Old National Bancorp — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unless otherwise noted, dollar amounts below are in millions. The unaudited filing compares results with the same 2013 periods; balance-sheet comparisons are principally with December 31, 2013.
Business context
Old National is a regional banking and financial-services company operating primarily in Indiana, Michigan, Illinois and Kentucky. The 2014 results reflect the completed acquisitions of Tower Financial (April 25) and United Bancorp (July 31), which expanded the bank’s branch network and materially increased assets, loans and deposits. Management cited expected integration savings, but did not quantify them.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $108.4 | $78.0 | $276.3 | $236.2 |
| Noninterest income | $34.4 | $47.8 | $114.6 | $140.3 |
| Total revenue (net interest income plus noninterest income) | $142.8 | $125.8 | $391.0 | $376.6 |
| Provision for loan losses | $2.6 | $(1.7) release | $2.2 | $(4.6) release |
| Noninterest expense | $100.0 | $96.7 | $286.3 | $273.8 |
| Net income | $29.1 | $23.9 | $74.4 | $76.4 |
| Diluted EPS | $0.26 | $0.23 | $0.70 | $0.75 |
| Fully taxable-equivalent net interest margin | 4.78% | 3.96% | 4.37% | 3.99% |
| Efficiency ratio | 67.41% | 72.96% | 70.21% | 69.30% |
Quarterly net income increased 21.7%, while nine-month net income declined 2.6%. The reported quarterly margin benefited substantially from acquired-loan accretion: excluding that income, fully taxable-equivalent margin was 3.32% versus 3.34% in Q3 2013; the comparable nine-month figures were 3.31% in both years. Management said Q3 accretion was unusually high due to payoffs of several large purchased credit-impaired loans and expected lower accretion in future periods.
At September 30, total assets were $11.180 billion, up 16.7% from year-end 2013; loans were $6.242 billion, up 22.8%, and deposits were $8.207 billion, up 13.8%. Much of the balance-sheet expansion reflected Tower and United. Cash and cash equivalents were $231.5 million. Shareholders’ equity was $1.407 billion.
For the first nine months, operating cash flow was $134.9 million, investing cash flow was $(49.6) million and financing cash flow was $(60.6) million; cash increased $24.7 million to $231.5 million. These consolidated cash-flow figures include acquisition-related effects and should not be read as a simple measure of deposit trends.
At September 30, short-term borrowings were $495.3 million and other borrowings were $871.7 million. Other borrowings rose from $556.4 million at year-end, including issuance of $175 million of senior unsecured notes at 4.125%, due in 2024. Deposits remained the principal funding source. The company reported $2.682 billion of available liquid funds and borrowing capacity at subsidiaries, in addition to $186.2 million at the parent. Consolidated Tier 1 leverage was 8.92%; Old National Bank’s Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 8.22%, 11.95% and 12.71%, respectively. The bank exceeded stated well-capitalized thresholds.
Material changes and unusual items
- Noninterest income fell 27.9% in Q3 and 18.3% year to date, chiefly because of adverse FDIC indemnification-asset adjustments. These reduced noninterest income by $19.1 million in Q3 and $36.9 million for nine months. Securities gains partially offset the decline.
- Net interest income rose as acquired assets and accretion income increased. Management cautioned that accretion should decline, while the related FDIC asset amortization also affects reported income.
- Acquisition and integration costs were $3.2 million in Q3 and $11.8 million for nine months. Reported noninterest expense also included operating expenses from acquired branches.
- Credit quality indicators were mixed: net charge-offs remained low at 0.03% of average loans for Q3, and total underperforming assets were $182.8 million, down from $191.1 million a year earlier but up from $165.7 million at year-end. Nonaccrual loans were $142.3 million, up from $128.4 million at year-end. Total criticized and classified assets reached $447.4 million, with acquired Tower and United credits contributing.
- The allowance for loan losses was $48.3 million, or 0.77% of loans excluding loans held for sale. Management said continued loan growth or credit deterioration could require additional provision expense. The allowance estimate is judgment-sensitive; management disclosed a $13.9 million range in its general reserve analysis.
- The FDIC loss-sharing asset fell to $28.0 million from $88.5 million at year-end. The company did not expect covered losses to exceed the $275 million threshold at which the FDIC reimburses 80% of eligible losses; the agreement has differing coverage periods and loss tiers.
- Old National reported $7.1 million fair value of pooled trust preferred securities with $10.9 million of unrealized losses. No impairment was recorded on these securities in the first nine months. A separate $0.1 million impairment was recorded on a limited partnership investment subject to Volcker Rule divestiture requirements.
- A certified class action concerning the bank’s historical overdraft transaction sequencing remained stayed pending interlocutory appeal. Management said it could not determine the probability or reasonably estimate any loss at this stage.
Outlook, risks and contingencies
Management expected lower purchased-loan accretion going forward and warned that loan growth or weaker credit could raise provision expense. It expected fee-card revenue to be negatively affected beginning July 2015 because the company’s assets exceeded $10 billion and triggered certain Dodd-Frank provisions. The filing gives no specific earnings or revenue guidance.
LSB Financial, valued at approximately $66.7 million when announced, was expected to close November 1, 2014, subject to customary conditions. Founders Financial had received regulatory and shareholder approval after quarter-end but remained subject to customary closing conditions. Risks highlighted include acquisition integration, customer and deposit attrition, credit quality, interest-rate movements, liquidity, competition, regulatory changes and economic conditions. The company stated that disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the Tower and United integrations deliver expected cost savings without significant customer, deposit or revenue attrition, and how remaining integration costs develop.
- How quickly acquired-loan accretion declines, and the resulting net interest margin and FDIC indemnification-asset income effects.
- Whether nonaccrual loans, criticized and classified assets, troubled restructurings and the allowance remain consistent with management’s credit-quality assessment.
- Progress and final terms of the LSB and Founders acquisitions, including purchase accounting, funding and integration effects.
- The sensitivity of funding costs, asset values and earnings to interest-rate changes, as well as capital and liquidity after acquisitions and debt issuance.
- Developments in the overdraft-fee class action and the potential effect of the 2015 fee-card revenue changes.