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ONB > SEC Filings for ONB > Form 10-Q on 1-Nov-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/


1-Nov-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 nine months ended September 30, 2013 and 2012, and financial condition as of September 30, 2013, compared to September 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 third quarter of 2013, net income was $23.9 million, or $0.23 per share. This compares to the $19.7 million, or $0.20 per share reported in the third 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.

On July 12, 2013, Old National completed its previously announced acquisition of 24 retail bank branches of Bank of America. The acquisition strengthened our presence in northern Indiana and expanded our footprint into southwestern Michigan. Old National assumed approximately $565 million in deposits as part of the transaction.

On September 9, 2013, Old National announced the execution of a definitive agreement to acquire Tower Financial Corporation ("Tower") through a stock and cash merger. The acquisition will expand Old National's presence in the attractive Fort Wayne market and help to solidify our standing as Indiana's bank. Tower currently operates six full-service banking centers in Fort Wayne and one in Warsaw, Indiana, with total deposits of $590 million and $452 million in loans at September 30, 2013. The transaction is expected to close in the first quarter of 2014 and is subject to approval by federal and state regulatory authorities.

Commercial loan growth slowed during the third quarter but we are encouraged as we continue to expand into growing markets. We have established a lending team in the Kalamazoo-Southwest Michigan market and believe this market could in time be another solid contributor to loan and fee income growth. Old National sold $96.9 million fixed-rate residential real estate loans at par on September 30, 2013, as we actively manage exposure to rising interest rates

Management remains focused on providing an efficient and effective branch banking network and closed 18 branches in August, taking a charge of $2.7 million during the quarter. Old National has now closed or sold 49 branches since September 2012. After the latest closing, 176 branches remain spread across Indiana, southern Illinois, western Kentucky, and southwestern Michigan. Management intends to consolidate or sell an additional seven banking centers during the fourth quarter of 2013.

Credit quality remained strong with quarterly net charge offs to average loans of 0.02% at September 30, 2013 compared to 0.03% a year ago. These lower loss rates, along with continuing improvement in asset quality and recoveries associated with our purchased credit impaired loans accounted for under ASC 310-30, contributed to recapture of $1.7 million of provision expense during the quarter. Non-performing loans to total loans improved to 3.20% compared to 5.64% at September 30, 2012.


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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, 2013 and 2012:



                                           Three Months Ended                         Nine Months Ended
                                              September 30,              %              September 30,               %
(dollars in thousands)                     2013           2012        Change         2013           2012          Change
Income Statement Summary:
Net interest income                      $  77,996      $ 74,150          5.2 %    $ 236,237      $ 224,396           5.3 %
Provision for loan losses                   (1,724 )         400           NM         (4,572 )        2,849            NM
Noninterest income                          47,755        40,867         16.9        140,314        138,542           1.3
Noninterest expense                         96,658        89,019          8.6        273,757        266,333           2.8
Other Data:
Return on average common equity               8.23 %        7.17 %                      8.58 %         8.57 %
Efficiency ratio (1)                         72.96         75.26                       69.30          71.71
Tier 1 leverage ratio                         8.80          8.78                        8.80           8.78
Net charge-offs to average loans              0.02          0.03                        0.07           0.17

(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 62% of revenues at September 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                    Nine Months Ended
                                              September 30,                         September 30,
(dollars in thousands)                   2013               2012               2013               2012
Net interest income                   $    77,996        $    74,150        $   236,237        $   224,396
Taxable equivalent adjustment               4,362              3,340             12,517              9,643

Net interest income-taxable
equivalent                            $    82,358        $    77,490        $   248,754        $   234,039

Average earning assets                $ 8,309,417        $ 7,572,282        $ 8,308,859        $ 7,458,316
Net interest margin                          3.75 %             3.92 %             3.79 %             4.01 %
Net interest margin-fully taxable
equivalent                                   3.96 %             4.09 %             3.99 %             4.18 %

Net interest income was $78.0 million and $236.2 million for the three and nine months ended September 30, 2013, up from the $74.2 million and $224.4 million reported for the three and nine months ended September 30, 2012. Taxable equivalent net interest income was $82.4 million and $248.8 million for the three and nine months ended September 30, 2013, up from the $77.5 million and $234.0 million reported for the three and nine months ended September 30, 2012. The net interest margin on a fully taxable equivalent basis was 3.96% and 3.99% for the three and nine months ended September 30, 2013, compared to 4.09% and 4.18% for the three and nine months ended September 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 $4.8 million and $16.0 million, or 23 and 26 basis points, during the three and nine months ended September 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 30 basis points while the cost of interest-bearing liabilities decreased 25 basis points in the quarterly year-over-year comparison. In the year-to-date comparison, the yield on interest earning assets decreased 37 basis points while the cost of interest-bearing liabilities decreased 25 basis points.

Average earning assets were $8.309 billion for the three months ended September 30, 2013, compared to $7.575 billion for the three months ended September 30, 2012, an increase of 9.7%, or $734.1 million. Average earning assets were $8.309 billion for the nine months ended September 30, 2013, compared to $7.458 billion for the nine months ended September 30, 2012, an increase of 11.4%, or $850.4 million. Included in average earning assets for the nine months ended September 30, 2013 is approximately $350.4 million from the Indiana Community Bancorp acquisition, which was acquired on September 15, 2012. Significantly affecting average earning assets at September 30, 2013 compared to September 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 38% of interest earning assets at September 30, 2013.

The $429.9 million increase in average loans from September 2012 is primarily a result of the remaining $350.0 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 $428.4 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 $563 million of cash and assumed approximately $565 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 remained below $10 billion in assets and will not be subject to certain provisions of the Dodd-Frank Act as a result of this transaction.


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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 nine 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. 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 remained stable as a percent of total funding.

Provision for Loan Losses

The provision for loan losses was a credit of $1.7 million for the three months ended September 30, 2013, compared to $0.4 million of expense for the three months ended September 30, 2012. The provision for loan losses was a credit of $4.6 million for the nine months ended September 30, 2013, compared to $2.8 million of expense for the nine months ended September 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) recoveries associated with our purchased credit impaired loans accounted for under ASC 310-30, (3) the continuing trend in improved credit quality, and (4) 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 September 30, 2013 was $47.8 million, an increase of $6.9 million, or 16.9%, from the $40.9 million reported for the three months ended September 30, 2012. For the nine months ended September 30, 2013, noninterest income was $140.3 million, an increase of $1.8 million, or 1.3%, from the $138.5 million reported for the nine months ended September 30, 2012. The increase in the quarterly comparison is primarily the result of increases in service charges on acquired deposit accounts, investment product fees, and adjustments to the FDIC indemnification asset. The increase in the year-to-date comparison is primarily the result of increases in investment product fees and insurance premiums and commissions and the gain on branch divestitures. Partially offsetting these increases were adjustments to the FDIC indemnification asset.

Net securities gains were $0.2 million and $3.0 million for the three and nine months ended September 30, 2013, compared to net securities gains of $2.7 million and $9.4 million for the three and nine months ended September 30, 2012. 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 in 2012 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.

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 $1.5 million to $17.6 million in the first nine 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 be challenged. Service charges and overdraft fees were $13.9 million for the three months ended September 30, 2013, compared to $12.8 million for the three months ended September 30, 2012. Service charges and overdraft fees were $36.8 million for the nine months ended September 30, 2013, compared to $38.6 million for the nine months ended September 30, 2012. For the three months ended September 30, 2013, the increase is primarily due to the acquisition of 24 bank branches from Bank of America, which occurred on July 12, 2013. For the nine months ended September 30, 2013, the $1.8 million decrease is primarily attributable to decreases in overdraft charges and changes in customer behavior. These decreases were partially offset by a $2.3 million increase associated with the acquisition of Indiana Community Bancorp and a $1.7 million increase associated with the acquisition of the bank branches from Bank of America.


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Mortgage banking revenue was $1.0 million and $3.8 million for the three and nine months ended September 30, 2013, compared to $0.8 million and $2.2 million for the three and nine months ended September 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.

Insurance premiums and commissions increased $1.5 million to $29.1 million for the nine months ended September 30, 2013, as compared to $27.6 million for the nine months ended September 30, 2012, primarily as a result of higher contingency income and commissions on property and casualty insurance.

Investment product fees were $4.5 million and $12.1 million for the three and nine months ended September 30, 2013, compared to $3.4 million and $9.5 million for the three and nine months ended September 30, 2012. The increase is primarily as a result of increases in annuity fees and mutual fund fees.

Income from company-owned life insurance increased $1.0 million and $1.2 million for the three and nine months ended September 30, 2013 as compared to the three and nine months ended September 30, 2012. The increase is primarily due to a $1.1 million single life insurance benefit that was received in the third quarter of 2013.

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 increased $2.5 million and $1.3 million for the three and nine months ended September 30, 2013 as compared to the three and nine months ended September 30, 2012. The increase in the quarterly comparison is primarily a result of a $1.4 million increase in gain on sales of foreclosed properties combined with a $1.6 million credit on the renewal of a contract. The increase in the year-to-date comparison is primarily a result of a $1.6 million credit on the renewal of a contract.

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 2013, adjustments to the FDIC indemnification asset resulted in noninterest expense of $2.1 million. This compares to noninterest expense of $4.9 million during the third quarter of 2012. The third quarter of 2012 included $1.9 million of expense associated with recoveries due to the FDIC.

During the first nine months of 2013, adjustments to the FDIC indemnification asset resulted in $5.9 million of noninterest expense. During the first nine months of 2012, adjustments to the FDIC indemnification asset resulted in $4.1 million of noninterest expense.

Noninterest Expense

Noninterest expense for the three months ended September 30, 2013, totaled $96.7 million, an increase of $7.7 million, or 8.6%, from the $89.0 million recorded for the three months ended September 30, 2012. For the nine months ended September 30, 2013, noninterest expense totaled $273.8 million, an increase of $7.5 million, or 2.8%, from the $266.3 million recorded for the nine months ended September 30, 2012. Included in the three months ended September 30, 2013 are approximately $2.3 million on noninterest expense related to the acquisition of the bank branches from Bank of America, $2.7 million of expenses associated with the consolidation of 18 branches and a $1.2 million charitable contribution. Included in the nine months ended September 30, 2013 are approximately $3.3 million on noninterest expense related to the acquisition of the bank branches from Bank of America, $3.0 million of expenses associated with the consolidation of 18 branches and a $1.2 million charitable contribution.


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Salaries and benefits is the largest component of noninterest expense. For the three months ended September 30, 2013, salaries and benefits were $51.8 million compared to $49.9 million for the three months ended September 30, 2012. For the nine months ended September 30, 2013, salaries and benefits were $151.5 million compared to $142.7 million for the nine months ended September 30, 2012. Included in the third quarter of 2013 is an increase of $2.1 million for salaries and benefits expense associated with the Bank of America branch acquisition. Included in the first nine months of 2013 is an increase of $2.1 million for salaries and benefits expense associated with the Bank of America acquisition, a $1.9 million increase in performance-based incentive compensation and a $2.2 million increase in hospitalization expense.

Occupancy expense was $12.6 million and $36.7 million for the three and nine months ended September 30, 2013, compared to $13.5 million and $39.2 million for the three and nine months ended September 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.

Marketing expense increased $0.7 million and $0.9 million for the three and nine months ended September 30, 2013 as compared to the three and nine months ended September 30, 2012. Marketing expense associated with the entry into new markets related to our acquisition of the bank branches from Bank of America was the primary reason for the increase.

Other real estate owned expense was $1.5 million and $4.0 million for the three and nine months ended September 30, 2013, compared to $0.4 million and $11.8 million for the three and nine months ended September 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.

Other expense was $7.6 million and $15.9 million for the three and nine months ended September 30, 2013, compared to $3.3 million and $8.5 million for the three and nine months ended September 30, 2012. Included in expense for the three months ended September 30, 2013 are approximately $2.1 million of expenses associated with the consolidation of 18 branches and a $1.2 million charitable contribution. Included in expense for nine months ended September 30, 2013 are approximately $1.0 million for loss on extinguishment of debt regarding the termination of $50.0 million of FHLB advances, an increase of approximately $0.9 million related to writedowns on branches that were sold, $2.1 million of expenses associated with the consolidation of 18 branches and a $1.2 million charitable contribution.

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.

$370 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 2013. The remaining eighty percent was recorded as a receivable from the FDIC. Additional non-reimbursable expenses of $242 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 2013.

$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.


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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 22.3% for the three months ended September 30, 2013, compared to 22.9% for the three months ended September 30, 2012. The provision for income taxes, as a percentage of pre-tax income, was 28.9% for the nine months ended September 30, 2013, compared to 26.8% for the nine months ended September 30, 2012. In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at September 30, 2013 based on the current estimate of the effective annual rate. The higher tax rate in the nine months of 2013 is the result of an increase in projected pre-tax book income combined with an increase in income tax expense of . . .

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