10-Q 1 osbc-20190331x10q.htm 10-Q

I

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 March 31, 2019

OR

☐ | 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

(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 every Interactive Data File required to be submitted 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☐

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 May 2, 2019, the Registrant has 29,896,529 shares of common stock outstanding at $1.00 par value per share.

OLD SECOND BANCORP, INC.

Form 10-Q Quarterly Report

Table of Contents

Cautionary Note Regarding Forward Looking Statements

| PART I |
|  | Page Number
Item 1. | Financial Statements | 4
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 36
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 50
Item 4. | Controls and Procedures | 51
| PART II |
Item 1. | Legal Proceedings | 51
Item 1.A. | Risk Factors | 51
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 51
Item 3. | Defaults Upon Senior Securities | 52
Item 4. | Mine Safety Disclosure | 52
Item 5. | Other Information | 52
Item 6. | Exhibits | 52
| Signatures | 53

2

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.

3

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

|  | (unaudited) |  |  |
|  | March 31, |  | December 31,
|  | 2019 |  | 2018
Assets |  |  |  |  |  |
Cash and due from banks |  | $ | 28,898 |  | $ | 38,599
Interest earning deposits with financial institutions |  |  | 11,438 |  |  | 16,636
Cash and cash equivalents |  |  | 40,336 |  |  | 55,235
Securities available-for-sale, at fair value |  |  | 509,090 |  |  | 541,248
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock |  |  | 11,179 |  |  | 13,433
Loans held-for-sale |  |  | 2,134 |  |  | 2,984
Loans |  |  | 1,903,146 |  |  | 1,897,027
Less: allowance for loan and lease losses |  |  | 19,316 |  |  | 19,006
Net loans |  |  | 1,883,830 |  |  | 1,878,021
Premises and equipment, net |  |  | 42,025 |  |  | 42,439
Other real estate owned |  |  | 6,365 |  |  | 7,175
Mortgage servicing rights, net |  |  | 6,715 |  |  | 7,357
Goodwill and core deposit intangible |  |  | 21,682 |  |  | 21,814
Bank-owned life insurance ("BOLI") |  |  | 62,002 |  |  | 61,544
Deferred tax assets, net |  |  | 17,271 |  |  | 21,280
Other assets |  |  | 20,902 |  |  | 23,473
Total assets |  | $ | 2,623,531 |  | $ | 2,676,003
Liabilities |  |  |  |  |  |
Deposits: |  |  |  |  |  |
Noninterest bearing demand |  | $ | 629,909 |  | $ | 618,830
Interest bearing: |  |  |  |  |  |
Savings, NOW, and money market |  |  | 1,061,216 |  |  | 1,040,668
Time |  |  | 432,387 |  |  | 457,175
Total deposits |  |  | 2,123,512 |  |  | 2,116,673
Securities sold under repurchase agreements |  |  | 42,361 |  |  | 46,632
Other short-term borrowings |  |  | 85,000 |  |  | 149,500
Junior subordinated debentures |  |  | 57,698 |  |  | 57,686
Senior notes |  |  | 44,183 |  |  | 44,158
Notes payable and other borrowings |  |  | 13,207 |  |  | 15,379
Other liabilities |  |  | 14,315 |  |  | 16,894
Total liabilities |  |  | 2,380,276 |  |  | 2,446,922
Stockholders’ Equity |  |  |  |  |  |
Common stock |  |  | 34,825 |  |  | 34,720
Additional paid-in capital |  |  | 119,126 |  |  | 119,081
Retained earnings |  |  | 183,634 |  |  | 175,463
Accumulated other comprehensive income (loss) |  |  | 1,736 |  |  | (4,079)
Treasury stock |  |  | (96,066) |  |  | (96,104)
Total stockholders’ equity |  |  | 243,255 |  |  | 229,081
Total liabilities and stockholders’ equity |  | $ | 2,623,531 |  | $ | 2,676,003

| March 31, 2019 |  | December 31, 2018
| Common |  | Common
| Stock |  | Stock
Par value | $ | 1.00 |  | $ | 1.00
Shares authorized |  | 60,000,000 |  |  | 60,000,000
Shares issued |  | 34,825,340 |  |  | 34,719,517
Shares outstanding |  | 29,895,022 |  |  | 29,763,078
Treasury shares |  | 4,930,318 |  |  | 4,956,439

See accompanying notes to consolidated financial statements.

4

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except per share data)

|  |  | (unaudited) |
|  | Three Months Ended March 31, |
|  | 2019 |  | 2018 |
Interest and dividend income |  |  |  |  |  |  |
Loans, including fees |  | $ | 24,099 |  | $ | 18,732 |
Loans held-for-sale |  |  | 22 |  |  | 24 |
Securities: |  |  |  |  |  |  |
Taxable |  |  | 2,414 |  |  | 2,170 |
Tax exempt |  |  | 2,098 |  |  | 2,061 |
Dividends from FHLBC and FRBC stock |  |  | 149 |  |  | 106 |
Interest bearing deposits with financial institutions |  |  | 114 |  |  | 49 |
Total interest and dividend income |  |  | 28,896 |  |  | 23,142 |
Interest expense |  |  |  |  |  |  |
Savings, NOW, and money market deposits |  |  | 771 |  |  | 344 |
Time deposits |  |  | 1,618 |  |  | 1,175 |
Securities sold under repurchase agreements |  |  | 149 |  |  | 79 |
Other short-term borrowings |  |  | 607 |  |  | 329 |
Junior subordinated debentures |  |  | 927 |  |  | 927 |
Senior notes |  |  | 672 |  |  | 672 |
Notes payable and other borrowings |  |  | 116 |  |  | - |
Total interest expense |  |  | 4,860 |  |  | 3,526 |
Net interest and dividend income |  |  | 24,036 |  |  | 19,616 |
Provision (release) for loan and lease losses |  |  | 450 |  |  | (722) |
Net interest and dividend income after provision for loan and lease losses |  |  | 23,586 |  |  | 20,338 |
Noninterest income |  |  |  |  |  |  |
Trust income |  |  | 1,486 |  |  | 1,495 |
Service charges on deposits |  |  | 1,862 |  |  | 1,592 |
Secondary mortgage fees |  |  | 136 |  |  | 162 |
Mortgage servicing rights mark to market (loss) gain |  |  | (819) |  |  | 305 |
Mortgage servicing income |  |  | 457 |  |  | 452 |
Net gain on sales of mortgage loans |  |  | 762 |  |  | 917 |
Securities gains, net |  |  | 27 |  |  | 35 |
Increase in cash surrender value of BOLI |  |  | 458 |  |  | 248 |
Death benefit realized on bank-owned life insurance |  |  | - |  |  | 1,026 |
Debit card interchange income |  |  | 987 |  |  | 1,012 |
Other income |  |  | 1,126 |  |  | 1,261 |
Total noninterest income |  |  | 6,482 |  |  | 8,505 |
Noninterest expense |  |  |  |  |  |  |
Salaries and employee benefits |  |  | 11,612 |  |  | 10,207 |
Occupancy, furniture and equipment |  |  | 1,989 |  |  | 1,558 |
Computer and data processing |  |  | 1,332 |  |  | 1,344 |
FDIC insurance |  |  | 174 |  |  | 156 |
General bank insurance |  |  | 250 |  |  | 251 |
Amortization of core deposit intangible |  |  | 132 |  |  | 21 |
Advertising expense |  |  | 234 |  |  | 341 |
Debit card interchange expense |  |  | 147 |  |  | 281 |
Legal fees |  |  | 126 |  |  | 159 |
Other real estate expense, net |  |  | 50 |  |  | 173 |
Other expense |  |  | 3,148 |  |  | 2,863 |
Total noninterest expense |  |  | 19,194 |  |  | 17,354 |
Income before income taxes |  |  | 10,874 |  |  | 11,489 |
Provision for income taxes |  |  | 2,406 |  |  | 2,000 |
Net income |  | $ | 8,468 |  | $ | 9,489 |
Net income available to common stockholders |  | $ | 8,468 |  | $ | 9,489 |
Basic earnings per share |  | $ | 0.28 |  | $ | 0.32 |
Diluted earnings per share |  |  | 0.28 |  |  | 0.31 |
Dividends declared per share |  |  | 0.01 |  |  | 0.01 |

See accompanying notes to consolidated financial statements.

5

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(In thousands)

|  | (unaudited) |
|  | Three Months Ended March 31, |
|  | 2019 |  | 2018 |
Net Income |  | $ | 8,468 |  | $ | 9,489 |
Unrealized holding gains (losses) on available-for-sale securities arising during the period |  |  | 9,192 |  |  | (8,808) |
Related tax (expense) benefit |  |  | (2,587) |  |  | 2,484 |
Holding gains (losses) after tax on available-for-sale securities |  |  | 6,605 |  |  | (6,324) |
Less: Reclassification adjustment for the net gains (losses) realized during the period |  |  |  |  |  |  |
Net realized gains |  |  | 27 |  |  | 35 |
Related tax expense |  |  | (8) |  |  | (10) |
Net realized gains after tax |  |  | 19 |  |  | 25 |
Other comprehensive income (loss) on available-for-sale securities |  |  | 6,586 |  |  | (6,349) |
Changes in fair value of derivatives used for cash flow hedges |  |  | (1,073) |  |  | 1,279 |
Related tax benefit (expense) |  |  | 302 |  |  | (362) |
Other comprehensive (loss) income on cash flow hedges |  |  | (771) |  |  | 917 |
Total other comprehensive income (loss) |  |  | 5,815 |  |  | (5,432) |
Total comprehensive income |  | $ | 14,283 |  | $ | 4,057 |

See accompanying notes to consolidated financial statements.

6

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

|  |  | (Unaudited)
|  | Three Months Ended March 31,
|  | 2019 |  | 2018
Cash flows from operating activities |  |  |  |  |  |
Net income |  | $ | 8,468 |  | $ | 9,489
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |
Net premium / discount from amortization (accretion) on securities |  |  | 723 |  |  | 706
Securities gains, net |  |  | (27) |  |  | (35)
Provision for (release of) loan and lease losses |  |  | 450 |  |  | (722)
Originations of loans held-for-sale |  |  | (25,815) |  |  | (31,096)
Proceeds from sales of loans held-for-sale |  |  | 27,224 |  |  | 33,305
Net gains on sales of mortgage loans |  |  | (762) |  |  | (917)
Change in fair value of mortgage servicing rights |  |  | 819 |  |  | (305)
Net discount / premium from (accretion) amortization on loans |  |  | (110) |  |  | 51
Increase in cash surrender value of BOLI |  |  | (458) |  |  | (248)
Net gains on sale of other real estate owned |  |  | (73) |  |  | (80)
Provision for other real estate owned valuation losses |  |  | - |  |  | 112
Depreciation of fixed assets and amortization of leasehold improvements |  |  | 638 |  |  | 537
Amortization of core deposit intangible |  |  | 132 |  |  | 21
Change in current income taxes receivable |  |  | 673 |  |  | 1,093
Provision for deferred tax expense |  |  | 1,732 |  |  | 907
Change in accrued interest receivable and other assets |  |  | 136 |  |  | (4,081)
Accretion of purchase accounting adjustment on time deposits |  |  | (25) |  |  | -
Amortization of purchase accounting adjustment on notes payable and other borrowings |  |  | 27 |  |  | -
Amortization of junior subordinated debentures issuance costs |  |  | 12 |  |  | 11
Amortization of senior notes issuance costs |  |  | 25 |  |  | 25
Change in accrued interest payable and other liabilities |  |  | (1,864) |  |  | (152)
Stock based compensation |  |  | 573 |  |  | 395
Net cash provided by operating activities |  |  | 12,498 |  |  | 9,016
Cash flows from investing activities |  |  |  |  |  |
Proceeds from maturities and calls including pay down of securities available-for-sale |  |  | 5,279 |  |  | 2,391
Proceeds from sales of securities available-for-sale |  |  | 81,524 |  |  | 2,522
Purchases of securities available-for-sale |  |  | (46,176) |  |  | (23,930)
Net proceeds from sales of FHLBC stock |  |  | 2,254 |  |  | 2,700
Net change in loans |  |  | (6,140) |  |  | 17,208
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 |  |  | 874 |  |  | 1,335
Net purchases of premises and equipment |  |  | (224) |  |  | (118)
Net cash provided by investing activities |  |  | 37,391 |  |  | 3,253
Cash flows from financing activities |  |  |  |  |  |
Net change in deposits |  |  | 6,864 |  |  | 39,123
Net change in securities sold under repurchase agreements |  |  | (4,271) |  |  | 11,448
Net change in other short-term borrowings |  |  | (64,500) |  |  | (70,000)
Net change in notes payable and other borrowings |  |  | (2,199) |  |  | -
Proceeds from exercise of stock options |  |  | 32 |  |  | -
Dividends paid on common stock |  |  | (297) |  |  | (296)
Purchase of treasury stock |  |  | (417) |  |  | (505)
Net cash used in financing activities |  |  | (64,788) |  |  | (20,230)
Net change in cash and cash equivalents |  |  | (14,899) |  |  | (7,961)
Cash and cash equivalents at beginning of period |  |  | 55,235 |  |  | 55,833
Cash and cash equivalents at end of period |  | $ | 40,336 |  | $ | 47,872

See accompanying notes to consolidated financial statements.

7

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in

Stockholders’ Equity

(In thousands)

|  |  |  |  |  |  |  |  |  |  | Accumulated |  |  |  |  |  |
|  |  |  |  | Additional |  |  |  |  | Other |  |  |  |  | Total
|  | Common |  | Paid-In |  | Retained |  | Comprehensive |  | Treasury |  | Stockholders’
|  | Stock |  | Capital |  | Earnings |  | Income (Loss) |  | Stock |  | Equity
Balance, December 31, 2017 |  | $ | 34,626 |  | $ | 117,742 |  | $ | 142,959 |  | $ | 1,479 |  | $ | (96,456) |  | $ | 200,350
Net income |  |  |  |  |  |  |  |  | 9,489 |  |  |  |  |  |  |  |  | 9,489
Other comprehensive income, net of tax |  |  |  |  |  |  |  |  |  |  |  | (5,432) |  |  |  |  |  | (5,432)
Dividends declared and paid, ($0.01 per share) |  |  |  |  |  |  |  |  | (296) |  |  |  |  |  |  |  |  | (296)
Vesting of restricted stock |  |  | 91 |  |  | (758) |  |  |  |  |  |  |  |  | 667 |  |  | -
Reclassification of stranded tax effects |  |  |  |  |  |  |  |  | (319) |  |  | 319 |  |  |  |  |  | -
Stock based compensation |  |  |  |  |  | 395 |  |  |  |  |  |  |  |  |  |  |  | 395
Purchase of treasury stock |  |  |  |  |  |  |  |  |  |  |  |  |  |  | (505) |  |  | (505)
Balance, March 31, 2018 |  | $ | 34,717 |  | $ | 117,379 |  | $ | 151,833 |  | $ | (3,634) |  | $ | (96,294) |  | $ | 204,001
Balance, December 31, 2018 |  | $ | 34,720 |  | $ | 119,081 |  | $ | 175,463 |  | $ | (4,079) |  | $ | (96,104) |  | $ | 229,081
Net income |  |  |  |  |  |  |  |  | 8,468 |  |  |  |  |  |  |  |  | 8,468
Other comprehensive loss, net of tax |  |  |  |  |  |  |  |  |  |  |  | 5,815 |  |  |  |  |  | 5,815
Dividends declared and paid, ($0.01 per share) |  |  |  |  |  |  |  |  | (297) |  |  |  |  |  |  |  |  | (297)
Vesting of restricted stock |  |  | 103 |  |  | (222) |  |  |  |  |  |  |  |  | 119 |  |  | -
Stock option exercised |  |  | 2 |  |  | 7 |  |  |  |  |  |  |  |  | 23 |  |  | 32
Stock warrants exercised |  |  |  |  |  | (313) |  |  |  |  |  |  |  |  | 313 |  |  | -
Stock based compensation |  |  |  |  |  | 573 |  |  |  |  |  |  |  |  |  |  |  | 573
Purchase of treasury stock |  |  |  |  |  |  |  |  |  |  |  |  |  |  | (417) |  |  | (417)
Balance, March 31, 2019 |  | $ | 34,825 |  | $ | 119,126 |  | $ | 183,634 |  | $ | 1,736 |  | $ | (96,066) |  | $ | 243,255

|  | Accumulated |  | Accumulated |  | Total
|  | Unrealized Loss |  | Unrealized |  | Accumulated Other
Components of accumulated other |  | on Securities |  | Loss on Derivative |  | Comprehensive
comprehensive income/(loss) |  | Available-for -Sale |  | Instruments |  | Income/(Loss)
Balance, December 31, 2017 |  | $ | 2,239 |  | $ | (760) |  | $ | 1,479
Reclassification of stranded tax effects |  |  | 482 |  |  | (163) |  |  | 319
Other comprehensive loss, net of tax |  |  | (6,350) |  |  | 918 |  |  | (5,432)
Balance, March 31, 2018 |  | $ | (3,629) |  | $ | (5) |  | $ | (3,634)
Balance, December 31, 2018 |  | $ | (4,038) |  | $ | (41) |  | $ | (4,079)
Other comprehensive income, net of tax |  |  | 6,586 |  |  | (771) |  |  | 5,815
Balance, March 31, 2019 |  | $ | 2,548 |  | $ | (812) |  | $ | 1,736

See accompanying notes to consolidated financial statements.

8

Table of Contents

Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(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 March 31, 2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 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, 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.

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, 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 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 to create a new model to follow for sale-leaseback transactions. The impact of this pronouncement will primarily affect lessees, 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. In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements” 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 standard as of January 1, 2019, and recorded right of use assets of $817,000 with a like lease liability. As of March 31, 2019, the right of use assets and lessee lease liability totaled $672,000. 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 lessor position; these tenant leases receivable balances and lessor lease liabilities totaled $142,000 as of March 31, 2019. As no lease incentives, initial direct costs, or prepayments were present with any of these lease arrangements, the present value of the lessee liabilities and lessor receivables was equal to the offsetting right of use assets and lessor lease liabilities, respectively. There was no impact to equity for the adoption of this standard on a modified retrospective basis.

In June 2016, the FASB issued ASU No. 2016-13 “Measurement of Credit Losses on Financial Instruments (Topic 326).” 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 loss rate model will be used for calculation of future risk assessments 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 at least two quarters in 2019 on a test basis to confirm the 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 this standard.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Subsequent Events

On April 16, 2019, the Company’s Board of Directors declared a cash dividend of $0.01 per share payable on May 6, 2019, to stockholders of record as of April 26, 2019; dividends of $298,000 were paid to stockholders on May 6, 2019.

Note 2 – Acquisitions

On April 20, 2018, the Company acquired Greater Chicago Financial Corp. (“GCFC”) and its wholly-owned subsidiary, ABC Bank, which operated four branches in the Chicago metro area. In addition to the acquisition price of $41.1 million, the Company retired the convertible and nonconvertible debentures held by GCFC upon acquisition, which totaled $6.6 million, including interest due. The purchase and the retirement of 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 loan valuation mark of $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 date of acquisition based on analysis of the fair value of assets acquired, less liabilities assumed. None of the $10.2 million 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 salaries and 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 GCFC 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 the assets acquired and liabilities assumed as of April 20, 2018. These fair value estimates are considered final as of March 31, 2019, and no further refinements to the 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

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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 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”) defining impaired loans as those that were either not accruing interest or exhibited credit risk factors consistent with nonperforming loans at the acquisition date, or (“non-PCI loans”).

The following table represents the acquired loans as of date of acquisition and as of March 31, 2019:

|  | April 20, 2018 |  | March 31, 2019
ABC Bank Acquired Loans |  | PCI |  | Non-PCI |  | PCI |  | Non-PCI
Fair Value |  | $ | 11,360 |  | $ | 216,234 |  | $ | 10,984 |  | $ | 167,311
Contractually required principal and interest payments |  |  | 19,447 |  |  | 220,308 |  |  | 18,046 |  |  | 169,002
Best estimate of contractual cash flows not expected to be collected |  |  | 6,537 |  |  | 2,511 |  |  | 5,969 |  |  | 965
Best estimate of contractual cash flows expected to be collected |  |  | 12,910 |  |  | 217,797 |  |  | 12,077 |  |  | 168,037

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.

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 $5.0 million at March 31, 2019, and $7.2 million at December 31, 2018. FRBC stock was recorded at $6.2 million at both March 31, 2019, and December 31, 2018.

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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 following table summarizes the amortized cost and fair value of the securities portfolio at March 31, 2019, and December 31, 2018, and the corresponding amounts of gross unrealized gains and losses:

|  |  |  |  | Gross |  | Gross |  |  |
|  | Amortized |  | Unrealized |  | Unrealized |  | Fair
March 31, 2019 |  | Cost |  | Gains |  | Losses |  | Value
Securities available-for-sale |  |  |  |  |  |  |  |
U.S. Treasuries |  | $ | 4,007 |  | $ | - |  | $ | (47) |  | $ | 3,960
U.S. government agencies |  |  | 10,511 |  |  | - |  |  | (151) |  |  | 10,360
U.S. government agencies mortgage-backed |  |  | 15,278 |  |  | 182 |  |  | (154) |  |  | 15,306
States and political subdivisions |  |  | 276,463 |  |  | 6,796 |  |  | (2,087) |  |  | 281,172
Collateralized mortgage obligations |  |  | 65,354 |  |  | 182 |  |  | (1,206) |  |  | 64,330
Asset-backed securities |  |  | 70,123 |  |  | 838 |  |  | (150) |  |  | 70,811
Collateralized loan obligations |  |  | 63,808 |  |  | 79 |  |  | (736) |  |  | 63,151
Total securities available-for-sale |  | $ | 505,544 |  | $ | 8,077 |  | $ | (4,531) |  | $ | 509,090

|  |  |  |  | Gross |  | Gross |  |  |
|  | Amortized |  | Unrealized |  | Unrealized |  | Fair
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 |  |  | 14,407 |  |  | 45 |  |  | (377) |  |  | 14,075
States and political subdivisions |  |  | 277,112 |  |  | 1,916 |  |  | (4,961) |  |  | 274,067
Collateralized mortgage obligations |  |  | 66,494 |  |  | 79 |  |  | (2,144) |  |  | 64,429
Asset-backed securities |  |  | 108,574 |  |  | 1,165 |  |  | (225) |  |  | 109,514
Collateralized loan obligations |  |  | 65,162 |  |  | 24 |  |  | (897) |  |  | 64,289
Total securities available-for-sale |  | $ | 546,867 |  | $ | 3,229 |  | $ | (8,848) |  | $ | 541,248

The fair value, amortized cost and weighted average yield of debt securities at March 31, 2019, by contractual maturity, were as follows in the table below. Securities not due at a single maturity date are shown separately.

|  |  |  |  | Weighted |  |  |  |  |
|  | Amortized |  | Average |  |  | Fair |
Securities available-for-sale |  | Cost |  | Yield |  |  | Value |
Due in one year or less |  | $ | 11,629 |  | 2.69 | % |  | $ | 11,643 |
Due after one year through five years |  |  | 6,814 |  | 2.53 |  |  |  | 6,818 |
Due after five years through ten years |  |  | 6,189 |  | 3.50 |  |  |  | 6,410 |
Due after ten years |  |  | 266,349 |  | 3.05 |  |  |  | 270,621 |
|  |  | 290,981 |  | 3.03 |  |  |  | 295,492 |
Mortgage-backed and collateralized mortgage obligations |  |  | 80,632 |  | 3.26 |  |  |  | 79,636 |
Asset-backed securities |  |  | 70,123 |  | 3.71 |  |  |  | 70,811 |
Collateralized loan obligations |  |  | 63,808 |  | 4.96 |  |  |  | 63,151 |
Total securities available-for-sale |  | $ | 505,544 |  | 3.40 | % |  | $ | 509,090 |

At March 31, 2019, the Company’s investments included $55.6 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”) 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 will drop to 75% if reimbursement requests exceed 9% of insured loans. In addition to the DOE guarantee, total added credit enhancement in the form of overcollateralization and/or subordination amounted to $11.7 million, or 12.44% of outstanding principal.

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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:

|  | March 31, 2019
|  | Amortized |  | Fair
Issuer |  | Cost |  | Value
GCO Education Loan Funding Corp |  | $ | 27,777 |  | $ | 27,731
Towd Point Mortgage Trust |  |  | 34,118 |  |  | 33,679
Student Loan Marketing Association |  |  | 25,824 |  |  | 26,153

Securities with unrealized losses at March 31, 2019, and December 31, 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 |  |  |  |  |  |  |  |
March 31, 2019 |  | in an unrealized loss position |  | in an unrealized loss position |  | Total
|  | 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
U.S. Treasuries |  | - |  | $ | - |  | $ | - |  | 1 |  | $ | 47 |  | $ | 3,960 |  | 1 |  | $ | 47 |  | $ | 3,960
U.S. government agencies |  | - |  |  | - |  |  | - |  | 4 |  |  | 151 |  |  | 10,360 |  | 4 |  |  | 151 |  |  | 10,360
U.S. government agencies mortgage-backed |  | - |  |  | - |  |  | - |  | 10 |  |  | 154 |  |  | 9,575 |  | 10 |  |  | 154 |  |  | 9,575
States and political subdivisions |  | 4 |  |  | 1 |  |  | 808 |  | 9 |  |  | 2,086 |  |  | 41,500 |  | 13 |  |  | 2,087 |  |  | 42,308
Collateralized mortgage obligations |  | - |  |  | - |  |  | - |  | 11 |  |  | 1,206 |  |  | 53,431 |  | 11 |  |  | 1,206 |  |  | 53,431
Asset-backed securities |  | 1 |  |  | 46 |  |  | 27,731 |  | 2 |  |  | 104 |  |  | 4,952 |  | 3 |  |  | 150 |  |  | 32,683
Collateralized loan obligations |  | 4 |  |  | 159 |  |  | 28,324 |  | 4 |  |  | 577 |  |  | 24,837 |  | 8 |  |  | 736 |  |  | 53,161
Total securities available-for-sale |  | 9 |  | $ | 206 |  | $ | 56,863 |  | 41 |  | $ | 4,325 |  | $ | 148,615 |  | 50 |  | $ | 4,531 |  | $ | 205,478

|  | Less than 12 months |  | 12 months or more |  |  |  |  |  |  |  |
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
Securities available-for-sale |  | 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 |  |  | 377 |  |  | 11,439 |  | 11 |  |  | 377 |  |  | 11,439
States and political subdivisions |  | 4 |  |  | 126 |  |  | 17,713 |  | 33 |  |  | 4,835 |  |  | 110,326 |  | 37 |  |  | 4,961 |  |  | 128,039
Collateralized mortgage obligations |  | 2 |  |  | 309 |  |  | 15,211 |  | 10 |  |  | 1,835 |  |  | 43,687 |  | 12 |  |  | 2,144 |  |  | 58,898
Asset-backed securities |  | - |  |  | - |  |  | - |  | 4 |  |  | 225 |  |  | 16,473 |  | 4 |  |  | 225 |  |  | 16,473
Collateralized loan obligations |  | 7 |  |  | 721 |  |  | 46,547 |  | 1 |  |  | 176 |  |  | 7,824 |  | 8 |  |  | 897 |  |  | 54,371
Total securities available-for-sale |  | 16 |  | $ | 1,256 |  | $ | 86,856 |  | 61 |  | $ | 7,592 |  | $ | 197,238 |  | 77 |  | $ | 8,848 |  | $ | 284,094

Recognition of other-than-temporary impairment was not necessary as of the three months ended March 31, 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 three months ended March 31, 2019 and 2018.

|  |  | Three Months Ended |
|  |  | March 31, |
Securities available-for-sale |  | 2019 |  | 2018 |
Proceeds from sales of securities |  | $ | 81,524 |  | $ | 2,522 |
Gross realized gains on securities |  |  | 605 |  |  | 35 |
Gross realized losses on securities |  |  | (578) |  |  | — |
Net realized gains |  | $ | 27 |  | $ | 35 |
Income tax expense on net realized gains |  |  | (8) |  |  | (10) |
Effective tax rate applied |  |  | 29.6 | % |  | 28.6 | %

Securities valued at $321.8 million as of March 31, 2019, an increase from $318.4 million at year-end 2018, were pledged to 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:

|  | March 31, 2019 |  | December 31, 2018 |
Commercial |  | $ | 324,450 |  | $ | 314,323 |
Leases |  |  | 87,730 |  |  | 78,806 |
Real estate - commercial |  |  | 835,904 |  |  | 820,941 |
Real estate - construction |  |  | 94,787 |  |  | 108,390 |
Real estate - residential |  |  | 399,866 |  |  | 407,068 |
HELOC |  |  | 133,859 |  |  | 140,442 |
Other 1 |  |  | 14,018 |  |  | 14,439 |
Total loans, excluding deferred loan costs and PCI loans |  |  | 1,890,614 |  |  | 1,884,409 |
Net deferred loan costs |  |  | 1,681 |  |  | 1,653 |
Total loans, excluding PCI loans |  |  | 1,892,295 |  |  | 1,886,062 |
PCI loans, net of purchase accounting adjustments |  |  | 10,851 |  |  | 10,965 |
Total loans |  | $ | 1,903,146 |  | $ | 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 76.9% and 77.9% of the portfolio at March 31, 2019, and December 31, 2018, respectively.

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

|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Recorded
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Investment
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 90 days or
|  |  |  |  |  |  |  | 90 Days or |  |  |  |  |  |  |  |  |  |  |  |  |  | Greater Past
|  | 30-59 Days |  | 60-89 Days |  | Greater Past |  | Total Past |  |  |  |  |  |  |  |  |  |  | Due and
March 31, 2019 |  | Past Due |  | Past Due |  | Due |  | Due |  | Current |  | Nonaccrual |  | Total Loans |  | Accruing
Commercial |  | $ | 10 |  | $ | - |  | $ | - |  | $ | 10 |  | $ | 324,440 |  | $ | - |  | $ | 324,450 |  | $ | -
Leases |  |  | 110 |  |  | - |  |  | - |  |  | 110 |  |  | 87,506 |  |  | 114 |  |  | 87,730 |  |  | -
Real estate - commercial |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 349 |  |  | 90 |  |  | - |  |  | 439 |  |  | 155,821 |  |  | 1,732 |  |  | 157,992 |  |  | -
Owner occupied special purpose |  |  | 599 |  |  | 2,021 |  |  | - |  |  | 2,620 |  |  | 188,132 |  |  | 516 |  |  | 191,268 |  |  | -
Non-owner occupied general purpose |  |  | 775 |  |  | 378 |  |  | - |  |  | 1,153 |  |  | 317,566 |  |  | 3,486 |  |  | 322,205 |  |  | -
Non-owner occupied special purpose |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 97,074 |  |  | 2,960 |  |  | 100,034 |  |  | -
Retail properties |  |  | 1,159 |  |  | - |  |  | - |  |  | 1,159 |  |  | 49,441 |  |  | - |  |  | 50,600 |  |  | -
Farm |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 13,805 |  |  | - |  |  | 13,805 |  |  | -
Real estate - construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 4,456 |  |  | - |  |  | 4,456 |  |  | -
Land |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 2,686 |  |  | - |  |  | 2,686 |  |  | -
Commercial speculative |  |  | - |  |  | 350 |  |  | - |  |  | 350 |  |  | 54,503 |  |  | - |  |  | 54,853 |  |  | -
All other |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 32,689 |  |  | 103 |  |  | 32,792 |  |  | -
Real estate - residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 803 |  |  | - |  |  | - |  |  | 803 |  |  | 68,650 |  |  | 337 |  |  | 69,790 |  |  | -
Multi-family |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 190,478 |  |  | - |  |  | 190,478 |  |  | -
Owner occupied |  |  | 282 |  |  | 10 |  |  | - |  |  | 292 |  |  | 136,177 |  |  | 3,129 |  |  | 139,598 |  |  | -
HELOC |  |  | 211 |  |  | 359 |  |  | 1 |  |  | 571 |  |  | 132,310 |  |  | 978 |  |  | 133,859 |  |  | 1
Other 1 |  |  | 8 |  |  | 30 |  |  | 3 |  |  | 41 |  |  | 15,630 |  |  | 28 |  |  | 15,699 |  |  | 3
Total, excluding PCI loans |  | $ | 4,306 |  | $ | 3,238 |  | $ | 4 |  | $ | 7,548 |  | $ | 1,871,364 |  | $ | 13,383 |  | $ | 1,892,295 |  | $ | 4
PCI loans, net of purchase accounting adjustments |  |  | 1,872 |  |  | - |  |  | - |  |  | 1,872 |  |  | 6,746 |  |  | 2,233 |  |  | 10,851 |  |  | -
Total |  | $ | 6,178 |  | $ | 3,238 |  | $ | 4 |  | $ | 9,420 |  | $ | 1,878,110 |  | $ | 15,616 |  | $ | 1,903,146 |  | $ | 4

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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
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Investment
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 90 days or
|  |  |  |  |  |  |  | 90 Days or |  |  |  |  |  |  |  |  |  |  |  |  |  | Greater Past
|  | 30-59 Days |  | 60-89 Days |  | Greater Past |  | Total Past |  |  |  |  |  |  |  |  |  |  | Due and
December 31, 2018 |  | Past Due |  | Past Due |  | Due |  | Due |  | Current |  | Nonaccrual |  | Total Loans |  | Accruing
Commercial |  | $ | 58 |  | $ | - |  | $ | 352 |  | $ | 410 |  | $ | 313,913 |  | $ | - |  | $ | 314,323 |  | $ | 361
Leases |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 78,806 |  |  | - |  |  | 78,806 |  |  | -
Real estate - commercial |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 1,768 |  |  | - |  |  | 33 |  |  | 1,801 |  |  | 160,892 |  |  | 1,579 |  |  | 164,272 |  |  | 36
Owner occupied special purpose |  |  | 826 |  |  | 135 |  |  | - |  |  | 961 |  |  | 192,426 |  |  | 395 |  |  | 193,782 |  |  | -
Non-owner occupied general purpose |  |  | 2,832 |  |  | 203 |  |  | - |  |  | 3,035 |  |  | 286,115 |  |  | 4,236 |  |  | 293,386 |  |  | -
Non-owner occupied special purpose |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 106,036 |  |  | 3,099 |  |  | 109,135 |  |  | -
Retail properties |  |  | - |  |  | 620 |  |  | - |  |  | 620 |  |  | 45,968 |  |  | - |  |  | 46,588 |  |  | -
Farm |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 13,778 |  |  | - |  |  | 13,778 |  |  | -
Real estate - construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 5,102 |  |  | - |  |  | 5,102 |  |  | -
Land |  |  | 266 |  |  | - |  |  | - |  |  | 266 |  |  | 2,478 |  |  | - |  |  | 2,744 |  |  | -
Commercial speculative |  |  | - |  |  | - |  |  | 350 |  |  | 350 |  |  | 55,060 |  |  | - |  |  | 55,410 |  |  | 355
All other |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 45,028 |  |  | 106 |  |  | 45,134 |  |  | -
Real estate - residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 801 |  |  | 156 |  |  | - |  |  | 957 |  |  | 69,148 |  |  | 353 |  |  | 70,458 |  |  | -
Multi-family |  |  | 545 |  |  | - |  |  | 179 |  |  | 724 |  |  | 195,504 |  |  | - |  |  | 196,228 |  |  | 180
Owner occupied |  |  | 1,241 |  |  | 705 |  |  | - |  |  | 1,946 |  |  | 135,360 |  |  | 3,076 |  |  | 140,382 |  |  | -
HELOC |  |  | 775 |  |  | - |  |  | - |  |  | 775 |  |  | 138,801 |  |  | 866 |  |  | 140,442 |  |  | -
Other 1 |  |  | 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 |  | $ | 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 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 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:

March 31, 2019 |  |  |  |  | Special |  |  |  |  |  |  |  |  |
|  | Pass |  | Mention |  | Substandard |  | Doubtful |  | Total
Commercial |  | $ | 316,162 |  | $ | 1,213 |  | $ | 7,075 |  | $ | - |  | $ | 324,450
Leases |  |  | 87,616 |  |  | - |  |  | 114 |  |  | - |  |  | 87,730
Real estate - commercial |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 152,313 |  |  | 1,364 |  |  | 4,315 |  |  | - |  |  | 157,992
Owner occupied special purpose |  |  | 183,197 |  |  | 2,055 |  |  | 6,016 |  |  | - |  |  | 191,268
Non-owner occupied general purpose |  |  | 314,375 |  |  | 201 |  |  | 7,629 |  |  | - |  |  | 322,205
Non-owner occupied special purpose |  |  | 95,578 |  |  | 1,496 |  |  | 2,960 |  |  | - |  |  | 100,034
Retail Properties |  |  | 48,833 |  |  | 608 |  |  | 1,159 |  |  | - |  |  | 50,600
Farm |  |  | 11,365 |  |  | 1,218 |  |  | 1,222 |  |  | - |  |  | 13,805
Real estate - construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | 4,456 |  |  | - |  |  | - |  |  | - |  |  | 4,456
Land |  |  | 2,686 |  |  | - |  |  | - |  |  | - |  |  | 2,686
Commercial speculative |  |  | 54,853 |  |  | - |  |  | - |  |  | - |  |  | 54,853
All other |  |  | 30,203 |  |  | - |  |  | 2,589 |  |  | - |  |  | 32,792
Real estate - residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 68,799 |  |  | - |  |  | 991 |  |  | - |  |  | 69,790
Multi-Family |  |  | 189,673 |  |  | 318 |  |  | 487 |  |  | - |  |  | 190,478
Owner occupied |  |  | 134,735 |  |  | 135 |  |  | 4,728 |  |  | - |  |  | 139,598
HELOC |  |  | 131,880 |  |  | 13 |  |  | 1,966 |  |  | - |  |  | 133,859
Other 1 |  |  | 15,671 |  |  | - |  |  | 28 |  |  | - |  |  | 15,699
Total, excluding PCI loans |  | $ | 1,842,395 |  | $ | 8,621 |  | $ | 41,279 |  | $ | - |  | $ | 1,892,295
PCI loans, net of purchase accounting adjustments |  |  | 815 |  |  | 2,893 |  |  | 7,143 |  |  | - |  |  | 10,851
Total |  | $ | 1,843,210 |  | $ | 11,514 |  | $ | 48,422 |  | $ | - |  | $ | 1,903,146

December 31, 2018 |  |  |  |  | Special |  |  |  |  |  |  |  |  |
|  | Pass |  | Mention |  | Substandard 2 |  | 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 “Other” class includes consumer, overdrafts and net deferred costs.

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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 Company had $443,000 and $448,000 in residential real estate loans in the process of foreclosure as of March 31, 2019, and December 31, 2018, respectively.

The following tables set forth the recorded investments, unpaid principal balance and related allowance, excluding purchased credit-impaired loans, by class of loans as of March 31, 2019 and for the three months then ended:

|  |  |  | Three Months Ended |
|  | As of March 31, 2019 |  | March 31, 2019 |
|  |  |  |  | Unpaid |  |  |  |  | Average |  | Interest |
|  | Recorded |  | Principal |  | Related |  | Recorded |  | Income |
|  | Investment |  | Balance |  | Allowance |  | Investment |  | Recognized |
With no related allowance recorded |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | - |  | $ | - |  | $ | - |  | $ | - |  | $ | - |
Leases |  |  | 114 |  |  | 154 |  |  | - |  |  | 57 |  |  | - |
Commercial real estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 1,810 |  |  | 2,015 |  |  | - |  |  | 1,735 |  |  | 1 |
Owner occupied special purpose |  |  | 516 |  |  | 661 |  |  | - |  |  | 455 |  |  | - |
Non-owner occupied general purpose |  |  | 576 |  |  | 589 |  |  | - |  |  | 857 |  |  | - |
Non-owner occupied special purpose |  |  | 2,960 |  |  | 3,575 |  |  | - |  |  | 1,480 |  |  | - |
Retail properties |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Farm |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Land |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Commercial speculative |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
All other |  |  | 103 |  |  | 131 |  |  | - |  |  | 76 |  |  | - |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 337 |  |  | 450 |  |  | - |  |  | 345 |  |  | - |
Multi-Family |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Owner occupied |  |  | 3,611 |  |  | 5,192 |  |  | - |  |  | 3,485 |  |  | 10 |
HELOC |  |  | 961 |  |  | 1,087 |  |  | - |  |  | 923 |  |  | - |
Other 1 |  |  | 5 |  |  | 6 |  |  | - |  |  | 6 |  |  | - |
Total impaired loans with no recorded allowance |  |  | 10,993 |  |  | 13,860 |  |  | - |  |  | 9,419 |  |  | 11 |
With an allowance recorded |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Leases |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Commercial real estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 174 |  |  | 174 |  |  | 72 |  |  | 285 |  |  | 6 |
Owner occupied special purpose |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Non-owner occupied general purpose |  |  | 2,968 |  |  | 3,951 |  |  | 21 |  |  | 3,033 |  |  | 2 |
Non-owner occupied special purpose |  |  | - |  |  | - |  |  | - |  |  | 1,549 |  |  | - |
Retail properties |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Farm |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Land |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Commercial speculative |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
All other |  |  | - |  |  | - |  |  | - |  |  | 29 |  |  | - |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 802 |  |  | 802 |  |  | 4 |  |  | 805 |  |  | 11 |
Multi-Family |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Owner occupied |  |  | 3,440 |  |  | 3,440 |  |  | 42 |  |  | 3,558 |  |  | 41 |
HELOC |  |  | 1,423 |  |  | 1,423 |  |  | 71 |  |  | 1,390 |  |  | 20 |
Other 1 |  |  | 23 |  |  | 24 |  |  | 12 |  |  | 23 |  |  | - |
Total impaired loans with a recorded allowance |  |  | 8,830 |  |  | 9,814 |  |  | 222 |  |  | 10,672 |  |  | 80 |
Total impaired loans |  | $ | 19,823 |  | $ | 23,674 |  | $ | 222 |  | $ | 20,091 |  | $ | 91 |

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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.

Impaired loans by class of loans as of December 31, 2018, and for the three months ended March 31, 2018, were as follows:

|  |  |  |  |  |  |  |  |  |  | Three Months Ended
|  | As of December 31, 2018 |  | March 31, 2018
|  |  |  | Unpaid |  |  |  | Average |  | Interest
|  | Recorded |  | Principal |  | Related |  | Recorded |  | Income
|  | Investment |  | Balance |  | Allowance |  | Investment |  | Recognized
With no related allowance recorded |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | - |  | $ | - |  | $ | - |  | $ | - |  | $ | -
Leases |  |  | - |  |  | - |  |  | - |  |  | 89 |  |  | -
Commercial real estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 1,659 |  |  | 1,782 |  |  | - |  |  | 417 |  |  | -
Owner occupied special purpose |  |  | 395 |  |  | 530 |  |  | - |  |  | 391 |  |  | -
Non-owner occupied general purpose |  |  | 1,138 |  |  | 1,159 |  |  | - |  |  | 602 |  |  | -
Non-owner occupied special purpose |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Retail properties |  |  | - |  |  | - |  |  | - |  |  | 541 |  |  | -
Farm |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Land |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Commercial speculative |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
All other |  |  | 49 |  |  | 73 |  |  | - |  |  | 199 |  |  | -
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 353 |  |  | 459 |  |  | - |  |  | 366 |  |  | -
Multi-Family |  |  | - |  |  | - |  |  | - |  |  | 2,362 |  |  | -
Owner occupied |  |  | 3,359 |  |  | 4,882 |  |  | - |  |  | 5,178 |  |  | 9
HELOC |  |  | 884 |  |  | 1,003 |  |  | - |  |  | 1,125 |  |  | -
Other 1 |  |  | 7 |  |  | 7 |  |  | - |  |  | 12 |  |  | -
Total impaired loans with no recorded allowance |  |  | 7,844 |  |  | 9,895 |  |  | - |  |  | 11,282 |  |  | 9
With an allowance recorded |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Leases |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Commercial real estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied general purpose |  |  | 396 |  |  | 396 |  |  | 3 |  |  | 152 |  |  | -
Owner occupied special purpose |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Non-owner occupied general purpose |  |  | 3,098 |  |  | 4,038 |  |  | 97 |  |  | - |  |  | -
Non-owner occupied special purpose |  |  | 3,099 |  |  | 3,575 |  |  | 139 |  |  | 1,788 |  |  | -
Retail properties |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Farm |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Land |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Commercial speculative |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
All other |  |  | 57 |  |  | 58 |  |  | 1 |  |  | - |  |  | -
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  |  | 808 |  |  | 808 |  |  | 4 |  |  | 826 |  |  | 11
Multi-Family |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Owner occupied |  |  | 3,676 |  |  | 3,679 |  |  | 46 |  |  | 3,559 |  |  | 37
HELOC |  |  | 1,357 |  |  | 1,357 |  |  | 49 |  |  | 1,064 |  |  | 11
Other 1 |  |  | 24 |  |  | 25 |  |  | 13 |  |  | - |  |  | -
Total impaired loans with a recorded allowance |  |  | 12,515 |  |  | 13,936 |  |  | 352 |  |  | 7,389 |  |  | 59
Total impaired loans |  | $ | 20,359 |  | $ | 23,831 |  | $ | 352 |  | $ | 18,671 |  | $ | 68

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

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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.

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 |
|  | Three Months Ended March 31, 2019 |
|  | # of |  | Pre-modification |  | Post-modification |
|  | contracts |  | recorded investment |  | recorded investment |
Troubled debt restructurings |  |  |  |  |  |  |  |  |
Real estate - commercial |  |  |  |  |  |  |  |  |
Investor occupied general purpose |  |  |  |  |  |  |  |  |
Other 1 |  | 1 |  | $ | 58 |  | $ | 58 |
Real estate - residential |  |  |  |  |  |  |  |  |
Owner occupied |  |  |  |  |  |  |  |  |
HAMP 2 |  | 1 |  |  | 105 |  |  | 9 |
HELOC |  |  |  |  |  |  |  |  |
HAMP 2 |  | 1 |  |  | 39 |  |  | 34 |
Other 1 |  | 1 |  |  | 39 |  |  | 38 |
Total |  | 4 |  | $ | 241 |  | $ | 139 |

|  | TDR Modifications |
|  | Three Months Ended March 31, 2018 |
|  | # of |  | Pre-modification |  | Post-modification |
|  | contracts |  | recorded investment |  | recorded investment |
Troubled debt restructurings |  |  |  |  |  |  |  |  |
Real estate - residential |  |  |  |  |  |  |  |  |
Investor |  |  |  |  |  |  |  |  |
Deferral 3 |  | 1 |  | $ | 165 |  | $ | 74 |
HELOC |  |  |  |  |  |  |  |  |
Rate 4 |  | 1 |  |  | 24 |  |  | 24 |
Other 1 |  | 4 |  |  | 218 |  |  | 217 |
Total |  | 6 |  | $ | 407 |  | $ | 315 |

1 Other: Change of terms from bankruptcy court.

2 HAMP: Home Affordable Modification Program.

3 Deferral: Refers to the deferral of principal.

4 Rate: Refers to interest rate reduction.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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 periods ended March 31, 2019, and March 31, 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 March 31, 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 first quarter of 2018 totaled $148,000; the balance of the non-PCI loan discount was $694,000 as of March 31, 2018.

|  | 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
Purchases |  |  | - |  |  | - |  |  | - |  |  | -
Accretion |  |  | (365) |  |  | (14) |  |  | - |  |  | (379)
Ending balance, March 31, 2019 |  | $ | 1,502 |  | $ | 1,085 |  | $ | 5,969 |  | $ | 8,556

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 months ended March 31, 2019, were as follows:

|  |  |  |  |  | Real Estate |  | Real Estate |  | Real Estate |  |  |  |  |  |
Allowance for loan and lease losses: |  | Commercial |  | Leases |  | Commercial |  | Construction |  | Residential |  | HELOC |  | Other 1 |  | Total
Beginning balance |  | $ | 2,832 |  | $ | 734 |  | $ | 10,470 |  | $ | 969 |  | $ | 1,931 |  | $ | 1,449 |  | $ | 621 |  | $ | 19,006
Charge-offs |  |  | 12 |  |  | - |  |  | 231 |  |  | - |  |  | 18 |  |  | - |  |  | 84 |  |  | 345
Recoveries |  |  | 30 |  |  | - |  |  | 23 |  |  | (1) |  |  | 50 |  |  | 46 |  |  | 57 |  |  | 205
Provision (Release) |  |  | 202 |  |  | 71 |  |  | (242) |  |  | (168) |  |  | (7) |  |  | (170) |  |  | 764 |  |  | 450
Ending balance |  | $ | 3,052 |  | $ | 805 |  | $ | 10,020 |  | $ | 800 |  | $ | 1,956 |  | $ | 1,325 |  | $ | 1,358 |  | $ | 19,316
Ending balance: Individually evaluated for impairment |  | $ | - |  | $ | - |  | $ | 93 |  | $ | - |  | $ | 46 |  | $ | 71 |  | $ | 12 |  | $ | 222
Ending balance: Collectively evaluated for impairment |  |  | 3,052 |  |  | 805 |  |  | 9,927 |  |  | 800 |  |  | 1,910 |  |  | 1,254 |  |  | 1,346 |  |  | 19,094
Ending balance: Acquired and accounted for ASC 310-30 |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Total ending allowance balance |  | $ | 3,052 |  | $ | 805 |  | $ | 10,020 |  | $ | 800 |  | $ | 1,956 |  | $ | 1,325 |  | $ | 1,358 |  | $ | 19,316
Loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance: Individually evaluated for Impairment |  | $ | - |  | $ | 114 |  | $ | 9,004 |  | $ | 103 |  | $ | 8,190 |  | $ | 2,384 |  | $ | 28 |  | $ | 19,823
Ending balance: Collectively evaluated for impairment |  |  | 324,450 |  |  | 87,616 |  |  | 826,900 |  |  | 94,684 |  |  | 391,676 |  |  | 131,475 |  |  | 15,671 |  |  | 1,872,472
Ending balance: Acquired and accounted for ASC 310-30 |  |  | - |  |  | - |  |  | 4,102 |  |  | 710 |  |  | 6,039 |  |  | - |  |  | - |  |  | 10,851
Total ending loans balance |  | $ | 324,450 |  | $ | 87,730 |  | $ | 840,006 |  | $ | 95,497 |  | $ | 405,905 |  | $ | 133,859 |  | $ | 15,699 |  | $ | 1,903,146

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

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Changes in the allowance for loan and lease losses by segment of loans based on method of impairment for three months ended March 31, 2018, were as follows:

|  |  |  |  |  | Real Estate |  | Real Estate |  | Real Estate |  |  |  |  |  |
Allowance for loan and lease losses: |  | Commercial |  | Leases |  | Commercial |  | Construction |  | Residential |  | HELOC |  | Other 1 |  | Total
Beginning balance |  | $ | 2,453 |  | $ | 692 |  | $ | 9,522 |  | $ | 923 |  | $ | 1,846 |  | $ | 1,446 |  | $ | 579 |  | $ | 17,461
Charge-offs |  |  | 16 |  |  | 5 |  |  | (96) |  |  | (16) |  |  | (60) |  |  | 27 |  |  | 99 |  |  | (25)
Recoveries |  |  | 17 |  |  | - |  |  | 367 |  |  | 3 |  |  | 911 |  |  | 47 |  |  | 79 |  |  | 1,424
Provision (Release) |  |  | 150 |  |  | (70) |  |  | (420) |  |  | 201 |  |  | (963) |  |  | 69 |  |  | 311 |  |  | (722)
Ending balance |  | $ | 2,604 |  | $ | 617 |  | $ | 9,565 |  | $ | 1,143 |  | $ | 1,854 |  | $ | 1,535 |  | $ | 870 |  | $ | 18,188
Ending balance: Individually evaluated for impairment |  | $ | - |  | $ | - |  | $ | 503 |  | $ | - |  | $ | 85 |  | $ | - |  | $ | - |  | $ | 588
Ending balance: Collectively evaluated for impairment |  |  | 2,604 |  |  | 617 |  |  | 9,062 |  |  | 1,143 |  |  | 1,769 |  |  | 1,535 |  |  | 870 |  |  | 17,600
Total ending allowance balance |  | $ | 2,604 |  | $ | 617 |  | $ | 9,565 |  | $ | 1,143 |  | $ | 1,854 |  | $ | 1,535 |  | $ | 870 |  | $ | 18,188
Loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance: Individually evaluated for impairment |  | $ | - |  | $ | - |  | $ | 4,740 |  | $ | 197 |  | $ | 10,008 |  | $ | 2,268 |  | $ | 17 |  | $ | 17,230
Ending balance: Collectively evaluated for impairment |  |  | 281,134 |  |  | 66,344 |  |  | 708,682 |  |  | 91,282 |  |  | 299,368 |  |  | 126,966 |  |  | 10,806 |  |  | 1,584,582
Total ending loan balance |  | $ | 281,134 |  | $ | 66,344 |  | $ | 713,422 |  | $ | 91,479 |  | $ | 309,376 |  | $ | 129,234 |  | $ | 10,823 |  | $ | 1,601,812

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:

|  | Three Months Ended |
|  | March 31, |
Other real estate owned |  | 2019 |  | 2018 |
Balance at beginning of period |  | $ | 7,175 |  | $ | 8,371 |
Property additions, net of acquisition adjustments |  |  | - |  |  | - |
Property improvements |  |  | - |  |  | 59 |
Less: |  |  |  |  |  |  |
Proceeds from property disposals, net of participation purchase and of gains/losses |  |  | 801 |  |  | 1,255 |
Period valuation adjustments |  |  | - |  |  | 112 |
Other adjustments |  |  | 9 |  |  | - |
Balance at end of period |  | $ | 6,365 |  | $ | 7,063 |

Activity in the valuation allowance was as follows:

|  | Three Months Ended |
|  | March 31, |
|  | 2019 |  | 2018 |
Balance at beginning of period |  | $ | 8,027 |  | $ | 8,208 |
Provision for unrealized losses |  |  | - |  |  | 112 |
Reductions taken on sales |  |  | (152) |  |  | (221) |
Balance at end of period |  | $ | 7,875 |  | $ | 8,099 |

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Expenses related to OREO, net of lease revenue includes:

|  | Three Months Ended |
|  | March 31, |
|  | 2019 |  | 2018 |
Gain on sales, net |  | $ | (73) |  | $ | (80) |
Provision for unrealized losses |  |  | - |  |  | 112 |
Operating expenses |  |  | 128 |  |  | 156 |
Less: |  |  |  |  |  |  |
Lease revenue |  |  | 5 |  |  | 15 |
Net OREO expense |  | $ | 50 |  | $ | 173 |

Note 7 – Deposits

Major classifications of deposits were as follows:

|  | March 31, 2019 |  | December 31, 2018 |
Noninterest bearing demand |  | $ | 629,909 |  | $ | 618,830 |
Savings |  |  | 314,029 |  |  | 304,400 |
NOW accounts |  |  | 449,288 |  |  | 425,878 |
Money market accounts |  |  | 297,899 |  |  | 310,390 |
Certificates of deposit of less than $100,000 |  |  | 224,899 |  |  | 230,781 |
Certificates of deposit of $100,000 through $250,000 |  |  | 145,397 |  |  | 159,953 |
Certificates of deposit of more than $250,000 |  |  | 62,091 |  |  | 66,441 |
Total deposits |  | $ | 2,123,512 |  | $ | 2,116,673 |

Note 8 – Borrowings

The following table is a summary of borrowings as of March 31, 2019, and December 31, 2018. Junior subordinated debentures are discussed in detail in Note 9:

|  | March 31, 2019 |  | December 31, 2018 |
Securities sold under repurchase agreements |  | $ | 42,361 |  | $ | 46,632 |
Other short-term borrowings 1 |  |  | 85,000 |  |  | 149,500 |
Junior subordinated debentures |  |  | 57,698 |  |  | 57,686 |
Senior notes |  |  | 44,183 |  |  | 44,158 |
Notes payable and other borrowings |  |  | 13,207 |  |  | 15,379 |
Total borrowings |  | $ | 242,449 |  | $ | 313,355 |

1 Includes short-term FHLBC advances for both periods presented as well as the 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 $42.4 million at March 31, 2019, and $46.6 million at December 31, 2018. The fair value of the pledged collateral was $75.8 million at March 31, 2019 and $72.8 million at December 31, 2018. At March 31, 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 March 31, 2019, the Bank had $85.0 million in short-term advances outstanding under the FHLBC compared to $145.5 million outstanding as of December 31, 2018; $70.0 million of the March 31, 2019, balance was issued at 2.54%, and the remaining $15.0 million was issued at rates ranging from 1.60% to 2.56%. 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

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

on hand in late January 2019. The Bank also assumed $23.4 million of long-term FHLBC advances with the ABC Bank acquisition. At March 31, 2019, these advances have a total outstanding balance of $13.2 million and are scheduled to mature over the next seven years with interest rates ranging between 1.60% and 2.83%. FHLBC stock held at March 31, 2019, was valued at $5.0 million, and any potential FHLBC advances were collateralized by securities with a fair value of $78.2 million and loans with a principal balance of $758.7 million, which carried a FHLBC calculated combined collateral value of $577.7 million. The Company had excess collateral of $405.1 million available to secure borrowings at March 31, 2019. The increase of 482.1% 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 also has $44.2 million of senior notes outstanding, net of deferred issuance costs, as of March 31, 2019 and December 31, 2018. The senior notes 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. As of March 31, 2019 and December 31, 2018, unamortized debt issuance costs related to the senior notes were $817,000 and $842,000, respectively, and are included as a reduction of 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. Distributions on the securities are payable quarterly at an annual rate of 7.80%, unless the Company 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. Upon conversion to a floating rate, a cash flow hedge was initiated which resulted in the total interest rate paid on the debt of 4.39% as of March 31, 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 March 31, 2019, and December 31, 2018, unamortized debt issuance costs related to the junior subordinated debentures were $680,000 and $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 together with the 2008 Plan, the “Plans”). The 2014 Plan was approved at the 2014 annual meeting of stockholders; a maximum of 375,000 shares were authorized to be issued under this plan. Following approval of the 2014 Plan, no further awards will be granted under the 2008 Plan or any other Company equity compensation plan. At the May 2016 annual stockholders meeting, an amendment to 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. The 2014 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights. Awards may be granted to selected directors and officers or employees under the 2014 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors. As of March 31, 2019, 169,791 shares remained available for issuance under the 2014 Plan.

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Notes to Consolidated Financial Statements

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

There were 4,500 stock options exercised in the three months ended March 31, 2019, and no stock options granted or exercised in the three months ended March 31, 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 three months ended March 31, 2019, is as follows:

|  |  |  |  |  |  | Weighted- |  |  |
|  |  |  | Weighted |  | Average |  |  |
|  |  |  | Average |  | Remaining |  |  |
|  |  |  | Exercise |  | Contractual |  | Aggregate
|  | Shares |  | per Price |  | Term (years) |  | Intrinsic Value
Beginning outstanding |  | 4,500 |  | $ | 7.49 |  | 0.1 |  | $ | 25
Canceled |  | - |  |  | - |  | - |  |  | -
Exercised |  | (4,500) |  |  | 7.49 |  | - |  |  | (27)
Expired |  | - |  |  | - |  | - |  |  | -
Ending outstanding |  | - |  | $ | - |  | - |  | $ | -
Exercisable at end of period |  | - |  | $ | - |  | - |  | $ | -

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 in control of the Company. Under the 2014 Plan, unless otherwise provided in the award agreement, upon a change in control of the Company, all stock options and stock appreciation rights will become fully exercisable, and all stock awards and cash incentive awards under the 2014 Plan shall become fully earned and vested immediately, if (i) the 2014 Plan and the respective award agreement is not an obligation of the successor entity following the change in control, or (ii) the 2014 Plan and the respective award agreement is an obligation of the successor entity following the change in control and the participant incurs a qualifying termination (generally termination without cause by the Company or termination by the employee for good reason). In the event of a change in control, performance-based awards generally will be fixed at the target performance level.

The Company granted restricted stock under its equity compensation plans beginning in 2005 and it began granting restricted stock units in February 2009. Awards of restricted stock 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. 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 no restricted stock units issued under the 2014 Plan during the three months ended March 31, 2019. There were 114,281 restricted stock units issued during the three months ended March 31, 2018. Compensation expense is recognized over the vesting period of the restricted 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 was $578,000 and $401,000 in the first three months of 2019 and 2018, respectively.

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Notes to Consolidated Financial Statements

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

A summary of changes in the Company’s unvested restricted awards for the three months ended March 31, 2019, is as follows:

|  | March 31, 2019
|  |  |  | Weighted
|  | Restricted |  | Average
|  | Stock Shares |  | Grant Date
|  | and Units |  | Fair Value
Unvested at January 1 |  | 552,281 |  | $ | 11.31
Granted |  | - |  |  | -
Vested |  | (111,437) |  |  | 7.34
Forfeited |  | - |  |  | -
Unvested at March 31 |  | 440,844 |  | $ | 12.31

Total unrecognized compensation cost of restricted awards was $2.5 million as of March 31, 2019, which is expected to be recognized over a weighted-average period of 1.84 years.

Note 11 – Earnings Per Share

The earnings per share – both basic and diluted – are included below as of March 31:

|  | Three Months Ended March 31, |  |
|  | 2019 |  | 2018 |  |
Basic earnings per share: |  |  |  |  |  |  |  |
Weighted-average common shares outstanding |  |  | 29,845,653 |  |  | 29,659,454 |  |
Net income |  | $ | 8,468 |  | $ | 9,489 |  |
Basic earnings per share |  | $ | 0.28 |  | $ | 0.32 |  |
Diluted earnings per share: |  |  |  |  |  |  |  |
Weighted-average common shares outstanding |  |  | 29,845,653 |  |  | 29,659,454 |  |
Dilutive effect of unvested restricted awards |  |  | 497,978 |  |  | 472,936 |  |
Dilutive effect of stock options and warrants |  |  | - |  |  | 36,358 |  |
Diluted average common shares outstanding |  |  | 30,343,631 |  |  | 30,168,748 |  |
Net Income |  | $ | 8,468 |  | $ | 9,489 |  |
Diluted earnings per share |  | $ | 0.28 |  | $ | 0.31 |  |

The above 2018 earnings per share calculation 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 March 31, 2018, and is 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 March 31, 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 risk-based capital regulatory guidelines, the Bank’s Board of Directors has established an internal guideline requiring the Bank 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 March 31, 2019, the Bank exceeded those thresholds.

At March 31, 2019, the Bank’s Tier 1 capital leverage ratio was 11.54%, an increase of 18 basis points from December 31, 2018, and is well above the 8.00% objective. The Bank’s total capital ratio was 14.47%, an increase of 33 basis points from December 31, 2018, and also well above the objective of 12.00%.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

Bank holding companies are 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 March 31, 2019, and December 31, 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. 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, 2018, under the heading “Supervision and Regulation.”

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

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

|  |  |  |  |  |  |  | Minimum Capital |  | To Be Well Capitalized Under |
|  |  |  |  |  |  |  | Adequacy with Capital |  | Prompt Corrective |
|  | Actual |  | Conservation Buffer if applicable 1 |  | Action Provisions 2 |
|  | Amount |  | Ratio |  | Amount |  | Ratio |  | Amount |  | Ratio |
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Common equity tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  | $ | 216,215 |  | 9.75 | % |  | $ | 155,231 |  | 7.000 | % |  |  | N/A |  | N/A |
Old Second Bank |  |  | 300,290 |  | 13.60 |  |  |  | 154,561 |  | 7.000 |  |  | $ | 143,521 |  | 6.50 | %
Total capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 292,151 |  | 13.17 |  |  |  | 232,922 |  | 10.500 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 319,601 |  | 14.47 |  |  |  | 231,915 |  | 10.500 |  |  |  | 220,871 |  | 10.00 |
Tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 272,840 |  | 12.30 |  |  |  | 188,548 |  | 8.500 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 300,290 |  | 13.60 |  |  |  | 187,681 |  | 8.500 |  |  |  | 176,641 |  | 8.00 |
Tier 1 capital to average assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 272,840 |  | 10.44 |  |  |  | 104,536 |  | 4.00 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 300,290 |  | 11.54 |  |  |  | 104,087 |  | 4.00 |  |  |  | 130,108 |  | 5.00 |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Common equity tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  | $ | 207,597 |  | 9.29 | % |  | $ | 142,444 |  | 6.375 | % |  |  | N/A |  | N/A |
Old Second Bank |  |  | 295,599 |  | 13.29 |  |  |  | 141,791 |  | 6.375 |  |  | $ | 144,571 |  | 6.50 | %
Total capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 282,126 |  | 12.63 |  |  |  | 220,648 |  | 9.875 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 314,600 |  | 14.14 |  |  |  | 219,637 |  | 9.875 |  |  |  | 222,417 |  | 10.00 |
Tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 263,125 |  | 11.78 |  |  |  | 175,960 |  | 7.875 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 295,599 |  | 13.29 |  |  |  | 175,153 |  | 7.875 |  |  |  | 177,934 |  | 8.00 |
Tier 1 capital to average assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 263,125 |  | 10.08 |  |  |  | 104,415 |  | 4.00 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 295,599 |  | 11.36 |  |  |  | 104,084 |  | 4.00 |  |  |  | 130,105 |  | 5.00 |

1 As of March 31, 2019, amounts are shown inclusive of a capital conservation buffer of 2.50%; as compared to December 31, 2018, of 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

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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, the Bank must keep a buffer of 0.625% for 2016, 1.25% for 2017, 1.875% for 2018, and 2.50% for 2019 and thereafter of minimum capital requirements in order to avoid additional limitations on capital distributions and certain other payments.

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 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.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

| · |  | 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, 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 March 31, 2019, and December 31, 2018, respectively, measured by the Company at fair value on a recurring basis:

|  | March 31, 2019
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Assets: |  |  |  |  |  |  |  |  |  |  |  |
Securities available-for-sale |  |  |  |  |  |  |  |  |  |  |  |
U.S. Treasury |  | $ | 3,960 |  | $ | - |  | $ | - |  | $ | 3,960
U.S. government agencies |  |  | - |  |  | 10,360 |  |  | - |  |  | 10,360
U.S. government agencies mortgage-backed |  |  | - |  |  | 15,306 |  |  | - |  |  | 15,306
States and political subdivisions |  |  | - |  |  | 261,616 |  |  | 19,556 |  |  | 281,172
Collateralized mortgage obligations |  |  | - |  |  | 64,330 |  |  | - |  |  | 64,330
Asset-backed securities |  |  | - |  |  | 70,811 |  |  | - |  |  | 70,811
Collateralized loan obligations |  |  | - |  |  | 63,151 |  |  | - |  |  | 63,151
Loans held-for-sale |  |  | - |  |  | 2,134 |  |  | - |  |  | 2,134
Mortgage servicing rights |  |  | - |  |  | - |  |  | 6,715 |  |  | 6,715
Interest rate swap agreements |  |  | - |  |  | 742 |  |  | - |  |  | 742
Mortgage banking derivatives |  |  | - |  |  | 167 |  |  | - |  |  | 167
Total |  | $ | 3,960 |  | $ | 488,617 |  | $ | 26,271 |  | $ | 518,848
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swap agreements |  | $ | - |  | $ | 742 |  | $ | - |  | $ | 742
Total |  | $ | - |  | $ | 742 |  | $ | - |  | $ | 742

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

|  | December 31, 2018
|  | 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 |  |  | - |  |  | 14,075 |  |  | - |  |  | 14,075
States and political subdivisions |  |  | - |  |  | 265,902 |  |  | 8,165 |  |  | 274,067
Corporate bonds |  |  | - |  |  | - |  |  | - |  |  | -
Collateralized mortgage obligations |  |  | - |  |  | 64,429 |  |  | - |  |  | 64,429
Asset-backed securities |  |  | - |  |  | 109,514 |  |  | - |  |  | 109,514
Collateralized loan obligations |  |  | - |  |  | 64,289 |  |  | - |  |  | 64,289
Loans held-for-sale |  |  | - |  |  | 2,984 |  |  | - |  |  | 2,984
Mortgage servicing rights |  |  | - |  |  | - |  |  | 7,357 |  |  | 7,357
Interest rate swap agreements |  |  | - |  |  | 672 |  |  | - |  |  | 672
Mortgage banking derivatives |  |  | - |  |  | 159 |  |  | - |  |  | 159
Total |  | $ | 3,923 |  | $ | 532,975 |  | $ | 15,522 |  | $ | 552,420
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swap agreements |  | $ | - |  | $ | 672 |  | $ | - |  | $ | 672
Total |  | $ | - |  | $ | 672 |  | $ | - |  | $ | 672

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

|  | Three Months Ended March 31, 2019
|  | Securities available-for-sale |  |  |
|  | Collateralized |  | States and |  | Mortgage
|  | Mortgage |  | Political |  | Servicing
|  | Obligation |  | Subdivisions |  | Rights
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 |  |  | - |  |  | (8) |  |  | (721)
Included in other comprehensive income |  |  | - |  |  | 171 |  |  | -
Purchases, issuances, sales, and settlements |  |  |  |  |  |  |  |  |
Purchases |  |  | - |  |  | 11,325 |  |  | -
Issuances |  |  | - |  |  | - |  |  | 177
Settlements |  |  | - |  |  | (97) |  |  | (98)
Ending balance March 31, 2019 |  | $ | - |  | $ | 19,556 |  | $ | 6,715

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Notes to Consolidated Financial Statements

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

|  | Three Months Ended March 31, 2018
|  | Securities available-for-sale |  |  |
|  | Collateralized |  | States and |  | Mortgage
|  | Mortgage |  | Political |  | Servicing
|  | Obligation |  | Subdivisions |  | Rights
Beginning balance January 1, 2018 |  | $ | 2,268 |  | $ | 14,261 |  | $ | 6,944
Transfers into Level 3 |  |  | - |  |  | - |  |  | -
Transfers out of Level 3 |  |  | - |  |  | - |  |  | -
Total gains or losses |  |  |  |  |  |  |  |  |
Included in earnings |  |  | 13 |  |  | - |  |  | 417
Included in other comprehensive income |  |  | 28 |  |  | (699) |  |  | -
Purchases, issuances, sales, and settlements |  |  |  |  |  |  |  |  |
Purchases |  |  | - |  |  | 13,085 |  |  | -
Issuances |  |  | - |  |  | - |  |  | 291
Settlements |  |  | (213) |  |  | (120) |  |  | (111)
Ending balance March 31, 2018 |  | $ | 2,096 |  | $ | 26,527 |  | $ | 7,541

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of March 31, 2019:

|  |  |  |  |  |  |  |  |  |  | Weighted
Measured at fair value |  |  |  |  |  |  | Unobservable |  |  |  | Average
on a recurring basis: |  | Fair Value |  | Valuation Methodology |  | Inputs |  | Range of Input |  | of Inputs
Mortgage servicing rights |  | $ | 6,715 |  | Discounted Cash Flow |  | Discount Rate |  | 10.0 -17.0% |  | 10.1 | %
|  |  |  |  |  |  | Prepayment Speed |  | 7.0 - 69.0% |  | 11.5 | %

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

|  |  |  |  |  |  |  |  |  |  | Weighted
Measured at fair value |  |  |  |  |  |  | Unobservable |  |  |  | Average
on a recurring basis: |  | Fair Value |  | Valuation Methodology |  | Inputs |  | Range of Input |  | of Inputs
Mortgage servicing rights |  | $ | 7,357 |  | Discounted Cash Flow |  | Discount Rate |  | 10.0 - 229.7% |  | 10.2 | %
|  |  |  |  |  |  | Prepayment Speed |  | 7.0 - 68.9% |  | 9.6 | %

In addition to the above, Level 3 fair value measurement included $19.6 million for state and political subdivisions representing various local municipality securities at March 31, 2019. This was classified as securities available-for-sale, and 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 March 31, 2018, was $26.5 million and collateralized mortgage obligation balance in Level 3 was $2.1 million. Both of these were classified as securities available-for-sale, and were valued using a discount based on market spreads of similar assets, but the 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 March 31, 2019, and December 31, 2018, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:

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Notes to Consolidated Financial Statements

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

|  | March 31, 2019
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Impaired loans 1 |  | $ | - |  | $ | - |  | $ | 8,608 |  | $ | 8,608
Other real estate owned, net 2 |  |  | - |  |  | - |  |  | 6,365 |  |  | 6,365
Total |  | $ | - |  | $ | - |  | $ | 14,973 |  | $ | 14,973

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 $8.8 million and a valuation allowance of $222,000 resulting in a decrease of specific allocations within the allowance for loan and lease losses of $130,000 for the three months ended March 31, 2019.

2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $6.4 million, which is made up of the outstanding balance of $15.2 million, net of a valuation allowance of $7.9 million and participations of $937,000 at March 31, 2019.

|  | December 31, 2018
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Impaired loans 1 |  | $ | - |  | $ | - |  | $ | 12,163 |  | $ | 12,163
Other real estate owned, net 2 |  |  | - |  |  | - |  |  | 7,175 |  |  | 7,175
Total |  | $ | - |  | $ | - |  | $ | 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 $352,000, resulting in an increase of specific allocations within the allowance for loan and lease losses of $208,000 for the year December 31, 2018.

2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $7.2 million, which is made up of the outstanding balance of $16.1 million, net of a valuation allowance of $8.0 million and participations of $900,000, at December 31, 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.

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. As of March 31, 2019 and 2018, the fair values of loans and leases are estimated on an exit price basis incorporating discounts for credit, liquidity and 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.

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Notes to Consolidated Financial Statements

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

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

|  | March 31, 2019
|  | Carrying |  | Fair |  |  |  |  |  |  |  |  |
|  | Amount |  | Value |  | Level 1 |  | Level 2 |  | Level 3
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 28,898 |  | $ | 28,898 |  | $ | 28,898 |  | $ | - |  | $ | -
Interest bearing deposits with financial institutions |  |  | 11,438 |  |  | 11,438 |  |  | 11,438 |  |  | - |  |  | -
Securities available-for-sale |  |  | 509,090 |  |  | 509,090 |  |  | 3,960 |  |  | 485,574 |  |  | 19,556
FHLBC and FRBC Stock |  |  | 11,179 |  |  | 11,179 |  |  | - |  |  | 11,179 |  |  | -
Loans held-for-sale |  |  | 2,134 |  |  | 2,134 |  |  | - |  |  | 2,134 |  |  | -
Net loans |  |  | 1,883,830 |  |  | 1,893,690 |  |  | - |  |  | - |  |  | 1,893,690
Accrued interest receivable |  |  | 11,083 |  |  | 11,083 |  |  | - |  |  | 11,083 |  |  | -
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest bearing deposits |  | $ | 629,909 |  | $ | 629,909 |  | $ | 629,909 |  | $ | - |  | $ | -
Interest bearing deposits |  |  | 1,493,603 |  |  | 1,491,384 |  |  | - |  |  | 1,491,384 |  |  | -
Securities sold under repurchase agreements |  |  | 42,361 |  |  | 42,361 |  |  | - |  |  | 42,361 |  |  | -
Other short-term borrowings |  |  | 85,000 |  |  | 85,000 |  |  | - |  |  | 85,000 |  |  | -
Junior subordinated debentures |  |  | 57,698 |  |  | 43,284 |  |  | 34,044 |  |  | 9,240 |  |  | -
Senior notes |  |  | 44,183 |  |  | 45,551 |  |  | 45,551 |  |  | - |  |  | -
Note payable and other borrowings |  |  | 13,207 |  |  | 13,207 |  |  | - |  |  | 13,207 |  |  | -
Interest rate swap agreements |  |  | 1,131 |  |  | 1,131 |  |  | - |  |  | 1,131 |  |  | -
Borrowing interest payable |  |  | 764 |  |  | 764 |  |  | - |  |  | 764 |  |  | -
Deposit interest payable |  |  | 963 |  |  | 963 |  |  | - |  |  | 963 |  |  | -

|  | 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 |  |  | -

Note 15 – Derivatives, Hedging Activities and Financial Instruments with Off-Balance Sheet Risk

Risk Management Objective of Using Derivatives

The 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

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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 financial instruments. Specifically, the Company enters into derivative financial instruments to 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 determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the 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 derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the 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 $75,000 will be reclassified as an increase to interest expense.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service the 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 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 customer derivatives and the offsetting derivatives are recognized directly in earnings.

The 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 securities changed 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 $273,000 of cash collateral pledged with one correspondent financial institution to support interest rate swap activity at March 31, 2019; $2.2 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

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

correspondent financial institution to support interest rate swap activity at December 31, 2018; no investment securities were required to be pledged. At March 31, 2019, the notional amount of non-hedging interest rate swaps was $184.2 million with a weighted average maturity of 6.3 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 March 31, 2019, and December 31, 2018.

Fair Value of Derivative Instruments

|  |  |  |  | March 31, 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 | 1,131
Total derivatives designated as hedging instruments |  |  |  |  |  | - |  |  | 1,131
Derivatives not designated as hedging instruments |  |  |  |  |  |  |  |  |
Interest rate swaps with commercial loan customers | 25 |  | 184,186 |  | Other Assets | 742 |  | Other Liabilities | 742
Interest rate lock commitments and forward contracts | 107 |  | 33,185 |  | Other Assets | 167 |  | Other Liabilities | -
Other contracts | 3 |  | 18,101 |  | Other Assets | - |  | Other Liabilities | 32
Total derivatives not designated as hedging instruments |  |  |  |  |  | 909 |  |  | 774
|  |  |  |  | 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

Disclosure of the Effect of Fair Value and Cash Flow Hedge Accounting

The fair value and cash flow hedge accounting related to derivatives covered under ASC Subtopic 815-20 impacted Accumulated Other Comprehensive Income (“AOCI”) and the Income Statement. The gain recognized in AOCI on derivatives totaled $1.1 million as of March 31, 2019, and a loss in AOCI of $1.2 million as of March 31, 2018. The amount of the loss reclassified from AOCI to interest income on the income statement totaled $5,000 and $74,000 for the three months ended March 31, 2019, and March 31, 2018, respectively.

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.

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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 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.

As of March 31, 2019, there were no derivatives in a net liability position. As of March 31, 2019, the Company has not posted any collateral related to derivative agreements.

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 March 31, 2019, and December 31, 2018.

The following table is a summary of letter of credit commitments:

|  | March 31, 2019 |  | December 31, 2018 |
|  | Fixed |  | Variable |  | Total |  | Fixed |  | Variable |  | Total |
Letters of credit: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Borrower: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial standby |  | $ | 319 |  | $ | 6,837 |  | $ | 7,156 |  | $ | 327 |  | $ | 7,158 |  | $ | 7,485 |
Commercial standby |  |  | - |  |  | 410 |  |  | 410 |  |  | - |  |  | 397 |  |  | 397 |
Performance standby |  |  | 532 |  |  | 6,238 |  |  | 6,770 |  |  | 532 |  |  | 6,381 |  |  | 6,913 |
|  |  | 851 |  |  | 13,485 |  |  | 14,336 |  |  | 859 |  |  | 13,936 |  |  | 14,795 |
Non-borrower: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Performance standby |  |  | - |  |  | 67 |  |  | 67 |  |  | - |  |  | 67 |  |  | 67 |
Total letters of credit |  | $ | 851 |  | $ | 13,552 |  | $ | 14,403 |  | $ | 859 |  | $ | 14,003 |  | $ | 14,862 |

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

Overview

The following discussion provides additional information regarding our operations for the quarter ended March 31, 2019, as compared to December 31, 2018 and March 31, 2018, and our financial condition at March 31, 2019 and December 31, 2018. This discussion should be read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our Form 10-K for the year ended December 31, 2018. The results of operations for the quarter ended March 31, 2019, are not necessarily indicative of future results.

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 banking 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 experienced total asset and overall market growth in the first quarter of 2019, compared to the fourth quarter and first quarter of 2018, and we believe we are positioned for further growth as we continue to serve our customers’ needs in a competitive economic environment. While industry and regulatory developments in the past few years have made it challenging to attain the levels of profitability and growth reflected prior to the economic recession of 2007-2009, we are continuing to seek to provide value to our customers and the communities in which we operate, by executing on growth opportunities in our local markets and developing new banking relationships. Overall stable market conditions over the past few years are reflected in the financials presented for the reporting period ended March 31, 2019.

The following provides an overview of some of the factors impacting our financial performance for the quarter ending March 31, 2019:

| · |  | This is the fourth 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, after the first quarter of 2018.

| · |  | Net income for the first quarter of 2019 was $8.5 million, or $0.28 per diluted share, compared to $9.5 million, or $0.31 per diluted share, for the first quarter of 2018.

| · |  | Net interest and dividend income was $24.0 million for the first quarter of 2019, compared to $19.6 million for the first quarter of 2018. The increase was primarily due to our acquisition of ABC Bank in the second quarter of 2018, which resulted in $227.6 million of additional loans, net of purchase accounting adjustments.

| · |  | Noninterest income was $6.5 million for the first quarter of 2019, compared to $8.5 million for the first quarter of 2018, which reflects a decrease of $2.0 million, or 23.8%. The reduction was primarily due to a $1.0 million BOLI death benefit recorded in the first quarter of 2018, as well as an interest rate driven mark to market loss on mortgage servicing rights.

| · |  | Noninterest expense was $19.2 million for the first quarter of 2019, compared to $17.4 million for the first quarter of 2018, which reflects an increase of $1.8 million, or 10.6%. The increase was primarily due to our acquisition of ABC Bank in the second quarter of 2018, which increased costs going forward due to growth in employees and facilities-related expenses.

| · |  | Asset quality remained consistent, with nonperforming loans as a percent of total loans remaining steady at 0.8% as of March 31, 2019 and March 31, 2018.

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| · |  | 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 March 31, 2019, PCI loans, net of purchase accounting adjustments, totaled $10.9 million, and PCI loans to total loans was 0.6%. We had no PCI loans before our acquisition of ABC Bank.

| · |  | Income tax expense increased in the first quarter of 2019 period compared to the like 2018 period due primarily to the BOLI death benefit of $1.0 million received in the first quarter of 2018, which was not taxable. The effective tax rate for the three months ended March 31, 2019 was 22.1%, compared to 17.4 % for the three months ended March 31, 2018.

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 Annual Report on Form 10-K for the year ended December 31, 2018, and 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 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 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

Our net income before taxes was $10.9 million in the first quarter of 2019 compared to $11.5 million in the first quarter of 2018. Net interest and dividend income increased $4.4 million, which was offset by a reduction of $2.0 million in noninterest income in the first quarter of 2019 compared to the first quarter of 2018, and an increase of $1.8 million in noninterest expense for the like periods. The decrease in pre-tax income was also due to a provision for loan and lease loss expense recorded in the first quarter of 2019 of $450,000, compared to a release of provision expense of $722,000 recorded in the first quarter of 2018 due to an insurance settlement recovery on a loan charge-off from a prior year.

The increase in net interest and dividend income was driven primarily by rising interest rates and loan growth due to the ABC Bank acquisition. Loans acquired, net of the purchase accounting adjustments, totaled $227.6 million in the second quarter of 2018. Loans and loans held for sale yielded 5.16% in the first quarter of 2019, compared to 4.75% in the first quarter of 2018.

Management has remained diligent in reviewing our loan portfolio to analyze and to determine if charge-offs are required. Loan growth experienced in the first quarter of 2019 totaled $6.1 million, primarily in real estate-commercial loans, commercial loans and leases. Management’s review of the loan portfolio concluded that $450,000 of provision expense was necessary, based on analysis of the allowance and loan portfolio held. The allowance for loan and lease loss analysis methodology remained consistent, with no material changes incorporated in the first quarter of 2019 from the prior quarter.

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Earnings for the first quarter of 2019 were $0.28 per diluted share on $8.5 million of net income, as compared to $0.31 per diluted share on net income of $9.5 million for the first quarter of 2018. Earnings in the 2019 period, compared to the like 2018 period, were positively impacted by increased loan volumes due to the ABC Bank acquisition, as well as organic loan growth and the favorable impact of a rising interest rate environment.

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.

Our net interest and dividend income increased by $4.4 million to $24.0 million for the quarter ended March 31, 2019, compared to $19.6 million for the quarter ended March 31, 2018. Our interest and dividend income increased $5.8 million, or 24.9%, for the quarter ended March 31, 2019, compared to the quarter ended March 31, 2018, and our tax equivalent interest and dividend income increased by $5.8 million, to $29.5 million, for the quarter ended March 31, 2019, from $23.7 million for the quarter ended March 31, 2018.

Average earning assets for the first quarter of 2019 were $2.44 billion, reflecting an increase of $12.6 million compared to the fourth quarter of 2018, and an increase of $264.5 million compared to the first quarter of 2018. Total average loans, including loans held-for-sale, totaled $1.90 billion in the first quarter of 2019, which reflected an increase of $37.6 million compared to the fourth quarter of 2018, and an increase of $292.6 million compared to the first quarter of 2018. The growth in average balances and resultant interest income in the year over year 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. In addition, the rising interest rate environment in the 2018 period and the repositioning on our securities portfolio over the past year has driven higher yields and growth in interest and dividend income. Total securities yields have increased by 47 basis points and total loan yields have increased by 41 basis points for the quarter ended March 31, 2019, compared to the quarter ended March 31, 2018, due to the repositioning of our securities portfolio into higher yielding securities and the rising interest rate environment.

Quarterly average interest bearing liabilities increased $5.8 million, or 0.3%, in the first quarter of 2019, compared to the fourth quarter of 2018, and increased $178.5 million, or 11.3%, compared to the first quarter of 2018. Growth from the prior year period was primarily due to deposits of $248.5 million, net of purchase accounting adjustments, recorded in our acquisition of ABC Bank in the second quarter of 2018. The average of other short-term borrowed funds, which primarily consist of FHLBC advances, reflected an increase of $14.7 million in the first quarter of 2019, compared to the fourth quarter of 2018, and an increase of $10.9 million compared to the first quarter of 2018. The short-term FHLBC advances were impacted by the higher interest rate environment in the first quarter of 2019, reflecting a cost of funds of 2.50% compared to 2.43% for the fourth quarter of 2018, and 1.53% for the first 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 $15.3 million for the first quarter of 2019, and an increase of $18.0 million for the fourth quarter of 2018. The average cost of funds on these long-term advances was 3.08% for the first quarter of 2019, and 2.87% for the fourth quarter of 2018. The rate on our junior subordinated debentures increased ten basis points in the first quarter of 2019, compared to the fourth quarter of 2018, but remained consistent at 6.52% compared to the first quarter of 2018.

Our net interest margin (on a tax-equivalent basis), expressed as a percentage of average earning assets, was 4.09% in the first quarter of 2019, reflecting a two basis point increase from the fourth quarter of 2018, and an increase of 33 basis points from the first quarter of 2018. The average tax-equivalent yield on earning assets increased to 4.90% for the first quarter of 2019, compared to 4.84% for the fourth quarter of 2018, and 4.42% for the first quarter of 2018. Increases in net interest margin and yield on average earning assets for the first quarter of 2019, compared to the first quarter of 2018, was attributable to growth in loan volumes and rates, as well as the restructuring of our securities portfolio into higher yielding holdings, as discussed above. The cost of funds on interest bearing liabilities was 1.12% for the first quarter of 2019, 1.06% for the fourth quarter of 2018, and 0.90% for the first 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.

We continue to observe competitive pressure to maintain reduced interest rates on loans retained at renewal. While our loan prices are targeted to achieve certain returns on equity, significant competition for commercial and industrial loans as well as commercial real estate loans has put pressure on loan yields, and our stringent underwriting standards limit our ability to make higher-yielding loans.

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The following tables set forth certain information relating to our average consolidated balance sheet and reflect the yield on average earning assets and cost of average interest bearing liabilities for the periods indicated. These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP tax equivalent (“TE”) basis using a marginal rate of 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

(In thousands - unaudited)

| Quarters Ended
| March 31, 2019 |  | December 31, 2018 |  | March 31, 2018
| Average |  | Income / |  | Rate |  | Average |  | Income / |  | Rate |  | Average |  | Income / |  | Rate
| Balance |  | Expense |  | % |  | Balance |  | Expense |  | % |  | Balance |  | Expense |  | %
Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest earning deposits with financial institutions | $ | 18,842 |  | $ | 114 |  | 2.45 |  | $ | 19,142 |  | $ | 104 |  | 2.16 |  | $ | 13,819 |  | $ | 49 |  | 1.44
Securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Taxable |  | 236,882 |  |  | 2,414 |  | 4.13 |  |  | 269,236 |  |  | 2,524 |  | 3.72 |  |  | 269,330 |  |  | 2,170 |  | 3.27
Non-taxable (TE) |  | 276,609 |  |  | 2,656 |  | 3.89 |  |  | 269,646 |  |  | 2,661 |  | 3.92 |  |  | 279,831 |  |  | 2,609 |  | 3.78
Total securities |  | 513,491 |  |  | 5,070 |  | 4.00 |  |  | 538,882 |  |  | 5,185 |  | 3.82 |  |  | 549,161 |  |  | 4,779 |  | 3.53
Dividends from FHLBC and FRBC |  | 11,463 |  |  | 149 |  | 5.27 |  |  | 10,758 |  |  | 131 |  | 4.83 |  |  | 8,920 |  |  | 106 |  | 4.82
Loans and loans held-for-sale 1 |  | 1,895,512 |  |  | 24,126 |  | 5.16 |  |  | 1,857,900 |  |  | 24,182 |  | 5.16 |  |  | 1,602,947 |  |  | 18,767 |  | 4.75
Total interest earning assets |  | 2,439,308 |  |  | 29,459 |  | 4.90 |  |  | 2,426,682 |  |  | 29,602 |  | 4.84 |  |  | 2,174,847 |  |  | 23,701 |  | 4.42
Cash and due from banks |  | 33,749 |  |  | - |  | - |  |  | 34,915 |  |  | - |  | - |  |  | 29,776 |  |  | - |  | -
Allowance for loan and lease losses |  | (19,235) |  |  | - |  | - |  |  | (19,247) |  |  | - |  | - |  |  | (18,263) |  |  | - |  | -
Other noninterest bearing assets |  | 181,767 |  |  | - |  | - |  |  | 187,355 |  |  | - |  | - |  |  | 166,507 |  |  | - |  | -
Total assets | $ | 2,635,589 |  |  |  |  |  |  | $ | 2,629,705 |  |  |  |  |  |  | $ | 2,352,867 |  |  |  |  |
Liabilities and Stockholders' Equity |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW accounts | $ | 448,518 |  | $ | 379 |  | 0.34 |  | $ | 429,042 |  | $ | 263 |  | 0.24 |  | $ | 429,301 |  | $ | 176 |  | 0.17
Money market accounts |  | 299,305 |  |  | 270 |  | 0.37 |  |  | 315,857 |  |  | 292 |  | 0.37 |  |  | 275,334 |  |  | 109 |  | 0.16
Savings accounts |  | 307,740 |  |  | 122 |  | 0.16 |  |  | 300,845 |  |  | 115 |  | 0.15 |  |  | 266,363 |  |  | 59 |  | 0.09
Time deposits |  | 445,076 |  |  | 1,618 |  | 1.47 |  |  | 461,677 |  |  | 1,643 |  | 1.41 |  |  | 382,422 |  |  | 1,175 |  | 1.25
Interest bearing deposits |  | 1,500,639 |  |  | 2,389 |  | 0.65 |  |  | 1,507,421 |  |  | 2,313 |  | 0.61 |  |  | 1,353,420 |  |  | 1,519 |  | 0.46
Securities sold under repurchase agreements |  | 45,157 |  |  | 149 |  | 1.34 |  |  | 44,628 |  |  | 138 |  | 1.23 |  |  | 40,275 |  |  | 79 |  | 0.80
Other short-term borrowings |  | 98,328 |  |  | 606 |  | 2.50 |  |  | 83,588 |  |  | 512 |  | 2.43 |  |  | 87,444 |  |  | 329 |  | 1.53
Junior subordinated debentures |  | 57,692 |  |  | 927 |  | 6.52 |  |  | 57,681 |  |  | 933 |  | 6.42 |  |  | 57,645 |  |  | 927 |  | 6.52
Senior notes |  | 44,171 |  |  | 672 |  | 6.17 |  |  | 44,146 |  |  | 672 |  | 6.04 |  |  | 44,071 |  |  | 672 |  | 6.18
Notes payable and other borrowings |  | 15,273 |  |  | 116 |  | 3.08 |  |  | 17,987 |  |  | 130 |  | 2.87 |  |  | - |  |  | - |  | -
Total interest bearing liabilities |  | 1,761,260 |  |  | 4,859 |  | 1.12 |  |  | 1,755,451 |  |  | 4,698 |  | 1.06 |  |  | 1,582,855 |  |  | 3,526 |  | 0.90
Noninterest bearing deposits |  | 625,423 |  |  | - |  | - |  |  | 634,611 |  |  | - |  | - |  |  | 554,624 |  |  | - |  | -
Other liabilities |  | 13,750 |  |  | - |  | - |  |  | 17,108 |  |  | - |  | - |  |  | 13,969 |  |  | - |  | -
Stockholders' equity |  | 235,156 |  |  | - |  | - |  |  | 222,535 |  |  | - |  | - |  |  | 201,419 |  |  | - |  | -
Total liabilities and stockholders' equity | $ | 2,635,589 |  |  |  |  |  |  | $ | 2,629,705 |  |  |  |  |  |  | $ | 2,352,867 |  |  |  |  |
Net interest income (TE) |  |  |  | $ | 24,600 |  |  |  |  |  |  | $ | 24,904 |  |  |  |  |  |  | $ | 20,175 |  |
Net interest margin (TE) |  |  |  |  |  |  | 4.09 |  |  |  |  |  |  |  | 4.07 |  |  |  |  |  |  |  | 3.76
Interest bearing liabilities to earning assets |  | 72.20 | % |  |  |  |  |  |  | 72.34 | % |  |  |  |  |  |  | 72.78 | % |  |  |  |

1 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 40, and includes fees of $229,000, $508,000 and $182,000 for the first quarter of 2019, the fourth quarter of 2018, and the first quarter of 2018, respectively. Nonaccrual loans are included in the above-stated average balances.

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Reconciliation of Tax-Equivalent Non-GAAP Financial Measures

Net interest income and net interest income to earning assets have been adjusted to a non-GAAP TE basis using a marginal rate of 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 measure to the GAAP equivalent for the periods indicated:

|  | Three Months Ended |
|  | March 31, |  | December 31, |  | March 31, |
|  | 2019 |  | 2018 |  | 2018 |
Net Interest Margin |  |  |  |  |  |  |  |  |  |
Interest income (GAAP) |  | $ | 28,896 |  | $ | 29,038 |  | $ | 23,142 |
Taxable-equivalent adjustment: |  |  |  |  |  |  |  |  |  |
Loans |  |  | 5 |  |  | 5 |  |  | 11 |
Securities |  |  | 558 |  |  | 559 |  |  | 548 |
Interest income (TE) |  |  | 29,459 |  |  | 29,602 |  |  | 23,701 |
Interest expense (GAAP) |  |  | 4,859 |  |  | 4,698 |  |  | 3,526 |
Net interest income (TE) |  | $ | 24,600 |  | $ | 24,904 |  | $ | 20,175 |
Net interest income (GAAP) |  | $ | 24,037 |  | $ | 24,340 |  | $ | 19,616 |
Average interest earning assets |  | $ | 2,439,308 |  | $ | 2,426,682 |  | $ | 2,174,847 |
Net interest margin (GAAP) |  |  | 4.00 | % |  | 3.98 | % |  | 3.66 | %
Net interest margin (TE) |  |  | 4.09 | % |  | 4.07 | % |  | 3.76 | %

Noninterest Income and Expense

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

|  |  |  |  |  |  |  |  |  |  | 1st Quarter 2019 |
Noninterest Income |  | Three Months Ended |  | Percent Change From |
(dollars in thousands) |  | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31, |
|  | 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018 |
Trust income |  | $ | 1,486 |  | $ | 1,633 |  | $ | 1,495 |  | (9.0) |  | (0.6) |
Service charges on deposits |  |  | 1,862 |  |  | 2,044 |  |  | 1,592 |  | (8.9) |  | 17.0 |
Residential mortgage banking revenue |  |  |  |  |  |  |  |  |  |  |  |  |  |
Secondary mortgage fees |  |  | 136 |  |  | 140 |  |  | 162 |  | (2.9) |  | (16.0) |
Mortgage servicing rights mark to market (loss) |  |  | (819) |  |  | (923) |  |  | 305 |  | 11.3 |  | (368.5) |
Mortgage servicing income |  |  | 457 |  |  | 389 |  |  | 452 |  | 17.5 |  | 1.1 |
Net gain on sales of mortgage loans |  |  | 762 |  |  | 669 |  |  | 917 |  | 13.9 |  | (16.9) |
Total residential mortgage banking revenue |  |  | 536 |  |  | 275 |  |  | 1,836 |  | 94.9 |  | (70.8) |
Securities gain, net |  |  | 27 |  |  | - |  |  | 35 |  | N/M |  | (22.9) |
Increase in cash surrender value of BOLI |  |  | 458 |  |  | 38 |  |  | 248 |  | N/M |  | 84.7 |
Death benefit realized on BOLI |  |  | - |  |  | - |  |  | 1,026 |  | - |  | (100.0) |
Debit card interchange income |  |  | 987 |  |  | 1,141 |  |  | 1,012 |  | (13.5) |  | (2.5) |
Other income |  |  | 1,126 |  |  | 1,371 |  |  | 1,261 |  | (17.9) |  | (10.7) |
Total noninterest income |  | $ | 6,482 |  | $ | 6,502 |  | $ | 8,505 |  | (0.3) |  | (23.8) |

N/M - Not meaningful

Noninterest income for the first quarter of 2019 decreased $20,000, or 0.3%, compared to the fourth quarter of 2018, and decreased $2.0 million, or 23.8%, from total noninterest income for the first quarter of 2018.

The nominal decrease in noninterest income in the first quarter of 2019, compared to the fourth quarter of 2018, was driven primarily by reductions in trust income, service charges on deposits, debit card interchange income, and other income which reduced net income by an aggregate of $728,000. These reductions were largely offset by aggregate increases of $708,000 resulting from growth in total residential mortgage banking revenue, securities gain, net, and an increase in the cash surrender value of BOLI.

The decrease in noninterest income for the year over year period of $2.0 million was primarily driven by a $1.3 million reduction in total residential mortgage banking revenue stemming from rising interest rates and the resultant mark to market loss on mortgage

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servicing rights. In addition, a $1.0 million BOLI death benefit was received in the first quarter of 2018 that was not repeated in the first quarter of 2019. These reductions were partially offset by aggregate increases of $480,000 resulting from growth in service charges on deposits and an increase in the cash surrender value of BOLI. The decrease in other income for the first quarter of 2019, compared to the first quarter of 2018, was primarily attributable to commercial swap fee income which decreased $56,000, and legal fee recoveries of $215,000 recorded in the first quarter of 2018.

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

|  |  |  |  |  |  |  |  |  |  | 1st Quarter 2019 |
Noninterest Expense |  | Three Months Ended |  | Percent Change From |
(dollars in thousands) |  | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31, |
|  | 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018 |
Salaries |  | $ | 8,634 |  | $ | 8,484 |  | $ | 7,335 |  | 1.8 |  | 17.7 |
Officers incentive |  |  | 882 |  |  | 784 |  |  | 787 |  | 12.5 |  | 12.1 |
Benefits and other |  |  | 2,096 |  |  | 1,167 |  |  | 2,085 |  | 79.6 |  | 0.5 |
Total salaries and employee benefits |  |  | 11,612 |  |  | 10,435 |  |  | 10,207 |  | 11.3 |  | 13.8 |
Occupancy, furniture and equipment expense |  |  | 1,989 |  |  | 1,922 |  |  | 1,558 |  | 3.5 |  | 27.7 |
Computer and data processing |  |  | 1,332 |  |  | 1,413 |  |  | 1,344 |  | (5.7) |  | (0.9) |
FDIC insurance |  |  | 174 |  |  | 170 |  |  | 156 |  | 2.4 |  | 11.5 |
General bank insurance |  |  | 250 |  |  | 259 |  |  | 251 |  | (3.5) |  | (0.4) |
Amortization of core deposit intangible asset |  |  | 132 |  |  | 133 |  |  | 21 |  | (0.8) |  | 528.6 |
Advertising expense |  |  | 234 |  |  | 242 |  |  | 341 |  | (3.3) |  | (31.4) |
Debit card interchange expense |  |  | 147 |  |  | 38 |  |  | 281 |  | 286.8 |  | (47.7) |
Legal fees |  |  | 126 |  |  | 147 |  |  | 159 |  | (14.3) |  | (20.8) |
Other real estate owned expense, net |  |  | 50 |  |  | 165 |  |  | 173 |  | (69.7) |  | (71.1) |
Other expense |  |  | 3,148 |  |  | 3,853 |  |  | 2,863 |  | (18.3) |  | 10.0 |
Total noninterest expense |  | $ | 19,194 |  | $ | 18,777 |  | $ | 17,354 |  | 2.2 |  | 10.6 |
Efficiency ratio (GAAP) 1 |  |  | 62.35 | % |  | 59.92 | % |  | 63.41 | % |  |  |  |
Adjusted efficiency ratio (non-GAAP)2 |  |  | 60.98 | % |  | 58.44 | % |  | 61.10 | % |  |  |  |

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 losses on securities and the BOLI death benefit recorded.

2 The 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 the 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 42 for a reconciliation of this non-GAAP measure to the most comparable GAAP equivalent.

Noninterest expense for the first quarter of 2019 increased $417,000, or 2.2%, compared to the fourth quarter of 2018, and increased $1.8 million, or 10.6%, compared to the first quarter of 2018.

The increase in noninterest expense in the first quarter of 2019, compared to the fourth quarter of 2018, was primarily attributable to a $1.2 million increase in salaries and employee benefit expense, as the fourth quarter of 2018 reflected lower levels of payroll taxes and deferred compensation expense. This increase was partially offset by a $705,000 decrease in other expense in the first quarter of 2019, compared to the fourth quarter of 2018, due to an accrual recorded in late 2018 for a commercial mortgage loan escrow, as well as other year-end expenses related to appraisals and consulting services.

The increase in noninterest expense in the first quarter of 2019, compared to the first quarter of 2018, is primarily attributable to our acquisition of ABC Bank, which resulted in an increase in salaries and employee benefits expense of $1.4 million, occupancy, furniture and equipment expense of $431,000, and amortization of core deposit intangibles of $111,000 for the first quarter of 2019, compared to the first quarter of 2018. Partially offsetting the year over year increases were reductions in debit card interchange expense of $134,000 in the first quarter of 2019 due to an accrual reduction regarding a discontinued debit card points program, a reduction in OREO valuation reserve expense of $112,000, and a decrease in advertising expense of $107,000. Other expense increased in the first quarter of 2019, compared to the first quarter of 2018, due to deferred director compensation accrual increases stemming from interest rate changes, growth in external audit fees, and an increase in ATM operating expenses attributable to additional ATMs acquired from our ABC Bank acquisition.

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Reconciliation of Adjusted Efficiency Ratio Non-GAAP Financial Measures

|  | GAAP |  | Non-GAAP |
|  |  | Three Months Ended |  |  | Three Months Ended |
|  | March 31, |  | December 31, |  | March 31, |  | March 31, |  | December 31, |  | March 31, |
|  | 2019 |  | 2018 |  | 2018 |  | 2019 |  | 2018 |  | 2018 |
Efficiency Ratio / Adjusted Efficiency Ratio |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest expense |  | $ | 19,194 |  | $ | 18,777 |  | $ | 17,354 |  | $ | 19,194 |  | $ | 18,777 |  | $ | 17,354 |
Less amortization of core deposit |  |  | 132 |  |  | 133 |  |  | 21 |  |  | 132 |  |  | 133 |  |  | 21 |
Less other real estate expense, net |  |  | 50 |  |  | 165 |  |  | 173 |  |  | 50 |  |  | 165 |  |  | 173 |
Less acquisition related costs |  |  | N/A |  |  | N/A |  |  | N/A |  |  | - |  |  | 119 |  |  | 246 |
Noninterest expense less adjustments |  | $ | 19,012 |  | $ | 18,479 |  | $ | 17,160 |  | $ | 19,012 |  | $ | 18,360 |  | $ | 16,914 |
Net interest income |  | $ | 24,036 |  | $ | 24,340 |  | $ | 19,616 |  | $ | 24,036 |  | $ | 24,340 |  | $ | 19,616 |
Taxable-equivalent adjustment: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans |  |  | N/A |  |  | N/A |  |  | N/A |  |  | 5 |  |  | 5 |  |  | 11 |
Securities |  |  | N/A |  |  | N/A |  |  | N/A |  |  | 558 |  |  | 559 |  |  | 548 |
Net interest income including adjustments |  |  | 24,036 |  |  | 24,340 |  |  | 19,616 |  |  | 24,599 |  |  | 24,904 |  |  | 20,175 |
Noninterest income |  |  | 6,482 |  |  | 6,502 |  |  | 8,505 |  |  | 6,482 |  |  | 6,502 |  |  | 8,505 |
Less death benefit related to BOLI |  |  | - |  |  | - |  |  | 1,026 |  |  | - |  |  | - |  |  | 1,026 |
Less securities gain, net |  |  | 27 |  |  | - |  |  | 35 |  |  | 27 |  |  | - |  |  | 35 |
Taxable-equivalent adjustment: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Increase in cash surrender value of BOLI |  |  | N/A |  |  | N/A |  |  | N/A |  |  | 122 |  |  | 10 |  |  | 66 |
Noninterest income (less) / including adjustments |  |  | 6,455 |  |  | 6,502 |  |  | 7,444 |  |  | 6,577 |  |  | 6,512 |  |  | 7,510 |
Net interest income including adjustments plus noninterest income (less) / including adjustments |  | $ | 30,491 |  | $ | 30,842 |  | $ | 27,060 |  | $ | 31,176 |  | $ | 31,416 |  | $ | 27,685 |
Efficiency ratio / Adjusted efficiency ratio |  |  | 62.35 | % |  | 59.92 | % |  | 63.41 | % |  | 60.98 | % |  | 58.44 | % |  | 61.10 | %

Income Taxes

We recorded a tax expense of $2.4 million on $10.9 million of pre-tax income for the first quarter of 2019 compared to an income tax expense of $2.9 million in the fourth quarter of 2018 and $2.0 million of income tax expense in the first quarter of 2018. The effective tax rate for the first quarter of 2019 was 22.1%, which was a decrease from 25.5% for the fourth quarter of 2018, and an increase from 17.4% in the first quarter of 2018. The effective tax rate for the first quarter of 2019 was lower than the linked quarter due to a tax benefit recorded related to restricted stock awards which vested in 2019, while the effective tax rate for the first quarter of 2019 reflected an increase over the prior year like quarter due to the receipt of a BOLI death benefit claim in the first quarter of 2018, which was not taxable.

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 March 31, 2019. We had no valuation reserve on the deferred tax assets as of March 31, 2019.

Financial Condition

Total assets decreased $52.5 million from $2.68 billion as of December 31, 2018, to $2.62 billion at March 31, 2019, due primarily to reductions in cash and cash equivalents as well as a $32.2 million decrease in securities available-for-sale. Total loans as of March 31, 2019, increased $6.1 million, or 0.3%, compared to December 31, 2018. Total deposits were $2.12 billion at March 31, 2019, an increase of $6.8 million from December 31, 2018, primarily due to growth in non-interest bearing demand, savings and NOW accounts, partially offset by reductions in time deposits.

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|  |  |  |  |  |  |  |  |  |  | March 31, 2019
Securities |  | As of |  | Percent Change From
(in thousands) |  | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
|  | 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018
Securities available-for-sale, at fair value |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Treasuries |  | $ | 3,960 |  | $ | 3,923 |  | $ | 3,895 |  | 0.9 |  | 1.7
U.S. government agencies |  |  | 10,360 |  |  | 10,951 |  |  | 12,730 |  | (5.4) |  | (18.6)
U.S. government agencies mortgage-backed |  |  | 15,306 |  |  | 14,075 |  |  | 13,844 |  | 8.7 |  | 10.6
States and political subdivisions |  |  | 281,172 |  |  | 274,067 |  |  | 285,540 |  | 2.6 |  | (1.5)
Corporate bonds |  |  | - |  |  | - |  |  | 703 |  | - |  | (100.0)
Collateralized mortgage obligations |  |  | 64,330 |  |  | 64,429 |  |  | 63,744 |  | (0.2) |  | 0.9
Asset-backed securities |  |  | 70,811 |  |  | 109,514 |  |  | 110,870 |  | (35.3) |  | (36.1)
Collateralized loan obligations |  |  | 63,151 |  |  | 64,289 |  |  | 59,616 |  | (1.8) |  | 5.9
Total securities |  | $ | 509,090 |  | $ | 541,248 |  | $ | 550,942 |  | (5.9) |  | (7.6)

Available-for-sale security sales during the three months ended March 31, 2019, consisted primarily of asset-backed securities, whereas purchases during the three month period were primarily tax exempt state and political subdivisions securities. During the first quarter of 2019 security sales resulted in net realized gains of $27,000, compared to no security gains or losses for the fourth quarter of 2018, and net realized gains of $35,000 for the first quarter of 2018.

Loans

Total loans were $1.90 billion as of March 31, 2019, an increase of $6.1 million from total loans as of December 31, 2018. The increase in total loans for the three month period was due primarily to organic growth in commercial and industrial, leases, and real estate-commercial loans. Total loans increased $301.3 million from March 31, 2018 to March 31, 2019, due primarily to our acquisition of ABC Bank in the second quarter of 2018, which resulted in total loans recorded of $227.6 million, net of purchase accounting adjustments. In addition, organic loan growth in commercial, real estate-construction, leases, and real estate-residential loans was recorded in the year over year period, and we purchased a $20.7 million portfolio of home equity loans in the fourth quarter of 2018.

|  |  |  |  |  |  |  |  |  | March 31, 2019
Loans | As of |  | Percent Change From
(in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018
Commercial | $ | 324,450 |  | $ | 314,323 |  | $ | 281,134 |  | 3.2 |  | 15.4
Leases |  | 87,730 |  |  | 78,806 |  |  | 66,344 |  | 11.3 |  | 32.2
Real estate - commercial |  | 835,904 |  |  | 820,941 |  |  | 713,422 |  | 1.8 |  | 17.2
Real estate - construction |  | 94,787 |  |  | 108,390 |  |  | 91,479 |  | (12.6) |  | 3.6
Real estate - residential |  | 399,866 |  |  | 407,068 |  |  | 309,376 |  | (1.8) |  | 29.2
HELOC |  | 133,859 |  |  | 140,442 |  |  | 129,234 |  | (4.7) |  | 3.6
Other 1 |  | 14,018 |  |  | 14,439 |  |  | 9,845 |  | (2.9) |  | 42.4
Total loans, excluding deferred loan costs and PCI loans |  | 1,890,614 |  |  | 1,884,409 |  |  | 1,600,834 |  | 0.3 |  | 18.1
Net deferred loan costs |  | 1,681 |  |  | 1,653 |  |  | 978 |  | 1.7 |  | 71.9
Total loans, excluding PCI loans |  | 1,892,295 |  |  | 1,886,062 |  |  | 1,601,812 |  | 0.3 |  | 18.1
PCI loans, net of purchase accounting adjustments |  | 10,851 |  |  | 10,965 |  |  | - |  | (1.0) |  | N/M
Total loans | $ | 1,903,146 |  | $ | 1,897,027 |  | $ | 1,601,812 |  | 0.3 |  | 18.8

N/M - Not meaningful

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 76.9% of the portfolio as of March 31, 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

We recorded a $450,000 provision for loan and lease losses for the quarter ended March 31, 2019, compared to a release of provision of $722,000 for the quarter ended March 31, 2018. In the first quarter of 2019, we determined additional reserves were necessary as a

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result of loan growth for the quarter. 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 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 $1.4 million at March 31, 2019, from $16.3 million at December 31, 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 0.8% as of March 31, 2019, from 0.9% as of December 31, 2018, and 0.8% as of March 31, 2018. The distribution of our nonperforming loans is shown in the following table.

|  |  |  |  |  |  |  |  |  | March 31, 2019 |
Nonperforming Loans | As of |  | Percent Change From |
(in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31, |
| 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018 |
Commercial | $ | - |  | $ | 352 |  | $ | - |  | (100.0) |  |  | N/M |  |
Leases |  | 114 |  |  | - |  |  | - |  | N/M |  |  | N/M |  |
Real estate-commercial, nonfarm |  | 8,925 |  |  | 9,738 |  |  | 4,740 |  | (8.3) |  |  | 88.3 |  |
Real estate-construction |  | 104 |  |  | 455 |  |  | 197 |  | (77.1) |  |  | (47.2) |  |
Real estate-residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  | 337 |  |  | 353 |  |  | 361 |  | (4.5) |  |  | (6.6) |  |
Multi-Family |  | - |  |  | 179 |  |  | - |  | (100.0) |  |  | N/M |  |
Owner occupied |  | 3,665 |  |  | 3,616 |  |  | 5,176 |  | 1.4 |  |  | (29.2) |  |
HELOC |  | 1,761 |  |  | 1,614 |  |  | 2,301 |  | 9.1 |  |  | (23.5) |  |
Other 1 |  | 31 |  |  | 34 |  |  | 17 |  | (8.8) |  |  | 82.4 |  |
Total nonperforming loans | $ | 14,937 |  | $ | 16,341 |  | $ | 12,792 |  | (8.6) |  |  | 16.8 |  |

N/M - Not meaningful

1 The “Other” class includes consumer and overdrafts.

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Loan Charge-offs, net of recoveries | Three Months Ended
(in thousands) | March 31, |  | % of |  | December 31, |  | % of |  | March 31, |  | % of
| 2019 |  | Total 1 |  | 2018 |  | Total 1 |  | 2018 |  | Total 1
Commercial | $ | (18) |  | (12.9) |  | $ | (13) |  | (1.6) |  | $ | (1) |  | 0.1
Leases |  | - |  | - |  |  | - |  | - |  |  | 5 |  | (0.3)
Real estate-commercial, nonfarm |  |  |  |  |  |  |  |  |  |  |  |  |  |
Owner general purpose |  | 87 |  | 62.1 |  |  | 14 |  | 1.7 |  |  | (41) |  | 2.8
Owner special purpose |  | (3) |  | (2.1) |  |  | - |  | - |  |  | (21) |  | 1.4
Non-owner general purpose |  | (15) |  | (10.7) |  |  | 903 |  | 109.9 |  |  | (313) |  | 21.6
Non-owner special purpose |  | 139 |  | 99.3 |  |  | - |  | - |  |  | (1) |  | 0.1
Retail properties |  | - |  | - |  |  | - |  | - |  |  | (87) |  | 6.0
Total real estate-commercial, nonfarm |  | 208 |  | 148.6 |  |  | 917 |  | 111.6 |  |  | (463) |  | 31.9
Real estate-commercial, farm |  | - |  | - |  |  | - |  | - |  |  | - |  | -
Real estate-construction |  |  |  |  |  |  |  |  |  |  |  |  |  |
Homebuilder |  | (1) |  | (0.7) |  |  | - |  | - |  |  | 2 |  | (0.1)
Land |  | - |  | - |  |  | - |  | - |  |  | (4) |  | 0.3
Commercial speculative |  | 2 |  | 1.4 |  |  | - |  | - |  |  | (18) |  | 1.2
All other |  | - |  | - |  |  | - |  | - |  |  | 1 |  | (0.1)
Total real estate-construction |  | 1 |  | 0.7 |  |  | - |  | - |  |  | (19) |  | 1.3
Real estate-residential |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  | (10) |  | (7.1) |  |  | (11) |  | (1.3) |  |  | (30) |  | 2.1
Multi-Family |  | (8) |  | (5.7) |  |  | (15) |  | (1.8) |  |  | (175) |  | 12.1
Owner occupied |  | (14) |  | (10.0) |  |  | (11) |  | (1.3) |  |  | (766) |  | 52.8
Total real estate-residential |  | (32) |  | (22.8) |  |  | (37) |  | (4.4) |  |  | (971) |  | 67.0
HELOC |  | (46) |  | (32.9) |  |  | (81) |  | (9.9) |  |  | (20) |  | 1.4
Other 2 |  | 27 |  | 19.3 |  |  | 36 |  | 4.3 |  |  | 20 |  | (1.4)
Net charge-offs / (recoveries) | $ | 140 |  | 100.0 |  | $ | 822 |  | 100.0 |  | $ | (1,449) |  | 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 charge-offs of $140,000 were recorded for the first quarter of 2019, compared to net charge-offs of $822,000 for the fourth quarter of 2018, and net recoveries of $1.4 million for the first quarter of 2018, reflecting continuing management attention to credit quality and remediation efforts. We have continued our conservative loan valuations and aggressive recovery efforts on prior charge-offs.

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

|  |  |  |  |  |  |  |  |  | March 31, 2019
Classified Assets | As of |  | Percent Change From
(in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018
Commercial | $ | 7,075 |  | $ | 137 |  | $ | - |  | N/M |  |  | N/M |
Leases |  | 114 |  |  | - |  |  | 610 |  | N/M |  |  | (81.3) |
Real estate-commercial, nonfarm |  | 22,079 |  |  | 22,661 |  |  | 6,098 |  | (2.6) |  |  | 262.1 |
Real estate-commercial, farm |  | 1,222 |  |  | 1,222 |  |  | 2,439 |  | - |  |  | (49.9) |
Real estate-construction |  | 2,589 |  |  | 2,610 |  |  | 371 |  | (0.8) |  |  | 597.8 |
Real estate-residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investor |  | 991 |  |  | 1,216 |  |  | 436 |  | (18.5) |  |  | 127.3 |
Multi-Family |  | 487 |  |  | 979 |  |  | - |  | (50.3) |  |  | N/M |
Owner occupied |  | 4,728 |  |  | 4,524 |  |  | 5,476 |  | 4.5 |  |  | (13.7) |
HELOC |  | 1,966 |  |  | 1,889 |  |  | 2,038 |  | 4.1 |  |  | (3.5) |
Other 1 |  | 28 |  |  | 31 |  |  | 18 |  | (9.7) |  |  | 55.6 |
Total classified loans |  | 41,279 |  |  | 35,269 |  |  | 17,486 |  | 17.0 |  |  | 136.1 |
Other real estate owned |  | 6,365 |  |  | 7,175 |  |  | 7,063 |  | (11.3) |  |  | (9.9) |
Total classified assets, excluding PCI loans |  | 47,644 |  |  | 42,444 |  |  | 24,549 |  | 12.3 |  |  | 94.1 |
PCI, net of purchase accounting adjustments |  | 10,851 |  |  | 10,965 |  |  | - |  | (1.0) |  |  | N/M |
Total classified assets | $ | 58,495 |  | $ | 53,409 |  | $ | 24,549 |  | 9.5 |  |  | 138.3 |

N/M - Not 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 we will sustain some loss if deficiencies remain uncorrected.

Total classified loans and total classified assets increased as of March 31, 2019, from the levels at December 31, 2018 and March 31, 2018 due to loans purchased in our acquisition of ABC Bank in the second quarter of 2018, and one large commercial credit which moved to classified status in the first quarter of 2019. 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, which is referred to as the “classified assets ratio.” The classified assets ratio was 14.91% for the period ended March 31, 2019, compared to 13.49% as of December 31, 2018 and 8.82% as of March 31, 2018. The increase in the classified assets ratio for the quarter ended March 31, 2019, is due to the one commercial credit which moved to classified status in the first quarter of 2019, as mentioned above; this credit is not past due as of quarter end, but we are monitoring closely for potential future cash flow issues.

Allowance for Loan and Lease Losses

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

|  | Three Months Ended |
| March 31, |  | December 31, |  | March 31,
| 2019 |  | 2018 |  | 2018
Allowance at beginning of period | $ | 19,006 |  |  | $ | 19,328 |  |  | $ | 17,461 |
Charge-offs: |  |  |  |  |  |  |  |  |  |  |
Commercial |  | 12 |  |  |  | 3 |  |  |  | 16 |
Leases |  | - |  |  |  | - |  |  |  | 5 |
Real estate - commercial |  | 231 |  |  |  | 939 |  |  |  | (96) |
Real estate - construction |  | - |  |  |  | - |  |  |  | (16) |
Real estate - residential |  | 18 |  |  |  | 10 |  |  |  | (60) |
HELOC |  | - |  |  |  | 6 |  |  |  | 27 |
Other 1 |  | 84 |  |  |  | 93 |  |  |  | 99 |
Total charge-offs |  | 345 |  |  |  | 1,051 |  |  |  | (25) |
Recoveries: |  |  |  |  |  |  |  |  |  |  |
Commercial |  | 30 |  |  |  | 16 |  |  |  | 17 |
Leases |  | - |  |  |  | - |  |  |  | - |
Real estate - commercial |  | 23 |  |  |  | 22 |  |  |  | 367 |
Real estate - construction |  | (1) |  |  |  | - |  |  |  | 3 |
Real estate - residential |  | 50 |  |  |  | 47 |  |  |  | 911 |
HELOC |  | 46 |  |  |  | 87 |  |  |  | 47 |
Other 1 |  | 57 |  |  |  | 57 |  |  |  | 79 |
Total recoveries |  | 205 |  |  |  | 229 |  |  |  | 1,424 |
Net charge-offs / (recoveries) |  | 140 |  |  |  | 822 |  |  |  | (1,449) |
Provision (release) for loan and lease losses |  | 450 |  |  |  | 500 |  |  |  | (722) |
Allowance at end of period | $ | 19,316 |  |  | $ | 19,006 |  |  | $ | 18,188 |
Average total loans (exclusive of loans held-for-sale) | $ | 1,893,659 |  |  | $ | 1,855,283 |  |  | $ | 1,600,594 |
Net charge-offs / (recoveries) to average loans |  | 0.01 | % |  |  | 0.04 | % |  |  | (0.09) | %
Allowance at period end to average loans |  | 1.02 | % |  |  | 1.02 | % |  |  | 1.14 | %
Ending balance: Individually evaluated for impairment | $ | 222 |  |  | $ | 352 |  |  | $ | 588 |
Ending balance: Collectively evaluated for impairment | $ | 19,094 |  |  | $ | 18,654 |  |  | $ | 17,600 |
Ending balance: Acquired and accounted for under ASC 310-30 | $ | - |  |  | $ | - |  |  | $ | - |

1 The “Other” class includes consumer and overdrafts.

Net charge-offs for the quarter ended March 31, 2019, totaled $140,000, compared to $822,000 for the quarter ended December 31, 2018, and $1.4 million of net recoveries for the quarter ended March 31, 2018. The coverage ratio of the allowance for loan and lease losses to nonperforming loans was 129.3% as of March 31, 2019, which was an increase from the coverage ratio of 116.3% as of December 31, 2018, and a decrease from 142.2% as of March 31, 2018. When measured as a percentage of average loans our total allowance for loan and lease losses was 1.02% of quarterly average loans as of both March 31, 2019 and December 31, 2018,

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and 1.14% as of March 31, 2018. The total allowance for loan and lease losses as a percent of total period end loans was 1.06% as of March 31, 2019, excluding the loans acquired 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 non-PCI loans, 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 purchase totaled $246.3 million as of March 31, 2019, net of purchase accounting adjustments, which included $1.2 million of credit discounts. At March 31, 2019, of our $19.3 million allowance for loan and lease losses, $1.9 million related to non-PCI loans. In management’s judgment, an adequate allowance for estimated losses has been established for inherent losses at March 31, 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.

We recorded PCI loans in our acquisition of ABC Bank, which totaled $10.9 million, net of purchase accounting adjustments, which included $6.0 million of credit discounts as of March 31, 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 period. Any decline in expected cash flows due only to changes in expected timing of cash flows is recognized prospectively as 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 the yield on the loan.

Other Real Estate Owned

As of March 31, 2019, OREO decreased to $6.4 million, compared to $7.2 million at December 31, 2018, and $7.1 million at March 31, 2018. There were no additions to the OREO portfolio in the first quarter of 2019. Property disposals in the first quarter of 2019 totaled $801,000 due to three property sales. There were no valuation write-downs in the first quarter of 2019, compared to $96,000 and $112,000 of valuation write-downs recorded in the fourth and first quarter of 2018, respectively.

|  |  |  |  |  |  |  |  |  | March 31, 2019
OREO | Three Months Ended |  | Percent Change From
(in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018
Beginning balance | $ | 7,175 |  | $ | 6,964 |  | $ | 8,371 |  | 3.0 |  |  | (14.3) |
Property additions |  | - |  |  | 721 |  |  | - |  | (100.0) |  |  | - |
Property improvements |  | - |  |  | - |  |  | 59 |  | - |  |  | (100.0) |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Property disposals |  | 801 |  |  | 414 |  |  | 1,255 |  | 93.5 |  |  | (36.2) |
Period valuation adjustments |  | - |  |  | 96 |  |  | 112 |  | (100.0) |  |  | (100.0) |
Other Adjustment |  | 9 |  |  | - |  |  | - |  | N/M |  |  | N/M |
Total other real estate owned | $ | 6,365 |  | $ | 7,175 |  | $ | 7,063 |  | (11.3) |  |  | (9.9) |

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 $3.9 million, or approximately 62.0% of total OREO at March 31, 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) | March 31, 2019 |  | December 31, 2018 |  | March 31, 2018
|  | Amount |  | % of Total |  |  | Amount |  | % of Total |  |  | Amount |  | % of Total
Single family residence | $ | 882 |  | 14 | % |  | $ | 1,137 |  | 16 | % |  | $ | 257 |  | 4 | %
Lots (single family and commercial) |  | 4,310 |  | 68 | % |  |  | 4,310 |  | 60 | % |  |  | 5,332 |  | 75 | %
Vacant land |  | 470 |  | 7 | % |  |  | 470 |  | 6 | % |  |  | 479 |  | 7 | %
Commercial property |  | 703 |  | 11 | % |  |  | 1,258 |  | 18 | % |  |  | 995 |  | 14 | %
Total other real estate owned | $ | 6,365 |  | 100 | % |  | $ | 7,175 |  | 100 | % |  | $ | 7,063 |  | 100 | %

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Deposits and Borrowings

|  |  |  |  |  |  |  |  |  | March 31, 2019
Deposits | As of |  | Percent Change From
(in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2019 |  | 2018 |  | 2018 |  | 2018 |  | 2018
Noninterest bearing demand | $ | 629,909 |  | $ | 618,830 |  | $ | 582,766 |  | 1.8 |  | 8.1
Savings |  | 314,029 |  |  | 304,400 |  |  | 274,029 |  | 3.2 |  | 14.6
NOW accounts |  | 449,288 |  |  | 425,878 |  |  | 442,119 |  | 5.5 |  | 1.6
Money market accounts |  | 297,899 |  |  | 310,390 |  |  | 281,860 |  | (4.0) |  | 5.7
Certificates of deposit of less than $100,000 |  | 224,899 |  |  | 230,781 |  |  | 216,843 |  | (2.5) |  | 3.7
Certificates of deposit of $100,000 through $250,000 |  | 145,397 |  |  | 159,953 |  |  | 123,132 |  | (9.1) |  | 18.1
Certificates of deposit of more than $250,000 |  | 62,091 |  |  | 66,441 |  |  | 41,299 |  | (6.5) |  | 50.3
Total deposits | $ | 2,123,512 |  | $ | 2,116,673 |  | $ | 1,962,048 |  | 0.3 |  | 8.2

Total deposits were $2.12 billion at March 31, 2019, which reflects a $6.8 million increase from total deposits of $2.12 billion at December 31, 2018, and an increase of $161.5 million over the $1.96 billion at March 31, 2018. The growth in deposits year over year was primarily due to our acquisition of ABC Bank, which added $248.5 million of deposits, net of purchase accounting adjustments. Total noninterest bearing demand accounts increased $11.1 million, or 1.8%, to $629.9 million at March 31, 2019, compared to noninterest bearing demand accounts of $618.8 million at December 31, 2018. Certificates of deposit reflected a decrease of $24.8 million, or 5.4%, at March 31, 2019, compared to December 31, 2018, and savings, NOW and money market accounts reflected growth of 2.0% at March 31, 2019, compared to December 31, 2018. In addition to total deposit growth experienced related to our ABC Bank acquisition, an increase in noninterest bearing demand deposits in the first quarter of 2019 compared to the linked quarter and year over year periods was attributable to strong commercial demand deposit growth stemming from operational fund increases as well as growth in commercial loan clients over the past year.

In addition to deposits, we obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled $42.4 million at March 31, 2019, a $4.3 million, or 9.2%, decrease from $46.6 million at December 31, 2018. We also recorded short-term advances of $85.0 million from the FHLBC at March 31, 2019, as compared to $149.5 million in short term borrowings outstanding at December 31, 2018. We also 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 $13.2 million as of March 31, 2019, compared to $15.4 million as of December 31, 2018.

The Company is indebted on senior notes totaling $44.2 million, net of deferred issuance costs as of March 31, 2019. These notes mature in December 2026, and include interest payable 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 $57.7 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 which resulted in the total interest rate paid on this debt of 4.39% as of March 31, 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 March 31, 2019, total stockholders’ equity was $243.3 million, which was an increase of $14.2 million from $229.1 million as of December 31, 2018. This increase is directly attributable to net income of $8.5 million for the first three months of 2019, and a change in accumulated other comprehensive net loss of $4.1 million at December 31, 2018, to a net gain of $1.7 million as of March 31, 2019. In addition, we paid $297,000 of dividends to our common stockholders in the first quarter of 2019.

Our total stockholders’ equity in 2018 included $4.8 million related to the value of a ten-year warrant to purchase shares of our common stock, with an exercise price of $13.43 per share. We issued the warrant in January 2009 as part of our Series B preferred stock issuance. 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 date of exercise, our closing market stock price was $14.23 per share, resulting in 45,836 shares being issued, and a net $313,000 reduction to treasury stock.

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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:

|  |  |  |  | March 31, |  | March 31,
|  | Well-Capitalized 1 |  |  | 2019 |  | 2018
The Company |  |  |  |  |  |  |  |  |
Common equity tier 1 capital ratio |  | N/A |  |  | 9.75 | % |  | 9.82 | %
Total risk-based capital ratio |  | N/A |  |  | 13.17 | % |  | 13.58 | %
Tier 1 risk-based capital ratio |  | N/A |  |  | 12.30 | % |  | 12.63 | %
Tier 1 leverage ratio |  | N/A |  |  | 10.44 | % |  | 10.44 | %
The Bank |  |  |  |  |  |  |  |  |
Common equity tier 1 capital ratio |  | 7.00 | % |  | 13.60 | % |  | 13.56 | %
Total risk-based capital ratio |  | 10.50 | % |  | 14.47 | % |  | 14.51 | %
Tier 1 risk-based capital ratio |  | 8.50 | % |  | 13.60 | % |  | 13.56 | %
Tier 1 leverage ratio |  | 5.00 | % |  | 11.54 | % |  | 11.19 | %

1 Represents 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.

As of March 31, 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 9.27% at March 31, 2019, due to net income generated for the first quarter 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 8.52% at March 31, 2019, compared to 7.81% as of December 31, 2018. Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, increased from 7.83% at December 31, 2018 to 8.54% at March 31, 2019.

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

| March 31, 2019 |  |  | December 31, 2018 |
(in thousands) | GAAP |  |  | Non-GAAP |  |  | GAAP |  |  | Non-GAAP |
Tangible common equity |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total Equity | $ | 243,255 |  |  | $ | 243,255 |  |  | $ | 229,081 |  |  | $ | 229,081 |
Less: Goodwill and intangible assets |  | 21,682 |  |  |  | 21,682 |  |  |  | 21,814 |  |  |  | 21,814 |
Add: Limitation of exclusion of core deposit intangible (80%) |  | N/A |  |  |  | 616 |  |  |  | N/A |  |  |  | 642 |
Adjusted goodwill and intangible assets |  | 21,682 |  |  |  | 21,066 |  |  |  | 21,814 |  |  |  | 21,172 |
Tangible common equity | $ | 221,573 |  |  | $ | 222,189 |  |  | $ | 207,267 |  |  | $ | 207,909 |
Tangible assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total assets | $ | 2,623,531 |  |  | $ | 2,623,531 |  |  | $ | 2,676,003 |  |  | $ | 2,676,003 |
Less: Adjusted goodwill and intangible assets |  | 21,682 |  |  |  | 21,066 |  |  |  | 21,814 |  |  |  | 21,172 |
Tangible assets | $ | 2,601,849 |  |  | $ | 2,602,465 |  |  | $ | 2,654,189 |  |  | $ | 2,654,831 |
Common equity to total assets |  | 9.27 | % |  |  | 9.27 | % |  |  | 8.56 | % |  |  | 8.56 | %
Tangible common equity to tangible assets |  | 8.52 | % |  |  | 8.54 | % |  |  | 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 is useful for us when reviewing risk based capital ratios and equity performance metrics.

Liquidity

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

Net cash inflows from operating activities were $12.5 million during the first three months of 2019, compared with net cash inflows of $9.0 million in the same period 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 inflows for the first three months of 2019 and 2018. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of outflows for the first three months of 2019 and 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 inflows from investing activities were $37.4 million in the first three months of 2019, compared to net cash inflows of $3.3 million in the same period in 2018. In the first three months of 2019, securities transactions accounted for net inflows of $42.9 million, and the principal change on loans accounted for net outflows of $6.1 million. In the first three months of 2018, securities transactions accounted for net outflows of $16.3 million, and net principal disbursed on loans accounted for net inflows of $17.2 million. Proceeds from claims on BOLI, net of premiums paid, accounted for net inflows of $1.2 million in the first quarter of 2018; there were no BOLI death benefits received in the first quarter of 2019. Proceeds from sales of OREO accounted for $874,000 and $1.3 million in investing cash inflows for the first three months of 2019 and 2018, respectively.

Net cash outflows from financing activities in the first three months of 2019 were $64.8 million, compared with net cash outflows of $20.2 million in the first three months of 2018. Net deposit inflows in the first three months of 2019 were $6.9 million compared to net deposit inflows of $39.1 million in the first three months of 2018. Other short-term borrowings had net cash outflows of $64.5 million in the first three months of 2019 and $70.0 million in the first three months of 2018. Changes in securities sold under repurchase agreements accounted for $4.3 million in net outflows and $11.4 million in net inflows in the first three months of 2019 and 2018, respectively.

Cash and cash equivalents for the three months ended March 31, 2019, totaled $40.3 million, as compared to $47.9 million as of March 31, 2018.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

As part of our normal operations, we are subject to interest-rate risk on the assets we invest in (primarily loans and securities) and the liabilities we fund with (primarily customer deposits and borrowed funds). Fluctuations in interest rates may result in changes in the fair market values of our financial instruments, cash flows, and net interest income. Like most financial institutions, we are also exposed to changes in both short-term and long-term interest rates.

In December 2018, the Federal Reserve raised short-term interest rates by 0.25%. There is a general market expectation that the Federal Reserve will hold short-term interest rates unchanged during 2019. Generally, Federal Reserve actions have not had a significant impact on long-term rates, although Federal Reserve officials began ending the reinvestment of their securities portfolio cash flow in October 2017 which could result in increases in long-term rates if federal budget deficits continue to increase. We seek to manage interest rate risk within guidelines established by policy, which is intended to limit our amount of rate exposure. We manage various market risks in our normal course of 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 our business activities and operations. In addition, since we do not hold a trading portfolio, we are not exposed to significant market risk from trading activities. Our interest rate risk exposures at March 31, 2019 and December 31, 2018 are outlined in the table below.

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. Our ALCO committee seeks to manage interest rate risk under a variety of rate environments by structuring our balance sheet and off-balance sheet positions, which includes interest rate swap derivatives as discussed in Note 15 of the financial statements included in this quarterly report. We seek to monitor and manage interest rate risk within our approved policy guidelines and limits.

We utilize simulation analysis to quantify the impact of various rate scenarios on net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities we hold are incorporated into the simulation model. Earnings at risk are calculated by comparing the net interest income of a stable interest rate environment to the net interest income of a different interest rate environment in order to determine the percentage change. As of December 31, 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 March 2019 were similar compared to those of December 2018. The general balance sheet composition, both assets and liabilities, did not change appreciably during the quarter, which resulted in little change to our interest rate risk profile. Overall, management considers the current level of interest rate 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 rate and the Bank's prime rate remained unchanged during the quarter at 2.50% and 5.50%, respectively.

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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%, 1%, and 2% and no change in the slope of the yield curve.

|  | Analysis of Net Interest Income Sensitivity
(dollars in thousands) |  | Immediate Changes in Rates
|  |  | (2.0) | % |  |  | (1.0) | % |  |  | (0.5) | % |  |  | 0.5 | % |  |  | 1.0 | % |  |  | 2.0 | %
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Dollar change |  | $ | (13,056) |  |  | $ | (5,748) |  |  | $ | (2,256) |  |  | $ | 1,325 |  |  | $ | 2,602 |  |  | $ | 5,058 |
Percent change |  |  | (12.9) | % |  |  | (5.7) | % |  |  | (2.2) | % |  |  | 1.3 | % |  |  | 2.6 | % |  |  | 5.0 | %
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Dollar change |  | $ | (12,303) |  |  | $ | (5,356) |  |  | $ | (2,062) |  |  | $ | 1,084 |  |  | $ | 2,145 |  |  | $ | 4,178 |
Percent change |  |  | (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.

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 March 31, 2019. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 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 March 31, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of 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, 2018.

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

As disclosed on our Form 8-K filed on January 16, 2009, on January 16, 2009, we issued a warrant to purchase 815,339 shares of our common stock (the “Warrant”) to the U.S. Department of the Treasury. The Warrant had a ten-year term with an exercise price, subject to anti-dilution adjustments, equal to $13.43 per share of our common stock. The Treasury subsequently sold the Warrant at auction to a third party investor.

On January 16, 2019, we issued 45,836 shares of our common stock in a cashless exercise of the Warrant. Pursuant to the terms of the Warrant, the holders of the Warrant used the amount by which 769,501 shares were deemed to be "in the money" as consideration for the $13.43 per share exercise price for the 45,836 shares we issued, and the entire Warrant was canceled in the exchange. The shares

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issued were exempt from registration under Section 3(a)(9) of the Securities Act of 1933, as amended, because we exchanged the shares with the warrant holders exclusively, and no commission or other remuneration was paid or given directly

or indirectly for soliciting the exchange. The shares issued were also exempt from registration as a transaction by an issuer not

involving a public offering under Section 4(a)(2) of the Securities Act of 1933, as amended, and, in particular, the safe harbor

provisions afforded by Rule 506 of Regulation D, as promulgated thereunder.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None.

Item 6. Exhibits

Exhibits:

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 March 31, 2019, and December 31, 2018; (ii) Consolidated Statements of Income for the three months ended March 31, 2019 and 2018; (iii) Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2019 and 2018; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 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.

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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: May 7, 2019 |

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