Old Second Bancorp (OSBC) Q1 2025: Net Interest Margin Expands 30bps, Deposits Drive Margin Resilience
Deposit-driven margin expansion and disciplined credit remediation defined Old Second Bancorp’s first quarter, with net interest margin up sharply and credit quality metrics hitting multi-year lows. Management’s tone shifted bullish on margin durability and capital flexibility, even as loan growth remains subdued and expense pressures persist. Pending merger integration and continued portfolio repositioning set the stage for a more flexible balance sheet in the second half.
Summary
- Deposit Inflows Bolster Margin: Core deposit growth and funding mix improvement drove a material net interest margin increase.
- Credit Cleanup Nears Completion: Aggressive charge-offs and criticized asset reductions support a cleaner loan book.
- Merger and Capital Optionality: Evergreen Bank Group integration and buyback flexibility position OSBC for opportunistic moves post-close.
Performance Analysis
Old Second Bancorp’s Q1 2025 results were anchored by a 30 basis point year-over-year improvement in net interest margin, with margin also up 20 basis points sequentially. This outperformance was powered by robust deposit growth—total deposits rose $84 million in the quarter—and a purposeful paydown of higher-cost short-term borrowings, following the First Merchants branch acquisition. Interest expense on interest-bearing liabilities fell 21 percent year-over-year, despite a modest dip in loan yields, as the cost of deposits declined to 82 basis points.
Loan balances decreased by $41 million, reflecting net paydowns in commercial and multifamily portfolios, alongside a deliberate reduction in the purchase participation portfolio, which shrank over 10 percent this quarter and nearly 49 percent since the West Suburban acquisition. Credit quality metrics improved sharply, with non-performing assets down 27 percent since year-end and criticized loans dropping to their lowest levels in three years. Noninterest income was mixed: wealth management and deposit fee income grew double digits, while mortgage banking income was pressured by servicing rights marks. Expenses were well contained, with noninterest expense up only $183,000 sequentially, and the efficiency ratio remained strong at 55.5 percent.
- Margin Expansion Surprises to Upside: Net interest margin rose 30bps YoY, driven by deposit mix and lower funding costs.
- Loan Book Repositioning Continues: Purchase participation portfolio cut by $46 million in the quarter, with more runoff targeted.
- Credit Quality Hits Multi-Year Bests: Criticized loans and non-performers fell to three-year lows, supporting future provisioning stability.
Overall, OSBC’s earnings power remains robust even as loan demand and growth are muted, with management prioritizing balance sheet stability and risk-adjusted returns over volume growth.
Executive Commentary
"Profitability of Old Second remains exceptionally strong, and balance sheet strengthening continues with our tangible equity ratio increasing 30 basis points from last quarter... Net interest margin improved 30 basis points year over year on both the GAAP and tax equivalent basis, and improved approximately 20 basis points compared to the prior quarter."
Jim Ecker, Chairman, President & CEO
"Deposit growth accelerated throughout the quarter and has been exceptionally strong. Obviously, you can see the power of the ability to grow deposits in an environment such as this... Sustained success on the deposit front positions us exceptionally well to rank profitability beyond our initial expectations as it relates to the pending merger with Evergreen."
Brad Adams, Chief Operating Officer & CFO
Strategic Positioning
1. Deposit-Led Margin Resilience
OSBC’s funding strategy is yielding tangible benefits, as core deposit inflows and branch acquisition synergies have allowed the bank to shed higher-cost funding, compressing interest expense and expanding net interest margin. Management expects this margin strength to persist, even in a modestly declining rate environment, due to low loan-to-deposit ratio and flexible balance sheet positioning.
2. Loan Portfolio Rebalancing and Credit Focus
The bank continues to aggressively reduce its purchase participation portfolio, targeting another $200 million runoff over the next two years. This move is designed to improve credit quality and reduce exposures where OSBC lacks direct lending control. Credit remediation efforts have sharply reduced criticized and classified assets, with management signaling that major credit cleanups are now largely behind them.
3. Capital Strength and M&A Optionality
Capital ratios improved materially, with tangible equity and CET1 both rising. The pending Evergreen Bank Group acquisition is expected to absorb some capital but leave OSBC with ample flexibility. Management has a buyback in place, but is precluded from acting until post-merger close, at which point capital deployment optionality increases.
4. Expense Discipline Amid Growth Constraints
Cost control remains a priority, with expense growth expected to normalize to around 4 percent for the year. While employee benefit and OREO-related costs pressured first quarter results, these are expected to moderate, and management remains focused on maintaining an industry-leading efficiency ratio.
5. Cautious Growth Outlook and Risk-Adjusted Returns
Loan growth remains subdued, reflecting both muted client demand amid macro uncertainty and OSBC’s discipline in prioritizing risk-adjusted returns over volume. Management signaled that any growth in the second half will be carefully underwritten, with no intent to “grow for the sake of growing.”
Key Considerations
OSBC’s first quarter demonstrates the power of disciplined balance sheet management in a volatile macro environment. The bank’s ability to expand margin and improve credit while limiting expense growth sets it apart, but forward growth will depend on both external demand and continued internal discipline.
Key Considerations:
- Deposit Mix as Margin Lever: Funding cost reductions from deposit inflows were the primary driver of margin outperformance.
- Credit Quality Cleanup: Aggressive charge-offs and runoff in riskier portfolios have reset the credit baseline, with further improvements expected but at a slower pace.
- M&A and Capital Deployment: The Evergreen Bank Group deal will reshape the balance sheet and open up capital actions, including buybacks, post-close.
- Expense Normalization Path: Non-recurring OREO and acquisition-related expenses should abate, supporting targeted efficiency ratio levels.
- Loan Growth Still Cautious: Management is signaling only low single-digit growth, with a focus on risk-adjusted returns and selective participation in loan purchases if spreads widen.
Risks
Primary risks include persistent macro uncertainty, especially around interest rate policy, tariffs, and sector-specific pressures in commercial and industrial lending. Loan demand remains soft, and any misstep in integrating the Evergreen acquisition could dilute strategic gains. Expense pressures from wage inflation and regulatory costs could also challenge efficiency targets if not tightly managed.
Forward Outlook
For Q2 2025, OSBC guided to:
- Stable to modestly lower net interest margin, with deposit growth as the key swing factor
- Expense growth moderating to the 4 percent range as OREO and acquisition costs abate
For full-year 2025, management maintained a cautious stance on loan growth, targeting low single digits, and expects capital ratios to remain strong post-Evergreen merger. Margin performance is expected to remain above peer averages, with flexibility to pursue share buybacks once regulatory restrictions lift.
- Potential for margin upside if deposit flows remain robust
- Further credit improvement anticipated, but at a slower cadence
Takeaways
Old Second’s margin expansion and credit improvement position it well for a volatile rate and credit cycle, but growth will depend on both market conditions and disciplined execution.
- Margin Resilience: Deposit-driven margin gains provide earnings stability even as loan growth lags, offering a buffer against macro headwinds.
- Credit Quality Reset: Aggressive charge-offs and portfolio repositioning have set a new baseline for credit, reducing future provisioning risk.
- Capital and M&A Optionality: Post-Evergreen, OSBC will have flexibility to deploy capital via buybacks or opportunistic asset growth, depending on market conditions.
Conclusion
OSBC’s Q1 2025 demonstrates the value of funding strength, credit discipline, and capital flexibility. While loan growth remains a challenge, the bank’s margin and balance sheet optionality position it to outperform peers as market conditions evolve.
Industry Read-Through
Old Second’s margin and funding outperformance highlight the critical importance of core deposits for regional banks in a volatile rate environment. The aggressive cleanup of criticized assets and focus on risk-adjusted returns mirrors a broader industry pivot from growth to resilience. Banks with strong deposit franchises and disciplined credit management are best positioned to defend profitability, while those reliant on higher-cost funding or aggressive loan growth may face margin compression and credit headwinds. The pending Evergreen integration also underscores the ongoing role of M&A in driving scale and optionality across the sector.