Old National Bancorp (ONB) 2018 Q2 法說會逐字稿

Welcome to the Old National Bancorp Second Quarter 2018 Earnings Conference Call.

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

Corresponding presentation slides can be found on the Investor Relations page at oldnational.com, and will be archived there for 12 months.

Before turning the call over, management will like to remind everyone that as noted on Slide 3, certain statements on today's call may be forward-looking in nature, and are subject to certain risks, uncertainties and other factors that could cause actual results to differ from those discussed.

The company's risk factors are fully disclosed and discussed within its SEC's filings.

In addition, certain slides contain non-GAAP measures, which management believes provides more appropriate comparisons.

These non-GAAP measures are intended to assist investors' understanding of performance trends.

Reconciliation for these numbers are contained within the appendix of the presentation.

I'd now like to turn the call over to Bob Jones for opening remarks.

Mr. Jones?

Great.

Thank you, Dorothy.

And obviously, last quarter I didn't do as good a job with those statements as you did and John Moran passed the buck to you, so I appreciate that.

Good morning, everybody, and thank you for joining us.

Slide 4 provides an overview of our second quarter, which by all accounts was very good and consistent with our guidance in prior quarters.

We did see very strong C&I growth of more than 21%, driven by a record quarter of production of almost $600 million.

Our reported total loan growth was slightly muted by the sale of almost $65 million in student loans that we had acquired via our Wisconsin partnership.

And we also did see the continuation of our balance sheet remake strategy with a decline in indirect loans.

Our commercial real estate outstandings were flat for the quarter, driven in large part by paydowns of over $100 million in loans that went to the secondary market, which is an abnormally high quarter of activity for us.

As you know, the secondary market has become very aggressive for quality commercial real estate.

I might add a bit of a cautionary statement here.

Commercial real estate remains a very good asset class for us, and we are comfortable with the quality of the portfolio we have built over the last few years.

While we still have capacity to increase our outstandings and remain committed to lending within our risk tolerance, we are beginning to see aggressive competition in the commercial real estate market, both in terms of structure and in pricing.

And that may impact our growth in commercial real estate going forward.

We did experience our normal seasonal decline in our end-of-period deposits.

Deposit pricing has become a much more aggressive, particularly from those banks who do not have strong deposit basis.

We continue to benefit from our diverse franchise and pricing discipline, and we're pleased with our lower-than-peer deposit beta of slightly over 10% through the cycle.

Just to remind you, today we have a top 10 deposit share in all but 4 of our top 20 MSAs and 20-plus market share in over 1/3 of our markets.

In many cases, we are the gorilla in setting the market price.

This should continue to allow us to be a market lagger in terms of deposit pricing during this rate cycle.

Our focus on operating leverage and expense control was evident in the quarter as we improved our operating leverage by over 220 basis points year-over-year.

On an adjusted basis, our efficiency ratio was just over 61%.

We continue to report strong credit results with net recoveries in the quarter.

We did see an increase in our provision for the quarter driven in large part by this strong loan growth that we had experienced.

In addition, there also the migration of large -- of one large credit to nonaccrual in Michigan and some movement in other categories.

While it's not concerning at this time, as we all know, we are in an extended recovery, and at some point, probably in the not-too-distant future, we will begin to see credit move back into the headlines for the industry.

At this stage, while we see some pockets of slight concern in our portfolio, we remain very confident in the quality of our portfolio as well as our reserve coverage.

As it does relate to the economy, John Moran pointed out to us that our -- post our Minnesota entry, our 5-state footprint is larger in terms of GDP than Canada.

We also enjoy strong economic indicators within the region with historically low unemployment and GDP growth higher than most regions.

While we continue to benefit from the strong economic activity, as evidenced by our near-record loan pipeline, we do not know the impact that the implemented and proposed tariffs will have on our markets.

Sectors that have or could be impacted are agriculture, nondomestic auto industries and manufacturing.

Currently, the largest impact is on the agricultural sector.

This is a sector that has been under pressure for some time and this is, yet again, one more challenge for our farmers.

As a reminder, we have slightly less than $300 million in outstandings.

And in most cases, have been able to secure additional collateral and feel the loss content as manageable.

During the quarter, we were quite busy in the Minnesota market.

We executed our conversion of what was AnchorBank successfully, and announced our new partnership with KleinBank.

Our performance for the quarter in Minnesota was extremely strong as it led our commercial loan growth with over $58 million.

We are very excited about the opportunity as we bring these 2 teams together to better serve the Twin Cities, Mankato and the west market.

A brief comment on M&A, while we continue to see several opportunities, we remain very selective partner and a focus on execution in our markets.

With those comments, I'll turn the call over to Jim Ryan for greater detail.

Thank you, Bob.

Starting on Slide 5, I will reiterate a few items that we think are important to our strong second quarter results.

Adjusted earnings per share was $0.29.

The most significant distinction between the second quarter and the first quarter was the $11.9 million in tax credit amortization.

Adjusted earnings per share for the second quarter excludes $2.5 million of merger charges, $2.2 million of student loan sale gains, $1.6 million of branch closure charges, and $1.5 million of securities gains.

Overall, we are very pleased with the results this quarter as we continue to execute our strategic initiatives.

Moving to Slide 6. Adjusted pretax preprovision net revenue was almost 20% higher year-over-year.

This result was driven by increased scale from our recent partnerships, maintaining our strong, low-cost deposit base and a continued focus on expense management.

Next, on Slide 7, as Bob highlighted, we had record commercial production during the quarter of almost $600 million.

This translated into more than 8% commercial growth, despite a large number of commercial real estate deals being refinanced to the secondary markets.

Despite the strong pull-through we experienced in the quarter, our commercial pipeline still stands at $1.7 billion.

Our loan yields increased 15 basis points, primarily aided by the increase in short-term rates during the quarter and an improved mix.

You should also note that our indirect portfolio was down 7%, and we sold our entire student loan portfolio during the quarter.

We inherited this book from our Wisconsin acquisition and opportunistically exited this portfolio.

Slide 8 demonstrates our year-over-year change in earning assets.

Again, this is very consistent with our stated strategy and ongoing remix objectives.

As a percentage of total earning assets, commercial loans are up almost 8%.

Less productive earning assets including indirect lending and securities are down 5% year-over-year.

Moving to Slide 9. You can see our deposit balance has increased on average.

However, they did experience their typical end-of-period seasonal decline.

We continue to believe that stable, low-cost, core funding creates a sustainable competitive advantage.

Our deposit beta is now just 10.3% current cycle to date.

Next, on Slide 10, our net interest margin exceeded our expectations and the outlook we provided you last quarter.

Our net interest margin excluding the accretion income was 3.25% and benefited from short-term rate increases and improved mix and day count.

Accreditable yield was up slightly from the first quarter.

We have provided the normal schedule for accretion in the appendix.

Slide 11 shows trends in adjusted noninterest income.

Mortgage revenue and wealth management were seasonally higher.

We have included the purchase versus refi percentage.

As you would expect, refies are only 17% of our volume.

Other fee areas were fairly stable.

Next, Slide 12 shows the trend in adjusted noninterest expenses.

We guided towards $115 million in the second quarter, with annual merit increases effective April 1. And we made the decision to increase our 401k match.

This increase in the match will cost $3 million to $4 million annually.

We decided the best long-term use of some of the federal tax savings was to invest in the financial health of our associates versus onetime bonuses and other short-term benefits.

Our adjusted efficiency ratio for the second quarter was 61.7%, a 134 basis point improvement from the second quarter of 2017.

Expense control remains a key focus in 2018, and we are committed to continuing to generate positive operating leverage.

Slide 13 has our credit metrics.

We reported net recoveries during the second quarter, while at the same time recording a $2.4 million provision expense.

Primarily reflecting our strong commercial loan growth and some commercial loan grade changes.

With 64 basis points against organic loans and 373 basis points of loan marked against the acquired loans, we continue to have very adequate reserve coverage.

Next, Slide 14 provides an update on our tax rate expectations.

Our statuary rate is expected to be 24.5% for the year.

This is the rate you should use to adjust for noncore and nonrecurring items.

For the full year, we continue to expect a net after-tax benefit of our tax credit business of approximately $3 million or about $0.02 per share.

The full year GAAP tax rate should be approximately 10% or approximately 14% on an FTE basis.

These tax rates are slightly higher than previously projected, but we now expect lower tax credit amortization.

Those numbers are expected to be $9 million to $11 million for the third quarter and $22 million to $24 million for the full year.

As we have discussed, the exact timing of this project can be difficult to project since many of these are construction projects on historical buildings.

We expect the tax credit amortization to be $1 million to $2 million in the fourth quarter.

Historical tax credit deals going forward will be contributed to a fund structure.

This should smooth quarterly volatility.

As we start contributing assets to the fund, we will provide projections for 2019.

Slide 15 provides some key takeaways from the quarter.

The first half of 2018 is off to a strong start with good execution against our strategic objectives.

We continue to show strong commercial growth funded by low-cost deposits, remixed our balance sheet into more productive earning assets, drove positive operating leverage, maintained strong credit metrics and sound risk management, and grew tangible book value per share by 7% annualized and continued our expansion strategy into high-growth markets from the KleinBank partnership.

Slide 16 provides details around our updated outlook.

Our expectations remain consistent with our outlook we framed last quarter, and our view on loan growth is unchanged.

Assuming no rate changes, we expect a stable to moderately increasing net interest margin excluding accretion income.

We remain positioned to benefit from future rate increases.

Fees should follow normal historical and seasonal patterns for the second quarter, generally being our best quarter.

As already highlighted, we expect run rate, noninterest expenses to decrease in the back half of the year with savings from our Minnesota partnership fully realized.

We expect to close on our Wisconsin branch, still have 10 branches in the fourth quarter.

We've already covered tax matters in detail in Slide 14.

Finally, with respect to Anchor performance, we continue to see great results.

From Day 1 to the end of second quarter, loans are up 13% on an annualized basis.

This is the second partnership in a row that has seen robust loan growth right out of the gates.

We expect the addition of Klein, another great platform in the Minneapolis market to bolster an already strong presence.

With that, we're happy to answer any questions that you might have.

And to remind you, we do have the rest of the team with us including Jim Sandgren and Daryl Moore.

Thank you, Dorothy.

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

Two, I guess, rate-based question.

So one, Jim, maybe if you can just discuss the margin in a little more detail, the core exclusive of the PAAs came a little, well, not a little but better than I would have anticipated.

So maybe as you look forward, if you could sort of discuss the biggest puts and takes as you see them?

I might have guessed it would've been the yield curve as the biggest pressure, but it looks like it might be deposit betas lagging as the biggest benefit perhaps?

And then as sort of a segue, if you might just spend a little more time discussing deposit pricing by market.

Bob, as you noted, you've got some places where it's kind of you guys and almost nobody else, but then some newer places, so just if you can bifurcate those, that'd be great, please.

Yes.

So Scott, we are pleased with the performance of our margin and a lot of it, in my opinion, was driven by the fact that we are able to lag some of the deposit rate pricing.

The guidance we give to a stable to slightly increasing, it kind of includes trend line increases we're seeing.

And as Jim will talk about, we are being defensive and being selective on where we're raising rates.

But that will continue, I think, either drive or not drive positive changes in the margin.

Certainly, the flat yield curve does not help our ability.

We have a lot of medium- to longer-term assets in our investment portfolio to residential portfolio.

So to the extent that, that 10-year stays stubbornly below 3%, that will be a challenging to margin growth going forward.

With respect to deposit pricing, Jim can answer a little bit...

Yes, Scott, so obviously, as Bob mentioned, in the markets where we have over 20% market share, we're really driving the deposit pricing and really haven't had to move off of our current chart rates.

I think where you're seeing more movement is certainly the newer markets where we have less than 5% market share.

So being a little bit defensive, as Jim pointed out, but it's nice to have that mix and to have that legacy deposit franchise has been very, very helpful through the cycle.

You're next question comes from the line of John Arfstrom from RBC Capital Markets.

Little bit on your loan growth targets.

On one hand, I think you're saying commercial was strong but commercial real estate is a little bit tougher.

Just talk a little bit about what you're seeing in commercial, and then give us an idea of kind of where and what is better and what's tougher in commercial real estate?

Yes.

I think we continue to benefit from a strong economy in the 5-state market.

We're seeing a lot of expansion and manufacturing inventory expansion, a lot of opportunities for folks as they think about what they're doing with their tax benefits.

And other side, as I mentioned briefly, we still don't quite know the impact that tariffs will have.

Right now, I think it's more of a conversation with folks other than just in the ag sector, Jon.

Commercial real estate, I don't want to -- while we see -- we're starting to see structure [in] pricing challenges.

I think the pipeline still remains strong, the quality of the projects we're seeing other than a few sectors remains good.

We're very cautious towards real estate -- excuse me, retail, obviously.

Multifamily is an area where we have a little bit of angst and then senior housing would be another one that we're just seeing a lot of issues around.

But the traditional warehouse, office development continues to remain strong, continue to have a really strong growth in the Wisconsin market.

We're starting to get good growth on in Minnesota, and even some of our legacy markets.

Okay.

And where would you like to see that loan mix go?

You've referenced the loan and deposit mix a couple of times but you're approaching 50% in commercial real estate.

Is that enough or do you want that to go higher?

I think we've got room to go a little bit higher.

Obviously, the trick and the key for us all is to fund that with low-cost deposits.

To the extent we can continue to do that, I think, we'll allow that to drift a little bit higher.

It's a better yielding asset, Jon, on the C&I side as we continue to wind down the indirect book.

And really, the indirect book that we talked about for is less of an issue of quality of credit.

It's really an issue of yield, as that's such a hypercompetitive market.

We just -- with the markets we've entered in with the quality of the program that Jim Sandgren's built, we just feel C&I and to a degree CRE, gives us a good replacement asset.

Okay, good.

And then just one follow-up on Scott's question on deposits.

That 6 basis point increase was better than we've seen from most of your peers.

Is there more to come there?

Some other competitors have had more of a step up that quarter.

Would you just say that, that's due to your deposit mix, and you don't see any unusual pressures there other than kind of just tracking up from here?

Yes.

I think Jim said it well, with a lot of that depends on the shape of the yield curve.

But at this stage, we're not feeling a significant amount of pressure.

I think, again, that just reinforces the beauty of the franchise that we've built that we can fund it with low-cost deposits and what was our legacy markets and then be selective in any rate increases.

But deposits, Chris Wolking go back 10 years ago, we kept talking about the quality of the deposit franchise, and it's finally becoming true and folks that have the ability to raise and retain deposits to low costs are going to be the winners in this cycle, and we think we're clearly there.

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

Maybe first question, for the last couple of years, you've talked a lot about the deposit base in those more community markets and the low betas.

What's going on the loan demand side?

Is there any kind of economic activity that's spurring growth?

Or is that maybe more in a runoff phase?

You know, actually, Terry, one of our better growth market this last quarter was Southern Indiana, which again, is not exactly the hypercompetitive economic market.

But I think, again, what Jim has built and with that gorilla theory, we're getting every at-bat can in those markets, and we've seen good growth out of Jasper, Indiana, for instance, which is a market that, as you well know, we've got a very strong competitor in.

So we continue to get at-bats.

And again, with the benefit of the stronger economy in the states we serve, I think even in -- would not be considered growth markets is still very good.

And then just a follow-up, Page 16, the outlook where you talk about the commercial and CRE growth of approximately 10%.

It sounds like in the back half of this year, it's going to be heavily weighted towards the C&I side.

And I guess based on CRE slowing down, do you see that growth rate of loans in the back of the year slowing down just given the CRE commentary where it's just not going to be as high as what we've seen at least through the first 2 quarters of this year?

No, I think we're very comfortable with the guidance, which should be consistent with the first 2 quarters.

CRE, it all depends on the secondary market, we had over $100 million, which was an abnormally high market.

But we've got a record pipeline, there's a good balance between C&I and CRE, and it's the CRE in those pipes that we're comfortable with.

Plus we've got some undrawn commitment shared in this CRE side and strong credits as well.

So comfortable with the guidance, the mix, I don't think the first half is going to be all that different -- or the second half shouldn't be all that different than the first half.

Right.

And then just lastly, you doubled your presence in the Twin Cities, obviously, you felt this scale was going to be necessary and the opportunities were there.

As you look at -- as you look across your franchise, are there any other markets that really stand out where you see opportunities and would like just a larger scale to make sure you can capitalize on those growth opportunities?

Sure, Michigan.

You think about how strong Grand Rapids is, it's a terrific market; Ann Arbor,, great market; even Kalamazoo has got a lot of good activity going on.

So that triangle that we've established there, clearly we'd like bigger scale.

Louisville continues to be a market where we have just had great success on the C&I side, and it would be nice to build out a franchise there.

Then we continue to look at Northern Indiana.

As everybody is aware in the second quarter there was a transaction in Northern Indiana that just, for us, didn't make financial sense.

But we'll continue to look at the right opportunity at the right price.

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

Maybe just a question on the balance sheet.

Obviously, the quarter was impacted by some seasonal deposit flows.

But can you remind us the target on the loan to deposit.

You still have some flexibility to peers, but we're right around 90%?

Yes.

We've never really come out with a target.

I think anytime we'd get it above 100%, we'd have to take a bit of a look at it.

But with Klein coming on, they've got such a low deposit -- loan-to-deposit ratio, we're comfortable that even with the growth we're seeing we're going to be well under that as we go forward.

Okay, great.

So a little bit more of a remix to the balance sheet, Bob, the -- kind of the securities portfolio trending flat?

Down?

Yes, flat to slightly down.

Again, I hate to keep bringing up Chris Wolking, it's kind of his story, but for years, Chris talked about getting our investments down to 25% in the infamous barbell, and we're finally at 25%.

So -- but we'd like to -- obviously, the yield on that, particularly, as a you look at reinvesting in the long-term, is not really what we wanted to focus on.

And it still generates a lot of good cash flow.

Great.

And if I could -- just one clarification on the fee income guidance.

Is that guidance relative to the reported $49 million or the adjusted ex the gains in the securities and the branch?

Yes.

The adjusted numbers, yes.

So $45 million, $46 million is kind of the start point for the next quarter?

Yes.

(Operator Instructions) Your next question comes from the line of Nathan Race with Piper Jaffray.

Jim a question on interest rate sensitivity.

Could you just remind us how -- or the percentage of the dollar -- amount of loans that are tied to either prime or LIBOR on the short end there?

Yes.

It varies, consistent with what we've done in the past.

About the commercial side, it's roughly just slightly over 50% is really variable rate in total.

And then the total loan portfolio, I think it's probably closer to 43% when you're throwing all the mortgages and some of the other, indirect auto.

So the commercial side, just slightly over 50% and just slightly over 40% when you look at the total loan portfolio.

Got it.

And I imagine that'll stay relatively flat with Klein coming on later this year?

It will.

And then -- but you know the nice benefit of doing more C&I lending and having that growth is, that tends to be a little shorter and a little bit more variable.

So just generally speaking, really like to see that.

Klein's asset sensitivity is pretty similar to ours, slightly asset sensitive.

So it will kind of maintain our current asset sensitivity position.

Okay, got it.

And changing gears a little bit and thinking about credit quality.

The reserve bill that we saw this quarter has been a little larger than we've seen in the past.

So just curious if the separate run rate's a good number to use going forward?

Obviously charge-offs were fairly benign this quarter and it's a little more scientific than that, but just any thoughts on the reserve bill from here, assuming loan growth continues at the pace we saw in 2Q?

Yes.

I think for a modeling purpose, I'd look at the year-to-date number as a way to really think about the back half of the year because you get movement both positive and negative in the loan grades, obviously, a large portion of the larger provision was because of the growth we had in C&I, but as I mentioned, we did have a large credit that moved.

But I think for the back half of the year I'd use the first half of the year is a good forecast.

And there are no further questions at this time.

Great.

Thank you so much.

Obviously, Lynell and John are available for any follow-on questions and appreciate your support.

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 6293046.

This replay will be available through August 7. If anyone has additional questions, please contact Lynell Walton at (812) 464-1366.

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