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ONB > SEC Filings for ONB > Form 10-Q on 2-Aug-2013All 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-Aug-2013

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 six months ended June 30, 2013 and 2012, and financial condition as of June 30, 2013, compared to June 30, 2012, and December 31, 2012. 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 second quarter of 2013, net income was $28.5 million, or $0.28 per share. This compares to the $27.2 million, or $0.29 per share reported in the second quarter of 2012. The increase in net income year over year is primarily the result of our acquisition of Indiana Community Bancorp which closed on September 15, 2012. Earnings per share comparisons are impacted by the 6.6 million shares issued during the third quarter of 2012 in conjunction with our acquisition of Indiana Community Bancorp.

Although loan growth remains tempered, total loan balances did increase $64.2 million from March 31, 2013. The largest increase was in the commercial loan portfolio. Although we believe we are in the midst of a macro recovery, the steeper yield curve could contribute to a slowdown of refinancing activity and weaker loan growth.

Management continues to focus on expenses and announced plans to consolidate eighteen additional banking centers. As part of an ongoing efficiency initiative, Old National continues to examine its locations closely, reviewing such items as market dynamics, deposits per branch, proximity to other offices and client traffic. The centers are scheduled to be closed in the third quarter of 2013.

Credit quality continues to improve with quarterly net charge offs to average loans of 0.04% at June 30, 2013 compared to 0.13% a year ago. These lower loss rates, along with continuing improvement in asset quality, contributed to recapture of $3.7 million of provision expense during the quarter. Non-performing loans to total loans improved to 3.84% compared to 5.13% at June 30, 2012.

Subsequent to quarter end the Company closed on its acquisition of 24 Bank of America branches in northern Indiana and the southwest Michigan market. Included in the transaction were approximately $575.0 million in deposits and $5.0 million in loans. The Company's total assets remain below $10.0 billion and the Company will not be subject to certain provisions of the Dodd Frank Act as a result of this transaction. Management will continue to actively pursue partnership opportunities to improve our deposit franchise within or contiguous to our geographic operating footprint.


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RESULTS OF OPERATIONS

The following table sets forth certain income statement information of Old
National for the three and six months ended June 30, 2013 and 2012:



                                          Three Months Ended                          Six Months Ended
                                               June 30,                 %                 June 30,                 %
(dollars in thousands)                    2013           2012        Change         2013           2012         Change
Income Statement Summary:
Net interest income                     $  79,191      $ 75,973          4.2 %    $ 158,241      $ 150,246          5.3 %
Provision for loan losses                  (3,693 )         393           NM         (2,848 )        2,449           NM
Noninterest income                         46,244        48,542         (4.7 )       92,559         97,675         (5.2 )
Noninterest expense                        86,916        86,027          1.0        177,099        177,314         (0.1 )
Other Data:
Return on average common equity              9.51 %       10.25 %                      8.75 %         9.31 %
Efficiency ratio (1)                        66.52         69.20                       67.44          70.06
Tier 1 leverage ratio                        8.80          9.00                        8.80           9.00
Net charge-offs to average loans             0.04          0.13                        0.10           0.24

(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. This is a non-GAAP financial measure that management believes to be helpful in understanding Old National's results of operations.

NM = Not meaningful

Net Interest Income

Net interest income is our most significant component of earnings, comprising over 63% of revenues at June 30, 2013. 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 level of accretion income on purchased loans, 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 the mix of assets and funding and the 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 in 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                     Six Months Ended
                                                 June 30,                              June 30,
(dollars in thousands)                   2013               2012               2013               2012
Net interest income                   $    79,191        $    75,973        $   158,241        $   150,246
Taxable equivalent adjustment               4,243              3,252              8,155              6,303

Net interest income-taxable
equivalent                            $    83,434        $    79,225        $   166,396        $   156,549

Average earning assets                $ 8,406,635        $ 7,440,566        $ 8,308,580        $ 7,401,333
Net interest margin                          3.77 %             4.08 %             3.81 %             4.06 %
Net interest margin-fully taxable
equivalent                                   3.97 %             4.26 %             4.01 %             4.23 %

Net interest income was $79.2 million and $158.2 million for the three and six months ended June 30, 2013, up from the $76.0 million and $150.2 million reported for the three and six months ended June 30, 2012. Taxable equivalent net interest income was $83.4 million and $166.4 million for the three and six months ended June 30, 2013, up from the $79.2 million and $156.5 million reported for the three and six months ended June 30, 2012. The net interest margin on a fully taxable equivalent basis was 3.97% and 4.01% for the three and six months ended June 30, 2013, compared to 4.26% and 4.23% for the three and six months ended June 30, 2012. The increase in net interest income is primarily due to the acquisition of Indiana Community Bancorp ("IBT") on September 15, 2012, combined with a change in the mix of interest earning assets and interest-bearing liabilities. The accretion associated with the purchased assets from IBT benefited net interest margin by $6.1 million and $11.2 million, or 29 and 27 basis points, during the three and six months ended June 30, 2013, respectively. We expect this accretion income to decline over time. The decrease in the net interest margin is primarily due to the yield on average earning assets decreasing faster than the cost of interest-bearing liabilities. The yield on interest earning assets decreased 49 basis points while the cost of interest-bearing liabilities decreased 27 basis points in the quarterly year-over-year comparison. In the year-to-date comparison, the yield on interest earning assets decreased 41 basis points while the cost of interest-bearing liabilities decreased 26 basis points.

Average earning assets were $8.407 billion for the three months ended June 30, 2013, compared to $7.441 billion for the three months ended June 30, 2012, an increase of 13.0%, or $966.1 million. Average earning assets were $8.309 billion for the six months ended June 30, 2013, compared to $7.401 billion for the six months ended June 30, 2012, an increase of 12.3%, or $907.2 million. Included in average earning assets for the six months ended June 30, 2013 is approximately $366.4 million from the Indiana Community Bancorp acquisition, which was acquired on September 15, 2012. Significantly affecting average earning assets at June 30, 2013 compared to June 30, 2012, was the increase in the size of the loan portfolio combined with an increase in the size of the investment portfolio. Year over year, the investment portfolio, which generally has an average yield lower than the loan portfolio, has increased as a percent of interest earning assets and was approximately 37% of interest earning assets at June 30, 2013.

The $468.3 million increase in average loans is primarily a result of the remaining $366.0 million of average loans acquired in the IBT acquisition. We have continued to experience growth in our commercial loan and residential mortgage loan portfolios, but continue to experience declines in our acquired loan portfolios.

The $447.9 million increase in the investment portfolio was in anticipation of the pending Bank of America branch acquisition. Old National began buying securities starting in the first quarter of 2013 when rates were favorable in advance of the close in July of 2013. The transaction received regulatory approval and we acquired approximately $542 million of cash and assumed approximately $575 million of deposits on July 12, 2013. The investment purchases had been funded with short term borrowings and FHLB advances with short maturities which were retired when the cash was received. The Company currently expects it will remain below $10 billion in assets and will not be subject to certain provisions of the Dodd-Frank Act.


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Positively affecting margin were increases in noninterest-bearing demand deposits, short-term borrowings and FHLB advances with short maturities combined with a decrease in time deposits. The increase in short-term borrowings and FHLB advances, as discussed above, was in anticipation of the branch acquisition from Bank of America. Approximately $537 million of short-term borrowings and FHLB advances were repaid on July 12, 2013 when the transaction closed. Over the past year, we have reduced the cost of our other borrowings by changing the composition of other borrowings. During the first six months of 2013, we terminated $50.0 million of FHLB advances. We also restructured $33.4 million of FHLB advances in the first quarter of 2013. During the fourth quarter of 2012, we terminated $50.0 million of FHLB advances. 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, which have an average interest rate higher than other types of deposits, have decreased as a percent of total funding. Year over year, short-term borrowings, which have an average interest rate lower than many types of funding, have increased as a percent of total funding.

Provision for Loan Losses

The provision for loan losses was a credit of $3.7 million for the three months ended June 30, 2013, compared to $0.4 million of expense for the three months ended June 30, 2012. The provision for loan losses was a credit of $2.8 million for the six months ended June 30, 2013, compared to $2.4 million of expense for the six months ended June 30, 2012. 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) is increasing at a slower pace than the percentage of our loan portfolio consisting of those loans where lower loss factors are applied (residential loans).

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 June 30, 2013 was $46.2 million, a decrease of $2.3 million, or 4.7%, from the $48.5 million reported for the three months ended June 30, 2012. For the six months ended June 30, 2013, noninterest income was $92.6 million, a decrease of $5.1 million, or 5.2%, from the $97.7 million reported for the six months ended June 30, 2012. The decrease is primarily the result of adjustments to the FDIC indemnification asset and a decrease in service charges on deposit accounts. Partially offsetting these decreases were increases from insurance premiums and commissions and the gain on branch divestitures.

Net securities gains were $1.8 million and $2.8 million for the three and six months ended June 30, 2013, compared to net securities gains of $6.2 million and $6.7 million for the three and six months ended June 30, 2012. Included in the second quarter and first six months of 2012 are securities gains of $7.0 million and $7.6 million, respectively. Partially offsetting these gains in 2012 were other-than-temporary-impairment charges of $0.8 million and $0.9 million, respectively, on five non-agency mortgage-backed securities and one trust preferred security.

Wealth management fees, which are dependent on the managed assets performance, continue to be impacted by uncertainties in the investment markets. Wealth management fees did increase by $1.1 million to $12.1 million in the first six months of 2013, primarily due to the acquisition of Indiana Community Bancorp on September 15, 2012.

Service charges and overdraft fees on deposit accounts, our largest source of noninterest income, continued to decline. Service charges and overdraft fees were $11.8 million for the three months ended June 30, 2013, compared to $12.9 million for the three months ended June 30, 2012. Service charges and overdraft fees were $22.9 million for the six months ended June 30, 2013, compared to $25.8 million for the six months ended June 30, 2012. For the six months ended June 30, 2013, the decrease is primarily attributable to a $4.2 million decrease in overdraft charges, which was partially offset by a $1.1 million increase associated with the acquisition of Indiana Community Bancorp. The net decrease of $3.1 million is primarily due to changes in customer behavior.

Mortgage banking revenue was $1.6 million and $2.9 million for the three and six months ended June 30, 2013, compared to $0.8 million and $1.3 million for the three and six months ended June 30, 2012. Mortgage banking revenue increased primarily as a result of an increase in gain on sale of loans, as we sold more production to the secondary market in 2013.


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Insurance premiums and commissions increased $1.4 million to $20.3 million for the six months ended June 30, 2013, as compared to $18.9 million for the six months ended June 30, 2012, primarily as a result of higher contingency income and commissions on property and casualty insurance.

Investment product fees were $4.1 million and $7.7 million for the three and six months ended June 30, 2013, compared to $3.2 million and $6.1 million for the three and six months ended June 30, 2012. The increase is primarily as a result of increases in annuity fees and mutual fund fees.

During the third quarter of 2012, Old National announced plans to sell the deposits of nine banking centers in southern Illinois and western Kentucky. The sales closed during the first quarter of 2013. Deposits at the time of sale were approximately $150.1 million and we received a deposit premium of $2.2 million on the sales.

Other income decreased $1.8 million and $1.2 million for the three and six months ended June 30, 2013 as compared to the three and six months ended June 30, 2012. The decreases are primarily a result of a decrease in gain on sales of foreclosed properties partially offset by an increase in customer derivative fee revenue.

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 second quarter of 2013, adjustments to the FDIC indemnification asset resulted in noninterest expense of $1.5 million. This compares to noninterest expense of $4.0 million during the second quarter of 2012. The second quarter of 2012 included a $4.3 million decrease in cash flows expected from the indemnification asset due primarily to improvement in loan loss expectations.

During the first six months of 2013, adjustments to the FDIC indemnification asset resulted in $3.8 million of noninterest expense. During the first six months of 2012, adjustments to the FDIC indemnification asset resulted in $0.8 million of noninterest income. The first six months of 2012 included $8.1 million of income associated with the impairment of covered other real estate owned, compared to $1.0 million of income associated with impairment of covered other real estate owned in the first six months of 2013.

Noninterest Expense

Noninterest expense for the three months ended June 30, 2013, totaled $86.9 million, an increase of $0.9 million, or 1.0%, from the $86.0 million recorded for the three months ended June 30, 2012. For the six months ended June 30, 2013, noninterest expense totaled $177.1 million, a decrease of $0.2 million, or 0.1%, from the $177.3 million recorded for the six months ended June 30, 2012. Included in the three and six months ended June 30, 2013 is approximately $1.3 million and $2.7 million of noninterest expense related to Indiana Community Bancorp, which was acquired on September 15, 2012.

Salaries and benefits is the largest component of noninterest expense. For the three months ended June 30, 2013, salaries and benefits were $48.7 million compared to $46.8 million for the three months ended June 30, 2012. For the six months ended June 30, 2013, salaries and benefits were $99.7 million compared to $92.8 million for the six months ended June 30, 2012. Included in the second quarter of 2013 is an increase of $1.1 million for salaries and benefits expense associated with former IBT associates. Also included in the second quarter of 2013 is a $0.8 million increase in hospitalization expense. Included in the first six months of 2013 is an increase of $2.3 million for salaries and benefits expense associated with former IBT associates. Also included in the first six months of 2013 is a $1.3 million increase in performance-based incentive compensation, a $1.8 million increase in hospitalization expense and a $1.0 million increase in commission expense.


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Occupancy expense was $12.0 million and $24.1 million for the three and six months ended June 30, 2013, compared to $13.3 million and $25.7 million for the three and six months ended June 30, 2012. Decreases in rent expense and building depreciation associated with our recent branch closures and consolidations were the primary reasons for the decrease in occupancy expense.

Professional fees increased $1.1 million for the six months ended June 30, 2013, compared to the six months ended June 30, 2012. The increase is primarily attributable to other professional fees associated with the BSA/AML consent order. Continued compliance with the June 4, 2012, consent order issued by our primary regulator resulted in increased professional fees during the first six months 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. These costs were partially offset by a decrease in legal fees.

FDIC assessment expense decreased $1.3 million and $1.0 million for the three and six months ended June 30, 2013 as compared to the three and six months ended June 30, 2012. The decreases are primarily a result of a decrease in the assessment rate due to the amending of certain call reports.

Other real estate owned expense was $1.5 million and $2.6 million for the three and six months ended June 30, 2013, compared to $1.6 million and $11.4 million for the three and six months ended June 30, 2012. The majority of the 2012 expense was associated with other real estate properties acquired from the FDIC; 80% of which was offset by a corresponding adjustment to the FDIC indemnification asset.

Amortization of intangibles was $4.4 million for the six months ended June 30, 2013, compared to $3.9 million for the six months ended June 30, 2012. The increase is primarily due to an adjustment to core deposit intangible amortization expense related to the sale of the nine branches during the first quarter of 2013.

Other expense was $4.1 million and $8.3 million for the three and six months ended June 30, 2013, compared to $3.4 million and $5.3 million for the three and six months ended June 30, 2012. Included in expense for 2013 is approximately $1.0 million for loss on extinguishment of debt regarding the termination of $50.0 million of FHLB advances and an increase of approximately $0.9 million related to writedowns on branches that were sold.

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.

$238 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 six months of 2013. The remaining eighty percent was recorded as a receivable from the FDIC. Additional non-reimbursable expenses of $188 thousand associated with holding and maintaining covered assets assumed in the Integra acquisition were also recorded in noninterest expense during the first six months of 2013.

$504 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 six months of 2012. The remaining eighty percent was recorded as a receivable from the FDIC. Additional non-reimbursableexpenses of $219 thousand associated with holding and maintaining covered assets assumed in the Integra acquisition were also recorded in noninterest expense during the first six months of 2012.


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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 32.5% for the three months ended June 30, 2013, compared to 28.6% for the three months ended June 30, 2012. The provision for income taxes, as a percentage of pre-tax income, was 31.5% for the six months ended June 30, 2013, compared to 28.2% for the six months ended June 30, 2012. In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at June 30, 2013 based on the current estimate of the effective annual rate. The higher tax rate in the second quarter and six months of 2013 is the result of an increase in projected pre-tax book income while tax-exemptincome remained relatively stable combined with an increase in income tax expense of approximately $1.3 million related to a change in Indiana tax rates and resulting adjustment to the deferred tax asset. See Note 16 to the consolidated financial statements for additional information.

FINANCIAL CONDITION

Overview

At June 30, 2013, our assets were $9.641 billion, an 11.0% increase compared to June 30, 2012 assets of $8.690 billion, and an increase of 1.0% compared to December 31, 2012 assets of $9.544 billion. The increase in assets is primarily the result of an increase in the investment portfolio in anticipation of the acquisition of 24 branches from Bank of America in the third quarter of 2013 and . . .

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