Old National Bancorp (ONB) 2004 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Old National Bancorp third quarter 2004 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. With us today are Chairman, Larry Dunigan, CEO, Bob Jones, Chief Operating Officer, Mike Hinton, Chief Financial Officer, John Poelker, and the Chief Credit Officer, Darrell Moore. At this time, the call will be turned over to Mr. Jones for some opening remarks.

I want to remind everybody that there is a copy of the presentation on the Web site and we will be following it. We will do our best to note the page we're talking from. I thought I would start out by talking about how pleased I am to be with all of you this morning, as well as, more importantly, how pleased I am to be at Old National. I think, as you know, this is my first call with the management team here. I am extremely pleased to be part of this organization and with the folks in this room.

I'm going to begin my presentation on page 4. I thought it would be of great valve for me to kind of give you my first 45 day assessment of Old National and where I think we have our strengths and our weaknesses and a little bit of where we're going. It's important to note that I visited all of our regions. I've spent a lot of time with a number of our employees, some clients and I feel like I have a good working knowledge of the culture of Old National and the opportunities and the challenges.

First and foremost, I will tell you that we have a deeply committed Board, committed to both the short-term and long-term actions that are necessary to improve the long-term performance of this company. More importantly to me, there is a deep commitment from t he associates that I've met with to the culture of Old National and, more importantly, to improving the performance.

We do have some critical positions that will be filled over the next period of time. I believe everybody is aware that John Poelker has announced his retirement. John has agreed to work with us with the transition to a new CFO. It is our intent to try to have that position filled by the end of the fourth quarter. John will then stay on for a period of time to help us with that transition as well as to ensure that we're in compliance with 404 and all the other actions. We'd be remiss if we didn't acknowledge John for all of his hard work over the period of time he has been with Old National and for my period of time over the 45 days.

We are also searching for two other very important positions. First is a Chief Risk Officer. It would be an individual to take management of all of the risk activities within Old National. That search will probably take us a little longer period of time in that there are not a lot of those positions out there today. In banks of our size, most notably are not searching for those positions. It is our hope to have that position filled by the end of the first quarter. Disposition, again, as I said, will take responsibility for all risk activities, including credit, audit, balance sheet and other risk activities and compliance activities within the company.

We are also looking for a CEO of our insurance group. We hope to have that position filled by the fourth quarter as well. As you well know, we have a significant investment in insurance operations. We're looking for someone to bring together those operations and to run that for us.

The last thing I would mention on this page is that we have spent a lot of time as a group and with other associates developing a strategic plan, which we're presenting to our Board in December, and will be sharing portions of that with you in our November 18th analyst and investor call. We're very comfortable that we've got a good plan in place and one that will carry us into the future of Old National.

If you want to turn to page 5, I'll just lay out what I've called "our performance imperatives" and this will lay the ground work for our presentation today, as well as our performance over the next period of time. First and foremost, we need to continue to strengthen our credit quality. Our self-assessment is that it's improving, yet there is still work to be done. Darrell Moore, our Chief Credit Officer, will be sharing with you the progress we've made as well as some of the challenges and opportunities that lie ahead. We need to continue and maintain an expense discipline, as I think you'll hear from Mike Hinton, our Chief Operating Officer. We have built a terrific foundation with Ascend. I think most of you know that I ran the Ascend-like program at Key and I will tell you that I've been very impressed with the processes and dedication that the Old National folks have brought to Ascend. I'm confident that we have laid that foundation for expense discipline as well as process improvement over a period of time as we go forward.

Finally and, probably, most important to all of you is that these two, plus a number of other actions on the part of Old National, we need to develop a consistent core earnings structure. What we will tell you is that our goal is to get to consistent quality earnings. As we say in our self-assessment, we're not there yet. An awful lot of hard work has been done prior to my arrival, a lot of work has been done since I've been here to get us there, but it is important to all of us that we are able to get to a point of consistency and quality in our earnings.

With that, I'll turn it over to Darrell Moore to give you an update on our credit.

Thank you, Bob. I'd like to direct your attention to page 7 and it's the Total Non-Accruals. As you can see, during the period covered by this chart we have reduced non-accruals by approximately $40 million. Nearly all that reduction, however, came in the third quarter of last year. Over the four quarter period since that time, while we've made good progress in moving individual non-accrual relationships out of the bank, new loans moving in that category have, essentially, offset those reductions.

We realize that if you view this alone you may be somewhat skeptical about the level of progress we've made in reducing the risk in portfolio over the last five quarters. In just a couple of slides, however, I'm going to review a chart that shows the level of problem loans which we would consider Criticized and Classified and have fallen dramatically.

If you review comments we made at the beginning of the year, you will be reminded that we generally felt good that credit quality had stabilized but that we would, in all likelihood, experience some bumps along the road before being able to reduce the level of non-accruals significantly. In this regard, we do not believe that the up tick at the end of the third quarter represents anything other than one of these bumps and that you'll see the trend of non-accruals move downward again at the end of the fourth quarter.

One of the strategies in moving the absolute level of non-accruals down is through the strategic periodic sale of non-performing loans. In the quarterly earnings press release we disclosed that we've entered into an ongoing agency agreement with a third party to facilitate a strategic option for periodic loan sales. While we do not know, at this time, the specific dollar on any non-accrual assets, if any, that may be sold in this quarter. We will say that the dollar amount of loans we are considering for sale is in the $40 to $50 million range and, more importantly, that our work with the third party facilitator indicates that our impairment allocation appears to be in line with current secondary market pricing levels.

If you move to page 8, we're going to look at non-accrual coverage trends. You see that our improving trends that are in increased coverage by the allowance of non-accrual loans were reversed slightly in the third quarter. This, obviously, was due to the increase in non-accruals that I just discussed. We do believe that the third quarter reversal was a one quarter event and that the improvement in this category will continue in the fourth quarter, especially if we choose to sell any significant levels of non-accrual loans.

On page 9, we show the progress we've made in reducing problem loans in the Company. For the purpose of this chart, problem loans are defined as our Criticized and Classified loans in the portfolio. The chart shows that the total risk profile of the loan portfolio has fallen significantly over the last five quarters from a high level of, roughly, $615 million to the present level of approximately $475 million.

To give you some additional prospective on the risk of the portfolio today versus where we were at the end of the third quarter last year, at September 30, 2003, our 20 largest Classified borrowers represented, roughly, $158 million in exposure to the bank. At September 30, 2004, our largest 20 Classified borrowers represented $90 million in exposure to the bank. We believe that the significant decline in problem loans, coupled with the significantly reduced level in delinquencies in our portfolio over the last several quarters, will ultimately translate into lower non-performing levels.

On page 10, we look at total charge-offs. This is a chart to fix the annualized charge-off rates at each quarter for the prior five quarters. As we have represented previously, 2004 is shaping up to be a better year than 2003 for us, the charge-offs in dollars for the first nine months at less than half of what they were through the first nine months of last year. However, we do recognize two remaining issues. First, while the level of charge-offs for the first nine months is on target from where we thought we would be and what we disclosed to you at the beginning of this year. The full-year charge-offs may be higher than what we predicted at the beginning of the year if we choose to sell a significant amount of loans in the fourth quarter. Second, one of our highest priorities in this are is to reduce the volatility of the charge-offs as reflected in this chart. While we obviously have no intention of managing charge-offs, solid credit administration practices should allow us future quarterly annualized charge-off rates which fall into a band which is significantly narrower than what you see on this chart.

In summary, overall, I think we continue to feel very confident that we have put the necessary steps into place that will ultimately lead us to the types of credit quality numbers that are satisfactory to both our shareholders and our associates. We are, however, reminded daily, what Bob said earlier, it's true, there is much work to be done in this portfolio.

At this time, I'd like to turn it over to Mike for his comments.

Thank you very much, Darrell. What I'd like to do is spend some time giving you some update on where we stand with our Ascend process. If I could direct you to slide 12, in our special call earlier this year to disclose our Ascend expectations, we showed you this chart and it was intended to help direct expectations about the magnitude and timing of Ascend impact upon performance. As you may recall, we said that we expected 2004 to be benefited by about $3 million, or three cents a share, exclusive of a special one-time charge, and we anticipated that to be predominately a fourth quarter occurrence. Our expectation was, and is, the significant benefit of $47 million, or 47 cents a share, should be realized for the full year 2005, and that the full $77 million that we identified in Ascend which show up in 2006.

I'd like to give you some idea of how we're tracking on those projections and if I could direct you to slide 13 and ask that you read this slide as a percent of dollars represented by the ideas. In other words, that 30 percent of ideas is complete should signify to you that 30 percent of the $77 million, or $23 million, are represented by completed ideas. These are ideas which have been documented by our group and project leaders that they have completed. The work is done. They've put in place all actions that were part of the project plans for those ideas and they have the expectation for us to realize those results. I would distinguish between completed and validated ideas to say we are validating these through our implementation coordination team. To date, we're validating at about a quarter of completed ideas. That should not suggest that there's doubt about those completed ideas, it's just that the actual realization and proof that either revenues or expense reductions occur will take some period of time and we will not validate until we have actually seen the results of that. Thirty percent of the dollars are represented in completed ideas, about a quarter of those currently validated. Another 51 percent of ideas are in-time and in progress so that half of the full $77 million of ideas is very much on track to meet the schedule that we had laid out in our Ascend plan. The13 percent of the dollars and ideas, which are not yet started, and that is by schedule that they were not to have been started.

Five percent of the dollars in our $77 million portfolio are running behind schedule right now. That's not to suggest that they won't occur, but they are running behind the schedule that we had. Only one percent of ideas are at-risk or have been withdrawn. I would like to add that, in the case of any withdrawn idea, new ideas have been submitted which more than compensate for the dollars that have been lost in withdrawn ideas.

On the next page is a quote from one of our associates which, I think, gives an indication to the greater benefit of Ascend, even beyond the $77 million of benefit that we hope to achieve given the implementation and fulfillment of all of our actions on this plan. That quote was that "one of the best benefits of Ascend is the process" which we developed for analyzing and justifying initiatives and the disciplined approach we have had in planning and implementing approved ideas. The accountability created, in a sense, should be a lasting value of the hard work we've invested for the past year. That, to me, said a great deal that our associates are seeing it this way. To echo what Bob Jones said earlier, I think the encouragement that we get in this from having an individual join us as CEO who has been through this process, has the benefit of being able to look back at it and reaffirm the commitment of the Company to getting these benefits is a very big factor.

With that, I'll turn it over to John Poelker.

Thank you very much, Mike. Good morning, ladies and gentlemen. I think you've all got the details of the earnings. Clearly, we're very pleased with the strong performance compared with the comparable period last year and, obviously, want to take some time to focus on the changes from where we were with the most recent weak quarter in the second quarter. The first couple of slides, starting with slide 16, a pretty high-level summary of the major factors impacting third quarter results and comparisons with prior periods. The following slides will go into some details to help you understand what has been going on.

Obviously, net income in the third quarter of $18.2 million, or $27 a share, represented a very significant improvement over the $11.8 million that we earned in the third quarter of last year. Net interest income down by $6.7 million, primarily a function of reduced level of earning assets. The net interest margin remained relatively unchanged from the 332 that we recorded in the third quarter of last year.

Mortgage revenue, obviously, down very significantly from last year, down $7.8 million. Clearly, a trend we're seeing throughout the industry as the refi boon that we benefited from in 2002 and early 2003 has, clearly, dramatically slowed.

Those negative results in terms of revenue were, clearly, more than offset by the $20 million reduction in our provision for loan losses. We're now very comfortable with our reserve levels and we think that the volatility that we've seen over the last two to three years in terms of provisions for loan losses is, hopefully and clearly, a thing that is behind us.

The other important factor in comparing to the third quarter of last year is the operating expenses were virtually unchanged from third quarter of last year. As Mike indicated, we fully expect to see some very positive trends in that line as Ascend benefits to be realized.

On page 17, just a real high-level overview of the comparison with the second quarter. A 10 cents per share improvement over the second quarter results, two big offsetting or countervailing factors, obviously, going on here. First of all, you know, in the second quarter we had a $25.1 million special charge on a pre-tax basis for the one-time cost associated with Ascend. That was an affect partially offset by a fairly significant reduction in revenue, compared to the second quarter, and we plan to spend a fair amount of time talking about that issue here this morning. Key components of that revenue reduction were, again, in net interest income and, this quarter compared to last quarter, primarily a function of the sale of mortgages in the second quarter. We have had a seasonal slowdown in both insurance and investment revenues and, again, a fairly negative comparison with regard to mortgage based on a continuing reduction in mortgage originations.

If you look at page 18, a very high-level comparison - you've got all this data, no need to spend much time here -- on a net income basis, 73 cents a share versus 97. If were to add back into the earnings this year, the 26 cents per share, the one-time charge from Ascend, our sort of operating earnings would just about be identical, two cents ahead of last year.

Looking at the balance sheet changes on page 19, from the second quarter we continue to have a reduction in our commercial loans. You see that total loans from - these are end of period numbers - total loans were down $30 million from where they were at the end of the second quarter with a $77 million decrease in commercial loans offsetting what we're continuing to see, nice increases in consumer lending. Consumer loans were up another $32 million in the quarter. Mortgages, even though total mortgage origination volume has softened, we've done a lot of work over the last three to four quarters in developing products in our mortgage operation that we want to put on our balance sheet to have the right interest rate credit characteristics. We actually increased our balance sheet portfolio mortgages from the end of the second quarter by $14 million.

As has been the case throughout the industry, we had a very dramatic move in the unrealized valuation of the investment portfolio reflecting the drop in long-term rates here at the end of the quarter. With our unrealized loss in the investment portfolio going from $44 million negative at June 30th to almost $26 million positive. That, obviously, has had a very positive impact on our capital ratios.

As we referred to in the press release, we continue to be very pleased with growth in core deposits, up another $62 million this quarter and, more significantly, the continued shift from higher cost CDs to lower cost transaction accounts, which now represents 61 percent of our total core deposit base.

On page 20, look at the year-to-date changes in our balance sheet and I've sort of alluded to some of this earlier. Total loans actually down $100 million from December 31, 2003. Again, increases in our consumer loans not quite offsetting declines in commercial loans. Mortgages, obviously, reflecting the sale of $400 million of mortgages at the end of June. Our investment portfolio we're holding fairly steady at, roughly, $3 billion, not much change there. Then you can see that the total deposits, while down a bit, are continuing to show the very significant shift out of higher cost CDs into lower cost and, frankly, more stable, transaction accounts.

Page 21 is probably a page that you'd like us to spend the most time with and we plan to do so. This is the change in revenue from the second quarter, which was fairly significant and dramatic, and I'd like to, basically, walk you through each one of these lines.

Net interest income down $4 million. Clearly, in this quarter compared to last quarter, a function of both a drop in earning assets almost all of which occasioned by the sale of mortgages, but also we had a decline in our net interest margin, as you know, from 338 to 330, down eight basis points. We think that that is a relatively sort of interim, or temporary, phenomena. A couple of things going on it the quarter, first of all, following the sale of mortgages at the end of June we had $400 million of cash to invest and most of that was invested in pretty short-term investments early in the quarter. Obviously, the yield on those investments was significantly below the yield on the mortgages that we sold. As you know, we had a fairly significant increase in short-term rates with Libor leading even the Fed funds rate increases and that had an impact, obviously, on our wholesale borrowed funds position. We're very pleased in the face of that interest rate environment to have been able to actually reduce the effect of cost of our total deposit base by three basis points. The eight basis point decline in the margin was really a function of some pretty short-term investments early in the quarter following the sale of our mortgages and the fact that the pretty rapid increase in short-term rates, primarily Libor, had an impact on our borrowed funds position in terms of the cost of our wholesale borrowed funds.

Not a lot of change in (indiscernible) management or deposit charges during the quarter, fairly stable. Insurance revenue down about $2.8 million, two factors there. One is that contingency income that we receive through our agency operations occurs on an annual basis, primarily in the first and second quarters. We also have some annual fees on certain of our businesses that are received in the second quarter. This is a very typical seasonal shift in our sort of timing of our insurance revenues and in terms of our own internal forecast of third quarter results we're right on top of what we expected them to be before the third quarter. Investment product revenue down. Most of that is a function of trends we're seeing throughout the financial services industry. Clearly, the summer months are always soft months for investment sales. We also had very high levels of annuity sales earlier in the year. This category of revenue, again, reflects both seasonal occurrences and, as we're seeing throughout the industry as well, some softness in investment product sales.

The biggest change from the second quarter was in mortgage. Keep in mind that during the second quarter we had something in the range of $5.5 million of non-recurring revenue. Part of it was from the gain of the mortgages, on the sale of those mortgages, and then we also had $2.5 billion recovery of mortgage servicing right of valuation. The second quarter included $5.5 million of kind of one-time charges. Third quarter, with regard to MSR impairment, we took a $300,000 impairment charge during the quarter, but we also had a slowdown in base originations in our mortgage business. Those are the key factors that impacted our third quarter revenue compared to second quarter. I'm sure you'll have some more detailed questions later, which we'll be happy to try to provide answers for.

Page 22 is just a trend chart. I think the important thing here is just something that everyone has identified as an issue for us and that is the continued decline in net interest income, which does, in fact, represent a very significant portion of our revenue. Our assessment of this is that this decline in net interest income, while the margin has declined slightly compared to where it was in the third quarter of last year, this reduction in net interest income is almost entirely a function of reduced levels of earning assets, some of which has been intentional, some of which has been unintentional. We have intentionally reduced the size of our investment portfolio over this timeframe by about $250 million. Our main rationale for that, the move has been to reduce our mark to market exposure in this period of fairly volatile interest rates and the impact that it has on our capital ratios. Commercial loans is probably the unintentional part in the sense that commercial loans have declined over this time period by about $200 million, a function of fairly soft origination and new business activity combined with our own internal efforts to improve the quality of that portfolio. A $400 million reduction in mortgages, which was clearly intentional, and our consumer loans have actually grown by $100 million, reflecting our continued increased focus on consumer lending.

Page 23, we're just looking at year-to-date Other Income. I would only point out two things here. Number one, of the $13 million increase in insurance agency revenues, about $9 million of that is a result of the acquisition of the IR&M agency in Ft. Wayne in July of last year. We've had very solid growth in our insurance agency revenue, even excluding the fact that we made a significant acquisition mid-way through last year. Clearly, the mortgage banking number is down significantly and I think we've talked enough about those. Mark Faris is here in case there are any more detailed questions in that regard.

Expenses, on page 24, again, the biggest impact on operating expenses this year has been the $25 million special charge for Ascend. I would point out here that of the remaining $9.5 million increase in operating expenses, about $7.5 million of that was related to the acquisition of IR&M. On a base of $250 million of sort of operating expenses, the increase over the first nine months of last year has been, essentially, deminomous (ph), a couple of million dollars reflecting our continued efforts to control operating expenses and, as Mike indicated, an area that we would expect to see continued progress. Those are some of the details of the third quarter and year-to-date results.

Near-term focus on page 25, we've talked about this. Clearly, continued strong efforts to reduce the level of non-performing assets and stabilize credit quality. I think Darrell covered those subjects well. Earning asset growth is, clearly, if you recall that chart that shows what has happened to our net interest income. Earning asset growth of a quality nature is a critical component of our ability to begin to create more stable earnings base as we move forward and, clearly, that will be supplemented with the benefits we expect from Ascend, which addressed by expenses and revenues.

With that, I'll turn it back over to Bob.

Slide 27, I thought I'd end just kind of talking about our commitment as the new management team of Old National. I'm going to speak to two communities here. First, just to the analysts, we commit you to have open and honest communication as well as to give you frank earnings guidance and analysis. It's our job and our commitment to you is to work with you to help you better understand where Old National is headed and the things we're doing. Finally, to our investors, and it's probably just as important to you as the analysts, as I said early on to improve the consistency of our earnings so that there isn't the erratic nature of earnings we've had in the past, strengthen the accountability beginning with myself all the way through all of our associates. We're in the process of implementing a new performance metric system within the Company that will strengthen that accountability and will help to improve the consistency of earnings. Finally, just living up to our obligation to deliver on our commitments.

With that, I'd like to turn to page 28 and we'll be glad to take any questions that you might have.

Thank you, Mr. Jones. Today's question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Scott Siefers, Sandler O'Neill and Partners.

Just a couple of questions regarding the outlook. On the margin, I just want to make sure I'm thinking about it in the right way. Are you indicating that the margin should kind of bounce back to, maybe, 335 or 340 type level or more that we've found the bottom after some of the unusual dynamics between the second and third quarter? Separately, on some of the Fee Income line items, specifically, insurance, should we be thinking about that that it will also bounce back or is this the more normalized level, kind of in the back half of the year and then assume some strength as you look at the first half of next year?

I'll have John Poelker answer the first one relative to margin, followed by Tom Clayton, who is the acting CEO of our insurance group.

With regard to the margin, I would look for sort of no change in the fourth quarter with regard to margin rather than some recovery back to the 335 to 340 kind of range. I think that the key component that could lead to further improvement in the margin in the fourth quarter would be if we begin to see some loan growth. We really believe that, in terms of our balance sheet position right now, that we are pretty well positioned for what we think interest rates will do. Our expectation right now is that margin would remain closer to the third quarter levels with sensitivity suggesting that if we do get some loan growth there's a possibility that it could actually increase a bit, but not much.

In regard to the insurance revenue, the $11.6 million, we do expect that to jump back up to sort of a higher run rate. The $14 million in the second quarter did include some of our contingency income. Our expectations for the fourth quarter would be in the $13 million plus range.

OK. Thank you very much.

Fred Cummings, Key Banc Capital

As a follow-up to Scott's question on the margin, can you talk about the outlook for your earning assets, I guess, excluding the potential sale of non-performing loans?

The key to that equation is really our commercial loan growth. As we mentioned in the press release, there are economic issues that have depressed commercial loan growth, but the reality is we are still building a new system of commercial lending, getting our lenders comfortable with the new credit processes we've put in place to improve the credit quality. We're beginning to see some momentum towards a greater generation of commercial loans, but I don't know that it's going to be enough to see a significant up tick or an up tick in the fourth quarter. The pipelines are about the same as they've been over the last period of time. The intangibles are that we're seeing some attitudinal shift, but I can't tell you that it's going to result in commercial loan growth in the fourth quarter. It would be more realistic to begin to look towards the first and second quarter for some growth.

On the consumer loan side, the fourth quarter will probably be - our pipelines have shrunk a little bit over the third quarter because we've had a number of promotions in the third quarter. I don't know that we'll see a big up tick in the fourth quarter. The mortgage business is, with the lowering of rates, we're starting to see some refinance business come back. We have a decent pipeline, but that is a business that we've got to shift to do more purchase mortgages versus refinances.

Bob, one issue you haven't talked about much is the capital issue in terms of how you'd like to manage capital once credit quality, I guess, the MPA ratios get down to more reasonable levels. What are your thoughts on what type of tangible common equity ratio should this company have and are you more inclined to buy back stock or target a certain dividend payout ratio in terms of capital management in the future?

Fred, I'm going to have John address that. We've just spend an awful lot of time on that and he has the details.

We believe that our tangible equity ratios today are probably lower than we would like them to be over the longer term, particularly in light of the current level of our non-performing assets. We have not established a specific ratio for where we want that number to end up. What we have done is taken a pretty hard look at what the numbers look like over the next 12 to 18 months and with the kind of earnings expectations that we have for next year we feel like we're in a position to move those ratios in the right direction without taking any kind of radical steps. We would expect to continue to have a stock buy back program at levels fairly comparable with where they are today. Clearly, our dividend payout ratio today is higher than we'd like it to be over the long term. We've talked about numbers in the 30 to 40 percent range, historically, and as we look at it today we don't see anything sort of changing that over the near term. It's an area that we are keeping a close eye on. We're comfortable with where we are today, but that comfort level is based on the expectation that we're going to get earnings improvement and reductions in non-performing loans.

I just have one last question for Mr. Clayton. With these contingency insurance commissions, are those at risk of being eliminated industry-wide?

I think that that's the $64,000 question. I think that there are some - some of the contingencies are based on loss ratios. Those are very sound business-based revenue sharing arrangements. Some of the ones at some of the larger brokers and agencies deal with, that we don't participate in, some of the placed service and some of the alleged illegal unethical behavior has, perhaps, has put a lot of this at risk. We'll continue to monitor it very closely. We have done some internal, not a formal investigation as such, but just to make sure that we are very consistent in how we deal with carriers and how we deal with our clients. Our contingency is $2 million to $3 million, typically, can vary from year to year. It's not a huge portion of our revenue at all, but it's certainly something that could, potentially, be at risk. If the market dynamics will, I guess, sort of settle that out over time and all insurance agencies will be on an equal footing on that.

Karen LaMark; Merrill Lynch Investment Management

I wonder if you can talk about the securities portfolio? It's picked up as a percentage of earning assets, obviously, because the loans dropped. Are you comfortable with the levels where you are and, maybe, talk a little bit about your plans going forward on that?

We're very comfortable with the level of our investment portfolio right now. As you know, the total portfolio has come down over the last year or so by $300 or $400 million from its peak. Your observation is astute in the sense, as we sold off mortgages and as our commercial loan portfolio has declined, that investment portfolios, as a percentage of assets, have sort of crept back up. We are comfortable where that portfolio is today, at $3 billion, even though it does now represent a little higher percentage of earning assets. At this point in time, have no plans to sort of significantly change the level of that portfolio.

OK. Then, a separate question, can you give us any kind of color and status on the three positions that you are looking to fill? Is this search actively underway and, maybe, some parameters or thoughts about the qualifications of the people that you're looking for?

The search is actively underway for the first two positions I referenced, the CFO and the Chief Risk Officer. We're actually using the same recruiting firm that recruited me to Old National. The thought was that they understood me and they understood the culture of Old National. We are looking for a seasoned CFO that has both expertise in the accounting controller side as well as expertise in dealing with the investment community and the balance sheet. We have got a number of candidates who are beginning the go through the process of interviewing. As I said, we expect to have that position, or we hope to have that position, filled by the end of the fourth quarter. For the Chief Risk Officer, again, we're using the same firm. It's a little slower process because it is just really a new position, particularly in banks of our size. We have outlined the position description and we're working with the firm to identify potential candidates. At this stage, we're very early in that process. Again, it'll probably be the end of the first quarter or sometime in the first quarter when we get that position filled. We're using a firm for the CEO search. We've got a number of candidates identified. We're looking for someone that has expertise at bringing together the agencies, as well as having expertise in dealing with bank insurance and that position will also be filled by the end of the fourth quarter.

Thank you.

Robert Hyduke (ph), American Express

I understand that S&P, in particular amongst the rating agencies, had some concerns about asset quality trends and wanted to see some improvement off the base from last year. Have you had conversations with them and, in the wake of the earnings release, what are they thinking in terms of the current ratings and the outlook and all that?

We have had conversations with both S&P and Moody's following the release of earnings yesterday. They're, at this stage of the game, OK. Obviously, until they were to do a formal ratings review, we can't suggest what their ultimate opinion was going to be. Based on our conversations with them yesterday, there's no suggestion that they're leaning toward changing the outlook. The most important factor, I think, to them is to continue reduction in our total portfolio of problem assets. This has been an area where we've worked closely with the rating agencies on over the last couple of years. That is the component of what's happening to our portfolio more than a quarter to quarter variation in the amount of non-accruals. Our sense of it right now is that we're obviously communicating with them very regularly. I guess that's about as much as I can say as to our rating agency issues. I talked to them yesterday and no indication of any significant concerns.

Do you have a timeframe for when you'd like to see your loss reserve coverage on your non-performing assets get back above one times?

Yes, we do. We think that if we're successful in the loan sale that you will see significant improvements in those coverage ratios of the underperforming loans. We think the strategy of ongoing loan sales is pretty critical in that regard and you'll see some real turnarounds if we're successful in doing that.

Are you talking like within a quarter, two quarters?

Yes. The sale, we hope, should happen in the fourth quarter which would lead to that improvement that Darrell referenced.

Great. Thanks a lot.

Don Jones; Credit Suisse First Boston

It seems like when we were listening to earnings a year ago on second, third, fourth quarter a lot of the outlook for, in regards to non-accrual loans, had been kind of similar to what it is now, possibly minus the potential sale of bad loans. With that in mind and as well as the up tick in non-accrual loans in the most recent quarter, what's the prognosis for it in the long run, kind of dovetailing what Robert was just talking about? What kind of concrete - I guess I'm just trying to figure out why there's been a fluctuation in the non-accruals as well as kind of a shortfall in terms of the expected improvement of the asset quality?

A good question. I think a couple of dynamics are in play here. One is, again, if you look at our absolute level of problem loans in the Company, you will see that the risk profile has come down significantly. What we're dealing with here is kind of the tail end of the sins of our underwriting where we've got certain loans in our portfolio that are not participating in whatever recovery we're seeing here in the Midwest. Most of the loans that went on in the third quarter into non-accrual, were not necessarily loans that stopped performing, but they were loans that were in industries that some of our other customers had participated in some recovery. These customers had not and so we were a little reluctant to keep them on in an accrual basis. We have not seen significant deterioration in the performance of our customers, but they just haven't come along as we had anticipated or hoped. I think what you'll see, if we are successful in loan sale, is kind of a step down again. If you look at that chart from the third quarter of last year, the real step down came from the sale of non-accruals and then we've been kind of constant going forward. I think, if we're successful, you will see a significant step down in non-accruals again and, then, we will not see an up tick in the non-accruals, but we'll see kind of a level or slowly decreasing level of non-accruals going forward. Again, this is non-accrual issue is not because we're finding additional problems in our portfolio, its just that some of these customers are not participating as we had hopefully expected they would in either increasing top line revenues or cash flow.

I think, to answer the first part of your question relative to prior year's statements and, obviously, I wasn't here, but I will tell you what you should get comfort out of is the maturation of the process. I think we're much better dealing with loan grades. We're much better at identifying problem credits. We've got an organization in place that we didn't have a year ago. We've hired some seasoned credit veterans. I know that we're much better at identifying the issues and dealing with them in a quicker manner than we probably were in the past. I think that maturity is a process. The understanding of the process by both the credit and commercial lending side gives us comfort that we're making progress on that.

OK. Was there a primary sector in which the most recent up tick came from?

No. There was not one single sector that contributed to that increase.

Last question, if I may, in regards to the mortgage business, there's been a little fluctuation in the recent year and a half or so in terms of revenues, what might be a possibility or what solutions are in place to potentially stabilize that line item?

I'll give a high-level view and then Mark Faris is here. The real opportunity for us is to switch from an industry or mortgage business that is focused on refinances and really move to a purchased mortgage business working with the realtors and other third parties, leveraging our community bank status throughout the franchise, as well as bringing servicing in-house, which we've already committed to do. That will get us to a little more consistency as well as be able to leverage our relationships out in the communities.

I would just add to that that we've got a significant number of initiatives in place now, from the training of our loan officers to the addition of new loan officers. As you all know, in the mortgage business the relationship is really directed from the loan officer to the realtor and that is where we have to focus. I think that it's going to be a fundamental change, which we may not see a lot of rapid improvement in but, over time, we believe that we're going to be in a position to stabilize the fluctuations in our earnings quite a bit.

OK. Great. Thanks so much for your time.

Fred Cummings, Key Banc Capital

Just two quick questions, one, Darrell, we did see a slight up tick in 90 days past due. Can you comment? Was that in the commercial or the consumer area?

I'm really glad you asked that question. The up tick in the 90 days related to two commercial credits in our company. What's interesting is we're seeing some customers understand the dynamics of pressing banks to move loans off delinquency lists by the end of calendar quarters for reporting purposes. We had two of those totaling about $4.5 million that we refused to succumb to our net pressure. I will tell you that since that time, we have those agreements with those customers worked out. You will see, I believe, I feel very confident that those numbers will fall back to the three, four, five basis point range that they've been over the last several quarters prior to the third quarter.

I think it's an indication of the maturity of the process that I spoke to. I think we were able to identify the credits. We were working with them and I think we held to our standards and we didn't blink and the client ended up blinking after the end of the quarter.

Two quick questions, Bob, are you standing by that guidance you gave, 58 to 65 cents for the second half of the year?

Yes.

Lastly, Bob, how was the incentive comp structure going to work for 2005? Is it a function of you guys hitting an absolute level of earnings per share with this project Ascend or is the Board evaluating management more on the basis of qualitative changes in what's going on at the Company? Can you give us some sense for how that might have changed?

For the Chairman's Committee, which is really the management group of the corporation, our incentive targets will be based on two major factors. One is risk adjusted revenue growth and the second one will be earnings per share growth. That will then be measured against how we perform against our peer group and that there'll be a multiplier based on peer performance comparison. What the Board has said to us is we need to grow risk adjusted revenue at a reasonable pace. We also need to grow our earnings per share in line with what our targets are, but, more importantly, we need to prove that we're growing at a rate at or above the meaning of our peer group. So we're going to be measured both in terms of performance against our plan as well as performance against our peers.

That plan will include the Ascend.

Right, and that plan does include the Ascend projections as well, Fred.

I'm assuming the Board, as you guys sell some non-performers here, I'm wondering how the Board looks at normalizing earnings when you look at growth rates year-over-year, if what a quarter number with 2004 would be what the Board considered to be a quarter number for 2004 or are they just looking at absolute numbers?

What they would look at is operating earnings, which is when you take the actual earnings of 2004, add back the Ascend charges. I don't know that we're going to get into trying to normalize the portfolio because it is what it is and, again, I think the key to that answer is the multiplier by the peer group. We need to perform better against our peers as well.

OK. Thanks, Bob.

Scott Siefers, Sandler O'Neill & Partners

Just a follow-up question on the earnings as we look into 2005, I believe earlier in the month when you had provided the update you had indicated a comfort level with the range of 171 to 185 for next year. If you look at this quarter's numbers and then sort of normalize things, it kind of feels like you might be at sort of 30 cent run rate or so. If you annualize that and then give full credit to the 47 cents for Ascend for next year, you still come up just a bit short of sort of the low range. I guess I'm curious as to how you're thinking about the dynamics for 2005? Bob, a related question, you've been through a restructuring program like this before, how do you think about the difficulty in getting revenues versus getting the cost cuts out of program like this?

We're still comfortable with the range for 2005. I think there is both the Ascend benefits we're going to get as well as some of the business changes that we are going to be seeing. Scott, the answer to your question, we're still comfortable with that range.

The second part of the question is really the more important one and, as you know, I went through this process at Key and it was very successful there. The small key to this process is to begin focusing on the client and the revenue as quickly as possible. Where I've spent a majority of my time since I've gotten here is working with the business lines as well as the geographic heads, is really getting focused on revenue growth as well as client acquisition and client retention. That's why our incentives, that Fred alluded to, are structured to focus on that risk-adjusted revenue growth as well as the metric systems that we're putting in for all of our line of business owners, are focused on how we can focus on the clients and revenue on a long-term basis. You need to be able to change the mentality from an inward focus to an external focus. When I talk about those intangibles, I'm beginning to see that happen gradually but it's very important to us that we get back to focusing on the client and focusing on driving consistent quality earnings through risk-adjusted revenue growth. Part of it is, and this is what you were hearing on the 18th, I think that we need to be realistic in our revenue aspirations as well because I think that will help us an awful lot with how we attract customers.

OK. Thank you very much.

Karen LaMark, Merrill Lynch Investment Management

Just to follow-up on the incentive question, can you tell us a little bit more about the peer group? I'm assuming you're talking about companies that are similar to yourselves in terms of mix and, maybe, more importantly, the geographic footprint, but if you could clarify that, it would be great?

We're actually using an outside party to develop a list of 30 peers that are like-size institutions that are geographically comparable in similar markets. It doesn't mean they're all in the Midwest, they are from points beyond as well. We're using that third party to both validate and to finalize that peer group and then they will actually be doing the analysis on how we perform against that peer group.

Thank you.

That's all the time we have for questions today. I'll turn the conference over to Mr. Jones for any additional or closing remarks.

I would just, again, thank you for your participation, your questions, and then just refer back to the commitments that we made to you and that is that we will give you open and honest communications. We look forward to seeing as many of you on the 18th that can make it. We're looking forward to telling you our story. Thank you very much.

This concludes Old National's call. Once again, the replay along with the presentation slides 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 1-888-203-1112, confirmation code 971727. This replay will be available until 12:00 midnight on November 12th. If anyone has additional questions, please contact Lynell Walton in Investor Relations at 812-464-1366. Thank you for your participation in today's conference call.