Old National Bancorp (ONB) 2010 Q4 法說會逐字稿

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  • Operator

  • Welcome to the Old National Bancorp fourth-quarter 2010 earnings conference call.

  • This call is being recorded and has been made accessible to the public in accordance with the SEC 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 noon Central today through February 14. To access the replay, dial 1-800-642-1687 and the conference ID code of 32868739. 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, Director of Investor Relations, for opening remarks. Ms. Walton, please go ahead.

  • Lynell Walton - VP IR

  • Thank you, Carly. Good morning, everyone. Just as a note, we are having some minor technical difficulties this morning. If you are joining us on the webcast today and the slides are not appearing, those slides are available in a link just below the webcast at OldNational.com on the Investor Relations section. Again, I apologize for this inconvenience.

  • Joining me today on Old National Bancorp's fourth-quarter 2010 earnings conference call are management members Bob Jones, Chris Wolking, Barbara Murphy, Daryl Moore and Joan Kissel.

  • On Slide 3, you will note the standard forward-looking language. Our discussion today will contain forward-looking statements. Such statements are based on information and assumptions that are available at this time and 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 Old National's filings with the SEC.

  • Slide 4 contains non-GAAP financial measures language. 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. We feel these adjusted metrics to be helpful in understanding Old National's results of operations and core performance trends. Reconciliations for such non-GAAP data are included within the presentation.

  • As we begin our financial and strategic review of the fourth quarter and 2010, we turn to Slide 5 where I have noted key areas of focus for our discussion today. First, Bob will highlight drivers and significant events impacting our fourth-quarter and full-year 2010 financial performance. We will then provide more detailed financial data as Chris will highlight the progress we've made in reducing our non-interest expense base, update you on our balance sheet strategy, including our recent redemption of our trust preferred debt, and maintaining our strong capital position, while Daryl will discuss our current quality -- credit quality trends and our outlook on these trends going forward. Finally, Barbara will provide an integration update on our recently-closed Monroe acquisition. Following our prepared remarks, we will be happy to open the line and take your questions.

  • With that, I'll turn the call over to Bob.

  • Bob Jones - President, CEO, Chairman

  • Thank you and good morning to everybody on the phone. I'm going to begin my remarks on Slide 7.

  • As you take a look at Old National's fourth quarter, the underlying performance is very consistent with our prior quarters. The quarter was driven by our solid credit performance, a continued focus on reducing our expenses, as well as our strong belief that capital management is very important during these interesting times and, finally, that we continue to take actions to position Old National to take advantage of the slow economic recovery. Throughout this call, we will reinforce these themes.

  • For the quarter, our income available to our common shareholders was $5.7 million, or $0.07 per share. This compared to a loss of $9.3 million or $0.11 per share for the same period last year. While we did earn $0.13 per share for the third quarter of 2010, but when you compare this quarter to that quarter, it's important to note that the fourth quarter includes some large charges not taken in the prior quarter. One of these was a $3.3 million discretionary bonus paid to all eligible employees at Old National, excluding members of our senior and executive management team.

  • When we suspended our incentives for 2010, our commitment to our associates was that if our performance was at a level where a one-time discretionary payment could be justified, we would review that in the fourth quarter. Upon our review with the Board, when they took into account our current credit and capital positions as well as the good work we've done on expense reductions, all of which lead to a better-than-planned net income performance, the Board and I felt strongly that we should reward the eligible associates with this one-time discretionary payment. This payment had not been accrued for in prior quarters, thus it had its full impact in the fourth quarter.

  • Other fourth-quarter expense items were the previously disclosed charge for the extinguishment of our debt, which was $3.8 million. As Chris will note, that had a very positive impact on our net interest margin. We also had charges in the quarter related to our Monroe acquisition and expense associated with our self-insured medical plan as well as other HR related costs.

  • We were pleased that the average loans increased quarter-over-quarter in the fourth quarter, driven mostly by the activity related to mortgage refinancing. But for those of you who have followed us for some time, particularly during these past few quarters of difficult economic times, we have not always been noted for our optimism, and always try to give you a realistic view of what we are seeing and hearing from our customers.

  • From a small-business and middle-market perspective, we are hearing and seeing more optimism. Clients are reporting an increase in productions and corresponding sales, though this optimism has yet to translate into significant increased loan demand. In fact, our line utilization decreased to 28.9% this quarter versus 31.9% last quarter. Our sense is that companies are using their cash balances first to finance their growth. At the same time, clients are not talking about significant changes in their hiring practices. Thus, our view is that while we are seeing increased optimism within the commercial sector, that has not translated into changes in the employment base, which tells us that unemployment rates will be slow to recover. These elevated unemployment numbers continue to put pressure on consumer borrowings and credit. With the deleveraging we continue to see from the consumer, it is logical that -- it logically follows that consumer lending will be soft for some time.

  • The sector where we continue to feel the least amount of optimism continues to be the real estate sector, particularly with any area involved in the housing markets. With the abundance of housing inventory available, it may be at least until 2012 before we see any appreciable recovery in this sector. Daryl will spend time during his presentation giving his regular perspective of where we are in the credit cycle, but the short version is that while we have seen some improvements, we are not at a point where we have seen enough of a sustainable recovery that would signify that we are completely past the challenging credit cycle.

  • Two other highlights for the quarter were the expansion of our net interest margin to 3.46%. Chris will elaborate more on this in his presentation, but of particular note is the month of December's margin, which was 3.56%, which again supports our decision to extinguish our debt.

  • We also closed on the Monroe transaction on January 1. As you will hear from each of our presenters, we remain very pleased with where we are as of today.

  • I should also note that we have been active in looking at other opportunities and believe that 2011 will be a period of strong activity in the industry for consolidation. We will continue to be driven by the value we create for our shareholders and the consistency of staying within our strategic boundaries.

  • Let's turn to Slide 8, where I will briefly highlight the full-year performance. For the year, we saw net income available to common shareholders of $0.44 per share versus $0.14 per share in 2009. The drivers for the year were the same as the fourth quarter -- improved credit costs, reduced expenses, and an expansion of our net interest margin.

  • Let me now turn the presentation over to Chris and I will return at the end to answer your questions. Chris?

  • Chris Wolking - SEVP, CFO

  • Thanks Bob. I will begin on Slide 10.

  • Fourth-quarter 2010 revenue was essentially flat to third quarter and continues to reflect the interest rate, economic and regulatory headwinds that the Company has been dealing with since the middle of 2009. Net interest income was down $200,000 compared to third quarter of 2010. Average earning assets declined by $101.5 million during the quarter, due primarily to our continued efforts to reduce our investment portfolio. Loans grew $16.9 million during the quarter, driven by a $110.4 million increase in residential real estate loans.

  • The better mix of earning assets did help lift the net interest margin four basis points from the third quarter, however, and we are now up significantly from our fourth-quarter 2009 net interest margin of 3.28%. This trend of modestly lower net interest income quarter-over-quarter since the second quarter of 2009 is driven by falling loans.

  • Average total loans have declined by $873.6 million at Old National since the second quarter of 2009. Fortunately, we've managed to increase our margin to offset the declining earning assets through disciplined deposit pricing and reducing our non-core funding.

  • Fees and service charges were flat in the fourth quarter compared to third quarter and are slightly down compared to the fourth quarter of 2009. Much like net interest income, fee and service charge revenue is modestly lower to flat quarter-over-quarter since the second quarter of 2009. We did see a slight increase of $100,000 in deposit service charge revenue compared to the third quarter, however. This is noteworthy because the fourth quarter was our first full quarter of Reg E implementation and our first full quarter without free checking.

  • I started my presentation with revenue trends to illustrate that the sluggish economy, low short-term interest rates and regulatory uncertainty as reflected by declining loans and flat non-interest income are major headwinds impacting our revenue. But I also think it is important to note our successes, a growing net interest margin and steady to slightly increasing deposit account service charges, to show that we are aggressively fighting these headwinds and doing what we can in this environment to lift revenue.

  • As you can see, though, on Slide 11, we have not changed our primary reactions or response to this difficult operating environment. We successfully reduced non-interest expense in 2010 and are committed to further cost cutting. We are maintaining high capital ratios and reducing leverage by shedding wholesale funding and investment assets. Our desire continues to be to use available capital to fund acquisitions or to return capital to our shareholders if we can't find the right opportunities.

  • We are committed to an asset sensitive balance sheet. We believe that maintaining an asset sensitive balance sheet is the best ready for us long-term because interest rates will rise, perhaps sharply, as the economy improves.

  • On Slide 12, you will see in the highlighted column that, as reported, total non-interest expenses for the fourth quarter were $83.3 million, $7.2 million higher than third quarter 2010 non-interest expenses of $76.1 million. Included in the fourth quarter were several large charges including $3.3 million paid in discretionary bonuses to all of our associates except senior and executive management, and $3.8 million in charges related to the termination of wholesale funding, most notably the call of Old National Bank Capital Trust II, a $100 million 8% coupon trust preferred debt security. Without these charges, non-interest expenses would have been approximately $1 million lower than third quarter.

  • The remaining columns on the slide show the steady reduction in non-interest expenses since the fourth quarter of 2009. I believe this illustrates our hard work and sustained commitment to reducing expenses.

  • Moving to Slide 13, for the full year, 2010 non-interest expenses are down 7.3%, or $24.7 million, compared to 2009. Much of this reduction has been due to staff reductions. From the second quarter of 2009, which was the first full quarter after our acquisition of the Indiana franchise of Charter One, our population of associates has declined by 384 FTE, or 13.4%.

  • Total salary and benefits costs for the full year of 2010 were $170.6 million, compared to $181.4 million for the full year of 2009, a reduction of 6%. Fourth-quarter salaries and employee benefits were $45.4 million, up from $41.7 million in Quarter 3, but fourth quarter includes several large items I showed in my previous slide, notably the discretionary bonus of $3.3 million and additional cost for our self-insured medical plan of $0.9 million.

  • Additionally, we had $1.3 million of severance expense in the third quarter of 2010, but only $500,000 in severance expenses in the fourth quarter, a difference of $800,000. We expect that the first quarter of 2011 will reflect the full salary impact of the fourth-quarter staff reductions.

  • We are obviously pleased with our lower operating expenses in 2010, but we still aspire to improve to a 65% efficiency ratio in 2012. We know we have a significant amount of work ahead of us to reach this goal. We are focused on improving productivity further in 2011. Last quarter, I shared with you some of the projects underway at the Company to improve productivity. The entire Company is engaged in reducing cost and is committed to attaining our efficiency ratio target.

  • Moving to Slide 14, I show that we continued to reduce our investment portfolio and wholesale funding during the quarter. The Federal Reserve deposits and other money market investments are included in total investments. Investments declined $118.4 million on average from the third quarter. In the period, though, the investment portfolio at December 31 was $249.2 million lower than September 30, reflecting the fact that cash flows from calls and maturities of investments occurred late in the quarter.

  • Wholesale funding, including brokerage certificates of deposit, declined on average $69.6 million during the fourth quarter and declined $226 million from period end September 30 to December 31, 2010. We terminated $50 million of Federal Home Loan Bank advances in October and called the $100 million Capital Trust II on December 15, so these reductions are not fully reflected in the average wholesale funding balance for the fourth quarter.

  • We expect to continue to use cash flows from the investment portfolio to reduce our wholesale funding in 2011. While we would like to shrink our investment portfolio further, our continued strong deposit growth may cause the investment portfolio to increase unless loan growth accelerates.

  • On Slide 15, I graph our tangible common equity tangible assets and tangible common equity to risk weighted asset ratios compared to the average ratios of our peer group. At the end of the third quarter 2010, our tangible common and tangible assets ratio was 159 basis points higher than the average ratio of our peer group.

  • Even though tangible common equity declined slightly due to the lower -- due to lower other comprehensive income at 12-31, our ratio increased in the fourth quarter. This was due to the $240.3 million decline in tangible assets from September 30. As I noted in the previous slide, the decline in tangible assets was due to the $249.2 million decline in the investment portfolio.

  • Our tangible common to risk-weighted assets ratio was 305 basis points higher than the average of our peer group at the end of the third quarter. Risk-weighted assets did not decline as much as tangible assets during the quarter due to the modest loan growth we experienced during the quarter. End of period December 31, 2010 loans were $40.7 million higher than at September 30, so this, along with the decline in tangible common equity due to the lower OCI, accounted for the modest decrease in our tangible common-to-risk-weighted assets in the fourth quarter.

  • Both capital ratios reflect leverage well within the capital guidelines we discussed at our Analyst Day presentation last November. Our guideline for tangible common equity as a percentage of tangible assets is 6% and our tangible common equity-to-risk-weighted assets guideline is 9%.

  • The fact that we are well within our capital guidelines allowed our Board of Directors last week to authorize a purchase of up to 2.25 million shares of our common stock and to declare a quarterly dividend of $0.07 per share. We will continue to evaluate our dividend quarterly.

  • While I don't include regulatory ratios in the slide, I should note that Tier 1 capital and total capital ratios declined from the third quarter due to the call of our trust preferred debt securities. Our Tier 1 ratio is 13.6% compared to 15.4% at September 30, and our total capital ratio is 14.8% compared to 17.3% at September 30.

  • Slide 16 shows the trend in our net interest margin during 2010. As I said at the beginning of my presentation, we have been pleased with the steady improvement in the margin. The four basis point improvement in the fourth quarter from the third quarter of 2010 is due to a ten basis point decline in our cost of interest-bearing liabilities compared to only a four basis point decline in the yield of earning assets. Calling Capital Trust II and terminating the FHLB advances contributed to the strong margin performance in December and gives us momentum into 2011.

  • The steady improvement in liability costs during the early quarters of 2010, however, was due to the disciplined pricing of our interest-bearing transaction savings deposits, the decline and repricing of our CD portfolio, and the increased checking account balances. Average checking account balances in the fourth quarter increased $120.2 million from the fourth quarter of 2009 and $82.3 million from the third quarter of 2010. Importantly, non-interest-bearing checking deposits grew $153.9 million year-over-year and $67.2 million in the fourth quarter.

  • I added a comment on Slide 16 that, even with the elimination of free checking in the fourth quarter, our account attrition was only 16.8%, well within our expectations, and most of which were small-balance accounts.

  • My final slide, Slide 17, shows the duration and book value of our investment portfolio at December 31. The total book value and duration do not reflect balances in money market investments or deposits at the Fed. Total money market investments and Federal Reserve account balances were $144.2 million at December 31, up from $43.1 million at September 30.

  • You will note that duration of the portfolio assets increased to 4.23 from 3.8 at September 30. Higher long-term rates contributed to the increase in the duration of our federal agency and mortgage-backed security portfolios, but our modeling indicates projected cash flows from the investment portfolio due to calls and maturities are likely to be quite high at $766 million for the next 12 months if rates are unchanged. We are still targeting a duration for the total investment portfolio of 3.5 to 3.6, including the impact of money market investments and deposits at the Fed.

  • Including money market investments and cash deposits to the Fed, our investment portfolio duration was 4.02 at December 31. I would expect that cash flows from the portfolio that are not used to reduce wholesale funding or to fund loans in 2011 will be reinvested in short-duration fixed-rate and floating rate securities.

  • In the fourth quarter, we took an other-than-temporary impairment charge of $619,000 against two of our trust preferred securities. We incurred no OTTI against our nonagency mortgage securities in the fourth quarter.

  • We sold approximately $38.4 million in book value of non-agency mortgage-backed securities in December. These securities had been included in our classified asset portfolio in the third quarter. The appendix of this presentation includes slides with data on our OTTI charges over the last two years, and the changes in the classified assets portfolio due to the sale of the non-agency mortgage securities.

  • Before I turn the presentation over to Daryl, I wanted to give you a short update on Monroe from the financial perspective. The transaction closed as planned on January 1. The deal was structured so that the exchange ratio was 1.275 shares of Old National per share of Monroe, unless Old National was trading at or above $10.98 per share, at which point the exchange ratio would drop to keep the total price of the deal capped. At closing, because ONB shares were trading above $10.98 per share, our final exchange ratio was 1.216 shares of Old National per share of Monroe. We issued approximately 7.575 million shares for the purchase, about 300,000 fewer shares than we anticipated based on the originally announced exchange ratio. We still expect the deal to be neutral to EPS in 2011 and $0.06 to $0.07 per share accretive in 2012. Final purchase accounting marks are not yet complete, but we will have more details on our first-quarter 2011 conference call.

  • I'll now turn the call over to Daryl.

  • Daryl Moore - EVP, Chief Credit Officer

  • Thank you Chris. I'll begin my part of the presentation on Slide 19, where we compare provision expense to net charge-offs for each quarter from the beginning of 2008, as well on an annual basis over that time period.

  • A couple of items to note -- first, you can see that, over the past three years, our provisions for loan losses have exceeded our net charge-offs on an annual basis. While this would not be unexpected for 2008 and 2009, our analysis also called for this level of provisioning in 2010 which might be counter to what you may be seeing in other institutions.

  • As I make my comments throughout the balance of the presentation, you will see that this approach is more of a function of our institution's view of the uncertainty related to economic conditions as opposed to concerns related to any expected increase in current portfolio risk. Additionally, you can see from the chart that not only were losses lower in 2010, but volatility of net charge-offs from quarter to quarter was lower than what we've experienced over the past two years.

  • Moving Slide 20, you can see in graphic form the fourth-quarter movement of criticized and classified loans. Criticize loans were up $9 million in the quarter while classified and non-accrual loans were up $2.4 million and $1.1 million respectively. For the full year, criticized loans, which are viewed by some as one potential indicator of future credit trends, fell by $19.5 million, while we saw increases of $13.3 million in classified loans and $3.9 million in non-accrual loans. Non-accrual level increases during the year notwithstanding, the fourth quarter saw the lowest quarterly dollar inflow of new relationships into non-accrual of any quarter throughout the year.

  • Slide 21 shows both 30-days or greater as well as 90-day or greater delinquency dollars as a percent of total loans. Total 30-day delinquencies were 69 basis points of total loans and 90-day delinquencies fell to 2 basis points at quarter's end. As reflected in the chart, quarter-end 30-plus day delinquency levels in 2010 were consistently lower than the linked-quarter periods of 2009. As you can see, Old National's delinquency levels compare very favorably to those of our peers.

  • Slide 22 shows Old National's allowance coverage of nonperforming assets as low as that of our peer group. As you can see, we continue to carry reserves for future loan losses close to the one-to-one coverage level and, given our provisioning over the last five quarters, have improved our standing with respect to the levels being posted by our peers.

  • On slide 23, we've provided some thoughts as to where we believe the credit environment could take us over the next number of quarters. While certainly not across all segments of lending cautious optimism as to the possibility of improvement in 2011 is at least being discussed by some of our clients. Although we have not yet seen any significant ongoing benefit of an improving economy in our overall credit quality numbers, we did see lower net charge-offs in 2010 and have observed some trends such as the slowdown in new non-accrual inflows in the last quarter and the reduced charge-off volatility mentioned previously, which may suggest a reason for optimism for the coming quarters. That having been said, we are much less confident in knowing how strong or sustainable any improvement in economic conditions might be.

  • We must also keep in mind that it will take some time before the benefits of any economic turnaround will be observable in our borrowers' balance sheets and profit and loss statements and, accordingly, translate to improved asset quality risk ratings. In addition, we believe that unemployment must improve meaningfully before we see any significant improvement in our retail portfolio risk dynamics.

  • In my final slide, we thought we would give you an update on our work with our new partner associates from the former Monroe Bank. As you would expect, we put into place our lending approval policies and underwriting overlays at the time of closing and have been operating under the same since that time as it relates to new loan requests and requests for renewals of existing loans. We also continue to gather updated financial information from clients on existing loans. With that information in hand, we will review those relationships to ensure proper risk identification and loan structuring.

  • With respect to those loans identified as troubled relationships, we've emphasized the criticality of understanding collateral values, especially commercial real estate collateral values in the current environment. We've also focused on the receipt and analysis of current financial information on these troubled credits. Both of these efforts are obviously made in an attempt to have as much information as possible to assure that our workout plans are appropriate and effective.

  • We've reviewed those loans currently identified as troubled relationships. As a part of that review, we have examined workout plans and evaluated each relationship to determine or confirm an appropriate course of action. Potential courses of action can range all the way from a sale in the secondary loan market of loans associated with a relationship to a hold-and-rehabilitate strategy.

  • At this point in time, we feel comfortable with the projections out of our due diligence efforts as to the level of problem assets, but have additional work to do around the impairment associated with those loans, as it appears it may be higher than originally forecasted.

  • With those comments, I'll turn the call over to Barbara.

  • Barbara Murphy - SEVP, Chief Banking Officer

  • Thanks Daryl. We celebrated the beginning of 2011 with the closing of Monroe Bank Corp. on January 1. You may recover that Monroe has approximately $800 million in assets, including $500 million in loans and $700 million in deposits and a total of 15 banking centers in both Monroe County and outside of Indianapolis. As of January 1, they also employed 203 associates. We plan for a May 14 conversion with two [MOT] conversions prior to the May 14 event, one accruing in March and the other in April.

  • We formed 19 teams made up of associates from both banks. These teams are focused on product mapping, IT conversions, customer communications, training, and operations consolidation networks. All mapping is complete and programming and data verification will be done at the end of February.

  • We have announced the consolidation of four banking centers in Bloomington. These offices are literally down the street from each other. We plan to occupy the Monroe Bank facilities and will be closing the Old National centers on conversion weekend.

  • The recent consolidation announcement also allows us to close two grocery store locations we had acquired outside of the Indianapolis region in the communities of Noblesville and Brownsburg from Charter One. We'll move to the new Monroe Bank full-sized regular retail centers there. These centers in the Indie region will also close on conversion weekend.

  • Our efforts are on track to realize more than 50% cost saves with this integration event. Some of these savings come from the branch consolidations where we will save the cost of 32 FTEs. Operations consolidations will also drive additional cost saves. These will take place after conversion and we can share more details about those impacts in our next call.

  • This concludes our comments for this morning. Operator, we are ready to open the line and take questions. Thank you.

  • Operator

  • (Operator Instructions). Scott Siefers, Sandler O'Neill.

  • Scott Siefers - Analyst

  • Good morning guys. I guess, Chris, probably the first couple of questions are good for you. They just both relate to the expense side. One, the discretionary bonuses -- just as we think about how that might manifest itself in 2011, whereas we had the $3.3 million kind of lump sum in the fourth quarter in 2010. Is that something maybe $1 million a quarter we would accrue for looking into 2011?

  • Chris Wolking - SEVP, CFO

  • Scott, I would say that, much like last year, it's all dependent on how well the year goes, so certainly include those if you think it's appropriate, but we certainly aren't including that in a run rate number here at the Bank.

  • Scott Siefers - Analyst

  • Okay. For our sort of outside modeling purposes, consider that something that took place in the fourth quarter? It's not -- as it's planned currently, probably not going to sort of catch up throughout 2011 or be forecast?

  • Chris Wolking - SEVP, CFO

  • Absolutely.

  • Bob Jones - President, CEO, Chairman

  • This is Bob. I just would add we've already communicated to our associates that we continue the suspension of our incentives for 2011. The Board and I have committed that. We'll look at it every order. If we see things appreciably much better than what we've built into our financial modeling, then we might be able to consider a discretionary bonus in the fourth quarter. But for modeling purposes, I wouldn't include anything in your models.

  • Scott Siefers - Analyst

  • Okay, perfect. That's helpful. then just a broader expense question -- you reiterated the efficiency ratio target for next year. I guess I'm just curious. As you kind of look at the mix of revenues and expenses that would help get you there, what's sort of order of magnitude of cost cuts that you could foresee maybe incurring or generating, I should say, as you look out over the next year or two?

  • Chris Wolking - SEVP, CFO

  • That's a very good question. I think, as we all know and you can sense from our reaction to our fourth-quarter numbers, we are very conservative about the revenue outlook for the Bank, so we don't have a significant amount of revenue built into our assumptions, so that implies some fairly significant cost cuts. So we are not prepared to talk about those kinds of targets right now. I think we just want to see how they transpire. But Scott, I will tell you that I meant it when the entire Company was engaged in this effort. It's a challenging exercise, but we know it's going to require a lot of work and everybody is on point with it.

  • Bob Jones - President, CEO, Chairman

  • Scott, I would add too that once we layer in Monroe and we go through their consolidations which we just announced and then you have the other activities, we'll be able to give you a better sense on next quarter's call. But safe to say we have a lot of wood to continue to chop in terms of reducing that cost level.

  • Scott Siefers - Analyst

  • Okay. That's helpful. Thank you very much.

  • Operator

  • Jon Arfstrom, RBC Capital Markets.

  • Jon Arfstrom - Analyst

  • Good morning all. Just one follow-up -- I'm not sure I'm going to get a great answer from you, Bob, but I'll ask it anyway.

  • Bob Jones - President, CEO, Chairman

  • Are you saying I don't give good answers, Jon, or what?!?

  • Jon Arfstrom - Analyst

  • No, I'm just saying that we'll just see how this one goes before I fire my next one. Where might management incentive come into play? I kind of look at it, and I don't have any problem with the merit increase or the incentives for the employees. But as a senior management team, what specifically needs to happen before you can go back to the Board and say, "You know what? As the senior management team, we've earned it." Because my view is you're working pretty hard. But I guess my question for you is what is -- what makes the Company successful enough to where you can say, okay, we deserve it as the management team?

  • Bob Jones - President, CEO, Chairman

  • That's a great question. And I can give you an answer. You may not like it. But I think the Board and I look at two components. One is the continued progress towards reducing cost. Probably -- more importantly is we need to see some growth in the topline revenue. So for us to go back to the Board in the fourth quarter, I'm going to need to see -- continue to see progress on the expense line. I'm going to have to see some growth in revenue. We cannot just continue to cost our way to prosperity, so I think it's a coupling of both of those.

  • I would further add, Jon, I think what -- my desire is that the associates that we gave a discretionary bonus to this year is clearly that first pool that we'd like to focus on. The next pool are the senior and executive leaders, absent myself, that we would like to go to next, and then ultimately, at some stage, you might consider giving me one. But I am the last one that would get paid in any kind of scenario that you just went through.

  • Jon Arfstrom - Analyst

  • Okay. That's helpful. I don't know, maybe, Chris or Daryl, can you comment a little bit on loan pricing for the quarter? Was there anything specific driving it, or is this more of a mix function?

  • Chris Wolking - SEVP, CFO

  • Actually, Jon, that might be -- Barbara could be a better one to answer that.

  • Barbara Murphy - SEVP, Chief Banking Officer

  • No, there was nothing specific driving this. It was just more of the same.

  • Bob Jones - President, CEO, Chairman

  • And that mix is important. We talked a couple of times about the increase in residential real estate assets, which we certainly see as better from an earning asset mix that investment portfolio assets, but certainly not as strong as commercial and consumer traditional loans.

  • Jon Arfstrom - Analyst

  • Then just maybe a question for you, Chris, on the buyback. I appreciate that announcement. I know your investors appreciate it as well. But how do you evaluate whether or not it makes sense at any particular point in time?

  • Chris Wolking - SEVP, CFO

  • I think it's all about -- as we talked about, Jon, our first deployment of capital, in our opinion, would be for attractive acquisition opportunities. So, that is still very active out there, as Bob said. So I think we will march forward with the buyback as we see those opportunities coming or going, and certainly dependent on the size and the type of acquisition that we actually do. Also, much like Monroe, we were delighted that our Monroe, new Monroe shareholders wanted our stock, and that gave us some ability also to consider the buyback.

  • Jon Arfstrom - Analyst

  • Is it something where you think you'll dip your toe in the water just to be active, or is it -- (multiple speakers)?

  • Chris Wolking - SEVP, CFO

  • It really is hard to say. I won't commit one way or the other at this juncture.

  • Bob Jones - President, CEO, Chairman

  • No, that's one we can't answer, Jon.

  • Jon Arfstrom - Analyst

  • Thank you.

  • Operator

  • Mac Hodgson, SunTrust.

  • Mac Hodgson - Analyst

  • Chris, maybe a question on the margin. I appreciate all the data you gave, and you might have commented on this -- the December margin up to 3.56%. I know you repaid the trust preferred in the quarter. As we look forward, is that kind of a good jumping off point for the margin?

  • Chris Wolking - SEVP, CFO

  • I like it. When you think in terms of the trend that we have seen and the fact that we did know that at 8% compared to everything else we've got on our balance sheet, that was pretty expensive funding. Given the nature of capital structure and the direction that the regulators are taking capital structure, it really didn't contribute much to our capital base. So we were pleased. It does give us some momentum going into 2011. We'll wait and see if that holds up or not.

  • Mac Hodgson - Analyst

  • Great. Then Daryl, on the Monroe, I think you mentioned the impairment may be a little higher than originally estimated. I believe the credit mark you all were taking was 5.5% to 6.5% was the range when the deal was announced. What sort of difference are you seeing as you go into those assets?

  • Daryl Moore - EVP, Chief Credit Officer

  • We are really not in a position to give that number yet. One of the things that we are working through is, as we calculate net present values for these, a lot of it is dependent upon current real estate values. We've ordered appraisals and are getting those appraisals in over time. So I really don't have a good number for you yet until we get all that information in.

  • Mac Hodgson - Analyst

  • Sure. That's fine. And then can you -- I forgot what this was when the deal was announced. Maybe, Chris, this is best for you. What's the expected capital, the impact on capital ratios, from the Monroe deal?

  • Chris Wolking - SEVP, CFO

  • (inaudible) it was 100% stock, so it really would be all of the tangible ratios. Let me take a look here. We happen to have this document in front of us. Our projection for tangible common and tangible assets was 8.7%. That compares to a 9.03% at June 30, 2010 and tangible common risk weighted at 13.09%. That compares to a 13.98% earlier in the year, so not a material change. Yes, it all depends on marks and all of those things that we are still working on.

  • Mac Hodgson - Analyst

  • Sure, one last one. Bob, on the -- Bob and Chris, I guess, on capital as well, on the dividend, I know you announced a repurchase plan. As you think about the dividend and (inaudible) things about the dividend, what sort of payout target is the Company reaching for? Then just try to give us a sense of when it might increase as earnings increase?

  • Bob Jones - President, CEO, Chairman

  • I think it's too early for us, given our view of the economy, to give you a payout ratio of the discussions we have with the Board. We'd say that, until we can get comfortable that the recovery is reality and we understand what normalized earnings are given the regulatory headwinds and the economy, that we can discuss payout ratios. I think that's part of the reason, in fact, the largest part. We went to the buyback because it gave us the flexibility with the M&A environment, as well as the regulatory issues, that we continue to work through. So we are just not at a point where we can think about discussing payout ratios until we hit some normalized earnings basis.

  • Mac Hodgson - Analyst

  • Great, thanks.

  • Operator

  • Emlen Harmon, Jefferies.

  • Emlen Harmon - Analyst

  • Thanks for taking my calls. I guess, on the loan growth front, I had a couple of questions. First is just in regard to residential real estate, obviously that portfolio grew pretty significantly in the quarter. I know you guys have mentioned it's the refi environment and that helping. Do you see -- is there any potential I guess for you to continue adding mortgages there and how comfortable are you because -- what size are you comfortable with that portfolio growing to?

  • Chris Wolking - SEVP, CFO

  • I think we continue to see the pipeline in that book be pretty good. We are comfortable with where we are on the balance sheet. We are looking at -- we don't like the longer-term assets, and we will make some decision to potentially sell some of the longer-term asset to maintain some of that duration flexibility we talked about. But it's such a small portion of the overall balance sheet, the yield we are getting off of that portfolio is very good and (inaudible), and the credit quality is very good.

  • Emlen Harmon - Analyst

  • Got you. Then maybe just across the other categories, kind of are you guys putting in place any efforts to grow loan balances organically? So I heard your message just kind of on line usage declining quarter-over-quarter. Do you guys have any efforts in place where you are trying to pick up share there?

  • Bob Jones - President, CEO, Chairman

  • Absolutely. I think we continue to focus, as we talked about at our investor day, the work that Barbara has done with the commercial banking unit, improving our turnaround from weeks to hours and days. We're very focused on that small-business group. We have re-energized the group. They are actively out calling. We do see opportunities but, again, you still see some cash balances that are pretty significant. In certain markets like Indianapolis, a fairly competitive environment where we are seeing some of our competitors being pretty aggressive on structural issues, and you have to balance the ability to grow versus the risk you want to put on. But no, we are very aggressive at it. Barbara, anything you want to add?

  • Barbara Murphy - SEVP, Chief Banking Officer

  • No.

  • Emlen Harmon - Analyst

  • Thanks for taking my calls.

  • Operator

  • Eileen Rooney, KBW.

  • Eileen Rooney - Analyst

  • Good morning everyone. Just a question on the timing of that FHLB termination. When did that happen in the quarter?

  • Chris Wolking - SEVP, CFO

  • I want to say in the first couple of weeks of October, pretty -- relatively early compared to when we called the trust preferred, Eileen.

  • Eileen Rooney - Analyst

  • Okay, great. What percent were those at?

  • Chris Wolking - SEVP, CFO

  • Boy, I can't even tell you. I don't know; I don't have that in front of me. There was a couple of them, and we restructured a couple of advances to week. I'm sure I can get that back to you.

  • Bob Jones - President, CEO, Chairman

  • We'll get back to everybody with that answer.

  • Eileen Rooney - Analyst

  • Chris, in your comments, I didn't quite catch this -- the TCE ratio target, TCE to tangible assets.

  • Chris Wolking - SEVP, CFO

  • That's 6%, and risk weighted assets is 9%. We talked about those at length at the Analyst Day. Unfortunately, you weren't there. Jon took copious (multiple speakers) lots of notes, but, again, I think we call those guidelines, so we are significantly higher than that right now. I certainly -- as we talked about then, we are not going to move down to those numbers aggressively. It's, much like earnings, much like incentives, everything is really driven around the economic environment and our M&A opportunities.

  • Eileen Rooney - Analyst

  • Got it. Then one last question. Once we're through this credit cycle, what is a long-term reserve-to-loan ratio in a normal environment for you guys?

  • Chris Wolking - SEVP, CFO

  • That's a great question that we can't answer. I'm not sure what normal is anymore. I would say that -- Daryl and I both come from the old adage when you build reserves during good times and you use them during bad times. So I'm not sure what that means other than we like reserves.

  • Eileen Rooney - Analyst

  • Okay. All right, thanks.

  • Operator

  • Stephen Geyen, Stifel Nicolaus.

  • Stephen Geyen - Analyst

  • Good morning. Maybe just a couple of questions for Daryl. You mentioned that the non-accruals or the inflows was down during the quarter to the lowest levels this year. I'm just maybe curious if you could reconcile the bit of modest jump in criticized class and classifieds (inaudible) maybe there were some larger loans that jumped into the criticized and classifieds that caused that increased relative to what you're seeing kind of across the portfolio?

  • Daryl Moore - EVP, Chief Credit Officer

  • Yes. I'll get to that. There were a couple of larger loans in the criticized area that came on in the quarter. And really the addition of those -- or those larger balances more than offset the handful-plus of loans that we resolved out of that category. So it was just kind of normal inflow/outflow in that category, but the inflow terms of size of individual loans was a little bigger.

  • On the problem loan, again, we had pretty good movement in and out of credits, but the credits that were moving in were just a little larger than the credits moving out, really nothing very unusual in the quarter. It's just the size of the individual credits.

  • Stephen Geyen - Analyst

  • Can you talk a bit about the change in flow in OREO?

  • Daryl Moore - EVP, Chief Credit Officer

  • In OREO?

  • Stephen Geyen - Analyst

  • Yes, OREO.

  • Daryl Moore - EVP, Chief Credit Officer

  • It's non-accrual. We had very little movement in OREO at all. As we look at our OREO properties, we only have one that's larger than $0.5 million. And so I think there's just not much happening in that category for us at this point in time.

  • Stephen Geyen - Analyst

  • Okay. Last question. You talked about Monroe Bank and the workout plan. You gave an update or some thoughts on kind of the size I believe when you announced the deal, the size of the credits you were looking at. Have you looked at -- I believe that was $500,000. Have you looked at credits. Is that kind of the standing number at this point, and maybe just the percent of the portfolio that is above or below that amount?

  • Chris Wolking - SEVP, CFO

  • I think that when we went in and looked at the due diligence, we were looking at those types of levels. We are in and applying our regular credit metrics to Monroe's portfolio today. So, we have a much deeper dive than the $0.5 million. Now, some of these credits will, in the regular cycle, come back around, and are not all being touched today. But it's business -- it's Old National business as usual on the Monroe portfolio. So it will take a couple of months to get through the bulk of it, but everything is being subjected to our regular internal credit process today. We are into the less than $0.5 million loans.

  • Stephen Geyen - Analyst

  • Great, thank you.

  • Operator

  • There are no further questions at this time.

  • Bob Jones - President, CEO, Chairman

  • Again, we appreciate everybody's interest and questions. If you have anything further, please give Lynell a call. Again, we apologize for the slight issue at the beginning of the call and hope everybody has a great day.

  • 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, www.OldNational.com. A replay of the call will also be available by dialing 1-800-642-1687, conference ID code of 32868739. This replay will be available through February 14. If anyone has additional questions, please contact Lynell Walton at 812-464-1368. Thank you for your participation in today's conference call. You may now disconnect.