KBRA Affirms Ratings for Old Second Bancorp, Inc.

27 Jul 2023   |   New York


KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Aurora, Illinois based Old Second Bancorp, Inc. (NASDAQ: OSBC) (“the company”). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for its subsidiary, Old Second National Bank. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

OSBC’s ratings reflect a very strong funding profile, anchored by a coveted low-cost and less price sensitive deposit franchise and underpinned by granular relationships, robust NIB deposit mix (40% of deposits at 2Q23), low levels of uninsured/uncollateralized deposits (<20% of total deposits), and strong on-balance sheet liquidity that is buffered by a low loan-to-deposits ratio (85% in 2Q23). Total deposit costs (0.24% in 2Q23) track among the lowest of all rated peers. Altogether, the company is considerably better-positioned than most peers to manage through the funding pressures stemming from the Fed’s monetary tightening activities. OSBC’s ratings also reflect robust earnings capacities in the current rate environment (core ROA of 1.74% in 1H23 and 1.23% in YE22), driven by a comparatively strong NIM that we consider more durable given the aforementioned inexpensive deposit base and a shorter duration investment portfolio (3-years). Supplementing the earnings profile are solid and relatively balanced noninterest income verticals (including moderate contributions from wealth management and card fees), contributing to a strong risk-weighted ROA that has averaged more than 2.00% in recent quarters. Strong earnings retention along with a pause in share buybacks have lifted capital ratios substantially higher over the year-ago period despite RWA growth. However, regulatory capital as measured by the consolidated CET1 ratio (10.3% at 2Q23), while ~100 bps higher than at 2Q22, tracks below the peer average. Given comparatively elevated NPA measures and increasing uncertainties in the macroeconomic environment, KBRA's expectation is for the CET1 ratio to trend towards or higher than the peer average over the near to medium term time horizon. The ratings are constrained by an NPA ratio that has tracked moderately above peers historically, part of which stems from acquired portfolios. Although, we recognize limited losses over time, due in part, to proactive credit administration and reasonable borrower/collateral credit strength, the credit environment had been rather benign for an extended period of time. However, we acknowledge the relatively balanced and granular loan portfolio with manageable office exposure (~5% of loans) and sufficient refreshed collateral valuations.

Rating Sensitivities

A rating upgrade is unlikely over the medium term. However, demonstrating better than peer through-the-cycle asset quality measures along with managing capital ratios more consistent with the average of higher rated peers could lead to positive rating momentum over time. Conversely, regression in credit quality measures, including material or persistently elevated credit losses leading to weak earnings could have negative rating implications. Additionally, aggressive capital management resulting in meaningful decline in the consolidated CET1 ratio could pressure ratings.

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