Old National Bancorp — Q1 2017 Form 10-Q
Business context and reporting period. This unaudited report covers the three months ended March 31, 2017, with balance-sheet comparisons to December 31, 2016 and March 31, 2016. Old National is a regional community bank operating primarily in Indiana, Kentucky, Michigan and Wisconsin. The May 2016 Anchor BanCorp acquisition materially increased the scale of the business; the company sold its insurance operations in May 2016.
Financial performance and condition
| Metric | Q1 2017 | Comparable period / change |
|---|---|---|
| Net interest income | $105.8 million | Up 23.5% from $85.6 million in Q1 2016 |
| Net interest margin | 3.32%; 3.50% taxable-equivalent | 3.32%; 3.52% taxable-equivalent in Q1 2016 |
| Noninterest income | $42.9 million | Down 13.2% from $49.5 million |
| Noninterest expense | $101.9 million | Up 3.6% from $98.4 million |
| Provision for loan losses | $0.35 million | $0.09 million in Q1 2016 |
| Net income / diluted EPS | $36.0 million / $0.27 | $27.0 million / $0.24 in Q1 2016 |
| Efficiency ratio | 64.66% | 68.76% in Q1 2016 |
| Operating cash flow | $120.0 million | $14.7 million in Q1 2016 |
Net interest income growth primarily reflected the larger earning-asset base following Anchor and higher acquired-loan accretion. Excluding acquired-loan accretion, taxable-equivalent net interest margin was 3.10%, versus 3.08% a year earlier. Noninterest income declined chiefly because the insurance business was sold; growth in mortgage banking, wealth management and other fees partly offset the reduction. Management cited $1.5 million of recoveries on Anchor loans previously charged off as part of higher other income. Expense growth included a $1.4 million pre-tax charge for consolidating 15 branches.
Balance sheet and funding at March 31, 2017: Assets were $14.87 billion, versus $11.93 billion a year earlier and $14.86 billion at year-end. Loans were $9.13 billion, up $121.3 million from year-end; deposits were $10.82 billion, up $78.1 million. Cash and cash equivalents were $217.0 million. Wholesale borrowings were $2.07 billion, including $1.44 billion of FHLB advances. Shareholders’ equity was $1.85 billion. Total funding was $12.89 billion, and wholesale funding represented 16% of total funding.
Net cash decreased $38.5 million during the quarter: operating activities provided $120.0 million, investing activities used $135.0 million, and financing activities used $23.5 million. The financing outflow included $17.6 million of common dividends. The quarterly dividend was $0.13 per share.
Consolidated capital ratios included an 8.49% Tier 1 leverage ratio, 11.43% common equity Tier 1 ratio and 12.24% total capital ratio. Old National Bank’s common equity Tier 1 ratio was 12.03%; the bank met the regulatory definition of well-capitalized. Management reported $2.81 billion of available funds at subsidiaries, including cash, unencumbered securities and borrowing capacity, subject to collateral availability and other conditions.
Material changes and outlook
- Anchor, acquired for approximately $459.8 million in May 2016, added substantial loans, deposits and assets and contributed to year-over-year growth. Integration and transaction costs totaled $15.9 million through March 31, 2017. Management expects acquired-loan accretion to decline over time, potentially offset by future acquisitions.
- Insurance premiums and commissions fell by about $13.0 million year over year following the sale of ONB Insurance Group. Mortgage banking revenue rose 45%, driven by increased secondary-market sales and production in Wisconsin.
- Management described loan demand as encouraging, with organic growth during the quarter, particularly in Wisconsin. It said it would slow indirect consumer originations, which it considers the least profitable, and continued to assess its branch network.
- No quantified earnings or revenue guidance is provided. Management said higher interest rates and asset yields supported the net-interest-income outlook, while noting that funding costs, balance-sheet mix and market rates affect results. Its model projected two-year cumulative net interest income 2.37% above base with an immediate 100-basis-point rate increase and 2.84% below base with a 50-basis-point decrease. Management cautioned that model outputs are not guarantees.
- The company anticipates tax-credit investment impairment charges of $4.4 million in Q3 2017 and $5.5 million in Q4 2017, recorded in other expense; none had been recorded through Q1. These are stated expectations, not guaranteed outcomes.
Risks, contingencies and unusual items
- Asset quality improved on some measures: underperforming assets were $143.3 million, or 1.57% of loans and other real estate owned, versus 1.82% at year-end and 2.08% a year earlier. Nonaccrual loans were $115.4 million; $25.1 million related to Anchor. Troubled debt restructurings totaled $49.2 million, of which approximately $34.2 million were included in nonaccrual loans.
- The allowance for loan losses was $49.8 million, or 0.55% of loans, compared with 0.55% at year-end and 0.72% a year earlier. Management warned that continued loan growth or lower recoveries could increase provision expense; potential sales of troubled loans could also create additional charge-offs.
- Available-for-sale securities had net unrealized losses of $47.2 million. Management said it did not intend to sell securities in unrealized-loss positions and did not expect to be required to sell them. Three pooled trust preferred securities had fair value of $8.3 million and unrealized losses of $8.6 million; no other-than-temporary impairment was recorded in Q1.
- Interest-rate, liquidity, credit and market risks remain material. Loan commitments totaled $2.42 billion and standby letters of credit $54.0 million, generally not reflected as funded balance-sheet obligations. The company also disclosed ordinary-course litigation, but said it was not then involved in material litigation and did not expect pending matters to materially affect consolidated financial condition.
- Management identified significant estimation risk in acquired-loan cash-flow assumptions, the loan-loss allowance, fair values, goodwill and tax assets. It noted that a future decrease in corporate tax rates could reduce the value of deferred tax assets. It also said the new lease standard could increase assets and liabilities by an estimated $80 million to $100 million, without a material expected income-statement impact.
Most important facts for investors to verify
- How much earnings growth is organic versus attributable to Anchor, acquired-loan accretion and other acquisition-related items, and whether integration savings are realized.
- Trends in nonaccrual loans, Anchor acquired-credit exposures, TDRs, charge-offs and allowance adequacy relative to loan growth.
- Whether deposit growth and pricing can support lending without greater reliance on wholesale funding, and how interest-rate changes affect net interest margin.
- The timing, basis and actual amount of the expected Q3 and Q4 tax-credit investment impairment charges.
- Capital and liquidity headroom, securities valuation exposures, and any material developments in contingencies or regulatory requirements.