OSBC 3rd Quarter Earnings Call - OLD SECOND BANCORP INC

Explicit Guidance:

• Q4 2026 Loan Growth: Targeted at a "low single-digit" level.
• Q1 2027 Loan Growth: Optimistic outlook for a strong start; pipeline described as one of the "more solid fourth quarters... in a long time" with expectation to "get out of the gates pretty well."
• Net Interest Margin (NIM): Expectation to maintain performance "solidly above a 520 basis points" in the near to intermediate term. Specifically forecasts a potential decline of "five basis points or so" in Q4 2026 due to loan growth expectations and deposit competition, then stabilizing within "plus or minus five basis points."
• Expense Growth: Projected to be "modest" in quarters ahead; specifically guided at "three to four percent" annually for the next year, noting that inflationary pressures on labor costs (healthcare) could run 20% in specific categories.
• Deposit Trends: Expects "deposit growth in the fourth quarter" with most acquisition-related attrition ("behind us"); future growth expected to come at a "little bit more rate."
• Reserve Levels: The allowance for credit losses (currently 1.23%) is viewed as a "steady state" rather than subject to significant further drawdown, as the bank will need to replenish funds for recurring PowerSport charge-offs.
• Capital Returns:
  • Buybacks: Expects to continue active share repurchases, targeting an annual reduction of approximately 5% of shareholders.
  • Dividends: Common dividend increased by 14% in Q4 2026.

Business-Segment Outlook:

• Wealth Management: Continues to show "strong performance and growth" quarter-over-quarter and year-over-year.
• Mortgage Banking: Income drivers shifting from volume to MSR mark-to-market valuations; pipeline expected to build for Q4 and Q1 2027.
• Commercial & Industrial (C&I): Pipeline is "broad-based," showing strength in small business, middle market, healthcare, and investment CRE.
• Consumer Lending: No immediate pullback in "PowerSport" demand; application volumes up slightly year-over-year despite turning down ~7% of applications due to borrower stress. "Collector car" business is performing strongly.
• Commercial Real Estate (CRE): Mentioned a specific "3.5% commercial real estate loan that repriced in the sixes" as a benefit; investment CRE is part of the strong pipeline.
• Syndications: Portfolio continues to wind down from a peak of $550M to ~$285M; viewed as "transactional" and will "not be a primary focus" or material part of the balance sheet going forward.
• Strategic Partnership (Zuccotti USA): Multi-year endorsement agreement with Ducati dealer network launched last week; expected to provide a "small boost" for Q4 2026 and a "substantial boost" to originations in 2027.

Market and Competitive Outlook:

• Deposit Competition: Described as "rapid" and a primary driver for the expected NIM compression; high-cost "wholesale deposit captions" from prior acquisitions are running off.
• Prepayment Environment: "Outsized payoffs" persist due to "high energy prices" and "broad-based inflation," impacting net loan growth despite strong origination activity.
• Credit Trajectory: Believes the company has reached an "inflection point"; classified loans are at levels "not been this low since before COVID"; credit metrics improved significantly, allowing for a focus on earnings power.

Macro / Industry Outlook:

• Interest Rates: Management views recent market instability (Middle East, inflation) as having reversed rate cut expectations into "rate hikes." Notes SOFR is ahead of Fed moves and has been high for some time.
• Inflation/Labor Costs: Anticipates real inflation between "4% and 5%"; projects employee healthcare benefit costs to rise "pretty close to 20 percent" next year.
• Economic Assumptions: Unemployment and GDP forecast inputs for loss rate models remain "fairly static" with no material changes to the upper end of the range.

Strategic Initiatives:

• M&A / Acquisition Appetite: Management intends to pursue "fill-in type" M&A (smaller than prior years) alongside buybacks; expects to have capital available to execute both. No specific targets for Q4, but "hopeful an opportunity arises next year."
• Capital Deployment: Confident in balance sheet strength to support 5% annual share buybacks while maintaining capital for M&A.
• Loan Book Optimization: Continued active reduction of syndication portfolio; focus on repricing lower-yielding loans and capturing higher short-term rates on variable loan books (approx. 45% of loan book repricing in next 3–4 quarters).

Risks and Headwinds to Outlook:

• NIM Compression: Potential loss of 5 bps in Q4 2026 driven by "rapid rise" in deposit competition, high loan-to-deposit ratio (~98.3%), and the cost of equity reduction from share repurchases.
• Credit Volatility: Recurring charge-offs in the "PowerSport" segment expected to continue quarter-over-quarter.
• Inflationary Cost Pressures: Significant escalation in employee benefit costs (healthcare) projected at ~20%, which could threaten expense growth targets if not managed.
• Rate Risk: While the loan book has short duration (50% variable with 30-day lag), management notes they are currently at the "marginal funding rate" relative to loan growth expectations.
• Regulatory/Economic Uncertainty: Acknowledged as factors in forward-looking statements; no specific regulatory changes cited beyond general economic environment impacts.

Management Tone on the Future:

• Confidence: High confidence in the credit trajectory ("turn the corner," "inflection point") and "exceptional margin performance."
• Caution/Hedges: Brad Adams hedged the margin forecast ("maybe I'm hedging a bit") acknowledging the unpredictability of rate environments, but remains "solidly above a 520" margin.
• Optimism: Jim Ecker described the credit position as "very good" and optimistic about loan growth opportunities and strategic growth in 2027.
• Cost Discipline: Acknowledges the difficulty of controlling expenses in an inflationary environment but feels the 3-4% guidance is a strong result given the context.

Miscellaneous:

• MSR Valuations: MSR mark-to-market valuations are expected to fluctuate with interest rates; recent increases contributed to non-interest income but are non-cash.
• Efficiency Ratio: Target remains "excellent" around 52%, though noted to be slightly elevated from 50.8% in the prior quarter due to expense timing.
• Tangible Book Value: Decreased slightly to $14.75 due to stock repurchases and security portfolio valuation impacts, not operational deterioration.