Old National Bancorp (ONB) 2006 Q2 法說會逐字稿

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  • Operator

  • Welcome to the Old National Bancorp Second Quarter 2006 earnings conference call. This call is being recorded and has been made accessible to the public in accordance with the SEC's regulation FD. The call along with corresponding presentation slides 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 5:30 p.m. central daylight time today through August 10th. To access the replay, dial 1-800-642-1687 conference ID code 2142198.

  • [OPERATOR INSTRUCTIONS]

  • At this time, the call will be turned over to Lynell Walton, Vice-President of Investor Relations for opening remarks. Ms. Walton?

  • - VP of Investor Relations

  • Thank you and again welcome to Old National Bancorp's second quarter earnings conference call.

  • With me today are Old National Bancorp's President and Chief Executive officer, Bob Jones, our Chief Financial Officer, Chris Wolking, Chief Credit Officer, Daryl Moore, and our Treasurer, Jim Ryan.

  • Before we begin, I would like to refer you to slide 3 and point out that the presentation today does contain forward-looking statements that are subject to certain risks and uncertainties that could cause the Company's actual future results to materially differ from those discussed. These results--these risks and uncertainties include but are not limited to those which are contained in this slide and in the Company's filings with the SEC.

  • Slide 4 contains our non-GAAP financial measures slide. Various numbers in this presentation have been adjusted for certain items to provide more comparable data between periods and as an aid to you in establishing more realistic trends going forward.

  • Included in the appendix to this presentation are the reconciliations for such non-GAAP data. We feel that these adjusted numbers provide for more meaningful comparisons and a better picture of financial trends as most of these are adjusted--are calculated as if hedge accounting had been allowed in 2005 and as consistent with 2006 presentation. We will be using these adjusted numbers throughout your discussion today.

  • Slide 5 is our agenda for the call. First Chris Wolking will provide a high level summary of the quarter, providing financial detail of our quarterly results including commercial loan and DDA growth within our various banking regions, and the deposit generating performance of our newer financial centers within our higher growth markets.

  • Next Jim Ryan will be discussing components of our net interest margins and provide detail as to the various drivers affecting our ability to maintain a stable margin for the quarter. Daryl Moore will then lead the analysis of our continued improvement in credit quality and will provide details regarding those statistics. Finally, Bob Jones will provide a progress update on our three strategic imperatives.

  • With that, I'll turn the call over to our CFO, Chris Wolking.

  • - CFO

  • Thanks, Lynell, and good afternoon to all of you on the phone. Thank you for being with us today.

  • I want to begin today's call by giving some color to what we believe to be a solid quarter for Old National, particularly in light of the operating environment that exists today for all banks.

  • The second quarter highlights for Old National are as follows. A number of positive trends developed in the quarter. A consistent stable margin, which we were very happy to see considering the rate environment of the quarter, positive growth in DDA both in terms of balances and accounts which begins to validate the work and the effort we've placed in cash management and retail account growth, and loan growth.

  • More importantly, loan growth in our target areas of commercial and small business and across our footprint, not just in the Indianapolis and Louisville markets, which we've designated as our high growth markets. Now, these were offset somewhat by a slow down in commercial real estate by design.

  • Certainly good expense management and finally and not to be minimized the continued positive trends in our credit quality. Clearly we're still in the midst of our turnaround, and Bob will update you further on our progress at the end of the call, but we've made good progress and remain committed to a turnaround strategy that is clearly showing results.

  • Let's begin on slide 8 with highlights from the quarter. Earnings for the quarter were $20.2 million or $0.30 per share. This is $0.01 than our second Quarter 2005 earnings of $0.31 when 2005 income is adjusted for the impact of the accounting for derivatives.

  • Year-to-date, Old National is 3.4% of year-to-date 2005 earnings per share when 2005 earnings of course are adjusted for the impact of derivatives accounting. Total loans increased $44.5 million at June 30, 2006 when compared to end of period balances at March 31, 2006.

  • CNI loans and leases were up 84.5 million for the period, but commercial and AG real estate loans were down 31.6 million. Commercial real estate loans alone were down 30.7 compared to March 31, 2006 as we continued to de-emphasize the production of certain classes of commercial real estate loans.

  • Our net interest margin was unchanged from the first quarter 2006 at 3.18% due largely to our ability to effectively manage interest-bearing transaction in savings accounts. Jim Ryan will provide more detail in the drivers of our second quarter margin during his presentation, particularly the positive impact from strong management of our core deposits.

  • Total criticized and classified loans continued the positive trend we've seen over the last several quarters. Criticized and classified loans declined from 221.4 million at March 31, 2006 to 202.7 million at June 30, 2006 or a decline of 8.4%. We obviously are quite pleased with the continued improvement in the quality of our loan portfolio. Net charge-offs were $4 million for the quarter, the lowest quarterly net charge-off since the first quarter of 2004.

  • Daryl Moore, of course will provide more detail on our credit quality in his presentation. Continuing on slide 9, you will see that fees, service charges, and other revenue declined 5.1 million from the first quarter, but you'll recall that first quarter included the $3 million pre-tax gain on the sale of our O'Fallon, Illinois retail banking center.

  • Additionally, first quarter is always a strong quarter for Old National insurance group because it includes our contingent revenue that normally comes annually in the first quarter. Old National insurance generated 2.4 million in contingent revenue during the first quarter of 2006. That of course wasn't repeated in the second quarter.

  • Service charges on deposits--deposit accounts were up $800,000 from the first quarter due primarily to reduced waivers of overdraft fees. Charging and collecting fees on transaction accounts continues to be a major focus of our regional banking associates.

  • Mortgage revenue was down $600,000 during the second quarter compared to first quarter, however we expect that our new partnership with SunTrust mortgage will lift revenue due to an expanded ray of mortgage products. We also expect improved productivity in mortgage from improved training and underwriting and processing support directly from SunTrust.

  • Non-interest expenses declined $4.8 million in the second quarter compared to the first quarter of 2006. Salary and benefit expenses declined $3.6 million during the quarter, of which $3.1 million was associated with various benefit expenses that were included, some first quarter reversals.

  • We accelerated our stock buyback during the second quarter by repurchasing approximately 900,000 shares during the quarter compared to 400,000 shares during the first quarter. We've repurchased about 1.9% of our outstanding shares through June 30, 2006. Certainly at this time we expect our stock repurchase to slow to the rate at which we repurchased stock in the first quarter.

  • On slide 10, you'll note that our investment portfolio declined modestly during the quarter, to 31.2% of total assets. The portfolio declined 13.9 million at June 30, 2006 compared to March 31, 2006. We are committed to continuing to shrink the size of the portfolio during the remainder of 2006.

  • You'll note that borrowed funding increased to 24% of total assets, an increase that has been inconsistent with our previous reductions quarter by quarter, but we certainly expect to use cash flows from the investment portfolio to reduce borrowed funding. We expect borrowed funding really to decrease for the remainder of the year and lock step with the decline in the investment portfolio.

  • Shareholders equity declined during the quarter due largely to our continued stock repurchase activity. Our total equity to assets ratio of 7.59% and our tangible common equity ratio of 6.42 at quarter end are consistent with the ranges we've established in previous calls. We expect to continue to actively manage our shareholders' equity to reflect both our risk profile and our opportunities for growth.

  • Total core deposits declined 8.5 million at June 30 compared to period end balances at March 31. We continued to reprice public sector customer and other hot money transaction savings accounts, so we really weren't surprised by the decline in these core deposit categories.

  • This strategy, which we began in the first quarter of 2006, is a component of our overall strategy to improve our net interest margin. Non-interest bearing demand deposit account balances increased 13.1 million compared to end of period balances at March 31.

  • Increased focus on increasing commercial and retail checking and retaining existing relationships plus the resources we've devoted to cash management retail marketing, as I mentioned earlier, are beginning to show the results we expected.

  • On the next slides, I've provided some detail on the growth in non-interest bearing checking deposits and commercial loans in our operating regions. On slide 12, I've listed the change in total commercial and commercial real estate loans by region from period end March 31 to June 30, 2006.

  • The Indianapolis region increased loans 17.4 million compared to March 31, 2006. This is a marked improvement over first quarter performance, and we expect Randy Richmond, the new regional president of Indianapolis and his new management team to continue to perform well.

  • Notably we saw strong loan growth in two of our slower growth markets, the northwest and western Kentucky regions. The northwest region, which includes Terre Haute, Indiana increased loans $15.7 million quarter-over-quarter and western Kentucky increased loans $5.6 million quarter-over-quarter.

  • Louisville experienced a pay down of two large loans totaling $9 million at the end of the second quarter which accounted for their $0.9 million reduction in commercial and commercial real estate loans for the quarter.

  • Continuing to slide 13, you'll see the change in non-interest bearing deposits for March 31. Louisville and Indianapolis both showed strong growth in demand deposits.

  • Louisville increased demand deposits 7.3% and Indianapolis increased deposits 5.4% during the quarter. Our slower growing regions, where we have high market share compared to Louisville and Indianapolis, also had nice increases in demand deposits during the quarter.

  • Now, my last slide, I've listed--for slide 14, I've listed the total core deposit growth of the branches we've opened in Indianapolis and Louisville since 2003. These are June 30, 2005 end of period balances compared to June 30, 2006. Really, with the exception of our Fishers Branch, we've experienced strong double digit percentage growth year-over-year in all of our Indianapolis branches.

  • Clay Terrace and Broad Ripple accelerated their deposit growth in 2006 after opening in late 2005. They're really back on track with the growth that we expected to see from those branches. We plan to open two additional branches in the Indianapolis market in 2006.

  • We're particularly pleased with the growth in core deposits at our Preston point branch in downtown Louisville, Kentucky. Core deposits at this branch grew 131% from June 30, 2005. Dennis Heitschman, the regional executive in Louisville, and his team generated these deposits largely through their commercial relationships.

  • We've opened the first retail branch in Louisville on Shelbyville Road in the second quarter and expect this branch to compliment our existing commercial deposit with a strong retail location. And our third Louisville branch, another retail branch, will open in the first quarter of 2007.

  • I think, in summary, as I mentioned at the beginning of my presentation, our deposit and loan growth has perhaps lagged the expectations we had at the beginning of the year, but the current trends are very, very positive. Loans and deposits have accelerated in our high growth regions, Louisville and Indianapolis, and we've also performed well in our lower growth regions, and we certainly expect these trends to be sustained for the remainder of 2006.

  • With that, I'll turn it over to Jim Ryan, our Treasurer, who will discuss second quarter margin and give you primarily the drivers of our second quarter margin and the outlook for the remainder of the year.

  • - Treasurer

  • Thank you, Chris. On slide 16 shows that net interest income was 59.6 million and the margin was 3.18% for the quarter, as Chris told you earlier, which was both consistent with the first quarter.

  • We were able to maintain our net interest income and our margins even though our interest rate risk model suggests that we are liability sensitive. Management actions were enough to offset the 50 basis point plus increase in short-term interest rates during the quarter.

  • On the next slide, I will explain how we're able to accomplish this primarily through deposit cost management as Chris mentioned earlier. Slide 17 shows that asset yields increased 18 basis points, which more than offset the increase in interest rate changes on liabilities of 13 basis points.

  • For example, during the quarter, now accounts rose only 7 basis points, while savings accounts actually decreased 17 basis points and money market accounts decreased four basis points. Mix changes, primarily increases in short-term wholesale funding, part the margin by 6 basis points.

  • Towards the end of the second quarter, we started seeing the initial benefits from the previously discussed deposit growth initiatives such as unbeatable checking, direct marketing campaigns, and investments in our small business and corporate cash management sales efforts.

  • To that end, DDA balances ended the quarter up $13 million and net new checking accounts grew by 1,017 during the quarter. While I do not have comparable net new checking account data from the previous quarters, we plan to report this number each quarter going forward to give you a sense of how successful our initiatives have been.

  • Also we continue to look for opportunities to reduce lower yielding assets, and we expect to move the investment portfolio into our long-term target of 25% to 30% of total assets to reduce the drag on the margin by the end of the year. And lastly while short-term interest rates rose faster and more than we anticipated when we started the year, we expect that our ongoing actions will allow us to at least maintain our margin at these levels.

  • Next Daryl will update you on the credit quality of the organization.

  • - EVP & Chief Credit Officer

  • Thank you, Jim. On slide 19, you can see that the delinquencies have shown a nice decline in 2006. In fact, at 49 basis points, delinquencies at quarter end were the lowest posted in the last 5.5 years in the Company.

  • When you look at total delinquencies as well as the trends in our criticized loans, and those I would refer to as the early credit metrics in our portfolio, you can clearly see that quality as measured by these benchmarks, has improved significantly. This is important from our perspective in that we can see that the trend of better quality is making its way through the portfolio and that we ultimately anticipate that we'll begin to move non-accruals down to lower levels.

  • As slide 20 shows, in the quarter we resumed our trend of declining classified and criticized loans, with loans in this category declining 18.6 million or 8.4%. This quarter now represents the 13th time in the last 14 quarters that we've shown decreased classified and criticized loan on a quarter to quarter basis.

  • Classified and criticized loans now stand at roughly $203 million, which reflects a $550 million decrease in the size of classified and criticized loans and the highest levels posted at the peak of our credit problems. As you can see on slide 21, non-accrual loans at quarter's end were 51.7 million, virtually the same as at the end of the first quarter.

  • Non-accruals have hovered in the $50 to $60 million range for the last seven quarters which is roughly 1/3 of the size of non-accrual loans at our credit problems. I want to give you some color on our commercial non-accruals. At the end of the quarter, we had only three non-accrual accounts in the portfolio that had exposure in excess of $5 million and only an additional seven loans with exposure in excess of $1 million.

  • Our top 20 non-accrual relationships now total roughly $32 million down roughly $4.6 million over the last three quarters. The largest non-accrual exposure currently in the portfolio is slightly less than $7 million. I think it's important to note that while our non-accrual totals have remained relatively flat over the intermediate term, as I pointed out earlier, the trend in our early credit metrics would certainly indicate that at some point in time we should begin to see further reductions in the non-accrual category.

  • Turning to slide 22, net charge-offs for the quarter were $4 million, a decrease of $1.5 million from the prior quarter. Annualized loss rate for the quarter stood at 33 basis points, about 13 basis points lower than the run rate in the first quarter and 60 basis points lower than the same quarter in 2005. We are pleased to be able to tell you that the lower loss rates in the second quarter are attributed to lower losses in both the commercial as well as the retail areas.

  • In summary, as you've heard every quarter for some time now, we are very focused in our efforts to improve credit in our institution. In this regard, we do manage to a model portfolio as it relates to asset quality ratings for our commercial outstandings. Monthly each of the regions is provided a summary of where their portfolios stand in relation to our model portfolio.

  • Any negative variances to the model draws management attention and requires action. I will continue to work hard at identifying loans that are showing deterioration early on in the cycle so they can be either rehabilitated in the short-term or moved out of the bank.

  • With that update, I will turn it over to Chris for some closing comments.

  • - CFO

  • Thank you, Daryl, and I'll apologize on Bob's behalf. He had to step away for a moment, so I'll address his closing comments. I'm certain I won't give them the same service as Bob would, but we're certainly available to answer questions as soon as I'm finished.

  • As we promised at the beginning of the call, I think we wanted to take a few minutes at the conclusion of the call to update you on where we feel we are in terms of our turnaround. I think this is relevant because we're at the mid-point of 2006 and approximately 18 months into our turnaround.

  • Two points I would make. Certainly the first is consistency. We are absolutely committed to the strategic imperatives we laid out and will stick with them.

  • The tactics within will change as we continue to evolve, but the mission remains the same. To build a high performance community bank.

  • Secondly, this is a long-term strategy, and we're 18 months into it, and I think it would be very easy to take shortcuts or to take actions that show immediate benefit to sustain of a long-term impact than not create the long-term shareholder value that we're after.

  • When we began our turnaround, we laid out three strategic imperatives, which while we clearly were executing against them in a parallel fashion, we also viewed the importance of these imperatives in a sequential manner. In other words, they built upon each other in our drive for quality earnings.

  • In that regard, the lynch pin for our success is to continue to improve our risk profile. We would estimate that we're approximately 70% of where we need to be. Clearly, as Daryl's update showed, we've made significant progress to improving the quality of our credit profile.

  • More importantly, we built a system that won't allow us to return to the credit environment that created our challenges. This is a very important element of our long-term strategy. We won't sacrifice credit quality for the sake of growth.

  • Therefore, in slow economic times, our loan growth may be less than more aggressive bank institutions. The second strategic imperative is improving our management discipline, and I would estimate that we're about 40 to 50% of where we need to be.

  • The majority of the systems are in place, and the level of accountability has increased significantly. In addition, we're much more disciplined in the allocation of our resources. The opportunity to improve is really one of culture. It's getting our employees to own the accountability and to take more responsibility in the performance and their markets.

  • Finally, the third strategic imperative is that of achieving consistent quality earnings. Clearly this is our ultimate goal, and I would estimate that we're about 30% to 40% of where we need to be.

  • Previously we laid out the key initiatives and tactics that we are working on to achieve this imperative. First, obviously is to improve our margin, and Jim Ryan gave you an update on that, and we feel we're executing on that promise.

  • Second is to improve our non-interest income and fee collection, and we began to see the benefits of these efforts with approximately $800,000 in additional service charge revenue in the second quarter.

  • Third is operating efficiency. Clearly the quarter showed a solid management of expense, but we also know that we've got room to go here and it certainly continues to be an area of focus and importance for us.

  • Fourth is sales management and product development. This is an area that presents the greatest opportunity for us in the area where we have the least amount of traction. It's also the most difficult.

  • Fifth is a move towards a stronger emphasis on small business. It's a game changer for us, but it is who we are and who our markets are as we put significant resources and emphasis in this important segment. Better credit quality, better margins will lead to improved and more consistent earnings.

  • Given all the above, we remain comfortable with the estimates as they stand today, the earnings estimates. Thanks for your participation, and we're glad to take your questions.

  • Operator

  • [OPERATOR INSTRUCTIONS]

  • Your first question comes from Scott Siefers with Sandler O'Neill.

  • - CFO

  • How are you, Scott?

  • - Analyst

  • Good, thanks, how are you guys doing?

  • - CFO

  • Good.

  • - Analyst

  • Just have a few questions. First I was hoping for a little more color on your deposit pricing strategy. Perhaps if you could sort of break down things as you see them both on the commercial and on the consumer side just to give us a better sense of where things might be trending.

  • - CFO

  • Great question, and I'll ask Jim Ryan to comment on those, Scott.

  • - Analyst

  • Okay.

  • - Treasurer

  • Really the big benefit that you saw in our retail deposit pricing strategy came as a result of our, I think, previously announced de-indexing of our market monitor account which traditionally had been the highest rate account we had in our franchise. It was previously indexed to 31 day treasury bills.

  • As a result of de-indexing which occurred early in the first quarter, we were able to manage that rate more effectively than having it free-floating against the index, and so that's why you saw us able to maintain balances in those accounts at nice levels and then actually decrease the rate by four basis points quarter-over-quarter.

  • Since then, we have--with the last fed bond rate increase, we have to pass some of that along, but for the most part, we think we can hold back a bear. On the commercial/public funds side, we worked a lot with our regional banking centers who had a lot of indexed accounts out there, and so we were able to successfully de-index some of those accounts which floated mostly against fed funds.

  • We were able to successfully de-index some of those accounts and get some relief there. That's where you saw some of the savings account decreases come out of.

  • - Analyst

  • Okay, and how--do you think that's kind of fully baked into the aggregate number as it stands now? In other words, any attrition there might have been due to that? Is that fully baked into the run rate?

  • - Treasurer

  • It's hard to say. Clearly these actions were taken. They started in the first quarter and continued onto the second quarter. We haven't taken a lot of action since then, but it's hard to say.

  • But I would say that generally speaking towards the end of the second quarter we would have seen a full rate impact, but obviously that didn't affect--not effective or a full effect for the full quarter.

  • - Analyst

  • Okay, and separately, I was just looking for a little more color on the expense side. Looks like you guys did a nice job particularly quarter to quarter on keeping costs down, so I was just looking for a little more color on that.

  • And then, Chris, I just wanted to make sure that I heard correctly. Were there some--did you say some benefit reversals in the second quarter or did I misunderstand you there?

  • - CFO

  • No. You did hear that correctly, Scott.

  • I unfortunately don't have all of the detail in front of me, but roughly $3.1 million of the expenses that we saw in the second quarter were first and second quarter reductions in those certain expenses, so it would have included a certain element of the first quarter expense also.

  • I don't believe that the entire run rate would be impacted by that number. We'll certainly try to provide additional color on that to you.

  • - Analyst

  • Okay.

  • - CFO

  • Sorry, I just don't have all that in front of me right now.

  • - Analyst

  • No problem, maybe I guess another way to think about things on a reported basis, just under $64 million quarterly run rate, and expenses just for our own modeling purposes, should we be looking a little higher, a little lower as we look out over the remainder of the year?

  • - CFO

  • I would expect that number to be a little bit lower, but again, without all the detail in front of me, I just can't say that for certain.

  • - Analyst

  • Fair enough. Thank you very much.

  • Operator

  • Your next question comes from Kenneth James with FTN Midwest Securities.

  • - CFO

  • Hi, Kenneth.

  • - Analyst

  • Hi, good afternoon. I just had a question on some of your commentary on commercial real estate and the kind of decline you saw there this quarter in referencing that it was targeted.

  • There's other banks in your marketplace that are going after that pretty aggressively and seeing some nice growth in the category of loans, and I'm just kind of wondering what you see differently, what concerns you there.

  • - EVP & Chief Credit Officer

  • Kenneth, this is Daryl, I wouldn't say that we have an absolute aversion to credit grow or commercial real estate, but it's our opinion that the markets in which we operate are slowing just a bit. We're taking a look at appraisals very closely.

  • We're buttoning up a little bit on pre-leasing requirements. We're looking toward stronger cash flows. I would say to you that we're still in that market but we're finding fewer and fewer deals that really qualify for our, maybe somewhat tighter requirements than the peers against which we operate.

  • - Analyst

  • Okay, fair enough. Thank you.

  • Operator

  • Your next question comes from David Konrad with KBW.

  • - Analyst

  • Good afternoon.

  • - CFO

  • Hi, David.

  • - Analyst

  • Scott actually asked my question, but just kind of a follow-up to his on the deposit side. I might be missing some cause and effect here, but kind of walk me through the logic. It looks like you scaled back rates a little bit on some of the core deposits, and we had around 94 million run off in those categories, but then it looks like then we had a supplement funding with about 100 million growth in borrowed funds at a much higher cost.

  • - CFO

  • Right.

  • - Analyst

  • How should we think about that? It doesn't quite make sense on the surface.

  • - CFO

  • Well, I think there's a couple of things that we saw going on in the balance sheet. Number 1, the deposits that Jim mentioned, the public sector and the hot money deposits, were extremely expensive to us, in many cases were at rates in excess of the fed funds rate.

  • And so we felt it was very important to manage those a little bit better and manage the expectations frankly of the customers involved. And that was a process we began in first quarter and continued through second quarter.

  • Certainly I think going forward, given that most of those balances -- a large portion of those balances that we would have expected to move probably have moved, and we have to be sensitive to perhaps our inability to make those numbers happen going forward.

  • In other words, that same kind of reduction in deposit expenses given the outlook for increasing rates. Secondly, I commented on the investment portfolio, and we are absolutely committed to continuing to reduce the investment portfolio.

  • So a lot of that borrowed funding is very short-term. Cash flows from the portfolio we expect to continue to be strong, so you'd expect to see--we'd expect to see those borrowed funding balances come down during the quarter.

  • So it was--there was two strategies at work there, but we felt it was very important to reestablish those core deposits at proper rates.

  • - Analyst

  • Thank you.

  • Operator

  • Your next question comes from Fred Cummings with Key Bank Capital.

  • - Analyst

  • Good afternoon. Couple questions. First, Daryl, were there any cells of non-performing loans this quarter?

  • - EVP & Chief Credit Officer

  • No, there were not, Fred.

  • - Analyst

  • Okay, and then secondly, Chris, I thought last quarter you guys talked about rolling out some marketing initiatives on the home equity side, and I notice that balances are down. What strategies do you have in place to grow that portfolio?

  • - CFO

  • That's a good question, Fred. I don't recall any specific strategies from last quarter, because at this point we're not involved in any specific strategies.

  • Our focus--and we continue especially on the retail side--has been checking accounts. So we've really got our branch people focused on calling efforts associated with checking and both interest-bearing and non-interest-bearing checking on the retail side. So that's where most of our marketing dollars have been placed.

  • Certainly we expect that home equity lending is obviously a corner stone of a community bank. And we have established a relationship now with SunTrust on the residential mortgage side. So perhaps that was what you were referring to.

  • - Analyst

  • And then as it relates to the outlook for commercial real estate loans in the back half of the year, would you expect those balances to continue to decline?

  • - EVP & Chief Credit Officer

  • Fred, this is Daryl. That's a difficult question to answer, because those loans are of fairly large size. We have a couple that either get refinanced or projects get sold.

  • I would say there's a possibility of a decline in those over the quarter, but I don't think we're managing to a decline, and we do continue to put on some commercial real estate.

  • - Analyst

  • One last question surrounding the margin. Jim, last quarter, you guys were a little more upbeat and optimistic about where the margin might be towards the end of the year.

  • Clearly you're thinking now flattish versus being up in the 330ish range by year end. Fundamentally what has been--what has caused that change in outlook? What's the most important variable impact in your change in view towards the margin?

  • - CFO

  • Fred, this is Chris, I may answer that question initially and let Jim provide some color. Clearly it's--I think that the current DDA in our DDA outlook--I think, if we would have looked at the initial expectations we had for core deposit growth, DDA growth in particular, we haven't yet seen those, and that clearly is exacerbated by the rate environment we find ourselves in.

  • I think we told you all at the beginning of the year that our expectations were built around a 4.5% to 4.75% fed funds rate. Certainly higher there today than what we expected. So both of those items certainly from my perspective have had a significant impact.

  • Jim?

  • - Treasurer

  • Yeah. The fact that we had long-term borrowings floating into our fed funds position obviously was anticipated, but the fact that we had some reductions in some of our now accounts, some of that stuff it is customers' preferences to take it out of their checking account, put it into the money market account and eventually buy the CD trying to ultimately seek the higher yield.

  • We didn't anticipate as much as we probably saw during the quarter, Fred, quite honestly, and so that really--we've had to replace that at probably the most expensive funding right now which is that fed fund bucket. That's really what the cause is for that kind of less than optimistic view of a higher margin.

  • - Analyst

  • Then lastly how is the balance sheet position now? Some prognosticators are suggesting it might very well ease early next year. With short-term coming down or the loan rate moving up, be more beneficial for Old National?

  • - Treasurer

  • Well, if you look at our publicly reported data, we still show that we are liability sensitive in the models, and obviously all of the actions, as I said earlier, all the actions we've taken during the quarter were really to try and offset that natural liability sensitive position that we have on.

  • So to the extent that the fed does move within six months of finishing their last ease, I think generally if you look at the model that suggests that we benefit. So, and we certainly had thought that during 2006 we would start to see some relief in the tail end of 2006 from further fed increases.

  • Operator

  • Your next question comes from Charles Ernst with Sandler O'Neill.

  • - Analyst

  • Good afternoon.

  • - CFO

  • Hi.

  • - Analyst

  • My first question is back on the expenses. I'm still a little bit unclear. I think you said that there was a reversal of about 3 million in the quarter, and it sounded like maybe half of it was from this quarter and half of it was from the prior quarter. Is that fair or how would you--can you add a little color there?

  • - CFO

  • Yes, and Charley, like I said, I don't have all that detail in front of me. I think it's fair to say that half of that was a first quarter expense and half of that was a second quarter expense.

  • - Analyst

  • So a 1.5 million roughly for the first quarter?

  • - CFO

  • Yes

  • - Analyst

  • Okay, and then just looking at your guidance from prior quarters, you all were targeting an efficiency ratio of 63% to 65%, I think that was for the year. How do you feel about that now, and is there any update to that?

  • - CFO

  • I think we'd expect, at least from this vantage point that it would be towards the upper end of that range. Maybe a little bit over that.

  • - Analyst

  • And that includes the fact that you've got to have a 1.5 million in expenses come back into the numbers next quarter in terms of the run rate?

  • - CFO

  • Yes.

  • - Analyst

  • Okay, and then on the fee income side, you all were assuming 155 to 162 million. Is there anything--any update there? Are you still comfortable with that level or how do you feel about that?

  • - CFO

  • I'm sorry, Charles, I missed that question.

  • - Analyst

  • The fee income, you all gave guidance previously of 155 to 162 million. How are you feeling about those numbers?

  • - CFO

  • We'd expect those numbers to be in that range.

  • - Analyst

  • Which implies that there's a pretty good ramp, I think, in the second half. So what are you feeling more optimistic on that'll come through in the second half?

  • - CFO

  • I think one of the things you have to consider in that number is also that in the first quarter we had $3 million of income from the sale of the O'Fallon branch. So I think, when you look at that number, perhaps the ramp-up isn't quite what you'd expect in that number.

  • - Analyst

  • Okay. And then in terms of your capital, you all said that you were at 6.42% tangible common equity. I'm calculating that you're below 6% now. Does that have any effect on your buy back and how am I different from your numbers?

  • - Treasurer

  • I think you're including the OCI adjustment. We actually have in the deck--the end page of the deck a reconciliation. So I think if you used OCI and went back to tangible comment, you'd get back to the 642 number that Chris quoted you.

  • - CFO

  • Tangible common number. Right.

  • - Analyst

  • Okay, and then lastly, the overall guidance, I guess you said you're comfortable with the range which is now 120 to 131. So that is--you're comfortable at a lower level? Is that safe to assume? First and last quarter?

  • - CFO

  • Well, I think we stay in that range.

  • - President & CEO

  • I'm sorry. I just came in, this is Bob Jones. I apologize I was in a board meeting that ran late, and I love you guys all dearly, but the chairman of the board told me to stick around, so I had to. I would say that's a very accurate--compared to where we were in the first quarter, I would surmise that you all dropped us based on what you saw and I think you were accurate and the range that exists today we're comfortable with.

  • - Analyst

  • Great. Thanks a lot.

  • - President & CEO

  • Great. Thank you.

  • Operator

  • [OPERATOR INSTRUCTIONS]

  • And your final question comes from Troy Ward with A.G. Edwards.

  • - President & CEO

  • Hey, Troy.

  • - Analyst

  • Hey, guys. I'm going to ask a couple questions, then I'd ask the moderator to put my line on mute to eliminate any background noise. First of all, the hot money issue you referenced several times being separate from the public funds money, where did that come from? Did that come from a special you ran maybe with a new branch or something like that and how much of that is left?

  • Secondly, the insurance trends, I know you can't really look, because of the seasonality quarter to quarter, but year-over-year is about 4%. Is that expected to be a good growth rate going forward? Thank you.

  • - Treasurer

  • We didn't mean to differentiate the public fund money from the hot money, it's just that it's the most sensitive--rate sensitive money we had in the organization, so we worked long and hard with our regional management teams to make sure that we weren't paying the highest rate for that most rate sensitive money. There was some customer attrition as a result of that.

  • - CFO

  • I think that's fair to say that it was primarily public sector customer money, but there was a mix of retail money in there, too, Troy.

  • - Treasurer

  • And some business money.

  • - CFO

  • Secondly, on the insurance numbers, about the only number I can point you to, Troy, is that if you do take out that $2.4 million from the first quarter, they did have good quarter-over-quarter growth.

  • Recall that really our Flynn insurance agency came online last year in May, so it's somewhat difficult to get second quarter to second quarter comparisons. We continue to be very happy with the performance of the insurance company, and I think as I mentioned at the last call last quarter when we discussed this, they're also very much focused on improving productivity and consolidating their various back offices of the agencies and reducing expenses.

  • Operator

  • At this time, there are no further questions. Bob, do you have any closing remarks?

  • - President & CEO

  • Well, I'd again apologize for not being here for the call. And I hear Chris did a wonderful job with my script, so we may have a trend starting here of letting Chris do these, and I'll stay with the board. Again, Lynell stands available to answer any calls and should you have any, give us a call. Thanks for your time.

  • Operator

  • This concludes Old National's call. Once again, a 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 1-800-642-1687, conference ID Code 2142198. This replay will be available through August 10th.

  • If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.