Old National Bancorp — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise. Comparisons are with the corresponding 2009 periods unless noted.
Business context
Old National is a regional banking company operating primarily in Indiana, Illinois, and Kentucky. Its businesses include community banking, treasury, insurance, wealth management, and brokerage. The unaudited interim statements include normal recurring adjustments; management cautions that interim results do not necessarily indicate full-year results.
Key financial results
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net interest income | $55.2 | $60.8 | $110.3 | $120.0 |
| Net interest margin | 3.20% | 3.28% | 3.16% | 3.29% |
| Fully taxable-equivalent net interest margin | 3.40% | 3.58% | 3.37% | 3.60% |
| Provision for loan losses | $8.0 | $12.0 | $17.3 | $29.3 |
| Noninterest income | $43.0 | $45.6 | $86.0 | $87.8 |
| Noninterest expense | $77.9 | $86.8 | $154.9 | $164.2 |
| Income before taxes | $12.3 | $7.7 | $24.0 | $14.3 |
| Net income | $10.5 | $9.6 | $20.6 | $19.0 |
| Net income available to common shareholders | $10.5 | $9.6 | $20.6 | $15.1 |
| Diluted earnings per common share | $0.12 | $0.15 | $0.24 | $0.23 |
Q2 return on average common equity was 4.91% (6.02% in Q2 2009); the efficiency ratio was 76.65% (77.50%). Six-month return on average common equity was 4.83% (4.73%); the efficiency ratio was 76.16% (74.91%). The six-month 2009 common earnings figure reflects preferred dividends and discount accretion of $3.9 million; no such deduction applied in 2010.
Balance sheet, cash flow, debt, and liquidity
- At June 30, total assets were $7.701 billion, down 3.9% from June 30, 2009 and modestly below $8.005 billion at year-end 2009. Total loans were $3.731 billion, down from $4.151 billion a year earlier; deposits were $5.647 billion, down from $5.799 billion.
- Cash and cash equivalents were $426.6 million. For the first six months, operating cash flow was $82.4 million, investing cash flow was positive $216.5 million, financing cash flow was negative $369.5 million, and cash declined $70.7 million.
- Short-term borrowings were $331.6 million and other borrowings were $604.4 million at June 30. The company repaid a $25 million FHLB advance and a $24 million long-term repurchase agreement and a $50 million senior unsecured note matured during Q2. Funding totalled $6.583 billion; wholesale borrowings were 14.2% of total funding, versus 18.9% a year earlier.
- Shareholders’ equity was $874.7 million. The consolidated Tier 1 leverage ratio was 9.87%, Tier 1 risk-based capital ratio 15.09%, and total risk-based capital ratio 16.97%. The bank subsidiary was described as well-capitalized under regulatory definitions. Equity includes approximately $195.7 million net proceeds from a 2009 common-stock offering.
- Management described liquidity as strong. The bank had stated capacity to borrow $744.9 million from the Federal Reserve discount window. Deposits without stated maturity were $3.864 billion; contractual obligations also included $1.783 billion of certificates of deposit and $445.0 million of operating leases.
Credit quality, securities, and material changes
- The allowance for loan losses was $71.9 million, or 1.93% of loans, and equalled 104.36% of nonperforming loans. Six-month net charge-offs were $15.0 million versus $26.3 million; annualized net charge-offs were 0.80% of average loans versus 1.13%.
- Nonperforming loans were $68.9 million, compared with $77.7 million a year earlier and $67.0 million at December 31, 2009. Underperforming assets were $76.3 million, down from $84.8 million a year earlier. Classified and criticized assets totalled $410.7 million.
- The investment securities portfolio was $2.883 billion, up 10.9% year over year. Management shortened portfolio duration to reduce exposure to rising rates; average duration was 3.39 years-equivalent as reported, versus 5.35 at June 30, 2009. Management warned this repositioning would lower future yields.
- Q2 included $6.0 million of securities gains and $2.8 million of impairment losses recognized in earnings; six-month amounts were $9.5 million and $3.3 million, respectively. Impairments related to pooled trust preferred securities and non-agency mortgage-backed securities. At June 30, non-agency mortgage securities had fair value of $164.7 million and approximately $30.1 million of net unrealized losses; pooled trust preferred securities had fair value of $10.5 million and $17.6 million of unrealized losses. Ten non-agency securities were below investment grade.
- Other Q2 items included a $1.4 million loss on extinguishment of debt and $0.9 million of expense related to closing five financial centers. Lower noninterest expense mainly reflected lower salaries and FDIC assessments; the 2009 comparison included a $4.0 million FDIC special assessment and acquisition-related costs.
- Q2 diluted EPS fell to $0.12 from $0.15 despite higher net income, principally reflecting the increase in shares outstanding following the 2009 stock offering. The common dividend was $0.07 per share in Q2, unchanged year over year; the six-month dividend was $0.14 versus $0.30.
Outlook, risks, and contingencies
Management reported some positive economic indicators but expected a slow financial-services recovery, continued low interest rates, a challenging credit environment, and weak loan demand for several more quarters. It cited expense rationalization, process improvement, implementation of new regulations, and steps to mitigate potential revenue losses from regulation. No specific earnings or financial guidance was provided.
Key exposures include deterioration in regional economic and real-estate conditions, weak loan and deposit growth, interest-rate and securities-market movements, credit impairment estimates, and regulatory changes. Management’s securities impairment and loan-loss estimates involve significant judgment. The company reported that it did not intend to sell available-for-sale securities in unrealized-loss positions and did not expect to be required to sell them before recovery.
A lawsuit concerning administration of trusts is pending; the company says it cannot reasonably estimate potential losses and has recorded no liability. It believes it has meritorious defenses, but an adverse outcome could materially affect results or financial condition in the period resolved. Loan commitments were $1.082 billion and standby letters of credit were $87.3 million, largely off balance sheet. Management reported disclosure controls effective at a reasonable-assurance level and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether net interest margin and core fee income stabilize, given lower asset yields, reduced loan demand, and the securities repositioning’s expected lower yields.
- Trends in nonperforming loans, criticized and classified assets, charge-offs, and the adequacy of the $71.9 million loan-loss allowance.
- Further credit deterioration or valuation changes in non-agency mortgage-backed and pooled trust preferred securities, including any additional impairment charges.
- Progress on expense controls and the revenue and cost effects of regulatory changes, as well as the timing and consequences of the pending trust litigation.
- Capital, liquidity, deposit trends, and debt maturities, particularly the 2011 obligations and the company’s reliance on wholesale funding.