Good morning, everyone, and thank you for joining us today for Old Second Bancorp, Inc.'s First Quarter 2021 Earnings Call. On the call today is Jim Eccher, the company's CEO; Gary Collins, the Vice Chairman of our Board; and the Company's CFO, Brad Adams. I will start with a reminder that Old Second's comments today may contain forward-looking statements about the company's business, strategies and prospects, which are based on management's existing expectation 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. On today's call, we will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled with their GAAP counterparts in our earnings release, which is available on our website at oldsecond.com under the Investor Relations tab. I will now turn the call over to Jim Eccher. Please go ahead.

Good morning everyone and thank you for joining us. I have several prepared opening remarks. I'll give my Old review of the quarter and then turn it over to Brad for additional details. I will then conclude with some summary comments and thoughts about the future before we open it up to questions. Net income was $11.9 million or $0.40 per diluted share in the quarter. Earnings this quarter were favourably impacted by $3 million reversal of provision for credit losses as well as MSR valuation mark-to-market gains of $1.1 million due to increases in market interest rates over the past quarter. Fee income increased from last quarter based on an increase in mortgage banking revenues due to growth in net gain on sales of mortgage loans, stemming from continued elevated demand for new mortgages and refinances. Yesterday, we announced an increase in our quarterly cash dividend from $0.01 to $0.05 per common share with asset quality continuing to improve in a very strong capital position. We believed there's time for shareholders to further benefit from our company's strong tracker of profitability. In regards to the balance sheet, approximately $28 million of PPP loans were forgiven by the SBA during the first quarter compared to approximately $63 million in the prior quarter, which resulted in a decrease to our net interest margin quarter-over-quarter from full recognition of net deferred fees on those loans upon payoff. Our loan-to-deposit ratio was 73.8% at March 31, 2021, a decline from last quarter due to additional federal stimulus funds received by our deposit customers as well as a $75.2 million decrease in loans, which is a significant decrease in the 89.1% loan-to-deposit ratio a year ago. Expense discipline continues to be strong with a slight increase noted in non-interest expense for the current quarter…

Thank you, Jim. Net interest income decreased $334,000 relative to last quarter, but increased almost $900,000 compared to the first quarter last year. The margin was favorably impacted by the net loan fee recorded due to the PPP loan forgiveness in the first quarter, but this impact was less than the prior quarter when $63 million was forgiven. This net PPP fee income offset further expansion of excess liquidity on the balance sheet and the impact of lower yielding PPP loan still outstanding. Positive net interest income variance compared to last year was due to the redemption of the OSBC Capital Trust I junior subordinated debentures in March last year. That resulted in acceleration of $635,000 debit of issuance costs increasing expense in the year ago period. We continue to have strong deposit inflows and substantial excess liquidity persisted for the entirety of the quarter. The second round of fiscal stimulus had a further dramatic impact on our liquidity position with substantial inflows towards the end. The strategy to deploy a portion of the excess liquidity will continue in the short-term, while being extremely cautious on both duration and credit. As expected our margin performance was stable on a core basis exclusive of the PPP factors and improving reported core trend this quarter was mitigated by the second round of stimulus checks. I'm not assuming at this point anyway that the deposit inflows will reverse quickly, but the outflow or bounce back is relatively quick, our margin outlook would improve. If economic conditions improve and loan growth returns to a level commensurate with that growth, our margin outlook would improve. I do not currently expect either of those conditions to occur in the short-term based on what we're saying and remain surprised that loan demand has not followed reported economic…

Okay. Thanks Brad. In closing, we remain encouraged with these trends. We're confident in our balance sheet and ready for the challenges ahead. For long-low [ph] rates is certainly not the best environment for a deposit base like Old Second, but we remain extremely profitable given our focus on expense discipline. We will remain still. We had taken the necessary steps to position ourselves well for a slowdown and recession. We believe our credit underwriting has remained discipline and our funding and capital position is strong. Today we have the balance sheet and liquidity to take advantage as things improve. That concludes our prepared comments this morning. So I will turn it over to the moderator and we can open it up to questions.

Thank you. [Operator Instructions] And our first question is from Chris McGratty with KBW. Please proceed.

Hi, good morning everybody.

Good morning, Chris.

Brad, maybe a question for you just on your margin balance sheet comments. Understanding the margins obviously a really challenging one with all the liquidity, but if I think about net interest income from the first quarter levels, are we at a point where we see growth in the future quarters?

Yes, I believe we are. I don't expect anything like what we saw in terms of pay downs towards the end of the quarter to happen again. And still expect that we'll be able to achieve some pretty meaningful growth this year on the loan side. Our margin this quarter, absent if you exclude the impact from the loan runoff would have been up pretty significantly. So the comments we've made over the last couple of quarters in terms of bottom and then potentially turning on margin, especially if we deploy more of the liquidity we should see growth from here.

Okay. So that probably means maybe earning assets don't grow, but the mix gets better and you maybe don't buy as many bonds in Q2, is that right?

Yes. I would expect to see earning assets grow. I would expect to see a stable – relatively stable margin. We obviously haven't an advantage next quarter as well.

Okay. And then in terms of the capital obviously the debt was opportunistic. I think you've talked in the past about some of these higher efficiencies having a balance sheet, I guess, what are the thoughts about taking those out? And can you remind us what's there? And then beyond the, you know, a couple hundred thousand of the buyback, would it be the expectation to reauthorize additional buybacks?

A requirement for an approval exists there, but I would point you to the comments around, we don't expect capital to meaningfully grow from here. We've got enough to fund both growth, any strategic opportunities that may present themselves here.

Okay. And on those – on the higher cost debt, is that just a quarter-to-quarter or is there something perhaps more imminent?

No. No. So the higher cost debt that would be a termination at the very end of the year, and that would obviously benefit next year.

Okay. Thank you.

Our next question is from Nathan Race with Piper Sandler.

Yes. Hi guys, good morning.

Hey, Nathan.

Good morning, Nathan.

Just hoping to expand a little bit on the loan growth outlook ex-PPP over the balance of this year, I appreciate there's some payoffs in the quarter that kind of crimped loan growth and [indiscernible] basis. But as you guys tend to look out over the next quarter or two, it sounds like there's still some sluggish demand with existing clients, but I'd love to hear your guys' thoughts just in terms of the opportunities to take market share on the commercial side of things across the Chicago land area. And then just kind of what you're seeing with some of your specialty segments as well lately?

Yes. Nathan, obviously a tough quarter on the origination side. There was a confluence of factors that led to a pretty weak quarter, really along pretty much every loan sector, right? First, we had an extremely strong fourth quarter that kind of depleted the pipeline both heading into the year, but certainly originations were not what we had hoped. Our clients and many of our borrowers are very flushed with liquidity and certainly is doing any CapEx right now. We had declined, I guess, I mentioned in pretty much every bucket. We also had line utilization contraction with several clients unexpectedly sold properties and obviously the one to four family and HELOC portfolios contracted due to a lot of refinancing. So leasing was soft as well. We are seeing – we are seeing an uptick in activity in our leasing group, along with our healthcare group. I'd love to tell you that the second half of next year is going to be strong, but that's going to be largely dependent on the economic recovery in our markets. I feel better today than, than I did 90 days ago, based on loan committee activity. And we'd still like to think we can get some low-to-mid single digit growth by the end of the year. Things do recover.

Got it. That's helpful color. And Brad, maybe just thinking about kind of the ACL trajectory from here came down a little bit here in the first quarter ex-PPP as you kind of think about just the macro environment and it seems like credit metrics internally are continuing to perform well. Any thoughts just in terms of kind of – if you guys kind of see yourselves getting back to kind of a pre-pandemic reserve level by the end of this year or is that this is just going to be kind of a gradual step down all else equal, somewhat of what we saw here in the first quarter?

I think it's probably too soon to call it whether it's the end of this year or not. I think that over the next two quarters, if things progress like they have been, I think our over-weighting of more bearish scenarios will be over certainly in the next 120 days or so, which would have a pretty meaningful impact on the next two quarters. Beyond that, I think there's some level of reserving that, that – reserving over pre-pandemic levels that's necessary just based on structural changes in the economy. i.e., brick and mortar, retail, and office space and proliferation of work from home, and what does all that do. But I don't think it's anywhere near the level that we're at today. And I think without any blips or large one-offs, which to be clear, we see no evidence of in our portfolios that certainly by 12 months from now, we should be down to a level that's closer to pre pandemic than it is current levels.

Got it. That's helpful. If I could just ask one other on the margin outlook ex-PPP, just with your expectations for excess liquidity levels to remain elevated. Can we expect a similar degree of securities portfolio purchases that we saw here in 1Q over the next quarter or two? Or how should we kind of be thinking about the decree of earning asset growth?

I would expect probably half the level of growth that you saw this quarter.

Okay, great. I appreciate all the color guys. Thank you.

Thank you.

[Operator Instructions] Our next question is from David Long with Raymond James.

Good morning, everyone.

Hey, David.

Hey, David.

As it relates to M&A, obviously it looks like there's some, an acceleration of activity here in the industry. How have your – how has your dialogue gone with other banks and M&A, and do you – are there, I guess maybe first of all, what's your appetite to do a deal here with your excess capital, and now that the economic backdrop looks a little clear? And then secondly, how receptive are potential acquirees if you will to those conversations?

Yes. David, I guess the bottom line is – we’re very interested in M&A at this point, now that the credit fog is kind of lifted here. Obviously, our capital levels are pretty robust. I will say that their conversations are active, and I would agree with you that certainly appears M&A is before us in Chicago. So, we are ready and very interested in finding a strategic partner.

That being said, our appetite remains the same just in terms of what is the return on the incremental capital invested and – relative to the cost equity capital. But certainly we have the flexibility within the balance sheet with substantial liquidity at the holding company and strong capital levels at the bank. I think there is a little bit of a sigh of relief out there in terms of some smaller banks. Everybody thought they were looking at two years of some very difficult sledding, and that doesn't look like it's going to be the case. So I think people feel like it's a second chance if they were on the fence before about whether it was the right time, I think there's a fair amount of people who were thinking it might be the right time.

Sure. And then as far as how comfortable you are with your capabilities, is there a size limit or a size minimum from an asset perspective that you would consider?

I don't think it makes sense and we said this before, it's not really worth our time and the application process kind of starts getting really [indiscernible] around $300 million, a little bit below that is okay. In terms of upper bounds, we would be very cautious on anything above $1 billion for sure and make sure it's the right deal, but I don't see anything eminent there.

Got it. Thanks guys.

Thanks, David.

And our next question is from Brian Martin with Janney Montgomery Scott.

Hi, good morning guys.

Good morning, Brian.

Hi, Jim. I guess just going or I guess that maybe it's for Brad, just kind of that the overweighting on that pessimistic scenario that I guess – I guess can you kind of quantify that if we think about what the impact could be as you do that, I don't know if you said, you thought about it was going to happen maybe later in the year, or it could happen later in the year, or the next couple of quarters, but just kind of understanding what that impact will be. I appreciate the color on the reserve level kind of getting back to some level of pre-pandemic, maybe a year out or so or – but just kind of quantifying that if you could.

Brian, I think the best way I can answer that is to point you to what we just did. I mean, we released a net three year and we came off the unemployment rate by 50 basis points to 75 basis points and maybe underweighted the barest [ph] case scenario by an additional 10% to 15%. Commensurate with that, we had $75 million in loan runoff and $500,000 recovery. So if you put all those pieces together, a reasonable person would probably approach that that underweighting the barest scenarios a little bit more probably knocked $1 million to $2 million off.

Got you. Okay. All right. And how about just the – you talk Brad the guide on the NII, but just the margin impact with that sub-debt in there, it sounded like your guide was stable on the margin with the drag of the sub-debt. I mean, the offset to that as you look at 2Q and beyond, I mean, where's the opposite to kind of get back to kind of your neutral outlook if you will. I mean, I guess, depending on the loan environment, I mean, I'm not sure what your intent is on the excess liquidity and deploying some of that, it sounds like you're cautious on that, but just understanding that reconciliation.

Well, I mean, having the sub-debt out there for the remainder of the year is going to cost us about $1 million, right? So if loans don't run out, then there's pretty much your offset. Additionally, if we deploy more liquidity and use up some of the cash position, that's earning a whopping 10 basis points which is a big number for us. I mean, we've got more than 10% of our assets by a healthy margin earning 10 basis points. I don't even really think about the reported margin anymore. I think about the margin exclusive of the excess cash that's on the balance sheet. And every time we get something deployed, something happens like another something happens like another fiscal stimulus and the government wires is 150 million bucks. And all of a sudden, we're right back where we were. But we have seen remarkable hoarding of cash by small business, very little loan demand, which is just completely out of line with the character of the economic numbers that are being thrown around in the broader discussion of the economy. It is quite surprising. Obviously as long as my career has been, we've never seen economic growth numbers like this with absolutely no participation and from loan demand, aggregate loan demand. It is truly remarkable. And I wouldn't have said that can continue, but I would have been wrong through the first three months of this year. I think some of the impact too is that I don't think Chicago is participating quite as fast as some other areas of the country. Certainly our unemployment rate here locally is more sticky than others, some of that has to do with just the pace of reopening and some of that just is, I'll say, regulatory or government based in terms of mandates and some of it's just pure caution, but there's a lot of factors that can drive micro economic performance to differ from national.

Got you. Okay. I appreciate the color and just the – going to the liquidity, are you guys still seeing deposit inflows kind of into second quarter here? Have you started to see that stabilize?

Now we're still getting money in every day.

Okay. So it's still going happen. And maybe just the last one on M&A, just the – kind of your ideal target or kind of what you guys are looking for in a target if you see some potential opportunities out there. Is it more – I mean, geographically, maybe in just kind of – if you have your prioritize, what's important to get out of an acquisition. What if you could give a little thought on that?

Chicago distribution is important to us, a base level of profitability something 50 basis point ROA or better. The opportunities for expense saves are important that will allow us the additional expense dollars we can allocate to hire organically. All the things that we've talked about in the past. We don't think there is very few opportunities that are really additive on the asset generation side. So it's a deposit game, which obviously we don't need the degree that we would have needed a year ago. But long-term, rates don't stay low forever either through inflation or growth or some combination thereof they're going higher. And profitability over the long-term in this business is 70% on the funding side and 30% on the assets. Once you adjust for charge offs and cost of capital that's not going to change based on some new economic paradigm. So our focus is over the long-term and its quality deposit franchises. And to the extent we can additional expense dollars savings that we can allocate towards organically hiring teams.

Got you. Okay. I appreciate all the color, Brad and Jim. Thanks.

Yes. Thanks Brian.

Ladies and gentlemen, we have reached the end of the question-and-answer session. Now I'd like to turn the call back over to Jim Eccher for the closing remarks.

Okay. Thank you for joining us this morning and we look forward to speaking with everyone again next week. Bye-bye.

And this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.