Old National Bancorp — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Comparisons are with the corresponding 2017 periods unless noted. Dollar amounts are in millions unless stated otherwise.
Business context and period
Old National Bancorp is a Midwest community banking company. Its sole reportable segment is community banking, with operations concentrated in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota. Results reflect the November 2017 Anchor (MN) acquisition; the company also had a pending acquisition of Klein Financial at quarter-end.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $130.8 | $108.5 | $391.4 | $318.6 |
| Provision for loan losses | $0.8 | $0.3 | $3.6 | $2.0 |
| Noninterest income | $46.0 | $46.4 | $137.2 | $138.6 |
| Noninterest expense | $119.4 | $103.7 | $367.0 | $308.4 |
| Income before taxes | $56.7 | $50.8 | $158.0 | $146.8 |
| Net income | $51.3 | $39.4 | $143.3 | $114.2 |
| Diluted EPS | $0.34 | $0.29 | $0.94 | $0.84 |
Q3 net income increased 30%; nine-month net income increased 26%. Net interest income rose 21% for the quarter and 23% year to date, primarily reflecting Anchor’s contribution, higher loan yields, and growth in earning assets. Noninterest income was broadly flat, while expenses rose 15% in Q3 and 19% year to date.
Taxable-equivalent net interest margin was 3.51% in Q3 versus 3.52% a year earlier, and 3.51% for the nine months versus 3.48%. Q3 return on average assets was 1.18%; return on average common equity was 9.28%. The reported efficiency ratio was 64.71% for Q3 and 66.74% year to date (non-GAAP measures as defined by the company). The effective tax rate fell to 9.4% in Q3 and 9.3% year to date, from 22.5% and 22.2%, respectively, mainly due to the lower federal tax rate and tax credits.
Financial condition, cash flow, and liquidity
- At September 30, total assets were $17.568 billion, loans $11.293 billion, deposits $12.598 billion, shareholders’ equity $2.221 billion, and cash and cash equivalents $286.8 million. Compared with September 30, 2017, assets rose $2.502 billion, mainly from Anchor.
- Total borrowings were $2.576 billion, including $1.555 billion of FHLB advances. Wholesale borrowings were 17% of total funding. FHLB advances had a 2.34% weighted-average rate; $426.6 million was contractually due in 2018.
- For the first nine months, operating cash flow was $180.5 million, investing cash flow was negative $115.3 million, and financing cash flow was negative $68.9 million. Cash declined $3.7 million to $286.8 million.
- Management reported $3.124 billion of available funds at subsidiaries, including cash, unencumbered securities, and borrowing capacity; the parent company reported $77.2 million in available cash. The bank subsidiary exceeded “well-capitalized” regulatory thresholds. Consolidated Tier 1 leverage was 8.56%; total risk-based capital was 12.09%.
- Common dividends were $0.13 per share for Q3 and $0.39 per share for the nine months, unchanged from 2017. Book value per share was $14.58; tangible common book value was $8.86 (non-GAAP).
Material changes and asset quality
- Total loans were nearly unchanged from June 30, at $11.293 billion, as commercial real estate growth was offset by paydowns and planned runoff. Compared with September 2017, commercial and commercial real estate loans grew 37%, while consumer loans declined $164.1 million.
- Nonperforming loans were 1.47% of loans, versus 1.46% a year earlier and 1.30% at December 2017. Nonaccrual loans were $148.8 million, up from $119.3 million a year earlier. Underperforming assets totaled $170.9 million; criticized and classified assets totaled $441.3 million, up $94.0 million year over year.
- The allowance for loan losses was $52.7 million, or 0.47% of loans, versus 0.53% a year earlier. Nine-month net charge-offs were $1.2 million, compared with $1.7 million in 2017. Management cited loan growth as a factor in higher provision expense and warned that lower recoveries or higher charge-offs could increase provision needs.
- Available-for-sale securities had $96.1 million of net unrealized losses, versus $56.4 million at December 2017, primarily reflecting higher long-term interest rates. Management said it did not intend, and did not expect to be required, to sell securities in loss positions; no other-than-temporary impairment was recorded in the nine-month period.
Outlook, commentary, and notable items
- No specific earnings or revenue guidance was provided. Management emphasized loan growth, fee income, expense discipline, and positive operating leverage, while noting higher deposit and borrowing costs and lower acquired-loan accretion weighed on quarterly net interest income. Management expects acquired-loan accretion to decline over time.
- The company expected to complete its Klein acquisition effective November 1, 2018, subject to customary closing conditions. The announced stock transaction was valued at approximately $439.5 million based on Old National’s September 28 share price; the value could change with its share price.
- The sale of ten Wisconsin branches closed October 26, 2018. It included approximately $231 million of deposits and no loans; management expected a net gain of approximately $14 million in Q4 2018.
- Tax-credit investment amortization was $21.8 million for the nine months, including $9.2 million in Q3, and management anticipated approximately $2 million of related amortization and discrete tax items in Q4. A $2.2 million gain from selling the remaining student-loan portfolio was recorded in Q2; a pooled trust security sale produced a $0.9 million loss in Q1.
- Management estimated adoption of the new lease standard would increase assets and liabilities by $125–$140 million, with no expected material income-statement effect. The expected one-time CECL allowance increase could not yet be reasonably estimated.
- Interest-rate sensitivity modeling estimated that an immediate +100 basis-point rate move would increase cumulative two-year net interest income by 0.93% versus base, while a 50-basis-point decrease would reduce it by 0.99%. Management cautioned that model results are not guarantees of actual outcomes.
- Risks include credit deterioration, interest-rate and funding pressures, acquisition integration and customer attrition, competition, economic conditions, and operational, cyber, regulatory, and legal risks. Moody’s ratings were investment grade with a negative outlook. The company said it was not currently involved in material litigation and believed pending matters would not materially affect consolidated financial condition, though results or cash flows in a particular period could be affected.
Investor verification points
- Verify the drivers and sustainability of earnings growth, including acquisition contribution, net interest margin, funding costs, and acquired-loan accretion.
- Track nonaccrual, criticized and classified assets, charge-offs, reserve coverage, and the eventual CECL transition impact.
- Assess securities valuation exposure, unrealized losses, interest-rate sensitivity, and funding and deposit trends.
- Confirm Klein closing and integration outcomes, and the realized gain and deposit effects of the Wisconsin branch sale.
- Review the composition and duration of tax-credit benefits and amortization, along with the timing and impact of lease-accounting adoption.