Old National Bancorp — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited consolidated results. Dollar amounts below are in millions unless stated otherwise.
Business context
Old National is a regional bank holding company whose community banking operations are its sole reportable segment. On May 1, it completed its acquisition of Anchor BanCorp Wisconsin for approximately $459.8 million, adding 46 banking centers and expanding in Wisconsin. On May 31, it sold ONB Insurance Group for approximately $91.8 million in cash. The quarter also marked the termination of the company’s FDIC loss-share agreements.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $99.3 | $92.1 | $185.0 | $183.1 |
| Noninterest income | $93.4 | $55.0 | $142.8 | $110.3 |
| Provision for loan losses | $1.3 | $2.3 | $1.4 | $2.3 |
| Noninterest expense | $121.5 | $109.7 | $219.8 | $225.8 |
| Income tax expense | $30.8 | $9.0 | $40.5 | $18.2 |
| Net income | $39.1 | $26.2 | $66.1 | $47.1 |
| Diluted EPS | $0.31 | $0.22 | $0.55 | $0.40 |
- Q2 noninterest income included a $41.9 million pretax gain on the insurance sale; the after-tax gain was $17.6 million. Thus, reported income growth was materially affected by a one-time transaction.
- Net interest margin was 3.39% in Q2 versus 3.57% a year earlier; on a fully taxable-equivalent basis, it was 3.57% versus 3.75%. For the first half, those measures were 3.35% versus 3.54% and 3.54% versus 3.72%, respectively. Management attributed margin pressure to lower acquired-loan accretion, low asset yields, higher funding costs, and mix changes.
- The reported effective tax rate rose to 44.1% in Q2 from 25.5%, and to 38.0% for the first half from 27.9%. The company cited the insurance-sale gain and $8.3 million of tax expense related to nondeductible goodwill.
- Q2 return on average common equity was 9.22% versus 7.11%; the non-GAAP efficiency ratio was 60.22% versus 70.52%. First-half figures were 8.26% versus 6.33% and 63.76% versus 73.36%, respectively.
Cash flow, balance sheet, and capital
- For the first half, operating cash flow was $55.5 million, investing cash flow was negative $182.2 million, and financing cash flow was positive $174.8 million. Cash and cash equivalents ended June at $267.9 million, up from $219.8 million at year-end 2015.
- At June 30, total assets were $14.42 billion, up from $11.99 billion at year-end, primarily reflecting Anchor. Total loans were $8.83 billion versus $6.95 billion at year-end; deposits were $10.45 billion versus $8.40 billion. Anchor contributed $1.64 billion of loans and $1.85 billion of deposits at acquisition.
- Short-term borrowings were $567.7 million and other borrowings $1.37 billion, totaling $1.94 billion. Total shareholders’ equity was $1.81 billion. The company reported $2.79 billion of available funds at subsidiaries, including cash, unencumbered securities, and borrowing capacity, plus $129.9 million at the parent.
- Capital ratios remained above stated regulatory minimums: consolidated Tier 1 leverage was 8.86%, common equity Tier 1 was 11.64%, and total capital was 12.38%. Old National Bank was reported as well-capitalized.
Material changes, outlook, and risks
- Anchor drove substantial balance-sheet expansion and contributed $11.4 million of Q2 operating expense; Q2 acquisition and integration charges were $7.2 million. Management cited organic loan growth of $186.5 million during the quarter, in addition to acquired loans.
- Debit-card and ATM fees fell year over year, partly due to the Durbin Amendment taking effect for the company in July 2015. Deposit-service charges also declined, in part following 2015 branch divestitures. Management said it remained focused on loan growth, fee income, and expense management; the filing gives no formal earnings or revenue guidance.
- Management expected termination of the frozen retirement plan and distribution of its trust fund in Q4 2016 to produce a pretax charge of $11–$13 million, while relieving future obligations and expense.
- Asset quality was mixed: nonaccrual loans were $160.3 million, up from $132.4 million at year-end but below $167.8 million a year earlier. Underperforming assets were $199.2 million, and criticized and classified assets totaled $363.5 million. The allowance was $51.8 million, or 0.59% of loans excluding loans held for sale; the lower ratio partly reflects acquired Anchor loans recorded at fair value without an acquisition-date allowance.
- Ending FDIC loss-share protection transfers future gains and losses on formerly covered assets fully to Old National; the FDIC made a final $8.7 million payment and the termination produced a nominal pretax gain. The company also disclosed $2.25 billion in loan commitments and $61.6 million in standby letters of credit.
- Key risks include integration and realization of acquisition savings, credit deterioration, interest-rate and margin sensitivity, deposit and funding conditions, and economic weakness in the company’s markets. Management noted that a 50-basis-point rate decline modeled a 3.45% reduction in two-year cumulative net interest income, while a 100-basis-point increase modeled a 2.62% increase; these are model estimates, not forecasts.
- The company reported no material adverse effect expected from pending litigation overall, but outcomes could affect a particular period. A checking-account overdraft-fee class action was settled for $4.75 million, accrued in 2015, and dismissed in June 2016. Disclosure controls were deemed effective at a reasonable-assurance level.
Investor verification priorities
- Assess earnings excluding the insurance-sale gain and the higher tax expense associated with the transaction.
- Track Anchor integration costs, deposit retention, organic growth, and whether anticipated cost savings are achieved.
- Review acquired-loan credit performance, nonaccrual trends, the allowance methodology, and the effect of ending FDIC loss-share coverage.
- Monitor net interest margin, deposit pricing, wholesale funding, and actual results versus the company’s interest-rate sensitivity models.
- Confirm the timing and final cost of the retirement-plan termination and distribution, expected to generate an $11–$13 million pretax charge.