Old National Bancorp (ONB) 2003 Q2 法說會逐字稿

Welcome to the Old National Bancorp second-quarter 2003 financial results conference call.

This call is being recorded and has been made accessible to the public in accordance with the SEC regulation FD.

The call will be archived for 12 months on the shareholder relations page at www.oldnational.com.

A replay of the call will also be available beginning at 12:30 PM Central time today through 12:00 midnight on August 8.

To access the replay, dial 1-888-203-1112, confirmation code 695482.

Those participating today will be analysts and members of the financial community.

At this time, all participants are in listen-only mode.

We will hold a question and answer session and instructions will follow at that time.

Over the course at this conference call, the company will make certain forward-looking statements in an effort to assist you in understanding its financial results and competitive outlook, including a discussion of the company's future plans.

These and other statements in this conference call that are not statements of current or historical facts constitute forward-looking statements.

Forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause the actual results of the company to be materially different from the historical results or from any future results expressed or implied by any forward-looking statements.

In addition, may disclose financial data based on operating earnings that is intended to provide comparable data between periods.

With us today is Old National Bancorp's Chairman of the Board and Chief Executive Officer, Jim Weisinger;

President and Chief Operating Officer Mike Hinton, the Chief Financial Officer John Poelker, the Chief Credit Officer, Darryl Moore (ph) and Executive Vice Presidents, Chris Melton (ph), Tom Clayton (ph) and Annette Hudgions.

At this time, the call will be turned over to Mr. Reisinger for opening remarks.

Thank you very much.

Thank you all for participating in the conference call this morning.

I think what we will do is just move right into the financial results with John Poelker.

He will turn it over to Darryl, then we will take some questions, then I will have some comments as we wrap up the end of the call.

So, John, if you would like to go ahead, please.

Thank you Jim, and good morning, everyone.

We had earnings as you know by now in the second quarter of 43 cents per share, which is pretty consistent with our recent quarters as the continued weakness in the Midwest economy and the historically low levels of interest rates continues to challenge us and hamper opportunities for earnings growth.

Clearly, the big story for the quarter was the further increase in our nonperforming loans and our related decision to add to the reserve for loan losses, which you know, we offset with further securities gains.

We are continuing to focus a lot of attention on credit issues and Darryl Moore will fill you in on not only our current situation, but our thoughts relative to future actions aimed at addressing that question.

Let me review some of the facts and then talk about some of the key factors that affected our earnings over the last quarter.

The earnings of 43 cents a share was actually up from the first quarter by 2 cents, but down a penny a share from the second quarter of last year.

On a year-to-date basis, our earnings are down just slightly over 3 percent with EPS of 87 cents this year compared to 84 cents last year.

For both the quarter and the year-to-date, the key dynamic impacting earnings, excluding the credit quality and securities gains issues, has been the impact of the lack of loan demand and low interest rates on our ability to grow net interest income.

You know as well as we, net interest income growth has been on a pretty steady decline since literally the first quarter of last year.

We did on a positive note, see a small uptick in loan volume during the second quarter.

Encouraging to us, and that follows a similar slight increase in the average loans outstanding during the first quarter.

It certainly does not suggest that we're out of the woods relative to the Midwest economy, but we certainly feel as if the downward trend I suspect of economic results has at least somewhat stabilized here and are encouraged with that loan growth over the last couple of quarters.

Our margin fell again in the second quarter compared to the first quarter by 11 basis points, down to 335 from 346.

We are continuing to focus a lot of attention on deposit pricing and the overall sort of funding piece of the equity, as you know, with a very short duration asset portfolio, in terms of both our loan portfolio and our investment portfolio, we're getting very significant cash flows, particularly out of mortgage related assets, and obviously, the reinvestment opportunities through the second quarter at least were somewhat challenging.

So we're focusing an awful lot of attention on the funding costs side of the question and are making some -- I guess I could characterize them as more aggressive moves over the next few months in terms of addressing deposit pricing.

On the very positive side, like it's been over the last three to four quarters, fee and service fee and service charge revenue growth continues to be a very significant contributor to our overall results and has in fact significantly surpassed the fall in net interest income.

Those fees and service charge revenues were up another $2 million compared to the first quarter and on a year to date basis, are up over $23 million, or close to 40 percent.

This is an area that we have been focusing on pretty intently for the last 3-4 years and clearly, the moves that we have made in the last two years relative to the upgrading and expansion of our mortgage banking opportunities combined with the activities, including acquisitions in our signature group, have been quite timely, given the impact on the margin of this economic slowdown.

Mortgage revenue was up slightly in the second quarter compared to the first quarter and we did recognize a further $2 million impairment charge during the quarter, reflecting the continued acceleration of prepayments fees as long-term rates continue to fall.

The outlook at this point in time is that longer-term rates and mortgage rates might be stabilizing here a little bit and are hopeful that further impairment charges in the second half of the year might be less then they were in the first half.

Deposit service charges continue to be a real positive on the fee income side, up 14 percent compared to last year, reflecting largely this year a true growth in volume reflecting the over 10 percent growth in our transaction account balances.

We really have not introduced any new products as such.

We continue to put a lot of focus on cross-selling activities and those sorts of marketing efforts, but the real growth in deposit related service charges is primarily a function of solid growth in transaction accounts.

The provision for loan losses for the quarter was $22.5 million, a sizable increase over the $9 million provision in the first quarter.

Raises our total reserve for loan losses to just under $100 million, 98 million to be exact, but represents 1.74 percent percent of total loans.

Clearly, the more significant issue is the relationship of the reserve to nonperforming.

We continue to be very sensitive to that issue and we are able -- with that addition to the reserve, we're able to maintain that coverage in the range of 70 percent of nonperforming.

Darryl will give you some more details on why we believe that a $98 million reserve is appropriate at this point in time in his remarks a little later on.

Obviously in an effort to offset that increase in the provision, we did take fairly significant securities gains during the quarter of just under $21 million.

As we have discussed with you in the past, we assess these moves obviously very carefully from the perspective of both our overall portfolio position, which at the end of the quarter, was in excess of $3.3 billion, and as importantly, our outlook for the impact of interest rates on future portfolio values.

We were very comfortable with our decision, which we basically made sort of midway through the quarter, to take these gains in the second quarter as an offset to provisioning and mortgage impairment and the continued downward pressure on the net interest margin.

And as it turns out, our timing was pretty close to impeccable in terms of taking those gains during June, because we obviously have had a significant backup in long-term rates here over the last 20-25 days.

And so our timing of recognizing those gains in June turned out to be pretty fortuitous.

Expenses did increase in the second quarter, compared to the first quarter by $3.8 million. 1.6 million of that increased related to severance charges and related charges in connection with our plans to close 10 branches in the third quarter.

These are underperforming branches, or branches that we feel we can consolidate with newer facilities.

We're not exiting any markets in this sort phase of branch question.

This is really in-market (ph) consolidation and sort of efficiency moves to eliminate some underperforming branches and consolidate our customer service operations in better locations and better markets within those markets.

These moves, combined with the moves we are making in our signature group relative to some underperforming trust offices and our continued efforts to streamline internal processes, we have focused a lot over the last six months on streamlining our lending processes, both the commercial and consumer side, are expected to result in reductions of future operating costs of something on the order of $5 million a year on an annualized basis.

Some other factors that have impacted recent increases in operating expenses during the quarter.

We've finalized the acquisition of a small insurance agency here in Evansville, the Will (ph) Agency.

That obviously added some to the expense growth in second quarter.

Clearly as mortgage volumes continue to grow, we're getting related increases in variable costs related to mortgage production.

And so, clearly, that impacted earnings in the quarter and we continue to focus on investments that are aimed at ensuring that we're ready for the turnaround when it does come.

We continue to invest in the Indianapolis market, and during the second quarter, completed the opening of two additional branches in the Indianapolis market, which obviously added to our costs.

So our cost control efforts are ongoing, but we are in fact continuing to make what we think are appropriate investments in technology and branches and product innovations aimed at ensuring to the extent that we can that we're ready for the turnaround when it comes.

In the meantime, we don't really see anything on the horizon that suggests that our operating earnings picture over the next two quarters will be significantly different from what it has been over the last 3-4 quarters.

The formula that we are working on at the moment is a continued focus on offsetting what we expect to be continued pressure on the margin with intense efforts in fee income without increasing or incurring extraordinary or too high levels of operating expenses in order to generate those fees.

And we are obviously spending the rest of our days working very diligently to ensure that we stabilize and begin to see some reduction in the negative impact that credit quality has had on our results over the last four quarters.

That provides a good segue for me to turn the microphone over to Darryl Moore to bring us up-to-date on credit issues.

Thank you, John.

As John pointed out, charge-offs in the second order were roughly $8.5 million, which are somewhat higher than what we expected when we last spoke to you.

Two significant items led to the higher-than-expected levels in losses in the second quarter.

First, we sold about $11 million of nonperforming residential mortgage loans and took a 2.2 million write-down on that sale.

Second, we chose to write down a single nonaccrual loan relationship by approximately $3.6 million.

The $8.5 million in losses in the second quarter when combined with the 12.7 million in the first quarter gives us an annualized loss rate of roughly 75 basis points.

While 14 of that $22 million in year-to-date losses is centered in two loans and the loss in the sale of the residential portfolio.

Nonetheless, losses are at levels higher than we expected when we started the year.

At this time, we're anticipating that quarterly kind of course of business losses will run in the 4-$5 million range for the balance of the year.

We are, however, not in a position to estimate total losses for the remainder of the year as that level will depend upon what decisions are made in the coming quarters with regard to additional sales of troubled and/or nonperforming loans.

Because we are absolutely committed, as John said, to reducing nonperforming loans in the company through the balance in the year, charge-offs levels in the last half of the year may be -- continue to be affected by our efforts in this regard.

In addition, the longer the significant softness in manufacturing continues, this puts on our borrowers ability to survive to take advantage of the next upturn.

Obviously, we remain very cautious on the charge upfront for the remainder of the year.

Non-accrual loans as John pointed out continued their increase and rose a very significant $30 million in the second quarter to $146.5 million.

As a percentage of loans, they now stand at 2.6 percent.

We do believe, however, that we have now seen the end of the quarterly increases in nonaccruals and are cautiously optimistic that we will see a net decrease in nonaccruals in the third quarter.

We believe this to be true, even if we make the decision not to sell additional troubled and/or nonperforming loans.

In addition, we are encouraged that the bulk of our significant loan problems are working their way through the system.

The fact that we have now experienced five consecutive quarters of declining criticized loan totals in the company and two consecutive quarters of declining classified loan outstandings.

On a cautious not, however, we continue to watch a group of borrowers that, given further deterioration in their financial condition, could become candidates for future non-accrual status.

On the bright side, total 90-day delinquencies stood at 10 basis points at the end of the second quarter, down a very significant 15 basis points from first-quarter levels.

In terms of dollars, 90 day plus delinquencies were down about $8.5 million, or roughly 60 percent from first-quarter levels.

While I have commented previously that this number tends to bounce around a bit from quarter-to-quarter, depending if we have one or two or very relatively larges credits that we're negotiating through, the 90 plus delinquency level at the end of the quarter was the lowest since the first quarter of 2001.

Other real estate owned remained at the 14 basis point level identical to the first quarter reported level and there were no restructured loans to report at June 30th.

With regard to the adequacy of the allowance for loan losses, the provision for loan losses in the second quarter, as John pointed out, was $22.5 million, which reflects an additional $15 million over the previously anticipated amount for the quarter.

As with many other banks, our allowance adequacy methodology gives us an indicated range of need.

One of the primary reasons for the additional provision was to move up in our range until we began to see reductions in the level of nonperforming assets.

The allowance, as John pointed out, now stands at $98 million, or 1.74 percent of (indiscernible) loans.

However, even with the higher level of provision as a result of this significant increase in non-accruals during the quarter, the reserve to non-accrual coverage ratio did slip slightly.

We did not see, however, any slippage in the reserve to underperforming assets coverage at the end of the quarter as a result of the combination of the additional provision as well as the significant reduction in 90-plus delinquent loans.

Loan loss provision levels for the balance of the year will also depend on what decisions are made in the coming quarters with regard to the additional sales of troubled and nonperforming loans.

In terms of an outlook, as I said last quarter, we did expect levels of non-accruals to increase in the second quarter as we fully draft (ph) where regulators were coming down on the non-accrual issue.

I think that the numbers posted in the second quarter showed that actual results were in-line with our expectations.

However as I said earlier, we believe that we have now seen the end of quarterly net increases in non-accruals, at least near-term and are optimistic that we will see a decrease in non-accruals in the third quarter.

How quickly we return to a more characteristic level of nonperforming assets and charge-off levels to a great degree depends upon when and to what magnitude the general business economy begins to rebound.

We're watching carefully the progress of the economy and how the continuing start and stop recovery might affect our borrowers in both the near and the intermediate term.

At this time, I would like to turn the call back to Jim for some final comments.

At this time, why don't we go ahead and take some questions.

I know there are some out there and we'd be be happy to take them.

Those questions can be for John or Darryll or any of the other participants in the room.

After we do that, I will have a couple of summary comments.

(Caller Instructions).

Scott Cyphers (ph), Sandler O'Neill.

Good morning everybody.

I was wondering if you could tell me what the size of the unrealized gain is in the securities portfolio?

And then to what extent should we anticipate continued gains in coming quarters?

And separately, I was hoping you could talk a little bit about your comfort level with continued bad debt (ph) and securities onto the balance sheet going forward?

Yes, Scott, this is John.

At June 30th, the unrealized gain in the portfolio was right about $90 million on the portfolio of 3.3 billion.

With regard to the issue of continued additions to the investment portfolio as a component of our earning asset mix, we are of the opinion that we would not expect to see significant additions to that portfolio in the near-term.

We are at a point, as everyone knows, of kind of diminishing returns relative to the spread opportunities if you fund that stuff with sort of matched funding.

And so our thinking at the moment is that we would not expect to see continued increases in the level of our investment portfolio.

We're obviously hopeful that we can began to move some of that cash flow into commercial and consumer loans over the next couple of quarters.

But even if that loan demand is not materialized in those kind of numbers, we would not expect to see much of an absolute increase in the size at the overall balance sheet.

Okay.

And just appetite (indiscernible) continued to take gains going forward, should we expect to see kind of a little more normalized number?

Yes.

I think we are clearly of the mind if that we will use gains if there is a need or if in our assessment, we think there is a logic to take gains.

But as has been the case in the last four quarters or so, not standing on their own as a way to just generate current income.

If we have opportunities relative to the need to offset additions to the reserve or those sort of kind of credit quality or economic related issues, we would take them.

But that would be our posture right now is that we would not expect to continue to take securities gains just in order to generate sort of current income.

Okay, thank you very much.

(Caller Instructions).

Marcelo Martino (ph), McDonald investments.

Good morning, guys.

Just a couple of questions.

First on the linked-quarter increase of $30 million to non-accrual loans.

I was just wondering if you could talk a little bit about the composition of that increase and if there are any large credits added to that.

This is Darryll.

The composition of that was mostly, again, in the manufacturing area.

There were no credits in excess of $0.5 million added, so you can see that there were a number of just relatively smaller credits that we moved to that category.

As far as the margin is concerned, what is your outlook for the second half of the year?

The person you hear laughing is the Chief Financial Officer.

We really do believe that we should see some stabilization of the margin, Marcelo.

This is so dependent on what goes on with interest rates, yield curves, fed actions, etc..

As I said, we are focusing on bringing the funding costs and the asset yield deterioration into better alignment.

I guess I feel reasonably comfortable in suggesting that we do not anticipate another 10 basis points per quarter sort of a deterioration.

Whether that number is zero or five basis points, it is very difficult to say.

We are -- we continue to be postured relative to our net interest income risk position in about as neutral a position as a bank can get.

And we are I think like most banks, slightly asset sensitive so that if we do get some upward tick in rates, it helps us a little.

If we get a further downward move in rates, it hurts us a little.

But fundamentally, we are not expecting the margin to change nearly to the extent that it did in the first half of the year in the second half of the year.

Okay, great.

Thank you.

(Caller Instructions).

Michael Diana (ph), Smith Barney.

Hi.

Darryl, apparently from the size of the reserve in relation to the nonperformers, you think the loss content is relatively limited in the nonperformers.

And in the past two quarters, you gave us some data on, for example, what portion of them were mortgages or what portion were still performing.

Can you give us anything like that?

Of the nonperforming to date, we have about $45 million of those, exclusive of the 1-4 family residential that are still performing out of that $146 million total.

The loss content in these -- the reason you don't see a significant absolute need for a higher allowance is that, as I said, we have reduced classified and criticized loans significantly of the past six months.

So that gives the some relief in that regard.

The other thing is that these non-accrual loans are not loans that have just recently propped up as you see them migrate to non-accrual.

They're loans that we have identified quite a while back.

We look at impairment any time a loan becomes criticized.

And so as they move to that non-accrual category, in our methodology, it does not create a significantly higher loss potential, because most of that loss potential has been captured prior to this time.

Does that answer your question, Mike?

Yes, thank you.

What about mortgage -- do you have those numbers?

Single-family mortgage?

Most of those, Michael, were liquidated with the sale.

I will make one comment.

The loss content in these loans, obviously, if we continued to hold these loans on our balance sheet and move forward with them, would be less than if we decide to package a group of loans and sell them.

Obviously, we're going to lose some value on those loans for the uncertainties of the buyers as well as the profit the buyers have to have in those, so I want to you that if we do decide ultimately at some point in time to package and sell some of these non-accruals, then the loss content in those may be higher than what we have specifically allocated for those should we decide to hold them and work them out over time.

Okay, thank you.

Joe Stephen, Stifel Nicholas.

A couple of my questions have already been answered, but let's talk about loan growth for a second.

On a year-over-year basis, it was relatively slow, just one percent.

But on a linked-quarter basis, it was 5.5 percent annualized.

Talk about your thoughts on loan growth going forward.

That is number one.

Number two - where are you seeing your better loan growth and what markets and what markets is it just a little bit slower?

Thanks, guys.

Let me try to address that.

You are right in pointing that out, particularly on commercial and consumer loans, as John had mentioned earlier, we have been encouraged the last couple of quarters that we have been able to see some growth in those categories.

Further, I would tell you that we have build (ph) up in the pipeline in all of our banking divisions.

But let me hasten to say that, clearly, the areas where we're getting the greatest growth are in our more metropolitan areas, and specifically in the Indianapolis marketplace.

In Indianapolis, we just went over $400 million in total loans outstanding and that has been about 40 months of our operations.

So that has been a big boost to us in this whole thing, but I think our projection as we look forward would be that we should be able to sustain the kind of growth that you have seen on that linked-quarter basis.

Thanks, Mike.

That does concludes today's question-and-answer session.

I will now turn the call back over to Mr. Risinger for any additional or closing remarks.

Thank you very much and thank you, John and Darryl, for your comments as usual.

Very fine report and I appreciate, Mike, your response also and those that are also here participating.

Obviously, we're living in very challenging times for our industry, and particularly those institutions that are operating in the manufacturing-dependent Midwest.

Our customers are suffering and as a result, the banking organizations are having a difficult time.

Indiana is particularly affected and that's the major market in which we operate.

Our state is the most highly industrialized state in the United States, relying on manufacturing for 20 percent of our jobs and 27 percent of gross state product.

The average dependence in the United States is 13 percent for jobs and 14 percent for gross state product.

So obviously the projected economic decline has been most difficult for the Midwestern region and those banks operating in Indiana.

In spite of that situation, Old National continues to manage through the downturn and I think we have produced solid returns for our shareholders.

Year-to-date, our results as John pointed out, were down just 3 percent.

We've added $15 million to the reserve in an attempt to be conservative and prudent.

We think that's the right thing to do, given the times.

We sold securities, which allowed us to cover that cost and the impairment of our mortgage servicing rights and we're very comfortable with that decision also.

The thing we also know is that decline is not going to go on forever.

In fact, manufacturing output has shown some strength in the latest two months, registering the first two gains since last summer.

The economy is expected to pick up, the anticipated pace is about 3.5 percent for the second half of '03, and by most accounts, next year, we should see gross product increase of 3-4 percent for 2004.

So we're expecting to benefit greatly from that.

We're also very excited with the things that we're doing in other parts of our company.

Chris and his group over at the Signature group and the trust in particular, but all areas are showing very tremendous growth and we're very appreciative of that and we think it positions our company very positively going forward so that we won't be so dependent on the margin.

Mike has pointed out the tremendous success we've had in the metro market strategy.

Indianapolis has performed extraordinarily well.

Mike mentioned that we're over $400 million in loans.

That alleviates some of the pressure that we have in other parts of the franchise.

When you look at the traditional community banks in the rural areas that we have, they're just not going to be able to grow to growth the way it should.

Indianapolis has helped alleviate that.

St. Louis, we're up and running and very pleased with the initial results over there.

We also believe that the metro markets will help us acquire funding at a little cheaper cost.

It's well acknowledged that urban markets have a little lower cost of funding that what you traditionally see in the rural area.

So we think that that is going to be very positive for us.

We believe that the credit quality has -- at least we hope that we have seen the end of this cycle and we all understand that this is a cycle that will move away.

Darryl has done a very fine job of working with the credits and moving some of those credits off.

And as he has pointed out, the criticized assets have dropped dramatically.

We do believe that there will be some positive increases as Darryl indicated in the third and fourth quarter we remain somewhat mildly optimistic that we have seen the worst of the days and we're very excited about the next two quarters.

The next two quarters will tell us a whole lot about our economy, about our industry and particularly about our bank.

We appreciate very much your continued interest in Old National and look forward to talking to you in October.

And that will conclude our conference today.

Thank you.

This concludes Old National's call.

Once again, a replay will be available for 12 months on the shareholder relations page of Old National's web site at www.oldnational.com.

A replay of the call will also be available by dialing 1-888-203-11112, confirmation code 695482.

This replay will be available at 2:00 midnight Central on August 8.

If anyone has additional questions, please contact Linnell (ph) Walton in the investor relations area at 812-464-1366.

Thank you for your participation in today's conference call.

(CONFERENCE CALL CONCLUDED)