OLD NATIONAL BANCORP quarterly report, Q2 FY2018

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Old National Bancorp — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results. Unless otherwise noted, dollar amounts below are in millions.

Business context

Old National is a Midwest community bank operating primarily in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota. The November 2017 Anchor (MN) acquisition significantly expanded the balance sheet and contributed to year-over-year growth. Management describes its strategy as loan growth, fee income, and expense control, with a focus on commercial lending and shifting assets toward higher-yielding loans.

Financial performance and position

  • Q2 earnings: Net income was $44.0, or $0.29 per diluted share, versus $38.9 and $0.28 a year earlier. Pre-tax income was $48.3 versus $49.4; lower income-tax expense supported the increase in net income.
  • First-half earnings: Net income was $92.0, or $0.60 per diluted share, compared with $74.8 and $0.55 in the first half of 2017.
  • Net interest: Q2 net interest income increased 26.5% to $132.0 year over year; first-half net interest income rose 24.0% to $260.5. Taxable-equivalent net interest margin was 3.55% in Q2 versus 3.42%, and 3.50% for the first half versus 3.46%. Management attributed improvement to Anchor, loan growth, higher loan yields, and asset mix; funding costs also rose.
  • Noninterest income and expense: Q2 noninterest income was essentially unchanged at $49.3. First-half income declined 1.1% to $91.2, including lower capital-markets income and securities gains. Q2 noninterest expense rose 26.9% to $130.5; first-half expense increased 21.0% to $247.6. Drivers included Anchor operating and integration costs and $12.6 of tax-credit investment amortization in the first half. The efficiency ratio was 69.58% for Q2 versus 64.05% a year earlier.
  • Balance sheet: Assets were $17.483 billion at June 30, 2018, up from $14.957 billion a year earlier, largely reflecting Anchor and commercial loan growth. Total loans were $11.296 billion, deposits $12.596 billion, and shareholders’ equity $2.200 billion. Total assets were slightly below December 31, 2017.
  • Credit quality: The allowance for loan losses was $53.7, or 0.48% of loans, versus $51.0 and 0.55% a year earlier. First-half provision was $2.8. The company recorded net recoveries of $0.5 for the first half. Nonaccrual loans were $139.1; nonperforming loans were 1.38% of loans. Under-performing assets were $161.5, or 0.92% of assets, compared with $150.9 a year earlier. Criticized and classified assets totaled $407.7.
  • Cash flow and liquidity: For the first six months, operating cash flow was $104.8, investing cash flow was negative $21.7, and financing cash flow was negative $99.6. Cash and cash equivalents ended at $273.9. Subsidiaries had $2.925 billion of stated available funds, including cash, unencumbered securities, and borrowing capacity; the parent reported $71.3 of available cash.
  • Debt and capital: Total borrowed funds were $2.530 billion, including $1.757 billion of FHLB advances. Consolidated Tier 1 leverage was 8.30%, common equity Tier 1 and Tier 1 risk-based capital were each 10.85%, and total risk-based capital was 11.87%. The bank subsidiary met the regulatory definition of well-capitalized.
  • Shareholder returns: The quarterly dividend was $0.13 per share. Book value was $14.44 per share and tangible common book value, a non-GAAP measure, was $8.70.

Material changes and unusual items

  • Anchor (MN), acquired in November 2017, added approximately $2.2 billion of assets at acquisition and drove much of the increase in average earning assets, loans, deposits, and expenses. Anchor-related transaction and integration costs totaled $17.0 through June 30, 2018.
  • Old National sold its remaining student-loan portfolio in Q2 for $64.9, recording a $2.2 gain included in other income.
  • Tax-credit investment amortization was $12.6 in the first half of 2018, versus none in the comparable 2017 period. Management anticipated approximately $15–$18 of tax-credit amortization, including discrete tax items, in the second half of 2018; timing depends on project completion.
  • The effective tax rate fell to 9.0% for Q2 and 9.2% for the first half, from 21.4% and 22.0%, respectively. The filing cites the federal corporate tax-rate reduction to 21% and increased federal tax credits.
  • Net unrealized losses on available-for-sale securities were $77.8 at June 30, up from $56.4 at year-end, primarily reflecting higher long-term interest rates. Management stated it did not intend, and did not expect to be required, to sell securities in unrealized-loss positions.
  • Old National entered an agreement to acquire Klein Financial for an estimated $433.8 in Old National shares, based on the June 20 share price. The transaction remained subject to regulatory approval and Klein shareholder approval, with closing anticipated in Q4 2018.
  • The planned sale of ten Wisconsin branches to Marine Credit Union includes approximately $261 of deposits and no loans; closing was expected in Q4 2018, subject to approvals and other conditions. Nine branches were consolidated in the first half of 2018, and one more was scheduled for Q3.

Outlook, risks, and contingencies

  • No specific earnings or full-year financial guidance is provided. Management said it expected loan growth and asset remixing to support net interest income, while noting that deposit and borrowing costs were increasing and that purchased-loan accretion income was expected to decline over time.
  • Interest-rate sensitivity modeling estimated that a 100-basis-point immediate rate increase would raise two-year cumulative net interest income by 1.21% from the base case; a 50-basis-point decrease would reduce it by 1.31%. Management cautioned that model results are not guarantees of actual outcomes.
  • Key risks include credit deterioration, interest-rate and liquidity exposure, acquisition integration and realization of cost savings, deposit competition, economic conditions, cybersecurity and operational risks, and regulatory or legal developments. Moody’s affirmed ratings but assigned a negative outlook.
  • Off-balance-sheet commitments included $3.218 billion of loan commitments and $85.7 of standby letters of credit. The filing says pending legal matters were not currently material to financial condition, but outcomes could affect results or cash flows in a future period.
  • Adoption of the new lease standard was expected to increase assets and liabilities by approximately $125–$140, with no material income-statement effect expected. The eventual allowance impact of the future CECL credit-loss standard could not yet be reasonably estimated; management expected a one-time increase to the allowance upon adoption.

Most important facts for investors to verify

  • Whether loan and deposit growth, net interest margin, and funding costs develop as management expected, particularly as rates change.
  • Whether higher criticized/classified and nonaccrual balances lead to greater provisions, charge-offs, or allowance needs.
  • Actual remaining Anchor integration costs, expense trends, and realization of acquisition-related benefits.
  • Approval, timing, and final economics of the Klein acquisition and Wisconsin branch sale.
  • Completion and timing of tax-credit projects, related amortization, and the resulting effective tax rate.
  • Capital, liquidity, and securities valuation effects from interest rates, including the reported unrealized securities losses.