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Operator
Welcome to the Old National Bank Corp. second-quarter 2008 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 Investor Relations page at www.oldnational.com. A replay of the call will also be available beginning at 1:00 P.M. Central Time today through August 11. To access the replay, dial 1-800-642-1687; conference ID code 32127175.
Those participating today will be analysts and members of the financial community. At this time, all participants are in a listen-only mode. Then we will hold a question-and-answer session, and instructions will follow at that time.
At this time, the call will be turned over to Lynell Walton, Vice President of Investor Relations, for opening remarks. Ms. Walton:
Lynell Walton - VP-IR
Thank you, Julianne, and good morning to all of you. We appreciate you joining us for Old National Bancorp's second-quarter 2008 earnings conference call. With me today are Old National Bancorp management members Bob Jones, Chris Wolking, Daryl Moore, Barbara Murphy, and Joan Kissel.
Before we begin our presentation, 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 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 information. 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 presentation are the reconciliations for such non-GAAP data. We feel that these adjusted metrics provide a meaningful look at our current performance, as well as our performance going forward.
At Old National, we are continually committed to providing honest and open communications regarding the analysis of our financial performance. And given the unprecedented negativity surrounding the entire financial services sector, feel it increasingly more important to do so. This commitment has led us to provide more granularity in three key areas, those being credit, capital, and the investment portfolio.
We have continued to provide balance sheet data for our banking regions and new financial centers, as well as significant non-interest income and expense items, although these slides are included in the appendix to the presentation. We will not be covering these specific slides during our prepared comments; however, we will be happy to answer any questions on these items during the Q&A session.
Slide 5 is our agenda for the call. First, Bob will provide Old National's perspective of the current economic environment, give you an update on the Indianapolis fraud incident we disclosed to you in April, as well as provide highlights of our second-quarter earnings results.
Daryl will then lead the discussion of our credit quality metrics, providing more granularity in the areas of our non-accrual loans, delinquency trends, and our home equity portfolio. Next, Chris will detail our expanding net interest margin, provide commentary on our capital position and detail the specific holdings within our investment portfolio.
Bob will then conclude with guidance for earnings and several other financial metrics, and then we will open the call for your questions. I will now turn the call over to our CEO, Bob Jones.
Bob Jones - President, CEO
Thanks, Lynell. Let me add my welcome to everyone that's on the call with us. We do appreciate your interest in Old National.
Before I review our performance for the second quarter, I thought it would be important for me to give you Old National's perspective on the economy today. I believe that this is important because it will give you a sense of the perspective we are taking to address the issues that we see facing our industry.
As we have said for some time now, we do see difficulty in the economy and it is having its continued effect on our industry. We continue to believe that Old National is very well-positioned to navigate through these difficult times, but, as we have also previously said, we are neither arrogant enough nor naïve enough to believe that we can totally escape the challenges that exist in today's market.
In our view, we are quarters, not months, away from seeing a recovery. We do believe that the housing challenges are moving into other sectors, most notably commercial real estate. We also believe that the effects of inflation will be felt by the consumer, who is dealing with record gas and food prices, the combination of which will affect their disposable income. Bottom line is that we continue to be very cautious and we continue to position ourselves for what portends to be a difficult period of time.
We obviously hope that the markets turn around quicker, but feel the prudent approach to meeting these challenges is to stay with the consistent approach we have used over the last few years. Our clients appreciate the consistency, and while we are conservative, we are also there for them in the long-term. If we are wrong and the markets turn quicker than we expect them to, it may cost us a few cents a year in earnings by missing out on some growth opportunities. On the other hand, if we choose the opposite approach of becoming more aggressive too soon, the challenges would be great. For that reason, we will stay with a conservative approach.
But all is not doom and gloom, especially in our home state of Indiana, where in a recent CNBC poll, Indiana was rated as the 13th top state for doing business; we were the highest-ranked state in the Midwest. In addition, the state of Indiana just announced its third straight year with a budget surplus. While we have seen our share of challenges in Indiana, the state, much like Old National, is positioned well to meet these challenges.
Now let me comment on the fraud in Indianapolis. As you can see from the charts we provided you in our earnings release, we did charge off $10.9 million related to the fraud this quarter. This amounted to 93 basis points of our 135 basis point net charge-off ratio.
We continue to work with the borrowers that were affected by the fraud. We have hired an outside firm of forensic accountants to help us through our investigation, and to date, we have not discovered any additional loans that were affected or have we discovered any control issues.
Our decision to charge off these credits is based on the continued documentation challenges and the subsequent collateral deficiencies, as well as the slowing economy. We continue to work with outside counsel as it relates to criminal and civil charges, and we continue to review our opportunities for insurance coverage.
Obviously, this is an ongoing investigation and we continue to focus on the best solutions as we work out of these credits. We will be pleased to answer your questions at the end of the call.
With all of that as a backdrop, let's turn to slide 7 to begin the review of our quarter. Given the slowing economy and the challenging times of the industry, we were very pleased this morning to announce earnings of $0.30 per share. Our net income for the quarter was equal to our earnings in the second quarter of 2007, and it did represent a 3.4% increase over the reported earnings of the first quarter of 2008.
Driving our performance was a continued improvement in our net interest margin, which increased 17 basis points over last quarter and 65 basis points over the second quarter of last year. We also saw good commercial loan growth this quarter -- 4.9% as measured end of period over end of period over last quarter.
This loan growth was driven by excellent performance in four markets, Vincennes, Evansville, Terre Haute, and Southern Illinois. Daryl will give you more detail on our credit performance, but we did see a small drop in our nonaccrual, classified and criticized loans. This is in part due to the previously mentioned large charge-off we took related to the Indianapolis fraud.
Given the current environment, we are very committed to maintaining a strong capital position. We were therefore very pleased that our tangible common equity ratio increased 19 basis points to 6.75%. At 6.75%, we are in the higher end of our target range of 6% to 7%, which we feel is very appropriate in these times. As you are aware, our Board did declare a $0.23 per share dividend for the quarter last week as an affirmation of our capital position.
Let me now turn the presentation over to Daryl Moore to give you additional insight into our credit performance.
Daryl Moore - EVP, Chief Credit Officer
Great. Thank you, Bob. I would like to begin my part of this quarter's presentation in reviewing the charge-offs for the quarter as shown on slide 9. All charge-offs in the quarter were an elevated 1.35% of average outstandings. As Bob previously mentioned, 93 basis points of that 135 basis point loss rate related to the Indianapolis fraud incident. If you recall, 26 basis points of the 52 basis point loss rate in the first quarter also related to the fraud matter.
Without the fraud related write-downs, the annualized loss rate for the first six months of the year would have been 34 basis points. While the fraud-related losses taken on specific loans to date have not exceeded the aggregate amount initially set aside for those particular loans, we have found it necessary to increase the allowance for losses against the remaining outstandings in this fraud-related portfolio by roughly $1.5 million. The amounts necessary to fund this additional reserve were a part of the provision made in the second quarter.
The provision for loan losses through the first half of the year totaled $27.6 million. With charge-offs of $22 million for the same period, this resulted in a year-to-date increase in the allowance for loan losses of $5.6 million.
As slide 10 reflects, nonaccrual loans dipped to 1.43% of total loans, down from 1.5% last quarter. In terms of dollars, nonaccrual loans fell $2.2 million in the quarter. While in today's environment any drop in nonaccruals during the quarter could be seen as significant success, we do need to keep in mind that $10.9 million write-down in the fraud loan portfolio that Bob referenced earlier did serve to decrease the nonaccrual outstandings during the quarter.
Conversely, partially offsetting the benefits of this write-down, it should be noted that $4.5 million of loans previously identified as fraud-related loans were downgraded from the substandard category into the nonaccrual category in the quarter.
Obviously, nonaccrual levels are not where we would like for them to be, and given our outlook on the economic environment previously outlined by Bob, it may be difficult to move these levels down in the near term.
The next slide gives a little more color on the exposure we have in our largest nonaccrual relationships. As you can see, at the end of the second quarter we had eight relationships in nonaccrual with exposures of $2 million or greater. The exposure in these relationships totaled $34.7 million and the impairment associated with those relationships was $12.4 million.
In breaking out these largest nonaccrual exposures, you can see from the slide that the balances are just slightly skewed to the commercial real estate portfolio. In terms of geographic distribution of these largest nonaccrual loans, $19.6 million, or more than half of the outstandings, were originated out of our Indianapolis area. Of this $19.6 million total, $12.3 million is associated with the fraud incident.
As slide 12 shows, we continue to manage our 90 plus delinquent loans well. We now have three consecutive quarters under out belt with 90 plus delinquency rates at the 3 basis point level. I believe that these levels would compare very favorably to most peer groups against which you would measure us.
As the next slide shows, other real estate owned as a percent of total loans did move up in the second quarter, increasing $1 million to a level of $3.3 million at quarter's end. Increases in the quarter came from both the one-to-four family residential and the commercial real estate portfolios.
Moving to slide 14, classified loans, which do include nonaccrual loans, fell during the quarter to 3.16% of total period-ending loans. This fall of 12 basis points from the first quarter represents a $4 million reduction, with classified loans now standing at $149.8 million.
With regard to our largest classified loans not in nonaccrual, there was a fair amount of movement in the quarter, with four of the five largest in that category having been downgraded to the category in the current quarter. Of these four large downgrades, three are involved in commercial real estate development related activities. This particular industry segment continues to show significant stress, and we would expect it to continue to do so over a number of quarters to come.
Slide 15 shows our criticized loan trends. Criticized loans fell to 2.06% of total loans in the second quarter, down from the 2.21% level at the end of the first quarter. In terms of dollars, this represents a $6.3 million reduction in the current quarter. Aggregate exposure in our top 20 criticized loans also fell slightly in the quarter.
Because we believe that changes in the levels of criticized loans can be a leading indicator of future credit risk trends, we continue to monitor this category very closely, and given the current economic environment, we believe we could see increases in criticized loans over the immediate term.
Another leading credit indicator is our 30-plus delinquency rate. As the next slide shows, since the beginning of 2007, our overall delinquencies have remained fairly constant, running in the 60 to 70 basis point range.
With regard to specific segment delinquencies, slide 17 shows our 30 day and greater delinquencies in the commercial real estate, residential real estate, and home-equity line of credit portfolios. As you can see, while commercial real estate delinquencies declined 6 basis points in the current quarter, they are 10 basis points higher than levels at the end of the second quarter last year.
Delinquencies in the residential real estate portfolio reflect a decreasing trend over the last four quarters, with delinquencies now down to 134 basis points, a 30 basis point improvement from the second quarter 2007 levels. Home-equity line of credit delinquencies rose 52 basis points in the quarter and are now 56 basis points higher than levels posted at the same date last year.
As you can see from the chart at the bottom of the slide, our commercial real estate exposure continues to fall as a percent of total loans, while our residential real estate and home-equity line of credit portfolios have remained relatively steady over the last year as a percent of total loans.
I think it is important to remind everyone that our first mortgage residential real estate portfolio consists mainly of legacy type loans as in the recent years, the majority of our production has been originated for sale into the secondary market.
The home-equity line portfolio is obviously a portfolio that we are all watching closely as both delinquencies and loss rates are up from 2007 levels. As you can see on slide 18, we've broken out our home-equity line of credit portfolio for you into loan-to-value bands. Roughly 35% of our current commitments are in lines with original loan-to-value ratios of 80% or greater.
With regard to actual outstandings, approximately 42% of outstandings were on lines where the original loan-to-value ratio equal or exceeded 80%.
Turning to slide 19, large dollar exposures in our home-equity line book are broken out for your review. As you can see, commitments of $0.5 million or greater represent only 3% of total commitments, and total commitment of $100,000 or greater, including those of $0.5 million or more, collectively represent only 25% of total commitments. So the individual exposure level in this portfolio are fairly granular.
The final slide in the credit section shows Old National's commercial real estate exposure as a percent of capital compared to community, midsized, and large bank group averages. As has been the case over some quarters, our exposure continues to be lower than that of both the midsized and community bank sets.
Maybe more importantly in this environment, the level of commercial real estate exposure as a percent of the ever-increasing in importance capital level continues to decline.
I will wrap up my section of the presentation with only a short reiteration of Bob's previous comments, that it is our opinion that we are not at the bottom of this credit cycle and that we expect to continue to see challenges across virtually every portfolio, at least in the near term. With those remarks, I'll turn the call over to Chris.
Chris Wolking - SEVP, CFO
Thank you, Daryl. I will begin on slide 22. As Bob said in his introduction, our net interest margin increased to 3.85%in the second quarter, [up] 17 basis points from a margin of 3.68% in the first quarter of 2008. At 3.85%, our net interest margin is 65 basis points higher than second quarter 2007 and 85 basis points higher than our first-quarter 2007 margin. Net interest income increased 2.6%, or $1.7 million, compared to the first quarter of 2008.
Average earning assets declined $118.4 million during the quarter, due primarily to the large decline in our investment portfolio. Based on average balances for the quarter, the investment portfolio was down $142.9 million compared to the first quarter of 2008. Average total loans increased $24.4 million in the second quarter, led by a $62.6 million increase in average commercial loans and leases.
Slide 23 illustrates the monthly trend in our fully taxable equivalent net interest margin, beginning in June 2007. The net interest margin in March 2008 was 3.77%. We improved to 3.85% in April and 3.88% in May before declining to 3.81% in June. Because our net interest income continues to be somewhat liability sensitive, our net interest margin improved during April and May, in step with the 75 basis point decline in the federal funds target rate from the middle of March to the end of April.
Additionally, our banking center managers remained focused on maintaining appropriate deposit pricing during the quarter.
In June, the net interest margin declined 7 basis points from May, largely due to the fact that the federal funds rate stopped declining and we began to see the impact on the margin of our decision to bring our net interest income rate sensitivity closer to a neutral position.
Slide 24 highlights the impact to our margin from declining short-term rates. Lower asset yields during the second quarter reduced the margin by 31 basis points, while lower interest-bearing liability costs lifted the margin 48 basis points.
I would like to provide a little more detail on the margin impact of the decline in liability costs during the quarter. Interest-bearing deposit costs, including the costs of brokered certificates of deposit, declined 56 basis points during the second quarter. Our borrowed funding rates declined 57 basis points. While we experienced a $141.1 million decline in average core deposits during the quarter, much of the decline was in expensive retail certificates of deposits and NOW accounts.
During the second quarter, we replaced a large portion of our shortest term wholesale funding, federal funds purchased, with Federal Home Loan Bank advances and brokered certificates of deposit with maturities of up to five years. Extending the maturity of our wholesale funding in the second quarter continued the work we began in the first quarter to reduce our liability sensitivity and decrease our exposure to rising short-term interest rates.
Slide 25 shows the quarterly trend in our cost of interest-bearing deposits compared to our peer group. As we have discussed in past quarters, our ability to maintain our deposit base at a lower cost than our peers contributed to our improved margin in 2007 and 2008. During the first quarter of 2008, our interest-bearing deposit costs, including the cost of brokered certificates of deposit, were 30 basis points lower than our peers. While we don't yet have peer data for the second quarter, we believe that we sustained a similar relationship to our peers' cost of deposits during the second quarter.
We expect our margin to be in the range of to 3.75% to 3.85% for the remainder of 2008. Lower short-term rates were a major driver of our improved margin during the second quarter, and we benefited from the fact that the federal funds target rate declined further than we had expected. Our margin forecast anticipates that we won't have an increase in the federal funds target rate until early fourth quarter.
Additionally, we expect to continue to extend the maturity of our wholesale funding and retail certificates of deposit to further reduce our exposure to rising short-term interest rates. This will likely increase our cost of interest-bearing liabilities during the second half of 2008.
On slide 26, note that tangible common equity as a percentage of tangible assets increased to 6.75%. Tangible equity as a percentage of tangible assets decreased to 6.21% in the second quarter. Tangible common equity increased to $6.5 million during the second quarter, while tangible assets declined $120.1 million by June 30. The difference between the market value and book value of the investment portfolio at June 30, 2008 contributed to a decrease of $29.1 million in other comprehensive income for the quarter.
The decrease in other comprehensive income related to the investment portfolio valuation accounted for much of the decline in our tangible equity to tangible assets ratio. Because $1.9 billion, or 95% of our $2 billion investment portfolio, is treated as available for sale, it is understandable that volatility in the fixed income security market would impact our security valuations and tangible equity.
Slide 27 is intended to give you a better understanding of our investment portfolio. The federal agency fixed income portfolio is comprised totally of senior debentures. We do not own the subordinated debt or preferred stock of the federal agencies. At June 30, 2008, the market value of our agency security portfolio was $333.2 million. As you can see on the slide, $179.9 million, or 54% of our total agency portfolio, is comprised of Fannie Mae senior debt. Fannie Mae is the largest holding in our agency portfolio.
Of the remaining agency senior debt, $64.1 million is Freddie Mac exposure; $79.2 million is Federal Home Loan Bank exposure; and $10 million is exposure to the Federal Farm Credit System.
The market value of our mortgage security portfolio was $1.1 billion at June 30. 77.5%, or $854 million of our mortgage securities, were CMO structures with collateral guaranteed by the federal agencies, or pass-through mortgage securities issued by the agencies. $247.8 million of our mortgage securities are non-agency CMOs. Our non-agency CMOs are all rated triple-A by the various debt ratings agencies and are comprised of fixed interest rate, jumbo, or Alt-A mortgage collateral.
Our corporate securities portfolio is made up of two major [components]. The market value of our portfolio of trust preferred securities totaled $49.2 million at June 30, 2008. Additionally, of the remaining $134.7 million of corporate securities, $111 million is managed by an outside investment manager unaffiliated with Old National Bank Corp.
Of the $49.2 million trust preferred securities, $38.5 million are pooled trust preferred securities comprised of nine different issues. We have no real estate investment in trust exposure in our pools. The issuers in our securities are primarily banks, but the pools do include a limited number of insurance companies. $11 million of our pooled trust preferred securities are currently rated AA or higher; $18.8 million are rated A2; and $8.7 million are rated A3.
The corporate security portfolio managed by the outside manager is managed to the Lehman Intermediate Corporate Bond index. All of the holdings are investment-grade, and by policy, no single company exposure can exceed 4% of the value of the manager's total portfolio.
The market value of our municipal securities was $328 million at June 30. Approximately 69%, or $226 million, of our municipal portfolio is insured by the monoline insurance companies. But of the $226 million insured portfolio, only 15%, or approximately $34 million, does not have an underlying investment-grade debt rating. The unrated insured portfolio of municipals represents approximately 10% of our total municipal securities portfolio and under 2% of our entire securities portfolio.
We did not incur other than temporary impairment on our investment portfolio in the second quarter. Of all of our portfolios, we are monitoring our non-agency CMOs and pooled trust preferred securities most closely for other than temporary impairment.
Seven of our pooled trust preferred securities totaling $27.5 million in market value at June 30 are rated lower than AA and subject to the guidance of EITF 9920. We rigorously model and stress test the cash flows of these securities for possible impairment. The current defaults and deferrals and our outlook for defaults and deferrals in the pools did not warrant OTTI in the second quarter.
As we continue to monitor these securities, it is possible that we may have OTTI on these securities in future quarters.
We stress test our non-agency CMOs by modeling losses equal to 50% of the current 60-day-plus delinquencies of the tranche. These securities did not warrant OTTI in the second quarter.
All of our trust preferred securities and non-agency CMO securities are considered available for sale on our balance sheet. As such, the impact of the market value adjustments of these securities is currently reflected in our tangible equity and our tangible equity ratios.
Finally, I would like to point out that we generated $1.1 million in net gains from calls of federal agency and other investment securities during the second quarter. Our total securities gains were $2.1 million for the quarter. Other expenses included a charge of $692,000 for impairment to intangibles related to our insurance agency. This information is referenced in our earnings release and in the slides in the appendix.
I'll turn the presentation back to Bob for final comments.
Bob Jones - President, CEO
Thanks, Chris. As Chris said and Lynell said, before I provide you with our guidance, let me remind you that in the appendix of this presentation, you will find additional detail related to our geographic performance, as well as other financial metrics. I also again would mention if there is information you would like us to include or things we could do differently, please let Lynell know.
I hope that during this call, you were able to gain a sense of our view of the economy and what we feel is a realistic and honest approach to dealing with the challenges that we see. As we note in every release and every investor presentation, we operate under three strategic imperatives, the third one being providing our shareholders with a consistent, quality return.
The focused execution of our strategies allows us to achieve that goal, and deviating from that, particularly during difficult times, will not happen at Old National.
It is that consistent approach that allows us to affirm our guidance for the full year at $1.13 to $1.19. This is an affirmation of what we told you when our original guidance was issued at the beginning of 2008, which we again affirmed following our first quarter.
Our cautious view of the economy and the credit markets have us slightly increasing our net charge-offs and provision guidance for the year. These numbers are also tempered by our continued efforts towards resolution of our Indianapolis fraud. You may remember that at the end of last quarter, we gave charge-off guidance of 55 basis points to 65 basis points and provision guidance of $27 million to $33 million.
We are able to offset the effect of the higher credit costs with the improved performance of our margin. As Chris said, we are raising our guidance for the full year to $3.75 to $3.85.
At this time, we will be more than happy to answer your questions. Julianne, if you could start the question-and-answer, that would be great.
Operator
(OPERATOR INSTRUCTIONS) Erika Penala, Merrill Lynch.
Erika Penala - Analyst
I'm sorry if I missed this during the prepared remarks, but do you believe that you have taken all the losses that you think will stem out of the Indianapolis fraud incident?
Bob Jones - President, CEO
You know, it is hard to say if we have taken all the losses. As Daryl said, we think we have properly provisioned for it. We will continue to work through the situation, but the provision is there to cover the losses.
Erika Penala - Analyst
Okay. And I guess sort of a more macro question related to credit. Did you get a sense in the second quarter whether or not the stimulus checks helped debt service on the consumer side?
Daryl Moore - EVP, Chief Credit Officer
I think that when you talk to our collection people, they will tell you that, yes, in fact it did help a bit. It was, I guess, similar in attributes to when people begin to get their tax returns back. We saw some of that cash flowing in to keep payments current. So I would say yes, we did see that a bit, and it could -- we'll watch to see what the next quarters bring in terms of delinquencies to see whether there's any material difference.
Bob Jones - President, CEO
Erika, another tangential effect of the stimulus checks was it did reduce overdrafts for the quarter. We saw the deposit activity offset some of our normal overdraft.
Erika Penala - Analyst
This is more of a housekeeping question, but I think in the slide presentation, you mentioned that your exposure to first mortgage and HELOC was about 16.5%. If we look at Call Report data from last quarter, the resi mortgage exposure is 24.5%. I guess, what is the shortfall? In other words, what is the difference between how you are filing with the Call Reports and how you showed the information in the slides?
Daryl Moore - EVP, Chief Credit Officer
Great question, Erika. And we look at this internally all the time. It is a difference between how things are reported on the Call Report versus what we do internally. And if I [believe] right, the Call Report is more collateral-based, and internally we focus more on purpose-based.
Bob Jones - President, CEO
The example, Erika, if we did a small business loan and took a mortgage on somebody's house, that may show up in our Call Report because of the collateral as a first mortgage. Whereas the original purpose of that loan is business, so we would classify that business purposes, but on a Call Report, it is not. The cash flow is coming from the business.
Erika Penala - Analyst
Got you. Okay. One more question, if I may. The $75 million expense run rate was a little higher than I expected. Was there anything related to the Indianapolis fraud incident in that run rate that may not reoccur in the next two quarters?
Bob Jones - President, CEO
You know, we did have some legal costs that we expensed in the quarter, but also the charge-down on the intangibles in that expense rate. Chris referenced the $669,000 on the write-down of the intangible on our insurance.
Just so you know what that is related to, we lost a large client at our insurance agency in Fort Wayne. As we looked at the goodwill associated with that and the effect of that large client, we determined that we had to write down the goodwill because of that large client loss.
Chris Wolking - SEVP, CFO
Erika, this is Chris. An appropriate run rate is $73.5 million for the quarter.
Erika Penala - Analyst
Okay. Thanks for the added disclosure.
Operator
Scott Siefers, Sandler O'Neill.
Scott Siefers - Analyst
I think just one or two [ticky tack] questions and then one strategic one. Daryl, how much of the Indianapolis fraud situation that is still left on non-performer though has not been charged off as of yet?
Daryl Moore - EVP, Chief Credit Officer
At the end of June, we had about $16 million in nonaccrual that relates to that issue, and we've got about -- just slightly less than $7 million in provision against that.
Bob Jones - President, CEO
If you look at the release, Scott, on page 2, it has a pretty good breakdown of that on the press release. So if you need further info --
Scott Siefers - Analyst
Okay, perfect. Thank you. Then, if Bob, just a kind of strategic question. There's sort of a diminishing pool of strong banks out there that have, I guess, the capital wherewithal to potentially do some M&A, in other words, take over some guys that might be a little more challenged in this kind of environment. How are you thinking about things from an M&A perspective? Has your thinking changed at all, et cetera?
Bob Jones - President, CEO
Yes, one, I think you are right. But I would also tell you we are going to be very disciplined in anything we look at. I hate to use food analogies, but they work for me, that I am not willing to take anything that is going to give me indigestion at this time.
So any opportunities we have are going to be consistent with our strategy, which is really northern Indiana, the area between Indianapolis and Louisville we call the I-65 corridor. We are going to be very, very cautious. I just -- because of our belief that we have not hit the bottom yet, I'm going to be very cautious before I acquire something that would cause us to set back in our forward momentum. And I do believe that there is going to be more opportunity in the upcoming quarters than what we have already seen.
Scott Siefers - Analyst
Afraid you're probably right. Great. Thank you very much.
Operator
(OPERATOR INSTRUCTIONS) Charlie Ernst, Sandler O'Neill.
Charlie Ernst - Analyst
Just wanted to talk a little bit about loan growth. You guys had a quarter of loan expansion, which hasn't happened a whole lot in the last three or four years. Can you just talk about what you are seeing and what your expectations are, maybe over the next year or two?
Bob Jones - President, CEO
A year or two might be a little long. One, I think it is a reflection on the great work that Barbara Murphy has brought to our Banking Group. Very disciplined, very focused. That growth is really in our sweet spot of C&I growth. Particularly noteworthy, that is in markets that most notably you would look as higher growth markets, and I think, again it reflects on that discipline.
I think, Charlie, it also reflects a little on the fact that some of our competitors are not able to possibly do the lending. You know, we are fortunate to have with us in the room our Regional President for three of those markets, which is Jim Sandgren. Maybe Jim can talk a little bit about what he is seeing in the market. Jim covers Evansville, Vincennes, and Southern Illinois, which are three of our top four markets. Jim?
Jim Sandgren - Regional CEO
Thanks, Bob. We had some really nice opportunities, specifically in a couple of our markets in Evansville and Vincennes, to do some very high rated lending to a couple of local universities, very high creditworthiness, and it provided a lot of additional lending on the balance sheet. So we have seen some nice opportunities there.
Bob Jones - President, CEO
As we look forward, Charlie, you're not going to see robust growth. You're going to see what we said last quarter. If you look at a percent reason, slight growth, but offset as well by our continued view towards real estate.
Charlie Ernst - Analyst
Okay, great. Thanks a lot.
Operator
Mac Hodgson, SunTrust Robinson.
Mac Hodgson - Analyst
Good morning. I was curious if you could provide some more color on commercial real estate. I know you mentioned that the housing challenges are moving into commercial real estate, and I think, Daryl, you mentioned four large downgrades in the commercial real estate category. Could you provide any more color about what you see in the marketplace, maybe use those credits as an example?
Bob Jones - President, CEO
Sure, let me just remind -- before Daryl gives you the granularity -- that we have been almost two years of caution towards real estate. And I think we're beginning to see that caution become a fact. But let's have Daryl give you a little more granularity there.
Daryl Moore - EVP, Chief Credit Officer
Mac, a couple of things. One is I don't need to tell anybody that we have had -- every bank has had issues with regard to the one-to-four family and subdivision lending. And we've got not a lot of that on our balance sheet, but we've got some, and most of it is showing signs of stress, lower absorptions, just like every other bank.
What we are beginning to see in addition to that is kind of the commercial retail. These strip centers that were being built in anticipation of larger residential developments being built around them, we are beginning to see, a the large residential developments don't happen, these retail centers are beginning to come out of ground, get finished, and not leased up.
What that does is that spills over then into your existing retail. As leases are coming up for maturity, the existing tenants are saying, hey, listen I can go to this new place or I can go someplace else to get lower lease rates. And so to keep them in their facilities, they are lowering their existing lease rates. So you've got a lot of supply. You have existing lease rates coming down. And it is just on these projects that are at [110] coverage last year; it's putting them very close to being breakeven in terms of cash flow.
With regard to our properties that are kind of these four non-accruals that went on in the past quarter, one of them -- really one, two, three of those are related to the fraud incident. They have been down -- well, one of those was downgraded into the nonperforming. The others that we see having gone in are -- we have one very -- legacy hotel. We don't have a big hotel industry, so we don't know much about it, but this is kind of an older one that got downgraded. And then one warehousing. We had a warehousing facility that was a little weak that we took.
So it is kind of across the board. I can't tell you that it is in one segment of commercial real estate. We are seeing weakness kind of across the entire portfolio.
Mac Hodgson - Analyst
Sure. That's helpful. Can you maybe remind me what the total exposure is to subdivision lending, or kind of the one-to-four family side of commercial real estate? Then maybe if you had a breakout of commercial real estate in the commercial retail category, that would be helpful as well.
Daryl Moore - EVP, Chief Credit Officer
Yes, I can give you some real general numbers. Our subdivision lending is less than $25 million today outstanding at the end of quarter, so it is not significant. You know, I can tell you what our breakdown on retail commercial real estate is. You've got to understand that many banks classify things differently. But in our area, it is in the $80 million to $90 million range.
Chris Wolking - SEVP, CFO
As we classify it.
Mac Hodgson - Analyst
Got you. Okay. That's helpful. Thanks.
Operator
Eileen Rooney, KBW.
Eileen Rooney - Analyst
Good morning, guys. Just had a couple of follow-up questions. I was wondering, when we're just talking about that commercial real estate, aside from the fraud-related stuff, are there any particular geographic areas that are experiencing more deterioration than others?
Chris Wolking - SEVP, CFO
I would definitely say Indianapolis is our weakest market with regard to commercial real estate.
Eileen Rooney - Analyst
Okay, what about on the C&I side?
Daryl Moore - EVP, Chief Credit Officer
Right now, the C&I side has not shown really the weakness that we expected to see, so we don't have any real pockets in the Company that are showing significant weakness in that portfolio at the present time.
Eileen Rooney - Analyst
Okay. Then just jumping away from that asset quality. Your personnel expenses seemed to pick up a little bit this quarter. I was just wondering if there was anything unusual in there or if this is a good run rate going forward.
Bob Jones - President, CEO
It is probably a good run rate, because in the second quarter we get our merit increases that we give our employees. On average, we were around 2.9% for merit increases for our associates.
Eileen Rooney - Analyst
Okay, that's great. That's all I had.
Operator
Stephen Geyen, Stifel Nicolaus.
Stephen Geyen - Analyst
I was just wondering, the Indianapolis region, you included the $12.3 million in fraud-related. How much of that is C&I and if you have any idea on time to resolution for some of those loans?
Bob Jones - President, CEO
Daryl is looking. Resolution, Stephen, would be awfully difficult, because of -- I hate to use the word moving parts, but there are so many parts moving between legal issues and working with the borrowers and getting documentation, I would be really hesitant to give you any resolutional time. We obviously hope to get it resolved sooner than later. We are quite frankly a little tired of talking about it. But it is going to take a little bit of time to work through those issues. I think Daryl may have your answer here.
Daryl Moore - EVP, Chief Credit Officer
Ask the question again, to make sure I'm giving you the right answer, Stephen.
Stephen Geyen - Analyst
Yes, on the bottom of page 11, in the piece that you provided to analysts, how much of that, the $12.3 million, how much of that is C&I?
Daryl Moore - EVP, Chief Credit Officer
None of that is C&I.
Stephen Geyen - Analyst
None of it is? Okay. And last question. Toyota's plant just north of town, they've announced some cutbacks because the Tundra may be cut back. Have you heard of any news of employment cuts?
Bob Jones - President, CEO
Yes, no employment cuts are planned, because we actually pick up the Highlander. And as they do the switchover, Toyota has guaranteed full employment for all of their associates at the plants. So really, it was good news for Evansville and Princeton. We pick up a better-selling product, no employment impact at all, and it shows a commitment from Toyota Japan to Princeton, which was very good news for us.
Stephen Geyen - Analyst
Great. Thank you.
Operator
Michael Cohen, SuNova Capital.
Bob Jones - President, CEO
Are you going to ask me about that margin again?
Michael Cohen - Analyst
No, I think it is reasonably clear.
Bob Jones - President, CEO
I think you were right last time we chatted.
Michael Cohen - Analyst
Yes, the non-expected margin expansion.
Slide 17, what was -- can you talk about sort of the last maybe three quarters delta in the home-equity 30-day delinquency? Is that just seasonality?? Because it seems like somewhat of a larger-than-average jump on the HELOCs from 1Q to 2Q.
Daryl Moore - EVP, Chief Credit Officer
Michael, this is Daryl. There is a bit of an abnormality in those numbers. At the end of the first quarter, we were in the 120 range. There actually is about a $0.5 million account in our home-equity that would be best classified as kind of a commercial workout that matured. It is still in those home-equity numbers, it was secured by a mortgage on the individual's residence. So it has distorted those numbers just a bit. We are trying to work through that and resolve it.
But having said all that, I would tell you that the trends of increasing delinquencies in home equities in our portfolio is a real trend and we will probably continue to see it rise.
Bob Jones - President, CEO
But it's safe to say not at that level (multiple speakers) quarter over quarter.
Michael Cohen - Analyst
Would it rise from the absolute level of 172 or are you assuming this $0.5 million somehow either migrates to another loan category or migrates off?
Chris Wolking - SEVP, CFO
Hopefully, it will migrate off. Without that specific account, the delinquencies were in the 153 range, which is obviously still higher than where we were at the end of the quarter. But I would hope that that $0.5 million would migrate off and not move to another category.
Michael Cohen - Analyst
Great, thank you.
Operator
There are no further questions at this time. I would now like to turn the call back over to Mr. Jones for any closing comment.
Bob Jones - President, CEO
The only closing comment is, as always, if you have further questions, please let Lynell know. Again, we are interested in your input on things we can do to better provide you with the information you want. And, particularly during these turbulent times, we appreciate your support of Old National. Thanks for being on the call.
Operator
This concludes Old National's call. Once again, a replay, along with the presentation slides, will be available for 12 months on the Investor Relations page of Old National's website at www.oldnational.com.
A replay of the call will also be available by dialing 1-800-642-1687; conference ID code 32127175. This replay will be available through August 11.
If anyone has any additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.