Old Second Bancorp, Inc. (OSBC) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Inc.'s Second Quarter 2026 Earnings Call. On the call today are Jim Eccher, the company's Chairman, President and CEO; Brad Adams, the company's COO and CFO; Darin Campbell, the company's Head of National Specialty Lending; and Gary Collins, the Vice Chairman of our Board. I will start with a reminder that Old Second's comments today will contain forward-looking statements about the company's business, strategies and prospects, which are based on management's existing expectations and the current economic environment. These statements are not a guarantee of future performance, and results may differ materially from those projected. Management would ask you to refer to the company's SEC filings for a full discussion of the company's risk factors. The company does not undertake any duty to update such forward-looking statements. On today's call, we will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts in our earnings release, which is available on our website at oldsecond.com on the homepage and under the Investor Relations tab. Now I will turn it over to Jim Eccher.

Okay. Good morning, and thank you for joining us. As customary, I have several prepared opening remarks. Give my overview of the quarter, then turn it over to Brad for additional details. I will then conclude with certain summary comments and thoughts about the future before we open it up to Q&A. From a GAAP perspective, net income was $28.2 million or $0.54 per diluted share in the second quarter and return on assets was 1.65%. Second quarter 2026 return on average tangible common equity was 15.58%, and the tax equivalent efficiency ratio was 51.72%. Excluding all adjusting items, which include MSR valuation adjustments and the costs related to the 2025 acquisition of Bancorp Financial and its wholly owned subsidiary, Evergreen Bank Group, net income for the quarter was $28.7 million or $0.55 per diluted share. Second quarter earnings were impacted by $9.2 million of net loan charge-offs, which primarily included 2 credits that we discussed at length on last quarter's earnings call. a commercial and industrial charge-off of $3 million in the warehousing and distribution business that has seen its cash flow position erode over the last year. A commercial real estate investor charge-off of $2.8 million that was an office property located in a western suburban of Chicago. This was an acquired credit that was restructured into an AB note in 2023 due to challenges facing the office market. At the time of the restructure, the B note was fully secured by the value of the underlying collateral, but has recently experienced a decline in value. And based on an updated valuation, the B notes collectibility is now in doubt and was charged off. The B note was previously fully allocated for prior quarters and a portion of the note was accounted for in purchase accounting adjustments as a result of the acquisition of Evergreen Bank Group. The property continues to produce cash flow adequately to support the A note at this time. Net charge-offs related to the Powersports business totaled $2.8 million, which is a $1.1 million reduction from the prior quarter as seasonality related to this loan portfolio usually results in higher usage of ATVs and UTVs that are collateral for these loans during the spring and summer months. I would note that the contribution margin in this business has continued to trend higher and remains robust. Tangible book value per share increased to $14.77 at the end of the quarter from [ $14.35 ] last quarter. The tangible equity ratio increased 12 basis points from last quarter from 11.07% to 11.19% and is 36 basis points higher than the like period 1 year ago. Common equity Tier 1 was 13.28% in the second quarter of 2026, increasing from 13.13% last quarter, but decreased 49 basis points from 1 year ago. This decline is primarily due to stock repurchases of approximately $40.2 million during 2026. Our financials reflect an exceptionally strong net interest margin of 5.23% for the second quarter. That's a 9 basis point improvement for last quarter and 38 basis point increase over the prior year like quarter on a tax equivalent basis. Pre-provision net revenues increased in the second quarter from the prior quarter, primarily due to day count, higher average balances and lower average time deposit balances. Total cost of deposits was 100 basis points for the second quarter compared to 105 basis points for the prior linked quarter and 84 basis points for the second quarter of 2025. For the second quarter 2026 compared to last quarter, tax equivalent income on average earning assets increased $2.8 million, while interest expense on average-bearing liabilities increased $658,000. The loan-to-deposit ratio stands at 96.4% as of June 30 compared to 93.2% last quarter and 83.3% as of June 30, 2025. Total loans increased $60.6 million during the second quarter, partially reversing seasonal declines in the previous quarter. Tax equivalent loan yield increased 12 basis points during the second quarter of 2026 compared to the linked quarter and reflected a 63 basis point increase for the quarter year-over-year. The increase in yield in comparison to the prior quarter is driven by higher short-term rates and repricing of lower-yielding loans that were originated in 2021 and 2022. Turning to credit. Asset quality trends improved during the quarter despite the elevated charge-offs. Nonperforming loans decreased $19 million and classified assets declined $16.5 million. In general, our collateral position remained stable on classified assets. We recorded $9.2 million of net charge-offs in the second quarter with the majority stemming from the powersports portfolio and one relationship each in commercial real estate investor and commercial. Overall, we're pleased with the credit trends as NPAs declined 25% in the quarter. The allowance for credit losses on loans was $70.4 million as of June 30 or 1.34% of loans from $72.1 million at March 31, 2026, which was 1.39% of loans. Unemployment and GDP forecast used in the future loss rate assumptions remained fairly static from last quarter with no material changes in the unemployment assumptions on the upper end of the range based on recent Fed projections. The impact of global tariff volatility and the war in Iran continues to be considered within our modeling. Provision levels quarter-over- linked-quarter decreased by $2.5 million to $7.5 million. and were partially driven by significant movements in delinquencies when compared to the forecast period, resulting in a negative qualitative adjustments. Additionally, some larger charge-offs taken during the quarter had been provided for or allocated for in prior quarters. Broadly, we are encouraged at the positive credit trends with the reduction in nonperforming assets and classified assets quarter-over-linked-quarter. The office portfolio continues to be under pressure broadly with valuations coming in at steep discounts to prior levels and rents declining broadly. The good news is we don't have anything classified in that vertical and very much of it on a relative basis, it only represents about 3% of the portfolio. Non-interest income increased $631,000 or 5% in the quarter compared to the prior linked quarter and a $2.4 million increase or 21.7% from the prior year [indiscernible] quarter. Wealth management had a strong quarter. Income was up there $245,000 quarter-over- linked-quarter and increased $525,000 compared to the prior year linked quarter. Mortgage banking income increased $97,000 compared to the linked quarter and increased $543,000 compared to the like period a year ago, primarily due to the changes in mortgage servicing rights, mark-to-market valuations. MSR valuation was flat quarter-over-linked-quarter. However, excluding the impact of mortgage servicing rights mark-to-market adjustments, mortgage banking income increased $164,000 over the prior year like period. Other income declined $176,000 in the second quarter compared to the prior linked quarter and increased to $551,000 compared to the prior year like quarter, driven largely by Powersports loan service fees and dealer chargebacks and lease syndication fees. Total noninterest expense for the second quarter increased $1 million from the prior linked quarter, driven by higher officer incentive and employee insurance costs within salaries and employee benefits, elevated OREO expenses as the first quarter of 2026 realized net gains on property sales as well as GAAP insurance refunds related to legacy Evergreen activity within other expense. Altogether, our efficiency ratio continues to be excellent as the tax equivalent efficiency ratio adjusted to exclude core deposit intangible amortization, OREO costs and the adjustments to net income, as noted earlier, was 50.8% for the second quarter compared to 51.7% for the first quarter. Overall, the bank continues to perform at an exceptionally high level. Operating leverage is strong. The margin is stable and fee income businesses are performing well. We're doing a nice job of adding additional talent throughout the organization. Credit is on an improving trend, and I'm hopeful that we will soon be able to demonstrate the full earnings power of Old Second. I'll now turn it over to Brad for additional color.

Thanks, Jim. I'll be brief. There's not a lot controversial from my corner of the world or confusing for that matter. Net interest income increased to $83.3 million for the quarter relative to last quarter's $81.1 million and increased by $19 million or almost 30% from the year ago quarter. The interesting thing about this quarter is tax equivalent loan yields increased by 12 basis points and the securities yields increased by 6 basis points. That is the fundamental driver of what I guess I would call a margin surprise increase of 9 basis points relative to our expectations of giving back a few. And that largely stemmed from interest rate increases along the curve, particularly in SOFR and overnight index swap rates that began after kind of instability in the Middle East kicked up and price of oil went up and all that, none of which could have been expected worked out well, I guess. Obviously, the margin is ridiculously good at this point. 5.23% relative to 5.14% last quarter, 38 basis points up year-over-year. We did have some loan growth this quarter on an average basis, it was only $14 million. Obviously, Jim went through the period end. Deposit runoff was a little higher than expected. Deposit funding costs came down, which I did not expect. I would say that both loan and deposit market competition is very robust right now. We are seeing that both in terms of pricing and structure on the loan side. And we are seeing deposit competition pretty significantly above the Fed funds curve and the treasury curve at this point. So things are pretty aggressive out there. Loan origination activity in the second quarter reflected a seasonal increase of $60 million and the pipeline remains strong. Certainly, the market environment, including pricing challenges due to tariffs and the uncertainty with the war in Iran results in some reluctance on borrowers to invest in capital projects. So we're still kind of in a wait-and-see mode on that front. Overall, I still feel pretty good about loan growth on a full year basis. I don't see much of a reason to step down what we talked about before, maybe a little bit more of a bias toward the low single-digit level. From a stock repurchase perspective, we acquired 732,000 shares during the second quarter at an average price of $21.08. The result obviously in a reduction to equity and growth in the treasury stock of $15.4 million. This enhanced EPS in the quarter by about $0.01. Year-to-date, repurchases under the stock repurchase program totaled 1.9 million shares at an average price of [indiscernible]. We had exhausted the previously approved stock repurchase program, which was 5% at the time pre-Evergreen. And the Board of Directors have approved a new plan to repurchase approximately 2.5 million shares through June 30, 2027. I would expect that we will continue to be active and aggressive in the repurchase of shares given our extremely strong capital position that far outstretches our projected capital needs over the next 12 to 24 months. Margin trends still feel very good and very stable in the near term. If you pin me down and hit me with a rock, I would say we'd probably give back a few basis points, but my track record is starting to look pretty poor on that prognostication. I realize I've been saying that for the last few quarters, and it hasn't happened. Obviously, rates along the curve went up quite a bit, as I said. Those trends remain stable here and high-cost deposit attrition slows, I would expect that few basis points of contraction to occur, but it may not. Loan growth for 2026, still target low to mid-single digits, as I said. Expense growth will continue to be modest in the quarters ahead. And that's it from my end. I'll turn the call back over to Jim.

Okay. Thanks, Brad. In closing, we are cautiously optimistic due to the improvements in credit metrics this quarter. I think we're particularly encouraged by a 30% reduction in our special mention loans. The rest of the bank is performing far ahead of our expectations. We remain optimistic about loan growth, as Brad mentioned, and the potential for more strategic growth opportunity as well. That concludes our prepared comments this morning. So I'll turn it over to the moderator, and we can open it up to Q&A.

[Operator Instructions] Your first question for today is from Nathan Race with Piper Sandler.

Obviously, some nice cleanup in terms of classified loans and nonperformers in the quarter. And it sounds like you guys largely mopped up some of the lingering credits on that office commercial real estate loan and also that C&I loan in the quarter. So just curious, as you look out over the next several quarters, what do you think is kind of a better kind of projection in terms of where charge-offs can shake out for Old Second with hopefully kind of more benign nonperforming inflows and so forth in the future?

Yes. I mean, I think the big takeaway for us this quarter is not only the meaningful reduction in criticized and classified NPAs, but to have a 30% reduction in special mention, which is generally a leading indicator for future problems. I think, gives us some optimism. Powersports also had a nice reduction in charge-offs. We're obviously going to see a little more charge-off in that vertical, but we're seeing -- maybe Darin can speak to this later, but we're certainly seeing a normalization in the seasonal trends in charge-offs. Having said that, we're still working through a couple of credits, but we haven't seen anything new really pop up in the last couple of quarters that had not been previously identified. So I think we're really close to having a very clean quarter on the credit front, which should -- I think which will really drive exceptional performance.

Okay. That's helpful. And then maybe, Brad, just thoughts on how the margin could trend in the back half of the year. I know it's going to be dependent on market rates similar to what we saw in terms of the impact in the second quarter. But just any thoughts in terms of what you're seeing in terms of kind of weighted average rates on loan production these days. And just any thoughts on kind of where deposits and overall cost trend?

Yes. I start with the caveat that there's like 52 ways that I can be wrong if something changes in the next week or something like that. The magnitude of the wrongness will be relatively subdued, though. if I had to guess, I would say that we would be at kind of a 5.18% range in the third quarter and maybe 5.15% in the fourth. That's my best guess. But I fully recognize my track record's [ crap ]. I think I said that the margin was going down before it crossed 5. So at least I'm wrong on the right side of it, which is somewhat comforting. But best guess, 100 ways, I could be wrong.

And underpinning that, is it essentially, Brad, that loan yields only go down from here and then deposit costs are likely going higher as well, albeit from a very, very low base.

Yes. So the things that are really driving it for us is the speed of attrition of what is effectively mimics wholesale on the deposit side. Our ability to backfill that growth with different types of deposits. Loan yields feel relatively stable. We've been in essentially the same rate environment, except for the last 3 months for almost 18 months, 24 months now on the asset side. Obviously, we've talked about this in the past, year 1 of kind of rates moving back lower is pretty great within the powersports business. Year 2 is a little bit not as good and year 3 is worse. So the tailwind of margin expansion from powersports is we're certainly in the very late innings of that. I've been remiss in pointing out at this point that another ridiculously strong increase in the contribution margin from powersports this quarter. The business continues to be exceptional. But I think the biggest thing is the biggest delta on margin and being able to nail it down right now is the speed of attrition on effectively wholesale deposits and our success in backfilling. It's a liability world these days. So I think you're seeing that from other banks. It's -- I've always believed it was a liability world just broadly, but more so today than ever.

Understood. And then maybe one last one just on capital management. Curious if we expect the pace of buybacks to step up relative to the second quarter. It looks like they came down a little bit versus 1Q. And then just within kind of the capital management context, curious kind of what the appetite and kind of prospects are on the acquisition front these days.

Latter question first. Well priced M&A that adds something to our franchise value is something we're always interested in. I believe the market is still favorable for that. As it relates to stock buyback activity, we have been buying as much as we can. I expect that to continue. Obviously, we're still growing capital, even buying back as much shares. But I think it's reasonable to expect that we will fully execute this authorization as well over the next 12 months.

Your next question is from Brandon Rud with Stephens Inc.

I guess my first one to follow up on one of your earlier answers there, Brad, the backfilling the higher rate attrition on the deposit side with core deposits, what rate is kind of needed now to generate that core deposit growth? Or maybe said another way, what's the blended interest-bearing deposit rate for that new growth?

I'm not sure -- I get the gist of the question. To maintain the margin, the reality is that if we ran out $200 million of effectively wholesale funding right now, it would be margin accretive to replace it with wholesale funding. That is the nature of the deposit competition that exists marginally right now. So I get what you're asking at what rate can we generate deposit growth. I'm not sure it really matters. It's just a question of how much wholesale funding are you willing to stomach. The reality is when you look like us, which is largely retail core deposit funded, all we're really giving up by adding wholesale funding is more asset sensitivity, which doesn't hurt. It's the trade I'm willing to make. So that's why what you're hearing from me is relatively bullish because there's these levers that are out there. And additionally, we could pay off the remainder of sub debt that exists out there, too. There are various levers that you can pull, the net-net of which is that margin feels pretty stable. But I'm contemplating therapy to not say, hey, the margin can go up from here. I don't really want to say that anymore. So it's gives and takes and what have you, I guess.

Okay. Yes. Got it. And then -- just on the expense side, the efficiency ratio is in the low 50s as a percent of assets, expenses are mid- to high 90s. Is there anything in the near term, any investments coming down the pipeline that may change either of those metrics?

Not materially, no. But the reality is that there's no deferred maintenance here. We have capital projects underway across the board to make us an even better bank, and we don't shy away from them. That's the challenge of growing a bank. So those things are continuing. They are in the run rate, and they are in the future prognostications.

Okay. Perfect. Maybe just one last one. Thanks for the comments on the commercial real estate charge-offs. On the C&I loan, is that still on balance sheet? Or is that now off balance sheet? Or maybe can you just kind of walk through that a bit more?

Yes. No, it's still on balance sheet, Brandon. The company is in the process of transacting, and we're just working through and being conservative with taking additional charges as to where we believe a sale price will eventually happen. So I expect that credit to be fully resolved within the next quarter.

Your next question for today is from Jeff Rulis with D.A. Davidson.

Just a couple of follow-ups on maybe the margin, Brad, I just wanted to kind of confirm that any sort of recovered interest on maybe some problem loan resolution that may have added to the -- I guess, any one-timers in that 5.23%. And then if you could, what -- do you have the June monthly average for margin?

I don't have it in front of me, but no, I'm not aware of any one-timers that positively impact the margin. It was largely stable throughout the quarter. It started going up. It was going up when we were on this call last quarter. I just didn't believe it can continue.

Yes. I mean I think largely, as Brad pointed out, there were 3 levers that drove it. We had some repricing of some 2021, 2022 vintage commercial real estate loans that came up for maturity. We had some high-yield deposit costs priced lower out. And then we had some securities also rolling off that were reinvested at higher yields.

Got it. And then on the -- just on the fee income front, your thoughts on -- I guess, we'd expect maybe BOLI to normalize, but that wealth management number pretty encouraging. If you could just kind of touch on kind of fee income -- overall fee income levels in the second half as you think.

Yes. I mean we've been a low single-digit grower in fee income. I mean wealth -- our wealth group continues to be successful in bringing in new assets under management. They've obviously benefited from an equity market uptick. But we fully expect it to drive, I would think, low single-digit growth. And if we see any pickup in the mortgage bank, we could get to mid-single digits.