Old Second Bancorp Inc 2026 Q3 Earnings Call

Okay. Good morning, and thank you for joining us. As customary, I have several prepared opening remarks. I'll give you my overview of the quarter and 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 questions. From a GAAP perspective, net income was $28.9 million or $0.56 per diluted share in the third quarter. Return on assets was 1.69%. Third quarter 2026 return on average tangible common equity was 15.77%, and the efficiency ratio was 52.34%. Excluding all adjusting items, which for the quarter was limited to MSR valuation adjustments, net income for the third quarter was $28.5 million or $0.55 per diluted share.

Third quarter 2026 earnings were impacted by $12.7 million of net loan charge-offs, which consisted of commercial and industrial loan net charge-offs of $9.2 million, primarily related to one relationship we have discussed on prior calls. $6 million of that $9.2 million was previously reserved for. This credit is a warehousing and distribution business that has seen its cash flow position deteriorate over the last year. We feel this credit is now largely behind us. The remaining portion of the charge-off is related to the powersport business, which totaled $3.1 million, which is comparable to the prior quarter of powersport charge-off level. Tangible book value per share decreased slightly to $14.75 as of September 30th from $14.77 as of June 30th. And the tangible equity to tangible asset ratio decreased 19 basis points from last quarter from 11.19% to 11%.

The modest declines in these metrics are primarily due to stock repurchases of approximately $39.5 million and the change in the value of the securities portfolio due to higher rates during the quarter. Our financials reflect an exceptionally strong net interest margin at 5.27% for the third quarter of 2026. That is a four basis point improvement from last quarter and 22 basis point increase over the prior year on a tax-equivalent basis. Pre-provision net revenues increased in the third quarter 2026 from the prior quarter, primarily due to day count, slightly higher average loan balances, and lower average savings and time deposit balances. Total cost of deposits was 102 basis points for the third quarter, compared to 100 basis points for the prior linked quarter and 133 basis points for the third quarter 2025.

For the third quarter 2026 compared to last quarter, tax equivalent income on average earning assets increased and interest expense on average interest-bearing liabilities increased nominally. Loan-to-deposit ratio is now 98.3% as of the end of the third quarter, compared to 96.4% last quarter and 91.4% as of September 30, 2025. Total loans declined nominally about $7.8 million during the third quarter. Tax-equivalent loan yields increased three basis points during the quarter compared to the linked quarter, but reflected a one basis point decrease for the quarter year over year. The increase in yields in comparison to the prior quarter is driven by higher short-term rates and repricing of lower yielding loans. We expect this to continue in the near term. Turning to credit, asset quality trends improved significantly during the quarter, excluding the elevated charge-offs resulting from the single credit we just discussed.

Classified loans decreased to $57.8 million, and non-performing loans decreased to $16.8 million. Criticized loans, an early indicator of stress, declined by $61.3 million or 38% during the quarter. As a percentage of loans, classified loans have not been this low since before COVID. Needless to say, we are extremely pleased with the credit trajectory and its implication for future quarters. The allowance for credit losses on loans was $64.2 million as of September 30, or 1.23% of total loans from $70.4 million at the end of the second quarter, which was 1.34% of loans. Unemployment and GDP forecast used in future loss rate assumptions remain 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.

Non-interest income declined $191,000 in the third quarter of 2026 compared to the prior linked quarter and nominally from the prior year linked quarter. Wealth management continues to reflect strong performance and growth quarter over linked quarter and prior year linked quarters. Mortgage banking income increased $436,000 compared to the linked quarter, and increased $762,000 compared to the like prior year period, primarily due to the changes in mortgage servicing rights mark-to-market valuations. MSR mark-to-market valuations increased $775,000 quarter over linked quarter and $1 million over the prior year period. Total non-interest expense for the third quarter of 2026 increased $370,000 from the prior linked quarter, driven by higher regular salaries, higher officer incentive, and employee insurance costs within salaries and employee benefits, and an increase in occupancy, furniture and equipment due to continued capital projects and growth in real estate taxes and office equipment costs.

These increases were partially offset by a decrease in other expense from several one-off expenses in the prior quarter. Our efficiency ratio continues to be excellent as the tax equivalent efficiency ratio adjusted to exclude core deposit intangibles, OREO costs, and the adjustments to net income, as noted earlier, was 52.06% for the third quarter, compared to 50.8% for the second quarter. Overall, the company continues to perform at an exceptionally high level. Operating leverage is strong. The margin is largely stable and fee businesses are performing well. The improvement in key credit metrics, including reductions in classifieds and criticized during the third quarter, will allow us to finish the year over the next quarter in a much better position to demonstrate the full earnings power of Old Second. I will now turn it over to Brad for more color.

Thanks, Jim. Net interest income increased to $84 million relative to the last quarter at $83.3 million. It also increased $1.3 million from last year. Loan yields increased 3 basis points while securities yields declined 5 basis points in the third quarter. Total yield on earning assets increased 6 basis points over the linked quarter to 640 basis points. Cost of interest-bearing deposits increased modestly at 2 basis points, and total cost of interest-bearing liabilities increased 1 basis point to 174. The end result was a 4 basis point increase in the tax equivalent NIM to 527 versus 523 last quarter. Obviously, we believe this continues to be exceptional margin performance. Average loans increased $5.5 million, or only 0.1%, over linked quarter and average deposits, however, decreased by $78 million or 1.4%. Deposit runoff is largely seasonal this quarter, with some residual runoff and high beta effectively wholesale deposit captions.

Loan origination activity in the third quarter was much better than it appears and in line with budget, but was offset by significant paydown and payoff activity. Loan prepayments through the first three quarters have already reached full year 2025 levels. Certainly, the market environment, including ongoing interest rate volatility, and due to high energy prices and broad-based inflation, has resulted in outsized payoffs, it appears to us. Our lending teams are continuing to work very hard and pipelines for the fourth quarter are building, which should also bode well for the first quarter of 2027 as well. From a stock repurchase perspective, we acquired 1.5 million shares during the third quarter, resulting in a reduction to equity and a growth in treasury stock to $39.2 million. Year-to-date repurchases total 3.4 million shares at an average price of $22.74. That is a $74.7 million reduction in equity.

This has a negative impact on the net interest margin, obviously, but a positive impact on earnings per share. We do expect to continue being active in the repurchase of shares given our extremely strong capital position and current and expected earnings trends. In addition, based on the strength of the balance sheet and resilient income statement trends, Old Second elected to increase the common dividend in the fourth quarter of 2026 by 14% as we continue to deliver growth commensurate with the bank's performance. Overall margin trends still feel very good. Obviously, rates along the curve went up quite a bit with recent instability in the Middle East and previous expectations for rate cuts have reversed course into rate hikes. If those trends remain stable from here and high cost deposit attrition slows, I would expect to maintain exceptional margin performance.

I do believe at this point, however, that we are likely to give back 5 basis points or so with our current loan growth expectations and the rapid rise we have seen in deposit competition recently. Loan growth in the fourth quarter of 2026 is being targeted in the low single-digit level. Expense growth will continue to be modest in the quarters ahead. That is it for my view, and I will turn the call back over to Jim.

Thanks, Brad. In closing, we feel despite the isolated charge-off, it was a pretty solid quarter for the company. We are optimistic due to the improvement in credit metrics this quarter and the rest of the bank is performing ahead of our expectations. We remain positive about loan growth opportunities and the potential for more strategic growth opportunity as well. That concludes our prepared comments this morning. I will turn it over to the moderator and open it up for questions.