Old National Bancorp (ONB) 2012 Q1 法說會逐字稿

Welcome to the Old National Bancorp's first-quarter 2012 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 OldNational.com. A replay of the call will also be available beginning at 1 p.m. central today through May 14. To access the replay dial 1-855-859-2056, conference ID code 70347875.

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.

Thank you, Brooke and good morning, everyone. Joining me today on Old National Bancorp's first-quarter 2012 earnings conference call are management members Bob Jones, Chris Wolking, Daryl Moore, Jim Ryan and Joan Kissel.

On slide 4, you will find 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 5 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 is 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 have planned a detailed financial and strategic discussion of the first quarter, please turn to slide 6 where you will see our agenda. Chris and Daryl will provide you with an in-depth look at our first-quarter performance with Chris discussing significant movement in various balance sheet and income statement items, including our net interest margin, as well as our strong capital metrics, while Daryl will update you on the continued improvement in our credit quality metrics and provide his commentary and our outlook in this area.

Bob will then provide a strategic update on the major factors impacting our current operating environment and Old National's focus area for the remainder of 2012 in response to these factors, as well as provide you with an update on our pending IBT transaction. Following these prepared remarks, we will be happy to open the line to take your questions.

Before we begin, I would like to thank Evansville's own Philharmonic Orchestra for graciously providing you the hold music you enjoyed before we began our call. With that, I will turn the call over to President-Elect of the Evansville Philharmonic Orchestra, Mr. Chris Wolking.

Thank you, Lynell. I will begin on slide 8 with earnings highlights for the first quarter. First-quarter net income was $21.7 million, or $0.23 per share. This compares to fourth-quarter 2011 earnings of $22.2 million, or $0.23 per share and first-quarter 2011 earnings of $16.4 million, or $0.17 per share.

When adjusted for first-quarter pretax merger and integration charges of approximately $800,000, our net income for the first quarter was $22.3 million, or $0.24 per share. The $800,000 in merger and integration costs in the first quarter includes expenses related to the Integra integration, as well as the pending acquisition of Indiana Bank & Trust.

Additionally, we incurred $1.9 million in costs related to the reappraisal of Integra-related other real estate owned. $1.9 million is the net cost to Old National after accounting for the increase in the FDIC loss share receivable. Fourth-quarter adjusted earnings per share was $0.27 per share adjusted for $5.2 million in merger and integration costs.

On slide 9, we note that core deposits at March 31, 2012 were $56.7 million higher than at December 31, 2011. Non-interest-bearing demand deposits increased $39.5 million for the period while customer certificates of deposit actually declined $72.9 million. So in the quarter, we saw healthy growth, plus a better mix of core deposits compared to fourth quarter 2011.

Net interest income for the quarter was $74.3 million, down $2.3 million compared to fourth quarter and up $12.9 million from the first quarter of 2011. Net interest margin was flat compared to fourth quarter at 4.20%. We saw a positive impact on net interest income from the accretion of the purchase accounting discount of the Monroe and Integra loan portfolios. Monroe accretion added $3 million in net interest income in the first quarter compared to $7.1 million last quarter and Integra accretion contributed $9.6 million compared to $6.3 million last quarter.

Fees, service charges and other revenue totaled $48.4 million for the quarter with $4.8 million attributable to the increase in our loss share receivable from the FDIC. The FDIC loss share receivable, also called the indemnification asset, declined by $10.4 million on our balance sheet from 12/31/11. Many factors contributed to the change in the indemnification asset, not all of which had current-period income statement impact.

Impacting the income statement was the $9.7 million charge to other real estate owned expense, which created a $7.7 million increase to the IA and did result in other income this quarter. Partially offsetting the $7.7 million increase in non-interest income was a $2.9 million decrease associated with an improvement in loss expectations for loans covered under the loss share agreement.

Non-interest expenses were $91.3 million in the quarter. $9.7 million of this expense was due to the lower value of the Integra other real estate owned I referenced above. Approximately $7 million of this $9.7 million expense was related to a single property in the Southeast United States.

Moving to slide 10, we have shown the change in pre-tax pre-provision income, not including securities gains and losses or merger and integration expenses. Note that the first quarter of 2012 includes the net impact of the Integra-related other real estate owned expense of $1.9 million. Even with the decline in the first quarter, our compound growth rate since the fourth quarter of 2009 is 26.2% annually, driven by our acquisitions and continued focus on reducing expenses in an economic environment that has made core revenue growth challenging.

Advancing to slide 11, you will see the changes in our loan portfolio over the last four quarters. There are several takeaways from this slide. First, average loans, not including the loans we acquired in our transactions, have declined since the first quarter of 2011. Average core loans were $3.771 billion in the first quarter of 2011 and had declined to $3.707 billion by the third quarter of 2011.

While still below year-ago balances, core loans have increased modestly from the low point in 2011. Much of our core loan growth has been due to growth in our residential mortgage loan portfolio, primarily our Quick Home refinance product.

While we continue to watch core loans closely, generating core loan growth is the most important goal of our banking relationship managers. Loans acquired in our Monroe Bank and Trust transaction have declined somewhat since the first quarter of 2011 and have been relatively stable over the last two quarters. We have worked out many of the impaired Monroe credits, but total loans could be impacted by further declines in this portfolio as additional impaired loans are resolved.

Average covered loans acquired in the Integra FDIC transaction declined $81.3 million from the fourth quarter of 2011. Non-covered loans, which are primarily consumer loans, declined $13.7 million from the fourth quarter. In total, average Integra loans declined $95 million compared to the fourth quarter of 2011 and represent the largest contributor to the decline in total average loans at the Company. Current Integra loan balances are consistent with our original performance expectations.

On slide 12, we have added information to provide a more complete picture of our outlook for growth in our core balance sheet. As I noted earlier, quality loan growth is the primary focus of our banking business unit. Commercial line utilization slipped a little from fourth quarter 2011, but has increased off the low we experienced in late 2010. At 36.3%, utilization currently, we are still lower than the 39.9% average utilization rate, which we experienced in the pre-financial crisis years of 2007 and 2008.

The commercial loan pipeline has also improved over the last half of 2011. Pipeline includes loans in the discussion phase, as well as approved and accepted loans. We believe the growth in first-quarter pipeline is reflective both of increased sales effort and increased need for borrowing from our current customers and prospects.

On slide 13, we provide a detail of our non-interest income for the quarter compared to previous quarters. As I said earlier, $4.8 million of our non-interest income was due to an increase in the receivable from the FDIC. Subtracting the $4.8 million from the total non-interest income for the quarter and subtracting $3.1 million in other income related to branch and property sales in the fourth quarter of 2011, our non-interest income increased approximately $600,000 from fourth quarter 2011.

As you can see though on the slide, service charges on deposit accounts declined $900,000 from the fourth quarter. With ongoing lower overdraft fee income, the banking business unit continues to evaluate our current account fees.

Comparing first quarter 2012 to first quarter 2011, you will note that insurance revenue was $1 million lower than the first quarter of 2011. Approximate $500,000 of the difference is due to lower contingency income compared to a year ago and $500,000 is due to other items, including the timing of premium payments from a customer we lost in 2011.

On slide 14, we have broken down our operating expenses for the quarter to give you a clearer picture of the progress we are making with our non-interest expenses. Obviously, the large expense related to the new appraisal of other real estate owned contributed significantly to our $91.3 million total non-interest expense in the first quarter.

Not including this other real estate owned expense incurred in the first quarter of $9.7 million, and acquisition and integration expenses in both the fourth quarter of 2011 and the first quarter of 2012, non-interest expenses declined from $88.5 million in the fourth quarter to $80.8 million in the first quarter, a decrease of $7.7 million.

Moving to slide 15, you will find our familiar trends in full-time equivalent employees and total employees. The first chart on this slide shows the trend in full-time equivalent employees since early 2009. By the end of 2011, our FTE employee count was 2551 and had increased during the fourth quarter due to overtime, the payment of accrued vacation and some post-conversion staff additions related to Integra. FTE employment was down by the end of the first quarter to 2530, reflecting a more normal post-conversion workload.

The second chart shows that total employees stood at 2679 at the end of 2011, primarily due to Integra associates that were transferred to the ONB payroll from the contract workforce for the newly converted branches and for additions to credit and other areas of the Company. Total employees increased by one associate during the first quarter of 2012. First-quarter staffing numbers do not include 81 contract Integra employees that were working at the Company as of March 31, 2012. This is down from 102 contract employees as of December 31, 2011. Contract associates are not on our payroll, but the cost of these associates are included in our salary and benefits expense line.

We continue to be focused on improved productivity and efficiency at Old National. Whether business unit or staff unit process improvements or expense savings opportunities related to the products and services we buy, we are committed to improving the Company's efficiency by reducing our expenses. An efficiency ratio of 65% is our aspirational goal and an important performance benchmark for our senior managers.

On slide 16, we provided a breakdown of the components of our net interest margin for the first quarter. Net interest margin on a fully taxable equivalent basis was 4.20% in the first quarter of 2012. The net interest income generated by the accretion of purchase accounting marks translated to an estimated 68 basis points of margin for the first quarter when annualized -- 16 basis points from the Monroe balance sheet and 52 basis points from the Integra balance sheet. The contribution to the net interest margin from the accretion of the purchase accounting discounts continues to be somewhat volatile.

We are seeing the beginning of the declining contribution from the accretion related to the Monroe balance sheet as we work out of the impaired Monroe loans. Integra accretion was slightly higher than anticipated in the first quarter due to improved expectations for future covered asset cash flows.

The net interest margin contribution from the core bank increased by 1 basis point compared to fourth quarter from 351 to 352. Core bank NIM benefited from the growth in demand deposits, the decline in certificates of deposit and the fourth-quarter maturity of our 6.75% subdebt. We also saw a slight increase in the yield of our investment portfolio to 3.33% in the first quarter from 3.28% in the fourth quarter.

For the remainder of 2012, we expect the net interest income contribution from the accretion of the purchase accounting mark of the Monroe balance sheet to decline. The Integra accretion should be stable during 2012, but some volatility is possible.

It is important to note that volatility in the margin contribution from changes to Integra cash flow expectations will be partially offset by changes to the FDIC indemnification asset. Combining these factors with our outlook for a stable to slightly lower core bank margin, second-quarter margin should be approximately 4%.

On slide 17, I graphed our tangible common equity to tangible assets and tangible common equity to risk-weighted asset ratios compared to the average ratios of our peer group. We are still maintaining capital ratios well in excess of the average ratios of our peers. TCE as a percentage of tangible assets increased from 8.97% at the end of the fourth quarter to 9.23% at March 31, 2012. Changes in tangible common equity and tangible assets both impacted the tangible common ratios.

GAAP shareholders' equity increased by $16.8 million from December 31 to March 31 due in part to the $0.23 per share earnings of the quarter combined with the $0.09 per share dividend. We continue to see significant unrealized gains in our available-for-sale investment portfolio, which contributed to an increase in OCI of $3.7 million. Goodwill and intangibles declined $2 million during the quarter. In the denominator, tangible assets decreased $27.1 million from the end of the fourth quarter driven largely by the decline in loans, which was offset partially by an increase in the investment portfolio.

Tangible common to risk-weighted assets ratio increased from 14.46% at December 31 to 14.88% at March 31, 2012. We continue to be mindful of maintaining the proper capital ratios given the inherent risk of our balance sheet. We expect to allow the IBT transaction to close and evaluate the resulting tangible equity ratios before we review other possible capital decisions. I will now turn the call over to Daryl.

Very good. Thank you, Chris and good morning to everyone. I would like to begin my remarks on slide 19 where you can see that we posted very strong results in the quarter with respect to both our 30 plus day, as well as our 90 plus day delinquency levels. As the top chart reflects, excluding covered loans, 30 plus delinquencies fell 33 basis points during the quarter to stand at 45 basis points at quarter's end.

As you can see, this compares very favorably to the 139 basis point results posted by the banks within our peer group for the trailing quarter. As you can also see from the chart, this 45 basis points represents the lowest level of delinquencies in the 14 quarters of performance shown. 90 plus day non-covered loan delinquencies, as you can see in the chart at the bottom of the slide, also fell in the quarter from 3 basis points to 1 basis point and continues to be at a level considerably lower than that of our peers whose average results are in the 55 basis point area.

If we dig into the individual portfolio of delinquencies a little deeper, for the quarter, we saw reductions in 30 plus delinquencies in each of the individual portfolio segments we track, including a reduction in our commercial real estate loan delinquencies.

On slide 20, you can see in the chart at the top of the slide that non-covered portfolio net charge-offs for the first quarter were $3.4 million, down from last quarter's level of $8.2 million. As reflected on the bottom chart of this slide, on an annualized basis, non-covered loan net charge-offs for the quarter were 33 basis points, down from 79 basis points in the fourth quarter, but up slightly from first-quarter 2011 where we posted results of 27 basis points.

Excluding covered, assets we recognized a $1 million provision for loan losses in the quarter, which was obviously less than the $3.4 million of net charge-offs for the period. Lower commercial portfolio balances, including criticized and classified credits that were moved out of the bank, had a major influence on the provision level in the quarter.

Overall consolidated losses in the non-covered portfolios were generally in line with or lower than targets established for 2012 with the exception of the commercial real estate portfolio, which experienced higher than target annualized losses in the quarter.

Moving onto slide 21, we have laid out net charge-offs separated by various portfolios for you. As you can see, the ONB core portfolio continues to perform well within the first-quarter annualized loss rate of 20 basis points. As the other portfolios which have come to us through our acquisitions mature, you can see that there is some lumpiness in results, especially in the Monroe portfolio.

It is important to note that while annualized net charge-off percentage within a category may be high, because of the size of the portfolio, the actual dollar amount of the losses taken in the quarter may be relatively small. For instance, with respect to the Integra non-covered portfolio, while the first-quarter loss rate was 3.52%, the net charge-offs related to this portfolio in the quarter were only $400,000. With portfolio average outstanding balances of only $44 million, the total potential impact on the Company is minimal. The elevated loss rate notwithstanding.

Moving onto slide 22, you can see that within the non-covered portfolio, criticized loans continued their downward trend showing a $3 million decrease in the quarter. Most of the decrease in non-covered loans in the quarter came from the ONB core portfolio, which, as you can see, fell by $2.3 million.

In addition to the decline in criticized loans, slide 23 reflects the continued trend of decreasing non-covered classified loan exposure. Non-covered classified loans fell $17.8 million in the quarter. $14.9 million of which came from the ONB core portfolio with an additional $2.9 million reduction contributed from the Monroe portfolio. Reductions in this category came from various avenues, including both upgrades, as well as payoffs.

As slide 24 reflects, non-accrual exposure fell by $2.3 million in the quarter. Non-accruals were down in the Monroe portfolio by $3.8 million while non-accruals in the ONB core portfolio increased by $1.5 million. Within the ONB core portfolio, the increase was predominantly related to the downgrade of commercial real estate loans.

Moving to slide 25, we see that, excluding covered and Monroe loans, the allowance coverage of non-performing assets improved 2 basis points in the quarter to 67%. While the ONB non-covered consolidated percentages reflect a 45% coverage, I would remind you that these numbers do not take into consideration the $27.6 million mark against the Monroe portfolio.

In this regard, if we move to slide 26, you can see that we have laid out for you what the combined allowance for loan losses and loan marks looks like as a percentage of the pre-marked loan portfolio. You can see that combined allowance and marks represent more than 8% of pre-marked Monroe portfolio and approximately 25% of the pre-marked Integra portfolio, which I would remind you is subject to our loss share agreement with the FDIC. On a combined basis, the allowance for loan losses and loan marks as a percentage of the pre-marked loan portfolio is 5.76%.

Moving past the credit quality slides onto slide 27, we wanted again to give you an idea of what our portfolio mix looks like with the covered loan assets included. As you can see, period-end covered loans from the Integra transaction totaled $548.6 million at March 31. This number reflects Integra-originated loans that carry the 80% loss share coverage and is net of $197.2 million mark.

Not included in the covered loan slice of the pie chart shown in yellow are approximately $44 million in Integra loans that are not covered by loss share arrangements. This set of loans consists mainly of non-real estate secured consumer loans.

Moving to slide 28, we show a breakout of the Integra covered portfolio by commercial and retail asset types and then further break down the asset quality rating distribution of the covered commercial assets. Commercial criticized, classified and non-accrual loans in this covered portfolio in aggregate fell roughly $13.2 million in the quarter with OREO balances down another $5.7 million. Covered loans 90 plus days or more delinquent declined $1.6 million in the quarter.

I would like to draw attention to the decline in the commercial grade one through six loans in the covered asset portfolio and make a quick comment about the same. You can see that we have had a somewhat meaningful decline in outstanding balances in this category since the end of the third quarter 2011. While some of the decline can be attributed to the undesired movement of relationships to other financial institutions, a segment of this reduction is a result of communications with selected borrowers of our desire not to continue to be involved in projects outside of our footprint.

Additionally, some of the reduction of outstandings in these categories came about as a result of the downgraded relationships into the criticized, classified categories, which makes our net reductions in those troubled categories even more notable.

Moving to slide 29, in summary, I would like to say it was another very solid quarter for the bank in terms of the reduction in our risk assets. Clearly, we continue to see an improving C&I portfolio with all major credit quality indicators that we track in that portfolio having an improved quarter.

With respect to the commercial real estate portfolio, however, risk assets continue at relatively high levels and it could be that you may not see this portfolio experience any material turnaround in the immediate term. We believe that we will have to see sustained progress in both occupancy, as well as lease rate metrics before any material improvement will be noted. In the meantime, many of our commercial real estate borrowers may continue to struggle to some degree.

The magnitude of the progress we will make in reducing risk assets throughout the portfolio over the remaining quarters of the year and equally as important the ability to grow our commercial portfolio during that same time period will depend, we believe, in great part on the levels of improvement in economic conditions.

Finally, we continue to make good progress with the Integra portfolio with our comfort level as to fully understanding the underlying risk in that portfolio continuing to grow over time. With those comments, I will turn the call over to Bob for final remarks.

Great, thank you, Daryl and good morning to everyone. My remarks will begin on slide 31. Chris and Daryl did an excellent job of providing you with the detail of our first-quarter results, a quarter that I would characterize as consistent with our forecasts with the exception of the large OREO expense related to Integra.

Before we open the call for your questions, I did want to provide you -- I wanted to close by providing you with our insights into the major macro and micro factors that we are focused on in the upcoming quarters. Our sense from conversations with our clients and prospects throughout the franchise is that the economy continues to recover at the same modest pace we discussed following the fourth quarter. We have begun to see employers increase their hiring to a point where a number of our clients have said they are having a difficult time finding employees.

The consumer continues to increase their spending throughout our markets, particularly in the real estate and the automobile segments, all of which should have a positive impact on future borrowings. Despite the hiring occurring within the C&I segment, a vast majority of our clients and prospects continue to use their own cash for capital expenditures and inventory expansion. Further validation of this point was seen in Chris' slide on line utilization.

Our agricultural segment has seen modest borrowings. Interestingly, what we have seen is a tale of two situations. Some clients have benefited from the higher commodity pricing and the result from that positive impact on earnings has reduced their borrowing needs. On the other side of the equation, the higher commodity prices have weakened some borrowers to the point where they may not meet our credit standards.

Given the Federal Reserve's continued focus on keeping interest rates low as part of their monetary policy, we anticipate that there will continue to be pressure on our net interest margin. While we were pleased that our core margin remained stable quarter-over-quarter, we do not anticipate -- we do anticipate moderate downward pressure on the margin.

A couple of comments relative to NIM. Given the large size of our investment portfolio and the fact that we remain slightly asset-sensitive, it would be very easy to begin to take additional risk in the investment portfolio to drive earnings. We will not do that. Much like our philosophy around credit, we will not sacrifice long-term value for short-term benefits. We very much view our investment portfolio as a tool to manage interest rate risk versus a key driver of earnings and as such, we will give up some earnings in order to manage risk.

Given our large marketshare in many of our markets and the fact we still have some large tranches of CD books maturing, we will continue to use our core deposits as a key tool to manage our net interest margin in conjunction with our disciplined loan pricing process.

We continue to remain committed to our M&A strategy and while there wasn't the normal slowdown in activity following the fourth quarter, we still believe that there will be opportunities for strong partnerships that are first and foremost focused on enhancing shareholder value. An important aspect of that value is ensuring that we can leverage our existing platform while increasing marketshare opportunities at the right price. The most important part is matching our expectations for shareholder return with the sellers' expectations.

Let me move on to the more micro factors we are focused on in the upcoming quarters beginning with the positive impact of purchase accounting. I wanted to label this bullet point as cocaine, but as is always the case, Lynell's common sense prevailed. I use the term cocaine because much like the drug, one can get addicted to the positive benefits of purchase accounting and allow it to mask the performance of your core bank.

Purchase accounting via accretable yield or the other positive financial impacts adds good value to our shareholders that improves earnings and increases capital. But at the same time, these earnings are not sustainable. We are very cognizant that these benefits tend to have a four to six-quarter life and if you do not realize that, you can get comfortable with the earnings that are not sustainable and you could wake up in banker's rehab.

Our continued focus is on improving our core bank profitability. M&A does that through leveraging our infrastructure and through core revenue growth. We also remain very focused on improving the balance of the core franchise and for us, that is a corporatewide focus on two key areas -- the first being quality loan growth and top-line revenue. For us, this is a continuing balancing act between our need for growth and our stated strategic imperative of improving our risk profile. Simply put, we will not sacrifice quality and returns for growth.

We acknowledge that this is a very difficult strategy, but with our market position, we are confident in our execution and believe it is the best long-term strategy for our shareholders. Chris covered our efforts on the other key area, that being expenses and improving our efficiency ratio. Our balanced approach of quality growth in revenue and controlling expenses is key. I would just remind you that a portion of our short-term incentive plan for our managers has a target of a 65% efficiency ratio. Thus, I can assure you we are all focused on this very important metric.

I am going to close with a brief update on Indiana Bank & Trust. Three months following the announcement of our partnership, we are even more encouraged. We love the franchise and the markets that they serve and the people at IBT have been terrific. For the most part, the client reaction has been positive.

Today, IBT did announce a loss of $2.6 million for the first quarter, mostly related to a fraudulent loan and targeted loan sales. Absent that, their performance was very consistent with our model. In addition, as noted in our press release, if we closed as of March 31, the exchange ratio would have been reduced slightly from 1.9 to 1.8241 based on a credit mark of $36.792 million as of 3/31/12. There was no adjustment in the exchange ratio for shareholder's equity or delinquency. Let me remind you this exchange ratio is subject to change either up or down between 3/31 and 10 days prior to closing, which we anticipate being in the third quarter. Brook, at this time, we will be glad to take questions.

(Operator Instructions). Stephen Geyen, Stifel Nicolaus.

Good morning. How are you guys today? Maybe just a couple of questions for Daryl. You mentioned the movement in the loan portfolio, the grade one to six outside of your footprint. And just curious how much credits remain outside of your footprint and whether you intend to move those off the books as well.

Yes, Stephen, I don't have the numbers or the dollars for you. I would tell you that if we have Integra borrowers that have no relationship with us and they are outside of our footprint, our strategy is to move those clients out over time. We can get back with you on the dollars, but I don't have those with me today. But that clearly is our strategy.

Okay. And the loan provision was driven I guess in part by classified and criticized loans. Just curious did you guys have any sales or was it just primarily driven by paydowns?

Just paydowns worked out through our special assets. We did not have any sales in the quarter to speak of.

Okay, thank you.

Scott Siefers, Sandler O'Neill.

Good morning, guys. How is everyone doing? Chris, I guess the first question is probably for you. Just on the OREO revaluation, I just want to get a little clearer perspective on how we should think about that maybe going forward. It sounds like this was pretty much a one-time thing, at least the overall dollar value being this high. But how frequently will those revaluations occur? Is that something that is kind of captured in I think the one-year lookback you have from an accounting standpoint or how can we think about that going forward?

Yes, and both Daryl and I will share some information on this. Scott, that large adjustment was related to other real estate owned, which, as you know, has a little different impact on the IA than what would be normally expected with normal cash flow expectations. So we would not expect to see anything of that magnitude going forward. It was largely taken care of this quarter. Not to say that something couldn't happen with appraisals, but that was a big number and something that we wouldn't anticipate going forward. Daryl?

Scott, we order and update appraisals on our OREO property at least annually. So as Chris said, it could be that we have appraisals that come in something lower than we have on the books today, but this was a very unusual circumstance, a very large relationship and as he said, we do not anticipate to have this magnitude of adjustment in OREO going forward.

Scott, just to add to that, I think Chris said in his remarks, this is a property down in the Southeast portion of the country and as you all know better than we do, the real estate values still haven't recovered in that portion, at least yet.

Okay, that is very helpful color and I appreciate it. And then just a separate question, Bob, probably best for you. I am just curious, as you look at kind of the changing complexion of the portfolio, you have got I guess a lot of runoff just in the acquired portfolios over the last several quarters. But then you have got the residential real estate piece that is showing some pretty nice growth and is becoming an increasingly large part of the overall portfolio. How do you think about the way the portfolio is changing? How large would you let the residential real estate piece go? I guess any color you can provide on your thoughts there I would appreciate.

Yes, Scott, I think we are comfortable with the growth as we see it for the upcoming quarters. Obviously, we would like to see C&I growth, which may temper some of our enthusiasm for keeping some of those real estate assets on the balance sheet. But given the rate environment and given the quality of that portfolio, we are still very comfortable with it. In a perfect world, I will grow that, as well as my C&I portfolio and get to that top-line revenue growth number we've talked about. But at this stage, we are comfortable and again, as you go back to the appendix on slide 40, you can see the quality of that portfolio continues to be very, very solid.

Okay. Yes, that's perfect. I appreciate it.

This is Chris.

I'm sorry.

I might add just one point too. I think that strong growth in the core deposit footings also gives us some comfort about adding those types of assets, adding real estate assets to the portfolio. When you have that kind of core deposit growth, it gives you a lot more flexibility with the asset side of the balance sheet and making decisions about asset growth.

Okay, that's good. I appreciate the color.

Emlen Harmon, Jefferies.

Hey, good morning. I guess, Chris, I would start off with a question for you. Could you give us a sense of just how you are thinking about overall balance sheet size, balance sheet size going forward? You talked to kind of good core deposit growth, but we are seeing still some runoff in kind of the other CD book in there. And should we be thinking about balance sheet growth going forward or is there still some potential runoff on the liability side where you can continue to shrink the securities book some going forward?

Yes, good question. Obviously, with strong deposit growth, we have to make some decisions about the asset side and therein lies the reason for a little bit of growth in our investment portfolio. But as Bob shared, our objective is to stay asset-sensitive and we would anticipate continuing to grow the investment portfolio with relatively speaking short duration assets.

In terms of overall size, the capital base gives us a tremendous amount of room to grow organically and that is certainly what we would like to see. And I would also say that, with large gains in our available for sale portfolio, we have lots of flexibility on the asset side as we see commercial loan growth. So I am very pleased about where we are positioning wise. We certainly can support any quality core asset growth that comes down the pipe to us.

Got you, thanks. And then I guess following up on that, you touched on hoping to see kind of commercial growth turning the corner and then at some point in the future here and Bob, in your comments, you noted that the demand environment still seems somewhat tepid, but could you give me a sense of just how competitive you are willing to get on the commercial side? What have you guys seen in terms of pricing and have you been able to kind of compete on that front at all?

Yes, great question. Absent Indianapolis, which let me remove that, but the balance of our franchise is competitive, but it is appropriately competitive. We are not seeing a lot of our competitors either taking structure or pricing risk. You are seeing a lot of aggressiveness, but I wouldn't say there is anything that -- the old adage, you can't compete with stupidity. We can compete in those franchises pretty well.

Indianapolis is very, very competitive right now. You saw a lot of new entrants to the market, which provides us some ability to work out of some portfolios. But it is also -- we are going to stay to our basic tenets, which is the point I made is our strategy is a little more difficult because we are not willing to sacrifice on structure. We will give a little bit on price, but we have got certain parameters. So I think everybody is focused on growth. I would just say we are focused on proper growth and over time, we think that is the best strategy.

Okay, thanks for taking the questions. I appreciate it.

Chris McGratty, KBW.

Good morning, guys. Bob, just a question on the deal. You gave color on the exchange ratio. Do you have the delinquency numbers for Indiana Community? I know you disclosed the other ones.

Yes, we don't, but we will get that for everybody. They didn't exceed any of the thresholds that were in our original agreement, but we can get that out to you. I don't have that. I just know that they were within the parameters and really we are not seeing a lot of change in that delinquency. And I would note that if you remove the one-time -- the fraudulent credit, marks have been pretty well.

On the core margin, I guess maybe can you just opine on when the accretion from these transactions kind of winds down, which it will over time? How are you guys thinking about kind of core margin at the bank?

As I said in my remarks, Chris, as you look at Monroe, we are really at the tail end of that benefit. We have been four quarters. We will get a little bit over the next couple, but we view that drug -- to go back to my cocaine -- as about a four to six-quarter. And so that is why we continue to focus so much on that core margin. And you are going to see some downward pressure on that margin, as Chris said. If you think about Monroe winding down, we will get a full-year, a couple quarters more of Integra for the balance of this year. So you are going to see some slight basis point reduction in that core margin. Chris, I don't know if there is anything you would add.

I always like to remind the group that the impact from Integra is a little bit different than what we would expect from Monroe because we have got a loss share partner on that. So they share on the good news and the bad news. So any lift that we would get in the margin due to improved outlook or quality expectations around those impaired assets will be subject to some changes in the indemnification asset, which will offset that.

That does also give us a little bit of comfort that we will have some stability, if you will, on that Integra margin going forward. But as Bob said, the Monroe contribution continues to -- the Monroe contribution continues to decline and we would expect that to begin to tail off here in the next few quarters.

Okay, great. And then one last one. What should we think about for an effective tax rate going forward?

We anticipated that question, but I didn't get the answer. Joan Kissel has the answer here, so I will let her add that color.

Okay. On a GAAP basis, we would imagine it would be probably 27% to 28%. On an FTE basis, it would be more like 34% to 35%.

Great, thanks a lot.

David Long, Raymond James.

Good morning, everyone. Most of my questions have been asked already, but the one that I still have left is looking at the total deposit cost up in the quarter despite a pretty nice shift in the mix, can you maybe just walk me through the costs there on the deposits and why the average costs moved higher in the quarter?

You might recall and unfortunately, I don't have the impact here from fourth quarter when we sold those deposit branches. We had a little bit of lift from core deposit intangibles, I believe, that would have lowered the CD costs. So the CD costs for the fourth quarter I think were about 40 basis points lower than they were first quarter this year. So that first-quarter number that we have got for our CDs is probably more representative of an accurate cost.

Now I think in our deck, we shared the runoff expectations or the repricing expectations -- it is in the appendix -- so you get a feel for the change in those CDs. But there is still some opportunity for us to see core deposit benefit as those CDs reprice. And the fact that we are continuing to get nice non-interest-bearing deposit growth has been a pleasant surprise. That number continues to be very resilient and still one of the cornerstones, I believe, to long-term franchise value for us. So I think on the deposit side, we will continue to have some benefits there, largely driven by CD repricing.

Got it. Thanks for the color.

Mac Hodgson, SunTrust Robinson Humphrey.

Good morning.

So you are down in that Southeast portion of the country here.

That's right, that's right. A couple kind of follow-up questions. A lot of my questions have already been answered. But on expenses, Chris, how should we think about that level going forward? Are all the Integra savings fully in the first-quarter run rate? Should we expect those to kind of continue to inch lower?

I think that is fair. There is still some timing issues there related to the Integra branches and those kinds of things. So I think that is something to look for. I wish I could give you some more definitive answers around that, but we just aren't able to do that at this time. So I would anticipate a little bit of increasing benefit there and we are working awfully hard on our core expense reduction initiatives and they never move fast enough for the CFO or they never move fast enough for the CEO. But I am very confident that whether it is on the procurement side or process improvements that we will see some benefit there going forward.

And I will tell you, that 65% efficiency target has really got particularly the staff units of the Company really engaged. So we are really swinging hard at that. Again, I can't give you any definitive numbers, but I can tell you that we are working awfully hard to bring that run rate down.

And on fee income, you mentioned service charges driven lower on overdraft. Is that seasonal or changing customer habits and what sort of changes would you expect making on the pricing side to offset that.

Yes, it is really all around customer habit. The beauty of Reg E and all the focus that has gone on in overdraft and financial literacy is you have seen a lot of behavior change out of the clients. So Barbara Murphy, who is running the bank, is continuing to look for opportunities to look for fees and other opportunities.

But the other side I would tell you is that we are fairly quick, if we see somebody that may have a lot of overdrafts, but it is behavior that probably presents a little more risk to us in terms of losses, we will ask a client to close out and I think it is consistent with our margin view and our loan pricing. I just don't want to keep getting overdraft fees for the sake of getting them. I think that there is more risk in that and quite frankly that client probably belongs at another institution that would be a little more tolerant of that behavior.

Maybe lastly on capital, I think you mentioned you would wait to close the Indiana Community deal before any capital actions. Does that relate to M&A as well? Would you wait on additional M&A until that transaction is closed and then remind us of your priorities on capital after that?

Yes, as you well know, M&A is not a perfect science, but ideally we would like to get this transaction closed and then our first priority after M&A would be we continue to realize the importance of the dividend and we still have the approved buyback. But we really want to get through IBT and see what the impact on our capital is at that time.

Has anything changed with the expected impact on your capital?

No, no, not at all.

Okay, great. All right, thanks.

Kenneth James, Sterne Agee.

Hey, good morning, gentlemen. How are you? I have a couple follow-ups just on a -- not to be too nitpicky -- but a couple of line item things here. On the FDIC asset indemnification or amortization, just kind of zeroing in on not the ORE stuff, but I guess the $2.9 million improvement. Is that consistent with what we would expect going forward out of that line kind of all else equal?

Interesting question. I think that is that element of volatility that I referred to and the benefit there is really in the margin. So the fact that our margin contribution from Integra was a little higher than we had anticipated is really resulting in that adjustment to the IA. So I wish I could predict those. I think it's --.

I wish he could predict them.

I think it is important -- we continue to remind everyone that there is still that 80/20 rule, that 80% of the good news and 80% of the bad news is really going to be subject to that FDIC override. So that is directly a result of the increased margin contribution from the Integra asset and that is the way we account for it. We try to match the timing of the news, both in the margin and in the other expense and other income line.

Okay, I guess the benefit you've -- I know that it has increased. I mean it goes over time, so I guess the opposing effect of that is spread out over time as well, right? So the $2.9 million is not just a strict one-time thing. I mean there has got to be some residual kind of drawdown of it.

That is exactly right. Now you are right because the IA change is also within the balance sheet as we filed our loss share certificates, there is different receivables and as we collect our cash from the FDIC. So there is other changes going on with the IA that are just balance sheet. But we will continue to try to call out all of the income statement impacts.

Again, I think it is important to note that that big change that we had was related to other real estate owned and that behaves a little bit differently in that you see all the results hit that statement at one time. And hopefully, we have got the biggest changes there behind us. But again, we could see something, as Daryl mentioned, in the future.

Okay. And then kind of circling back on the deposit costs or the CD costs, is any of that jump-up related to purchase accounting adjustments on any of the acquisitions or is that just the pure cost of the mix that remained after it shrank quite a bit this quarter?

There was a little bit of that, but I think the biggest change would be that change from fourth quarter to first quarter resulting from the sale of the CD book in the Chicago markets. I didn't -- as I was peeling back that onion, I didn't see anything other particularly noticeable.

We are still priced well below market on our CD book and as those tranches mature, we should get some benefit.

Okay. And then lastly on the closing of Indiana Community, you said third quarter?

Correct.

Care to guess will it be very near the beginning of the third quarter or mid -- just --?

You know I can't answer that.

Oh, okay.

We appreciate you trying though.

Just trying to get my model right, guys.

We continue to work. And Kenneth, I would just add it is the first time an analyst said I apologize for being picky because that is really your job, so we appreciate that.

Okay. All right, guys. Well, thanks a lot.

John Rodis, FIG Partners.

Good morning, guys. Just one quick question on I guess again on fee income, the insurance line item. Typically you see a spike in the first quarter and I didn't see maybe as big a one this quarter. Just wondering what was going on there.

It is really around contingencies. As you know, contingencies are driven by natural disasters, other areas, health of the insurance carriers and we were down about $0.5 million in contingencies. And then there is another $0.5 million that is related around timing of some premiums and then we did lose a client last year that would have been in the first quarter that is not in that first quarter this year. And so that aggregates about $1 million in total change in those fees.

Okay, thanks, Bob.

At this time, there are no further questions. I will turn the conference back to the presenters for closing remarks.

We have none. If you have any follow-up questions, as always, contact Lynell. We will get right back to you. I would just add we continue to try to do our best in disclosures around the FDIC and the acquisitions. So if there are still suggestions on things we could do better, let us know. Hope everybody has a great day.

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, oldnational.com. A replay of the call will also be available by dialing 1-855-859-2056, conference ID code 70347875. This replay will be available through May 14. If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Again 812-464-1366. Thank you for your participation in today's conference call. You may now disconnect.