Old National Bancorp — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise.
Business context and reporting period
Old National is a regional bank holding company with banking, insurance, and wealth management businesses, operating primarily in Indiana, southeastern Illinois, western Kentucky, and southwestern Michigan. It completed its acquisition of Tower Financial on April 25, 2014. United Bancorp was acquired after quarter-end, on July 31, 2014. Acquisitions of LSB Financial and Founders Financial were pending at the filing date.
Financial results and key metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $84.5 | $79.2 | $168.0 | $158.2 |
| Noninterest income | $39.7 | $46.2 | $80.2 | $92.6 |
| Net interest income plus noninterest income | $124.1 | $125.4 | $248.2 | $250.8 |
| Provision for loan losses | $(0.4) credit | $(3.7) credit | $(0.4) credit | $(2.8) credit |
| Noninterest expense | $98.1 | $86.9 | $186.4 | $177.1 |
| Net income | $18.8 | $28.5 | $45.3 | $52.4 |
| Diluted EPS | $0.18 | $0.28 | $0.44 | $0.52 |
| Fully taxable-equivalent net interest margin | 4.07% | 3.97% | 4.14% | 4.01% |
| Efficiency ratio | 75.85% | 66.52% | 71.80% | 67.44% |
At June 30, 2014, total assets were $10.388 billion, total loans $5.539 billion, deposits $7.555 billion, and shareholders’ equity $1.277 billion. Cash and cash equivalents were $236.7 million. The allowance for loan losses was $46.2 million, or 0.83% of loans excluding loans held for sale.
For the first six months, operating cash flow was $71.5 million, investing cash flow was $(143.8) million, financing cash flow was $102.2 million, and cash and cash equivalents increased $30.0 million.
Short-term borrowings were $467.6 million and other borrowings were $902.0 million at quarter-end. The bank reported a 7.97% Tier 1 leverage ratio, 11.98% Tier 1 risk-based capital ratio, and 12.77% total risk-based capital ratio; management said the bank met the regulatory definition of well-capitalized. Subsidiaries had $3.026 billion of available funds, including cash, unencumbered securities, and borrowing capacity.
Material changes versus prior comparable periods
- Q2 net income declined 34% year over year; six-month net income declined 14%. Management attributed the Q2 decline mainly to faster amortization of the FDIC indemnification asset and acquisition and integration costs.
- Net interest income rose 6.7% in Q2 and 6.1% for the six-month period, supported by higher earning assets, lower funding costs, and accretion income on acquired credit-impaired loans. Excluding that accretion, the fully taxable-equivalent margin was 3.26% in Q2 versus 3.29% a year earlier, and 3.31% for six months versus 3.30%.
- Noninterest income fell 14.3% in Q2 and 13.3% year to date. The decline reflected FDIC indemnification asset adjustments and, for the six-month comparison, a prior-year branch-sale gain. Noninterest expense rose 12.9% in Q2 and 5.2% year to date, including acquisition-related costs and acquired-branch operating expenses.
- Loans increased $455.9 million from December 31, 2013, including Tower-acquired balances. Management reported $111.4 million of organic loan growth during Q2, excluding Tower, and described it as the strongest organic quarterly growth since 2008.
- Credit quality improved on several measures: underperforming assets were $157.7 million versus $230.9 million a year earlier; nonaccrual loans were $118.0 million versus $189.8 million. Net charge-offs were $0.6 million for the first six months, compared with $2.6 million in 2013.
Outlook, commentary, risks, and unusual items
- Management said the loan pipeline remained strong and expressed increasing optimism, while cautioning that one or two quarters do not establish a trend. It expected purchased-loan accretion income to decline over time and noted that future loan growth could increase provision expense.
- The $51.4 million FDIC loss-sharing asset included $28.9 million expected to be amortized through noninterest income over the next 27 months. The six-month income statement included a negative $17.8 million FDIC indemnification asset adjustment.
- Acquisition and integration costs were material. Detailed MD&A reports $6.1 million for Q2 and $8.6 million for the first six months; the executive summary describes Q2 costs as $6.3 million.
- Management expected fee-card revenue to be negatively affected beginning July 2015 because assets exceeded $10 billion and triggered certain Dodd-Frank Act provisions.
- Interest-rate sensitivity modeling showed a 3.82% decline in projected one-year net interest income under an immediate 300-basis-point rate increase; two-year cumulative net interest income increased 1.80% in that scenario. Management cautioned that model results are not guarantees.
- Unrealized losses on pooled trust preferred securities were $11.6 million, with fair value of $6.4 million. Management reported no intent or expected need to sell securities in unrealized-loss positions. A separate $0.1 million other-than-temporary impairment charge was recorded on a limited partnership investment.
- A class action concerning the bank’s historical overdraft-fee transaction sequencing remained pending. The appeal was accepted and trial-court proceedings stayed; management said it could not estimate the probability or amount of a loss.
- Loan commitments were $1.382 billion and standby letters of credit $68.7 million. The filing describes risks including economic weakness, credit deterioration, interest-rate changes, acquisition integration and FDIC loss-sharing estimates.
Most important facts for investors to verify
- Whether organic loan growth and management’s strong pipeline persist, and how much reported growth reflects acquisitions.
- Whether margin performance holds as purchased-loan accretion declines and funding costs or interest rates change.
- The trajectory of FDIC indemnification asset amortization and its effect on noninterest income and earnings.
- Acquisition integration costs, realized cost savings, deposit retention, and the funding and capital impact of subsequent and pending acquisitions.
- Credit trends, particularly Tower-acquired criticized and classified loans, nonaccruals, troubled debt restructurings, and adequacy of loan-loss reserves.
- The outcome and potential financial exposure of the overdraft-fee litigation, which the filing does not quantify.