Old National Bancorp (ONB) 2017 Q4 法說會逐字稿

Welcome to the Old National Bancorp Fourth Quarter and Full Year 2017 Earnings Conference Call.

This call is being recorded and has been made accessible to the public in accordance with the SEC's Regulation FD.

The call, along with corresponding presentation slides, will be archived for 12 months on the Investor Relations page at oldnational.com.

A replay of the call will also be available beginning at 1:00 p.m.

Central Time on January 23 through February 6. To access the replay, dial 1 (855) 859-2056; conference ID code, 6268317.

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, Dorothy, and good morning, everyone.

Welcome to Old National Bancorp's conference call to discuss our fourth quarter and full year 2017 earnings.

Joining me are Bob Jones, Jim Sandgren, Jim Ryan, Daryl Moore, John Moran and Mike Woods.

Before I begin the discussion of our results, I would like to remind you that some comments today may contain forward-looking statements that are subject to certain risks, uncertainties and other factors that could cause the company's actual future results to differ materially from those discussed.

Please refer to the forward-looking statements disclosure contained on Slide 3 of this presentation, as well as Old National's SEC filings for a full discussion of our risk factors.

As referenced on Slide 4, various non-GAAP financial measures will be discussed on this call.

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 these non-GAAP measures to the most directly comparable GAAP financial measure are appropriately referenced and included within the presentation.

Turning to Slide 5 into earnings.

We did, indeed, have a strong, fundamentally sound quarter highlighted by double-digit organic commercial loan growth, low cost of deposits and a decline in legacy non-interest expenses; and probably most significantly, the closing of our Minnesota partnership less than 90 days following announcement.

Our reported fourth quarter did include a previously disclosed revaluation to our deferred tax asset, which was an estimated $39.3 million.

The fourth quarter also included other anticipated pretax charges as outlined on the slide.

Looking through these charges, our adjusted net income would have been $32.7 million or $0.22 per share.

For the full year 2017, on Slide 6, the story remains the same.

In fact, and it's not a typo, our percentage of organic loan growth, both in total and for our commercial portfolio, were the same for the quarter as they were for the year.

Fundamentals, as measured by credit quality, operating leverage and growth, were very good.

With a solid foundation in place, we are excited as we head into 2017 -- 2018, excuse me.

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

Thank you, Lynell, and good morning, everyone.

I'm happy to report that Old National had a very strong close to an important year.

As Lynell already stated, our net income for the fourth quarter reflects the impact of one-time noncash charges.

We'll provide some additional detail around those after we discuss our business performance, which was an extremely positive and increasingly familiar story.

Fueled by strong commercial loan growth and fee-based business revenue gains, Old National continued the positive momentum that defined 2017.

If you turn to Slide 8, I'll begin with a closer look at our loan growth both quarter-over-quarter and year-over-year.

As a reminder, we closed on our Minnesota partnership on November 1, which for purposes of this slide, we have depicted as Day 1 Minnesota.

Excluding these acquired loans, we experienced total quarter-over-quarter and year-over-year organic loan growth of 4.8%.

As I alluded to in my opening statement, this was driven largely by strong commercial growth during the quarter and throughout the year.

In spite of a couple of large seasonal C&I line paydowns, our commercial portfolio still grew by an impressive 10.1% in the fourth quarter, which is the same percentage growth we experienced for the full year of 2017.

We continued to see runoff in our less profitable indirect portfolio as we continue to be focused on our overall balance sheet remix strategy.

Overall, these annual growth numbers are aligned with the guidance we provided at the start of 2017 and they represent a very successful year of executing our growth market strategy.

While we experienced good commercial loan growth in multiple markets, I'm excited to report that our new Minnesota region led the way with over $36 million in growth since November 1. Bob will touch more on the early success of this partnership in his remarks, so I'll simply note here that our new commercial producers have absolutely hit the ground running.

We also had very strong growth in Milwaukee, Louisville, Indianapolis and Grand Rapids.

In others words, the heavy lifting we've done over the last several years in terms of franchise repositioning is really starting to yield the kind of results we thought they would.

Today, we find ourselves very well-positioned in some of the most attractive markets in the Midwest.

Turning your attention to Slide 9, the graph at the left details new commercial and commercial real estate production, which grew by nearly 23% compared to fourth quarter 2016.

Of the $563.9 million in new quarterly production, 61% was in the CRE category, with the remaining 39% in C&I.

This was virtually the same mix we saw in the third quarter of this year.

The middle graph depicts our production yield, which grew by 44 basis points quarter-over-quarter and by nearly 100 basis points year-over-year.

While rising short-term rates certainly attributed to our improved yield, we also attribute some of the gains to our CRE and C&I mix, with CRE loans typically having longer terms and amortizations, driving yields up.

Again, more than 60% of our total commercial loans originated in Q4 had variable rates, so this bodes well going forward in a potential rising rate environment.

The final graph on Slide 9 shows our quarterly loan pipeline results.

As you can see, our pipeline exceeded $1.4 billion as of 12/31/17 with $319 million in accepted category and another $258 million in the proposed classification.

These pipeline numbers represent a 7% increase compared to Q3 levels and a solid 20% increase in our discussion category.

Overall, we are pleased the pipeline's continued to rebuild after 3 quarters in a row of robust commercial production and our clients are clearly getting more active in discussing expansion.

Considering the strength of our new Minnesota market as well as others throughout our footprint, we would expect to grow our commercial pipeline and ultimately new production and balance sheet growth in the coming months.

Bolstered by robust economy and tailwinds from the recent tax reform, business owners in our markets are expressing a great deal of confidence, and we are in a good position to benefit from that positive momentum.

It's also important to note that we now have over $640 million in future advances on commercial construction projects that we would expect to generate growth in the quarters ahead.

Slide 10 takes an even deeper dive into our loan production and yield trends for the quarter.

Beginning with the top graph, you can see that residential mortgage production dipped in the quarter while the production yield expanded.

The downward trend in production is largely related to seasonality and we're optimistic that these numbers will begin to trend more positively as weather and activity improves in the months to come.

The consumer direct slide on the bottom left illustrates a slight increase in year-over-year production and a dip in production compared to our third quarter results, again, due to seasonality.

The graph on the bottom right illustrates our ongoing balance sheet realignment strategy.

As you can see, our indirect production is down substantially over Q4 2016 and down slightly from the third quarter of '17.

While balances continued to decline, our yield has improved significantly over 2016, although we did see a small drop in yield quarter-over-quarter due to stronger credit metrics and shorter terms on new production.

It's worth noting that we didn't raise our rates in this category until the beginning of 2018, so we anticipate seeing an uptick in yield in the first quarter.

Turning now to Slide 11, which focuses on fee-based business revenue, I'll begin at the upper left with a look at Wealth Management.

Our 11% increase in quarterly revenue compared to last quarter can be attributed to a combination of market confidence and the benefits of a large estate fee.

As you can see, for the full year 2017, our Wealth Management division recorded revenue of $37.3 million, which represents a 7.8% increase over 2016.

Our Minnesota region currently does not have a Wealth Management presence, but we will certainly look to find the right partner or build a team of wealth client advisors over time.

Moving to our investment division, you'll see that our quarterly revenue of $5.8 million was 11.5% higher than both last quarter and Q4 of 2016, while our full year 2017 revenue of $21 million outpaced 2016 by 11.7%.

The Minnesota region contributed nearly $200,000 in investment revenue from the team of financial advisors.

Our investment division as a whole has enhanced its asset base recurring revenue, which now stands at 60%, by 10 percentage points over the past 15 months.

This should enable us to take further advantage of market highs and continue to emphasize our financial planning and advisory model.

The mortgage graph slide on the bottom left reveals a dip in both quarterly and annual mortgage revenue.

The decline from Q3 is primarily due to normal seasonality, while the year-over-year decline is attributable to the industry-wide reduction in refinance activity.

Seasonally, our mortgage pipeline is down to just over $69 million and the current mix is more than 70% purchased versus less than 30% of refinance activity.

Our Minnesota mortgage originator team continues to be extremely excited to have a wider array of products and a larger balance sheet to provide more options for our clients.

While the Minnesota region contributed less than $100,000 in revenues in the fourth quarter, we remain very optimistic that mortgage will be a strong line of business for us in Twin Cities and Mankato going forward.

The final graph on Slide 11 shows the continued growth in our Capital Markets division.

While fourth quarter production is lower than Q3, you can see that our $6.5 million in 2017 revenue more than doubled our 2016 output.

The primary driver of this growth continues to be strong sales production and customer interest rate derivatives or swaps, boosted by our increased commercial loan production during the year.

We also continue to see meaningful growth in our foreign exchange revenue.

Again, long term, we feel like the addition of our Minnesota region will drive meaningful increases to our capital markets revenue given its strong commercial lending focus and dynamic economy.

Overall, this is a quarter that capped off a very successful year of organic loan growth and strategic balance sheet realignment that was further strengthened by fee-based business revenue gains.

It was also a quarter and full year that saw us execute on the promise of a focused and well-defined growth market strategy that has Old National poised for continued success in 2018 and beyond.

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

Good morning, and thank you, Jim.

Starting on Slide 13, I will highlight a few of the accounting details for our Minnesota partnership that we closed on November 1. The total loan mark was -- excuse me, $47.4 million or 2.9%, slightly higher than our original model due to higher loan volume and an increase in interest rates from the announcement to close.

We also recorded goodwill of $173 million, which was slightly higher than originally announced.

This increase was mostly attributable to the increase in our share price from announcement date to the closing date.

Intangibles were $27.3 million.

We are already beginning to realize cost savings and our systems conversion is set for early May.

We remain on track to achieve the full 36% cost savings we outlined at announcement and those will be reflected fully beginning in the third quarter.

Moving to Slide 14.

I'm pleased to report that adjusted pretax pre-provision income was more than $223 million in 2017, which represented a 10.5% increase year-over-year.

The growth in adjusted pretax pre-provision income reflects strong underlying fundamentals in our banking, wealth management, investments and capital markets businesses, and our relentless focus on expense reductions.

During 2018, we will remain focused on growing adjusted pretax pre-provision income as well as continuing our expense discipline, and we are reaffirming our commitment to driving positive operating leverage.

As demonstrated on Slide 15, our adjusted efficiency ratio improved 230 basis points year-over-year.

We also saw an improvement in our adjusted operating leverage of over 370 basis points year-over-year with stronger revenues and a moderation of operating cost despite investments in people and technology.

Moving to Slide 16.

You'll see the trend of our reported net interest margin as well as a graph depicting the portion of our margin attributable to accretion income.

Our net interest margin, excluding the benefit from accretion income, increased 8 basis points in the quarter from higher interest income from loans, slightly higher-than-normal interest collected nonaccrual loans and the contribution from our Minnesota partnership.

Because of tax reform, we have also shown the 17 basis points contribution from the fully taxable equivalent adjustment in our net interest margin graph in recent quarters.

With the new 21% statutory federal tax rate, we expect our FTE net interest margin will drop 8 to 9 basis points in the first quarter.

As you know, this decline only affects the reported margin and has no impact on net income.

Although it does impact a handful of performance ratios, most notably the efficiency ratio.

Our forecast for FTE margin, excluding accretion income, is 3.12% in the first quarter.

This forecast reflects 8 to 9 basis points in lower FTE adjustment, 4 basis points from 2 fewer days in the first quarter as compared to the fourth quarter and 3 basis points for our more normal levels of interest and nonaccruals.

This is partially offset by the remaining impact of the December rate hike and a full quarter of Minnesota.

We have updated Slide 33 in the appendix with the scheduled accretion income for 2018.

We anticipate approximately $30 million in scheduled accretion income during 2018, including the Minnesota partnership.

An important reminder, our projections for accretion income include only scheduled accretion and do not include any prepayments.

Shifting to noninterest expenses on Slide 17.

ONB legacy noninterest expenses defined in the slide totaled $100.7 million in the fourth quarter and represent a 6.8% reduction from the fourth quarter of last year.

The reduction in legacy operating costs reflect the continued focus on cost control and reduction in branches.

Minnesota's expenses were $9.5 million for the last 2 months of the year.

As we look forward to the first quarter, we anticipate approximately $115 million in quarterly core operating expenses, including a full quarter for Minnesota, which is consistent with the run rate in the fourth quarter despite higher employment-related cost that seasonally occur in the first half of the year.

Further improvement operating cost should occur in the second half of the year as we fully integrate our Minnesota partnership.

Our Minnesota integration expenses are tracking with the original expectations.

As such, we anticipate pretax charges of approximately $9 million in 2018.

Moving to Slide 18.

Our tangible common equity ratio and our tangible common book value per share were impacted from several less ordinary items, including the noncash charge for the DTA revaluation, along with purchase accounting adjustments, merger and branch consolidation cost realized in the fourth quarter.

We previously disclosed that we expected the DTA revaluation to be approximately $41 million.

We were able to positively impact the revaluation from a handful of strategic actions taken in the fourth quarter, partially offset by higher unrealized losses in the investment portfolio at quarter end.

We anticipate that the estimated $39.3 million revaluation will be earned back in less than 2 years.

While the GAAP charge was $39.3 million, the impact to regulatory capital was nearly 45% lower at $22 million since a portion of the DTA was disallowed for regulatory capital purposes already.

Additionally, there is a distinct possibility that our regulatory ratios will be positively impacted in the first quarter as more clarity from the regulators on the disallowed portion of our AMT credits emerge.

Our final slide is Page 19.

Updates on our new expectations around FTE and GAAP tax rates for 2018.

These rates include the impact from the anticipated tax credit shown below.

The tax benefits from the tax credit business will be spread evenly over the year, but we anticipate having tax credit amortization during all 4 quarters of 2018.

The first quarter tax credit amortization will be a relatively small percentage of the range listed on the slide, with most of the tax amortization for the year recognized in the middle 2 quarters.

This is subject to project completion and can be tough to model.

We plan to provide an update each quarter around the expected amortization.

I will now turn the call over to Daryl.

Thank you, Jim.

We'll start the credit quality segment of this morning's call with the customary review of charge-offs and provision expense for the quarter, as shown on Slide 21.

Net charge-offs for the quarter were $800,000 compared to $1.1 million last quarter and 0 in the fourth quarter of 2016.

For the full year, we posted net charge-offs of $2.5 million or 3 basis points of average loans, compared to $3.4 million or 4 basis points of average loans in 2016.

Net charge-offs were again assisted by relatively strong recoveries.

For the quarter, recoveries were 76% of gross charge-offs, which was lower than last quarter where recoveries were 100% of gross charge-offs.

For the full year, recoveries represented 80% of gross charge-offs, relatively consistent with the 77% recovery rate posted in 2016.

For the current quarter, we recognized provision expense of $1 million compared to provision expense of $300,000 last quarter and a $1.8 million recapture in the fourth quarter of 2016.

The $1 million provision in the current quarter was 125% of net charge-offs for the period compared to a full year 2017 coverage ratio of 120%.

Provision expense to net charge-offs was roughly 29% for the full year of 2016.

While the allowance need remained relatively level in the period, there were some moving parts from the quarter that are important to acknowledge.

In the nonacquired portfolio, lower loss rates and reduced measured impairment accounted for a decrease in allowance requirements of roughly $2.5 million in the quarter, which was generally offset by increased need associated with loan growth and special mention loan increases.

While the ending allowance for loan losses as a percent of period -- or in the period loans fell 8 basis points to 45 basis points, I would remind you that we also have marks on the acquired loans, which at the end of the current quarter, totaled $136 million or 1.21% of pre-marked loan outstandings.

Accordingly, the combined ALLL and March to end-of-period loan balances stood at 1.66%, 11 basis points higher than third quarter end levels.

The credit quality trend chart on the next slide provides a picture of the improvements made in our nonperforming and underperforming exposure over the last 12 quarters.

While the trend points out the apparent reduced risk exposure in the portfolio, what is also interesting to note is that we did not see the historical jump in nonperforming loans in the quarter that we have typically seen when integrating partnership portfolios.

We believe that the bank in Minnesota had an approach to credit management that's very similar to Old National's and did a nice job of both identifying and managing loan portfolio risks.

Continuing with the current slide, you can see that special mention loans again experienced an increase in the quarter.

Without the addition of Minnesota loans, special mention loans were up $11.4 million or 9%.

Including Minnesota loans, special mention loans were up $57.9 million in the period.

The non-Minnesota related increase in special mention loans can be attributed to a great extent to the downgrade in the quarter of $11.4 million commercial real estate relationship in our Wisconsin market.

However, this special mention segment of loans remains fairly fluid, as evidenced by our successful efforts in eliminating, by payment in full, the exposure of a separate Wisconsin commercial real estate loan of $10.1 million.

Substandard accruing loans remain relatively constant in the quarter, increasing less than $1 million, excluding the Minnesota portfolio additions, which totaled $10.7 million.

With respect to nonaccrual loans, you can see that excluding the Minnesota-related additions, we decreased our nonaccrual exposure by $10.9 million in the quarter.

Almost all of this improvement came as a result of either payoffs or upgrade of credits.

When accounting for the addition of $16.5 million in Minnesota nonaccruals, we posted an increase of $5.6 million in this category in the period.

Overall, credit quality in the quarter remained relatively stable, the increase in special mention loans notwithstanding.

As with many of the banks you probably follow, we do not, at the present time, seen any -- see any particular loan segment emerging as an immediate concern.

However, we do continue to watch closely our indirect auto portfolio on the consumer side as well as certain exposures in the commercial real estate portfolio, including multi-family, office and retail subsegments.

On the commercial and industrial side, the agriculture portfolio continues to carry higher relative risk rankings, but we did see an improvement in the weighted average risk rate of that portfolio in 2017 due, in some part, to the selective exiting of some of the higher-risk relationships.

Finally, as I alluded to previously with our new Minnesota partnership, I believe we have associated ourselves with a group of strong lending professionals that will work well with and enhance our lending culture, both on the production as well as the credit sides of the bank.

The very positive impression we gained during our due diligence activities has been confirmed with all of the interaction we have had to date with our new Minnesota associates.

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

Great.

Thanks, Daryl, and good morning, everyone, and thank you for joining us.

While the fourth quarter was noisy by any standard given the implications of the Tax Cuts and Jobs Act and the other actions that we took, the noise only served to reinforce our optimism for 2018.

The impact of the tax reform bill goes well beyond just our income statement.

Our clients appear ready to move from feeling good about their businesses to investing in their businesses.

Our conversation with clients about technology investments, inventory expansion and other capital expenditures have increased in recent weeks.

And with our shareholders in mind, we have chosen to take a longer view regarding actions we may take with additional earnings from the lower tax rate and for now would anticipate that most of it will drop to the bottom line.

We did make an incremental investment into our foundation during the fourth quarter as part of our continued commitment to our communities.

We will also look at additional technology investments that are focused on improving our client experience.

In addition, we are looking at some potential investments and employee benefits.

Another important item in the fourth quarter was our ongoing focus on expenses.

We have made considerable progress on our client experience program and have brought this expertise in-house.

Despite the optimism that we all feel for economic activity, as my old college football coach used to say, "You need to make hay when the sun shines.” We will continue to invest and focus on improving the client experience and reducing our cost at the same time by enhancing technology and the processes.

We did close another 14 branches in the fourth quarter.

This makes a total of 181 branch closures or sales over the last 7 years.

I should note that over the same period of time, we have more than doubled our assets, while our number of branches has only increased by 30.

Our average deposits per branch during the same period of time increased from $30 million to $65 million.

We will continue to review our branch system as we continue to make technology improvements and delivery model changes and would expect that you should see a continual reduction in our branches.

This quarter did see an impact from the expected tax credit amortization, as is required by accounting standards, driven by our historical and affordable housing tax credit line of business.

We continue to believe in this business as a valuable tool to help us improve our communities and we remain committed under the constraints of the legislation.

Despite all the noise in the quarter, I am very pleased with the results, which reflected many of the same themes of prior quarters.

We had good loan growth, supported by strong credit and low deposit cost.

When coupled with better performance for most of our fee-based businesses, you can see why we are very optimistic about the foundation that we have built for 2018 and beyond.

A microcosm of that optimism is the performance of our newest associates in Minnesota.

For the full year 2017, total loan growth for the region was 10.9%, of which, total commercial loan growth was 11.4%.

Deposit growth for the year was 3.7%.

Even more impressive has been the team's performance since we closed on the partnership.

Total loan growth of $35.2 million, driven by commercial loan growth of $36.1 million and, as Jim said, the pipeline is strong.

I should note that this is the second deal in a row that we have seen strong loan growth right out of the gate.

It reinforces the belief that our ability to bring a bigger balance sheet with better capital and an enhanced product set and allow the excellent team in the market to serve their clients as they have always done, is a winning combination.

Deposit growth for the same period was $43.2 million, an equally impressive performance.

This performance is a true testament to the leadership team in the market and their associates.

So far, we have retained all key individuals and the team's attitude has been nothing short of incredible.

To be fair and transparent, we still need to complete the conversion and acknowledge that, that will have an impact on our clients and our associates, but we remain very optimistic that in 2018, we will see a continuation of these positive trends in Minnesota.

I'm sure that one of your first questions will be our appetite for future partnerships.

To quote John Moran, we will remain an active looker and a selective disciplined buyer.

As we have said before, if it is the right market with the right people and we can partner at the right price, we are interested, but we do not feel any need to do a deal given the quality of the franchise that exists today.

Given the positive economic activity that is occurring within our franchise and the foundation that we have built, we do feel very good about 2018.

Let me highlight a few key factors that are driving that optimism beyond the changes in tax rates, the anticipated rate hikes and the potential for regulatory changes.

For many years, we have faced the headwinds of accretion income.

While we have been able to maintain consistent earnings per share, underneath that number, we were a little bit like the duck paddling feverishly under the water to achieve that pace.

For 2018, accretion will only be around 5% of our total revenue, which includes the Minnesota partnership.

The impact on our net income is less and the challenging work that was going on under the surface, as we've pivoted the franchise, is starting to pay off and you should see more tangible evidence of that in our 2018 with stronger core performance.

Our expected expense run rate, as Jim said, in the first and second quarter, will be comparable to our fourth quarter expenses, plus an incremental increase of about $5 million for the quarter, because of the full quarter with Minnesota.

For modeling purposes, this should be approximate $115 million.

It is important to note that in this first and second quarter run rate, it will include the seasonal expenses for FICA Amerisic Center, as well as any additional investments in technology and other key areas.

For the second half of the year, the run rate should decline as we gain the benefits from the conversion of our Minnesota partnership.

Loan growth will continue to be a key focus for us, and we anticipate that it will be mid-single digits as we continue to execute our balance sheet remix by de-emphasizing indirect loans and offsetting this decline with stronger commercial loan growth, which we also expect to be very comparable to the strong year we had in 2017 of around 10%.

This loan growth will be supported by the strength of our core deposit franchise, which becomes more relevant as we move into the potential of a rising rate environment.

Our ability to fund loan growth through low-cost core deposits is one area that will differentiate us from many banks.

Our outlook for credit remains quarter consistent.

As Daryl outlined, at this stage, we do not see any major sector or cyclical shifts in our portfolio.

Any issues we anticipate at this stage will be one-off exceptions to the balance of the portfolio.

But I would remind everyone that, that credit utopia cannot last forever.

We will remain diligent to our risk profile and underwriting standards, otherwise known as Daryl being Daryl.

With those brief closing comments, Dorothy, let's open the line for questions.

(Operator Instructions) Your first question comes from the line of Scott Siefers with Sandler O'Neill + Partners.

Believe it or not, you guys banked through most of my questions in the outlook, so I appreciate that.

This one, I do hate to do you -- to do to you, just to waste your guys' time and everyone's time, but on the margin, Jim, would you mind walking through the puts and takes you see in the margin again in the first quarter and where it all fleshes out?

Sure.

Sure.

So the -- obviously, the first thing that we're looking at is the drop in the FTE, Scott.

As you saw, it was up 17 basis points.

It's been running historically.

And we think that's probably 8 to 9 basis points a quarter.

And then as we look at the day count adjustment, obviously, the first quarter is always a short quarter, and that's approximately 4 basis points from just 2 fewer days.

And then the other kind of negative is the slightly lower nonaccrual interest.

We had a good quarter in the fourth quarter.

So that's about 3 basis points.

There's some offsets there, the full rate increase, full Minnesota kind of offsets, and that's why we said approximately 3.12% for the quarter on the -- which we did in margin less the accretion income.

Okay.

So 3.20 core margin is kind of where it all fleshes out?

3-1-2.

Oh, I'm sorry.

3.12%...

Yes.

Started 3.26% less 8 or 9 for the FTE, plus the 4 basis points for the fewer days, the 3 basis points for the nonaccruals, and then there's plus or minus, there's some benefits there from full Anchor and full…

Rate hike.

Rate hike, thank you.

Yes.

Okay.

And then what would be your best guess as to how the margin kind of trajects through the remainder of the year?

In other words, beyond the first quarter and maybe with the incremental rate hike?

So if you could forecast what the long end of that curve's going to do, Scott, we can probably give you a better outlook.

Obviously, rate hikes will become less important on the short end depending on the shape of that curve.

Just also, we've been very disciplined in holding deposit cost, and every incremental move from here is obviously going to put pressure on the industry to raise deposit rates.

And so I think the benefit is going to be less going forward for the industry just because of the deposit betas alone.

Yes.

Okay.

That certainly stands to reason.

Okay.

Sorry for making you go through that again, but I appreciate you doing that, Jim.

Your next question comes from the line of Chris McGratty with KBW.

Maybe a question for Jim to start.

With the closing of the deal, any change in thoughts in the securities portfolio, either size or composition?

And maybe entering the year, should we be assuming declines on a portion of earning assets as you kind of remix, as you talked about, Bob?

Or is that $4 billion-ish about the level that you expect?

I think it's about the right level.

I think the good news is we have lots of flexibility, and we actually brought the duration in.

It came in to 4.15.

And so I think we feel comfortable with the current level, but the good news is, we've got a lot of flexibility in that portfolio.

It still generates a lot of cash flow even in this environment.

So we'll let the balance sheet be the right size, but we're comfortable with the current balances.

Okay.

And maybe while I have you, just to make sure I got the expense.

I think you said $115 million a quarter core for Q1, Q2, and then a decline in the back half.

With the conversion occurring in early, I guess, May, you said, and that would suggest the savings would be in the second quarter.

How should we be thinking about the step-down in cost in the back half?

Yes.

I think it's -- the third quarter will be the first quarter that would fully reflect the 36% cost savings we expect to come out of the income.

Okay.

So the $115 million -- the $115 million is kind of the second quarter number, and then do we kind of grow with inflation from there?

Or is it -- are you discussing the step-down from $115 million and then...

We'll start to see some benefit in 2Q because it's -- but it's obviously less than the third quarter when we have the full run rate.

So really, the 36% is really applied to the Minnesota, Kansas.

To answer your question, Chris, you should see a step-down in third quarter versus second quarter as we take the full benefit of those expenses.

So the core expenses will be higher in the first half of the year than second half of the year, based on Minnesota.

And again, as I've said in my comments, any -- at this stage, any incremental investments we make will be included in that core expense run rate.

Got it.

If I could sneak one more in on fees.

If we -- it looks like you're about $1 million you didn't get yet from Minnesota, and then first quarter is obviously seasonally a little bit challenging for the industry.

Is that 43-ish number for kind of adjusted fee income a decent run rate for the first quarter?

I know you called out a trust -- a large trust estate fee.

I'm not sure if that was a big number.

Yes.

Obviously, the seasonality of the mortgage business will have some impact, but I think for modeling purposes, that 43-ish plus is probably a good number as you go forward.

You got some seasonality.

We still have to get through a conversion in Minnesota to see the impact on service charges.

But net-net, I think that's pretty good for a floor.

Your next question comes from the line of Nathan Race with Piper Jaffray.

Just a question on the commercial production yields in the quarter.

Obviously, we saw some firmer pricing there, so I was just curious how much of that is just a function of the last couple rate hikes that we had versus maybe some differences you'll see from a competitive aspect in either spreads or structure.

Yes.

I think really, obviously, LIBOR kind of led the interest rate hikes, and then we got prime rate increase in December.

So that was certainly a big driver of it.

And then as I alluded to, I think with the -- a little bit higher mix of CRE in our commercial portfolio, those tend to have longer terms and amortizations, and yields are a little bit higher in that group as well.

So still, obviously, very competitive out there, but nice to see the hike in yields.

And then, Bob, just thinking about the pipeline and just kind of commercial line utilization in the quarter, obviously, your pipelines are up noticeably from the third quarter.

So just curious how much of increased optimism across your client base is actually translating to that growth versus just some of your efforts to get larger in some of these stronger areas?

Yes.

I'd say for the pipeline, at the end of the fourth quarter, almost all of that's through Jim and his team's efforts.

I think we'll see, towards the end of this first quarter, you'll start to see reality hit for the clients because it takes time to put on paper than to make it happen.

So any pipeline increase is really because of Jim and his team.

And again, that's part of our optimism going into the year, is that we think there's -- you could expect some upside in that pipeline as clients get more optimistic.

Your next question comes from the line of Terry McEvoy with Stephens.

Bob, I just want to make sure I understand you correctly.

You talked about potentially reinvesting the tax savings in a later date in something you discussed in the future.

But then when you were talking about that $115 million expense run rate, you did mention increase in technology and client experience, et cetera.

I just want to make sure I understand how much of the tax savings will you be reinvesting, or at a future date, you think we're going to get additional commentary there.

Yes.

I'd answer it this way, Terry.

The numbers we gave you include any investments that we would make.

If by chance we make anything that's not in the run rates we gave you, we'll be clear to disclose that to you.

But at this stage, I just don't see that.

We think -- we believe that we're comfortable with those run rates and we can do the things we want to do.

It's important to realize the subtlety of a comment I made.

We brought the expertise in-house to be able to continue to look for ability to reduce cost and reduce processes.

So I'm hoping to be able to self-fund it, I think, over the year to be able to make those investments.

And then as it relates to tax reform and M&A.

How has that changed your conversations with potential sellers as it relates to overall pricing given the just lower tax rate enthusiasm and optimism around growth?

Yes.

I think it's a little too early to tell, to be honest with you.

I think everybody's still trying to figure out what the heck their write-down is, and everybody's responding to the daily news of people using some of those proceeds.

So I think in terms of any pricing, it's a little early.

My sense is we'll settle in and then you get to a new norm and things will continue almost like they have in '17, but I think it's a little too early to tell.

And just last question for Daryl.

The special mention loans from Minnesota, the $46.5 million, it just looks a little large on the graph here on Page 22.

Was that number and level expected when you announced the deal?

It was.

And Terry, what I -- and I want to make sure everybody understands is those special mention loans have some slight weaknesses in them.

And what you typically see when we bring on loans on balance sheet is that we don't have all the information.

We see some weaknesses.

We'll park it in that category.

And then as we review those loans over the first year and get more financial information, a lot of those things just flow out.

So that number did not concern us at all in this transaction.

Terry, that's what we call Daryl being Daryl.

Your next question comes from the line of Andy Stapp with Hilliard Lyons.

I tried to hit star 2 because my questions were answered, but I guess it didn't take.

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

Just on the Minnesota topic.

On the growth, what would you call out?

Is there anything in there?

Is it larger loans?

Is it pent-up production?

Is it health of the market?

I mean, the way I see it, maybe it's 1/3 of the organic growth during the quarter.

So is it seems a little bit outsized.

Is there anything to call out?

I think it's the basics.

We've got a great team that's been doing strong C&I lending.

That's one of the real appeals we had when we looked at Jeff Hawkins and Jim Collins and the team up there.

They just -- they've got a great niche, Jon, and they just continue to execute.

They've kept the blinders on for all the noise, and we're optimistic that we'll continue through next year.

Okay.

Maybe Jim, for you.

I'm not sure I got this comment right on the commercial and construction backlog pipeline.

Can you go through that again and then just maybe give us an idea of kind of what and where is there...

Yes.

Sure, Jon.

So $640 million was the number I quoted.

And so what that is, is commercial, it's construction advances that still have yet to be made on certainly larger commitments.

So these are projects that are in some percentage of completion that we will be advancing over the coming months and quarters.

So certainly, that gives us some optimism as we look forward to additional balance sheet growth.

Okay.

All right.

That helps.

And then Daryl, maybe one for you.

You guys kind of touched on credit, I guess.

But you called out indirect auto and certain parts of commercial real estate.

Is there anything you're seeing at this point that bothers you?

Or is it just more of the same?

I think it's -- well, there's things that bother me, right?

I think from an industry perspective, I think it's more of the same.

I think everybody has talked about indirect.

We saw our losses not high this year, but creeping up a little bit.

Our delinquencies at year end were a little elevated.

So that portfolio, I think generally across-the-board with most banks, everybody's kind of watching to see where the dynamics go.

Retail commercial real estate, everybody's got their eye on that, right?

Just the changing dynamics of that whole segment.

And then the fact that we put so much multi-family on over the years.

What we're seeing though is we see a fair number of our developers actually backing off that a little bit, which kind of portends to where is demand going to be versus supply.

So it's all those nuances, but nothing really smacks you straight in the face, but it's just, okay, let's just watch what we've got going on here and take care of business.

Your next question comes from the line of John Rodis with FIG Partners.

Bob, I wanted to -- could you just go back to your comment on yield accretion?

Did you say you expected total yield accretion, which is -- you projected to be like $30 million.

You said you expect that to be less than 5% of total revenues this year.

Yes.

Okay.

So that's down from what?

It was like 6.5% last year?

Oh, yes.

Actually, if you go back to some days, if you look at the chart, and if Lynell was doing her job, she'd tell me exactly what page -- Page 33 in the appendix.

I mean -- heck back in '14, it was $86 million of revenue that was probably -- it's probably 20-plus percent of our revenue.

So the point we're making is, and we understand that, I guess, wrap's a strong word.

But as I said I think a year ago or maybe sooner, I had accretion income tattooed on my forehead, and I'm hoping that, that goes away as we really a focus on just what the core engine's doing versus what is an accounting methodology that's necessary.

No.

That makes sense.

And then Bob, another just follow-up to, I think, Chris's question on fee income.

I think you said around $43 million was a good starting point.

Now that excludes Anchor.

Is that correct?

Yes.

You can add a little bit in there for Anchor on this positive service charge as they really don't add much else into the equation.

And part of what I was saying, we've got to get at least a quarter or 2 of performance from Anchor to be able to give you a better idea of what their performance will be because we're going to make some changes.

We hope not many, but some.

So $43 million to $44 million in total.

Is that sort of the right way to think about it in the near term?

As I think I said, that's probably a floor.

I think what we're trying to do is all the nuances of the market and some of our wealth businesses, you understand there's flexibility and there's seasonality in those numbers as well.

So I think what we don't know is any -- as you well know, John, we don't include any revenue enhancements.

We've got the ability to take capital markets and wealth to Minnesota and still in Wisconsin, quite frankly.

So we think there's upside.

But if you need a number, I'd use a floor at $43 million, understanding seasonality and upside from the service charges out of Minnesota.

Yes.

No, that makes sense.

And then just one other question, just to make sure the operating expense guidance of $115 million, that includes the expenses for the tax credit amortization?

No.

Those are just core operating...

And timing on those tax credit amortizations kind of, if you remember, that's a nuance because of the way we have to account for those.

Those aren't steady expenses.

Those are kind of like one-timers.

Our sense is that as we think about the closing of those projects is tied towards latter part of second quarter, maybe sneaking into the third quarter.

So we'll let you know.

But for your modeling, we've excluded those from that core number.

Okay.

And then, so I guess, Jim, the full year guidance of the effective tax rate of 12% to 14%, does that include the benefit of the tax credits?

It does, and we'll have to accrue those benefits over the full year, even though those amortizations will occur, as Bob said, more heavily in 2 and 3Q.

But the tax benefits are spread evenly across the full year.

It's a goofy accounting standard.

I understand.

So I mean -- but if you -- on Page 19, if tax credit amortization's $17 million to $20 million, then roughly $4 million to $5 million a quarter, you add that on top of the $115 million?

Correct.

Your next question comes from the line of [Eric Grubelich], bank investor.

Just a question about one of your slides.

I think it was put in the deck about the branch sales and closures.

So if you -- if we make the assumption that for the foreseeable future, you don't do anything new on the M&A side, is there anything left to do there?

Is it just small items?

Or is there more to come with any kind of branch consolidation?

No.

Absolutely more to come.

Our customers' behavior has changed, obviously, with our investment into mobile.

Jim's also been doing some work on universal banker model, which helps us quite a bit.

So speaking for the board and for myself, you should expect to see a continuation.

And we haven't actually -- some markets will take a hard look at it as client behavior changes and maybe demographics change.

So this is an ongoing quarterly discussion between our management team.

So Bob, if you're looking at doing more of that, this is maybe a difficult question to answer.

But if you look at the accretion impact or the profitability benefit when you've closed branches before, do you see that as better or worse going forward, if you do more branches?

So in other words, the impact on your expense base.

Should there be more of a benefit or maybe less of a benefit now?

Well, from the expense side, it should be a consistent benefit to what we've seen in the past because those are fairly well-fixed costs.

You've got the real estate cost, you've got the cost of labor.

And, quite frankly, what we've been pleasantly surprised with is our ability to retain those deposits.

So the upside comes on the revenue where we've gotten better spread income and a little better fee-based income because we've retained.

I think Jim's told the story.

We closed a branch.

It'd be close at the moment within 10 miles and we had over 90% retention.

So obviously, expenses are going to be consistent and we just think there's upside to the revenue because the client's behavior has changed.

(Operator Instructions) And there are no further questions at this time.

Great.

Obviously, you'll have follow-up questions.

Let Lynell, John or Jim know.

And we appreciate everybody's time and attention.

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 6268317.

This replay will be available through February 6. If anyone has additional questions, please contact Lynell Walton at (812) 464-1366.

Thank you for your participation in today's conference call.