Old National Bancorp (ONB) 2018 Q3 法說會逐字稿

Welcome to Old National Bancorp Third 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 would like to remind everyone that as noted on Slide 2, 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 filings.

In addition, certain slides contain non-GAAP measures, which management believes provide 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 this presentation.

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

Mr. Jones?

Great.

Thank you, Dorothy, and good morning, everyone, and welcome to Old National's third quarter earnings call.

We're all glad you're here with us this morning.

Joining me are Jim Ryan, Daryl Moore, Jim Sandgren, John Moran and Lynell Walton.

And as always, following our prepared comments, we'll all be available to answer your questions.

So the headline for this call can simply be, this morning, Old National announced their best quarterly net income in their 184-year history.

We can then just drop the mic.

It's really not our style, and somehow, I don't think you would appreciate that hubris, and more importantly, there are several subtext to the quarter that need further detail.

One of the subtexts or, what we call, themes is discipline.

This quarter reflected the continued discipline that we have built in our operating model.

We have disciplined credit by focusing on the granularity of our portfolio as evidenced by our average commercial loan origination for the quarter being slightly over $500,000.

Lending only in our markets and not purchasing syndicated credits and our strong underwriting led to only 6 basis points of charge-offs for the quarter.

Similarly, the disciplined culture that we have built around expense management drove an adjusted efficiency ratio of 58.6%, [and] a year-over-year improvement in our operating leverage of more than 400 basis points.

We were also able to hold down deposit costs, which only increased 7 basis points in a rising rate and a highly competitive environment, which indicates the value of our deposit franchise in concert with the disciplined approach to pricing.

M&A is another important area of discipline, and for context, while John Moran has done some incredible work for us, we have also discovered that he had his own unique Mocabulary.

We have come to call these Moran-isms.

So to use my first Moran-ism, we are very reluctant to break the box of discipline when it comes to M&A.

Prices and expectations appear to be rising, and in the focus for -- and our focus will be to have the right opportunity and the right markets with our owners in mind.

Given all the positives for the quarter, there were areas that did not meet our expectations.

This was led by loan growth, specifically commercial and CRE loan growth.

Given the record pipeline and the record production we had last quarter, we had very -- we had higher expectations for this quarter, while our pipeline remains at near-record levels, our activity has slowed somewhat from last quarter with our commercial CRE production down from a higher $598 million to $455 million for the third quarter.

A large portion of this was timing, and it does not appear to be any symptomatic issues.

That said, growth was below our expectations.

As with many banks, we had an unusually high level of payoffs this quarter.

Almost 65% of those payoffs were loans for companies or properties that are either sold or they're refinanced on the secondary market.

But as Jim will cover later in the presentation, based on our pipeline and the positive economic activity we see in our markets, we are still very comfortable that our growth will be close to what we have seen in prior quarters for the fourth quarter, absent, again, any unusual spike in payoff activity.

Economic activity does remain high in our markets, and the feedback from our clients is positive as they view 2019.

For the most part, clients have ignored any geopolitical noise, domestic or otherwise.

Rising rates do create some angst as does the potential for upward pressure on inflation.

Time will tell what effect the rising rates will have on our borrowers.

While we have seen some modest impact at this stage, it does not appear to be concerning.

As we said last quarter, there remain some segments of our portfolio that we are cautious towards, but overall, we remain comfortable with our credit.

As was noted in our 8-K filing of last week, we have received final regulatory approval for our KleinBank partnership.

We expect an 11/1 closing with the conversion set for the second quarter of 2019.

We remain very enthusiastic with the opportunity that exists in Minnesota.

As to additional M&A, the market remains active.

And my final Moran-ism is, we remain an active looker and a selective buyer.

With those brief comments, let me turn the call over to Jim Ryan.

Thank you, Bob.

Starting on Slide 4, I will reiterate a few items we think are important to our record third quarter net income.

Both reported and adjusted earnings per share were $0.34.

The most significant distinction between the third quarter and the second quarter was the strong decline in our noninterest expense.

The primary driver of this decline was the fully realized savings from the Anchor, Minnesota transaction and ongoing efforts to improve operating leverage.

Adjusted earnings per share excludes the items we noted on the slide.

Moving to Slide 5, adjusted pretax pre-provision net revenue was 21% 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.

We have improved the operating leverage by 287 basis points and 434 basis points year-to-date and year-over-year, respectively.

Next, on Slide 6, as Bob mentioned, we had a large number of payoffs and commercial deals being refinanced in the secondary market.

Our loan yields improved from higher interest rates and higher-than-normal levels of interest collected on nonaccruals, which was offset by lower accretion income.

Slide 7 demonstrates our year-over-year change in earning assets.

Again, this is very consistent with our stated strategy and ongoing balance sheet [remix] objectives.

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

Less productive earning assets, including indirect auto and securities, both continue to decline as a percentage of our total balance sheet.

On a linked quarter basis, looking at actual dollars outstanding, indirect was down almost 4%.

Moving to Slide 8, you can see our end of period deposit balances are unchanged at quarter-end.

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

Our deposit beta is now [just 13%] current cycle to date.

As a reminder, we expect to close on the sale of 10 branches located in Wisconsin with approximately $240 million in deposits on October 26.

Next, on Slide 9, our net interest margin exceeded our expectations and the outlook we provided you last quarter.

Our net interest margin excluding accretion income was 3.32%.

Asset repricing continued to behave as we would expect, and our funding cost remain well controlled thus far.

This quarter benefited from higher-than-collected -- higher-than-normal interest collected on nonaccrual loans and day count.

The contribution from accretion income was down 11 basis points from the second quarter and is now running less than 5% of total revenue.

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

Slide 10 shows trends in adjusted noninterest income.

Capital markets revenue increased, while mortgage revenue wealth management were seasonally lower.

Other fees were stable.

We have included the purchase versus refi percentage, and as you would expect, refis were only 18% of our volume.

Next, Slide 11 shows the trend in adjusted noninterest expenses.

We were pleased with the $108 million we reported for the third quarter, now that the Anchor, Minnesota partnership is fully integrated.

Our adjusted efficiency ratio for third quarter was 58.7%, a 251 basis point improvement from the third quarter of 2017.

As Bob said, expense control is an important part of our culture, and we remain committed to generating positive operating leverage.

Slide 12 has our credit metrics.

We recorded $0.8 million in provision during the third quarter, while posting net charge-offs of $1.7 million.

On a year-to-date basis, we have recorded $3.6 million in provision, while posting net charge-offs of $1.2 million.

With 61 basis points against organic loans and 383 basis points on loan mark against the acquired loans, we believe that we have more than adequate reserve coverage.

Next, Slide 13 provides an update on our tax rate expectations.

Our marginal tax rate is expected to be approximately 25% for the year.

This would be the rate you would use to adjust for noncore, nonreocurring items.

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

The full year GAAP tax rate should be approximately 10% to 11%, which translates to 14% to 15% on an FTE basis.

Based upon your and other investor feedback regarding the volatility of historical tax credits [that caused our] reporting, new credits going forward will be contributed to a fund.

This should [smooth] quarterly volatilities we had in the 2019.

The anticipated tax credit amortization next year should be de minimis.

We are projecting our 2019 GAAP tax rate to be approximately 20% or 24% on an FTE basis.

Slide 14 provides some key takeaways from the quarter.

As we refer to the final quarter of 2018, we are pleased with our results thus far driven by good execution against our strategic objectives.

While loan growth was somewhat softer this quarter due to payoff activity, we are pleased with our year-to-date progress.

We -- we've maintained our low cost deposit base, remixed our balance sheet into more productive earning assets, driven positive operating leverage, maintained strong credit metrics and sound risk management, grown tangible book value per share by over 7% annualized and continued our expansion strategy into higher growth markets with our Klein partnership.

Slide 15 provides details on our updated outlook.

Our expectations remain consistent with the outlook we framed last quarter, and our view on total loan growth is mid-single digits annualized for the fourth quarter with higher growth coming from the commercial portfolios, absent unusually high payoffs.

We expect a stable to moderately increasing net interest margin, excluding accretion income.

Fees should follow normal historical and seasonal patterns.

As we have provided last quarter, we continue to expect run rate noninterest expenses to be approximately $220 million for the back half of the year, with some seasonality expected in the fourth quarter.

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

We expect to close our Wisconsin branch sale of 10 branches in October and close on our Klein partnership November 1. We expect the addition of Klein, a second great platform in Minnesota, to bolster an already strong market presence.

As Bob noted, we expect the Klein systems conversion to occur in the second quarter of 2019, and the third quarter should reflect the full cost savings we previously disclosed.

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

And as Bob already mentioned, we do have the rest of the team with us here, including Jim Sandgren, Daryl Moore, John Moran and Lynell Walton.

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

Want to maybe just start on the loan growth outlook.

Obviously, you guys are dealing with some payoffs this quarter that I think a lot of the industries struggled with as well.

But it sounds like production volumes have picked up noticeably on the commercial side of things.

So just curious to get your updated thoughts on how we should think about loan growth in the fourth quarter on a net basis and in the 2019 as well?

Yes, I think it's consistent with what we've said before.

Total loans will be somewhere mid-single digit led by our commercial and CRE production, which would be high single digit to low double digit, but there's nothing we see in activity that is concerning.

The payoffs just -- our #1 payoff was a large retail company that's sold.

And quite frankly, it was one that given our concern on the retail sector probably was headed to a lower grade.

So these things happen and you just kind of go forward.

Okay.

Got it.

And kind of thinking about the core margin going forward, Jim, I was wondering if you could provide the breakout between LIBOR and prime?

Obviously, LIBOR tend to lag the increasing prime that we saw during the third quarter.

So just curious if you could provide that breakdown?

And kind of how we should think about the progression of the core NIM with Klein coming onboard, just given a lot of the excess liquidity that you guys will be absorbing with that transaction?

Yes.

So just generally speaking, we will benefit -- the margin will benefit from the Klein partnership, slightly offset by the fact that we're selling those branches in Wisconsin.

And with respect to the total loan portfolio, still 42% variable, 22% of that's tied to LIBOR, 13% of that's tied to prime, and then we can [add] various other industries like treasuries that also make a part of the repricing.

Commercial portfolio is 51% variable with -- 30% of that are more tied to LIBOR.

Okay.

And just to clarify on the 4Q guide, so that does not include the impact of the rate hike that we had here in September?

Yes.

I mean, I think we're kind of steady and slightly improving as where we would call the margin just generally speaking.

Obviously, the margin benefited from slightly higher interest on nonaccruals.

But generally speaking, we're steady to slightly positive.

Okay.

Got it.

And if I could just sneak 1 more in on the accretion outlook.

With Klein coming onboard, does the $5 million or so of accretion scheduled for the fourth quarter, is that included in your guys' forecast on Slide 17 there?

Yes.

No, it is not.

And obviously, we're getting ready to do those marks as we close on the transaction.

So we'll have slightly more accretion in terms of total dollars in the fourth quarter.

Do you have any outside accretion for 2019 with Klein coming on board on top of what you guys have laid out on slide 17?

Yes.

I mean, obviously, there will be some accretion that comes from that transaction.

But I'll just remind you that the credit mark is a lot lower than we've seen it from previous transaction.

So there's just going to be a lot less volatility in those things.

I think it'll be closer to the way that the [Anchor] transaction came onboard in terms of total accretion contribution.

Yes.

I would just add, this is Bob, our general overall and the outlook slide at the back of the presentation really does not include Klein.

So that's just, what we would call, legacy Old National pre-Klein, since we haven't been able to do the marks and everything [as we] come through on the closing.

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

Just a question on expenses.

You guys have had a very good history of buying banks and then shutting a lot of branches and selling some nonstrategics.

How should we be thinking about just expenses going into '19, once you get the savings from Klein?

Are there any big investments that the bank needs to make?

Or should this be, once we adjust for the kind of the cost savings that are targeted, this is the bank they can grow expenses with inflation?

Yes.

I think that latter is the better way to look at it, Chris.

We clearly will have some investments, but our word of the day is reallocate.

If you've got to make an investment, you've got to find ways to do it.

We're still not where we need to be in our backroom areas and certain other parts of the company as efficient as we want to be.

But Jim Ryan has done a great job of saying, if you need additional investment, you got to find ways to fund it through your own reallocation.

So your analogy of using inflation as a parameter is a good one.

It's still going to be a big focus.

Quite frankly, I have got a history going on the road that we never be a sub-60 efficiency, and we're there and we're going to continue to focus on as we build scale in this model.

If I could ask about loan growth to Bob, you talked about payoffs and most of your peers have talked about that.

Is that -- and I think you talked about M&A being a factor.

How much of the loss of loan growth, if you will, is going to the nonbanks?

Because that's, I think, a theme that we're all trying to figure out.

When does that stop?

Yes, well, we wish we knew when it was going to stop.

I'd just give you a example.

Our top 5, and the largest one I referenced was a retailer that sold the company.

Then we had a senior living care [that] sold, and then the next 3 largest were all -- went to the secondary market, and they are real estate projects.

A good example, we had a $10-plus million credit in Kentucky, that's a very, very good client of ours.

[Got a deal it] there is just no way we can compete with it.

So it tells you something, Chris.

The secondary market acting the way it is, it's pretty aggressive at this stage.

Great.

And if one kind of technical, if I can get that in.

The higher interest reversals, do you have the dollar amount that was in the quarter that was flowing to the margin?

Chris, we'll get to you.

We'll get to you, Chris.

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

Just to be clear, ex paydowns, was loan volume in line with what you were thinking about and talking about 3 months ago?

Yes, pretty close, I think we're slightly off.

Part of it is really, as Daryl and I have talked about over time, we're a little cautious towards nonowner-occupied commercial real estate.

Some of the lack of production really was some of those credits that came out of our pipeline.

But absent that, Terry, I think it's right in line, particularly, on the C&I side.

Okay.

And then just Slide 13.

So there's a basically about $0.02 headwind from the change in tax strategy or the tax credit business, am I reading that slide correctly?

Yes.

That is what it contributed to us this year.

We'll continue to generate the business, which will generate a few fees, but de minimis in general.

So we won't see a lot of that contribution come through in 2019.

Probably in 2020 going forward, we'll see some more.

Based on the overall feedback that $0.02 headwind is probably worth it because I think, we spent a lot of time just explaining that business.

Yes.

I spent about 80% of my morning going through that slide as well, so I appreciate that.

It's all about you, T. Mc.

It's all about you.

Appreciate it.

And then, Bob, maybe just a last question for you.

As you think about 2019, without speaking specific in terms of those targets but what are you focused on?

Is it ROA?

Is it preprovision net revenue growth or return on capital?

Kind of how do you evaluate next year and line up some financial metrics that you think will drive success of the company?

Yes, it's a great question, Terry.

Yes, I think ROTCE would be one we focus on.

The efficiency ratio is still going to be very important for us as well.

But pretax, preprovision net revenue would be third, but for us, we really think that ROTCE gives us a better sense.

ROA is important, but as you know, the asset side can have some fluctuation.

So we really like the return on our investors capital.

(Operator Instructions) Your next question comes from the line of Kevin Reevey with D.A. Davidson.

I like the Moran-isms.

So we actually have a whole book of Moran-isms.

Turns out, we brought this up at dinner one night with John's wife, and she's got a longer book of Moran-isms.

You should publish that one day, I'm sure it'll be a bestseller.

Well, if you put it on in books by KP, they have to run at twice the speed, because that's the way he speaks.

So my first question is related to the Capital Markets' fee line item.

That was up a lot linked quarter.

Can you give us some color as to what was going on in that line item?

And how we should think about that particular line item going into the fourth quarter?

Yes.

[It's a slops] , as people -- as rising rates, people are starting to use that product a lot more.

I think we have moved into some of the more sophisticated markets and our Louisville team does a great job with this.

It's really that kind of where it is coming from.

Seeing about the fourth quarter, obviously, those are transactional in nature, but we clearly see a lot more interest from our clients as you -- move in the fourth quarter in that product.

And then sticking with the non-interest income line item, there was a decline in wealth management fees.

Could you provide some color as to what was happening there?

Equity markets.

A lot of that fee's based on the value of the portfolio.

Well, a large portion of that book is fixed income.

Obviously, as the markets have gone through their volatility, we have seen some impact.

And the other thing, there's a volatility in that business because a lot of that fee comes from the maturing of wills, and when you get that fee, it's hard to predict.

So -- but yes, I think consistent in the fourth quarter,] [you'll have a look at that] .

Great.

And then last question, the jump in nonaccruals, was -- were there any commonality between those credits?

No, actually it's -- I'm glad you asked.

So 2 large credits that moved.

One is the real estate deal that's been on the book since probably 2007, 2008.

It's a TIF, and with TIFs, you go back and reevaluate property tax.

Property taxes came in lower, so the value to the TIF was affected.

So we made the decision to move that to nonaccrual.

We're comfortable with where we are at the credit.

We continue to work through it.

The other was a medical company.

They've probably just got a little over their skis, and we're working with them to recapitalize and do some things.

Both of those loans, at least, the medical company is paying as agreed, the other one is paying -- excuse me, there's quite -- the medical company is not paying as agreed now.

So but 2 really and then no commonality, 2 exceptions to the -- as we see it.

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

Just want to talk a little bit about funding costs and deposit costs.

Your numbers have been better, better than your peers and I'm just curious.

And I know the balance is relatively flat and that's fine, but I'm just curious where you've seen opportunities to grow?

And give us an idea of some of the hotspots where you're seeing some of the deposit pricing pressure?

Yes.

As you'd expect it, deposit pressures, they are really in the larger markets like Indianapolis that have been just hypercompetitive.

There are opportunities to grow.

We've had good success in Southwest Michigan, Grand Rapids.

We're seeing actually, Terry -- or, Jon, some good opportunities up in the Twin Cities.

And I think it's the value of, again, this franchise that Jim has built, which is, we can fund in some of these noncompetitive markets and then kind of do some targeted price exceptions.

Interestingly, you mentioned deposit balances.

We went back and I think 8 of the last 9 years, the third quarter has been flat to down for us.

So there's just something in our DNA in the third quarter that our clients tend to go down, obviously, we see some stronger seasonality in the fourth quarter.

Okay.

Then back on Chris McGratty's question on the payoffs, do you -- are you hopeful that, that will slow?

I mean, do you see any signs that some of those payoffs could slow?

It seems like it was unusually large this quarter.

Yes, it was unusually large.

And again, I gave you kind of the high level.

The largest one was one, quite frankly, Daryl was probably happy that it paid off.

All things be an equal, we think it's going to slow.

Activity is good.

We just had all of our commercial relationship managers together the week before last up in Indianapolis, and the attitude and morale was excellent.

They are busy.

There is a little bit of stupidity creeping back into the market, particularly on nonowner-occupied series.

So if we're going to have some softness, that might be where it is, but other -- we're seeing good commercial, C&I growth.

So we feel good.

Okay.

And then last one on M&A.

You touched on pricing in your prepared comments.

But talk a little bit about how active the market is in terms of the frequency of deals you've been shown?

And what really is the issue?

Is it just price?

The private banks have not adjusted pricing to the public markets?

Well, it's a little bit of that.

I think it's -- we don't feel compelled to have to do anything, Jon.

To answer your first part, we're seeing a lot of books.

John Moran is busy, looking at a lot.

He's getting a lot of inbound calls.

He's using a lot of Moran-isms as you respond.

But we're just going to stay very disciplined.

We just do not feel compelled to have to do anything.

We've build the franchise that we feel very proud of.

If we have the right opportunity and the right market, and based on our pricing parameters, we can form a partnership.

We're happy to do it.

We're not going to go into markets that don't make sense.

And we're not going to pay prices that put our shareholders at risk.

You have a follow-up question from the line of Terry McEvoy with Stephens.

Sorry.

Just last question on the fourth quarter expense outlook.

If I do the $220 million adjusting for the third quarter, I'm looking at about $112 million and then plus $1 million or $2 million for the tax credit amortization.

Am I looking at that correctly?

Yes, that's correct, Terry.

That would be a little bit on the high side as you think about it.

We've got some true-ups you look at normally in the fourth quarter that are all seasonality.

You have medical insurance incentives and other things.

But until we get those true-ups, we really don't have a good barometer.

But I would say, your $112 million is a little bit on the high side, but the math works.

There are no further questions at this time.

Are there any closing remarks?

Well, the only thing I would say is, this morning, our General Counsel was supposed to bring donuts in -- to us and he didn't.

So if we're a little cranky in the call, it's related to that.

Thank you all for being with us.

If you have follow-up questions, Lynell is always available.

Thank you.

This conclude -- 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, 8898768.

This replay will be available through November 5. If anyone has additional questions, please contact Lynell Walton at (812) 464-1366.

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