Old Second Bancorp, Inc.

Good morning, everyone, and thank you for joining us today for Old Second Bank Corp. Incorporated's second quarter 2024 earnings call. On the call today are Jim Ecker, the company's chairman, president, and CEO, Brad Adams, the company's COO and CFO, 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. Now I will turn it over to Jim Ecker.

Okay, good morning, everyone, and thank you for joining us. I have several prepared opening remarks. I'll give 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 for questions. Net income was $21.9 million, or $0.48 per diluted share, in the second quarter of 2024. The return on assets was 1.57%. Second quarter of 2024, return on average changeable common equity was 17.66%, and the tax equivalent efficiency ratio was 53.29%. Second quarter 2024 earnings were negatively impacted by $3.8 million of provision for credit losses in the absence of significant loan growth, which reduced the after-tax earnings by $0.06 per diluted share. However, despite this, profitability old second remains exceptionally strong, and balance sheet strengthening continues with our tangible equity ratio increasing by 35 basis points linked quarter to 9.39%. Common equity Tier 1 increased to 12.41% in the second quarter of 2024, and we feel very good about profitability and our balance sheet positioning at this point. Our financials continue to be positively impacted by higher market interest rates. Pre-provisioned net revenues remain stable and exceptionally strong. For the second quarter of 2024, compared to the prior year-like period, income on average earning assets decreased 663,000 or 0.9%, while interest expense on average interest-bearing liabilities increased 3.2 million or 31.3%. The increase in interest expense is rate-driven and primarily due to remixing and exception pricing on certain commercial deposits. Our average other short-term borrowings and other borrowings were significantly less in the second quarter of 2024 compared to the prior linked quarter and year-over-year quarter as our daily funding needs were reduced. And in the second quarter of 2023, we retired $45 million of senior debt. These actions reduced interest expense on borrowing, offsetting some of the growth in interest expense stemming from higher rates offered on deposits. The second quarter of 2024 reflected an increase in total loans of $7.2 million from the prior linked quarter primarily due to growth in commercial, lease, and construction portfolios, net of payoffs on a few large credits during the quarter. Comparatively, loan growth in the second quarter of 2023 was $12.2 million and a net decrease in loans of $73.5 million in the first quarter of 2024. The historical trend for our bank is loan growth in the second and third quarters of the year due to seasonal demand and business activities. 2023 was an anomaly as the savvy commercial customers realized interest rates were about to increase and sought funding prior to those market rate increases in late first quarter 2023. By the second quarter of 2023, loan growth had tempered due to market rate increases in the late first quarter and second quarter of 2023. Currently, activity within our loan committee has picked up as pipelines are at their highest level at 18 months and up 3x from 12-31-23, providing optimism for loan growth in the second half of the year. Net interest margin increased slightly this quarter, driven by continuing higher rates on variable securities and loans, partially offset by higher funding costs. Loan yields reflected a five-basis point increase during the second quarter of 2024 compared to the link quarter, and 21 basis point increase year over year. Funding costs increased due to increases in both rates and growth in time deposit balances. The tax equivalent net interest margin was 4.63% for the second quarter compared to 4.58% for the first quarter of 2024 and 4.64% in the second quarter of 2023. The margins remain relatively stable in the year over year period due to the impact of rising rates on both the variable portions of the loan and securities portfolio, as well as the deposit base and our short-term borrowing costs. The loan-to-deposit ratio is 88% as of June 30, 2024, compared to 86% last quarter and 85% as of June 30 of last year. As we have said, our focus continues to be balance sheet optimization. I'll let Brad talk about this in a moment. The second quarter of 2024 saw improving asset quality metrics and moderate actions taken on substantive credits, continuing remediation trends noted primarily since late last year. Our belief remains that the fourth quarter of 2023 represented an inflection point in our credit trends. Old Second began substantially downgrading large amounts of commercial real estate loans, including office and healthcare, at the end of 2021, and accelerating through 2022. Substandard and criticized loans went from approximately 60 million or a little more than 1% of loans in the third quarter of 21 to a peak of nearly 300 million or 7% of loans in the first quarter of 2023. At the end of the second quarter of 2024, substandard and criticized loans are down to 187.4 million, which is approximately 15.9 million less than year-end 2023, and more than 40% below peak levels. The expectation remains for further improvement throughout the rest of the year. Encouragingly, our special mention loans decreased more than 55% from one year ago and are at their lowest levels in over two years. We continue to expect realization of a relatively less costly resolution on a number of non-performers in the near future, and remain hopeful we can recover some of the losses realized in the second half of 2023. Commercial real estate valuations are heavily dependent upon the market level of interest rates as a primary determinant of cash flow for a given property. A movement in rates such as we have seen is substantial enough to significantly impair the equity positions in a large percentage of commercial real estate credits. Additionally, the residual stress brought upon by the pandemic and commercial real estate office and healthcare has not abated. We believe we have been proactive and realistic in addressing commercial real estate loans facing deterioration from higher interest rates, declining appraisal values, and cash flow pressures. As we discussed last quarter on the call and consistent with our expectations, we recorded net charge-offs of 5.8 million in the second quarter compared to 3.7 million in the first quarter of 2024. One specific current period charge off of $4.1 million on a previously allocated loan. One final charge off of $1.5 million related to a note sale and charge offs related to a transfer to OREO of $550,000 were partially offset by approximately $217,000 of net recoveries during the second quarter of 2024. The good news is that criticized and classified loans continue to decline. and the remainder of the portfolio remains well-behaved. Continued stress testing has not raised any new red flags for us, and the bulk of our loan portfolio has transitioned and is seasoning into this higher-rate environment. We have said this before, but it's worth repeating, that being short duration on the asset side has probably put us at the vanguard in terms of commercial real estate stress. We remain disciplined and did not offer seven- or ten-year maturities on commercial real estate assets a few years ago. The allowance for credit losses on loans decreased 42.3 million, decreased to 42.3 million as of June 30th, 2024, or 1.1% of total loans from 44.1 million at March 31st of 2024, which was also 1.1% of total loans. Unemployment and GDP forecast used in future loss rate assumptions remain fairly static from last quarter. The change in provision level quarter over link quarter reflects the reduction in our allowance allocations on substandard loans, which largely relates to the 29% reduction in criticized assets since June 30th, 2023. I think investors should know that with our continuing level of strong profitability, we will be aggressive in addressing weak credits and that we remain confident in the strength of our portfolios. Non-interest income continued to perform well with growth noted quarter over late quarter in wealth management fees, card-related income, and mortgage banking income, excluding the impact of mortgage servicing rights mark to market. A death benefit of $893,000 was realized on one bully contract in the second quarter of 2024 with no like benefit in the prior late quarter or prior year like period. Expense discipline continues to be strong, with the second quarter of 2024 total non-interest expense at $364,000 less than the prior link quarter, primarily due to reductions in salaries and employee benefits and a gain on the sale of an Oriole property. Our efficiency ratio continues to be excellent. As we look forward, we are continuing on doing more of the same, which is managing liquidity, building capital, and also building commercial loan origination capability for the long term. The goal is to continue to build towards a more stable long-term balance sheet mix featuring more loans and less securities in order to maintain the returns on equity commensurate with our recent performance. I'll now turn it over to Brad for additional color.

Thank you, Jim. Net interest income decreased by $93,000 or 0.2% to $59.7 million for the quarter ended June 30th. relative to the prior quarter of $59.8 million, down $3.9 million or 6.1% from the year-ago-like quarter. Securities yields increased 16 basis points due to the variable portion of the portfolios, and loan yields were five basis points higher in the second quarter compared to the first quarter of 2024. Total yield on interest-earning assets increased six basis points, linked quarter to 567 basis points, This was partially offset by a 15 basis point increase in the cost of interest bearing deposits and a two basis point increase to interest bearing liabilities in aggregate. The end result was a five basis point increase in the tax equivalent NEM to 463 compared to 458 last quarter. We believe this continues to be exceptional margin performance and surpassed our expectations modestly. Deposit flows this quarter continue to display signs of seasonality. and overall stabilization from what we saw last year. Average deposits decreased $4.3 million link quarter and period end total deposits decreased $86.5 million from the prior quarter. Deposit pricing in our markets remains exceptionally aggressive relative to the Treasury curve and is still largely pricing off overnight borrowing level costs. Public funds provided a bit of a headwind this quarter as fixed income markets offer an attractive alternative. On an overall basis, we are continuing to add duration, albeit at a more modest pace than I would like. In totality, marginal spreads remain unattractive at this point. An old second does not feel the pressure to swell in order to overcome expected margin pressures. Marginal returns on allocated equity remain poor for outsized growth, and flat NII performance for the year is more difficult in the absence of loan growth. But we have made progress in extending duration, and the outlook for loan growth is improving. My position remains that markets continue to believe inflationary trends are far easier to kill than they actually are in real life. Rate cuts right around the corner. is not a realistic expectation without significant declines in real demand and consumption. Regardless, the deeply inverted yield curve ensures poor spreads in our industry, so we're continuing to focus on compounding book value and maximizing returns. For us, that means being careful with expenses and pricing risk appropriately. Credit-protected securities have been a better avenue at times this year. point is that we are being careful. As a result, margin trends for the remainder of the year are expected to be relatively flat, maybe slightly down. If I'm wrong and a couple of rate cuts actually occur, we would lose a few basis points. Absolute NII growth from second quarter levels will be a function of our ability to find some loan growth. The loan to deposit ratio remains low at 87.9%, and our ability to source liquidity from the securities portfolio remains Old seconds should continue to build capital as evidenced by the 35 basis point improvement in the TCE ratio over the link quarter, which means we have added an astonishing 222 basis points of TCE and $2.37 of tangible book value per share over the last 12 months. I expect at least two people will ask in a few moments what we are going to do with all this capital. It's a fair question. Sometimes I'm wrong, but I always try to be safe when that occurs. Building capital today earns a nice return relative to the recent past, and I continue to have conviction in the belief that an opportunity to invest that excess capital is coming. M&A looks like it's starting to get interesting. If that does not come to fruition, we will return capital. A buyback is in place and is on the table. Dividend levels will be considered as well. Non-interest expense decreased $364,000 from the previous quarter, primarily due to reduction in salaries and benefits, due to a timing of officer incentive and rules and related payroll taxes paid in the first quarter, as well as a small decrease in occupancy costs, primarily due to seasonal maintenance, and a small gain recorded on an Oreo sale. As noted last quarter, quarterly wages and benefits are closer to $23 million run rate going forward in the near term. Given the revenue performance, employee investment costs have been running high for a while now, but we will maintain the ability to dial back as conditions warrant. With that, I'd like to turn the call back over to Jim.