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ONB > SEC Filings for ONB > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for OLD NATIONAL BANCORP /IN/

Form 10-Q for OLD NATIONAL BANCORP /IN/


2-May-2014

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 months ended March 31, 2014 and 2013, and financial condition as of March 31, 2014, compared to March 31, 2013, and December 31, 2013. 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 first quarter of 2014, net income was $26.5 million, or $0.26 per share. This compares to the $23.9 million, or $0.24 per share reported in the first quarter of 2013. The improvement is primarily the result of lower non-interest expenses. Total revenue remained relatively flat as the improvement in interest income and insurance contingency fees were offset by higher amortization expense associated with our FDIC indemnification asset.

Loan growth is our top focus and our new chief banking officer has this at the top of his agenda. He encourages a culture of cooperation and teamwork and considers both the originators and underwriters to be critical members of the lending team. Loan growth in our new higher-growth markets was encouraging during the quarter but our strong work out efforts of purchased credit impaired loans continue to keep loan balances relatively constant as these loans, subject to FDIC loss-sharing agreements, purposely decline.

Credit quality remained strong. Nonaccrual loan balances were $112.1 million at March 31, 2014, a decrease of $98.4 million since March 31, 2013, and a decrease of $16.3 million since December 31, 2013. Criticized loans have also improved to $119.8 million at March 31, 2014, compared to $141.5 million and $143.8 million at March 31, 2013 and December 31, 2013, respectively. We had net recoveries of $0.4 million and recorded $37 thousand of provision expense in the first quarter of 2014.

Management continues to focus on expanding our distribution network and transitioning the franchise to higher growth markets. Subsequent to quarter-end, Old National received regulatory approval of the previously announced agreement and plan of merger with Tower Financial Corporation ("Tower"). This transaction expands our presence in the attractive Fort Wayne market and helps to solidify our standing as Indiana's bank. Tower operates six full-service banking centers in Fort Wayne and one in Warsaw, Indiana with loans of approximately $408 million, deposits of $577 million, and a $750 million wealth management portfolio at March 31, 2014. The transaction closed on April 25, 2014.

The previously announced agreement and plan of merger with Ann Arbor-based United Bancorp, Inc. ("United") remains pending and is currently expected to close early in the third quarter, subject to approval by United's shareholders and regulatory authorities, as well as the satisfaction of other customary closing conditions. This acquisition is expected to add an additional 18 branch offices in Southern Michigan, approximately $657 million in loans, $813 million in deposits, and a $685 million wealth management portfolio at March 31, 2014. This transaction will double Old National's presence in Michigan to thirty-six banking centers.


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RESULTS OF OPERATIONS

The following table sets forth certain income statement information of Old
National for the three months ended March 31, 2014 and 2013:



                                              Three Months Ended
                                                   March 31,                %
         (dollars in thousands)               2014           2013        Change
         Income Statement Summary:
         Net interest income                $  83,478      $ 79,050          5.6 %
         Provision for loan losses                 37           845        (95.6 )
         Noninterest income                    40,563        46,315        (12.4 )
         Noninterest expense                   88,252        90,183         (2.1 )
         Other Data:
         Return on average common equity         9.03 %        8.00 %
         Efficiency ratio (1)                   67.77         68.34
         Tier 1 leverage ratio                   9.32          8.71
         Net charge-offs to average loans       (0.03 )        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.

Net Interest Income

Net interest income is our most significant component of earnings, comprising over 67% of revenues at March 31, 2014. 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
                                                             March 31,
     (dollars in thousands)                            2014             2013
     Net interest income                            $    83,478      $    79,050
     Taxable equivalent adjustment                        3,931            3,912

     Net interest income-taxable equivalent         $    87,409      $    82,962

     Average earning assets                         $ 8,276,267      $ 8,210,526
     Net interest margin                                   4.03 %           3.85 %
     Net interest margin-fully taxable equivalent          4.22 %           4.04 %

Net interest income was $83.5 million for the three months ended March 31, 2014, up from the $79.1 million reported for the three months ended March 31, 2013. Taxable equivalent net interest income was $87.4 million for the three months ended March 31, 2014, up from the $83.0 million reported for the three months ended March 31, 2013. The net interest margin on a fully taxable equivalent basis was 4.22% for the three months ended March 31, 2014, compared to 4.04% for the three months ended March 31, 2013. Both the three months ended March 31, 2014 and 2013 include accretion income (interest income in excess of contractual interest income) associated with purchased credit impaired loans. Excluding this accretion income in both periods, net interest income on a fully taxable equivalent basis would have been $69.5 million for the three months ended March 31, 2014, compared to $68.0 million for the three months ended March 31, 2013; and the net interest margin on a fully taxable equivalent basis would have been 3.36% in 2014 and 3.31% in 2013.

The increase in net interest income is primarily due to the increase in accretion income recorded in the first three months of 2014 compared to the first three months of 2013, combined with a change in the mix of interest earning assets and interest-bearing liabilities. We expect this accretion income to decline over time.

The increase in the net interest margin is primarily due to the yield on average earning assets increasing while the cost of interest-bearing liabilities decreased. The yield on interest earning assets increased 7 basis points while the cost of interest-bearing liabilities decreased 15 basis points in the quarterly year-over-year comparison. The yield on interest earning asset is calculated by dividing annualized taxable equivalent net interest income by average interest assets while the cost of interest-bearing liabilities is calculated by dividing annualized interest expense by average interest-bearing liabilities.

Average earning assets were $8.276 billion for the three months ended March 31, 2014, compared to $8.211 billion for the three months ended March 31, 2013, an increase of 0.8%, or $65.7 million. Affecting average earning assets at March 31, 2014 compared to March 31, 2013, was the increase in the size of the investment portfolio combined with a decrease in the size of the loan portfolio. Despite the sale of $96.9 million of residential real estate loans during the third quarter of 2013, our residential mortgage loan portfolio grew $19.7 million over the past twelve months. In addition, we experienced growth of $43.8 million in our commercial loan portfolio and $85.9 million in our consumer loan portfolio over the past twelve months. These increases were more than offset by the $69.8 million decrease in our commercial real estate loan portfolio and the $150.5 million decrease in our covered loan portfolio. The loan portfolio, which generally has an average yield higher than the investment portfolio, was approximately 61% of average interest earning assets at March 31, 2014.

The $143.6 million increase in the average balance of the investment portfolio from March 31, 2013 to March 31, 2014 can be attributed to the reinvestment of excess cash acquired as part of the Bank of America branch acquisition.

Positively affecting margin were increases in noninterest-bearing demand deposits, NOW and savings accounts, money market accounts combined with a decrease in time deposits and borrowed funds. Average time deposits, which have an average interest rate higher than other types of deposits, decreased $243.7 million since March 31, 2013. In addition, average borrowed funds declined $17.6 million year over year.


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Provision for Loan Losses

The provision for loan losses was $37 thousand for the three months ended March 31, 2014, compared to $845 thousand for the three months ended March 31, 2013. 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) improvement associated with our purchased credit impaired loans accounted for under ASC310-30, (3) the continuing trend in improved credit quality, and (4) a decrease in our commercial real estate loan balances (which carry higher loss rates than other loan categories) in conjunction with improving average asset quality ratings on the remaining commercial real estate loans in our portfolio.

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 March 31, 2014 was $40.6 million, a decrease of $5.7 million, or 12.4%, from the $46.3 million reported for the three months ended March 31, 2013. The decrease is primarily the result of adjustments to the FDIC indemnification asset and the gain on branch divestitures that was recorded in the first quarter of 2013. There was no corresponding branch divestiture transaction in the first quarter of 2014. Partially offsetting these decreases were increases in insurance revenue, insurance contingency fees and gains on the sale of foreclosed properties.

Net securities gains were $0.5 million for the three months ended March 31, 2014, compared to net securities gains of $1.0 million for the three months ended March 31, 2013. Included in the first three months of 2014 is a $100 thousand other-than-temporary-impairment charge on one limited partnership investment.

Service charges and overdraft fees on deposit accounts, our largest source of noninterest income, continued to be challenged. Service charges and overdraft fees were $11.1 million for both the three months ended March 31, 2014 and the three months ended March 31, 2013, respectively. Included in the first quarter of 2014 is $1.0 million from the newly acquired Bank of America branches.

Debit card and ATM fees decreased $0.1 million to $5.7 million for the three months ended March 31, 2014, as compared to $5.8 million for the three months ended March 31, 2013. The newly acquired Bank of America branches contributed $0.5 million during the first quarter of 2014.

Mortgage banking revenue was $0.6 million for the three months ended March 31, 2014, compared to $1.3 million for the three months ended March 31, 2013. Mortgage production slowed in the first quarter of 2014 as higher interest rates stymied refinance activity and bad weather led to low levels of mortgage production, among other factors. As a result, mortgage banking revenue decreased as we sold less production to the secondary market in 2014.

Insurance premiums and commissions increased $1.1 million to $12.0 million for the three months ended March 31, 2014, as compared to $10.9 million for the three months ended March 31, 2013, primarily as a result of higher contingency income and commissions on property and casualty insurance.

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 $1.4 million for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase is primarily a result of a $1.7 million increase in gain on sales of foreclosed properties.


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Noninterest Income Related to Covered Assets

The indemnification asset, on the acquisition date, reflects the reimbursements expected to be received from the FDIC. Deterioration in our expectation of credit quality of the OREO would immediately increase the basis of the indemnification asset while deterioration in the expected credit quality of the loans would increase the basis of the indemnification asset prospectively. The offset for both OREO and loans is recorded through the consolidated statement of income. Increases in the credit quality or cash flows of loans (reflected as an adjustment to yield and accreted into income over the remaining life of the loans) decrease the basis of the indemnification asset, with the decrease being amortized into income over the same period or the life of the loss share agreements, whichever is shorter.

For the first quarter of 2014, adjustments to the FDIC indemnification asset resulted in noninterest expense of $7.3 million. This compares to noninterest expense of $2.3 million during the first quarter of 2013. The increase in expense is primarily the result of lower levels of expected loss claims on covered loans and other real estate in 2014.

At March 31, 2014, $38.2 million of the remaining indemnification asset is expected to be amortized and reported in noninterest income over the next 30 months.

Noninterest Expense

Noninterest expense for the three months ended March 31, 2014, totaled $88.3 million, a decrease of $1.9 million, or 2.1%, from the $90.2 million recorded for the three months ended March 31, 2013. Included in the three months ended March 31, 2014 is approximately $2.8 million of operating costs related to 24 branches acquired from Bank of America during the third quarter of 2013. Also included in the three months ended March 31, 2014 is approximately $2.5 million of expense related to the upcoming acquisitions of Tower and United. Offsetting these increases were decreases in occupancy expense, amortization of intangibles and other expense.

Salaries and benefits is the largest component of noninterest expense. For the three months ended March 31, 2014, salaries and benefits were $51.4 million compared to $51.0 million for the three months ended March 31, 2013. Included in the first quarter of 2014 is $1.8 million of salaries and benefits expense associated with the newly acquired Bank of America bank branches. Also included in the first quarter of 2014 is a $0.6 million decrease in performance-based incentive compensation and a $0.7 million decrease in pension expense.

Occupancy expense was $10.9 million for the three months ended March 31, 2014, compared to $12.1 million for the three months ended March 31, 2013. A decrease in real estate tax expense combined with a decrease in rent expense associated with our recent branch closures and consolidations were the primary reasons for the decrease in occupancy expense.

Marketing expense increased $1.0 million for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. Marketing expense increased primarily as a result of our entry into the new Michigan market.

Amortization of intangibles was $1.8 million for the three months ended March 31, 2014, compared to $2.5 million for the three months ended March 31, 2013. Included in 2013 was a $0.6 million adjustment to core deposit intangible amortization expense related to the sale of the nine branches.

Other expense for the three months ended March 31, 2014, totaled $2.8 million, a decrease of $1.3 million compared to the three months ended March 31, 2013. Included in expense for the three months ended March 31, 2013 was approximately $0.7 million for loss on extinguishment of debt related to the termination of a $25.0 million FHLB advance. Included in the first three months of 2014 is a reduction of $0.5 million in the provision for unfunded commitments compared to the first three months of 2013.

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.


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Approximately $129 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 quarter of 2014. The remaining eighty percent was recorded as a receivable from the FDIC. The reversal of additional non-reimbursable expenses of $13 thousand associated with holding and maintaining covered assets assumed in the Integra acquisition were also recorded in noninterest expense during the first quarter of 2014.

Approximately $123 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 quarter of 2013. The remaining eighty percent was recorded as a receivable from the FDIC. Additional non-reimbursable expenses of $122 thousand associated with holding and maintaining covered assets assumed in the Integra acquisition were also recorded in noninterest expense during the first quarter of 2013.

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 25.9% for the three months ended March 31, 2014, compared to 30.3% for the three months ended March 31, 2013. In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at March 31, 2014 based on the current estimate of the effective annual rate. The lower tax rate in the first three months of 2014 is the result of lower projected pre-tax book income for 2014, as well as lower projected state taxes. See Note 16 to the consolidated financial statements for additional information.

FINANCIAL CONDITION

Overview

At March 31, 2014, our assets were $9.545 billion, a 1.3% decrease compared to March 31, 2013 assets of $9.674 billion, and a decrease of 0.4% compared to December 31, 2013 assets of $9.582 billion. The decrease in assets is primarily the result of decreases in the investment portfolio, the covered loan segment of the loan portfolio, and the FDIC indemnification asset.

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 $8.288 billion at March 31, 2014, a decrease of 1.7% from March 31, 2013.

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 $32.0 million of 15- and 20-year fixed-rate mortgage-backed securities, $169.8 million of U.S. government-sponsored entity and agency securities and $577.5 million of state and political subdivision securities in our held-to-maturity investment portfolio at March 31, 2014. During the third quarter of 2013, state and political subdivision securities with a fair value of $357.8 million were transferred from the available-for-sale portfolio to the held-to-maturity portfolio. We moved these securities to our held-to-maturity portfolio to better align with the percentage of these securities held by our peers and to protect our tangible common equity against rising interest rates.

Trading securities, which consist of mutual funds held in a trust associated with deferred compensation plans for former Monroe Bancorp directors and executives, are recorded at fair value and totaled $3.7 million at March 31, 2014 compared to $3.2 million at March 31, 2013.


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At March 31, 2014, the total investment securities portfolio was $3.193 billion compared to $3.282 billion at March 31, 2013, a decrease of $89.3 million or 2.7%. Investment securities increased $13.5 million compared to December 31, 2013, an increase of 0.4%. Investment securities represented 38.5% of earning assets at March 31, 2014, compared to 38.9% at March 31, 2013, and 38.4% at December 31, 2013. A decrease in agency mortgage-backed securities from March 31, 2013 was the primary reason for the decrease in the investment portfolio. Stronger commercial loan demand in the future and management's decision to deleverage the balance sheet could result in a further reduction in the securities portfolio. As of March 31, 2014, management does not intend to sell any securities with an unrealized loss position and does not believe we will be required to sell such securities.

The investment securities available-for-sale portfolio had net unrealized losses of $22.5 million at March 31, 2014, an increase of $71.7 million compared to net unrealized gains of $49.2 million at March 31, 2013, and a decrease of $11.6 million compared to net unrealized losses of $34.1 million at December 31, 2013. The decline in value from March 31, 2013 is a result of the increase in interest rates that began during the second quarter of 2013. Included in the first quarter of 2014 is a $100 thousand other-than-temporary-impairment charge on one limited partnership investment. See the consolidated statements of comprehensive income for the impact of other-than-temporary-impairment in other comprehensive income and Note 6 to the consolidated financial statements for details on management's evaluation of securities for other-than-temporary-impairment.

The investment portfolio had an average duration of 4.52 at March 31, 2014, compared to 4.06 at March 31, 2013, and 4.84 at December 31, 2013. Effective duration measures the percentage change in value of the portfolio in response to a change in interest rates. Generally, there is more uncertainty in interest rates over a longer average maturity, resulting in a higher duration percentage. The annualized average yields on investment securities, on a taxable equivalent basis, were 2.94% for the three months ended March 31, 2014, compared to 2.96% for the three months ended March 31, 2013, and 2.87% for the three months ended December 31, 2013.

Residential Loans Held for Sale

Residential loans held for sale were $6.2 million at March 31, 2014, compared to $14.6 million at March 31, 2013, and $7.7 million at December 31, 2013. At March 31, 2014, loans held for sale was made up entirely of mortgage loans held for immediate sale in the secondary market with servicing released. These loans are sold at or prior to origination at a contracted price to an outside investor on a best efforts basis and remain on the Company's balance sheet for a short period of time (typically 30 to 60 days). These loans are sold without recourse and Old National has experienced no material losses. Mortgage originations are subject to volatility due to interest rates and home sales.

We have elected the fair value option under FASB ASC 825-10 (SFAS No. 159) prospectively for residential loans held for sale. The aggregate fair value exceeded the unpaid principal balance by $0.1 million and $0.4 million as of March 31, 2014 and March 31, 2013, respectively. At December 31, 2013, the aggregate fair value exceeded the unpaid principal balances by $0.1 million.

Finance Leases Held for Sale

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