Earnings Call Transcript - OSBC Q4 2025

Operator, Operator

Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Inc.'s Fourth Quarter 2025 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 home page under the Investor Relations tab. Now I will turn it over to Jim Eccher.

James Eccher, CEO

Good morning, and thank you for joining us, and thanks for your patience as we worked through some technical difficulties there. I have several prepared opening remarks. I will give you my overview of the quarter and then turn it over to Brad for additional details. We will then conclude with summary comments and thoughts about the future before we open it up to Q&A. From a GAAP perspective, net income was $28.8 million or $0.54 per diluted share in the fourth quarter, and ROA was 1.64%. Fourth quarter 2025 return on average tangible common equity was 16.15% and the tax equivalent efficiency ratio was 53.98%. Fourth quarter earnings were impacted by a couple of material adjusting items, the first being a $428,000 pretax loss on mortgage servicing rights and a $2.5 million pretax acquisition-related expenses driven by $1.5 million of computer and data processing related to the core systems conversion, as well as systems related to acquired operations. Excluding those two items, net income for the fourth quarter was $30.8 million or $0.58 per diluted share. Tangible book value per share increased 61 basis points to $14.12. The tangible equity ratio increased 61 basis points from last quarter from 10.41% to 11.02% and is 98 basis points higher than the like period one year ago. Common equity Tier 1 was 12.99% in the fourth quarter, increasing from 12.44% last quarter and increasing 17 basis points from one year ago. Our financials continue to reflect an exceptionally strong net interest margin at 5.09% for the fourth quarter, which is a 4 basis point improvement from last quarter and a 41 basis point increase over the prior year like quarter on a tax-equivalent basis. Pre-provision net revenues decreased from both interest-earning deposits and securities, balance declines, coupled with a decline in rates. The total cost of deposits was 115 basis points for the fourth quarter compared to 133 basis points for the prior linked quarter and 89 basis points from the fourth quarter of 2024. For the fourth quarter 2025 compared to last quarter, tax equivalent income on average earning assets decreased $1.8 million, while interest expense on average interest-bearing liabilities decreased $2 million. Loan-to-deposit ratio now sits at 93.9% as of year-end compared to 91.4% last quarter and 83.5% as of December 31, 2024. The fourth quarter 2025 experienced a slight decrease in total loans of $12.4 million from last quarter. Tax equivalent loan yields declined 11 basis points during the fourth quarter of 2025 compared to the linked quarter, but reflected a 48 basis point increase for the quarter year-over-year. The decrease in yield comparison to the prior quarter is primarily a function of Fed rate cuts working through the portfolio. Asset quality trends were relatively unchanged. Nonperforming loans increased $4.8 million and classified assets increased by $10 million. In general, our collateral position is very good on Q4 downgrade credits. We recorded $6 million of net loan charge-offs in the fourth quarter of 2025 with the majority, about 75%, stemming from the Powersport portfolio and commercial real estate owner-occupied. With regards to Powersports, I would say that losses given default are running a bit higher than we expected. However, yields in that portfolio are much higher than expected, and the contribution margin is both above expectations and improving. Due to the nature of the Powersport business, gross charge-offs are anticipated to run at a higher rate than Old Second has historically experienced, especially in a higher interest rate environment. This is the nature of what is a very good business. Investors should know that the contribution margin is now at a multiyear high in this business, and we're very bullish on our 2026 performance. The allowance for credit losses on loans was $72.3 million, as of December 31, 2025, or 1.38% of total loans compared to $75 million at September 30, 2025, which was 1.43% of total loans. Unemployment and GDP forecasts used in 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 the global tariff volatility continues to be considered within our modeling. Provision levels quarter-over-linked quarter, exclusive of day 2 purchase accounting impacts decreased $3 million and were largely driven by the Powersport portfolio, net charge-off levels with other losses associated with the previously allocated provisions. Noninterest income reflected a slight decrease in the fourth quarter compared to the prior quarter, but continue to perform well compared to the prior year like quarter. Noninterest income in the third quarter of 2025 reflected a $430 death benefit on a BOLI policy which was not experienced in the fourth quarter of 2025. Mortgage banking income was flat compared to the linked quarter and declined $668,000 compared to the like prior year period, primarily due to the volatility of mortgage servicing rights mark-to-market valuations. Excluding the impact of mortgage servicing right mark-to-market adjustments, mortgage banking income increased nominally quarter over linked quarter and from the prior year like period. Other income decreased nominally in the fourth quarter of 2025 compared to the prior linked quarter, but increased $550,000 compared to the prior year like quarter driven largely by Powersports service fees. Noninterest income increased $544,000 compared to the prior year like quarter as wealth management fees increased $238,000 or 7.2% and service charges on deposits increased $198,000 or 7.5%. Total noninterest expenses for the fourth quarter of 2025 declined $10.2 million from the prior linked quarter. The fourth quarter experienced a decrease of $9.3 million in acquisition-related costs. Our efficiency ratio continues to be excellent and the tax equivalent efficiency ratio adjusted to exclude core deposit intangibles, amortization, OREO costs and the adjustments to net income, as noted earlier, was 51.28% for the fourth quarter compared to 52.1% for the third quarter 2025. So our focus continues to be on the optimization of the balance sheet to perform and withstand the variability of the current and future interest rates. We continue to reduce reliance on wholesale funding as we allow the legacy Evergreen Bank broker CDs to run off and reprice higher cost deposits in the falling interest rate environment. With that, I'll turn it over to Brad for additional color.

Bradley Adams, CFO

Thanks, Jim. I don't have a ton to talk about today. I would say that we're pretty excited to close the year like this. Running at a north of a 5% margin and ROA handsomely above 1.5% and ROTCE above 17.5% on an operating basis is pretty exceptional performance that we're proud of. EPS is up about 30% over last year. Integration is fully done; integration at the end of last year as well. That's a lot of work. And to close the year like that, this is especially gratifying. This quarter is not very complex. Most of the stuff that we talked about last quarter is still true. So I'll be relatively brief. Net interest income increased nominally this quarter relative to last quarter both around the $83 million level. Loan yields decreased about 11 basis points and securities yields decreased a bit more at 14 basis points. Total yield on interest-earning assets decreased 8 basis points over the linked quarter. Cost of interest-bearing deposits decreased more at 24 basis points, and total interest-bearing liabilities decreased 15 basis points. The end result was a 4 basis point improvement in the tax equivalent NIM, which is obviously pretty awesome. Tax equivalent NIM for the fourth quarter of 2025 increased 41 basis points from 4.68% for the period last year. Average loans increased $60 million or $1.2 million over the linked quarter with average deposits declining $200 million, a level we expected. Deposit runoff is largely concentrated in high beta effectively wholesale deposit captions as planned. Loan origination activity in the fourth quarter, you may not know, was actually very good and activity remains robust. Certainly, the market environment, marginal spreads is far more favorable than it was in the first half of the year and certainly at this time last year. Payoffs, especially in the participation book have resulted in relatively flat balance sheet growth in the fourth quarter. This is interesting. Balances in the CRE loan participations acquired with West Suburban declined by $53 million in the fourth quarter of this year, the largest quarter runoff that we have seen to date in that portfolio. This was a significant headwind to growing the balance sheet this quarter. Organic activity remains exceptionally strong. Other than that, everything I said last quarter remains true to the best of my knowledge. The balance sheet is exceptionally well positioned and margin trends feel stable. We may tick down modestly in the first quarter, but I expect to still be above 5%. Loan growth is targeted in the mid-single-digit level for next year. Expense growth will be modest. Pre-inflationary trends in employee benefits and salaries are going to be moderated by the realization of the cost savings associated with Evergreen. A buyback is on the table; we haven't done anything this quarter. It's becoming inevitable. I don't have anything to add about the tax rate other than it was really high this quarter. Please don't ask me about that. There isn't a lot of complicated stuff to go over beyond that. So I'll turn the call back over to Jim.

James Eccher, CEO

Okay. Thanks, Brad. In closing, we're very proud of the year we just concluded, and we believe the level of performance is reflective of the strength of the bank we are building. We're optimistic about next year or this year and all the opportunities that are in front of Old Second. I would like to thank our team for their hard work and execution in 2025, including integrations and systems conversions and upgrades that have made us a much better Old Second. I could not be more excited about the things we can accomplish next year. That concludes our prepared comments this morning. So I'll turn it over to the moderator, and we can open it up to questions.

Operator, Operator

Our first question for today is from Jeff Rulis with D.A. Davidson.

Jeff Rulis, Analyst

On the expense side, I just wanted to see if those cost savings, Brad, I could tell you, are those fully captured? Or is there a tailwind to '26 that leads to that muted expense growth from your perspective?

Bradley Adams, CFO

There's a tailwind to '26. Employee benefits are expected to be up solidly in the double digits next year just with inflationary trends that we're seeing in health insurance. We've done a lot of things to restructure to keep those costs contained. But we've got a couple of branch closings that are scheduled and some other expense initiatives. All in all, it's going to look like we're just kind of doing a good job, not as good as flat, but not as bad as it would be just on a pure apples-to-apples basis. So it kind of feels like a 3% type level as we get those final cost savings run through.

Jeff Rulis, Analyst

Got you. And then on the credit front, Jim, I guess the charge-off from the Powersports, and you really outlined that clearly; very profitable on the margin front. Just wanted to see on the net charge-off pace. I think we talked about kind of 30 basis point level, a little higher. Is anything that front-end loaded? Or could we expect kind of 30-40 going forward? And then secondly, on the credit side, is that 30- to 89-day bucket, a little bit of an increase? Anything to note on that balance?

James Eccher, CEO

Yes, good question. I think we need to be accustomed to a little bit higher net charge-off rate due to Powersports. That's just the nature of that business. I think if you look at the $6 million in charge-offs, $4.5 million was Powersport related, so only $1.5 million in the legacy book, which is more in line with our historical trends. But given that, we're in a higher interest rate environment, we expect Powersports to have maybe elevated charge-offs in the next couple of quarters. And I think we have to look at that hand-in-hand with the contribution margin, which I mentioned was at a multiyear high. So obviously, that's flowing through the margin and profitability. As it relates to the 30-89, we had a couple of larger loans that were just past maturity. We had a couple of loans that migrated into non-accrual that we're working through. One has a very low loan to value. The other is a mixed-use property in Chicago that has been very slow to lease up and it's going to take another couple of quarters to work through that one.

Operator, Operator

Your next question for today is from Nathan Race with Piper Sandler.

Adam Kroll, Analyst

This is Adam Kroll on for Nathan Race. So maybe just a question for Brad on the margin. I was curious if you could kind of frame out expectations for the first quarter with the full quarter impact of the December rate cut and just your overall positioning if we were to get another cut or two in the middle part of the year and just where you think the NIM can settle out over the longer term?

Bradley Adams, CFO

I'd be very surprised if we're not around the 5% level for the full year 2027. I was my machine there. 2027, I have no comment on at this point.

Adam Kroll, Analyst

And I was just curious if you have the purchase accounting accretion number for the quarter?

Bradley Adams, CFO

It's a few hundred thousand. I've talked about that before. It's down substantially from last quarter. The thing that I would really like people to focus on is that the amount of purchase accounting that we have in our numbers this year in aggregate is less than the amount of purchase accounting that we're getting off the solar loan book. It's nothing. I think there was $150,000. It's not something that I really think is material to anyone's understanding of Old Second at this point. It was down substantially linked quarter. But the thing to keep in mind here is that the purchase accounting impact on the Powersports portfolio is negative for the next two years. So the go-forward business is better than what you're trying to isolate as the unrepeatable portion in the current periods. It's actually a tailwind going forward relative to a headwind.

Adam Kroll, Analyst

Got it. No, that's super helpful. And then maybe just moving to deposits. You've called out letting exception price deposits run off from the acquisition. So I guess I'm curious how much is remaining of those deposits and if you're seeing opportunities to reduce deposit costs on your legacy non-maturity deposits?

Bradley Adams, CFO

We talked about this last quarter. The thing to remember is that fixing and returning to an Old Second-like funding profile is a multistage process. Some of it we did prior to bringing on the Evergreen balance sheet; and some of it we'll do after. We probably need to replace $300 million to $400 million in deposits with our type of funding in order to complete the process. In terms of the amount of wholesale funding, effective wholesale funding that's on the balance sheet right now, that's part of the reason why the margin is so darn resilient at this point, because we do have substantially more funding that benefits from falling rates than we typically otherwise would have. So it's not necessarily a bad thing to focus on, at least at this stage. It's not what I want over the long term, but right now it's actually a benefit. I would say just the number to keep in mind is that I would like to look $300 million to $400 million different on the liability side.

Adam Kroll, Analyst

Got it. And then maybe just last one for me. Digging into the mid-single-digit loan growth, I was curious what your expectations are for growth in the Powersports vertical specifically?

Unknown Executive, Executive

Slightly less than that would be my expectation.

Operator, Operator

Your next question for today is from Terry McEvoy with Stephens.

Terence McEvoy, Analyst

Could you remind us what a typical Powersport borrower looks like? I'm curious about where they fit in this K-shaped economy and whether there has generally been any seasonality related to charge-offs in that portfolio.

James Eccher, CEO

Sure. Terry, Darin, if you're there and on, do you want to take that one?

Darin Campbell, Head of National Specialty Lending

Yes, I can do that. Terry, the average FICO score for our Powersports portfolio is 730, with the majority falling into your Tier 1 category, which has an average FICO score of 776. Regarding seasonality, our busy season begins on March 1 and continues through the second and third quarters, which is when we see most of our business originating. In terms of risk, delinquency and losses tend to be higher in the other two quarters, particularly at year-end when we compete with holiday spending, causing numbers to spike before stabilizing in the second quarter. I've been doing this for 30 years, and the trends in this portfolio have remained consistent throughout that time.

Terence McEvoy, Analyst

Great. And then as a follow-up, Brad, just capital management. I think you said share repurchase is inevitable. I look back; the stock is up 20% from three months ago. So the stock is higher. Is that just a comment on where your capital levels are? Or should I read into maybe the M&A market and what you see happening in '26?

Bradley Adams, CFO

No. The M&A market feels good. There's no shortage of discussions happening. The question is what's the right deal for Old Second at the right time and how much capital do we need to do that? Clearly, I got it wrong in that we were basically running a big Christmas savings account in order to acquire the capital for an acquisition, and we needed a fraction of what we had saved up. So it's just a function of what we need versus what we have. Obviously, we generated a ton of capital, and I'm not uncomfortable where we are. I just don't really see a need to grow it much from here is the thing.

Operator, Operator

Your next question is from Brian Martin with Janney.

Brian Martin, Analyst

Can you discuss the production this quarter compared to the payoffs, and the situation with the West Suburban piece that was running off? Specifically, how much ran off in West Suburban and what remains that could pose a challenge going forward? Additionally, I’m interested in your perspective on the mid-single-digit loan growth and the improved production, which seems to be the best it has been in a long time.

James Eccher, CEO

Yes, Brian. The fourth quarter actually, surprisingly, was our best production quarter of the year. And normally, that's a softer quarter along with the first quarter, but it was exceptionally strong along multiple verticals. The challenge, as Brad pointed out, we had some pretty big paydowns. Some of it was welcomed in the syndication portfolio, but we also had early payoffs in multifamily and commercial real estate; a lot of it is stemming from property sales. What I think we get encouraged is the pipeline today or as of the end of the year is the highest it's been in probably 6 to 7 quarters. So that gives us a lot of optimism that we're going to have a pretty good first half of '26. And I think mid-single-digit growth is certainly achievable this year.

Brian Martin, Analyst

Got you. How large is the syndication book currently? How much has it decreased, and how much further do we anticipate it to go? Will this pose a challenge moving forward?

James Eccher, CEO

At the end of 2021, when we closed on West Suburban, we had about $772 million in commitments, and that has remained the same through the end of 2025. From a balance perspective, we have about $285 million left. I anticipate that one-third of that will continue to run off, and we'll likely retain the remainder.

Bradley Adams, CFO

I would tell you that those numbers that Jim is referencing are inclusive of some additions related to Evergreen. So what you're really talking about over a 5-year period is almost an 80% reduction in that loan book.

Brian Martin, Analyst

Yes, I understand. Brad, you mentioned that margins are stable but may decline slightly in the first quarter. What modest headwind should we expect in that period? Regarding the balance sheet, it seems there are still a few hundred million dollars in exception-based brokered CDs that are currently advantageous but will continue to decrease. That's what's left regarding the anticipated runoff.

Bradley Adams, CFO

I'm just being really pessimistic, man, because the reality is that the biggest headwind to the margin is probably going to be deciding to buy treasuries, especially if people keep making noise about invading countries that are largely ICE. So the more we see moves like that, I would be comfortable adding assets that largely don't offer, obviously, a 5% spread. So it's just a function of that. I also just don't want to go on here and say that, hey, the margin is going to go up from 5.09. I'm not going to say that. So I'm the biggest headwind, Brian, me personally.

Brian Martin, Analyst

Got you. Okay. And Jim, regarding the criticized or classified items, it seems that classifieds have increased slightly. How do you anticipate those trends will develop moving forward? Additionally, how are the trends in special mentions? I’m not sure if you referred to those, but were they up or down this quarter?

James Eccher, CEO

Yes. We classified, certainly, we had a lot of migration in and migration out. I think where we're seeing a little bit of degradation of that portfolio is in the C&I book and companies just showing weaker performance. By and large, collateral positions are pretty good. We're not seeing a whole lot of loss given default at this point. But it's going to take some time to work through this. I think the positive news from our perspective is the net change in special mention or watch loans was down materially. We had, I think, only a couple of loans migrate in, and we had over $15 million in reduction in that bucket. So those are early-stage indicators for us. So that should help us moving forward.

Brian Martin, Analyst

So the special mention were down on a linked quarter basis? Or did I hear that wrong?

James Eccher, CEO

Yes, down $15 million in the quarter.

Brian Martin, Analyst

Down $15 million. Okay. Perfect. And the last one or two for me, and I'll jump off was the clarification on the expenses. Brad, you mentioned a 3% growth year-over-year in expenses. So were you referring to 25% expenses to 263, or was there something else you were talking about regarding your comments?

Bradley Adams, CFO

No, that's what I'm talking about.

Brian Martin, Analyst

Can you provide any insights on the buyback plan? Do you expect to start this quarter, and will it be based on pricing, making it opportunistic?

Bradley Adams, CFO

I expect it will begin in relatively short order, yes. I'm not price sensitive at this point.

Brian Martin, Analyst

Got you. Okay. And the M&A environment, you said it's good with lots of discussions. What is kind of the optimal target today look like for Old Second if you are looking at M&A? I mean, the last one was obviously asset-driven.

Bradley Adams, CFO

I'm not sure how much that I can be helpful on an answer there because I can tell you that I wouldn't have described Evergreen, if you'd asked me that 18 months ago. So I think the only thing that investors can be certain of is that we're not going to do anything unless it makes us a better bank, and that's what we're focused on.

James Eccher, CEO

Yes, Brian, I would say our priority this year is really fully integrating Evergreen, which we're about there, but really focusing on organically growing the balance sheet and optimizing it. That would be priority one.

Operator, Operator

We have reached the end of the question-and-answer session. And I will now turn the call over to Jim Eccher for closing remarks.

James Eccher, CEO

Okay. Thanks, everyone, for joining us this morning. Again, I apologize for the technical difficulties. We look forward to speaking with you again next quarter. Goodbye.

Operator, Operator

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.