Old Second Bancorp Signals Strength Despite Credit Bumps

Old Second ((OSBC)) has held its Q4 earnings call. Read on for the main highlights of the call.

Old Second Bancorp’s earnings call painted a picture of a bank leaning into its strengths: strong profitability, a resilient 5%-plus margin, and a fortified capital base, even as it works through elevated charge-offs in its niche Powersports book and prepares to replace several hundred million dollars of higher-cost wholesale deposits. Management’s tone was confident and forward-leaning, arguing that margin expansion, cost savings from completed integrations, and a growing loan pipeline outweigh near-term credit and funding headwinds, with an eye toward a stronger 2026.

Strong Quarterly Profitability

Old Second reported GAAP net income of $28.8 million, or $0.54 per diluted share, in the fourth quarter, with adjusted net income of $30.8 million, or $0.58 per share, after excluding mortgage servicing rights (MSR) losses and acquisition items. That performance put earnings per share roughly 30% above the prior year, underscoring how the bank has leveraged its expanded platform to drive higher profits despite a more challenging credit and rate backdrop. Management emphasized that this level of earnings power reflects core operations rather than one-off acquisition noise.

High Margin and Improved Net Interest Margin

Net interest margin (NIM) remained a standout, with the tax-equivalent NIM at 5.09% in Q4, up 4 basis points from the prior quarter and 41 basis points year over year. In a sector where many peers are seeing margin compression, Old Second’s ability to expand NIM highlights disciplined pricing, a favorable asset mix, and easing deposit costs. Management signaled that even as rates drift lower, the franchise can sustain an above-5% margin over the medium term.

Robust Returns and Improving Efficiency

Returns and efficiency metrics underscored the bank’s operating leverage. Return on average assets came in at 1.64%, while return on average tangible common equity reached 16.15%, with management noting operating ROTCE north of 17.5%. The tax-equivalent efficiency ratio stood at 53.98%, and the adjusted efficiency ratio improved to 51.28% from 52.1% in the prior quarter. These figures indicate Old Second is extracting more earnings from each dollar of assets and revenue, validating the cost discipline and integration work done since recent acquisitions.

Capital Strength and Tangible Book Value Growth

Capital continue to trend higher, providing both a cushion and strategic flexibility. Tangible book value per share rose 61 basis points to $14.12, while the tangible equity ratio climbed to 11.02%, up 61 basis points sequentially and 98 basis points year over year. Common Equity Tier 1 capital reached 12.99%, up from 12.44% last quarter and 17 basis points year over year. This steady build in capital supports potential capital returns, such as share repurchases, while positioning the bank to absorb credit volatility and fund measured growth.

Expense Reduction and Integration Savings

The completion of integration work is now showing up clearly in the cost line. Total noninterest expenses fell $10.2 million compared with the prior quarter, driven largely by a $9.3 million reduction in acquisition-related costs as integration wrapped up. Management expects that once the remaining cost-saves are fully realized, overall expenses will grow only modestly—around 3% year over year in 2026—despite meaningful inflation in employee benefits. This suggests the bank has room to keep improving efficiency as revenue grows.

Noninterest Income Growth Year over Year

Noninterest income grew $544,000 year over year, with a healthy contribution from fee businesses. Wealth management fees rose $238,000, up 7.2% year over year, while service charges increased $198,000, up 7.5%. Mortgage banking income was flat sequentially but down $668,000 from a year earlier, tied mainly to MSR mark-to-market volatility rather than underlying production weakness. Excluding the MSR impact, management noted mortgage banking income would have been modestly higher, signaling a broadly stable fee-income base with upside from wealth and deposit-related services.

Loan Origination Momentum and Pipeline Strength

On the growth front, average loans increased roughly $60 million sequentially, and management described the fourth quarter as the best production quarter of the year. Importantly, the loan pipeline exiting the quarter was the largest seen in six to seven quarters, giving visibility into future growth. For 2026, the bank is targeting mid-single-digit loan growth, balancing selective expansion with disciplined credit standards as it leans into its improving origination engine.

Balance Sheet Positioning and Deposit Cost Trends

The balance sheet is being actively positioned for a lower-rate and gradually less wholesale-dependent environment. The loan-to-deposit ratio rose to 93.9% from 91.4% sequentially (and 83.5% a year ago), indicating more of the balance sheet is being deployed into earning assets. At the same time, the total cost of deposits fell to 1.15% from 1.33% in the prior quarter, helping to sustain the strong NIM. Management is allowing high-beta wholesale and acquisition-era deposits to run off while focusing on core funding, a strategy that should support stable margins even as rates shift.

Elevated Net Charge-offs in Powersports Portfolio

Credit costs were a notable blemish, concentrated in the bank’s Powersports portfolio. Net loan charge-offs totaled $6.0 million in Q4, with roughly 75%—about $4.5 million—tied to Powersports exposures. Management emphasized that elevated gross charge-offs in this portfolio are expected near term and are part of the risk-return profile of the business, which carries high contribution margins. Still, investors will be watching whether these losses remain within the bank’s expectations and adequately covered by existing reserves.

Asset Quality Softness Beyond Powersports

Beyond Powersports, asset quality showed some deterioration. Nonperforming loans increased by $4.8 million, and classified assets rose by $10 million sequentially, largely due to a couple of larger credits moving into nonaccrual. Management also flagged ongoing issues in certain mixed-use commercial real estate leasing that could take several quarters to fully resolve. While these trends are manageable in the context of strong profitability and capital, they highlight that credit normalization is underway.

Sequential Yield Pressure on Loans and Earning Assets

The rate environment is beginning to exert some pressure on yields. Tax-equivalent loan yields slipped by 11 basis points quarter over quarter, and the total yield on earning assets declined 8 basis points as prior Fed rate cuts flowed through the portfolio. The bank’s strong NIM suggests it has room to absorb this pressure, but further rate declines could test its ability to keep expanding or even holding the margin line, making ongoing repricing and funding strategies critical.

Mortgage Servicing Rights Volatility

Mortgage-related revenue was dampened by MSR volatility. The quarter included a $428,000 pretax loss on mortgage servicing rights, with overall mortgage banking income down $668,000 from a year earlier largely because of mark-to-market swings. Management stressed that, excluding MSR, mortgage banking income was modestly higher, implying that the core franchise is stable and that the drag is primarily accounting-driven. Still, MSR marks will remain a swing factor in reported earnings from quarter to quarter.

Replacing Acquisition-Era Wholesale Deposits

A key strategic task ahead is reshaping the funding mix. Management highlighted the need to replace approximately $300 million to $400 million of acquisition-related, wholesale-style deposits (notably Evergreen brokered CDs) to return to a more desirable funding profile. As these balances run off, the bank will look to deepen core relationships and attract more stable deposits, which could temporarily pressure funding volumes but should enhance the balance sheet’s long-term resilience and cost structure.

Acquisition-Related and Systems Conversion Costs

The quarter still reflected some residual acquisition and conversion noise. Q4 included $2.5 million of pretax acquisition-related expenses, including $1.5 million tied to computer and data processing for core systems conversion. Purchase accounting accretion has now dwindled to only a few hundred thousand dollars. With the heavy lifting largely done, these items should fade further, making reported results cleaner and making it easier for investors to gauge the true earnings run-rate.

Runoff in Syndications and Participations

Old Second is also seeing a steady runoff of syndicated and participated commercial real estate balances acquired with West Suburban. CRE participations declined by $53 million in Q4, the largest quarterly runoff to date. Overall syndication commitments have fallen sharply from about $772 million in 2021 to roughly $285 million outstanding at year-end, with management expecting about one-third of the remaining balances to run off. This deliberate shrinkage reduces exposure to non-core, lower-margin assets and frees capacity for more relationship-driven lending.

Inflationary Pressure on Employee Benefits

Despite the progress on integration costs, the bank is not immune to inflationary pressures, particularly in employee benefits. Management anticipates double-digit growth in health insurance and related benefits expenses in 2026. However, this will be partially offset by ongoing cost-savings initiatives elsewhere, enabling them to keep total expense growth to about 3% year over year. For investors, this suggests that operating leverage may persist, though the margin for error on cost control is narrowing.

Forward-Looking Guidance and Outlook

Looking ahead, management’s guidance calls for mid-single-digit loan growth in 2026, supported by a robust pipeline, and an NIM that should stay above 5%, even if it ticks modestly lower in the first quarter. They expect modest expense growth around 3%, despite double-digit employee-benefit inflation, thanks to remaining efficiency gains and integration benefits. The funding strategy centers on reducing reliance on wholesale sources by allowing Evergreen brokered CDs to run off and replacing roughly $300–$400 million of those balances with more stable deposits. Acquisition-related costs are expected to decline further, and management plans to initiate share repurchases, backed by strong capital ratios—CET1 at 12.99%, tangible equity at 11.02%, and tangible book value at $14.12. While they foresee elevated near-term net charge-offs in the Powersports portfolio, current reserves of $72.3 million, or 1.38% of loans, and strong profitability give them confidence in navigating this phase.

In summary, Old Second’s earnings call showcased a bank that is using its strong margin, rising capital, and improving efficiency to offset pockets of credit and funding pressure. Elevated Powersports charge-offs, some softening in asset quality, and the task of replacing wholesale deposits are clear watchpoints, but management’s tone and guidance suggest these are manageable within the context of powerful core earnings. For investors, the story is one of a high-margin, well-capitalized regional bank transitioning from integration mode to optimization and capital-return mode, with 2026 framed as a year where today’s groundwork begins to fully pay off.