Old National Bancorp — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; balance-sheet comparisons are primarily with December 31, 2018 and June 30, 2018. Dollar amounts below are in U.S. dollars.
Business context and reporting period
Old National Bancorp is a Midwest community bank operating primarily in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota. Its November 2018 acquisition of Klein Financial expanded the balance sheet and contributed materially to year-over-year comparisons. Management said its priorities remain loan growth, credit discipline, expense control, and integrating Klein; it described the company as an active but disciplined potential acquirer.
Financial performance and condition
- Q2 earnings: Net income was $63.0 million, versus $44.0 million a year earlier; diluted EPS was $0.36, versus $0.29. Combined net interest and noninterest income was $206.4 million, up from $181.3 million.
- First-half results: Net income was $119.2 million versus $92.0 million; diluted EPS was $0.68 versus $0.60. Net interest income was $302.3 million, up 16.0%, and noninterest income was $97.6 million, up 7.1%.
- Interest income and margins: Q2 net interest margin was 3.66% on a taxable-equivalent basis, up from 3.55% a year earlier. Net interest income growth reflected higher average earning assets, including Klein, and improved asset yields; higher deposit and borrowing costs partly offset the benefit. Q2 acquired-loan accretion income was $11.8 million.
- Fees, expenses, and taxes: Q2 noninterest income rose 3.9% year over year, with growth in mortgage banking and capital markets partly offset by lower other income and the prior-year student-loan portfolio sale gain. Noninterest expense declined 1.8% in Q2, but increased 1.4% for the first half, principally reflecting Klein-related operating and integration costs. Q2 effective tax rate was 18.6%, versus 9.0%, primarily because fewer federal tax credits were available.
- Profitability measures: Q2 return on average assets was 1.26%, return on average common equity 9.13%, and management’s non-GAAP efficiency ratio 59.35% (69.58% a year earlier). The efficiency comparison includes a substantial year-earlier tax-credit amortization expense.
- Loans and credit: Total loans were $12.05 billion at June 30, down $22.4 million from March 31 and down $197.3 million from year-end. Management reported record commercial loan production in Q2. The allowance for loan losses was $56.3 million, or 0.47% of loans. Nonperforming loans were 1.34% of loans; underperforming assets were $164.7 million, or 1.37% of loans plus other real estate owned. Criticized and classified assets totaled $540.6 million, up from $407.7 million at June 30, 2018; management cited acquired Klein credits as a factor in the portfolio.
- Liquidity and funding: Cash and cash equivalents totaled $301.0 million. Deposits were $14.36 billion, compared with $14.35 billion at year-end; total borrowed funds were $2.73 billion, up from $2.53 billion. The filing reports $3.45 billion of available funds at subsidiaries, including cash, unencumbered securities, and borrowing capacity, plus $46.8 million at the parent.
- Cash flow: First-half operating cash flow was $74.8 million, versus $104.8 million. Investing activities used $216.3 million, largely reflecting securities purchases; financing activities provided $125.3 million. Cash and cash equivalents declined $16.2 million during the half-year.
- Capital and shareholder returns: Consolidated CET1 was 11.89%, total risk-based capital 12.82%, and the leverage ratio 8.82%; the bank subsidiary exceeded well-capitalized thresholds. First-half dividends were $0.26 per share. The company repurchased 3.3 million shares for $58.1 million during the first half.
Material changes, outlook, and risks
- Klein consideration was $406.5 million in Old National shares; the acquired company had $2.16 billion of assets at closing. Acquisition goodwill was $208.0 million. Through June 30, Old National had expensed $18.8 million of transaction and integration costs; additional integration costs will be expensed as incurred.
- Management provided no specific earnings or financial guidance. It said its 2019 focus was integration and execution, while maintaining its acquisition strategy. Management noted that stronger future commercial loan demand could lead it to reduce securities holdings.
- Management identified the slightly inverted Treasury yield curve as a potential pressure on spreads and net interest income, while stating that balance-sheet and derivative actions were intended to mitigate the risk. Its interest-rate model projected a 1.60% decline in net interest income under an immediate 50-basis-point rate decrease and increases of roughly 0.99%–1.15% under immediate increases of 100–300 basis points; management cautioned that model outputs are not guarantees.
- Credit results could be affected by future loan growth, lower recoveries, higher charge-offs, or weaker economic conditions. CRE lending is a material exposure, although the bank’s CRE loans were 189% of risk-based capital, below the stated 300% regulatory guideline.
- Old National was preparing for CECL adoption, expected in 2020. The company anticipated a one-time increase in the allowance at adoption but said the amount could not yet be reasonably estimated; it expected to identify a range in its Q3 2019 report. It planned to use the permitted three-year regulatory capital transition relief.
- The company was developing a LIBOR-to-SOFR transition plan for exposed contracts. It also disclosed Moody’s negative outlook, notwithstanding investment-grade ratings.
- Legal matters were described as ordinary-course; the company said it was not involved in material litigation and did not expect pending matters to materially affect consolidated financial condition, though a particular period’s results or cash flows could be affected. Off-balance-sheet loan commitments were $2.98 billion and standby letters of credit $101.3 million.
Important facts for investors to verify
- How much future earnings growth is attributable to Klein versus organic growth, and whether integration costs and expected cost savings develop as planned.
- Whether loan production translates into sustained loan growth, and how criticized/classified credits and acquired Klein loans perform.
- Trends in deposit pricing, funding mix, net interest margin, and acquired-loan accretion as rates and the yield curve change.
- The expected CECL day-one allowance increase and regulatory capital effects when the company provides its estimate.
- Capital deployment, including share repurchases, dividends, and the capacity to fund growth while maintaining capital and liquidity.