10-Q 1 osbc-20200331x10q.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, 2020

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

As of May 5, 2020, the Registrant has 29,684,419 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 | 5
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 39
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 57
Item 4. | Controls and Procedures | 59
| PART II |
Item 1. | Legal Proceedings | 59
Item 1.A. | Risk Factors | 59
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 62
Item 3. | Defaults Upon Senior Securities | 63
Item 4. | Mine Safety Disclosure | 63
Item 5. | Other Information | 63
Item 6. | Exhibits | 63
| Signatures | 64

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:

| · |  | our ability to execute our growth strategy, including realizing the benefits from our recent strategic hires;

| · |  | the impact of the recent outbreak of the novel coronavirus, or COVID-19, on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy (including, without limitation, the Coronavirus Aid, Relief and Economic Security Act, or the CARES Act), and the resulting effect of these items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers;

| · |  | 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 any bank acquisition 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 raise cost-effective funding to support business plans 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 and those vendors performing a service on the Company’s behalf;

| · |  | 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;

| · |  | risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;

| · |  | 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;

negative changes in our capital position;

| · |  | the adverse effects of events such as outbreaks of contagious disease, war or terrorist activities, or essential utility outages, including deterioration in the global economy, instability in credit markets and disruptions in our customers’ supply chains and transportation;

| · |  | changes in trade policy and any related tariffs; and

| · |  | each of the factors and risks under the heading “Risk Factors” in our 2019 Annual Report on Form 10-K, Part II, Item 1A, Risk Factors, in this Form 10-Q, and in subsequent filings we make with the SEC.

3

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.

4

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,
|  | 2020 |  | 2019
Assets |  |  |  |  |  |
Cash and due from banks |  | $ | 27,627 |  | $ | 34,096
Interest earning deposits with financial institutions |  |  | 45,511 |  |  | 16,536
Cash and cash equivalents |  |  | 73,138 |  |  | 50,632
Securities available-for-sale, at fair value |  |  | 449,694 |  |  | 484,648
Federal Home Loan Bank Chicago ("FHLBC") and Federal Reserve Bank Chicago ("FRBC") stock |  |  | 9,917 |  |  | 9,917
Loans held-for-sale |  |  | 10,049 |  |  | 3,061
Loans |  |  | 1,957,204 |  |  | 1,930,812
Less: allowance for credit losses on loans |  |  | 30,045 |  |  | 19,789
Net loans |  |  | 1,927,159 |  |  | 1,911,023
Premises and equipment, net |  |  | 44,579 |  |  | 44,354
Other real estate owned |  |  | 5,049 |  |  | 5,004
Mortgage servicing rights, net |  |  | 4,108 |  |  | 5,935
Goodwill and core deposit intangible |  |  | 21,147 |  |  | 21,275
Bank-owned life insurance ("BOLI") |  |  | 61,714 |  |  | 61,763
Deferred tax assets, net |  |  | 14,292 |  |  | 11,459
Other assets |  |  | 35,964 |  |  | 26,474
Total assets |  | $ | 2,656,810 |  | $ | 2,635,545
Liabilities |  |  |  |  |  |
Deposits: |  |  |  |  |  |
Noninterest bearing demand |  | $ | 702,598 |  | $ | 669,795
Interest bearing: |  |  |  |  |  |
Savings, NOW, and money market |  |  | 1,043,572 |  |  | 1,015,285
Time |  |  | 449,472 |  |  | 441,669
Total deposits |  |  | 2,195,642 |  |  | 2,126,749
Securities sold under repurchase agreements |  |  | 51,236 |  |  | 48,693
Other short-term borrowings |  |  | 6,375 |  |  | 48,500
Junior subordinated debentures |  |  | 25,773 |  |  | 57,734
Senior notes |  |  | 44,297 |  |  | 44,270
Notes payable and other borrowings |  |  | 26,609 |  |  | 6,673
Other liabilities |  |  | 41,101 |  |  | 25,062
Total liabilities |  |  | 2,391,033 |  |  | 2,357,681
Stockholders’ Equity |  |  |  |  |  |
Common stock |  |  | 34,957 |  |  | 34,854
Additional paid-in capital |  |  | 121,081 |  |  | 120,657
Retained earnings |  |  | 209,915 |  |  | 213,723
Accumulated other comprehensive (loss) income |  |  | (1,819) |  |  | 4,562
Treasury stock |  |  | (98,357) |  |  | (95,932)
Total stockholders’ equity |  |  | 265,777 |  |  | 277,864
Total liabilities and stockholders’ equity |  | $ | 2,656,810 |  | $ | 2,635,545

| March 31, 2020 |  | December 31, 2019
| Common |  | Common
| Stock |  | Stock
Par value | $ | 1.00 |  | $ | 1.00
Shares authorized |  | 60,000,000 |  |  | 60,000,000
Shares issued |  | 34,957,384 |  |  | 34,853,757
Shares outstanding |  | 29,706,390 |  |  | 29,931,809
Treasury shares |  | 5,250,994 |  |  | 4,921,948

See accompanying notes to consolidated financial statements.

5

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except per share data)

|  |  | (unaudited) |
|  | Three Months Ended March 31, |
|  | 2020 |  | 2019 |
Interest and dividend income |  |  |  |  |  |  |
Loans, including fees |  | $ | 23,597 |  | $ | 24,099 |
Loans held-for-sale |  |  | 36 |  |  | 22 |
Securities: |  |  |  |  |  |  |
Taxable |  |  | 2,163 |  |  | 2,414 |
Tax exempt |  |  | 1,455 |  |  | 2,098 |
Dividends from FHLBC and FRBC stock |  |  | 125 |  |  | 149 |
Interest bearing deposits with financial institutions |  |  | 75 |  |  | 114 |
Total interest and dividend income |  |  | 27,451 |  |  | 28,896 |
Interest expense |  |  |  |  |  |  |
Savings, NOW, and money market deposits |  |  | 635 |  |  | 771 |
Time deposits |  |  | 1,766 |  |  | 1,618 |
Securities sold under repurchase agreements |  |  | 116 |  |  | 149 |
Other short-term borrowings |  |  | 109 |  |  | 607 |
Junior subordinated debentures |  |  | 1,364 |  |  | 927 |
Senior notes |  |  | 673 |  |  | 672 |
Notes payable and other borrowings |  |  | 130 |  |  | 116 |
Total interest expense |  |  | 4,793 |  |  | 4,860 |
Net interest and dividend income |  |  | 22,658 |  |  | 24,036 |
Provision for credit losses |  |  | 7,984 |  |  | 450 |
Net interest and dividend income after provision for credit losses |  |  | 14,674 |  |  | 23,586 |
Noninterest income |  |  |  |  |  |  |
Trust income |  |  | 1,532 |  |  | 1,486 |
Service charges on deposits |  |  | 1,726 |  |  | 1,862 |
Secondary mortgage fees |  |  | 270 |  |  | 136 |
Mortgage servicing rights mark to market loss |  |  | (2,134) |  |  | (819) |
Mortgage servicing income |  |  | 468 |  |  | 457 |
Net gain on sales of mortgage loans |  |  | 2,246 |  |  | 762 |
Securities (losses) gains, net |  |  | (24) |  |  | 27 |
Change in cash surrender value of BOLI |  |  | (49) |  |  | 458 |
Card related income |  |  | 1,287 |  |  | 1,285 |
Other income |  |  | 1,000 |  |  | 828 |
Total noninterest income |  |  | 6,322 |  |  | 6,482 |
Noninterest expense |  |  |  |  |  |  |
Salaries and employee benefits |  |  | 12,918 |  |  | 11,612 |
Occupancy, furniture and equipment |  |  | 2,301 |  |  | 1,989 |
Computer and data processing |  |  | 1,335 |  |  | 1,332 |
FDIC insurance |  |  | 57 |  |  | 174 |
General bank insurance |  |  | 246 |  |  | 250 |
Amortization of core deposit intangible |  |  | 128 |  |  | 132 |
Advertising expense |  |  | 109 |  |  | 234 |
Card related expense |  |  | 532 |  |  | 355 |
Legal fees |  |  | 131 |  |  | 126 |
Other real estate expense, net |  |  | 237 |  |  | 50 |
Other expense |  |  | 3,008 |  |  | 2,940 |
Total noninterest expense |  |  | 21,002 |  |  | 19,194 |
(Loss) income before income taxes |  |  | (6) |  |  | 10,874 |
(Benefit from) provision for income taxes |  |  | (281) |  |  | 2,406 |
Net income |  | $ | 275 |  | $ | 8,468 |
Basic earnings per share |  | $ | 0.01 |  | $ | 0.28 |
Diluted earnings per share |  |  | 0.01 |  |  | 0.28 |
Dividends declared per share |  |  | 0.01 |  |  | 0.01 |

See accompanying notes to consolidated financial statements.

6

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(In thousands)

|  |  | (unaudited) |
|  | Three Months Ended March 31, |
|  | 2020 |  | 2019 |
Net Income |  | $ | 275 |  | $ | 8,468 |
Unrealized holding (losses) gains on available-for-sale securities arising during the period |  |  | (6,376) |  |  | 9,192 |
Related tax benefit (expense) |  |  | 1,797 |  |  | (2,587) |
Holding (losses) gains after tax on available-for-sale securities |  |  | (4,579) |  |  | 6,605 |
Less: Reclassification adjustment for the net (losses) gains realized during the period |  |  |  |  |  |  |
Net realized (losses) gains |  |  | (24) |  |  | 27 |
Related tax benefit (expense) |  |  | 7 |  |  | (8) |
Net realized (losses) gains after tax |  |  | (17) |  |  | 19 |
Other comprehensive (loss) income on available-for-sale securities |  |  | (4,562) |  |  | 6,586 |
Changes in fair value of derivatives used for cash flow hedges |  |  | (2,530) |  |  | (1,073) |
Related tax benefit |  |  | 711 |  |  | 302 |
Other comprehensive loss on cash flow hedges |  |  | (1,819) |  |  | (771) |
Total other comprehensive (loss) income |  |  | (6,381) |  |  | 5,815 |
Total comprehensive (loss) income |  | $ | (6,106) |  | $ | 14,283 |

|  | Accumulated |  | Accumulated |  | Total
|  | Unrealized Gain |  | Unrealized Gain |  | Accumulated Other
|  | (Loss) on Securities |  | (Loss) on Derivative |  | Comprehensive
|  | Available-for -Sale |  | Instruments |  | Income/(Loss)
For the Three Months Ended |  |  |  |  |  |  |  |  |
Balance, December 31, 2018 |  | $ | (4,038) |  | $ | (41) |  | $ | (4,079)
Other comprehensive income (loss), net of tax |  |  | 6,586 |  |  | (771) |  |  | 5,815
Balance, March 31, 2019 |  | $ | 2,548 |  | $ | (812) |  | $ | 1,736
Balance, December 31, 2019 |  | $ | 6,827 |  | $ | (2,265) |  | $ | 4,562
Other comprehensive loss, net of tax |  |  | (4,562) |  |  | (1,819) |  |  | (6,381)
Balance, March 31, 2020 |  | $ | 2,265 |  | $ | (4,084) |  | $ | (1,819)

See accompanying notes to consolidated financial statements.

7

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

|  |  | (Unaudited)
|  | Three Months Ended March 31,
|  | 2020 |  | 2019
Cash flows from operating activities |  |  |  |  |  |
Net income |  | $ | 275 |  | $ | 8,468
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |
Net premium / discount from amortization on securities |  |  | 506 |  |  | 723
Securities losses (gains), net |  |  | 24 |  |  | (27)
Provision for credit losses |  |  | 7,984 |  |  | 450
Originations of loans held-for-sale |  |  | (50,418) |  |  | (25,815)
Proceeds from sales of loans held-for-sale |  |  | 45,706 |  |  | 27,224
Net gains on sales of mortgage loans |  |  | (2,246) |  |  | (762)
Mortgage servicing rights mark to market loss |  |  | 2,134 |  |  | 819
Net discount from accretion on loans |  |  | (409) |  |  | (110)
Net change in cash surrender value of BOLI |  |  | 49 |  |  | (458)
Net gains on sale of other real estate owned |  |  | (23) |  |  | (73)
Provision for other real estate owned valuation losses |  |  | 158 |  |  | -
Depreciation of fixed assets and amortization of leasehold improvements |  |  | 662 |  |  | 638
Amortization of core deposit intangibles |  |  | 128 |  |  | 132
Change in current income taxes (payable) / receivable |  |  | (1,430) |  |  | 673
(Benefit from) / Provision for deferred tax expense |  |  | (333) |  |  | 1,732
Change in accrued interest receivable and other assets |  |  | (4,081) |  |  | 136
Amortization of purchase accounting adjustment on notes payable and other borrowings |  |  | 12 |  |  | 27
Amortization of junior subordinated debentures issuance costs |  |  | 643 |  |  | 12
Amortization of senior notes issuance costs |  |  | 27 |  |  | 25
Change in accrued interest payable and other liabilities |  |  | 8,925 |  |  | (1,889)
Stock based compensation |  |  | 729 |  |  | 573
Net cash provided by operating activities |  |  | 9,022 |  |  | 12,498
Cash flows from investing activities |  |  |  |  |  |
Proceeds from maturities and calls, including pay down of securities available-for-sale |  |  | 16,046 |  |  | 5,279
Proceeds from sales of securities available-for-sale |  |  | 18,126 |  |  | 81,524
Purchases of securities available-for-sale |  |  | (6,100) |  |  | (46,176)
Net proceeds from sales of FHLBC stock |  |  | - |  |  | 2,254
Net change in loans |  |  | (27,716) |  |  | (6,140)
Proceeds from sales of other real estate owned, net of participation purchase |  |  | 311 |  |  | 874
Net purchases of premises and equipment |  |  | (887) |  |  | (224)
Net cash (used in) provided by investing activities |  |  | (220) |  |  | 37,391
Cash flows from financing activities |  |  |  |  |  |
Net change in deposits |  |  | 68,893 |  |  | 6,864
Net change in securities sold under repurchase agreements |  |  | 2,543 |  |  | (4,271)
Net change in other short-term borrowings |  |  | (42,125) |  |  | (64,500)
Redemption of junior subordinated debentures |  |  | (32,604) |  |  | -
Issuance of term note |  |  | 20,000 |  |  | -
Net change in notes payable and other borrowings, excluding term note issuance |  |  | (76) |  |  | (2,199)
Proceeds from exercise of stock options |  |  | - |  |  | 32
Dividends paid on common stock |  |  | (300) |  |  | (297)
Purchase of treasury stock |  |  | (2,627) |  |  | (417)
Net cash provided by (used in) financing activities |  |  | 13,704 |  |  | (64,788)
Net change in cash and cash equivalents |  |  | 22,506 |  |  | (14,899)
Cash and cash equivalents at beginning of period |  |  | 50,632 |  |  | 55,235
Cash and cash equivalents at end of period |  | $ | 73,138 |  | $ | 40,336

See accompanying notes to consolidated financial statements.

8

Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in

Stockholders’ Equity

(In thousands)

|  |  |  |  |  |  |  |  |  |  | Accumulated |  |  |  |  |  |
|  |  |  |  | Additional |  |  |  |  | Other |  |  |  |  | Total
(unaudited) | Common |  | Paid-In |  | Retained |  | Comprehensive |  | Treasury |  | Stockholders’
|  | Stock |  | Capital |  | Earnings |  | Income (Loss) |  | Stock |  | Equity
For the Three Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, December 31, 2018 |  | $ | 34,720 |  | $ | 119,081 |  | $ | 175,463 |  | $ | (4,079) |  | $ | (96,104) |  | $ | 229,081
Net income |  |  |  |  |  |  |  |  | 8,468 |  |  |  |  |  |  |  |  | 8,468
Other comprehensive income, 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
Balance, December 31, 2019 |  | $ | 34,854 |  | $ | 120,657 |  | $ | 213,723 |  | $ | 4,562 |  | $ | (95,932) |  | $ | 277,864
Net income |  |  |  |  |  |  |  |  | 275 |  |  |  |  |  |  |  |  | 275
Other comprehensive loss, net of tax |  |  |  |  |  |  |  |  |  |  |  | (6,381) |  |  |  |  |  | (6,381)
Adoption of ASU 2016-13 |  |  |  |  |  |  |  |  | (3,783) |  |  |  |  |  |  |  |  | (3,783)
Dividends declared and paid, ($0.01 per share) |  |  |  |  |  |  |  |  | (300) |  |  |  |  |  |  |  |  | (300)
Vesting of restricted stock |  |  | 103 |  |  | (305) |  |  |  |  |  |  |  |  | 202 |  |  | -
Stock option exercised |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | -
Stock based compensation |  |  |  |  |  | 729 |  |  |  |  |  |  |  |  |  |  |  | 729
Purchase of treasury stock from taxes withheld on stock awards |  |  |  |  |  |  |  |  |  |  |  |  |  |  | (411) |  |  | (411)
Purchase of treasury stock from stock repurchase program |  |  |  |  |  |  |  |  |  |  |  |  |  |  | (2,216) |  |  | (2,216)
Balance, March 31, 2020 |  | $ | 34,957 |  | $ | 121,081 |  | $ | 209,915 |  | $ | (1,819) |  | $ | (98,357) |  | $ | 265,777

9

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 – Basis of Presentation and Changes in Significant Accounting Policies

Except as set forth below in this Note 1, 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, 2020, are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. 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, 2019. 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.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Measurement of Credit Losses on Financial Instruments (Topic 326),” also known as Current Expected Credit Losses, or CECL. 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 reflects 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 also requires available-for-sale debt securities to have a credit loss recorded through an allowance rather than write-downs through an other than temporary impairment analysis. In addition, an allowance must be established for the credit risk related to unfunded commitments. ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and was adopted as of January 1, 2020, by the Company.

Upon issuance of ASU 2016-13, the Company set up a CECL committee, with the goal of establishing a timeline for CECL data collection, implementation, parallel runs, testing, and model validation. The Company has implemented a software solution provided by a third party vendor to assist in the determination of the allowance for credit losses (“ACL”), and the third party validation process was completed in the fourth quarter of 2019. The Company accumulated historical data by loan pools and collateral classifications. All historical data, model assumptions and calculation parameters were analyzed by the third party validation team, and management made enhancements to the software model used based on their recommendations.

Our approach for estimating expected life-time credit losses for loans includes the following components:

| · |  | An initial forecast period of one year for all portfolio segments and off-balance-sheet credit exposures. This period reflects management’s expectation of losses based on forward-looking economic scenarios over that time.

| · |  | A historical reversion loss forecast period covering the remaining contractual life, adjusted for prepayments, by portfolio segment based on the historical loss rate of loans within those segments.

| · |  | The initial loss forecast period and historical reversion loss rate is based on economic conditions at the measurement date.

| · |  | We primarily utilized the static pool and migration analysis methods to estimate credit losses. Such methods would obtain estimated life-time credit losses using the conceptual components described above.

Based on our portfolio composition at December 31, 2019, and the economic environment at that time, we recorded an overall increase in our ACL for loans and leases of $5.9 million and an ACL for unfunded commitments was established of $1.7 million. Approximately $2.5 million of the increase to the ACL on loans resulted from the transfer of the non-accretable purchase accounting adjustments on purchased credit impaired loans. There was no impact from adoption of CECL on securities available-for sale. As a result of the adoption of this new standard on January 1, 2020, we recorded a reduction to retained earnings of approximately $3.7 million, which was net of the $1.4 million deferred tax asset impact stemming from adoption. The Company finalized internal control processes and disclosure documentation related to adoption of this standard during the first quarter of 2020.

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Notes to Consolidated Financial Statements

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

As of March 31, 2020, a provision for credit losses was recorded based on the current uncertainty experienced in the macroeconomic environment, primarily due to falling interest rates and the impact of COVID-19. This additional ACL was not considered part of the ASU 2016-13 adoption, as these changes in the assessment of the ACL occurred after the January 1, 2020, adoption. We recorded a provision for credit losses of $8.0 million during the first quarter of 2020, comprised of $5.5 million of allowance for credit losses related to loans, and $2.5 million of ACL related to unfunded commitments. We will continue to assess and evaluate the estimated future credit loss impact of current market conditions in subsequent reporting periods, which will be highly dependent on credit quality, macroeconomic forecasts and conditions, the local and national response to the COVID-19 pandemic, as well as the composition of our loans and available-for-sale securities portfolio.

Change in Significant Accounting Policies

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, 2019. 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.

In addition to the significant accounting policies presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, on January 1, 2020, as discussed above, the Company adopted ASU 2016-13, referred to as Current Expected Credit Losses, or CECL, an expected loss methodology which replaces the incurred loss methodology for determining the Company’s provision for loan losses and allowance for loan and lease losses. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with ASU 2016-02 “Leases (Topic 842)” (“ASU 2016-02”). In addition, ASU 2016-13 made changes to the accounting for available-for-sale debt securities. One such change is to require credit-related impairments to be recognized as an allowance for credit losses rather than as a write-down of the securities amortized cost basis when management does not intend to sell or believes that it is not more likely than not that they will be required to sell the securities prior to recovery of the securities amortized cost basis.

Allowance for Credit Losses

The allowance for credit losses (“ACL”) is an estimate of the expected credit losses on the loans held for investment, unfunded loan commitments, and available-for-sale debt securities portfolios.

Allowance for Credit Losses on Loans

The ACL is calculated according to GAAP standards and is maintained by management at a level believed adequate to absorb estimated credit losses that are expected to occur within the existing loan portfolio through their contractual terms. The ACL is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans. Determination of the ACL is inherently subjective in nature since it requires significant estimates and management judgment, and includes a level of imprecision given the difficulty of identifying and assessing the factors impacting loan repayment and estimating the timing and amount of losses. While management utilizes its best judgment and information available, the ultimate adequacy of the ACL is dependent upon a variety of factors beyond the Company’s direct control, including, but not limited to, the performance of the loan portfolio, consideration of current economic trends, changes in interest rates and property values, estimated losses on pools of homogeneous loans based on an analysis that uses historical loss experience for prior periods that are determined to have like characteristics with the current period such as pre-recessionary, recessionary, or recovery periods, portfolio growth and concentration risk, management and staffing changes, the interpretation of loan risk classifications by regulatory authorities and other credit market factors. While each component of the ACL is determined separately, the entire balance is available for the entire loan portfolio.

The ACL methodology consists of measuring loans on a collective (pool) basis when similar risk characteristics exist. The Company has identified the following loan portfolios and measures the ACL using the following methods:

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Notes to Consolidated Financial Statements

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

| · |  | Commercial loans – the Company uses a migration analysis, and within this segment classifies six different risk levels to assign a loss rate based on historical losses, as well as applying a qualitative factor adjustment in addition to the loss rates applied, as discussed below.

| · |  | Leases – the Company uses a remaining life methodology, also known as WARM (weighted average remaining life), as this segment is relatively new to the Company and more than four years of the Company’s own historical loss data is not available. In accordance with accounting standards, a peer group has been identified and is used to estimate losses for this portfolio.

| · |  | Real estate – commercial (“CRE”) – this loan portfolio is segregated into two segments:

| o |  | CRE owner occupied – the Company uses a migration analysis, and within this segment classifies six different risk levels to assign a loss rate based on historical losses, as well as applying a qualitative adjustment in addition to the loss rates applied, as discussed below.

| o |  | CRE investor – the Company uses a migration analysis, and within this segment classifies six different risk levels to assign a loss rate based on historical losses, as well as applying a qualitative adjustment in addition to the loss rates applied, as discussed below.

| · |  | Real estate – construction – the Company uses a static segment analysis, which relies on the Company’s historical loss rates, as well as a qualitative adjustment in addition to the loss rates applied.

| · |  | Real estate-residential - this loan portfolio is segregated into two segments:

| o |  | Residential owner occupied and Residential investor – the Company uses a static segment analysis, applying historical loss rates from periods with like characteristics as the current period, and also a qualitative adjustment in addition to the loss rates applied.

| · |  | Multifamily – the Company uses a migration analysis, and within this segment, the Company classifies six different risk levels to assign a loss rate based on historical losses, as well as applying a qualitative adjustment in addition to the loss rates applied.

| · |  | HELOCs – this portfolio is segregated into two segments, a HELOC legacy segment which uses a static pool analysis, and a HELOC purchased segment, which uses the WARM method, and applies loss rates from the institutions from which the Company purchased the HELOCs, if available.

Purchased credit deteriorated loans (“PCD loans”), are purchased loans that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by the Company’s assessment. The Company records acquired PCD loans by adding the expected credit losses (i.e. allowance for credit losses) to the purchase price of the financial assets rather than recording through the provision for credit losses in the income statement. The expected credit loss, as of the acquisition day, of a PCD loan is added to the allowance for credit losses. The non-credit discount or premium is the difference between the unpaid principal balance and the amortized cost basis as of the acquisition date. Subsequent to the acquisition date, the change in the ACL on PCD loans is recognized through the provision for credit losses. The non-credit discount or premium is accreted or amortized, respectively, into interest income over the remaining life of the PCD loan on a level-yield basis. In accordance with the transition requirements within the standard, the Company’s purchased credit impaired loans (“PCI loans”) were treated as PCD loans. PCI loans meeting nonperforming criteria were historically excluded from our nonperforming disclosures as long as their cash flows and the timing of such cash flows continue to be estimable and probable of collection. As a result of CECL implementation on January 1, 2020, PCI loans became PCD loans. PCD loans that meet the definition of nonperforming are now included in nonperforming disclosures.

The qualitative factors applied to each loan portfolio consist of the impact of other internal and external qualitative and credit market factors as assessed by management through a detailed loan review, ACL analysis and credit discussions. These internal and external qualitative and credit market factors include:

| · |  | changes in lending policies and procedures, including changes in underwriting standards and collections, charge-offs and recovery practices;

| · |  | changes in international, national, regionally and local conditions (specific factors which impact portfolios or discrepancies with national economic factors which are utilized within the economic forecast);

| · |  | changes in the experience, depth and ability of lending management;

| · |  | changes in the volume and severity of past due loans and other similar loan conditions;

| · |  | changes in the nature and volume of the loan portfolio and terms of loans;

| · |  | the existence and effect of any concentrations of credit and changes in the levels of such concentrations (this characteristic requires any portfolio exceeding 25% of capital to have a factor considered unless the pool is otherwise well diversified or holds a relatively low inherent risk);

| · |  | effects of other external factors, such as competition, legal or regulatory factors, on the level of estimated credit losses;

| · |  | changes in the quality of our loan review functions; and

| · |  | changes in the value of underlying collateral for collateral dependent loans.

The impact of the above listed internal and external qualitative and credit market risk factors is assessed within predetermined ranges to adjust the ACL totals calculated.

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Notes to Consolidated Financial Statements

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

In addition to the pooled analysis performed for the majority of our loan and commitment balances, we also review those loans that have collateral dependency or nonperforming status which requires a specific review of that loan, per our individually analyzed CECL calculations. Finally, we maintain a component of the ACL for those factors that cannot be quantified in the above analysis or are as yet unknown to us, due to changing economic conditions and other aspects of credit risk; which is known as the Company’s “Other Reserves.”

Loans are charged off against the ACL when management believes the uncollectibility of a loan balance is confirmed, while recoveries of amounts previously charged-off are credited to the ACL. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off. Approved releases from previously established ACL reserves authorized under our ACL methodology also reduce the ACL. Additions to the ACL are established through the provision for credit losses on loans, which is charged to expense.

The Company’s ACL methodology is intended to reflect all loan portfolio risk, but management recognizes the inability to accurately depict all future credit losses in a current ACL estimate, as the impact of various factors cannot be fully known. Accrued interest receivable on loans is excluded from the amortized cost basis of financing receivables for the purpose of determining the allowance for credit losses. All calculations conform to GAAP.

Allowance for Credit Losses on Unfunded Loan Commitments

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk by a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The ACL related to off-balance sheet credit exposures, which is within other liabilities on the Company’s balance sheet, is estimated at each balance sheet date under the CECL model, and is adjusted as determined necessary through the provision for credit losses on the income statement. The estimate for ACL on unfunded loan commitments includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life.

Allowance for Credit Losses on Securities Available-for-Sale

For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will sell, the security before recovery of its amortized cost basis. If either of the aforementioned criteria exists, the Company will record an ACL related to securities available-for-sale with an offsetting entry to the provision for credit losses on securities on the income statement. If either of these criteria does not exist, the Company will evaluate the securities individually to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors, such as market interest rate fluctuations.

In evaluating securities available-for sale for potential impairment, the Company considers many factors, including the financial condition and near-term prospects of the issuer, which for debt securities considers external credit ratings and recent downgrades; and its ability and intent to hold the security for a period of time sufficient for a recovery in value. The Company also considers the extent to which the securities are issued by the federal government or its agencies, and any guarantee of issued amounts by those agencies. The amount of the impairment related to other factors is recognized in other comprehensive income (loss).

Accrued interest receivable on securities available-for-sale is excluded from the amortized cost basis of those securities for the purpose of determining the allowance for credit losses. All calculations conform to GAAP.

Risks and Uncertainties

In December 2019, a novel strain of coronavirus (COVID-19) was reported to have surfaced in China, and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in the Company’s markets. In response to the COVID-19 pandemic, the State of Illinois and most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential.

While the Company’s business has been designated an essential business, which allows the Bank to continue to serve its customers, the Company serves many customers that have been deemed, or who are employed by businesses that have been deemed, to be non-essential.

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Notes to Consolidated Financial Statements

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

Many of the Company’s customers that have been categorized to date as essential businesses, or who are employed by businesses that have been categorized as essential businesses, have been adversely affected by the COVID-19 pandemic.

The impact of the COVID-19 pandemic is fluid and continues to evolve. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and is anticipated to have a material adverse effect on the Company’s business and results of operations. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic have had and are expected to continue to have a significant and adverse effect on the Company’s business and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and the Company’s customers, employees and vendors.

As of March 31, 2020, our consolidated balance sheet included goodwill of $18.6 million. During the first quarter of 2020, we considered whether a quantitative assessment of goodwill was required as a result of the significant economic disruption caused by the COVID-19 pandemic. Impacts of the economic disruptions were noted to have occurred over the latter half of March, specifically, such as a decline in the trading price of our common stock and an increase in the U.S. unemployment rate. After considering qualitative factors regarding the expected impacts of the pandemic on our business, operations and financial condition, we determined that these conditions did not indicate that it is more likely than not that the Company’s carrying value exceeded our fair value as of March 31, 2020, based on information available at this time, as these negative market indicators were not observed over a sustained period of time. However, further delayed recovery or further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.

Subsequent Events

On April 21, 2020, the Company’s Board of Directors declared a cash dividend of $0.01 per share payable on May 11, 2020, to stockholders of record as of May 1, 2020; dividends of $297,000 are scheduled to be paid to stockholders on May 11, 2020.

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. These fair value estimates were considered final as of March 31, 2019, and no further refinements to the values recorded are anticipated.

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

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Notes to Consolidated Financial Statements

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

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.

Federal Home Loan Bank of Chicago (“FHLBC”) and Federal Reserve Bank of Chicago (“FRBC”) stock are considered nonmarketable equity investments. FHLBC stock was recorded at $3.7 million at March 31, 2020, and December 31, 2019. FRBC stock was recorded at $6.2 million at March 31, 2020, and December 31, 2019.

The following tables summarize the amortized cost and fair value of the securities portfolio at March 31, 2020, and December 31, 2019, and the corresponding amounts of gross unrealized gains and losses:

|  |  |  |  | Gross |  | Gross |  |  |
|  | Amortized |  | Unrealized |  | Unrealized |  | Fair
March 31, 2020 |  | Cost 1 |  | Gains |  | Losses |  | Value
Securities available-for-sale |  |  |  |  |  |  |  |
U.S. Treasury |  | $ | 4,011 |  | $ | 141 |  | $ | - |  | $ | 4,152
U.S. government agencies |  |  | 7,870 |  |  | - |  |  | (147) |  |  | 7,723
U.S. government agencies mortgage-backed |  |  | 16,021 |  |  | 1,234 |  |  | - |  |  | 17,255
States and political subdivisions |  |  | 244,429 |  |  | 12,353 |  |  | (1,687) |  |  | 255,095
Collateralized mortgage obligations |  |  | 56,104 |  |  | 709 |  |  | (3,410) |  |  | 53,403
Asset-backed securities |  |  | 82,005 |  |  | 210 |  |  | (4,488) |  |  | 77,727
Collateralized loan obligations |  |  | 36,104 |  |  | 69 |  |  | (1,834) |  |  | 34,339
Total securities available-for-sale |  | $ | 446,544 |  | $ | 14,716 |  | $ | (11,566) |  | $ | 449,694

|  |  |  |  | Gross |  | Gross |  |  |
|  | Amortized |  | Unrealized |  | Unrealized |  | Fair
December 31, 2019 |  | Cost 1 |  | Gains |  | Losses |  | Value
Securities available-for-sale |  |  |  |  |  |  |  |  |  |  |  |
U.S. Treasury |  | $ | 4,010 |  | $ | 26 |  | $ | - |  | $ | 4,036
U.S. government agencies |  |  | 8,502 |  |  | - |  |  | (165) |  |  | 8,337
U.S. government agencies mortgage-backed |  |  | 16,164 |  |  | 443 |  |  | (19) |  |  | 16,588
States and political subdivisions |  |  | 240,399 |  |  | 11,207 |  |  | (2,431) |  |  | 249,175
Collateralized mortgage obligations |  |  | 57,059 |  |  | 963 |  |  | (38) |  |  | 57,984
Asset-backed securities |  |  | 82,114 |  |  | 617 |  |  | (887) |  |  | 81,844
Collateralized loan obligations |  |  | 66,898 |  |  | 29 |  |  | (243) |  |  | 66,684
Total securities available-for-sale |  | $ | 475,146 |  | $ | 13,285 |  | $ | (3,783) |  | $ | 484,648

1 Excludes accrued interest receivable of $3.0 million and $3.2 million at March 31, 2020 and December 31, 2019, respectively, that is recorded in other assets on the consolidated balance sheet.

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Notes to Consolidated Financial Statements

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

The fair value, amortized cost and weighted average yield of debt securities at March 31, 2020, 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 |  | $ | 6,606 |  | 2.42 | % |  | $ | 6,625 |
Due after one year through five years |  |  | 6,287 |  | 2.11 |  |  |  | 6,509 |
Due after five years through ten years |  |  | 16,117 |  | 2.96 |  |  |  | 16,506 |
Due after ten years |  |  | 227,300 |  | 3.01 |  |  |  | 237,330 |
|  |  | 256,310 |  | 2.97 |  |  |  | 266,970 |
Mortgage-backed and collateralized mortgage obligations |  |  | 72,125 |  | 3.30 |  |  |  | 70,658 |
Asset-backed securities |  |  | 82,005 |  | 2.75 |  |  |  | 77,727 |
Collateralized loan obligations |  |  | 36,104 |  | 3.59 |  |  |  | 34,339 |
Total securities available-for-sale |  | $ | 446,544 |  | 3.03 | % |  | $ | 449,694 |

At March 31, 2020, the Company’s investments included $55.8 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 $4.8 million, or 8.52% of outstanding principal.

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

|  | March 31, 2020
(in thousands) |  | Amortized |  | Fair
Issuer |  | Cost |  | Value
GCO Education Loan Funding Corp |  | $ | 27,911 |  | $ | 26,501
Towd Point Mortgage Trust |  |  | 33,360 |  |  | 31,996

Securities with unrealized losses with no corresponding allowance for credit losses at March 31, 2020 and December 31, 2019, 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, 2020 |  | 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. government agencies |  | - |  | $ | - |  | $ | - |  | 4 |  | $ | 147 |  | $ | 7,723 |  | 4 |  | $ | 147 |  | $ | 7,723
States and political subdivisions |  | 4 |  |  | 588 |  |  | 25,038 |  | 2 |  |  | 1,099 |  |  | 5,904 |  | 6 |  |  | 1,687 |  |  | 30,942
Collateralized mortgage obligations |  | 12 |  |  | 3,339 |  |  | 35,811 |  | 2 |  |  | 71 |  |  | 1,051 |  | 14 |  |  | 3,410 |  |  | 36,862
Asset-backed securities |  | 9 |  |  | 2,530 |  |  | 36,074 |  | 2 |  |  | 1,958 |  |  | 29,244 |  | 11 |  |  | 4,488 |  |  | 65,318
Collateralized loan obligations |  | 3 |  |  | 849 |  |  | 16,140 |  | 2 |  |  | 985 |  |  | 11,187 |  | 5 |  |  | 1,834 |  |  | 27,327
Total securities available-for-sale |  | 28 |  | $ | 7,306 |  | $ | 113,063 |  | 12 |  | $ | 4,260 |  | $ | 55,109 |  | 40 |  | $ | 11,566 |  | $ | 168,172

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Notes to Consolidated Financial Statements

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

|  | Less than 12 months |  | 12 months or more |  |  |  |  |  |  |  |
December 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. government agencies |  | - |  |  | - |  |  | - |  | 4 |  |  | 165 |  |  | 8,337 |  | 4 |  |  | 165 |  |  | 8,337
U.S. government agencies mortgage-backed |  | 3 |  |  | 10 |  |  | 3,018 |  | 2 |  |  | 9 |  |  | 843 |  | 5 |  |  | 19 |  |  | 3,861
States and political subdivisions |  | 6 |  |  | 1,665 |  |  | 41,043 |  | 2 |  |  | 766 |  |  | 6,593 |  | 8 |  |  | 2,431 |  |  | 47,636
Collateralized mortgage obligations |  | 2 |  |  | 26 |  |  | 9,054 |  | 2 |  |  | 12 |  |  | 1,209 |  | 4 |  |  | 38 |  |  | 10,263
Asset-backed securities |  | 4 |  |  | 839 |  |  | 54,540 |  | 1 |  |  | 48 |  |  | 3,238 |  | 5 |  |  | 887 |  |  | 57,778
Collateralized loan obligations |  | 4 |  |  | 62 |  |  | 21,927 |  | 4 |  |  | 181 |  |  | 25,020 |  | 8 |  |  | 243 |  |  | 46,947
Total securities available-for-sale |  | 19 |  | $ | 2,602 |  | $ | 129,582 |  | 15 |  | $ | 1,181 |  | $ | 45,240 |  | 34 |  | $ | 3,783 |  | $ | 174,822

Upon the adoption of ASU 2016-13 as of January 1, 2020, and again as of March 31, 2020, we performed an analysis to determine if any of the unrealized losses on securities available-for-sale were comprised of credit losses as compared to unrealized losses due to market interest rate adjustments. The Company’s assessment included a review of the severity and duration of the unrealized loss; the financial condition and near-term prospects of the issuer, including external credit ratings and recent downgrades; and the Company’s ability and intent to hold the security for a period of time sufficient for a recovery in value. The Company also considered the extent to which the securities are issued by the federal government or its agencies, and any guarantee of issued amounts by those agencies. No credit losses were determined to be present as of the date of CECL adoption or as of the quarter ended March 31, 2020, as there was no credit quality deterioration noted. Therefore, no provision for credit losses on securities was recognized for the first quarter end.

The following table presents net realized gains (losses) on securities available-for-sale for the three months ended March 31, 2020 and 2019.

|  |  | Three Months Ended |
|  |  | March 31, |
Securities available-for-sale |  | 2020 |  | 2019 |
Proceeds from sales of securities |  | $ | 18,126 |  | $ | 81,524 |
Gross realized gains on securities |  |  | 17 |  |  | 605 |
Gross realized losses on securities |  |  | (41) |  |  | (578) |
Net realized (losses) gains |  | $ | (24) |  | $ | 27 |
Income tax benefit (expense) on net realized (losses) gains |  | $ | 7 |  | $ | (8) |
Effective tax rate applied |  |  | 29.2 | % |  | 29.6 | %

Securities valued at $320.3 million as of March 31, 2020, a decrease from $320.8 million at year-end 2019, 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 and Allowance for Credit Losses on Loans

Major segments of loans were as follows:

|  | March 31, 2020 |  | December 31, 2019
Commercial |  | $ | 364,626 |  | $ | 332,842
Leases |  |  | 126,237 |  |  | 119,751
Commercial real estate - Investor |  |  | 503,905 |  |  | 520,095
Commercial real estate - Owner occupied |  |  | 349,595 |  |  | 345,504
Construction |  |  | 78,159 |  |  | 69,617
Residential real estate - Investor |  |  | 69,429 |  |  | 71,105
Residential real estate - Owner occupied |  |  | 129,982 |  |  | 136,023
Multifamily |  |  | 195,297 |  |  | 189,773
HELOC |  |  | 93,165 |  |  | 91,605
HELOC - Purchased |  |  | 30,880 |  |  | 31,852
Other 1 |  |  | 15,929 |  |  | 12,258
Total loans, excluding deferred loan costs and PCI loans |  |  | 1,957,204 |  |  | 1,920,425
Net deferred loan costs |  |  | - |  |  | 1,786
Total loans, excluding PCI loans |  |  | 1,957,204 |  |  | 1,922,211
PCI loans |  |  | - |  |  | 8,601
Total loans, including deferred loan costs and PCI loans |  | $ | 1,957,204 |  | $ | 1,930,812
Allowance for credit losses on loans |  |  | (30,045) |  |  | (19,789)
Net loans 2 |  | $ | 1,927,159 |  | $ | 1,911,023

1 The “Other” segment for 2020 includes consumer and overdrafts in this table and in subsequent tables within this footnote 4 - Loans and Allowance for Credit Losses on Loans.

2 Excludes accrued interest receivable of $6.4 million and $6.5 million at March 31, 2020 and December 31, 2019, respectively, that is recorded in other assets on the consolidated balance sheet.

In connection with the Company’s adoption of ASU 2016-13 as of January 1, 2020, the PCI loans and deferred fees and costs are included in their respective segments. PCI loans meeting nonperforming criteria were historically excluded from our nonperforming disclosures as long as their cash flows and the timing of such cash flows continue to be estimable and probable of collection. As a result of CECL implementation on January 1, 2020, PCI loans became PCD loans. PCD loans that meet the definition of nonperforming are now included in nonperforming disclosures.

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 74.1% and 75.4% of the portfolio at March 31, 2020, and December 31, 2019, respectively.

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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 presents the collateral dependent loans and the related ACL allocated by segment of loans as of March 31, 2020:

|  |  |  |  | Accounts |  |  |  |  |  | ACL
March 31, 2020 |  | Real Estate |  | Receivable |  | Other |  | Total |  | Allocation
Commercial |  | $ | - |  | $ | 2,416 |  | $ | 3 |  | $ | 2,419 |  | $ | 89
Leases |  |  | - |  |  | - |  |  | 264 |  |  | 264 |  |  | 61
Commercial real estate - Investor |  |  | 4,430 |  |  | - |  |  | - |  |  | 4,430 |  |  | 203
Commercial real estate - Owner occupied |  |  | 8,459 |  |  | - |  |  | - |  |  | 8,459 |  |  | 204
Construction |  |  | 2,245 |  |  | - |  |  | - |  |  | 2,245 |  |  | 852
Residential real estate - Investor |  |  | 859 |  |  | - |  |  | - |  |  | 859 |  |  | -
Residential real estate - Owner occupied |  |  | 3,739 |  |  | - |  |  | - |  |  | 3,739 |  |  | 137
Multifamily |  |  | 1,497 |  |  | - |  |  | - |  |  | 1,497 |  |  | 318
HELOC |  |  | 1,004 |  |  | - |  |  | - |  |  | 1,004 |  |  | -
HELOC - Purchased |  |  | 114 |  |  | - |  |  | - |  |  | 114 |  |  | -
Other |  |  | - |  |  | - |  |  | 9 |  |  | 9 |  |  | 3
Total |  | $ | 22,347 |  | $ | 2,416 |  | $ | 276 |  | $ | 25,039 |  | $ | 1,867

The following table presents the activity in the allowance for credit losses (“ACL”) for the three months ended March 31, 2020. The Company’s estimate of the ACL reflects losses over the expected remaining contractual life of the loans.

|  |  |  | Impact of |  | Provision |  |  |  |  |  |
|  | Beginning |  | Adopting |  | for Credit |  |  |  |  |  | Ending
Allowance for credit losses |  | Balance |  | ASC 326 |  | Losses |  | Charge-offs |  | Recoveries |  | Balance
Three months ended March 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 3,015 |  | $ | (292) |  | $ | 539 |  | $ | 97 |  | $ | 12 |  | $ | 3,177
Leases |  |  | 1,262 |  |  | 501 |  |  | 127 |  |  | - |  |  | - |  |  | 1,890
Commercial real estate - Investor |  |  | 6,218 |  |  | (741) |  |  | 536 |  |  | 13 |  |  | 21 |  |  | 6,021
Commercial real estate - Owner occupied |  |  | 3,678 |  |  | (848) |  |  | 329 |  |  | 1,109 |  |  | 1 |  |  | 2,051
Construction |  |  | 513 |  |  | 1,334 |  |  | 2,184 |  |  | - |  |  | - |  |  | 4,031
Residential real estate - Investor |  |  | 601 |  |  | 740 |  |  | 534 |  |  | - |  |  | 21 |  |  | 1,896
Residential real estate - Owner occupied |  |  | 1,257 |  |  | 1,320 |  |  | 769 |  |  | 1 |  |  | 23 |  |  | 3,368
Multifamily |  |  | 1,444 |  |  | 1,732 |  |  | 674 |  |  | - |  |  | - |  |  | 3,850
HELOC |  |  | 1,161 |  |  | 1,526 |  |  | (485) |  |  | 83 |  |  | 141 |  |  | 2,260
HELOC - Purchased |  |  | - |  |  | - |  |  | 850 |  |  | - |  |  | - |  |  | 850
Other |  |  | 640 |  |  | 607 |  |  | (558) |  |  | 98 |  |  | 60 |  |  | 651
|  | $ | 19,789 |  | $ | 5,879 |  | $ | 5,499 |  | $ | 1,401 |  | $ | 279 |  | $ | 30,045

The following table presents activity in the allowance for loan and lease losses for the three months ended at March 31, 2019, as determined in accordance with ASC 310 prior to the adoption of ASU 2016-13:

|  |  |  | Provision |  |  |  |  |  |
|  | Beginning |  | for Loan |  |  |  |  |  | Ending
Allowance for loan and lease losses: |  | Balance |  | Losses |  | Charge-offs |  | Recoveries |  | Balance
Three months ended March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 2,832 |  | $ | 202 |  | $ | 12 |  | $ | 30 |  | $ | 3,052
Leases |  |  | 734 |  |  | 71 |  |  | - |  |  | - |  |  | 805
Commercial real estate - Investor |  |  | 5,492 |  |  | 207 |  |  | 144 |  |  | 20 |  |  | 5,575
Commercial real estate - Owner occupied |  |  | 3,835 |  |  | (603) |  |  | 87 |  |  | 3 |  |  | 3,148
Construction |  |  | 969 |  |  | (24) |  |  | - |  |  | (1) |  |  | 944
Residential real estate - Investor |  |  | 629 |  |  | (3) |  |  | 6 |  |  | 16 |  |  | 636
Residential real estate - Owner occupied |  |  | 1,302 |  |  | 4 |  |  | 12 |  |  | 26 |  |  | 1,320
Multifamily |  |  | 1,143 |  |  | 2 |  |  | - |  |  | 8 |  |  | 1,153
HELOC |  |  | 1,449 |  |  | (170) |  |  | - |  |  | 46 |  |  | 1,325
HELOC - Purchased |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Other 1 |  |  | 621 |  |  | 764 |  |  | 84 |  |  | 57 |  |  | 1,358
|  | $ | 19,006 |  | $ | 450 |  | $ | 345 |  | $ | 205 |  | $ | 19,316

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)

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

|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 90 days or
|  |  |  |  |  |  |  | 90 Days or |  |  |  |  |  |  |  |  |  |  | Greater Past
|  | 30-59 Days |  | 60-89 Days |  | Greater Past |  | Total Past |  |  |  |  |  |  |  | Due and
March 31, 2020 |  | Past Due |  | Past Due |  | Due |  | Due |  | Current |  | Total Loans |  | Accruing
Commercial |  | $ | 1,032 |  | $ | 46 |  | $ | 2,279 |  | $ | 3,357 |  | $ | 361,269 |  | $ | 364,626 |  | $ | -
Leases |  |  | 613 |  |  | 63 |  |  | 123 |  |  | 799 |  |  | 125,438 |  |  | 126,237 |  |  | -
Commercial real estate - Investor |  |  | 2,235 |  |  | - |  |  | 1,422 |  |  | 3,657 |  |  | 500,248 |  |  | 503,905 |  |  | 59
Commercial real estate - Owner occupied |  |  | 5,062 |  |  | 2,080 |  |  | 4,060 |  |  | 11,202 |  |  | 338,393 |  |  | 349,595 |  |  | -
Construction |  |  | 675 |  |  | - |  |  | 555 |  |  | 1,230 |  |  | 76,929 |  |  | 78,159 |  |  | 555
Residential real estate - Investor |  |  | 291 |  |  | 100 |  |  | 696 |  |  | 1,087 |  |  | 68,342 |  |  | 69,429 |  |  | -
Residential real estate - Owner occupied |  |  | 4,183 |  |  | 167 |  |  | 2,139 |  |  | 6,489 |  |  | 123,493 |  |  | 129,982 |  |  | 736
Multifamily |  |  | 1,815 |  |  | 561 |  |  | 69 |  |  | 2,445 |  |  | 192,852 |  |  | 195,297 |  |  | -
HELOC |  |  | 1,459 |  |  | - |  |  | 329 |  |  | 1,788 |  |  | 91,377 |  |  | 93,165 |  |  | 56
HELOC - Purchased |  |  | 49 |  |  | - |  |  | 65 |  |  | 114 |  |  | 30,766 |  |  | 30,880 |  |  | -
Other |  |  | 537 |  |  | 3 |  |  | 8 |  |  | 548 |  |  | 15,381 |  |  | 15,929 |  |  | -
Total |  | $ | 17,951 |  | $ | 3,020 |  | $ | 11,745 |  | $ | 32,716 |  | $ | 1,924,488 |  | $ | 1,957,204 |  | $ | 1,406

|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Recorded
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Investment
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 90 days or
|  |  |  |  |  |  |  | 90 Days or |  |  |  |  |  |  |  |  |  |  |  |  |  | Greater Past
|  | 30-59 Days |  | 60-89 Days |  | Greater Past |  | Total Past |  |  |  |  |  |  |  |  |  |  | Due and
December 31, 2019 |  | Past Due |  | Past Due |  | Due |  | Due |  | Current |  | Nonaccrual |  | Total Loans |  | Accruing
Commercial |  | $ | 1,271 |  | $ | 925 |  | $ | 2,103 |  | $ | 4,299 |  | $ | 328,399 |  | $ | 144 |  | $ | 332,842 |  | $ | 2,132
Leases |  |  | 362 |  |  | - |  |  | 81 |  |  | 443 |  |  | 118,979 |  |  | 329 |  |  | 119,751 |  |  | 128
Commercial real estate - Investor |  |  | 626 |  |  | 95 |  |  | 343 |  |  | 1,064 |  |  | 517,336 |  |  | 1,695 |  |  | 520,095 |  |  | 348
Commercial real estate - Owner occupied |  |  | 2,469 |  |  | 1,026 |  |  | - |  |  | 3,495 |  |  | 336,829 |  |  | 5,180 |  |  | 345,504 |  |  | -
Construction |  |  | 26 |  |  | - |  |  | - |  |  | 26 |  |  | 69,498 |  |  | 93 |  |  | 69,617 |  |  | -
Residential real estate - Investor |  |  | 141 |  |  | 125 |  |  | - |  |  | 266 |  |  | 70,051 |  |  | 788 |  |  | 71,105 |  |  | -
Residential real estate - Owner occupied |  |  | 3,450 |  |  | 1,351 |  |  | - |  |  | 4,801 |  |  | 128,650 |  |  | 2,572 |  |  | 136,023 |  |  | -
Multifamily |  |  | 10 |  |  | 1,700 |  |  | - |  |  | 1,710 |  |  | 187,995 |  |  | 68 |  |  | 189,773 |  |  | -
HELOC |  |  | 735 |  |  | 50 |  |  | 18 |  |  | 803 |  |  | 89,438 |  |  | 1,364 |  |  | 91,605 |  |  | 20
HELOC - Purchased |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 31,672 |  |  | 180 |  |  | 31,852 |  |  | -
Other 1 |  |  | 28 |  |  | - |  |  | - |  |  | 28 |  |  | 13,997 |  |  | 19 |  |  | 14,044 |  |  | -
Total, excluding PCI |  |  | 9,118 |  |  | 5,272 |  |  | 2,545 |  |  | 16,935 |  |  | 1,892,844 |  |  | 12,432 |  |  | 1,922,211 |  |  | 2,628
PCI loans, net of purchase accounting adjustments |  |  | 261 |  |  | - |  |  | - |  |  | 261 |  |  | 5,377 |  |  | 2,963 |  |  | 8,601 |  |  | -
Total |  | $ | 9,379 |  | $ | 5,272 |  | $ | 2,545 |  | $ | 17,196 |  | $ | 1,898,221 |  | $ | 15,395 |  | $ | 1,930,812 |  | $ | 2,628

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

The table presents loans on nonaccrual for which there was no related allowance for credit losses as of March 31, 2020, and December 31, 2019:

|  |  | March 31, 2020 |  | December 31, 2019
|  |  |  |  | Nonaccrual |  |  |  | Nonaccrual
|  |  | Nonaccrual |  | With no ACL |  | Nonaccrual |  | With no ACL
Commercial |  |  | $ | 2,418 |  | $ | 2,279 |  | $ | 144 |  | $ | -
Leases |  |  |  | 187 |  |  | 69 |  |  | 329 |  |  | 70
Commercial real estate - Investor |  |  |  | 1,750 |  |  | 1,750 |  |  | 1,695 |  |  | 1,590
Commercial real estate - Owner occupied |  |  |  | 7,436 |  |  | 7,357 |  |  | 5,180 |  |  | 2,366
Construction |  |  |  | 2,245 |  |  | 50 |  |  | 93 |  |  | 93
Residential real estate - Investor |  |  |  | 859 |  |  | 859 |  |  | 788 |  |  | 788
Residential real estate - Owner occupied |  |  |  | 3,406 |  |  | 3,406 |  |  | 2,572 |  |  | 2,475
Multifamily |  |  |  | 69 |  |  | 69 |  |  | 68 |  |  | 68
HELOC |  |  |  | 1,004 |  |  | 1,004 |  |  | 1,364 |  |  | 1,154
HELOC - Purchased |  |  |  | 114 |  |  | 114 |  |  | 180 |  |  | 180
Other |  |  |  | 9 |  |  | 1 |  |  | 19 |  |  | 2
Total, excluding PCI loans |  |  |  | 19,497 |  |  | 16,958 |  |  | 12,432 |  |  | 8,786
PCI loans, net of purchase accounting adjustments |  |  |  | - |  |  | - |  |  | 2,963 |  |  | 2,963
Total |  |  | $ | 19,497 |  | $ | 16,958 |  | $ | 15,395 |  | $ | 11,749

The Company recognized $152,000 of interest on nonaccrual loans during the three months ended March 31, 2020.

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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

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. The Company follows guidance of ASC 310-20 when determining whether a modification, extension, or renewal of a loan constitutes a current period origination. Generally, current period renewals of credit are re-underwritten at the point of renewal and considered current period financing receivables. The following table summarizes loans held for investment by year of origination and the related credit quality indicators at March 31, 2020:

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Revolving |  |
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Loans |  |
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Converted |  |
|  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Revolving |  | To Term |  |
|  | 2020 |  | 2019 |  | 2018 |  | 2017 |  | 2016 |  | Prior |  | Loans |  | Loans |  | Total
Commercial |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  | $ | 13,380 |  | $ | 48,708 |  | $ | 20,606 |  | $ | 10,684 |  | $ | 3,837 |  | $ | 4,074 |  | $ | 232,347 |  | $ | - |  | $ | 333,636
Special Mention |  |  | - |  |  | 11,152 |  |  | - |  |  | 17 |  |  | 394 |  |  | 49 |  |  | 8,118 |  |  | - |  |  | 19,730
Substandard 1 |  |  | - |  |  | 246 |  |  | 2,672 |  |  | - |  |  | 2,188 |  |  | - |  |  | 6,154 |  |  | - |  |  | 11,260
Total commercial |  |  | 13,380 |  |  | 60,106 |  |  | 23,278 |  |  | 10,701 |  |  | 6,419 |  |  | 4,123 |  |  | 246,619 |  |  | - |  |  | 364,626
Leases |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 14,148 |  |  | 65,670 |  |  | 22,923 |  |  | 10,133 |  |  | 9,848 |  |  | 2,892 |  |  | - |  |  | - |  |  | 125,614
Special Mention |  |  | - |  |  | 359 |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 359
Substandard 1 |  |  | - |  |  | - |  |  | - |  |  | 77 |  |  | 187 |  |  | - |  |  | - |  |  | - |  |  | 264
Total leases |  |  | 14,148 |  |  | 66,029 |  |  | 22,923 |  |  | 10,210 |  |  | 10,035 |  |  | 2,892 |  |  | - |  |  | - |  |  | 126,237
Commercial real estate - Investor |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 10,194 |  |  | 187,200 |  |  | 113,009 |  |  | 80,622 |  |  | 61,530 |  |  | 43,051 |  |  | 1,412 |  |  | - |  |  | 497,018
Special Mention |  |  | - |  |  | 153 |  |  | - |  |  | 583 |  |  | 19 |  |  | 59 |  |  | - |  |  | - |  |  | 814
Substandard 1 |  |  | - |  |  | 4,059 |  |  | 146 |  |  | - |  |  | 275 |  |  | 1,593 |  |  | - |  |  | - |  |  | 6,073
Total commercial real estate - investor |  |  | 10,194 |  |  | 191,412 |  |  | 113,155 |  |  | 81,205 |  |  | 61,824 |  |  | 44,703 |  |  | 1,412 |  |  | - |  |  | 503,905
Commercial real estate - Owner occupied |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 28,511 |  |  | 60,137 |  |  | 86,544 |  |  | 48,503 |  |  | 54,557 |  |  | 48,603 |  |  | 1,828 |  |  | - |  |  | 328,683
Special Mention |  |  | - |  |  | 557 |  |  | 560 |  |  | 2,805 |  |  | 5,325 |  |  | 1,161 |  |  | - |  |  | - |  |  | 10,408
Substandard 1 |  |  | 1,046 |  |  | 3,498 |  |  | 1,054 |  |  | 2,509 |  |  | 1,691 |  |  | 706 |  |  | - |  |  | - |  |  | 10,504
Total commercial real estate - owner occupied |  |  | 29,557 |  |  | 64,192 |  |  | 88,158 |  |  | 53,817 |  |  | 61,573 |  |  | 50,470 |  |  | 1,828 |  |  | - |  |  | 349,595
Construction |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 9,239 |  |  | 36,982 |  |  | 16,472 |  |  | 3,248 |  |  | 1,035 |  |  | 1,339 |  |  | 7,388 |  |  | - |  |  | 75,703
Special Mention |  |  | 42 |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 42
Substandard 1 |  |  | - |  |  | - |  |  | 2,364 |  |  | - |  |  | - |  |  | 50 |  |  | - |  |  | - |  |  | 2,414
Total construction |  |  | 9,281 |  |  | 36,982 |  |  | 18,836 |  |  | 3,248 |  |  | 1,035 |  |  | 1,389 |  |  | 7,388 |  |  | - |  |  | 78,159
Residential real estate - Investor |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 3,599 |  |  | 22,824 |  |  | 12,634 |  |  | 10,586 |  |  | 3,543 |  |  | 13,388 |  |  | 1,403 |  |  | - |  |  | 67,977
Special Mention |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Substandard 1 |  |  | 346 |  |  | - |  |  | 644 |  |  | 4 |  |  | - |  |  | 458 |  |  | - |  |  | - |  |  | 1,452
Total residential real estate - investor |  |  | 3,945 |  |  | 22,824 |  |  | 13,278 |  |  | 10,590 |  |  | 3,543 |  |  | 13,846 |  |  | 1,403 |  |  | - |  |  | 69,429
Residential real estate - Owner occupied |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 1,505 |  |  | 27,584 |  |  | 16,814 |  |  | 26,024 |  |  | 11,519 |  |  | 39,578 |  |  | 2,390 |  |  | - |  |  | 125,414
Special Mention |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Substandard 1 |  |  | - |  |  | 73 |  |  | - |  |  | 625 |  |  | 386 |  |  | 3,484 |  |  | - |  |  | - |  |  | 4,568
Total residential real estate - owner occupied |  |  | 1,505 |  |  | 27,657 |  |  | 16,814 |  |  | 26,649 |  |  | 11,905 |  |  | 43,062 |  |  | 2,390 |  |  | - |  |  | 129,982
Multifamily |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 4,167 |  |  | 56,534 |  |  | 45,839 |  |  | 46,900 |  |  | 13,903 |  |  | 20,624 |  |  | 312 |  |  | - |  |  | 188,279
Special Mention |  |  | - |  |  | - |  |  | 1,634 |  |  | - |  |  | 10 |  |  | - |  |  | - |  |  | - |  |  | 1,644
Substandard 1 |  |  | - |  |  | - |  |  | 2,374 |  |  | 619 |  |  | - |  |  | 2,381 |  |  | - |  |  | - |  |  | 5,374
Total multifamily |  |  | 4,167 |  |  | 56,534 |  |  | 49,847 |  |  | 47,519 |  |  | 13,913 |  |  | 23,005 |  |  | 312 |  |  | - |  |  | 195,297
HELOC |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 957 |  |  | 3,541 |  |  | 2,448 |  |  | 2,916 |  |  | 1,176 |  |  | 1,500 |  |  | 78,986 |  |  | - |  |  | 91,524

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Notes to Consolidated Financial Statements

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

Special Mention |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 13 |  |  | - |  |  | 13
Substandard 1 |  |  | 29 |  |  | 9 |  |  | 50 |  |  | 67 |  |  | 29 |  |  | 555 |  |  | 889 |  |  | - |  |  | 1,628
Total HELOC |  |  | 986 |  |  | 3,550 |  |  | 2,498 |  |  | 2,983 |  |  | 1,205 |  |  | 2,055 |  |  | 79,888 |  |  | - |  |  | 93,165
HELOC - Purchased |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 30,766 |  |  | - |  |  | - |  |  | 30,766
Special Mention |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Substandard 1 |  |  | - |  |  | 65 |  |  | 49 |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 114
Total HELOC - purchased |  |  | - |  |  | 65 |  |  | 49 |  |  | - |  |  | - |  |  | 30,766 |  |  | - |  |  | - |  |  | 30,880
Other |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 258 |  |  | 3,442 |  |  | 1,334 |  |  | 551 |  |  | 737 |  |  | 423 |  |  | 8,835 |  |  | - |  |  | 15,580
Special Mention |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | -
Substandard 1 |  |  | - |  |  | - |  |  | 340 |  |  | 8 |  |  | 1 |  |  | - |  |  | - |  |  | - |  |  | 349
Total other |  |  | 258 |  |  | 3,442 |  |  | 1,674 |  |  | 559 |  |  | 738 |  |  | 423 |  |  | 8,835 |  |  | - |  |  | 15,929
Total loans |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Pass |  |  | 85,958 |  |  | 512,622 |  |  | 338,623 |  |  | 240,167 |  |  | 161,685 |  |  | 206,238 |  |  | 334,901 |  |  | - |  |  | 1,880,194
Special Mention |  |  | 42 |  |  | 12,221 |  |  | 2,194 |  |  | 3,405 |  |  | 5,748 |  |  | 1,269 |  |  | 8,131 |  |  | - |  |  | 33,010
Substandard 1 |  |  | 1,421 |  |  | 7,950 |  |  | 9,693 |  |  | 3,909 |  |  | 4,757 |  |  | 9,227 |  |  | 7,043 |  |  | - |  |  | 44,000
Total loans |  | $ | 87,421 |  | $ | 532,793 |  | $ | 350,510 |  | $ | 247,481 |  | $ | 172,190 |  | $ | 216,734 |  | $ | 350,075 |  | $ | - |  | $ | 1,957,204

1 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.

Credit quality indicators by loan segment at December 31, 2019 were as follows:

December 31, 2019 |  |  |  |  | Special |  |  |  |  |  |  |  |  |
|  | Pass |  | Mention |  | Substandard 2 |  | Doubtful |  | Total
Commercial |  | $ | 307,948 |  | $ | 13,206 |  | $ | 11,688 |  | $ | - |  | $ | 332,842
Leases |  |  | 119,045 |  |  | 377 |  |  | 329 |  |  | - |  |  | 119,751
Commercial real estate - Investor |  |  | 510,640 |  |  | 4,529 |  |  | 4,926 |  |  |  |  |  | 520,095
Commercial real estate - Owner occupied |  |  | 330,891 |  |  | 6,657 |  |  | 7,956 |  |  | - |  |  | 345,504
Construction |  |  | 69,355 |  |  | - |  |  | 262 |  |  | - |  |  | 69,617
Residential real estate - Investor |  |  | 69,715 |  |  | - |  |  | 1,390 |  |  | - |  |  | 71,105
Residential real estate - Owner occupied |  |  | 132,258 |  |  | 134 |  |  | 3,631 |  |  | - |  |  | 136,023
Multifamily |  |  | 187,560 |  |  | 1,710 |  |  | 503 |  |  | - |  |  | 189,773
HELOC |  |  | 89,804 |  |  | 12 |  |  | 1,789 |  |  | - |  |  | 91,605
HELOC - Purchased |  |  | 31,672 |  |  | - |  |  | 180 |  |  |  |  |  | 31,852
Other 1 |  |  | 13,685 |  |  | - |  |  | 359 |  |  | - |  |  | 14,044
Total, excluding PCI loans |  | $ | 1,862,573 |  | $ | 26,625 |  | $ | 33,013 |  | $ | - |  | $ | 1,922,211
PCI loans, net of purchase accounting adjustments |  |  | 573 |  |  | 261 |  |  | 7,767 |  |  | - |  |  | 8,601
Total |  | $ | 1,863,146 |  | $ | 26,886 |  | $ | 40,780 |  | $ | - |  | $ | 1,930,812

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

2 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.

The Company had $585,000 and $831,000 in residential real estate loans in the process of foreclosure as of March 31, 2020, and December 31, 2019, respectively.

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

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Notes to Consolidated Financial Statements

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

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:

There was no TDR activity for the period ended March 31, 2020.

|  | TDR Modifications |
|  | Three Months Ended March 31, 2019 |
|  | # of |  | Pre-modification |  | Post-modification |
|  | contracts |  | recorded investment |  | recorded investment |
Troubled debt restructurings |  |  |  |  |  |  |  |  |
Commercial real estate - owner occupied |  |  |  |  |  |  |  |  |
Other 1 |  | 1 |  | $ | 58 |  | $ | 58 |
Residential real estate - owner occupied |  |  |  |  |  |  |  |  |
HAMP 2 |  | 1 |  |  | 105 |  |  | 9 |
HELOC |  |  |  |  |  |  |  |  |
HAMP 2 |  | 1 |  |  | 39 |  |  | 34 |
Other 1 |  | 1 |  |  | 39 |  |  | 38 |
Total |  | 4 |  | $ | 241 |  | $ | 139 |

1 Other: Change of terms from bankruptcy court.

2 HAMP: Home Affordable Modification Program.

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, 2020, and March 31, 2019, for loans that were restructured within the 12 month period prior to default.

Note 5 – 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 |  | 2020 |  | 2019 |
Balance at beginning of period |  | $ | 5,004 |  | $ | 7,175 |
Property additions, net of acquisition adjustments |  |  | 491 |  |  | - |
Property improvements |  |  | - |  |  | - |
Less: |  |  |  |  |  |  |
Proceeds from property disposals, net of participation purchase and of gains/losses |  |  | 288 |  |  | 801 |
Period valuation adjustments |  |  | 158 |  |  | - |
Other adjustments |  |  | - |  |  | 9 |
Balance at end of period |  | $ | 5,049 |  | $ | 6,365 |

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Notes to Consolidated Financial Statements

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

Activity in the valuation allowance was as follows:

|  | Three Months Ended |
|  | March 31, |
|  | 2020 |  | 2019 |
Balance at beginning of period |  | $ | 6,712 |  | $ | 8,027 |
Provision for unrealized losses |  |  | 158 |  |  | - |
Reductions taken on sales |  |  | (466) |  |  | (152) |
Balance at end of period |  | $ | 6,404 |  | $ | 7,875 |

Expenses related to OREO, net of lease revenue includes:

|  | Three Months Ended |
|  | March 31, |
|  | 2020 |  | 2019 |
Gain on sales, net |  | $ | (23) |  | $ | (73) |
Provision for unrealized losses |  |  | 158 |  |  | - |
Operating expenses |  |  | 102 |  |  | 128 |
Less: |  |  |  |  |  |  |
Lease revenue |  |  | - |  |  | 5 |
Net OREO expense |  | $ | 237 |  | $ | 50 |

Note 6 – Deposits

Major classifications of deposits were as follows:

|  | March 31, 2020 |  | December 31, 2019 |
Noninterest bearing demand |  | $ | 702,598 |  | $ | 669,795 |
Savings |  |  | 338,134 |  |  | 307,015 |
NOW accounts |  |  | 428,419 |  |  | 425,792 |
Money market accounts |  |  | 277,018 |  |  | 282,478 |
Certificates of deposit of less than $100,000 |  |  | 231,704 |  |  | 227,578 |
Certificates of deposit of $100,000 through $250,000 |  |  | 150,185 |  |  | 151,279 |
Certificates of deposit of more than $250,000 |  |  | 67,584 |  |  | 62,812 |
Total deposits |  | $ | 2,195,642 |  | $ | 2,126,749 |

Note 7 – Borrowings

The following table is a summary of borrowings as of March 31, 2020, and December 31, 2019. Junior subordinated debentures are discussed in more detail in Note 8:

|  | March 31, 2020 |  | December 31, 2019 |
Securities sold under repurchase agreements |  | $ | 51,236 |  | $ | 48,693 |
Other short-term borrowings 1 |  |  | 6,375 |  |  | 48,500 |
Junior subordinated debentures |  |  | 25,773 |  |  | 57,734 |
Senior notes |  |  | 44,297 |  |  | 44,270 |
Notes payable and other borrowings |  |  | 26,609 |  |  | 6,673 |
Total borrowings |  | $ | 154,290 |  | $ | 205,870 |

1 Includes short-term FHLBC advances for both periods presented.

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 $51.2 million at March 31, 2020, and $48.7 million at December 31, 2019. The fair value of the pledged collateral was $71.2 million at March 31, 2020, and $70.7 million at December 31, 2019. At March 31, 2020, there were no customers with secured balances exceeding 10% of stockholders’ equity.

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Notes to Consolidated Financial Statements

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

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, 2020, the Bank had $6.4 million in short-term advances outstanding under the FHLBC compared to $48.5 million outstanding as of December 31, 2019; the remaining $6.4 million was issued at rates ranging from 2.03% to 2.23%. The Bank also assumed $23.4 million of long-term FHLBC advances with the ABC Bank acquisition in 2018. At March 31, 2020, one advance remains in long-term status, with a total outstanding balance of $6.6 million, at a 2.83% interest rate, and is scheduled to mature on February 2, 2026. FHLBC stock held at March 31, 2020 was valued at $3.7 million, and any potential FHLBC advances were collateralized by securities with a fair value of $51.0 million and loans with a principal balance of $568.3 million, which carried a FHLBC-calculated combined collateral value of $481.6 million. The Company had excess collateral of $344.3 million available to secure borrowings at March 31, 2020.

The Company also has $44.3 million of senior notes outstanding, net of deferred issuance costs, as of March 31, 2020 and December 31, 2019. The senior notes were issued in December 2016 with a ten year 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, 2020, and December 31, 2019, unamortized debt issuance costs related to the senior notes were $703,000 and $730,000, 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.

On February 24, 2020, the Company originated a $20.0 million term note with a correspondent bank in anticipation of the redemption of the Company’s 7.80% cumulative trust preferred securities issued by Old Second Capital Trust I and related junior subordinated debentures. See the discussion in Note 8 – Junior Subordinated Debentures. The term note was issued for a three year term at one-month Libor plus 175 basis points, requires principal and interest payments quarterly, and the balance of this note is included within Notes Payable and Other Borrowings on the Consolidated Balance Sheet. The Company also has an undrawn line of credit of $20.0 million with a correspondent bank to be used for short-term funding needs; advances under this line can be outstanding up to 360 days from the date of issuance. This line of credit has not been utilized since early 2019.

Note 8 – Junior Subordinated Debentures

On March 2, 2020, the Company redeemed 7.80% cumulative trust preferred securities issued by Old Second Capital Trust I (“OSBCP”) and related debentures, which totaled $32.6 million. These debentures were originally issued in 2003 for a term of 30 years at 7.80%, and subject to regulatory approval, were able to be called in whole or in part by the Company after June 30, 2008. The Company received regulatory approval to redeem the debentures in early 2020, and notified OSBCP stockholders of the redemption in late January 2020. Cash disbursed for the redemption, including accrued interest on the debentures, totaled $33.0 million, or $10.13 per OSBCP share. The OSBCP redemption was funded by cash on hand and the $20 million term note discussed in Note 7 – Borrowings. Upon redemption of the junior subordinated debentures related to OSBCP in March 2020, the Company recognized the remaining unamortized debt issuance costs of $635,000.

The Company issued $25.0 million of cumulative trust preferred securities through a private placement completed by another 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 4.40% for the quarter ended March 31, 2020, compared to the rate paid for the quarter ended March 31, 2019, of 4.39%. 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.

The junior subordinated debentures issued by the Company are disclosed on the Consolidated Balance Sheet, and the related interest expense for each issuance is included in the Consolidated Statements of Income. As of March 31, 2020, and December 31, 2019, the remaining unamortized debt issuance costs related to the junior subordinated debentures were $1,000 and $644,000 respectively, and are included as a reduction to the balance of the junior subordinated debentures on the Consolidated Balance Sheet. The remaining deferred issuance costs on the junior subordinated debentures related to the issuance of Old Second Capital Trust II will be amortized to interest expense over the remainder of the 30-year term of the notes and are included in the Consolidated Statements of Income.

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Notes to Consolidated Financial Statements

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

Note 9 – Equity Compensation Plans

Stock-based awards are outstanding under the Company’s 2014 Equity Incentive Plan, as amended (the “2014 Plan”), and the Company’s 2019 Equity Incentive Plan (the “2019 Plan” and together with the 2014 Plan, the “Plans”). The 2019 Plan was approved at the May 2019 annual stockholders’ meeting and the number of authorized shares under the 2019 Plan is fixed at 600,000. Following approval of the 2019 Plan, no further awards were to be granted under the 2014 Plan or any other prior Company equity compensation plan. The 2019 Plan authorizes the granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights (“SARs”). Awards may be granted to selected directors, officers, employees or eligible service providers under the 2019 Plan at the discretion of the Compensation Committee of the Company’s Board of Directors. As of March 31, 2020, 341,985 shares remained available for issuance under the 2019 Plan.

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

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. During the first quarter of 2020, there were no stock options granted or exercised, and as of March 31, 2020, there were no stock options outstanding.

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 137,944 restricted stock units issued under the 2019 Plan during the three months ended March 31, 2020. No restricted stock units were issued under the 2014 Plan during the three months ended March 31, 2019. 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 Plans was $735,000 and $578,000 in the first three months of 2020 and 2019, respectively.

A summary of changes in the Company’s unvested restricted awards for the three months ended March 31, 2020, is as follows:

|  | March 31, 2020
|  |  |  | Weighted
|  | Restricted |  | Average
|  | Stock Shares |  | Grant Date
|  | and Units |  | Fair Value
Unvested at January 1 |  | 555,283 |  | $ | 12.85
Granted |  | 137,944 |  |  | 12.26
Vested |  | (119,452) |  |  | 11.00
Forfeited |  | - |  |  | -
Unvested at March 31 |  | 573,775 |  | $ | 13.09

Total unrecognized compensation cost of restricted awards was $4.0 million as of March 31, 2020, which is expected to be recognized over a weighted-average period of 2.1 years.

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Notes to Consolidated Financial Statements

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

Note 10 – Earnings Per Share

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

|  | Three Months Ended March 31, |  |
|  | 2020 |  | 2019 |  |
Basic earnings per share: |  |  |  |  |  |  |  |
Weighted-average common shares outstanding |  |  | 29,929,763 |  |  | 29,845,653 |  |
Net income |  | $ | 275 |  | $ | 8,468 |  |
Basic earnings per share |  | $ | 0.01 |  | $ | 0.28 |  |
Diluted earnings per share: |  |  |  |  |  |  |  |
Weighted-average common shares outstanding |  |  | 29,929,763 |  |  | 29,845,653 |  |
Dilutive effect of unvested restricted awards 1 |  |  | 560,842 |  |  | 497,978 |  |
Diluted average common shares outstanding |  |  | 30,490,605 |  |  | 30,343,631 |  |
Net Income |  | $ | 275 |  | $ | 8,468 |  |
Diluted earnings per share |  | $ | 0.01 |  | $ | 0.28 |  |
1 Includes the common stock equivalents for restricted share rights that are dilutive. |  |

Note 11 – 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, 2020, the Bank exceeded those thresholds.

At March 31, 2020, the Bank’s Tier 1 capital leverage ratio was 11.36%, a decrease of 114 basis points from December 31, 2019, but is well above the 8.00% objective. The Bank’s total capital ratio was 14.07%, a decrease of 116 basis points from December 31, 2019, but also well above the objective of 12.00%. The reduction in the ratios is primarily due to a $30.0 million dividend the Bank paid the Company in March 2020.

Bank holding companies are generally required to maintain minimum levels of capital in accordance with capital guidelines implemented by the Board of Governors of the Federal Reserve System. The general bank and holding company capital adequacy guidelines are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of March 31, 2020, and December 31, 2019.

In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital requirements for U.S. banking institutions, which went into effect on January 1, 2015. The Basel III Rules are applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” generally holding companies with consolidated assets of less than $3 billion. The Company is currently considered a “small bank holding company.” A detailed discussion of the Basel III Rules is included in Part I, Item 1 of the Company’s Form 10-K for the year ended December 31, 2019, under the heading “Supervision and Regulation.”

At March 31, 2020, and December 31, 2019, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “well capitalized” under current regulatory defined capital ratios.

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Notes to Consolidated Financial Statements

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

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

|  |  |  |  |  |  |  | Minimum Capital |  | Well Capitalized |
|  |  |  |  |  |  |  | Adequacy with Capital |  | Under Prompt Corrective |
|  | Actual |  | Conservation Buffer, if applicable 1 |  | Action Provisions 2 |
|  | Amount |  | Ratio |  | Amount |  | Ratio |  | Amount |  | Ratio |
March 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Common equity tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  | $ | 251,168 |  | 10.85 | % |  | $ | 162,044 |  | 7.000 | % |  |  | N/A |  | N/A |
Old Second Bank |  |  | 296,496 |  | 12.89 |  |  |  | 161,014 |  | 7.000 |  |  | $ | 149,513 |  | 6.50 | %
Total capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 303,182 |  | 13.09 |  |  |  | 243,194 |  | 10.500 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 323,510 |  | 14.07 |  |  |  | 241,425 |  | 10.500 |  |  |  | 229,929 |  | 10.00 |
Tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 276,168 |  | 11.93 |  |  |  | 196,767 |  | 8.500 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 296,496 |  | 12.89 |  |  |  | 195,517 |  | 8.500 |  |  |  | 184,016 |  | 8.00 |
Tier 1 capital to average assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 276,168 |  | 10.57 |  |  |  | 104,510 |  | 4.00 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 296,496 |  | 11.36 |  |  |  | 104,400 |  | 4.00 |  |  |  | 130,500 |  | 5.00 |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Common equity tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  | $ | 251,477 |  | 11.14 | % |  | $ | 158,020 |  | 7.000 | % |  |  | N/A |  | N/A |
Old Second Bank |  |  | 322,496 |  | 14.35 |  |  |  | 157,315 |  | 7.000 |  |  | $ | 146,078 |  | 6.50 | %
Total capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 327,886 |  | 14.53 |  |  |  | 236,944 |  | 10.500 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 342,280 |  | 15.23 |  |  |  | 235,978 |  | 10.500 |  |  |  | 224,741 |  | 10.00 |
Tier 1 capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 308,102 |  | 13.65 |  |  |  | 191,858 |  | 8.500 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 322,496 |  | 14.35 |  |  |  | 191,026 |  | 8.500 |  |  |  | 179,789 |  | 8.00 |
Tier 1 capital to average assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated |  |  | 308,102 |  | 11.93 |  |  |  | 103,303 |  | 4.00 |  |  |  | N/A |  | N/A |
Old Second Bank |  |  | 322,496 |  | 12.50 |  |  |  | 103,199 |  | 4.00 |  |  |  | 128,998 |  | 5.00 |

1 Amounts are shown inclusive of a capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes.

2 The prompt corrective action provisions are only applicable at the Bank level. The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized.”

As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provides banking organizations that adopt CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we have elected to utilize the five-year CECL transition. The cumulative amount that is not recognized in regulatory capital, in addition to the $3.8 million Day 1 impact of CECL adoption, will be phased in at 25% per year beginning January 1, 2022. As of March 31, 2020, the capital measures of the Company exclude $5.2 million, which is the Day 1 impact to retained earnings and 25% of the $8.0 million increase in the allowance for credit losses in the first quarter of 2020, excluding PCD loans.

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Notes to Consolidated Financial Statements

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

Dividend Restrictions

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

Stock Repurchase Program

In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase Program”). Repurchases by us under the Repurchase Program may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. During the first quarter of 2020, we repurchased 312,723 shares of our common stock at a weighted average price of $7.06 per share pursuant to the Repurchase Program.

Note 12 – 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.

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Notes to Consolidated Financial Statements

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

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

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

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

| · |  | The fair value of impaired loans with specific allocations of the allowance for credit 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 fair value, less costs to sell. Fair values are based on third party appraisals of the property, resulting in a Level 3 classification, or an executed pending sales contract. 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, 2020, and December 31, 2019, respectively, measured by the Company at fair value on a recurring basis:

|  | March 31, 2020
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Assets: |  |  |  |  |  |  |  |  |  |  |  |
Securities available-for-sale |  |  |  |  |  |  |  |  |  |  |  |
U.S. Treasury |  | $ | 4,152 |  | $ | - |  | $ | - |  | $ | 4,152
U.S. government agencies |  |  | - |  |  | 7,723 |  |  | - |  |  | 7,723
U.S. government agencies mortgage-backed |  |  | - |  |  | 17,255 |  |  | - |  |  | 17,255
States and political subdivisions |  |  | - |  |  | 243,938 |  |  | 11,157 |  |  | 255,095
Collateralized mortgage obligations |  |  | - |  |  | 53,403 |  |  | - |  |  | 53,403
Asset-backed securities |  |  | - |  |  | 77,727 |  |  | - |  |  | 77,727
Collateralized loan obligations |  |  | - |  |  | 34,339 |  |  | - |  |  | 34,339
Loans held-for-sale |  |  | - |  |  | 10,049 |  |  | - |  |  | 10,049
Mortgage servicing rights |  |  | - |  |  | - |  |  | 4,108 |  |  | 4,108
Interest rate swap agreements |  |  | - |  |  | 11,115 |  |  | - |  |  | 11,115
Mortgage banking derivatives |  |  | - |  |  | 732 |  |  | - |  |  | 732
Total |  | $ | 4,152 |  | $ | 456,281 |  | $ | 15,265 |  | $ | 475,698
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swap agreements, including risk participation agreements |  | $ | - |  | $ | 16,912 |  | $ | - |  | $ | 16,912
Total |  | $ | - |  | $ | 16,912 |  | $ | - |  | $ | 16,912

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Notes to Consolidated Financial Statements

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

|  | December 31, 2019
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Assets: |  |  |  |  |  |  |  |  |  |  |  |
Securities available-for-sale |  |  |  |  |  |  |  |  |  |  |  |
U.S. Treasury |  | $ | 4,036 |  | $ | - |  | $ | - |  | $ | 4,036
U.S. government agencies |  |  | - |  |  | 8,337 |  |  | - |  |  | 8,337
U.S. government agencies mortgage-backed |  |  | - |  |  | 16,588 |  |  | - |  |  | 16,588
States and political subdivisions |  |  | - |  |  | 243,756 |  |  | 5,419 |  |  | 249,175
Collateralized mortgage obligations |  |  | - |  |  | 57,984 |  |  | - |  |  | 57,984
Asset-backed securities |  |  | - |  |  | 81,844 |  |  | - |  |  | 81,844
Collateralized loan obligations |  |  | - |  |  | 66,684 |  |  | - |  |  | 66,684
Loans held-for-sale |  |  | - |  |  | 3,061 |  |  | - |  |  | 3,061
Mortgage servicing rights |  |  | - |  |  | - |  |  | 5,935 |  |  | 5,935
Interest rate swap agreements |  |  | - |  |  | 2,771 |  |  | - |  |  | 2,771
Mortgage banking derivatives |  |  | - |  |  | 250 |  |  | - |  |  | 250
Total |  | $ | 4,036 |  | $ | 481,275 |  | $ | 11,354 |  | $ | 496,665
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swap agreements, including risk participation agreements |  | $ | - |  | $ | 5,974 |  | $ | - |  | $ | 5,974
Total |  | $ | - |  | $ | 5,974 |  | $ | - |  | $ | 5,974

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

|  | Three Months Ended March 31, 2020
|  | Securities available-for-sale |  |  |
|  | States and |  | Mortgage
|  | Political |  | Servicing
|  | Subdivisions |  | Rights
Beginning balance January 1, 2020 |  | $ | 5,419 |  | $ | 5,935
Total gains or losses |  |  |  |  |  |
Included in earnings |  |  | (6) |  |  | (1,859)
Included in other comprehensive income |  |  | (325) |  |  | -
Purchases, issuances, sales, and settlements |  |  |  |  |  |
Purchases |  |  | 6,100 |  |  | -
Issuances |  |  | - |  |  | 307
Settlements |  |  | (31) |  |  | (275)
Ending balance March 31, 2020 |  | $ | 11,157 |  | $ | 4,108

|  | Three Months Ended March 31, 2019
|  | Securities available-for-sale |  |  |
|  | States and |  | Mortgage
|  | Political |  | Servicing
|  | Subdivisions |  | Rights
Beginning balance January 1, 2019 |  | $ | 8,165 |  | $ | 7,357
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)

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of March 31, 2020:

|  |  |  |  |  |  |  |  |  |  | Weighted
Measured at fair value |  |  |  |  |  |  | Unobservable |  |  |  | Average
on a recurring basis: |  | Fair Value |  | Valuation Methodology |  | Inputs |  | Range of Input |  | of Inputs
Mortgage servicing rights |  | $ | 4,108 |  | Discounted Cash Flow |  | Discount Rate |  | 10.0 - 17.0% |  | 10.1 | %
|  |  |  |  |  |  | Prepayment Speed |  | 7.0 - 71.8% |  | 20.7 | %

The following table and commentary presents quantitative and qualitative information about Level 3 fair value measurements as of December 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 |  | $ | 5,935 |  | Discounted Cash Flow |  | Discount Rate |  | 10.0 - 58.8% |  | 10.1 | %
|  |  |  |  |  |  | Prepayment Speed |  | 0.0 - 69.0% |  | 14.1 | %

In addition to the above, Level 3 fair value measurement included $11.2 million for state and political subdivisions representing various local municipality securities at March 31, 2020. 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, 2019, was $19.6 million. This was 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, 2020, and December 31, 2019, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:

|  | March 31, 2020
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Individually evaluated loans 1 |  | $ | - |  | $ | - |  | $ | 23,436 |  | $ | 23,436
Other real estate owned, net 2 |  |  | - |  |  | - |  |  | 5,049 |  |  | 5,049
Total |  | $ | - |  | $ | - |  | $ | 28,485 |  | $ | 28,485

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 $25.3 million and a valuation allowance of $1.9 million resulting in an increase of specific allocations within the allowance for credit losses on loans of $732,000 for the three months ended March 31, 2020.

2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $5.0 million, which is made up of the outstanding balance of $12.3 million, net of a valuation allowance of $6.4 million and a participation of $937,000 at March 31, 2020.

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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, 2019
|  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Impaired loans 1 |  | $ | - |  | $ | - |  | $ | 7,435 |  | $ | 7,435
Other real estate owned, net 2 |  |  | - |  |  | - |  |  | 5,004 |  |  | 5,004
Total |  | $ | - |  | $ | - |  | $ | 12,439 |  | $ | 12,439

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 $8.6 million and a valuation allowance of $1.2 resulting in an increase of specific allocations within the allowance for credit losses on loans of $783,000 for the year December 31, 2019.

2 OREO is measured at fair value, less costs to sell, and had a net carrying amount of $5.0 million, which is made up of the outstanding balance of $12.6 million, net of a valuation allowance of $6.7 million and a participation of $937,000, at December 31, 2019.

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 13 – 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. For March 31, 2020 and December 31, 2019, 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.

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

|  | March 31, 2020
|  | Carrying |  | Fair |  |  |  |  |  |  |  |  |
|  | Amount |  | Value |  | Level 1 |  | Level 2 |  | Level 3
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 27,627 |  | $ | 27,627 |  | $ | 27,627 |  | $ | - |  | $ | -
Interest bearing deposits with financial institutions |  |  | 45,511 |  |  | 45,511 |  |  | 45,511 |  |  | - |  |  | -
Securities available-for-sale |  |  | 449,694 |  |  | 449,694 |  |  | 4,152 |  |  | 434,385 |  |  | 11,157
FHLBC and FRBC stock |  |  | 9,917 |  |  | 9,917 |  |  | - |  |  | 9,917 |  |  | -
Loans held-for-sale |  |  | 10,049 |  |  | 10,049 |  |  | - |  |  | 10,049 |  |  | -
Net loans |  |  | 1,927,159 |  |  | 1,947,974 |  |  | - |  |  | - |  |  | 1,947,974
Interest rate swap agreements |  |  | 11,115 |  |  | 11,115 |  |  | - |  |  | 11,115 |  |  |
Interest receivable on securities and loans |  |  | 9,392 |  |  | 9,392 |  |  | - |  |  | 9,392 |  |  | -
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest bearing deposits |  | $ | 702,598 |  | $ | 702,598 |  | $ | 702,598 |  | $ | - |  | $ | -
Interest bearing deposits |  |  | 1,493,044 |  |  | 1,496,968 |  |  | - |  |  | 1,496,968 |  |  | -
Securities sold under repurchase agreements |  |  | 51,236 |  |  | 51,236 |  |  | - |  |  | 51,236 |  |  | -
Other short-term borrowings |  |  | 6,375 |  |  | 6,375 |  |  | - |  |  | 6,375 |  |  | -
Junior subordinated debentures |  |  | 25,773 |  |  | 9,257 |  |  | - |  |  | 9,257 |  |  | -
Senior notes |  |  | 44,297 |  |  | 42,689 |  |  | 42,689 |  |  | - |  |  | -
Note payable and other borrowings |  |  | 26,609 |  |  | 27,003 |  |  | - |  |  | 27,003 |  |  | -
Interest rate swap agreements |  |  | 16,795 |  |  | 16,795 |  |  | - |  |  | 16,795 |  |  | -
Interest payable on deposits and borrowings |  |  | 1,728 |  |  | 1,728 |  |  | 4 |  |  | 1,724 |  |  | -

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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, 2019
|  | Carrying |  | Fair |  |  |  |  |  |
|  | Amount |  | Value |  | Level 1 |  | Level 2 |  | Level 3
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 34,096 |  | $ | 34,096 |  | $ | 34,096 |  | $ | - |  | $ | -
Interest bearing deposits with financial institutions |  |  | 16,536 |  |  | 16,536 |  |  | 16,536 |  |  | - |  |  | -
Securities available-for-sale |  |  | 484,648 |  |  | 484,648 |  |  | 4,036 |  |  | 475,193 |  |  | 5,419
FHLBC and FRBC stock |  |  | 9,917 |  |  | 9,917 |  |  | - |  |  | 9,917 |  |  | -
Loans held-for-sale |  |  | 3,061 |  |  | 3,061 |  |  | - |  |  | 3,061 |  |  | -
Net loans |  |  | 1,911,023 |  |  | 1,915,531 |  |  | - |  |  | - |  |  | 1,915,531
Interest rate swap agreements |  |  | 2,771 |  |  | 2,771 |  |  | - |  |  | 2,771 |  |  | -
Interest receivable on securities and loans |  |  | 9,697 |  |  | 9,697 |  |  | - |  |  | 9,697 |  |  | -
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest bearing deposits |  | $ | 669,795 |  | $ | 669,975 |  | $ | 669,975 |  | $ | - |  | $ | -
Interest bearing deposits |  |  | 1,456,954 |  |  | 1,457,832 |  |  | - |  |  | 1,457,832 |  |  | -
Securities sold under repurchase agreements |  |  | 48,693 |  |  | 48,693 |  |  | - |  |  | 48,693 |  |  | -
Other short-term borrowings |  |  | 48,500 |  |  | 48,500 |  |  | - |  |  | 48,500 |  |  | -
Junior subordinated debentures |  |  | 57,734 |  |  | 51,188 |  |  | 33,614 |  |  | 17,574 |  |  | -
Senior notes |  |  | 44,270 |  |  | 46,269 |  |  | 46,269 |  |  | - |  |  | -
Note payable and other borrowings |  |  | 6,673 |  |  | 7,003 |  |  | - |  |  | 7,003 |  |  | -
Interest rate swap agreements |  |  | 5,921 |  |  | 5,921 |  |  | - |  |  | 5,921 |  |  | -
Interest payable on deposits and borrowings |  |  | 1,079 |  |  | 1,079 |  |  | - |  |  | 1,079 |  |  | -

Note 14 – 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 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. In December of 2019, the Company also executed a loan pool hedge of $50 million to convert variable rate loans to a fixed rate index for a five year term.

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 income/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 $625,000 will be reclassified as an increase to interest income and an additional $600,000 will be reclassified as an increase to interest expense.

Non-designated Hedges

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

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

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 with financial counterparties 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.

In December of 2019, the Company also executed a loan pool hedge of $50.0 million to convert variable rate loans to a fixed rate index for a five year term. This transaction falls under hedge accounting standards and is paired against a pool the Bank’s Libor-based loans. Overall, the new swap only bolsters income in down rate scenarios by a modest degree. We consider the current level of interest rate risk to be moderate but intend to continue looking for market opportunities for further hedging opportunities.

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 a net $2.0 million of cash collateral held by one correspondent financial institution to support interest rate swap activity at March 31, 2020; $14.6 million of investment securities were required to be pledged to one correspondent financial institution. The Bank had $114,000 of cash collateral pledged with one correspondent financial institution to support interest rate swap activity at December 31, 2019; $11.0 million of investment securities were required to be pledged to two correspondent financial institutions. At March 31, 2020, the notional amount of non-hedging interest rate swaps was $193.4 million with a weighted average maturity of 6.0 years. At December 31, 2019, the notional amount of non-hedging interest rate swaps was $177.9 million with a weighted average maturity of 5.9 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, 2020, and December 31, 2019.

Fair Value of Derivative Instruments

|  |  |  |  | March 31, 2020
| No. of Trans. |  | Notional Amount $ |  | Balance Sheet Location | Fair Value $ |  | Balance Sheet Location | Fair Value $
Derivatives designated as hedging instruments |  |  |  |  |  |  |  |  |
Interest rate swaps | 2 |  | 75,774 |  | Other Assets | 2,838 |  | Other Liabilities | 8,518
Total derivatives designated as hedging instruments |  |  |  |  |  | 2,838 |  |  | 8,518
Derivatives not designated as hedging instruments |  |  |  |  |  |  |  |  |

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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 swaps with commercial loan customers | 350 |  | 193,418 |  | Other Assets | 8,277 |  | Other Liabilities | 8,277
Interest rate lock commitments and forward contracts | 46 |  | 80,500 |  | Other Assets | 732 |  | Other Liabilities | -
Other contracts | 4 |  | 28,052 |  | Other Assets | - |  | Other Liabilities | 118
Total derivatives not designated as hedging instruments |  |  |  |  |  | 9,009 |  |  | 8,395
|  |  |  |  | December 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 | 2 |  | 75,774 |  | Other Assets | - |  | Other Liabilities | 3,150
Total derivatives designated as hedging instruments |  |  |  |  |  | - |  |  | 3,150
Derivatives not designated as hedging instruments |  |  |  |  |  |  |  |  |
Interest rate swaps with commercial loan customers | 25 |  | 177,872 |  | Other Assets | 2,771 |  | Other Liabilities | 2,771
Interest rate lock commitments and forward contracts | 87 |  | 23,667 |  | Other Assets | 250 |  | Other Liabilities | -
Other contracts | 4 |  | 28,176 |  | Other Assets | - |  | Other Liabilities | 53
Total derivatives not designated as hedging instruments |  |  |  |  |  | 3,021 |  |  | 2,824

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 loss recognized in AOCI on derivatives totaled $4.1 million as of March 31, 2020, and $800,000 as of March 31, 2019. The amount of the loss reclassified from AOCI to interest income on the income statement totaled $86,000 and $5,000 for the three months ended March 31, 2020, and March 31, 2019, 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.

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 FDIC.

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, 2020, and December 31, 2019.

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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 is a summary of letter of credit commitments:

|  | March 31, 2020 |  | December 31, 2019 |
|  | Fixed |  | Variable |  | Total |  | Fixed |  | Variable |  | Total |
Letters of credit: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Borrower: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial standby |  | $ | 329 |  | $ | 9,381 |  | $ | 9,710 |  | $ | 339 |  | $ | 9,612 |  | $ | 9,951 |
Commercial standby |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |  |  | - |
Performance standby |  |  | 571 |  |  | 6,070 |  |  | 6,641 |  |  | 571 |  |  | 6,212 |  |  | 6,783 |
|  |  | 900 |  |  | 15,451 |  |  | 16,351 |  |  | 910 |  |  | 15,824 |  |  | 16,734 |
Non-borrower: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Performance standby |  |  | - |  |  | 67 |  |  | 67 |  |  | - |  |  | 67 |  |  | 67 |
Total letters of credit |  | $ | 900 |  | $ | 15,518 |  | $ | 16,418 |  | $ | 910 |  | $ | 15,891 |  | $ | 16,801 |
Unused loan commitments |  | $ | 112,537 |  | $ | 326,945 |  | $ | 439,482 |  | $ | 111,348 |  | $ | 320,120 |  | $ | 431,468 |

As of January 1, 2020, we adopted ASU 2016-13, and per CECL guidance, the Company recorded an allowance for credit losses on unfunded commitments of $1.7 million. As of March 31, 2020, the Company evaluated current market conditions, including the impacts related to COVID-19 and market interest rate reductions during the first quarter of 2020, and based on that analysis under CECL methodology, the Company recorded a provision for credit losses related to unfunded commitments of $2.5 million. The Company will continue to assess the credit risk at least quarterly, and adjust the allowance for unfunded commitments, which is carried within other liabilities on our Consolidated Balance Sheet, as needed, with the appropriate offsetting entry to the provision for credit losses on our Consolidated Statements of Income.

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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 three months ended March 31, 2020, as compared to the three months ended March 31, 2019, and our financial condition at March 31, 2020, compared to December 31, 2019. 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, 2019. The results of operations for the three months ended March 31, 2020, are not necessarily indicative of future results. Dollar amounts presented in the following tables are in thousands, except per share data, and March 2020 and 2019 amounts are unaudited.

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

We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” on page 3 of this report.

Business Overview

The Company is a bank holding company headquartered in Aurora, Illinois. Through our wholly-owned subsidiary bank, Old Second National Bank, a national banking organization also headquartered in Aurora, Illinois, we offer a wide range of financial services through our 29 banking centers located in Cook, DeKalb, DuPage, Kane, Kendall, LaSalle and Will counties in Illinois. These banking centers offer access to a full range of traditional retail and commercial banking services including treasury management operations as well as fiduciary and wealth management services. We focus our business on establishing and maintaining relationships with our clients while maintaining a commitment to provide for the financial services needs of the communities in which we operate. We emphasize relationships with individual customers as well as small to medium-sized businesses throughout our market area. We also have extensive wealth management services, which includes a registered investment advisory platform in addition to trust administration and trust services related to personal and corporate trusts and employee benefit plan administration services.

Recent Events—COVID-19

In December 2019, a novel strain of coronavirus (COVID-19) was reported to have surfaced in China, and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in our markets. In response to the COVID-19 pandemic, the State of Illinois and most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential.

While o ur business has been designated an essential business, which allows us to continue to serve our customers, we serve many customers that have been deemed, or who are employed by businesses that have been deemed, to be non-essential. In addition, many of our customers that have been categorized to date as essential businesses, or who are employed by businesses that have been categorized as essential businesses, have been adversely affected by the COVID-19 pandemic.

The impact of the COVID-19 pandemic is fluid and continues to evolve. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and has had an adverse effect on our business and results of operations. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020, for the first time. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic has had and is expected to continue to have a significant and adverse effect on our business and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our customers, employees and vendors.

Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and in the United States as a whole.

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Temporary Operational Changes

We have taken a number of steps to protect our employees, customers and communities. As part of our efforts to exercise social distancing, in March 2020, we closed all of our banking lobbies (other than by appointment) and are conducting most of our business at this time through drive-thru tellers and through electronic and online means. In addition, a majority of our workforce is working from home.

Results of Operation and Financial Condition

We are monitoring the impact of the COVID-19 pandemic on our results of operation and financial condition. While we did not yet have a significant impact to our financial condition as of March 31, 2020, in the form of incurred losses or any communications from our borrowers that significant losses were imminent, we nevertheless determined it prudent to increase our provision for credit losses in anticipation of continued market risk and uncertainty at this time. Our provision for credit losses was $8.0 million for the first quarter of 2020, which was impacted by both our adoption of the new CECL methodology and the expected impact, as of March 31, 2020, of the COVID-19 pandemic and market interest rate reductions. Our provision for credit losses for periods ending after March 31, 2020 may be materially impacted by the COVID-19 pandemic.

We also adjust our investment securities portfolio to market each period end and review for any impairment that would require a provision for credit losses. As this time, we have determined there is no need for a provision for credit losses related to our investment securities portfolio. Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments in the future on the securities we hold as well as reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.

As of March 31, 2020, we had $18.6 million of goodwill. During the first quarter of 2020, we considered whether a quantitative assessment of our goodwill was required because of the significant economic disruption caused by the COVID-19 pandemic. At March 31, 2020, we determined no goodwill impairment was required, since the negative market indicators were not observed over a sustained period of time. However, further delayed recovery or further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our results of operations and financial condition.

Lending Operations and Accommodations to Borrowers

During this unprecedented situation, we have established client assistance programs, including offering commercial, consumer, and mortgage loan payment deferrals for certain clients. As of May 4, 2020, we had executed 239 of these deferrals on outstanding loan balances of $104.1 million. In accordance with interagency guidance issued in March 2020, these short term deferrals are not considered troubled debt restructurings. We have also suspended late fees for consumer loans through June 30, 2020. We have also paused new foreclosure and repossession actions until June 30, 2020, and will continue to re-evaluate based on the ongoing COVID-19 pandemic. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time. Future governmental actions may require these and other types of customer-related responses.

We are also participating in the Coronavirus Aid, Relief and Economic Security Act (“CARES” Act). As of May 4, 2020, we had processed 267 loan applications for the SBA Paycheck Protection Program (“PPP”), representing a total of $96.3 million. We remain ready to continue to fund eligible client requests if Congress appropriates additional funds.

Capital and Liquidity

As of March 31, 2020, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by credit losses.

We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic and our participation in the PPP. As customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit.

The Federal Reserve Bank has provided a lending facility that will allow us to obtain funding specifically for loans that we make under the PPP, which will allow us to retain existing sources of liquidity for our traditional operations. PPP loans will be pledged as collateral on any of our borrowings under the Federal Reserve Bank’s lending facility. These factors, together or in combination with other events or occurrences that may not yet be known or anticipated, may materially and adversely affect our business, financial condition and results of operations.

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We have also developed new processes to monitor our liquidity on a daily basis, and have run stress testing based on various economic assumptions under stress and severe stress scenarios. In addition, management is communicating multiple times each week in structured meetings with key staff to seek to ensure all current events related to the COVID-19 pandemic, such as federal government stimulus check receipt and PPP loan fundings, are managed appropriately.

Financial Overview

Our community-focused banking franchise experienced growth in total loans in the first quarter of 2020, compared to both the year ended December 31, 2019, and the first quarter of 2019, and we believe we are positioned for further moderate loan growth as we continue to serve our customers’ needs in a competitive economic environment. While the impact of the COVID-19 pandemic continues to evolve and is not yet known, and regulatory and governmental developments stemming from the economic and social disruption caused by the pandemic have not yet been fully implemented, we realize this pandemic will make it challenging to attain the levels of profitability and growth reflected in the past five years. 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, while ensuring the safety and soundness of our Bank, our customers and our employees during the COVID-19 pandemic.

The following provides an overview of some of the factors impacting our financial performance for the three month period ended March 31, 2020, compared to the like period ended March 31, 2019:

| · |  | Net income for the first quarter of 2020 was $275,000, or $0.01 per diluted share, compared to $8.5 million, or $0.28 per diluted share, for the first quarter of 2019.

| · |  | Net interest and dividend income was $22.7 million for the first quarter of 2020, compared to $24.0 million for the first quarter of 2019. The decrease in 2020 was primarily due to the year over year decline in market interest rates, which negatively impacted loan and security income, in spite of growth in our loan portfolio of $54.1 million in the same period. In addition, the recognition of $635,000 in deferred issuance costs due to the redemption of our trust preferred securities issued by Old Second Capital Trust I and related junior subordinated debentures reduced net interest and dividend income.

| · |  | A provision for credit losses of $8.0 million was recorded for the first quarter of 2020, consisting of $5.5 million related to loans and $2.5 million related to unfunded commitments, compared to a provision for loan and lease losses of $450,000 in the first quarter of 2019. We adopted the new CECL accounting standard effective January 1, 2020, which measures the allowance based on management’s best estimate of lifetime expected credit losses inherent in our lending activities, which resulted in a $5.9 million allowance for credit losses related to loans and a $1.7 million allowance for credit losses related to unfunded commitments as of January 1, 2020. The provision expense recorded in the first quarter of 2020 was impacted by both the new CECL methodology applied and the expected impact, as of March 31, 2020, of the COVID-19 pandemic on future losses.

| · |  | Noninterest income was $6.3 million for the first quarter of 2020, compared to $6.5 million for the first quarter of 2019, a decrease of $160,000, or 2.5%. The decrease was primarily due to interest rate driven mark to market losses on mortgage servicing rights (“MSRs”) of $2.1 million in the first quarter of 2020, compared to losses of $819,000 in the first quarter of 2019, and a net change in the cash surrender value of bank owned life insurance (“BOLI”) of ($49,000) for the first quarter of 2020, compared to $458,000 in the first quarter of 2019. Partially offsetting these reductions was an increase in the net gain on sales of mortgage loans of $2.2 million in the first quarter of 2020, compared to $762,000 in the first quarter of 2019, due to the volume of new mortgages and refinancing related to the decline in interest rates in 2020.

| · |  | Noninterest expense was $21.0 million for the first quarter of 2020, compared to $19.2 million for the first quarter of 2019, an increase of $1.8 million, or 9.4%. The increase in 2020 was primarily due to an increase in salaries and employee benefit expense related to hires in mid-year 2019 within our commercial lending team, as well as growth in occupancy, furniture and equipment expense due to scheduled facilities repairs.

| · |  | The provision for income taxes was a net benefit of $281,000 for the first quarter of 2020, compared to tax expense of $2.4 million for the first quarter of 2019. The decrease in tax expense of $2.7 million was due to a decrease in pretax income compared to the first quarter of 2019.

| · |  | Asset quality remained consistent with nonperforming loans as a percent of total loans remaining relatively steady at 0.9% as of March 31, 2020, and 0.8% as of March 31, 2019.

| · |  | During the first quarter of 2020, we repurchased 312,723 shares of our common stock at a weighted average price of $7.06 per share pursuant to our stock repurchase program.

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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.

Of the significant accounting policies used in the preparation of our consolidated financial statements, we have identified certain items as critical accounting policies based on the associated estimates, assumptions, judgments and complexity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2019.

Determining the allowance for loan and lease losses has historically been identified as a critical accounting policy. On January 1, 2020, we adopted the new CECL accounting methodology which requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans and other financial assets measured at amortized cost. Previously, an allowance for loan and lease losses was recognized based on probable incurred losses. The accounting estimates relating to the allowance for credit losses is also a “critical accounting policy” as:

| · |  | changes in the provision for credit losses can materially affect our financial results;

| · |  | estimates relating to the allowance for credit losses require us to project future borrower performance, including cash flows, delinquencies and charge-offs, along with, when applicable, collateral values, based on a reasonable and supportable forecast period utilizing forward-looking economic scenarios in order to estimate probability of default and loss given default; and

| · |  | the allowance for credit losses is influenced by factors outside of our control such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions such as trends in housing prices, interest rates, GDP, inflation, energy prices and unemployment; and

| · |  | considerable judgment is required to determine whether the models used to generate the allowance for credit losses produce an estimate that is sufficient to encompass the current view of lifetime expected credit losses.

Because our estimates of the allowance for credit losses involve judgment and are influenced by factors outside our control, there is uncertainty inherent in these estimates. Our estimate of lifetime expected credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions and other factors outside of our control. Changes in such estimates could significantly impact our allowance and provision for credit losses. See Note 1 – Basis of Presentation and Changes in Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report for a discussion of our Allowance for Credit Losses.

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

Overview

Three months ended March 31, 2020 and 2019

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Our pretax losses totaled $6,000 in the first quarter of 2020 compared to pretax income of $10.9 million in the first quarter of 2019. The decrease of $10.9 million in pretax income for the first quarter of 2020, compared to the like quarter in 2019, was primarily due to the $8.0 million provision for credit losses in the first quarter of 2020, which was impacted by both our adoption of the new CECL methodology and the expected impact, as of March 31, 2020, of the COVID-19 pandemic and market interest rate reductions, which compared to a $450,000 provision for loan and lease losses in the first quarter of 2019. Our net income was $275,000, or $0.01 per diluted share, for the first quarter of 2020, compared to net income of $8.5 million, or $0.28 per diluted share, for the first quarter of 2019.

The decrease in net income was also driven by a $1.4 million decrease in net interest and dividend income in the first quarter of 2020, compared to the first quarter of 2019, primarily due to the impact of the reduction in market interest rates on loans and securities in the year over year period. Loan growth of $54.1 million was recorded year over year, but interest income on loans declined $500,000 from the quarter ended March 31, 2019, to March 31, 2020. Securities available-for-sale decreased $59.4 million as of March 31, 2020, compared to March 31, 2019, which enhanced the reduction in securities related income of $894,000 in the same year over year period. In addition, our total noninterest income remained relatively static in the first quarter of 2020 compared to the first quarter of 2019, while our noninterest expense increased $1.8 million in the first quarter of 2020, compared to the like quarter in 2019.

Management has remained diligent in reviewing our loan portfolio to analyze and determine if charge-offs are required. Average loan growth, including loans held for sale, in the first quarter of 2020, compared to the first quarter of 2019, totaled $49.9 million, primarily from organic growth in our commercial leases, and real estate-commercial portfolios.

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 decreased by $1.4 million, to $22.7 million, for the first quarter of 2020, from $24.0 million for the first quarter of 2019. This decline was attributable to the decrease in our interest and dividend income of $1.4 million, or 5.0%, for the first quarter ended March 31, 2020, compared to the first quarter of 2019. Interest and dividend income for the first quarter of 2020 reflected a decrease of $217,000, or 0.8%, compared to the fourth quarter of 2019.

Average earning assets for the three months ended March 31, 2020, were $2.5 billion, reflecting an increase of $32.4 million, or 1.3%, compared to the fourth quarter of 2019, and an increase of $19.7 million, or 0.8%, compared to the first quarter of 2019. Total average loans, including loans held-for-sale, totaled $1.95 billion in the first quarter of 2020, which reflected an increase of $42.1 million compared to the fourth quarter of 2019, and an increase of $49.9 million compared to the first quarter of 2019. The growth in average loan balances, due to an increase in commercial, lease and real estate-commercial loans stemming from organic growth, was offset by the reduction in market interest rates over the past year, which resulted in a decrease in interest income of $490,000 related to loans in the year over year period. For the first quarter of 2020, the yield on average loans decreased to 4.89%, compared to the yield on average loans of 4.92% for the fourth quarter of 2019 and 5.16% for the first quarter of 2019. Securities also reflected a reduction in yields, due to both decreases in market interest rates over the past year and volumes used to fund loan growth. Total average securities for the first quarter of 2020 decreased $10.1 million from the fourth quarter of 2019, and decreased $37.8 million from the first quarter of 2019. The yield on average securities declined to 3.39% for the first quarter of 2020, compared to 3.41% for the fourth quarter of 2019 and 4.00% for first quarter of 2019.

Average interest bearing liabilities increased $18.6 million, or 1.1%, in the first quarter of 2020, compared to the fourth quarter of 2019, but decreased $109.8 million, or 6.2%, compared to the first quarter of 2019. The growth in average interest bearing deposits of $26.1 million from the prior quarter was due to seasonal deposit fluctuations from income tax refunds, commercial deposit build for projects to be deployed later in the year, and uncertainty in the market due to the COVID-19 pandemic. The reduction in average interest bearing deposits of $26.4 million from the prior year period was more than offset by an increase in noninterest bearing deposits for the same period of $51.3 million, as market interest rate reductions over the past year have provided less incentive to maintain funds in interest bearing deposits.

Average other short-term borrowings, which primarily consist of FHLBC advances, decreased $5.7 million in the first quarter of 2020, compared to the fourth quarter of 2019, and decreased $75.3 million compared to the first quarter of 2019. The average rate paid on short-term FHLBC advances was impacted by the reduction in interest rates in the first quarter of 2020, resulting in an average rate of 1.90% for the first quarter of 2020, compared to 1.99% for the fourth quarter of 2019 and 2.50% for the first quarter of 2019. As of

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March 31, 2020, notes payable and other borrowings consisted of one long-term FHLBC advance of $6.6 million we acquired in our acquisition of ABC Bank, and a $20.0 million term note with a correspondent bank originated in the first quarter of 2020 to fund our redemption of the Old Second Capital Trust I trust preferred securities and related junior subordinated debentures of $32.6 million. This redemption occurred in March 2020 and resulted in an increase in the cost of the average junior subordinated debentures for the first quarter of 2020 due to the recognition of the remaining unamortized deferred issuance costs of $635,000. The rate paid on the redeemed junior subordinated debentures was 7.8%, in comparison to the rate to be paid going forward on the newly executed $20.0 million term note of one month Libor plus 175 basis points.

Our net interest margin, on a tax-equivalent (TE) basis, expressed as a percentage of average earning assets, was 3.77% for the first quarter of 2020, reflecting a nine basis point decrease from the fourth quarter of 2019, and a 32 basis point decrease from the first quarter of 2019. The average tax-equivalent yield on earning assets decreased to 4.55% for the first quarter of 2020, compared to 4.59% for the fourth quarter of 2019, and 4.90% for the first quarter of 2019. The decreases in net interest margin and the yield on average earning assets for the first quarter of 2020, compared to the fourth quarter of 2019, was primarily attributable to a decline in security volumes and interest rate reductions which impacted loans and securities in the first quarter of 2020. The cost of funds on interest bearing liabilities was 1.17% for the first quarter of 2020, 1.09% for the fourth quarter of 2019, and 1.12% for the first quarter of 2019. The increase in our cost of funds in the first quarter of 2020 compared to the fourth quarter of 2019 and the first quarter of 2019, was primarily driven by the redemption of our junior subordinated debentures and the resulting recognition of $635,000 of deferred issuance costs in March 2020, partially offset by a decline in the volume and rates paid on short-term borrowings.

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.

The following tables set forth certain information relating to our average consolidated balance sheet and reflect the yield on average earning assets and cost of average interest bearing liabilities for the periods indicated. These yields reflect the related interest, on an annualized basis, divided by the average balance of assets or liabilities over the applicable period. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets in the following tables have been adjusted to a non-GAAP TE basis using a marginal rate of 21% in 2020 and 2019 to more appropriately compare returns on tax-exempt loans and securities to other earning assets.

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Analysis of Average Balances,
Tax Equivalent Income / Expense and Rates
(Dollars in thousands - unaudited)
| Quarters Ended
| March 31, 2020 |  | December 31, 2019 |  | March 31, 2019
| Average |  | Income / |  | Rate |  | Average |  | Income / |  | Rate |  | Average |  | Income / |  | Rate
| Balance |  | Expense |  | % |  | Balance |  | Expense |  | % |  | Balance |  | Expense |  | %
Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest earning deposits with financial institutions | $ | 27,989 |  | $ | 75 |  | 1.08 |  | $ | 27,720 |  | $ | 115 |  | 1.65 |  | $ | 18,842 |  | $ | 114 |  | 2.45
Securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Taxable |  | 273,429 |  |  | 2,163 |  | 3.18 |  |  | 285,437 |  |  | 2,323 |  | 3.23 |  |  | 236,882 |  |  | 2,414 |  | 4.13
Non-taxable (TE)1 |  | 202,289 |  |  | 1,842 |  | 3.66 |  |  | 200,365 |  |  | 1,857 |  | 3.68 |  |  | 276,609 |  |  | 2,656 |  | 3.89
Total securities (TE)1 |  | 475,718 |  |  | 4,005 |  | 3.39 |  |  | 485,802 |  |  | 4,180 |  | 3.41 |  |  | 513,491 |  |  | 5,070 |  | 4.00
Dividends from FHLBC and FRBC |  | 9,917 |  |  | 125 |  | 5.07 |  |  | 9,763 |  |  | 143 |  | 5.81 |  |  | 11,463 |  |  | 149 |  | 5.27
Loans and loans held-for-sale 1, 2 |  | 1,945,383 |  |  | 23,636 |  | 4.89 |  |  | 1,903,290 |  |  | 23,623 |  | 4.92 |  |  | 1,895,512 |  |  | 24,126 |  | 5.16
Total interest earning assets |  | 2,459,007 |  |  | 27,841 |  | 4.55 |  |  | 2,426,575 |  |  | 28,061 |  | 4.59 |  |  | 2,439,308 |  |  | 29,459 |  | 4.90
Cash and due from banks |  | 32,549 |  |  | - |  | - |  |  | 34,417 |  |  | - |  | - |  |  | 33,749 |  |  | - |  | -
Allowance for credit losses on loans |  | (23,507) |  |  | - |  | - |  |  | (20,063) |  |  | - |  | - |  |  | (19,235) |  |  | - |  | -
Other noninterest bearing assets |  | 172,712 |  |  | - |  | - |  |  | 173,249 |  |  | - |  | - |  |  | 181,767 |  |  | - |  | -
Total assets | $ | 2,640,761 |  |  |  |  |  |  | $ | 2,614,178 |  |  |  |  |  |  | $ | 2,635,589 |  |  |  |  |
Liabilities and Stockholders' Equity |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW accounts | $ | 422,065 |  | $ | 233 |  | 0.22 |  | $ | 417,198 |  | $ | 300 |  | 0.29 |  | $ | 448,518 |  | $ | 379 |  | 0.34
Money market accounts |  | 280,828 |  |  | 236 |  | 0.34 |  |  | 288,376 |  |  | 285 |  | 0.39 |  |  | 299,305 |  |  | 270 |  | 0.37
Savings accounts |  | 322,618 |  |  | 166 |  | 0.21 |  |  | 305,374 |  |  | 121 |  | 0.16 |  |  | 307,740 |  |  | 122 |  | 0.16
Time deposits |  | 448,763 |  |  | 1,766 |  | 1.58 |  |  | 437,236 |  |  | 1,805 |  | 1.64 |  |  | 445,076 |  |  | 1,618 |  | 1.47
Interest bearing deposits |  | 1,474,274 |  |  | 2,401 |  | 0.66 |  |  | 1,448,184 |  |  | 2,511 |  | 0.69 |  |  | 1,500,639 |  |  | 2,389 |  | 0.65
Securities sold under repurchase agreements |  | 47,825 |  |  | 116 |  | 0.98 |  |  | 45,146 |  |  | 146 |  | 1.28 |  |  | 45,157 |  |  | 149 |  | 1.34
Other short-term borrowings |  | 23,069 |  |  | 109 |  | 1.90 |  |  | 28,772 |  |  | 144 |  | 1.99 |  |  | 98,328 |  |  | 606 |  | 2.50
Junior subordinated debentures |  | 47,200 |  |  | 1,364 |  | 11.62 |  |  | 57,728 |  |  | 933 |  | 6.41 |  |  | 57,692 |  |  | 927 |  | 6.52
Senior notes |  | 44,284 |  |  | 673 |  | 6.11 |  |  | 44,258 |  |  | 673 |  | 6.03 |  |  | 44,171 |  |  | 672 |  | 6.17
Notes payable and other borrowings |  | 14,762 |  |  | 130 |  | 3.54 |  |  | 8,768 |  |  | 72 |  | 3.26 |  |  | 15,273 |  |  | 116 |  | 3.08
Total interest bearing liabilities |  | 1,651,414 |  |  | 4,793 |  | 1.17 |  |  | 1,632,856 |  |  | 4,479 |  | 1.09 |  |  | 1,761,260 |  |  | 4,859 |  | 1.12
Noninterest bearing deposits |  | 676,755 |  |  | - |  | - |  |  | 678,136 |  |  | - |  | - |  |  | 625,423 |  |  | - |  | -
Other liabilities |  | 28,490 |  |  | - |  | - |  |  | 28,026 |  |  | - |  | - |  |  | 13,750 |  |  | - |  | -
Stockholders' equity |  | 284,102 |  |  | - |  | - |  |  | 275,160 |  |  | - |  | - |  |  | 235,156 |  |  | - |  | -
Total liabilities and stockholders' equity | $ | 2,640,761 |  |  |  |  |  |  | $ | 2,614,178 |  |  |  |  |  |  | $ | 2,635,589 |  |  |  |  |
Net interest income (GAAP) |  |  |  | $ | 22,658 |  |  |  |  |  |  | $ | 23,189 |  |  |  |  |  |  | $ | 24,037 |  |
Net interest margin (GAAP) |  |  |  |  |  |  | 3.71 |  |  |  |  |  |  |  | 3.79 |  |  |  |  |  |  |  | 4.00
Net interest income (TE)1 |  |  |  | $ | 23,048 |  |  |  |  |  |  | $ | 23,582 |  |  |  |  |  |  | $ | 24,600 |  |
Net interest margin (TE)1 |  |  |  |  |  |  | 3.77 |  |  |  |  |  |  |  | 3.86 |  |  |  |  |  |  |  | 4.09
Interest bearing liabilities to earning assets |  | 67.16 | % |  |  |  |  |  |  | 67.29 | % |  |  |  |  |  |  | 72.20 | % |  |  |  |

1 Tax equivalent basis is calculated using a marginal tax rate of 21% in 2020 and 2019. See the discussion entitled “Non-GAAP Presentations” below and the table on page 46 that provides a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent.

2 Interest income from loans is shown on a tax equivalent basis, which is a non-GAAP financial measure, as discussed in the table on page 46, and includes fees of $294,000, $397,000 and $229,000 for the first quarter of 2020, the fourth quarter of 2019, and the first quarter of 2019, 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 and dividend income (TE) and net interest income (TE) to average interest earning assets are non-GAAP measures that have been adjusted on a TE basis using a marginal rate of 21% for 2020 and 2019 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, |
Net Interest Margin |  | 2020 |  | 2019 |  | 2019 |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |
Interest income (GAAP) |  | $ | 27,451 |  | $ | 27,668 |  | $ | 28,896 |
Taxable-equivalent adjustment: |  |  |  |  |  |  |  |  |  |
Loans |  |  | 3 |  |  | 3 |  |  | 5 |
Securities |  |  | 387 |  |  | 390 |  |  | 558 |
Interest and dividend income (TE) |  |  | 27,841 |  |  | 28,061 |  |  | 29,459 |
Interest expense (GAAP) |  |  | 4,793 |  |  | 4,479 |  |  | 4,859 |
Net interest income (TE) |  | $ | 23,048 |  | $ | 23,582 |  | $ | 24,600 |
Net interest income (GAAP) |  | $ | 22,658 |  | $ | 23,189 |  | $ | 24,037 |
Average interest earning assets |  | $ | 2,459,007 |  | $ | 2,426,575 |  | $ | 2,439,308 |
Net interest margin (GAAP) |  |  | 3.71 | % |  | 3.79 | % |  | 4.00 | %
Net interest margin (TE) |  |  | 3.77 | % |  | 3.86 | % |  | 4.09 | %

Noninterest Income

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

|  |  |  |  |  |  |  |  |  |  | 1st Quarter 2020 |
Noninterest Income |  | Three Months Ended |  | Percent Change From |
(Dollars in thousands) |  | March 31, |  | December 31, |  | March 31, |  | 4th Quarter |  | 1st Quarter |
|  | 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019 |
Trust income |  | $ | 1,532 |  | $ | 1,700 |  | $ | 1,486 |  | (9.9) |  | 3.1 |
Service charges on deposits |  |  | 1,726 |  |  | 1,874 |  |  | 1,862 |  | (7.9) |  | (7.3) |
Residential mortgage banking revenue |  |  |  |  |  |  |  |  |  |  |  |  |  |
Secondary mortgage fees |  |  | 270 |  |  | 151 |  |  | 136 |  | 78.8 |  | 98.5 |
Mortgage servicing rights mark to market (loss) gain |  |  | (2,134) |  |  | 240 |  |  | (819) |  | N/M |  | (160.6) |
Mortgage servicing income |  |  | 468 |  |  | 473 |  |  | 457 |  | (1.1) |  | 2.4 |
Net gain on sales of mortgage loans |  |  | 2,246 |  |  | 1,113 |  |  | 762 |  | 101.8 |  | 194.8 |
Total residential mortgage banking revenue |  |  | 850 |  |  | 1,977 |  |  | 536 |  | (57.0) |  | 58.6 |
Securities gain, net |  |  | (24) |  |  | 35 |  |  | 27 |  | (168.6) |  | N/M |
Change in cash surrender value of BOLI |  |  | (49) |  |  | 370 |  |  | 458 |  | (113.2) |  | (110.7) |
Death benefit realized on BOLI |  |  | - |  |  | 872 |  |  | - |  | N/M |  | N/M |
Card related income |  |  | 1,287 |  |  | 1,428 |  |  | 1,285 |  | (9.9) |  | 0.2 |
Other income |  |  | 1,000 |  |  | 986 |  |  | 828 |  | 1.4 |  | 20.8 |
Total noninterest income |  | $ | 6,322 |  | $ | 9,242 |  | $ | 6,482 |  | (31.6) |  | (2.5) |

N/M - Not meaningful

Noninterest income for the first quarter of 2020 decreased $2.9 million, or 31.6%, compared to the fourth quarter of 2019, and decreased $160,000, or 2.5%, compared to the first quarter of 2019.

The $2.9 million decrease in noninterest income in the first quarter of 2020, compared to the fourth quarter of 2019, was driven primarily by $2.1 million of mark to market losses on MSRs in the first quarter of 2020 due to market interest rate reductions, a $168,000 decrease in trust income due to a reduction in the value of assets under management due to market interest rate declines, $49,000 in market interest rate-driven losses on the cash surrender value of BOLI in the first quarter of 2020, and a $872,000 BOLI death benefit recorded in the

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fourth quarter of 2019 that was not repeated in the first quarter of 2020. These variances were partially offset by a $1.1 million increase in net gain on sales of mortgage loans in the first quarter of 2020 compared to the fourth quarter of 2019.

Noninterest income decreased $160,000, or 2.5%, in the year over year period, primarily driven by $2.1 million of mark to market losses on MSRs in the first quarter of 2020, compared to $819,000 of losses in the first quarter of 2019. Partially offsetting the year over year losses was growth in trust income of $46,000, secondary mortgage fees of $134,000, net gain on the sale of mortgage loans of $1.5 million, and other income of $172,000. The increase in other income for the first quarter of 2020, compared to the first quarter of 2019, was primarily attributable to an increase in commercial loan interest rate swap fees of $147,000.

Noninterest Expense

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

|  |  |  |  |  |  |  |  |  |  | 1st Quarter 2020 |
Noninterest Expense |  | Three Months Ended |  | Percent Change From |
(Dollars in thousands) |  | March 31, |  | December 31, |  | March 31, |  | 4th Quarter |  | 1st Quarter |
|  | 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019 |
Salaries |  | $ | 9,761 |  | $ | 9,315 |  | $ | 8,634 |  | 4.8 |  | 13.1 |
Officers incentive |  |  | 958 |  |  | 680 |  |  | 882 |  | 40.9 |  | 8.6 |
Benefits and other |  |  | 2,199 |  |  | 1,613 |  |  | 2,096 |  | 36.3 |  | 4.9 |
Total salaries and employee benefits |  |  | 12,918 |  |  | 11,608 |  |  | 11,612 |  | 11.3 |  | 11.2 |
Occupancy, furniture and equipment expense |  |  | 2,301 |  |  | 2,140 |  |  | 1,989 |  | 7.5 |  | 15.7 |
Computer and data processing |  |  | 1,335 |  |  | 1,285 |  |  | 1,332 |  | 3.9 |  | 0.2 |
FDIC insurance |  |  | 57 |  |  | - |  |  | 174 |  | 100.0 |  | (67.2) |
General bank insurance |  |  | 246 |  |  | 246 |  |  | 250 |  | - |  | (1.6) |
Amortization of core deposit intangible asset |  |  | 128 |  |  | 129 |  |  | 132 |  | (0.8) |  | (3.0) |
Advertising expense |  |  | 109 |  |  | 250 |  |  | 234 |  | (56.4) |  | (53.4) |
Card related expense |  |  | 532 |  |  | 596 |  |  | 355 |  | (10.7) |  | 49.9 |
Legal fees |  |  | 131 |  |  | 195 |  |  | 126 |  | (32.8) |  | 4.0 |
Other real estate owned expense, net |  |  | 237 |  |  | 99 |  |  | 50 |  | N/M |  | N/M |
Other expense |  |  | 3,008 |  |  | 3,280 |  |  | 2,940 |  | (8.3) |  | 2.3 |
Total noninterest expense |  | $ | 21,002 |  | $ | 19,828 |  | $ | 19,194 |  | 5.9 |  | 9.4 |
Efficiency ratio (GAAP)1 |  |  | 66.28 | % |  | 62.65 | % |  | 60.72 | % |  |  |  |
Adjusted efficiency ratio (non-GAAP)2 |  |  | 65.48 | % |  | 61.24 | % |  | 59.42 | % |  |  |  |

N/M - Not meaningful

1 The efficiency ratio shown in the table above is a GAAP financial measure calculated as noninterest expense, excluding amortization of core deposits and OREO expenses, divided by the sum of net interest income and total noninterest income less any BOLI death benefit recorded, net gains or losses on securities and mark to market gains or losses on MSRs.

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

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

Noninterest expense increased $1.2 million, or 5.9%, for the first quarter of 2020, compared to the fourth quarter of 2019, and increased $1.8 million, or 9.4%, compared to the first quarter of 2019.

The $1.2 million increase in noninterest expense in the first quarter of 2020, compared to the fourth quarter of 2019, is primarily attributable to a $1.3 million increase in salaries and employee benefits, a $161,000 increase in occupancy, furniture and equipment expense, and a $138,000 increase in other real estate owned expense primarily due to a valuation writedown on one property, which was partially offset by decreases of $141,000 in advertising expense and $272,000 in other expense. Other expense decreased in the first quarter of 2020, compared to the fourth quarter of 2019, due to a market interest rate driven decline in the valuation of deferred director compensation and a reduction in consulting fees.

The $1.8 million increase in noninterest expense in the first quarter of 2020, compared to the first quarter of 2019, is primarily attributable to growth in our commercial lending team in mid-2019, which resulted in higher salaries and employee benefits in the first quarter of 2020. In addition, repairs and planned maintenance on bank owned properties occurred in the first quarter of 2020, which resulted in

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higher occupancy, furniture and equipment expense. Card related expense also increased year over year due to growth in transactional volumes and system upgrades, as well as other real estate owned expense due to property valuation writedowns in 2020. Partially offsetting the year over year increases were decreases in FDIC insurance and advertising expense.

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, |
Efficiency Ratio / Adjusted Efficiency Ratio |  | 2020 |  | 2019 |  | 2019 |  | 2020 |  | 2019 |  | 2019 |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest expense |  | $ | 21,002 |  | $ | 19,828 |  | $ | 19,194 |  | $ | 21,002 |  | $ | 19,828 |  | $ | 19,194 |
Less amortization of core deposit |  |  | 128 |  |  | 129 |  |  | 132 |  |  | 128 |  |  | 129 |  |  | 132 |
Less other real estate expense, net |  |  | 237 |  |  | 99 |  |  | 50 |  |  | 237 |  |  | 99 |  |  | 50 |
Noninterest expense less adjustments |  | $ | 20,637 |  | $ | 19,600 |  | $ | 19,012 |  | $ | 20,637 |  | $ | 19,600 |  | $ | 19,012 |
Net interest income |  | $ | 22,658 |  | $ | 23,189 |  | $ | 24,036 |  | $ | 22,658 |  | $ | 23,189 |  | $ | 24,036 |
Taxable-equivalent adjustment: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans |  |  | N/A |  |  | N/A |  |  | N/A |  |  | 3 |  |  | 3 |  |  | 5 |
Securities |  |  | N/A |  |  | N/A |  |  | N/A |  |  | 387 |  |  | 390 |  |  | 558 |
Net interest income including adjustments |  |  | 22,658 |  |  | 23,189 |  |  | 24,036 |  |  | 23,048 |  |  | 23,582 |  |  | 24,599 |
Noninterest income |  |  | 6,322 |  |  | 9,242 |  |  | 6,482 |  |  | 6,322 |  |  | 9,242 |  |  | 6,482 |
Less death benefit related to BOLI |  |  | - |  |  | 872 |  |  | - |  |  | - |  |  | 872 |  |  | - |
Less securities (losses) gains, net |  |  | (24) |  |  | 35 |  |  | 27 |  |  | (24) |  |  | 35 |  |  | 27 |
Less MSRs mark to market (loss) gain |  |  | (2,134) |  |  | 240 |  |  | (819) |  |  | (2,134) |  |  | 240 |  |  | (819) |
Taxable-equivalent adjustment: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Change in cash surrender value of BOLI |  |  | N/A |  |  | N/A |  |  | N/A |  |  | (13) |  |  | 330 |  |  | 122 |
Noninterest income (less) / including adjustments |  |  | 8,480 |  |  | 8,095 |  |  | 7,274 |  |  | 8,467 |  |  | 8,425 |  |  | 7,396 |
Net interest income including adjustments plus noninterest income (less) / including adjustments |  | $ | 31,138 |  | $ | 31,284 |  | $ | 31,310 |  | $ | 31,515 |  | $ | 32,007 |  | $ | 31,995 |
Efficiency ratio / Adjusted efficiency ratio |  |  | 66.28 | % |  | 62.65 | % |  | 60.72 | % |  | 65.48 | % |  | 61.24 | % |  | 59.42 | %

Income Taxes

We recorded a tax benefit of $281,000 on $6,000 of pretax loss for the first quarter of 2020, compared to income tax expense of $2.9 million on $12.5 million of pretax income in the fourth quarter of 2019, and $2.4 million of income tax expense on $10.9 million of pretax income in the first quarter of 2019. The effective tax rate for the first quarter of 2020 was not meaningful, due to the low level of pretax net loss, compared to an effective tax rate of 23.4% for the fourth quarter of 2019, and 22.1% for the first quarter of 2019.

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, 2020. We had no valuation reserve on the deferred tax assets as of March 31, 2020.

Financial Condition

Total assets increased $21.3 million from $2.64 billion at December 31, 2019, to $2.66 billion at March 31, 2020, due primarily to an increase in cash and cash equivalents of $22.5 million, and loan growth of $26.4 million, partially offset by a reduction of $35.0 million in securities available-for-sale. Total deposits were $2.20 billion at March 31, 2020, an increase of $68.9 million from December 31, 2019, primarily due to increases in noninterest bearing demand accounts, savings accounts, and time deposits.

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|  |  |  |  |  |  |  |  |  |  | March 31, 2020
Securities |  | As of |  | Percent Change From
(Dollars in thousands) |  | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
|  | 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019
Securities available-for-sale, at fair value |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Treasuries |  | $ | 4,152 |  | $ | 4,036 |  | $ | 3,960 |  | 2.9 |  | 4.8
U.S. government agencies |  |  | 7,723 |  |  | 8,337 |  |  | 10,360 |  | (7.4) |  | (25.5)
U.S. government agencies mortgage-backed |  |  | 17,255 |  |  | 16,588 |  |  | 15,306 |  | 4.0 |  | 12.7
States and political subdivisions |  |  | 255,095 |  |  | 249,175 |  |  | 281,172 |  | 2.4 |  | (9.3)
Collateralized mortgage obligations |  |  | 53,403 |  |  | 57,984 |  |  | 64,330 |  | (7.9) |  | (17.0)
Asset-backed securities |  |  | 77,727 |  |  | 81,844 |  |  | 70,811 |  | (5.0) |  | 9.8
Collateralized loan obligations |  |  | 34,339 |  |  | 66,684 |  |  | 63,151 |  | (48.5) |  | (45.6)
Total securities |  | $ | 449,694 |  | $ | 484,648 |  | $ | 509,090 |  | (7.2) |  | (11.7)

Available-for-sale security sales during the three months ended March 31, 2020, totaled $18.1 million and primarily consisted of collateralized loan obligations, whereas purchases during the three month period of 2020 totaled $6.1 million and were primarily tax exempt state and political subdivisions securities. During the first quarter of 2020 security sales resulted in net realized losses of $24,000, compared to $27,000 of security gains, net, for the three months ended March 31, 2019.

Loans

Total loans were $1.96 billion as of March 31, 2020, an increase of $26.4 million from December 31, 2019. The increase in total loans in the first three months of 2020 was due primarily to organic growth in our commercial, leases, construction, and multifamily loan portfolios, partially offset by reductions in our commercial real estate-investor, residential real estate-investor, and residential real estate-owner occupied portfolios. Total loans increased $54.1 million from March 31, 2019, to March 31, 2020, due primarily to organic loan growth in our commercial, leases, commercial real estate-investor, and multifamily portfolios, partially offset by reductions in our commercial real estate-owner occupied, construction, residential real estate-owner occupied, and HELOC-purchased portfolios. As required by CECL, the balance (or amortized cost basis) of PCD loans are carried on a gross basis (rather than net of the associated credit loss estimate), and the expected credit losses for PCD loans are estimated and separately recognized as part of the allowance for credit losses. Accordingly, at January 1, 2020, $2.5 million of purchase accounting adjustments related to PCD loans were reclassified to the allowance for credit losses from loans, resulting in an increase to total PCD loans.

|  |  |  |  |  |  |  |  |  | March 31, 2020
Loans | As of |  | Percent Change From
(Dollars in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019
Commercial | $ | 364,626 |  | $ | 332,842 |  | $ | 324,450 |  | 9.5 |  | 12.4
Leases |  | 126,237 |  |  | 119,751 |  |  | 87,730 |  | 5.4 |  | 43.9
Commercial real estate - Investor |  | 503,905 |  |  | 520,095 |  |  | 472,839 |  | (3.1) |  | 6.6
Commercial real estate - Owner occupied |  | 349,595 |  |  | 345,504 |  |  | 363,065 |  | 1.2 |  | (3.7)
Construction |  | 78,159 |  |  | 69,617 |  |  | 94,787 |  | 12.3 |  | (17.5)
Residential real estate - Investor |  | 69,429 |  |  | 71,105 |  |  | 69,790 |  | (2.4) |  | (0.5)
Residential real estate - Owner occupied |  | 129,982 |  |  | 136,023 |  |  | 139,598 |  | (4.4) |  | (6.9)
Multifamily |  | 195,297 |  |  | 189,773 |  |  | 190,478 |  | 2.9 |  | 2.5
HELOC |  | 93,165 |  |  | 91,605 |  |  | 91,809 |  | 1.7 |  | 1.5
HELOC - Purchased |  | 30,880 |  |  | 31,852 |  |  | 42,050 |  | (3.1) |  | (26.6)
Other 1 |  | 15,929 |  |  | 12,258 |  |  | 14,018 |  | 29.9 |  | 13.6
Total loans, excluding deferred loan costs and PCI Loans |  | 1,957,204 |  |  | 1,920,425 |  |  | 1,890,614 |  | 1.9 |  | 3.5
Net deferred loan costs |  | - |  |  | 1,786 |  |  | 1,681 |  | (100.0) |  | (100.0)
Total loans, excluding PCI loans |  | 1,957,204 |  |  | 1,922,211 |  |  | 1,892,295 |  | 1.8 |  | 3.4
PCI loans, net of purchase accounting adjustments |  | - |  |  | 8,601 |  |  | 10,851 |  | (100.0) |  | (100.0)
Total loans | $ | 1,957,204 |  | $ | 1,930,812 |  | $ | 1,903,146 |  | 1.4 |  | 2.8

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 real estate, construction, residential, multifamily, and HELOCs) has been and continues to be a sizeable portion of our portfolio. These categories comprised 74.1% of the portfolio as of March 31, 2020, compared to 75.4% of the portfolio as of

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December 31, 2019. We continue to oversee and seek to manage our loan portfolio in accordance with interagency guidance on risk management.

Asset Quality

The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for credit losses at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. During the first quarter of 2020, we adopted ASU 2016-13, or CECL.

We recorded a $5.5 million provision for credit losses on loans for the first quarter of 2020, compared to a $450,000 provision for loan and lease losses for the first quarter of 2019. In the first quarter of 2020, we determined provision expense was necessary at a level higher than our net charge-offs for the quarter, which were $1.1 million, due to the guidance under the newly adopted CECL methodology, which requires a provision based on future expected credit losses, as compared to the previously used incurred loss model. 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 credit losses on loans. In addition, a separate allowance for credit losses on unfunded commitments of $1.7 million was established under CECL guidelines as of January 1, 2020, and $2.5 million of provision for credit losses on unfunded commitments was recorded as of March 31, 2020. The significant increase in the total provision for credit losses stems from our CECL model calculations due to the COVID-19 pandemic and market interest rate reductions.

Nonperforming loans consist of nonaccrual loans, performing restructured accruing loans and loans 90 days or greater past due. Remediation work continues in all segments. Nonperforming loans increased by $6.0 million at March 31, 2020, to $21.8 million from $15.8 million at December 31, 2019. 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 increased to 1.1% as of March 31, 2020, from 0.8% as of December 31, 2019, and March 31, 2019. The distribution of our nonperforming loans is shown in the following table.

|  |  |  |  |  |  |  |  |  | March 31, 2020 |
Nonperforming Loans | As of |  | Percent Change From |
(Dollars in thousands) | March 31, |  | December |  | March 31, |  | December |  | March 31, |
| 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019 |
Commercial | $ | 2,418 |  | $ | 2,247 |  | $ | - |  | 7.6 |  |  | N/M |  |
Leases |  | 187 |  |  | 410 |  |  | 114 |  | (54.4) |  |  | 64.0 |  |
Commercial real estate - Investor |  | 1,809 |  |  | 2,092 |  |  | 6,503 |  | (13.5) |  |  | (72.2) |  |
Commercial real estate - Owner occupied |  | 7,436 |  |  | 5,180 |  |  | 2,422 |  | 43.6 |  |  | 207.0 |  |
Construction |  | 2,800 |  |  | 93 |  |  | 104 |  | N/M |  |  | N/M |  |
Residential real estate - Investor |  | 859 |  |  | 788 |  |  | 337 |  | 9.0 |  |  | 154.9 |  |
Residential real estate - Owner occupied |  | 4,736 |  |  | 3,169 |  |  | 3,665 |  | 49.4 |  |  | 29.2 |  |
Multifamily |  | 69 |  |  | 68 |  |  | - |  | 1.5 |  |  | N/M |  |
HELOC |  | 1,400 |  |  | 1,603 |  |  | 1,707 |  | (12.7) |  |  | (18.0) |  |
HELOC - Purchased |  | 114 |  |  | 180 |  |  | 54 |  | (36.7) |  |  | 111.1 |  |
Other 1 |  | 9 |  |  | 19 |  |  | 31 |  | (52.6) |  |  | (71.0) |  |
Total nonperforming loans | $ | 21,837 |  | $ | 15,849 |  | $ | 14,937 |  | 37.8 |  |  | 46.2 |  |

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
(Dollars in thousands) | March 31, |  | % of |  | December 31, |  | % of |  | March 31, |  | % of
| 2020 |  | Total 1 |  | 2019 |  | Total 1 |  | 2019 |  | Total 1
Commercial | $ | 85 |  | 7.6 |  | $ | (18) |  | (150.0) |  | $ | (18) |  | (12.9)
Leases |  | - |  | - |  |  | 2 |  | 16.7 |  |  | - |  | -
Commercial real estate - Investor |  | (8) |  | (0.7) |  |  | (635) |  | N/M |  |  | 124 |  | 88.6
Commercial real estate - Owner occupied |  | 1,108 |  | 98.8 |  |  | 585 |  | N/M |  |  | 84 |  | 60.0
Construction |  | - |  | - |  |  | 1 |  | 8.3 |  |  | 1 |  | 0.7
Residential real estate - Investor |  | (21) |  | (1.9) |  |  | 15 |  | 125.0 |  |  | (10) |  | (7.1)
Residential real estate - Owner occupied |  | (22) |  | (2.0) |  |  | 72 |  | 600.0 |  |  | (14) |  | (10.0)
Multifamily |  | - |  | - |  |  | (7) |  | (58.3) |  |  | (8) |  | (5.7)
HELOC |  | (58) |  | (5.2) |  |  | (53) |  | (441.7) |  |  | (46) |  | (32.9)
HELOC - Purchased |  | - |  | - |  |  | - |  | - |  |  | - |  | -
Other 2 |  | 38 |  | 3.4 |  |  | 50 |  | 416.7 |  |  | 27 |  | 19.3
Net charge-offs | $ | 1,122 |  | 100.0 |  | $ | 12 |  | 100.0 |  | $ | 140 |  | 100.0

N/M - Not meaningful

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 $1.1 million were recorded for the first quarter of 2020, compared to net charge-offs of $12,000 for the fourth quarter of 2019, and $140,000 for the first quarter of 2019, reflecting continuing management attention to credit quality and remediation efforts. The growth in net charge-offs for the first quarter of 2020 was primarily due to one large charge-off related to a nonperforming note sale. 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, 2020
Classified Assets | As of |  | Percent Change From
(Dollars in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019
Commercial | $ | 11,260 |  | $ | 11,688 |  | $ | 7,075 |  | (3.7) |  |  | 59.2 |
Leases |  | 264 |  |  | 329 |  |  | 114 |  | (19.8) |  |  | 131.6 |
Commercial real estate - Investor |  | 6,073 |  |  | 4,926 |  |  | 11,748 |  | 23.3 |  |  | (48.3) |
Commercial real estate - Owner occupied |  | 10,504 |  |  | 7,956 |  |  | 11,553 |  | 32.0 |  |  | (9.1) |
Construction |  | 2,414 |  |  | 262 |  |  | 2,589 |  | 821.4 |  |  | (6.8) |
Residential real estate - Investor |  | 1,452 |  |  | 1,390 |  |  | 991 |  | 4.5 |  |  | 46.5 |
Residential real estate - Owner occupied |  | 4,568 |  |  | 3,631 |  |  | 4,728 |  | 25.8 |  |  | (3.4) |
Multifamily |  | 5,374 |  |  | 503 |  |  | 487 |  | 968.4 |  |  | N/M |
HELOC |  | 1,628 |  |  | 1,789 |  |  | 1,912 |  | (9.0) |  |  | (14.9) |
HELOC - Purchased |  | 114 |  |  | 180 |  |  | 54 |  | (36.7) |  |  | 111.1 |
Other 1 |  | 349 |  |  | 359 |  |  | 28 |  | (2.8) |  |  | N/M |
Total classified loans, excluding PCI loans |  | 44,000 |  |  | 33,013 |  |  | 41,279 |  | 33.3 |  |  | 6.6 |
Other real estate owned |  | 5,049 |  |  | 5,004 |  |  | 6,365 |  | 0.9 |  |  | (20.7) |
Total classified assets, excluding PCI loans |  | 49,049 |  |  | 38,017 |  |  | 47,644 |  | 29.0 |  |  | 2.9 |
PCI, net of purchase accounting adjustments |  | - |  |  | 8,601 |  |  | 10,851 |  | (100.0) |  |  | (100.0) |
Total classified assets | $ | 49,049 |  | $ | 46,618 |  | $ | 58,495 |  | 5.2 |  |  | (16.1) |

N/M - Not meaningful

1 The “Other” class includes consumer and overdrafts.

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 increased as of March 31, 2020, from the levels at December 31, 2019, and March, 31, 2019, primarily due to inclusion of PCD loans in their respective segments at March 31, 2020. Total classified assets, including PCI loans, reflected an increase as of March 31, 2020, compared to the level at December 31, 2019 but a decline from the level one year ago. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the allowance for credit losses on loans as another measure of overall

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change in loan related asset quality, which is referred to as the “classified assets ratio.” The classified assets ratio was 15.26% for the period ended March 31, 2020, compared to 11.11% as of December 31, 2019, and 14.91% as of March 31, 2019. The increase in the classified assets ratio for period ended March 31, 2020, compared to March 31, 2019, is also due to the inclusion of the PCD loans in their respective segments within the calculation which were previously excluded. The increase in total PCD loans as of March 31, 2020, of $11.0 million compared to December 31, 2019, is due to the January 1, 2020, reclassification of the credit-related component of the purchase accounting adjustments carried on the loans previously referred to as PCI loans to the allowance for credit losses, per CECL guidance. The PCD balance of $11.0 million is included within total classified assets, as applicable, under CECL guidance.

Allowance for Credit Losses on Loans

Upon adoption of CECL on January 1, 2020, (Day One), we recognized an increase in our ACL on outstanding loans of $5.9 million and an increase in our allowance for credit losses on unfunded commitments of $1.7 million as a cumulative effect adjustment from change in accounting policies. Approximately $2.5 million of the increase to the ACL resulted from the transfer of the non-accretable purchase accounting adjustments on PCD loans. The Day One adjusting entries resulted in a $3.8 million reduction to retained earnings, and a deferred tax asset adjustment of $1.4 million. At March 31, 2020, the ACL on loans totaled $30.0 million, and the allowance for credit losses on unfunded commitments, included in other liabilities, totaled $4.2 million. This reserve build was driven by the $8.0 million provision expense in the first quarter of 2020, augmented by the previously mentioned impact from CECL adoption on January 1, 2020. The total increase in the allowance for credit losses reflects forecasted credit deterioration due to the COVID-19 pandemic. Our allowance for credit losses on loans to total loans was 1.5% as of March 31, 2020, compared to 1.0% at both December 31, 2019, and March 31, 2019.

See Note 1 – Basis of Presentation and Changes in Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report for discussion of our ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

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Below is a reconciliation of the activity in the allowance for credit losses on loans for the periods indicated (dollars in thousands):

|  | Three Months Ended |
| March 31, |  | December 31, |  | March 31,
| 2020 |  | 2019 |  | 2019
Allowance at beginning of period | $ | 19,789 |  |  | $ | 19,651 |  |  | $ | 19,006 |
Charge-offs: |  |  |  |  |  |  |  |  |  |  |
Commercial |  | 97 |  |  |  | 10 |  |  |  | 12 |
Leases |  | - |  |  |  | 2 |  |  |  | - |
Commercial real estate - Investor |  | 13 |  |  |  | - |  |  |  | 144 |
Commercial real estate - Owner occupied |  | 1,109 |  |  |  | 587 |  |  |  | 87 |
Construction |  | - |  |  |  | 1 |  |  |  | - |
Residential real estate - Investor |  | - |  |  |  | - |  |  |  | 6 |
Residential real estate - Owner occupied |  | 1 |  |  |  | 97 |  |  |  | 12 |
Multifamily |  | - |  |  |  | - |  |  |  | - |
HELOC |  | 83 |  |  |  | 40 |  |  |  | - |
HELOC - Purchased |  | - |  |  |  | - |  |  |  | - |
Other 1 |  | 98 |  |  |  | 98 |  |  |  | 84 |
Total charge-offs |  | 1,401 |  |  |  | 835 |  |  |  | 345 |
Recoveries: |  |  |  |  |  |  |  |  |  |  |
Commercial |  | 12 |  |  |  | 28 |  |  |  | 30 |
Leases |  | - |  |  |  | - |  |  |  | - |
Commercial real estate - Investor |  | 21 |  |  |  | 635 |  |  |  | 20 |
Commercial real estate - Owner occupied |  | 1 |  |  |  | 2 |  |  |  | 3 |
Construction |  | - |  |  |  | - |  |  |  | (1) |
Residential real estate - Investor |  | 21 |  |  |  | (15) |  |  |  | 16 |
Residential real estate - Owner occupied |  | 23 |  |  |  | 25 |  |  |  | 26 |
Multifamily |  | - |  |  |  | 7 |  |  |  | 8 |
HELOC |  | 141 |  |  |  | 93 |  |  |  | 46 |
HELOC - Purchased |  | - |  |  |  | - |  |  |  | - |
Other 1 |  | 60 |  |  |  | 48 |  |  |  | 57 |
Total recoveries |  | 279 |  |  |  | 823 |  |  |  | 205 |
Net charge-offs |  | 1,122 |  |  |  | 12 |  |  |  | 140 |
Adoption of ASU 326 |  | 5,879 |  |  |  | - |  |  |  | - |
Provision for credit losses on loans |  | 5,499 |  |  |  | 150 |  |  |  | 450 |
Allowance at end of period | $ | 30,045 |  |  | $ | 19,789 |  |  | $ | 19,316 |
Average total loans (exclusive of loans held-for-sale) | $ | 1,941,760 |  |  | $ | 1,899,849 |  |  | $ | 1,893,659 |
Net charge-offs / (recoveries) to average loans |  | 0.06 | % |  |  | 0.00 | % |  |  | 0.01 | %
Allowance at period end to average loans |  | 1.55 | % |  |  | 1.04 | % |  |  | 1.02 | %
Ending balance: Individually evaluated for impairment | $ | 1,867 |  |  | $ | 1,212 |  |  | $ | 222 |
Ending balance: Collectively evaluated for impairment | $ | 28,178 |  |  | $ | 18,577 |  |  | $ | 19,094 |

1 The “Other” class includes consumer and overdrafts.

The coverage ratio of the allowance for credit losses on loans to nonperforming loans was 137.6% as of March 31, 2020, which was an increase from the coverage ratio of 124.9% as of December 31, 2019, and an increase from 129.3% as of March 31, 2019. When measured as a percentage of average loans, our total allowance for credit losses on loans was 1.55% as of March 31, 2020, and 1.02% as of March 31, 2019. This increase was driven by the adoption of CECL as of January 1, 2020.

We recorded PCD loans (formerly PCI loans), which refers to loans that showed evidence of deteriorated credit quality upon purchase, in our acquisition of ABC Bank. PCD loans totaled $11.0 million, net of purchase accounting adjustments, as of March 31, 2020, and the credit-related component of the purchase accounting adjustments on these loans, which totaled $2.5 million, was reclassified to allowance for credit losses on loans, per CECL guidance, on January 1, 2020. We perform re-estimations of cash flows on our PCD 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 credit losses during the period.

In management’s judgment, adequate allowance for credit losses has been established that is sufficient to encompass the current view of lifetime expected credit losses at March 31, 2020, and general changes in lending policy, procedures and staffing, as well as other external

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factors, such as the impacts of the COVID-19 pandemic. However, there can be no assurance that actual losses will not exceed the estimated amounts in the future, based on unforeseen economic events, changes in business climates and the condition of collateral at the time of default and repossession.

Other Real Estate Owned

As of March 31, 2020, OREO totaled $5.0 million, reflecting no material change from the $5.0 million at December 31, 2019, and $6.4 million at March 31, 2019. There were two property additions which totaled $491,000 to the OREO portfolio in the first quarter of 2020. The net book value of four property disposals in the first quarter of 2020 totaled $288,000. Four valuation write-downs occurred in the first quarter of 2020 with an expense total of $158,000, compared to $519,000 of OREO valuation write-downs in the fourth quarter of 2019, and no valuation write-downs recorded in the first quarter of 2019.

|  |  |  |  |  |  |  |  |  | March 31, 2020
OREO | Three Months Ended |  | Percent Change From
(Dollars in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019
Balance at beginning of period | $ | 5,004 |  | $ | 4,682 |  | $ | 7,175 |  | 6.9 |  |  | (30.3) |
Property additions, net of acquisition adjustments |  | 491 |  |  | 567 |  |  | - |  | (13.4) |  |  | NM |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Proceeds from property disposals, net of participation purchase and of gains/losses |  | 288 |  |  | 125 |  |  | 801 |  | 130.4 |  |  | (64.0) |
Period valuation adjustments |  | 158 |  |  | 120 |  |  | - |  | 31.7 |  |  | N/M |
Other adjustments |  | - |  |  | - |  |  | 9 |  | N/M |  |  | N/M |
Balance at end of period | $ | 5,049 |  | $ | 5,004 |  | $ | 6,374 |  | 0.9 |  |  | (20.8) |

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 $3.7 million, or approximately 73.1% of total OREO at March 31, 2020, 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, with one exception. One parcel of raw land remains challenging to dispose of, and, while not material in value, remains held as OREO in excess of the time allowed per regulatory guidance.

OREO Properties by Type |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) | March 31, 2020 |  | December 31, 2019 |  | March 31, 2019
|  | Amount |  | % of Total |  |  | Amount |  | % of Total |  |  | Amount |  | % of Total
Single family residence | $ | 450 |  | 9 | % |  | $ | 174 |  | 3 | % |  | $ | 882 |  | 14 | %
Lots (single family and commercial) |  | 3,747 |  | 74 | % |  |  | 3,945 |  | 79 | % |  |  | 4,310 |  | 68 | %
Vacant land |  | 41 |  | 1 | % |  |  | 41 |  | 1 | % |  |  | 470 |  | 7 | %
Commercial property |  | 811 |  | 16 | % |  |  | 844 |  | 17 | % |  |  | 703 |  | 11 | %
Total other real estate owned | $ | 5,049 |  | 100 | % |  | $ | 5,004 |  | 100 | % |  | $ | 6,365 |  | 100 | %

Deposits and Borrowings

|  |  |  |  |  |  |  |  |  | March 31, 2020
Deposits | As of |  | Percent Change From
(Dollars in thousands) | March 31, |  | December 31, |  | March 31, |  | December 31, |  | March 31,
| 2020 |  | 2019 |  | 2019 |  | 2019 |  | 2019
Noninterest bearing demand | $ | 702,598 |  | $ | 669,795 |  | $ | 629,909 |  | 4.9 |  | 11.5
Savings |  | 338,134 |  |  | 307,015 |  |  | 314,029 |  | 10.1 |  | 7.7
NOW accounts |  | 428,419 |  |  | 425,792 |  |  | 449,288 |  | 0.6 |  | (4.6)
Money market accounts |  | 277,018 |  |  | 282,478 |  |  | 297,899 |  | (1.9) |  | (7.0)
Certificates of deposit of less than $100,000 |  | 231,704 |  |  | 227,578 |  |  | 224,899 |  | 1.8 |  | 3.0
Certificates of deposit of $100,000 through $250,000 |  | 150,185 |  |  | 151,279 |  |  | 145,397 |  | (0.7) |  | 3.3
Certificates of deposit of more than $250,000 |  | 67,584 |  |  | 62,812 |  |  | 62,091 |  | 7.6 |  | 8.8
Total deposits | $ | 2,195,642 |  | $ | 2,126,749 |  | $ | 2,123,512 |  | 3.2 |  | 3.4

Total deposits were $2.2 billion at March 31, 2020, which reflects a $68.9 million increase from total deposits of $2.13 billion at December 31, 2019, and an increase of $72.1 million from the $2.12 billion at March 31, 2019. The increase in deposits at March 31,

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2020, compared to December 31, 2019, was due primarily to increases in noninterest bearing demand, savings, NOW accounts, and certificates of deposit of less than $100,000 and more than $250,000. The increase in deposits in the year over year period was primarily due to noninterest bearing demand deposits of $72.7 million, or 11.5%, an increase in savings accounts of $24.1 million, or 7.7%, and an aggregate increase in time deposits of $17.1 million, or 4.0%. These increases in the year over year period were partially offset by an aggregate decrease in NOW and money market deposits of $41.8 million, or 5.6%.

In addition to deposits, we obtained funding from other sources in all periods presented. Securities sold under repurchase agreements totaled $51.2 million at March 31, 2020, a $2.5 million, or 5.2%, increase from $48.7 million at December 31, 2019, and an $8.9 million, or 21.0%, increase from March 31, 2019. We also recorded short-term borrowings of $6.4 million from the FHLBC at March 31, 2020, as compared to $48.5 million in short-term borrowings at December 31, 2019, and $85.0 million at March 31, 2019. Our notes payable and other borrowings is comprised of one remaining $6.6 million long-term FHLBC advance acquired in our ABC Bank acquisition, which matures on February 20, 2026. In addition, notes payable and other borrowings includes a $20.0 million term note originated with a correspondent bank in the first quarter of 2020, to facilitate in the redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures, completed on March 2, 2020. Notes payable and other borrowings of $26.6 million as of March 31, 2020, increased $19.9 million from December 31, 2019, and increased $13.4 million from March 31, 2019. All prior period balances were comprised solely of long-term FHLBC advances acquired with the ABC Bank acquisition in 2018.

The Company is indebted on senior notes totaling $44.3 million, net of deferred issuance costs, as of March 31, 2020. 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 $25.8 million, net of deferred issuance costs, of junior subordinated debentures, which are related to the trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust II (“Trust II”). The Trust II issuance converted from fixed to floating rate at three month LIBOR plus 150 basis points 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 4.40% as of March 31, 2020, as compared to 6.77%, which was the rate paid during the period prior to the June 15, 2017, rate reset. The Company also redeemed $32.6 million of trust preferred securities issued by its statutory trust subsidiary, Old Second Capital Trust I, on March 2, 2020, as noted above. The cash paid at redemption of $33.0 million included accrued interest of $438,000 on the debentures, and resulted in a payment of $10.13 per preferred share.

Capital

As of March 31, 2020, total stockholders’ equity was $265.8 million, which was a decrease of $12.1 million from $277.9 million as of December 31, 2019. This decrease is attributable to a decline in accumulated other comprehensive income of $6.4 million in the first quarter of 2020 due to an increase in unrealized losses on available-for-sale securities and swaps, and a reduction to retained earnings of $3.8 million upon the adoption of ASU 2016-13 (CECL) as of January 1, 2020. In addition, our treasury stock increased $2.4 million in the first quarter of 2020, primarily due to repurchases of our common shares pursuant to our stock repurchase program, and we paid $300,000 of dividends to our common stockholders in the three months ended March 31, 2020. Net income was $275,000 for the first three months of 2020.

In the third quarter of 2019, our Board of Directors authorized a stock repurchase program, in which we may repurchase up to approximately 1.5 million shares (or approximately 5%) of our outstanding common stock by September 2020, through open market purchases, trading plans established in accordance with U.S. Securities and Exchange Commission rules, privately negotiated transactions, or by other means. The actual means and timing of any repurchases, quantity of purchased shares and prices will be, subject to certain limitations, at the discretion of management and will depend on a number of factors, including, without limitation, market prices of our common stock, general market and economic condition, and applicable legal and regulatory requirements. These share purchases are anticipated to be funded by our cash on hand. During the first quarter of 2020, we repurchased 312,723 shares of our common stock at a weighted average price of $7.06 per share pursuant to our stock repurchase program

The following table shows the regulatory capital ratios and the current well capitalized regulatory requirements for the Company and the Bank as of the dates indicated:

|  | Minimum Capital |  | Well Capitalized |  |  |  |  |  |  |  |  |
|  | Adequacy with |  | Under Prompt |  |  |  |  |  |  |  |  |
|  | Capital Conservation |  |  | Corrective Action |  | March 31, |  | December 31, |  | March 31,
|  | Buffer, if applicable 1 |  | Provisions 2 |  | 2020 |  | 2019 |  | 2019
The Company |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Common equity tier 1 capital ratio |  | 7.00 | % |  | N/A |  |  | 10.85 | % |  | 11.14 | % |  | 9.75 | %
Total risk-based capital ratio |  | 10.50 | % |  | N/A |  |  | 13.09 | % |  | 14.53 | % |  | 13.17 | %
Tier 1 risk-based capital ratio |  | 8.50 | % |  | N/A |  |  | 11.93 | % |  | 13.65 | % |  | 12.30 | %
Tier 1 leverage ratio |  | 4.00 | % |  | N/A |  |  | 10.57 | % |  | 11.93 | % |  | 10.44 | %
The Bank |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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Common equity tier 1 capital ratio |  | 7.00 | % |  | 6.50 | % |  | 12.89 | % |  | 14.35 | % |  | 13.60 | %
Total risk-based capital ratio |  | 10.50 | % |  | 10.00 | % |  | 14.07 | % |  | 15.23 | % |  | 14.47 | %
Tier 1 risk-based capital ratio |  | 8.50 | % |  | 8.00 | % |  | 12.89 | % |  | 14.35 | % |  | 13.60 | %
Tier 1 leverage ratio |  | 4.00 | % |  | 5.00 | % |  | 11.36 | % |  | 12.50 | % |  | 11.54 | %

1 Amounts are shown inclusive of a capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes.

2 The prompt corrective action provisions are only applicable at the Bank level.

As part of its response to the impact of the COVID-19 pandemic, in the first quarter of 2020, U.S. federal regulatory authorities issued an interim final rule that provides banking organizations that adopt CECL during the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital relative to regulatory capital determined under the prior incurred loss methodology, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition in total). In connection with our adoption of CECL on January 1, 2020, we have elected to utilize the five-year CECL transition. The cumulative amount that is not recognized in regulatory capital, in addition to the $3.8 million Day 1 impact of CECL adoption, will be phased in at 25% per year beginning January 1, 2022. As of March 31, 2020, the capital measures of the Company exclude $5.2 million, which is the Day 1 impact to retained earnings, and 25% of the $8.0 million increase in the allowance for credit losses in the first quarter of 2020, excluding PCD loans.

As of March 31, 2020, the Company, on a consolidated basis, exceeded the minimum capital ratios to be deemed “well capitalized” and met the now fully phased-in capital conservation buffer requirements. In addition to the above regulatory ratios, our GAAP common equity to total assets ratio, which is used as a performance measurement for capital analysis and peer comparisons, decreased from 10.54% at December 31, 2019, to 10.00% at March 31, 2020. Our GAAP tangible common equity to tangible assets ratio was 9.28% at March 31, 2020, compared to 9.81% as of December 31, 2019. Our non-GAAP tangible common equity to tangible assets ratio, which management also considers a valuable performance measurement for capital analysis, decreased from 9.83% at December 31, 2019, to 9.30% at March 31, 2020.

In November 2019, the federal banking agencies published final rules to provide an optional simplified measure of capital adequacy for qualifying community banking organizations, which we refer to as the community bank leverage ratio (“CBLR”) framework. Generally, under the CBLR framework, qualifying community banking organizations with total assets of less than $10 billion, and limited amounts of off-balance-sheet exposures and trading assets and liabilities, may elect whether to be subject to the CBLR framework if they have a CBLR of greater than 9%. Qualifying community banking organizations that elect to be subject to the CBLR framework and continue to meet all requirements under the framework would not be subject to risk-based or other leverage capital requirements and, in the case of an insured depository institution, would be considered to have met the well capitalized ratio requirements for purposes of the FDIC’s Prompt Corrective Action framework. The final rule became effective on January 1, 2020. We do not have any immediate plans to elect to use the community bank leverage ratio framework, but may make such an election in the future.

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

| March 31, 2020 |  |  | December 31, 2019 |
Tangible common equity | GAAP |  |  | Non-GAAP |  |  | GAAP |  |  | Non-GAAP |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total Equity | $ | 265,777 |  |  | $ | 265,777 |  |  | $ | 277,864 |  |  | $ | 277,864 |
Less: Goodwill and intangible assets |  | 21,147 |  |  |  | 21,147 |  |  |  | 21,275 |  |  |  | 21,275 |
Add: Limitation of exclusion of core deposit intangible (80%) |  | N/A |  |  |  | 508 |  |  |  | N/A |  |  |  | 534 |
Adjusted goodwill and intangible assets |  | 21,147 |  |  |  | 20,639 |  |  |  | 21,275 |  |  |  | 20,741 |
Tangible common equity | $ | 244,630 |  |  | $ | 245,138 |  |  | $ | 256,589 |  |  | $ | 257,123 |
Tangible assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total assets | $ | 2,656,810 |  |  | $ | 2,656,810 |  |  | $ | 2,635,545 |  |  | $ | 2,635,545 |
Less: Adjusted goodwill and intangible assets |  | 21,147 |  |  |  | 20,639 |  |  |  | 21,275 |  |  |  | 20,741 |
Tangible assets | $ | 2,635,663 |  |  | $ | 2,636,171 |  |  | $ | 2,614,270 |  |  | $ | 2,614,804 |
Common equity to total assets |  | 10.00 | % |  |  | 10.00 | % |  |  | 10.54 | % |  |  | 10.54 | %
Tangible common equity to tangible assets |  | 9.28 | % |  |  | 9.30 | % |  |  | 9.81 | % |  |  | 9.83 | %

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.

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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. In addition, due to the potential impacts to our liquidity stemming from the COVID-19 pandemic, our senior management team monitors cash balances daily to ensure we have adequate liquidity to meet our operational and financing needs. As of March 31, 2020, our cash on hand liquidity increased $22.5 million, or 44.5%, over the cash balances held as of December 31, 2019.

Net cash inflows from operating activities were $9.0 million during the first three months of 2020, compared with net cash inflows of $12.5 million in the same period of 2019. Originations of loans held-for-sale, net of proceeds from sales of loans held-for-sale, were a source of outflows of funds for the three months ended March 31, 2020. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, were a source of inflows for the first three months of 2019. Interest paid, net of interest received, combined with changes in other assets and liabilities were a source of inflows for the first three months of 2020 and a source of outflows for first three months of 2019. The management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows. Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, as part of the balance sheet management process.

Net cash outflows from investing activities were $220,000 in the first three months of 2020, compared to net cash inflows of $37.4 million in the same period in 2019. In the first three months of 2020, securities transactions accounted for net inflows of $28.1 million, and the principal change on loans accounted for net outflows of $27.7 million. In the first three months of 2019, securities transactions accounted for net inflows of $42.9 million, and net principal on loans funded accounted for net outflows $6.1 million. Proceeds from sales of OREO accounted for $311,000 and $874,000 in investing cash inflows for the first three months of 2020 and 2019, respectively.

Net cash inflows from financing activities in the first three months of 2020 were $13.7 million, compared with net cash outflows of $64.8 million in the first three months of 2019. Net deposit inflows in the first three months of 2020 were $68.9 million compared to net deposit inflows of $6.9 million in the first three months of 2019. Other short-term borrowings had net cash outflows of $42.1 million in the first three months of 2020 and $64.5 million in the first three months of 2019. Changes in securities sold under repurchase agreements accounted for $2.5 million in net inflows and $4.3 million in net outflows in the first three months of 2020 and 2019, respectively. The redemption of our Old Second Capital Trust I trust preferred securities and related junior subordinated debentures resulted in cash outflows of $32.6 million in the first quarter of 2020, which was partially offset by a $20.0 million term note cash inflow which was originated to partially fund this trust preferred redemption.

Cash and cash equivalents for the three months ended March 31, 2020, totaled $73.1 million, as compared to $40.3 million as of March 31, 2019. In addition to cash and cash equivalents on hand or held as deposits with other financial institutions, we rely on funding sources from customer deposits, cash flows from securities available-for-sale and loans, and a line of credit with the FHLBC to meet potential liquidity needs. These sources of liquidity are immediately available to satisfy any funding requirements due to depositor or borrower demands through the ordinary course of our business. Additional sources of funding include a $20 million undrawn line of credit held by the Company with a third party financial institution, as well as unpledged securities available-for-sale.

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 (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 have an exposure to changes in both short-term and long-term interest rates.

In the first quarter of 2020, the Federal Reserve cut short-term interest rates on three separate occasions. One cut occurred on the scheduled meeting date in January, and the other two were announced prior to the scheduled meeting date in March. In response to the COVID-19 pandemic, the Federal Reserve aggressively cut rates as low as they could without taking rates negative. Overall the Fed Funds upper bound target rate dropped from 1.75% to 0.25% during the quarter, a decline of 1.50%. As a result, the Bank's prime also dropped by 1.50% from 4.75% to 3.25%. The general market consensus is that the Federal Reserve will keep the Fed Funds rates unchanged for the foreseeable future in an effort to combat the harsh economic effects of COVID-19. We manage interest rate risk within guidelines established by policy which are intended to limit the amount of rate exposure. In practice, we seek to manage our interest rate risk exposure well within our guidelines so that such exposure does not pose a material risk to our future earnings.

We manage various market risks in the normal course of our operations, including credit, liquidity risk, and interest-rate risk. Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of our business

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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, 2020, and December 31, 2019, 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 asset-liability 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 14 of our consolidated financial statements included in this quarterly report. We seek to monitor and manage interest rate risk within approved policy guidelines and limits.

We use simulation analysis to quantify the impact of various rate scenarios on our net interest income. Specific cash flows, repricing characteristics, and embedded options of the assets and liabilities held by us 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, 2019, 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 projected increases in income across all up rate interest rate shock scenarios as of March 2020 were moderately higher than those in December 2019. With the exception of some deposit growth, the general balance sheet composition of both assets and liabilities did not change appreciably during the first quarter of 2020. However, we completed an internal historical deposit study on both decay rates and betas. The results of these studies were used to update assumptions within the asset liability model. These assumption updates were the primary driver of the moderate uptick in income projected across all up rate scenarios. Management feels the asset liability modelling results using the new deposit assumptions more accurately reflect the bank’s true interest rate risk position. Management still considers the current level of interest rate risk to be moderate but intends to continue looking for market opportunities to flatten its interest rate risk profile.

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. Due to recent dramatic market interest rate declines, it was not possible to calculate any down rate scenario because rates would fall below zero in all down rate scenarios.

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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, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Dollar change |  |  | N/M |  |  |  | N/M |  |  |  | N/M |  |  | $ | 2,076 |  |  | $ | 4,287 |  |  | $ | 8,710 |
Percent change |  |  | N/M |  |  |  | N/M |  |  |  | N/M |  |  |  | 2.4 | % |  |  | 4.9 | % |  |  | 9.9 | %
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Dollar change |  |  | N/M |  |  | $ | (6,229) |  |  | $ | (2,670) |  |  | $ | 993 |  |  | $ | 2,016 |  |  | $ | 3,856 |
Percent change |  |  | N/M |  |  |  | (6.6) | % |  |  | (2.8) | % |  |  | 1.1 | % |  |  | 2.1 | % |  |  | 4.1 | %

N/M - Not meaningful

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, 2020. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2020, 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.

We adopted the new guidance under Accounting Standards Update 2016-13, (ASC Topic 326) “Measurement of Credit Losses on Financial Instruments,” also known as Current Expected Credit Losses, or CECL, on January 1, 2020. The Company implemented new accounting processes and procedures, which required us to update our internal controls over accounting for the allowance for credit losses, and the related disclosures under the new guidance. As a result of the adoption of CECL, we implemented new internal controls designed to mitigate the risks associated with these new processes and to provide assurance at a reasonable level of the fair presentation of our consolidated financial statements and related disclosures. There were no other changes in the Company’s internal controls over financial reporting during the quarter ended March 31, 2020, 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

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Note Regarding Any Forward-Looking Statements,” risks and matters described elsewhere in this Quarterly Report on Form 10-Q and in our other filings with the SEC.

We are providing these additional risk factors to supplement the risk factors contained in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2019.

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The COVID-19 pandemic has adversely affected our business and results of operations, and the ultimate impacts of the pandemic on our business, financial condition and results of operations will depend on future developments and other factors that are highly uncertain and will be impacted by the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets and has had an adverse effect on our business and results of operations. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability. In response to the COVID-19 pandemic, the government of the State of Illinois and of most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. T hese restrictions and other consequences of the pandemic have resulted in significant adverse effects for many different types of businesses, including, among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees nationwide and in markets in which we operate.

The ultimate effects of COVID-19 on the broader economy and the markets that we serve are not known nor is the ultimate length of the restrictions described above and any accompanying effects. Moreover, the Federal Reserve has taken action to lower the Federal Funds rate, which may negatively affect our interest income and, therefore, earnings, financial condition and results of operation. Additional i mpacts of COVID-19 on our business could be widespread and material, and may include, or exacerbate, among other consequences, the following:

| · |  | employees contracting COVID-19;

| · |  | reductions in our operating effectiveness as our employees work from home;

| · |  | a work stoppage, forced quarantine, or other interruption of our business;

| · |  | unavailability of key personnel necessary to conduct our business activities;

| · |  | effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating our financial reporting and internal controls;

| · |  | sustained closures of our branch lobbies or the offices of our customers;

| · |  | declines in demand for loans and other banking services and products;

| · |  | declines in the stability of our deposit base, as well as our capital and liquidity position;

| · |  | reduced consumer spending due to both job losses and other effects attributable to COVID-19;

| · |  | unprecedented volatility in United States financial markets;

| · |  | volatile performance of our investment securities portfolio;

| · |  | decline in the credit quality of our loan portfolio, owing to the effects of COVID-19 in the markets we serve, leading to a need to increase our allowance for credit losses;

| · |  | declines in value of collateral for loans, including real estate collateral;

| · |  | declines in the net worth and liquidity of borrowers and loan guarantors, impairing their ability to honor commitments to us; and

| · |  | declines in demand resulting from businesses being deemed to be “non-essential” by governments in the markets we serve, and from “non-essential” and “essential” businesses suffering adverse effects from reduced levels of economic activity in our markets.

These factors, together or in combination with other events or occurrences that may not yet be known or anticipated, may materially and adversely affect our business, financial condition and results of operations.

In March 2020, we announced programs to support our customers, employees, and communities during the COVID-19 pandemic. A significant number of our borrowers have enrolled in one of our programs to defer all loan payments for up to 90 days. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time.

The ongoing COVID-19 pandemic has resulted in meaningfully lower stock prices for many companies, as well as the trading prices for many other securities. The further spread of the COVID-19 outbreak, as well as ongoing or new governmental, regulatory and private sector responses to the pandemic, may materially disrupt banking and other economic activity generally and in the areas in which we operate. This could result in further decline in demand for our banking products and services, and could negatively impact, among other things, our liquidity, regulatory capital and our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.

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We are taking precautions to protect the safety and well-being of our employees and customers. However, no assurance can be given that the steps being taken will be adequate or deemed to be appropriate, nor can we predict the level of disruption which will occur to our employee’s ability to provide customer support and service. If we are unable to recover from a business disruption on a timely basis, our business, financial condition and results of operations could be materially and adversely affected. We may also incur additional costs to remedy damages caused by such disruptions, which could further adversely affect our business, financial condition and results of operations.

The extent to which COVID-19 impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after COVID-19 has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’ global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.

The COVID-19 pandemic has resulted in a higher allowance for credit losses (“ACL”) determined in accordance with the Current Expected Credit Loss, or CECL standard, and may result in increased volatility and further increases in our allowance for credit losses.

The measure of our ACL is dependent on the adoption and interpretation of applicable accounting standards. The Financial Accounting Standards Board issued a new credit impairment model, the Current Expected Credit Loss, or CECL standard, which has become effective and was adopted by us in the first quarter of 2020. Under the CECL model, we are required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount and certain management judgments over the life of the loan. This initial measurement took place as of January 1, 2020, at the time of our adoption of CECL, and measurements will occur periodically thereafter. The adoption of the CECL model has materially affected how we determine our ACL and, combined with the effects of the COVID-19 pandemic, required us to significantly increase our allowance as of March 31, 2020. As discussed in this report, we adopted CECL in the first quarter of 2020. As a result, credit loss allowances increased in the quarter ended March 31, 2020, by approximately $7.5 million, resulting in a corresponding $3.8 million decrease in retained earnings.

The CECL model may create more volatility in the level of our ACL, as compared to the “incurred loss” standard that we previously applied in determining our ACL. The CECL model requires us to estimate the lifetime “expected credit loss” with respect to loans and other applicable financial assets, which may change more rapidly than the level of “incurred losses” that would have been used to determine our allowance for loan losses under the prior incurred loss standard. The potentially material effects of the COVID-19 pandemic on lifetime expected credit loss, and the challenges associated with estimating lifetime credit losses in view of the uncertain ultimate impacts of the pandemic, may result in increased volatility and significant additions to our ACL in the future, which could have a material and adverse effect on our business, financial condition and results of operations.

As a participating lender in the SBA Paycheck Protection Program (“PPP”), we are subject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Stability Act, or CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. On April 24, 2020, an additional $320 billion of PPP loan funding was authorized. Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. We may be exposed to the risk of litigation, from both customers and non-customers that approached us regarding PPP loans, regarding our process and procedures used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by us, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated,

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funded, or serviced by us, the SBA may deny our liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

The outbreak of COVID-19, or an outbreak of other highly infectious or contagious diseases, could disrupt banking and other financial activity in the areas in which we operate and could potentially create widespread business continuity issues for us.

Our business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions. We rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the outbreak could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which we operate and could create widespread business continuity issues for us. We have already shifted a substantial portion of our workforce to work remotely and have restricted access to our branch lobbies. However, we could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in one or more of our market areas. We also face heightened cybersecurity, information security and operational risks as a result of work-from-home arrangements.

The borrowing needs of our clients may increase, especially during this challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.

A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our clients under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our clients, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of March 31, 2020, we had $439.5 million in unfunded credit commitments to our clients. Actual borrowing needs of our clients may exceed our expectations, including due to the COVID-19 pandemic, as our clients’ companies may be more dependent on our credit commitments due, among other things, business challenges, a lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from private investment firms. This could adversely affect our credit quality and our liquidity, which could adversely affect our ability to fund operations and meet obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.

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

Stock Repurchases

In September 2019, our board of directors authorized the repurchase of up to 1,494,826 shares of our common stock (the “Repurchase Program”). Repurchases by us under the Repurchase Program may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means.

The actual means and timing of any repurchases, quantity of purchased shares and prices will be, subject to certain limitations, at the discretion of management and will depend on a number of factors, including, without limitation, market prices of our common stock, general market and economic conditions, and applicable legal and regulatory requirements. Repurchases under the Repurchase Program may be initiated, discontinued, suspended or restarted at any time; provided that repurchases under the Repurchase Program after September 19, 2020 would require Federal Reserve non-objection or approval. We are not obligated to repurchase any shares under the Repurchase Program.

The following table presents our stock repurchases for the quarter ended March 31, 2020.

|  |  |  |  |  |  | Total Number of |  | Maximum Number
|  | Total |  |  |  |  | Shares Purchased |  | of Shares that May
|  | Number of |  |  | Average |  | as Part of Publicly |  | Yet Be
(Dollars in thousands, except for per share |  | Shares |  |  | Price Paid |  | Announced Plans |  | Purchased Under
amounts) |  | Purchased |  |  | per Share |  | or Programs |  | the Plans or Programs
January 1, 2020 - January 31, 2020 |  | - |  | $ | - |  | - |  | 1,494,826
February 1, 2020 - February 29, 2020 |  | - |  |  | - |  | - |  | 1,494,826
March 1, 2020 - March 31, 2020 |  | 312,723 |  |  | 7.06 |  | 312,723 |  | 1,182,103
Total |  | 312,723 |  | $ | 7.06 |  | 312,723 |  | 1,182,103

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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, 2020, and December 31, 2019; (ii) Consolidated Statements of Income for the three months ended March 31, 2020 and 2019; (iii) Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2020 and 2019; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019; 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 8, 2020 |

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