Q1 2024 Old Second Bancorp Inc Earnings Call

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Speaker Change: Good morning, everyone and thank you for joining us today for old second Bancorp's first quarter 'twenty 'twenty four earnings call.

Speaker Change: On the call today are Jim <unk>, the company's chairman, President and CEO, Brad Adams, the company's C O O N CFO and Gary Collins, 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.

Speaker Change: On management's existing expectations and the current economic environment.

Speaker Change: 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 Companys risk factors. The company does not undertake any duty to update such forward looking statements.

Speaker Change: 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 old second dot com on the homepage under the Investor Relations tab now I will turn it over to Jim Edgar the floor is yours.

James L. Eccher: Hey, good morning, and thank you for joining us.

James L. Eccher: As customary I have several prepared opening remarks and will give my overview of the quarter and then turn it over to Brad for additional color.

James L. Eccher: I will then conclude with certain summary comments and thoughts about the future before we open it up for questions.

James L. Eccher: Net income was $21 3 million or <unk> 47 per diluted share in the first quarter.

Bradley S. Adams: On assets was 151%.

Bradley S. Adams: First quarter 2020 for return on average tangible common equity was 17, 8% and the tax equivalent efficiency ratio was 53.09%.

Bradley S. Adams: First quarter earnings were negatively impacted by $3 $5 million of provision for credit losses, which reduced after tax earnings by <unk> <unk> per share.

Bradley S. Adams: However, profitability old sector remains exceptionally strong and balance sheet strengthening continues with our tangible common equity ratio, increasing by 51 basis points linked quarter to 9.0% to 4%.

Bradley S. Adams: Common equity tier one cross 12% this quarter and we feel very good about profitability and our balance sheet positioning at this point.

Bradley S. Adams: Our financials continue to be positively impacted by higher market interest rates pre provision net revenues remained stable and exceptionally strong.

Bradley S. Adams: For the first quarter of 2024 compared to the prior year period income on earning assets increased $3 2 million or four 5% while interest expense increased $7 5 million.

Bradley S. Adams: Kris in both cases is rate driven however, exception pricing on certain commercial deposits as.

Bradley S. Adams: As well as growth in average balances on short other short term borrowings compared to the prior year like period caused a net decrease in.

Bradley S. Adams: The net interest margin, which is attributable to both interest rate and volume factors on the liability side.

Bradley S. Adams: First quarter of 2024 reflected a decrease in total loans of $73 5 million from the prior linked quarter.

Bradley S. Adams: Primarily due to a few payoffs on some large credits towards the end of the quarter.

Bradley S. Adams: The historical trend for our bank is really softer first quarter of originations due to limited new projects in construction during the winter season.

Bradley S. Adams: 2023 was an anomaly as a savvy commercial customers realized interest rates were about to increase in site funding prior to those market rate increases in late first quarter 2023.

Bradley S. Adams: Our loan growth was much larger than a year ago like period compared to the first quarter of 2024.

Bradley S. Adams: Activity within our loan committee remains modest relative to prior periods due to both the higher interest rate environment lower demand and seasonal impacts.

Bradley S. Adams: Our net interest margin compressed slightly this quarter driven by higher funding costs loan field loan yields reflected a seven basis point increase during the first quarter compared to the linked quarter and 37 basis points increase year over year.

Bradley S. Adams: Funding costs increased due to the increases in both rates and growth in time deposit balances.

The tax equivalent net interest margin was $4 five 8% for the first quarter compared to $4 six 2% for the fourth quarter and $4, 74% in the first quarter 2023.

Bradley S. Adams: The net interest margin decreased 16 basis points in the year over year quarter due to the impact of rising rates on the cost of funds, which was partially mitigated by growth in interest income driven by the variable portion of the loan and securities portfolio.

Bradley S. Adams: The loan to deposit ratio is 86% at March 31, 2024, compared to 88% last quarter and 82% a year ago.

Bradley S. Adams: As we said last quarter, our focus continues to be balance sheet optimization and I'll, let Brad talk about more of that in a minute.

Bradley S. Adams: First quarter, 2024 reflected stable asset quality metrics and much more moderate actions taken on substandard credits compared to the fourth quarter of 2023.

Bradley S. Adams: Our hope and belief remains that the prior quarter represented an inflection point in our credit trends.

Bradley S. Adams: Old second began substantially downgrading large amounts of commercial real estate loans, including office and health care at the end of 2021 and accelerating through 2022.

Bradley S. Adams: Substandard criticized loans went from approximately $60 million or a little more than 1% of loans at third quarter of 2021 to a peak of nearly $300 million.

Bradley S. Adams: Or over 7% of loans in the first quarter 2023.

Bradley S. Adams: As of the end of the first quarter of 2024 substandard criticized loans are down to $200 million, which is approximately $3 2 million less than year end 2023, and that trend expectation remains for further improvement through the remainder of the year.

Bradley S. Adams: Encouragingly, our special mentioned loans are now at their lowest level in over two years. We continued to expect realization of a relatively less costly resolution on a number of non performers in the near future.

Bradley S. Adams: We remain hopeful we can recover some of the losses realized in the second half of 2023.

Bradley S. Adams: The reality is that commercial real estate valuations are heavily dependent upon the market level of interest rates as a primary determine of cash flows for a given property.

Bradley S. Adams: A movement in rates such as we have seen is substantial enough to significantly impair the equity positions and a large percentage of commercial real estate credits.

Bradley S. Adams: Additionally, the residual stress brought upon by the pandemic that office and health care is not abated. We believe we are being proactive and realistic and addressing commercial real estate loans facing deterioration from higher interest rates declining appraisal values and cash flow pressures.

Bradley S. Adams: As we discussed last quarter on the call and consistent with our expectations. We recorded net charge offs of $3 7 million in the quarter. One specific current period charge off of $3 9 million and a previously allocated loan was partially offset by approximately 159000 of net recoveries during the first quarter the one charge.

Bradley S. Adams: It was due to the receipt of an updated appraisal on a health care property.

Bradley S. Adams: The good news is that criticized and classified loans are declining and the remainder of the portfolio remains well behaved.

Bradley S. Adams: Continued stress testing and renewal rates has not raised any new red flags for us and the bulk of our loan portfolio as transition and is seasoning into the higher rate environment.

Bradley S. Adams: Being short duration on the asset side has obviously helped us immensely in terms of interest rate risk management, but probably put us at the forefront in terms of commercial real estate stress.

Bradley S. Adams: That belief is reinforced by the experience that a significant percentage of our sub standard loans acquired secondary participations.

Bradley S. Adams: The allowance for credit losses on loans decreased to $44 1 million as of March 31, 2024, or one 1% of total loans from $44 3 million at year end 2023, which was also one 1% of total loans.

Bradley S. Adams: Unemployment and GDP forecast using the future loss rate assumptions remain fairly static from last quarter. The change in provision level quarter over linked quarter reflects the reduction in our allowance allocations on substandard loans, which are largely largely relates to the 31% reduction in criticized assets since March 30.

Bradley S. Adams: The one to 2023.

Speaker Change: I think investors should know that we are continuing.

Speaker Change: We are continuing with the level of strong profitability and we will be aggressive in addressing weak credits and that we remain confident in the strength of our portfolios.

Speaker Change: Noninterest income continued to perform well with growth noted quarter over linked quarter and fully in mortgage banking income.

Speaker Change: Income bounce back from a weak fourth quarter due to changes in market conditions mortgage banking income increased $1 3 million quarter over linked quarter, primarily due to minimal MSR gains recorded in the first quarter of 24 compared to the MSR losses of $1 3 million for the prior quarter.

Expense discipline continues to be strong with the usual seasonal uptick noted in the first quarter of 2024 compared to the prior linked quarter, primarily due to the annual increase in wage rates as well as growth in payroll related taxes and four one company match due to pay out of employee related annual incentives in the first quarter.

Speaker Change: 2024.

Speaker Change: In addition, our occupancy costs have increased quarter over the linked quarter due to the rollout of multiple updated branches at our corporate office.

Speaker Change: Our efficiency ratio continues to be excellent as.

Speaker Change: 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.

Speaker Change: The goal is obviously 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 at equity commensurate with our recent performance.

Speaker Change: I'll now turn it over to Brad for additional color in his comments.

Unknown Executive: Good morning, everyone, and thank you for joining us today for Old Second Bancorp's first 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.

Bradley S. Adams: Thank you Jim not a lot of surprises from us this quarter, which I think is good news net.

Bradley S. Adams: Net interest income decreased by $1 5 million or two 4% to $59 8 million for the quarter relative to the prior quarter of $61 2 million, a decrease of $4 3 million or 7% from the year ago quarter.

Unknown Executive: 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.

Bradley S. Adams: Loan yields were seven basis points higher than the first quarter and securities yields were flat total yield on interest, earning assets increased six basis points over the linked quarter to 561 basis points, but that was offset by 29 basis point increase in the cost of interest bearing deposits.

Bradley S. Adams: And an 18 basis point increase in interest bearing liabilities in aggregate.

Bradley S. Adams: The end result was the expected four basis point decrease in the tax equivalent NIM to 458.

Bradley S. Adams: From four six to last quarter.

Unknown Executive: 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 home page, and under the Investor Relations tab. Now I will turn it over to Jim Eccher. The floor is yours.

Bradley S. Adams: Which we believe continues to be exceptional margin performance.

Bradley S. Adams: Core margin was a little bit stronger than that as we saw a decrease in accretable yield of a few hundred thousand dollars.

Bradley S. Adams: I'm pretty certain we're pretty much done with that at this point, we've only got about 600000 or so left to accrete. So from this point forward core margin as actual margin for us.

James L. Eccher: Good morning, and thank you for joining us. As is customary, I have several prepared opening remarks and will give my overview of the quarter and then turn it over to Brad for additional color. I will then conclude with certain summary comments and thoughts about the future before we open it up for questions. Net income was $21.3 million, or 47 cents per diluted share, in the first quarter. Return on assets was 1.51%, and First Quarter 2024 Return on Average Tangible Common Equity was 17.8%, and the Tax Equivalent Efficiency Ratio was 53.09%.

Bradley S. Adams: Deposit flows this quarter continued to display signs of stabilization and actually some growth.

Bradley S. Adams: Average deposits increased only $3 million over the linked quarter, but period end total deposits increased by $38 million.

Bradley S. Adams: It's not really anything that we did on our rates I think others being kind of anticipatory of rate cuts at Peel back some time deposit pricing, making hard relatively more attractive and you can see that showing up in the balances I would say that we are still some 30% to 40 basis points below market leaders in that pricing, but.

James L. Eccher: First quarter earnings were negatively impacted by $3.5 million of provision for credit losses, which reduced after-tax earnings by six cents per share. However, profitability of Old Second remains exceptionally strong, and balance sheet strengthening continues with our tangible common equity ratio increasing by 51 basis points linked quarter to 9.04%. Common Equity Tier 1 crossed 12% this quarter, and we feel very good about profitability in 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.

Bradley S. Adams: Others have fallen off so I guess as an alternative we picked up more dollars on that front.

Bradley S. Adams: Our interest rate outlook hasn't really changed on that front and we havent, we havent peeled back pricing at all in anticipation of any rate cuts.

Bradley S. Adams: Deposit pricing overall remains exceptionally aggressive relative to the treasury curve.

Bradley S. Adams: And is still largely pricing off of overnight borrowing pricing.

Bradley S. Adams: We did add some time deposits as I mentioned as others pulled back.

Bradley S. Adams: Not a lover of time deposits, but they arent exactly garbage either in the rate cut expectations that were in the marketplaces. We discussed this last quarter, we're quite simply wrong.

James L. Eccher: For the first quarter of 2024, compared to the prior light year period, income on earning assets increased $3.2 million, or 4.5%, while interest expense increased $7.5 million. The increase in both cases is rate-driven; however, exception pricing and certain commercial deposits, as well as growth in average balances on other short-term borrowings compared to the prior year-like period caused a net decrease, and the interest margin, which is attributable to both interest rate and volume factors on the liability side.

Bradley S. Adams: The growth here remains short.

Bradley S. Adams: Our largely pricing less than a year and does offer significant value relative to overnight borrowing rates.

Bradley S. Adams: You can see our reliance there has fallen somewhat significantly relative to prior quarters on an overall basis, we are continuing to add duration and expect margin trends.

Bradley S. Adams:

Bradley S. Adams: From the bounce back end market rate indices to be absorbed by a projected growth in the securities portfolio beginning in the second quarter of 2024.

James L. Eccher: The first quarter of 2024 reflected a decrease in total loans of $73.5 million from the prior-linked quarter end, primarily due to a few payoffs and some large credits towards the end of the quarter. The historical trend for our bank is a really softer first quarter of originations due to limited new projects and construction during the winter season. 2023 was an anomaly as savvy commercial customers realized interest rates were about to increase and sought funding prior to those market rate increases in late first quarter 2023.

Bradley S. Adams: There aren't going to alerts at anything, but we are looking to add more fixed rate product.

Bradley S. Adams: As we've seen long rates ticked back up here recently, it's going to give us another opportunity to move some variable rate product out of the portfolio as we've been consistently doing over the last 18 months.

Bradley S. Adams: Incrementally I'm more bullish on margin and I was at this time last quarter.

Bradley S. Adams: But I highly expect that we will give back the upside on in terms of reducing further duration.

Speaker Change: I think thats prudent at this point.

Speaker Change: The concentration of variable rate securities will resume its decline if the market continues to move on the path that has been on in recent weeks.

James L. Eccher: Our loan growth was much larger in the year ago, like period compared to the first quarter of 2024, although activity within our loan committee remains modest relative to prior periods. Due to both the higher interest rate environment, lower demand, and seasonal impact, our net interest margin compressed slightly this quarter, driven by higher funding costs. Loan yields reflected a 7 basis point increase during the first quarter compared to the previous quarter and 37 basis points increase year over year. Funding costs increased due to the increases in both rates and growth in time deposit balances.

Speaker Change: I would be remiss, if I didn't point out that all of the relatively minor margin compression that we've seen to date is attributable to the balance sheet actions to reduce this asset sensitivity, specifically and most notably the reduction in variable rate securities.

Speaker Change: In totality marginal spreads remain an attractive at this point and we don't feel the pressure to swell in order to overcome expected margin pressures.

Speaker Change: Marginal returns on allocated equity remain poor for outsized growth, but I still think we can see relatively flat net interest income performance for the year, we have made a ton of progress in reducing asset sensitivity over the last year and.

James L. Eccher: The tax equivalent net interest margin was 4.58% for the first quarter compared to 4.62% for the fourth quarter and 4.74% in the first quarter of 2023. The net interest margin decreased 16 basis points in the year-over-year quarter due to the impact of rising rates on the cost of funds, which is partially mitigated by growth in interest income driven by the variable portion of the loan and securities portfolio. The loan-to-deposit ratio was 86% at March 31st, 2024, compared to 88% last quarter and 82% a year ago.

Speaker Change: And we are extending duration in our loan portfolio at this point as well.

Speaker Change: I am pleased markets have lost some of the inexplicable bloodlust for rate cuts that we were talking about last quarter and I look forward to more rational fed speak in the face of persistent inflationary trends.

Ex the extent of my soap box and rental rates for this quarter, but margin trends for the remainder of the year expected to be relatively flat maybe slightly down.

If I'm wrong in a couple of rate cuts actually occur we would lose a few basis points.

Speaker Change: The loan to deposit ratio remains low at 86, 1% and our ability to support liquidity from the securities portfolio continues as the fair value adjustment on the portfolio was only 800000 loss over the prior linked quarter.

James L. Eccher: As we said last quarter, our focus continues to be balance sheet optimization, and I'll let Brad talk about more of that in a minute. The first quarter of 2024 reflected stable asset quality metrics and much more moderate actions taken on substandard credits compared to the fourth quarter of 2023. Our hope and belief remains that the prior quarter represented an inflection point in our credit trend. Old Second began substantially downgrading large amounts of commercial real estate loans, including office and health care, at the end of 2021 and accelerating through 2022.

Speaker Change: From $84 $2 million to $85 million.

Speaker Change: This total unrealized loss remains high but we will be recaptured relatively quickly.

Speaker Change: Net result is that old second should continue to build capital quickly as evidenced by the 51 basis point improvement in the TCE ratio over the linked quarter, which means that we have added an astonishing 221 basis points of TCE and $2 23, a tangible book value over the last 12 months.

Speaker Change: As of March 31, 2024, we have approximately $880 million in undrawn borrowing capacity and an additional $365 million in Unpledged Securities and short liquidity at the bank is excellent and the holding company is in a very strong position as well.

James L. Eccher: Substandard and criticized loans went from approximately $60 million, or a little more than 1% of loans, in the third quarter of 2021 to a peak of nearly $300 million, or over 7% of loans in the first quarter of 2023. As of the end of the first quarter of 2024, substandard and criticized loans are down to $200 million, which is approximately $3.2 million less than year-end 2023, and the trend expectation remains for further improvement through the remainder of the year.

Speaker Change: I mentioned last quarter that we received non objection from the fed in December 2023 to revisiting stock repurchases, we haven't done anything yet, but it's getting very close based on the rationale I discussed last quarter.

Noninterest expense increased $1 2 million from the previous quarter.

Speaker Change: Primarily due to growth in salaries and employee benefits as well as a small increase in occupancy costs due to seasonal maintenance and depreciation on new office and remodeled branches.

James L. Eccher: Encouragingly, our special mention loans are now at their lowest level 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 we remain hopeful we can recover some of the losses realized in the second half of 2023. The reality is that commercial real estate valuations are heavily dependent upon the market level of interest rates as a primary determinant of cash flows for a given property.

Speaker Change: Salaries and employee benefits reflected the annual increase in base salary rates paid to employees in the first quarter as well as an increase in payroll taxes, 401, K matches and employee benefit costs over the prior linked quarter.

Speaker Change: I expect quarterly wages and benefits to be lower than $23 million going forward in the near term given.

Given the revenue performance employee the investment costs had been running high but we will maintain the ability to dial back as conditions warrant.

James L. Eccher: A movement in rates such as we have seen is substantial enough to significantly impair equity positions and a large percentage of commercial real estate credits. Additionally, the residual stress brought upon by the pandemic in office and healthcare has not abated.

Save this quarter that we saw.

Speaker Change: Two or three kind of 300 to 400000 dollar items within salaries that make it kind of linked quarter artificially high.

James L. Eccher: We believe we are being proactive and realistic in addressing commercial real estate loans facing deterioration from higher interest rates, declining appraisal values, and cash flow pressure. As we discussed last quarter on the call, and consistent with our expectations, we recorded net charge-offs of $3.7 million in the quarter. One specific current period charge-off of $3.9 million on a previously allocated loan was partially offset by approximately $159,000 of net recoveries during the first quarter. The one charge-up was due to the receipt of an updated appraisal on a health care property.

Speaker Change: These include.

Speaker Change: <unk>.

Speaker Change: Better than expected performance on performance.

Speaker Change: Base stock issuance that also had an impact on the tax rate as well.

Speaker Change: With that I'd like to turn the call back over to Jim.

James L. Eccher: Okay. Thanks, Brad in closing we are confident in our balance sheet and the opportunities that are ahead for old second.

James L. Eccher: Our primary focus today remains on assessing and monitoring risks within the loan portfolio and optimizing the earning asset mix in order to reduce our overall <unk>.

James L. Eccher: <unk> interest rates.

James L. Eccher: Net interest margin trends are stable and income statement efficiency remains at record levels.

James L. Eccher: The good news is that criticized and classified loans are declining, and the remainder of the portfolio remains well-behaved. Continued stress testing at renewal rates has not raised any new red flags for us, and the bulk of our loan portfolio has transitioned and is maturing into the higher rate environment. Being short duration on the asset side has obviously helped us immensely in terms of interest rate risk management but probably put us at the forefront in terms of commercial real estate stress.

Speaker Change: The expectation for continuing efficiency gives me confidence that we are well positioned to deliver another strong year in 2024.

Speaker Change: That concludes our prepared comments. This morning, so I'll turn it over to the moderator and we'll open it up for questions.

Speaker Change: Certainly the floor is now open for questions.

Speaker Change: Have any questions or comments. Please press star one on your phone at this time. We also will posing your question. Please pickup your handset listening on a speaker phone to provide optimum sound quality. Please I will just a moment, while we poll for questions.

James L. Eccher: The belief is reinforced by the experience that a significant percentage of our substandard loans required secondary participation. The allowance for credit losses on loans decreased to $44.1 million as of March 31, 2024, or 1.1% of total loans from $44.3 million at year-end 2023, which was also 1.1% of total loans. Unemployment and GDP forecasts using the future loss rate assumptions remained fairly static from last quarter.

Nathan James Race: Your first question is coming from Nathan race with Piper Sandler. Please pose your question your line is less.

Nathan James Race: Hi, guys. Good morning, Thanks for taking the question.

Nathan James Race: Just curious to get your updated thoughts on how we should be thinking about charge offs going forward. Obviously, you had some stability in NPA and classified loan levels in the quarter. So first would just be curious to see are the driver of the charge offs. This quarter looked like it came from the owner owner occupied CRE bucket. So I'm not sure. If these are some of the levels that we've been talking about in past quarters, we used to.

James L. Eccher: The change in provision level, quarter over link quarter, reflects the reduction in our allowance allocations on substandard loans, which largely relates to the 31% reduction in criticized assets since March 31st of 2023. I think investors should know that we are continuing. We are continuing with our level of strong profitability, and we will be aggressive in addressing weak credits and we remain confident in the strength of our portfolios. Non-interest income continued to perform well, with growth noted quarter over linked quarter in BOLI and mortgage banking income.

Nathan James Race: And just generally what youre seeing in terms of lost content over the next quarter or two.

Nathan James Race: If you if you refer back to last quarter's call. We had said that we expected a $3 million to $4 million loss, we had thought with that charge offs would could fall into last quarter, but the timing of things didn't allow to make that possible.

Nathan James Race: So this charge off was expected in terms of what we were trying to communicate any way.

Nathan James Race: We may have $1 million or two.

James L. Eccher: BOLI income bounced back from a weak fourth quarter due to changes in market conditions. Mortgage banking income increased $1.3 million quarter over link quarter, primarily due to minimal MSR gains recorded in the first quarter of 2024, compared to MSR losses of $1.3 million for the prior quarter. Expense discipline continues to be strong, with the usual seasonal uptick noted in the first quarter of 2024 compared to the prior link quarter, primarily due to the annual increase in wage rates as well as growth in payroll-related taxes and 401k company match due to the payout of employee-related annual incentives in the first quarter of 2024. In addition, our occupancy costs have increased quarter over the link quarter due to the rollout of multiple updated branches at our corporate

Nathan James Race: Next quarter, but I view that as kind of 50% likely.

Nathan James Race: Absent that I don't see.

Nathan James Race: Significant losses absent something changing our surprise propping up.

Nathan James Race: We tried to communicate that we had reached an inflection point last quarter, we haven't seen anything in the three months that would lead us to change that communication.

Speaker Change: The only other thing I'd add natus, we haven't really seen any new problems.

Speaker Change: Crop up here.

Speaker Change: In the last quarter or so and in any future charge offs that we will realize will more than likely be on previously allocated credits.

Speaker Change: Okay great.

Speaker Change: And can you guys just remind us kind of how youre thinking about loan growth going forward I understand demand is low and I imagine the pipeline slowed as well as I believe you touched on Jim, but just any thoughts on how you see kind of a cadence of loan growth and also how you guys are expecting deposits to trend over the course of 2024.

James L. Eccher: Our efficiency ratio continues to be excellent. As we look forward, we're continuing to do 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 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 and his comments. Thank you, Jim. Not

Speaker Change: Yes, I can talk touch on the.

Speaker Change: The loan pipeline ill, let Brad talk about about deposit flows, but if you throw out 2023, historically, our first quarter loan origination is usually pretty moderate that was the case again this year coupled with the fact that we had some significant large payoffs and paydowns due to sales of some properties.

Bradley S. Adams: Thank you, Jim. Not a lot of surprises from us this quarter, which I think is good news. Net interest income decreased by 1.5 million or 2.4% to 59.8 million for the quarter, relative to the prior quarter of 61.2 million, a decrease of 4.3 million or 7% from the year ago like quarter. However, loan yields were seven basis points higher in the first quarter. Security Yields Were Flat. Total yield on interest-earning assets increased six basis points over the linked quarter to 561 basis points, but that was offset by a 29 basis point increase in the cost of interest-bearing deposits and an 18 basis point increase in interest-bearing liabilities in aggregate.

Speaker Change: Loan demand I would say is somewhat muted relative to last year activity in our loan committee is picking up.

Speaker Change: We feel we still have the organic loan origination capacity internally to produce still in the low low to mid single digit loan growth this year.

The teams are performing well and certainly marginal returns on some of the opportunities. We're looking at are not overly attractive in some cases, so to brad's point before we're not looking we're not looking to swallow balance sheet to mitigate margin compression, we're being very selective and opportunistic, but we still feel low to mid single.

Bradley S. Adams: The end result was the expected four basis point decrease in the tax equivalent NEM to 4.58 from 4.62 last quarter, which we believe continues to be exceptional margin performance. The core margin was a little bit stronger than that, as we saw a decrease in accretable yield of a few hundred thousand dollars. Pretty certain we're pretty much done with that at this point.

Speaker Change: Digits is achievable this year.

Speaker Change: I'll, let Brad talk about deposit flows.

Bradley S. Adams: Yes, the game is getting easier so.

Bradley S. Adams: I think one thing that if you look at our deposit trends and I've seen the industry and the flows from noninterest bearing and into other.

Bradley S. Adams: Posit captions.

Bradley S. Adams: For us as I mentioned in the open to close ratio is positive for the first time in a long time and old second has historically been a net grower of checking accounts.

Bradley S. Adams: We've only got about 600,000 or so left to accrete. So from this point forward, core margin is actual margin for us. Deposit flows this quarter continue to display signs of stabilization and actually some growth. Average deposits increased only $3 million over the linked quarter, but period end total deposits increased by $38 million.

Bradley S. Adams: Absent the period of volatility coming out of acquisitions.

Bradley S. Adams: Our deposit attrition within that caption is more a function demographically I think than anything else just the struggle that scene at the lower end of the pay scale and lower demographics.

Bradley S. Adams: It's not really anything that we did on rates. I think others, being kind of anticipatory of rate cuts, have peeled back some time to profit pricing, making ours relatively more attractive, and you can see that showing up in the balances. I would say that we are still some 30 to 40 basis points below market leaders in that pricing, but others have fallen off, so I guess, as an alternative, we've picked up more dollars on that front.

Bradley S. Adams: We are seeing some pricing pressure in commercial account balances, but nothing that we can't match and certainly at rates well below overnight borrowing levels.

Bradley S. Adams: The speed of the mix shift that we saw coming into time deposits and coming out of overnight borrowings surprised us a little bit.

Bradley S. Adams: I don't know if that will continue but certainly you can you can see a fair amount of volatility in market Red eight interest rate expectations and it does make sense for some volatility to bleed through into deposit markets as well from that.

Bradley S. Adams: Our interest rate outlook hasn't really changed on that front, and we haven't peeled back pricing at all in anticipation of any rate cuts. Deposit pricing overall remains exceptionally aggressive relative to the Treasury curve, and is still largely priced off of overnight borrowing prices. We did add some time deposits, as I mentioned, as others had peeled back. I'm not a lover of time deposits, but they aren't exactly garbage either.

Bradley S. Adams: I'm more bullish than I expected it to be on deposit funding I can tell you that I think I think we're certainly to <unk>.

Bradley S. Adams: Fortunate position at 40% of our deposit.

Portfolio in DDA noninterest bearing obviously is going to provide us a nice floor for for any future margin compression. It doesn't help our stated goal of reducing asset sensitivity to have that overnight borrowing position have been a period of weeks.

Bradley S. Adams: And the rate cut expectations that were in the marketplace as we discussed this last quarter were quite simply wrong. The growth here remains weak. We are largely pricing in less than a year, and it does offer significant value relative to overnight borrowing rates. As you can see, our reliance there has fallen somewhat significantly relative to prior quarters. On an overall basis, we are continuing to add duration and expect margin trends from the bounce back in market rate indices to be absorbed by projected growth in the securities portfolio, beginning in the second quarter of 2024.

Speaker Change: That was certainly interesting but.

Speaker Change: Things feel very good on the deposit front at this point.

Speaker Change: Okay, Great and then just turning to the margin Bryan I think you alluded to greater stability and higher for longer rate environment for year over at least perhaps next quarter or two.

Speaker Change: Just within that context, I understand and you guys, obviously have a pretty short duration Securities book. So just curious you know how much casually coming off the securities portfolio over the next couple of quarters and how you guys are thinking about redeploying that just given this fairly soft.

Bradley S. Adams: We aren't going to lurch at anything, but we are looking to add more fixed-rate product. As we've seen longer rates tick back up here recently, it's going to give us another opportunity to move some variable-rate product out of the portfolio, as we've been consistently doing over the last 18 months. Incrementally, I'm more bullish on margin than I was at this time last quarter, but I highly expect that we'll get back the upside in terms of reducing further duration. I think that's prudent at this point.

Speaker Change: <unk>.

Speaker Change: Environment.

Speaker Change: <unk> loans.

Speaker Change: If things keep trending likelier sharing trending out of a mind to grow the securities portfolio at this point it wont be significant maybe $100 million or so.

Speaker Change: <unk> $300 million over a period over the next 12 months.

Speaker Change: I think that there is value coming when.

The thing is when there is this kind of volatility in interest rate markets it creates opportunity.

Bradley S. Adams: The concentration of variable rate securities will resume its decline if the market continues to move on the path that it has been on in recent weeks. I would be remiss if I didn't point out that all of the relatively minor margin compression that we have seen to date is attributable to balance sheet actions to reduce this asset sensitivity, specifically, and most notably, the reduction in variable rate securities. In totality, marginal spreads remain unattractive at this point, and we don't feel the pressure to swell in order to overcome expected margin pressures.

Speaker Change: And I expect.

At least right now that it's going to continue trending in our favor in terms of there will be more rate further out the curve.

Speaker Change: And my bias will be to continue to sell variable and by fixed.

Speaker Change: So we'll see if we get that opportunity we don't that's okay too.

Speaker Change: What we've tried to communicate over the last 12 to 18 months is that.

Bradley S. Adams: Marginal returns on allocated equity remain poor for outsized growth, but I still think we can see relatively flat net interest income performance for the year. We have made a ton of progress in reducing asset sensitivity over the last year, and we are extending duration in the loan portfolio at this point as well. I'm pleased markets have lost some of the inexplicable bloodlust for rate cuts that we were talking about last quarter, and I look forward to more rational Fed speak in the face of persistent inflationary trends.

Speaker Change: There certainly could have been additional margin upside.

Speaker Change: What you've gotten instead as margin stability as we've taken asset sensitivity off the table I expect that trend to continue.

Speaker Change: Can you just remind us how much cash flow coming off.

Speaker Change: Maturing so just natural amortization in the portfolio would throw off about $25 million to $50 million per quarter.

Speaker Change: Okay, Great I'll step back.

Speaker Change: Hello.

Speaker Change: Thanks, Thanks, guys.

Bradley S. Adams: That's the extent of my soapboxing on rates for this quarter, but 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 could lose a few bases.

Speaker Change: Your next question is coming from Chris Mcgratty with Keybanc. Please pose your question. Your line is open.

Speaker Change: Hi, This is Nick <unk> on for Chris Good morning, guys.

Bradley S. Adams: The loan-to-deposit ratio remains low at 86.1 percent, and our ability to support liquidity from the securities portfolio continues as the fair value adjustment on the portfolio was only $800,000 loss over the prior linked quarter, from 84.2 to 85 million. This total unrealized loss remains high, but will be recaptured relatively quickly. The net result is that Old Second should continue to build capital quickly, as evidenced by the 51 basis point improvement in the TCE ratio over the linked quarter.

Speaker Change: Okay.

Nick: Maybe just given.

Nick: Given the speed of the capital build you could speak to the priority on buybacks versus M&A do you have any specific level of the stock.

Nick: Guys, a lean more into the buybacks from here.

So we've talked about this a little bit last quarter.

Nick: It's not one variable, but I would say that.

Nick: It's very difficult to do M&A, if you traded seven times earnings that math is if you're in a kind of.

Bradley S. Adams: This means that we have added an astonishing 221 basis points of TCE and $2.23 of tangible book value over the last 12 months. As of March 31st, 2024, we have approximately $880 million in undrawn borrowing capacity and an additional $365 million in unpledged securities. Short liquidity at the bank is excellent, and the holding company is in a very strong position as well. I mentioned last quarter that we received no objection from the Fed in December 2023 to resume stock repurchases. We haven't done anything yet, but it's getting very close based on the rationale I discussed last quarter.

Nick: P arbitrage game.

Nick: A crappy trade.

Nick: So our stock becomes relatively attractive.

Nick: When you talk about buying lower quality balance sheet. It say, one five times, just pulling a number out of that versus buying higher quality balance sheet at one two times. So the methodology. We communicated last quarter was is that.

Projecting earnings 12 month forward, what's tangible book value per share and ROE below that in terms of the current trading price.

Nick: I think that's a level, that's very attractive to us and that remains the case.

Bradley S. Adams: Non-interest expense increased $1.2 million from the previous quarter, primarily due to growth in salaries and employee benefits, as well as a small increase in occupancy costs due to seasonal maintenance and depreciation on new offices and remodeled branches. Salaries and employee benefits reflected an annual increase in base salary rates paid to employees in the first quarter, as well as an increase in payroll taxes, 401k matches, and employee benefit costs over the prior-linked quarter.

Nick: I alluded in the prepared comments that we are very close to that threshold.

Speaker Change: Alright, Thank you for that and then.

Speaker Change: Maybe one more just on yes.

Speaker Change: Yes.

Speaker Change: Outflows.

Speaker Change: Towards the end of the quarter I think the higher for longer kind of became <unk>.

Speaker Change: More consensus I guess are you seeing anymore.

Deposit outflows towards the end of the quarter or do you think that there.

Speaker Change: Eric.

Bradley S. Adams: I expect quarterly wages and benefits to be lower than $23 million going forward in the near term. Given the revenue performance, employee investment costs have been running high, but we will maintain the ability to dial back as conditions warrant, say this quarter that we saw. Two or three kinds of 300 to $400,000 items within salaries that make it kind of a link quarter artificially high. Those include better than expected performance on performance-based stock issuance, that also had an impact on the tax rate as well.

Speaker Change: Play for us.

Eric: And I tried to allude to this as well its purely seasonal factors. We don't have a deposit base. That's made up of people doing interest rate speculation.

Eric: Five and $10000 checking accounts and it's just a function of when pay periods occur wins pay day versus winter bills do in tax payments and tax refunds in normal people stuff.

Speaker Change: Okay I'll step back thank you guys.

Speaker Change: Thanks, Nick.

Speaker Change: Once again, if you do have any questions or comments. Please press star one on your phone at this time.

Speaker Change: Next question is coming from Terry Mcevoy with Stephens, Inc. Please pose your question your line is less.

James L. Eccher: With that, I'd like to turn the call back over to Jim.

James L. Eccher: Okay, thanks, Brad. In closing, we are confident in our balance sheet and the opportunities that are ahead for Old Second. Our primary focus today remains on assessing and monitoring risks within the loan portfolio and optimizing the earning asset mix in order to reduce our overall sensitivity to interest rates. Furthermore, interest margin trends are stable, and income statement efficiency remains at a record level. The expectation of continuing efficiency gives me confidence that we are well positioned to deliver another strong year in 2024. That concludes our prepared comments this morning, so I'll turn it over to the moderator, and we'll open it up for questions.

Speaker Change: Morning. This is brendan on for on for Terry.

Speaker Change: Brendan.

Brendan: I just have a quick one.

Brendan: Can you expand on the impacts of the market rates had on the salaries and benefits lines and then also what we are going to occur going forward.

Brendan: If rates remain unchanged and you maintain the current high levels of <unk>.

Profitability.

Brendan: We.

Brendan: Interest rates on the salaries and benefits line as a couple of items that drive it higher one.

Brendan: You've got bonuses that are paid out in the first quarter. So youre fully maxing out FICA for your higher paid employees. So you've got a higher share there and then I mentioned earlier that performance based restricted stock vesting came.

Operator: Certainly. The floor is now open for questions. If you have any questions or comments, please press star 1 on your phone at this time. We ask that while asking your question, you please pick up your handset if listening on a speakerphone to provide optimum sound quality. Please hold just a moment while we poll for questions. Your first question is coming from Nathan Race with Piper Sandler. Please pose your question; your line is live.

Brendan: It came in above target based on old second performing at the 98 percentile of the peer group on Aro TCE and efficiency.

Brendan: That.

Brendan: Increased share issuance related to those performance stock also has an impact on the tax rate, which is what it was a little bit lower this quarter.

Nathan James Race: Hi guys, good morning. Thanks for taking the time to answer the question. I'm just curious to kind of get your updated thoughts on how we should be thinking about charge-offs going forward. Obviously, you know, there was some stability in MPA and Class 5 loan levels in the quarter. So first, we'd just be curious about the driver of the charge-offs. This quarter looked like it came from the owner-occupied CRE bucket, so I'm not sure if these are some of the loans that we've been talking about in past quarters recently and just generally kind of what you're seeing in terms of lost content over the next quarter or two.

Speaker Change: Those of you that listen no I'm loathe to talk about tax rate, because I'm always wrong about it.

Speaker Change: And I had said that salaries and benefits are expected to be kind of closer or even below $23 million per quarter going forward.

Speaker Change: Okay.

Speaker Change: Only thing that can make us wrong on that.

Speaker Change: <unk>.

Speaker Change: Hey, there's a virus in a bunch of people get sick in healthcare claims go through the roof.

James L. Eccher: If you refer back to last quarter's call, we had said that we expected a $3 to $4 million loss. We had thought that that charge-off could fall into this quarter, but the timing of things didn't make that possible. So this charge-off was expected in terms of what we were trying to communicate anyway. We may have a million or two next quarter, but I view that as kind of 50% likely, absent that I don't see significant losses absent something changing or a surprise propping up. We tried to communicate that we had reached an inflection point last quarter, and we haven't seen anything in the three months since that would lead us to change that communication.

Speaker Change: The kind of stuff that I can't predict but.

Speaker Change: There's no step change here, it's just a <unk>.

Speaker Change: First quarter, one off type stuff.

Speaker Change: Okay got it.

Speaker Change: And maybe one you classified them.

Speaker Change: Multifamily loans are pretty low I'm. Just curious can you talk about what youre seeing in in your markets and trends in your own portfolio.

Speaker Change: Yes, I think.

Speaker Change: Certainly.

Speaker Change: Our focus.

Speaker Change: Asset quality continues to be on an office and health care. Those are the those are the two main areas that we're seeing some stress.

Speaker Change: Nothing new has cropped up in office.

Speaker Change: Our health care for that matter in the last quarter or two.

James L. Eccher: The only other thing I'd add, Nate, is we haven't really seen any new problems crop up here in the last quarter or so, and any future charge-offs that we will realize will more than likely be on previously allocated credit.

Speaker Change: We continue to work through that I think.

Speaker Change: One of the other things we're struggling with is you know a third of our.

Speaker Change: Classified loans are almost a third of our purchase participations.

Speaker Change: Some are SNCC credits, where we don't have a voice at the table so working out of those.

Unknown Executive: Okay, great. And can you guys just remind us kind of how you're thinking about loan growth going forward? I understand, you know, demand is low. And, you know, I imagine the pipeline slowed as well, as I believe you touched on, Jim, but just any thoughts on how you see kind of the cadence of loan growth and also how you guys are expecting deposits to trend over the course of 2024?

Speaker Change: Is going to be a challenge, it's going to take time, but I think the good news is when you have a third of your <unk>.

Unknown Executive: Unknown Speaker

Speaker Change: Classifieds and criticized.

Speaker Change: Declining almost 31% from a year ago.

Speaker Change: Certainly.

Speaker Change: Woods well for for future migration.

Speaker Change: Okay.

James L. Eccher: I can touch on the loan pipeline, but I'll let Brad talk about deposit flows.

Speaker Change: Those are my questions I appreciate I appreciate you answering them.

Thanks, Brian.

James L. Eccher: But if you throw out 2023, historically, our first quarter loan origination is usually pretty moderate. That was the case again this year, coupled with the fact that we had some significant, large payoffs and paydowns due to sales of some properties. Loan demand, I would say, is somewhat muted relative to last year's activity in our Loan Committee. It's picking up, though.

Speaker Change: Your next question is coming from Brian Martin with Janney. Please pose your question your line is live.

Brian Martin: Hey, good morning, guys.

Brian Martin: Brian Hey, Brian Hey, Jim maybe I missed it just in your comments just to be clear on the I know, they're down but just the level of criticized loans in the quarter I know that the classified was participant criticized level in the quarter was at about $200 million is that what you said or do you have that number.

James L. Eccher: Yeah that sounds right Brian.

James L. Eccher: We feel we still have the organic loan origination capacity internally to produce, you know, still in the low to mid-single-digit loan growth this year. The teams are performing well, and certainly, you know, marginal returns on some of the opportunities we're looking at are not overly attractive in some cases. So we're, to Brad's point before, we're not looking to swallow the balance sheet to mitigate margin compression. We're being very selective and opportunistic. We still feel that low to mid-single digits is achievable this year. I'll let Brad talk about deposit flows.

Jim Edgar: Okay.

Jim Edgar: Maybe that's why you're looking at.

Speaker Change: Go ahead.

Speaker Change: Yes.

Speaker Change: $200 million.

Okay.

Speaker Change: Okay, and then just for Brad on the Securities repricing. It sounds like it's maybe $100 million or so this year is are those mostly treasury securities Brad I thought thats, what I don't want that.

Bradley S. Adams: That is yes that is.

Bradley S. Adams: Almost entirely treasuries that we had bought a bunch of kind of.

Bradley S. Adams: Two through four year treasuries back in 2021 and 2020.

Bradley S. Adams: Just looking to get our money back if we were right about what rates were going to do.

Bradley S. Adams: Yeah, the game's getting easier, so... I think one thing that if you look at our deposit trends and I've seen the industry and the flows from non interest-bearing and into other deposit categories, For us, as I mentioned, the open to close ratio is positive for the first time in a long time, and Old Second has historically been a net grower of checking accounts, absent the period of volatility coming out of acquisitions.

Bradley S. Adams: Which we were and we got our money back so.

We've got a little bit more comment I didn't answer that first question totally right somebody asked.

Bradley S. Adams: What the cash coming off the portfolio normal amortization is the 25% to 50, but we still got some lumpy things coming at us over the next six months.

Bradley S. Adams: Okay. We got we got a ton of cash coming out and we got.

Bradley S. Adams: Plenty of opportunities for higher yields on that.

Bradley S. Adams: Our deposit attrition within that category is more of a function demographically, I think, than anything else, just the struggle that's seen at the lower end of the pay scale and lower demographics. We are seeing some pricing pressure on commercial account balances, but nothing that we can't match and certainly at rates well below overnight lending levels. The speed of the mixed shift that we saw coming into time deposits and coming out of overnight lending surprised us a little bit.

Bradley S. Adams: I, certainly like where we are today relative to where we were last quarter in terms of reinvestment opportunities.

Bradley S. Adams: Okay, I mean, it seemed like last quarter, there was about $100 million on the treasury stuff that was coming due.

Bradley S. Adams: Sounds like now the expectation is loan demand is off that maybe you just redeploy that into the securities book and maybe grow it from that Jim and Jim and I might add we still believe we can grow loans and there is no substitute for that.

Bradley S. Adams: I don't have a problem with being at a $400 million overnight borrowing level.

Bradley S. Adams: I don't know if that will continue, but certainly, you can see a fair amount of volatility in market interest rate expectations, and it does make sense for some volatility to spill through into deposit markets as well. I'm more bullish than I expected to be on deposit funding, I can tell you that.

Bradley S. Adams: No issue with that especially as it gives us something that re prices if we're wrong about short rates.

Bradley S. Adams: So I don't see any reason to shrink the balance sheet I guess is the main takeaway here.

Bradley S. Adams: This quarter came in light on a period end basis, a little better on an average basis.

Bradley S. Adams: And I think, you know, I think we're certainly in a fortunate position at 40% of our deposit. (inaudible)

Bradley S. Adams: I would I would guide you to the average balance sheet more so than the period end.

Speaker Change: Got you. Okay. That's helpful and then maybe just on the capital.

Speaker Change: Buyback versus M&A.

Bradley S. Adams: It doesn't help our stated goal of reducing asset sensitivity to have that overnight borrowing position halved in a period of weeks. That was certainly interesting. You know, things feel very good on the deposit front at this.

M&A I mean, I guess, how is the market given absent your stock price.

Speaker Change: The impact that has been just as far as the level of opportunities youre seeing on the M&A side versus balancing that with.

Speaker Change: Stock price and then the potential for the earnings where tangible book is heading to just thinking about M&A potential.

Nathan James Race: Okay, great. And then just turn to the margin. Brad, I think you alluded to, you know, greater stability in a higher for longer rate environment from here over at least perhaps the next quarter or two. And just within that context, I understand you guys obviously have a pretty short-duration securities book. So just curious, you know, how much cashflow is coming off the securities portfolio in the next couple quarters and how you guys are thinking about redeploying that just given the fairly soft Environment for Growth and Loans.

M&A is still challenging here right I mean, there is an awful lot of people that.

Speaker Change: It certainly are struggling and are likely to under earn over the years ahead, especially in a higher for longer scenario, but.

Speaker Change: Those people also have.

Speaker Change: Our fair value problem in terms of where the balance sheet will be March so.

Speaker Change: That kind of M&A takes an awful lot of capital.

Bradley S. Adams: If things keep trending like they're trending out of the mind to grow the securities portfolio at this point, it won't be significant, maybe 100 million or so, maybe 300 million over a period over the next 12 months. I think that there is value coming when You know, the thing is, when there is this kind of volatility in interest rate markets, it creates opportunity, and I expect, at least right now, that it's going to continue trending in our favor in terms of there being more rates further out the curve, and my bias would be to continue to sell variable and buy fixed. We'll see if we get that opportunity. If we don't, that's okay, too.

Speaker Change: I am not terribly opposed to it but.

Speaker Change: It is it as onerous.

Speaker Change: And I think that.

Speaker Change: There is some equilibrium level of rates where.

Speaker Change: Balances the level of fair value marks versus pricing expectations versus <unk>.

Speaker Change: Going it alone in hoping for rates to fall.

Speaker Change: I don't know where it is but M&A activity is still muted.

Speaker Change: And the people that.

The easy transaction to do with somebody who has got an awful lot of on deploy deposits I think we've seen one of those recently.

Speaker Change: But that's.

Speaker Change: That's not something that we're going to be able to compete with on price at our current valuation.

Speaker Change: Got you Okay. That's all I had thank you.

Bradley S. Adams: What we've tried to communicate over the last 12 to 18 months is that there certainly could have been additional margin upside. What you've gotten instead is margin stability as we've taken asset sensitivity off the table. I expect that trend to continue.

Yes.

Speaker Change: Thank you. This does conclude the Q&A session I would now like to turn the floor back over to Jim <unk> for closing remarks.

James L. Eccher: Okay. Thanks, everyone for your interest in our company and for joining US. This morning, and we look forward to speaking with you again next quarter Goodbye.

Nathan James Race: Right. Can you just remind us how much cash earlier is coming off or maturing? So just now.

Bradley S. Adams: maturing. So just the natural amortization of the portfolio would throw off about $25 to $50 million.

Speaker Change: Thank you everyone. This does conclude today's conference call. You may disconnect. Your phone lines at this time and have a wonderful day. Thank you for your participation.

Nathan James Race: Okay, great. I'll sit back.

Operator: Your next question is coming from Chris McGratty with KBW. Please post your question. Your line is live.

Nicholas James Moutafakis: Hi, this is Nick Moutafakis on for Chris. Good morning, guys.

Unknown Executive: See you, Nick. See you, Nick. Bye, Nick.

Bradley S. Adams: Maybe just on given the speed of the capital build, you could speak to the priorities on buybacks versus M&A, you know, any specific level of the stock, for you guys to lean more into buybacks from here.

Bradley S. Adams: So we talked about this a little bit last quarter. You know, it's not one variable, but I would say that one, it's very difficult to do M&A if you trade at seven times earnings, and that the math is if you're in a kind of an eArbitrage game like the Crappy Trade. So our stock becomes relatively attractive when you talk about buying a lower quality balance sheet at say one and a half times, just pulling a number out of a hat versus buying a higher quality balance sheet. 1.2 times.

Bradley S. Adams: So the methodology we communicated last quarter was that, you know, projecting earnings 12 months forward, what's the tangible book value per share? And are we below that in terms of the current trading price? I think that's a level that's very attractive to us, and that remains the case. I alluded in the prepared comments that we are very close.

Unknown Executive: All right, thank you for that. And then maybe one more on, you know, the NID outflows. You know, towards the end of the quarter, I think the hire for longer kind of became more consensus. More consensus, I guess we've seen any more. Deposit Outflows Toward the End of the Quarter It's, you know, five and $10,000 checking accounts, and it's just a function of when pay periods occur. Wins Payday vs. Winner Bills Due and Tax Payments and Tax Refunds and, you know, normal people stuff. Okay, I'll step back. Thank you, guys.

Unknown Executive: Yep.

Operator: Once again, if you do have any questions or comments, please press star one on your phone at this time. Your next question is coming from Terry McEvoy with Stephen Zink. Please pose your question. Your line is live.

Brandon Rudon: Morning, this is Brandon Rudon on behalf of Terry. I just have a quick one.

Brandon Rudon: Can you expand on the impact that market rates had on the salaries and benefits lines? And then also, what would occur going forward if rates remain unchanged, and you maintain these current high levels of profitability?

Bradley S. Adams: It's not interest rates on the salaries and benefits line. It's a couple items that drive it higher.

Bradley S. Adams: You've got bonuses that are paid out in the first quarter, so you're fully maxing out FICA for your higher-paid employees. So you've got a higher share there. And then I mentioned earlier that performance-based restricted stock vesting came in above target based on Old Second performing at the 90th percentile of the peer group on ROTCE and efficiency. That increased share issuance related to performance stock also has an impact on the tax rate, which is why it was a little bit lower this quarter.

Bradley S. Adams: Those of you that listen know I'm loathe to talk about tax rates because I'm always wrong about them. Unknown Speaker Okay. I'd said that salaries and benefits I expected to be kind of closer to or even below $23 million per quarter going forward. The only thing that can make us wrong on that is if, you know, say there's a virus and a bunch of people get sick and healthcare claims go through the roof. You know, that's the kind of stuff that I can't predict, but there's no step change here. It's just First Quarter One Offee type stuff.

Brandon Rudon: Got it. And maybe one, your classified multifame loans are pretty low. I'm just curious, can you talk about what you're seeing in your markets and trends and in your own portfolio?

James L. Eccher: Yeah, I think, you know, certainly, our focus on asset quality continues to be on office and health care. Those are the two main areas that we're seeing some stress in. Nothing new has cropped up in the office, or healthcare for that matter, in the last quarter to continue to work through that. I think one of the other things we're struggling with is, you know, a third of our Classified loans are almost a third are purchase participations, and some are SNCC credits whereby we don't have a voice at the table.

James L. Eccher: So working out of those is going to be a challenge. It's going to take time. But I think the good news is when you have a third of your classifieds and criticized declining almost 31 percent from a year ago. That certainly bodes well for future migration.

Brandon Rudon: Okay, those are my questions. I appreciate I appreciate you answering them.

Brian Martin: Your next question is coming from Brian Martin with JANI. Please pose your question. Your line is live.

Brian Martin: Hey, Brian. Hey, Brian. Hey, Jim, maybe I missed it just in your comments. Just to be clear on the I know that it's down, but just the level of criticized loans in the quarter, and I know what the classified was, but just the criticized level in the quarter, was it about 200 million? Is that what you said? Or do you have that number?

James L. Eccher: Yeah, I have that. It sounds right, Brian.

Unknown Speaker: [inaudible]

Brian Martin: Okay, and then just for Brad, on the securities repricing, it sounds like it's maybe $100 million or so this year. Are those mostly Treasury securities, Brad? I thought that was what, I don't know, last quarter or the quarter before.

Bradley S. Adams: That is, yeah, that is almost entirely treasury. So we had bought a bunch of kind of two through four year treasuries back in 2021 and 2020, just looking to get our money back if we were right about what rates we were going to do, which we were, and we got our money back. We've got a little bit more coming. I didn't answer that first question.

Bradley S. Adams: Totally right. Somebody asked about the cash coming off the portfolio. Normal amortization is between 25 and 50, but we've still got some lumpy things coming at us over the next couple of years. Okay, we got we got a ton of cash coming out. We have, plenty of opportunities for higher yields on that. I certainly like where we are today relative to where we were last quarter in terms of reinvestment.

Brian Martin: Okay, I mean, last quarter, there was about 100 million in Treasury stuff that was coming due, but it sounds like now that the expectation of loan demand is soft, that maybe you just redeploy that into the securities book and maybe, you know, grow it from that. You know, we still believe we can grow loans, and there's no substitute for that. I don't have a problem with being at a $400 million overnight borrowing level; there is no issue with that, especially as it gives us something that the reprices were wrong about the short rate.

Brian Martin: So, I don't see any reason to shrink the balance sheet. I guess that is the main takeaway. This quarter came in light on a period-end basis, a little better on an average basis, pointing you to the average balance sheet more so than the period. Gotcha. Okay, that's helpful. And then maybe just on capital, kind of, you know, the buyback versus the M&A. I mean, I guess, how is the market, you know, given your absent stock price and the, you know, the impact that has, but just as far as the level of, you know, opportunities you're seeing on the M&A side versus balancing that with the stock price and then the potential for the earnings with where Tangible Book is heading, and then the potential for the earnings with where Tangible Book is heading. So, you know, thinking about

Bradley S. Adams: M&A is still challenging here, right? I mean, there are an awful lot of people that are certainly struggling and are likely to under-earn over the years ahead, especially in a hire-for-longer scenario. Those people also have a fair value problem in terms of where their balance sheet would be valued. That kind of M&A takes an awful lot of capital. You know, I'm not terribly opposed to it, but it is, it is onerous. And I think that there is some equilibrium level of rates where it balances the level of fair value marks versus pricing expectations versus, you know, going in alone and hoping for rates to fall.

Bradley S. Adams: I don't know where it is, but M&A activity is still muted, and the people that say, "The easy transaction to do with somebody who's got an awful lot of undeployed deposits. We've seen one of those recently. But that's not something that we're going to be able to compete with on price at our current valuation."

Brian Martin: Gotcha. Okay, that's all I had. Thanks.

James L. Eccher: Thank you. This does conclude the Q&A section. I would now like to turn the floor back over to Jim Ecker for closing remarks.

James L. Eccher: Okay, thanks everyone for your interest in our company and for joining us this morning, and we look forward to speaking with you again next quarter. Goodbye.

Operator: Thank you, everyone. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.