Old National Bancorp (ONB) 2012 Q3 法說會逐字稿

Welcome to the Old National Bancorp third-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 PM Central today through November 12. To access the replay, dial 1-855-859-2056, conference ID code 35894910.

Those participating today will be analysts and members of the financial community. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will hold a question-and-answer session.

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

Thank you, Holly, and good morning.

We'd be remiss if we did not acknowledge the pending landfall of Hurricane Sandy and the potential impact that may have on many of you. Please know that from the Old National family, you're in our thoughts and prayers, along with you and your family and your colleagues.

Joining me today on Old National Bancorp's third-quarter 2012 earnings conference call are management members Bob Jones, Barbara Murphy, Chris Wolking, Daryl Moore, and Joan Kissel.

This conference call will contain forward-looking statements, and on slide three you will find the standard forward-looking statement disclosure. 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 differ materially from historical or projected performance. These risks and uncertainties include, but are not limited to, those which are contained in this disclosure and in the Company's periodic filings with the SEC.

Today's presentation also includes the use of non-GAAP financial measures, and you'll find the corresponding disclosure on slide four. 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 are useful supplemental information in understanding Old National's results and core performance trends. Reconciliation for such non-GAAP measures are appropriately referenced and included within the presentation.

Turning to slide five, you will see the specific third-quarter items we'll be covering today. Chris, Daryl, and I will provide you with an in-depth look at our third-quarter performance, including our continued organic loan growth, change in our net interest margin, various expense initiatives, and our strong capital position, as well as our credit quality metrics. Barbara will discuss our newest acquisition, Indiana Community, and the progress we're making in these new markets. Bob will then provide a strategic update, including an overview of the local economy and the current M&A environment. At the conclusion of our prepared remarks, we'll be happy to open the line and take your questions.

I'd like to begin our third-quarter performance review with slide six as I am pleased to announce Old National reported earnings this morning of $19.7 million, or $0.20 per share. The highlight of the third quarter was our closing and successful conversion of Indiana Community Bancorp. As such, we did incur $4.9 million of merger and integration expenses associated with this acquisition during the third quarter, compared to $0.8 million of acquisition expenses in the second quarter.

Conditions in the marketplace during the third quarter provided us the opportunity to improve the risk profile of our balance sheet as we sold $39.5 million of non-agency mortgage-backed securities. This sale, along with others, resulted in $2.7 million of securities gains in the third quarter. This compares to $6.2 million of securities gains during the second quarter of 2012.

Expense associated with the indemnification asset, which represents the amount we expect to collect from the FDIC under our loss share agreement, along with the amount related to the estimated improvements in cash flow expectations that are being amortized over the same period, for which those cash flows are being accreted into income, was $4.9 million for the third quarter. This compares to an expense of $4.0 million in the second quarter.

The quarter also contained $0.8 million in expenses relating to our branch optimization project, which we announced on August 16. We anticipate additional costs of $2 million to $2.5 million associated with this project in the fourth quarter of 2012. In addition, as we progress on our BSA/AML project, we anticipate up to $1 million of costs in the fourth quarter, as well as additional acquisition and integration costs of $1 million to $1.5 million associated with Indiana Community.

Now I'll turn the call over to Chris.

Thank you, Lynell.

I'd like to add a couple of comments to Lynell's highlights. Of course, the most important highlight of the third quarter was the closing of our acquisition of Indiana Community Bancorp in September. I will provide additional financial information related to the acquisition in a following slide, but I'd like to underscore how pleased we are to have completed the transaction. We are excited about the prospects in Columbus and southeastern Indiana and look forward to the contribution the company will make to Old National.

Included in the securities transactions for the quarter were $39.5 million in sales of non-agency mortgage-backed securities. The securities have accounted for much of our mortgage security other-than-temporary impairment charges over previous quarters.

As of September 30, 2012, $32 million of non-agency mortgage-backed securities remained on the balance sheet, down from $85.9 million at the beginning of 2012. The non-agency mortgage securities we sold had been carried as other classified assets. I have included additional detail on the investment portfolio in the appendix.

While we don't expect additional securities gains in the fourth quarter of 2012, we may sell securities to generate liquidity for our branch sales to sustain loan growth or to continue to reduce market risk on our balance sheet.

Moving to slide eight, you'll see our pre-tax, pre-provision income without securities gains and merger and integration expenses was $28.2 million in the third quarter, compared to $33.1 million in the second quarter and down slightly from $28.6 million in the third quarter of 2011.

This quarter, we adjusted the bar chart to show the contribution purchase accounting-driven accretion income has made to our pre-tax, pre-provision income. There are several fairly volatile items that are included in the non-accretion component of pre-tax, pre-provision income, most notably the amortization expense associated with the FDIC indemnification asset. So it is difficult to draw conclusions from the trend during 2012 of the non-accretion component of income.

But this graph does illustrate the fact that accretion income has been an important contributor to our earnings since the first quarter in 2011. In the third quarter, accretion income from acquired assets declined $2.5 million. Based on the trends we are seeing for the third quarter, total interest income from the Integra and Monroe purchased assets, which includes both accretion income and contractual interest, may be $20 million to $25 million lower in 2013 than 2012. We believe much of this will be offset by the interest income from the ICB purchase in 2013, however.

I noted that the volatility in the non-accretion component of pre-tax, pre-provision income, driven largely by the changes in the expense of the indemnification asset. In the first quarter of 2012, we had $4.8 million in income associated with the IA. In the second quarter, we incurred a cost of a $4 million, and in the third quarter, we incurred IA amortization expense of $4.9 million. Additionally, in the third quarter, we incurred $800,000 of costs related to our branch optimization program and over $200,000 in costs related to our BSA/AML project.

On slide nine, I've illustrated our success in managing the impaired assets acquired in the Monroe and Integra transactions. This graph presents the performance of the impaired assets only and does not include the income from the performing loans we purchased in the deals.

In the third quarter, loan interest income related to Monroe impaired assets was $1 million, compared to $3.3 million income in the second quarter. As we've noted in past calls, we expected this contribution to slow as we worked out of the largest of the Monroe impaired assets. You will note that the non-accretable component of the fair market value discount associated with Monroe impaired assets did not change significantly from the second quarter.

Loan interest income from Integra-impaired assets was $12.3 million during the third quarter, compared to $13.9 million in the second quarter. As we have seen in past quarters, significant increases in loan interest income from quarter to quarter on Integra-impaired assets is offset by higher amortization expense related to the IA asset. Recall from our loss share agreement that the FDIC absorbs 80% of higher expected losses and has paid 80% of anticipated recoveries.

As of September 15, 2012, the ICB mark to fair value of impaired assets totaled $47.4 million. By September 30, we had recognized $300,000 as loan income, and $11.6 million of the original discount was considered accretable yield. The remaining 3.5 -- $35.5 million of loan discount was considered non-accretable as of September 30.

Like we have done with the accretable and non-accretable discounts for Monroe and Integra impaired assets, we will provide a schedule of the performance of our acquired ICB-impaired assets beginning in the fourth quarter of 2012.

On slide 10, I've provided financial detail on the Indiana Community transaction. It is important to note that the loan mark and goodwill numbers are subject to change, particularly during the fourth quarter, if information becomes available which would indicate adjustments are required to the purchase price allocation.

The loan mark is lower than we anticipated in our due diligence in January because total loans declined during the protracted period between announcement and closing. The percentage discount declined because ICB was able to work out of several nonperforming and low-quality loans prior to closing. Goodwill increased primarily due to a higher-than-modeled ONB stock price at closing, the increase in the exchange ratio from 1.9 to 1.9455, and a lower-than-anticipated core deposit intangible.

Total merger and integration costs are expected to be $4 million to $5 million lower than originally planned.

While we don't yet have complete information on our expected income contribution from Indiana Community, we do expect that our expense savings will be over 35% of ICB's expenses. Earnings-per-share accretion for the first 12 months for our ownership of ICB should be higher than the $0.06 to $.08 per share we originally forecasted. I will be able to discuss more fully the likely 12 months' EPS impact after fourth-quarter results are available.

Moving to slide 11, you will see that the average loans, excluding those loans we purchased in our three bank acquisitions, increased $106 million from the second quarter of 2012 and $177 million compared to the third quarter of 2011. This is our second consecutive quarter of meaningful average core loan growth. It is important to note that Monroe purchased loans only decreased $3 million from the average balance of the second quarter, which may represent stability in that portfolio.

While we have had several quarters of growth in core residential real estate and consumer loans, core commercial and CRE loans also increased from June 30, 2012. End-of-period commercial and CRE loans, excluding covered loans and ICB loans, were $17.4 million higher at September 30 compared to June 30. We've now experienced two consecutive quarters of commercial loan growth. This is too early to be termed a trend, but it is good to see the commercial growth two quarters in a row.

Slide 12 shows a 36.3% commercial line utilization rate in the third quarter. While still under our average 2007 to 2008 utilization of 39.9%, line utilization has remained fairly steady in the 36% to 37% range throughout 2012.

The commercial loan pipeline declined $78 million during the quarter to $466 million. We experienced a high level of commercial loan closings during the quarter, however, which explains much of the decline in the pipeline. We closed $187 million in new commercial loans during the third quarter, compared with $175 million in the second quarter and only $98 million in the first quarter of 2012.

On slide 13, the graph shows non-interest income of $38 million, down $4.1 million from the second quarter of 2012. Other income declined $2.1 million, reflecting a decrease in income from the disposition of other real estate. Trust insurance and investment brokerage revenue declined $1 million from the second quarter, representing similar seasonal declines to that which we experienced in the third quarter of 2011.

FDIC indemnification asset amortization resulted in $900,000 higher costs in the third quarter than in Q2. Amortization of the FDIC indemnification asset reflected as a negative income entry in our quarterly results should continue as we work out of the covered assets. As of September 30, 2012, the indemnification asset on the balance sheet was $111.8 million, down from $168.1 million on September 30, 2011.

As I noted earlier, if loss expectation on the covered assets were to increase, we would see a decrease in interest income, an increase in other income, and an increase in the FDIC indemnification asset. Most likely, however, we will continue to see amortization expense in future quarters.

Total non-interest expenses, shown on slide 14, were $89 million, compared to $86 million in the second quarter. Core expenses were relatively flat compared to the second quarter, while ICB-related one-time costs increased to $4.9 million in the third quarter. We expect additional one-time charges of $2 million to $2.5 million related to branch optimization and $1 million to $1.5 million in costs related to ICB to be incurred in the fourth quarter.

Additionally, we should see $750,000 to $1 million in expense related to our project to improve our BSA/AML environment in the fourth quarter. Expenses related to this project should increase to $2 million to $2.5 million in the first quarter of 2013, due to an increase in professional fees associated with the project.

Slide 15 provides details on the branch optimization project we announced early in the third quarter, plus other expense savings and productivity improvement initiatives that are underway. The Company continues to work very hard on a variety of projects to improve productivity and reduce expenses. We believe in a disciplined, thoughtful approach to these projects to ensure we generate cost savings that are sustainable.

Recall that our branch optimization will result in the consolidation of 19 branches late in the fourth quarter of 2012 and the sale of an additional nine branches in Q1 2013. We should see the full impact of the expense reductions in the second quarter of 2013.

For the first full year after the consolidations and sales, we expect expense savings of $6.5 million to $7.5 million with net benefit before tax of $3 million to $4 million annually, depending on customer attrition. As of September 30, 2012, the nine branches under contract to be sold had $168 million in deposits. We do not anticipate selling loans with these branch sales.

Procurement is an area we believe has significant opportunity with. By centralizing certain procurement functions and introducing a consistent approach to our vendor contracts, we have saved almost $3 million over last year. Additionally, our procurement team has helped avoid future costs that would likely have occurred in contract and pricing negotiations and helped reduce one-time costs associated with our acquisitions.

Additionally, we are implementing operational scorecards within many of our business units to give us insight into productivity and to help identify process improvement opportunities. We have projects underway in several areas, including insurance, third-party claims administration, banking operations, credit underwriting, and accounts payable.

Moving to slide 16, I have provided a breakdown of our net interest margin. Net interest margin on a fully taxable equivalent basis was 4.09% for the third quarter, down from 4.26% in the second quarter. The net interest income generated by the accretion of purchase accounting discounts translated to an estimated 62 basis points of margin for the third quarter when annualized.

Accretion of ICB discount accounted for two basis points of margin, accretion of discount from Monroe accounted for 12 basis points of margin, and accretion from Integra assets accounted for 48 basis points. In the second quarter, Monroe margin contribution was 21 basis points and Integra contribution was 55 basis points. Income from accretion from Monroe assets declined $1.8 million and income from Integra accretion declined $1 million compared to second quarter.

Because the ICB acquisition closed on September 15, accretion income related to ICB was not significant for the third quarter. We will provide an outlook on ICB accretion income for 2013 at our 2012 fourth-quarter earnings call.

If we consider net interest margin using third-quarter earning assets as the denominator in the calculation for comparability, the core NIM may decline another 2 to 3 basis points in the fourth quarter. Continued repricing of our CDs should help lower the cost of liabilities going forward, but investment cash flows are being reinvested into securities at lower yields than our average portfolio yield. Even with continued loan growth, asset yields will likely remain under pressure.

We added slide 17 to show you our trend in tangible book value per share. Tangible book value per share ended the quarter at $8.04, down 3.7% from the second quarter's $8.35 per share. The tangible book value was impacted by the goodwill and intangibles associated with the Indiana Community closing and this quarter's earnings. Primarily, of course, the per-share book value was impacted by the issuance of 6.6 million shares of common stock for the purchase of ICB.

As you can see in the trends, we have increased our tangible book value per share since the first quarter of 2010, during a period when we have been actively acquiring banks for cash and stock. While we acknowledge that purchase accounting-driven accretion income has helped increase book value, we believe that we've done an effective job utilizing equity by returning an appropriate dividend to our shareholders and simultaneously building long-term shareholder value with quality acquisitions.

Our focus over the past several years on building tangible equity has put us in a strong position and gives us many options going forward. As we consider the impact of new or potential regulatory requirements that may impact capital, evaluate acquisitions, and finish our budget for 2013, we will have a clearer picture of near-term capital requirements. Our priorities for utilizing capital remain organic growth, acquisitions, and to return capital to shareholders. We will balance these priorities as the opportunities are presented to us.

In the near term, we believe organic growth will be modest at best, but we continue to expect opportunities to acquire banks and bank branches in markets that will add value to ONB shareholders. I'll now turn the call over to Daryl Moore.

Thank you, Chris, and good morning to everyone.

I'd like to begin my remarks this morning on slide 19, where we have laid out net charge-off trends, separated performance in our core portfolio from that of our three most recent purchased portfolios.

As you can see, the ONB core portfolio continues to perform very well, roughly $0.5 million in net losses, representing 6 basis points of net charge-offs in the third quarter.

With respect to the Monroe portfolio, we did post net losses of approximately $600,000, the majority of which was centered in one credit, which resulted in 75 basis points of losses in the quarter. While relatively high compared to the other portfolios, you can see that the quarterly trend continues in the right direction.

We had good successes in the Integra portfolio where, as you can see, we were in a net recovery position in the quarter. On a consolidated basis, you can see that our net charge-offs in the third quarter on an annualized basis were a very respectable 3 basis points, continuing a three-quarter trend of lower loss rates.

Moving to slide 20, we can see that, excluding the covered Monroe and Indiana Community loans, the allowance coverage of nonperforming assets fell 5 basis points in the quarter to 54%. This decline in coverage came about mainly as a result of an increase in restructured loans in the ONB core portfolio.

The increase in this restructured category was driven mainly by the addition of a $9.4 million commercial real estate exposure in our Indianapolis market. This loan is currently a performing accruing asset, but met the definition of a restructured loan in Class V accordingly in the quarter.

While the ONB noncovered consolidated percentages now reflect a 27% coverage, I would remind you that these numbers do not take into consideration the $20 million currently outstanding mark on the Monroe portfolio and the new to the quarter $84.7 million mark on the Indiana Community bank portfolio. Obviously, it is the addition of the Indiana Community Bank nonperforming loans brought over at fair market value without a corresponding allowance which was the most significant contributor to the decrease in coverage ratio in the quarter.

As we move to slide 21, you can see that we have laid out for you what the combined allowance for loan losses and loan marks look like as a percentage of the pre-marked loan portfolio. You can see that combined allowance and marks represents slightly more than 6% of the pre-marked Monroe portfolio and roughly 15% of the Indiana bank portfolio. Additionally, you can see that the allowance in mark on the Integra portfolio remain in excess of 25% of the pre-marked Integra portfolio, which, I would remind you, the majority of which 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 5.81%.

Slide 22 shows a breakout of the Integra covered portfolio by commercial and retail asset types, and then further breaks down the asset quality rating distribution of the covered commercial assets. Commercial criticized, classified, and nonaccrual loans in this covered portfolio, in aggregate, fell roughly $17.6 million in the quarter and OREO balance was up $6.6 million. Covered loans 90 day or more delinquent declined $0.5 million in the quarter to stand roughly at $100,000 at quarter's end.

On slide 23, you can see that we again had very strong results in the quarter with respect to both our 30-plus- and 90-plus-day delinquency levels. Delinquencies exclusive of the Indiana Community Bank portfolio stood at 52 basis points at quarter's end, up slightly from the 47-basis-point level at the end of the second quarter. Delinquencies associated with the Indiana Community Bank were much higher at 200 basis points with a material portion of these coming from the residential real estate portfolio.

Because of the timing of closing and conversion, workout days -- excuse me, work days to collect the residential portfolio were more limited than usual, which we believe was a contributing factor to the higher delinquency level in this portfolio. We are hopeful that renewed collection efforts will reduce the level of delinquencies in that portfolio as we move along over the next several quarters. Even with this increase, the 65 basis-point level of delinquency on a consolidated basis continues to compare very favorably to the 129 basis-point results posted by banks within our peer group for the trailing quarter.

As you can see at the chart at the bottom of the slide, 90-day-plus noncovered loan delinquencies continue at very low levels with this quarter's results, again, at 1 basis point. These results continue to be at a level considerably lower than that of our peers, whose average trailing quarter results stood at 59 basis points.

Moving to slide 24, you can see that within the noncovered portfolio, criticized loans rose for the second straight quarter, increasing by $32.2 million. $24.5 million of this increase came from the acquisition of the Indiana Community Bank portfolio, with the remaining $0.7 million coming from the Old National noncovered portfolio. Within that remaining ONB noncovered portfolio, we saw the addition of 11 loans to our largest 20 criticized list in the quarter, so the increase was significant in terms of the numbers of credits added. Until we see a meaningful improvement in the economy, we may continue to see credits downgraded into this special mention category.

Classified loans also showed an increase in the quarter as well, as shown on slide 25. Uncovered classified loans rose $51.6 million in the quarter, $29.3 million of which came from Indiana Community Bank, with the remaining $22.3 million increase coming from ONB's noncovered portfolio. Here again, we saw the addition of six loans to our largest 20 classified loans in the core bank portfolio, so the increase was certainly notable. Increases in these classified loans in the ONB noncovered portfolio were not limited to any particular industry or geographic region.

As slide 26 reflects, nonaccrual exposure increased by $62.1 million this quarter, due entirely to the Indiana Community Bank acquisition, which added $67.1 million in accruals -- or in nonaccruals for the balance sheet. Without the Indiana Community acquisition, non-accruals would have declined by $5 million in the period.

On slide 27, we again laid out for you our agriculture exposure, which we believe is important to note given the ongoing effects of the summer drought on this segment. As you can see, our total exposure is just north of $300 million, which represents slightly less than 8.5% of our total commercial loan exposure and roughly 29% capital, plus the allowance. Most of that exposure is to borrowers in the crop farming segment.

While final numbers have not yet been documented in the form of financial statements presented to the bank by our farmers, the general consensus is that because of crop insurance coverage and some late rains, the crop farming segment may not be impacted as severely as once anticipated. And as we noted last quarter, over the last several years farm operating results have been solid and should provide some additional cushion for this borrower set.

Livestock segment, however, is a very different story with borrowers in that industry suffering dramatically, mostly as a result of high feed prices. Charge-offs in the third quarter included $700,000 in write-downs for this segment of the portfolio. We will continue to monitor the agricultural situation and act accordingly as we get more clarity around final yields.

In summary, while the addition of the Indiana Community Bank asset certainly had the effect of increasing our criticized, classified, and nonperforming loans significant in the quarter, we also saw meaningful increases in the criticized and classified categories within the core bank noncovered portfolio. With the core bank noncovered criticized loans now up in two consecutive quarters, coupled with the current quarter increase in classified loans, we are paying close attention to the seemingly increasing risk in our commercial lending portfolios. Certainly, our client base continues to be very cautious and guarded about near-term economic prospects, and as I said, we will continue to watch [grade] migration dynamics closely.

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

Thank you, Daryl.

As has been mentioned, two weeks before the end of the quarter the Indiana Community Bancorp transaction was closed and the conversion occurred over the weekend of September 15.

Of the original 17 locations, we've aligned three offices in southern Indiana to be managed from our Louisville region. 11 locations in Columbus, Seymour, and other local communities are now folded into our Bloomington north central region. We have expanded the responsibilities of Mark Bradford, a region president and former CEO of the Monroe bank, which we acquired in 2011, to grow and further develop the combination of these strong north central Indiana markets.

We've already consolidated two locations and we will close a retirement village banking location in January. In addition, we were able to consolidate one of our existing Old National locations in Indianapolis into one of the Indiana Community locations.

Before the conversion event occurred, we were able to change deposit pricing and the deposit product lineup, including the elimination of free checking. As occurred with us when we eliminated free checking, we have experienced an exit of small-balance Indiana Community DDA accounts, but balances are still solid with about $740 million at the end of September.

Commercial loans that are not special assets are primarily being managed in Indianapolis where Indiana Community had an LPO and in Columbus, with a very small proportion being handled out of Louisville. We've been able to absorb the loans in Indy with current ONB relationship managers and one Indiana Community relationship manager. In Columbus, we've created a new market president role and promoted Zac Nelson, who has extensive commercial background and is now managing our relationship managers there. We lost a couple of relationship managers to local small banks and already hired replacements, one of whom worked at Old National several years ago and has come back.

Zac Nelson will also be working with Jody [Literal], the senior vice president of the Indiana Community trust organization, who, along with the entire group of trust associates, has elected to be part of our organization, and we look forward to the added benefits and high-profile clients they will bring to our combined team.

Because of the strong demographics and opportunities for expanded product offerings, we've already hired one brokerage services rep to serve the Columbus market and are hiring an additional mortgage loan originator.

Many of you know Columbus is home to Cummins Engine, who is a strong employer locally as well as nationally and internationally. Cummins recently announced a reduction of about 1,500 jobs. Local intelligence tells us 100 to 120 of these job reductions are in Columbus and Seymour. They are reported to be plant production personnel who are close to retirement age, and there are no administrative nor professional level jobs that are impacted, and the reduction will occur at year-end.

In addition to brokerage services and mortgage volume, and our regular deposit and loan activity, we're also seeing some activity with indirect auto dealers and some loan volume starting to come through these outlets, which is also a good indicator of future business to come.

In conclusion, we've been active for two weeks before quarter-end and three weeks since, and I can confirm that, at this stage, this new market will provide a nice growth opportunity for us. The integration process seems to be more active and ahead of pace from where we usually have been with prior deals.

I'll now turn the call over to our CEO, Bob Jones.

Thank you, Barbara, and let me just begin by reiterating what Lynell said. Our thoughts and prayers are with all of you that may be affected by Hurricane Sandy. Please let us know if there is anything we can do to assist you.

As we wrap up Old National's third-quarter 2012 analyst and investor call on slide 31, I thought it would be helpful to provide you with a review of the economy in our markets, as well as other business factors that may impact your 2013 earnings models.

First, I wanted to share my perspective on the third quarter. This quarter is symbolic of the nuances that purchased accounting can have on reported earnings. As we have spoken about in prior quarters, most of the significant benefit of accretion attributable to purchase accounting has a potential life span of four to six quarters.

This quarter, we saw the benefits of the accretion attributable to our Monroe acquisition significantly reduced. We would anticipate you may see that happen with our Integra acquisition in the first half of 2013. Obviously, some of that potential reduction in accretion will be replaced by our recently closed transaction, but I would encourage you, as you think about your 2013 models, to anticipate the reduction of this benefit from prior acquisitions.

Also as you build your models, remember that we had to issue 6.6 million shares for the acquisition of Indiana Community Bank, taking our total share account to 101.4 million shares.

In addition to the impact purchased accounting has on our earnings, we also saw this quarter the continued volatility of our indemnification asset with the FDIC, which had a negative $4.9 million impact on the quarter, as compared to $4 million last quarter. As we continue to work through this portfolio, we would anticipate that this volatility will continue and could have a negative impact on our reported earnings.

Our goal all along has been to give you clarity into the core earnings of the Company, and from that perspective I was pleased with the quarter. We are obviously very happy with our continued loan growth across both commercial and consumer segments, and remain cautiously optimistic for the potential of growth going forward. We are benefiting from the hard work of our associate and we are truly beginning to take advantage of the market share we have built in many of our key markets.

This ability to take advantage of our market share was reflected in our net interest margin. Our core net interest margin was virtually flat at a time when we grew loans, which affirms that we are still able to maintain our pricing discipline. In fact, the greater challenge with our margin is our desire to minimize the risk and duration in our investment portfolio.

In light of our loan growth, we also remain diligent in maintaining our focus on credit quality. As reflected in our net charge-offs, we have an historical track record of a conservative credit culture and we are all committed to ensuring that this imperative is still met.

Finally as you think about the quarter, I was pleased with our focus on core expenses. The expenses related to our closing on Indiana Community, our branch optimization project, and our efforts to improve our BSA/AML system masked some of the progress that we have made. But we remain deeply committed to achieving our aspirational target of a 65% efficiency ratio, though I must admit a little lift in interest rates would certainly help.

The highlight of the quarter was clearly the completion of the Indiana Community transaction. Barbara gave you a great overview of the integration. I would just add that the attitude and morale of our new associates is tremendous, and we are very pleased with the acceptance in our new markets.

I will close with a few general observations on the economy and the mood of our business and consumer clients. Overall, the economies in our markets remain in a slow recovery, but I will say that once I made my polling of our clients this quarter, more than one has raised the issue that the recovery appears to be slowing. This was visibly evidenced by what Barbara spoke about with Cummins's recent announcement of layoffs in excess of 1,000, less than 10% of which are in our markets.

This slowing recovery is reflected in the increase in our classified and criticized assets and is also a direct reflection of the confidence of our business owners. The Indiana Business Council just released their business confidence index, and it shows the confidence of business owners in our markets at a two-year low. Business owners cite the gridlock in Washington as one of the key issues, along with the impact of the Affordable Healthcare legislation. Many cite great frustration with our political leadership.

On a positive note, Indiana was named one of the top 10 states to do business with by a national site selection group. We were the only Midwest state recognized, and the group specifically noted Indiana's reduced corporate tax rate, along with property tax caps and a prepared workforce.

The consumer has a much better view of their future. The IU Kelley School of Business, in conjunction with the Indiana Business Research Center, completes a monthly poll of consumer confidence, and their October results show the highest level of consumer confidence in over two years. This may be fueled by historically low interest rates and the resurgence of the housing market.

In closing, we remain committed to our focus on mergers and acquisitions. Like many of you, we anticipated that there would be much more activity than what has occurred. As we speak with potential partners, a couple of potential reasons appear to be creating the logjam. There still remains a discrepancy between seller and buyer expectations, somewhat fueled by a belief that the economy and industry may recover quicker than many of us expect. We believe that this may be tempered in the near future when the reality of the slow economy and continued low interest rates are compounded by the regulatory changes in Basel III.

With those comments, Operator, we will now be open -- happy to open the line for questions. And thank you for your time.

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

Good morning, guys.

Scott, if nothing else, you're consistent, buddy.

I try. I try. I appreciate that acknowledgement, though. I hope you guys are doing well.

I just had a couple of questions. Chris, maybe first one for you. I appreciate the commentary on the direction of the core margin, and I know it sounds like there's going to be a little more clarity on the PAAs, the ones we introduced -- or now that we've introduced Indiana Community maybe with 90 days or so from now. But to the extent you can, just was curious if you might venture a guess on reported margin for the fourth quarter.

I would really feel more comfortable not. I think, Scott, it's that question about IBT and the combined continued march down of Monroe and Integra. I'd really rather talk a little bit more about that after we see a full quarter of ICB.

Okay. All right. Sounds good.

And then, Bob, next question was for you, kind of dovetailing on the comments that you made in your closing remarks. As I look at things for the last couple of quarters, obviously there is a little noise introduced in the equation with the balance sheet of INCB, but basically the last couple of quarters your guys' loan growth has been a little stronger than I might have anticipated. Beyond the comments that you cited sort of countervailing commercial, maybe slowing consumer may be a little better, I wondered if you could speak to the competitive dynamics or where you guys stand in that field and how you see things from that perspective.

Happy to. I hope everyone noticed that while we can't give you any optimism for the future of loan growth, we can surely maintain our negative view on credit cultures. If nothing else, we're consistent.

Scott, I would say that, as always, Indianapolis remains extremely competitive. We are seeing competitors, both on structure and pricing, be pretty aggressive. Fortunately, the pricing dynamics in Indy are more on the larger credits and our more national partners. Structure tends to come down more into the smaller credits, and again, we won't get into those games.

Absent Indianapolis, it's competitive. You see good, strong competition, but I would say that it's rational in most cases. Again, smaller banks tend to be a little irrational. But for the most part, we're able to take advantage of that market share and have a fairly level playing field of competition. Again, Indy's tough, and Louisville is coming along a little more difficult, but we have a little better opportunity in Louisville.

Okay. Perfect. And then, I guess along those lines, what you mentioned on credit, I guess last question for you, Daryl. On the one hand, certainly sort of a characteristic, cautious tone from you. By the same token, I think the charge-off numbers have been extraordinarily low, somehow even lower this quarter. I guess to a certain extent, I also still remember your comments from, I guess it's probably five years or so ago now, right at the start of the real estate downturn, as kind of a precursor to what actually happened.

I guess if you could sort of characterize your magnitude of concern on things you're seeing, or is it just your general conservatism? However you can answer that kind of question qualitatively.

Sorry that we're all laughing here, Scott. We're all looking at Daryl to see how he's going to answer.

(Multiple speakers) inherent conservatism, so (multiple speakers).

Scott, I think that maybe the difference this time than where we were five years ago is if you look at many of our mid- and small-sized businesses, they're just holding their own, right? So they've not had good strong topline revenue growth. They're managing their margins pretty well. Their expenses are well managed. But any kind of blip that comes along seems to set these guys back a little bit more of a higher magnitude than when things are going great.

So if you've got a company that has just been clicking along okay, when you get some margin compression, then it kind of sets them back. If the topline revenues come down for a quarter or two, it's going to set them back.

So this environment is more susceptible to higher credit risk in our portfolio of these little blips than we were five or six years ago. If the economy doesn't improve, that's going to continue with our clients and we could see some increasing risk. If the economy turns back around, I don't think you're going to have a wholesale big increase in risk in the portfolio. It's just where this economy is going, I think.

Yes. Okay. That makes sense. I definitely appreciate the color, guys.

Thanks, Scott. And again, thoughts and prayers with all of you on the East Coast.

Dan Werner, Morningstar.

Couple quick questions. You discussed the line usage of Old National. How does that compare to what you've brought on with Indiana Community customers? Is there a significant difference between their commercial customer usage and yours?

Yes, Dan, I would say this. The Indiana Community profile is probably a little less C&I, a little more small business and commercial real estate, so their line utilization would probably be a little higher, if I had to wager a guess. But they probably don't have as many lines committed. So as you are building those models, I wouldn't think much about variable usage of lines in the IBT portfolio.

Okay. And then, on page 34 of your -- of the review, I'm looking at the balance sheet and looking at the deposits and the organic change on some of those deposit categories. Was the organic change primarily from Old National or was there some contributed by Indiana Community? I'm trying to get a better sense of, since it is such a recent closing, how much anticipated runoff on deposits are you going to get, especially given the branch consolidation that you guys are currently undergoing within Old National and Indiana Community?

So Dan, that would actually be just the IBT -- or the core Old National prior to IBT.

Okay.

So that is more -- the large runoff in the non-interest-bearing DDA, we had one large client in our Bloomington market that was a hospital that got bought, and they consolidated their accounts in the parent, and unfortunately the parent didn't bank with us. The balance of that is really Barbara's work at trying to reduce deposit costs and margins. But the larger run down there is a singular client, almost, who had significant balances in Bloomington.

And these are quarter-end numbers, so they're just subject to some inherent volatility, but I think important to note there is the change in other -- what we call other time deposits, which is our CDs, our most expensive core deposit. And back and forth, we see some of that stuff moving into lower-expense transaction accounts, but some of it is leaving the bank, which has been a help to our margin on the core side.

Okay. Okay. All right. Thank you.

Jon Arfstrom, RBC Capital Markets.

Just a question on commitments. I didn't find the number; I didn't hear you talk about it, but can you maybe give us an update in terms of commitments during the quarter?

Loan commitments?

Loan commitments?

Yes. Yes.

We'll have to get back to you on that. We'll pull the number and we'll make sure everybody gets that number. We don't have it off the top of our head, Jon.

Okay. I mean, I guess that it gets to the question of some of your tone is a little bit cautious, but we've all come to expect that from you. On the other hand, we have the commercial loan up and the commercial real estate up, and I think some pretty good description on the pipeline.

Then I guess what I'm trying to get at is, are you optimistic? Do you think you can keep this pace up going in terms of loan growth, because obviously the core numbers are pretty decent?

You know, I would say cautiously optimistic. I think -- and I probably should let Barbara speak. She's the one who does all the work.

But we are seeing a lot more activity out of our RMs. And I would tell you that the one thing I've noticed a significant change, Jon, we've been able to take advantage of market share in many of these markets, whether it's Terre Haute, Evansville, Bloomington, which gives me some optimism. But as you know, we're never very optimistic on the upside. We're a little more pessimistic on the downside. Barbara, anything you would add?

No, I think that covers it.

Yes, but reasonably optimistic. I think the activity level continues. The calling activity is there. The pipeline dropped a little bit because of closings, but we're tracking it weekly and I think the activity level is consistent over the last three quarters. So as much as the economy continues to drag, I think we're as optimistic as we can be.

Okay. Is the pipeline becoming increasingly commercial and commercial real estate? I understand it's probably still residential heavy, but maybe a little bit on the mix?

That pipeline would not include any residential. It's all C&I and CRE. It's a pretty good balance.

Okay. Good. Okay, that's helpful. And then, I guess in terms of the M&A, you talked about the dam breaking. Maybe anything qualitative you can add in terms of -- has the mood of the sellers been softening at all? Are there more conversations? Just maybe an update on that front.

You know, I'd say we're seeing -- books maybe have picked up a little. I think conversations are consistent with where they've been. I think we'll be able to judge the better mood after we get through reported earnings and people get the reality of the margin.

I think as you all know -- you're smarter than I am. You're seeing a lot of banks talking about margin compression, and then whatever happens with Basel, and you saw Comptroller Curry come out again today and talk about reserve releases. I think that confluence of all those issues, our expectation is there may be more opportunity, but we've got to get some balance between our expectations on price and the sellers' as well.

And just a last question on that, is it your sense the potential sellers feel they have anyone on their side or is this just something that they're going to have to fight on their own?

I'm not sure any bank thinks they have anybody on their side right now, Jon.

All right. Thank you.

Chris McGratty, KBW.

Chris, one for you. How should I think about the size of the investment portfolio going forward? And maybe you could discuss what you're buying in terms of yield and product, and then what's coming off? Obviously, banks are struggling with that this quarter.

Right. The size of that portfolio is driven as much by our continued success in deposits as anything else.

I think -- and I don't have yields on what we've been buying here more recently, but suffice it to say we're looking at short-duration product where we can with a little bit of spread. I think given our success in growing our mortgage whole loan business, just our residential mortgages, with relatively low duration and low LTV type product, that's where I'm choosing to put most of my option risk investments.

So I'd expect that the investment portfolio will continue to contract. It's hard to say if the quarter-over-quarter change is something that you might expect going forward, but I don't know that we've necessarily changed anything. Some of it is too driven by whether we sell some assets or not, but I don't expect that in the fourth quarter. So great deposit growth, but that means probably low-yielding investment opportunities.

Okay. That's helpful. Daryl, for you, obviously with the purchase accounting the reserve dropped because of the logistic of the accounting. How should I think about you balancing your cautionary comments with respect to credit and just further reductions in the reserve? Or is this probably a good level to assume?

I think that as we look going forward, we're going to take a lot of things into consideration. If we continue to get growth, that's obviously going to spur some additional need for the provision. Bob, I think, talked about and made it clear that the OCC is not wild about release of reserves, so we're going to have to be careful about that. And we're just going to watch our trends.

It's so difficult to say where we are going forward, but those are going to be the factors that we're going to have to consider as the quarters go along.

Great. One last one for you, Bob, your comments on M&A. There's a lot to do about banks in the $10 billion threshold today. Maybe you could comment on that in terms of additional expenses once you've reached the $10 billion. And then, would you consider a larger deal, potentially an MOE, to really gain scale in a more efficient manner?

Let me comment to the second part, Chris, on an MOE. As a guy that lived through the Key-Society merger that many of you may not have been around, I don't believe there is such a thing as an MOE. Somebody has got to be in charge.

So would we do a transformational deal that would make sense to our shareholders? Absolutely, if it's the right deal and it made sense for the shareholders, we could provide great returns, we would do it. But we would prefer to say something transformational. I just -- MOEs, I lived through a couple years of very difficult times and I just don't think they make sense.

To your first part, I just think we will continue to look for opportunities. As you think about $10 billion, the way it's tracked, as you know, it's the end of the year, so given the time it takes to get a deal approved even if we announced something in the fourth quarter, it wouldn't be approved until sometime in 2013, which means that we'd get above $10 billion in 2013. Durbin affects us on the six of 2014, so we clearly believe we've got time to either put in mitigants or to continue to grow.

I think our Board has been very clear. If you're going to go above $10 billion, don't just go to $10.1 billion. Make sure you make it meaningful and you can cover the costs that are associated with growing it.

Now all practical purposes, other than Durbin, today we're complying with almost all requirements of a $10 billion bank because Chris has been at the forefront of stress testing and many of the other things we're doing are much like a $10 billion. The biggest effect is obviously Durbin, and maybe we get a good election in November and reality sets in, or commonsense, maybe we get a chance to look at Durbin again.

And what's that impact of Durbin?

It's about $2 million to $3 million a quarter on a gross basis. There's things we can do to offset some of that cost, but it would really come out of our service charge and other areas.

Okay. In just the last one, on the BSA, the guidance you gave, should I be thinking of those as one-time catch-ups in the reinvestment, or is this just kind of pure investing in compliant systems (multiple speakers)

The ones that Chris and Lynell referenced are really the one-time charges related to outside resources we have to bring in to help us with the lookback and some of the systems and the audit of all this, so those are really costs that should go away. There is an ongoing support for BSA, but it's not material to your models.

Great. Thank you very much.

Thanks. Good questions, Chris.

Stephen Geyen, Stifel Nicolaus.

Hey, Stephen. How are you?

I'm well. Thank you. Maybe just clarification on the merger expense so far. You had the $1.5 million projected for fourth quarter. In total, I guess it's about half -- the expenses so far are about half of the total expected expense, and just curious if that's going to be front-end loaded in 2013.

Stephen, it shouldn't. That protracted period of -- between our announcement and closing allowed ICB to take some of those costs. So they actually pulled that through their earnings. Do you have that number, Lynell?

Yes. INCB incurred $7 million -- it's on the bottom of slide 10 -- that they had already incurred on their books before closing.

So I think we'd expect fourth quarter to be about the end of it.

Got it. Okay. Got it. And last question. Where are you at with the cost saves with the Integra acquisition? You mentioned the 35% there, I guess, at the closing.

Yes. I would tell you that all of the Integra expenses, they're all in our run rate, so whatever is left. And again, we've only got a couple branches left and not much else. So all of those cost saves are out, and you can build -- third quarter ought to give you a pretty good sense of what Integra's costs. There's not much there.

And I would add those branches that we're selling in the first quarter, probably the last vestige of that, too, and that won't hit us -- we won't see the benefit of that until second quarter, and by then we're done.

Okay. Great. Thank you.

Thanks, Stephen.

Emlen Harmon, Jeffries.

Chris, maybe kick it off with a question for you. You talked about the Monroe accretion kind of starting to roll over. How should we be thinking about the pace of that and how it comes off over time? And maybe just, what are the key drivers there that we should be thinking about?

Well, I don't have a number for you there, Emlen, except for that which we saw in terms of decrease this quarter, which I think was about $1 million.

But I think as we look for -- what I've seen there that's interesting with Monroe is the loans that we've acquired there have stabilized somewhat, and also the non-accretable yield has begun to stabilize. So I'd like to think that we'll see some fairly consistent numbers, but if you look year over year, we had so much of that early in 2012. That's really where we're driving our estimates for the full-year impact of 2013 versus 2012.

Got you. Okay. Thanks. And then, you guys noted in the deck that you had sold about $40 million in classified assets. Could you just give a little bit of the nature of those loans and whatever has come from the cover, noncovered portfolio (multiple speakers)

(Multiple speakers) they were investments, Emlen. That's out of our mortgage-backed portfolio.

Got you. Okay. Got it. Those are the [NBS] sales you talked about, okay.

And I think there is a pretty good slide in the appendix, Lynell. Did we keep that slide this time? I believe we did, that kind of takes that number --

We did (multiple speakers)

-- in a little more detail, Emlen.

Okay. Got it. Thanks. That was it for me.

Great. Thanks, Emlen.

Mac Hodgson, SunTrust Robinson Humphrey.

Just a quick -- couple quick questions. One, back on the spread income and the decline in accretion income. I just want to be sure I understood. You said a decline of $20 million to $25 million relative to the full-year 2012?

From both IBT and Monroe, and then, obviously, some of that will get replaced with -- or, excuse me, from Integra and Monroe. And then, obviously, some of that will be replaced by IBT, and I think it's safe to say as you're looking at your model, Monroe would serve as a pretty good semblance to what IBT might be able to do for us. Again, we'll give you better color at the fourth quarter.

I think if you just look at the total discounts, it's kind of remarkable how close they are. But now, the nature of the loans are different, and we -- I'd really feel better talking about that after I've seen a full quarter and we take any kind of adjustments to the purchase accounting numbers, once we see a full quarter of performance.

Okay. And then, on expenses, I know kind of a lot of noise on expenses the next couple quarters. If we look at just the core $82.5 million core expenses for this quarter, and just kind of take out all the stuff we're going to see the next couple of quarters, obviously you have the $6.5 million to $7.5 million of annual expenses coming out from the branch optimization. You've got a full quarter impact of Indiana Community, net of, obviously, the savings you're going to have.

Anything else we should think about that's going to affect that core number? Is there any sort of core expense growth? Is there an opportunity to get more cuts to get that core number down? I'm just trying to think.

There's no growth, other than our normal merit increases which will come in the second quarter. I would anticipate that you shouldn't see anything going up, and more than likely you should see the number come down slightly as we work through our procurement and operational excellence programs.

And then, one for you, Daryl, and you may have mentioned this. But on the increase in criticized and classified, how much of that, if any, was from the ag portfolio?

Very little (multiple speakers)

Okay. That's all I had. Thanks.

Great. Thanks, Mac.

At this time, there are no further questions.

Great. If any of the participants have further questions, as always Lynell is open. And again, our thoughts and prayers are with all of you dealing with Sandy.

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 and conference ID code 3589-4910. This replay will be available through November 12.

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