Business context and reporting period
Old National Bancorp’s Form 10-K covers the fiscal year ended December 31, 2011, with comparisons to 2010 and 2009. The Indiana-based financial holding company provides community banking, wealth management, insurance and related services, primarily in Indiana, Illinois and Kentucky. It operated 183 financial centers and had 2,551 full-time-equivalent employees at year-end.
2011 included the January acquisition of Monroe Bancorp and the July FDIC-assisted acquisition of Integra Bank. Integra’s acquired assets included loans and real estate subject to FDIC loss-sharing arrangements.
Financial results and condition
| Metric | 2011 | 2010 |
|---|---|---|
| Net interest income | $272.9 million | $218.4 million |
| Noninterest income | $182.9 million | $170.2 million |
| Noninterest expense | $348.5 million | $314.3 million |
| Provision for loan losses | $7.5 million | $30.8 million |
| Net income available to common shareholders | $72.5 million | $38.2 million |
| Diluted EPS | $0.76 | $0.44 |
| Return on average assets | 0.86% | 0.50% |
| Efficiency ratio | 73.80% | 79.25% |
| Net interest margin, taxable-equivalent basis | 3.87% | 3.40% |
Net interest income plus noninterest income was $455.8 million in 2011. Net interest margin benefited approximately 50 basis points from accretion on acquired assets, a benefit management expected to decline over time. Net charge-offs fell to 0.49% of average loans from 0.75%.
At December 31, 2011, total assets were $8.61 billion, loans were $4.77 billion, deposits were $6.61 billion and shareholders’ equity was $1.03 billion. Year over year, assets rose 18.5%, loans 27.3%, deposits 21.0% and equity 17.6%, substantially reflecting acquisitions. Cash and cash equivalents were $222.9 million, down from $251.6 million. Cash from operations was $143.7 million; investing activities provided $1.01 billion and financing activities used $1.18 billion.
Short-term borrowings were $424.8 million and other borrowings $290.8 million, together $715.6 million versus $720.1 million in 2010. The company prepaid $119.2 million of FHLB advances and $80.0 million of structured repurchase agreements and repaid $150 million of subordinated bank notes at maturity. The bank had $720.6 million of stated discount-window borrowing capacity. Old National Bank’s year-end regulatory ratios included 13.40% total risk-based capital, 12.16% Tier 1 risk-based capital and 7.42% Tier 1 leverage; it met the well-capitalized definition.
Material changes versus prior period
- Net income increased $34.2 million, driven principally by the Monroe and Integra acquisitions and lower loan-loss provision expense.
- Noninterest expense increased 10.9%, including acquisition and integration costs of approximately $6.6 million for Monroe and $11.1 million for Integra, higher compensation and a $2.0 million litigation accrual.
- Reported underperforming assets rose to $340.5 million from $77.1 million, largely due to acquired Integra covered loans and real estate. Excluding covered assets, underperforming assets were 1.45% of total assets, compared with 1.06% in 2010; nonperforming loans excluding covered loans were 2.82% of loans, versus 1.90%.
- The allowance for loan losses declined to $58.1 million from $72.3 million, or 1.22% of loans versus 1.93%. Acquired loans were recorded at fair value, with acquisition-date credit risk reflected in the purchase accounting rather than a carried-over allowance.
- Net securities gains fell to $8.7 million from $17.1 million. The company recorded $1.4 million of impairment losses in earnings on available-for-sale securities in 2011.
Outlook, commentary, risks and unusual items
Management described the recovery as slow and expected 2012 revenue growth to remain challenging amid persistently low interest rates. Its stated priorities were revenue growth, expense reduction, loan growth under conservative underwriting, and selective acquisitions. Management continued to target a 65% efficiency ratio by the end of 2012; the 2011 ratio was 73.80%. No specific earnings or revenue guidance was provided.
On January 25, 2012, Old National agreed to acquire Indiana Community Bancorp for approximately $79.2 million in stock, subject to regulatory approval, with closing expected in the second quarter of 2012. The board also raised the quarterly dividend to $0.09 per share from $0.07, effective after year-end.
- Credit and acquired-asset risk: Legacy nonaccrual loans and criticized/classified loans increased, while reported problem assets include substantial acquired covered assets. FDIC reimbursement is tiered: 80% of losses up to $275.0 million, no reimbursement on the next $192.2 million, and 80% above that level; recoveries are shared back with the FDIC.
- Investment risk: The portfolio included $85.9 million of non-agency mortgage-backed securities and $7.3 million of pooled trust preferred securities, with significant unrealized losses and credit-rating deterioration in some holdings.
- Interest-rate and funding risk: Management cited sensitivity to rate changes, low loan demand, and the possibility that wholesale funding may become less available or more expensive. Its models showed a 4.17% reduction in one-year net interest income under an immediate 300-basis-point rate increase.
- Legal matters: A tentative settlement in a trust-administration case led to a $2.0 million accrual. A separate class action concerning checking-account practices remained unresolved; management could not estimate the probability or amount of loss.
- Regulatory and operating risks: Dodd-Frank implementation, capital-rule changes, acquisition integration, deposit retention, cybersecurity, competition and regional economic weakness could affect results. Management reported effective internal control over financial reporting, and the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of earnings and margin improvement came from acquired operations and purchase-accounting accretion, and how that accretion is expected to run off.
- Whether credit quality in the legacy portfolio stabilizes, and the performance and realized losses of Integra’s covered assets against the FDIC reimbursement tiers.
- Whether the lower allowance remains adequate given higher nonaccrual and criticized/classified balances, and the effects of acquired-loan cash-flow revisions.
- Progress toward the 65% efficiency-ratio target, including integration costs, expense run-rate and sustainable organic revenue growth.
- Liquidity, deposit mix and refinancing needs, including the maturity profile of large certificates of deposit and borrowings.
- Completion, regulatory approval, integration costs and expected returns of the Indiana Community Bancorp transaction; also verify dividend sustainability and the litigation outcomes.