News Column

OLD SECOND BANCORP INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 13, 2014

Overview

The Company is a financial services company with its main headquarters located in Aurora, Illinois. The Company is the holding company of Old Second National Bank (the "Bank"), a national banking organization headquartered in Aurora, Illinois and provides commercial and retail banking services, as well as a full complement of trust and wealth management services. The Company has offices located in Cook, Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois. The following management's discussion and analysis presents information concerning our financial condition as of June 30, 2014, as compared to December 31, 2013, and the results of operations for the six months and three months ended June 30, 2014, and 2013. This discussion and analysis is best read in conjunction with our consolidated financial statements as well as the financial and statistical data appearing elsewhere in this report and our 2013 Form 10-K. In the markets where the Company operates, economies continued to recover at a modest and incremental but fitful pace. The economies in these markets continued to show gradual improvement in the second quarter of 2014 along with similar moderate improvements in the national consumer and business spending. Commercial Real Estate in our market areas has stabilized with only vacant land continuing to reflect little or no growth. Residential mortgage demand has increased but is still below levels seen in 2013. Management continues to focus on growing commercial business with smaller customers as well as customers in a variety of industries approaching middle market levels. The Company remains vigilant in analyzing loan portfolio quality and making decisions to charge-off loans. To that end, the Company recognized improved asset quality by recording a $1.0 million loan loss reserve release in the quarter with net income of $2.0 million. This compared to a $1.8 million loan loss reserve release and a net income of $3.5 million for the same period in 2013. The $1.0 million loan loss reserve release for the period was appropriate in light of ongoing improvements in loan portfolio quality. Net income of $3.1 million (before taxes) in the second quarter of 2014 compares to $3.5 million for the second quarter of 2013. In addition to the larger loan loss reserve release in second quarter 2013, last year's quarter included stronger residential mortgage banking revenue as well as $745,000 in securities gains compared to a lower level of securities gains of $295,000 in 2014 second quarter. In April 2014, the Company concluded a successful capital raise issuing 15,525,000 common shares with net proceeds in excess of $64.0 million. Proceeds have been used to pay accrued but previously deferred and unpaid interest on trust preferred securities, to repurchase certain shares of Series B Stock and to pay the accrued as well as otherwise accumulated but unpaid dividends on Series B Stock. The remaining proceeds will be used for general corporate purposes including payment for various services required during the offering. On April 28, 2014, the Company repurchased Series B Stock at an agreed upon price reached in private negotiations. Payments of $22.9 million were made to a large private investor with other payments totaling $1.4 million made to directors of the Company. On May 15, 2014, the Company paid $10.3 million on accumulated but unpaid dividends related to the Series B Stock. Results of Operations Earnings per share for the second quarter of 2014 were $0.26 per diluted share on $7.5 million of net income to common stockholders. Absent the benefits from gain on redemption of the Series B stock and Series B dividends waived by holders of Series B stock redeemed, the Company realized $0.02 per diluted share in the quarter. These results compare to $0.15 per diluted share, on net income to common stockholders of $2.2 million for the second quarter of 2013 and net income available to common stockholders of $630,000 for the first quarter of 2014. All 2014 Series B dividends incorporate an increase in the dividend rate from 5% to 9% in February of 2014. The Company completed the redemption of 25,669 shares of its Series B Stock in the quarter. As previously disclosed, the Company completed a public offering of common stock in April. Net proceeds of over $64.0 million were used to pay the accrued but unpaid interest on trust preferred junior subordinated debentures, the accumulated but unpaid dividends on the Series B Stock and to complete this redemption. The redemption price for such Series B Stock was 94.75% of the liquidation value of the Series B Stock provided that the holders of shares entered into agreements to forbear payment of dividends due and to waive any rights to such dividend upon redemption. The Company also redeemed all shares of Series B Stock held by directors of the Company on the same terms. These redemptions at below liquidation value resulted in a benefit of $1.3 million to net income available to common stockholders in the quarter. An additional benefit of $5.4 million reflecting both reversal of dividends previously accrued as well as dividends accumulated but not accrued by the Company and waived by holders upon redemption, is reflected in net income available to common stockholders. Absent these benefits, the Company realized $0.02 per diluted share in the quarter. 36 --------------------------------------------------------------------------------

Table of Contents Net Interest Income Net interest and dividend income increased $264,000 from $13.4 million for the quarter ended June 30, 2013, to $13.7 million for the quarter ended June 30, 2014. Average earning assets increased $49.7 million, or 2.8%, from a total of $1.76 billion in the second quarter of 2013. Loan production in 2014 drove average loans, including loans held for sale, to a nominal improvement of $2.0 million reversing the trend of declining average loan volume seen in recent periods. On a sequential quarter basis, average loan volume, including loans held for sale, increased $14.5 million also reversing a 2013 trend of declining volume in this metric. Repeating comments from previous reports, management continues to develop loan pipelines and expects that pipeline volume will generate future loan growth. As loan volume continues measured but slow paced growth, management decreased total securities in the second quarter of 2014 to 29.0% of total assets down from 31.4% at the end of 2013. The net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, decreased from 3.07% in the second quarter of 2013 to 3.04% in the second quarter of 2014. The average tax-equivalent yield on earning assets decreased from 3.83% in the second quarter of 2013 to 3.66% in the second quarter of 2014. For the same comparative period, the cost of funds on interest bearing liabilities decreased from 0.96% to 0.82% providing some offset to the decrease in earning asset yield. The growth of lower yielding securities (average balance up again in the sixth month period year over year continuing a 2013 trend of increasing volume of this metric) and reductions in higher yielding loans were the main causes of decreased net interest income. Period loan yields are reflective of competitive pressures on new loan yield. Additionally, management continued to see pressure to reduce interest rates on loans retained at renewal and found it necessary to accept rate concessions to keep the business. Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios. This includes tax-equivalent net interest income (including its individual components) and net interest margin (including its individual components) to total average interest earning assets. Management believes that these measures and ratios provide users of the financial information with a more accurate view of the performance of the interest earning assets and interest bearing liabilities and of the Company's operating efficiency for comparison purposes. Other financial holding companies may define or calculate these measures and ratios differently. See the tables and notes below for supplemental data and the corresponding reconciliations to GAAP financial measures for the three and six-month periods ended June 30, 2014, and 2013. The following tables set forth certain information relating to the Company's average consolidated balance sheets and reflect the yield on average earning assets and cost of average liabilities for the periods indicated. Dividing the related interest by the average balance of assets or liabilities derives the disclosed rates. Average balances are derived from daily balances. For purposes of discussion, net interest income and net interest income to total earning assets on the following tables have been adjusted to a non-GAAP tax equivalent ("TE") basis using a marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets. 37

-------------------------------------------------------------------------------- Table of Contents ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT INTEREST AND RATES Three Months ended June 30, 2014, and 2013 (Dollar amounts in thousands - unaudited) 2014 2013 Average Average Balance Interest Rate Balance Interest Rate Assets Interest bearing deposits $ 30,333$ 20 0.26 % $ 43,933$ 27 0.24 % Securities: Taxable 628,766 3,352 2.13 569,877 2,698 1.89 Non-taxable (TE) 23,613 182 3.08 20,752 268 5.17 Total securities 652,379 3,534 2.17 590,629 2,966 2.01 Dividends from Reserve Bank and FHLBC stock 10,292 78 3.03 10,742 76 2.83 Loans and loans held-for-sale (1) 1,120,918 13,104 4.62 1,118,892 13,974 4.94 Total interest earning assets 1,813,922 16,736 3.66 1,764,196 17,043 3.83 Cash and due from banks 36,827 - - 22,948 - - Allowance for loan losses (25,146) - - (38,228) - - Other noninterest bearing assets 233,369 - - 194,782 - - Total assets $ 2,058,972$ 1,943,698 Liabilities and Stockholders' Equity NOW accounts $ 309,380$ 65 0.08 % $ 297,918$ 65 0.09 % Money market accounts 309,843 83 0.11 319,236 115 0.14 Savings accounts 242,512 40 0.07 230,822 41 0.07 Time deposits 457,818 1,210 1.06 497,262 1,800 1.45 Interest bearing deposits 1,319,553 1,398 0.42 1,345,238 2,021 0.60 Securities sold under repurchase agreements 25,224 - - 24,692 - - Other short-term borrowings 8,681 3 0.14 769 - - Junior subordinated debentures 58,378 1,388 9.51 58,378 1,314 9.00 Subordinated debt 45,000 198 1.74 45,000 205 1.80 Notes payable and other borrowings 500 4 3.16 500 4 3.16 Total interest bearing liabilities 1,457,336 2,991 0.82 1,474,577 3,544 0.96 Noninterest bearing deposits 389,926 - - 357,802 - - Other liabilities 19,210 - - 35,202 - - Stockholders' equity 192,500 - - 76,117 - - Total liabilities and stockholders' equity $ 2,058,972 $



1,943,698

Net interest income (TE) $ 13,745$ 13,499 Net interest income (TE) to total earning assets 3.04 % 3.07 % Interest bearing liabilities to earning assets 80.34 % 83.58 % (1).Interest income from loans is shown on a TE basis as discussed below and includes fees of $563,000 and $551,000 for the second quarter of 2014 and 2013, respectively. Nonaccrual loans are included in the above-stated average balances. 38

-------------------------------------------------------------------------------- Table of Contents ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT INTEREST AND RATES Six Months ended June 30, 2014, and 2013 (Dollar amounts in thousands - unaudited) 2014 2013 Average Average Balance Interest Rate Balance Interest Rate Assets Interest bearing deposits $ 27,072$ 35 0.26 % $ 56,395$ 69 0.24 % Securities: Taxable 622,634 6,854 2.20 559,114 4,996 1.79 Non-taxable (TE) 21,101 410 3.89 15,407 451 5.85 Total securities 643,735 7,264 2.26 574,521 5,447 1.90 Dividends from Reserve Bank and FHLBC stock 10,292 154 2.99 10,971 152 2.77 Loans and loans held-for-sale 1 1,113,704 26,092 4.66 1,131,210 28,945 5.09 Total interest earning assets 1,794,803 33,545 3.72 1,773,097 - 34,613 3.89 Cash and due from banks 33,383 - - 26,411 - - Allowance for loan losses (26,118) - - (38,609) - - Other noninterest bearing assets 234,760 - - 199,076 - - Total assets $ 2,036,828$ 1,959,975 Liabilities and Stockholders' Equity NOW accounts $ 306,483$ 129 0.08 % $ 294,504$ 129 0.09 % Money market accounts 312,309 177 0.11 324,279 238 0.15 Savings accounts 238,455 81 0.07 226,380 82 0.07 Time deposits 462,950 2,531 1.10 501,450 3,653 1.47



Interest bearing deposits 1,320,197 2,918 0.45 1,346,613

4,102 0.61 Securities sold under repurchase agreements 24,884 1 0.01 22,490 1 0.01 Other short-term borrowings 6,409 4 0.12 22,182 19 0.17 Junior subordinated debentures 58,378 2,775 9.51 58,378 2,601 8.91 Subordinated debt 45,000 394 1.74 45,000 401 1.77 Notes payable and other borrowings 500 8 3.18 500 8 3.18 Total interest bearing liabilities 1,455,368 6,100 0.84 1,495,163 7,132 0.96 Noninterest bearing deposits 381,863 - - 355,651 - - Other liabilities 28,940 - - 34,398 - - Stockholders' equity 170,657 - - 74,763 - - Total liabilities and stockholders' equity $ 2,036,828$ 1,959,975 Net interest income (TE) $ 27,445$ 27,481 Net interest income (TE) to total earning assets 3.08 % 3.13 % Interest bearing liabilities to earning assets 81.09 % 84.32 % 1 Interest income from loans is shown on a TE basis as discussed below and includes fees of $1.1 million and $1.2 million for the first six months of 2014 and 2013, respectively. Nonaccrual loans are included in the above stated average balances. 39

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As indicated previously, net interest income and net interest income to earning assets have been adjusted to a non-GAAP TE basis using a marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets. The table below provides a reconciliation of each non-GAAP TE measure to the GAAP equivalent for the periods indicated: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Net Interest Margin Interest income (GAAP) $ 16,643$ 16,932$ 33,347$ 34,422 Taxable-equivalent adjustment: Loans 29 17 54 33 Securities 64 94 144 158 Interest income - TE 16,736 17,043 33,545 34,613 Interest expense (GAAP) 2,991 3,544 6,100 7,132 Net interest income -TE $ 13,745$ 13,499$ 27,445$ 27,481 Net interest income (GAAP) $ 13,652$ 13,388$ 27,247$ 27,290 Average interest earning assets $ 1,813,922$ 1,764,196$ 1,794,803$ 1,773,097 Net interest margin (GAAP) 3.02 % 3.04 % 3.06 % 3.10 % Net interest margin - TE 3.04 % 3.07 % 3.08 % 3.13 % Asset Quality The Company's $1.0 million loan loss reserve release in the second quarter of 2014 compares to a $1.8 million reserve release in the second quarter of 2013. The provision for loan loss creates a reserve for probable and estimable losses inherent in the loan portfolio. Reserve releases reflect management's measured decision that probable and estimable losses have been reduced. On a quarterly basis, management estimates the amount required and records the appropriate provision or release to maintain an adequate reserve for all potential and estimated loan losses. The $1.0 million loan loss reserve release in the second quarter of 2014 continues a trend of quarterly reserve releases seen in 2013 and in first quarter 2014. In each of the five prior quarters, management concluded that quarterly releases were justified with quarterly amounts ranging from $1.0 million to $2.5 million. Nonperforming loans decreased to $28.9 million at June 30, 2014 from $38.6 million at March 31, 2014. Net charge-offs totaled $620,000 in second quarter 2014 while net charge-offs totaled $1.8 million for the second quarter of 2013. The distribution of the Company's remaining nonperforming loans are included in the following table. June 30, 2014 Nonperforming Loans as of Dollar Change From (in thousands) June 30, March 31, December 31, March 31, December 31, 2014 2014 2013 2014 2013 Real estate-construction $ 807$ 2,888$ 2,729$ (2,081)$ (1,922) Real estate-residential: Investor 3,932 3,876 6,615 56 (2,683) Owner occupied 5,535 5,901 6,190 (366) (655) Revolving and junior liens 2,199 2,726 3,209 (527) (1,010) Real estate-commercial, nonfarm 16,390 23,172 21,024 (6,782) (4,634) Real estate-commercial, farm - - - - - Commercial 56 24 27 32 29 Other - - - - - $ 28,919$ 38,587$ 39,794$ (9,668)$ (10,875)



Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due. Remediation work continues in all segments. Importantly, new migration to nonaccrual continues to be minimal.

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Table of Contents Loan Charge-offs, net of recoveries Three Months Ended (in thousands) June 30, March 31, December 31, 2014 2014 2013 Real estate-construction Homebuilder $ (130)$ (35) $ - Land - 1 (1) Commercial speculative (226) - 62 All other (6) 65 1 Total real estate-construction (362) 31 62 Real estate-residential Investor (13) 92 547 Owner occupied 96 8 (15) Revolving and junior liens 206 499 139 Total real estate-residential 289 599



671

Real estate-commercial, nonfarm Owner general purpose 182 - - Owner special purpose 347 259 (3) Non-owner general purpose 145 18 (1,258) Non-owner special purpose - - - Retail properties (1) (89) 296 Total real estate-commercial, nonfarm 673 188



(965)

Real estate-commercial, farm - - - Commercial (32) (11) (7) Other 52 (2) 5 $ 620$ 805$ (234) Charge-offs for the second quarter 2014 were, in many instances, from previously established specific reserves on nonaccrual loans deemed uncollectible. Gross charge-offs for the second quarter of 2014 were $2.0 million compared to $3.1 million for the second quarter of 2013 reflecting our efforts to improve loan quality in better but still challenging markets. Recoveries were $1.4 million and $1.3 million for the same time periods, respectively. June 30, 2014 Classified loans as of Dollar Change From (in thousands) June 30, March 31, December 31, March 31, December 31, 2014 2014 2013 2014 2013 Real estate-construction $ 4,330$ 6,430$ 3,024$ (2,100)$ 1,306 Real estate-residential: Investor 5,312 7,674 9,750 (2,362) (4,438) Owner occupied 5,841 6,847 7,699 (1,006) (1,858) Revolving and junior liens 3,097 3,645 3,971 (548) (874) Real estate-commercial, nonfarm 19,634 27,633 37,297 (7,999) (17,663) Real estate-commercial, farm - - - - - Commercial 312 455 481 (143) (169) Other 1 - 1 1 - $ 38,527$ 52,684$ 62,223$ (14,157)$ (23,696) Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. Loans classified as substandard are inadequately protected by either the current net worth and paying capacity of the obligor, or by the collateral pledged to secure the loan, if any. These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and carry the distinct possibility that the Company will sustain some loss if deficiencies remain uncorrected. Classified assets include both classified loans and OREO. Management monitors a ratio of classified assets to the sum of Bank Tier 1 capital and the allowance for loan and lease loss reserve as another measure of overall change in loan related asset quality. 41

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With the decline in both classified loans and OREO in the second quarter of 2014, this ratio improved to 31.27% at June 30, 2014 from 38.44% at March 31, 2014 and down from 43.44% at December 31, 2013.

Allowance for Loan and Lease Losses

Below is a reconciliation of the activity for loan losses for the periods indicated (in thousands): Three Months Ending June 30, March 31, December 31, 2014 2014 2013 Allowance at beginning of quarter $ 25,476$ 27,281$ 29,547 Charge-offs: Commercial 3 4 8 Real estate - commercial 760 329 608 Real estate - construction 105 68 63 Real estate - residential 978 849 1,100 Consumer and other loans 139 110 123 Total charge-offs 1,985 1,360 1,902 Recoveries: Commercial 35 15 15 Real estate - commercial 87 141 1,573 Real estate - construction 467 37 1 Real estate - residential 689 250 429 Consumer and other loans 87 112 118 Total recoveries 1,365 555 2,136 Net charge-offs (recoveries) 620 805 (234) Loan loss reserve release (1,000) (1,000) (2,500) Allowance at end of period $ 23,856$ 25,476$ 27,281 Average total loans (exclusive of loans held-for-sale) 1,118,089 1,104,065



1,072,320

Net charge-offs to average loans 0.06 % 0.07 % (0.02) % Allowance at period end to average loans 2.13 % 2.31 %



2.54 %

Ending balance: Individually evaluated for impairment $ 1,440$ 1,247$ 2,395 Ending balance: Collectively evaluated for impairment $ 22,416$ 24,229$ 24,886 The coverage ratio of the allowance for loan losses to nonperforming loans was 82.5% at June 30, 2014 up from 66.0% as of March 31, 2014 and 68.6% as of December 31, 2013. Management updated the estimated specific allocations in the second quarter after receiving more recent appraisals of collateral or information on cash flow trends related to the impaired credits. This update resulted in a sharply lower amount required in the reserve for estimable losses on these credits at the end of the second quarter 2014 compared to year end 2013. The estimated general allocation was also lower but essentially unchanged from December 31, 2013, as the overall credit condition of our loan portfolio adjusted for environmental factors remained relatively stable during the quarter. The third component of the Company's loan loss reserve analysis showed lower required reserves, most notably in the pooled commercial real estate category. Management determined that the dollar amount of loans in this component was less than $3.3 million or markedly lower at period end second quarter 2014 compared to $17.2 million at year end 2013. In summary, after careful and detailed review, management determined an appropriate amount to release from the allowance for loan losses. Factors considered include loan growth or contraction, the quality and composition of the loan portfolio and loan loss experience. The above changes in estimates were made by management to be consistent with observable trends within loan portfolio segments and in conjunction with market conditions and credit review administration activities. Management also reviewed and evaluated several environmental factors. These factors are evaluated on an ongoing basis and are included in the assessment of the adequacy of the allowance for loan losses. After a review of the adequacy of the loan loss reserve at June 30, 2014, management concluded that a $1.0 million reserve release was justified. When measured as a percentage of loans outstanding, the total allowance for loan losses decreased slightly from 2.5% of total loans as of December 31, 2013 to 2.1% of total loans at June 30, 2014. In management's judgment, an adequate, 42

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measured and entirely appropriate allowance for estimated losses has been established for inherent losses at June 30, 2014; however, there can be no assurance that actual losses will not exceed the estimated amounts in the future.

Other Real Estate Owned OREO decreased modestly to $39.2 million at June 30, 2014, from $40.2 million at March 31, 2014 and $41.5 million at December 31, 2013. Disposition activity and valuation writedowns in the second quarter exceeded additions to OREO as shown below. Three Months Ended (in thousands) June 30, March 31, December 31, 2014 2014 2013 Beginning balance $ 40,220$ 41,537$ 49,066 Property additions 4,655 4,688 4,998 Development improvements 131 - 13 Less: Property disposals 4,949 5,569 10,784 Period valuation adjustments 825 436 1,756 Other real estate owned $ 39,232$ 40,220$ 41,537 The OREO valuation reserve decreased to $17.9 million, which is 31.3% of gross OREO at June 30, 2014. The valuation reserve represented 33.9% and 34.9% of gross OREO at June 30, 2013, and December 31, 2013, respectively. In management's judgment, the property valuation allowance as established presents OREO at current estimates of fair value less estimated costs to sell; however, there can be no assurance that additional losses will not be incurred on disposition or upon update to valuation in the future. Of note, one commercial property of five lots valued in total at $1.0 million has been in OREO for over five years. OREO Properties by Type (in thousands) June 30, 2014 March 31, 2014 December 31, 2013 Amount % of Total Amount % of Total Amount % of Total Single family residence $ 3,485 9 % $ 4,730 12 % $ 4,658 11 % Lots (single family and commercial) 15,002 38 % 14,298 36 % 15,020 36 % Vacant land 2,595 7 % 3,135 8 % 3,135 8 % Multi-family 5,175 13 % 5,045 12 % 1,783 4 % Commercial property 12,975 33 % 13,012 32 % 16,941 41 % Total OREO properties $ 39,232 100 % $ 40,220 100 % $ 41,537 100 % Noninterest Income 2nd Qtr 2014 Three Months Ended Dollar Change From (in thousands) 2nd Qtr 1st Qtr 2nd Qtr 1st Qtr 2nd Qtr 2014 2014 2013 2014 2013 Trust income $ 1,677$ 1,459$ 1,681$ 218$ (4) Service charges on deposits 1,796 1,720 1,799 76 (3) Residential mortgage banking revenue 1,257 727 2,821 530 (1,564) Securities (loss) gains, net 295 (69) 745 364 (450) Increase in cash surrender value of bank-owned life insurance 366 358 372 8 (6) Death benefit realized on bank-owned life insurance - - 375 - (375) Debit card interchange income 930 830 900 100 30 Other income 1,160 1,296 1,147 (136) 13 Total noninterest income $ 7,481$ 6,321$ 9,840$ 1,160$ (2,359) 43

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Table of Contents On a sequential quarter basis residential mortgage banking revenue results showed an encouraging increase but remains well below levels seen in 2013. Trust income improved from first quarter and returned to the level seen in second quarter 2013. Other categories of Company noninterest income were essentially flat or down quarter over quarter with the exception of gains on securities sales. Similar results are found when comparing second quarter 2014 to second quarter 2013 with two noteworthy exceptions. Last year, the Company recorded sizable gains on securities sales. Second quarter 2013 also included a death benefit realized on bank owned life insurance. Noninterest Expense 2nd Qtr 2014 Three Months Ended Dollar Change From (in thousands) 2nd Qtr 1st Qtr 2nd Qtr 1st Qtr 2nd Qtr 2014 2014 2013 2014 2013 Salaries $ 7,128$ 6,872$ 6,987$ 256$ 141 Bonus 592 709 621 (117) (29) Benefits and other 1,463 1,520 1,569 (57) (106) Total salaries and employee benefits 9,183 9,101 9,177 82 6 Occupancy expense, net 1,185 1,481 1,242 (296) (57) Furniture and equipment expense 984 983 1,104 1 (120) FDIC insurance 627 279 1,024 348 (397) General bank insurance 343 489 491 (146) (148) Amortization of core deposit intangible assets 511 512 525 (1) (14) Advertising expense 459 303 328 156 131 Debit card interchange expense 412 378 362 34 50 Legal fees 409 257 486 152 (77) Other real estate owned expense, net 1,650 1,008 3,302 642 (1,652) Other expense 3,289 2,725 3,510 564 (221) Total noninterest expense $ 19,052$ 17,516$ 21,551$ 1,536$ (2,499)



Expenses increased in second quarter from first quarter largely on higher expenses related to OREO valuation adjustments and reduced gain on sale of OREO properties. Second quarter expenses for consulting, web site development, printing, franchise tax and a debit card fraud loss also contributed to the sequential quarter noninterest expense increase.

Total noninterest expense for second quarter declined 11.6% compared to second quarter 2013. Sharply lower expense related to OREO and FDIC insurance were the main sources of the expense decline. Income Taxes



The Company recorded a tax expense of $1.1 million on $3.1 million pre-tax income for the second quarter of 2014. For the six months ended June 30, 2014, tax expense was composed of $77,000 in current income tax benefit and $2.3 million in deferred income tax expense.

There have been no significant changes in the Company's ability to utilize the deferred tax assets through June 30, 2014. As such, the Company has not changed the valuation reserve on the deferred tax assets in 2014. On September 12, 2012, the Company and the Bank, as rights agent, entered into the Amended and Restated Rights Agreement and Tax Benefits Preservation Plan (the "Tax Benefits Plan"). The Tax Benefits Plan amended and restated the Rights Agreement, dated September 17, 2002. The purpose of the Tax Benefits Plan is to protect the Company's deferred tax asset against an unsolicited ownership change, which could significantly limit the Company's ability to utilize its deferred tax assets. The Tax Benefits Plan was ratified by the Company's stockholders at the Company's 2013 annual meeting. In connection with the public offering, the Company amended the Tax Benefits Plan on April 3, 2014, to allow two investors to purchase more than 5% of the Company's common stock. A copy of the amended plan document is attached as Exhibit 10.1. 44

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Table of Contents Financial Condition Total assets increased $42.8 million, or 2.1%, from December 31, 2013, to $2.05 billion as of June 30, 2014. Loans increased by $31.5 million, or 2.9%, as management continued to emphasize credit quality under an overarching relationship lending program. At the same time, loan charge-off activity reduced balances and collateral that previously secured loans moved to OREO. OREO decreased $2.3 million, or 5.5% at June 30, 2014, compared to year end 2013. Available-for-sale securities decreased by $42.4 million while held-to-maturity securities increased $8.1 million in the six months ended June 30, 2014. The core deposit intangible asset related to the Heritage Bank acquisition in February 2008 decreased from $1.2 million at December 31, 2013, to $154,000 as of June 30, 2014. Management performed an annual review of the core deposit intangible assets as of November 30, 2013. Based upon that review and ongoing quarterly monitoring, management determined there was no impairment of the core deposit intangible asset as of June 30, 2014. Loans Total loans were $1.13 billion as of June 30, 2014, an increase of $31.5 million from $1.10 billion as of December 31, 2013. The increase in loans reflects successful loan production work in the period after extensive work in previous periods to build a robust loan pipeline. An overriding effort to develop relationship based loan clients also resulted in current loan clients more closely reflecting our core clientele. Our existing commercial clients continue to be reluctant in utilizing existing lines of credit to the extent we would prefer. Challenging economic headwinds and an intensely competitive environment served to temper overall loan growth. June 30, 2014 Major Classification of Loans as of



Dollar Change From (in thousands) June 30, March 31, December 31, March 31, December 31,

2014 2014 2013 2014



2013

Commercial $ 106,752$ 98,321$ 94,736$ 8,431$ 12,016 Real estate - commercial 599,796 579,297 560,233 20,499 39,563 Real estate - construction 32,265 32,016 29,351 249 2,914 Real estate - residential 368,592 375,781 390,201 (7,189) (21,609) Consumer 3,064 2,837 2,760 227 304 Overdraft 381 301 628 80 (247) Lease financing receivables 8,722 9,227 10,069 (505) (1,347) Other 12,700 13,019 12,793 (319) (93) 1,132,272 1,110,799 1,100,771 21,473 31,501 Net deferred loan costs 475 438 485 37 (10) $ 1,132,747$ 1,111,237$ 1,101,256$ 21,510$ 31,491 The quality of the loan portfolio incorporates not only Company credit decisions but also the economic health of the communities in which the Company operates. The local economies are still subject to the economic headwinds that have been experienced nationwide. The uneven and occasionally adverse economic conditions continue to affect the midwest region in particular and financial markets generally. As the Company is located in a corridor with significant open space and undeveloped real estate, real estate lending (including commercial, residential, and construction) has been and continues to be a sizeable portion of the portfolio. These categories comprised 88.3% of the portfolio as of June 30, 2014, compared to 89.0% of the portfolio as of December 31, 2013. The Company continues to oversee and manage its loan portfolio in accordance with interagency guidance on risk management. 45

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Table of Contents Securities June 30, 2014 (in thousands) Securities Portfolio As of Dollar Change From June 30, March 31, December 31, March 31, December 31, Securities available-for-sale, at fair value 2014 2014 2013 2014 2013 U.S. Treasury $ 1,538$ 1,540$ 1,544$ (2) $ (6) U.S. government agencies 1,653 1,665 1,672 (12) (19) States and political subdivisions 15,753 26,459 16,794 (10,706) (1,041) Corporate bonds 31,350 31,272 15,102 78 16,248 Collateralized mortgage obligations 33,083 51,124 63,876 (18,041) (30,793) Asset-backed securities 246,437 288,152 273,203 (41,715) (26,766) Collateralized debt obligations - - - - - Total securities available-for-sale $ 329,814$ 400,212$ 372,191$ (70,398)$ (42,377) Securities held-to-maturity, at amortized cost U.S. government agency mortgage-backed $ 37,306$ 35,292$ 35,268$ 2,014$ 2,038 Collateralized mortgage obligations 227,377 229,006 221,303 (1,629) 6,074 Total securities held-to-maturity $ 264,683$ 264,298$ 256,571$ 385$ 8,112 Total securities $ 594,497$ 664,510$ 628,762$ (70,013)$ (34,265) Total securities decreased from $664.5 million at March 31, 2014, to $594.5 million at June 30, 2014. Held-to-maturity securities of $264.7 million at June 30, 2014, were essentially unchanged from the end of the first quarter. Available-for-sale securities were $400.2 million at March 31, 2014, and declined to $329.8 million at the end of the second quarter. Purchases during the quarter ended June 30, 2014, were $71.1 million, most of these in the asset-backed category student loan guaranteed investments. Second quarter sales were $131.3 million, also primarily asset-backed securities. These securities were sold to raise cash for potential reinvestment in either other student loan guaranteed securities or other higher yielding investments.



The Company's Board of Directors, at their July 15, 2014, meeting approved changes to the Investment Policy to allow purchases of collateralized loan obligations for the investment portfolio. Policy guidelines dictate that securities purchased are Volcker Rule compliant, are rated "A-" or higher, and meet other stringent credit assessments.

Additionally, the Company owned securities from five issuers where each issuer holding exceeded 10% of total stockholders' equity. Company investment managers have assessed the quality of the issuers to confirm that underwriting standards meet expectation and the requirements under the Company's Investment Policy. Further, all of these securities are guaranteed by the U. S. Department of Education. The net unrealized losses on available-for-sale securities in the portfolio, net of deferred tax benefit, decreased by $1.4 million from $2.4 million at December 31, 2013, to $1.0 million as of June 30, 2014. Note 2 of the consolidated financial statements contains additional information related to the investment portfolio. Deposits and Borrowings June 30 2014 Deposit Detail As of Dollar Change From (in thousands) June 30, March 31, December 31, March 31,



December 31,

2014 2014 2013 2014



2013

Noninterest bearing $ 393,964$ 387,090$ 373,389$ 6,874

$ 20,575 Savings 238,167 244,944 228,589 (6,777) 9,578 NOW accounts 310,721 309,385 297,852 1,336 12,869 Money market accounts 304,766 318,192 309,859 (13,426) (5,093) Certificates of deposits: of less than $100,000 274,971 282,569 288,345 (7,598) (13,374) of $100,000 or more 178,235 182,101 184,094 (3,866) (5,859) $ 1,700,824$ 1,724,281$ 1,682,128$ (23,457)$ 18,696 46

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Table of Contents Total deposits increased $18.7 million, or 1.1%, during the six month period ended June 30, 2014 to $1.70 billion. During the same period, savings, NOW and money market deposit volume increased by $17.4 million. Also during the period, time deposits decreased by $19.2 million while noninterest bearing demand increased $20.6 million. We continue to be among market share leaders in our home counties of Kane and Kendall in Illinois. Average balance for interest bearing deposits was $1.32 billion for the six month period reflecting first half of 2014. Average balance for noninterest bearing deposits was $381.9 million in the same period. Similar to the trends discussed above, when compared to 2013 first half year information, average balances in 2014 reflect lower interest bearing deposit volumes, especially in time deposits, but increased noninterest bearing deposits. Management believes that reductions in average time deposits reflect maturities of deposits from past higher rate environments. One of the Company's most significant borrowing relationships continued to be the $45.5 million credit facility with Bank of America. That credit facility was originally composed of a $30.5 million senior debt facility and $500,000 in term debt, as well as $45.0 million of Subordinated Debt. The subordinated debt and the term debt portion of the senior debt facility mature on March 31, 2018. The interest rate on the senior debt facility resets quarterly and is based on, at the Company's option, either the lender's prime rate or three-month LIBOR plus 90 basis points. The interest rate on the subordinated debt resets quarterly, and is equal to three-month LIBOR plus 150 basis points. The Company had no outstanding balance on the senior line of credit when it matured but did have $500,000 in principal outstanding in term debt and $45.0 million in principal outstanding in subordinated debt at the end of both December 31, 2013, and June 30, 2014. The term debt is secured by all of the outstanding capital stock of the Bank. The Company has made all required interest payments on the outstanding principal amounts on a timely basis. The credit facility agreement contains usual and customary provisions regarding acceleration of the senior debt upon the occurrence of an event of default. The senior debt agreement also contains certain customary representations and warranties as well as financial and negative covenants. At June 30, 2014, the Company was out of compliance with one of the financial covenants contained within the credit agreement. Previously, the Company had been out of compliance with two of the financial covenants. The agreement provides that upon an event of default as the result of the Company's failure to comply with a financial covenant, the lender may (i) terminate all commitments to extend further credit, (ii) increase the interest rate on the revolving line of the term debt by 200 basis points, (iii) declare the senior debt immediately due and payable and (iv) exercise all of its rights and remedies at law, in equity and/or pursuant to any or all collateral documents, including foreclosing on the collateral. The total outstanding principal amount of the senior debt is the $500,000 in term debt. Because the subordinated debt is treated as Tier 2 capital for regulatory capital purposes, the agreement does not provide the lender with any rights of acceleration or other remedies with regard to the subordinated debt upon an event of default caused by the Company's failure to comply with a financial covenant.



The Company increased its securities sold under repurchase agreements to $38.1 million at June 30, 2014, from $22.6 million at December 31, 2013. The Company had no other short-term borrowings at June 30, 2014 representing a decrease from $5.0 million at December 31, 2013.

The Company is also obligated on $58.4 million of junior subordinated debentures.

Capital As of June 30, 2014, total stockholders' equity was $192.6 million, which was an increase of $44.9 million from $147.7 million as of December 31, 2013. This increase was primarily attributable to the capital raise conducted in second quarter in which the Company issued 15,525,000 shares of common stock with net proceeds exceeding $64.0 million. Subsequent to the offering, the Company used $19.7 million to pay all outstanding interest on the junior subordinated debentures and repurchase 25,669 shares of Series B Stock. The Company repurchased the preferred shares for 94.75% of the liquidation value totaling payments of $24.3 million. Payments of $22.9 million were made to a large private investor with other payments totaling $1.4 million made to directors of the Company. Lastly, the Company used $10.3 million to pay all accumulated and outstanding Series B Stock dividends. As part of the Series B Stock repurchase agreements, the holders of the Series B Stock agreed to forbear any rights to accumulated, unpaid dividends. The remaining proceeds from the capital raise are being held for general corporate purposes. The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighting of the Bank's assets, developed by the OCC and the other bank regulatory agencies. In connection with the current economic environment, the Bank's current level of nonperforming assets and the risk-based capital guidelines, the Bank's board of directors has determined that the Bank should maintain a Tier 1 leverage capital ratio at or above eight percent (8%) and a total risk-based capital ratio at or above twelve percent (12%). The Bank currently exceeds those thresholds. See Note 11 -Regulatory and Capital Matters for a complete discussion of all regulatory capital guidelines. As previously announced in the third quarter of 2010, the Company elected to defer regularly scheduled interest payments on $58.4 million of junior subordinated debentures related to the trust preferred securities issued by its two statutory trust subsidiaries, Old Second Capital Trust I and Old Second Capital Trust II. Because of the deferral on the subordinated debentures, the trusts deferred regularly scheduled dividends on their trust preferred securities. On April 21, 2014, the Company paid the accumulated and unpaid interest on the trust preferred securities and terminated the deferral period. The interest was not immediately paid by the indenture 47 --------------------------------------------------------------------------------



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trustees to the holders of such trust preferred securities. Instead, the trustees held the interest payments in irrevocable deposit accounts to pay such amounts on the next applicable payment dates under the indentures to holders of the securities on the record dates set forth in the appropriate indenture. During the fourth quarter 2012, the U.S. Treasury ("Treasury") announced the continuation of individual auctions of the Series B Stock that was issued through the Troubled Asset Relief Program and Capital Purchase Program (the "CPP"). At that time, the Company was informed that the Series B Stock would be auctioned. Auction transactions were settled in first quarter 2013 reflecting Treasury's efforts to conclude the CPP. The auctions were successful for the Treasury as all of the Series B Stock held by Treasury was sold to third parties, including certain of our directors. At December 31, 2013 and June 30, 2014, Old Second Bancorp carried $72.9 million and $47.3 million, respectively of Series B Stock in total stockholders' equity. Pursuant to the terms of the Series B Stock, the dividends paid on the Series B Stock increased from 5% to 9% in February 2014. Beginning January 1, 2015, the Company and the Bank will be subject to the new capital requirements of Basel III. The Basel III Rules not only increase selected minimum regulatory capital ratios, but also introduce a new Common Equity Tier 1 capital ratio and the concept of a capital conservation buffer. The rules revise the criteria that certain instruments must meet to qualify as Tier 1 or Tier 2 capital. The Basel III Rules permit smaller banking organizations to retain, through a one-time election, the existing treatment of accumulated other comprehensive income. Management is reviewing the new rules to assess their impact on the Company. 48 --------------------------------------------------------------------------------

Table of Contents The Company's non-GAAP tangible common equity to tangible assets and the Tier 1 common equity to risk weighted assets increased to 7.09% and 6.48%, respectively, at June 30, 2014, compared to 3.67% and 0.77%, respectively, at December 31, 2013. The issuance of 15,525,000 common shares net of repurchasing 25,669 Series B Stock resulted in a positive impact on the regulatory ratios and the non-GAAP ratios noted above in the quarter ending June 30, 2014. The Company does not anticipate any significant effect to the Bank's regulatory ratios as the Company does not have any immediate plans to use any of the proceeds to increase Bank capital. (unaudited) (unaudited) As of June 30, As of December 31, (dollars in thousands) 2014 2013 2013 Tier 1 capital Total equity $ 192,618$ 71,102 $ 147,692 Tier 1 adjustments: Trust preferred securities allowed 56,625 27,195 51,577



Cumulative other comprehensive loss (income) 5,339 10,484

7,038 Disallowed goodwill and intangible assets (154) (2,226) (1,177) Disallowed deferred tax assets (64,302) - (70,350) Other (550) (530) (581) Tier 1 capital $ 189,576$ 106,025 $ 134,199 Total capital Tier 1 capital $ 189,576$ 106,025 $ 134,199 Tier 2 additions: Allowable portion of allowance for loan losses 16,597 17,016 15,898 Additional trust preferred securities disallowed for Tier 1 capital - 29,430 5,048 Subordinated debt 27,000 36,000 36,000 Tier 2 additions subtotal 43,597 82,446 56,946 Allowable Tier 2 43,597 82,446 56,946 Other Tier 2 capital components (6) (6) (6) Total capital $ 233,167$ 188,465 $ 191,139 Tangible common equity Total equity $ 192,618$ 71,102 $ 147,692 Less: Preferred equity 47,331 72,396 72,942 Goodwill and intangible assets 154 2,226 1,177 Tangible common equity $ 145,133$ (3,520) $ 73,573 Tier 1 common equity Tangible common equity $ 145,133$ (3,520) $ 73,573 Tier 1 adjustments: Cumulative other comprehensive income 5,339 10,484 7,038 Other (64,852) (530) (70,931) Tier 1 common equity $ 85,620$ 6,434 $ 9,680 Tangible assets Total assets $ 2,046,864$ 1,932,934 $ 2,004,034 Less: Goodwill and intangible assets 154 2,226 1,177 Tangible assets $ 2,046,710$ 1,930,708 $ 2,002,857 Total risk-weighted assets On balance sheet $ 1,283,134$ 1,308,166 $ 1,224,438 Off balance sheet 37,403 35,125 36,023 Total risk-weighted assets $ 1,320,537$ 1,343,291 $ 1,260,461 Average assets Total average assets for leverage $ 1,993,966$ 1,940,942 $ 1,927,217 49

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