OLD NATIONAL BANCORP quarterly report, Q1 FY2018

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Old National Bancorp — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018. Unless otherwise noted, dollar amounts below are in millions. Comparisons are with Q1 2017 or December 31, 2017, as specified.

Business context

Old National is a Midwest community bank operating primarily in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota. Results reflect the November 2017 Anchor (MN) acquisition, which added substantial assets, loans, deposits, and expenses and affects year-over-year comparability. Management describes its priorities as loan growth, fee income, and expense management.

Financial performance and condition

  • Earnings: Net income was $48.0 million, up from $36.0 million; diluted EPS was $0.31 versus $0.27. Pretax income was $52.9 million versus $46.5 million. The effective tax rate fell to 9.4% from 22.6%, primarily reflecting the lower federal corporate rate and increased tax credits.
  • Revenue and margins: Net interest income rose 21.5% to $128.6 million. Tax-equivalent net interest margin was 3.45%, down from 3.50%; management attributed margin pressure to higher funding costs, lower acquired-loan accretion, and asset/liability mix. Noninterest income was $42.4 million, down 1.2%.
  • Costs and profitability ratios: Noninterest expense increased 15.5% to $117.6 million, including Anchor-related operating and integration costs and branch-consolidation impairments. The efficiency ratio was 65.94%, compared with 64.66%. Return on average assets was 1.10%, versus 0.98%.
  • Loans and credit: Loans were $11.239 billion at quarter-end, up $120.6 million from year-end and $2.107 billion year over year. The allowance for loan losses was $50.4 million, or 0.45% of loans, versus 0.55% a year earlier. Provision was $0.4 million; net charge-offs were approximately $0.4 million, or 0.01% of average loans. Nonaccrual loans totaled $127.3 million; criticized and classified assets were $423.6 million, up $100.5 million year over year.
  • Cash flow: Operating cash flow was $62.3 million, compared with $120.0 million in Q1 2017. Investing activities used $27.0 million and financing activities used $47.5 million; cash and cash equivalents declined $12.2 million to $278.2 million. These cash-flow figures should be interpreted in the context of bank balance-sheet and funding activity.
  • Balance sheet and funding: Total assets were $17.496 billion; deposits were $12.789 billion; total borrowed funds were $2.371 billion; and shareholders’ equity was $2.179 billion. At quarter-end, consolidated Tier 1 leverage was 8.11%, common equity Tier 1 was 10.71%, and total risk-based capital was 11.72%. The bank subsidiary met the regulatory definition of well-capitalized.
  • Liquidity and debt: The filing reported $3.056 billion of available funds at subsidiaries, including cash, unencumbered securities, and borrowing availability, plus $54.6 million at the parent. FHLB advances were $1.664 billion, with $902.0 million contractually due in 2018. Moody’s affirmed the company’s A3 rating and the bank’s Aa3 long-term deposit rating; the outlook was negative.

Material changes and notable items

  • The Anchor (MN) acquisition contributed materially to balance-sheet and earnings growth. Management cited $11.6 million of acquired operating expenses and $2.3 million of acquisition and integration costs in Q1 2018.
  • Noninterest income was broadly stable, with higher deposit-service, debit-card, and investment-product fees offset by lower capital-markets income, securities gains, and other income.
  • Management early-adopted hedge-accounting guidance and reclassified securities between available-for-sale and held-to-maturity portfolios. The available-for-sale portfolio had $69.0 million of net unrealized losses at March 31, 2018, versus $56.4 million at year-end. No other-than-temporary impairment was recorded, and management said it did not intend, nor expect to be required, to sell securities in unrealized-loss positions.
  • Branch actions include ten planned consolidations during 2018 and an agreement to sell ten Wisconsin branches to Marine Credit Union, including approximately $274 million of deposits and no loans. Closing was expected in Q3 2018, subject to approvals and other conditions.
  • Cash dividends were $0.13 per share. The company repurchased a limited number of shares in connection with employee incentive programs; no 2018 public stock repurchase plan was authorized.

Outlook, risks, and contingencies

  • Management reported steady commercial loan demand and said the rate increase in March 2018 marginally improved its outlook for net interest income and margin. No specific earnings or revenue guidance was provided.
  • Management expects acquired-loan accretion to decline over time, potentially offset by future acquisitions. It anticipated $15–18 million of tax-credit investment amortization in Q2 2018, contingent on project completion.
  • Management described itself as an active but selective prospective acquirer and said it was not compelled to pursue a partnership. It also planned to continue evaluating branch-consolidation opportunities.
  • Key disclosed risks include interest-rate and funding-cost changes, credit deterioration, economic conditions, acquisition integration and realization of expected savings, deposit or customer attrition, competition, and operational, technology, cyber, regulatory, and legal risks. The filing cautions that interest-rate sensitivity estimates depend on modeling assumptions and are not guarantees of actual results.
  • Loan commitments totaled $3.181 billion and standby letters of credit $71.9 million; these are off-balance-sheet exposures. The company stated it was not involved in material litigation, while noting that pending legal matters could affect a particular future period.

Important facts for investors to verify

  1. How much of earnings and loan growth reflects Anchor (MN), and whether integration costs and anticipated savings develop as management expects.
  2. Whether net interest margin stabilizes as interest rates, deposit pricing, and acquired-loan accretion change.
  3. Trends in criticized/classified and nonaccrual loans, particularly acquired Anchor loans, and whether the allowance remains adequate as the portfolio grows.
  4. Execution and regulatory status of the planned branch sale and consolidations, including the expected transfer of approximately $274 million in deposits.
  5. Liquidity and refinancing needs, including the 2018 FHLB advance maturities, and the implications of Moody’s negative outlook.
  6. Changes in securities valuation losses, tax-credit project timing and amortization, and final accounting adjustments related to tax reform and the Anchor acquisition.