Old National Bancorp (ONB) 2016 Q2 法說會逐字稿

Welcome to the Old National Bancorp second-quarter 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 1PM Central time on August 1 through August 15. To access the replay, dial 855-859-2056 conference ID code: 4357-6759. 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. Welcome to Old National Bancorp's second-quarter earnings conference call. Joining me are Bob Jones, Jim Sandgren, Jim Ryan, Daryl Moore 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 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 a financial measure of actual results. Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation.

Before moving into the heart of our earnings discussion, I just wanted to take a moment and acknowledge the many moving parts or what is affectionately called, noise, in our numbers this quarter. We realize this doesn't make your jobs any easier. It is our intention with this call to do our best to highlight this noise and as we've termed them, notable items, so you can evaluate the core results and strong underlying fundamentals of our performance this quarter.

As we turn to slide 5, you can see the strategic actions that were accomplished during the quarter as they relate to our initiatives for the year. First, the closing of our partnership with Anchor Bank and entering into the state of Wisconsin. This transaction closed May 1, so our financial results in the quarter contain two months of Anchor operating income and expenses along with the issuance of an additional 20.4 million shares of common stock.

The second strategic action is the sale of our insurance subsidiary, which closed on May 31. So there are two months of insurance income and expenses in our quarterly results. The third strategic action is the early termination of our FDIC loss share agreement, which means no more covered loans and no more indemnification asset going forward.

Slide 6 contains a some of the financial highlights of the second quarter with our reported net income of $39.1 million and earnings per share of $0.31. Notable items impacting this quarter are included on this slide and had a net positive impact of $8.7 million on an after-tax basis.

So the biggest highlights of the quarter are: first, our over 11% organic loan growth; and second, the 5.5% increase we saw in our tangible book value, even after closing the largest partnership in our history. In addition, we had quarter-over-quarter organic growth in our fee income businesses. All of these will be discussed in greater detail throughout our prepared comments.

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

Thank you, Lynell. Good morning, everyone. From a bank perspective, the headline for Old National's second quarter is simple, we continue to produce significant organic loan growth throughout our franchise. To be specific the 11.3% organic growth that we experienced was our best results since the second quarter of 2014 and it marks five consecutive quarters of meaningful loan growth.

If you'll turn to slide 8, I will begin with a closer examination of our loan growth numbers. As you can see, the first green bar is labeled Day 1 Anchor. This represents the more than $1.6 billion loan portfolio that moved to Old National's books when we closed our partnership on May 1 of this year. The second green bar reflects the $199.1 million in organic loan growth that we experienced during the quarter, driven primarily by increases in commercial of over $154 million and indirect of nearly $33 million.

What is truly unprecedented -- it's the reason we chose to label the first green bar the way we did, is that from May 1 to quarter end, our new Wisconsin market accounted for $39 million in new organic loan growth or almost 20% of our quarterly total. To say we are pleased with these early results in Wisconsin is an understatement. I can tell you that this success is directly attributable to the strong leadership and team we have in place in the market, which has absolutely hit the ground running.

We also experienced impressive growth from a number of our markets across our footprint. In addition to the $39 million in new loans in Wisconsin, we saw a $32 million increase in our Louisville/Lexington market, a $30 million increase in both our Bloomington/Columbus and South Bend/Elkhart markets, followed by gains of $15 million and $11 million in our Indianapolis and Ann Arbor markets respectively. Simply put, these results provide evidence that our growth strategy is working. Quarter-after-quarter, we are now reaping the benefits of having repositioned our franchise in vibrant growing markets.

Slide 9 details our commercial and commercial real estate results for the quarter. I'll start by focusing on the new quarterly production graph on the left, which illustrates a 5.2% year-over-year gain in a very strong 26.3% quarter-over-quarter production increase. For the quarter, 63% of our new commercial loans were of the commercial real estate variety with the remaining 37% falling under C&I.

A deeper dive reveals that approximately 60% of all loans in the CRE category were concentrated in non-owner occupied investment real estate. I can tell you that we are very comfortable with the somewhat higher levels of CRE given our deep relationships with these borrowers, the credit underwriting and structure of these loans, and the additional experience and expertise gained through the Anchor Bank partnership. In fact, we will be leveraging the expertise throughout our footprint through the creation of a new CRE specialty underwriting group.

We will continue to stay true to our conservative risk appetite as we underwrite and ultimately close these CRE loans, which remain at a low 163% of capital. It's also worth noting that 59% of all new commercial loans produced in the quarter were variable rate loans, which will serve us well once we eventually experience some much-needed interest rate relief.

The middle graph shows that our production yield remain steady on both a year-over-year and quarter-over-quarter basis. We are particularly pleased with our stable yield on our new production in light of the competitive marketplace for these loans. The final graph depicts our commercial loan pipeline, which with the inclusion of our new Wisconsin markets has surpassed the $1 billion mark for the first time in Old National history. Specifically, our pipeline stood at $1.117 billion on June 30 with $489 million classified in either the proposed or accepted categories.

To put this in perspective, a year ago our pipeline stood at $740 million, meaning we've experienced a 51% year-over-year gain in our total pipeline numbers. Even after our strong commercial production generated in the second quarter, we are encouraged by the continued increase in our pipeline. Taken together, the graphs on slide 9 illustrate that our commercial lending team continues do an outstanding job of creating new business opportunities, all while maintaining strong credit quality.

Moving to slide 10, you will see that we had a nice lift in wealth management revenue for the quarter with a 16% increase over Q1 2016. These gains were fueled by an improvement in the overall market conditions for the quarter, absent the impact from the Brexit vote, as well as new revenue generated by our client advisors. As a reminder, Anchor Bank did not have a wealth management division, but we will continue to look for partnership opportunities in the market post conversion.

Improved market conditions also helped our investments division move from $3.9 million in first-quarter revenue to $4.1 million, excluding Anchor for the second quarter. When you factor in revenue from Anchor starting May 1, investments experienced a 21% quarter-over-quarter increase.

Our Wisconsin market has added a talented group of investment advisors to our already strong team. They had also utilized the LPL platform, so the transition has been a very smooth one. We are encouraged by the early production from the team and look forward to even more growth going forward.

Our mortgage division experienced a 38% quarter-over-quarter revenue gain, excluding Anchor and an almost 80% quarter-over-quarter gain, when you factor in the $1.2 million in revenues from Anchor. From a legacy perspective, mortgage loan production in the second quarter increased nearly 60% from $114 million in the first quarter to $182 million in Q2. When you add the new production from our Wisconsin region of $84 million, we saw an increase of $152 million or 133% from the first quarter of this year.

Of the new production experienced in the quarter, approximately 60% was purchase volume versus 40% of refinance volume. Our locked pipeline stands at nearly $180 million, which is a recent high as a low rate environment continues to drive opportunity. The insurance division, which Lynell mentioned was sold as of May 31, reported $7 million in revenues, which resulted in a net contribution of less than $200,000 to the bottom line for their final two months with the bank.

In closing, the second quarter was another strong one for Old National, both from an organic loan growth and fee-based business perspective. This was highlighted by tremendous early success in Wisconsin, the likes of which we have not seen with any previous partnership. Not only is this a testament to the top-notch producers we have in this market, who are incredibly excited to be part of the Old National team and who have not missed a beat, it's also an illustration of the strong steady leadership of our Wisconsin Region CEO, Len Devaisher, and Milwaukee Region President, Kevin Anderson.

As Bob mentioned the day we announced our intent to partner with Anchor, these markets are an ideal fit for our brand and our culture. We are truly excited about what the future holds. Our results this quarter also continue to demonstrate that our growth strategy is working very well and that we remain poised to take advantage of continued organic growth opportunities in future quarters.

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

Thank you, Jim. I would like to begin by touching on two of the strategic actions Lynell mentioned in the opening of the call. First, on slide 12, is the closing of our partnership with Anchor Bank. This slide depicts the Day 1 balances and the resulting accounting entries recorded as of the closing date.

Most notable is the 4.5% loan mark compared to the 5.4% mark we estimated on announcement day. The 4.5% loan mark compares favorably to our more recent transactions and is a testament to the good progress Anchor Bank made with its portfolio.

The second action is the sale of our insurance subsidiary. On slide 13 shows the reconciliation of the sales proceeds to the after-tax book gain that was recorded during the quarter. Of significance is the $8.3 million increase in income tax expense associated with the nondeductible goodwill in the insurance subsidiary. It's also worth noting that the goodwill and intangibles were reduced by $47.5 million as part of the transaction.

Moving to slide 14, the graph depicts the trend in our total revenue. Excluding the gain on the sale of insurance, we experienced 11.6% in total revenue growth quarter-over-quarter. It's important to note that the Durbin Amendment, which became effective for us in July 2015, resulted in a $2.9 million decline in our interchange income during the second quarter of 2016 compared to the same period a year ago.

The graph on slide 15 shows the trend of our GAAP net interest margin and our core net interest margin. Our reported GAAP margin obviously benefited from strong organic loan growth we experienced in the quarter and the addition of two months of Anchor. As we have seen from past transactions, the margin contribution from purchase accounting can be more impactful in the early periods.

Given the likelihood of no Fed fund rate increases in 2016, and assuming the yield curve remains where it's at today, we expect continued pressure on our core margin. We're estimating our core net interest margin could fall 3 to 5 basis points in the third quarter without additional actions. We're looking for ways to offset the impact by increasing new loan production and spreads and by slightly reducing our asset sensitivity when opportunities present themselves.

Shifting to non-interest expenses on slide 16, you will see the progress we have made year-over-year in reducing our operational expenses as defined on the slide. Operational expenses declined 7.2% from the second quarter of 2015. We are pleased with this result given that our annual merit increases took affect at the beginning of April and added an estimated $1 million in additional salaries and benefits expense in the second quarter.

The conversion of Anchor Bank is set for mid-September, so we should start to realize cost savings in the fourth quarter of 2016. The impact of cost savings associated with the Anchor integration will not be fully realized until the first quarter of 2017. We still anticipate achieving 32% cost savings following the Anchor integration. To help you with your modeling, we have given guidance on the slide as to what we estimate our operational expenses to be for the remainder of the year.

Moving to slide 17, adjusted pretax pre-provision income grew by 9.8% quarter-over-quarter as a result of the strong underlying fundamentals in our banking and fee-based businesses and the contribution from Anchor for two months.

The table on slide 18 shows the notable items that impacted this quarter, as well as estimates of those numbers for the remainder of the year. As I mentioned earlier, the conversion of Anchor systems will occur mid-September. We will have some additional integration expenses during the remainder of the year. Our current forecast for the full cost to integrate is approximately $37 million versus the original due diligence estimate of $46.5 million we previously stated with our partnership announcement.

The early termination of our pension should occur in the fourth quarter, resulting in an after-tax charge of approximately $8.5 million. This nonrecurring cost is still dependent on the distribution method selected by participants along with current interest rates. As a reminder, the termination of this plan should result in annualized savings of $2 million to $3 million beginning in the first quarter of 2017.

As we discussed earlier in this presentation, income tax expense in the second quarter of 2016 was impacted by an $8.3 million charge relating to the nondeductible goodwill on the sale of Old National Insurance. We had anticipated this charge in our decision to sell this business, since the nondeductible goodwill was recorded as a part of the tax reacquisition of JWF Insurance companies in 2005. For modeling purposes, we expect the second half of 2016 tax rate as follows: approximately 24% on a GAAP basis; and approximately 35% on a fully tax equivalent basis.

Slide 20 shows the projected change in net interest income resulting from changes in interest rates. Our asset sensitivity increased during the quarter, primarily as a result of adding the Anchor balance sheet into our models. Our investment portfolio duration declined to approximately 3.6% as a result of expected higher prepayments on mortgage securities, calls on agency securities, and the addition of securities from Anchor.

Slide 21 shows the changes that resulted in a 5.5% increase in our tangible book value per share, even though we closed on our largest partnership in Company history. We issue 20.4 million shares during the quarter making our current share count 135 million.

I will now turn the call over to Darrell.

Thank you, Jim. Slide 23 provides a look at net charge-offs and loan-loss provision trends over both the last quarter and the last year. Net charge-offs in the current quarter were roughly $200,000 compared to $1.6 million last quarter and $1 million for the second quarter of 2015. Gross charge-offs of $2.7 million this quarter were also lower than the $3.9 million levels experienced both last quarter and in the second quarter of last year.

Gross charge-offs are a metric we're watching more closely, as we think that we could expect to see lower levels of recoveries going forward as we get farther out from the losses we experienced during the great recession. Combining the single basis point loss rate in the current quarter, with the 9 basis points in losses last quarter, annualized losses stand at 5 basis points at June 30.

On the provision for loan loss front, the current quarter's provision of $1.3 million was significantly higher than the $100,000 provision last quarter, but $1 million lower than the $2.3 million provision expense in the second quarter of last year. While strong quarterly growth -- loan growth, slightly higher seen [pool] loss rates and the movement of the Integra and Monroe FAZ91 acquisition portfolio loans into the bank's non-marked portfolio created additional need for provision in the quarter.

Some of that increase was offset by a significant drop in special mention loans that I will speak of in just a minute, lower retail loss rates, and a net decrease in total measured impairment. As noted on the slide, the allowance for loan and lease losses as a percentage of pre-marked loan balances stands at only 58 basis points; however, it's important to remember that we have significant marks on our acquired portfolios.

Although the allowance for loan and lease losses as a percent of total pre-mark loan balances fell from 71 basis points to 58 basis points in the quarter, due to the addition of the Anchor Bank loans that came over without any allowance of cash to them, the combined allowance in marks as a percent of total pre-mark loans increased significantly from 2.05% to 2.35% as a result of the addition of the marks associated with the Anchor loans.

Moving to slide 24, at the top of the page you see the graph which reflects the reduction in special mention loans I noted earlier, indicating a drop of $35 million or 26% of quarter starting balances in the category, when you disregard the increase in special mention loans associated with the newly acquired a Anchor portfolio. While the reduction resulted in part from payoffs and upgrades out of the portfolio, it also benefited from the downgrade of relatively large credits into the classified category.

Despite the addition of these two relatively large credits, substandard accruing loans were up only slightly in the quarter as we saw a number of loans either paid or upgraded out of this category. If we've seen any continuing trend in substandard accruing loans it's been in the agricultural related segment. We continue to see some downgrades in asset quality ratings for our farming clients, based upon historic operating performance. And are watching grain markets closely as the ability to sell harvested crop at a reasonable pricing levels will be key to any success this particular segments what experience in 2016.

Finally substandard non-accruing and doubtful loans increased $42.4 million per quarter, $35 million of which came from the Anchor portfolio. Increases in the non-Anchor Bank non-accrual totals were associated in part with the addition of a number of agricultural borrowers. The quarter continue to trend of relatively good credit performance for the bank with low levels of charge-offs, generally positive trends in criticized and classified loans and our ability to add to our allowance for loan loss reserves.

The agricultural industry continues to experience stress, but we've been able to generally either provide ongoing support to our borrowers with the addition of farmland as collateral or our borrowers have been able to refinance their exposure with other banks that may not be taking as disciplined an approach with this industry as we are at the present time.

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

Good morning. Thank you, Darrell. Since we were last together, we did announce a number of promotions that were part of our strategic reorganization. As part of that announcement, let me welcome Jim Ryan, as a formal participant to our quarterly call. While most of you know Jim from our NDRs or conferences, today is his first call as Old National's CFO. I also want to acknowledge Jim Sandgren in his recent promotion to President and Chief Operating Officer.

Both Jims or as we affectionately called them, the James gang, are off to a great start in their new roles. We look forward to a bright future with both of them in their expanded leadership roles.

I should also mention that Chris Wolking maybe the happiest guy at Old National. He is truly enjoying his new role leading our capital markets and specialty products efforts and has already made a very positive impact on yields and production.

As has become our custom, I thought I would start my remarks with an overview of the economic activity in our markets to give you a better sense of our customer activity as well as their psyche. There's still a great deal of positive activity within our markets, evenly distributed throughout all four states.

Most customers do report strong sales pipelines and good customer activity. While this positive mood shifts slightly to the negative as we discuss the global our national economy, we are still getting a strong sense that the real economy is better than what has been discussed in the media or certainly in the political arenas.

Brexit, while very real, has had little impact on our customers. My sense is that other than those customers who have global operations, there is a general sense that it will have little impact in the future. The immediate issue with Brexit was on the equity markets and the psychological effects on the consumers.

Our home state of Indiana, which was the center of the political universe for a few days, just closed out its fiscal year reporting a slightly over $50 million surplus. We now have a $2.2 billion surplus in the state of Indiana.

Overall, the mood and tone of our customers and prospects remains positive, which is reflected in the loan volume and pipeline numbers that Jim Sandgren discussed in the strong credit results for the quarter. As we think about our second quarter, those strong credit results are consistent with how Old National's performed historically.

We have for the most part reported better than peer quality credit driven by our conservative risk appetite. But this quarter did see a continuation of a trend that began in 2015 and has continued throughout 2016, strong loan production and revenue growth in the face of challenging interest rates and the volatility of the equity markets.

One of the challenges that many of you have expressed to us has been our flat to declining tangible book value, caused in part by our multiple acquisitions. The second quarter marked our fourth consecutive quarter of growth in the tangible book value. We have seen an almost 15% growth in tangible book over the last four quarters.

Overall, this was a quarter driven by a strong focus on the fundamentals, excellent loan production, strong credit, stable core margin, and expense control. This focus on fundamentals and execution will be critical as we navigate the interest rate waters in the quarters to come. While we can all be cautious and frustrated with the lower for longer, the greater challenge maybe the long end of the curve in a virtual zero tenure when you take into account inflation.

This challenge will be partially offset by execution and our strong loan pipeline but it will also require our continued focus on expense management. We will get some support from our upcoming Anchor integration but we will also continue to jam on all areas for opportunities to reduce costs. In addition, given the uptick in the equity markets since the low of Brexit, which the Dow is up just under 8% since that time, our fee-based businesses could see a stronger quarter in the coming months.

Challenged only by the potential of continued terrorist events or the fog of the presidential election. Our greatest risk beside interest rates is the continued downturn in our service charge revenue as we strive to better align our fee schedule with the needs of our clients and with the regulators. While this is consistent with our mission as a community bank, it may put more downward pressure on this line item.

Overall, I'm very pleased with this quarter. Clearly, we are seeing the benefits of our transformation strategy as our new markets have performed above expectations, particularly our newest partner in Wisconsin. Strong loan growth, continued strength in the pipeline, excellent credit trends, growing our tangible book value and continued execution should continue to drive our basic bank strategy.

Moving to slide 27, we wanted to close by reinforcing our commitment to our owners. While we do not do this on every call, I can assure you that it's top-of-mind with our Board and our management team. While we cannot control the market reaction to our earnings and strategy, we have maintained a long-term view for investors that has driven by consistent quality earnings supported by our conservative risk profile and a basic bank strategy. As such, we've returned 42% to our owners this quarter through our dividend, which was yielding 4% as of Friday.

Our capital position remained strong in the previously discuss intangible book value growth almost 50% of the last year is a recognition of the feedback we have received from many of you. I will defer to each of you as how our price-to-book compares. But what I do want to reinforce that this quarter illustrates what we have transformed Old National into, with a stronger growth profile, supported by a solid credit capital and execution, all driven with our owners in mind.

Holly, at this time, we'll be glad to open it up for questions.

(Operator Instructions)

Scott Siefers, Sandler O'Neill.

Mr. Consistent.

Thanks, Bob. I got lucky this quarter. I was nervous after that 4Q slip-up I had. (laughter) Hope you guys are doing well.

Now you know what we feel like on a quarterly basis, Scott. (laughter)

Just a couple quick questions for you. First, maybe for Jim Sandgren. Curious on your loan growth comments. If you could speak a little more on CRE and the increasing contributions bringing to total growth? Then maybe if you could speak specifically to the creation of the CRE specialty group that you alluded to? Maybe discuss a little bit about how that is different from what you guys were doing enterprise-wide previously, please?

Sure. Be glad to, Scott. Certainly for the quarter and the last couple of quarters, we've seen a little bit of a tick-up in our commercial real estate opportunities. We've seen some growth there certainly the last two months starting in May and June with the Anchor team. That's their expertise. We've been able to leverage some of that across our footprint. I'll have Daryl talk a little bit about the CRE specialty group. But in recent visits up to that market, I know Daryl and I have a huge amount of confidence as we spend time with Jim Saer, who is now the Chief Credit Officer of our commercial real estate group and then Kevin O'Driscoll, who heads up the production side of things.

A real deep understanding, they have some big bank experience with commercial real estate. So it's given us a real sense of comfort. That being said, we'll continue to keep a very close eye on this portfolio. It doesn't add a huge amount from a concentration standpoint, it's just something we'll have to look at as we go forward. But we have seen some nice opportunities to grow the balance sheet and like I said, keep a close eye on it going forward. But Daryl might be able to speak to the specialty group.

Yes, Scott. What we've decided to do is really on our complex or larger commercial real estate loans, anything over $5 million, we're going to take that extra piece that Jim just talked about with Jim Saer who came out of the Wells organization. He and his underwriters have a very disciplined approach. They've applied some metrics that we weren't applying before, like debt yield. They've got sophistication around yields, around the types of projects. So we're going to leverage that, look at their policy as we already have and begin to develop some more specific guidelines for those types of projects.

All those complex commercial real estate deals will be underwritten by Jim's group. Anything less than the $5 million or uncomplicated or less complicated projects will be continued to be underwritten through our conventional underwriting team. So, as I looked at it, what I saw was the ability to really add some more sophistication because of the experience they had and overlie that on our existing underwriting. I really do think, from a risk perspective, it's going to ramp things up for us just a little bit. I feel pretty good about it.

Okay. Perfect. Thanks. That's good color. Then maybe separately, Jim Ryan, hopefully kind of a softball for your first official question as CFO. Can you walk through the revenue impact from the insurance sale in the 3Q and the 4Q? In other words, you still have roughly the $7 million or so in the 2Q, does that just go to zero or is there some residual amount that sticks with us into 3Q, 4Q? Maybe if you could just discuss that progression please?

Thank you, Scott. I really appreciate the softball question. (laughter) No, you hit the nail on the head. We do not anticipate any revenue in the third quarter from the insurance operations. You can tell that the contribution, net of your expenses in the second quarter was de minimis, it was barely positive. So from this perspective, we would anticipate that would have been the case in the third and fourth quarters as well.

Okay. Perfect. All right. I think that does it for me. Thank you guys, very much.

Thanks, Scott.

Emlen Harmon, Jefferies.

I think I get a vote for Mr. Consistency too. As I'm always the number two guy here. (laughter)

Always the bridesmaid, never the bride, Emlen.

That's right. On the Wisconsin growth, it was good to see that market leading in its first quarter. Do you feel like the growth is on a sustainable trajectory there? Were there any aspects, I guess, to the acquisition that kind of helped boost the growth in that market, whether it was them being able to do larger deals or if there was anything specific that aided the growth rate there?

Yes, it's a great question, Emlen. I would tell you that the future there is very bright. I think that we've got through a second and a first quarter as partners and saw production, which was beyond any we even expected. I think the future is even brighter as we begin to align more product sets up there, more product opportunities, give them more support. But the morale is excellent. I think the lesson we learned or the take away is, the majority of the folks at Anchor had big bank experience. So they understood our credit constraints and our credit risk profile.

I think again, everything there is very positive. It kind of falls into the answer of the question on commercial real estate. What we found there was deep industry expertise that layered on top of our risk profile, just gives us more comfort that we can take a little more ability to take on some commercial real estate but still under our conservative risk profile. Again, that's that big bank experience I referenced.

Got it. Okay. Thanks. Then you guys had noted there's going to be a little bit, or some more help from a cost saving to come in the first quarter of 2017, So appreciate you laying out the third-quarter or fourth-quarter expense outlook. What kind of -- all else being equal, what kind of drop should we expect into the first quarter of 2017?

Yes. Really, a bulk of the cost savings, so that would be 32% of the original Anchor expenses, are really going to come in the first quarter. We will see some benefit in the fourth quarter, Emlen. Typically, its 30 plus days post-integration, that we start to see a bulk of the cost savings coming through. So you can imagine that we'll see some of that in the fourth quarter but we'll start to realize basically I would say a vast majority of the cost savings from the initial integration starting 1Q 2017.

Okay. What's just kind of tricky for us is maybe understanding how much is actually in the second-quarter run rate from Anchor. Do you have a sense of what -- just the dollar drop from 4Q to 1Q is? Next year?

Repeat that question, Emlen?

I understand the majority of the cost saves are going to hit in the first quarter. Just what is the dollar difference from the fourth quarter to the first quarter? How much are you actually picking up on a dollars basis?

Emlen, if you take -- we had about $11.4 million in expenses for the quarter from Anchor. So if you take that over two months it's about $6.5 million per month. So you're going to get very little in the fourth quarter. I would take about 25% to 30% of that number in terms of what your savings would be in the first quarter. So, if you save $17 million or so on a run rate basis, we should be able to pick up about 30% drop of that number in the first quarter if that helps you.

Okay. That does. Thank you.

Chris McGratty, KBW.

Bob, it's actually Mike Perito stepping on for Chris.

Pretty soon, we're not going to let Chris even use his name. (laughter)

It has a little bit better ring than mine so I like to run with it. A couple quick follow-ups on some of the questions that have already asked. So, on the growth outlook, the pipeline is over $1 billion. It seems like it's pretty strong across the multiple footprints. As we think about what the franchise can achieve now with Anchor on board, is it a high single-digit range? Is that reasonable? It would seem like anything 5%, 6% would be too conservative just given where the pipeline is and the closings that you already have in the pipeline.

Yes. I think that's a great, again, all things being equal you could get into a recession or [political if] you don't know. If you said today as we look forward I think high single-digits is consistent with where we see.

Okay. Then -- on the provision, obviously some of it will be driven by growth -- I appreciated Daryl's comments that on the gross charge-offs the recoveries are slimming here. As you look to the agricultural side, a two-part question here, one, what are the average sizes of some of these ag credits that you have? Is there anything substantial that could potentially drive a relatively large quarter-over-quarter Delta in provisioning? Two, as you think about near-term provisioning as a whole, should we start to see a steady ramp from this 2Q level as you continue to put up decent growth? Or are there other factors that drove the $1.3 million in the quarter?

This is Daryl. With respect to the ag portfolio, we don't see anything, let me start, we don't have a lot of significantly large ag credits. We have some in the $5 million, $6 million range but those are a handful. We don't see anything today. Now, I say today, that would make us feel like we've got any exposure to large provisions going forward. A lot of that has to do with the remaining growing crop year as well as the prices, but there's nothing in there today at we haven't already accounted for that we're concerned about.

With respect to the near-term provisioning. I think a couple of things. I think you hit it on the head, growth. I think, depending upon the growth that we have that could stimulate some higher provisioning. You never know about the impairment or the PDs but I would say generally as we're looking forward, a good share of higher provision is going to be associated with the growth in the portfolio as we see it today.

Okay. Thanks, Daryl. That was helpful. Then Bob, maybe just one more high-level question for you. You guys make the point to point out the tangible book value growth. It seems with a pipeline over $1 billion, obviously that's not all going to close but that's about 7% of your balance sheet size, which is a significant number. Can you maybe just update us on how you guys are thinking about your capital priorities now that Anchor is on board with the backdrop of the stronger organic growth and also the tangible book value growth year over year you guys have seen?

Yes, really our focus is on organic growth. I think we've all said in our comments one way or another. We think, we continue to see the franchises transform from a very low growth to a better growth profile. The capital will be used to fund that growth. The obvious tangential question is M&A. At this stage, we're really focused on execution. As I've said all along, we built a house. I don't know that I need to do anything else to make it any better. If we get an opportunity where clearly going to look at it but we're all just very, very keenly focused on execution and growth and take advantage of these new markets that we're in.

All right. Great. Thanks, everyone. Appreciate it.

Thank you. Tell Chris hello.

I will.

Terry McEvoy, Stephens.

Let's start with a question -- I've been focused a lot on the Anchor deal and haven't really kept up on the rationalization of the branch franchise. You took a small expense last quarter. Could you just remind us what you're doing with the branches? How you think about the earn back period on some of these expenses? What you have, what you have planned for second half of this year?

Yes. Really in Wisconsin we have no branch closures or consolidations. We obviously didn't have a franchise there. We owe it to the team up there to take a little bit a year or so, to look at that franchise and see where opportunities for growth are. So the branch closures that we had in this quarter were really related to our Michigan market. It's a good example. We've been up there for a while. We've begun to look a customer patterns and Jim and his team have had a couple of closures in the Michigan market that cost is related to.

Then you talked a lot about the growth opportunity in Wisconsin and Anchor. I guess, on the flip side, as soon as the deal was announced, it's a competitive market, I'm sure your competitors are calling in some of the better clients at Anchor. What type of run off have you had and is pretty consistent with your initial expectations?

Actually it's better than we expected. We've had de minimis amount of run off and again, I can't tell you how much we appreciate the leadership of Chris Bauer and Tom Dolan and Martha Hayes up in those markets. They, from day one, were very aggressive in going out and talking to clients. Great advocates for Old National and then we put some of our best and brightest up there in Linda [Vacher] and Kevin Anderson and we haven't lost any RMs. We really had very little client loss. So were off to a great start and we continue to make sure we support them as best we can.

Just maybe just one last one. You put out such a nice presentation, slide 33, the drop in the consumer direct production yield, volume was up a lot. Is something going on there? It just caught my eye this morning.

Yes, this is Jim. So what we had was a home equity line of credit promotion that we really kicked off in the beginning of the second quarter, offering some teaser rates for 12-month introductory levels. So, it did, as you can see, help drive some nice growth in the home equity portfolio, which we haven't seen for a while. So, that's what's driving that reduction in yields there.

Yes, but you have got to give Chris some kudos his first month -- quarter on the job, he drew indirect yields up.

That was noted. (laughter) I appreciate that. Thanks, everyone.

Chris, he just doesn't want anyone to think he forgot about you.

Exactly. Thank you.

Thank you.

Jon Arfstrom, RBC Capital Markets.

A few follow-ups, just on the pipeline numbers on slide 9. Do you have an idea of how much of that is from Anchor and call it what the legacy bank looks like in term of the pipeline?

Yes, Jon. So the Wisconsin contribution there is just a little bit over $200 million. So the legacy piece is about, a little over $900 million.

Okay. Good. Then Jim Ryan, maybe for you. The lower merger and integration charges, anything notable there? What's a little better than we though? What's driving that?

Yes. Just really, good execution with our vendor management group just trying to drive down early termination charges on their key IT contracts, most notably their core service provider. There was some great negotiation done on behalf of the Anchor team and our team just driving those contracts lower.

Okay. Okay. Good. Daryl, for you, did you disclose the size of your ag exposure, the overall total?

No. It's about $280 million at this point in time.

Okay. So small, very small. Okay. Anything else outside of ag that you're watching more carefully?

I would say all banks are watching commercial real estate. Despite what we've said about the growth, everybody's looking at that and making sure that we don't get too heated there. We have very small energy. We've gotten a little bit of coal, we are watching that. Outside of that, everything else seems to be moving along pretty well, Jon

Okay. Good. Then around the horn to you, Bob. On M&A, is Bob Jones saying pause? Did Jim Ryan turn out the lights on the M&A department, when he changed chairs or what, what are you thinking?

No, not at all, Jon. I think, I get criticized when I use this analogy but I think we've earned the right to be a little more selective in our partners. We've built -- we're in the markets we want to be in. If we get a deal that makes a lot of sense with reduced earn back, great strategic opportunities, good expense saves. We clearly have to look at it, but I can tell you that we're spending a lot more energy on execution and really trying to drive higher quality earnings.

Okay. When does the rebranding take place?

September. Mid-September when we do the conversion.

Okay. Got it. All right. Thank you.

Thanks, Jon.

John Moran, Macquarie.

I wanted to circle back on OpEx for the, I don't know, third or fourth time now. I understand that you've got 25% to 30% of Anchor that would drop out in 1Q. Then in addition to that, I think you said there are $2 million to $3 million in saves out of the pension and that would be expected to start hitting -- does that hit 4Q? Is that already in 4Q's guide or is that incremental in 1Q?

There would be just a little bit of benefit in the fourth quarter. Depending on exactly when we execute that's really in the guidance. Then most of the benefit, though, will be in the first Q of 2017.

Okay. Got it. That's helpful. Then, Jim, I think you mentioned 3 to 5 basis points of margin compression, all else equal but, all else not equal because there is a strong pipeline, good loan growth here. Then you mentioned reducing some asset sensitivity. Would that be done, I assume that what you're getting at is layering in some duration in the investor securities book or swaps?

That's absolutely correct. When opportunities present themselves. So if we get a backup in interest rates, we might look at putting some additional duration on the investment portfolio. It probably won't move the needle meaningfully but nonetheless, we're going to continue to look for opportunities, maybe swapping some stuff back to fixed rate on the loan side. Those types of actions. When opportunities present themselves, I think we'll give us a chance that insulating from some of the flatter yield curve we find ourselves in today.

Got you. So, historically you guys have run pretty neutral, I think even if I'm remembering correctly, a little bit liability sensitive. So you just kind of walk that back in terms of the asset sensitivity that you put on the last year or two years?

Yes. I think that's a great observation. We are more asset sensitive than we've ever been as a bank. So we got more asset sensitive in the second quarter, primarily as a result of bringing on the Anchor balance sheet, even though they have commercial real estate loans, most of those loans are variable rate in nature. So we will look for ways to still remain asset sensitive and to benefit if rates ever do rise. But that is an expensive position to maintain. So to the extent that we feel comfortable adding some additional duration, we will look for those opportunities.

Terrific. Thanks for taking the question.

Thanks, John.

Peyton Green, Piper Jaffray.

Welcome back, Mr. Green.

Thank you. My questions have actually been asked and answered. But I guess maybe, Bob, if we step back and take a look at what you all have done over the last five years, there's been a whole lot of change in the franchise. What are you most optimistic about in terms of driving returns over the next two or three years? Then what are the biggest challenges for you to get there?

I think the opportunities are really growth. We're just seeing -- I think we're at the beginning of seeing what this franchise can look like in terms of the growth, both on the commercial -- we don't talk about retail a lot, but as part of our United Bank & Trust partnership in Ann Arbor, we brought on an extremely talented management team, part of which -- we have a gentleman now running our retail bank that's got Huntington and Old Kent and Fifth Third background that Ray Webb is doing a great job. So I think the growth is optimistic.

I wouldn't be my normal honest self if I didn't say that I think we've made some good progress on expenses. I think we still have an opportunity to do a better job on reducing cost. I will tell you were all very focused on it but at the right manner of doing that. As you think forward, I think the risks for all of us is just this yield curve and the interest rate environment. The question at the end is what keeps you awake at night? I'm not sure that stock price would be at the top of that list for me as I think through what we've done and kind of where that stock price sits. I wouldn't be doing my job if I wasn't focused on it.

Okay. Then maybe, with regard to retail or consumer, the indirect auto numbers have been very good for you all. Would there be a decision tree that would change your mind on keeping indirect auto versus something else? Could it be a funding mechanism for other growth later on?

Yes, I think that's a great question, Peyton. I think that's one of the things Chris is looking at. Chris is two months on the job in indirect and the balance of his capital markets -- you saw the yield increase there through some of his efforts. But we've asked Chris and Chris is going to take a real hard look at that portfolio to see if it's the best use of capital and funding. I think as you look forward to the future, we will have some more decisions to communicate there.

Okay. Great. Thank you for taking my questions.

Thanks, Peyton. Glad to have you back.

John Moran, Macquarie.

Welcome back.

Thanks. Thanks for taking the follow-up. I have got a ticky-tack modeling question. Just on the tax rate -- I know you guys are guiding for a step-down here in the back half of 2016. But do we -- is it fair to assume that goes back up in 2017 to the 26%, 27%, 28% -ish level?

John, we're always looking at opportunities to keep that tax rate in check. So obviously as we make more income that will put pressure on that rate, but I don't know if we're willing to say this point in time that rate is going to go back up from here. I think we're continuing to look for ways to moderate that rate even into 2017.

As part of what Chris is focused on in the capital markets with some of his transactions in that group, we've also got some way to moderate our taxes. So, as Jim said, we're feeling keenly focused on it.

Okay. Thanks very much for taking the follow-up.

Thanks, John.

At this time, we have no further questions. I'll turn the conference call back over to management for their closing remarks.

Great. Thank you all. Thank you for your insightful questions. Any follow-up, let Lynell know. We look forward to talking to you again soon.

This concludes Old National's call. Once again, the 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: 4357-6759. This replay will be available through August 15. If anyone has any additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.