Old Second Bancorp Inc Q2 2026 Earnings Call

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 in 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. 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. I'll 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 two 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 suburb of Chicago. This was an acquired credit that was restructured into an A/B 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. Based on an updated valuation, the B note's collectibility is now in doubt and was charged off.

The B-note was previously fully allocated for in 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 powersport 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 at last quarter.

The tangible equity ratio increased 12 basis points from last quarter, from 11.07%-11.19%, and is 36 basis points higher than the like period one 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 one 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 nine 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 of 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 30th, compared to 93.2% last quarter and 83.3% as of June 30th, 2025. Total loans increased $60.6 million during the second quarter, partially reversing seasonal declines in the previous quarter. Tax equivalent loan yields 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. Non-performing 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 30th, or 1.34% of loans, from $72.1 million at March 31st, 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 non-performing 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-like 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 to $543,000 compared to 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.

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 powersport loan service fees and dealer chargebacks and lease indication fees. Total non-interest 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.

Our efficiency ratio continues to be excellent as the tax equivalent efficiency ratio adjusted to exclude core deposit and tangible 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, increased by $19 million or almost 30% from the year-ago like quarter. The interesting thing about this quarter is tax equivalent loan yields increased by 12 basis points and the securities yields increased by six basis points. That is the fundamental driver of what I guess I would call a margin surprise, an increase of nine basis points relative to our expectations of giving back a few.

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's 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 I 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, we are seeing deposit competition pretty significantly above the Fed funds curve and the Treasury curve at this point. 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 a war in Iran results in some reluctance in some borrowers to invest in capital projects. 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. That results, obviously, in a reduction to equity and growth in 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 $20.31. We had exhausted the previously approved stock repurchase program, which was 5% at the time, pre-Evergreen. The board of directors have approved a new plan to repurchase approximately two and a half million shares through June 30th, 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 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. That's it from my end. I 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. I'll turn it over to the moderator, and we can open it up to Q&A.

Certainly. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Your first question for today is from Nathan Race with Piper Sandler.

Hey, guys. Good morning. Thanks for taking the questions.

Morning, Nate. Obviously, some nice cleanup in terms of classified loans and non-performers 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.

Just curious, as you look out over the next several quarters, what do you think is a better projection in terms of where charge-offs can shake out for Old Second with hopefully more benign non-performer inflows and so forth in the future?

Yeah, Nate, I think the big takeaway for us this quarter is not only the meaningful reduction in criticizing 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, and Derek 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. I think we're really close to having a very clean quarter on the credit front, I think, which will really drive exceptional performance.

Okay, that's helpful. Thanks, Jim. 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. Just any thoughts in terms of what you're seeing in terms of kind of where average rates on loan production these days and just any thoughts on kind of where deposits and overall cost trend?

Start with a 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 518 range in the third quarter and maybe 515 in the fourth. That's my best guess. I fully recognize my track record's crap. I think I said that the margin was going down before it crossed five. At least I'm wrong on the right side of it, which is somewhat comforting. Best guess. 100 ways I could be wrong.

Underpinning that is, it's essentially, Brad, that loan yields can only go down from here, deposit costs are likely going higher as well, albeit from a very low base.

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 three months, for almost 18 months, 24 months now on the asset side. Obviously, we've talked about this in the past. Year one of kind of rates moving back lower is pretty great within the powersports business. Year two is a little bit not as good, year three is worse. 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. 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.

Okay. Helpful. It's a liability world these days.

I think you're seeing that from other banks. I've always believed it was a liability world just broadly, but more so today than ever.

Understood. 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. 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.

Okay, great. I appreciate all the color. Thanks, guys. Thanks, Nate. Your next question is from Brandon Rood with Stephens Inc.

Morning. Morning, Brandon. 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. 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 a trade I'm willing to make. That's why what you're hearing from me is relatively bullish because there's these levers that are out there.

Additionally, we can 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. I'm contemplating therapy to not say, "Hey, the margin can go up from here." I don't really want to say that anymore. It's gives and takes and what have yous, I guess.

Okay. Yeah. Got it. Thank you for that. 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. 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. Those things are continuing. They are in the run rate, and they are in the future prognostications.

Okay, perfect. Thank you. 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? Maybe can you just kind of walk through that a bit more?

Yeah. No, it's still on balance sheet, Brad. 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. I expect that credit to be fully resolved within the next quarter.

Okay. Thank you very much.

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

Davidson. Thanks. Good morning. Just a couple follow-ups on maybe the margin, Brad.

Just wanted to kind of confirm that any sort of recovered interest on maybe some problem loan resolution that may have added or I guess any one-timers in that 523, and then if you could, 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 impacted the margin.

And in- It was largely stable throughout the quarter.

It started going up. Okay.

It was going up when we were on this call last quarter. I just didn't believe it can continue.

Yeah, I think largely, as Brad pointed out, there were three 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. We had some securities also rolling off that were reinvested at higher yields.

Got it. Maybe just on the fee income front, your thoughts on. I guess we'd expect maybe mortgage 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, if you think those levels are sustainable.

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

Okay. Maybe the last one, just to confirm, the Evergreen kind of merger cost as well as cost saves, that's pretty much we've seen the end of it. Just wanted to kind of housekeeping.

I believe so, yes. We have one- Okay branch we just shuttered last month, so we'll have a little bit of a pickup on a go-forward basis there.

Yeah, we're largely through that.

Got it. Thank you. Your next question is from Daniel Kohut with Raymond James.

Good morning, guys. Thanks for taking my questions. Brad, I appreciate the commentary on share repurchases, sounds like you're going to be continuing that going forward. I'm just wondering how sensitive you guys are to the share price and valuation, and at what point do share repurchases not make sense from your perspective?

I'm not sensitive to it. The reality is that we have more capital than we would otherwise need. Certainly, absent M&A opportunities, we have more capital than any M&A opportunity that we would have an appetite for. The reality is that buying back fully this authorization would still not result in capital levels going down. It's a lever to return capital to shareholders such that we don't grow it as fast. It really is that simple. It's a tax-efficient return of capital to shareholders. Although I don't like that 1% tax one tiny bit. I feel remiss if I don't throw an editorial in there, whatever.

Yep. Understood. Thanks. Apologies if I missed this, going into the loan growth, it looked great in the quarter, what stood out to me was the commercial growth. Can you just provide maybe a little bit more detail there, just given the impressive growth and also considering the competitive backdrop that you had talked about?

Yeah. As Brad mentioned, it remains exceptionally competitive. First quarter, we saw some pullback, which we normally do in the first quarter. Growth this quarter really came from really three or four buckets. Our middle market C&I group, a commercial real estate group, sponsored finance, PowerSport had some growth this quarter when we thought maybe it would be relatively flat. Daryn can speak to that, second quarter and third quarter are generally pretty good in that business, we're optimistic that we may see some growth in the third quarter as well. Those are the drivers. The competition remains fierce. There's no question about it, we're encouraged by our pipelines today.

Great. Thanks for taking my questions.

Thank you. Once again, if you would like to ask a question, please press star one.

Your next question for today is from Brian Martin with Brean Capital.

Hey, good morning, guys. Hey, Brian.

Hey, Brian. Just on the credit front, Jim, I guess that seems like there's some nice improvement potentially coming.

I know you've got a couple credits you talked about still working through, but can you just give some thought on how you think credit plays out? Over the next couple of quarters, what would you expect in terms of some meaningful resolution, just a handful of things coming back, or just in general given what you see today?

Yeah. We printed, what, 70 basis points in charge-offs this quarter. I'd like to say we're going to get back into that 35-45 basis points. We're going to run a little bit higher with powersport. We saw a nice reduction second quarter over first. We're working through a couple more credits, we're optimistic we're going to see improvement again next quarter, not only in charge-off levels, but in overall migration, and we hope to see further reductions in classifies and NPAs.

Okay. Is there anything, I guess, in terms of how much of a reduction in NPAs we could see in the coming quarters? Are there a couple of meaningful things you're working on? Is it just some granular stuff, or just bigger picture how to think about- We're not even halfway through the quarter, we've already had a couple small wins early in the quarter.

There's a couple of larger ones we're optimistic that we can hopefully get resolved. We certainly aren't seeing anything new that has popped up in the last couple of quarters. We're encouraged. As I mentioned in my prepared comments, the fact that special mention was down 30%, it's usually a pretty good leading indicator as to future migration trends.

Yep. Do you have that number, Jim, what the special mention were? You said 30% from the previous quarter? Just what's the barometer there?

They were down $12.5 million in the quarter.

Thank you. From about $40 million to $27 million.

Okay, perfect. All right. Just one or two last ones from me. Brad, you talked about just kind of the M&A, which you've talked about in the past, but in terms of size, are you guys, preference-wise, if you found an opportunity, smaller or bigger? If you kind of comment just on how you're thinking about that with the approval times and whatnot, but it seems like it had been smaller, but maybe that's not the case.

I'd say the bias is towards smaller right now, but I don't really rule anything out. It's just that at the end of the day, the question is: does doing a transaction make the franchise more valuable?

Yeah. 99 times out of 100, that's a deposit-based question.

Obviously not always, because we've done an asset generator deal. There's no interest in betting the farm at this point. What we have here is pretty special. It's what shows up in the profitability numbers. It's not easy to find a transaction that makes you a better bank, they're out there with some work on the front end and the back end. I am optimistic we can get something done in relatively short order.

Got you. Just last one. You talked about that contribution margin. I guess your outlook for that contribution margin, I think it was up again this quarter.

I'll let Darin answer that one.

Yeah. That's fine. It's Brian, right?

Hey, Brian. Yeah. Great. Hey.

Yeah. Contribution margin for the National Specialty Lending, as Jim and Brad both mentioned, is at a historical high for us. I expect that to continue through this year, with some reduction coming next year, coming down a little bit next year as we change rates a little bit lower in the middle of this year. You'll start seeing, as the portfolio turns over, a little bit more of that impact into 2027 than you would this year. Nothing material, but you will see it come down a little bit in 2027.

Yeah, Jim. Okay. Brian, I think what's important to understand in that portfolio, APR on that is right now over 10%.

The loss rate came down from a little over 2% to 180. You can see the contribution margin well over 8.5% in that business, which is extraordinary.

Yeah, no, it's great. I think that answers most. The only thing I could ask you, Brad, that I don't know that you haven't commented on or maybe it's just not something you'd want to at this point, but just in terms of the stability and the margin near-term, if we think about going into next year, what's kind of the puts and takes on directionally where you would expect the margin to be, whether, not quantifying a number, but just kind of directionally how you think about it as you go into next year?

Well, I think we've won this war 47 times now. I'd say if that becomes 57 times, then maybe interest rates would go down along the curve and inflation would dampen, and then you would probably give back a little bit of margin. Normally I talk about this stuff over a beer, but I fundamentally believe that the world is shedding the idea that rates are somehow anchored to zero interest rate policy. I believe those days are done. As long as that is the case, and I'm correct about that, then fundamentally this is a very high margin financial institution just based on the quality of the funding. I am very bullish, a very elevated margin for a very long time, I guess is the way I'd put that.

Okay. That's helpful. I appreciate the taking the questions, guys.

Yep. Thanks, Brian. We have reached the end of the question and answer session.

I will now turn the call over to James Eccher for closing remarks.

Okay. Thanks, everyone, for joining us this morning. We look forward to talking to you again in the third quarter. Goodbye. This concludes today's conference.

You may disconnect your lines at this time. Thank you for your participation.