Old National Bancorp — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Old National is a regional bank holding company with banking operations in Indiana, Illinois, Kentucky and Michigan, plus an insurance business. Financial statement amounts below are in millions unless otherwise noted.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $92.1 | $84.5 | $183.1 | $168.0 |
| Noninterest income | $55.0 | $39.7 | $110.3 | $80.2 |
| Noninterest expense | $109.7 | $98.1 | $225.8 | $186.4 |
| Provision for loan losses | $2.3 | $(0.4) credit | $2.3 | $(0.4) credit |
| Net income | $26.2 | $18.8 | $47.1 | $45.3 |
| Diluted earnings per share | $0.22 | $0.18 | $0.40 | $0.44 |
| Tax-equivalent net interest margin | 3.75% | 4.07% | 3.72% | 4.14% |
| Efficiency ratio | 70.52% | 75.85% | 73.36% | 71.80% |
Q2 total revenue, measured as net interest income plus noninterest income, was $147.1 million, up about 19% year over year. Management attributed stronger net income primarily to acquisitions and higher fee income. For the first half, net income rose modestly even as diluted EPS declined, with weighted-average diluted shares increasing to 117.6 million from 102.4 million.
- Balance sheet at June 30: Assets were $12.08 billion, loans $6.77 billion, deposits $8.81 billion, and shareholders’ equity $1.46 billion. Compared with June 30, 2014, assets grew 16%, loans 22%, and deposits 17%; acquisitions were a major contributor.
- Liquidity and funding: Cash and cash equivalents were $195.2 million. Wholesale borrowings totaled $1.60 billion, including $530.4 million short-term borrowings and $1.07 billion other borrowings. The filing reports $2.73 billion of available subsidiary funds, including cash, unencumbered securities and borrowing capacity.
- Debt: Other borrowings included $175 million of 4.125% senior notes due 2024 and $799.5 million of Federal Home Loan Bank advances. Other borrowings increased from $920.1 million at year-end 2014.
- Cash flow, first half: Operating activities provided $36.8 million, versus $71.5 million in 2014; investing activities used $10.8 million, versus $143.8 million; financing activities used $70.8 million, versus providing $102.2 million. Cash declined $44.8 million to $195.2 million.
- Capital: The consolidated Tier 1 leverage ratio was 8.20%; the bank subsidiary’s was 8.52%. The bank met the regulatory definition of well-capitalized. Shareholders’ equity-to-assets was 12.06%.
Material changes and notable items
- Recent acquisitions of United, LSB and Founders expanded the balance sheet and contributed to revenue, expenses, goodwill and loan growth. Founders closed January 1, 2015; no loans were acquired during Q2, and management reported $120.7 million of Q2 loan growth including loans held for sale, primarily organic production.
- Net interest income increased 9% year over year, but margin declined. Management cited lower yields, higher funding costs, acquisition-related asset and liability mix, and lower accretion income on acquired loans. Tax-equivalent NIM excluding acquired-loan accretion was 3.15% in Q2 versus 3.26% a year earlier.
- Noninterest expense rose 12% in Q2 and 21% for the first half, reflecting acquired operations, integration, higher personnel and occupancy costs, and branch actions. Q2 included $4.0 million of branch divestiture/closure/consolidation costs and $1.5 million of acquisition and integration charges.
- In the first half, Old National repurchased 5.3 million shares for $74.6 million and paid $28.1 million in common dividends. A new plan approved July 23 authorizes repurchases of up to 7 million shares through January 31, 2016.
- Other comprehensive loss was $13.8 million in Q2, mainly from unrealized losses on available-for-sale securities; the six-month loss was $6.5 million. Available-for-sale securities had $12.4 million of net unrealized losses at June 30, versus $1.3 million at year-end 2014.
Outlook, risks and contingencies
- Management expected the Durbin Amendment, effective for Old National July 1, 2015, to reduce debit card and ATM fees by approximately $4–$6 million pre-tax in the second half of 2015.
- Management expected sales of 17 branches and related deposits and loans to close before September 30, 2015, and expected acquisition integration and branch actions to be substantially complete by the end of Q3. It anticipated benefits from workforce reductions and integration synergies, but provided no quantified savings target.
- Management’s rate model projected net interest income approximately 1.01% higher over the next 12 months under its stated rate assumptions. The two-year model showed net interest income 2.17% higher with an immediate 100-basis-point increase and 2.52% lower with a 50-basis-point decrease; model outputs are not guarantees.
- Credit quality merits attention: nonaccrual loans were $167.8 million, up from $140.9 million at year-end 2014; total underperforming assets were $196.1 million, up from $170.5 million. The allowance for loan losses was $50.2 million, or 0.74% of loans excluding loans held for sale. Management cited loan growth and higher impairments as reasons for Q2 provision expense and warned that further growth or deterioration could require additional provision.
- FDIC-covered loans and other real estate continued to decline. The covered-asset loss-sharing arrangement generally reimburses 80% of eligible losses within specified thresholds; management did not expect losses to exceed the $275 million first threshold. The related loss-sharing asset was $16.5 million at June 30.
- An Indiana class action concerning overdraft-fee transaction sequencing returned to the trial court on a remaining contract good-faith claim after appellate rulings removed several other claims, including those that could support treble damages. Management said it could not determine the probability or amount of a material loss at this stage. The company otherwise stated pending litigation was not expected to materially affect consolidated financial condition, though an outcome could affect a particular period’s results or cash flows.
- Additional risks include integration and cost-savings execution, competition, economic and credit conditions in the company’s markets, interest-rate and liquidity changes, and valuation assumptions for acquired loans, goodwill and securities. The filing reports effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the planned branch sales closed on schedule, and the realized gain, deposit retention and expense savings.
- Whether the forecast Durbin-related fee reduction falls within the estimated $4–$6 million range and how fee income trends thereafter.
- Trends in nonaccrual loans, criticized/classified assets, acquired-loan performance, charge-offs and allowance coverage.
- Whether acquisition synergies offset elevated operating costs and declining acquired-loan accretion income.
- Capital and liquidity after share repurchases, dividends, branch transactions and any further balance-sheet growth.
- Developments in the overdraft-fee litigation and any resulting contingency accrual or disclosure.