Old National Bancorp — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Unaudited consolidated financial statements; dollar amounts below are in millions unless otherwise indicated.
Business context and reporting period
Old National is a regional banking company operating primarily in Indiana, Illinois and Kentucky. Results were substantially affected by its January 1 acquisition of Monroe Bancorp and the July 29 FDIC-assisted acquisition of Integra Bank. Integra added 52 branches, acquired assets with an estimated fair value of approximately $1.8 billion and deposits of approximately $1.4 billion. The FDIC loss-sharing agreements cover specified acquired loans and real estate assets.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $72.6 | $54.2 | $196.3 | $164.4 |
| Noninterest income | $47.3 | $42.0 | $133.7 | $127.9 |
| Provision for loan losses | Credit of $0.1 | $6.4 expense | $6.4 expense | $23.7 expense |
| Noninterest expense | $95.2 | $76.1 | $254.8 | $231.0 |
| Net income | $16.8 | $11.9 | $50.2 | $32.5 |
| Diluted earnings per share | $0.18 | $0.13 | $0.53 | $0.37 |
| Fully taxable-equivalent net interest margin | 3.96% | 3.42% | 3.75% | 3.38% |
- Reported net interest income increased 34.0% in the quarter and 19.4% year to date. Management attributed the increase principally to the Monroe and Integra acquisitions, lower funding costs and acquired-loan accretion. Acquired-asset accretion increased margin by 68 basis points in Q3 and 42 basis points year to date; management expected this benefit to decline each quarter.
- Total assets were $8.93 billion at September 30, up 19.0% from September 30, 2010. Loans were $4.85 billion, including $711.3 million of covered Integra loans; deposits were $6.87 billion; shareholders’ equity was $1.03 billion.
- Cash and cash equivalents were $269.2 million, versus $172.3 million a year earlier and $251.6 million at year-end 2010. For the first nine months, operating cash flow was $112.2 million, investing cash flow was positive $857.7 million and financing cash flow was negative $952.2 million; cash increased $17.7 million. Investing cash flow included acquired-bank cash and FDIC-assisted transaction flows.
- Short-term borrowings were $341.0 million and other borrowings were $443.9 million at quarter-end. Wholesale funding was 10.3% of total funding, down from 14.8% a year earlier. The company repaid $150 million of 6.75% subordinated bank notes after quarter-end.
- The reported efficiency ratio was 77.56% for Q3 versus 77.66% a year earlier; year-to-date it was 74.47% versus 77.21%. Return on average common equity was 6.61% for Q3 and 6.75% year to date.
Material changes versus comparable periods
- Q3 net income rose to $16.8 million from $11.9 million, while year-to-date net income increased to $50.2 million from $32.5 million. Earnings benefited from higher net interest income and materially lower loan-loss provision, partly offset by higher operating costs and taxes.
- Noninterest expense rose 25.0% in Q3 and 10.3% year to date, primarily due to the acquisitions, integration and retention costs, resumed incentive compensation, and higher professional fees. Q3 included $6.8 million of Integra acquisition and integration costs, approximately $3.2 million for the incentive plan, and a $2.0 million litigation accrual.
- Nonperforming loans excluding covered loans were $124.8 million, up from $69.8 million at September 30, 2010. Underperforming assets excluding covered assets were $135.3 million, or 3.26% of loans and other real estate owned, versus 2.08% a year earlier. Management said Monroe-related acquired loans were the primary driver of the increase.
- The allowance for loan losses was $65.2 million, down from $72.1 million a year earlier; it equaled 1.58% of loans excluding covered loans, versus 1.95%. Net charge-offs excluding covered loans declined to $13.5 million year to date from $21.1 million.
- Shareholders’ equity increased from $895.7 million at September 30, 2010, including approximately $90.1 million of shares issued for Monroe. The share count increased to 94.8 million outstanding at September 30, 2011, from 87.2 million a year earlier.
Outlook, commentary, risks and unusual items
- Management anticipated $2.5–$3.5 million of additional Integra acquisition and integration costs in Q4 2011 and potentially $3.5–$4.5 million in 2012, primarily related to branch divestitures. Following systems conversion and branch consolidation, management expected a 75% reduction in operating expense associated with the Integra franchise and cited an aspirational 65% efficiency-ratio target.
- All 52 Integra branches initially reopened under Old National; 13 had closed by October 31, 2011. An agreement signed October 13 provided for selling deposits of four Chicago-area branches, approximately $185 million, for a stated premium of about $0.5 million; Old National would retain the loans. Closing was expected around December 3, 2011.
- Integra loss sharing reimburses 80% of covered losses up to $275 million, none of losses between $275 million and $467.2 million, and 80% above $467.2 million. Covered loans were $711.3 million and covered OREO was $31.9 million at quarter-end. The economics depend on asset performance, FDIC reimbursement and compliance with agreement terms.
- Management described continued weak loan demand and economic uncertainty in its markets, and identified credit quality, real estate values, interest rates, liquidity, acquisition integration, deposit/customer attrition and regulatory change as risks. Management also cautioned that interest-rate simulation results are not guarantees: a parallel 3% rate increase was modeled to reduce one-year net interest income by 4.89%; the modeled one-year effect of a 1% increase was a 0.32% increase.
- Unusual items included $7.5 million of Q3 acquired-loan mark accretion benefiting net interest income, $2.0 million accrued for a tentative settlement of long-running trust litigation, and a higher effective tax rate. The Q3 effective tax rate was 32.4% versus 12.8% a year earlier; year-to-date it was 26.9% versus 13.8%.
- Capital ratios remained above regulatory minimums: consolidated Tier 1 leverage was 7.88%, Tier 1 risk-based capital was 12.17% and total risk-based capital was 13.67%. The filing reported bank leverage of 7.08% and bank total capital of 12.27% in the acquisition discussion.
- Other contingencies include a checking-account class action for which management could not estimate the likelihood or amount of loss; the class had not been certified and discovery was ongoing. The filing states pending legal matters could affect results or cash flows in a particular period.
Most important facts for investors to verify
- Whether Integra integration, branch consolidation and projected expense savings proceed on schedule and within management’s cost estimates.
- Performance of acquired and legacy loans, trends in nonaccrual/classified assets, and adequacy of the allowance; assess covered assets separately from unprotected exposures.
- Actual FDIC loss-share reimbursements, the agreement’s coverage bands and any related true-up liability; the recorded FDIC indemnification asset was $168.1 million and the true-up liability was $14.1 million.
- Sustainability of earnings excluding acquired-loan accretion and other acquisition-related or unusual items, and the effect of a higher effective tax rate and rising expenses.
- Developments in the trust-litigation settlement and checking-account class action, and any material change in capital, funding costs or liquidity.