Old National Bancorp (ONB) 2015 Q3 法說會逐字稿

Welcome to the Old National Bancorp third-quarter 2015 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 the 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 time on October 26 through November 9. To access the replay dial 1-855-859-2056 and conference ID code 45967302.

Those participating today will be analysts and members of the financial community. (Operator Instructions). At this time, the call will be turned over to Lynell Walton for opening remarks. Ms. Walton?

Thank you, Holly. Good morning and welcome to Old National Bancorp's third-quarter earnings conference call. Joining me are Jim Sandgren, Chris Wolking, Daryl Moore, Bob Jones, 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 statements disclosure contained on Slide 3 as well as our SEC filings for full discussion of the Company's risk factors.

Additionally, as you review Slide 4, certain non-GAAP financial measures will be discussed on this 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 the financial measure of actual results. Reconciliations for such non-GAAP measures are appropriately referenced and included in the presentation.

We are very pleased with our results in the third quarter. Please turn to Slide 5 where we will begin the discussion of our third-quarter performance. Our loan balances increased $90 million or 5.6% annualized (technical difficulty) second quarter. This growth is net of loans sold and covered loans and is entirely attributable to new production in both our legacy and newly acquired markets throughout our footprint.

We were also pleased with the improvement in our operating leverage as we saw a decline in operational expenses of 3.5%. We did close on the sale of 17 branches in August and are slated to consolidate an additional four branches in December. These actions are a logical step in our transition to higher growth markets and, as Chris will explain, should result in additional cost savings.

The prudent use of capital remains a priority for us as we repurchased 694,000 shares during the third quarter. We still have 306,000 shares available under the current authorization and our tangible book value increased 3.8% during the third quarter.

Finally, I'm pleased to report that Old National earned $37.7 million or $0.33 per share for third quarter. These results represent a 50% increase in earnings per share over the second quarter of 2015.

On Slide 6, we have included other metrics that further demonstrate our positive momentum. Excluding integration and divestiture charges and the net gain on our recent branch sales, our earnings per share and net income were slightly below third quarter of 2014. In reviewing this comparison, however, it is important to note that the Durbin Amendment became effective for Old National beginning July 1 and did reduce our third-quarter interchange income by $2.7 million on a pretax basis.

With that overview, I'll now turn the call over to Jim Sandgren.

Thank you, Lynell, and good morning everyone. As Lynell indicated in her opening remarks, the third quarter saw us continue our recent trend of solid organic loan growth. I'll begin my detailed comments on Slide 8, which reflects our 5.6% annualized organic loan growth for the quarter. As indicated on the slide, the $98 million in total loan growth produced in the quarter excluding sold and covered loans can largely be attributed to new business generated throughout our footprint, which is consistent with our basic bank strategy. Of the $98 million in growth, commercial industrial and commercial real estate lending accounted for $42.4 million of these gains while consumer lending generated $41.2 million in new growth and residential mortgage lending contributed another $14.2 million. We were certainly pleased to see growth in all of our loan categories during the quarter.

Again, the quarter was highlighted by solid growth in our C&I and CRE loan portfolios. I'm happy to report that we saw meaningful growth in many of our geographic regions throughout the Company. We continue to see tremendous results in our Louisville and Lexington markets with $27 million in new growth during the third quarter. We also saw nice growth in our Bloomington and Columbus markets with increased balances of $11.2 million, Evansville with growth $9 million, and finally, our Terre Haute and Lafayette markets which generated increased commercial balances of $8.7 million.

As you can see, we experienced growth in both our newer markets as well as our legacy markets. A very strong September provided an excellent push to help us achieve this solid growth.

Slide 9 details our commercial and commercial real estate production for the quarter. As the bar graph on the left illustrates, the $373.2 million of new quarterly production nearly matched the $378 million produced in the second quarter. It's also worth noting our average new loan size for the quarter remained relatively low at less than $450,000.

We did see an increase in CRE versus C&I production in the quarter. CRE represented 55% of the total production while C&I was 45%. This compares to our year-to-date commercial production of 58% C&I and 42% CRE.

Just a reminder that our CRE production continues to be focused on in-franchise lending to borrowers that are well known to the Bank and who typically support these credits in some manner personally.

One final note on production is the fact that we closed over $120 million in construction loans during the quarter and have only funded balances on these loans of $7 million. So this should provide a nice boost to commercial balances in the fourth quarter and on into 2016.

The center graph on Slide 9 illustrates the continued positive momentum of our loan rates. Our third-quarter yield of 3.4% on new commercial production represents a 3 basis point increase over our second-quarter 2015 yield of 3.37%. This marks the fourth consecutive quarter of yield growth on a commercial loan production. We are proud of this trend, especially in light of the hypercompetitive market for commercial loans that we are experiencing in most of our markets. These increased yields certainly provide a nice replacement too much lower returns we are currently receiving on our investment portfolio. I'd also like to note that 64% of these new loans were of the variable-rate variety, which bodes well as the market stabilizes and interest rates ultimately rebound.

The graph on the right focuses on our commercial loan pipeline. While the $702 million in the pipeline as of September 30 is a bit short of the record mark established last quarter, it does represent a 21% increase over third quarter of 2014. Part of the reason the pipeline is down is due to the fact that our relationship managers finished the quarter with a flourish by closing and funding over $30 million in commercial loans in the last few days of September alone. With $170 million in the accepted category and another $183 million classified as proposed, we still feel very good about our current pipeline the ability to generate additional loan growth in the months ahead.

As I mentioned on last quarter's call, our commercial team is doing an outstanding job throughout the footprint of producing new business opportunities and we continue to enjoy outstanding cooperation and collaboration between our lending and credit teams.

Moving to Slide 10, you can see that we experienced some downward movement in our fee-based business revenue for the first time in a number of quarters. Specifically for our wealth management and investment businesses, much of this is attributable to the downturn in the equities markets. Lower market value certainly caused the decrease in revenues in wealth management and to a degree in our investments business. Investments was also negatively impacted by the branch sales in mid-August as we lost four of our financial advisors in the transaction. We are confident that we are well-positioned to see a rebound in both business lines as conditions stabilize.

The slight downward trend in our insurance division partially reflects the fact that August and September are traditionally lower revenue months in our insurance business. That being said, we continue to be pleased with our ability to retain business in a very competitive marketplace.

Mortgage revenue also saw decline during the quarter, which can be attributed to the shift in our mix of residential mortgage loans. During the quarter, we experienced a notable increase in our production of jumbo loans and construction loans, both of which we retain on our balance sheet and obviously forgo any immediate fee income from the sale of these loans. While the mix has impacted revenue for the quarter, we continue to be very pleased from overall production standpoint. Year-to-date, our mortgage loan originators have produced $481 million of new residential mortgage loans versus $206 million year-to-date last year, an impressive increase of over 130%.

In spite of some of the challenges faced by our fee-based businesses in the quarter, we are encouraged by the continued success of our cross-sell referral program for our associates. If you'll recall, we launched the program back in February and it has resulted in more than 34,000 referrals to date while generating tremendous collaboration and knowledge sharing throughout the organization.

While our referral volume continues to grow, we are even more encouraged by the fact that our close ratio continues to improve, now 38% year-to-date versus 35% year-to-date through the second quarter of this year. For these reasons, we remain confident that we are in a great position to experience some significant wins in our fee-based businesses in the coming quarters.

In closing, the third quarter provided a strong illustration Old National's ability to continue to produce organic loan growth throughout our footprint in spite of competitive market conditions. I am convinced that we have positioned ourselves in the right markets and we have the right people in place that are laser-focused on taking great care of our customers and actively seeking new ones in our continuing effort to drive more revenue. Together, I am confident we will do just that going forward.

With that, I will now turn the call over to Chris.

Thank you, Jim. I will begin on Slide 12 with the graph showing total revenue compared to last quarter and to the third quarter of 2014. Total revenue was $156.8 million in the third quarter but included $15.4 million in branch sales gains. Without the branch sale gains, revenue was $141.4 million for the quarter.

Net interest income was $5 million higher than second quarter 2015 while noninterest income, excluding the branch sale gains, was $10.7 million lower than the second quarter. Jim reviewed several of the quarter-over-quarter differences in noninterest revenue, but the largest contributors to lower noninterest income for the third quarter were higher IA amortization charges and lower debit card interchange income.

We were under the Durbin interchange fee mandate beginning July 1, and it cost us $2.7 million in the quarter. The impact from the Durbin change was within the range we expected.

We incurred $6.6 million of indemnification asset expense in Q3 compared to $1.5 million in the second quarter. $5.9 million of the third-quarter amortization expense was related to the full recovery of a single impaired Integra loan. We had not expected to resolve this loan until late 2016.

Third-quarter 2014 net interest income included accretion income of $34.3 million compared to $20.6 million in the third quarter of 2015. Net interest income without accretion was $2.9 million higher in the third quarter of 2015 compared to third quarter of 2014.

Moving to Slide 13, I've shown third-quarter net interest margin compared to third quarter 2014 and second quarter of 2015. Third-quarter net interest margin was 19 basis points higher than second-quarter. Core net interest margin was 3.14% in the third quarter, 1 basis point lower than second quarter of 2015.

Third-quarter core NIM was 4 basis points higher than we expected due to higher-than-expected recoveries from non-accruing assets, higher yield on our investment portfolio, and strong yields on loan production. We believe next quarter's core net interest margin will be in the range of 3.09% to 3.11%, assuming no change in short-term interest rates. As long as short-term interest rates remain low and we see limited opportunities to reinvest our portfolio cash flows, we expect ongoing pressure on core net interest margin. Continued strong loan growth may mitigate pressure on the core margin, however.

Accretion income, while still variable quarter-to-quarter, continues to decline. In the third quarter of last year, accretion income contributed 146 basis points to our reported net interest margin, compared to only 80 basis points this quarter. As I noted earlier, third-quarter accretion income was higher than Q2 due to the resolution of one of the few remaining large Integra loans. Much of this additional accretion was offset by the higher indemnification asset expense in the quarter. We expect the contribution from accretion income to decline gradually going forward because most of our remaining accretion is related to noncredit impaired purchased loans. This discount should be recognized into income gradually as the loans mature and are renewed.

On Slide 14, I provided further discussion of our purchased assets in the remaining fair value discount. I've broken down our purchased loans into credit impaired and noncredit impaired loans. The pie chart on the left side of the slide shows our purchased loans not covered by FDIC loss share. Nearly $1.3 billion of our noncovered purchased loans are considered non-impaired and carry a remaining discount of approximately $68 million. Only $53 million of the noncovered loans are considered credit impaired. Credit impaired noncovered assets carry a remaining fair value discount of $26 million.

The pie chart on right side of the slide shows the remaining loans covered by the FDIC loss share. Approximately $83 million of the remaining covered loans are considered purchased credit impaired assets and carry a $20 million discount. $71 million of the remaining loans, while still covered by FDIC loss share, are not considered credit impaired loans.

We believe there are important takeaways from this information. First, our remaining purchased credit impaired loans total $136 million but have a remaining acquisition discount of $46 million, or 34% of the customer balance. Based on the historical success our credit workout team has had recovering discount on purchased credit impaired loans, we should recognize a portion of this discount as interest income in the future as these loans are remediated.

Secondly, note that the largest component of our purchased loan portfolio is noncredit impaired. The $1.4 billion non-impaired portfolio carries $71 million of acquisition discount. While a fairly large discount in dollar terms, it is only approximately 5% of the customer balance.

As you can see from this slide, most of our total acquired loan portfolio is of high quality and is not considered impaired. These loans are with strong new customers with whom we intend to expand our business relationships. We expect the acquisition discount on these loans to accrete into net interest margin consistently and somewhat gradually as these loans approach their renewal dates. These loans should renew in the future at market interest rates. The market interest rate and the provision expense at the time of renewal should reflect the asset quality rating and the expected loss on the loans.

On Slide 15, you will see that operational expenses without acquisition and divestiture charges were $100.6 million, down 3.5% from the second quarter of this year. We completed the divestiture of 17 branches during the quarter. Total full-time equivalent employees were 245 FTE lower than the third quarter of 2014, a decline of 8.4%.

Adjusted for acquisition and divestiture costs and the gain on our branch sales, our efficiency ratio for the quarter was 67.2%. We are on track to bring our fourth-quarter operating costs to between $95 million and $96 million in the fourth quarter of 2015.

Moving to Slide 16, I have added more information on the planned purchase of several branch properties that we are currently leasing. This is the transaction we disclosed in the 8-K on October 8. These properties were originally sold and leased back in 2007 and 2008. There are 14 branches included in this transaction and we expect to close on all 14 in November of this year. With the repurchase of the properties, we will terminate the corresponding leases simultaneously. Terminating the leases will release approximately $12 million in deferred gains that will be recognized at closing. When we consider the elimination of the net lease expense, the new depreciation expense, the reduction in future deferred gain income and lost investment portfolio income from investing $66 million in the properties, we believe we should see $500,000 to $600,000 in benefit in 2016 in addition to the $12 million gain recognize and 2015. I'll provide further information on this transaction during our fourth-quarter call in January.

On Slide 17, I've updated our interest rate sensitivity for September 30. The bullets on the left side of the slide reflect the critical factors that contribute to our rate sensitivity. The most significant driver of the change in net interest income from rising rates in our models are the assumptions we use for the sensitivity of our transaction accounts. 22.2% of our non-interest-bearing checking balances are considered sensitive to rising interest rates as of 9/30.

Our projected change in one year's net interest income with an immediate increase of 100 basis points all along the yield curve declined to a negative $2.2 million from approximately zero at June 30. This was due primarily to the sale of almost $556 million in deposits with the August branch divestiture. With the model change in rates that is consistent with the market's outlook for future rate, net interest income should increase approximately $2 million over one year. The forward curves we used in this model are included in the appendix on Slide 28.

The change in our modeled output does not represent a change in our outlook or strategy. We expect to maintain a balance sheet that should generate higher interest income with rising interest rates. We will continue to extend the repricing of our deposits in funding and reduce the duration of assets when possible. Our investment portfolio declined slightly during the quarter and the duration of the total portfolio shortened to 4.03 at September 30 from 4.23 in the second quarter 2015.

Slide 18 shows the change in tangible common equity and in tangible book value per share since June 30, 2015. At September 30, tangible book value per share was $7.45, up from $7.18 per share. Much of the increase in tangible book value per share was due to earnings, plus we repurchased approximately 700,000 shares in the quarter compared to 1.9 million shares in the second quarter. Of the $7 million share repurchase the board authorized for 2015, we have 306,000 shares remaining. We expect to complete the authorized repurchase in the fourth quarter.

I'll now turn the call over to Daryl.

Thank you, Chris. We'll begin our credit discussion this quarter on Slide 20, where we'll overview our charge-off and provision expense performance for the quarter. Bolstered by strong recoveries of $3.3 million in the period, we are pleased to be able to report that we posted net recoveries in the quarter of $900,000, or 5 basis points of average loans. This compares to net charge-offs of $1 million or 6 basis points of average loans last quarter and net charge-offs of $0.5 million or 3 basis points of average loans in the third quarter of last year.

On the strength of our recoveries in the quarter, we were able to lower our provision for loan-loss expense to roughly $200,000, down from $2.3 million last quarter and $2.6 million in the third quarter of 2014.

In addition to the net recoveries posted in the quarter, the level of provisioning was also influenced by the growth in the loan portfolio during the third quarter as well as a meaningful increase in substandard loans in the period, which I will discuss shortly.

On a consolidated basis, the allowance for loan losses as a percent of end-of-period pre-marked loans student 0.74% at September 30 compared to 0.73% at the end of last quarter. The combined allowance in loan marks as a percent of total pre-marked loan outstandings stood at 2.41% at the end of the current quarter compared to the 2.71% level at June 30. Further details for the allowance of loan marks can be found in the appendix on Slide 32.

With respect to changes in the portfolio risk profile in the quarter, on Slide 21, you can see that we had a nice reduction in special mention loans, lowering those categorized assets by $32.7 million, or 19%, in the quarter. However, substandard accruing loans increased by $22.5 million in the period as a meaningful part of the improvement in the special mention category came from downgrades into the substandard accruing classification. With respect to the larger loans which migrated to this category in the quarter, active workout strategies have been applied to each and some progress is being made on several of them.

The final chart on the slide shows that nonaccrual and doubtful loans decreased nicely in the quarter falling $27.1 million from $167.8 million to $140.7 million. We had two significant nonaccrual loans pay in full in the quarter, which, along with upgrades in line pay-downs, contributed to this improvement.

Overall, the quarter was a good one for the Bank with respect to our credit metrics. With charge-offs and provisioning at low levels and significant reductions in special mention and nonaccrual credits, the only negative trend in the quarter was our increase in substandard loans.

As I mentioned last quarter, the one sector of our loan portfolio that we continue to watch very closely is our agricultural segment. Early reports indicate that the crop yield losses that our farmers were expecting as a result of the flooding experienced in many of our geographies may not be as severe as initially expected. This is good news in that the agricultural community continues to be beset very thin margins and the near-term prospects for improvement in that regard are not strong. As our intent is to continue to support the good farmers in our portfolio throughout this cycle, we may see an overall increase in the risk profile of our agricultural portfolio in the intermediate term.

Finally, several quarters ago, we talked about our exposure to the energy industry communicating that we had reviewed our portfolio of borrowers that we felt could be negatively affected by the dynamics in this industry and didn't at that time see any significant exposure to loss. We thought it important to follow back up with you at this time to confirm that we have not seen any significant negative impact to our portfolio related to low gas and oil prices but that we will continue to watch this segment for any signs of weakness.

With those comments, I'll turn the call over to Bob for concluding remarks.

Great. Thank you, Daryl, and good morning everyone. As we conclude the formal portion of today's call, I thought it would be beneficial to you to give a quick perspective on my view of the third quarter, then follow-up with a qualitative outlook for 2016.

Obviously, the third quarter was a little noisy given the number of actions that we took. As you move beyond the noise, the headline for the quarter is that we are executing on our key items of focus for 2015. Net interest income showed solid growth that was fueled by good loan growth and a continuation of strong credit metrics. This combination of solid loan growth supported by excellent credit truly represents what we are as a Company.

Our non-interest income was negatively affected by the Durbin Amendment, the large IA offset and the equity markets. The encouraging signs for me are the strength of our sales activities and the amount of new business that we are adding in all areas, a sizable portion of which is coming from our newest markets.

As Chris noted, we have made good progress on expenses and I continue to be very pleased with the commitment at all levels to being good stewards of our expense dollars. This is critical not only to allow us to achieve the level of efficiency that we desire but also in light of the ambiguity that the Federal Reserve has shown of late as it pertains to their intentions. I for one wish they would just get it over with. The lack of clarity that exists today creates an undue anxiety in the economy, which has a negative impact on business sentiment and, if we're not careful, may push the economy in reverse.

I would note that there is a disconnect between what the media is reporting about the economy and what we are hearing from our clients in all markets. The number one issue we hear from our clients and prospects is that they cannot staff adequately to meet the demand for their products and services. The activity in our pipeline would support this assertion. It is very rare that we hear a client frustrated with the economic activity. In fact, the majority of time, it is just the opposite.

The competitive environment continues to be at a very high level in all markets. And for the most part, this competition is rational, though in some markets, particularly the larger markets that we serve, we continue to see irrational pricing and structure driven mostly by our largest competitors. Given that we are fully staffed with seasoned relationship managers, we are able to compete on the strength of our people and their time in the market. When we get into a hyper competitive process, we are more than likely to give on pricing rather than structure.

All in all, a very solid quarter and one that continues the positive trends that we have seen this year. These trends set us up well for 2016. We believe that the foundation that we have built over the last a few years with our entry into the new markets and the focus on being better stewards of cost and capital give way to an optimistic view of 2016.

Our focus for 2016 will not change significantly. We will focus on growing core revenue, continuing to reduce our expense base and being good stewards of our owners' capital, in other words old-fashioned banking will continue to drive us.

I would add that given the foundation we've built and the good potential for net income growth, we remain keenly focused on our need to grow our tangible book in order to achieve the value we feel our stock deserves.

In closing, let me say we look forward to having you all in Ann Arbor on November 18 and 19 to discuss more detail our plans for execution and give you a better sense of why we are optimistic about our 2016. Our format for the event is designed to be very interactive and is not a traditional dog and pony show. We find the less formal presentation time at investor conferences to be the most valuable. In that style, we will have five panels targeted to key areas of focus based on the feedback we receive from investors at your conferences or from those of you on the phone. This format is designed to allow you to ask whatever question or topic that is on your mind, and these panels will be facilitated by a moderator, but the key to their success is your involvement. Lynell will be sending out more details on the panel very soon. And for those of you who may not be able to attend, if you have any questions or topics you would like addressed, please forward those on to Lynell prior to the event and we'll make sure that we do respond.

With that, Holly, we'll be glad to open the lines up for questions.

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

So Scott, we are going to start calling you Star One.

I like it. It's better than most of the nicknames I've had. (laughter) Hope you guys are doing well and thank you for taking the question.

Let's see, either Bob or Jim, I guess I was hoping you could just touch on the increasing yields on new production. I think you've had several quarters in a row of slightly higher yields. I'm just curious if you can add a bit more color as to what's behind that, you know, whether it's high risk appetite, mix shift, maybe inappropriate pricing previously that you've kind of rationalized, just from your standpoint how you see things playing out and how much more you could allow those to elevate in the future.

Yes, Scott, great question. I will say this. You know Daryl better than most of us. It isn't about increasing risk. I think what we are really seeing is better discipline around our RMs, the fact that we are in some of these new markets where we are finally getting on our toes and getting out and generating new business. And given the position we have in the markets, I think it's been very helpful to us. Clearly, we're seeing competition but I think the yield on the pricing is really reflective of the markets we're in and our competitive position in those markets.

Okay, perfect. Thank you. And then Chris, just a quick follow-up on the margin. I Just want to make sure thinking about things correctly. So first, thank you for the color on the core margin expectations into the fourth quarter. I think as we look at the reported, obviously a nice lift this quarter from purchase accounting benefits. I think you've used up most of what you would expect for the full year based on some of the disclosures that you guys have had. So I imagine the core, or excuse me, the reported margin should come down fairly precipitously in the fourth quarter. Is that a good way to think about things?

You know, it's always hard to anticipate, especially on the impaired assets. Scott, that's why I tried to call out the remaining discount on either impaired assets or on non-impaired assets. And as I noted, that was one of our last large Integra assets that we really didn't expect to remediate until next year and, frankly, we did a much better job on that asset than obviously we would have anticipated given the indemnification asset we had to charge. So it's really difficult for me to call out anything specific for next quarter but as we've stated for a couple quarters, as we work through those impaired assets, it should be a gradual decline over a fairly long period of time as these assets are renewed and booked into our just the normal balance of assets.

Scott, I would say, versus a precipitous drop, it's really more of a gradual decline over time. The one large credit, while important, doesn't have that much of a material impact on that number. And I think where we would encourage people to look is more the graduate our team of that decline versus the cliff.

Okay, all right. That's perfect. Thank you guys very much, appreciate it.

Emlen Harmon, Jefferies.

So you are Star Two. (laughter) If you got a little quicker, Emlen, you could be Star One next quarter!

Another cup of coffee next quarter apparently. A quick question for Chris. It sounds like the shift in your expectation for interest rate sensitivity is primarily driven by your deposit assumptions. Can you give us a sense if there is a mix in your actual deposit base or if it's something you are seeing differently in the market, you're going about your assumptions in a different way? I'd just be kind of curious how you're thinking about that.

Emlen, I think the quarter-over-quarter change obviously was the divestiture of the deposits in the third quarter. And I don't -- while we've kind of rebalanced some of those with some interest rate swaps and things of that sort, I'd anticipate that we'll continue to recover that rate sensitivity going forward. That's just -- it just takes a little time to execute. So that really was the quarter-over-quarter change.

I don't know that materially our mix of deposits has changed dramatically from Q2 to Q3. It's still a fairly nice balance of transaction accounts and those transaction accounts, as you know, are -- the repricing is so much driven by assumptions and they can be different from obviously one bank to another bank. So we feel like we continue to have pretty reasonable and conservative assumptions around our repricing and that's why we like to call it out when we have these discussions every quarter.

Got it, thanks. And while I've got you going, Chris, on the expense guide for the fourth quarter, does that include the full effect of the LSB and founders' cost saves? And then I presume there's also some benefit from the branch transaction that would follow in 2016. Is that fair?

Well, we do have a few branches that we still anticipate consolidating in the fourth quarter, and we had some charges related to that in the third quarter. I think we called those out as being $2 million in the stacked bar graph.

But I think, as we go into fourth quarter, it's all of the above. Everything going into the fourth quarter anticipates all of the consolidations and those kinds of things.

Emlen, I don't know that we'll have any effect from the branch purchase in the fourth quarter other than the potential to gain should the transaction close. The branch sales you'll get the full effect of that in the fourth quarter, which is really one of the more material drivers of getting to that$95 million to $96 million number, plus continued actions. We've got over 40 programs or actions that we are working on today that are all related to cost reductions. And you get those benefits over the period of time, and it gives us good momentum going into 2016.

And as Bob stated and we've talked about before, I can't do much about interest rates but we can keep looking at expenses, working on expenses, whether it's in the procurement area or -- there are just all kinds of opportunities for us to continue to manage expenses, and we've got our foot on the accelerator for those projects.

Got you.

The actual acquisition of the properties really is such a late Q4 and that I'm really looking at being more of a 2016 benefit, other than the gain of course.

Got it, yes. That's right. I was thinking -- when I was talking about 2016, I was talking about the acquisitions but branch, so much going on there, transaction probably isn't the fair way to phrase that question originally. So that was helpful. Thank you.

Chris McGratty, KBW.

Bob, I want to ask about your prepared comments, about the focus on tangible book growth. You guys have been on a self-imposed probation for M&A for some time. At what point does that or have we started to shift more toward getting more scale in some of the new markets and willing to do a deal again?

Great question. So Chris, I would just say, if you go back to our three core strategies, which is we continue to focus on execution on core revenue growth, cost reductions and being better stewards of capital, if we can find a transaction that is compelling enough to meet most of those criteria, and it would be in one of the markets that we've identified, then clearly we would be willing to consider a transaction. But I would emphasize the word "compelling".

Again, as I've said all along, we've built the foundation of the house and now if I need to add on or remodel a little bit, we're in a position to do that. But I would tell you that the business owners are very excited about the fact they're just executing. It's a lot more fun to be driving in loan business and wealth business and insurance sales than having a massive group of people doing integrations. But I also have got to do what's fair for the long-term value of our shareholders.

Okay. And just so I'm clear, it sounds like a little bit of a shift in willingness to consider a deal from your clause comments. Is that a fair kind of take-away?

That's a fair comment, but I think I would underscore the word "compelling". I don't want anybody to get all nervous that Jim and I are out dancing with a lot of dancers. Right now, I spend probably 80% of my time on driving revenue, and that's a general shift from where I was two or three years ago. But if we found the right transaction, clearly I've got to do what's right for the long-term value here.

Okay, that's helpful. Just on the sale-leaseback transaction and reverse sale-leaseback, aside from the minimal cost savings that you will get from that, is there a -- how do we think about that $66 million purchase price? Does that just flow through? Maybe help me with the P&L impact. Does that flow through capital as kind of an adjustment to capital levels?

No. The actual $66 million is just a shift in assets. It kind of comes out of the investment portfolio (multiple speakers) into real estate. The gain, $12 million, if you've watched our financials, we've talked about that deferred gain for a number of years. And I think there's about $50 million in deferred gain on the balance sheet today associated with all of the sale-leasebacks. So that comes out of a liability really into equity.

Yes, the only capital effect, Chris, would be depending on what we do with the gain. As you think about that gain, we would look at a couple of options as you -- again, assuming that gain happens. Chris and I have discussed ways to reduce costs in 2016, looking for ways to be better stewards of capital. And that could either be let it flow to income and increase tangible book or have it do a buyback so that you could increase EPS. But we look at all of those options, probably with the first part of that equation being the more we try to do. If there's anything we can do to materially reduce our cost structure going forward, it would be a prudent thing for us to do.

But it does go through the income statement to the gain.

Okay, got it. And this, the last one, for Daryl. Have you guys disclosed if you have any direct exposure to energy, or are your comments in the past just kind of indirect benefits of lower oil?

Yes, we've not disclosed our direct but it's minimal.

Okay. Thank you.

Jon Arfstrom, RBC Capital Markets.

Mr. Arfstrom, welcome back to the call.

Thank you very much. I'm the fourth person in the roster. I'm happy about that.

I didn't want to say that. You know, the better way to look at that, if you are a Cubs fan, you are batting cleanup, Jon.

That's true, that's true. As long as we're on the sports topic, I do have a business question but, Bob, will you be wearing the Wal-Mart khakis like Harbaugh for the investor day, our would you be more professional?

I will have Wal-Mart khakis with that tacky sweatshirt, but I'll have my Buckeye socks on.

All right. I got it, got it.

I will say, Jon, I had a whole litany of sports analogies in my script and Lynell gave me the stink eye and said take them out, so --

I'm glad I can provide those for you.

You can blame her for the lack of humor in my script.

All right. Just on the efficiency topic, you touched on a little bit on Emlen's question. But efficiency opportunities for here, give us an idea of where you see some of the larger opportunities?

Really across the board. Right now, we've got well over 40 active projects that are cost related. A lot of those are related to our back room. As you look for either outsourcing, consolidating, better systems, you're looking at productivity enhancements. Jon, they're just -- everyone is focused on it. Chris has done a great job of engineering the process. You know, do we have a lot of grand slams? Probably not. We've got a lot of single, doubles, maybe a triple here and there. But you look at the branch transaction, it's a good example of we're looking under every rock to find those areas. We are committed and I think, as you get closer to Ann Arbor, you're going to hear more and more about those opportunities as well.

Okay, okay, good. And Bob, maybe for you or Jim, just the Louisville and Lexington comment, why is that going so well? And you didn't mention Michigan, and I'm just curious if it was just something unique to this quarter, or just give us an idea of how it's going in Michigan?

Michigan is going very well. Obviously, we're still in a retain and gain mode in Michigan, so our RMs -- Grand Rapids has gone extremely well. We've had some terrific growth in Grand Rapids. Kalamazoo continues to do well. You know, Ann Arbor's doing good. You know, we've still got some retention we are working through there but the growth was there. It just wasn't as meaningful as the other markets.

Lexington, Louisville, quite frankly, is just a great example of hiring great people. The market president we brought into Lexington had a great book of business from his prior employer. He's already hired another RM. We've got some other folks joining the team. He's got no baggage. In other words, he's not worrying about retention. He's on a full mode to generate new business, which works well. And I think that is true for Louisville as well as they continue to go forward. Honestly, there's a reason we are going to Ann Arbor, which is how pleased we are to be in that market. And I think you'll see, as you meet that team, that there are very engaged and feeling very positive.

And on the Kentucky piece?

Just good people, Jon. I apologize. I jumped from Ann Arbor to Lexington to Louisville there. Hired great people. You know, Lexington, we've got a guy that came to us with a great reputation and had a senior role at a bank. He's already hired another guy and just he's out prospecting all day long and it's a great position to be in. So, I think Lexington and Louisville both are just a great example of tremendous people focused on driving new business.

Okay, good. Then just one last on the construction activity, Jim, that you mentioned. It just helps us gauge the health of the market. But give us an idea of type of construction loans? Is it multi-family? Is it a builder book? Is it commercial projects? What is it?

Yes, it's really more -- yes, we haven't done much on the multi-family. I think what we've found, we've found some very strong either retail tenants, some investment-grade type tenants on some of these properties. But yes, we are really encouraged by -- I think this kind of speaks to what Bob talked about earlier in the call -- the fact that our customers are really feeling good and bullish on the future.

But it's -- multi-family is something that we are a little bit leery of, so we haven't done a lot of that. It's been really more non-owner occupied stuff, but getting good guarantor support and pretty strong leases in place. So it's kind of a nice mix.

All right. Thanks for the help.

Terry McEvoy, Stephens.

Just I'll start with a question for Chris. I am just trying to true up the Integra loan and the higher indemnification asset. And maybe one way for me to look at it is if I look at the remaining discount on the purchased credit impaired, Integra loans went from [$2 million to $20 million]. Is that the type of impact that you saw from that loan and net interest income this last quarter?

Yes, think that's fair. And correspondingly, our indemnification asset at the end of the third quarter was really relatively small compared to where we started four or five years ago. So again, given the ability to remediate that loan early allowed us to recognize that accretion income and offset the IA that -- since we solved it and remediated 100%, you knock out some of that IA associated with that specific asset because you don't expect to need that coverage from the FDIC.

Terry, I think, to your topline, the offset to that is the $6.6 million in IA amortization we took. So I think your analysis spot on.

Okay, thanks. And then I guess just looking at future fee income and the branch sales, and I know you mentioned some employees that left that were fee generating, if you look and think about those branches going forward, how much of a headwind will they really create in 4Q and into 2016 as it relates to wealth management, mortgage insurance, and how much of that was coming from those branches?

Very, very, very little. We had a very small presence of wealth in those markets. In fact, we still kept the largest client that we had in that market. We had a little bit of seasonality in deposit service charges because of the University, but net-net over a year period of time, it would be de minimus. You saw the impact of our investment side. Insurance was de minimus as well. So from a noninterest income basis, that sale has very little effect. I wouldn't even call it a headwind; I would call it a stagnant wind, if that's even a word.

Then just a last question. I don't know if you disclosed the size of the ag portfolio or the reserve that you may have against it, but any color on the size and reserve would be helpful given that you've called it out now couple of times on the calls.

Yes, Daryl is getting that number. I would tell you it's not that significant but as soon as he gets to the right page, we'll get there. Have you got another question we can answer. How's the weather in Portland?

It is very cold.

Yes.

What about the consumer indirect yields going from 2.39% up to 2.51%? I know somebody earlier just talked about the increase in loan yields. Anything specific, mix shift? Because it was, it did catch my eye as I went through the presentation.

Yes, we -- July 1 is our change out of the model years and at that time, we took the opportunity to tweak up some of the rates. That would've been the second time this year that we had made some slight increases to our loan rates. And thankfully we've been able to really increase spread and volume continues to be very, very good. So we've been happy with that. We've got great relationships with our dealers and pretty bullish on 2016 from an industry standpoint as well.

Terry, our ag portfolio was about $325 million. So, it's, as a percent of capital, about 20% capital, a little more than that. Our reserve against that, interestingly enough, is -- and I don't have the exact number, but we struggle with that basically every quarter because we've had such small losses over the years in that portfolio. So if you just apply kind of the losses and where we are, you would come up with a reserve that is slightly less than where we are today. So we looked at that. We don't have a huge reserve against that, but more than you might expect with respect to the historic losses.

Great, very helpful. Thanks so much.

(Operator Instructions). John Moran, Macquarie.

Hey. Just a quick follow-up on Terry's question there. It sounds like wealth management and investment income hurt really this quarter more by volatility than exiting any of these markets or the -- (multiple speakers)

Absolutely.

Okay.

I can tell you the wealth was almost entirely related to the volatility in the equity market. Investment, we had four producers. They were good producers. They weren't any of our top-tier producers. And I think ongoing, we've actually replaced two of them in other markets, so we should get the additional benefits. So, again, we don't see any headwinds coming from the sale on our noninterest income side.

Got it, got it. And then those line items would be, given that the volatility has sort of subsided here and we've snapped back, is it fair to sort of say 2Q run rate might be a better way to look at this one going forward? You know, obviously not --

Yes, I think that's exactly right. And again, I go back to the comment I made from the sales side, we continue to see very good sales activity and sale wins. And the nice thing on our wealth side, we are seeing bigger books and bigger opportunities that we are getting a chance to do because of the new markets.

Insurance, I might mention, we had no significant client loss in the third quarter, which is a very important renewal period for us, and we felt very good about the renewals, the rates that we were able to get.

Okay. And then I'm going to circle back on OpEx again here, and I know you guys have talked about it in a couple of different questions here. But if we think about 4Q kind of $95 million to $96 million and then all of the initiatives that you still have that are ongoing, is it fair to say, and maybe it's a little early for 2016, we'd probably get more in Ann Arbor on this. But it sounds like what you're saying is that this is going to get whittled down in 2016 at the same time that hopefully topline is kind of growing and we are getting closer to sort of achieving long-term efficiency goals.

Bingo.

Okay, perfect.

Spot on, I mean I think, you know, clearly we've made what I would say is good progress. And again, what I would argue is we have made sustainable progress in reducing costs. But I think as you look at the ambiguity in the interest rate environment, just the change in our business, you've got to continue to look at costs. And as we move into our 2016 planning, Chris and I will set a very healthy target for our teams to achieve. And I can tell you there's a lot of energy around it and a lot of understanding. So we keep pointing to the fourth quarter, but I think, for cost, that is a good quarter to look at. But we'll continue to whittle it down from there.

Got it. So it's more here's kind of the starting line as opposed to we are in the end zone?

Absolutely.

Yes, we are not doing any touchdown dances.

Okay. Terrific. Thanks for taking the questions, guys.

Thank you. And at this time, there are no further questions. I'll turn the conference call back over to you for closing remarks.

Great. As always, if you have follow-up questions, please get them to Lynell. I would just again reiterate, one, how excited we are to see everybody in Ann Arbor to expose folks to that great market. As you know, we are having our directors on one of the panels, but obviously we're trying something new, and it's really an interactive session that we think is going to add great value and be more transparent with you as investors. So please come prepared or else we're going to have a lot of dancing going on. So with that, we look forward to seeing everybody in Ann Arbor.

Thank you. This concludes Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old National's website OldNational.com. A replay of the call will also be available by dialing 1-855-859-2056, conference ID code 45967302. This replay will be available through November 9. If anyone has any additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation on today's conference call.