Executive Summary / Key Takeaways

• Old Second Bancorp’s $189 million acquisition of Bancorp Financial/Evergreen Bank transforms the bank’s earnings power by adding a $715 million powersports loan portfolio yielding over 10%, driving net interest margin to 5.05% despite Fed rate uncertainty
• Third quarter 2025 GAAP earnings of $0.18 per share severely understate underlying profitability due to $13.2 million in acquisition-related credit provisions and $11.8 million in integration costs; adjusted EPS of $0.53 reveals a more accurate picture of core earnings capacity
• Asset quality “softening” is largely attributable to the inherited powersports portfolio and isolated C&I credits in transportation; management has proactively built reserves to 1.43% of loans while emphasizing strong collateral coverage on downgraded relationships
• The bank’s community banking moat faces intensifying pressure from larger regional competitors with superior technology platforms, making execution of cost synergies and digital investment critical to sustaining market share in suburban Chicago markets
• Trading at 1.12x tangible book value with a 5%+ NIM and management guiding to mid-teen returns on tangible common equity, the risk/reward hinges on whether powersports credit losses remain within modeled ranges and integration delivers promised cost savings ahead of schedule

Setting the Scene

Old Second Bancorp, founded in 1871 and headquartered in Aurora, Illinois, operates a pure-play community banking model with 55 branches concentrated in the Chicago metropolitan area and surrounding counties. The bank generates revenue through three integrated activities: commercial and consumer lending (85% of revenue), deposit gathering that funds these loans, and a growing wealth management platform that contributes modest but expanding fee income.

Unlike national money-center banks, OSBC’s strategy rests on relationship-driven banking—building deep, multi-product ties with small-to-medium businesses and high-net-worth families that translate into sticky, low-cost deposits and pricing power on loans.

This approach has historically produced stable, if unspectacular, returns in a market dominated by larger incumbents. The regional banking landscape in Illinois features formidable competitors: Wintrust Financial (WTFC) with over $50 billion in assets and an aggressive commercial lending engine; Old National Bancorp (ONB) wielding a 300+ branch network across multiple states; and First Busey Corporation (BUSE) leveraging recent acquisitions to build scale. Against these better-capitalized, technologically advanced rivals, OSBC’s key advantage has been hyper-local execution and disciplined credit underwriting. The bank’s 154-year history in Aurora provides an entrenched deposit franchise that larger competitors cannot easily replicate, but this moat is increasingly tested by digital-first customer expectations and the pricing pressure that scale players can exert on loan yields.

The current investment thesis emerges from a deliberate strategic pivot: management is using selective, earnings-accretive acquisitions to solve the scale gap while introducing higher-yielding specialty lending that traditional community banks typically avoid. The July 2025 completion of the Bancorp Financial deal—adding $1.43 billion in assets and a Nevada-based powersports lending platform—represents the boldest expression of this strategy. This move immediately repositions OSBC’s earnings profile but injects new risks unfamiliar to its historical credit culture, creating the central tension for investors: can management harness the yield advantage while controlling the inherently higher losses of indirect consumer lending?

Strategic Differentiation and Portfolio Transformation

The Bancorp Financial acquisition brings a specialized powersports loan portfolio that fundamentally alters OSBC’s risk-return equation. At $715.5 million, this portfolio represents 14% of total loans and carries a weighted average yield of 10.25% on new originations—a full 400 basis points above traditional auto loans. Management explicitly acquired this asset to “broaden the scope of our consumer lending and offering a higher yield in a lower rate environment.” The economic logic is clear: in a scenario where Fed funds rates settle around 3%, these loans would still generate 8-9% coupons, providing a durable NIM cushion that pure commercial lenders lack.

Why this matters: Powersports lending is not a commodity business. The collateral—motorcycles, ATVs, snowmobiles—depreciates faster than automobiles and is harder to repossess and liquidate, leading to higher default rates and loss severities. This is not a design flaw but a structural characteristic that must be priced correctly. OSBC’s inherited portfolio carries a 730 FICO average, indicating prime-quality borrowers, yet net charge-offs in Q3 reached $2.98 million—58% of total bank charge-offs—despite representing only 14% of the loan book. Management anticipated this dynamic, stating that “due to the nature of the Powersports business, gross charge-offs are anticipated to run at a higher rate than Old Second has historically experienced, especially in a higher interest rate environment like today.”

The critical implication for investors is margin contribution, not gross loss rates. With yields exceeding 10% and reserves already built to reflect higher expected losses, the net contribution margin remains strongly positive. Management confirmed that “losses given default are running a little bit higher than we expected. However, loan yields are much higher than expected, and the contribution margin is both above expectations and improving.” This validates the thesis that specialty lending can enhance earnings power if managed with precision. The risk lies in consumer recession severity—if unemployment spikes beyond management’s models, loss rates could overwhelm the yield buffer, compressing ROA from the 1.50%+ management targets.

Technology and competitive positioning amplify both opportunity and threat. OSBC’s community banking platform lacks the advanced digital treasury tools of WTFC or ONB, creating a gap in efficiency and customer acquisition cost. The powersports business operates through indirect dealer relationships rather than direct digital channels, partially insulating it from this weakness but adding operational complexity. Management’s rapid integration—completing systems conversions in under three months and achieving cost savings ahead of schedule—demonstrates execution competence. However, the bank’s modest technology spend relative to peers constrains its ability to compete for next-generation commercial clients who demand seamless API-based cash management. This creates a strategic imperative: deliver the promised $3 million quarterly run-rate savings from the acquisition and redeploy capital toward digital capabilities, or risk ceding core deposit share to better-equipped competitors.

Financial Performance: Core Strength Beneath Acquisition Noise

Third quarter 2025 results appear disastrous at first glance. GAAP net income plunged 57% year-over-year to $9.9 million ($0.18 per share), while net income for the first nine months still fell 22% to $51.5 million. These headline numbers, however, mask the underlying earnings engine. The acquisition of Bancorp Financial triggered $13.2 million in Day 2 credit loss provisions for non-PCD loans and $11.8 million in one-time integration costs, together representing $0.35 per share in transitory charges. Excluding these items, adjusted net income was $28.4 million ($0.53 per share), up 18% year-over-year and revealing that the core franchise is firing on all cylinders.

Revenue growth underscores the transformation. Net interest and dividend income jumped 37% in Q3 to $82.8 million, driven by the $1.19 billion loan portfolio acquired from Bancorp Financial plus $89 million in organic growth. The tax-equivalent net interest margin expanded 41 basis points year-over-year to 5.05%, a remarkable achievement in an environment where most banks are fighting margin compression. This was not a one-time purchase accounting benefit; the 67 basis point increase in loan yields to 6.95% reflects the structural shift toward higher-yielding consumer credits. Deposit costs did rise to 133 basis points, up 61 basis points sequentially, but this increase was fully anticipated as OSBC absorbed Evergreen’s higher-rate funding base. Management is actively remixing this funding, targeting $200 million in market-priced deposits to be replaced with legacy Old Second core relationships over the next 6-18 months, which should provide modest NIM tailwind into 2026.

The balance sheet is strong enough to support this strategy while returning capital. Total assets reached $6.99 billion, up $1.34 billion from year-end 2024, funded by $991.5 million in assumed deposits and $140.5 million in equity issued to Bancorp Financial shareholders. The tangible common equity ratio actually improved to 10.41% from 10.04% at year-end, demonstrating that the acquisition was less dilutive than initially projected. This capital strength enabled a 17% dividend increase and active share repurchases—326,854 shares retired in Q3 at $18 per share—signaling management’s confidence in prospective earnings power. Critically, the loan-to-deposit ratio sits at 91.4%, providing ample capacity to fund organic growth without tapping wholesale funding markets.

Credit quality presents a more nuanced picture. Nonperforming assets rose modestly, but classified assets increased $38.4 million, with the majority reflecting administrative downgrades in the transportation and logistics sector rather than systemic deterioration. Management emphasized that “our collateral position is very good on these downgraded credits,” with many backed by SBA 504 guarantees. The powersports portfolio contributed $2.98 million in net charge-offs, a figure that will persist but is already priced into the 1.43% allowance coverage ratio. The Day 1 and Day 2 reserves added $30.7 million to the allowance, lifting it to $75 million—a prudent buildup that absorbs near-term volatility while the portfolio seasons.

Outlook, Guidance, and Execution Risk

Management’s commentary reveals unusual confidence for a bank navigating acquisition integration. Jim Eccher declared the third quarter “our best quarter in 2.5 years as far as organic growth,” with $72 million in core loan growth excluding acquisitions and pipelines at a two-year high. This momentum supports guidance for low single-digit organic growth in 2025, accelerating in the second half as seasonal construction lending and sponsor finance activity ramp. The sponsor finance group alone is expected to originate $150-200 million annually, providing a steady fee and loan generation engine.

The margin outlook is surprisingly bullish. Bradley Adams asserted that “the bottom margin for Old Second at Fed funds rate around 3% does not go below 4.50% by any stretch of the imagination,” citing the powersports coupon resilience and OSBC’s asset-sensitive balance sheet. The bank’s variable-rate assets reprice faster than its low-beta deposit base, meaning rising rates flow directly to NIM expansion. Even in a declining rate scenario, management contends inflation will remain sticky enough to prevent aggressive Fed cuts, while the powersports portfolio’s 8-9% floor yields provide structural protection. This is a critical assumption: if rates fall to zero as in 2020, NIM would compress, but management argues the underlying floor has been raised by the specialty loan mix.

Cost guidance is equally constructive. Core operating expenses are expected to grow only 4-5% annually over the next two years, with acquisition cost saves offsetting inflationary pressures in employee benefits and technology. The rapid systems conversion and early achievement of integration milestones suggest the $3 million quarterly run-rate savings target is conservative. This disciplined expense trajectory is essential to offsetting the higher provision expense from powersports and maintaining efficiency ratios in the mid-50s range.

The primary execution risk lies in credit normalization. Management has modeled consumer recession scenarios assuming shallow, short downturns, but powersports lending has not been tested through a severe, protracted unemployment spike. If losses given default exceed 30% or recovery rates disappoint, the contribution margin could erode, forcing additional reserve builds that pressure earnings. The second risk is competitive: if WTFC or ONB aggressively price commercial real estate loans in OSBC’s markets, the bank may face a choice between sacrificing yield or losing volume, potentially straining the loan-to-deposit ratio above 95% and requiring higher-cost funding.

Valuation Context

At $18.48 per share, OSBC trades at 13.8x trailing earnings and 1.12x tangible book value per share of $13.51—a modest premium to book that reflects the market’s uncertainty around acquisition integration. The P/S ratio of 2.73x aligns with regional bank peers, while the 1.35% dividend yield provides modest income support. Relative to direct competitors, OSBC’s valuation appears undemanding: Wintrust trades at 11.6x earnings but 1.22x book with superior scale, while First Busey commands 20.5x earnings reflecting its recent growth surge. Old National trades at 13.4x earnings and 0.95x book, suggesting OSBC’s multiple is in line despite a more complex credit story.

The key valuation driver will be the sustainability of core earnings above $2.00 per share. If management delivers on its guidance—mid-teens ROTCE, 5%+ NIM, and effective cost control—the current 1.1x book valuation would prove conservative, as ROE expansion typically commands higher multiples. Conversely, if powersports losses exceed modeled ranges or integration costs persist beyond 2025, earnings could stagnate around $1.80-1.90, leaving little multiple expansion potential. The balance sheet provides downside protection: tangible common equity of 10.41% and a debt-to-equity ratio of 0.33x offer ample cushion against credit stress, while $653 million in excess collateral provides liquidity flexibility.

Conclusion

Old Second Bancorp is executing a deliberate strategy to transform its earnings power through specialty lending while preserving its core community banking franchise. The Bancorp Financial acquisition, though noisy in Q3, has already delivered a 5.05% NIM and a clear path to mid-teens returns on tangible equity if credit performance remains within modeled bounds. The powersports portfolio’s 10%+ yields provide a structural advantage over traditional commercial lenders, but investors must accept inherently higher loss volatility as the trade-off.

The critical variables that will determine success are credit normalization in the powersports segment and competitive deposit retention. If management’s assertion that “losses are a little higher than expected, but yields are much higher” holds through a consumer slowdown, OSBC will exit 2025 with a meaningfully higher earnings run rate and justified multiple expansion. If not, the market will likely remain skeptical, capping the stock near current book value. For now, the combination of a fortified balance sheet, proven local deposit franchise, and differentiated loan mix creates an asymmetric risk/reward profile: limited downside given strong capital and reserves, with upside contingent on execution of a well-defined integration plan.