Old National Bancorp — Q2 2017 Form 10-Q
Business context and reporting period. Old National Bancorp is a Midwest community bank holding company. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are generally with 2016. The company reported one operating segment, community banking. The 2016 Anchor acquisition and sale of ONB Insurance Group (ONI) materially affect year-over-year comparisons.
Financial performance and condition
- Q2 earnings: Net interest income was $104.3 million, up 5.0% year over year. Net income was $38.9 million versus $39.1 million; diluted EPS was $0.28 versus $0.31. Return on average assets was 1.05% and return on average common equity was 8.33%.
- First-half earnings: Net income was $74.8 million versus $66.1 million; diluted EPS was $0.55 in both periods. Net interest income increased 13.6% to $210.1 million.
- Revenue, expenses and margins: Q2 noninterest income was $49.3 million, down 47.2%, largely because 2016 included a $41.9 million pretax ONI sale gain and insurance income before divestiture. Q2 noninterest expense fell 15.4% to $102.8 million, reflecting the divestiture, lower 2016 acquisition/integration costs and other expense reductions. Tax-equivalent net interest margin was 3.42%, down from 3.57%; the efficiency ratio was 64.05%, compared with 60.22%.
- Balance sheet and lending: At June 30, total assets were $14.96 billion, total loans $9.23 billion, deposits $10.68 billion and shareholders’ equity $1.89 billion. Loans grew 4.6% year over year, led by commercial and commercial real estate lending. Deposits increased 2.2% year over year but declined $59.5 million from year-end 2016.
- Credit quality: Nonperforming loans were 1.51% of loans, down from 1.97% a year earlier. Underperforming assets were $150.9 million versus $199.2 million; total criticized and classified assets were $344.9 million, up from $323.0 million at year-end 2016. The allowance was $51.0 million, or 0.55% of loans; first-half net charge-offs were $0.5 million. Troubled debt restructurings rose to $60.4 million from $40.7 million at year-end, with $46.2 million included in nonaccrual loans.
- Cash flow and liquidity: For the first six months, operating cash flow was $148.1 million, investing cash outflow $154.7 million and financing cash inflow $13.8 million; cash and cash equivalents increased $7.2 million to $262.7 million. Available funds at bank subsidiaries, including cash, unencumbered securities and borrowing capacity, totaled $2.77 billion. Management reported that the bank exceeded regulatory capital requirements; consolidated Tier 1 leverage was 8.65% and total risk-based capital was 12.31%.
- Debt and funding: Borrowed funds totaled $2.26 billion, including $1.52 billion of FHLB advances. FHLB advances increased from $1.35 billion at year-end 2016; $778.8 million were contractually due in the remainder of 2017. Wholesale funding was 17% of total funding.
Material changes versus comparable periods
- Net interest income rose with higher average earning assets, partly reflecting the Anchor acquisition and loan growth. Margin nevertheless narrowed as acquired-loan accretion declined, funding costs rose and asset/liability mix changed.
- Q2 and first-half noninterest income were substantially lower than 2016 because ONI was sold in May 2016; the 2016 comparison also included its sale gain. Recurring fee categories were mixed, with first-half mortgage banking, investment product and capital markets income increasing.
- Expenses fell year over year, in part because 2016 included Anchor acquisition and integration costs and ONI operating costs. Branch consolidation also lowered occupancy expense; the company reported 188 banking centers versus 206 a year earlier.
- Nonaccrual loans and underperforming assets improved year over year, although troubled debt restructurings increased from year-end 2016.
Outlook, commentary and risks
- Management emphasized organic commercial and retail loan growth, fee income, low-cost core deposits, credit quality and expense discipline. It reported steady commercial loan demand and planned to slow less-profitable indirect consumer loan originations in 2017. The filing provides no specific earnings or revenue guidance.
- Management expected acquired-loan accretion to decline over time. It also anticipated tax-credit investment impairment charges of $4.4 million in Q3 2017 and $5.5 million in Q4 2017; none had been recorded in the first half.
- Interest-rate sensitivity modeling projected net interest income 1.91% higher under an immediate 100-basis-point increase and 2.62% lower under a 50-basis-point decrease, relative to the model base case. Management cautioned that model outcomes are not guarantees.
- Key risks include credit deterioration, economic weakness in the company’s markets, interest-rate and funding changes, deposit attrition, competition, execution of acquisition integration and other forward-looking uncertainties. Loan commitments were $2.59 billion and standby letters of credit $53.0 million; these are off-balance-sheet exposures. Management said it was not involved in material litigation and did not expect pending matters to materially affect consolidated financial condition, while noting outcomes could affect a particular period.
- Available-for-sale securities had $19.7 million of net unrealized losses at quarter-end. Three pooled trust preferred securities had a fair value of $8.1 million and unrealized losses of $8.7 million; management reported no other-than-temporary impairment in the first half and no intent or expected need to sell securities in loss positions.
- Upcoming accounting changes include the expected credit-loss standard, effective in 2020, for which the company could not yet estimate the impact; lease accounting was expected to increase assets and liabilities by $80–$100 million, with no material income-statement impact expected.
Important facts for investors to verify
- Whether commercial loan growth and fee-income gains can offset margin pressure and lower acquired-loan accretion.
- Whether nonperforming loans continue to decline and whether the larger TDR balance requires additional reserves or charge-offs.
- Execution and cost of the planned Q3/Q4 tax-credit investment impairments, and the underlying recoverability of those investments.
- Deposit trends, borrowing costs and the refinancing or repayment of the $778.8 million of FHLB advances due in the remainder of 2017.
- How much reported earnings depend on unusual, nonrecurring items, tax credits and acquisition-related accounting effects.
- Actual outcomes and funding needs for the $2.59 billion of loan commitments and other contingent exposures.