Old National Bancorp — Q3 2010 Form 10-Q
Business context and reporting period: Regional banking company serving primarily Indiana, Illinois and Kentucky. This unaudited filing covers the quarter and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods unless otherwise noted. Financial amounts below are in millions except per-share data.
Financial results and position
- Quarter earnings: Net income and income available to common shareholders were $11.9 million, versus $4.0 million. Diluted EPS was $0.13 versus $0.06.
- Nine-month earnings: Net income was $32.5 million versus $23.1 million; income available to common shareholders was $32.5 million versus $19.2 million, the prior-year amount reflecting preferred dividends and discount accretion. Diluted EPS was $0.37 versus $0.29.
- Net interest: Quarterly net interest income was $54.2 million, down 4.0%; nine-month net interest income was $164.4 million, down 6.8%. Fully taxable-equivalent net interest margin was 3.42% for the quarter and 3.38% year to date, compared with 3.51% and 3.57%.
- Other revenue and costs: Noninterest income rose 7.6% to $42.0 million for the quarter and 0.9% to $127.9 million year to date. Noninterest expense declined 9.4% to $76.1 million and 6.9% to $231.0 million, respectively. The efficiency ratio was 76.64% for the quarter and 76.32% year to date, versus 83.39% and 77.58%.
- Credit costs: Provision for loan losses was $6.4 million in Q3 and $23.7 million for nine months, down from $12.2 million and $41.5 million. Nine-month net charge-offs were $21.1 million versus $39.0 million; the annualized Q3 net charge-off rate was 0.66% versus 1.25%.
- Balance sheet at September 30: Assets were $7.506 billion, down 5.9% year over year. Loans totaled $3.703 billion, down from $4.036 billion; deposits were $5.439 billion, down from $5.694 billion. Shareholders’ equity was $895.7 million, versus $865.4 million a year earlier.
- Liquidity and funding: Cash and cash equivalents were $172.3 million, down from $225.7 million at September 30, 2009 and $497.3 million at year-end 2009. Total deposits plus wholesale borrowings were $6.385 billion, down 6.5% year over year. Noninterest-bearing deposits increased 21.2% year over year; time deposits declined 20.6%.
- Debt and capital: Short-term borrowings were $367.8 million and other borrowings $578.3 million. The Tier 1 leverage ratio was 10.24%; Tier 1 risk-based and total risk-based capital ratios were 15.37% and 17.25%. The bank subsidiary met the regulatory definition of well-capitalized. Common dividends were $0.07 per share for Q3 and $0.21 year to date.
- Cash flows for nine months: Operating activities provided $84.5 million and investing activities provided $163.5 million; financing activities used $573.1 million. Cash and cash equivalents decreased $325.0 million to $172.3 million.
Material changes versus prior periods
- Lower interest income and a smaller average earning-asset base reduced net interest income. Management attributed margin pressure chiefly to earning-asset yields falling faster than funding costs and to a shift from loans toward lower-yielding securities.
- Lower loan-loss provision and reduced expenses supported improved earnings. Management reported an 8.6% year-over-year decline in full-time-equivalent employees; eight branches had closed in 2010, with three more scheduled to close in November.
- Loan demand remained weak, and conservative underwriting also constrained loan growth. Commercial and commercial real estate loans were down $240.1 million year over year; consumer loans were down 13.7%. Residential real estate loans increased as more new production was retained.
- Asset quality was mixed: nonperforming loans were $69.8 million, down from $73.7 million a year earlier but up from $67.0 million at December 31, 2009. Nonperforming loans were 1.89% of loans versus 1.83% a year earlier. The allowance was $72.1 million, or 103.3% of nonperforming loans, versus 94.4% a year earlier.
- Net securities gains were $3.3 million in Q3 and $12.8 million year to date, primarily from portfolio sales as management shortened duration. This was partly offset by $3.3 million of nine-month securities impairment charges. Management said shorter duration reduced exposure to rising rates but would lower future yields.
- In the second quarter, $143.8 million of municipal securities were transferred from available-for-sale to held-to-maturity. The available-for-sale portfolio had net unrealized gains of $35.8 million at September 30, 2010, compared with net unrealized losses of $13.0 million at year-end 2009.
Outlook, risks and unusual items
- Acquisition: On October 6, 2010, after quarter-end, Old National announced an all-stock agreement to acquire Monroe Bancorp for an indicated value of approximately $83.5 million. Monroe had approximately $846 million of assets and $685 million of deposits at June 30, 2010. Closing was expected early in Q1 2011. Management expected the deal to improve its Indiana position and be accretive after one-time charges; no specific earnings guidance was provided.
- Credit and securities risks: Management cited continued weakness in its markets and uncertainty in residential real estate. Non-agency mortgage-backed and pooled trust preferred securities remain notable exposures: their fair values were $163.0 million and $8.4 million, with unrealized losses of approximately $21.6 million and $19.7 million, respectively. Ten non-agency securities were below investment grade. Further collateral deterioration could produce additional impairment.
- Other significant items: The company recorded $2.3 million of debt-extinguishment losses year to date related to prepayments, and $0.9 million of branch-closure and lease-termination expense. Lower deposit service-charge income reflected reduced overdraft and returned-item fees, including the effect of new regulatory requirements. FDIC assessment expense declined year over year partly because of a 2009 special assessment; $25.4 million of prepaid assessments remained to be expensed over the next two years.
- Contingencies: A long-running trust-administration lawsuit remained pending. The company said it could not reasonably estimate potential losses, recorded no liability, and believed an adverse resolution could materially affect results in the period resolved. The filing also describes ordinary-course litigation whose outcomes cannot be predicted with certainty.
- Other risks and controls: Management identified economic, credit, liquidity, interest-rate, market, regulatory and execution risks. It stated disclosure controls were effective at a reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter. No material change to previously disclosed risk factors was reported.
Most important facts for investors to verify
- Whether the Monroe Bancorp transaction closed on the expected timetable and achieved the anticipated cost savings, revenue opportunities and accretion.
- Subsequent trends in nonperforming loans, net charge-offs, criticized and classified assets, and adequacy of the $72.1 million loan-loss allowance.
- Further impairment or valuation changes in non-agency mortgage-backed and pooled trust preferred securities, including the assumptions underlying expected cash flows.
- Whether net interest margin, loan demand, deposit mix and fee income stabilized, and whether expense reductions improved efficiency without impairing franchise growth.
- Developments in the trust litigation and any resulting loss estimate, reserve or material cash-flow effect.
- Liquidity and capital after the substantial cash decline and planned acquisition; confirm regulatory ratios and funding capacity remain strong.