Executive Summary / Key Takeaways

• The Evergreen acquisition transforms OSBC's earnings power: While Q3 GAAP earnings took a $23.9M acquisition hit, adjusted core earnings rose 18% YoY to $28.4M, driven by a new powersport lending portfolio yielding 10.25% that management describes as "both above expectations and improving" despite higher charge-offs.

• A 5% net interest margin is not a typo in 2025: OSBC's 5.03% NIM represents a 41 basis point year-over-year improvement, positioning it among the most profitable community banks in the Midwest and demonstrating pricing discipline that larger competitors cannot match in the current rate environment.

• Credit quality is stronger than the numbers suggest: Nonperforming loans at 0.90% remain well-controlled, and management's aggressive reduction of the purchase participation portfolio (down 49% since West Suburban) has cut substandard loans by 56% from peak levels, creating a cleaner balance sheet heading into potential economic stress.

• The market is mispricing a deposit franchise upgrade: The First Merchants branch acquisition added $268M in core deposits, while the Evergreen deal brought $1.23B in funding that management is actively remixing away from higher-cost wholesale sources, targeting a 90% loan-to-deposit ratio that will further reduce funding costs.

• Capital returns are accelerating from a position of strength: Despite deploying $49M in cash for the Evergreen deal, tangible book value increased to $13.51 per share, management raised the dividend 17%, and a 327,000-share buyback demonstrates confidence in the stock's valuation relative to the transformed earnings power.

Setting the Scene: A 154-Year-Old Bank Learning New Tricks

Old Second Bancorp, founded in 1871 and headquartered in Aurora, Illinois, has spent a century and a half building one of the most defensible community banking franchises in the Chicago metropolitan area. The company operates through a single community banking segment, serving individual customers and small to medium-sized businesses across 55 banking centers in the Chicagoland area. This geographic concentration is not a limitation but a moat—deep relationships and local market knowledge allow OSBC to price loans and deposits with precision that larger regional banks cannot replicate.

The banking industry in 2025 faces a fundamental challenge: deposit competition from fintechs and money market funds, margin pressure from inverted yield curves, and credit concerns from commercial real estate exposure. OSBC's response has been counterintuitive and effective. While peers struggle to maintain 3-4% net interest margins, OSBC has expanded its NIM to 5.03% in Q3 2025, a level that management notes "I haven't seen a lot of in my 25 years doing this." This margin strength reflects disciplined loan pricing, a granular deposit base with low-cost core funding, and strategic asset-liability positioning that reduces sensitivity to rate cuts.

The company's recent acquisition strategy reveals a deliberate shift in focus. Historically, OSBC targeted deposit acquisitions to fund organic loan growth. The December 2024 First Merchants (FRME) branch deal—five locations adding $268M in deposits—fit this pattern perfectly. But the July 2025 Bancorp Financial acquisition represents a strategic departure. This $1.43B asset deal added $1.19B in loans and introduced powersport lending, a high-yield consumer finance business that yields 10.25% on new originations. Management calls this an "unusual" but "attractive" move, transforming OSBC from a traditional community lender into a diversified consumer finance platform while maintaining its core deposit franchise.

Business Model Evolution: From Community Bank to Specialty Finance

OSBC's business model centers on relationship-based community banking, but the Evergreen acquisition adds a critical new dimension. The core community banking operation generates net interest income through commercial real estate, commercial and industrial loans, and residential mortgages, complemented by wealth management services that grew revenue 26% in Q3 2025. This traditional business benefits from what management describes as "exceptionally well collateral protected" loans, with two-thirds of classified assets carrying strong protection even in stress scenarios.

The powersport lending portfolio, acquired through Evergreen, represents $715.5M of consumer loans for motorcycles, ATVs, and similar vehicles. This business carries higher gross charge-offs—$3.69M in the first nine months of 2025, with management expecting a $3M quarterly run rate—but generates yields that more than compensate. The weighted average FICO score of 730 and focus on top-tier borrowers (75% in the top two tiers) demonstrate disciplined underwriting. As CEO Brad Adams notes, "losses given default are running a little bit higher than we expected, but loan yields are much higher than expected, and the contribution margin is both above expectations and improving." This trade-off—accepting higher charge-offs for substantially higher yields—boosts overall portfolio returns in a way that traditional banks cannot replicate.

The wealth management business, while smaller at $3.5M quarterly revenue, shows explosive growth with new assets under management increasing "exponentially" due to key hires. This fee-based revenue diversifies income streams and provides stability through rate cycles. Residential mortgage banking, though volatile due to MSR mark-to-market adjustments, contributed $792K in Q3 2025, a 752% increase from the prior year as refinancing activity picked up.

Financial Performance: Core Strength Obscured by Acquisition Noise

Q3 2025's GAAP results appear disappointing at first glance: net income fell to $9.9M ($0.18 per share) from $23.0M ($0.50 per share) in Q3 2024. However, this decline stems entirely from acquisition accounting and integration costs. The $23.9M increase in noninterest expense includes $11.5M in direct acquisition costs, while the $17.7M increase in provision for credit losses reflects a $13.2M "Day Two" non-PCD provision for acquired Evergreen loans and a $6.5M standard provision for loan growth and credit downgrades.

The adjusted picture tells a different story. Excluding these one-time items, core net income rose 18% to $28.4M, demonstrating that the underlying business is accelerating. Net interest income increased $22.2M, or 37%, driven by the Evergreen acquisition and organic loan growth. The net interest margin expanded 20 basis points sequentially and 41 basis points year-over-year to 5.03%, a level that management considers exceptional and sustainable.

Credit quality metrics support the thesis that OSBC is not sacrificing underwriting for growth. Nonperforming loans represent 0.90% of total loans, up from 0.80% at year-end but down from 1.30% a year ago. The increase in nonaccrual loans to $34.1M reflects primarily administrative movements and a single $13.5M commercial credit that management believes is "exceptionally well collateral protected." Classified assets increased to $142.8M, but management emphasizes that two-thirds carry strong collateral coverage, and early-stage special mention loans are down 50% from last quarter.

The allowance for credit losses stands at $75M, or 1.40% of loans, up from 1.10% at year-end. This build reflects the higher-loss nature of the powersport portfolio but remains conservative relative to actual charge-off experience. Net charge-offs of $5.1M in Q3 were dominated by powersport loans ($3.7M) and two lease relationships ($848K), with the commercial portfolio showing minimal losses.

Strategic Execution: Integration and Balance Sheet Optimization

The Evergreen integration has proceeded faster and more smoothly than management anticipated. Systems conversion was completed in October 2025, just three months after closing, which management calls "the best we have ever done." This rapid integration allows OSBC to begin optimizing the combined balance sheet immediately. The company has already sold the bulk of Evergreen's securities portfolio and is reducing reliance on wholesale funding, including $96.9M in brokered deposits that will run off by 2027.

Management's funding strategy is deliberate and value-creating. Evergreen's legacy deposit base included higher-cost money market accounts that OSBC is actively repricing downward. The goal is to replace these with core Old Second-style deposits, reducing the overall cost of funds by 30-70 basis points over the next 6-18 months. This deposit remixing, combined with a target loan-to-deposit ratio of 90%, will further enhance the net interest margin and reduce liability sensitivity.

The purchase participation portfolio reduction demonstrates proactive risk management. Since the West Suburban acquisition, OSBC has shrunk this portfolio by $376M, or nearly 49%, eliminating third-party credit risk and improving portfolio transparency. This strategic derisking contributed to the 56% reduction in substandard and criticized loans from peak levels, reaching a 2.5-year low by year-end 2024.

Capital management reflects confidence in the transformed business model. Despite using $49M in cash consideration for Evergreen, tangible book value increased to $13.51 per share. The company announced a 17% dividend increase and repurchased 327,000 shares in a private transaction at a modest discount to market. Management notes that "capital will build quickly from here" given the strong core profitability and limited acquisition-related dilution.

Competitive Positioning: Margin Leadership in a Fragmented Market

OSBC competes directly with larger regional banks including Wintrust Financial (WTFC), First Busey (BUSE), Associated Banc-Corp (ASB), and Cathay General (CATY). These competitors operate at significantly larger scale—WTFC holds $55B in assets, ASB $44B, and CATY $23B compared to OSBC's $7B. However, OSBC's 5.03% NIM substantially exceeds peer levels, reflecting superior pricing discipline and deposit franchise quality.

The efficiency ratio comparison reveals OSBC's scale disadvantage. While WTFC operates at a mid-50s efficiency ratio and ASB in the 55-60 range, OSBC's ratio appears higher based on its cost structure. However, this metric is improving as Evergreen cost saves are realized and acquisition integration costs dissipate. Management expects "significant inflation in employee benefits expense" to be "largely absorbed by cost save realization," keeping core expense growth in the 4% range.

Where OSBC clearly leads is in credit quality focus and local market penetration. The company's granular deposit base and relationship lending model produce customer retention rates that larger banks cannot match. In suburban Chicago counties, OSBC's market share, while modest at an estimated 2-5%, is deeply entrenched through decades of local presence. This community moat allows premium pricing on loans and sticky low-cost deposits, directly supporting the exceptional NIM.

The powersport lending business creates a differentiated product offering that none of OSBC's direct regional competitors provide. This consumer finance niche generates yields 300-400 basis points above traditional commercial loans, diversifying revenue and enhancing returns. While competitors focus on scale-driven commercial lending, OSBC has carved out a defensible specialty finance vertical that leverages its consumer underwriting expertise.

Risks and Asymmetries: What Could Break the Thesis

The powersport lending business presents the most significant risk to the investment thesis. This portfolio exposes OSBC to unique credit risks—higher default rates, rapid collateral depreciation, and repossession difficulties—that differ from traditional auto or mortgage lending. In a consumer recession, which management believes "tends to be very shallow and very short," losses could accelerate beyond the expected $3M quarterly run rate. The weighted average FICO of 730 provides some comfort, but the portfolio's concentration in a single asset class creates vulnerability to economic stress.

Commercial real estate exposure represents another material risk. At 57.5% of total loans, CRE concentration exceeds many peers and subjects OSBC to potential valuation declines in office and retail properties. While management has "strengthened a lot of commercial real estate credits over this year" and notes that "office has largely been dealt with," a broad CRE downturn could pressure collateral values and increase provisioning needs.

Interest rate risk cuts both ways. While management has positioned the balance sheet to be "less sensitive than maybe people expect," a series of rapid rate cuts could compress the NIM from its current 5%+ level. Management estimates each 25 basis point cut would reduce NIM by only 4 basis points on a pro forma basis, but sustained easing could challenge the exceptional margin performance.

Integration execution risk, while mitigated by the successful systems conversion, remains relevant. The Evergreen acquisition nearly doubled the loan portfolio and introduced an entirely new business line. Any missteps in credit culture, underwriting standards, or operational processes could erode the expected synergies and increase losses beyond projected levels.

Valuation Context: Paying for Transformation

At $19.62 per share, OSBC trades at 13.3 times trailing earnings and 1.45 times tangible book value of $13.51. These multiples appear reasonable for a bank undergoing strategic transformation while maintaining a 5% NIM and 9.25% ROE. The price-to-operating cash flow ratio of 10.1x and price-to-free cash flow of 10.7x suggest the market is not fully crediting the improved cash generation from the higher-yielding loan portfolio.

Relative to peers, OSBC's valuation appears conservative. WTFC trades at 12.6x earnings with an 11.69% ROE, while BUSE commands 18.2x earnings despite a lower 5.33% ROE. ASB's 30.4x P/E reflects its struggling profitability (3.79% ROE), making OSBC's 13.3x multiple attractive for a bank with superior margins and improving returns. CATY's 11.5x P/E is comparable but lacks OSBC's growth trajectory from the Evergreen acquisition.

The dividend yield of 1.43% and payout ratio of 16.22% indicate substantial capacity for dividend growth as capital builds. Management's 17% dividend increase and recent share repurchase signal confidence in the stock's valuation relative to intrinsic value. With an enterprise value of $1.20B and enterprise-to-revenue of 3.87x, OSBC trades in line with regional bank peers but offers superior margin expansion potential.

Conclusion: A Community Bank with Specialty Finance Upside

Old Second Bancorp has executed a strategic transformation that few community banks attempt, let alone accomplish successfully. The Evergreen acquisition adds a high-yielding powersport lending platform to a core community banking franchise that already generates exceptional margins. While GAAP earnings reflect acquisition noise, core profitability is accelerating, credit quality remains disciplined, and capital management is aggressive.

The investment thesis hinges on two factors: management's ability to maintain credit discipline in the powersport portfolio while capturing its yield advantage, and the successful remixing of Evergreen's deposit base to reduce funding costs. Both appear on track based on early results and management commentary. The 5% NIM provides a substantial buffer against potential margin compression, while the local community banking moat ensures deposit stability.

For investors, OSBC offers exposure to a regional bank with specialty finance upside trading at reasonable multiples. The market's focus on near-term acquisition costs obscures the long-term earnings power of a transformed business model. If management executes on integration and credit oversight, the stock's valuation should re-rate to reflect the superior returns of a diversified consumer and commercial lending platform. The key variables to monitor are powersport charge-off trends, deposit cost reduction progress, and sustained NIM performance above 5%.