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ONB > SEC Filings for ONB > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for OLD NATIONAL BANCORP /IN/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for OLD NATIONAL BANCORP /IN/


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is an analysis of our results of operations for the three and nine months ended September 30, 2012 and 2011, and financial condition as of September 30, 2012, compared to September 30, 2011, and December 31, 2011. This discussion and analysis should be read in conjunction with the consolidated financial statements and related notes. This discussion contains forward-looking statements concerning our business that are based on estimates and involves certain risks and uncertainties. Therefore, future results could differ significantly from our current expectations and the related forward-looking statements.

EXECUTIVE SUMMARY

During the third quarter of 2012, net income was $19.7 million, or $0.20 per share. This compares favorably to the $16.8 million, or $0.18 per share reported in the third quarter of 2011. The increase in earnings year over year is primarily the result of our acquisition of Integra Bank, our first FDIC-assisted transaction, which closed on July 29, 2011. During the third quarter of 2012, we continued to benefit from the accretion associated with the purchased credit impaired loans and other purchase accounting adjustments. We expect these benefits to diminish over time.

On September 15, 2012, Old National closed on its acquisition of Indiana Community Bancorp. Old National assumed assets with a fair value of approximately $906.8 million, including $496.2 million of loans, and $784.6 million of deposits. Non-interest expense included $4.9 million of acquisition and integration costs during the quarter and we expect to incur an additional $1.0 to $1.5 million of acquisition and integration costs in the fourth quarter of 2012.

Old National recorded a $1.3 million core deposit intangible asset associated with the acquired deposits and a $1.7 million customer relationship intangible associated with the trust business. These intangible assets will be amortized on an accelerated basis over the estimated economic lives of 7 and 12 years, respectively. Goodwill of $86.7 million was also recorded in conjunction with the transaction.

Regulatory capital remained strong after the transaction with consolidated Tier 1 capital to total average assets ("leverage ratio") of 8.78% and total capital to risk-adjusted assets of 14.06%. These ratios were 7.79% and 12.59%, respectively, for the Bank.

In addition, the Company continues to focus on initiatives to enhance revenue and drive down expenses. The Company announced the pending sale of deposits from nine former Integra branch locations as well as eight of the banking centers, and the planned consolidation of an additional 19 banking centers into nearby Old National locations. The consolidations are scheduled for the fourth quarter of 2012 and the pending sales will close during the first quarter of 2013. We incurred $0.8 million of costs associated with these transactions during the third quarter and anticipate additional lease termination and deconversion costs of $2.0 million to $2.5 million during the fourth quarter of 2012. Offsetting these efficiency initiatives will be higher costs of continued compliance with BSA/AML programs.


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RESULTS OF OPERATIONS

The following table sets forth certain income statement information of Old
National for the three and nine months ended September 30, 2012 and 2011:



                                          Three Months Ended                         Nine Months Ended
                                             September 30,              %              September 30,               %
(dollars in thousands)                    2012           2011        Change         2012           2011         Change
Income Statement Summary:
Net interest income                     $  74,150      $ 72,592          2.1 %    $ 224,396      $ 196,278         14.3 %
Provision for loan losses                     400           (82 )         NM          2,849          6,437        (55.7 )
Noninterest income                         40,867        47,326        (13.6 )      138,542        133,736          3.6
Noninterest expense                        89,019        95,158         (6.5 )      266,333        254,841          4.5
Other Data:
Return on average common equity              7.17 %        6.61 %                      8.57 %         6.75 %
Efficiency ratio (1)                        75.26         77.56                       71.71          74.47
Tier 1 leverage ratio                        8.78          7.88                        8.78           7.88
Net charge-offs to average loans             0.03          0.40                        0.17           0.41

(1) Efficiency ratio is defined as noninterest expense before amortization of intangibles as a percent of fully taxable net interest income and noninterest income, excluding net gains from securities transactions. This presentation excludes intangible amortization and net securities gains, as is common in other company disclosures, and better aligns with true operating performance.

NM = Not meaningful

Net Interest Income

Net interest income is our most significant component of earnings, comprising over 61% of revenues at September 30, 2012. Net interest income and margin are influenced by many factors, primarily the volume and mix of earning assets, funding sources and interest rate fluctuations. Other factors include prepayment risk on mortgage and investment-related assets and the composition and maturity of earning assets and interest-bearing liabilities. Loans typically generate more interest income than investment securities with similar maturities. Funding from client deposits generally cost less than wholesale funding sources. Factors such as general economic activity, Federal Reserve Board monetary policy and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize our mix of assets and funding and our net interest income and margin.

Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities. For analytical purposes, net interest income is also presented in the table that follows, adjusted to a taxable equivalent basis to reflect what our tax-exempt assets would need to yield in order to achieve the same after-tax yield as a taxable asset. We used the federal statutory tax rate in effect of 35% for all periods adjusted for the TEFRA interest disallowance applicable to certain tax-exempt obligations. This analysis portrays the income tax benefits associated with tax-exempt assets and helps to facilitate a comparison between taxable and tax-exempt assets. Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully taxable equivalent basis. Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons.


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                                              Three Months Ended                Nine Months Ended
                                                September 30,                     September 30,
(dollars in thousands)                      2012             2011             2012             2011
Net interest income                      $    74,150      $    72,592      $   224,396      $   196,278
Taxable equivalent adjustment                  3,340            2,914            9,643            8,842

Net interest income-taxable equivalent   $    77,490      $    75,506      $   234,039      $   205,120

Average earning assets                   $ 7,572,282      $ 7,626,682      $ 7,458,316      $ 7,287,482

Net interest margin                             3.92 %           3.81 %           4.01 %           3.59 %
Net interest margin-fully taxable
equivalent                                      4.09 %           3.96 %           4.18 %           3.75 %

Net interest income was $74.2 million and $224.4 million for the three and nine months ended September 30, 2012, up from the $72.6 million and $196.3 million reported for the three and nine months ended September 30, 2011. Taxable equivalent net interest income was $77.5 million and $234.0 million for the three and nine months ended September 30, 2012, up from the $75.5 million and $205.1 million reported for the three and nine months ended September 30, 2011. The net interest margin on a fully taxable equivalent basis was 4.09% and 4.18% for the three and nine months ended September 30, 2012, compared to 3.96% and 3.75% for the three and nine months ended September 30, 2011. The increase in both net interest income and net interest margin is primarily due to the acquisition of Integra Bank on July 29, 2011 combined with a change in the mix of interest earning assets and interest-bearing liabilities. The accretion associated with the purchased assets from Integra Bank benefited net interest margin by 48 basis points and 52 basis points during the three and nine months ended September 30, 2012. The accretion associated with the purchased assets from Integra Bank benefited net interest margin by 68 basis points and 42 basis points during the three and nine months ended September 30, 2011. We expect this accretion income to decline over time. The yield on interest earning assets decreased 17 basis points while the cost of interest-bearing liabilities decreased 37 basis points in the quarterly year-over-year comparison. In the year-to-date comparison, the yield on average earning assets increased 12 basis points while the cost of interest-bearing liabilities decreased 38 basis points.

Average earning assets were $7.572 billion for the three months ended September 30, 2012, compared to $7.627 billion for the three months ended September 30, 2011, a decrease of 0.7%, or $54.4 million. Average earning assets were $7.458 billion for the nine months ended September 30, 2012, compared to $7.287 billion for the nine months ended September 30, 2011, an increase of 2.3% or $170.8 million. Included in average earning assets for the three and nine months ended September 30, 2012 is approximately $111.1 million and $37.0 million, respectively, from the Indiana Community Bancorp acquisition, which was acquired on September 15, 2012. Significantly affecting average earning assets at September 30, 2012 compared to September 30, 2011, was the increase in the size of the loan portfolio combined with a decrease in the size of the investment portfolio and the decrease in interest earning cash balances at the Federal Reserve. A $420.0 million increase in average loans was partially offset by a $91.9 million decrease in average investment securities and a $157.3 million decrease in interest earning cash balances. The increase in average loans is primarily a result of the remaining $569.8 million of average loans acquired in the Integra Bank acquisition. This increase in acquired loans was partially offset by a decline in commercial and commercial real estate loans that was affected by weak loan demand in our markets. Year over year, the loan portfolio, which generally has an average yield higher than the investment portfolio, has increased as a percent of interest earning assets and was approximately 65 percent of interest earnings assets at September 30, 2012.

Also positively affecting margin was an increase in noninterest-bearing demand deposits combined with decreases in time deposits and other borrowings. During the last six months of 2011, we prepaid $102.0 million of FHLB advances and $80.0 million of structured repurchase agreements. In the fourth quarter of 2011, $150.0 million of subordinated bank notes matured. On June 30, 2012 we redeemed $13.0 million of subordinated notes and $3.0 million of trust preferred securities. Year over year, time deposits and other borrowings, which have an average interest rate higher than other types of deposits, have decreased as a percent of total funding. Year over year, noninterest-bearing demand deposits have increased as a percent of total funding.


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Provision for Loan Losses

The provision for loan losses was $0.4 million for the three months ended September 30, 2012, compared to a credit of $0.1 million for the three months ended September 30, 2011. The provision for loan losses was $2.8 million for the nine months ended September 30, 2012, compared to $6.4 million for the nine months ended September 30, 2011. Impacting the provision over the past twelve months are the following factors: (1) the loss factors applied to our performing loan portfolio have decreased over time as charge-offs were substantially lower,
(2) the continuing trend in improved credit quality, and (3) the percentage of our legacy loan portfolio consisting of those loans where higher loss factors are applied (commercial and commercial real estate loans) fell while the percentage of our loan portfolio consisting of those loans where lower loss factors are applied (residential loans) increased.

Noninterest Income

We generate revenues in the form of noninterest income through client fees and sales commissions from our core banking franchise and other related businesses, such as wealth management, investment consulting, investment products and insurance. Noninterest income for the three months ended September 30, 2012 was $40.9 million, a decrease of $6.4 million, or 13.6%, from the $47.3 million reported for the three months ended September 30, 2011. For the nine months ended September 30, 2012, noninterest income was $138.5 million, an increase of $4.8 million, or 3.6%, from the $133.7 million reported for the nine months ended September 30, 2011. The decrease in the quarterly comparison is primarily the result of adjustments to the FDIC indemnification asset. The increase in the year-to-date comparison is primarily the result of increases in net security gains.

Net securities gains were $2.7 million and $9.4 million for the three and nine months ended September 30, 2012, compared to net securities gains of $2.9 million and $4.5 million for the three and nine months ended September 30, 2011. Included in the third quarter and first nine months of 2012 are securities gains of $2.9 million and $10.5 million, respectively. Partially offsetting these gains were other-than-temporary-impairment charges of $0.2 million and $1.1 million, respectively, on six non-agency mortgage-backed securities and one trust preferred security. The securities gains in 2012 were a result of our continuing efforts to reduce the size and duration of the investment portfolio as well as to help with the liquidity needed to retire the subordinated notes and trust preferred securities. Included in the third quarter and first nine months of 2011 are securities gains of $2.9 million and $5.0 million, respectively. Partially offsetting these gains for the nine months ended September 30, 2011 were other-than-temporary-impairment charges of $0.5 million on three non-agency mortgage-backed securities.

Service charges and overdraft fees on deposit accounts were $12.8 million for the three months ended September 30, 2012, compared to $14.0 million for the three months ended September 30, 2011. The decrease in revenue is primarily attributable to a decrease in overdraft charges. Service charges and overdraft fees would have declined year-over-year without the Integra Bank acquisition and the $6.1 million it contributed during the nine months ended September 30, 2012.

Debit card and ATM fees were $5.7 million and $17.9 million for the three and nine months ended September 30, 2012, compared to $6.8 million and $18.7 million for the three and nine months ended September 30, 2011. A decrease in interchange income is the primary reason for the decrease.

Investment product fees were $9.5 million for the nine months ended September 30, 2012, compared to $8.5 million for the nine months ended September 30, 2011. The increase is primarily as a result of increases in mutual fund fees and other investment advisory fees.

Revenue from company-owned life insurance was $1.7 million and $4.7 million for the three and nine months ended September 30, 2012, compared to $1.4 million and $3.9 million for the three and nine months ended September 30, 2011. We anticipate this revenue will continue to slowly improve.

Other income increased $3.3 million for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. The increase is primarily a result of increases in customer derivative fee revenue, rental income from an operating lease, gains on sales of foreclosed properties and other miscellaneous income.


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Noninterest Income Related to Covered Assets

Income and expense associated with the FDIC loss sharing agreements is reflected in the change in the FDIC indemnification asset. This balance includes discount accretion, gains on the write-up of the FDIC indemnification asset, and expense from the reduction of the FDIC indemnification asset upon the removal of loans, OREO and unfunded loan commitments. Loans are removed when they have been fully paid off, fully charged off, sold or transferred to OREO. The change in the FDIC indemnification asset also includes income due to the FDIC, as well as the income statement effects of other loss share transactions.

For the third quarter of 2012, adjustments to the FDIC indemnification asset resulted in noninterest income/ (expense) of ($4.9) million. This compares to noninterest income of $0.5 million during the third quarter of 2011. Adjustments to the FDIC indemnification asset resulted in noninterest income/(expense) of ($4.1) million during the first nine months of 2012 compared to $0.5 million during the nine months ended September 30, 2011.

The decrease in income year over year is primarily the result of improvement in our loan loss expectations, which was partially offset by impairment of other real estate.

Noninterest Expense

Noninterest expense for the three months ended September 30, 2012, totaled $89.0 million, a decrease of $6.1 million, or 6.5%, from the $95.2 million recorded for the three months ended September 30, 2011. Salaries, benefits and professional fees declined after the Integra systems conversion in December 2011. For the nine months ended September 30, 2012, noninterest expense totaled $266.3 million, an increase of $11.5 million, or 4.5%, from the $254.8 million recorded for the nine months ended September 30, 2011. An increase in other real estate expense is the primary reason for the increase in noninterest expense in the year-to-date comparison. Included in the nine months ended September 30, 2012 is $10.6 million of impairment associated with certain OREO properties acquired in our FDIC assisted transaction. Also included in the three and nine months ended September 30, 2012 is approximately $4.9 million and $6.4 million, respectively, related to Integra and Indiana Community Bancorp acquisition and integration costs.

Salaries and benefits is the largest component of noninterest expense. For the three months ended September 30, 2012, salaries and benefits were $49.9 million compared to $52.3 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, salaries and benefits were $142.7 million compared to $139.9 million for the nine months ended September 30, 2011. Included in the third quarter of 2012 is an increase of $3.4 million for salaries and benefits expense associated with former IBT associates, which includes severance and retention accruals. Offsetting the increase from IBT is a reduction of approximately $5.2 million in salaries and benefits expense associated with former Integra Bank associates. Also included in the third quarter of 2012 is a $0.3 million decrease in hospitalization and long-term disability insurance expense. Included in the first nine months of 2012 is $3.4 million of salaries and benefits expense associated with former IBT associates. Partially offsetting the increase from IBT is a reduction of approximately $2.9 million in salaries and benefits expense associated with former Integra Bank associates. Also included in the first nine months of 2012 is a $6.4 million increase in expense related to the reinstatement of our performance-based incentive compensation plan. Partially offsetting this increase is a $1.3 million decrease in hospitalization and long-term disability expense, a $1.8 million decrease in severance expense and a $0.6 million decrease in restricted stock expense and our cost containment efforts.

Occupancy expense was $39.2 million for the nine months ended September 30, 2012, compared to $37.8 million for the nine months ended September 30, 2011. The increase was primarily attributable to increases in real estate taxes and building depreciation expense.

Professional fees decreased $2.1 million and $1.3 million for the three and nine months ended September 30, 2012, compared to the three and nine months ended September 30, 2011. The decreases are primarily attributable to legal and other professional fees associated with the acquisition of Integra Bank in 2011. Continued compliance with the June 4, 2012, consent order issued by our primary regulator is expected to result in increased professional fees during the fourth quarter of 2012 and first quarter of 2013 as the Company continues to progress on this project. The consent order requires the Bank to, among other things:
continue to review, update, and implement a written institution-wide, ongoing BSA/AML risk assessment that accurately identifies BSA/AML risks; ensure that Bank management reviews, updates, and implements its risk-based processes to obtain and analyze appropriate customer due diligence information to monitor for and investigate suspicious activity; ensure adherence to a written program for appropriate identification, analyzing and monitoring of transactions with greater than normal risk; maintain an effective BSA independent testing function; and ensure and maintain sufficient personnel with requisite expertise and skills who receive adequate on-going training.


Table of Contents

Loan expense increased $0.6 million and $1.5 million for the three and nine months ended September 30, 2012, compared to the three and nine months ended September 30, 2011. The increase is primarily attributable to loan expense associated with the acquisition of Integra Bank.

For the three and nine months ended September 30, 2012, FDIC assessment expense was $1.3 million and $4.1 million compared to $1.7 million and $5.6 million for the three and nine months ended September 30, 2011. The decrease is primarily due to a lower assessment rate.

Other real estate owned expense was $0.4 million and $11.8 million for the three and nine months ended September 30, 2012, compared to $0.6 million and $1.7 million for the three and nine months ended September 30, 2011. The increase is primarily due to expense related to decreased valuations of other real estate owned acquired in our FDIC assisted transaction. Eighty percent of these impairment losses are reimbursable by the FDIC upon ultimate sale of the property.

Other expense for the three months ended September 30, 2012, totaled $3.3 million, a decrease of $1.8 million compared to the three months ended September 30, 2011. Other expense for the nine months ended September 30, 2012, totaled $8.5 million, a decrease of $1.4 million compared to the nine months ended September 30, 2011. The decreases are primarily attributable to an accrual for a litigation settlement of $2.0 million in September 2011.

Noninterest Expense Related to Covered Assets

Noninterest expense related to covered assets are included in OREO expense, legal and professional expense and other covered asset-related expenses, and may be subject to FDIC reimbursement. Expenses must meet certain FDIC criteria in order for the expense amounts to be reimbursed. Certain amounts reflected in these balances may not be reimbursed by the FDIC if they do not meet the criteria.

$671 thousand, or twenty percent of the expense associated with holding and maintaining covered assets assumed in the Integra acquisition, are not reimbursable by the FDIC and were recorded as noninterest expense during the first nine months of 2012. The remaining eighty percent was recorded as a receivable from the FDIC. Additional non-reimbursable expenses of $359 thousand associated with holding and maintaining covered assets assumed in the Integra acquisition were also recorded in noninterest expense during the first nine months of 2012. Expense of $164 thousand was recorded during the third quarter of 2011 associated with holding and maintaining OREO properties assumed in the Integra acquisition.

Provision for Income Taxes

We record a provision for income taxes currently payable and for income taxes payable or benefits to be received in the future, which arise due to timing differences in the recognition of certain items for financial statement and income tax purposes. The major difference between the effective tax rate applied to our financial statement income and the federal statutory tax rate is caused by interest on tax-exempt securities and loans. The provision for income taxes, as a percentage of pre-tax income, was 22.9% for the three months ended September 30, 2012, compared to 32.4% for the three months ended September 30, 2011. The decrease in the quarterly comparison is primarily a result of adjustments to our state income tax apportionment rates. The provision for income taxes, as a percentage of pre-tax income, was 26.8% for the nine months ended September 30, 2012, compared to 26.9% for the nine months ended September 30, 2011. In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at September 30, 2012 based on the current estimate of the effective annual rate. The tax rate was effectively the same for the nine months of 2012 and 2011. See Note 16 to the consolidated financial statements for additional information.


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FINANCIAL CONDITION

Overview

At September 30, 2012, our assets were $9.383 billion, a 5.0% increase compared to September 30, 2011 assets of $8.933 billion, and an increase of 9.0% compared to December 31, 2011 assets of $8.610 billion. The increase from September 30, 2011 is primarily a result of the acquisition of Indiana Community Bancorp, which occurred in the third quarter of 2012. Year over year, we have also reduced our reliance on higher cost deposits and other borrowings. Time deposits and other borrowings, which have an average interest rate higher than other types of deposits, have decreased as a percent of total funding. Year over year, noninterest-bearing demand deposits have increased as a percent of total funding.

Earning Assets

Our earning assets are comprised of investment securities, portfolio loans, loans held for sale, money market investments, interest earning accounts with the Federal Reserve and trading securities. Earning assets were $8.054 billion at September 30, 2012, an increase of 4.4% from September 30, 2011.

Investment Securities

We classify the majority of our investment securities as available-for-sale to give management the flexibility to sell the securities prior to maturity if needed, based on fluctuating interest rates or changes in our funding requirements. However, we do have $63.2 million of 15- and 20-year fixed-rate mortgage pass-through securities, $174.8 million of U.S. government-sponsored . . .

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