Old Second Bancorp, Inc.

Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Inc., fourth 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. Please go ahead.

Good morning, everyone, and thank you for joining us this morning. I have several prepared opening remarks and 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 $19.1 million, or 42 cents, per diluted share in the fourth quarter of 2024, and return on assets was 1.34%. Fourth quarter 2024 return on average tangible common equity was 13.79%, and the tax equivalent efficiency ratio was 54.61%. Fourth quarter 2024 earnings were significantly impacted by several items. First was a $3.5 million provision for credit losses in the absence of significant loan growth, which reduced after-tax earnings by $0.06 per diluted share. We also had $1.7 million in Oriel write-downs, or $0.03 per diluted share. And lastly, a $1.5 million merger-related expense, or just shy of $0.03 per diluted share. However, despite all this, profitability over the second remains exceptionally strong, and balance sheet strengthening continues with our tangible equity ratio decreasing only modestly from last quarter due to dilution to tangible equity from the first merchant's cash acquisition in the fourth quarter of 2024. The tangible equity ratio increased by 151 basis points over the past year to end at 10.04%. Common equity tier one was 12.82% in the fourth quarter. And we feel very good both about profitability in our balance sheet positioning at this point. Our financials continue to reflect a strong and stable net interest margin, even as market interest rates decline. Pre-provision net revenues remain stable and exceptionally strong. For the fourth quarter of 2024, compared to the prior year-like period, income on average earning assets increased $1.6 million, or 2.1%, while interest expense on average interest-bearing liabilities increased $1.2 million, or 9.9%. The increase in interest expense is rate-driven and primarily due to remixing market pricing on certain commercial deposits. The fourth quarter of 2024 reflected a slight decrease in total loans of $9.7 million from the prior linked quarter end, primarily due to some large pay downs in commercial real estate owner-occupied and multifamily portfolios during the quarter. Comparatively, loan growth in the third quarter of 2024 was $14.5 million, and loan growth for the prior year fourth quarter was $13.4 million. The historical trend for our bank is loan growth in the second and third quarters of the year due to seasonal construction and business activities. Currently, activity within loan committee remains modest relative to prior periods, primarily due to many customers waiting to see how market volatility improves. including changes due to the fourth quarter 2024 election results and any further interest rate reductions play out over the coming three to six months. Tax equivalent net interest margin increased by four basis points this quarter, driven by continuing high interest rates on variable securities and loans, as well as reduction in our funding costs due to the close of the five branch purchase from First Merchants in early 2024. Loan yields reflected a 12 basis point decrease during the fourth quarter compared to the link quarter, but a 16 basis point increase year over year. Funding costs decreased primarily due to approximately $267 million of deposits acquired from First Merchants, which allowed us to pay down our other short-term borrowings at the Federal Home Loan Bank and significantly lower our cost of funds. The tax equivalent net interest margin was 4.68% for the fourth quarter of 2024 compared to 4.64% for the third quarter of 2024 and 4.62% in the fourth quarter of 2023. The net interest margin has remained 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 portfolios as well as the growth in our deposit base and other short-term borrowing costs. Loan-to-deposit ratio is in good shape. It's at 84% as of December 31, 2024, compared to 89% last quarter and 88% as of December 31, 2023. As we have said on prior calls, our focus continues to be balance sheet optimization, and I'll let Brad talk about that more in a minute. In terms of credit, this is a mixed quarter with both some good news and bad news. Bad news first, we recorded an $8.6 million charge off on a C&I loan that was downgraded last quarter. Based on audited financials, collateral field audits, and bankruptcy declarations, we believe we are in a much better position on this credit. Subsequent investigation and workout actions indicate otherwise, which unfortunately happens in some bankruptcy cases as they develop. Currently, our carrying balance is effectively $0.37 on the dollar. This represents our current best estimate at recovery at this point, but additional loss is possible as more facts come to light. We will continue to actively monitor this matter and take actions to best protect our interests. We also recorded a $1.7 million in the Oreo valuation expense in the quarter. These represent charges below recent appraisals to immediately and contractually clear two properties from our folks soon. These are loans that have been identified long ago and have been worked their way through the resolution process. A $16.4 million commercial real estate loan was foreclosed on in the fourth quarter. Notably, no loss is expected in the properties under contract for a first quarter sale. with significant earnest money already received. We remain optimistic this asset will sell clear in the next few weeks. And now for the good news, substandard and criticized loans decreased significantly in the fourth quarter. These balances now total 129.9 million and decreased by 31% or 58 million from last quarter. In the first quarter of 2023, substandard and criticized loans were nearly 300 million Year-end 2024 balances represented a decline of more than 56% from peak levels and are near their lowest levels in two and a half years. Classified and non-accrual balances continue to improve significantly on both a year-over-year and link quarter basis, and we expect further substantial non-costly improvement in the very near term. Special mention loans. also continue to improve dramatically. These balances are down 46% from one year ago. When your portfolio is short duration, it's important for investors to know when interest rates rise as quickly as they did, it's important to be realistic and pragmatic about its impacts. We've been very aggressive in addressing weak credits and remain confident in the strength of our portfolios. The bulk of the largest problems we have seen have been acquired, but we've made a few mistakes ourselves We'll learn from those and be better. Continued stress testing has not raised any new red flags for us, and the bulk of our loan portfolio has transitioned into the higher rate environment and will be impacted with downward rate movements going forward. The allowance for credit losses on loans decreased to $43.6 million as of December 31, 2024, or 1.1% of total loans from $44.4 million at the end of the third quarter, which was also 1.1% of total loans. Unemployment and GDP forecasts to use in our 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. The change in provision level quarter over late quarter reflects the reduction in our allowance allocations on substandard loans, which largely relates to the 27% reduction in criticized assets year over year. Non-interest income continues to perform well with growth in the fourth quarter of 2024 compared to the link quarter in wealth management fees, service charges on deposits, and mortgage banking income. Excluding the impact of mortgage servicing rates, mark-to-market adjustments, mortgage banking income was flat quarter over link quarter. Other income decreased in the fourth quarter of 2024 compared to the prior link quarter in prior year-like quarter, with the link quarter variance primarily due to recoveries on vendor contract and other contract incentives received in the third quarter of 24. Expense discipline continues to be strong, with total non-interest expense in the fourth quarter of 2024 at $5 million more than the prior link quarter, primarily due to an increase in incentive accruals and first merchants acquisition costs incurred of $1.5 million in the fourth quarter of 2024 compared to 471,000 in the third quarter. Our efficiency ratio continues to be excellent as the tax equivalent efficiency ratio adjusted to exclude acquisition costs and OREO costs was 54.61% for the fourth quarter of 2024 compared to 52.31% for the prior linked quarter. As we look forward, We're focused 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 obviously to continue to create a more stable long-term balance sheet mix featuring more loans and less securities in order to maintain the returns on equity commensurate with the recent performance. I'll now turn it over to Brad for additional color.

Thank you, Jim. There's not a lot controversial for me to talk about, so I'll add a few comments and pass the puck back to Jim, but I don't really feel the need to be much up on a soapbox this quarter. Net interest income increased by $1 million to $61.6 million for the quarter relative to the prior quarter of $60.6 million, an increase of $349,000 from the year-ago quarter. Tax equivalent securities yields decreased 10 basis points and loan yields were 12 basis points lower in the fourth quarter compared to third quarter. Total yield on interest-earning assets decreased 11 basis points. That was more than offset by a seven basis point decline in the cost of interest-bearing deposits, and a 22 basis point decrease in net interest-bearing liabilities in aggregate. The end result was a four basis point increase in the tax equivalent NEM to 468 for the quarter, from 464 last quarter, which we believe continues to be exceptional performance. Deposits closed this quarter continue to display signs of seasonality and stabilization. Average deposits increased 114 million or 2.5 percent. And period end total deposits increased 303 million or 6.8 percent from the prior quarter, primarily due to the deposits acquired from first merchants branches. Deposit pricing in our markets remains exceptionally aggressive relative to the Treasury curve. and is largely pricing off overnight borrowing levels. Public funds provided a bit of a headwind this quarter as fixed income markets offer an attractive alternative. It's always nice when I don't have to go out on a limb with a claim that the forward curve is nonsense. It's the first time in a little bit. Relative to last quarter and many times over the last two years, expectations have become much more realistic relative to absolute economic conditions and federal deficit constraints. We are very proud of the balance sheet decisions we have made over the entirety of the cycle and continue to believe we are well positioned for what is to come. Duration is a bit more attractive, as we see here today, so our bias leans in that direction, but not dramatically so. Relatively poor marginal spreads persist, and Old Second is continuing to focus on compounding book value and maximizing returns. For us, that means being careful with expenses and pricing risk appropriately. As a result of the recent rate cuts and their impact on indices, margin trends for 2025 are expected to trend down slowly. Success in funding loan growth with the newly acquired deposits offers the opportunity to upside to these expectations. As Jim mentioned, the loan deposit ratio is now sub 84% from 89 plus in the fourth quarter compared to the third quarter, and that's due to those purchase deposits and the branch deal. Our ability to source liquidity from the securities portfolio remains, and our current short-term borrowing level is negligent. Old Second continues to build capital, as evidenced by 151 basis point improvement in the TCE over the past year, which means we have added a fairly astonishing $1.65 intangible book value over that time. This quarter, capital was essentially flat. That is a result of the use of cash for the purchase of the first merchant's acquisitions. I would note that the relatively minor move in AOCI should indicate to investors just how short our securities portfolio is, given the magnitude of the backup and rates relative to third quarter. Capital will build more slowly from here. And I do believe that the overall M&A environment remains exceptionally favorable to a bank like Old Second. If that does not come to fruition, we will return capital. A buyback is in place and is on the table. Non-interest expense increased $5 million from the previous quarter, primarily due to acquisition-related costs and Oreo write-downs, as well as various other credit remediation efforts. Incentive accruals are probably higher than I would have thought in the fourth quarter. That's a function of relative performance as we calculate it relative to peer groups. Metrics like ROA and return on tangible equity adjusted for AOCI so as not to have huge outliers for people who have impaired capital positions. Old second performed exceptionally well at essentially the 99th percentile, which puts us in the position of hitting payout for the bulk of our officer base despite the fact that our overall performance for the year was slightly below what we expected. And again, primarily because of that bonus accrual. But overall, the performance continues to be excellent. Margin trends are stable to modestly down. We're hopeful for overall operating expense in 2025. It's in the 4%, maybe 5% range, and we're targeting loan growth in the mid-single digits. I know we said that last year, but I feel more optimistic about it this year. Overall, things feel great. We're very proud of where we are and believe that our future is extremely bright. With that, I'd like to turn the call back over to Jim.