Overview

Old Second Bancorp, Inc. (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 trust services. The Company has offices located in Cook, Kane, Kendall, DeKalb, DuPage, LaSalle and Will counties in Illinois. On February 8, 2008, the Company completed its acquisition of HeritageBanc, Inc. ("Heritage") and merged Heritage Bank with and into Old Second National Bank. As a result of the merger, the Company expanded its franchise into southwestern Cook County and the higher growth markets of the south Chicago suburbs by adding five retail banking locations and one mobile banking operation. This acquisition provided additional market penetration and allowed the Company to fill in its footprint surrounding the Chicago metropolitan area. The Company also offers insurance products through Old Second Financial, Inc.

Since the acquisition of Heritage, all major integration initiatives have been completed, and the Company began to realize economic benefits of the transaction in the second quarter of 2008. The acquired client base provided revenue opportunities for both the corporate and retail business units as the Company's retail and mortgage services, wealth management and employee benefit services offerings were more expansive than the previous product and services offered to Heritage clientele. Additionally, access to remote capture services and other treasury management products also became available to complement the traditional commercial deposit and loan products previously offered. The Company paid consideration of $43.0 million in cash and 1,563,636 shares of the Company's stock valued at $27.50 per share to consummate the Heritage acquisition. Details related to the allocation of the purchase price for this business combination are discussed in Note 2. The terms of the credit facilities that were established to complete the acquisition are detailed in Note 9.

Recent Developments

Recent events in the U.S. and global financial markets, including the deterioration of the worldwide credit markets, have created significant challenges for financial institutions such as the Company. Dramatic declines in the housing market during the past year, marked by falling home prices and increasing levels of mortgage foreclosures, have resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. In addition, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions, as a result of concern about the stability of the financial markets and the strength of counterparties.

In response to the crises affecting the U.S. banking system and financial markets and attempt to bolster the distressed economy and improve consumer confidence in the financial system, on October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the "Stabilization Act"). The Stabilization Act authorizes the Secretary of the U.S. Treasury and the Federal Deposit Insurance Corporation (the "FDIC") to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system. Pursuant to the Stabilization Act, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.

On October 14, 2008, the U.S. Treasury announced that it will purchase equity stakes in eligible financial institutions that wish to participate. This program, known as the Capital Purchase Program, allocates $250 billion from the $700 billion authorized by the Stabilization Act to the U.S. Treasury for the purchase of senior preferred shares from qualifying financial institutions. Eligible institutions will be

able to sell equity interests to the U.S. Treasury in amounts equal to between 1% and 3% of the institution's risk-weighted assets. In conjunction with the purchase of preferred stock, the U.S. Treasury will receive warrants to purchase common stock from the participating institutions with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the U.S. Treasury's standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds equity issued under the Capital Purchase Program. Many financial institutions have already announced that they will participate in the Capital Purchase Program. While the Company's management is confident that the Company has sufficient capital to support continued growth, the Company has applied to participate in the Capital Purchase Program.

Also on October 14, 2008, using the systemic risk exception to the FDIC Improvement Act of 1991, the U.S. Treasury authorized the FDIC to provide a 100% guarantee of newly-issued senior unsecured debt and deposits in non-interest bearing accounts at FDIC insured institutions. Initially, all eligible financial institutions will automatically be covered under this program, known as the Temporary Liquidity Guarantee Program, without incurring any fees for a period of 30 days. Coverage under the Temporary Liquidity Guarantee Program after the initial 30-day period is available to insured financial institutions at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing deposits. After the initial 30-day period, institutions will continue to be covered under the Temporary Liquidity Guarantee Program unless they inform the FDIC that they have decided to opt out of the program. The Company is assessing its participation in the Temporary Liquidity Guarantee Program and anticipates that it will participate in the insurance program covering the non-interest bearing deposits but not participate in the program to guarantee unsecured senior debt.

Under the Troubled Asset Auction Program, another initiative based on the authority granted by the Stabilization Act, the U.S. Treasury, through a newly-created Office of Financial Stability, will purchase certain troubled mortgage-related assets from financial institutions in a reverse-auction format. Troubled assets eligible for purchase by the Office of Financial Stability include residential and commercial mortgages originated on or before March 14, 2008, securities or obligations that are based on such mortgages, and any other financial instrument that the Secretary of the U.S. Treasury determines, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, is necessary to promote financial market stability. The U.S. Treasury has not issued any definitive guidance regarding this program and the Company's management has not determined whether or not it will participate.

Under the Stabilization Act, the U.S. Treasury is also required to establish a program that will guarantee principal of, and interest on, troubled assets originated or issued prior to March 14, 2008, including mortgage-backed securities. The program may take any form and may vary by asset class, but it must be voluntary and self-funding. The U.S. Treasury has the authority to set premiums to reflect the credit risk characteristics of the insured assets. The U.S. Treasury has solicited requests for comments on how the program should be structured but no program has been implemented to date. The Stabilization Act also temporarily increases the amount of insurance coverage of deposit accounts held at FDIC-insured depository institutions, including Old Second National Bank, from $100,000 to $250,000. The increased coverage is effective during the period from October 3, 2008 until December 31, 2009.

It is not clear at this time what impact the Stabilization Act, the Capital Purchase Program, the Temporary Liquidity Guarantee Program, the Troubled Asset Auction Program, other liquidity and funding initiatives of the Federal Reserve and other agencies that have been previously announced, and any additional programs that may be initiated in the future will have on the Company's future financial condition and results of operations.

The preceding is a summary of recently enacted laws and regulations that could materially impact the Company's results of operations or financial condition. This discussion is qualified in its entirety by reference to such laws and regulations and should be read in conjunction with "Supervision and Regulation" discussion contained in ITEM 1: BUSINESS of the Company's 2007 Form 10-K.

Results of Operations

Net income for the third quarter of 2008 decreased to $4.1 million, $0.30 diluted earnings per share, compared with $6.1 million, or $0.49 diluted earnings per share, in the third quarter of 2007. Earnings for the first nine months of 2008 also decreased to $1.25 per diluted share, on $17.0 million in net income, compared with $1.37 per diluted share in the first nine months of 2007, on earnings of $17.6 million. Earnings in the first nine months of 2008 were primarily affected by the Heritage acquisition, gains on sales of securities as well as an increased provision for loan losses. The Company's earnings in 2008 included the contribution of Heritage since its acquisition on February 8, 2008. Realized losses on securities totaled $20,000 in the third quarter of 2008, which brought the net realized gains total to $1.4 million for the year. In the third quarter of 2007, there was $11,000 in realized gains from sold securities, which brought the net realized gains total to $493,000 for that year. The Company recorded a $9.1 million provision for loan losses in the nine months ended September 30, 2008, which included an addition of $6.3 million in the third quarter. In the same period in 2007, the provision for loan losses was $1.2 million, $600,000 of which was added in the third quarter. The return on average equity decreased from 15.70% in the first nine months of 2007, to 11.65% for the same period in 2008.

The transaction charges related to Heritage, net of taxes calculated at a 35% statutory rate, totaled $16,000 in the third quarter of 2008 and $612,000, or $.04 per diluted share in the first nine months of 2008. Core net income, which is calculated by excluding these transaction costs, was $17.6 million in the first nine months of 2008, which equates to core diluted earnings per share of $1.29 and a core return on average equity of 12.07%. Management believes that the exclusion of the transaction charges more accurately reflects income from continuing operations, and references to core net income, core diluted earnings per share, and ratios identified as "core" are all non-GAAP measurements.

Net Interest Income

Net interest income increased from $50.8 million in the first nine months of 2007 to $66.1 million in the first nine months of 2008. Average earning assets grew $360.2 million, or 15.5%, from September 30, 2007 to September 30, 2008, primarily due to organic growth and the Heritage acquisition. The Company acquired $329.0 million in earning assets through the acquisition, which included $283.6 million in loans and $45.0 million in investments. Average interest bearing liabilities increased $317.1 million, or 15.4%, from September 30, 2007 and such increase was influenced by these same factors as the asset growth. Additionally, the Company's borrowings increased $43.0 million as a result of financing the cash portion of the consideration paid to Heritage shareholders for the acquisition. The net interest margin (tax equivalent basis), expressed as a percentage of average earning assets, increased from 3.06% in the first nine months of 2007 to 3.41% in the first nine months of 2008. The average tax-equivalent yield on earning assets decreased from 6.70% in the first nine months of 2007 to 6.02%, or 68 basis points, in the first nine months of 2008. At the same time, the cost of funds on interest bearing liabilities decreased from 4.18% to 3.03%, or 115 basis points.

Net interest income increased from $17.3 million in the third quarter of 2007 to $23.6 million in the third quarter of 2008. During the same period, the net interest margin (tax-equivalent basis), expressed as a percentage of average earning assets, increased from 3.01% in 2007 to 3.61% in 2008. The third quarter 2008 net interest income was enhanced by growth in average earning assets of $306.3 million, or 12.8%, which included the acquisition and organic growth factors discussed above. The average tax-equivalent yield on earning assets decreased from 6.74% in the third quarter of 2007 to 5.83% in the third quarter of 2008, or 91 basis points. The cost of interest-bearing liabilities also decreased from 4.23% to 2.57%, or 166 basis points, in the same period. The general decrease in interest rates lowered interest expense to a greater degree than it reduced interest income, and thereby improved the net interest margin.

Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios. In addition to the "core" earnings discussion related to the Heritage acquisition transaction costs found in the results of operation section of the preceding page, management

has traditionally disclosed other certain non-GAAP ratios to evaluate and measure the Company's performance. 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 month and nine month periods ended September 30, 2008 and 2007.

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 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.

                         ANALYSIS OF AVERAGE BALANCES,

                       TAX EQUIVALENT INTEREST AND RATES

                 Three Months ended September 30, 2008 and 2007

                   (Dollar amounts in thousands - unaudited)



                                           2008                               2007
                               Average                            Average
                               Balance      Interest    Rate      Balance      Interest    Rate
Assets
Interest bearing deposits    $      2,277   $      30    5.16 % $        643   $       4    2.43 %
Federal funds sold                  8,217          40    1.90         11,114         138    4.86
Securities:
Taxable                           309,470       3,591    4.64        378,666       4,605    4.86
Non-taxable (tax
equivalent)                       150,496       2,283    6.07        145,993       2,298    6.30
Total securities                  459,966       5,874    5.11        524,659       6,903    5.26
Loans and loans held for
sale (1)                        2,228,863      34,110    5.99      1,856,568      33,989    7.16
Total interest earning
assets                          2,699,323      40,054    5.83      2,392,984      41,034    6.74
Cash and due from banks            51,600           -       -         53,054           -       -
Allowance for loan losses         (22,114 )         -       -        (16,906 )         -       -
Other noninterest-bearing
assets                            208,456           -       -        128,468           -       -
Total assets                 $  2,937,265                       $  2,557,600

Liabilities and
Stockholders' Equity
NOW accounts                 $    322,074   $     760    0.94 % $    255,402   $   1,207    1.87 %
Money market accounts             577,267       2,658    1.83        520,238       5,168    3.94
Savings accounts                  112,364         145    0.51        101,626         228    0.89
Time deposits                   1,029,253       8,987    3.47        991,867      12,377    4.95
Interest bearing deposits       2,040,958      12,550    2.45      1,869,133      18,980    4.03
Securities sold under
repurchase agreements              45,285         182    1.60         55,565         612    4.37
Federal funds purchased            34,350         196    2.23         64,625         893    5.41
Other short-term
borrowings                        160,301         848    2.07         80,412       1,058    5.15
Junior subordinated
debentures                         58,378       1,072    7.35         57,399       1,053    7.34
Subordinated debt                  45,000         495    4.30              -           -       -
Notes payable and other
borrowings                         24,484         219    3.50         17,359         282    6.36
Total interest bearing
liabilities                     2,408,756      15,562    2.57      2,144,493      22,878    4.23
Noninterest bearing
deposits                          307,664           -       -        258,546           -       -
Accrued interest and other
liabilities                        17,423           -       -         16,455           -       -
Stockholders' equity              203,422           -       -        138,106           -       -
Total liabilities and
stockholders' equity         $  2,937,265                       $  2,557,600
Net interest income (tax
equivalent)                                 $  24,492                          $  18,156
Net interest income (tax
equivalent) to total
earning assets                                           3.61 %                             3.01 %
Interest bearing
liabilities to earning
assets                              89.24 %                            89.62 %

                         ANALYSIS OF AVERAGE BALANCES,

                       TAX EQUIVALENT INTEREST AND RATES

                 Nine Months ended September 30, 2008 and 2007

                   (Dollar amounts in thousands - unaudited)



                                           2008                               2007
                               Average                            Average
                               Balance      Interest    Rate      Balance      Interest    Rate
Assets
Interest bearing deposits    $     1,435   $       41    3.75 % $     1,117   $       28    3.31 %
Federal funds sold                 7,828          124    2.08         7,233          275    5.01
Securities:
Taxable                          359,510       12,551    4.65       355,085       12,528    4.70
Non-taxable (tax
equivalent)                      153,494        6,894    5.99       147,089        6,528    5.92
Total securities                 513,004       19,445    5.05       502,174       19,056    5.06
Loans and loans held for
sale (1)                       2,163,915      103,176    6.26     1,815,462       98,622    7.16
Total interest earning
assets                         2,686,182      122,786    6.02     2,325,986      117,981    6.70
Cash and due from banks           50,061            -       -        50,647            -       -
Allowance for loan losses        (20,578 )          -       -       (16,479 )          -       -
Other noninterest-bearing
assets                           194,597            -       -       126,976            -       -
Total assets                 $ 2,910,262                        $ 2,487,130

Liabilities and
Stockholders' Equity
NOW accounts                 $   292,457   $    2,217    1.01 % $   246,555   $    3,122    1.69 %
Money market accounts            553,800        9,173    2.21       488,099       14,343    3.93
Savings accounts                 111,292          487    0.58       104,834          670    0.85
Time deposits                  1,079,447       32,742    4.05       982,797       36,321    4.94
Interest bearing deposits      2,036,996       44,619    2.93     1,822,285       54,456    4.00
Securities sold under
repurchase agreements             45,621          720    2.11        54,673        1,830    4.48
Federal funds purchased           59,075        1,359    3.02        51,753        2,133    5.43
Other short-term
borrowings                       119,767        2,249    2.47        74,842        2,968    5.23
Junior subordinated
debentures                        58,267        3,209    7.34        46,164        2,577    7.44
Subordinated debt                 38,923        1,287    4.34             -            -       -
Notes payable and other
borrowings                        23,811          673    3.71        15,615          745    6.29
Total interest bearing
liabilities                    2,382,460       54,116    3.03     2,065,332       64,709    4.18
Noninterest bearing
deposits                         314,592            -       -       255,431            -       -
Accrued interest and other
liabilities                       18,250            -       -        16,939            -       -
Stockholders' equity             194,960            -       -       149,428            -       -
Total liabilities and
stockholders' equity         $ 2,910,262                        $ 2,487,130
Net interest income (tax
equivalent)                                $   68,670                         $   53,272
Net interest income (tax
equivalent) to total
earning assets                                           3.41 %                             3.06 %
Interest bearing
liabilities to earning
assets                             88.69 %                            88.79 %

As indicated previously, net interest income and net interest income to earning assets 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. The table below provides a reconciliation of each non-GAAP TE measure to the GAAP equivalent for the periods indicated:

                                                  Effect of Tax Equivalent Adjustment
                                              Three Months Ended         Nine Months Ended
                                                September 30,              September 30,
                                              2008          2007         2008         2007

Interest income (GAAP)                     $    39,195    $  40,186    $ 120,217    $ 115,546
Taxable equivalent adjustment - loans               60           44          156          150
Taxable equivalent adjustment -
securities                                         799          804        2,413        2,285
Interest income (TE)                            40,054       41,034      122,786      117,981
Less: interest expense (GAAP)                   15,562       22,878       54,116       64,709
Net interest income (TE)                   $    24,492    $  18,156    $  68,670    $  53,272
Net interest and income (GAAP)             $    23,633    $  17,308    $  66,101    $  50,837
Net interest income to total interest
earning assets                                    3.48 %       2.87 %       3.29 %       2.92 %
Net interest income to total interest
earning assets (TE)                               3.61 %       3.01 %       3.41 %       3.06 %

Provision for Loan Losses

In the first nine months of 2008, the Company recorded a $9.1 million provision for loan losses, which included an addition of $6.3 million in the third quarter. Additionally, management continues to believe that the $3.0 million allowance for loan losses assumed in the Heritage transaction in the first quarter was adequate to address the risks specific to the loan portfolio purchased. Approximately $2.4 million of the September 30, 2008 problem loan total was acquired through the Heritage Bank acquisition and these loans have a total specific allocation estimate of $711,000 at September 30, 2008. In the first nine months of 2007, the provision for loan losses was $1.2 million, $600,000 of which was added in the third quarter. Nonperforming loans increased to $65.7 million at September 30, 2008 from $6.0 million at December 31, 2007, and $5.6 million at September 30, 2007. Charge-offs, net of recoveries, totaled $4.8 million and $77,000 in the first nine months of 2008 and 2007, respectively. Net charge-offs totaled $3.7 million in the third quarter of 2008 and $45,000 in the third quarter of 2007. Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio.

Nonperforming loans increased $59.7 million from $6.0 million at December 31, 2007 to $65.7 million at September 30, 2008. Nonperforming loans also increased on a linked quarter basis from $30.7 million at June 30, 2008. The nonperforming loans at September 30, 2008 were heavily concentrated in a handful of credit relationships. Four relationships made up 58.1% of the total, and ten relationships made up 75.6% of the total nonperforming loans. The following narrative provides detail relative to each of the largest four nonperforming relationships.

† The first nonperforming commercial and residential land developer relationship has a total exposure outstanding of $14.0 million. $5.7 million of this amount was past due more than ninety days and still accruing interest. . . .