Interest Rate Cuts And Rising Expenses May Reduce Future Profitability

Key Takeaways

• Rising interest expenses and slow loan growth could constrain margins and limit revenue expansion, affecting future earnings.
  
• Interest rate cuts and increased noninterest expenses may reduce profitability and net income growth despite efficiency efforts.
  
• Old Second Bancorp's financial resilience, stable margins, improved asset quality, and strategic growth initiatives signal strong profitability and potential share price stability or growth.

Catalysts

Operates as the bank holding company for Old Second National Bank that provides community banking services.

• Old Second Bancorp's interest expense is increasing significantly due to remixing and market pricing on commercial deposits, which could compress net margins as loan and security yield increases are partly offset by higher funding costs.
  
• A slowdown in loan growth, with activity remaining modest due to market volatility and pending economic factors, could limit future revenue expansion, potentially impacting earnings growth.
  
• Expectations of interest rate cuts, indicated by a 7-basis-point decline in net interest margin for each 25-basis-point cut, could directly impact net interest income and reduce profitability.
  
• The potential for subdued credit quality improvement and lingering non-performing loans could necessitate continued provisioning, potentially impacting net earnings if recoveries do not materialize as expected.
  
• Increases in noninterest expenses, primarily due to incentives and acquisition costs, could limit net income growth even as efficiency measures are maintained.

Old Second Bancorp Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Old Second Bancorp's revenue will decrease by -4.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 32.0% today to 36.1% in 3 years time.
• Analysts expect earnings to reach $84.0 million (and earnings per share of $1.85) by about December 2027, down from $84.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.1x on those 2027 earnings, up from 9.9x today. This future PE is about the same as the current PE for the US Banks industry at 13.1x.
• Analysts expect the number of shares outstanding to grow by 0.4% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.17%, as per the Simply Wall St company report.

Old Second Bancorp Future Earnings Per Share Growth

Risks

• Old Second Bancorp's strong profitability and increasing tangible equity ratio demonstrate financial resilience, potentially supporting share price stability or growth, as higher equity ratios reduce risk and enhance investor confidence.
  
• Despite rising interest expenses, the bank's net interest margin remains stable, supported by loan and security yields, which could positively impact revenue and earnings if maintained amid fluctuating interest rates.
  
• Asset quality improvements and reductions in substandard and criticized loans decrease credit risk, enhancing the bank's net margins and earnings stability by potentially reducing future loan loss provisions.
  
• The 20% increase in the common dividend indicates strong financial health and profitability, which could attract investors, support share price stability, and positively impact future earnings if this trend continues.
  
• Continued expansion efforts, such as the acquisition of new branches, signal strategic growth initiatives that could lead to increased market share and revenue, challenging expectations of a share price decline.

Valuation

• The analysts have a consensus price target of $20.5 for Old Second Bancorp based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $23.0, and the most bearish reporting a price target of just $18.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $232.6 million, earnings will come to $84.0 million, and it would be trading on a PE ratio of 13.1x, assuming you use a discount rate of 6.2%.
• Given the current share price of $18.71, the analyst's price target of $20.5 is 8.7% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.