307		$	4		1.14	%	$	576		$	1		0.15	%
Federal funds sold		216			7			3.24		3,967			58			1.47		9,627			105			1.09
Securities:
Taxable		338,167			12,064			3.57		320,185			10,624			3.32		314,724			10,883			3.46
Non-taxable (tax equivalent)		139,137			7,400			5.32		97,221			5,023			5.17		64,997			3,825			5.88
Total securities		477,304			19,464			4.08		417,406			15,647			3.75		379,721			14,708			3.87
Loans and loans held for sale		1,629,615			103,551			6.35		1,437,030			83,653			5.82		1,232,129			74,562			6.05
Total interest earning assets		2,107,496			123,025			5.84		1,858,710			99,362			5.35		1,622,053			89,376			5.51
Cash and due from banks		55,063			—			—		52,228			—			—		45,993			—			—
Allowance for loan losses		(15,522		)	—			—		(18,295		)	—			—		(17,017		)	—			—
Other noninterest-bearing assets		92,297			—			—		73,372			—			—		50,747			—			—
Total assets		$	2,239,334							$	1,966,015							$	1,701,776
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest bearing transaction accounts		$	237,027		1,699			0.72		$	244,806		1,018			0.42		$	216,859		836			0.39
Savings accounts		573,334			10,289			1.79		515,646			5,403			1.05		508,337			5,430			1.07
Time deposits		819,341			26,052			3.18		696,013			18,602			2.67		541,588			16,967			3.13
Interest bearing deposits		1,629,702			38,040			2.33		1,456,465			25,023			1.72		1,266,784			23,233			1.83
Repurchase agreements		45,993			1,303			2.83		37,006			450			1.22		46,990			511			1.09
Federal funds purchased and other borrowed funds		114,560			4,308			3.76		71,515			1,037			1.45		33,369			477			1.43
Junior subordinated debentures		31,625			2,448			7.74		31,625			2,486			7.86		15,962			1,233			7.72
Notes payable		2,910			125			4.30		1,638			43			2.63		619			14			2.23
Total interest bearing liabilities		1,824,790			46,224			2.53		1,598,249			29,039			1.82		1,363,724			25,468			1.87
Noninterest bearing deposits		253,649			—			—		227,912			—			—		199,572			—			—
Accrued interest and other liabilities		16,052			—			—		13,856			—			—		13,227			—			—
Stockholders’ equity		144,843			—			—		125,998			—			—		125,253			—			—
Total liabilities and stockholders’ equity		$	2,239,334							$	1,966,015							$	1,701,776
Net interest income (tax equivalent)					$	76,801		3.31	%				$	70,323		3.53	%				$	63,908		3.64	%
Net interest income (tax equivalent) to total earning assets								3.64	%							3.78	%							3.94	%
Interest bearing liabilities to earnings assets		86.59		%						85.99		%						84.07		%

 

Notes:  Nonaccrual loans are included in the above stated average balances.  Tax equivalent basis is calculated using a marginal rate of 35%

For purposes of this discussion, both net interest income and net interest margin have been adjusted to a fully tax equivalent basis to more appropriately compare the returns on certain tax-exempt loans and securities to those interest-earning assets.  The effect of such adjustments is presented in the following table:

 

		Effect of Tax Equivalent Adjustment
		2005			2004			2003
Net interest income		$	73,999		$	68,359		$	62,376
Tax equivalent adjustment		2,802			1,964			1,532
Tax equivalent net interest income		$	76,801		$	70,323		$	63,908

 

13

 

The following table allocates the changes in net interest income to changes in either average balances or average rates for earnings assets and interest bearing liabilities. The changes in interest due to both volume and rate have been allocated proportionately to the change due to balance and due to rate. Interest income is measured on a tax equivalent basis using a 35% rate.

 

ANALYSIS OF YEAR-TO-YEAR CHANGES IN NET INTEREST INCOME

 

		2005 Compared to 2004									2004 Compared to 2003
		Change Due to									Change Due to
		Average			Average			Total			Average			Average			Total
		Balance			Rate			Change			Balance			Rate			Change
EARNING ASSETS/INTEREST INCOME
Interest bearing deposits		$	1		$	(2	)	$	(1	)	$	—		$	3		$	3
Federal funds sold		(84		)	33			(51		)	(75		)	28			(47		)
Securities:
Taxable		616			824			1,440			187			(446		)	(259		)
Tax-exempt		2,226			151			2,377			1,711			(513		)	1,198
Loans and loans held for sale		11,821			8,077			19,898			12,015			(2,924		)	9,091
TOTAL EARNING ASSETS		14,580			9,083			23,663			13,838			(3,852		)	9,986
INTEREST BEARING LIABILITIES/ INTEREST EXPENSE
Interest bearing transaction accounts		(33		)	714			681			113			69			182
Savings accounts		662			4,224			4,886			78			(105		)	(27		)
Time deposits		3,598			3,852			7,450			4,369			(2,734		)	1,635
Repurchase agreements		131			722			853			(117		)	56			(61		)
Federal funds purchased and other borrowed funds		897			2,374			3,271			553			7			560
Trust preferred debentures		—			(38		)	(38		)	1,231			22			1,253
Notes payable		45			37			82			27			2			29
INTEREST BEARING LIABILITIES		5,300			11,885			17,185			6,254			(2,683		)	3,571
NET INTEREST INCOME		$	9,280		$	(2,802	)	$	6,478		$	7,584		$	(1,169	)	$	6,415

 

The following table presents the composition of the securities portfolio by major category as of December 31, of each year indicated:

 

SECURITIES PORTFOLIO COMPOSITION

 

		2005					2004					2003
					% of					% of					% of
		Amount			Portfolio		Amount			Portfolio		Amount			Portfolio
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities		$	10,737		2.24	%	$	992		0.22	%	$	2,011		0.49	%
U.S. Government agencies		313,671			65.51	%	313,169			69.14	%	320,539			77.98	%
States and political subdivisions		145,971			30.48	%	131,590			29.05	%	82,296			20.02	%
Mortgage-backed securities		—			0.00	%	185			0.04	%	1,541			0.37	%
Other securities		8,470			1.77	%	7,006			1.55	%	4,648			1.13	%
		$	478,849		100.00	%	$	452,942		100.00	%	$	411,035		100.00	%

 

14

 

SECURITIES AVAILABLE FOR SALE-MATURITY AND YIELDS

 

The following table presents the expected maturities or call dates and weighted average yield of securities by major category as of December 31, 2005. Yields are calculated on a tax equivalent basis using a 35% rate.

 

							After One But					After Five But
		Within One Year					Within Five Years					Within Ten Years					After Ten Years					Total
		Amount			Yield		Amount			Yield		Amount			Yield		Amount			Yield		Amount			Yield
U.S. Treasury securities		$	993		2.40	%	$	4,853		3.79	%	$	4,891		4.01	%	$	—		0.00	%	$	10,737		3.76	%
U.S. government agencies		72,796			2.92	%	172,020			3.75	%	47,547			4.96	%	21,307			4.97	%	313,670			3.83	%
States and political subdivisions		10,341			2.96	%	17,930			3.48	%	54,654			3.73	%	63,047			3.39	%	145,972			3.50	%
		84,130			2.92	%	194,803			3.73	%	107,092			4.29	%	84,354			3.79	%	470,379			3.72	%
Other securities																						8,470
		$	84,130		2.92	%	$	194,803		3.73	%	$	107,092		4.29	%	$	84,354		3.79	%	$	478,849		3.73	%

 

As of December 31, 2005, net unrealized losses of $7,562,000, offset by deferred income taxes of $3,000,000, resulted in a decrease in equity capital of $4,562,000. As of December 31, 2004, net unrealized gains of $538,000, offset by deferred income taxes of $214,000, resulted in an increase in equity capital of $324,000.

 

LOAN PORTFOLIO

 

The following table presents the composition of the loan portfolio at December 31, for the years indicated:

 

		2005			2004			2003			2002			2001
Commercial and industrial		$	168,052		$	170,535		$	191,390		$	208,535		$	186,435
Real estate - commercial		590,328			512,661			456,391			411,122			310,297
Real estate - construction		361,859			269,537			218,519			120,899			112,206
Real estate - residential		548,651			514,020			408,789			262,304			214,740
Installment / Others		35,492			42,323			44,449			59,007			71,780
Gross loans		1,704,382			1,509,076			1,319,538			1,061,867			895,458
Unearned discount		—			—			—			—			(3		)
Total loans		1,704,382			1,509,076			1,319,538			1,061,867			895,455
Allowance for loan losses		(15,329		)	(15,495		)	(18,301		)	(15,769		)	(12,313		)
Loans, net		$	1,689,053		$	1,493,581		$	1,301,237		$	1,046,098		$	883,142

 

MATURITY AND RATE SENSITIVITY OF LOANS

 

The following table sets forth the remaining contractual maturities for certain loan categories at December 31, 2005:

 

					Over 1 Year
					Through 5 Years						Over 5 Years
		One Year			Fixed			Floating			Fixed			Floating
		or Less			Rate			Rate			Rate			Rate			Total
Commercial and industrial		$	93,476		$	46,534		$	19,007		$	7,827		$	1,208		$	168,052
Real estate		342,729			515,420			116,268			89,936			436,485			1,500,838
Installment / Others		10,562			20,183			4,233			467			47			35,492
Total		$	446,767		$	582,137		$	139,508		$	98,230		$	437,740		$	1,704,382

 

15

 

NONPERFORMING ASSETS

 

The following table sets forth the amounts of nonperforming assets at December 31, of the years indicated:

 

		2005			2004			2003			2002			2001
Nonaccrual loans		$	3,845		$	5,129		$	2,265		$	4,803		$	2,560
Loans past due 90 days or more and still accruing interest		2,752			116			381			641			771
Restructured loans		—			—			—			—			—
Total nonperforming loans		6,597			5,245			2,646			5,444			3,331
Other real estate owned		251			—			663			131			—
Total nonperforming assets		$	6,848		$	5,245		$	3,309		$	5,575		$	3,331

 

Accrual of interest is discontinued on a loan when principal or interest is ninety days or more past due, unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, interest previously accrued but not collected in the current period is reversed against current period interest income. Interest accrued in prior years but not collected is charged against the allowance for loan losses. Interest income of approximately $334,000 was recorded during 2005, $229,000 was recorded during 2004, and no interest income recorded during 2003, on loans in nonaccrual status at year-end. Interest income, which would have been recognized during 2005, 2004, and 2003, had these loans been on an accrual basis throughout the year, was approximately $636,000, $409,000, and $167,000, respectively.

 

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

 

The following table summarizes, for the years indicated, activity in the allowance for loan losses, including amounts charged off, amounts of recoveries, additions to the allowance charged to operating expense, and the ratio of net charge-offs to average loans outstanding:

 

		2005			2004			2003			2002			2001
Average total loans (exclusive of loans held for sale)		$	1,617,557		$	1,421,483		$	1,183,290		$	969,982		$	794,147
Allowance at beginning of year		$	15,495		$	18,301		$	15,769		$	12,313		$	9,690
Charge-offs:
Commercial and industrial		674			402			971			752			1,063
Real estate		70			18			42			25			145
Installment and other loans		305			337			463			383			294
Total charge-offs		1,049			757			1,476			1,160			1,502
Recoveries:
Commercial and industrial		468			688			489			462			142
Real estate		—			11			25			128			4
Installment and other loans		62			152			243			221			139
Total recoveries		530			851			757			811			285
Net charge-offs (recoveries)		519			(94		)	719			349			1,217
Provision for loan losses		353			(2,900		)	3,251			3,805			3,840
Allowance at end of period		$	15,329		$	15,495		$	18,301		$	15,769		$	12,313
Net charge-offs (recoveries) to average loans		0.03		%	-0.01		%	0.06		%	0.04		%	0.15		%
Allowance at year end to average loans		0.95		%	1.09		%	1.55		%	1.63		%	1.55		%

 

16

 

The provision for loan losses is based upon management’s estimate of losses inherent in the portfolio and its evaluation of the adequacy of the allowance for loan losses. Factors which influence management’s judgement in estimating loan losses are the composition of the portfolio, past loss experience, loan delinquencies, nonperforming loans, and other factors that, in management’s judgment, deserve evaluation in estimating loan losses.

 

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

 

The following table shows the Company’s allocation of the allowance for loan losses by types of loans and the amount of unallocated allowance, at December 31, of the years indicated:

 

		2005					2004					2003					2002
					Loan Type					Loan Type					Loan Type					Loan Type
					to Total					to Total					to Total					to Total
		Amount			Loans		Amount			Loans		Amount			Loans		Amount			Loans
Commercial and industrial		$	3,332		9.9	%	$	5,221		11.3	%	$	3,728		14.5	%	$	6,016		19.5	%
Real estate - commercial		1,379			34.6	%	1,349			34.1	%	5,766			34.7	%	4,500			38.8	%
Real estate - construction		8,059			21.2	%	6,144			17.8	%	6,080			16.5	%	1,166			11.5	%
Real estate - residential		332			32.3	%	700			34.0	%	277			30.9	%	500			24.7	%
Installment and other loans		738			2.1	%	400			2.8	%	1,410			3.4	%	945			5.5	%
Unallocated		1,489			—		1,681			—		1,040			—		2,642			—
Total		$	15,329		100.0	%	$	15,495		100.0	%	$	18,301		100.0	%	$	15,769		100.0	%

 

CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES,

AND OFF-BALANCE SHEET ARRANGEMENTS

 

The Company has various financial obligations that may require future cash payments. The following table presents, as of December 31, 2005, significant fixed and determinable contractual obligations to third parties by payment date.

 

		Within			One to			Three to			Over
		One Year			Three Years			FiveYears			Five Years			Total
		Amount			Amount			Amount			Amount			Amount
Deposits without a stated maturity		$	1,059,152		$	—		$	—		$	—		$	1,059,152
Certificates of deposit		578,310			248,694			49,025			97			876,126
Federal funds purchased, security repurchase agreements and FHLB advances		227,625			—			—			—			227,625
Borrowed funds		3,200			—			—			—			3,200
Junior subordinated debentures		—			—			—			31,625			31,625
Purchase obligations		3,678			5,434			5,434			2,718			17,264
Operating leases		509			1,247			896			465			3,167
Other		1,825			—			—			—			1,825
Total		$	1,874,299		$	255,425		$	55,355		$	34,905		$	2,219,984

 

Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The purchase obligation amounts presented above primarily relate to certain contractual payments for services provided for information technology, capital expenditures, and the outsourcing of certain operational activities.

 

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