Business Context and Reporting Period
Company: Old National Bancorp
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Overview: Old National Bancorp is a financial holding company operating primarily in Indiana, Illinois, and Kentucky. The reporting period covers the third quarter of 2008, a time of significant financial market stress. The company reported net income of $17.0 million for the quarter, a decrease from $22.6 million in the same period of 2007, driven by higher loan loss provisions and lower net interest income.
Key Financial Metrics
| Metric | Q3 2008 | Q3 2007 | YTD 2008 | YTD 2007 |
|---|---|---|---|---|
| Net Income | $17.0 million | $22.6 million | $55.8 million | $52.9 million |
| Diluted EPS | $0.26 | $0.34 | $0.85 | $0.80 |
| Net Interest Income | $59.6 million | $55.2 million | $180.7 million | $161.4 million |
| Net Interest Margin | 3.79% | 3.37% | 3.77% | 3.19% |
| Provision for Loan Losses | $6.8 million | $0 | $34.4 million | $2.4 million |
| Noninterest Income | $39.0 million | $37.6 million | $129.4 million | $111.1 million |
| Noninterest Expense | $72.5 million | $65.5 million | $218.2 million | $207.0 million |
| Total Assets | $7.57 billion | $7.83 billion | N/A | |
| Total Loans | $4.68 billion | $4.75 billion | N/A | |
| Total Deposits | $5.35 billion | $5.87 billion | N/A | |
| Shareholders' Equity | $635.4 million | $647.4 million | N/A | |
| Cash & Equivalents | $194.0 million | $197.2 million | N/A |
Material Changes vs. Prior Period
- Provision for Loan Losses: The most significant change was the recording of a $6.8 million provision in Q3 2008 (compared to zero in Q3 2007) and $34.4 million year-to-date. This increase is primarily attributed to the deterioration of credits associated with the misconduct of a former loan officer in the Indianapolis market and general softening in credit quality.
- Asset Quality: Nonaccrual loans increased to $68.4 million (1.46% of total loans) from $49.3 million (1.04%) in the prior year. Criticized and classified loans increased 16.5% compared to the prior quarter.
- Investment Portfolio: The investment securities portfolio decreased by $191.8 million year-over-year due to sales and maturities. The portfolio held net unrealized losses of $74.2 million, primarily due to interest rate changes and market stress, though management does not believe these are other-than-temporary impairments.
- Deposits: Total deposits declined 9.0% year-over-year to $5.35 billion, driven by the runoff of high-cost brokered certificates of deposit and a shift toward lower-cost savings deposits.
- Income Tax Expense: The effective tax rate dropped significantly to 11.8% for Q3 2008 (from 17.3% in 2007) and 2.8% year-to-date (from 16.1% in 2007), largely due to a $6.6 million reversal of unrecognized tax benefits related to a favorable Tax Court decision.
Guidance, Outlook, and Risks
- Outlook: Management expects credit markets to remain challenging. The company is focusing on maintaining a well-capitalized position, improving its risk profile, and managing through the credit cycle. They remain cautious regarding consumer, construction, and commercial real estate credit quality.
- TARP Participation: In a subsequent event (October 27, 2008), Old National was preliminarily approved to participate in the Treasury's Troubled Asset Relief Program (TARP) Capital Purchase Program, eligible for up to $150 million in capital. The company has 30 days to decide on participation.
- Interest Rate Risk: Modeling indicated the company was within policy limits for rising rate scenarios but fell into the "yellow" or "red" zones for falling rate scenarios (specifically a 200 basis point drop over 24 months). Management is working to reduce exposure to falling rates.
- Key Risks:
- Credit Risk: Continued deterioration in the real estate market and the impact of the former loan officer's misconduct.
- Market Risk: Sensitivity to interest rate changes and the valuation of the investment portfolio, particularly pooled trust preferred securities ($19.5 million).
- Liquidity Risk: Moody's changed the company's outlook to negative in October 2008 due to high dividend payments impacting holding company liquidity.
Investor Verification Checklist
- Loan Loss Provision Adequacy: Verify if the $34.4 million YTD provision is sufficient given the $15.6 million in charge-offs related to the former loan officer and the 16.5% increase in criticized loans.
- Investment Portfolio Valuation: Review the $74.2 million in unrealized losses on available-for-sale securities to confirm management's assertion that they are not "other-than-temporary" impairments, specifically regarding the $19.5 million in pooled trust preferred securities.
- TARP Decision: Monitor the company's final decision regarding the $150 million TARP capital injection and the associated restrictions on executive compensation and dividends.
- Deposit Stability: Assess the sustainability of the shift from high-cost brokered deposits to lower-cost savings deposits and the impact on future net interest margins.
- Interest Rate Sensitivity: Evaluate the company's hedging strategies to mitigate the identified risk in the "falling rate" scenarios which currently fall outside the "green zone" policy limits.