Old National Bancorp (ONB) 2004 Q2 法說會逐字稿

Welcome to the Old National Bancorp second-quarter 2004 financial results conference call.

This call is being recorded and has been made available to the public in accordance with the SEC's Regulation FD.

The call will be archived for 12 months on the shareholder investor 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 6.

To access the replay, dial 1-888-203-1112, confirmation code 602151.

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

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

Then we will hold a question-and-answer session and instructions will follow at that time.

Over the course of 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.

For these statements, Old National Bancorp plans the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

A complete copy of the Company's forward-looking statement disclaimer is included on page 6 of the Company's second-quarter earnings release available on the Company's website at www.OldNational.com.

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

With us today are Old National Bancorp's interim Chairman of The Board, Larry Dunigan;

President and Chief Operating officer, Mike Hinton; the Chief Financial Officer, John Poelker; and the Chief Credit Officer, Daryl Moore.

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

Please go ahead, sir.

Good morning.

We're glad to share with you some very positive second-quarter results.

We will have a question-and-answer session at the end of our presentation.

Now here to present our second quarter is the Chief Financial Officer, John Poelker.

Thank you, Larry and good morning ladies and gentlemen.

We were obviously very pleased with the results for the quarter, which exceeded our own expectations and as adjusted for the impact of the one-time charge on the ASCEND program, pretty comfortably exceeded the street estimates out there for our second quarter results.

We do recognize that the results this quarter were a little noisy, and I wanted to discuss some of these nonrecurring and one-time events and provide a little color on those adjustments.

Clearly, the most significant item was $25.1 million in charges related to the implementation of our ASCEND program.

This is a number of pretty much right on what we expected it to be, and that we announced in early June.

As you recall, these charges included payments to our consultants who assisted us in the program; a gain sharing payment program with our employees in appreciation for their intense involvement in this project over the last 6 months; a write-down of some surplus properties; and lastly provisions for severance for employees whose jobs will be eliminated.

This clearly represents the great bulk of these kinds of one-time charges associated with ASCEND and from here on out, we will clearly obviously be having net positive benefit on earnings from the program.

Partially offsetting that negative charge in the first quarter were 2 pretty significant gains related to our mortgage operation.

First, we did have a recovery of previously adjusted MSR values during the quarter reflecting the increase in rates.

That amounted to $2.6 million positive adjustment to the valuation of the MSRs, and that was followed -- that followed a $1.5 million write-down of MSR values in the first quarter.

We also sold, as we had indicated in the 10-Q last quarter, a $400 million portfolio of individual mortgages.

We completed that sale during the quarter, and recognized the gain on that sale of $2.6 million, most of which, as you know, would have been created through the creation in an effect the mortgage servicing rights on the loans that we will retain for servicing.

The net of those 2 big items, the ASCEND charges, and the gains on the mortgage operation totaled about $20 million net, 13.7 million after-tax, and equated to sort of a net charge to earnings during the quarter of 20 cents per share.

Underneath this reduced level of reported net income, and nonrecurring items was a quarter which we really feel strongly provides a lot of positives relative to our progress in restoring our earnings momentum.

Credit quality is clearly showing significant signs of improvement.

Noninterest revenue continues to grow very strongly and a number of our operations recorded record levels of revenue during the quarter.

Operating expenses even before we get ASCEND in full gear fell to their lowest level in 5 quarters, and what I would like to do before we open it up for questions is to give you a little detail on some of these topics.

While chargeoffs this quarter did exceed our provision of $7.5 million, the majority of those chargeoffs taken during the second quarter were related to nonaccrual loans that had previously been identified.

It is very important to note that chargeoffs for the first 6 months of this year totaled $16 million, and are right on our earlier forecast of chargeoffs for the full year in the range of $30 million.

We don't see anything on the horizon right now that suggests that normalized chargeoffs from here to the end of the year will be much off of our original target.

We did show further reduction in nonperforming loans during the quarter, down to 97.6 million from March 31st, and clearly well below the 146 million that we reported at June 30th of last year.

This is the third or fourth quarter in a row now when we have managed to show net reduction in our nonperforming loans.

Our reserve for loan losses remains in excess of $100 million, and while that is down a little bit from where we were at the end of March, we are now showing a 106 percent coverage of nonperforming, which is the highest coverage of nonperforming loans in the last 18 months.

And as a percentage of total loan portfolio, particularly impacted by the sale of 400 million in mortgages, showed a pretty significant increase.

Total problem classified and criticized credits continued to come down during the quarter.

Another $34 million reduction from March, and now down $123 million since June of last year, and equally importantly, total delinquencies in our portfolio at the end of June stood at 71 basis points, and that is the lowest level of delinquencies in the portfolio in the last 4 years.

Daryl is here with us this morning as usual, and will be prepared to provide any additional information or commentary on credit quality when we get to the Q&A.

Fee income was a particularly encouraging this quarter.

Noninterest income grew by $7 million compared with the first quarter, and we are showing significant gains in literally all of the operations.

Clearly, mortgage is the area that had the sort of most noise in it.

It showed the most significant turnaround from the first quarter when we actually reported slightly negative revenue in our mortgage area.

Backing the negative adjustment of MSRs of $1.4 million out of our first-quarter results, which show an unnormalized operating revenue from mortgage operations in the first quarter of about 1.1 million.

If you back out the gain and the MSR adjustment from second-quarter results, you get about $1.9 million in operating revenue from mortgage which is a nice improvement, particularly in light of the fact that mortgage volume and activity across the country is down the very dramatically from last year.

So, we feel pretty good about where we stand with mortgage on a go-forward basis.

Clearly not able to reach last year's levels, but the trends look pretty healthy right now.

Trust asset management and investment product sales related revenues increased to 11.8 million this quarter from a 10.7 in the first, a very nice 10 percent quarter-over-quarter improvement in those key elements of revenue, and compared with the same quarter of last year, those revenues are up 13.5 percent.

That is probably the best kind of run rate of revenue from those important categories that we have seen in a couple of years.

Our insurance agency operations continue to contribute very significantly to fee revenue growth with second quarter revenue just shy of the record $14.5 million that we recorded in the first quarter.

Clearly, aided by the acquisitions we have made in that important business.

Insurance revenue is up almost $12 million compared with the first half of last year.

As we look forward, we are very excited, I think is a fair word, about the dramatic improvement in our operating efficiencies that we began -- will begin accruing to us over the next 18 months as the ASCEND project really begins to take hold.

But, even beyond that enthusiasm for the future reductions of expenses, we are very pleased with the reduction in and core operating expenses this quarter when measured against last quarter if you exclude ASCEND charges.

Those core operating expenses this quarter were just over $73 million, which is the lowest level for that element of our income statement since the first quarter of last year.

So, as Larry indicated, we see a lot of positives in this quarter's core operating results; expenses are clearly under control.

Credit quality appears to be stabilizing, and very steadily improving.

Key revenue categories look very strong.

We think the outlook continues to look pretty rosy relative to our operations over the next 12 to 18 months.

I am sure you have a lot of questions for us, so at this point in time, we will open it up to questions.

Thank you.

The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Joe Stieven with Stifel, Nicolaus.

First of all, good quarter.

Can you guys -- there's 2 things I've got questions on.

First can you talk about your -- not nonperformers went down but can you talk about your watch list, number 1?

Number 2, talk about obviously the key going forward is going to be your growth in loans, in your loan pipeline?

That is number 2.

Number 3, can you talk -- help us a little bit on the tax rate?

Thanks guys.

Let Daryl talk about the watch list.

Let Mike talk about loan growth and I will talk about tax rates.

Our classified loans continue to come down.

We have had net reductions through the first half of the year of about $67 million.

Just in classified and criticized, about 35 of that was in the classified category with about 30 of that being in the criticized category.

The reduction in classified, that is our sixth straight quarter of significant reductions in classified.

We are coming off of 3 straight quarters of reduction in criticized.

So the trends continue to show that those classified and criticized are coming down.

Relative to your question on sort of what is happening in the pipeline with lending, we have -- we continue to be gratified with the growth that we have had a consumer loan, and that has showed very steady growth, and is reflecting the efforts of some specific efforts to market consumer loans.

They were up again in the second quarter, and that really is a record of several quarters in a row now where we have been able to get that.

The difficult thing for us, though, has been on the commercial loan side and frankly it takes a lot of consumer loans to offset not getting commercial loan growth.

The good news that I can give you is that the pipelines continue to be at the kind of size that we expect as we monitor that on a monthly basis.

And that we are closing commercial loans, new underwriting of about 80 to $100 million every single month.

The difficult thing for us in this most recent period has been that what is paying off or being eliminated from the bank both by on purpose and on a voluntary basis is offsetting virtually everything that we're underwriting.

What I would ask you to think about on that though is, that obviously that runoff slows down at some point, and we should get the real benefit out of the fact that the pipeline continues to be at expected levels.

Okay.

Joe, taxes, our effective tax rate in the second quarter was actually below 30 percent, like 29.8 percent.

That is clearly an unusually low effective tax rate -- that's a taxable equivalent basis.

The reason for it is that with that reduced level of earnings impacted by the ASCEND charge, we still have such a high percentage of our portfolio in municipal securities that our relative tax-exempt income to taxable income when you get down to levels of net income like this starts to have a pretty significant impact on that effective tax rate.

We have not done anything to tax reserves, or try to be conservative in terms of any tax adjustments.

This is just purely the impact of higher levels of tax-exempt income relative to total income as a result of the special charge.

So as we move forward, you guys trying to figure out what kind of tax rate to build into your models.

And as we move forward, I think we will see a gradual return on a sort of annualized basis of our effective tax rate back to that sort of 33, 32 percent kind of range.

That's what I was wondering is what do we need to build in going forward.

Okay.

Thanks guys.

Good quarter.

Fred Cummings at KeyBanc Capital Markets.

Good morning.

Just a point of clarification, John.

The improvement in expenses linked-quarter, is that due to a decline in headcount?

Not really.

I mean I suspect that we may have had a little bit of a headcount from just kind of normal attrition, Fred, but it is not related to the implementation of any of the ASCEND ideas at this point in time.

Some of those ideas are being implemented, but we have not had -- I don't think any kind of meaningful reduction in staffing at this point in time.

We think it is primarily just across the board a combination of a closer attention to expense.

Tom Clayton is here with a kind of heads up HR.

Tom?

We've had the notification of a number of people in regard to reduced headcount, but those jobs have not yet been eliminated for the most part and that will begin mostly during the third quarter.

I would say that the fact that we have not been adding to staff and we have been very diligent about making sure that that doesn't happen, has helped not offset other expense reductions because of headcount growth.

Okay.

Then a related question.

With respect to losing people you don't want to lose, particularly on the production side, commercial loan officers, retail branch managers, given some of the uncertainty; can you give us an update on attrition from that perspective?

Have you lost any of your major commercial loan producers?

Have you lost any of your better branch managers in light of this restructuring that is taking place?

Obviously there have been a handful of resignations that we haven't chosen.

But, I can say without question that none of those have been our largest commercial producers and relationship managers.

I would tell you that I continue to be very comfortable and optimistic that those folks understand the degree at which they are important in this organization, and have a very important role and continue to be loyal and interested in being a part of Old National going forward.

Believe me, we are spending a lot of time on that front.

I can imagine so.

One last issue.

The growth that we're seeing in deposits, it's actually pretty impressive.

To what extent is that public funds; to what extent is it related to an increase in escrow balances versus core growth?

Or your commercial businesses?

That really has no influence from public funds or escrow balances.

Those are core balances and transaction accounts of both on a retail and commercial based basis.

We have concentrated on that.

Any runoff has come in our CD, so all of our efforts have been there.

The small-business initiative that we've have had and concentration on sort of premium type commercial retail -- or checking accounts are primarily responsible for the growth.

Okay.

All right.

Thanks Mike.

Karen Lemark (ph) with ML Investment Managers.

A couple questions.

If you go to your noninterest income line items which as you pointed out showed substantial growth, for trust in the deposits service charges and the insurance premiums, can you share what is different sort of organicically ex-ing out the acquisitions on insurance?

What are you doing differently that is enabling that kind of growth?

You know, you're seeing that growth in this quarter, but I would suggest to you that that while it is nice to report them as records, all sort of in the same quarter, it is not sudden.

We have been having a steady growth in most of those categories, and that is probably a 2-year long effort to integrate particularly our brokerage operations, retail investments, and trust into our whole banking sales model, setting expectations with those fee income business lines right along with our bankers and monitoring on a weekly basis what we have done.

Measuring the referrals from bankers into each of those lines, and on a reciprocal basis, going back into banking and we have just seen a steady increase as we have continue to monitor and manage on that basis.

Going forward, the pace will obviously vary, but it shouldn't be considered unusual?

No, absolutely not.

Do you care to comment at all about the second half, either in aggregate the estimates out there or maybe the components?

No, Karen, I think we're going to stick with our belief right now that we're not going to comment on estimates.

There is a lot of moving parts.

ASCEND benefits are going to start accruing here, but our position right now is that we are not going to comment on estimates for the second half.

Okay.

Lastly any update on the CEO search?

I can tell you that we're right on track with that.

And we're in the process and have actually included our second interviews with the final candidates.

And it is still looks like we are right on target for an announcement sometime in August.

Great.

Thank you very much.

(OPERATOR INSTRUCTIONS) Troy Ward at A.G. Edwards.

Just some questions on the chargeoff line.

The chargeoffs, even if you back out the sale part of it, the chargeoffs are running around 12 million this quarter.

First quarter obviously was down considerably because of the asset sales.

What do you see happening in the second half here to keep you in that $30 million range -- 7 a quarter?

I think that we have done pretty a exhaustive review of what we have in non-accruals and what we have that might move in and out of those non-accruals and we're pretty convinced that the impairment that we have on those if they go bad is going to be well within that $15 million for the balance of the year.

So, I don't think that what we know today, we have much concern at all that we are going to be outside that $15 million range.

Obviously, if we decide and this is something that is always on the drawing board, if we decide to sell loans, we will look at the impact on the chargeoffs of the sale of the loans, but right now we just don't think that even with the combination of some amount of sale, that we are going to have much difficulty in meeting that $15 million for the balance of the year.

What impact if any did the block sale this quarter have on nonperforming loans?

It didn't at all.

The loans that were sold this quarter were all loans that were performing loans.

Now what they will have an impact on going forward is obviously the level of reserve we have to have against those decrease in those amounts of loans and probably more importantly, a big chunk of those loans that were sold are loans that were in our estimation carried a higher risk of default.

And so we do not believe that we will see a continuance of the non-accrual loans in that 1 residential portfolio stay at the $11 million mark.

We think we will be able to begin to move those down and won't have the refill of those buckets because we've sold off most of those higher -- probably default loans.

Going forward, what is your thought about -- obviously the chargeoffs exceeded the provision this quarter.

What are your thoughts about going forward?

Obviously, we don't manage chargeoffs from quarter-to-quarter but I think the chargeoffs will be within that $15 million for the balance of the year.

You anticipate the provision would stay in that range as well?

That is our prediction at this point.

What are you seeing from a Midwest feel on the trends?

Is manufacturing -- can you see that it is having that positive impact?

Has it turned the corner towards having a positive impact not only on new loans but on the portfolio, the existing portfolio?

The answer to that is no.

We have seen some rebound in some segments of manufacturing, but generally and overall in the portfolio, we just have not seen that segment pick up yet.

We're not seeing a lot of capital expenditures from that.

We're not seeing a lot of line usage.

It still is a segment, at least in the Midwest that has yet to participate fully in the recovery.

Okay.

Just a bit of a question.

In the first quarter you had in the other income and the noninterest -- you had a number of 8 billion and then it dropped 5.3.

What was in that and what kind of run rate do you think is a go forward on that number?

8 million in the first quarter Troy included a couple of nonrecurring things.

We had a gain on the sale of a branch, a piece of property.

We had an accounting reclassification in there.

The 5.5 to $6 million range for other income line is probably sort of the kind of run rate there.

Great.

Thank you gentlemen.

Fred Cummings at KeyBanc Capital Markets.

Just one follow-up question as that relates to the ASCEND project.

John, you might want to speak to this as you look at the anticipated revenue enhancements you site implementation of risk-based pricing, can you tell us what areas of the portfolio are you going to apply risk-based pricing to?

That really obviously relates to our commercial lending activity.

We are just about ready to implement a new risk-based capital allocation methodology for our internal profitability reporting and we are moving toward integrating that into commercial loan pricing models.

We've spent a lot of time over the last 6 months as a matter-of-fact in connection with our kind of restructuring of the way we think about commercial lending and how we're going about that lending.

To make sure that we're getting adequately compensated for the risk, it is the whole risk-based pricing equation, but it will be used exclusively at least initially in our commercial lending operation, and there is no sort of a big drop dead date effective September 1st -- all loans get priced using risk-based pricing.

We think this is a question of kind of integrating this approach into our loan pricing methodologies on a gradual basis over the next probably 12 months or so.

John, I was asking really in relation to the growth expectations.

I would imagine this really would suggest a more conservative pricing in some instances and I'm somewhat concerned about given the Midwest economy your loan growth outlook.

I am wondering clearly do you think this will slow the rate of growth as you implement risk-based pricing on the commercial side?

Have you guys changed your underwriting structure?

I understand that before it was more decentralized across some of the regions and are you going to centralize that process and --?

This is Mike Hinton.

I would like to weigh in on that for a minute. 2 things.

One is I respect your concerned about the risk-based pricing and the potential impact upon loan volume.

What I would want to counter with is if you look at what our lenders do today, as we sort of target FTP spreads, they will base their pricing off of FTP without -- no fault of theirs -- without any regard to sort of what is the risk and the requirement for capital on those credits.

When we start supplying the information, the risk-based information to be utilized for pricing on those loans, what we've modeled in our own sort of makeshift fashion right now is that there is at least as much incentive to be able to be more aggressive in pricing on those better credits that are available in the market as there is the need to be more conservative in pricing on those credits which fall into a 5 or 6 or 7 range.

So, yes, there will be some impact but frankly the pressure ought to be on the end of the ratings that we would probably like to avoid any way.

Okay.

The underwriting, Daryl can speak to that, but he has led a total change in our underwriting processes, which is in place and working well today.

Daryl?

As we probably have talked about before, we have separated underwriting from production and they report up to 2 different areas of the bank now, and we basically 2 locations, Evansville and Indianapolis in which we do that centralized commercial underwriting at this point in time.

Okay.

One last question.

Do you guys have any appetite to say purchase loans from any other banks in order to grow your volumes?

We are looking at that.

We have traditionally not done that.

I would say that we are looking at a couple of opportunities to perhaps buy pools of loans.

I would characterize our appetite right now as being limited exclusively to consumer loans.

It could include some mortgage product.

And our understanding in terms of our talking with other people in the market and on the street is that we should be able to find some product out there that matches up pretty well with our own existing current underwriting standards.

So this is not a strategy driven by a desire to extend credit risks were to get more credit risk in the portfolio.

It is really driven by a desire to utilize the very significant liquidity that we have right now, and to find essentially investment alternatives to portfolio securities.

So, we haven't done anything yet, but we are looking at it, and I guess the best I can do is to assure you and the rest of the listener that this is going to be done carefully and with a very keen eye on the impact on credit risk.

Okay.

We think there are some big opportunities out there.

As you guys know probably better than we, there are pockets of the economy out there where people have gotten more loan demand than they can fund.

That is one of the beauties about this banking system that we have.

It does offer opportunities to this intermediate some of those funds to the right places.

Okay.

Thank you.

Troy Ward.

Just a follow-up on the liquidity comment.

What movement have you -- did you see in the second quarter in the securities portfolio?

Were you adding to that and what was the net position of the unrealized position at the end of the quarter?

We were moving the portfolio down as we have indicated.

We have been trying over the last 2 or 3 quarters to reduce the size of the investment portfolio.

You will see an increase in the portfolio size right at the end of the quarter at June 30the as a result of the sale of mortgages.

I think about $150 million of those proceeds we put into essentially Fed funds sold.

We are net sellers of Fed funds for the first few weeks in July for the first time in a very long time.

We are obviously keeping those excess funds very short right now.

The unrealized position in the investment portfolio obviously moved from a positive at the end of March to a negative at the end of June.

We will give those numbers completely in the 10-Q, but it went from pretty positive to pretty negative.

Nothing beyond what you will see at other banks, and nothing that particularly alarms us, but clearly the impact of that kind of an interest rate move on a $3 billion portfolio is going to move those numbers pretty significantly.

And when you talk about reducing the size of the portfolio, are we doing that mainly through not reinvesting the cash flows?

Yes, we're not anticipating any sales.

That is just a pure cash flow reinvestment strategy and that is really why we're looking at things like bulk loan purchases.

We are looking -- obviously as Mike indicated, we are getting increasingly optimistic about loan growth.

That cash flow coming out of the investment portfolio today is running about 35 to $50 million and we are essentially, simply reinvesting that and waiting for loan growth.

Just a follow-up on that consumer potential purchase of consumer loans from other parties.

Can you drill down what type of specifically consumer loans you are looking at?

I'm not ready to answer that yet, Troy.

This would be -- the possibilities things like home equities, they are straight consumer loan pools, but we have not gotten that far in our analysis yet.

And one follow-up for Larry.

First quarter call, you did give us a little more color on the executive search by indicating whether they are external or internal candidates.

Are you willing to do that again this quarter?

Both continue to be a possibility, Troy.

Okay.

Great.

Thank you much.

Gentlemen, there are no further questions at this time.

I will turn the conference back over to you for any additional or closing remarks.

Thank you very much for your questions and thank you for joining us today.

We are pleased to have had the opportunity to talk with you and I hope you are equally excited about what we all saw in the second quarter.

Thank you.

This concludes Old National's call.

Once again a replay will be available for 12 months on the relations page of Old National's website at www.OldNational.com.

A replay of the call will also be available by dialing 1-888-203-1112; confirmation code 602151.

This replay will be available until 12:00 Midnight on August 6.

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

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