Old National Bancorp (ONB) 2015 Q1 法說會逐字稿

Welcome to the Old National Bancorp first quarter 2015 earnings conference call. This call is being recorded, and has 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 on April 27 through May 11. To access the replay, dial (855) 859-2056, conference ID code 23961693.

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 for opening remarks. Ms. Walton?

Thank you, Holly. Good morning, everyone. Joining me today on Old National Bancorp's First Quarter 2015 Earnings Conference Call are Bob Jones, Chris Wolking, Daryl Moore, Jim Sandgren, Jim Ryan, and Joan Kissel.

Some comments today may contain forward-looking statements that are subject to certain risks and uncertainties that could cause the Company's actual future results to materially differ from those discussed. Please refer to the forward-looking statement disclosure contained on Slide 3, as well as our SEC filings, for a full discussion of the Company's risk factors.

Additionally, as you'll review Slide 4, certain non-GAAP financial measure will be discussed on this conference call. References to non-GAAP measures are only provided to assist you in understanding Old National's results and performance trends, and should not be relied upon as a financial measure of actual results. Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation.

I'll begin the analysis of our first-quarter earnings on Slide 5, where I'll provide an update on our performance as they relate to our 2015 initiatives. Our first strategic initiative for 2015 is to grow organic revenue. Our organic loan growth during the first quarter was $2.2 million when looking at period-end balances, while year-over-year we had experienced organic loan growth of $341 million, or 7% on a period-end basis. This loan growth is net of loans acquired through acquisitions, and excludes the change in covered loans.

In addition, adjusted revenue grew 15.1% over first quarter of 2014 results. As Bob outlined for you in last quarter's call, we have initiated a new Company-wide referral program, and are very excited about the positive reaction we've received, both geographically across our footprint and across all lines of business.

In just the first 60 days of this new program, Old National associates have logged over 7,300 referrals. We're also pleased that our core net interest margin remained relatively stable during the first quarter as compared to the fourth quarter of 2014.

Our second strategic initiative for 2015 is to improve the operating leverage of the Company. As we discussed on our first quarter earnings call, we have initiated actions which we believe will improve the efficiencies of our organization. These actions include branch sales and consolidations, an early retirement program and other work force reductions. To date, these actions are all tracking as planned from a timing perspective, and we continue to anticipate annualized non-interest expense savings of $23 million to $27 million upon completion.

Our final strategic initiative is prudent use of our capital and providing the best possible return for our shareholders. We did utilize our stock repurchase program in the first quarter, and repurchased 3.4 million shares during that time. Also during the first quarter, we increased our quarterly cash dividend to $0.12 per share.

Turning to Slide 6, you'll see we reported quarterly GAAP net income this morning of $20.9 million, or $0.18 per share. Included in these GAAP reported earnings are charges related to our efficiency initiatives -- namely $4.4 million in severance charges, and $2.6 million in charges relating to our branch actions. Also in the quarter were $4 million in merger and integration charges. I'll now turn the call over to Chris to provide more details.

Thank you, Lynell. The graph on Slide 8 tracks the increase in our adjusted income since 2011. Adjusted income is defined in the bullet point on the slide has increased 13.5% annually from 2011 to 2014. We're pleased with the annual growth in adjusted income through 2014, and believe we will see strong performance in 2015 due to the successful integration of our acquisitions, the outlook for loan origination, and the anticipated cost savings once we complete our efficiency initiatives. We should begin to see the full benefit of the integration of our acquisitions and branch consolidations and branch sales by the beginning of the fourth quarter 2015.

Slide 9 shows the Company's revenue performance annually from 2011 through 2014, and compares first quarter 2015 to first quarter of 2014. The dark blue segments of the stacked bar graphs show revenue without securities gains, accretion income, and the amortization indemnification asset. This revenue grew 5.2% annually from 2011 through 2014.

Including accretion revenue and minus indemnification asset expense, revenue grew at the same rate annually through 2014, but from a higher starting point in 2011. Revenue less securities gains, accretion, and IA amortization was $130 million in the first quarter of 2015, up from $112.9 million in the first quarter of 2014.

The four bank acquisitions we closed during list year, Tower Bancorp in Fort Wayne, United Bancorp in Ann Arbor, Lafayette Savings Bank in Lafayette, Indiana, and Founders Bancorp in Grand Rapids, Michigan, contributed to the strong revenue increase over first quarter 2014. We closed on Founders on January 1 of this year.

Compared to first quarter 2014, average loans were $1.8 billion higher in the first quarter of 2015, contributing to a $7.5 million increase in net interest income, while Management fees and mortgage banking revenue were also higher when compared to first quarter 2014.

We should note in Slide 9 that accretion income net of the amortization of the IA increased from $37.3 million in 2011 to $43.3 million in 2014. We expect the net accretion to decline gradually over the next three years. I've included the new slide later in the deck that shows our annual forecast for net accretion income.

Moving to Slide 10, I've shown the annual trend in our non-interest expense, and I compared first-quarter 2015 expenses to first quarter 2014. Operating expenses are reflected in the dark blue segments of the stacked bar graph. Operating expenses increased 3.8% annually from 2011 to 2014. 2014 includes a partial year's expenses for Tower, United, and Lafayette Savings Bank, all of which closed after the first quarter of 2014.

Operating expenses for the first quarter of 2015 were $101.7 million. This includes a full quarter of expenses for Lafayette Savings Bank, which closed on November 1, 2014. Operating expenses for Founder's Bank, which closed on January 1, 2015, are listed as a separate segment of the bar graph, and were $3.5 million for the quarter.

I also listed separately the cost from mergers and integration, our severance and early retirement program costs, and costs related to the branch consolidations. The total cost in the quarter for these programs was $11 million. Without the merger and integration cost and the costs associated with our efficiency programs, our efficiency ratio for the quarter would have been 68.9%.

The first quarter of 2015 we completed our early retirement program. We expect to reduce 136 FTE through the early retirement program and other position reductions. In addition, we expect 164 staff reductions through the sales of the southern Illinois market, and selected branches in eastern Indiana, and branch consolidations. A total of 36 branches are expected to be closed or sold by the end of the third quarter of this year.

We are consolidating 19 branches. We closed three branches in Q1, closed three in early April, and expect to close the remaining 13 branches by the end of May. The sales of 17 branches to two different banks should close during the third quarter of 2015.

The expense savings from the branch sales in consolidations, plus other efficiency measures, should be $23 million to $27 million annually, or $5.75 million to $6.75 million quarterly. We should see a full quarter of savings in the fourth quarter of 2015. Additionally, as noted in the footnote of Slide 10, we expect $4 million to $5 million in annual savings once LSB and Founders are fully integrated, and we should see a full-quarter's benefit from this quarter also in the fourth quarter. In the second quarter of 2015 we expect an additional $1 million to $2 million of integration expenses related to LSB and Founders, and an additional $4 million to $5 million of costs for the branch sales and consolidation.

Slide 11 shows the components of our net interest margin for the quarter. Fully taxable equivalent net interest margin declined to 3.7% -- 3.83% last quarter and 4.22% in the first quarter of 2014. 56 basis points of first-quarter 2015 margin was due to the accretion of discount associated with purchase accounting for our acquisitions.

Our total loan mark on Founders Bank, which I noted earlier closed in January, was 5.3%, or $19.3 million. This is lower than the mark we anticipated when we announced the deal. Core net interest margin was 3.14% in the quarter, one basis point lower than the fourth quarter of 2014. Fewer days in the first quarter caused a 3-basis-point decline in the core margin. While average loan balances were higher in the first quarter, the margin benefit of higher loans was largely offset by lower total earning asset yields during the quarter.

Finally, margin in the quarter was helped two basis points from an increase in interest collected on loans previously treated as non-accrual. Had we had the same number of days in the quarter as fourth quarter 2014, we believe core net interest margin would have been closer to 3.17%. We expect next quarters core net interest margin to be in the range of 3.14% to 3.16%.

Continued low short-term rates and limited opportunities to invest our portfolio cash flows and assets with acceptable risk and maturity may continue to put pressure on net interest margin. As Jim Sandgren will discuss in his presentation, however, our loan pipeline is strong and should result in the opportunity to deploy investment portfolio cash flows into loans.

Slide 12 is the new slide that illustrates the history and our forecast of accretion income and indemnification asset expense through 2017. We have had ongoing questions from you about the future impact on earnings of the accretion created by purchase accounting. We realize this is quite complicated, particularly when we layer on the impact of the remaining FDIC indemnification asset, and the additional purchase accounting discount created by the four new acquisitions. As you can see by the trend line on the slide, net accretion, which is accretion minus the amortization of IA expense, is forecast to decline at a gradual slope over the next three years.

Accretion net of IA expense should be $38.9 million in 2015, approximately $4.5 million less than our actual net accretion of $43.4 million in 2015. 2016 net accretion contribution should decline to $33.9 million in 2016, approximately $5 million less than our projected 2015 net accretion. This accretion schedule is based on projected amortization with expected loan renewals and pay-downs.

If pay-downs accelerate from our projections, accretion income could be higher in earlier periods and lower in later periods. Note that our projections show a remaining discount of $66.9 million at the end of 2017, so accretion income will likely be a contributor to net interest income in 2017, and in the years after 2017. I've included historical information on the indemnification asset since the 2011 FDIC-assisted acquisition of the Integra Bank assets on Slide 34 of the deck.

Moving to Slide 13, I've provided information on our sensitivity to rising interest rates. The graph on the right-hand portion of the slide shows two of our modeled rate scenarios -- the impact on net interest income for one year if interest rates increase 100 basis points all along the yield curve, and the impact on net interest income if interest rates increase based on the forward rate yield curve, as of the quarter end reflected in the graph. As you can tell by the progression of the modeled results since third quarter of 2014, we've continued to increase our asset sensitivity, and our net interest income should increase when interest rates rise.

The bullet points on the left side of the slide reflect several important factors that influence our sensitivity to interest rates. The major drivers of the rate risk in our models are the assumptions we use for the rate sensitivity of our transaction accounts. We believe our assumptions are conservative.

Total interest-bearing transaction accounts increased from 8 basis points to 44 basis points, if rates increase 100 basis points immediately. 21.5% of our non-interest-bearing checking accounts are considered in our models to be sensitive to rising interest rates. We believe our models accurately represent our current sensitivity to interest rates, and we will likely maintain our current asset sensitivity.

Slide 14 shows the change in tangible common equity since December 31, 2014. We reduced tangible common equity during the quarter from $896.2 million at December 31, 2014, to $851.6 million at March 31, 2015. We increased the quarterly dividend per share to $0.12, repurchased 3.4 million shares of stock during the quarter, and used a combination of cash and stock to purchase Founders Bank. In October 2014, the Board authorized a 6-million share buy-back. We have 1.9 million shares left to buy back under this authorization, and expect to complete the share buy-back in the second quarter.

Tangible book value per share as of March 31, 2015, was $7.28 per share, down from $7.67 per share at December 31, 2014. Because we were able to repurchase more shares in the first quarter than we anticipated, TBB per share declined in Q1 more than we had anticipated. We expect tangible book value to increase once we finished our stock buy-back.

Slide 15 shows the trend in our key capital ratios during 2014. While we show capital beginning to track somewhat lower than our peer group, we believe our capital ratios accurately reflect our balance sheet risk. I expect both our risk-based capital and tangible common equity ratios to increase during 2015, after we have completed our share buy-back. I'll now turn the call over to Jim Sandgren.

Thank you Chris, and good morning, everyone. From both a bank perspective and a fee-based business perspective, the first quarter of 2015 saw a continuation of the positive momentum that was generated throughout 2014. Among the main positives we experienced was our annual organic loan growth of 7%, record commercial loan pipeline numbers, and a significant increase in our mortgage loan business.

If you'll turn to Slide 17, I'll start my comments by focusing on loan growth, excluding covered loans for the quarter. The slide depicts both end-of-period balances and average balances for both a quarter-over-quarter and year-over-year perspective. As you can see on the bar graph on the bottom left, we experienced year-over-year loan growth in excess of $1.8 billion, $341.4 million of which was due to organic growth, with the remainder attributable to obtained through our Tower, United, LSB, and Founders partnerships.

The year-over-year organic growth we enjoyed was largely fueled by an $85.1-million increase in commercial and commercial real estate loans, and a $261-million increase in consumer loans, primarily driven by indirect.

Turning to the bar graph on the top left corner, you'll see that nearly all of our quarter-over-quarter loan growth of $342.3 million was driven by our newly completed Founders partnership; however, a closer examination of our first-quarter 2015 commercial loan results reveals a very solid quarter from a new origination perspective.

Moving to Slide 18, you can see that commercial loan production increased nearly $75 million, from $153.2 million in first quarter 2014 to $227.8 million in the current quarter, representing an improvement of nearly 50%. Loan production was solid in many of our markets, but particularly strong in Louisville, Kentucky, Kalamazoo, and Ann Arbor, Michigan.

Unfortunately, the higher quarterly loan production was offset by some significant principal reductions, and an unexpectedly high $176.5 million in pay-offs with large commercial and commercial real estate balances. Some of these borrowers took advantage of the low rate environment to refinance their loans in the secondary market, while other large borrowers sold their businesses and/or real estate holdings, and some utilized cash on hand to ultimately retire their debt.

In spite of these pay-offs, we were able to maintain a majority of these relationships, and in some cases we will have lending opportunities with these borrowers in the near future. While we were obviously disappointed by this unexpected rise in pay-offs, we remain very encouraged by the higher level of production year over year, and the stable and increasing yield on our new commercial loan production depicted by the blue line. As you can see, our yields on new commercial loans have been very stable over the past three quarters since we peaked in Q1 2014, and we did see a slight increase in Q2 2015 yields.

If you'll turn to Slide 19, I'd like to highlight some other positive quarterly results. If you'll recall, we reported record pipeline numbers during both the third and fourth quarters of last year. I'm pleased to say that our commercial team continues to raise the bar with regard to our pipeline. As of March 31, our pipeline was up to $833 million, with $190 million of that in the accepted category, and another $175 million classified as proposed. In these two most important pipeline categories, we have seen a 46% increase quarter over quarter, and a 93% increase year over year.

As you can see on the bottom of the slide, we have also included pipeline information for our newer markets in which we have recently completed a partnership. These pipeline numbers are included in the bar graph above. We have seen meaningful growth in three out of the four markets. The one market that did not experience growth in its pipeline, Ann Arbor, Michigan, had a strong quarter in loan production, which fueled positive regional balance sheet growth.

Of particular note, the commercial loan pipeline in Fort Wayne has more than doubled over the past 90 days, with many of their loans in the proposed and accepted categories. I'd also like to point out that all of the $24.8 million you see in the Grand Rapids commercial loan pipeline as of March 31 has been categorized as accepted, since Founders chose to limit its pipeline to only those loans that have reached approved status. To provide consistency in future quarters, we will be broadening the definition of the commercial loan pipeline in Grand Rapids to also include the proposed and discussion categories.

These record pipeline numbers provide strong evidence we are moving in right direction and continuing to execute our plan. That being said, we completely understand that it is imperative that we move as many of these pipeline loans out of the balance sheet as soon as reasonably possible.

From a commercial line utilization perspective, we were down 1.8% compared to fourth quarter 2014. This is primarily due to some significant line pay-downs which also negatively impact the balances. As indicated on Slide 19, 1% of line utilization represents roughly $13.5 million in outstanding. Overall, I believe these results continue to illustrate that our strategy of moving our franchise into stronger growth markets is working. It also demonstrates we have the right people in these key markets to continue to build.

Slide 20 illustrates the continued positive momentum of our fee-based businesses. As many of you know, 2014 was an exceptional year for our insurance, wealth management and investments divisions, and we are continuing to experience growth in all three business lines. Our 46.6% year-over-year increase in total wealth management revenue is largely attributable to our Tower and United partnerships, and the strength, expertise, and client base of the associates who are now part of the Old National team.

It's also worth noting that late in the quarter we closed the single-largest piece of business ever in our trust company's history out of our Indianapolis region. Now for the first time our trust company has surpassed the $8 billion mark in assets under management.

Insurance revenue for the first quarter was approximately $12 million, consistent with the first quarter of 2014, and in line with our expectations. Contigency income always provides a nice boost to first-quarter insurance revenue, which it did again in 2015; however it was down compared to first-quarter 2014, but last year's contingency revenue was unusually high due to lower loss rates.

Turning to investments, I'll note that not only is revenue increasing, our recurring revenue is now at 40%. We also have added some tremendous advisors through our recent partnerships, and we expect them to play a large role in driving growth in 2015 as they continue to become more acclimated to Old National. Lastly it is our intention to replace the advisors loss to our southern Illinois and eastern Indiana divestitures with more advisors in both Michigan and Indianapolis.

I've added mortgage banking to the slide in order to illustrate the exceptional results we continue to see in this business category. As we talked about last quarter, the mortgage expertise we obtained through our United partnership is significant, as evidenced by a 400% year-over-year increase in our mortgage fee income. Much of this increase can be attributed to our newest partners in Ann Arbor, Lafayette and Grand Rapids. Additionally, our pipeline of locked loans remains strong, and we are very optimistic about continued growth in our mortgage business in future quarters.

I'd also like to pick up on a topic that Lynell touched upon in her opening remarks, and which Bob spoke about in some detail last quarter. In February of this year, we launched a new cross-sell referral program that has proven to be very successful. As of last Friday, more than 7,300 referrals have already been logged through this new initiative. These referrals have our sales staff in every line of business energized, motivated, and working together better than ever before. I firmly believe we will reap the benefits of this enhanced cross-selling strategy and culture in the months to come.

In closing, I feel very good about our progress in both our fee-based business and our core bank. I believe our quarterly results illustrate that we are executing our plans. As I've said in previous quarters, we have strong leadership and experienced, motivated producers in place throughout our footprint. With our partnership activity winding down, they will be able to focus like never before on executing our revenue growth strategy. With that, I will now turn the call over to Daryl.

Thank you, Jim. On Slide 22, we lay out provision expense and charge-off results for the two most recent quarters, as well as the first quarter of 2014 for current-quarter comparison purposes. On a consolidated basis we posted net recoveries in the quarter of $1 million, or 6 basis points of average loans. This compares to charge-offs of $1.3 million last quarter, which represented 8 basis points of losses on average loans.

Given the net recovery position in the quarter, on a consolidated basis we booked no provision expense for the period. While this zero provision was comparable to our 2014 first-quarter provisions, it was $900,000 lower than the provision expense posted last quarter. On a consolidated basis, the allowance for loan losses as a percent of period pre-marked loans stood at 0.72% at March 31, compared to 0.74% at the end of last quarter. As importantly, though, the combined allowance and loan marks as a percent of total pre-marked loan outstandings stood at 2.97% at the end of the first quarter, down just slightly from the 3.04% total at year end.

On Slide 23 we show you trends in criticized and classified loans over the past year. We've displayed not only information for the consolidated portfolio, but also trends reflecting what the portfolio would have looked like absent the effect of our four most recent partnership. As you can see at the top of the slide, our non-covered special mention loans decreased $10.9 million in the quarter, from $194.8 million to $183.9 million. The decrease was accomplished even in light of the addition of $13.5 million of special-mention loans associated with the Founders partnership, and was achieved through a combination of pay-downs, pay-offs and upgrades, along with a few down grades.

Moving to the lower left quadrant, we see that substandard accruing loans also reflect a decline in the quarter, falling by $12.2 million in the period to a level of $95.6 million. While this decline was achieved despite the addition of $8.6 million in Founders loans, a great share of the improvement was generated from the downward movement of a couple of loans out of this category into the non-accrual loan segment.

The final chart on this slide shows that non-covered, non-accrual loans increased fairly significantly in the quarter, rising $17.6 million to $125.7 million to $143.3 million. While roughly $10 million of this increase is attributed to the newly acquired Founders portfolio, as I just mentioned we did have a couple of loans that migrated into this category from the substandard accruing loan category in the quarter. With the posting of net recoveries in the quarter we again are pleased with our performance in that category.

We're also encouraged by declining balances in our special mention loans, which reversed a two-quarter trend of increasing exposure in this class. We are, however, dealing with several larger commercial credits that are experiencing some difficulties, and would expect they will need to continue to be closely managed throughout at least the balance of the year. Several of these credits were moved to non-accrual in the quarter, while some remain in an accruing status and in fee for performance.

As I've mentioned over the last several quarters, competition for good quality loans continues to be very stiff, and proper structuring of loans in the area of term, guarantees, and covenants remain a challenge in the current environment. The delicate balancing act of producing meaningful loan growth without sacrificing the basic tenants of proven underwriting continues to be a challenge for all banks. With those comments, I'll turn the call over to Bob for concluding remarks.

Great. Thank you, Daryl. Slide 25 is a good summary of the key points that have been made on this morning's call. It also captures the critical areas we are focused on as a team. As I reflect back on our performance this quarter, I was pleased with many of the metrics that related to our strategic focus for this year. We were able to increase our adjusted revenue by 15% over the first quarter of 2014, but more importantly, I do believe we have built a very solid foundation for future growth in 2015, with a strong loan pipeline in our banking group, along with comparable pipelines in our fee-based businesses.

These, along with the early results of our enhanced referral program, give me the confidence that we should see growth over the next few quarters. While it is difficult to quantify attitude, I can honestly say that there is a tremendous commitment in understanding by all of our associates that driving quality revenue growth is crucial for us to create shareholder value.

Our operational expenses reflect the investments we've made in our new markets, which are important for us to achieve our growth targets. But at the same time, I am most encouraged that by truly abiding with our stated pause does mean pause, we have quickly been able to execute, not just talk about, a number of key initiatives this quarter, that should provide our investors with $23 million to $27 million in annualized cost savings.

I was very pleased at the response to our early retirement program, which exceeded our initial expectations, and will allow us to reduce head count, and at the same time treat long-tenured associates with the respect that they deserve. Our other programs, further head count reductions, branch closing, consolidations and sales, as Chris stated earlier on, are on track and we remain committed to our 63% efficiency target for the fourth quarter of this year.

Clearly an area of some disappointment for us was organic loan growth, particularly when we had a 70% increase in overall loan originations, which did include a 50% increase in just commercial loan production, as compared to the first quarter of 2014, and we did maintain a very strong loan pipeline. Jim did a good job of providing an overview of the reasons why the growth did not occur, and I take comfort from the fact we are consistent in our approach of not sacrificing credit quality for growth.

Each of our large payoffs had unique characteristics. The over-arching theme is that the borrower either found better terms, terms such as non-recourse notes or other examples of loan structure we were not comfortable with, or they found rates that did not meet our hurdle thresholds. In addition, it is worth noting that some of the benefit of our net recovery position and charge-offs is due to the good work that Daryl and his team have done in moving some of our lower-grade credits out of the bank. Those numbers would have been included in the pay-offs Jim noted. In either case, we remain consistent to our risk appetite statement.

As I just mentioned, the offset to our minimal loan growth remains our credit quality, which was excellent. As Daryl has stated many times in these calls, we continue to look for ways to increase our risk profile in order to book quality credits, while at the same time not sacrificing long term value to our investors. Clearly this is a balancing act and one that Daryl does very well. As he mentioned, though, we have seen some evidence of deterioration in our lowest-grade credits with a few recent downgrades, and we will need to be prudent to ensure this does not become a trend. I have great confidence in the ability of our credit teams to ensure our credit quality should stay very strong.

I will now recap the detail that Chris reviewed relative to our capital strategy, other to reinforce both mine and the Board's strong desire to continue to be focused on using our capital with our shareholders' best interests always at the top of our mind. Overall, this was a quarter for Old National that included many positives, and should portend for good momentum as we move forward.

Clearly the quarter also had a number of what I would characterize as show-me areas. We continue to talk about strong pipelines, strong loan originations, and positive momentum, yet good core loan growth has not occurred for two consecutive quarters. While I remain confident it will, I can understand any skepticism that exists. I also am not willing to sacrifice loan quality for growth.

Another area where we owe it to our investors to demonstrate results is with our expenses. We made measurable progress with a number of significant initiatives this quarter. Again, I believe we are well positioned to achieve our expense reduction goals in the coming quarters. But I also understand this has been an area of focus for some time, and it's time to actually show the results.

Finally, based on feedback from many of you on the call as well as a number of investors, we provided you with an estimation of the impact of accretion on our future earnings. While clearly this is a very volatile number based on a number of factors, our hope is that you will see that the declining positive impact is much more gradual in nature than immediate -- in other words a slope versus a cliff. As we traverse down this slope, we remain confident the incremental earnings that we will gain from these new markets should cushion and off-site any negative impact by the reduction shown. Please let us know if this analysis was helpful.

Turning to Slide 26, I will close by giving you additional color on our last two partnerships, as well as an exciting new initiative in Lexington, Kentucky. We had a very successful conversion during the first quarter of our Lafayette, Indiana, bank, and remain very pleased with where we are in the process. We have had minimal client and associate attrition, and there's a great deal of positive client-focused activity occurring. This past weekend we had a very successful conversion of our Grand Rapids partnership, and as we speak we have over 35 ambassadors assisting our four new Grand Rapids branches, and serving their clients.

I am very encouraged by the team we have in place, as well as some recent new additions to that team, which along with the great leadership of Lori Beard our Market President, makes me even more confident that Grand Rapids market has an exciting future for Old National.

Just as a side note, just before this call I reached out to Lori and asked her how it was going. Her response was well, I've already had three hugs and I got a $4.5-million loan application this morning, so I'm confident we're off to a good start with the new Old National in Grand Rapids.

Finally we were able to hire a very seasoned lender in the Lexington, Kentucky, market, and we've recently opened up a satellite office in Lexington. Lexington is a market that we have looked at for some time, and feel that this satellite office is the best and most efficient means of understanding the market. We have hired an outstanding individual who should be able to bring with him additional RMs, and to date in just three weeks, he has already built a loan pipeline of $35 million. It is very important to note that all credit authority remains with Daryl, and that the individual we have hired has a very strong credit background at a very well-respected regional bank.

Holly, with those closing comments we'll be happy to answer any and all questions.

(Operator Instructions)

Our first question comes from the line of Scott Siefers with Sandler O'Neill Partners.

Scott, we always talk about consistent quality earnings. You're always consistent quality in getting that button first.

Well, I try. I have a good associate who does a nice job. But morning guys. I hope everybody is doing well. Let's see. Bob or Jim, I was hoping you could chat a little bit more about loan growth. You gave a lot of good color in there, but I'm just curious as to the CRE pay-off, to what extent do you think those are transitory versus an issue that will stick with us for a while? You obviously have a very good C&I, but it is of course being impacted by this CRE issue. What are your thoughts on the headwind that's going to present as we look forward throughout the rest of the year?

I wish I could be a little more optimistic, Scott. I think with the rate environment where it is, I think all of us were hoping that the Fed might get a little more aggressive mid-year. I personally don't see that happening until maybe third quarter or fourth quarter in term of rates going up. Clearly you're going to have a lot of opportunities for lower rates with clearly the structures that we don't look for. Competition is still very tough. Hopefully, we've gotten through a good chunk of the largest pay-offs, but I think that environment, particularly under our risk appetite, could continue for a short time coming up.

Okay. All right, thank you. If I can switch gears for a second over to the cost side, just based on the disclosures you have made around the timing of the cost savings from the newer efficiency program, as well as the cost savings -- by that I mean the sales and closures, as well, and then just the cost savings on deals, it sounds like fourth quarter will be the first undisturbed quarter from a full run rate perspective. Is your anticipation that we might hover around this level of core expenses for a while and then have a more steeper drop as we get into the fourth quarter, or will the first quarter mark a high-water mark, and then we sort of gradually slow down or excuse me, gradually grind down such that costs are lower in every sequential quarter throughout the year?

Yes, I think it's more of a slope, Scott, as we head to that fourth quarter. You're absolutely correct. The fourth quarter will be an undisturbed quarter by a disturbed Management team, maybe, (laughter) but clearly it will be an undisturbed quarter.

As you use our head count as a proxy, the vast majority of our branch closures will occur in the second quarter, which is about 40% of the total head count we've talked about. For modeling purposes, you can assume that first quarter a little bit of a high-water number; come down at some 40% of an annualized basis on the second quarter. The balance of it should be through the third quarter. I would estimate that the remaining cost saves for the acquisition should be completely through in the second quarter, for the most part.

The other thing, just for everybody on the phone, remember in the third quarter adding to the disturbed nature will be that's where we will have the gain on the sale of our southern Illinois and the other branches, as well. Again, our whole intent was really that sale would offset a number of the one-time charges that we've had associated with it. But clearly, we have communicated to our Board and to ourselves that the fourth quarter really begins to show all the work we've been putting in this for the last few quarters.

Scott, this is Chris. I might just add as we anticipate those sales in the third quarter, there is some resources required just to handle those conversions. Much like an acquisition, those dispositions take resources, too. It will take, once we get through those sales of those branches, we should see those costs come down, as well. That happens mid-third quarter.

Okay, that's perfect. Thank you very much.

Great. Thanks, Scott.

Your next question will come from Chris McGratty with Keefe, Bruyette, and Woods.

Good morning, Chris.

Good morning, everybody. I wanted to follow up on Scott's, just on the expenses. If I look at your adjusted expenses in the first quarter, it's around $105 million. I take your -- the efficiency of $23 million to $27 million, about $6 million a quarter; and then additional $1 million, $1.5 million from the deals, that would suggest a low to mid $90 million in terms of million run rate. Is that what you're posturing for us to consider for fourth quarter being clean, like low $90 millions, or is this a mid-$90 millions run rate for the bank?

I'd say closer to the low $90 millions. You're not far off.

Okay, so low $90 millions. That's helpful. On the buy-back, obviously you're going to get through it this quarter. Can you remind us the capital target that you are looking at? Is there any contemplation, given that it seems the messages still hold on deals, how would you consider re-authorizing a buy-back mid-year, or is that just get the capital levels right and then see where you're at?

This is Chris. A lot of it depends, too, I think on the size of our balance sheet and how successful we are with our shift from low-risk assets in the investment portfolio to quality loans, which would imply a little higher need for risk-weighted capital ratio. I think from a tangible standpoint, we're pretty comfortable where we are. Short of something dramatic, I think we want to get through this authorization, see how the numbers line up, and then look at things again. As Bob has said, there's -- a lot of it depends on how the economy looks, how rates look, what all of those earnings impacts are for us going forward.

A last question, Daryl, on credit. It sounded like a little bit more cautious on some credits that are popping up. Is the expectation to build, assuming we don't get any more recoveries, build provisioning from here? Obviously zero is pretty tough to go lower. But the question is, is the provisioning going to go materially higher over the next few quarters to get through these head winds?

Chris, I'll just tell you -- this is Bob, I'll let Chris actually answer the question -- but we actually had to change Daryl's slide, because if we hadn't put the fourth quarter to compare first quarter, the first quarter would have been called Flat Line Daryl, because it was zero meant zero.

Chris, you're right. I just don't see any possibility for continuing zero provisions in the quarter, or for the balance of the year. It all depends just how we work through some of these handful of non-accruals we have as to the level of that provision; but I would -- as I'm looking at Bob, I just don't think anyone has expectations we're going to have zero provisions on a go-forward basis, so it will be higher.

Yes, and I would argue also, Chris, as we continue to build the balance sheet, you're going to obviously provision for growth, as well. Really my desire would be to be able to provision, because I think it will be reflective of growth in the balance sheet. As good of work as Daryl does, we can't continue to get the net recoveries like he has.

Then the tax rate will stay about here from here?

The tax rate was a little interesting this quarter. We had a couple of discrete items that impacted our fully taxable equivalent rate up. That was up like 39.9%, close to 40%. We would expect that to come down back to a more normalized 34.5%, 35% on an FTE basis, and probably 28% on average for the year on a GAAP basis, so a little higher this quarter than we expect to see going forward.

All right, that's helpful. Thanks a lot guys.

Thanks, Chris.

Your next question will come from the line of Emlen Harmon with Jefferies.

Good morning, Emlen.

Hi. Good morning, everyone. Bow, how are you?

Good, how are you doing?

Doing good, thanks. Maybe to kick it off talking about Lexington. Is that satellite office that you're opening effectively an LPO, or is it that a full-service facility? What's your ability or desire to add de novo there over time?

Great question. We like the word satellite much better, because LPO has some negative connotations, but it is actually an LPO. Just a short story. Our advisory board in Louisville, Jim Sandgren went to a meeting probably 90 days ago and one of our advisory board members said there's this gentleman that is just as good as I've ever dealt with in the banking who's a little frustrated with his current employer. He's in Lexington. I think he would be a perfect candidate for Old National. Jim did a great job, with along with Daryl, of talking to this person. He really wanted to join the team. We were very comfortable with him. Most of his background is credit.

We've looked at Lexington now for gosh, eight plus years, at either acquiring or doing something. It's an important market in Kentucky. We're going to start with this individual. He believes he can bring in additional producers. We'll see how the market accepts our style, our credit quality, our penetration. Over time, Emlen, we may open a branch there. My hope is that we will be as successful as we think we can be, and then we'll try to open a few branches.

I think it's a good example of pause means pause. We don't want to put capital at risk. This is a good way to test markets where we believe we can get really good growth. We're not going to go out and do this in places outside our footprint, but I think we're seeing enough opportunity to lift out producers in some key markets like Lexington that we'd be silly not to at least try.

Got it, thank you. It's helpful. Your footprint tends to have, I would say, more manufacturing exposure than most. Have you seen any -- are your customers, rather, seeing any economic events just from a stronger dollar and volatility in oil prices? How is that affecting the outlook there?

Actually a pretty positive impact, mostly driven by the lower gas prices. What we hear from our clients is the cost of production is gone because of the cost of fuel going down helps. Clearly the stronger dollar has hurt some of our larger exporters. But the beauty of our markets tend to be we're a little more -- less international, more domestic. Again, I think as evidenced by the pipeline and the optimism you're hearing from Jim, our clients feel very good about where they are today.

Got it. Thank you very much.

Thanks, Emlen.

Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.

Good morning, Mr. Arfstrom.

Good morning. A few questions here. On the pipeline, either Jim or Bob, what do you think is behind the increased pipeline? Is it a wider net, is it new markets, is it overall optimism by the borrower? What would you attribute that to?

I'd say all three of the above, plus I think Jim's leadership, and that's why I'll answer the question. I think Jim has done a very good job. We talked about this referral program. I know that's a warm and fuzzy, but we held our first-ever sales summit mid-February that Jim lead. It just -- you get people focused.

Jon, I'd also argue the fact we are not so engaged in integrations and due diligence and partnerships really allows us to get on our toes and be busy, but clearly activity level amongst our folks is very strong. Our clients feel very good. The new markets as Jim said between Kalamazoo and Ann Arbor, a lot of good production there. But we're seeing it throughout the footprint. The level of cooperation between credit and origination is very strong, as well.

I did have a question on the referrals. If you could maybe give us an idea of the top two or three referrals, type of referrals, that are coming through? Is it as simple as mortgage or wealth, or are there other different examples?

Yes, obviously a lot of them are coming from and to retail banking, but I'd say the biggest pick-up has been in the insurance business. Big percentages are coming to insurance, and investments as well, to our financial advisors and wealth management, too. It's really been a nice -- I think it's been spread out among all of our lines of business.

Mortgage you almost feel is part of that retail banking group, but mortgage is almost as high -- is the highest one. Again, I think there's a huge spirit of cooperation and understanding of the great products and services that we have across all of our lines of business. I think we did spend a lot of time back in February talking to everybody, reminding them of just the experience and expertise that we have in all of our lines of business. I think that's starting to really pay off for us.

Good. Maybe Chris one for you, in terms of we've talked a lot about expenses, but maybe a little built on the revenue outlook. It seems like with the pipelines and the stabilizing margin you're anticipating some decent net interest income growth. Is there -- can you provide us any update in terms of what you're thinking there?

Jon, we are probably as asset-sensitive as we have ever been at the Company. That will have an impact. As Bob said, if the short-term rate increase gets pushed out 60, 90 a year from where we are today, that will have an impact on our ongoing net interest margin. But frankly, the nice increase in the loan outlook gives me some comfort when we have to think about reinvesting cash flows from the investment portfolio.

I feel like we're on the cusp of being able to drive a lot of those to the investment portfolio, which would allow us to keep the balance sheet about the same, keep our capital and all of the work we're doing in buy-backs and such in play. It's really that rotation out of low-risk assets into better-quality assets that I'm anxious to see. But interest rates will clearly have an impact on our net interest income.

Low-risk, low-yielding assets.

Low-risk, low-yielding, that's right. It's awfully hard to get excited about current investment portfolio opportunities out there as rates stand right now.

Okay. Then Bob, just last one. How long does the pause last? I like this, by the way. I think it's overdue. I don't mean that in a negative way, but getting efficient and cross-selling I think is a good thing for your Company.

It's all about execution at this stage. We're in all the markets we want to be in. We still look at books. There's been nothing that would cause me to go back on our pause means pause. Jon, I'd be honest. I'd be -- think 2015's all about execution. I think about fourth quarter being our undisturbed quarter. I don't want to disturb that. Unless we see something I can't live without, I just don't see us changing.

I think we're very encouraged by a little bit of what we see going on in Lexington. We've been able to hire. We just hired a very strong RM in Kalamazoo that joined us from a regional. We just hired another RM in Grand Rapids. I think Jim Sandgren and I are of the mind that we can go out and hire talent in our Markets, and get a much better return for our investors.

Okay. All right, thank you.

Thanks, Jon.

Your next question will come from the line of John Moran with Macquarie Capital.

Good morning, John.

Hi, good morning. How's it going?

Good.

Chris, I think you just hit on some of this here, but I guess investments as a percentage of earning assets sitting 33%, 34% of earning assets today. With the re-mix, where do you think you could work that down to over the next couple quarters, or is there a target there or a hope?

Yes, the operative word you used is down. I think as you look -- especially if you look at period end, December 31, fourth quarter you'll see a fairly nice decrease of the investment portfolio as we've rotated those assets in with the loans. I wish I could hold the number out there. Clearly at 33%, it's -- in those mid-30%s, it's higher than we'd like to see it. I'd always like to be somewhere in the 20%s.

But we have to do what we have to do. Fortunately, we've had some tremendous deposit growth. That requires us to make those investments where we can deploy that cash. We'll keep working at it. A day doesn't go by where I don't mention to Jim Sandgren we want more loans. That's what it's all about.

I would argue a minute doesn't go by that I don't walk down to Sandgren's office and say we need more loans.

I can attest to both. (laughter)

All right. The other one I had for you was just on production yields. It looked like on commercial they popped up a little bit. I'm trying to balance that against some of the commentary that you had about competitive environment. Do you think it's sustainable here, or that we've seen the worst of the erosion, and despite it still being a tough environment where folks are slugging it out, that maybe pricing has just gotten -- found a bottom?

I don't know about that. I wish that was the case. I think we're going to continue to see heightened competition from a pricing structure standpoint, I think, for the balance of the year. I think probably the biggest thing is just the mix of loans that went on the books in the first quarter. I'd love to see that trend continue going up. I think it was probably just more a function of a mix of the loans that we were putting on the balance sheet for first quarter.

Got you. Thanks, that's helpful.

Thanks, John.

Your next question will come from the line of Andy Stapp with Hilliard Lions.

Good morning, Andy.

Good morning. Have all the United cost savings been realized?

Oh, yes. United is fully integrated. We've been operating as a region, so we're in good shape running as a region. We're in good shape with United. The only remaining costs to come out would be clearly Founders. As you know, we converted this weekend, and we still have a little bit of Lafayette. But all the other ones -- we're a rip the Band-Aid organization.

Okay. Do you have a rough break-out of the line items that were impacted by non-interest expenses that you talked about in your press release? I know most of them were in salaries and benefits. Any other line items?

We have a slide, I think in the deck.

Oh, do you?

Andy, if you don't see what you need there just give us a call, and we'll try to break that down a little bit more clearly for you.

Okay, great. The rest of my questions have been answered. Thank you.

Great. Thanks, Andy.

Sure.

(Operator Instructions)

Your next question will come from Stephen Geyen with D.A. Davidson.

Good morning, Stephen.

Hi, good morning. How are you?

Good.

First off, you talk about the rotation from securities into loans, and that's great. The margin held in there this quarter. What is the yield on the cash flow from the securities?

Stephen, I'd have to go back and look at that. The interesting thing about our portfolio, as you know, we've got a lot of short-term stuff, but then we've got a lot of longer-term municipal bonds. It's not inconsequential. I think if you look at the yield on the portfolio from fourth quarter to first quarter, we were able to hold it pretty close. I think we actually went up a basis point but it was -- it's down 20 basis points from first quarter 2014.

I think you can surmise from that that we're giving up some fairly high-yielding municipal bonds just through cash flows and refinancing; but that we're also trying to stay out of the really short-term stuff that might be a drag on the margin. It was a little bit of both. We'll just continue to do what we can with the investment portfolio and cash flows, and re-deploy them where we think we're getting a good risk-return trade-off that's consistent with our desire to be asset sensitive.

Okay. Do you have a good estimate as far as what the yield was on that $340 million in loans, the core growth this quarter?

I don't have that number. I think the only number we included in there was your new origination numbers.

Yes, we just had it for the production.

The yield -- I think yield on loans on the commercial side is awfully hard to look, because we report the accretion income as well in that number, so we can probably split that out for you, as well.

We'll try to get that analysis done for you, Stephen, and get it to you on the mix, but it's a good question.

Okay, that's great. One final question related to the margin, how you think that might play out over the course of the rest of 2015?

Again, I go back to my discussion about interest rates. Clearly, if rates go up, I think we will certainly -- short-term rates go up, we should see a benefit from that. There's really no clarity around the direction of rates. As I noted, as long as we continue to re-deploy cash flows or not get the benefit of our strong deposit franchise from a rate standpoint, it will be tough to maintain that core margin. But we think we're closer to the end of those low rates than we are at the beginning.

You heard Chris say at least for the next quarter we're reasonably comfortable that relatively flat, and we're hoping that rates go up; but if not, it's still a tough thing to maintain.

Okay, it makes sense thanks. One final question. You talked a little bit about this last quarter, I believe. Just wanted to clarify, but as far as the branch sales and the closings and everything -- and you gave some great color as far as the cost saves and the progression through the year -- do you have any additional color clarification on the impact to revenue?

Honestly, Stephen, if you think of the franchise we're selling, it's very deposit-rich with not a lot of assets. We don't think that it's a meaningful impact on revenue. I think with the sale we've got, it's really mostly deposits.

Okay. As far as fee income not significant, either?

No. A little bit on service charges, but none of those franchises had very much in the wealth or investment side.

Got it. Okay, thank you.

The reason you sell them is because you're not making a lot of money there.

All right. Got it.

Currently we have no further questions. I'll turn the call back over to you for closing remarks.

Great. Well thanks again everybody for your time. As always, if you have follow-up questions, let Lynell know. If there's additional color we can add in future slides we're always happy to do it. Again, thanks for your time.

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 (855) 859-2056, conference ID code 23961693. This replay will be available through May 11. If anyone has any additional questions, please contact Lynell Walton at (812) 464-1366. Thank you for your participation on today's conference call. Bye-bye.