UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended ~~September~~June 30, ~~2017~~2019


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

For transition period from to

Commission File Number ~~0 -10537~~0-10537

(Exact name of Registrant as specified in its charter)


Delaware		36-3143493
(State or other jurisdiction		(I.R.S. Employer Identification Number)
of incorporation or organization)

37 South River Street, Aurora, Illinois 60507

(Address of principal executive offices) (Zip Code)

(630) 892-0202

(Registrant’s telephone number, including area code)

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate Web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of ‘‘large accelerated filer,’’ ‘‘accelerated filer,’’ ‘‘smaller reporting company,’’ and ‘‘emerging growth company’’ in Rule 12b–2 of the Exchange Act.

Large accelerated filer☐Accelerated filer☒

Non-accelerated filer☐Smaller reporting company☐Emerging growth company☐

~~(Do not check if a smaller reporting company)~~

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Yes ☐ No ☒


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	OSBC	The Nasdaq Stock Market
Preferred Securities of Old Second Capital Trust I	OSBCP	The Nasdaq Stock Market

As of ~~November 3, 2017,~~August 2, 2019, the Registrant ~~had 29,627,086~~has 29,896,529 shares of common stock outstanding at $1.00 par value per share.

~~Tableof Contents~~

OLD SECOND BANCORP, INC.

Form 10-Q Quarterly Report

Table of Contents

Cautionary Note Regarding Forward Looking Statements

~~Tableof Contents~~

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report and other publicly available documents of the Company contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act, including with respect to management’s expectations regarding future plans, strategies and financial performance, including regulatory developments, industry and economic trends, and other matters. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, can be identified by the inclusion of such qualifications as “expects,” “intends,” “believes,” “may,” “will,” “would,” “could,” “should,” “plan,” “anticipate,” “estimate,” “possible,” “likely” or other indications that the particular statements are not historical facts and refer to future periods. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and may be outside of the Company’s control. Actual events and results may differ materially from those described in such forward-looking statements due to numerous factors, including:

negative economic conditions that adversely affect the economy, real estate values, the job market and other factors nationally and in our market area, in each case that may affect our liquidity and the performance of our loan portfolio;

our ability to achieve anticipated results from our acquisition of Greater Chicago Financial Corp. depends on the state of the economic and financial markets going forward. Specifically, we may incur more credit losses than expected, cost savings may be less than expected, anticipated strategic gains may be significantly harder or take longer to achieve than expected or may not be achieved in their entirety, and customer attrition may be greater than expected;

the financial success and viability of the borrowers of our commercial loans;

changes in U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that may affect, among other things, our liquidity and the value of our assets and liabilities;

competitive pressures from other financial service businesses and from nontraditional financial technology (“FinTech”) companies;

any negative perception of our reputation or financial strength;

ability to raise additional capital on acceptable terms when needed;

ability to use technology to provide products and services that will satisfy customer demands and create efficiencies in operations;

adverse effects on our information technology systems resulting from failures, human error or cyberattacks;

adverse effects of failures by our vendors to provide agreed upon services in the manner and at the cost agreed, particularly our information technology vendors;

the impact of any claims or legal actions, including any effect on our reputation;

losses incurred in connection with repurchases and indemnification payments related to mortgages;

the soundness of other financial institutions and other counter-party risk;

changes in accounting standards, rules and interpretations and the impact on our financial statements;

our ability to receive dividends from our subsidiaries;

a decrease in our regulatory capital ratios;

adverse federal or state tax assessments;

litigation or government enforcement actions;

legislative or regulatory changes, particularly changes in regulation of financial services companies;

increased costs of compliance, heightened regulatory capital requirements and other risks associated with changes in regulation and the current regulatory environment, including the Dodd-Frank Act; and

each of the factors and risks under the heading “Risk Factors” in our 2018 Annual Report on Form 10-K and in subsequent filings we make with the SEC.

Because the Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain, there can be no assurances that future actual results will correspond to any forward-looking statements and you should not rely on any forward-looking statements. Additionally, all statements in this Form 10-Q, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events, except as required by applicable law.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)


	(unaudited)				(unaudited)
	September 30,		December 31,		June 30,		December 31,
	2017		2016		2019		2018
Assets
Cash and due from banks	$	32,772	$	33,805	$	38,036	$	38,599
Interest bearing deposits with financial institutions		14,730		13,529
Interest earning deposits with financial institutions						20,181		16,636
Cash and cash equivalents		47,502		47,334		58,217		55,235
Securities available-for-sale, at fair value		533,484		531,838		492,080		541,248
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock		10,393		7,918		10,608		13,433
Loans held-for-sale		1,641		4,918		5,142		2,984
Loans		1,594,191		1,478,809		1,902,943		1,897,027
Less: allowance for loan losses		16,465		16,158
Less: allowance for loan and lease losses						19,372		19,006
Net loans		1,577,726		1,462,651		1,883,571		1,878,021
Premises and equipment, net		37,971		38,977		42,551		42,439
Other real estate owned		9,024		11,916		5,668		7,175
Mortgage servicing rights, net		6,684		6,489		5,818		7,357
Goodwill and core deposit intangible		8,944		9,018		21,561		21,814
Bank-owned life insurance ("BOLI")		61,403		60,332		62,322		61,544
Deferred tax assets, net		42,394		53,464		14,277		21,280
Other assets		23,241		16,333		21,791		23,473
Total assets	$	2,360,407	$	2,251,188	$	2,623,606	$	2,676,003

Liabilities
Deposits:
Noninterest bearing demand	$	556,874	$	513,688	$	632,900	$	618,830
Interest bearing:
Savings, NOW, and money market		947,969		950,849		1,023,621		1,040,668
Time		384,272		402,248		421,253		457,175
Total deposits		1,889,115		1,866,785		2,077,774		2,116,673
Securities sold under repurchase agreements		26,853		25,715		54,166		46,632
Other short-term borrowings		125,000		70,000		87,125		149,500
Junior subordinated debentures		57,627		57,591		57,710		57,686
Senior notes		44,033		43,998		44,208		44,158
Notes payable and other borrowings						11,035		15,379
Other liabilities		17,016		11,889		34,324		16,894
Total liabilities		2,159,644		2,075,978		2,366,342		2,446,922

Stockholders’ Equity
Common stock		34,626		34,534		34,825		34,720
Additional paid-in capital		117,458		116,653		119,762		119,081
Retained earnings		145,767		129,005		192,612		175,463
Accumulated other comprehensive loss		(632)		(8,762)
Accumulated other comprehensive income (loss)						6,112		(4,079)
Treasury stock		(96,456)		(96,220)		(96,047)		(96,104)
Total stockholders’ equity		200,763		175,210		257,264		229,081
Total liabilities and stockholders’ equity	$	2,360,407	$	2,251,188	$	2,623,606	$	2,676,003


	September 30, 2017		December 31, 2016		June 30, 2019		December 31, 2018
	Common		Common		Common		Common
	Stock		Stock		Stock		Stock
Par value	$	1.00	$	1.00	$	1.00	$	1.00
Shares authorized		60,000,000		60,000,000		60,000,000		60,000,000
Shares issued		34,625,734		34,534,234		34,825,340		34,719,517
Shares outstanding		29,627,086		29,556,216		29,896,529		29,763,078
Treasury shares		4,998,648		4,978,018		4,928,811		4,956,439

See accompanying notes to consolidated financial statements.

~~Tableof Contents~~

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except per share data)


	(unaudited)				(unaudited)					(unaudited)			(unaudited)
	Quarters Ended September 30,				Nine Months Ended September 30,				Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016		2019		2018		2019		2018
Interest and dividend income
Loans, including fees	$	18,208	$	13,496	$	52,202	$	39,593	$	24,924	$	22,512	$	49,023	$	41,248
Loans held-for-sale		34		48		95		115		31		35		53		55
Securities:
Taxable		2,424		3,954		7,994		12,547		2,223		2,392		4,637		4,562
Tax exempt		1,628		180		4,188		579		2,141		2,114		4,239		4,175
Dividends from FHLBC and FRBC stock		94		83		271		251		156		111		305		217
Interest bearing deposits with financial institutions		37		64		91		98		111		97		225		146
Total interest and dividend income		22,425		17,825		64,841		53,183		29,586		27,261		58,482		50,403
Interest expense
Savings, NOW, and money market deposits		239		193		695		577		759		501		1,530		845
Time deposits		1,077		931		3,081		2,622		1,641		1,444		3,259		2,619
Securities sold under repurchase agreements										147		104		296		183
Other short-term borrowings		224		23		482		69		575		276		1,182		605
Junior subordinated debentures		930		1,084		3,073		3,251		931		927		1,858		1,854
Senior notes		672		-		2,017		-		672		672		1,344		1,344
Subordinated debt		-		245		-		727
Notes payable and other borrowings		-		2		-		6		107		95		223		95
Total interest expense		3,142		2,478		9,348		7,252		4,832		4,019		9,692		7,545
Net interest and dividend income		19,283		15,347		55,493		45,931		24,754		23,242		48,790		42,858
Provision for loan losses		300		-		1,050		-
Net interest and dividend income after provision for loan losses		18,983		15,347		54,443		45,931
Provision for loan and lease losses										450		1,450		900		728
Net interest and dividend income after provision for loan and lease losses										24,304		21,792		47,890		42,130
Noninterest income
Trust income		1,468		1,403		4,564		4,274		1,739		1,645		3,225		3,140
Service charges on deposits		1,722		1,756		4,955		4,961		1,959		1,769		3,821		3,361
Secondary mortgage fees		195		322		594		795		203		195		339		357
Mortgage servicing rights mark to market loss		(194)		(147)		(756)		(1,921)
Mortgage servicing rights mark to market (loss) gain										(1,137)		(105)		(1,956)		200
Mortgage servicing income		451		437		1,330		1,280		491		627		948		1,079
Net gain on sales of mortgage loans		1,095		2,177		3,715		5,031		1,163		1,240		1,925		2,157
Securities gain (loss), net		102		(1,959)		(165)		(2,020)
Securities gains, net										986		312		1,013		347
Increase in cash surrender value of BOLI		362		383		1,071		987		320		351		778		599
Death benefit realized on BOLI										-		-		-		1,026
Debit card interchange income		1,075		1,013		3,131		3,009		1,166		1,132		2,153		2,144
Gain (loss) on disposal and transfer of fixed assets, net		-		-		10		(1)
Other income		1,567		1,209		3,739		3,751		1,253		1,366		2,379		2,627
Total noninterest income		7,843		6,594		22,188		20,146		8,143		8,532		14,625		17,037
Noninterest expense
Salaries and employee benefits		10,049		9,014		31,167		26,854		11,587		12,355		23,199		22,562
Occupancy, furniture and equipment		1,482		1,500		4,510		4,427		1,925		1,652		3,914		3,210
Computer and data processing		1,081		1,105		3,283		3,093		1,524		2,741		2,856		4,085
FDIC insurance		199		228		512		793		116		165		290		321
General bank insurance		246		269		780		839		236		299		486		550
Amortization of core deposit intangible		24		-		74		-		121		97		253		118
Advertising expense		255		430		1,093		1,212		381		492		615		833
Debit card interchange expense		285		363		1,033		1,186		233		301		380		582
Legal fees		162		242		450		594		243		286		369		445
Other real estate expense, net		680		426		1,928		2,043		248		429		298		602
Other expense		2,455		3,005		8,128		8,505		3,512		3,469		6,660		6,332
Total noninterest expense		16,918		16,582		52,958		49,546		20,126		22,286		39,320		39,640
Income before income taxes		9,908		5,359		23,673		16,531		12,321		8,038		23,195		19,527
Provision for income taxes		1,831		1,860		6,023		5,865		3,043		1,777		5,449		3,777
Net income	$	8,077	$	3,499	$	17,650	$	10,666	$	9,278	$	6,261	$	17,746	$	15,750

Basic earnings per share	$	0.27	$	0.12	$	0.60	$	0.36	$	0.31	$	0.21	$	0.59	$	0.53
Diluted earnings per share		0.27		0.12		0.59		0.36		0.31		0.21		0.58		0.52
Dividends declared per share										0.01		0.01		0.02		0.02

See accompanying notes to consolidated financial statements.

~~Tableof Contents~~

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(In thousands)

(unaudited)

(unaudited)

Quarters Ended September 30,

Nine Months Ended  September 30,


2017

2016

2017

2016
Net Income

$
8,077

$
3,499

$
17,650

$
10,666

Unrealized holding gains (losses) on available-for-sale securities arising during the period

2,971

(616)

13,798

5,151
Related tax (expense) benefit

(1,191)

237

(5,516)

(2,071)
Holding gains (losses) after tax on available-for-sale securities

1,780

(379)

8,282

3,080

Less: Reclassification adjustment for the net gains (losses) realized during the period

Net realized gains (losses)

102

(1,959)

(165)

(2,020)
Income tax (expense) benefit on net realized gains (losses)

(42)

782

64

807
Net realized gains (losses) after tax

60

(1,177)

(101)

(1,213)
Other comprehensive income  on available-for-sale securities

1,720

798

8,383

4,293

Accretion and reversal of net unrealized holding gains on held-to-maturity securities

-

-

-

5,939
Related tax expense

-

-

-

(2,446)
Other comprehensive income on held-to-maturity securities

-

-

-

3,493

Changes in fair value of derivatives used for cashflow hedges

19

(254)

(445)

(4,278)
Related tax benefit

8

102

192

1,714
Other comprehensive income (loss) on cashflow hedges

27

(152)

(253)

(2,564)

Total other comprehensive income

1,747

646

8,130

5,222
Total comprehensive income

$
9,824

$
4,145

$
25,780

$
15,888


	(unaudited)				(unaudited)
	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Net Income	$	9,278	$	6,261	$	17,746	$	15,750

Unrealized holding gains (losses) on available-for-sale securities arising during the period		8,645		(1,391)		17,837		(10,199)
Related tax (expense) benefit		(2,432)		392		(5,019)		2,876
Holding gains (losses) after tax on available-for-sale securities		6,213		(999)		12,818		(7,323)

Less: Reclassification adjustment for the net gains realized during the period
Net realized gains		986		312		1,013		347
Related tax expense		(276)		(88)		(284)		(98)
Net realized gains after tax		710		224		729		249
Other comprehensive income (loss) on available-for-sale securities		5,503		(1,223)		12,089		(7,572)

Changes in fair value of derivatives used for cash flow hedges		(1,569)		515		(2,642)		1,794
Related tax benefit (expense)		442		(145)		744		(507)
Other comprehensive (loss) income on cash flow hedges		(1,127)		370		(1,898)		1,287

Total other comprehensive income (loss)		4,376		(853)		10,191		(6,285)
Total comprehensive income	$	13,654	$	5,408	$	27,937	$	9,465


	Accumulated		Accumulated		Total
	Unrealized Gain		Unrealized Gain		Accumulated Other
	(Loss) on Securities		(Loss) on Derivative		Comprehensive
	Available-for -Sale		Instruments		Income/(Loss)
For the Three Months Ended
Balance, March 31, 2019	$	2,548	$	(812)	$	1,736
Other comprehensive income (loss), net of tax		5,503		(1,127)		4,376
Balance, June 30, 2019	$	8,051	$	(1,939)	$	6,112

Balance, March 31, 2018	$	(3,629)	$	(5)	$	(3,634)
Other comprehensive (loss) income, net of tax		(1,222)		369		(853)
Balance, June 30, 2018	$	(4,851)	$	364	$	(4,487)



For the Six Months Ended
Balance, December 31, 2018	$	(4,038)	$	(41)	$	(4,079)
Other comprehensive income (loss), net of tax		12,089		(1,898)		10,191
Balance, June 30, 2019	$	8,051	$	(1,939)	$	6,112

Balance, December 31, 2017	$	2,239	$	(760)	$	1,479
Reclassification of stranded tax effects		482		(163)		319
Other comprehensive (loss) income, net of tax		(7,572)		1,287		(6,285)
Balance, June 30, 2018	$	(4,851)	$	364	$	(4,487)

See accompanying notes to consolidated financial statements.

~~Tableof Contents~~

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

Nine Months Ended  September 30,

2017

2016

Cash flows from operating activities

Net income

$
17,650

$
10,666

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Depreciation of fixed assets and amortization of leasehold improvements

1,760

1,682

Change in fair value of mortgage servicing rights

756

1,921

Loan loss reserve

1,050

-

Provision for deferred tax expense

5,682

5,476

Originations of loans held-for-sale

(113,077)

(147,187)

Proceeds from sales of loans held-for-sale

119,059

150,247

Net gain on sales of mortgage loans

(3,715)

(5,031)

Net discount accretion of purchase accounting adjustment on loans

(1,115)

-

Change in current income taxes receivable

111

300

Increase in cash surrender value of BOLI

(1,071)

(987)

Change in accrued interest receivable and other assets

(6,849)

(2,659)

Change in accrued interest payable and other liabilities

4,571

(246)

Net premium amortization/discount (accretion) on securities

1,320

(517)

Securities losses, net

165

2,020

Amortization of core deposit

74

-

Amortization of junior subordinated debentures issuance costs

36

36

Amortization of senior notes issuance costs

77

-

Stock based compensation

897

482

Net gain on sale of other real estate owned

(454)

(316)

Provision for other real estate owned losses

1,630

1,305

Net (gain) loss on disposal  and transfer of fixed assets

(10)

1

Net cash provided by operating activities

28,547

17,193

Cash flows from investing activities

Proceeds from maturities and calls including pay down of securities available-for-sale

105,327

62,868

Proceeds from sales of securities available-for-sale

152,476

271,374

Purchases of securities available-for-sale

(246,971)

(153,252)

Proceeds from maturities and calls including pay down of securities held-to-maturity

-

3,372

Net disbursements/proceeds from (purchases) sales of FHLBC stock

(2,475)

600

Net change in loans

(118,711)

(71,600)

Improvements in other real estate owned

-

(16)

Proceeds from sales of other real estate owned, net of participation purchase

5,512

5,247

Proceeds from disposition of premises and equipment

13

-

Net purchases of premises and equipment

(852)

(1,163)

Net cash used in (provided by) investing activities

(105,681)

117,430

Cash flows from financing activities

Net change in deposits

22,330

18,296

Net change in securities sold under repurchase agreements

1,138

12,536

Net change in other short-term borrowings

55,000

(15,000)

Payment of senior note issuance costs

(42)

-

Dividends paid on common stock

(888)

(592)

Purchase of treasury stock

(236)

(254)

Net cash provided by financing activities

77,302

14,986

Net change in cash and cash equivalents

168

149,609

Cash and cash equivalents at beginning of period

47,334

40,338

Cash and cash equivalents at end of period

$
47,502

$
189,947

~~Tableof Contents~~

~~Old Second Bancorp, Inc. and Subsidiaries~~

~~Consolidated Statements of Cash Flows - Continued~~

~~(In thousands)~~

(unaudited)

Nine Months Ended  September 30,
Supplemental cash flow information

2017

2016
Income taxes paid, net

$
230

$
160
Interest paid for deposits

3,802

3,142
Interest paid for borrowings

4,890

4,021
Non-cash transfer of loans to other real estate owned

3,701

1,223
Non-cash transfer of premises to other real estate owned

95

-
Non-cash transfer of securities held-to-maturity to securities available-for-sale

-

244,823


		(Unaudited)
	Six Months Ended June 30,
	2019		2018
Cash flows from operating activities
Net income	$	17,746	$	15,750
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium / discount from amortization on securities		1,476		1,388
Securities gains, net		(1,013)		(347)
Provision for loan and lease losses		900		728
Originations of loans held-for-sale		(64,762)		(72,820)
Proceeds from sales of loans held-for-sale		64,181		73,187
Net gains on sales of mortgage loans		(1,925)		(2,157)
Change in fair value of mortgage servicing rights		1,956		(200)
Net discount / premium from accretion on loans		(246)		(776)
Increase in cash surrender value of BOLI		(778)		(599)
Net gains on sale of other real estate owned		(150)		(104)
Provision for other real estate owned valuation losses		196		366
Depreciation of fixed assets and amortization of leasehold improvements		1,278		1,142
Net (gains) / losses on disposal and transfer of fixed assets		(3)		-
Amortization of core deposit intangible		253		118
Change in current income taxes receivable		2,395		197
Provision for deferred tax expense		3,013		3,468
Change in accrued interest receivable and other assets		(2,570)		(1,075)
Accretion of purchase accounting adjustment on time deposits		(38)		-
Amortization of purchase accounting adjustment on notes payable and other borrowings		54		-
Amortization of junior subordinated debentures issuance costs		24		23
Amortization of senior notes issuance costs		50		50
Change in accrued interest payable and other liabilities		16,575		8,195
Stock based compensation		1,241		1,098
Net cash provided by operating activities		39,853		27,632
Cash flows from investing activities
Proceeds from maturities and calls including pay down of securities available-for-sale		27,863		20,136
Proceeds from sales of securities available-for-sale		120,596		92,746
Purchases of securities available-for-sale		(82,930)		(54,550)
Net proceeds from sales of FHLBC stock		2,825		2,624
Net change in loans		(6,195)		(4,418)
Proceeds from claims on BOLI		-		1,204
Improvements in other real estate owned		-		(59)
Proceeds from sales of other real estate owned, net of participation purchase		1,452		2,068
Proceeds from disposition of fixed assets		3		-
Net purchases of premises and equipment		(1,390)		(710)
Cash paid for acquisition, net of cash and cash equivalents retained		-		(35,711)
Net cash provided by investing activities		62,224		23,330
Cash flows from financing activities
Net change in deposits		(38,861)		(9,587)
Net change in securities sold under repurchase agreements		7,534		18,497
Net change in other short-term borrowings		(62,375)		(49,298)
Net change in notes payable and other borrowings		(4,398)		-
Proceeds from exercise of stock options		32		-
Dividends paid on common stock		(597)		(594)
Purchase of treasury stock		(430)		(505)
Net cash used in financing activities		(99,095)		(41,487)
Net change in cash and cash equivalents		2,982		9,475
Cash and cash equivalents at beginning of period		55,235		55,833
Cash and cash equivalents at end of period	$	58,217	$	65,308

See accompanying notes to consolidated financial statements.

~~Tableof Contents~~

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in

Stockholders’ Equity

(In thousands)


							Accumulated												Accumulated
			Additional				Other				Total				Additional				Other				Total
	Common		Paid-In		Retained		Comprehensive		Treasury		Stockholders’		Common		Paid-In		Retained		Comprehensive		Treasury		Stockholders’
	Stock		Capital		Earnings		Loss		Stock		Equity		Stock		Capital		Earnings		Income (Loss)		Stock		Equity
Balance, December 31, 2015	$	34,427	$	115,918	$	114,209	$	(12,659)	$	(95,966)	$	155,929
For the Three Months Ended
Balance, March 31, 2019													$	34,825	$	119,126	$	183,634	$	1,736	$	(96,066)	$	243,255
Net income						10,666						10,666						9,278						9,278
Other comprehensive income, net of tax								5,222				5,222								4,376				4,376
Dividends declared and paid						(592)						(592)
Vesting of restricted stock		106		(106)								-
Tax effect from vesting of restricted stock				174								174
Stock based compensation				482								482
Purchase of treasury stock										(254)		(254)
Balance, September 30, 2016	$	34,533	$	116,468	$	124,283	$	(7,437)	$	(96,220)	$	171,627

Balance, December 31, 2016	$	34,534	$	116,653	$	129,005	$	(8,762)	$	(96,220)	$	175,210
Net income						17,650						17,650
Other comprehensive income, net of tax								8,130				8,130
Dividends declared and paid						(888)						(888)
Dividends declared and paid, ($0.01 per share)																		(300)						(300)
Vesting of restricted stock		92		(92)								-				(32)						32		-
Stock based compensation				897								897				668								668
Purchase of treasury stock										(236)		(236)										(13)		(13)
Balance, September 30, 2017	$	34,626	$	117,458	$	145,767	$	(632)	$	(96,456)	$	200,763
Balance, June 30, 2019													$	34,825	$	119,762	$	192,612	$	6,112	$	(96,047)	$	257,264

Balance, March 31, 2018													$	34,717	$	117,379	$	151,833	$	(3,634)	$	(96,294)	$	204,001
Net income																		6,261						6,261
Other comprehensive loss, net of tax																				(853)				(853)
Dividends declared and paid, ($0.01 per share)																		(298)						(298)
Stock based compensation																703								703
Balance, June 30, 2018													$	34,717	$	118,082	$	157,796	$	(4,487)	$	(96,294)	$	209,814

~~Seeaccompanyingnotes~~to~~consolidatedfinancialstatements~~.


							Accumulated
			Additional				Other				Total
	Common		Paid-In		Retained		Comprehensive		Treasury		Stockholders’
	Stock		Capital		Earnings		Income (Loss)		Stock		Equity
For the Six Months Ended
Balance, December 31, 2018	$	34,720	$	119,081	$	175,463	$	(4,079)	$	(96,104)	$	229,081
Net income						17,746						17,746
Other comprehensive income, net of tax								10,191				10,191
Dividends declared and paid, ($0.01 per share)						(597)						(597)
Vesting of restricted stock		103		(254)						151		-
Stock option exercised		2		7						23		32
Stock warrants exercised				(313)						313		-
Stock based compensation				1,241								1,241
Purchase of treasury stock										(430)		(430)
Balance, June 30, 2019	$	34,825	$	119,762	$	192,612	$	6,112	$	(96,047)	$	257,264

Balance, December 31, 2017	$	34,626	$	117,742	$	142,959	$	1,479	$	(96,456)	$	200,350
Net income						15,750						15,750
Other comprehensive loss, net of tax								(6,285)				(6,285)
Dividends declared and paid, ($0.01 per share)						(594)						(594)
Vesting of restricted stock		91		(758)						667		-
Reclassification of stranded tax effects						(319)		319				-
Stock based compensation				1,098								1,098
Purchase of treasury stock										(505)		(505)
Balance, June 30, 2018	$	34,717	$	118,082	$	157,796	$	(4,487)	$	(96,294)	$	209,814

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(~~Table~~Dollar amounts in thousands, except per share data, unaudited)

Note 1 – Summary of Significant Accounting Policies

The accounting policies followed in the preparation of the interim consolidated financial statements are consistent with those used in the preparation of the annual financial information. The interim consolidated financial statements reflect all normal and recurring adjustments that are necessary, in the opinion of management, for a fair statement of results for the interim period presented. Results for the period ended ~~September~~June 30, ~~2017,~~2019, are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2017.~~2019. These interim consolidated financial statements are unaudited and should be read in conjunction with the audited financial statements and notes included in Old Second Bancorp, Inc.’s (the “Company”) annual report on Form 10-K for the year ended December 31, ~~2016.~~2018. Unless otherwise indicated, amounts in the tables contained in the notes to the consolidated financial statements are in thousands. Certain items in prior periods have been reclassified to conform to the current presentation.

The Company’s consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (“GAAP”) and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. 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.

~~All significant~~Significant accounting policies are presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2016.~~2018. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.

Recent Accounting Pronouncements

~~In May 2014, the FASB issued ASU No. 2014-09~~ ~~"Revenue from Contracts with Customers (Topic 606)."~~ The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In August 2015, the FASB issued ASU 2015-14 “~~Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date~~.” This accounting standards update defers the effective date of ASU 2014-09 for an additional year. ASU 2015-14 will be effective for annual reporting periods beginning after December 15, 2017. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this update recognized at the date of initial application. Early application is not permitted. In March 2016, the FASB issued ASU 2016-08 “~~Revenue from Contracts with Customers (TOPIC 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” and in April 2016, the FASB issued ASU 2016-10 “Revenue from Contracts with Customers (TOPIC 606): Identifying Performance Obligations and Licensing.”~~ ASU 2016-08 requires the entity to determine if it is acting as a principal with control over the goods or services it is contractually obligated to provide, or an agent with no control over specified goods or services provided by another party to a customer. ASU 2016-10 was issued to further clarify ASU 2014-09 implementation regarding identifying performance obligation materiality, identification of key contract components, and scope. The Company is assessing the impact of ASU 2014-09 and other related ASUs as noted above on its accounting and disclosures within noninterest income, as any interest income impact was not included in the scope of this final ASU pronouncement. Adoption of this ASU is expected to affect the methodology used to record certain recurring revenue streams within trust and asset management fees, but this impact is not anticipated to be significant to the Company’s financial statements. The Company will adopt ASU 2015-14 and related issuances on January 1, 2018, with a cumulative effect adjustment to opening retained earnings, if an adjustment is deemed to be material.

In February 2016, the FASB issued ASU No. 2016-02 “Leases (Topic 842).” This ASU was issued to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. One key revision from prior guidance was to include operating leases within assets and liabilities recorded; another revision was ~~included which created~~to create a new model to follow for sale-leaseback transactions. The impact of this pronouncement will primarily affect lessees, ~~primarily,~~ as virtually all of their assets will be recognized on the balance sheet, by recording a right of use asset and lease liability. This pronouncement is effective for fiscal years beginning after December 15, 2018. ~~The Company is assessing the impact of ASU 2016-02 on its accounting and disclosures.~~

In ~~March 2016,~~July 2018, the FASB issued ASU No. ~~2016-09 “~~2018-11, ~~Stock Compensation -~~“Leases (Topic 842): Targeted Improvements ~~to Employee Share-Based Payment Accounting (Topic 718).~~” ~~FASB issued~~which provided additional guidance on the transition method, including application as a cumulative-effect adjustment to equity and practical expedients to use when accounting for lease components. The Company adopted this ~~ASU~~standard as ~~part~~of January 1, 2019, and recorded right of use assets of $817,000 with a like lease liability. As of June 30, 2019, the right of use assets and lessee lease liability both totaled $561,000. As no lease incentives, initial direct costs, or prepayments were present with any of these lease arrangements, the present value of the ~~Simplification Initiative. This ASU involves several aspects~~lessee liabilities was equal to the offsetting right of use assets. The Company also recorded leases receivable related to lessor leases of $174,000 as of January 1, 2019 with a like entry to lease liabilities for the ~~accounting~~lessor position; these tenant leases receivable balances and lessor lease liabilities both totaled approximately $100,000 as of June 30, 2019. There was no impact to equity for ~~share-based payment transactions, including the income tax consequences, classification of awards as either equity or~~

~~Tableof Contents~~

liability, and classification on the statement of cash flows. ASU 2016-09 is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. This standard was adopted by the Company effective January 2017; the adoption of this standard ~~did not have~~on a ~~material effect on the Company’s operating results or financial condition.~~modified retrospective basis.

In June 2016, the FASB issued ASU No. 2016-13 “Measurement of Credit Losses on Financial Instruments (Topic 326).” This ASU ~~2016-13~~ was issued to provide financial statement users with more useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date to enhance the decision making process. The new methodology to be used should reflect expected credit losses based on relevant vintage historical information, supported by reasonable forecasts of projected loss given defaults, which will affect the collectability of the reported amounts. This new methodology will also require available-for-sale debt securities to have a credit loss recorded through an allowance rather than write-downs. ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019. The Company is assessing the impact of ASU 2016-13 on its accounting and disclosures, and has determined that a combination of loss rate models utilizing weighted average remaining life, migration and vintage analysis will be used for calculation of future expected losses based on data availability and the characteristics of each loan pool being assessed upon the ASU’s adoption in 2020. The Company has accumulated historical data by loan pools and collateral classifications, and is on track to calculate estimates for the last two quarters in 2019 on a parallel test basis to confirm the ~~process~~model processes and determine financial statement impact prior to adoption in 2020. The Company is also developing internal control processes and disclosure documentation related to adoption of ~~accumulating data and evaluating model options to support future risk assessments.~~this standard.

~~In March 2017, the FASB issued ASU No. 2017-08 “Receivables-Nonrefundable Fees and Other Costs – Premium Amortization on Purchased Callable Debt Securities (Subtopic 310-20)~~.” This ASU was issued to shorten the amortization period for the premium to the earliest call date on debt securities. This premium is required to be recorded as a reduction to net interest margin during the shorter yield to call period, as compared to prior practice of amortizing the premium as a reduction to net interest margin over the contractual life of the instrument. This ASU does not change the current method of amortizing any discount over the contractual life of the debt security, and this pronouncement is effective for fiscal years beginning after December 15, 2018, with earlier adoption permitted. The Company adopted ASU 2017-08 as a change in accounting principle in the third quarter of 2017 on a modified retrospective basis, which required the Company to reflect its adoption effective January 1, 2017. The effect of amortizing the premium over a shorter period negatively impacted the net interest margin for the first nine months of 2017, and will continue to decrease future quarterly net interest income by approximately 10 basis points a quarter until the premium, which is $25.0 million as of September 30, 2017, is fully amortized. As a result of management’s analysis, the impact of the change in accounting principle as a result of ASU 2017-08 to adjust beginning of year retained earnings was considered insignificant and, accordingly, the impact was adjusted through current period earnings.

~~In August 2017, the FASB issued ASU 2017-12, “~~Table~~Derivatives~~of Contents

Old Second Bancorp, Inc. and ~~Hedging:Targeted Improvements~~Subsidiaries

Notes to ~~Accounting for Hedging Activities”.~~ The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoptionConsolidated Financial Statements

(Dollar amounts in an interim period, permitted. The Company plans to adopt ASU 2017-12 on January 1, 2018. ASU 2017-12 requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. While the Company continues to assess all potential impacts of the standard, we currently expect adoption to have an immaterial impact on our consolidated financial statements.thousands, except per share data, unaudited)

Subsequent Events

On ~~October 17, 2017,~~July 16, 2019, the Company’s Board of Directors declared a cash dividend of $0.01 per share payable on ~~November 6, 2017,~~August 5, 2019, to stockholders of record as of ~~October 27, 2017;~~July 26, 2019; dividends of ~~$296,000~~$299,000 were paid to stockholders on ~~November 6, 2017.~~August 5, 2019.

Note 2 – Acquisitions

On ~~October 28, 2016,~~April 20, 2018, the Company acquired Greater Chicago Financial Corp. (“GCFC”) and its wholly-owned subsidiary, ABC Bank, ~~acquired~~which operated four branches in the Chicago ~~branch~~metro area. In addition to the acquisition price of ~~Talmer Bank~~$41.1 million, the Company retired the convertible and ~~Trust,~~nonconvertible debentures held by GCFC upon acquisition, which totaled $6.6 million, including interest due. The purchase and the ~~banking subsidiary~~retirement of ~~Talmer Bancorp, Inc. (“Talmer”). As~~the debentures were funded with the Company’s cash on hand, and all GCFC common stock was retired and cancelled simultaneous with the close of the transaction. The Company acquired $227.6 million of loans, net of purchase accounting adjustments, and $248.5 million of deposits, net of purchase accounting adjustments for time deposits. Purchase accounting adjustments recorded include a ~~result~~loan valuation mark of ~~this transaction,~~$11.2 million, a core deposit intangible of $3.1 million, a fixed asset valuation adjustment of $1.5 million, and goodwill of $10.2 million. In addition, a deferred tax asset of $3.5 million was recorded as of the ~~Bank recorded assets with a~~date of acquisition based on analysis of the fair value of ~~approximately $230.9~~assets acquired, less liabilities assumed. None of the $10.2 million ~~including approximately $221.0~~recorded as goodwill is expected to be deductible for tax purposes. No acquisition related costs were incurred in the first quarter of 2019. Acquisition related costs incurred by the Company for the year ended December 31, 2018, totaled $3.5 million, pre-tax, and included $1.1 million of ~~loans,~~salaries and ~~assumed deposits~~employee benefits related expenses, and $1.8 million of data processing, computer and ATM related conversion costs. Acquisition costs incurred for the year ending December 31, 2017, related to the merger with aGCFC were $65,000, and were expensed as incurred.

The assets and liabilities associated with the acquisition of GCFC were recorded in the Consolidated Balance Sheets at their estimated fair values as of the acquisition date. In many cases the determination of these fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change, as noted below. The following table shows the estimated fair value of ~~approximately $48.9 million. Goodwill~~the assets acquired and liabilities assumed as of ~~$8.4 million was included within~~April 20, 2018. These fair value estimates were considered final as of March 31, 2019, and no further refinements to the ~~total~~values listed below are anticipated.

The below table summarizes the assets acquired, less the liabilities assumed, related to the GCFC/ABC Bank acquisition. All amounts are listed at their estimated fair values as of date of acquisition, and have been accounted for under the acquisition method of accounting.


GCFC/ABC Bank Acquisition Summary
As of Date of Acquisition
		April 20, 2018
Assets
Cash and due from banks	$	6,669
Interest bearing deposits with financial institutions		500
Securities available-for-sale, at fair value		72,091
Federal funds sold		4,300
FHLBC stock		1,549
Loans		227,594
Premises and equipment		5,339
Other real estate owned		401
Goodwill and core deposit intangible		13,280
Deferred tax assets, net		3,459
Other assets		1,767
Total assets	$	336,949

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)


Liabilities
Noninterest bearing demand	$	58,005
Savings, NOW and money market		91,494
Time		98,999
Total deposits		248,498
Securities sold under repurchase agreements		5,623
Other short-term borrowings		10,875
Notes payable and other borrowings		23,367
Other liabilities		1,406
Total liabilities		289,769

Cash consideration paid		47,180
Total Liabilities Assumed and Cash Consideration Paid for Acquisition	$	336,949

Loans acquired in the GCFC acquisition were initially recorded ~~upon acquisition; net cash~~at fair value with no separate allowance for loan losses. The Company reviewed the loans at acquisition to determine which loans should be considered purchased credit impaired (“PCI loans”), defined as impaired loans as those that were either not accruing interest or exhibited credit risk factors consistent with nonperforming loans at the acquisition date, or purchased non-credit impaired loans (“non-PCI loans”), defined as loans acquired that did not show signs of ~~$181.5 million was paid for~~deteriorated credit quality at acquisition.

The following table represents the ~~purchase.~~acquired loans as of date of acquisition and as of June 30, 2019:


	April 20, 2018				June 30, 2019
ABC Bank Acquired Loans	PCI		Non-PCI		PCI		Non-PCI
Fair Value	$	11,360	$	216,234	$	11,889	$	164,645
Contractually required principal and interest payments		19,447		220,308		18,393		166,194
Best estimate of contractual cash flows not expected to be collected		6,537		2,511		5,500		759
Best estimate of contractual cash flows expected to be collected		12,910		217,797		12,893		165,435

Note 3 – Securities

Investment Portfolio Management

Our investment portfolio serves the liquidity needs and income objectives of the Company. While the portfolio serves as an important component of the overall liquidity management at the Bank, portions of the portfolio also serve as income producing assets. The size and composition of the portfolio reflects liquidity needs, loan demand and interest income objectives. Portfolio size and composition will be adjusted from time to time. While a significant portion of the portfolio consists of readily marketable securities to address liquidity, other parts of the portfolio may reflect funds invested pending future loan demand or to maximize interest income without undue interest rate risk.

~~Tableof Contents~~

Investments are comprised of debt securities and non-marketable equity investments. Securities available-for-sale are carried at fair value. Unrealized gains and losses, net of tax, on securities available-for-sale are reported as a separate component of equity. This balance sheet component changes as interest rates and market conditions change. Unrealized gains and losses are not included in the calculation of regulatory capital.

FHLBC and FRBC stock are considered nonmarketable equity investments. FHLBC stock was recorded at ~~$5.6~~$4.4 million at ~~September~~June 30, ~~2017,~~2019, and ~~$3.1~~$7.2 million at December 31, ~~2016, and is necessary to maintain access to FHLBC advances, which are utilized as a component to meet the Bank’s daily funding needs.~~2018. FRBC stock was recorded at ~~$4.8~~$6.2 million at ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016.~~ 2018.

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

The following ~~table summarizes~~tables summarize the amortized cost and fair value of the securities portfolio at ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, and the corresponding amounts of gross unrealized gains and losses:


			Gross			Gross								Gross		Gross
	Amortized		Unrealized			Unrealized			Fair			Amortized		Unrealized		Unrealized		Fair
September 30, 2017	Cost			Gains			Losses			Value
June 30, 2019												Cost		Gains		Losses		Value
Securities available-for-sale
U.S. Treasuries	$	4,001		$	-		$	(11)		$	3,990	$	4,008	$	17	$	-	$	4,025
U.S. government agencies		13,475			15			(39)			13,451		9,954		-		(142)		9,812
U.S. government agencies mortgage-backed		11,131			18			(119)			11,030		16,586		462		(49)		16,999
States and political subdivisions		224,648			5,173			(789)			229,032		241,176		11,236		(1,117)		251,295
Corporate bonds		10,823			20			(266)			10,577
Collateralized mortgage obligations		81,693			228			(1,535)			80,386		64,207		866		(206)		64,867
Asset-backed securities		134,542			865			(3,648)			131,759		82,119		888		(282)		82,725
Collateralized loan obligations		52,803			505			(49)			53,259		62,825		55		(523)		62,357
Total securities available-for-sale	$	533,116		$	6,824		$	(6,456)		$	533,484	$	480,875	$	13,524	$	(2,319)	$	492,080


			Gross		Gross						Gross		Gross
	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
December 31, 2016	Cost		Gains		Losses		Value
December 31, 2018									Cost		Gains		Losses		Value
Securities available-for-sale
U.S. Treasury									$	4,006	$	-	$	(83)	$	3,923
U.S. government agencies										11,112		-		(161)		10,951
U.S. government agencies mortgage-backed	$	42,511	$	-	$	(977)	$	41,534		14,407		45		(377)		14,075
States and political subdivisions		68,718		258		(273)		68,703		277,112		1,916		(4,961)		274,067
Corporate bonds		10,957		9		(336)		10,630
Collateralized mortgage obligations		174,352		374		(3,799)		170,927		66,494		79		(2,144)		64,429
Asset-backed securities		146,391		341		(8,325)		138,407		108,574		1,165		(225)		109,514
Collateralized loan obligations		102,504		29		(896)		101,637		65,162		24		(897)		64,289
Total securities available-for-sale	$	545,433	$	1,011	$	(14,606)	$	531,838	$	546,867	$	3,229	$	(8,848)	$	541,248

The fair value, amortized cost and weighted average yield of debt securities at ~~September~~June 30, ~~2017,~~2019, by contractual maturity, were as follows in the table below. Securities not due at a single maturity date are shown separately.


			Weighted						Weighted
	Amortized		Average		Fair		Amortized		Average		Fair
Securities available-for-sale	Cost		Yield		Value		Cost		Yield		Value
Due in one year or less	$	3,400	2.60	%	$	3,405	$	2,489	2.50	%	$	2,493
Due after one year through five years		5,846	2.74			5,831		4,659	1.88			4,679
Due after five years through ten years		16,105	2.52			16,057		4,658	3.29			4,922
Due after ten years		227,596	2.98			231,757		243,332	3.15			253,038
		252,947	2.94			257,050		255,138	3.12			265,132
Mortgage-backed and collateralized mortgage obligations		92,824	2.72			91,416		80,793	3.16			81,866
Asset-backed securities		134,542	2.41			131,759		82,119	3.06			82,725
Collateralized loan obligations		52,803	4.38			53,259		62,825	4.90			62,357
Total securities available-for-sale	$	533,116	2.91	%	$	533,484	$	480,875	3.35	%	$	492,080

At ~~September~~June 30, ~~2017,~~2019, the Company’s investments ~~include $110.6~~included $55.7 million of asset-backed securities that are backed by student loans originated under the Federal Family Education Loan program (“FFEL”). Under the FFEL, private lenders made federally guaranteed student loans to parents and students. While the program was modified several times before elimination in 2010, FFEL securities are generally guaranteed by the U.S Department of Education ~~“DOE”~~(“DOE”) at not less than 97% of the outstanding principal amount of the loans. The guarantee will reduce to 85% if the DOE receives reimbursement requests in excess of 5% of insured loans; reimbursement

~~Tableof Contents~~

will drop to 75% if reimbursement requests exceed 9% of insured loans. In addition to the ~~U.S. Department of Education~~DOE guarantee, total added credit enhancement in the form of overcollateralization and/or subordination amounted to ~~$12.3~~$4.7 million, or ~~10.42%,~~8.23% of outstanding principal.

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

The Company has invested in securities issued from three originators that individually amount to over 10% of the Company’s stockholders equity. Information regarding these three issuers and the value of the securities issued follows:


	September 30, 2017				June 30, 2019
	Amortized		Fair		Amortized		Fair
Issuer	Cost		Value		Cost		Value
GCO Education Loan Funding Corp	$	27,555	$	26,505	$	27,809	$	27,593
Towd Point Mortgage Trust		29,544		29,445		33,927		34,472
Student Loan Marketing Assocation		25,654		25,803
Student Loan Marketing Association						25,831		26,091

Securities with unrealized losses at ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands except for number of securities):


	Less than 12 months					12 months or more										Less than 12 months					12 months or more
September 30, 2017	in an unrealized loss position					in an unrealized loss position					Total
June 30, 2019																in an unrealized loss position					in an unrealized loss position					Total
	Number of	Unrealized		Fair		Number of	Unrealized		Fair		Number of	Unrealized		Fair		Number of	Unrealized		Fair		Number of	Unrealized		Fair		Number of	Unrealized		Fair
Securities available-for-sale	Securities	Losses		Value		Securities	Losses		Value		Securities	Losses		Value		Securities	Losses		Value		Securities	Losses		Value		Securities	Losses		Value
U.S. Treasuries	1	$	11	$	3,990	-	$	-	$	-	1	$	11	$	3,990	-	$	-	$	-	-	$	-	$	-	-	$	-	$	-
U.S. government agencies	2		39		6,701	-		-		-	2		39		6,701	-		-		-	4		142		9,812	4		142		9,812
U.S. government agencies mortgage-backed	2		13		2,089	4		106		4,096	6		119		6,185	-		-		-	6		49		4,039	6		49		4,039
States and political subdivisions	7		789		24,843	-		-		-	7		789		24,843	-		-		-	7		1,117		28,016	7		1,117		28,016
Corporate bonds	-		-		-	3		266		10,078	3		266		10,078
Collateralized mortgage obligations	4		238		21,281	8		1,297		43,684	12		1,535		64,965	-		-		-	6		206		24,995	6		206		24,995
Asset-backed securities	1		265		4,293	9		3,383		76,725	10		3,648		81,018	1		215		27,593	1		67		3,208	2		282		30,801
Collateralized loan obligations	1		49		7,948	-		-		-	1		49		7,948	3		90		17,077	4		433		24,979	7		523		42,056
Total securities available-for-sale	18	$	1,404	$	71,145	24	$	5,052	$	134,583	42	$	6,456	$	205,728	4	$	305	$	44,670	28	$	2,014	$	95,049	32	$	2,319	$	139,719


	Less than 12 months					12 months or more										Less than 12 months					12 months or more
December 31, 2016	in an unrealized loss position					in an unrealized loss position					Total
December 31, 2018																in an unrealized loss position					in an unrealized loss position					Total
	Number of	Unrealized			Fair	Number of	Unrealized			Fair	Number of	Unrealized			Fair	Number of	Unrealized			Fair	Number of	Unrealized			Fair	Number of	Unrealized			Fair
Securities available-for-sale	Securities	Losses			Value	Securities	Losses			Value	Securities	Losses			Value	Securities	Losses			Value	Securities	Losses			Value	Securities	Losses			Value
U.S. Treasuries																-	$	-	$	-	1	$	83	$	3,923	1	$	83	$	3,923
U.S. government agencies																3		100		7,385	1		61		3,566	4		161		10,951
U.S. government agencies mortgage-backed	11	$	957	$	40,636	1	$	20	$	898	12	$	977	$	41,534	-		-		-	11		377		11,439	11		377		11,439
States and political subdivisions	12		273		35,241	-		-		-	12		273		35,241	4		126		17,713	33		4,835		110,326	37		4,961		128,039
Corporate bonds	1		183		4,817	2		153		5,328	3		336		10,145
Collateralized mortgage obligations	16		3,402		117,752	7		397		18,109	23		3,799		135,861	2		309		15,211	10		1,835		43,687	12		2,144		58,898
Asset-backed securities	4		328		17,604	12		7,997		107,112	16		8,325		124,716	-		-		-	4		225		16,473	4		225		16,473
Collateralized loan obligations	-		-		-	12		896		81,613	12		896		81,613	7		721		46,547	1		176		7,824	8		897		54,371
Total securities available-for-sale	44	$	5,143	$	216,050	34	$	9,463	$	213,060	78	$	14,606	$	429,110	16	$	1,256	$	86,856	61	$	7,592	$	197,238	77	$	8,848	$	284,094

Recognition of other-than-temporary impairment was not necessary inas of the three ~~and nine~~ months ended ~~September~~June 30, ~~2017 or 2016.~~2019. The changes in fair value related primarily to interest rate fluctuations. Our review of other-than-temporary impairment determined that there was no credit quality deterioration.

The following table presents net realized gains (losses) on securities available-for-sale for the ~~quarters~~three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016.~~2018.



		Quarter Ended				Nine Months Ended				Three Months Ended						Six Months Ended
		September 30,				September 30,				June 30,						June 30,
Securities available-for-sale	2017		2016		2017		2016		2019			2018			2019			2018
Proceeds from sales of securities									$	39,072		$	90,224		$	120,596		$	92,746
Gross realized gains on securities	$	474	$	1,380	$	911	$	1,518		986			312			1,591			347
Gross realized losses on securities		(371)		(3,339)		(1,076)		(3,538)		-			—			(578)			—
Securities realized gains (losses), net	$	103	$	(1,959)	$	(165)	$	(2,020)
Net realized gains									$	986		$	312		$	1,013		$	347
Income tax expense on net realized gains									$	(276)		$	(88)		$	(284)		$	(98)
Effective tax rate applied										28.0	%		28.2	%		28.0	%		28.2	%

~~The majority~~Securities valued at $324.9 million as of ~~the net realized losses in the prior year~~June 30, 2019, an increase from $318.4 million at year-end 2018, were ~~incurred~~pledged to ~~meet the funding needs related to the Talmer branch acquisition in late 2016.~~

secure deposits and borrowings, and for other purposes.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Note 4 – Loans

Major classifications of loans were as follows:


	September 30, 2017		December 31, 2016		June 30, 2019		December 31, 2018
Commercial	$	257,356	$	228,113	$	337,848	$	314,323
Leases		69,305		55,451		98,379		78,806
Real estate - commercial		739,136		736,247		825,091		820,941
Real estate - construction		94,868		64,720		93,079		108,390
Real estate - residential		419,583		377,851		393,547		407,068
Consumer		2,770		3,237
HELOC						128,673		140,442
Other1		10,550		11,973		13,533		14,439
		1,593,568		1,477,592
Total loans, excluding deferred loan costs and PCI loans						1,890,150		1,884,409
Net deferred loan costs		623		1,217		1,959		1,653
Total loans, excluding PCI loans						1,892,109		1,886,062
PCI loans, net of purchase accounting adjustments						10,834		10,965
Total loans	$	1,594,191	$	1,478,809	$	1,902,943	$	1,897,027

1 The “Other” class includes consumer and overdrafts.

It is the policy of the Company to review each prospective credit prior to making a loan in order to determine if an adequate level of security or collateral has been obtained. The type of collateral, when required, will vary from liquid assets to real estate. The Company’s access to collateral, in the event of borrower default, is assured through adherence to lending laws, the Company’s lending standards and credit monitoring procedures. With selected exceptions, the Bank makes loans solely within its market area. There are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single economic sector, although the real estate related categories listed above represent ~~78.6%~~75.7% and ~~79.7%~~77.9% of the portfolio at ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, respectively.

Aged analysis of past due loans by class of loans was as follows:


															Recorded																Recorded
															Investment																Investment
															90 days or																90 days or
					90 Days or										Greater Past						90 Days or										Greater Past
	30-59 Days		60-89 Days		Greater Past		Total Past								Due and		30-59 Days		60-89 Days		Greater Past		Total Past								Due and
September 30, 2017	Past Due		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
June 30, 2019																	Past Due		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
Commercial	$	-	$	89	$	-	$	89	$	257,060	$	207	$	257,356	$	-	$	-	$	-	$	-	$	-	$	337,697	$	151	$	337,848	$	-
Leases		-		685		149		834		68,275		196		69,305		156		143		-		-		143		98,111		125		98,379		-
Real estate - commercial
Owner occupied general purpose		253		-		537		790		154,429		457		155,676		561		654		-		-		654		145,155		1,395		147,204		-
Owner occupied special purpose		513		-		-		513		172,866		359		173,738		-		828		-		-		828		186,249		499		187,576		-
Non-owner occupied general purpose		649		-		-		649		251,933		1,165		253,747		-		2,241		149		-		2,390		323,258		568		326,216		-
Non-owner occupied special purpose		-		248		-		248		93,498		-		93,746		-		144		-		-		144		97,051		2,960		100,155		-
Retail properties		-		-		-		-		45,149		1,113		46,262		-		604		-		-		604		48,793		1,138		50,535		-
Farm		-		-		383		383		15,584		-		15,967		387		1,210		-		-		1,210		12,195		-		13,405		-
Real estate - construction
Homebuilder		-		-		-		-		2,644		-		2,644		-		-		-		-		-		4,370		-		4,370		-
Land		-		-		-		-		3,235		-		3,235		-		342		-		-		342		2,625		-		2,967		-
Commercial speculative		-		-		-		-		34,817		-		34,817		-		-		-		-		-		59,216		-		59,216		-
All other		63		-		-		63		53,904		205		54,172		-		-		-		-		-		26,424		102		26,526		-
Real estate - residential
Investor		-		-		-		-		52,361		492		52,853		-		685		140		-		825		67,782		383		68,990		-
Multifamily		-		-		-		-		117,544		4,757		122,301		-
Multi-family																		69		-		-		69		191,695		-		191,764		-
Owner occupied		40		-		-		40		124,414		4,127		128,581		-		553		202		-		755		129,413		2,625		132,793		-
Revolving and junior liens		732		22		100		854		113,956		1,038		115,848		103
Consumer		2		-		-		2		2,760		8		2,770		-
HELOC																		331		138		-		469		127,085		1,119		128,673		-
Other1		1		-		-		1		11,172		-		11,173		-		6		-		-		6		15,462		24		15,492		-
Total, excluding PCI loans																	$	7,810	$	629	$	-	$	8,439	$	1,872,581	$	11,089	$	1,892,109	$	-
PCI loans, net of purchase accounting adjustments																		449		-		-		449		7,029		3,356		10,834		-
Total	$	2,253	$	1,044	$	1,169	$	4,466	$	1,575,601	$	14,124	$	1,594,191	$	1,207	$	8,259	$	629	$	-	$	8,888	$	1,879,610	$	14,445	$	1,902,943	$	-

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)


															Recorded																Recorded
															Investment																Investment
															90 days or																90 days or
					90 Days or										Greater Past						90 Days or										Greater Past
	30-59 Days		60-89 Days		Greater Past		Total Past								Due and		30-59 Days		60-89 Days		Greater Past		Total Past								Due and
December 31, 2016	Past Due		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
December 31, 2018																	Past Due		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
Commercial	$	57	$	74	$	-	$	131	$	227,742	$	240	$	228,113	$	-	$	58	$	-	$	352	$	410	$	313,913	$	-	$	314,323	$	361
Leases		-		286				286		54,799		366		55,451				-		-		-		-		78,806		-		78,806		-
Real estate - commercial
Owner occupied general purpose		758		-		-		758		135,599		879		137,236		-		1,768		-		33		1,801		160,892		1,579		164,272		36
Owner occupied special purpose		-		-		-		-		177,755		385		178,140		-		826		135		-		961		192,426		395		193,782		-
Non-owner occupied general purpose		667		379		-		1,046		229,315		1,930		232,291		-		2,832		203		-		3,035		286,115		4,236		293,386		-
Non-owner occupied special purpose		-		-		-		-		118,052		1,013		119,065		-		-		-		-		-		106,036		3,099		109,135		-
Retail properties		-		-		-		-		53,474		1,179		54,653		-		-		620		-		620		45,968		-		46,588		-
Farm		1,353		-		-		1,353		13,509		-		14,862		-		-		-		-		-		13,778		-		13,778		-
Real estate - construction
Homebuilder		-		-		-		-		3,883		-		3,883		-		-		-		-		-		5,102		-		5,102		-
Land		-		-		-		-		3,029		-		3,029		-		266		-		-		266		2,478		-		2,744		-
Commercial speculative		-		-		-		-		22,654		74		22,728		-		-		-		350		350		55,060		-		55,410		355
All other		364		-		-		364		34,509		207		35,080		-		-		-		-		-		45,028		106		45,134		-
Real estate - residential
Investor		237		-		-		237		54,924		936		56,097		-		801		156		-		957		69,148		353		70,458		-
Multifamily		-		-				-		96,502		-		96,502
Multi-family																		545		-		179		724		195,504		-		196,228		180
Owner occupied		274		-		-		274		116,900		6,452		123,626		-		1,241		705		-		1,946		135,360		3,076		140,382		-
Revolving and junior liens		225		405		-		630		99,374		1,622		101,626		-
Consumer		10		36		-		46		3,191		-		3,237		-
HELOC																		775		-		-		775		138,801		866		140,442		-
Other1		14		-		-		14		13,176		-		13,190		-		53		5		3		61		16,000		31		16,092		3
Total, excluding PCI loans																	$	9,165	$	1,824	$	917	$	11,906	$	1,860,415	$	13,741	$	1,886,062	$	935
PCI loans, net of purchase accounting adjustments																		1,452		-		-		1,452		7,248		2,265		10,965		-
Total	$	3,959	$	1,180	$	-	$	5,139	$	1,458,387	$	15,283	$	1,478,809	$	-	$	10,617	$	1,824	$	917	$	13,358	$	1,867,663	$	16,006	$	1,897,027	$	935

1 The “Other” class includes consumer, overdrafts and net deferred costs.

Credit Quality Indicators

The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparison ~~against~~to industry averages, historical payment experience, and current economic trends. This analysis includes loans with outstanding balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and residential mortgages. Loans with a classified risk rating are reviewed quarterly regardless of size or loan type. The Company uses the following definitions for classified risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the ~~institution~~Bank will sustain some loss if the deficiencies are not corrected. The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Credits that are not covered by the definitions above are pass credits, which are not considered to be adversely rated.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Credit Quality Indicators by class of loans were as follows:


September 30, 2017			Special
June 30, 2019													Special
	Pass		Mention		Substandard 1		Doubtful		Total		Pass		Mention		Substandard		Doubtful		Total
Commercial	$	245,603	$	11,371	$	382	$	-	$	257,356	$	326,965	$	3,179	$	7,704	$	-	$	337,848
Leases		68,274		-		1,031		-		69,305		98,254		-		125		-		98,379
Real estate - commercial
Owner occupied general purpose		153,039		1,274		1,363		-		155,676		142,385		1,357		3,462		-		147,204
Owner occupied special purpose		172,216		1,163		359		-		173,738		175,763		4,880		6,933		-		187,576
Non-owner occupied general purpose		250,497		2,085		1,165		-		253,747		320,735		788		4,693		-		326,216
Non-owner occupied special purpose		90,113		-		3,633		-		93,746		97,195		-		2,960		-		100,155
Retail Properties		43,922		1,227		1,113		-		46,262		48,793		604		1,138		-		50,535
Farm		13,472		-		2,495		-		15,967		10,977		1,218		1,210		-		13,405
Real estate - construction
Homebuilder		2,644		-		-		-		2,644		4,370		-		-		-		4,370
Land		3,235		-		-		-		3,235		2,967		-		-		-		2,967
Commercial speculative		34,817		-		-		-		34,817		59,216		-		-		-		59,216
All other		52,898		894		380		-		54,172		26,253		-		273		-		26,526
Real estate - residential
Investor		52,205		-		648		-		52,853		67,961		-		1,029		-		68,990
Multifamily		117,544		-		4,757		-		122,301
Multi-Family												191,271		-		493		-		191,764
Owner occupied		123,600		563		4,418		-		128,581		128,885		135		3,773		-		132,793
Revolving and junior liens		113,871		-		1,977		-		115,848
Consumer		2,762		-		8		-		2,770
Other		11,173		-		-		-		11,173
HELOC												126,455		140		2,078		-		128,673
Other 1												15,468		-		24		-		15,492
Total, excluding PCI loans											$	1,843,913	$	12,301	$	35,895	$	-	$	1,892,109
PCI loans, net of purchase accounting adjustments												820		1,725		8,289		-		10,834
Total	$	1,551,885	$	18,577	$	23,729	$	-	$	1,594,191	$	1,844,733	$	14,026	$	44,184	$	-	$	1,902,943

December 31, 2016

Special


Pass

Mention

Substandard 1

Doubtful

Total
Commercial

$
214,028

$
11,558

$
2,527

$
-

$
228,113
Leases

53,366

976

1,109

55,451
Real estate - commercial

Owner occupied general purpose

135,503

53

1,680

-

137,236
Owner occupied special purpose

172,353

5,402

385

-

178,140
Non-owner occupied general purpose

229,448

913

1,930

-

232,291
Non-owner occupied special purpose

114,293

-

4,772

-

119,065
Retail Properties

52,207

1,267

1,179

-

54,653
Farm

11,840

1,240

1,782

-

14,862
Real estate - construction

Homebuilder

3,883

-

-

-

3,883
Land

3,029

-

-

-

3,029
Commercial speculative

22,654

-

74

-

22,728
All other

34,696

-

384

-

35,080
Real estate - residential

Investor

55,001

-

1,096

-

56,097
Multifamily

96,502

-

-

-

96,502
Owner occupied

115,831

570

7,225

-

123,626
Revolving and junior liens

99,286

-

2,340

-

101,626
Consumer

3,236

-

1

-

3,237
Other

13,165

25

-

-

13,190
Total

$
1,430,321

$
22,004

$
26,484

$
-

$
1,478,809

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)


December 31, 2018			Special
	Pass		Mention		Substandard		Doubtful		Total
Commercial	$	305,993	$	8,193	$	137	$	-	$	314,323
Leases		78,806		-		-		-		78,806
Real estate - commercial
Owner occupied general purpose		157,334		1,660		5,278		-		164,272
Owner occupied special purpose		186,218		3,429		4,135		-		193,782
Non-owner occupied general purpose		284,818		202		8,366		-		293,386
Non-owner occupied special purpose		104,526		1,510		3,099		-		109,135
Retail Properties		44,805		-		1,783		-		46,588
Farm		11,307		1,249		1,222		-		13,778
Real estate - construction
Homebuilder		5,102		-		-		-		5,102
Land		2,744		-		-		-		2,744
Commercial speculative		55,410		-		-		-		55,410
All other		42,524		-		2,610		-		45,134
Real estate - residential
Investor		69,242		-		1,216		-		70,458
Multi-Family		195,249		-		979		-		196,228
Owner occupied		135,858		-		4,524		-		140,382
HELOC		138,553		-		1,889		-		140,442
Other 1		16,061		-		31		-		16,092
Total, excluding PCI loans	$	1,834,550	$	16,243	$	35,269	$	-	$	1,886,062
PCI loans, net of purchase accounting adjustments		907		2,906		7,152		-		10,965
Total	$	1,835,457	$	19,149	$	42,421	$	-	$	1,897,027

1 The ~~substandard credit quality indicator~~“Other” class includes ~~both potential problem loans that are currently performing~~consumer, overdrafts and ~~nonperforming loans.~~net deferred costs.

The Company had ~~$1.2 million~~$519,000 and ~~$1.8 million~~$448,000 in residential real estate loans in the process of foreclosure as of ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, respectively. ~~The Company also had $937,000 and $225,000 in residential real estate included in OREO as of September 30, 2017, and December 31, 2016, respectively.~~

1517

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

~~Impaired~~The following tables set forth the recorded investments, unpaid principal balance and related allowance, excluding purchased credit-impaired loans, ~~which include nonaccrual loans and accruing troubled debt restructurings,~~ by class of loans as of June 30, 2019 and for the ~~September 30, 2017 periods listed were as follows:~~three and six months then ended:


							Three Months Ended				Six Months Ended
	As of June 30, 2019						June 30, 2019				June 30, 2019
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Leases		11		11		-		63		-		6		-
Commercial real estate
Owner occupied general purpose		963		1,163		-		1,386		2		1,311		3
Owner occupied special purpose		499		652		-		508		-		447		-
Non-owner occupied general purpose		568		590		-		572		-		853		-
Non-owner occupied special purpose		2,960		3,575		-		2,960		-		1,480		-
Retail properties		1,138		1,159		-		569		-		569		-
Farm		-		-		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-		-		-
Land		-		-		-		-		-		-		-
Commercial speculative		-		-		-		-		-		-		-
All other		102		132		-		102		-		75		-
Residential
Investor		383		500		-		360		-		368		-
Multi-Family		-		-		-		-		-		-		-
Owner occupied		3,096		4,588		-		3,354		11		3,228		21
HELOC		1,118		1,483		-		1,039		1		1,001		1
Other 1		4		5		-		5		-		5		-
Total impaired loans with no recorded allowance		10,842		13,858		-		10,918		14		9,343		25

With an allowance recorded
Commercial		151		151		-		75		-		76		-
Leases		114		154		125		57		-		57		-
Commercial real estate
Owner occupied general purpose		664		685		199		419		2		530		8
Owner occupied special purpose		-		-		-		-		-		-		-
Non-owner occupied general purpose		56		57		1		1,512		-		1,577		2
Non-owner occupied special purpose		-		-		-		-		-		1,549		-
Retail properties		-		-		-		-		-		-		-
Farm		-		-		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-		-		-
Land		-		-		-		-		-		-		-
Commercial speculative		-		-		-		-		-		-		-
All other		-		-		-		-		-		29		-
Residential
Investor		798		798		4		800		11		803		22
Multi-Family		-		-		-		-		-		-		-
Owner occupied		3,363		3,363		41		3,402		41		3,519		80
HELOC		1,381		1,381		76		1,402		19		1,369		39
Other 1		20		21		9		21		-		22		-
Total impaired loans with a recorded allowance		6,547		6,610		455		7,688		73		9,531		151
Total impaired loans	$	17,389	$	20,468	$	455	$	18,606	$	87	$	18,874	$	176

Nine Months Ended

As of September 30, 2017

September 30, 2017

Unpaid

Average

Interest

Recorded

Principal

Related

Recorded

Income


Investment

Balance

Allowance

Investment

Recognized
With no related allowance recorded

Commercial

$
207

$
360

$
-

$
123

$
-
Leases

196

227

-

281

-
Commercial real estate

Owner occupied general purpose

457

495

-

1,169

-
Owner occupied special purpose

359

509

-

372

-
Non-owner occupied general purpose

1,218

1,592

-

1,481

2
Non-owner occupied special purpose

-

-

-

507

-
Retail properties

1,113

1,199

-

1,146

-
Farm

-

-

-

-

-
Construction

Homebuilder

-

-

-

-

-
Land

-

-

-

-

-
Commercial speculative

-

-

-

37

-
All other

205

231

-

206

-
Residential

Investor

1,374

1,627

-

1,607

36
Multifamily

4,757

4,965

-

2,379

-
Owner occupied

8,150

9,524

-

8,987

119
Revolving and junior liens

1,991

2,173

-

2,237

27
Consumer

8

8

-

104

-
Total impaired loans with no recorded allowance

20,035

22,910

-

20,636

184

With an allowance recorded

Commercial

-

-

-

-

-
Leases

-

-

-

-

-
Commercial real estate

Owner occupied general purpose

-

-

-

-

-
Owner occupied special purpose

-

-

-

-

-
Non-owner occupied general purpose

-

-

-

123

-
Non-owner occupied special purpose

-

-

-

-

-
Retail properties

-

-

-

-

-
Farm

-

-

-

-

-
Construction

Homebuilder

-

-

-

-

-
Land

-

-

-

-

-
Commercial speculative

-

-

-

-

-
All other

-

-

-

-

-
Residential

Investor

-

-

-

-

-
Multifamily

-

-

-

-

-
Owner occupied

-

-

-

402

-
Revolving and junior liens

51

51

6

26

2
Consumer

-

-

-

-

-
Total impaired loans with a recorded allowance

51

51

6

551

2
Total impaired loans

$
20,086

$
22,961

$
6

$
21,187

$
186

1 The “Other” class includes consumer, overdrafts and net deferred costs.

1618

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Impaired loans by class of loans as of December 31, ~~2016,~~2018, and for the ~~nine~~three and six months ended ~~September~~June 30, ~~2016,~~2018, were as follows:


							Nine Months Ended										Three Months Ended				Six Months Ended
	As of December 31, 2016						September 30, 2016				As of December 31, 2018						June 30, 2018				June 30, 2018
			Unpaid				Average		Interest				Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Principal		Related		Recorded		Income		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized		Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial	$	240	$	388	$	-	$	326	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Leases		366		371		-		-		-		-		-		-		-		-		89		-
Commercial real estate
Owner occupied general purpose		1,881		2,131		-		2,412		66		1,659		1,782		-		645		3		683		3
Owner occupied special purpose		385		518		-		580		-		395		530		-		433		-		384		-
Non-owner occupied general purpose		1,744		2,010		-		1,655		2		1,138		1,159		-		40		-		601		-
Non-owner occupied special purpose		1,013		1,649		-		506		-		-		-		-		-		-		-		-
Retail properties		1,179		1,235		-		990		-		-		-		-		-		-		541		-
Farm		-		-		-		636		-		-		-		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-		-		-		-		-		-		-		-
Land		-		-		-		-		-		-		-		-		-		-		-		-
Commercial speculative		74		81		-		80		-		-		-		-		-		-		-		-
All other		207		221		-		-		-		49		73		-		195		-		197		-
Residential
Investor		1,841		2,308		-		1,864		35		353		459		-		366		-		371		-
Multifamily		-		-		-		-		-
Multi-Family												-		-		-		-		-		2,362		-
Owner occupied		9,824		11,391		-		9,916		120		3,359		4,882		-		4,696		9		4,726		18
Revolving and junior liens		2,484		3,018		-		2,527		9
Consumer		-		-		-		-		-
HELOC												884		1,003		-		933		1		933		1
Other 1												7		7		-		17		-		11		-
Total impaired loans with no recorded allowance		21,238		25,321		-		21,492		232		7,844		9,895		-		7,325		13		10,898		22

With an allowance recorded
Commercial		-		-		-		2		-		-		-		-		-		-		-		-
Leases		-		-		-		-		-		-		-		-		-		-		-		-
Commercial real estate
Owner occupied general purpose		-		-		-		-		-		396		396		3		152		-		-		-
Owner occupied special purpose		-		-		-		-		-		-		-		-		-		-		-		-
Non-owner occupied general purpose		246		595		246		132		31		3,098		4,038		97		-		-		-		-
Non-owner occupied special purpose		-		-		-		-		-		3,099		3,575		139		3,337		-		1,550		-
Retail properties		-		-		-		-		-		-		-		-		-		-		-		-
Farm		-		-		-		-		-		-		-		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-		-		-		-		-		-		-		-
Land		-		-		-		-		-		-		-		-		-		-		-		-
Commercial speculative		-		-		-		-		-		-		-		-		-		-		-		-
All other		-		-		-		-		-		57		58		1		-		-		-		-
Residential
Investor		-		-		-		-		-		808		808		4		819		11		822		22
Multifamily		-		-		-		-		-
Multi-Family												-		-		-		-		-		-		-
Owner occupied		803		853		803		356		-		3,676		3,679		46		3,661		36		3,544		73
Revolving and junior liens		-		-		-		23		-
Consumer		-		-		-		-		-
HELOC												1,357		1,357		49		1,232		13		1,153		24
Other 1												24		25		13		2		-		2		-
Total impaired loans with a recorded allowance		1,049		1,448		1,049		513		31		12,515		13,936		352		9,203		60		7,071		119
Total impaired loans	$	22,287	$	26,769	$	1,049	$	22,005	$	263	$	20,359	$	23,831	$	352	$	16,528	$	73	$	17,969	$	141

1 The “Other” class includes consumer, overdrafts and net deferred costs.

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist: (1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-by-case basis during the loan collection process with modifications generally initiated at the request of the borrower. These modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an opportunity to refinance into more affordable monthly payments.

~~Tableof Contents~~

The specific allocation of the allowance for loan and lease losses for TDRs is determined by calculating the present value of the TDR cash flows by discounting the original payment less an assumption for probability of default at the original note’s issue rate, and adding this amount to the present value of collateral less selling costs. If the resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance (i.e., specific reserve) as a component of the allowance for loan and lease losses or charges off the impaired balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. The allowance for loan and lease losses also includes an allowance based on a loss migration analysis for each loan category on loans and leases that are not individually evaluated for specific impairment. All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.

TDRs that were modified during the period are as follows:

TDR Modifications

TDR Modifications

Quarter Ended September 30, 2017

Nine Months Ended September 30, 2017

# of

Pre-modification

Post-modification

# of

Pre-modification

Post-modification


contracts

recorded investment

recorded investment

contracts

recorded investment

recorded investment

Troubled debt restructurings

Real estate - residential

Owner occupied

HAMP1

1

$
36

$
33

1

$
36

$
33

Other2

1

42

42

1

42

42

Revolving and junior liens

HAMP1

1

49

49

1

49

49

Other2

1

49

33

7

448

418

Total

4

$
176

$
157

10

$
575

$
542


	TDR Modifications					TDR Modifications
	Three Months Ended June 30, 2019					Six Months Ended June 30, 2019
	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - commercial
Investor occupied general purpose
Other1	-	$	-	$	-	1	$	58	$	57
Real estate - residential
Owner occupied
HAMP2	2		294		292	3		399		299
HELOC
HAMP2	-		-		-	1		39		34
Other1	-		-		-	1		39		39
Total	2	$	294	$	292	6	$	535	$	429


	TDR Modifications					TDR Modifications					TDR Modifications					TDR Modifications
	Quarter Ended September 30, 2016					Nine Months Ended September 30, 2016					Three Months Ended June 30, 2018					Six Months Ended June 30, 2018
	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - commercial
Other2	-	$	-	$	-	2	$	312	$	211
Owner occupied special purpose
Other1											1	$	110	$	56	1	$	110	$	56
Real estate - residential
Owner occupied
HAMP1	-		-		-	1		239		235
Revolving and junior liens
HAMP1	-		-			4		469		433
Other2	1		70		70	1		70		70
HAMP2											1		49		39	1		49		39
HELOC
Rate3																1		24		24
Other1											3		305		287	7		523		503
Total	1	$	70	$	70	8	$	1,090	$	949	5	$	464	$	382	10	$	706	$	622

1Table ~~HAMP: Home Affordable Modification Program~~of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

21 Other: Change of terms from bankruptcy ~~court~~court.

2HAMP: Home Affordable Modification Program.

3 Rate: Refers to interest rate reduction.

TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. There was no TDR default activity for the ~~nine months~~periods ended ~~September~~June 30, ~~2017,~~2019 and ~~September~~June 30, ~~2016,~~2018, for loans that were restructured within the 12 month period prior to default.

The following table details the accretable discount on all of the Company’s purchased loans, both non-PCI loans and PCI loans as of June 30, 2019. The Company’s PCI loans were recorded commensurate with the second quarter 2018 acquisition of ABC Bank; no PCI loans were held prior to that time. Non-PCI loan activity during the first quarter of 2018 stemmed from the Company’s acquisition of the Chicago branch of Talmer Bank and Trust in late 2016. The accretable discount recorded in the second quarter of 2019 totaled $1.1 million; the balance of the non-PCI loan discount was $10.8 million as of June 30, 2018.


Purchased Accounting Accretion
(dollars in thousands)
For the Three Months Ended	Accretable Discount- Non-PCI Loans		Accretable Discount- PCI Loans		Non-Accretable Discount- PCI Loans		Total
Beginning balance, April 1, 2019	$	1,502	$	1,085	$	5,969	$	8,556
Accretion		(286)		(108)		-		(394)
Charge-offs		-		(48)		(467)		(515)
Transfer		-		2		(2)		-
Balance, June 30, 2019	$	1,216	$	931	$	5,500	$	7,647


For the Six Months Ended	Accretable Discount - Non-PCI Loans		Accretable Discount - PCI Loans		Non-Accretable Discount - PCI Loans		Total
Beginning balance, January 1, 2019	$	1,867	$	1,099	$	5,969	$	8,935
Accretion		(651)		(122)				(773)
Charge-offs				(48)		(467)		(515)
Transfer				2		(2)		-
Balance, June 30, 2019	$	1,216	$	931	$	5,500	$	7,647

1821

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Note 5 – Allowance for Loan and Lease Losses

Changes in the allowance for loan and lease losses by segment of loans based on method of impairment for the three and six months ended June 30, 2019, were as follows:


					Real Estate		Real Estate		Real Estate
Allowance for loan and lease losses:	Commercial		Leases		Commercial		Construction		Residential		HELOC		Other1		Total

Three months ended June 30, 2019
Beginning balance	$	3,052	$	805	$	10,020	$	800	$	1,956	$	1,325	$	1,358	$	19,316
Charge-offs		67		-		42		1		-		279		85		474
Recoveries		6		-		12		2		14		12		34		80
Provision (Release)		386		156		527		19		(180)		277		(735)		450
Ending balance	$	3,377	$	961	$	10,517	$	820	$	1,790	$	1,335	$	572	$	19,372

Six months ended June 30, 2019
Beginning balance	$	2,832	$	734	$	10,470	$	969	$	1,931	$	1,449	$	621	$	19,006
Charge-offs		79		-		273		1		18		279		169		819
Recoveries		36		-		35		1		64		58		91		285
Provision (Release)		588		227		285		(149)		(187)		107		29		900
Ending balance	$	3,377	$	961	$	10,517	$	820	$	1,790	$	1,335	$	572	$	19,372

Ending balance: Individually evaluated for impairment	$	113	$	12	$	206	$	-	$	45	$	70	$	9	$	455
Ending balance: Collectively evaluated for impairment		3,264		949		9,907		820		1,745		1,265		563		18,513
Ending balance: Acquired and accounted for ASC 310-30		-		-		404		-		-		-		-		404
Total ending allowance balance	$	3,377	$	961	$	10,517	$	820	$	1,790	$	1,335	$	572	$	19,372

Loans:
Ending balance: Individually evaluated for Impairment	$	151	$	125	$	6,848	$	102	$	7,640	$	2,499	$	24	$	17,389
Ending balance: Collectively evaluated for impairment		337,697		98,254		818,243		92,977		385,907		126,174		15,468		1,874,720
Ending balance: Acquired and accounted for ASC 310-30		-		-		4,092		674		6,068		-		-		10,834
Total ending loans balance	$	337,848	$	98,379	$	829,183	$	93,753	$	399,615	$	128,673	$	15,492	$	1,902,943

1 The “Other” class includes consumer, overdrafts and net deferred costs.

Changes in the allowance for loan and lease losses by segment of loans based on method of impairment for three and ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2018, were as follows:


					Real Estate		Real Estate		Real Estate												Real Estate		Real Estate		Real Estate
Allowance for loan losses:	Commercial		Leases		Commercial		Construction		Residential		Consumer		Other		Total
Three months ended September 30, 2017
Allowance for loan and lease losses:																	Commercial		Leases		Commercial		Construction		Residential		HELOC		Other1		Total
Three months ended June 30, 2018
Beginning balance	$	2,150	$	791	$	8,107	$	857	$	2,576	$	848	$	507	$	15,836	$	2,604	$	617	$	9,565	$	1,143	$	1,854	$	1,535	$	870	$	18,188
Charge-offs		13		98		22		19		7		82		-		241		15		8		504		-		5		65		102		699
Recoveries		6		-		43		11		459		45		6		570		92		-		21		-		105		91		73		382
(Release) Provision		(104)		77		505		165		(607)		(1)		265		300		(5)		25		1,455		255		(136)		(171)		27		1,450
Ending balance	$	2,039	$	770	$	8,633	$	1,014	$	2,421	$	810	$	778	$	16,465	$	2,676	$	634	$	10,537	$	1,398	$	1,818	$	1,390	$	868	$	19,321

Nine months ended September 30, 2017
Six months ended June 30, 2018
Beginning balance	$	1,629	$	633	$	9,547	$	389	$	2,692	$	833	$	435	$	16,158	$	2,453	$	692	$	9,522	$	923	$	1,846	$	1,446	$	579	$	17,461
Charge-offs		20		215		300		23		1,178		262		-		1,998		31		13		408		(16)		(55)		92		201		674
Recoveries		13		-		124		89		850		166		13		1,255		109		-		388		3		1,016		138		152		1,806
Provision (Release)		417		352		(738)		559		57		73		330		1,050		145		(45)		1,035		456		(1,099)		(102)		338		728
Ending balance	$	2,039	$	770	$	8,633	$	1,014	$	2,421	$	810	$	778	$	16,465	$	2,676	$	634	$	10,537	$	1,398	$	1,818	$	1,390	$	868	$	19,321

Ending balance: Individually evaluated for impairment	$	-	$	-	$	-	$	-	$	6	$	-	$	-	$	6	$	-	$	-	$	503	$	-	$	85	$	-	$	-	$	588
Ending balance: Collectively evaluated for impairment	$	2,039	$	770	$	8,633	$	1,014	$	2,415	$	810	$	778	$	16,459		2,676		634		10,034		1,398		1,733		1,390		868		18,733
Ending balance: Acquired and accounted for ASC 310-30																		-		-		-		-		-		-		-		-
Total ending allowance balance																	$	2,676	$	634	$	10,537	$	1,398	$	1,818	$	1,390	$	868	$	19,321

Loans:
Ending balance	$	257,356	$	69,305	$	739,136	$	94,868	$	419,583	$	2,770	$	11,173	$	1,594,191
Ending balance: Individually evaluated for impairment	$	207	$	196	$	3,147	$	205	$	16,323	$	8	$	-	$	20,086	$	-	$	-	$	4,475	$	193	$	11,138	$	-	$	19	$	15,825
Ending balance: Collectively evaluated for impairment	$	257,149	$	69,109	$	735,989	$	94,663	$	403,260	$	2,762	$	11,173	$	1,574,105		299,536		66,687		803,789		115,293		393,770		127,986		15,062		1,822,123
Ending balance: Acquired and accounted for ASC 310-30																		2		-		4,146		1,556		5,509		-		1		11,214
Total ending loan balance																	$	299,538	$	66,687	$	812,410	$	117,042	$	410,417	$	127,986	$	15,082	$	1,849,162

~~Changes in the allowance for loan losses by segment of loans based on method of impairment for three and nine months ended September 30, 2016, were as follows:~~

Real Estate

Real Estate

Real Estate

Allowance for loan losses:

Commercial

Leases

Commercial

Construction

Residential

Consumer

Other

Total
Three months ended September 30, 2016

Beginning balance

$
1,420

$
275

$
8,954

$
380

$
2,933

$
862

$
998

$
15,822
Charge-offs

76

-

792

9

220

100

-

1,197
Recoveries

10

-

27

60

199

57

5

358
Provision (Release)

141

71

753

39

(577)

118

(545)

-
Ending balance

$
1,495

$
346

$
8,942

$
470

$
2,335

$
937

$
458

$
14,983

Nine months ended September 30, 2016

Beginning balance

$
2,041

$
55

$
9,013

$
265

$
1,694

$
1,190

$
1,965

$
16,223
Charge-offs

95

13

1,484

9

657

250

-

2,508
Recoveries

22

-

255

71

718

184

18

1,268
(Release) Provision

(473)

304

1,158

143

580

(187)

(1,525)

-
Ending balance

$
1,495

$
346

$
8,942

$
470

$
2,335

$
937

$
458

$
14,983

Ending balance: Individually evaluated for impairment

$
-

$
-

$
264

$
-

$
250

$
-

$
-

$
514
Ending balance: Collectively evaluated for impairment

$
1,495

$
346

$
8,678

$
470

$
2,085

$
937

$
458

$
14,469

Loans:

Ending balance

$
136,819

$
47,215

$
617,280

$
28,786

$
357,846

$
3,325

$
11,581

$
1,202,852
Ending balance: Individually evaluated for impairment

$
583

$
-

$
8,426

$
76

$
14,038

$
-

$
-

$
23,123
Ending balance: Collectively evaluated for impairment

$
136,236

$
47,215

$
608,854

$
28,710

$
343,808

$
3,325

$
11,581

$
1,179,729

1922

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

1 The “Other” class includes consumer, overdrafts and net deferred costs.

Note 6 – Other Real Estate Owned

Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation reserve, for the periods presented are itemized in the following table:


	Quarters Ended				Nine Months Ended				Three Months Ended				Six Months Ended
	September 30,				September 30,				June 30,				June 30,
Other real estate owned	2017		2016		2017		2016		2019		2018		2019		2018
Balance at beginning of period	$	11,724	$	16,252	$	11,916	$	19,141	$	6,365	$	7,063	$	7,175	$	8,371
Property additions		176		255		3,796		1,223
Property additions, net of acquisition adjustments										-		2,812		-		2,812
Property improvements		-		4		-		16		-		-		-		59
Less:
Proceeds from property disposals, net of participation purchase and of gains/losses		1,956		2,002		5,058		4,931		501		709		1,302		1,964
Period valuation adjustments		920		365		1,630		1,305		196		254		196		366
Other adjustments										-				9		-
Balance at end of period	$	9,024	$	14,144	$	9,024	$	14,144	$	5,668	$	8,912	$	5,668	$	8,912

Activity in the valuation allowance was as follows:


	Quarters Ended				Nine Months Ended				Three Months Ended				Six Months Ended
	September 30,				September 30,				June 30,				June 30,
	2017		2016		2017		2016		2019		2018		2019		2018
Balance at beginning of period	$	8,304	$	13,377	$	9,982	$	14,127	$	7,875	$	8,099	$	8,027	$	8,208
Provision for unrealized losses		920		365		1,630		1,305		196		254		196		366
Reductions taken on sales		(421)		(488)		(2,809)		(2,178)		(10)		(5)		(162)		(226)
Balance at end of period	$	8,803	$	13,254	$	8,803	$	13,254	$	8,061	$	8,348	$	8,061	$	8,348

Expenses related to OREO, net of lease revenue includes:


	Quarters Ended				Nine Months Ended				Three Months Ended				Six Months Ended
	September 30,				September 30,				June 30,				June 30,
	2017		2016		2017		2016		2019		2018		2019		2018
Gain on sales, net	$	(276)	$	(249)	$	(454)	$	(316)	$	(77)	$	(24)	$	(150)	$	(104)
Provision for unrealized losses		920		365		1,630		1,305		196		254		196		366
Operating expenses		221		361		1,037		1,217		129		213		257		369
Less:
Lease revenue		185		51		285		163		-		14		5		29
Net OREO expense	$	680	$	426	$	1,928	$	2,043	$	248	$	429	$	298	$	602

Note 7 – Deposits

Major classifications of deposits were as follows:


	September 30, 2017		December 31, 2016		June 30, 2019		December 31, 2018
Noninterest bearing demand	$	556,874	$	513,688	$	632,900	$	618,830
Savings		260,268		256,159		311,887		304,400
NOW accounts		417,054		419,417		426,511		425,878
Money market accounts		270,647		275,273		285,223		310,390
Certificates of deposit of less than $100,000		219,152		228,993		220,973		230,781
Certificates of deposit of $100,000 through $250,000		114,373		110,992		144,148		159,953
Certificates of deposit of more than $250,000		50,747		62,263		56,132		66,441
Total deposits	$	1,889,115	$	1,866,785	$	2,077,774	$	2,116,673

2023

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Note 8 – Borrowings

The following table is a summary of borrowings as of ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016.~~2018. Junior subordinated debentures are discussed in detail in Note 9:


	September 30, 2017		December 31, 2016		June 30, 2019		December 31, 2018
Securities sold under repurchase agreements	$	26,853	$	25,715	$	54,166	$	46,632
FHLBC advances1		125,000		70,000
Other short-term borrowings 1						87,125		149,500
Junior subordinated debentures		57,627		57,591		57,710		57,686
Senior notes		44,033		43,998		44,208		44,158
Notes payable and other borrowings						11,035		15,379
Total borrowings	$	253,513	$	197,304	$	254,244	$	313,355

1 ~~Included in other~~Includes short-term ~~borrowings on~~FHLBC advances for both periods presented as well as the ~~balance sheet.~~outstanding portion of an operating line of credit as of December 31, 2018, which totaled $4 million.

The Company enters into deposit sweep transactions where the transaction amounts are secured by pledged securities. These transactions consistently mature overnight from the transaction date and are governed by sweep repurchase agreements. All sweep repurchase agreements are treated as financings secured by U.S. government agencies and collateralized mortgage-backed securities and had a carrying amount of ~~$26.9~~$54.2 million at ~~September~~June 30, ~~2017,~~2019, and ~~$25.7~~$46.6 million at December 31, ~~2016.~~2018. The fair value of the pledged collateral was ~~$41.5~~$73.8 million at ~~September~~June 30, ~~2017~~2019 and ~~$43.0~~$72.8 million at December 31, ~~2016.~~2018. At ~~September~~June 30, ~~2017,~~2019, there were no customers with secured balances exceeding 10% of stockholders’ equity.

The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC. Total borrowings are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans. As of ~~September~~June 30, ~~2017,~~2019, the Bank had ~~$125.0~~$87.1 million in short-term advances outstanding under the FHLBC as compared to ~~$70.0~~$145.5 million outstanding as of December 31, ~~2016. As~~2018; $65.0 million and $10.0 million of ~~September~~the June 30, ~~2017,~~2019, balance was issued at 2.43% and 2.45%, respectively, and the remaining $12.1 million was issued at rates ranging from 1.60% to 2.03%. The additional $4.0 million in other short-term borrowings as of December 31, 2018, was the outstanding portion of a $20.0 million line of credit the Company has with a correspondent bank for short-term funding needs; advances under the line can be outstanding up to 360 days from the date of issuance. This line of credit was repaid with operating cash on hand in late January 2019. The Bank also assumed $23.4 million of long-term FHLBC advances with the ABC Bank acquisition. At June 30, 2019, these advances have a total outstanding balance of $11.0 million and are scheduled to mature over the next seven years with interest rates ranging between 2.19% and 2.83%. FHLBC stock held at June 30, 2019 was valued at ~~$5.6~~$4.4 million, and any potential FHLBC advances were collateralized by securities with a fair value of ~~$87.4~~$78.2 million and loans with a principal balance of ~~$251.3~~$605.9 million, which carried a FHLBC calculated combined collateral value of ~~$273.8~~$489.6 million. The Company had excess collateral of ~~$74.5~~$317.2 million available to secure borrowings at ~~September~~June 30, ~~2017.~~2019. The increase of 394.5% since December 2018 is due to the completion of an analysis of FHLB loan collateral eligibility in the first quarter of 2019, which expanded the capacity of funding at the FHLB as additional loan collateral was deemed acceptable.

The Company ~~completed a debt retirement and simultaneous senior debt offering in the fourth quarter of 2016. Subordinated debt of $45.0~~also has $44.2 million ~~and $500,000~~ of senior notes outstanding, ~~were paid off with the proceeds~~net of ~~a $45.0 million senior notes~~deferred issuance costs, as of June 30, 2019 and ~~cash on hand.~~December 31, 2018. The senior notes ~~mature~~were issued in December 2016 with a ten years maturity, and terms include interest payable semiannually at 5.75% for five years. Beginning December 2021, the senior debt will pay interest at a floating rate, with interest payable quarterly at three month LIBOR plus 385 basis points. The notes are redeemable, in whole or in part, at the option of the Company, beginning with the interest payment date on December 31, 2021, and on any floating rate interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest. ~~Debt~~As of June 30, 2019 and December 31, 2018, unamortized debt issuance costs ~~incurred for~~related to the senior notes ~~issuance totaled $1.0 million,~~were $791,000 and ~~are being deferred~~$842,000, respectively, and ~~recorded to expense over the ten year term of the notes. The unamortized costs~~ are included as a reduction toof the balance of the senior notes on the Consolidated Balance Sheet. These deferred issuance costs will be amortized to interest expense over the ten year term of the notes and are included in the Consolidated Statements of Income.

Note 9 – Junior Subordinated Debentures

The Company completed the sale of $27.5 million of cumulative trust preferred securities by its unconsolidated subsidiary, Old Second Capital Trust I, in June 2003. An additional $4.1 million of cumulative trust preferred securities were sold in July 2003. The trust preferred securities may remain outstanding for a 30-year term but, subject to regulatory approval, can be called in whole or in part by the Company after June 30, 2008. ~~When not in deferral, distributions~~Distributions on the securities are payable quarterly at an annual rate of 7.80%., unless the Company

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

elects to defer such interest payments as permitted by the terms of the securities. The Company issued a new $32.6 million subordinated debenture to Old Second Capital Trust I in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.

The Company issued an additional $25.0 million of cumulative trust preferred securities through a private placement completed by an additional, unconsolidated subsidiary, Old Second Capital Trust II, in April 2007. These trust preferred securities also mature in 30 years, but subject to the aforementioned regulatory approval, can be called in whole or in part on a quarterly basis commencing June 15, 2017. The quarterly cash distributions on the securities were fixed at 6.77% through June 15, 2017, and float at 150 basis points over three-month LIBOR thereafter. ~~The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points on June 15, 2017.~~ Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of ~~4.30%~~4.40% as of ~~September~~June 30, ~~2017,~~2019, compared to the rate paid prior to June 15, 2017 of 6.77%. The Company issued a new $25.8 million subordinated debenture to Old Second Capital Trust II in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.

Both of the debentures issued by the Company are disclosed on the Consolidated Balance Sheet as junior subordinated debentures and the related interest expense for each issuance is included in the Consolidated Statements of Income. As of ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, unamortized debt issuance costs related to the junior subordinated debentures were

~~Tableof Contents~~

~~$752,000~~$668,000 and ~~$787,000~~$692,000 respectively, and are included as a reduction to the balance of the junior subordinated debentures on the Consolidated Balance Sheet. These deferred issuance costs will be amortized to interest expense over the 30-year term of the notes and are included in the Consolidated Statements of Income.

Note 10 – Equity Compensation Plans

Stock-based awards are outstanding under the Company’s 2008 Equity Incentive Plan (the “2008 Plan”) ~~and~~, the Company’s 2014 Equity Incentive Plan, as amended (the “2014 Plan”), and the Company’s 2019 Equity Incentive Plan” (the “2019 Plan” and together with the 2008 Plan and the 2014 Plan, the “Plans”). The ~~2014~~2019 Plan was approved at the ~~2014~~May 2019 annual stockholders’ meeting and the number of ~~stockholders; a maximum of 375,000~~authorized shares ~~were authorized to be issued~~ under ~~this plan.~~the 2019 Plan is fixed at 600,000. Following approval of the 2014 Plan, no further awards ~~will~~were to be granted under the 2008 Plan or any other prior Company equity compensation ~~plan.~~Atplan, and following the ~~May 2016 annual stockholders meeting, an amendment to~~approval of the 2019 Plan, no further awards will be granted under the 2014 ~~Plan authorized an additional 600,000 shares to be issued, which resulted in a total of 975,000 shares authorized for issuance under this plan.~~Plan. The ~~2014~~2019 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation ~~rights.~~rights (“SARs”). Awards may be granted to selected directors, ~~and~~ officers, employees or ~~employees~~eligible service providers under the ~~2014~~2019 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors. As of ~~September~~June 30, ~~2017, 453,209~~2019, 460,394 shares remained available for issuance under the ~~2014~~2019 Plan.

There were 4,500 stock options exercised and no stock options granted in the six months ended June 30, 2019, and no stock options granted or exercised in the ~~third quarter of 2017 and 2016.~~six months ended June 30, 2018. All stock options are granted for a term of ten years. There is no unrecognized compensation cost related to unvested stock options as all stock options of the Company’s common stock have fully vested.

A summary of stock option activity in the Plans for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, is as follows:


				Weighted-
		Weighted		Average						Weighted-
		Average		Remaining				Weighted		Average
		Exercise		Contractual	Aggregate			Average		Remaining
	Shares	Price		Term (years)	Intrinsic Value			Exercise		Contractual	Aggregate
							Shares	per Price		Term (years)	Intrinsic Value
Beginning outstanding	94,500	$	25.82	-		-	4,500	$	7.49	0.1	$	25
Canceled	-		-	-		-	-		-	-		-
Exercised							(4,500)		7.49	-		(27)
Expired	-		-	-		-	-		-	-		-
Exercised	-		-	-		-
Ending outstanding	94,500	$	25.82	0.3	$	-	-	$	-	-	$	-

Exercisable at end of period	94,500	$	25.82	0.3	$	-	-	$	-	-	$	-

Generally, restricted stock and restricted stock units granted under the Plans vest three years from the grant date, but the Compensation Committee of the Company’s Board of Directors has discretionary authority to change some terms including the amount of time until the vest date.

~~Awards under the 2008 Plan will become fully vested upon a merger or change~~

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in ~~control of the Company.~~ thousands, except per share data, unaudited)

Under the ~~2014~~2019 Plan, unless otherwise provided in an award agreement, upon the occurrence of a change in control, ofall stock options and SARs then held by the ~~Company,~~participant will become fully exercisable immediately if, and all stock awards and cash incentive awards will become fully earned and vested immediately if, (i) the ~~2014~~2019 Plan is not an obligation of the successor entity following ~~the~~a change in control or (ii) the ~~2014~~2019 Plan is an obligation of the successor entity following ~~the~~a change in control and the participant incurs a termination of service without cause or for good reason following the change in control. Notwithstanding the immediately preceding sentence, if the vesting of an ~~involuntary termination,~~award is conditioned upon the achievement of performance measures, then such vesting will generally be subject to the ~~stock options, stock appreciation rights, stock awards~~following: if, at the time of the change in control, the performance measures are less than 50% attained (pro rata based upon the time of the period through the change in control), the award will become vested and ~~cash incentive awards under~~exercisable on a fractional basis with the ~~2014 Plan~~numerator being equal to the percentage of attainment and the denominator being 50%; and if, at the time of the change in control, the performance measures are at least 50% attained (pro rata based upon the time of the period through the change in control), the award will become fully ~~exercisable~~earned and ~~vested. Performance-based awards generally will vest based~~vested immediately upon ~~the level of achievement of the applicable performance measures through~~ the change in control.

The Company granted restricted stock under its equity compensation plans beginning in 2005 and it began granting restricted stock units in February 2009. ~~Restricted~~Awards of restricted stock ~~awards~~ under the Plans generally entitle holders to voting and dividend rights upon grant and are subject to forfeiture until certain restrictions have lapsed including employment for a specific period. ~~Restricted~~Awards of restricted stock units under the Plans are also subject to forfeiture until certain restrictions have lapsed including employment for a specific period, but do not entitle holders to voting rights until the restricted period ends and shares are transferred in connection with the units.

There were ~~161,500~~139,606 restricted ~~awards~~stock units issued under the 2019 Plan during the six months ended June 30, 2019. There were 254,281 restricted stock units issued under the 2014 Plan during the ~~nine~~six months ended ~~September~~June 30, ~~2017. There were 130,000 restricted awards issuedduring the nine months ended September 30, 2016.~~2018. Compensation expense is recognized over the vesting period of the restricted ~~award~~stock unit based on the market value of the award on the issue date. Total compensation cost that has been recorded for the ~~2014 Plan~~Plans was ~~$925,100~~$1.3 million and ~~$485,000~~$1.1 million in the first ~~nine~~six months of ~~2017~~2019 and ~~2016,~~2018, respectively.

~~Tableof Contents~~

A summary of changes in the Company’s unvested restricted awards for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, is as follows:


	September 30, 2017			June 30, 2019
		Weighted			Weighted
	Restricted	Average		Restricted	Average
	Stock Shares	Grant Date		Stock Shares	Grant Date
	and Units	Fair Value		and Units	Fair Value
Nonvested at January 1	409,000	$	5.89
Unvested at January 1				552,281	$	11.30
Granted	161,500		11.04	139,606		12.81
Vested	(91,500)		5.07	(113,937)		7.40
Forfeited	(14,000)		7.53	-		-
Nonvested at September 30	465,000	$	7.79
Unvested at June 30				577,950	$	12.44

Total unrecognized compensation cost of restricted awards was ~~$2.0~~$3.8 million as of ~~September~~June 30, ~~2017,~~2019, which is expected to be recognized over a weighted-average period of ~~2.11~~2.07 years. ~~Total unrecognized compensation cost~~

Tableof ~~restricted awards was $1.1 million as of September 30, 2016, which was expected~~Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to ~~be recognized over a weighted-average period of 1.99 years.~~Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Note 11 – Earnings Per Share

The earnings per share – both basic and diluted – are included below as of ~~September 30 (in thousands except for share and per share data):~~June 30:


	Quarters Ended September 30,				Nine Months Ended September 30,				Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016		2019		2018		2019		2018
Basic earnings per share:
Weighted-average common shares outstanding		29,627,086		29,554,716		29,591,811		29,524,796		29,896,231		29,747,078		29,871,081		29,703,508
Net income	$	8,077	$	3,499	$	17,650	$	10,666	$	9,278	$	6,261	$	17,746	$	15,750
Basic earnings per share	$	0.27	$	0.12	$	0.60	$	0.36	$	0.31	$	0.21	$	0.59	$	0.53

Diluted earnings per share:
Weighted-average common shares outstanding		29,627,086		29,554,716		29,591,811		29,524,796		29,896,231		29,747,078		29,871,081		29,703,508
Dilutive effect of nonvested restricted awards1		473,967		282,228		425,081		303,221
Dilutive effect of stock options		2,556		1,238		2,473		413
Dilutive effect of unvested restricted awards										493,661		539,166		495,808		506,234
Dilutive effect of stock options and warrants										-		51,038		-		43,698
Diluted average common shares outstanding		30,103,609		29,838,182		30,019,365		29,828,430		30,389,892		30,337,282		30,366,889		30,253,440
Net Income	$	8,077	$	3,499	$	17,650	$	10,666
Net income									$	9,278	$	6,261	$	17,746	$	15,750
Diluted earnings per share	$	0.27	$	0.12	$	0.59	$	0.36	$	0.31	$	0.21	$	0.58	$	0.52

Number of antidilutive options and warrants excluded from the diluted earnings per share calculation		900,839		967,339		900,839		977,426

1 Includes the common stock equivalents for restricted share rights that are dilutive.

The above 2018 earnings per share calculation ~~did not include~~also includes a warrant for 815,339 shares of common stock, at an exercise price of $13.43 per share, that was outstanding as of ~~September~~June 30, ~~2017,~~2018, and ~~September 30, 2016, because the warrant~~ was ~~anti-dilutive. Of note, the ten year~~considered dilutive. The ten-year warrant was issued in 2009, and was sold at auction by the U.S. Treasury in June 2013 to a third party investor. This warrant was not included as a dilutive factor as of June 30, 2019, due to its cashless exercise on January 16, 2019. As of the date of exercise, the Company’s closing market stock price was $14.23 per share, resulting in 45,836 shares being issued. The cashless warrant exercise resulted in a net $313,000 reduction to treasury stock as these shares were issued from stock held by the Company.

Note 12 – Regulatory & Capital Matters

The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighted Bank assets, developed by the Office of the Comptroller of the Currency (the “OCC”) and the other bank regulatory agencies. In connection with the current ~~economic environment, the Bank’s current level of nonperforming assets and the~~ risk-based capital regulatory guidelines, the Bank’s Board of Directors has ~~determined that~~established an internal guideline requiring the Bank ~~should~~to maintain a Tier 1 leverage capital ratio at or above eight percent (8%) and a total risk-based capital ratio at or above twelve percent (12%). At ~~September~~June 30, ~~2017,~~2019, the Bank exceeded those thresholds.

At ~~September~~June 30, ~~2017,~~2019, the Bank’s Tier 1 capital leverage ratio was ~~10.63%~~11.96%, an increase of 3960 basis ~~point~~points from December 31, ~~2016,~~2018, and is well above the 8.00% objective. The Bank’s total capital ratio was ~~13.52%~~14.83%, an increase of 769 basis points from December 31, ~~2016,~~2018, and also ~~modestly~~well above the objective of 12.00%.

~~Tableof Contents~~

Bank holding companies are generally required to maintain minimum levels of capital in accordance with capital guidelines implemented by the Board of Governors of the Federal Reserve System. The general bank and holding company capital adequacy guidelines are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of ~~September~~June 30, ~~2017,~~2019 and December 31, ~~2016.~~2018.

In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital requirements for U.S. banking institutions, which went into effect on January 1, 2015. The Basel III Rules are applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” generally holding companies with consolidated assets of less than $3 billion. The Company is currently considered a “small bank holding company.” A detailed discussion of the Basel III Rules is included in Part I, Item 1 of the Company’s Form 10-K for the year ended December 31, ~~2016,~~2018, under the heading “Supervision and Regulation.”

At ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Capital levels and industry defined regulatory minimum required levels are as follows:


					Minimum Capital				To Be Well Capitalized Under								Minimum Capital				To Be Well Capitalized Under
					Adequacy with Capital				Prompt Corrective								Adequacy with Capital				Prompt Corrective
	Actual				Conservation Buffer if applicable1				Action Provisions2				Actual				Conservation Buffer if applicable1				Action Provisions2
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2017
June 30, 2019
Common equity tier 1 capital to risk weighted assets
Consolidated	$	170,622	8.88	%	$	110,482	5.750	%		N/A	N/A		$	226,851	10.26	%	$	154,772	7.000	%		N/A	N/A
Old Second Bank		243,109	12.67			110,330	5.750		$	124,720	6.50	%		311,457	13.96			156,175	7.000		$	145,019	6.50	%
Total capital to risk weighted assets
Consolidated		239,269	12.46			177,627	9.250			N/A	N/A			302,844	13.70			232,107	10.500			N/A	N/A
Old Second Bank		259,569	13.52			177,590	9.250			191,989	10.00			330,825	14.83			234,232	10.500			223,078	10.00
Tier 1 capital to risk weighted assets
Consolidated		221,579	11.54			139,207	7.250			N/A	N/A			283,476	12.83			187,806	8.500			N/A	N/A
Old Second Bank		243,109	12.67			139,111	7.250			153,502	8.00			311,457	13.96			189,641	8.500			178,485	8.00
Tier 1 capital to average assets
Consolidated		221,579	9.69			91,467	4.00			N/A	N/A			283,476	10.85			104,507	4.00			N/A	N/A
Old Second Bank		243,109	10.63			91,480	4.00			114,350	5.00			311,457	11.96			104,166	4.00			130,208	5.00

December 31, 2016
December 31, 2018
Common equity tier 1 capital to risk weighted assets
Consolidated	$	154,537	8.76	%	$	90,411	5.125	%		N/A	N/A		$	207,597	9.29	%	$	142,444	6.375	%		N/A	N/A
Old Second Bank		221,153	12.53			90,456	5.125		$	114,724	6.50	%		295,599	13.29			141,791	6.375		$	144,571	6.50	%
Total capital to risk weighted assets
Consolidated		216,769	12.29			152,126	8.625			N/A	N/A			282,126	12.63			220,648	9.875			N/A	N/A
Old Second Bank		237,306	13.45			152,176	8.625			176,436	10.00			314,600	14.14			219,637	9.875			222,417	10.00
Tier 1 capital to risk weighted assets
Consolidated		191,988	10.88			116,904	6.625			N/A	N/A			263,125	11.78			175,960	7.875			N/A	N/A
Old Second Bank		221,153	12.53			116,930	6.625			141,199	8.00			295,599	13.29			175,153	7.875			177,934	8.00
Tier 1 capital to average assets
Consolidated		191,988	8.90			86,287	4.00			N/A	N/A			263,125	10.08			104,415	4.00			N/A	N/A
Old Second Bank		221,153	10.24			86,388	4.00			107,985	5.00			295,599	11.36			104,084	4.00			130,105	5.00

1 As of ~~September~~June 30, ~~2017,~~2019, amounts are shown inclusive of a capital conservation buffer of ~~1.25%~~2.50%; as compared to December 31, ~~2016,~~2018, of ~~0.625%~~1.875%.

2 The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized.”

Dividend Restrictions

In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be paid by a bank without prior regulatory approval. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital requirements described above. Pursuant to the Basel III rules that came into effect January 1, 2015 and were fully phased in as of January 1, 2019, the Bank must keep a capital conservation buffer of ~~0.625% for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter of~~2.50% above the new regulatory minimum capital requirements, which must consist entirely of Common Equity Tier 1 capital in order to avoid additional limitations on capital distributions and certain other payments.

~~Tableof Contents~~

Note 13 – Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy established by the Company also requires an entity to maximize the use of observable

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair value are:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.

Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own view about the assumptions that market participants would use in pricing an asset or liability.

The majority of securities available-for-sale are valued by external pricing services or dealer market participants and are classified in Level 2 of the fair value hierarchy. Both market and income valuation approaches are utilized. Quarterly, the Company evaluates the methodologies used by the external pricing services or dealer market participants to develop the fair values to determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value. The Company uses the following methods and significant assumptions to estimate fair value:

Government-sponsored agency debt securities are primarily priced using available market information through processes such as benchmark spreads, market valuations of like securities, like securities groupings and matrix pricing.

Other government-sponsored agency securities, MBS and some of the actively traded real estate mortgage investment conduits and collateralized mortgage obligations are priced using available market information including benchmark yields, prepayment speeds, spreads, volatility of similar securities and trade date.

State and political subdivisions are largely grouped by characteristics (e.g., geographical data and source of revenue in trade dissemination systems). Because some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities.

Auction rate securities are priced using market spreads, cash flows, prepayment speeds, and loss analytics. Therefore, the valuations of auction rate asset-backed securities are considered Level 2 valuations.

Asset-backed collateralized loan obligations were priced using data from a pricing matrix supported by our bond accounting service provider and are therefore considered Level 2 valuations.

Annually every security holding is priced by a pricing service independent of the regular and recurring pricing services used. The independent service provides a measurement to indicate if the price assigned by the regular service is within or outside of a reasonable range. Management reviews this report and applies judgment in adjusting calculations at year end related to securities pricing.

Residential mortgage loans available for sale in the secondary market are carried at fair market value. The fair value of loans held-for-sale is determined using quoted secondary market prices.

Lending related commitments to fund certain residential mortgage loans, e.g., residential mortgage loans with locked interest rates to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party investors, as well as forward commitments for future delivery of MBS are considered derivatives. Fair values are estimated based on observable changes in mortgage interest rates including prices for MBS from the date of the commitment and do not typically involve significant judgments by management.

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income to derive the resultant value. The Company is able to compare the valuation model inputs, such as the discount rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates to widely available published industry data for reasonableness.

Interest rate swap positions, both assets and liabilities, are based on valuation pricing models using an income approach reflecting readily observable market parameters such as interest rate yield curves.

The fair value of impaired loans with specific allocations of the allowance for loan and lease losses is essentially based on recent real estate appraisals or the fair value of the collateralized asset. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are made in the appraisal process by the appraisers to reflect differences between the available comparable sales and income data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are based on third party appraisals of the property,

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Assets and Liabilities Measured at Fair Value on a Recurring Basis:

The tables below present the balance of assets and liabilities at ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, respectively, measured by the Company at fair value on a recurring basis:


	September 30, 2017								June 30, 2019
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Securities available-for-sale
U.S. Treasury	$	3,990	$	-	$	-	$	3,990	$	4,025	$	-	$	-	$	4,025
U.S. government agencies		-		13,451		-		13,451		-		9,812		-		9,812
U.S. government agencies mortgage-backed		-		11,030		-		11,030		-		16,999		-		16,999
States and political subdivisions		-		216,672		12,360		229,032		-		244,120		7,175		251,295
Corporate bonds		-		10,577		-		10,577
Collateralized mortgage obligations		-		77,894		2,492		80,386		-		64,867		-		64,867
Asset-backed securities		-		131,759		-		131,759		-		82,725		-		82,725
Collateralized loan obligations		-		53,259		-		53,259		-		62,357		-		62,357
Loans held-for-sale		-		1,641		-		1,641		-		5,142		-		5,142
Mortgage servicing rights		-		-		6,684		6,684		-		-		5,819		5,819
Interest rate swap agreements		-		128		-		128		-		2,695		-		2,695
Mortgage banking derivatives		-		289		-		289		-		298		-		298
Total	$	3,990	$	516,700	$	21,536	$	542,226	$	4,025	$	489,015	$	12,994	$	506,034

Liabilities:
Interest rate swap agreements, including risk participation agreements	$	-	$	1,566	$	-	$	1,566	$	-	$	5,446	$	-	$	5,446
Total	$	-	$	1,566	$	-	$	1,566	$	-	$	5,446	$	-	$	5,446


	December 31, 2016								December 31, 2018
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Securities available-for-sale
U.S. Treasury									$	3,923	$	-	$	-	$	3,923
U.S. government agencies										-		10,951		-		10,951
U.S. government agencies mortgage-backed	$	-	$	41,534	$	-	$	41,534		-		14,075		-		14,075
States and political subdivisions		-		46,477		22,226		68,703		-		265,902		8,165		274,067
Corporate bonds		-		10,630		-		10,630		-		-		-		-
Collateralized mortgage obligations		-		167,808		3,119		170,927		-		64,429		-		64,429
Asset-backed securities		-		138,407		-		138,407		-		109,514		-		109,514
Collateralized loan obligations		-		101,637		-		101,637		-		64,289		-		64,289
Loans held-for-sale		-		4,918		-		4,918		-		2,984		-		2,984
Mortgage servicing rights		-		-		6,489		6,489		-		-		7,357		7,357
Interest rate swap agreements		-		673		-		673		-		672		-		672
Mortgage banking derivatives		-		287		-		287		-		159		-		159
Total	$	-	$	512,371	$	31,834	$	544,205	$	3,923	$	532,975	$	15,522	$	552,420

Liabilities:
Interest rate swap agreements, including risk participation agreements	$	-	$	1,667	$	-	$	1,667	$	-	$	756	$	-	$	756
Total	$	-	$	1,667	$	-	$	1,667	$	-	$	756	$	-	$	756

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are as follows:


	Nine Months Ended September 30, 2017						Six Months Ended June 30, 2019
	Securities available-for-sale						Securities available-for-sale
	Collateralized		States and		Mortgage		Collateralized		States and		Mortgage
	Mortgage		Political		Servicing		Mortgage		Political		Servicing
	Obligation		Subdivisions		Rights		Obligation		Subdivisions		Rights
Beginning balance January 1, 2017	$	3,119	$	22,226	$	6,489
Beginning balance January 1, 2019							$	-	$	8,165	$	7,357
Transfers into Level 3								-		-		-
Transfers out of Level 3								-		-		-
Total gains or losses
Included in earnings (or changes in net assets)		32		-		(354)
Included in earnings								-		(17)		(1,701)
Included in other comprehensive income		7		(501)		-		-		500		-
Purchases, issuances, sales, and settlements
Purchases		-		10,994		-		-		17,554		-
Issuances		-		-		951		-		-		417
Settlements		(666)		(20,359)		(402)		-		(19,027)		(254)
Ending balance September 30, 2017	$	2,492	$	12,360	$	6,684
Ending balance June 30, 2019							$	-	$	7,175	$	5,819


	Nine Months Ended September 30, 2016				Six Months Ended June 30, 2018
	Securities available-for-sale				Securities available-for-sale
	States and		Mortgage		Collateralized		States and		Mortgage
	Political		Servicing		Mortgage		Political		Servicing
	Subdivisions		Rights		Obligation		Subdivisions		Rights
Beginning balance January 1, 2016	$	111	$	5,847
Beginning balance January 1, 2018					$	2,268	$	14,261	$	6,944
Transfers into Level 3						-		-		-
Transfers out of Level 3		(42)		-		-		-		-
Total gains or losses
Included in earnings (or changes in net assets)		-		(1,394)
Included in earnings						26		-		520
Included in other comprehensive income		9		-		31		(551)		-
Purchases, issuances, sales, and settlements
Purchases						-		19,934		-
Issuances		-		1,148		-		-		668
Settlements		(78)		(526)		(554)		(15,195)		(320)
Ending balance September 30, 2016	$	-	$	5,075
Ending balance June 30, 2018					$	1,771	$	18,449	$	7,812

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of ~~September~~June 30, ~~2017:~~2019:

Weighted

Measured at fair value

Unobservable

Average

Unobservable

Average

on a recurring basis:

Fair Value

Valuation Methodology

Inputs

Range of Input

of Inputs

Fair Value

Valuation Methodology

Inputs

Range of Input

of Inputs

Mortgage servicing rights

6,684

Discounted Cash Flow

Discount Rate

10.0 - 1576.2%

10.2

5,819

Discounted Cash Flow

Discount Rate

8.9% - 22.1%

10.1

Prepayment Speed

7.0 - 68.3%

10.0

Prepayment Speed

7.0 - 69.0%

14.2

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of December 31, ~~2016:~~2018:

Weighted

Measured at fair value

Unobservable

Average

Unobservable

Average

on a recurring basis:

Fair Value

Valuation Methodology

Inputs

Range of Input

of Inputs

Fair Value

Valuation Methodology

Inputs

Range of Input

of Inputs

Mortgage servicing rights

6,489

Discounted Cash Flow

Discount Rate

10.0 - 17.0%

10.2

7,357

Discounted Cash Flow

Discount Rate

10.0 - 229.7%

10.2

Prepayment Speed

6.5 - 77.8%

9.6

Prepayment Speed

7.0 - 68.9%

9.6

~~Tableof Contents~~

In addition to the above, Level 3 fair value measurement included ~~$12.4~~$7.2 million for state and political subdivisions representing various local municipality securities ~~and $2.5 million of collateralized mortgage obligations~~ at ~~September~~June 30, ~~2017. Both of these were~~2019. This was classified as securities available-for-sale, and ~~were~~was valued using a discount based on market spreads of similar assets, but the liquidity premium was an unobservable input. The state and political subdivisions securities balance in Level 3 fair value at ~~September~~June 30, ~~2016,~~2018, was ~~zero; the securities were transferred to~~$18.4 million and collateralized mortgage obligation balance in Level 3 ~~in the fourth quarter~~was $1.8 million. Both of ~~2016. Given the small dollar amount~~these were classified as securities available-for-sale, and ~~size of the municipality involved, this is categorized as Level 3~~were valued using a discount based on market spreads of similar assets, but the ~~payment stream received by the Company from the municipality. That payment stream is otherwise~~liquidity premium was an unobservable input.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:

The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP. These assets consist of impaired loans and OREO. For assets measured at fair value on a nonrecurring basis at ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016,~~2018, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:


	September 30, 2017								June 30, 2019
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Impaired loans1	$	-	$	-	$	45	$	45	$	-	$	-	$	6,092	$	6,092
Other real estate owned, net2		-		-		9,024		9,024		-		-		5,668		5,668
Total	$	-	$	-	$	9,069	$	9,069	$	-	$	-	$	11,760	$	11,760

1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans; had a carrying amount of ~~$51,000~~$6.5 million and a valuation allowance of ~~$6,000~~$455,000 resulting in ~~a decrease~~an increase of specific allocations within the allowance for loan and lease losses of ~~$92,000~~$103,000 for the ~~nine~~six months ended ~~September~~June 30, ~~2017.~~2019.

2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of ~~$9.0~~$5.7 million, which is made up of the outstanding balance of ~~$18.7~~$14.7 million, net of a valuation allowance of ~~$8.8~~$8.1 million and participations of ~~$900,000~~$937,000 at ~~September~~June 30, ~~2017.~~2019.


	December 31, 2016								December 31, 2018
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Impaired loans1	$	-	$	-	$	-	$	-	$	-	$	-	$	12,163	$	12,163
Other real estate owned, net2		-		-		11,916		11,916		-		-		7,175		7,175
Total	$	-	$	-	$	11,916	$	11,916	$	-	$	-	$	19,338	$	19,338

1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans; had a carrying amount of $12.5 million and a valuation allowance of ~~$1.0 million,~~$352,000, resulting in an increase of specific allocations within the allowance for loan and lease losses of ~~$1.0 million~~$208,000 for the year December 31, ~~2016.~~2018.

2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of ~~$11.9~~$7.2 million, which is made up of the outstanding balance of ~~$23.5~~$16.0 million, net of a valuation allowance of ~~$10.0~~$8.0 million and participations of ~~$1.6 million,~~$900,000, at December 31, ~~2016.~~2018.

The Company has estimated the fair values of these assets based primarily on Level 3 inputs. OREO and impaired loans are generally valued using the fair value of collateral provided by third party appraisals. These valuations include assumptions related to cash flow projections, discount rates, and recent comparable sales. The numerical ranges of unobservable inputs for these valuation assumptions are not meaningful.

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

Note 14 – Fair Values of Financial Instruments

The estimated fair values approximate carrying amount for all items except those described in the following table. Securities available-for-sale fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the security. The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC or another member institution at par. FHLBC stock is carried at cost and considered a Level 2 fair value. ~~Fair~~As of June 30, 2019 and 2018, the fair values of loans ~~were~~and leases are estimated on an exit price basis incorporating discounts for ~~portfolios of loans with similar financial characteristics, such as type~~credit, liquidity and ~~fixed or variable interest rate terms. Cash flows were discounted using current rates at which similar loans would be made to borrowers with similar ratings and for similar maturities.~~marketability factors. The fair value of time deposits is estimated using discounted future cash flows at current rates offered for deposits of similar remaining maturities. The fair values of borrowings were estimated based on interest rates available to the Company for debt with similar terms and remaining maturities. The fair value of off balance sheet volume is not considered material.

~~Tableof Contents~~

The carrying amount and estimated fair values of financial instruments were as follows:


	September 30, 2017										June 30, 2019
	Carrying		Fair								Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3		Amount		Value		Level 1		Level 2		Level 3
Financial assets:
Cash and due from banks	$	32,772	$	32,772	$	32,772	$	-	$	-	$	38,036	$	38,036	$	38,036	$	-	$	-
Interest bearing deposits with financial institutions		14,730		14,730		14,730		-		-		20,181		20,181		20,181		-		-
Securities available-for-sale		533,484		533,484		3,990		514,642		14,852		492,080		492,080		4,025		480,880		7,175
FHLBC and FRBC Stock		10,393		10,393		-		10,393		-
FHLBC and FRBC stock												10,608		10,608		-		10,608		-
Loans held-for-sale		1,641		1,641		-		1,641		-		5,142		5,142		-		5,142		-
Loans, net		1,577,726		1,568,457		-		-		1,568,457
Net loans												1,883,571		1,913,235		-		-		1,913,235
Accrued interest receivable		8,669		8,669		-		8,669		-		11,096		11,096		-		11,096		-

Financial liabilities:
Noninterest bearing deposits	$	556,874	$	556,874	$	556,874	$	-	$	-	$	632,900	$	632,900	$	632,900	$	-	$	-
Interest bearing deposits		1,332,241		1,329,668		-		1,329,668		-		1,444,874		1,444,338		-		1,444,338		-
Securities sold under repurchase agreements		26,853		26,853		-		26,853		-		54,166		54,166		-		54,166		-
Other short-term borrowings		125,000		125,000		-		125,000		-		87,125		87,125		-		87,125		-
Junior subordinated debentures		57,627		59,524		33,320		26,204		-		57,710		42,874		34,284		8,590		-
Senior notes		44,033		46,958		-		46,958		-		44,208		45,784		45,784		-		-
Note payable and other borrowings												11,035		11,035		-		11,035		-
Interest rate swap agreements		1,439		1,439		-		1,439		-		2,700		2,700		-		2,700		-
Borrowing interest payable		773		773		-		773		-		116		116		-		116		-
Deposit interest payable		573		573		-		573		-		914		914		-		914		-

December 31, 2016

Carrying

Fair


Amount

Value

Level 1

Level 2

Level 3
Financial assets:

Cash and due from banks

$
33,805

$
33,805

$
33,805

$
-

$
-
Interest bearing deposits with financial institutions

13,529

13,529

13,529

-

-
Securities available-for-sale

531,838

531,838

-

506,493

25,345
FHLBC and FRBC Stock

7,918

7,918

-

7,918

-
Loans held-for-sale

4,918

4,918

-

4,918

-
Loans, net

1,462,651

1,453,429

-

-

1,453,429
Accrued interest receivable

5,928

5,928

-

5,928

-

Financial liabilities:

Noninterest bearing deposits

$
513,688

$
513,688

$
513,688

$
-

$
-
Interest bearing deposits

1,353,097

1,351,000

-

1,351,000

-
Securities sold under repurchase agreements

25,715

25,715

-

25,715

-
Other short-term borrowings

70,000

70,000

-

70,000

-
Junior subordinated debentures

57,591

55,163

32,404

22,759

-
Subordinated debenture

43,998

43,998

-

43,998

-
Interest rate swap agreements

994

994

-

994

-
Borrowing interest payable

202

202

-

202

-
Deposit interest payable

599

599

-

599

-

~~Note 15 – Financial Instruments with Off-Balance Sheet Risk and Derivative Transactions~~

To meet the financing needs of its customers, the Bank, as a subsidiary of the Company, is a party to various financial instruments with off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to originate and sell loans as well as financial standby, performance standby and commercial letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Bank’s exposure to credit loss for loan commitments and letters of credit is represented by the dollar amount of those instruments. Management generally uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments.

2933

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)


	December 31, 2018
	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial assets:
Cash and due from banks	$	38,599	$	38,599	$	38,599	$	-	$	-
Interest bearing deposits with financial institutions		16,636		16,636		16,636		-		-
Securities available-for-sale		541,248		541,248		3,923		529,160		8,165
FHLBC and FRBC stock		13,433		13,433		-		13,433		-
Loans held-for-sale		2,984		2,984		-		2,984		-
Net loans		1,878,021		1,867,594		-		-		1,867,594
Accrued interest receivable		10,940		10,940		-		10,940		-

Financial liabilities:
Noninterest bearing deposits	$	618,830	$	618,830	$	618,830	$	-	$	-
Interest bearing deposits		1,497,843		1,495,614		-		1,495,614		-
Securities sold under repurchase agreements		46,632		46,632		-		46,632		-
Other short-term borrowings		149,500		149,500		-		149,500		-
Junior subordinated debentures		57,686		47,625		32,989		14,636		-
Senior notes		44,158		45,008		45,008		-		-
Note payable and other borrowings		15,379		15,379		-		15,379		-
Interest rate swap agreements		58		58		-		58		-
Borrowing interest payable		281		281		-		281		-
Deposit interest payable		973		973		-		973		-

~~Interest Rate Swap Designated as a Cash Flow Hedge~~

~~The Company entered into a forward starting interest rate swap on August 18, 2015,~~Note 15 – Derivatives, Hedging Activities and Financial Instruments with an effective date of June 15, 2017. This transaction had a notional amount totaling $25.8 million as of September 30, 2017, was designated as a cash flow hedge of certain junior subordinated debentures and was determined to be fully effective during the period presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other assets with changes in fair value recorded in other comprehensive income. The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. The Company expects the hedge to remain fully effective during the remaining term of the swap. The Bank will pay the counterparty a fixed rate and receive a floating rate based on three month LIBOR. Management concluded that it would be advantageous to enter this transaction given that the Company has trust preferred securities~~that changed from fixed rate to floating rate on June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.~~Off-Balance Sheet Risk

~~Summary information about the interest rate swap designated as a cash flow hedge is as follows:~~

As of

September 30, 2017

December 31, 2016
Notional amount

$
25,774

$
25,774

Unrealized loss

(1,439)

(994)

~~Other Interest Rate Swaps~~Risk Management Objective of Using Derivatives

The ~~Bank also has~~Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative ~~positions~~financial instruments. Specifically, the Company enters into derivative financial instruments to ~~assist with risk management~~manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are ~~not designated as hedging instruments. These~~determined by interest rates. The Company’s derivative ~~positions relate~~financial instruments are used to ~~transactions~~manage differences in ~~which~~ the ~~Bank enters an~~amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s loan portfolio.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate ~~swap with a client while at the same time entering into an offsetting~~derivatives are to add stability to interest expense and to manage its exposure to interest rate ~~swap with another financial institution. Per contractual requirements with~~movements. To accomplish this objective, the ~~correspondent financial institution, the Bank had $4.2 million in securities available-for-sale pledged to support~~Company primarily uses interest rate swap activity with one correspondent financial institution at September 30, 2017. The Bank had $6.2 million in securities pledged to support interest rate swap activity with one correspondent financial institution at December 31, 2016.

In connection with each transaction, the Bank agreed to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Bank agreed to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to convert a variable rate loan to a fixed rate loan and isswaps as part of ~~the Company’s~~its interest rate risk management strategy. ~~Because~~Interest rate swaps designated as cash flow hedges involve the ~~Bank acts~~receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. During 2019 and 2018, such derivatives were used to hedge the variable cash flows associated with existing variable-rate borrowings.

For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are received on the Company’s variable-rate borrowings. During the next twelve months, the Company estimates that an additional $207,000 will be reclassified as an ~~intermediary for~~increase to interest expense.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service the ~~client,~~Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the ~~underlying derivative contracts offset each other~~customer derivatives and ~~do not generally affect~~ the results of operations. Fair value measurements include an assessment of credit risk related to the client’s ability to perform on their contract position, however, and valuation estimates related to that exposureoffsetting derivatives are ~~discussed~~recognized directly in Note 13 above. At September 30, 2017, the notional amount of non-hedging interest rate swaps was $349.4 million with a weighted average maturity of 6.7 years. At December 31, 2016, the notional amount of non-hedging interest rate swaps was $85.8 million with a weighted average maturity of 7.3 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.earnings.

The ~~Bank~~Company also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans as well as selling forward mortgage-backed securities contracts. Loan interest rate lock commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to originate residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue. Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.

Disclosure of Fair Values of Derivative Instruments on the Balance Sheet

The Company entered into a forward starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017. This transaction had a notional amount totaling $25.8 million as of December 31, 2018, was designated as a cash flow hedge of certain junior subordinated debentures and was determined to be fully effective during the period presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other liabilities with changes in fair value recorded in other comprehensive income, net of tax. The amount included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. The Company expects the hedge to remain fully effective during the remaining term of the swap. The Bank will pay the counterparty a fixed rate and receive a floating rate based on three month LIBOR. The trust preferred securitieschanged from fixed rate to floating rate in June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.

The Bank also has interest rate derivative positions to assist with risk management that are not designated as hedging instruments. These derivative positions relate to transactions in which the Bank enters an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. The Bank had $69,000 of cash collateral pledged with one correspondent financial institution to support interest rate swap activity at June 30, 2019; $6.1 million of investment securities were required to be pledged to two correspondent financial institutions. The Bank had $260,000 of cash collateral pledged with one correspondent financial institution to support interest rate swap activity at December 31, 2018; no investment securities were required to be pledged. At June 30, 2019, the notional amount of non-hedging interest rate swaps was $182.0 million with a weighted average maturity of 6.1 years. At December 31, 2018, the notional amount of non-hedging interest rate swaps was $188.9 million with a weighted average maturity of 6.6 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of June 30, 2019 and December 31, 2018.

Fair Value of Derivative Instruments


			June 30, 2019
	No. of Trans.	Notional Amount $	Balance Sheet Location	Fair Value $	Balance Sheet Location	Fair Value $
Derivatives designated as hedging instruments
Interest rate swaps	1	25,774	Other Assets	-	Other Liabilities	2,700
Total derivatives designated as hedging instruments				-		2,700

Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers	25	182,033	Other Assets	2,695	Other Liabilities	2,695
Interest rate lock commitments and forward contracts	149	59,296	Other Assets	298	Other Liabilities	-
Other contracts	3	18,048	Other Assets	-	Other Liabilities	51
Total derivatives not designated as hedging instruments				2,993		2,746

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Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

			December 31, 2018
	No. of Trans.	Notional Amount $	Balance Sheet Location	Fair Value $	Balance Sheet Location	Fair Value $
Derivatives designated as hedging instruments
Interest rate swaps	1	25,774	Other Assets	-	Other Liabilities	58
Total derivatives designated as hedging instruments				-		58

Derivatives not designated as hedging instruments
Interest rate swaps with commercial loan customers	25	188,931	Other Assets	672	Other Liabilities	672
Interest rate lock commitments and forward contracts	63	18,130	Other Assets	159	Other Liabilities	-
Other contracts	3	18,155	Other Assets	-	Other Liabilities	26
Total derivatives not designated as hedging instruments				831		698

~~The following table presents derivatives not designated as hedging instruments as of September 30, 2017, and periodic changes in the values~~Disclosure of the ~~interest rate swaps are reported in other noninterest income. Periodic changes in the value~~Effect of ~~the forward contracts related to mortgage loan origination are reported in the net gain on sales of mortgage loans.~~Fair Value and Cash Flow Hedge Accounting

Asset Derivatives

Liability Derivatives

Notional or

Contractual

Balance Sheet

Balance Sheet


Amount

Location

Fair Value

Location

Fair Value
Interest rate swap contracts net of credit valuation

$
349,367

Other Assets

$
128

Other Liabilities

$
128
Interest rate lock commitments and forward contracts

28,591

Other Assets

289

N/A

-
Total

$
417

$
128

The ~~following table presents~~fair value and cash flow hedge accounting related to derivatives ~~not designated as hedging instruments~~covered under ASC Subtopic 815-20 impacted Accumulated Other Comprehensive Income (“AOCI”) and the Income Statement. The gain recognized in AOCI on derivatives totaled $1.6 million as of ~~December 31, 2016.~~June 30, 2019, and a loss in AOCI of $473,000 as of June 30, 2018. The amount of the loss reclassified from AOCI to interest income on the income statement totaled $10,000 and $42,000 for the three months ended June 30, 2019, and June 30, 2018, respectively. The amount of the loss reclassified from AOCI to interest income or interest expense on the income statement totaled $15,000 and $116,000 for the six months ended June 30, 2019, and June 30, 2018, respectively.

Asset Derivatives

Liability Derivatives

Notional or

Contractual

Balance Sheet

Balance Sheet


Amount

Location

Fair Value

Location

Fair Value
Interest rate swap contracts net of credit valuation

$
85,807

Other Assets

$
673

Other Liabilities

$
673
Interest rate lock commitments and forward contracts

31,980

Other Assets

287

N/A

-
Total

$
960

$
673

Credit-risk-related Contingent Features

For derivative transactions involving counterparties who are lending customers of the Company, the derivative credit exposure is managed through the normal credit review and monitoring process, which may include collateralization, financial covenants and/or financial guarantees of affiliated parties. Agreements with such customers require that losses associated with derivative transactions receive payment priority from any funds recovered should a customer default and ultimate disposition of collateral or guarantees occur.

Credit exposure to broker/dealer counterparties is managed through agreements with each derivative counterparty that require collateralization of fair value gains owed by such counterparties. Some small degree of credit exposure exists due to timing differences between when a gain may occur and the subsequent point in time that collateral is delivered to secure that gain. This is monitored by the Company and procedures are in place to minimize this exposure. Such agreements also require the Company to collateralize counterparties in circumstances wherein the fair value of the derivatives result in loss to the Company.

Other provisions of such agreements include the definition of certain events that may lead to the declaration of default and/or the early termination of the derivative transaction(s):

If the Company either defaults or is capable of being declared in default on any of its indebtedness (exclusive of deposit obligations), then the Company could also be declared in default on its derivative obligations.

If a merger occurs that materially changes the Company's creditworthiness in an adverse manner.

If certain specified adverse regulatory actions occur, such as the issuance of a Cease and Desist Order, or citations for actions considered Unsafe and Unsound or that may lead to the termination of deposit insurance coverage by the Federal Deposit Insurance Corporation.

The Bank also issues letters of credit, which are conditional commitments that guarantee the performance of a customer to a third party. The credit risk involved and collateral obtained in issuing letters of credit are essentially the same as that involved in extending loan commitments to our customers. In addition to customer related commitments, the Company is responsible for letters of credit commitments that relate to properties held in OREO. The following table represents the Company’s contractual commitments due to letters of credit as of ~~September~~June 30, ~~2017,~~2019, and December 31, ~~2016.~~2018.

Tableof Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share data, unaudited)

The following table is a summary of letter of credit ~~commitments (in thousands):~~commitments:


	September 30, 2017						December 31, 2016						June 30, 2019						December 31, 2018
	Fixed		Variable		Total		Fixed		Variable		Total		Fixed		Variable		Total		Fixed		Variable		Total
Letters of credit:
Borrower:
Financial standby	$	177	$	3,748	$	3,925	$	137	$	4,047	$	4,184	$	339	$	6,468	$	6,807	$	327	$	7,158	$	7,485
Commercial standby		-		122		122		-		126		126		-		1,613		1,613		-		397		397
Performance standby		66		7,912		7,978		83		8,498		8,581		251		6,174		6,425		532		6,381		6,913
		243		11,782		12,025		220		12,671		12,891		590		14,255		14,845		859		13,936		14,795
Non-borrower:
Performance standby		-		422		422		95		525		620		-		67		67		-		67		67
Total letters of credit	$	243	$	12,204	$	12,447	$	315	$	13,196	$	13,511	$	590	$	14,322	$	14,912	$	859	$	14,003	$	14,862

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Table of Contents

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company is a financial services company with its main headquarters located in Aurora, Illinois. The Company is the holding company of Old Second National Bank (the “Bank”), a national banking organization headquartered in Aurora, Illinois, thatfollowing discussion provides commercial and retail banking services, as well as a full complement of trust and wealth management services. The Company has offices located in Cook, Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois. The following management’s discussion and analysis presentsadditional information ~~concerning~~regarding our ~~financial condition as of September 30, 2017, as compared to December 31, 2016, and the results of~~ operations for the three and ~~nine~~six months ~~September~~ended June 30, ~~2017,~~2019, as compared to June 30, 2018, and ~~September~~our financial condition at June 30, ~~2016.~~2019 compared to December 31, 2018. This discussion ~~and analysis is best~~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 ended December 31, ~~2016.~~2018. The results of operations for the ~~quarter September~~three and six months ended June 30, ~~2017,~~2019, are not necessarily indicative of future ~~results.~~results (dollar amounts in thousands, except per share data, unaudited).

In this report, unless the context suggests otherwise, references to the “Company,” “we,” “us,” and “our” mean the combined business of Old Second Bancorp, Inc. and its subsidiary bank, Old Second National Bank (the “Bank”).

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 in Aurora, Illinois. Through our wholly-owned subsidiary bank, Old Second National Bank, a national banking organization also headquartered in Aurora, Illinois, we offer a wide range of financial services through our 29 banking centers located in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois. 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.

Financial Overview

Our community-focused banking franchise ~~has~~ experienced total asset and overall market growth in the ~~past year,~~second quarter of 2019, compared to the first quarter of 2019 and isthe second quarter of 2018, and we believe we are positioned for further ~~success~~growth as we continue to serve our customers’ needs in a competitive economic environment. ~~Industry~~While industry and regulatory developments in the past few years have made it challenging to attain the levels of profitability and growth reflected ~~a decade ago. As~~prior to the economic recession of 2007-2009, we ~~look~~are continuing to seek to provide value to our customers and the communities in which we operate, by executing on growth opportunities ~~identified~~ in our local markets ~~are being developed into~~and developing new banking relationships. WeOverall stable market conditions over the past few years are ~~encouraged by sustained~~reflected in the financials presented for the reporting period ended June 30, 2019.

The following provides an overview of some of the factors impacting our financial performance for the quarter ending June 30, 2019:

This is the fifth quarter of results of operations that included our acquisition of Greater Chicago Financial Corp., and its wholly-owned subsidiary bank, ABC Bank, which closed on April 20, 2018.

Net income for the second quarter of 2019 was $9.3 million, or $0.31 per diluted share, compared to $6.3 million, or $0.21 per diluted share, for the second quarter of 2018. Net income for the six months ended June 30, 2019, totaled $17.7 million, or $0.58 per diluted share, compared to $15.8 million, or $0.52 per diluted share for the six months ended June 30, 2018.

Net interest and dividend income was $24.8 million for the second quarter of 2019, compared to $23.2 million for the second quarter of 2018. The increase was primarily due to a full period of the increased loan volume resulting from our acquisition of ABC Bank on April 20, 2018, which added $227.6 million in loans, net of purchase accounting adjustments, as well as the increase in interest rates in the year over year period. Net interest and dividend income was $48.8 million for the six months ended June 30, 2019, compared to $42.9 million for the like period in 2018.

Noninterest income was $8.1 million for the second quarter of 2019, compared to $8.5 million for the second quarter of 2018. The reduction was primarily due to a $1.1 million interest rate driven mark to market loss on mortgage servicing rights (“MSR”) recorded in the second quarter of 2019, compared to $105,000 of MSR losses recorded in the second quarter of 2018, which was partially offset by security gains, net, of $986,000 for the second quarter of 2019. Noninterest income was $14.6 million for the six months ended June 30, 2019, which reflected a 14.2% decrease from the like period in 2018, due primarily to a decline of $2.2 million in income related to MSR losses for the six month period.

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Noninterest expense was $20.1 million for the second quarter of 2019, compared to $22.3 million for the second quarter of 2018, which reflects a decrease of $2.2 million, or 9.7%. The decrease in expense was due to our acquisition of ABC Bank, which resulted in higher costs in the second quarter of 2018 due to data conversion and salary continuation and retention agreements issued to ABC Bank employees. For the six months ended June 30, 2019, noninterest expense totaled $39.3 million, compared to $39.6 million for the like 2018 period, reflecting a decrease of $320,000, or 0.8%.

Income tax expense increased in the second quarter of 2019 period compared to the like 2018 period due primarily to the increase in pretax income of $4.3 million. The effective tax rate for the three months ended June 30, 2019, was 24.7%, compared to 22.1% for the three months ended June 30, 2018. Income tax expense for the six months ended June 30, 2019, totaled $5.4 million, which was $1.7 million, or 44.3%, higher than the income tax expense for the six months ended June 30, 2018, due primarily to the increase in pretax income of $3.7 million.

Asset quality remained consistent; with nonperforming loans as a percent of total loans remaining relatively steady at 0.7% as of June 30, 2019 and 0.8% as of June 30, 2018.

We added $11.4 million of purchase credit impaired loans (“PCI loans”), net of purchase accounting adjustments, in our acquisition of ABC Bank in the second quarter of 2018. As of June 30, 2019, PCI loans, net of purchase accounting adjustments, totaled $10.8 million, and PCI loans to total loans was 0.6%. We had no PCI loans before our acquisition of ABC Bank.

Critical Accounting Policies

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. The most critical of these significant accounting policies are the policies related to the allowance for loan and lease losses, fair valuation methodologies, income taxes and the accounting related to loans acquired in business combinations. Our significant accounting policies are more fully described in Note 1 to the audited consolidated financial statements contained in our ~~credit performance as nonperforming loan totals remain at low levels~~Annual Report on Form 10-K for the year ended December 31, 2018, and ~~strong sales efforts~~the more significant assumptions and estimates made by management are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2018. There have ~~driven loan growth and portfolio diversity. The Company generated increased~~been no material changes to our significant accounting policies or the estimates made pursuant to those policies from those disclosed in our 2018 Annual Report on Form 10-K during the most recent quarter.

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 income to interest earning assets on a tax equivalent (“TE”) basis, 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 ~~three month period~~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 ~~September~~June 30, ~~2017, as~~2019 and 2018

Our income before taxes was $12.3 million in the second quarter of 2019, compared to $8.0 million in the second quarter of 2018. The $4.3 million increase in pretax income for the second quarter of 2019, compared to the like 2018 quarter, resulted in an increase to income tax expense of $1.3 million for the second quarter of 2019, compared to the like 2018 quarter. Our net income was $9.3

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million, or $0.31 per diluted share, for the second quarter of 2019, compared to net income of $6.3 million, or $0.21 per diluted share, for the second quarter of 2018.

The increase in net income was impacted by a $2.3 million increase in interest and dividend income in the second quarter of 2019, compared to the second quarter of 2018, primarily as a result of higher loan yields in the 2019 period ~~ended September 30, 2016. The Company’s~~due to rising interest rates, as well as the impact of a full period of the increased loan volume resulting from our ABC Bank acquisition, partially offset by a $813,000 increase in interest expense. In addition, our noninterest expense decreased $2.2 million in the second quarter of 2019, compared to the like quarter in 2018, which was partially offset by a decrease of $389,000 in noninterest income ~~growth also contributed~~in the second quarter of 2019, compared to the ~~overall~~second quarter of 2018.

Management has remained diligent in reviewing our loan portfolio to analyze and determine if charge-offs are required. Average loan growth, including loans held for sale, in the second quarter of 2019 totaled $1.8 million, primarily in commercial loans and leases. Management’s review of the loan portfolio resulted in $450,000 of provision expense in the second quarter of 2019, based on analysis of the allowance and loan portfolio held, a decrease of $1.0 million, compared to $1.5 million in provision expense in the like 2018 quarter. The allowance for loan and lease loss analysis methodology remained consistent, with no material changes incorporated in the second quarter of 2019 from the prior quarter.

Six months ended June 30, 2019 and 2018

Our income before taxes was $23.2 million for the six months ended June 30, 2019, compared to $19.5 million for the six months ended June 30, 2018. Our net income was $17.7 million, or $0.58 per diluted share, for the six months ended June 30, 2019, compared to net income of $15.8 million, or $0.52 per diluted share, for the six months ended June 30, 2018.

The increase in ~~earnings~~net income was impacted by an $8.1 million increase in interest and dividend income for the ~~third quarter and nine~~six months ended ~~September~~June 30, ~~2017~~2019, compared the like period of 2018, driven by increased average loan volumes due to the ABC Bank acquisition and organic loan growth, as ~~compared~~well higher yields on loans due to ~~like periods~~the rising interest rate environment, partially offset by a $2.1 million increase in ~~the prior year. However, the positive earnings impact of the growth~~interest expense and an additional $228,000 in provision expense. Also impacting net ~~interest~~ income ~~and~~was a $2.4 million decrease in noninterest income for the ~~third~~six months ended June 30, 2019, compared to the 2018 period, driven primarily by mark to market losses of $2.0 million on MSR’s for the six months ended June 30, 2019, compared to a $200,000 gain on mark to market losses on MSRs in the like 2018 period.

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 June 30, 2019 and 2018

Our net interest and dividend income increased by $1.5 million, from $23.2 million for the second quarter of 2018, to $24.8 million for the second quarter of 2019. Our interest and ~~nine months~~dividend income increased $690,000, or 2.4%, for the second quarter 2019, compared to the first quarter of ~~2017 was partially offset by~~2019, and reflected an increase ~~in noninterest expense. Noninterest expenses~~of $2.3 million, or 8.5%, compared to the second quarter of 2018. Tax equivalent interest and dividend income increased by $2.3 million, or 8.4%, from $27.8 million for the second quarter of 2018, to $30.2 million for the second quarter of 2019.

Average earning assets for the second quarter of 2019 were ~~negatively impacted primarily by~~$2.45 billion, reflecting an increase ~~in employee costs~~of $8.4 million compared to the first quarter of 2019, and an increase of $55.6 million compared to the second quarter of 2018. Total average loans, including loans held-for-sale, totaled $1.90 billion in the ~~year over year periods. Finally, an income tax benefit was recorded in the third~~second quarter of ~~2017 due to a State~~2019, which reflected an increase of ~~Illinois tax rate increase; this credit had a significantly favorable impact which contributed~~$1.8 million compared to the first quarter of 2019, and an increase of $88.2 million compared to the second quarter of 2018. The growth in ~~net~~average balances and resultant interest income in the year over year ~~periods for~~period was primarily due to $227.6 million of loans acquired, net of purchase accounting adjustments, in our acquisition of ABC Bank on April 20, 2018. Organic loan growth and the ~~quarter~~rising interest rate environment also drove growth in interest and ~~nine months.~~

~~Results of Operations~~

~~Net income before taxes of $9.9 million in~~dividend income. For the ~~third~~second quarter of ~~2017 compares to $5.4 million in the third quarter of 2016. When~~2019, yields on average securities increased by 14 basis points and yields on average loans increased by 28 basis points, each compared to the ~~third~~second quarter of 2016, the third quarter of 2017 reflected higher levels of net interest and dividend income, a provision for loan loss of $300,000, and increased levels of noninterest income and noninterest expense. Noninterest income in the 2017 period was favorably impacted by net gains recorded on securities portfolio sales as compared to net losses in the like prior year period, as well as an increase in trust revenue2018, due to ~~growth in our customer base. Noninterest expense increased in~~ the third quarter of 2017 when compared to the third quarter of 2016 primarily due to an increase in salaries and employee benefits due to higher insurance costs, as well as an increase in OREO related valuation costs. An income tax benefit of $1.6 million was recorded in the third quarter of 2017 due to a State of Illinois taxrising interest rate ~~change; this nonrecurring item increased the Company’s deferred tax asset by a like amount.~~

Net income before taxes of $23.7 million for the nine months ended September 30, 2017 was favorable as compared to the $16.5 million pretax income for the nine months ended September 30, 2016. Net interest margin was the largest contributor to this favorable variance, as loan growth and securities repositioning have resulted in increased volumes and more favorable yields for the year to date period.

Management has remained diligent with loan portfolio review to analyze loan quality and decide whether charge-offs are required. In the third quarter of 2017, management’s review of the loan portfolio concluded that an additional provision for loan losses should be recorded of $300,000, stemming from third quarter 2017 loan growth and collateral shortfalls on a few credits as a result of updated appraisals. The allowance for loan losses was adequate and appropriate for estimated incurred losses at September 30, 2016; neither a loan loss reserve release nor an additional loan loss provision was deemed necessary for the like 2016 quarter.

Earnings for the third quarter of 2017 were $0.27 per diluted share on $8.1 million of net income as compared to $0.12 per diluted share on net income of $3.5 million for the third quarter of 2016. For the nine month period ended September 30, 2017, earnings were $0.59 per diluted share on $17.7 million of net income, as compared to $0.36 per diluted share on $10.7 million of income for the prior year like period. Earnings growth in the 2017 period, as compared to the like 2016 period, stems from the acquisition of the Chicago branch of Talmer Bank and Trust, which was completed on October 28, 2016. This acquisition resulted in a cash payment of $181.5 million for loans, net of purchased loan discount totaling $221.0 million, deposits of $48.9 million, goodwill of $8.4 million, core deposit intangible of $659,000, and other immaterial assets and liabilities. The performance of the acquired loan portfolio, security portfolio restructuring to higher yielding instruments, and robust organic loan growth in the year over year period were the primary factors driving the earnings increase for the 2017 third quarter and year to date periods. environment.

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~~Net Interest Income~~

~~Net~~Average interest ~~and dividend income increased by $3.9~~bearing liabilities decreased $40.8 million, from $15.3 million for the quarter ended September 30, 2016, to $19.3 million for the quarter ended September 30, 2017. Total average loans, including loans held-for-sale, increased by $44.3 millionor 2.3%, in ~~the third quarter of 2017 as compared to~~ the second quarter of ~~2017, and $361.9 million as~~2019, compared to the ~~third~~first quarter of ~~2016. Average earning assets were $2.12 billion~~2019, and decreased $24.4 million, or 1.4%, compared to second quarter of 2018. The reduction in average interest bearing deposits from the prior quarter and prior year periods was partially offset with growth in noninterest bearing deposits, primarily commercial demand deposits, of $26.8 million for the ~~third~~year over year period. Average other short-term borrowings, which primarily consist of FHLBC advances, decreased $5.0 million in the second quarter of ~~2017, which reflected an increase~~2019, compared to the first quarter of ~~$6.4~~2019, and increased $35.2 million, compared to the second quarter of ~~2017,~~2018. The average rate paid on short-term FHLBC advances were impacted by the higher interest rate environment resulting in an average rate of 2.47% for the second quarter of 2019, compared to 2.50% for the first quarter of 2019, and 1.90% for the second quarter of 2018. In addition, we acquired notes payable and other borrowings in our acquisition of ABC Bank, consisting solely of long-term FHLBC advances, which resulted in an increase to average interest bearing liabilities of $13.1 million for the second quarter of 2019, an increase of $15.3 million for the first quarter of 2019, and an increase of ~~$212.5~~$19.8 million ~~as compared to~~for the ~~third~~second quarter of ~~2016.~~2018. The significant increase in interest and dividend income of $3.9 million, or 25.6%, in the three months ended September 30, 2017 as compared to the like 2016 period, was driven by growth in the loan portfolio primarily due to the Talmer branch acquisition. In addition, the average yield on the securities portfolio increased by 103 basis points in the year over year period due to portfolio repositioning to higher yielding tax exempt securities; the average tax exempt securities portfolio increased by $185.5 million, and earned 138 basis points more in the third quarter of 2017 as compared to the third quarter of 2016.

Quarterly average interest bearing liabilities as of September 30, 2017, decreased $11.9 million, or 0.8%, compared to June 30, 2017, but increased $87.8 million, or 6.0%, when compared to September 30, 2016. Growth from the prior year like period was due to the Talmer branch purchase of $48.9 million of commercial deposits, as well as organic commercial deposit growth. As the deposit growth in the year over year period was driven by commercial demand accounts, the cost of funds ~~did not materially increase from this volume change. However, each quarter presented reflects an increase in~~on these long-term advances was 3.28% for the ~~FHLBC borrowing, which is within other short-term borrowings, as this facility was used to fund loan growth. The cost of interest bearing liabilities in the third~~second quarter of ~~2017 increased to 80 basis points from 67 basis points in~~2019, 3.08% for the ~~third~~first quarter of ~~2016, primarily due to~~2019, and 1.92% for the ~~senior note issuance in late 2016.~~second quarter of 2018. The ~~$45.0 million senior debt issuance, at~~rate on our junior subordinated debentures was within a seven basis point range over the past year, reflecting an average ~~cost~~rate of ~~6.11% in~~6.47% for the ~~third~~second quarter of ~~2017 net of issuance costs, replaced~~2019, 6.52% for the ~~prior subordinated notes outstanding, which had an average cost of 2.13% in the third~~first quarter of ~~2016. This issuance resulted in a $430,000 increase to interest expense, which drove~~2019, and 6.45% for the ~~overall higher cost~~second quarter of ~~funds in 2017.~~2018.

~~The~~Our net interest margin, ~~(on~~on a tax-equivalent ~~basis),~~(TE) basis, expressed as a percentage of average earning assets, was ~~3.77% in~~4.15% for the ~~third~~second quarter of ~~2017,~~2019, reflecting a six basis point increase from the first quarter of 2019, and an increase of 616 basis points from the second quarter of ~~2017, and growth of 55 basis points from the third quarter of 2016.~~2018. The average tax-equivalent yield on earning assets increased to ~~4.32%~~4.94% for the ~~third~~second quarter of ~~2017, as~~2019, compared to ~~3.70%~~4.90% for the ~~third~~first quarter of ~~2016.~~2019, and 4.67% for the second quarter of 2018. Increases in net interest margin and yield on average earning assets for the ~~third~~second quarter of ~~2017 as~~2019, compared to ~~prior periods presented~~the first quarter of 2019, was attributable to growth in loan volumes and rates, ~~as well as~~and the ~~securities portfolio repositioning~~increase in net interest margin was also due to ~~higher yielding tax exempt holdings, as discussed above.~~growth in noninterest bearing demand accounts, which are a less expensive source of funding. The cost of funds on interest bearing liabilities was ~~0.80%~~1.13% for the ~~third~~second quarter of ~~2017 and 0.67%~~2019, 1.12% for the ~~third~~first quarter of ~~2016.~~ 2019, and 0.92% for the second quarter of 2018. The increase in our cost of funds in each period was driven by the rising interest rate environment, specifically impacting the rates on NOW accounts, newly issued time deposits and FHLBC advances.

~~Tax equivalent~~Six months ended June 30, 2019 and 2018

Our net interest and dividend income increased by ~~$11.5~~$5.9 million, from ~~$46.3~~$42.9 million for the ~~nine~~six months ended ~~September~~June 30, ~~2016,~~2018, to ~~$57.8~~$48.8 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017.~~ 2019. Our interest and dividend income increased $8.1 million, or 16.0%, for the six months ended June 30, 2019, compared to the six months ended June 30, 2018. Tax equivalent interest and dividend income increased by $8.1 million from $51.5 million for the six months ended June 30, 2018 to $59.6 million for the six months ended June 30, 2019.

Average earning assets for the ~~nine~~six months ended ~~September~~June 30, ~~2017 increased $188.4~~2019 were $2.44 billion, reflecting an increase of $159.5 million as compared to the ~~like average period in 2016, and the~~six months ended June 30, 2018. The yield on average earning assets for the ~~nine~~six months ended June 30, 2019 was 4.92%, compared to 4.55% for the six months ended June 30, 2018. Total average loans, including loans held-for-sale, totaled $1.90 billion for the six months ended June 30, 2019, which reflected an increase of ~~2017~~$189.8 million compared to the six months ended June 30, 2018. The growth in average loan balances and the resultant interest income was ~~4.22%~~primarily due to $227.6 million of loans acquired, net of purchase accounting adjustments, in our acquisition of ABC Bank on April 20, 2018, organic loan growth and the rising interest rate environment. For the six months ended June 30, 2019, yields on average securities increased by 30 basis points and yields on average loans increased by 37 basis points, each as compared to ~~3.69% for~~ the ~~like 2016 period.~~ six months ended June 30, 2018, due primarily to the rising interest rate environment.

Average interest bearing liabilities increased $76.4 million, or 4.6%, in the six months ended June 30, 2019, compared to the six months ended June 30, 2018. The increase was due primarily to increases in interest bearing deposits of $46.8 million and other short-term borrowings of $23.1 million, which primarily consist of FHLBC advances. The average rate paid on short-term FHLBC advances were impacted by the higher interest rate environment, resulting in an average rate of 2.49% for the ~~nine~~six months ended ~~September~~June 30, ~~2017, increased $74.5 million, or 5.0%, when~~2019, compared to ~~like prior year period. Net~~1.68% for the six months ended June 30, 2018. In addition, we acquired notes payable and other borrowings in our acquisition of ABC Bank, consisting solely of long-term FHLBC advances, which resulted in an increase to average interest bearing liabilities of $14.1 million for the six months ended June 30, 2019 and an increase of $10.0 million for the six months ended June 30, 2018. The average cost of funds on these long-term advances was 3.16% for the six months ended June 30, 2019, compared to 1.92% for the six months ended June 30, 2018. The rate on our junior subordinated debentures was 6.49% for both the six months ended June 30, 2019 and 2018.

Our net interest margin (TE) for the six months ended June 30, 2019, was 4.12% compared to 3.88% for the six months ended June 30, 2018, reflecting a 24 basis point increase. The increase in net interest margin for the ~~nine~~six months ended ~~September~~June 30, ~~2017, was 3.68%, as~~2019, compared to ~~3.23% for~~ the ~~nine~~six months ended ~~September~~June 30, ~~2016, for an increase~~2018, was due primarily to the ABC Bank acquisition and organic loan growth, as well as a shift to noninterest bearing deposit accounts, which partially offset increases in cost of ~~45 basis points.~~funds due to the rising rate environment.

~~Management continued~~We continue to observe competitive pressure to maintain reduced interest rates on loans retained at renewal. While ~~the Bank~~our loan prices ~~loans~~are targeted to achieve certain ~~return~~returns on equity, ~~targets,~~ significant competition for ~~both~~ 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.

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The following tables set forth certain information relating to ~~the Company’s~~our average consolidated balance ~~sheets~~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 onin the following tables have been adjusted to a non-GAAP tax equivalent (“TE”) basis using a marginal rate of ~~35%~~21% in 2019 and 2018 to more appropriately compare returns on tax-exempt loans and securities to other earning assets.


Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates
Quarters Ended


	June 30, 2019						March 31, 2019						June 30, 2018
	Average			Income /		Rate	Average			Income /		Rate	Average			Income /		Rate
	Balance			Expense		%	Balance			Expense		%	Balance			Expense		%
Assets
Interest earning deposits with financial institutions	$	19,053		$	111	2.34	$	18,842		$	114	2.45	$	19,161		$	97	2.03
Securities:
Taxable		229,263			2,223	3.89		236,882			2,414	4.13		268,591			2,392	3.57
Non-taxable (TE)2		290,743			2,710	3.74		276,609			2,656	3.89		286,611			2,676	3.74
Total securities		520,006			4,933	3.80		513,491			5,070	4.00		555,202			5,068	3.66
Dividends from FHLBC and FRBC		11,317			156	5.53		11,463			149	5.27		8,619			111	5.17
Loans and loans held-for-sale 1, 2		1,897,324			24,958	5.28		1,895,512			24,126	5.16		1,809,077			22,552	5.00
Total interest earning assets		2,447,700			30,158	4.94		2,439,308			29,459	4.90		2,392,059			27,828	4.67
Cash and due from banks		33,618			-	-		33,749			-	-		36,720			-	-
Allowance for loan and lease losses		(19,435)			-	-		(19,235)			-	-		(18,494)			-	-
Other noninterest bearing assets		174,075			-	-		181,767			-	-		176,608			-	-
Total assets	$	2,635,958					$	2,635,589					$	2,586,893

Liabilities and Stockholders' Equity
NOW accounts	$	442,430		$	373	0.34	$	448,518		$	379	0.34	$	443,586		$	238	0.22
Money market accounts		288,698			262	0.36		299,305			270	0.37		317,775			193	0.24
Savings accounts		313,822			124	0.16		307,740			122	0.16		298,240			70	0.09
Time deposits		422,975			1,641	1.56		445,076			1,618	1.47		460,909			1,444	1.26
Interest bearing deposits		1,467,925			2,400	0.66		1,500,639			2,389	0.65		1,520,510			1,945	0.51
Securities sold under repurchase agreements		44,184			147	1.33		45,157			149	1.34		44,655			104	0.93
Other short-term borrowings		93,369			575	2.47		98,328			607	2.50		58,199			276	1.90
Junior subordinated debentures		57,704			931	6.47		57,692			927	6.52		57,657			927	6.45
Senior notes		44,196			672	6.10		44,171			672	6.17		44,096			672	6.11
Notes payable and other borrowings		13,101			107	3.28		15,273			116	3.08		19,795			95	1.92
Total interest bearing liabilities		1,720,479			4,832	1.13		1,761,260			4,860	1.12		1,744,912			4,019	0.92
Noninterest bearing deposits		645,580			-	-		625,423			-	-		618,765			-	-
Other liabilities		19,586			-	-		13,750			-	-		15,679			-	-
Stockholders' equity		250,313			-	-		235,156			-	-		207,537			-	-
Total liabilities and stockholders' equity	$	2,635,958					$	2,635,589					$	2,586,893
Net interest income (TE) 2				$	25,326					$	24,599					$	23,809
Net interest margin (TE) 2						4.15						4.09						3.99
Interest bearing liabilities to earning assets		70.29	%					72.20	%					72.95	%

1Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 39, and includes fees of $184,000, $229,000 and $233,000 for the second quarter of 2019, the first quarter of 2019, and the second quarter of 2018, respectively. Nonaccrual loans are included in the above-stated average balances.

2 Tax equivalent basis is calculated using a marginal tax rate of 21% in 2019 and 2018. See the discussion entitled “Non-GAAP Presentations” below and the table on page 45 that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent.

3342

Table of Contents

~~ANALYSIS OF AVERAGE BALANCES,~~

~~TAX EQUIVALENT INTEREST AND RATES~~

~~(In thousands - unaudited)~~


Analysis of Average Balances,																			Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates																			Tax Equivalent Income / Expense and Rates
Six Months Ended June 30,																			Six Months Ended June 30,

	Quarters Ended
	September 30, 2017						June 30, 2017						September 30, 2016						2019						2018
	Average					Rate	Average					Rate	Average					Rate	Average			Income /		Rate	Average			Income /		Rate
	Balance			Interest		%	Balance			Interest		%	Balance			Interest		%	Balance			Expense		%	Balance			Expense		%
Assets
Interest bearing deposits with financial institutions	$	11,685		$	37	1.24	$	11,938		$	31	1.03	$	50,054		$	64	0.50
Interest earning deposits with financial institutions																			$	18,948		$	225	2.39	$	16,505		$	146	1.78
Securities:
Taxable		327,892			2,424	2.96		361,504			2,607	2.88		624,844			3,954	2.53		233,051			4,637	4.01		268,959			4,562	3.42
Non-taxable (TE)		220,540			2,504	4.54		225,182			2,536	4.50		35,046			277	3.16
Non-taxable (TE)2																				283,715			5,366	3.81		283,240			5,285	3.76
Total securities		548,432			4,928	3.59		586,686			5,143	3.51		659,890			4,231	2.56		516,766			10,003	3.90		552,199			9,847	3.60
Dividends from FHLBC and FRBC		8,339			94	4.51		7,699			92	4.78		7,918			83	4.19		11,390			305	5.40		8,769			217	4.99
Loans and loans held-for-sale1		1,553,473			18,265	4.60		1,509,188			17,445	4.57		1,191,574			13,567	4.46
Loans and loans held-for-sale 1 , 2																				1,896,422			49,084	5.22		1,706,581			41,319	4.88
Total interest earning assets		2,121,929			23,324	4.32		2,115,511			22,711	4.26		1,909,436			17,945	3.70		2,443,526			59,617	4.92		2,284,054			51,529	4.55
Cash and due from banks		31,028			-	-		39,425			-	-		41,344			-	-		33,683			-	-		33,267			-	-
Allowance for loan losses		(16,478)			-	-		(15,779)			-	-		(15,767)			-	-
Allowance for loan and lease losses																				(19,335)			-	-		(18,379)			-	-
Other noninterest bearing assets		185,906			-	-		189,928			-	-		190,213			-	-		177,904			-	-		171,585			-	-
Total assets	$	2,322,385					$	2,329,085					$	2,125,226					$	2,635,778					$	2,470,527

Liabilities and Stockholders' Equity
NOW accounts	$	422,913		$	108	0.10	$	432,248		$	107	0.10	$	384,588		$	89	0.09	$	445,457		$	752	0.34	$	436,483		$	414	0.19
Money market accounts		273,440			85	0.12		280,482			86	0.12		265,135			64	0.10		293,972			532	0.36		296,672			302	0.21
Savings accounts		262,573			46	0.07		265,066			40	0.06		257,808			40	0.06		310,798			246	0.16		282,390			129	0.09
Time deposits		389,037			1,077	1.10		392,779			1,025	1.05		401,999			931	0.92		433,964			3,259	1.51		421,882			2,619	1.25
Interest bearing deposits		1,347,963			1,316	0.39		1,370,575			1,258	0.37		1,309,530			1,124	0.34		1,484,191			4,789	0.65		1,437,427			3,464	0.49
Securities sold under repurchase agreements		32,800			4	0.05		35,652			4	0.05		31,892			1	0.01		44,668			296	1.34		42,477			183	0.87
Other short-term borrowings		72,065			220	1.19		58,572			146	0.99		22,174			22	0.39		95,835			1,182	2.49		72,741			605	1.68
Junior subordinated debentures		57,621			930	6.46		57,609			1,059	7.35		57,573			1,084	7.53		57,698			1,858	6.49		57,651			1,854	6.49
Senior notes		44,021			672	6.11		43,995			672	6.11		-			-	-		44,184			1,344	6.13		44,084			1,344	6.15
Subordinated debt		-			-	-		-			-	-		45,000			245	2.13
Notes payable and other borrowings		-			-	-		-			-	-		500			2	1.57		14,181			222	3.16		9,952			95	1.92
Total interest bearing liabilities		1,554,470			3,142	0.80		1,566,403			3,139	0.80		1,466,669			2,478	0.67		1,740,757			9,691	1.12		1,664,332			7,545	0.91
Noninterest bearing deposits		551,768			-	-		557,265			-	-		472,599			-	-		635,557			-	-		586,871			-	-
Other liabilities		19,395			-	-		18,047			-	-		15,539			-	-		16,688			-	-		14,829			-	-
Stockholders' equity		196,752			-	-		187,370			-	-		170,419			-	-		242,776			-	-		204,495			-	-
Total liabilities and stockholders' equity	$	2,322,385					$	2,329,085					$	2,125,226					$	2,635,778					$	2,470,527
Net interest income (TE)				$	20,182					$	19,572					$	15,467
Net interest income (TE)
to total earning assets						3.77						3.71						3.22
Net interest income (TE) 2																						$	49,926					$	43,984
Net interest margin (TE) 2																								4.12						3.88
Interest bearing liabilities to earning assets		73.26	%					74.04	%					76.81	%					71.24	%					72.87	%

1 Interest income from loans is shown on a TEtax equivalent basis, which is a non-GAAP financial measure, as discussed ~~below~~in the table on page 39, and includes fees of ~~$722,000, $573,000~~$413,000 and ~~$700,000~~$415,000 for the ~~third quarter~~first six months of ~~2017, the fourth quarter of 2016~~2019 and ~~the third quarter of 2016,~~2018, respectively. Nonaccrual loans are included in the above-stated average balances.

~~Table~~2 Tax equivalent basis is calculated using a marginal tax rate of ~~Contents~~

Analysis of Average Balances,
Tax Equivalent Interest and Rates
Nine Months Ended September 30, 2017, and 2016
(In thousands - unaudited)

2017

2016

Average

Rate

Average

Rate

Balance

Interest

%

Balance

Interest

%
Assets

Interest bearing deposits with financial institutions
$
11,913

$
91

1.01

$
25,960

$
98

0.50
Securities:

Taxable

370,161

7,994

2.88

682,997

12,547

2.45
Non-taxable (TE)

196,120

6,443

4.38

36,340

891

3.27
Total securities

566,281

14,437

3.40

719,337

13,438

2.49
Dividends from FHLBC and FRBC

7,886

271

4.58

7,955

251

4.21
Loans and loans held-for-sale1

1,516,872

52,365

4.55

1,161,312

39,778

4.50
Total interest earning assets

2,102,952

67,164

4.22

1,914,564

53,565

3.69
Cash and due from banks

34,670

-

-

32,617

-

-
Allowance for loan losses

(16,184)

-

-

(16,145)

-

-
Other noninterest bearing assets

189,533

-

-

193,443

-

-
Total assets
$
2,310,971

$
2,124,479

Liabilities and Stockholders' Equity

NOW accounts
$
427,242

$
316

0.10

$
383,870

$
261

0.09
Money market accounts

279,143

254

0.12

272,657

198

0.10
Savings accounts

262,352

125

0.06

258,062

118

0.06
Time deposits

392,049

3,081

1.05

404,210

2,622

0.87
Interest bearing deposits

1,360,786

3,776

0.37

1,318,799

3,199

0.32
Securities sold under repurchase agreements

32,764

10

0.04

35,022

3

0.01
Other short-term borrowings

62,308

472

1.00

26,040

66

0.33
Junior subordinated debentures

57,609

3,073

7.11

57,561

3,251

7.53
Senior notes

43,998

2,017

6.11

-

-

-
Subordinated debt

-

-

-

45,000

727

2.12
Notes payable and other borrowings

-

-

-

500

6

1.58
Total interest bearing liabilities

1,557,465

9,348

0.80

1,482,922

7,252

0.65
Noninterest bearing deposits

544,925

-

-

465,094

-

-
Other liabilities

20,814

-

-

13,037

-

-
Stockholders' equity

187,767

-

-

163,426

-

-
Total liabilities and stockholders' equity
$
2,310,971

$
2,124,479

Net interest income (TE)

$
57,816

$
46,313

Net interest income (TE) to total earning assets

3.68

3.23
Interest bearing liabilities to earning assets

74.06
%

77.45
%

1~~Interest income from loans is shown on a TE basis as discussed~~21% in 2019 and 2018. See the discussion entitled “Non-GAAP Presentations” below and ~~includes fees~~the table on page 45 that provides a reconciliation of ~~$1.8 million for~~each non-GAAP measure to the ~~first nine months of 2017 and 2016. Nonaccrual loans are included in the above-stated average balances.~~most comparable GAAP equivalent.

~~Table~~Reconciliation of ~~Contents~~

Tax-Equivalent Non-GAAP Financial Measures

Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios. This includes tax-equivalent net interest income (including its individual components) and net interest margin (including its individual components) to total average interest earning assets. Management believes that these measures and ratios provide users of the financial information with a more accurate view of the performance of the interest earning assets and interest bearing liabilities and of the Company’s operating efficiency for comparison purposes. Other financial holding companies may define or calculate these measures and ratios differently. See the tables and notes below for supplemental data and the corresponding reconciliations to GAAP financial measures for the three month periods ended September 30, 2017, June 30, 2017, and September 30, 2016, and the nine month periods ended September 30, 2017 and 2016.

Net interest income (TE) and net interest income (TE) to earning assets are non-GAAP measures that have been adjusted toon a ~~non-GAAP~~ TE basis using a marginal rate of ~~35%~~21% for 2019 and 2018 to more appropriately compare returns on tax-exempt loans and securities to other earning assets. The table below provides a reconciliation of each non-GAAP TE(TE) measure to the GAAP equivalent for the periods indicated:

Quarters Ended

Nine Months Ended

September 30,

June 30,

September 30,

September 30,


2017

2017

2016


2017

2016

Net Interest Margin

Interest income (GAAP)

$
22,425

$
21,800

$
17,825

$
64,841

$
53,183

Taxable-equivalent adjustment:

Loans

23

23

23

68

70

Securities

876

888

97

2,255

312

Interest income (TE)

23,324

22,711

17,945

67,164

53,565

Interest expense (GAAP)

3,142

3,139

2,478

9,348

7,252

Net interest income (TE)

$
20,182

$
19,572

$
15,467

$
57,816

$
46,313

Net interest income  (GAAP)

$
19,283

$
18,661

$
15,347

$
55,493

$
45,931

Average interest earning assets

$
2,121,929

$
2,115,511

$
1,909,436

$
2,102,952

$
1,914,564

Net interest margin (GAAP)

3.61
%

3.54
%

3.20
%

3.53
%

3.20
%
Net interest margin  (TE)

3.77
%

3.71
%

3.22
%

3.68
%

3.23
%

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	Three Months Ended									Six Months Ended
	June 30,			March 31,			June 30,			June 30,
	2019			2019			2018			2019			2018
Net Interest Margin
Interest income (GAAP)	$	29,586		$	28,896		$	27,261		$	58,482		$	50,403
Taxable-equivalent adjustment:
Loans		3			5			5			8			16
Securities		569			558			562			1,127			1,110
Interest income (TE)		30,158			29,459			27,828			59,617			51,529
Interest expense (GAAP)		4,832			4,860			4,019			9,692			7,545
Net interest income (TE)	$	25,326		$	24,599		$	23,809		$	49,925		$	43,984
Net interest income (GAAP)	$	24,754		$	24,036		$	23,242		$	48,790		$	42,858
Average interest earning assets	$	2,447,700		$	2,439,308		$	2,392,059		$	2,443,526		$	2,284,054
Net interest margin (GAAP)		4.06	%		4.00	%		3.90	%		4.03	%		3.78	%
Net interest margin (TE)		4.15	%		4.09	%		3.99	%		4.12	%		3.88	%

Noninterest Income and Expense

Three months ended June 30, 2019 and 2018

The following table details the major components of noninterest income for the periods presented:


							2nd Quarter 2019
Noninterest Income	Three Months Ended						Percent Change From
(dollars in thousands)	June 30,		March 31,		June 30,		March 31,	June 30,
	2019		2019		2018		2019	2018
Trust income	$	1,739	$	1,486	$	1,645	17.0	5.7
Service charges on deposits		1,959		1,862		1,769	5.2	10.7
Residential mortgage banking revenue
Secondary mortgage fees		203		136		195	49.3	4.1
Mortgage servicing rights mark to market (loss)		(1,137)		(819)		(105)	(38.8)	(982.9)
Mortgage servicing income		491		457		627	7.4	(21.7)
Net gain on sales of mortgage loans		1,163		762		1,240	52.6	(6.2)
Total residential mortgage banking revenue		720		536		1,957	34.3	(63.2)
Securities gain, net		986		27		312	N/M	216.0
Increase in cash surrender value of BOLI		320		458		351	(30.1)	(8.8)
Debit card interchange income		1,166		987		1,132	18.1	3.0
Other income		1,253		1,126		1,366	11.3	(8.3)
Total noninterest income	$	8,143	$	6,482	$	8,532	25.6	(4.6)

Noninterest income for the second quarter of 2019 increased $1.7 million, or 25.6%, compared to the first quarter of 2019, and decreased $389,000, or 4.6%, compared to the second quarter of 2018.

The increase in noninterest income in the second quarter of 2019, compared to the first quarter of 2019, was driven primarily by a $959,000 increase in securities gain, net, due to select security sales in the second quarter. In addition, increases were reflected in trust income, service charges on deposits, total residential mortgage banking revenue, debit card interchange income, and other income, which resulted in an aggregate $840,000 increase in noninterest income in the second quarter of 2019, compared to the first quarter of 2019. These increases were partially offset by an increase in MSR mark to market losses of $318,000 in the second quarter of 2019, compared to the prior linked quarter, due to interest rate driven valuation reductions and a decrease of $138,000 related to the cash surrender value of BOLI in the second quarter of 2019, compared to the prior linked quarter.

The decrease in noninterest income for the year over year period of $389,000 was primarily driven by a $1.2 million reduction in total residential mortgage banking revenue in the second quarter of 2019, resulting primarily from an increase in MSR mark to market losses of $1.0 million due to interest rate valuation reductions. These reductions were partially offset by aggregate increases of $992,000 resulting from growth in trust income, service charges on deposits, securities gain, net, and debit card interchange income.

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Six months ended June 30, 2019 and 2018

The following table details the major components of noninterest income for the periods presented:


Noninterest Income	Six Months Ended				YTD
(dollars in thousands)	June 30,		June 30,		Percent
	2019		2018		Change
Trust income	$	3,225	$	3,140	2.7
Service charges on deposits		3,821		3,361	13.7
Residential mortgage banking revenue
Secondary mortgage fees		339		357	(5.0)
Mortgage servicing rights mark to market (loss) gain		(1,956)		200	N/M
Mortgage servicing income		948		1,079	(12.1)
Net gain on sales of mortgage loans		1,925		2,157	(10.8)
Total residential mortgage banking revenue		1,256		3,793	(66.9)
Securities gain, net		1,013		347	191.9
Increase in cash surrender value of BOLI		778		599	29.9
Death benefit realized on BOLI		-		1,026	(100.0)
Debit card interchange income		2,153		2,144	0.4
Other income		2,379		2,627	(9.4)
Total noninterest income	$	14,625	$	17,037	(14.2)

N/M - Not meaningful

Noninterest income for the six months ended June 30, 2019 decreased $2.4 million, or 14.2%, compared to the six months ended June 30, 2018. The decrease in noninterest income for the six months ended June 30, 2019, compared to the prior year period, was primarily driven by a $2.0 million reduction in total residential mortgage banking revenue stemming from rising interest rates and the resultant MSR mark to market valuation losses, and a reduction in other income due to a decline in commercial swap fees. These decreases were partially offset by an increase in service charges on deposits, securities gain, net, and an increase in income due to the change in the cash surrender value of BOLI.

Three months ended June 30, 2019 and 2018

The following table details the major components of noninterest expense for the periods presented:


										2nd Quarter 2019
Noninterest Expense	Three Months Ended									Percent Change From
(dollars in thousands)	June 30,			March 31,			June 30,			March 31,	June 30,
	2019			2019			2018			2019	2018
Salaries	$	9,004		$	8,634		$	9,703		4.3	(7.2)
Officers incentive		893			882			740		1.2	20.7
Benefits and other		1,690			2,096			1,912		(19.4)	(11.6)
Total salaries and employee benefits		11,587			11,612			12,355		(0.2)	(6.2)
Occupancy, furniture and equipment expense		1,925			1,989			1,652		(3.2)	16.5
Computer and data processing		1,524			1,332			2,741		14.4	(44.4)
FDIC insurance		116			174			165		(33.3)	(29.7)
General bank insurance		236			250			299		(5.6)	(21.1)
Amortization of core deposit intangible asset		121			132			97		(8.3)	24.7
Advertising expense		381			234			492		62.8	(22.6)
Debit card interchange expense		233			147			301		58.5	(22.6)
Legal fees		243			126			286		92.9	(15.0)
Other real estate owned expense, net		248			50			429		396.0	(42.2)
Other expense		3,512			3,148			3,469		11.6	1.2
Total noninterest expense	$	20,126		$	19,194		$	22,286		4.9	(9.7)
Efficiency ratio (GAAP)1		61.91	%		62.35	%		69.16	%
Adjusted efficiency ratio (non-GAAP)2		60.66	%		60.98	%		57.88	%

1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding OREO expenses and amortization of core deposits, divided by the sum of net interest income and total noninterest income less net gains and

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losses on securities and any BOLI death benefit recorded.

2The adjusted efficiency ratio shown in the table above is a non-GAAP financial measure calculated as noninterest expense, excluding OREO expenses, amortization of core deposits and acquisition costs, divided by the sum of net interest income on a fully tax equivalent basis, total noninterest income less net gains and losses on securities and any BOLI death benefit, and includes a tax equivalent adjustment on the increase in cash surrender value of BOLI recorded.

See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” on page 48 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent.

Noninterest expense for the second quarter of 2019 increased $932,000, or 4.9%, compared to the first quarter of 2019, and decreased $2.2 million, or 9.7%, compared to the second quarter of 2018.

The increase in noninterest expense in the second quarter of 2019, compared to the first quarter of 2019, was primarily attributable to a $198,000 increase in other real estate expense, net, due to valuation writedowns, and an increase of $364,000 in other expense due to growth in appraisal and commercial loan related fees, consulting fees, and the timing of audit fees. Computer and data processing also reflected an increase in the second quarter of 2019, compared to the first quarter of 2019, as various projects with software requirements were renewed or enhanced in the current quarter.

The decrease in noninterest expense in the second quarter of 2019, compared to the second quarter of 2018, is primarily attributable to ABC Bank acquisition-related costs recorded in the second quarter of 2018, such as data conversion costs included within computer and data processing, salaries expense stemming from employee continuation and retention accruals, and advertising expense. An increase was reflected in occupancy, furniture and equipment expense of $273,000 for the second quarter of 2019, compared to the second quarter of 2018, which partially offset the overall decrease in noninterest expense in the second quarter of 2019, as we acquired four additional branches with the ABC Bank acquisition, and recorded the commensurate additional costs associated with those branches for a full quarter in the 2019 period.

Six months ended June 30, 2019 and 2018

The following table details the major components of noninterest expense for the periods presented:


Noninterest Expense	Six Months Ended						YTD
(dollars in thousands)	June 30,			June 30,			Percent
	2019			2018			Change
Salaries	$	17,638		$	17,038		3.5
Officers incentive		1,775			1,527		16.2
Benefits and other		3,786			3,997		(5.3)
Total salaries and employee benefits		23,199			22,562		2.8
Occupancy, furniture and equipment expense		3,914			3,210		21.9
Computer and data processing		2,856			4,085		(30.1)
FDIC insurance		290			321		(9.7)
General bank insurance		486			550		(11.6)
Amortization of core deposit intangible asset		253			118		114.4
Advertising expense		615			833		(26.2)
Debit card interchange expense		380			582		(34.7)
Legal fees		369			445		(17.1)
Other real estate owned expense, net		298			602		(50.5)
Other expense		6,660			6,332		5.2
Total noninterest expense	$	39,320		$	39,640		(0.8)
Efficiency ratio (GAAP)1		62.13	%		66.50	%
Adjusted efficiency ratio (non-GAAP)2		60.82	%		59.10	%

See the section entitled “Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures” on page 48 for a reconciliation

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of this non-GAAP measure to the most comparable GAAP equivalent.

Noninterest expense for the six months ended June 30, 2019, decreased $320,000, or 0.8%, compared to the six months ended June 30, 2018, primarily due to the decrease in computer and data processing costs year over year of $1.2 million. The higher costs in the 2018 period were related to the ABC Bank acquisition data conversion in the second quarter of 2018. In addition, other real estate owned expense, net, decreased $304,000 in the six months ended June 30. 2019, compared to the six months ended June 30, 2018, driven by the decline in other real estate held. Partially offsetting these decreases were increases in occupancy, furniture and equipment expenses of $704,000, amortization of core deposit intangibles of $135,000, and other expenses increased $328,000 due primarily to consulting fees and commercial loan related costs.

Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures


	GAAP									Non-GAAP
		Three Months Ended									Three Months Ended
	June 30,			March 31,			June 30,			June 30,			March 31,			June 30,
	2019			2019			2018			2019			2019			2018
Efficiency Ratio / Adjusted Efficiency Ratio
Noninterest expense	$	20,126		$	19,194		$	22,286		$	20,126		$	19,194		$	22,286
Less amortization of core deposit		121			132			97			121			132			97
Less other real estate expense, net		248			50			429			248			50			429
Less acquisition related costs		N/A			N/A			N/A			-			-			3,168
Noninterest expense less adjustments	$	19,757		$	19,012		$	21,760		$	19,757		$	19,012		$	18,592

Net interest income	$	24,754		$	24,036		$	23,242		$	24,754		$	24,036		$	23,242
Taxable-equivalent adjustment:
Loans		N/A			N/A			N/A			3			5			5
Securities		N/A			N/A			N/A			569			558			562
Net interest income including adjustments		24,754			24,036			23,242			25,326			24,599			23,809
Noninterest income		8,143			6,482			8,532			8,143			6,482			8,532
Less securities gain, net		986			27			312			986			27			312
Taxable-equivalent adjustment:
Increase in cash surrender value of BOLI		N/A			N/A			N/A			85			122			93
Noninterest income (less) / including adjustments		7,157			6,455			8,220			7,242			6,577			8,313

Net interest income including adjustments plus noninterest income (less) / including adjustments	$	31,911		$	30,491		$	31,462		$	32,568		$	31,176		$	32,122
Efficiency ratio / Adjusted efficiency ratio		61.91	%		62.35	%		69.16	%		60.66	%		60.98	%		57.88	%

Income Taxes

We recorded tax expense of $3.0 million on $12.3 million of pretax income for the second quarter of 2019, compared to income tax expense of $2.4 million in the first quarter of 2019, and $1.8 million of income tax expense in the second quarter of 2018. The effective tax rate for the second quarter of 2019 was 24.7%, compared to 22.1% for the first quarter of 2019, and 22.1% for the second quarter of 2018. The effective tax rate for the second quarter of 2019 was higher than the prior linked quarter due to a tax benefit recorded related to restricted stock awards which vested in the first quarter of 2019, while the effective tax rate for the second quarter of 2019 reflected an increase over the prior year like quarter due to higher levels of taxable income in the second quarter of 2019.

We recorded tax expense of $5.4 million on $23.2 million of pretax income for the six months ended June 30, 2019, compared to income tax expense of $3.8 million on $19.5 million of pretax income for the six months ended June 30, 2018. The effective tax rate for the six months ended June 30, 2019 was 23.5%, which was an increase from the effective tax rate of 19.3% for the six months ended June 30, 2018, due to higher levels of taxable income in the second quarter of 2019, as the 2018 period included $1.0 million of proceeds from a nontaxable BOLI death benefit.

Income tax expense reflected all relevant statutory tax rates and GAAP accounting. There were no significant changes in our ability to utilize the deferred tax assets during the quarter ended June 30, 2019. We had no valuation reserve on the deferred tax assets as of June 30, 2019.

Financial Condition

Total assets decreased $52.4 million from $2.68 billion at December 31, 2018, to $2.62 billion at June��30, 2019, due primarily to a decrease of $49.2 million in securities available-for-sale, as well as a $7.0 million decrease in the deferred tax assets, net. Total loans

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as of June 30, 2019, increased $5.9 million, or 0.3%, compared to December 31, 2018. Total deposits were $2.08 billion at June 30, 2019, a decrease of $38.9 million from December 31, 2018, primarily due to reductions in time, NOWs and money markets, partially offset by an increase in noninterest bearing demand accounts.


							June 30, 2019
Securities	As of						Percent Change From
	June 30,		December 31,		June 30,		December 31,	June 30,
	2019		2018		2018		2018	2018
Securities available-for-sale, at fair value
U.S. Treasuries	$	4,025	$	3,923	$	3,876	2.6	3.8
U.S. government agencies		9,812		10,951		12,216	(10.4)	(19.7)
U.S. government agencies mortgage-backed		16,999		14,075		13,407	20.8	26.8
States and political subdivisions		251,295		274,067		276,112	(8.3)	(9.0)
Corporate bonds		-		-		700	-	(100.0)
Collateralized mortgage obligations		64,867		64,429		61,432	0.7	5.6
Asset-backed securities		82,725		109,514		109,263	(24.5)	(24.3)
Collateralized loan obligations		62,357		64,289		66,638	(3.0)	(6.4)
Total securities	$	492,080	$	541,248	$	543,644	(9.1)	(9.5)

Available-for-sale security sales during the three months ended June 30, 2019 totaled $32.1 million and consisted of asset-backed securities and state and political subdivisions, whereas purchases during the three month period were primarily tax exempt state and political subdivisions securities. During the second quarter of 2019 security sales resulted in net realized gains of $986,000, compared to $27,000 of security gains, net, for the first quarter of 2019, and security gains, net, of $312,000 for the second quarter of 2018.

Loans

Total loans were $1.90 billion as of June 30, 2019, an increase of $5.9 million from December 31, 2018. The increase in total loans for the six month period was due primarily to organic growth in commercial loans, leases, and real estate-commercial loans. Total loans increased $53.8 million from June 30, 2018 to June 30, 2019, due primarily to organic loan growth in commercial, leases, and real estate-commercial, as well as a select HELOC bulk loan purchase of $20.7 million in November 2018.


							June 30, 2019
Loans	As of						Percent Change From
	June 30,		December 31,		June 30,		December 31,	June 30,
	2019		2018		2018		2018	2018
Commercial	$	337,848	$	314,323	$	299,536	7.5	12.8
Leases		98,379		78,806		66,687	24.8	47.5
Real estate - commercial		825,091		820,941		808,264	0.5	2.1
Real estate - construction		93,079		108,390		115,486	(14.1)	(19.4)
Real estate - residential		393,547		407,068		404,908	(3.3)	(2.8)
HELOC		128,673		140,442		127,986	(8.4)	0.5
Other 1		13,533		14,439		13,969	(6.3)	(3.1)
Total loans, excluding deferred loan costs and PCI loans		1,890,150		1,884,409		1,836,836	0.3	2.9
Net deferred loan costs		1,959		1,653		1,112	18.5	76.2
Total loans, excluding PCI loans		1,892,109		1,886,062		1,837,948	0.3	2.9
PCI loans, net of purchase accounting adjustments		10,834		10,965		11,214	(1.2)	(3.4)
Total loans	$	1,902,943	$	1,897,027	$	1,849,162	0.3	2.9

1 The “Other” class includes consumer and overdrafts.

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, construction, residential, and HELOCs) has been and continues to be a sizeable portion of our portfolio. These categories comprised 75.7% of the portfolio as of June 30, 2019, compared to 77.9% of the portfolio as of December 31, 2018. We continue to oversee and manage our loan portfolio in accordance with interagency guidance on risk management.

Asset Quality

~~The Company~~We recorded a $450,000 provision for loan and lease losses ~~expense~~for the quarter ended June 30, 2019, compared to a provision of ~~$300,000 in~~$1.5 million for the ~~third~~quarter ended June 30, 2018. In the second quarter of ~~2017. On~~2019, we determined provision expense was necessary at a ~~quarterly basis, management~~

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level approximately commensurate with net charge-offs for the quarter, which were $394,000. Runoffs on our acquired loan portfolios are trending with expectations. 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 loan and lease losses.

Nonperforming loans ~~increased~~consist of nonaccrual loans, performing restructured accruing loans and loans 90 days or greater past due. We do not consider our PCI loans, which showed evidence of deteriorated credit quality at acquisition, to be nonperforming assets as long as their cash flows and the timing of such cash flows continue to be estimable and probable of collection. Therefore, interest income is recognized through accretion of the difference between the carrying value of these loans and the present value of expected future cash flows. As a result, management has excluded PCI loans from the nonperforming loans in the table below. Remediation work continues in all segments. Nonperforming loans decreased by ~~$270,000~~$3.7 million at ~~September~~June 30, ~~2017,~~2019, to $12.7 million from ~~$16.0~~$16.3 million at December 31, ~~2016.~~2018. Credit metrics continue to be relatively stable regarding nonperforming loan levels, and management is carefully monitoring loans considered to be in a classified status. Nonperforming loans as a percent of total loans decreased to ~~1.0%~~0.7% as of ~~September~~June 30, ~~2017,~~2019, from ~~1.1%~~0.9% as of December 31, ~~2016,~~2018, and ~~1.4%~~increased slightly from 0.6% as of ~~September~~June 30, ~~2016.~~2018. The distribution of ~~the Company’s~~our nonperforming loans is ~~included~~shown in the following table.


							September 30, 2017								June 30, 2019
Nonperforming Loans	As of						Percent Change From		As of						Percent Change From
(in thousands)	September 30,		December 31,		September 30,		December 31,	September 30,
	2017		2016		2016		2016	2016	June 30,		December 31,		June 30,		December 31,	June 30,
									2019		2018		2018		2018	2018
Commercial									$	151	$	352	$	-	(57.1)	N/M
Leases										125		-		-	N/M	N/M
Real estate-commercial, nonfarm										6,773		9,738		5,012	(30.4)	35.1
Real estate-construction	$	205	$	281	$	76	(27.0)	169.7		102		455		635	(77.6)	(83.9)
Real estate-residential:
Investor		492		936		1,364	(47.4)	(63.9)		383		353		409	8.5	(6.4)
Multifamily		4,757		-		-	N/M	N/M
Multi-Family										-		179		-	(100.0)	N/M
Owner occupied		4,266		6,552		5,755	(34.9)	(25.9)		3,228		3,616		4,278	(10.7)	(24.5)
Revolving and junior liens		1,977		2,240		2,257	(11.7)	(12.4)
Real estate-commercial, nonfarm		3,631		5,386		7,345	(32.6)	(50.6)
Real estate-commercial, farm		383		-		-	N/M	N/M
Commercial		207		240		583	(13.8)	(64.5)
Leases		345		366		-	(5.7)	N/M
Other		8		-		-	N/M	N/M
HELOC										1,873		1,614		1,524	16.0	22.9
Other 1										24		34		16	(29.4)	50.0
Total nonperforming loans	$	16,271	$	16,001	$	17,380	1.7	(6.4)	$	12,659	$	16,341	$	11,874	(22.5)	6.6

N/M - Not meaningful

1 The “Other” class includes consumer and overdrafts.

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~~N/M -~~ ~~Not Meaningful~~

~~Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due. Remediation work continues in all segments.~~


Loan Charge-offs, net of recoveries	Quarters Ended									Three Months Ended
(in thousands)	September 30,		% of	June 30,		% of	September 30,		% of
	2017		Total1	2017		Total1	2016		Total1	June 30,		% of	March 31,		% of	June 30,		% of
Real estate-construction
Homebuilder	$	-	-	$	(1)	(0.2)	$	(7)	(0.8)
Land		-	-		(48)	(7.3)		(2)	(0.2)
All other		8	(2.4)		(11)	(1.7)		(42)	(5.0)
Total real estate-construction		8	(2.4)		(60)	(9.2)		(51)	(6.0)
Real estate-residential
Investor		(28)	8.5		(16)	(2.4)		(3)	(0.4)
Multifamily		(17)	5.2		129	19.7		(13)	(1.5)
Owner occupied		(40)	12.2		723	110.4		(75)	(8.9)
Revolving and junior liens		(367)	111.5		(109)	(16.6)		112	13.3
Total real estate-residential		(452)	137.4		727	111.1		21	2.5
										2019		Total1	2019		Total1	2018		Total1
Commercial										$	61	15.5	$	(18)	(12.9)	$	(77)	(24.3)
Leases											-	-		-	-		8	2.5
Real estate-commercial, nonfarm
Owner general purpose		-	-		(1)	(0.2)		-	-		42	10.7		87	62.1		27	8.5
Owner special purpose		-	-		(6)	(0.9)		(3)	(0.4)		-	-		(3)	(2.1)		-	-
Non-owner general purpose		(43)	13.1		(39)	(6.0)		132	15.7		(12)	(3.0)		(15)	(10.7)		(20)	(6.3)
Non-owner special purpose		-	-		-	-		636	75.8		-	-		139	99.3		476	150.2
Retail properties		22	(6.80)		4	0.6		-	-		-	-			-		-	-
Total real estate-commercial, nonfarm		(21)	6.3		(42)	(6.5)		765	91.1		30	7.7		208	148.6		483	152.4
Real estate-commercial, farm		-	-		-	-		-	-		-	-		-	-		-	-
Commercial		7	(2.1)		1	0.2		66	7.9
Leases		98	(29.8)		-	-		-	-
Consumer		37	(11.2)		34	5.2		43	5.1
Other		(6)	1.8		(5)	(0.8)		(5)	(0.6)
Net (recoveries) / charge-offs	$	(329)	100.0	$	655	100.0	$	839	100.0
Real estate-construction
Homebuilder											-	-		(1)	(0.7)		-	-
Land											-	-		-	-		(2)	(0.6)
Commercial speculative											(2)	(0.5)		2	1.4		-	-
All other											1	0.3			-		2	0.6
Total real estate-construction											(1)	(0.2)		1	0.7		-	-
Real estate-residential
Investor											(3)	(0.8)		(10)	(7.1)		(63)	(19.9)
Multi-Family											-	-		(8)	(5.7)		(11)	(3.5)
Owner occupied											(11)	(2.8)		(14)	(10.0)		(26)	(8.2)
Total real estate-residential											(14)	(3.6)		(32)	(22.8)		(100)	(31.6)
HELOC											267	67.8		(46)	(32.9)		(26)	(8.2)
Other 2											51	12.8		27	19.3		29	9.2
Net charge-offs / (recoveries)										$	394	100.0	$	140	100.0	$	317	100.0

1 Represents the percentage of net charge-offs attributable to each category of loans.

2 The “Other” class includes consumer and overdrafts.

Net ~~recoveries~~charge-offs of $394,000 were recorded for the ~~third~~second quarter of ~~2017 reflected~~2019, compared to net charge-offs of $140,000 for the first quarter of 2019 and net charge-offs of $317,000 for the second quarter of 2018, reflecting continuing management attention to credit quality. Gross charge-offs for the quarter ended September 30, 2017 were $241,000 compared to $1.2 million for the quarter ended September 30, 2016. Gross recoveries for the quarter ended September 30, 2017 were $570,000 compared to $358,000 for the quarter ended September 30, 2016. In comparison to the linked quarter, the third quarter of 2017quality and remediation efforts. We have continued ~~to reflect~~our conservative loan valuations and aggressive recovery efforts on prior charge-offs.

The following table shows classified assets by segment for the following periods.


							September 30, 2017								June 30, 2019
Classified Loans	As of						Percent Change From
(in thousands)	September 30,		December 31,		September 30,		December 31,	September 30,
Classified Assets									As of						Percent Change From
	2017		2016		2016		2016	2016	June 30,		December 31,		June 30,		December 31,	June 30,
									2019		2018		2018		2018	2018
Commercial									$	7,704	$	137	$	393	N/M	N/M
Leases										125		-		539	N/M	(76.8)
Real estate-commercial, nonfarm										19,186		22,661		12,362	(15.3)	55.2
Real estate-commercial, farm										1,210		1,222		1,248	(1.0)	(3.0)
Real estate-construction	$	380	$	458	$	254	(17.0)	49.6		273		2,610		366	(89.5)	(25.4)
Real estate-residential:
Investor		648		1,096		1,171	(40.9)	(44.7)		1,029		1,216		1,029	(15.4)	-
Multifamily		4,757		-		-	N/M	N/M
Multi-Family										493		979		3,302	(49.6)	(85.1)
Owner occupied		4,418		7,225		6,432	(38.9)	(31.3)		3,773		4,524		5,428	(16.6)	(30.5)
Revolving and junior liens		1,977		2,340		3,078	(15.5)	(35.8)
Real estate-commercial, nonfarm		7,633		9,946		13,220	(23.3)	(42.3)
Real estate-commercial, farm		2,495		1,782		1,801	40.0	N/M
Commercial		382		2,527		1,519	(84.9)	(74.9)
Leases		1,031		1,109		783	(7.0)	31.7
Consumer		8		1		1	N/M	N/M
HELOC										2,078		1,889		1,633	10.0	27.3
Other 1										24		31		18	(22.6)	33.3
Total classified loans	$	23,729	$	26,484	$	28,259	(10.4)	(16.0)		35,895		35,269		26,318	1.8	36.4

Other real estate owned										5,668		7,175		8,912	(21.0)	(36.4)
Total classified assets, excluding PCI loans										41,563		42,444		35,230	(2.1)	18.0
PCI, net of purchase accounting adjustments										10,834		10,965		11,214	(1.2)	(3.4)
Total classified assets									$	52,397	$	53,409	$	46,444	(1.9)	12.8

N/M - Not ~~Meaningful~~meaningful

1 The “Other” class includes consumer and overdrafts.

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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 ~~the Company~~we will sustain some loss if deficiencies remain uncorrected.

~~Classified assets include both~~Total classified loans increased as of June 30, 2019, from the levels at December 31, 2018 and ~~OREO.~~June 30, 2018, primarily due to one large commercial credit which moved to classified status in the first quarter of 2019. Total classified assets reflected a slight decline as of June 30, 2019, from the level at December 31, 2018, and an increase compared to the level one year ago. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the allowance for loan and lease losses as another measure of overall change in loan related asset ~~quality. This~~quality, which is referred to as the “classified assets ratio.” The classified assets ratio ~~ended at 12.62%~~was 12.56% for the period ended ~~September~~June 30, ~~2017.~~2019, compared to 13.49% as of December 31, 2018 and 12.01% as of June 30, 2018. The decrease in the classified assets ratio for the quarter ended June 30, 2019, compared to December 31, 2018, is due to a $1.5 million decrease in other real estate owned and the continuing accretion of PCI loans, net of purchase accounting adjustments.

Allowance for Loan and Lease Losses

Below is a reconciliation of the activity for loan losses for the periods indicated (in thousands):


		Quarters Ended								Nine Months Ended
	September 30,			June 30,			September 30,			September 30,			September 30,				Three Months Ended								Six Months Ended
	2017			2017			2016			2017			2016			June 30,			March 31,			June 30,			June 30,			June 30,
																2019			2019			2018			2019			2018
Allowance at beginning of period	$	15,836		$	15,741		$	15,822		$	16,158		$	16,223		$	19,316		$	19,006		$	18,188		$	19,006		$	17,461
Charge-offs:
Commercial		13			6			76			20			95			67			12			15			79			31
Leases		98			-			-			215			13			-			-			8			-			13
Real estate - commercial		22			4			792			300			1,484			42			231			504			273			408
Real estate - construction		19			-			9			23			9			1			-			-			1			(16)
Real estate - residential		7			976			220			1,178			657			-			18			5			18			(55)
Consumer		82			80			100			262			250
Other		-			-			-			-			-
HELOC																	279			-			65			279			92
Other 1																	85			84			102			169			201
Total charge-offs		241			1,066			1,197			1,998			2,508			474			345			699			819			674
Recoveries:
Commercial		6			5			10			13			22			6			30			92			36			109
Leases		-			-			-			-			-			-			-			-			-			-
Real estate - commercial		43			46			27			124			255			12			23			21			35			388
Real estate - construction		11			60			60			89			71			2			(1)			-			1			3
Real estate - residential		459			249			199			850			718			14			50			105			64			1,016
Consumer		45			46			57			166			184
Other		6			5			5			13			18
HELOC																	12			46			91			58			138
Other 1																	34			57			73			91			152
Total recoveries		570			411			358			1,255			1,268			80			205			382			285			1,806
Net (recoveries) / charge-offs		(329)			655			839			743			1,240
Loan loss reserve provision		300			750			-			1,050			-
Net charge-offs / (recoveries)																	394			140			317			534			(1,132)
Provision (release) for loan and lease losses																	450			450			1,450			900			728
Allowance at end of period	$	16,465		$	15,836		$	14,983		$	16,465		$	14,983		$	19,372		$	19,316		$	19,321		$	19,372		$	19,321

Average total loans (exclusive of loans held-for-sale)	$	1,550,229		$	1,505,572		$	1,186,279		$	1,513,693		$	1,157,159		$	1,894,454		$	1,893,659		$	1,806,209		$	1,894,058		$	1,703,969
Net (recoveries) / charge-offs to average loans		(0.02)	%		0.04	%		0.07	%		0.05	%		0.11	%
Net charge-offs / (recoveries) to average loans																	0.02	%		0.01	%		0.02	%		0.03	%		(0.07)	%
Allowance at period end to average loans		1.06	%		1.05	%		1.26	%		1.09	%		1.29	%		1.02	%		1.02	%		1.07	%		1.02	%		1.13	%

Ending balance: Individually evaluated for impairment	$	6		$	98		$	514		$	6		$	514		$	455		$	222		$	498		$	455		$	498
Ending balance: Collectively evaluated for impairment	$	16,459		$	15,738		$	14,469		$	16,459		$	14,469		$	18,513		$	19,094		$	18,823		$	18,513		$	18,823

Ending balance: Acquired and accounted for ASC 310-30																$	404		$	-		$	-		$	404		$	-

1 The “Other” class includes consumer and overdrafts.

Net charge-offs for the quarter ended June 30, 2019, totaled $394,000, compared to $140,000 for the quarter ended March 31, 2019, and $317,000 for the quarter ended June 30, 2018. The coverage ratio of the allowance for loan and lease losses to nonperforming loans was ~~101.2% as of September 30, 2017, which was a minimal reduction from the coverage of 101.4%~~153.0% as of June 30, ~~2017, but greater than~~2019, which was an increase from the ~~86.2%~~ coverage ratio of 129.3% as of ~~September~~March 31, 2019, and a decrease from 162.7% as of June 30, ~~2016.~~2018. When measured as a percentage of average loans, ~~as of September 30, 2017,~~our total allowance for loan and lease losses ~~increased to 1.06%~~was 1.02% of ~~total~~quarterly average loans ~~from 1.05%~~ as of June 30, ~~2017,~~2019 and ~~decreased from 1.26%~~March 31, 2019 and 1.07% as of ~~average loans at September~~June 30, ~~2016.~~2018. The total allowance for loan

Tableof Contents

and lease losses as a percent of total period end loans was ~~1.15%~~1.05% as of ~~September~~June 30, ~~2017,~~2019, excluding the loans acquired ~~from~~in our acquisition of ABC Bank and in our Talmer branch purchase.

In accordance with the accounting guidance for business combinations, there was no allowance brought forward on any of the acquired loans in our acquisition of ABC Bank or our Talmer branch purchase. For purchased non-credit impaired loans (“non-PCI loans”), which refers to loans acquired in our acquisition that did not show signs of credit deterioration at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to organic loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses. The aggregate non-PCI loans related to our acquisition of ABC Bank and the Talmer branch ~~acquisition, which are effectively “reserved” for potential future losses in the remaining $667,000 credit mark component~~purchase totaled $227.1 million as of ~~the~~June 30, 2019, net of purchase accounting ~~discount recorded.~~adjustments of $1.2 million, which included $915,000 of credit discounts. At June 30, 2019, of our $19.4 million allowance for loan and lease losses, $1.5 million related to non-PCI loans. In management’s judgment, an adequate allowance for estimated losses has been established for inherent losses at ~~September~~June 30, ~~2017,~~2019, and general changes in lending policy, procedures and staffing, as well as other external factors. 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. ~~Loan loss~~

We recorded PCI loans, which refers to loans that showed evidence of deteriorated credit quality upon purchase, in our acquisition of ABC Bank. PCI loans totaled $10.8 million, net of purchase accounting adjustments, as of June 30, 2019, and included $5.5 million of credit discounts as of June 30, 2019. We perform re-estimations of cash flows on our PCI loan portfolio on a quarterly basis. Any decline in expected cash flows as a result of these re-estimations, due in any part to a change in credit, is deemed credit impairment, and recorded as provision for loan and lease losses during the ~~quarter ended September 30, 2017, increased $300,000~~period. Any decline in expected cash flows due only to changes in expected timing of cash flows is recognized prospectively as ~~compared~~a decrease in yield on the loan and any improvement in expected cash flows, once any previously recorded impairment is recaptured, is recognized prospectively as an adjustment to ~~like quarter of 2016 and decreased $450,000 as compared to second quarter of 2017.~~the yield on the loan.

~~Tableof Contents~~

Other Real Estate Owned

As of ~~September~~June 30, ~~2017,~~2019, OREO ~~ended~~decreased to $5.7 million, compared to $7.2 million at ~~$9.0 million. This compares to $11.7~~December 31, 2018, and $8.9 million at June 30, ~~2017, and $14.1 million at September 30, 2016. New~~2018. There were no additions to the OREO portfolio of $176,000 in the third quarter of 2017 were minimal. Valuation write-downs continued with an expense of $920,000 in the third quarter of 2017, the majority of which was recorded on three properties, compared to $392,000 in the second quarter of ~~2017 and $365,000~~2019. Property disposals in the ~~third~~second quarter of ~~2016. The OREO net book value decreased~~2019 totaled $501,000 due to three property sales. Five valuation write-downs occurred in the ~~first nine months~~second quarter of ~~2017 due~~2019 with an expense total of $195,000, compared to ~~24 property sales, net~~$254,000 of ~~a participation purchase. These sales provided $5.5 million in total proceeds, including net gains on OREO sales of $454,000. In addition, net~~ valuation ~~reserve~~ write-downs ~~of $1.6 million on 35 OREO properties were~~ recorded in the ~~first nine months~~second quarter of ~~2017; both of these reductions were partially offset by 13 property transfers into OREO from nonaccrual or fixed asset status totaling $3.8 million.~~2018.

September 30, 2017
OREO
Quarters Ended

Percent Change From
(in thousands)
September 30,

June 30,

September 30,

June 30,

September 30,

2017

2017

2016

2017

2016
Beginning balance
$
11,724

$
13,481

$
16,252

(13.0)

(27.9)

Property additions

176

204

255

(13.7)

(31.0)

Property improvements

-

-

4

N/M

N/M

Less:

Property disposals

1,956

1,569

2,002

24.7

(2.3)

Period valuation adjustments

920

392

365

134.7

152.1

Total other real estate owned
$
9,024

$
11,724

$
14,144

(23.0)

(36.2)


							June 30, 2019
OREO	Three Months Ended						Percent Change From
	June 30,		December 31,		June 30,		December 31,	June 30,
	2019		2018		2018		2018	2018
Balance at beginning of period	$	6,365	$	6,964	$	7,063	(8.6)	(9.9)
Property additions, net of acquisition adjustments		-		721		2,812	(100.0)	-
Less:
Proceeds from property disposals, net of participation purchase and of gains/losses		501		414		709	21.0	(29.3)
Period valuation adjustments		196		96		254	104.2	(22.8)
Balance at end of period	$	5,668	$	7,175	$	8,912	(21.0)	(36.4)

~~N/M -~~ ~~Not Meaningful~~

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 ~~$5.2~~$4.5 million, or approximately ~~57.5%~~80.2% of total OREO at ~~September~~June 30, ~~2017,~~2019, 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
(in thousands)	September 30, 2017				December 31, 2016				September 30, 2016
													June 30, 2019				December 31, 2018				June 30, 2018
		Amount	% of Total			Amount	% of Total			Amount	% of Total			Amount	% of Total			Amount	% of Total			Amount	% of Total
Single family residence	$	937	11	%	$	225	2	%	$	1,218	9	%	$	370	7	%	$	1,137	16	%	$	2,460	4	%
Lots (single family and commercial)		5,536	61	%		7,322	61	%		8,795	62	%		4,162	73	%		4,310	60	%		4,395	49	%
Vacant land		628	7	%		636	5	%		636	4	%		440	8	%		470	6	%		470	5	%
Multi-family		-	0	%		264	2	%		264	2	%
Commercial property		1,923	21	%		3,469	30	%		3,231	23	%		696	12	%		1,258	18	%		1,587	18	%
Total OREO properties	$	9,024	100	%	$	11,916	100	%	$	14,144	100	%
Total other real estate owned													$	5,668	100	%	$	7,175	100	%	$	8,912	76	%

3rd Quarter 2017

Noninterest Income

Quarters Ended

Percent Change From

(in thousands)

September 30,

June 30,

September 30,

June 30,

September 30,


2017

2017

2016

2017

2016

Trust income

$
1,468

$
1,638

$
1,403

(10.4)

4.6

Service charges on deposits

1,722

1,615

1,756

6.6

(1.9)

Residential mortgage banking revenue

1,547

1,711

2,789

(9.6)

(44.5)

Securities gain (loss), net

102

(131)

(1,959)

177.9

105.2

Increase in cash surrender value of BOLI

362

350

383

3.4

(5.5)

Debit card interchange income

1,075

1,081

1,013

(0.6)

6.1

Gain on disposal and transfer of fixed assets

-

12

-

N/M

N/M

Other income

1,567

1,041

1,209

50.5

29.6

Total noninterest income

$
7,843

$
7,317

$
6,594

7.2

18.9

~~N/M~~ ~~- Not Meaningful~~

3952

Table of Contents

~~Of the noninterest income categories, securities gain (loss), net, experienced the largest increases on both a linked quarter~~Deposits and year over year basis, as shown above, primarily due to more favorable investment sales in 2017. The net security losses incurred in 2016 were necessary for liquidity purposes due to funding needs related to the Talmer branch purchase. Mortgage banking revenues have decreased over the last year as the rising rate environment has reduced originations and refinancing; mortgage loans held for sale originations are $34.1 million less year to date 2017 than the prior year to date period. Finally, the favorable variance in other income was driven by growth in commercial loan swap fee income; $547,000 of commercial loan swap fee income was recorded in the third quarter of 2017, as compared to $175,000 in the third quarter of 2016.Borrowings

3rd Quarter 2017

Noninterest Expense

Quarters Ended

Percent Change From

(in thousands)

September 30,

June 30,

September 30,

June 30,

September 30,


2017

2017

2016

2017

2016

Salaries

$
7,704

$
7,972

$
7,205

(3.4)

6.9

Bonus

1,114

854

521

30.4

113.8

Benefits and other

1,231

1,719

1,288

(28.4)

(4.4)

Total salaries and employee benefits

10,049

10,545

9,014

(4.7)

11.5

Occupancy, furniture and equipment expense

1,482

1,462

1,500

1.4

(1.2)

Computer and data processing

1,081

1,112

1,105

(2.8)

(2.2)

FDIC insurance

199

165

228

20.6

(12.7)

General bank insurance

246

264

269

(6.8)

(8.6)

Amortization of core deposit intangible asset

24

25

-

(4.0)

N/M

Advertising expense

255

452

430

(43.6)

(40.7)
��
Debit card interchange expense

285

399

363

(28.6)

(21.5)

Legal fees

162

184

242

(12.0)

(33.1)

Other real estate owned expense, net

680

539

426

26.2

59.6

Other expense

2,455

2,839

3,005

(13.5)

(18.3)

Total noninterest expense

$
16,918

$
17,986

$
16,582

(5.9)

2.0

Efficiency ratio (defined below)

57.66
%

64.03
%

66.21
%


							June 30, 2019
Deposits	As of						Percent Change From
	June 30,		December 31,		June 30,		December 31,	June 30,
	2019		2018		2018		2018	2018
Noninterest bearing demand	$	632,900	$	618,830	$	620,807	2.3	1.9
Savings		311,887		304,400		301,832	2.5	3.3
NOW accounts		426,511		425,878		435,514	0.1	(2.1)
Money market accounts		285,223		310,390		320,949	(8.1)	(11.1)
Certificates of deposit of less than $100,000		220,973		230,781		249,049	(4.2)	(11.3)
Certificates of deposit of $100,000 through $250,000		144,148		159,953		175,174	(9.9)	(17.7)
Certificates of deposit of more than $250,000		56,132		66,441		58,526	(15.5)	(4.1)
Total deposits	$	2,077,774	$	2,116,673	$	2,161,851	(1.8)	(3.9)

~~N/M -~~ ~~Not Meaningful~~

~~The efficiency ratio shown in the table above is calculated as noninterest expense excluding OREO expenses, amortization~~Total deposits were $2.08 billion at June 30, 2019, which reflects a $38.9 million decrease from total deposits of ~~core deposits~~$2.12 billion at December 31, 2018, and ~~acquisition costs, divided by the sum~~a decrease of net interest income on a fully tax equivalent basis, total noninterest income less net gains and losses on securities and includes a tax equivalent adjustment on the increase in cash surrender value of BOLI.

~~Third quarter 2017 noninterest expense decreased $1.1~~$84.1 million from the second quarter of 2017, and increased $336,000 from the third quarter of 2016. These variances are primarily due to salary and employee benefit related cost fluctuations due to certain one-time costs recorded$2.16 billion at June 30, 2018. The decrease in 2017, as well as an increase in employee insurance premiums in 2017. The second quarter of 2017 included a one-time cost incurred related to executive relocation and recruitment of $294,000, as well as higher levels of employee insurance costs asdeposits at June 30, 2019, compared to ~~the prior year. Although the overall employee count has not significantly increased~~December 31, 2018, was due primarily to declines in money market accounts and certificates of deposit, which was partially offset by growth in noninterest bearing demand, savings and NOW accounts. The reduction in deposits in the year over year period ~~the hiring~~reflected an aggregate decrease in NOW, money market and time deposits of ~~additional staff~~$106.2 million or 126.3%, partially offset by aggregate increases in ~~compliance~~demand deposits and ~~risk management roles has increased the overall wage base~~savings accounts of ~~the Company. A reduction in debit card interchange expense was recorded in the third quarter of 2017 due~~$22.1 million, or 2.6% In addition to ~~reversal of an accrual~~total deposit growth experienced related to ~~the debit card rewards program. Finally, other expense has declined over the last year due to reductions~~our ABC Bank acquisition, an increase in ~~loan related expenses, including remediation costs as the loan portfolio quality continues to improve.~~

~~Other expenses have minimal fluctuations, as continued efficiencies with operational processes have contributed to maintaining the majority of~~ noninterest ~~expense components with insignificant variation.~~

~~Income Taxes~~

~~The Company recorded a tax expense of $1.8 million on $9.9 million pre-tax income for the third quarter of 2017.~~ ~~Income tax expense reflected all relevant statutory tax rates and GAAP accounting. The effective tax rate for the third quarter of 2017 was 18.5%, a decrease from 28.9%~~bearing demand deposits in the second quarter of 2017 and 34.7% in the third quarter of 2016. A nonrecurring income tax benefit of $1.6 million was recorded in the third quarter of 2017, stemming from the State of Illinois tax rate increase effective July 1, 2017, which increased the Company’s net deferred tax asset by a like amount. In addition, the impact of the tax exempt securities growth in the first and second quarters of 2017 contributed to the tax rate decrease in the third quarter of 2017 as2019 compared to the ~~prior year.~~

There have been no significant changes in the Company’s ability to utilize the deferred tax assets through September 30, 2017. The Company has no valuation reserve on the deferred tax assets as of September 30, 2017.

~~Tableof Contents~~

~~Financial Condition~~

Total assets increased $109.2 million from $2.25 billion as of December 31, 2016, to $2.36 billion at September 30, 2017, due primarily to organic loan growth. Total loans increased $115.4 million, or 7.8%, when compared to December 31, 2016, which was funded by significant deposit growth and FHLBC advances. Securities increased a modest $1.6 million in total, but the securities portfolio experienced select significant shifts in type of investments held year to date.

September 30, 2017
Securities

As of

Percent Change From
(in thousands)

September 30,

December 31,

September 30,

December 31,

September 30,


2017

2016

2016

2016

2016
Securities available-for-sale, at fair value

U.S. Treasuries

$
3,990

$
-

$
-

N/M

N/M
U.S. government agencies

13,451

-

1,503

N/M

N/M
U.S. government agencies mortgage-backed

11,030

41,534

43,723

(73.4)

(74.8)
States and political subdivisions

229,032

68,703

22,254

233.4

929.2
Corporate bonds

10,577

10,630

10,730

(0.5)

(1.4)
Collateralized mortgage obligations

80,386

170,927

204,390

(53.0)

(60.7)
Asset-backed securities

131,759

138,407

140,173

(4.8)

(6.0)
Collateralized loan obligations

53,259

101,637

108,284

(47.6)

(50.8)
Total securities

$
533,484

$
531,838

$
531,057

0.3

0.5

~~N/M~~ ~~- Not Meaningful~~

~~The securities portfolio ended the third~~first quarter of ~~2017 at $533.5 million, an increase of $1.6 million from $531.8 million at December 31, 2016,~~2019 and ~~an increase of $2.4 million from September 30, 2016. Available-for-sale purchases during~~ the ~~third quarter of 2017 and~~ year over year ~~periods were primarily tax exempt state and political subdivisions securities; treasuries and government agencies also increased in the~~like period ~~ending September 30, 2017. This portfolio repositioning~~ was ~~performed~~attributable to enhance overall asset yield due to the rising interest rate environment. During the third quarter of 2017 security sales resulted in net realized gains of $102,000, as compared to net realized losses of $193,000 for the fourth quarter of 2016 and losses of $2.0 million for the third quarter of 2016.

~~Loans~~

Total loans were $1.59 billion as of September 30, 2017, an increase of $115.4 million from the total as of December 31, 2016, driven by growth in the commercial, real estate-construction and leases portfolios. In addition, a home equity portfolio purchase of $16.7 million from TCF Bank in the second quarter of 2017 contributed to the total residential real estate growth of $41.7 million for the 2017 year to date period. Loan portfolio repositioning continued to drive reductions in commercial real estate concentrations, and to grow commercial and lease financing to diversify the portfolio. Total loans increased $391.7 million from September 30, 2016, due to the organic growth previously discussed as well as $221.0 million of loans from the Talmer branch purchase.

September 30, 2017
Loans
As of

Percent Change From
(in thousands)
September 30,

December 31,

September 30,

December 31,

September 30,

2017

2016

2016

2016

2016
Commercial
$
257,356

$
228,113

$
136,819

12.8

88.1
Leases

69,305

55,451

47,215

25.0

46.8
Real estate - commercial

739,136

736,247

617,280

0.4

19.7
Real estate - construction

94,868

64,720

28,786

46.6

229.6
Real estate - residential

419,583

377,851

357,846

11.0

17.3
Consumer

2,770

3,237

3,325

(14.4)

(16.7)
Other

10,550

11,973

10,517

(11.9)

0.3

1,593,568

1,477,592

1,201,788

7.8

32.6
Net deferred loan costs

623

1,217

1,064

(48.8)

(41.4)
Total loans
$
1,594,191

$
1,478,809

$
1,202,852

7.8

32.5

The quality of the loan portfolio is impacted by not only Company credit decisions but also the economic health of the communities in which the Company operates. As the Company is located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial, residential, and construction) has been and continues to be a sizeable portion of the portfolio. These categories comprised 78.6% of the portfolio as of September 30, 2017, compared to 79.7% of the portfolio as of

~~Tableof Contents~~

~~December 31, 2016. The Company continues to oversee and manage its loan portfolio in accordance with interagency guidance on risk management.~~

~~Deposits and Borrowings~~

September 30, 2017
Deposits
As of

Percent Change From
(in thousands)
September 30,

December 31,

September 30,

December 31,

September 30,

2017

2016

2016

2016

2016
Noninterest bearing demand
$
556,874

$
513,688

$
473,477

8.4

17.6
Savings

260,268

256,159

253,454

1.6

2.7
NOW accounts

417,054

419,417

391,188

(0.6)

6.6
Money market accounts

270,647

275,273

259,495

(1.7)

4.3
Certificates of deposit of less than $100,000

219,152

228,993

230,748

(4.3)

(5.0)
Certificates of deposit of $100,000 through $250,000

114,373

110,992

105,868

3.0

8.0
Certificates of deposit of more than $250,000

50,747

62,263

63,152

(18.5)

(19.6)
Total deposits
$
1,889,115

$
1,866,785

$
1,777,382

1.2

6.3

Total deposits were $1.89 billion on September 30, 2017, which reflects a $22.3 million increase from total deposits of $1.87 billion as of December 31, 2016, and a $111.7 million increase from $1.78 billion as of September 30, 2016. Total noninterest bearing demand accounts experienced increases of $43.2 million, or 8.4%, in volumes for the first nine months of 2017, while certificates of deposit reflected a decrease of $18.0 million, or 4.5%, for the same period. Growth in deposits in the third quarter of 2017 was attributed to seasonal tax refunds, as well as strong commercial demand deposit growth stemming from ~~seasonal and~~ operational ~~funds~~fund increases as well as growth in commercial loan ~~clients. The total deposit growth of 6.3% in~~clients over the ~~year over year period is also partially attributable to the $48.9 million of deposits acquired with the Talmer branch purchase in 2016.~~past year.

In addition to deposits, ~~the Bank~~we obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled ~~$26.9~~$54.2 million at ~~September~~June 30, ~~2017,~~2019, a $7.5 million, or 16.3%, an increase from ~~$25.7~~$46.6 million at December 31, ~~2016. The Bank~~2018. We also recorded ~~an advance~~short-term borrowings of ~~$125.0~~$87.1 million from ~~Federal Home Loan Bank of Chicago~~the FHLBC at ~~September~~June 30, ~~2017,~~2019, as compared to ~~$70.0~~$149.5 million in short-term borrowings at December 31, ~~2016.~~2018. We assumed $23.4 million of long-term FHLBC advances in our ABC Bank acquisition, with maturities scheduled over the next seven years and paying interest at rates of 1.60% to 2.83%. These long-term advances totaled $11.0 million as of June 30, 2019, compared to $15.4 million as of December 31, 2018.

The Company is indebted on senior notes totaling ~~$44.0~~$44.2 million, net of deferred issuance costs, ~~which were issued in the fourth quarter~~as of ~~2016.~~June 30, 2019. These notes mature in December 2026, and include interest payable ~~semiannually~~semi-annually at 5.75% for five years. Beginning December 2021, the interest becomes payable quarterly at three month LIBOR plus 385 basis points. The Company is also indebted on ~~$57.6~~$57.7 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its two statutory trust subsidiaries, Old Second Capital Trust I and 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 on June 15, 2017. Upon conversion to a floating rate, we initiated a cash flow hedge ~~was initiated~~ which resulted in the total interest rate paid on this debt of ~~4.30%~~4.40% as of ~~September~~June 30, ~~2017,~~2019, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017 rate reset.

Capital

As of ~~September~~June 30, ~~2017,~~2019, total stockholders’ equity was ~~$200.8~~$257.3 million, which was an increase of ~~$25.6~~$28.2 million from ~~$175.2~~$229.1 million as of December 31, ~~2016.~~2018. This increase is directly attributable to ~~nine~~net income of $17.7 million for the first six months of ~~net income in 2017~~2019, and a ~~reduction~~change in ~~the~~ accumulated other comprehensive net income (loss), which was a net loss ~~offset slightly by $888,000~~of $4.1 million at December 31, 2018, and a net gain of $6.1 million as of June 30, 2019. In addition, we paid $597,000 of dividends ~~paid~~ to our common ~~shareholders~~stockholders in ~~2017.~~the six months ended June 30, 2019.

~~In 2015, the Company redeemed all outstanding shares of the Company’s Series B preferred stock; as of September 30, 2015, no shares of the Series B Stock remained outstanding~~. ~~After this redemption, the Company’s~~Our total stockholders’ equity ~~continues to include~~in 2018 included $4.8 million related to ~~reflect~~ the value of a ~~ten year~~ten-year warrant to purchase shares of ~~its~~our common stock, with an exercise price of $13.43 per ~~share,~~share. We issued the warrant in January 2009 as part of ~~the original~~our Series B preferred stock issuance. ~~A discussion~~We redeemed all of our Series B preferred stock as of September 30, 2015. The warrant was subsequently sold at auction by the U.S. Treasury in June 2013 to a third party investor. The warrant was exercised on January 16, 2019, in a cashless transaction. As of the ~~2009 issuance, including this warrant, is included~~date of exercise, our closing market stock price was $14.23 per share, resulting in ~~Item 7, “Management’s Discussion~~45,836 shares being issued, and ~~Analysis of Financial Condition and Results of Operations” of the Company’s Form 10-K for the year ended December 31, 2016, under the heading “Capital”.~~a net $313,000 reduction to treasury stock.

4253

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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:


	Well-Capitalized Plus Capital		June 30,		December 31,		June 30,
	Conservation Buffer1		2019		2018		2018
The Company
Common equity tier 1 capital ratio	N/A		10.26	%	9.29	%	8.49	%
Total risk-based capital ratio	N/A		13.70	%	12.63	%	11.87	%
Tier 1 risk-based capital ratio	N/A		12.83	%	11.78	%	10.99	%
Tier 1 leverage ratio	N/A		10.85	%	10.08	%	9.37	%

The Bank
Common equity tier 1 capital ratio	7.00	%	13.96	%	13.29	%	12.62	%
Total risk-based capital ratio	10.50	%	14.83	%	14.14	%	13.51	%
Tier 1 risk-based capital ratio	8.50	%	13.96	%	13.29	%	12.62	%
Tier 1 leverage ratio	5.00	%	11.96	%	11.36	%	10.75	%

1Represents ratios required to be considered well capitalized under prompt corrective action provisions plus the now fully-phased in capital conservation buffer of 2.5%. The prompt corrective action provisions are only applicable at the Bank level.

~~The Company’s~~As of June 30, 2019, 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, increased from 8.56% at December 31, 2018, to 9.81% at June 30, 2019, due to net income generated for the first six months of 2019, as well as a more favorable position related to unrealized gains on securities available-for-sale. Our GAAP tangible common equity to tangible assets ratio was 9.06% at June 30, 2019, compared to 7.81% as of December 31, 2018. Our non-GAAP tangible common equity to tangible assets ratio, ~~was 8.16%~~which management also considers a valuable performance measurement for capital analysis, increased from 7.83% at ~~September 30, 2017, compared to 7.41% as of~~ December 31, ~~2016,~~2018 to 9.08% at June 30, 2019.

Reconciliation of Tangible Common Equity to Tangible Assets Ratio Non-GAAP Measure


	June 30, 2019						December 31, 2018
	GAAP			Non-GAAP			GAAP			Non-GAAP
Tangible common equity
Total Equity	$	257,264		$	257,264		$	229,081		$	229,081
Less: Goodwill and intangible assets		21,561			21,561			21,814			21,814
Add: Limitation of exclusion of core deposit intangible (80%)		N/A			591			N/A			642
Adjusted goodwill and intangible assets		21,561			20,970			21,814			21,172
Tangible common equity	$	235,703		$	236,294		$	207,267		$	207,909
Tangible assets
Total assets	$	2,623,606		$	2,623,606		$	2,676,003		$	2,676,003
Less: Adjusted goodwill and intangible assets		21,561			20,970			21,814			21,172
Tangible assets	$	2,602,045		$	2,602,636		$	2,654,189		$	2,654,831

Common equity to total assets		9.81	%		9.81	%		8.56	%		8.56	%
Tangible common equity to tangible assets		9.06	%		9.08	%		7.81	%		7.83	%

The non-GAAP intangible asset exclusion reflects the 80% core deposit limitation per Basel III guidelines within risk based capital calculations, and ~~8.12% at September 30, 2016.~~

(unaudited)

As of September 30,

As of December 31,

As of September 30,
(in thousands)

2017

2016

2016

Tier 1 capital

Total equity

$
200,763

$
175,210

$
171,627
Tier 1 adjustments:

Trust preferred securities allowed

55,395

47,997

48,728
Cumulative other comprehensive loss

632

8,762

7,437
Disallowed intangible assets

(8,830)

(8,761)

-
Disallowed deferred tax assets

(26,381)

(31,220)

(32,882)
Tier 1 capital

$
221,579

$
191,988

$
194,910

Tangible common equity

Total Equity

$
200,763

$
175,210

$
171,627
Less: Intangible assets

8,830

8,761

-
Tangible common equity

$
191,933

$
166,449

$
171,627

Tangible assets

Total assets

$
2,360,407

$
2,251,188

$
2,112,751
Less: Goodwill and intangible assets

8,830

8,761

-
Tangible assets

$
2,351,577

$
2,242,427

$
2,112,751

is useful for us when reviewing risk based capital ratios and equity performance metrics.

Liquidity

Liquidity is ~~the Company’s~~our ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments. ~~The~~Our liquidity ~~of the Company~~ principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and ~~its~~our ability to borrow funds. ~~The Company monitors its~~We monitor our borrowing capacity at the FHLBC as part of ~~its~~our liquidity management process as supervised by ~~the~~our Asset and Liability Committee (“ALCO”) and reviewed by ~~the~~our Board of Directors.

Net cash inflows from operating activities were ~~$28.5~~$39.9 million during the first ~~nine~~six months of ~~2017,~~2019, compared with net cash inflows of ~~$17.2~~$27.6 million in the same period ~~in 2016.~~of 2018. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale,

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were a source of outflows for the first six months of 2019 and inflows for the ~~first nine months of 2017 and 2016.~~2018. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of ~~outflows~~inflows for the first ~~nine~~six months of ~~2017~~2019 and ~~2016.~~2018. 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~~inflows from investing activities were ~~$105.7~~$62.2 million in the first ~~nine~~six months of ~~2017,~~2019, compared to net cash inflows of ~~$117.4~~$23.3 million in the same period in ~~2016.~~2018. In the first ~~nine~~six months of ~~2017,~~2019, securities transactions accounted for net inflows of ~~$10.8~~$68.4 million, and the principal change on loans accounted for net outflows of $6.2 million. In the first six months of 2018, securities transactions accounted for net inflows of $61.0 million, and net principal disbursed on loans accounted for net outflows of ~~$118.7~~$4.4 million. ~~In the first nine months~~Proceeds from claims on BOLI, net of ~~2016, securities transactions~~premiums paid, accounted for net inflows of ~~$184.4~~$1.2 million ~~and net principal disbursed on loans accounted for net outflows~~in the second quarter of ~~$71.6 million.~~2018; there were no BOLI death benefits received in the second quarter of 2019. Proceeds from sales of OREO accounted for ~~$5.5 million~~$1.5 and ~~$5.2~~$2.1 million in investing cash inflows for the first ~~nine~~six months of ~~2017~~2019 and ~~2016,~~2018, respectively.

Net cash ~~inflows~~outflows from financing activities in the first ~~nine~~six months of ~~2017~~2019 were ~~$77.3~~$99.1 million, compared with net cash ~~inflows~~outflows of ~~$15.0~~$41.5 million in the first ~~nine~~six months of ~~2016.~~2018. Net deposit ~~inflows~~outflows in the first ~~nine~~six months of ~~2017~~2019 were ~~$22.3~~$38.9 million compared to net deposit ~~inflows~~outflows of ~~$18.3~~$9.6 million in the first ~~nine~~six months of ~~2016.~~2018. Other short-term borrowings had net cash ~~inflows related to FHLBC advances~~outflows of ~~$55.0~~$62.4 million in the first ~~nine~~six months of ~~2017~~2019 and ~~outflows of $15.0~~$49.3 million in the first ~~nine~~six months of ~~2016.~~2018. Changes in securities sold under repurchase agreements accounted for ~~$1.1~~$7.5 million in net inflows and ~~$12.5~~$18.5 million in net inflows in the first ~~nine~~six months of ~~2017~~2019 and ~~2016,~~2018, respectively.

Cash and cash equivalents for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, totaled ~~$47.5~~$58.2 million, as compared to ~~$189.9~~$65.3 million as of ~~September~~June 30, ~~2016. The significantly higher balance at~~2018. 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 ~~end~~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 ~~2016 period was in anticipation~~ordinary course of our business. Additional sources of funding include a $20 million undrawn line of credit held by the ~~$181.5~~Company with a third party financial institution, as well as unpledged securities available-for-sale. As of June 30, 2019, our unused borrowing capacity from the FHLBC totaled $317.2 million, ~~paid for the Talmer branch purchase in October 2016.~~and unpledged securities available-for-sale totaled $153.5 million.

~~Tableof Contents~~

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

As part of ~~its~~our normal operations, ~~the Company is~~we are subject to interest-rate risk on the assets ~~it invests~~we invest in (primarily loans and securities) and the liabilities ~~it funds~~we fund with (primarily customer deposits and borrowed funds)~~, as well as its ability to manage such risk.~~. Fluctuations in interest rates may result in changes in the fair market values of ~~the Company’s~~our financial instruments, cash flows, and net interest income. Like most financial institutions, ~~the Company has~~we have an exposure to changes in both short-term and long-term interest rates.

In ~~June 2017,~~December 2018, the Federal Reserve raised short-term interest rates by 0.25%. There is a ~~general~~current market expectation that the Federal Reserve will ~~move~~reduce short-term interest rates ~~higher~~ in ~~December~~the latter half of ~~2017.~~2019. Generally, Federal Reserve actions have not had a significant impact on long-term rates, although Federal Reserve officials ~~have announced a schedule to end~~began ending the reinvestment inof their securities portfolio ~~starting~~cash flow in October 2017 which could result in increases in long-term ~~rates. The Company manages~~rates if federal budget deficits continue to increase. We manage interest rate risk within guidelines established by a policy which limits ~~the~~are intended to limit our amount of rate exposure. In practice, we seek to manage our interest rate risk exposure ~~is maintained~~ well within ~~those guidelines.~~ our guidelines so that such exposure does not pose a material risk to our future earnings.

~~The Company manages~~

We manage various market risks in ~~its~~the normal course of our operations, including credit, liquidity risk, and interest-rate risk. Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of ~~the Company’s~~our business activities and operations. In addition, since ~~the Company does~~we do not hold a trading portfolio, ~~it is~~we are not exposed to significant market risk from trading activities. ~~The Company’s~~Our interest rate risk exposures ~~estimated~~ at ~~September 30, 2017, and~~ December 31, ~~2016,~~2018 and June 30, 2019 are outlined in the table below.

~~The Company's~~Our net income can be significantly influenced by a variety of external factors, including: overall economic conditions, policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities, competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships between indices (such as LIBOR and prime), and balance sheet growth or contraction. ~~The Company's~~Our ALCO committee seeks to manage interest rate risk under a variety of rate environments by structuring ~~the Company's~~our balance sheet and off-balance sheet positions, which ~~include~~includes interest rate swap derivatives as discussed in Note 15 of the financial statements included in this quarterly report. ~~The~~We seek to monitor and manage interest rate risk ~~is monitored and managed~~ within our approved policy guidelines and limits.

~~The Company utilizes~~We utilize simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by ~~the Company~~us are incorporated into the simulation model. Earnings at risk isare calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a

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different interest rate ~~environments~~environment in order to determine the percentage change. Significant declines in interest rates that occurred during the first half of 2012 have made it impossible to calculate valid interest rate scenarios for rate declines of 2.0% or more, a situation that continues to date. As of ~~September 30, 2017 and~~ December 31, ~~2016, the Company’s analyses reflected~~2018, we had modest amounts of earnings gains (in both dollars and percentage) should interest rates rise, and limited earnings reductions should interest rates fall. The changes in income across the various interest rate scenarios as of ~~September 30, 2017~~June 2019 were ~~similar~~largely unchanged compared to those ~~increases~~of December 2018. The general balance sheet composition, both assets and liabilities, did not change appreciably during the quarter, which resulted in ~~Federal Home Loan Bank borrowings.~~little change to our interest rate risk profile. Overall, management considers the current level of interest rate ~~risks~~risk to be moderate, but intends to continue closely monitoring changes in that risk in case corrective actions might be needed in the future. The Federal ~~funds~~Funds rate and the ~~Bank’s~~Bank's prime rate remained unchanged during the quarter at ~~1.25%~~2.50% and ~~4.25%~~5.50%, respectively.

The following table summarizes the effect on annual income before income taxes based upon an immediate increase or decrease in interest rates of 0.5% ~~and~~, 1%, and ~~an increase of~~ 2% ~~assuming~~and no change in the slope of the yield curve. Because of declines in market interest rates, it was not possible to calculate a decrease of 2% because many of the market interest rates would fall below zero in that scenario.


	Analysis of Net Interest Income Sensitivity															Analysis of Net Interest Income Sensitivity
(dollars in thousands)	Immediate Changes in Rates
		(1.0)	%		(0.5)	%		0.5	%		1.0	%		2.0	%	Immediate Changes in Rates
September 30, 2017
																	(2.0)	%		(1.0)	%		(0.5)	%		0.5	%		1.0	%		2.0	%
June 30, 2019
Dollar change	$	(4,860)		$	(2,159)		$	1,175		$	2,393		$	4,630			N/A		$	(5,329)		$	(2,037)		$	1,386		$	2,705		$	5,149
Percent change		(6.5)	%		(2.9)	%		1.6	%		3.2	%		6.2	%		N/A			(5.5)	%		(2.2)	%		1.4	%		2.8	%		5.4	%

December 31, 2016
December 31, 2018
Dollar change	$	(4,404)		$	(2,141)		$	1,145		$	2,406		$	4,866		$	(12,303)		$	(5,356)		$	(2,062)		$	1,084		$	2,145		$	4,178
Percent change		(6.6)	%		(3.2)	%		1.7	%		3.6	%		7.3	%		(12.2)	%		(5.3)	%		(2.1)	%		1.1	%		2.1	%		4.2	%

The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies. The above results do not take into account any management action to mitigate potential risk.

~~Tableof Contents~~

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended, as of ~~September~~June 30, ~~2017.~~2019. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of ~~September~~June 30, ~~2017,~~2019, the Company’s internal controls were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities and Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified.

There were no changes in the Company’s internal controls over financial reporting during the quarter ended ~~September~~June 30, ~~2017,~~2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

~~Forward-looking Statements~~

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

The ~~Company’s ability to predict results or~~design of any system of controls and procedures is based in part upon certain assumptions about the ~~actual effect~~likelihood of future ~~plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and~~events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future ~~prospects~~conditions, regardless of the Company and its subsidiaries, are detailed in the “Risk Factors” section included under Item 1.A. of Part I of the Company’s most recent Annual Report in Form 10-K. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.how remote.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

The Company and its subsidiaries, from time to time, are involved in collection suits in the ordinary course of business against its debtors and are defendants in legal actions arising from normal business activities. Management, after consultation with legal counsel, believes that the ultimate liabilities, if any, resulting from these actions will not have a material adverse effect on the financial position of the Bank or on the consolidated financial position of the Company.

Item 1.A. Risk Factors

There have been no material changes from the risk factors set forth in Part I, Item 1.A. “Risk Factors,” of the Company’s Form 10-K for the year ended December 31, ~~2016 and the risk factors set forth under the heading “Risk Factors” in the Company’s Registration Statement~~ 2018.

Tableof Form S-3 (File No. 333-219680), which are incorporated herein by reference. Please refer to those sections of the Company’s Form 10-K and Registration Statement on Form S-3 for disclosures regarding the risks and uncertainties related to the Company’s business.Contents

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

~~N/A~~Not applicable

Item 5. Other Information

None.

~~Tableof Contents~~

Item 6. Exhibits

Exhibits:






3.1	Amendment to Old Second Bancorp, Inc.’s Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on May 22, 2019).


10.1	~~First Amendment of~~ Old Second Bancorp, Inc. ~~Employment Agreement with James Eccher, dated as of September 1, 2017~~2019 Equity Incentive Plan (incorporated by reference to ~~Exhibit 10.1 of~~Appendix A to the Company’s ~~Current Report on Form 8-K~~definitive proxy statement filed on ~~September 1, 2017)~~April 19, 2019).


10.2	Form of ~~Compensation and Benefits Assurance~~Employee Time Vesting Restricted Stock Unit Agreement (incorporated by reference to Exhibit ~~10.2 of~~4.8 to the Company’s ~~Current Report on~~ Form ~~8-K~~S-8 Registration Statement (333-231807) filed on ~~September 1, 2017)~~May 29, 2019).

10.3	Form of Director Time Vesting Restricted Stock Unit Agreement (incorporated by reference to Exhibit 4.9 to the Company’s Form S-8 Registration Statement (333-231807) filed on May 29, 2019).


31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).

31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).

32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at ~~September 30, 2017,~~March 31, 2019, and December 31, ~~2016;~~2018; (ii) Consolidated Statements of Income for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 and ~~2016;~~2018; (iii) Consolidated Statements of Stockholders’ Equity for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 and ~~2016;~~2018; (iv) Consolidated Statements of Cash Flows for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 and ~~2016;~~2018; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.*

	* As provided in Rule 406T of Regulation S-T, these interactive data files shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 as amended, or otherwise subject to liability under those sections.

4657

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	OLD SECOND BANCORP, INC.


		BY:	/s/ James L. Eccher
			James L. Eccher
			President and Chief Executive Officer
			(principal executive officer)


		BY:	/s/ Bradley S. Adams
			Bradley S. Adams
			Executive Vice President and Chief Financial Officer
			(principal financial and accounting officer)


DATE: ~~November~~August 7, ~~2017~~2019

4758


	PART I
		Page Number
Item 1.	Financial Statements	34
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	3238
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	4455
Item 4.	Controls and Procedures	4556
	PART II

Item 1.	Legal Proceedings	4556
Item 1.A.	Risk Factors	4556
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	4557
Item 3.	Defaults Upon Senior Securities	4557
Item 4.	Mine Safety Disclosure	4557
Item 5.	Other Information	4557
Item 6.	Exhibits	4657

	Signatures	4758


	(unaudited)
	Nine Months Ended September 30,
Supplemental cash flow information	2017		2016
Income taxes paid, net	$	230	$	160
Interest paid for deposits		3,802		3,142
Interest paid for borrowings		4,890		4,021
Non-cash transfer of loans to other real estate owned		3,701		1,223
Non-cash transfer of premises to other real estate owned		95		-
Non-cash transfer of securities held-to-maturity to securities available-for-sale		-		244,823


							Nine Months Ended
	As of September 30, 2017						September 30, 2017
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial	$	207	$	360	$	-	$	123	$	-
Leases		196		227		-		281		-
Commercial real estate
Owner occupied general purpose		457		495		-		1,169		-
Owner occupied special purpose		359		509		-		372		-
Non-owner occupied general purpose		1,218		1,592		-		1,481		2
Non-owner occupied special purpose		-		-		-		507		-
Retail properties		1,113		1,199		-		1,146		-
Farm		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-
Land		-		-		-		-		-
Commercial speculative		-		-		-		37		-
All other		205		231		-		206		-
Residential
Investor		1,374		1,627		-		1,607		36
Multifamily		4,757		4,965		-		2,379		-
Owner occupied		8,150		9,524		-		8,987		119
Revolving and junior liens		1,991		2,173		-		2,237		27
Consumer		8		8		-		104		-
Total impaired loans with no recorded allowance		20,035		22,910		-		20,636		184

With an allowance recorded
Commercial		-		-		-		-		-
Leases		-		-		-		-		-
Commercial real estate
Owner occupied general purpose		-		-		-		-		-
Owner occupied special purpose		-		-		-		-		-
Non-owner occupied general purpose		-		-		-		123		-
Non-owner occupied special purpose		-		-		-		-		-
Retail properties		-		-		-		-		-
Farm		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-
Land		-		-		-		-		-
Commercial speculative		-		-		-		-		-
All other		-		-		-		-		-
Residential
Investor		-		-		-		-		-
Multifamily		-		-		-		-		-
Owner occupied		-		-		-		402		-
Revolving and junior liens		51		51		6		26		2
Consumer		-		-		-		-		-
Total impaired loans with a recorded allowance		51		51		6		551		2
Total impaired loans	$	20,086	$	22,961	$	6	$	21,187	$	186


	TDR Modifications					TDR Modifications
	Quarter Ended September 30, 2017					Nine Months Ended September 30, 2017
	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - residential
Owner occupied
HAMP1	1	$	36	$	33	1	$	36	$	33
Other2	1		42		42	1		42		42
Revolving and junior liens
HAMP1	1		49		49	1		49		49
Other2	1		49		33	7		448		418
Total	4	$	176	$	157	10	$	575	$	542


			Asset Derivatives			Liability Derivatives
	Notional or
	Contractual		Balance Sheet			Balance Sheet
	Amount		Location	Fair Value		Location	Fair Value
Interest rate swap contracts net of credit valuation	$	349,367	Other Assets	$	128	Other Liabilities	$	128
Interest rate lock commitments and forward contracts		28,591	Other Assets		289	N/A		-
Total				$	417		$	128


Analysis of Average Balances,
Tax Equivalent Interest and Rates
Nine Months Ended September 30, 2017, and 2016
(In thousands - unaudited)

	2017						2016
	Average					Rate	Average					Rate
	Balance			Interest		%	Balance			Interest		%
Assets
Interest bearing deposits with financial institutions	$	11,913		$	91	1.01	$	25,960		$	98	0.50
Securities:
Taxable		370,161			7,994	2.88		682,997			12,547	2.45
Non-taxable (TE)		196,120			6,443	4.38		36,340			891	3.27
Total securities		566,281			14,437	3.40		719,337			13,438	2.49
Dividends from FHLBC and FRBC		7,886			271	4.58		7,955			251	4.21
Loans and loans held-for-sale1		1,516,872			52,365	4.55		1,161,312			39,778	4.50
Total interest earning assets		2,102,952			67,164	4.22		1,914,564			53,565	3.69
Cash and due from banks		34,670			-	-		32,617			-	-
Allowance for loan losses		(16,184)			-	-		(16,145)			-	-
Other noninterest bearing assets		189,533			-	-		193,443			-	-
Total assets	$	2,310,971					$	2,124,479

Liabilities and Stockholders' Equity
NOW accounts	$	427,242		$	316	0.10	$	383,870		$	261	0.09
Money market accounts		279,143			254	0.12		272,657			198	0.10
Savings accounts		262,352			125	0.06		258,062			118	0.06
Time deposits		392,049			3,081	1.05		404,210			2,622	0.87
Interest bearing deposits		1,360,786			3,776	0.37		1,318,799			3,199	0.32
Securities sold under repurchase agreements		32,764			10	0.04		35,022			3	0.01
Other short-term borrowings		62,308			472	1.00		26,040			66	0.33
Junior subordinated debentures		57,609			3,073	7.11		57,561			3,251	7.53
Senior notes		43,998			2,017	6.11		-			-	-
Subordinated debt		-			-	-		45,000			727	2.12
Notes payable and other borrowings		-			-	-		500			6	1.58
Total interest bearing liabilities		1,557,465			9,348	0.80		1,482,922			7,252	0.65
Noninterest bearing deposits		544,925			-	-		465,094			-	-
Other liabilities		20,814			-	-		13,037			-	-
Stockholders' equity		187,767			-	-		163,426			-	-
Total liabilities and stockholders' equity	$	2,310,971					$	2,124,479
Net interest income (TE)				$	57,816					$	46,313
Net interest income (TE) to total earning assets						3.68						3.23
Interest bearing liabilities to earning assets		74.06	%					77.45	%


							3rd Quarter 2017
Noninterest Income	Quarters Ended						Percent Change From
(in thousands)	September 30,		June 30,		September 30,		June 30,	September 30,
	2017		2017		2016		2017	2016
Trust income	$	1,468	$	1,638	$	1,403	(10.4)	4.6
Service charges on deposits		1,722		1,615		1,756	6.6	(1.9)
Residential mortgage banking revenue		1,547		1,711		2,789	(9.6)	(44.5)
Securities gain (loss), net		102		(131)		(1,959)	177.9	105.2
Increase in cash surrender value of BOLI		362		350		383	3.4	(5.5)
Debit card interchange income		1,075		1,081		1,013	(0.6)	6.1
Gain on disposal and transfer of fixed assets		-		12		-	N/M	N/M
Other income		1,567		1,041		1,209	50.5	29.6
Total noninterest income	$	7,843	$	7,317	$	6,594	7.2	18.9


	(unaudited)
	As of September 30,		As of December 31,		As of September 30,
(in thousands)	2017		2016		2016

Tier 1 capital
Total equity	$	200,763	$	175,210	$	171,627
Tier 1 adjustments:
Trust preferred securities allowed		55,395		47,997		48,728
Cumulative other comprehensive loss		632		8,762		7,437
Disallowed intangible assets		(8,830)		(8,761)		-
Disallowed deferred tax assets		(26,381)		(31,220)		(32,882)
Tier 1 capital	$	221,579	$	191,988	$	194,910

Tangible common equity
Total Equity	$	200,763	$	175,210	$	171,627
Less: Intangible assets		8,830		8,761		-
Tangible common equity	$	191,933	$	166,449	$	171,627

Tangible assets
Total assets	$	2,360,407	$	2,251,188	$	2,112,751
Less: Goodwill and intangible assets		8,830		8,761		-
Tangible assets	$	2,351,577	$	2,242,427	$	2,112,751