With its credit problems deepening, Old Second Bancorp Inc. of Aurora, Ill., is slashing expenses and its dividend in an attempt to return to profitability and boost its tangible common equity ratio.
But analysts said the $2.9 billion-asset company might need to do even more, given that 5.42% of its assets are nonperforming.
William Skoglund, Old Second's chairman, has outlined numerous cuts, including laying off 10% of its staff, or 62 people. He said that most of the layoffs were in sales and commercial lending, and that he does not expect to trim additional jobs. "Any more and we think we would be cutting into the muscle of the organization," he said.
Old Second shrunk its dividend by 75%, to 4 cents a share. The goal is to get its tangible common equity ratio, now at 4.41%, north of 5%, Skoglund said.
In a March 25 letter to shareholders, he described the dividend cut as "a precautionary measure" meant to help ensure a strong capital position even if the economy worsens significantly.
Analysts applauded the company's efforts but said it might just be buying time before it has to look for outside capital.
Daniel Arnold, an analyst at Sandler O'Neill & Partners LP, said a tangible common equity ratio above 5% is desirable but not entirely satisfying. "It would certainly put them in a better place than what they were. But if things get worse, 5% might not prove to be enough."
At some point Old Second still might need to raise capital by selling common shares, which would be dilutive, Arnold said. "If things were to worsen, particularly on the commercial real estate side, their capital cushion begins to look a little thin," he said.
In a March 18 research note, Eileen Rooney, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc., cited two concerns: the nonperforming assets ratio and the construction and development loans that make up 16% of the company's portfolio. She also wrote that Old Second might need to further raise its tangible common equity ratio.
Brian Martin, an analyst with Howe Barnes Hoefer & Arnett Inc., called the dividend cut "prudent" in a March 19 note because "it helps delay and/or eliminate the need for a near-term capital raise." And for Old Second, he wrote, "there is a good chance a capital raise, even a punitive one, could not get done in the current environment."
Old Second reported a $5.2 million fourth-quarter loss, after posting a $1.7 million profit for the fourth quarter of 2007. It had a $21.2 million provision, compared with no provision in the year-earlier period. Nonperforming assets rose 2,000%, to $123.8 million.
However, the company's yearend regulatory capital ratios exceeded the minimums to be classified as well capitalized. Adjusting for the $73 million Old Second received from the Treasury Department's Troubled Asset Relief Program on Jan. 16, it had a core capital ratio of 9.02%, a Tier 1 risk-based capital ratio of 10.65% and a total risk-based capital ratio of 13.74%.
Skoglund said Old Second should save $1 million a month from its cost-cutting initiative. The company is not paying bonuses to executives this year. It is also reducing matching contributions to 401(k) plans and eliminating profit-sharing accruals. Branch sales are a possibility.
Old Second walked "a fine line" with the layoffs, Skoglund said. "We want to be in a position to go back and grow quickly once things begin to rebound."
But Arnold said growth is not likely anytime soon for Old Second. He said expense reductions were a good idea, because if they return the company to profitability, that would benefit its capital ratios further. "They are cost-cutting in the near term rather than looking at revenue growth," he said.
