Old Second Bancorp - Q2 2024

Transcript

Operator (participant)

Good morning, everyone, and thank you for joining us today for Old Second Bancorp's second quarter 2024 earnings call. On the call today are Jim Eccher, the company's Chairman, President, and CEO. Brad Adams, the company's COO and CFO. And Gary Collins, the 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 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. 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 homepage and under the Investor Relations tab. Now I will turn it over to Jim Eccher.

Jim Eccher (Chairman, President and CEO)

Okay. Good morning, everyone, and thank you for joining us. I have several prepared opening remarks, and I'll give my overview of the quarter and then turn it over to Brad for additional details. I will then conclude with certain summary comments and thoughts about the future before we open it up for questions. Net income was $21.9 million, or $0.48 per diluted share in the second quarter of 2024. The return on assets was 1.57%. Second quarter 2024 return on average tangible common equity was 17.66%, and the tax equivalent efficiency ratio was 53.29%.

Second quarter 2024 earnings were negatively impacted by $3.8 million of provision for credit losses in the absence of significant loan growth, which reduced the after-tax earnings by $0.06 per diluted share. However, despite this profitability, Old Second remains exceptionally strong and balance sheet strengthening continues, with our tangible equity ratio increasing by 35 basis points linked quarter to 9.39%. Common Equity Tier 1 increased to 12.41% in the second quarter of 2024, and we remain, we feel very good about profitability and our balance sheet positioning at this point. Our financials continue to be positively impacted by higher market interest rates. Pre-provision net revenues remain stable and exceptionally strong.

For the second quarter of 2024 compared to the prior year-ago period, income on average interest-earning assets decreased $663,000 or 0.9%, while interest expense on average interest-bearing liabilities increased $3.2 million or 31.3%. The increase in interest expense is rate driven and primarily due to repricing and exception pricing on certain commercial deposits. Our average other short-term borrowings and other borrowings were significantly less in the second quarter of 2024 compared to the prior linked quarter and year-over-year quarter as our daily funding needs were reduced. In the second quarter of 2023, we retired $45 million of senior debt. These actions reduced interest expense on borrowings, offsetting some of the growth in interest expense stemming from higher rates offered on deposits.

The second quarter of 2024 reflected an increase in total loans of $7.2 million from the prior linked quarter, primarily due to growth in commercial, lease, and construction portfolios, net of payoffs on a few large credits during the quarter. Comparatively, loan growth in the second quarter of 2023 was $12.2 million and a net decrease in loans of $73.5 million in the first quarter of 2024. The historical trend for our bank is loan growth in the second and third quarters of the year due to seasonal demand and business activities. 2023 was an anomaly as the savvy commercial customers realized interest rates were about to increase and sought funding prior to those market rate increases in late first quarter 2023.

By the second quarter of 2023, loan growth had tempered due to market rate increases in the late first quarter and second quarter of 2023. Currently, activity within our loan committee has picked up as pipelines are at their highest level in 18 months and up 3x from 12/31/2023, providing optimism for loan growth in the second half of the year. Net interest margin increased slightly this quarter, driven by continuing higher rates on variable securities and loans, partially offset by higher funding costs. Loan yields reflected a 5 basis point increase during the second quarter of 2024 compared to the linked quarter, and 21 basis point increase year-over-year. Funding costs increased due to increases in both rates and growth in time deposit balances.

The tax equivalent net interest margin was 4.63% for the second quarter, compared to 4.58% for the first quarter of 2024, and 4.64% in the second quarter of 2023. The margins remain relatively stable in the year-over-year period due to the impact of rising rates on both the variable portions of the loan and securities portfolio, as well as the deposit base and our short-term borrowing costs. The loan-to-deposit ratio is 88% as of June 30th, 2024, compared to 86% last quarter and 85% as of June 30 of last year. As we have said, our focus continues to be balance sheet optimization.

I'll let Brad talk about this in a moment. The second quarter of 2024 saw improving asset quality metrics and moderate actions taken on substandard credits, continued remediation trends noted primarily since late last year. Our belief remains that the fourth quarter of 2023 represented an inflection point in our credit trends. Old Second began substantially downgrading large amounts of commercial real estate loans, including office and healthcare, at the end of 2021 and accelerating through 2022. 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 7% of loans, in the first quarter of 2023.

At the end of the second quarter of 2024, substandard and criticized loans are down to $187.4 million, which is approximately $15.9 million less than year-end 2023 and more than 40% below peak levels. The expectation remains for further improvement throughout the rest of the year. Encouragingly, our special mention loans decreased more than 55% from one year ago and are at their lowest levels in over two years. We continue to expect realization of a relatively less costly resolution on a number of nonperformers in the near future and remain hopeful we can recover some of the losses realized in the second half of 2023. Commercial real estate valuations are heavily dependent upon the market level of interest rates as a primary determinant of cash flow for a given property.

A movement in range rates such as we have seen, is substantial enough to significantly impair the equity positions in a large percentage of commercial real estate credits. Additionally, the residual stress brought upon by the pandemic in commercial real estate, office and healthcare has not abated. We believe we have been proactive and realistic in addressing commercial real estate loans facing deterioration from higher interest rates, declining appraisal values and cash flow pressures. As we discussed last quarter on the call and consistent with our expectations, we recorded net charge-offs of $5.8 million in the second quarter, compared to $3.7 million in the first quarter of 2024.

One specific current period charge-off of $4.1 million on a previously allocated loan, one final charge-off of $1.5 million related to a note sale and charge-offs related to a transfer to OREO of $550,000 were partially offset by approximately $217,000 in net recoveries during the second quarter of 2024. The good news is that criticized and classified loans continue to decline and the remainder of the portfolio remains well behaved. Continued stress testing has not raised any new red flags for us, and the bulk of our loan portfolio has transitioned and is seasoning into this higher rate environment. We have said this before, but it's worth repeating, that being short duration on the asset side has probably put us at the vanguard in terms of commercial real estate stress.

We remain disciplined and did not offer 7- or 10-year maturities on commercial real estate assets a few years ago. The allowance for credit losses on loans decreased to $42.3 million as of June 30th, 2024, or 1.1% of total loans, from $44.1 million at March 31st, 2024, which was also 1.1% of total loans. Unemployment and GDP forecasts used in future loss rate assumptions remain fairly static from last quarter. The change in provision level quarter-over-quarter reflects the reduction in our allowance allocations on substandard loans, which largely relates to the 29% reduction in criticized assets since June 30th, 2023.

I think investors should know that with our continuing level of strong profitability, we will be aggressive in addressing weak credits and that we remain confident in the strength of our portfolios. Non-interest income continued to perform well, with growth noted quarter-over-quarter and wealth management fees, card-related income and mortgage banking income, excluding the impact of mortgage servicing rights mark-to-market. A death benefit of $893,000 was realized on 1 BOLI contract in the second quarter of 2024, with no life benefit in the linked quarter or prior year like Q period. Expense discipline continues to be strong, with the second quarter of 2024 total non-interest expense at $364,000 less than the prior linked quarter, primarily due to reductions in salaries and employee benefits and a gain on the sale of an OREO property.

Our Efficiency Ratio continues to be excellent. 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. The goal is 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.

Brad Adams (COO and CFO)

Thank you, Jim. Net interest income decreased by $93,000 or 0.2% to $59.7 million for the quarter ended June thirtieth, relative to the prior quarter of $59.8 million. Down $3.9 million or 6.1% from the year-ago linked quarter. Securities yields increased 16 basis points due to the variable portion of the portfolios, and loan yields were 5 basis points higher in the second quarter compared to the first quarter of 2024. Total yield on interest-earning assets increased 6 basis points linked quarter to 567 basis points. This was partially offset by a 15 basis point increase in the cost of interest-bearing deposits and a 2 basis point increase to interest-bearing liabilities in aggregate.

The end result was a 5 basis point increase in the tax equivalent NIM to 463, compared to 458 last quarter. We believe this continues to be exceptional margin performance and surpassed our expectations modestly. Deposit flows this quarter continued to display signs of seasonality and overall stabilization from what we saw last year. Average deposits decreased $4.3 million linked quarter, and period-end total deposits decreased $86.5 million from the prior quarter. Deposit pricing in our markets remains exceptionally aggressive relative to the treasury curve, and is still largely pricing off overnight borrowing level costs. Public funds provided a bit of a headwind this quarter as fixed income markets offer an attractive alternative. On an overall basis, we are continuing to add duration, albeit at a more modest pace than I would like.

In totality, marginal spreads remain unattractive at this point, and Old Second does not feel the pressure to swell in order to overcome expected margin pressures. Marginal returns on allocated equity remain poor for outsized growth, and flat NII performance for the year is more difficult in the absence of loan growth. But we have made progress in extending duration, and the outlook for loan growth is improving. My position remains that markets continue to believe inflationary trends are far easier to kill than they actually are in real life. Rate cuts right around the corner is not a realistic expectation without significant declines in real demand and consumption. Regardless, the deeply inverted yield curve ensures poor spreads in our industry, so we're continuing to focus on compounding book value and maximizing returns. For us, that means being careful with expenses and pricing risk appropriately.

Credit-protected securities have been a better avenue at times this year. The point is that we are being careful. As a result, 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 would lose a few basis points. Absolute NII growth from second quarter levels will be a function of our ability to find some loan growth. The loan-to-deposit ratio remains low at 87.9%, and our ability to source liquidity from the securities portfolio remains.

Old Second should continue to build capital, as evidenced by the 35 basis point improvement in the TCE ratio over the linked quarter, which means we have added an astonishing 222 basis points of TCE and $2.37 of tangible book value per share over the last 12 months. I expect at least two people will ask in a few moments what we are going to do with all this capital. It's a fair question. Sometimes I'm wrong, but I always try to be safe when that occurs. Building capital today earns a nice return relative to the recent past, and I continue to have conviction in the belief that an opportunity to invest that excess capital is coming. M&A looks like it's starting to get interesting. If that does not come to fruition, we will return capital.

A buyback is in place and is on the table. Dividend levels will be considered as well. Non-interest expense decreased $364,000 from the previous quarter, primarily due to a reduction in salaries and benefits due to a timing of officer incentive accruals and related payroll taxes paid in the first quarter, as well as a small decrease in occupancy costs, primarily due to seasonal maintenance and a small gain recorded on an OREO sale. As noted last quarter, quarterly wages and benefits are closer to $23 million run rate going forward in the near term. Given the revenue performance, employee investment costs have been running high for a while now, but we will maintain the ability to dial back as conditions warrant. With that, I'd like to turn the call back over to Jim.

Jim Eccher (Chairman, President and CEO)

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

Moderator (participant)

At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that you're in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we pull for questions. We do have our first questioner, Jeff Rulis from D.A. Davidson.

Jeff Rulis (Managing Director and Senior Research Analyst)

Thanks. Good morning. Brad, I'll stay off the capital questions, but maybe on the credit side, just possibly an update on the credits we talked about, either the Chicago office or the California Healthcare, just to try to get an update on timing and status, if we could.

Jim Eccher (Chairman, President and CEO)

Sure. Sure. Well, I think that, you know, the big story this quarter, we had, you know, we had two, two major charge-offs, and really, that was the extent of the pain we took this quarter. They were, they were both credits that had been on the horizon here for several quarters.

...One was a Chicago office building that we took a final charge out of the $4 million, and then the other was a note sale that we were able to execute on that required about a $1.5 million additional charge. So, we feel good about resolving those two. I think what investors should know is we've made significant headway in reducing non-accrual loans this quarter, with more than a dozen credits that we resolved. As far as, you know, office, you know, obviously still, you know, a very important part of the portfolio that we're watching over. We only have $23 million now in office exposure. $9 million in Chicago and $14 million in the suburbs.

We've got a reserve against the entire portfolio, north of 5%, so we feel like we've got our arms around that pretty well. Healthcare has been a slower remediation process, but we've seen no new red flags pop up in that portfolio and actually starting to see some improvement in occupancy and performance.

Jeff Rulis (Managing Director and Senior Research Analyst)

And Jim, just, just on your tone, it sounded as if the, kind of the net charge off outlook, barring surprises, seems like the second half chunkier than the back half. And the expectation, just to confirm, is that you'd expect losses to be more modest ahead?

Jim Eccher (Chairman, President and CEO)

Yeah, that's correct. I feel momentum is still very strong in credit remediation, but I don't see chunkier charges in the coming quarters anyway.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay. Maybe hop into the, the pipeline pickup trends. Wanted to kind of get your sense of, is it-- is that more something you're doing in-house? Do you feel like it's just the market picking up or, or maybe a combo of both? And then the second part of that question is, could you frame up what the second half looks like? Is that kind of low or mid-single digit growth on net?

Jim Eccher (Chairman, President and CEO)

Yeah. I mean, we've been pretty disciplined, Jeff. I would say the first half of this year, we were not seeing the risk-adjusted spreads that we would have liked to have seen, so we were really on the sidelines. We've seen more opportunities. And, you know, we gotta get them across the finish line here, but I would expect, you know, hopefully low- to mid-single-digit growth for 3Q and 4Q this year.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay, appreciate it. I'll step back. Thanks.

Operator (participant)

We now hear from Chris McGratty with KBW. I'm sorry, we have Terry McEvoy with Stephens.

Terry McEvoy (Managing Director and Research Analyst)

Hi, good morning, everyone.

Brad Adams (COO and CFO)

Morning, Terry. Morning.

Terry McEvoy (Managing Director and Research Analyst)

Maybe, if I could just ask a question on the expense outlook for the second half of this year. The personnel and expenses overall came in a bit above what was discussed on the last call, and would be curious on, with your outlook for the second half of the year.

Brad Adams (COO and CFO)

Relatively flat. I thought I said $23 million last quarter. But so maybe at $400,000 above that level. Second half of the year is always about, you know, how your overall year performance is tracking relative to budget and how that works with Incentive Accruals. So it... You can be wrong by $500,000 in any given quarter and still be pretty darn close. It's kind of a horseshoes and hand grenades kind of thing, but I don't see anything. Labor market conditions have improved. We've been able to hire who we wanted. I don't see any real surprises coming at us at this point. So I think we are where we are.

I'll say I'm broadly very happy with what expense trends have done over the last year and also over the last three years. It's no secret. It's been a wildly inflationary time, and I feel like we've done a really good job keeping a lid on things.

Terry McEvoy (Managing Director and Research Analyst)

And then, there seems to be fears that when CRE loans mature, that's when the losses materialize, that, that wasn't obviously what happened last quarter. So when I look at the $25 million of maturities in Q3, and was it $40 million of Q4, are those loans built into the reserve today? And, and ultimately, you know, how should I-- how are you thinking about potential loss content there?

Brad Adams (COO and CFO)

Yeah, we've been cynical, depressed people on upcoming maturities for the better part of two years now. That's a function of why we were downgrading credits two years ago and felt like we were alone in doing so. There is no surprises coming. We have looked at maturities that are less than 24 months, 24 months out, for a while now, and we've been very cynical, depressing people that you wouldn't want to talk to at cocktail parties. I think that the kind of bowling ball through a garden hose has been the preponderance of our industry to offer 7- and 10-year maturities, which Jim alluded to, you know, back in 2020 and 2021. That's not a game that we played in. So we're a short-duration asset shop. Always have been.

Believe we always will be. There's nothing coming at us that is either unexpected or outsized in terms of maturities.

Terry McEvoy (Managing Director and Research Analyst)

... Appreciate that. And then maybe one last one, Brad. I think you said M&A is starting to get interesting. Might have been the quote there. So, don't mean to ask a capital question, but I have to kind of take the bait on your statement there.

Brad Adams (COO and CFO)

Yeah. You know, our statements have been... Our strategy has been to build capital. I think that there are several reasons to do that. The first of which is that, at this point, greater than any point over the last 10 years, is that capital earns a nice return. The cost of funding is now 5.4% in the market, so a levered return on Equity is pretty darn good, even if you're not using it at this point. So it allows you to have a margin of safety. That margin of safety is also, you know, both economic based, is a recession around the corner, and that's something people like to talk about.

But it's also, if times are difficult in our industry, which they have been, with very low returns, some people might begin to throw in the towel. We have Capital flexibility to include cash in a deal, so you can balance accretion. I don't know whether a deal is gonna happen for us, and that I realize that's the question. But I can tell you that if we do get an opportunity, we will be exceptionally disciplined on price. That hasn't changed. If we don't get an opportunity, as I said, we will return the capital.

Terry McEvoy (Managing Director and Research Analyst)

Understood. Thank you for taking my questions.

Brad Adams (COO and CFO)

Yes, sir. Thank you.

Operator (participant)

We now have Chris McGratty with KBW.

Brad Adams (COO and CFO)

Chris, are you having?

Chris McGratty (Managing Director)

Can you hear me now, Brad?

Brad Adams (COO and CFO)

Yes, I can.

Chris McGratty (Managing Director)

Well, all right. Cool. The optimization of the Balance Sheet was mentioned a couple times in prepared remarks by you and Jim.

Brad Adams (COO and CFO)

Yes.

Chris McGratty (Managing Director)

What's left to do? Obviously, hedging is probably hard in this environment, because of the curve, but what's left to do? What's coming off the Bond Portfolio every month? Just help us a little bit on that.

Brad Adams (COO and CFO)

Well, we've had a lot come off the Bond Portfolio. The structure of the yield curve for the bulk of this quarter meant that we simply laddered it back out short, which did offer a pickup in yield. What I'd like to see is a steepening. I don't know... I think a steepening is coming. I don't know whether it's recession driven with a short-end falling, or if it's things people become less pessimistic and the long end picks up. If we can get a steepening, obviously the latter would be better.

If we can get that, then what we would do is take off, add duration aggressively, by selling variable securities, and reduce the overall size of the Bond Portfolio with loan growth to more like a 15% level from a 20% level. That would be the ideal scenario. I would remind investors that we are what we are, and smarter people than us have tried to bet on interest rates, and a large percentage of them wind up with a tin cup in their hand on street corners. Betting on interest rates is a fool's errand. We will always be inherently sensitive and better off if rates are higher, because of being a very good deposit base. And anybody that wants us to bet that away would be making a mistake.

So we do better when rates are high. That's no secret, and we are doing quite well. If short rates fall, we will do slightly worse. But we will invest capital wisely, and we will earn nice returns in any environment.

Chris McGratty (Managing Director)

Thanks for that. Maybe just a follow-up, kind of combining the expense and the NII commentary.

Brad Adams (COO and CFO)

Yeah.

Chris McGratty (Managing Director)

Efficiency ratio, the Efficiency Ratio, Brad or Jim, like, if we get the forward curve, we get a cut, 100 basis points of cuts, obviously, margins will go down. You're obviously gonna probably be a little bit more careful on cost, but, like, where does the efficiency ratio settle in if, if the, if the futures market's right with 100 cuts?

Brad Adams (COO and CFO)

So low 50s and higher rates, mid- to high 50s in very low rates. I don't see us going back above 60, given our size and scale that we have now. But I also don't think we're ever going back to zero, given all the things that resulted from that. I think it would take an absolute idiot to think that was a good idea at this point. So, in a world where rates aren't zero, deposits are worth fundamentally more than most investors have a memory of. So I think that as long as short rates don't cross 200 basis points at any time soon, we are above 4% margin shop-

Chris McGratty (Managing Director)

Okay

Brad Adams (COO and CFO)

... as we are structured today.

Chris McGratty (Managing Director)

So mid to upper fifties with, with-

Brad Adams (COO and CFO)

Yes.

Chris McGratty (Managing Director)

the former. Okay, got it.

Brad Adams (COO and CFO)

The big difference today than versus where we were last time, we were in a potential scenario where rates were gonna be cut, was our Balance Sheet just wasn't as optimized, right? We were sitting at low to mid sixties on our loan-to-deposit ratio. So we've got much stronger, you know, pre-tax, pre-provision earnings power now.

Chris McGratty (Managing Director)

Okay. Perfect. Thank you.

Brad Adams (COO and CFO)

Yes, sir.

Operator (participant)

Our next questioner is Nathan Race with Piper Sandler.

Nathan Race (Managing Director and Senior Research Analyst)

... Yeah. Hi, guys. Good morning. Thanks for taking my call.

Brad Adams (COO and CFO)

Hey, good morning.

Nathan Race (Managing Director and Senior Research Analyst)

Is it, in terms of funding loan growth in 3Q and 4Q, is that mostly gonna be sourced from securities portfolio runoff? Does that imply maybe the margin can expand a little bit more here in 3Q?

Brad Adams (COO and CFO)

I would like to stay flat on the margin. It wasn't my expectation that it would go up this quarter. Yes, I would say that if loan growth is strong, which we believe it is trending in that direction, that at least half of it would come out of the bond portfolio, and you may see overnight borrowings tick up a bit, or you may see deposit growth. You know, we had deposit growth last quarter. We had some lumpiness happen this quarter. I don't see any reason why deposits can't grow.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, great. And then, Greg, can you just remind us the impact on the margin with each 25 cut from the Fed?

Brad Adams (COO and CFO)

Oh, 5-7 basis points decline. In the earlier-

Nathan Race (Managing Director and Senior Research Analyst)

Can you just remind us in terms of the floating rate assets that you have on the balance sheet, both in loans and securities, coming out of the quarter?

Brad Adams (COO and CFO)

About 50%.

Nathan Race (Managing Director and Senior Research Analyst)

Okay.

Brad Adams (COO and CFO)

We're about 50/50, but the fixed portion of the balance sheet generally has an effective duration a little over three. So, you know, rates down will hit us without a lot of weight. There is no question about that.

Nathan Race (Managing Director and Senior Research Analyst)

Okay.

Brad Adams (COO and CFO)

But also, you get a pickup, you get a pickup in the benefit of the free funding, and deposit costs will come down. So ... And that's when you, that's when you start looking at growth as well.

Nathan Race (Managing Director and Senior Research Analyst)

Mm-hmm. Got it. That's helpful. Just one last one. It sounds like charge-offs may, there may be some additional cleanup here in the third quarter. And I imagine those are already, largely allocated for, but just in terms of kind of where you guys want to see the reserve settle out, coming out of the third quarter, any thoughts on what that level should be relative to total loans?

Jim Eccher (Chairman, President and CEO)

Yeah, I think the reserve at these levels, as a percentage of total loans, is probably an appropriate level for us. But to answer your earlier question, I don't see the magnitude of charge-offs in the second half of this year based on the remediation progress we're making on a number of loans and have already realized some progress this quarter. So I think a reserve level in close proximity where we're at now is appropriate.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, great. I appreciate all the color. Thanks, guys.

Brad Adams (COO and CFO)

Thanks, Nate.

Jim Eccher (Chairman, President and CEO)

Thank you.

Operator (participant)

We now hear from David Long with Raymond James.

David Long (Managing Director of Banking)

Good morning, everyone.

Brad Adams (COO and CFO)

Hey, Dave.

David Long (Managing Director of Banking)

Brad, I wanted to ask you about the deposit pricing. Obviously, you guys have a great core deposit base. Total deposit costs amongst the lowest of your peer group. You know, in your marketplace where I reside, I'm still getting some pretty nice offers, 5%+ on savings accounts. How much do you see the deposit, if we stay higher for longer for the back half of the year, how much higher do you see that deposit, total deposit cost for Old Second changing?

Brad Adams (COO and CFO)

So I think what's largely going on here is that a bank such as ourselves, which is a good retail deposit bank, a natural mix of the deposits is probably like 25% Time Deposits. We got down around 10 or 12 because Time Deposits became a bad deal for consumers, and that's what happens in with a curve that is at zero across any level of duration. So time deposits became just simply not a thing. And what we're seeing now is, as that mix shifts going back and there is a transition, and we'll probably start trending towards a 20% Time Deposit mix. I don't see any reason why it shouldn't be that. And that's gonna be the primary determinant of pickup and deposit costs for us.

Now, there is a percentage of the deposit base that is a lot of money. For us, that's much lower than everybody else. We have very few accounts that have more than $10 or $15 million in them. You can count them on fingers and toes. So for that customer, for our industry, fixed income markets are simply a better deal. And fighting with fixed income markets for that money results in the big pickups in deposit costs that you've seen in our industry, and that's simply not a game that we're in to win. That's not what banks should be doing. Sophisticated large public funds and commercial customers should have a diversified Liquidity portfolio.

It's simply true that banks are having to fight with fixed income markets for funding because they got duration wildly wrong when rates were low and going higher. And that's what happens when you're stuck. We are simply not stuck.

David Long (Managing Director of Banking)

Got it. Thank you for the, for that color. And then, on the credit side of things, a lot of talk about commercial, particularly the office space. Hearing more from Chief Credit Officers that C&I needs to be more closely watched and regulators need to look more at C&I. How is the performance of your C&I book, and are there any segments there that you're a little bit more concerned about?

Jim Eccher (Chairman, President and CEO)

... Yeah, I mean, so far, Dave, our C&I portfolios is holding up very well. Got about, I think, a little over a third of our portfolios now in C&I, which we're pleased about. Only about less than $20 million is classified in that book. We have seen a couple credits that we're keeping an eye on, but by and large, a lot of our C&I clients still have a relatively low leverage Balance Sheet and producing pretty good top line results. But we are obviously watchful with the variable, you know, significantly variable portion of that portfolio is in C&I. We're seeing a little bit of stress, but right now, it's behaving very well.

David Long (Managing Director of Banking)

Got it. Thanks for taking my questions, guys.

Brad Adams (COO and CFO)

Thanks, Dave.

Operator (participant)

A reminder before our next participants, that if you have a question you would like to pose, to please press star one on your keypad. Star one. We now have Brian Martin with Janney Montgomery Scott.

Brian Martin (Director of Bank & Thrift)

Hey, good morning, guys.

Brad Adams (COO and CFO)

Hey, Brian.

Jim Eccher (Chairman, President and CEO)

Hey, good morning, Brian.

Brian Martin (Director of Bank & Thrift)

Hey, most of my questions are answered, but just, Brad, just on the securities portfolio, just for clarity, how much of that is coming off in the second half of the year? And the percentage of that that's variable rate, just on the securities book, I think it was about 20% last quarter. It sounded like it dropped a bit this quarter.

Brad Adams (COO and CFO)

Yeah, not much. I mean, you have the type of volatility that we've seen has been not much to a dropping, that is. The type of volatility that we've seen means that there are times when variable securities are quite simply a better deal, and they were for the bulk of the second quarter. So you take the best value for your money. In terms of coming off the bond portfolio, I would expect no less than $100 million over the remainder of the year. So it feels fine to support loan growth for the bulk of it. I said at least half a few minutes ago.

Brian Martin (Director of Bank & Thrift)

Yep.

Brad Adams (COO and CFO)

All the flexibility we need, feel very good.

Brian Martin (Director of Bank & Thrift)

Yes. And what that comes off at what, Brad? I mean, those is it pretty low rate, that $100 million?

Brad Adams (COO and CFO)

Yeah. Yeah, it's, I mean, it's, it's certainly lower than the blended overall securities portfolio yield, which I think is like 3.20 or something like that. So, it's significantly lower than that.

Brian Martin (Director of Bank & Thrift)

Okay. Gotcha. Okay, and then just on the credit front, just the progress you made this quarter and kind of some of the comments, I guess, the resolutions at this point seem to be, you know, less costly. But in terms of any lumpy resolutions you expect here in the back half of the year, I mean, do you expect another meaningful decline in the non-performers or, you know, the classifieds or criticized here as you kind of get the back half of the year? Is it more of a slower decline now, given some of the, you know, the heavy lifting you've done?

Jim Eccher (Chairman, President and CEO)

Yeah, I mean, I don't know if we'll get, you know, 23% reduction in Non-accruals next quarter, but we are already realizing some remediation on a number of fronts. Momentum is good. You know, what's encouraging is there's been very little migration into Non-accrual. This quarter, we only saw $1 million and saw obviously twenty, you know, $22 million reduction. So, when you have a slowdown in migration, that allows you to really work on working some credits out and we expect that momentum to continue in the next quarter.

Brian Martin (Director of Bank & Thrift)

Gotcha. Okay. Thanks, Jim. And then, Brad, not to disappoint you on at least getting two questions on capital,

Brad Adams (COO and CFO)

Thank you.

Brian Martin (Director of Bank & Thrift)

You had one. The second one on the Buyback, and I know you talked about if you go that route or if that's a possibility, the pricing kind of where it was making sense. But given the rally in the market here, at least some of the banks, can you—I guess, as your—if you go that route, has your outlook changed on how you would think about, you know, the profitability of that? At what pricing it would look more attractive?

Brad Adams (COO and CFO)

No, I started flirting with the Buyback talk about a year ago.

Brian Martin (Director of Bank & Thrift)

Yep.

Brad Adams (COO and CFO)

I think our stock's up 25-30% or something like over that. I don't know what it is. It's, it's probably about like that. I think it's up 20% a month. Tangible book value is up 26%. On a relative basis, it's the same. Certainly, it would've been. I could have acted all smug that we bought back a big slug of stock at $12.50 or something, but ultimately, it's a relative game, and nothing's really changed.

Brian Martin (Director of Bank & Thrift)

Gotcha. Okay. That's all I had, guys. Thank you.

Brad Adams (COO and CFO)

All right.

Jim Eccher (Chairman, President and CEO)

Thanks, Brian.

Operator (participant)

We have reached the end of the question and answer session, and I will now turn the call back over to James Eccher for closing remarks.

Jim Eccher (Chairman, President and CEO)

Okay. Thanks, everyone, for your interest in our company, and we look forward to speaking with you again next quarter. Goodbye, and have a great day.