Old National Bancorp (ONB) 2021 Q3 法說會逐字稿

Hello. Welcome to the Old National Bancorp Third Quarter 2021 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.

Management would like to remind everyone that certain statements on today's call may be forward looking in nature and are subject to certain risks and 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. The 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 Jim Ryan for opening remarks. Mr. Ryan, you may begin.

Good morning. Starting on Slide 4, we are pleased to share our third quarter results and an update on our partnership with First Midwest Bank.

I would characterize this quarter's results as right on plan. Earnings per share were $0.43 and net income was almost $72 million. During the quarter, commercial loans, excluding PPP loans, grew at a strong 7.4% on an annualized basis, with $1 billion in new production. We also ended the quarter with a robust $2.7 billion commercial pipeline. Core deposits grew nicely by $327 million during the quarter.

Our net interest margin was stable. Capital markets and wealth management revenue were strong and mortgage revenue rebounded from last quarter. Expenses were well managed and down slightly primarily due to onetime benefits from incentive and real estate tax accruals. Credit quality metrics remained benign with another quarter of net recoveries. Adjusted ROATCE was a strong 15.16%, and the adjusted efficiency ratio was 55.4%.

During the quarter, we worked hard with our clients on the PPP forgiveness process. 95% of Round 1 loans have been forgiven by the SBA, and we already have 51% of Round 2 loans through the forgiveness process. Remaining fees totaled $14 million.

Most of our reported credit quality metrics improved during the quarter. We have reduced our reserves consistent with our modeling as a result of the improving economic conditions. We still have approximately 32% of reserves supported by qualitative adjustments given the long-term impacts from the pandemic, expectations for higher inflation, persistent labor supply and supply chain challenges. As we gain additional clarity around these issues, we may develop more confidence in moving our reserve closer to day 1 CECL levels.

A quick update on hiring. We continued to add significant talent during the quarter, especially on our wealth management team. This was highlighted by 3 key individuals that joined our wealth team from the former Wells Abbot Downing group, including Jim Steiner, who started Abbot Downing and who will now assume the role of our Chief Investment Officer. The team will help expand our high net worth and institutional services. They opened a Scottsdale, Arizona wealth management office to better serve the growing number of clients in that area. We also hired 2 new commercial relationship managers in St. Louis to build upon our recent success in that market. Our talent pipeline remained strong, and we will continue to hire talented team members.

Moving to Slide 5, which contains a quick refresher on some of our accomplishments and next steps with our merger with First Midwest. Both companies have tremendous integration history and experience, and as a result, our work is going well. We have decisioned and communicated most client segment and support areas organizational structures and leadership. We've also settled on our core processing system, along with the -- most of the supporting applications. We remain on track for a second quarter 2022 system conversion. You probably saw First Midwest's earnings this morning. The results for the quarter were strong and consistent with expectations.

We also received 99% support from our special shareholder meeting, and First Midwest shareholders provided a similar level of support. We've also received OCC approval. Our application with Federal Reserve remains pending with the board in Washington, D.C., along with the merger applications of many other bank holding companies. We stand ready to close quickly once we receive final Fed approval.

You may have seen that we were sued by the Fair Housing Center of Central Indiana, a nonprofit advocacy organization with a history of filing lawsuits alleging lending discrimination. We strongly and categorically deny the claims in this lawsuit regarding certain of our lending practices. Old National is committed to engaging in fair and equal lending practices. A testament to this is that we have been named one of the world's most ethical companies for the past decade. As is customary for us and many public companies, I am unable to comment further on this pending litigation.

Lastly, despite potential distractions from the lingering pandemic-related issues and our transformational merger, we have remained focused on serving our clients and communities, and I think our results illustrate the success of those efforts.

I will now turn the call over to Brendon.

Thank you, Jim.

Turning to Slide 6. Our GAAP earnings per share and our adjusted earnings per share were both $0.43. Adjusted earnings exclude $1.4 million in early merger-related charges, which were largely offset by $1.2 million in debt securities gains.

Slide 7 shows the trend in commercial loans and the related commercial pipeline and production trends, all excluding the impact of PPP loans. Q3 represents our fifth consecutive quarter of organic loan growth, and over that year, commercial outstandings have grown 11%. Our strong commercial production of $1 billion was once again led by our Louisville and Minnesota markets, with all of the regions posting quarter-over-quarter growth. On-balance-sheet production was also well balanced by product with a 60-40 split between CRE and C&I, respectively. Commercial activity remained strong throughout the quarter. And we are heading into Q4 with a very healthy $2.7 billion pipeline, with almost $800 million in the accepted category.

Turning briefly to pricing. New money yields on commercial loans increased from prior quarter, which meaningfully narrowed the gap between new production and portfolio yields. The investment portfolio increased $263 million this quarter as deposit growth once again outpaced total loan growth. We continue to put much of our excess liquidity to work in our investment portfolio, with new money yields of 1.62% and a portfolio duration well within 5 years.

Moving to Slide 8. Both period-end and average deposit balances increased nicely from Q2 levels, with most of the growth coming from business clients in the noninterest-bearing demand category. Total cost of deposits for the quarter was unchanged at 6 basis points, while total interest-bearing liabilities declined 1 basis point from Q2.

Next, on Slide 9, you will see details of our net interest income and margin. Net interest income increased $1.7 million quarter-over-quarter. Excluding the impact of PPP, net interest income increased $1.3 million, which is the third consecutive quarter we have outperformed our stated objective of holding NII stable through earning asset growth. Net interest margin increased 1 basis points to 2.92% from prior quarter, and core margin excluding accretion and PPP declined just 2 basis points to 2.7%.

Slide 10 shows trends in adjusted noninterest income. Adjusted noninterest income of $53 million in Q3 was $2 million higher than the second quarter. Our wealth line of business continued to be a bright spot and is on pace for a record year. Our capital markets business had another strong quarter. And mortgage revenues rebounded nicely following the pipeline valuation decrease in Q2. While mortgage production was down slightly in the quarter, an increase in the size of the pipeline and stabilizing value resulted in a $5.4 million increase in revenue. This increase was partially offset by a $2 million decrease in gain on sale income as margins continued to normalize.

Next, Slide 11 shows the trend in adjusted noninterest expenses. Adjusting for merger charges and tax credit amortization, noninterest expense was $118 million. The quarter-over-quarter improvement was driven by an accrual adjustment to incentives as well as a reduction in real estate taxes. Both of these items are not expected to recur. Turning to PPP loans on Slide 12, you will see a roll forward of those balances, which stood at $355 million at quarter end. We continue to assist clients with forgiveness, and approximately 95% of Round 1 and 51% of Round 2 loans are now formally through the SBA forgiveness process. Unamortized fees on the remaining loans totaled $14 million. We anticipate half of the remaining loans will be forgiven and the related fees recognized in the fourth quarter of 2021.

Slide 13 shows our credit trends. The quarter proved to be another good one from a credit performance perspective. 30-plus delinquencies ticked up 1 basis point but remained at a near-cycle low of 10 basis points. With respect to charge-offs, we were fortunate again this quarter to be able to post a net recovery mostly due to the resolution and full recovery of our previously written-down senior living credit. The nonperforming loans-to-total loan ratio was -- once again hit a new cycle low at 94 basis points. While this metric remains higher than peers, the net charge-off to NPL ratio is significantly better than peers. We believe our approach to identifying troubled credits early and our patient approach to work out results in better outcomes for our clients and ultimately lower costs for the bank.

On Slide 14, you will see the details of our third quarter allowance, which stands at $108 million, a decline of $1.5 million from Q2. The improving economic outlook and the positive trends in credit quality support a modestly lower reserve level. And while our outlook on credit remains optimistic, we recognize the economy has not fully recovered; and have made the decision to maintain our higher level of qualitative reserves, which stood at $35 million at quarter end. As a reminder: We also continued to carry $38 million in unamortized [marks] from our acquired portfolios.

As I wrap up my comments, here are some key takeaways. We are very pleased with the fundamental results in the quarter. Strong commercial loan growth led to higher core net interest income despite interest rate headwinds. Our fee-based businesses, led by wealth, mortgage and capital markets, continue to perform well and in line with expectations. Expenses remained well controlled. And our strong credit quality continues to keep credit costs low.

Slide 15 includes thoughts on our outlook for 2021. We ended the quarter with a healthy $2.7 billion commercial pipeline, which supports our favorable outlook on loan growth. This historically low interest rate environment will continue to put pressure on net interest income, which should be mitigated through continued earning asset growth. The PPP loan forgiveness process continued for our clients. We expect the runoff of approximately half of the Round 2 balances to occur in the fourth quarter, with the recognition of the related unamortized fees to occur at that time.

We expect our fee businesses to continue to perform well. We were encouraged by the momentum in our wealth business, and a strong commercial activity should help maintain the high level of performance in our capital markets business. Mortgage revenue should follow industry trends and be seasonally lower in the fourth quarter. Our other fee lines are expected to be stable in the near term.

We would expect to see a $3 million increase in noninterest expenses in the fourth quarter given the nonrecurring items impacting our third quarter performance. Lastly, a brief update on taxes: We continue to expect a reduction in the volatility caused by our tax credits as we work through the last of the remaining 1-year historical tax credit commitments. In total, we're expecting approximately $6 million in tax credit amortization for the year [and a] corresponding full year effective tax rate of approximately 22%.

With that, we are happy to answer any questions that you may have. And we do have the full team here, including Jim Sandgren, Daryl Moore and John Moran.

(Operator Instructions) Our first question comes from the line of Ben Gerlinger with Hovde Group.

I just wanted to take a moment. Let's assume that the deal closes in the fourth quarter, which it probably will. So there's going to be a lot of noise [and] integration over the next, let's call it, 6 months, so are there any areas in which you feel like there's a low-hanging fruit or opportunity to grow loans outside of Chicago? I know that the Minnesota market was an area of pretty healthy growth. And that playbook post those 2 deals a couple of years ago seemed to be chugging right along, so I was kind of curious if you could talk about some of the opportunities that you see that present themselves right away and kind of what you are focusing on in that 2- to 3-year goal either footprint-wide or in Chicago itself.

Yes. Ben, this is Jim Sandgren. Yes, you're exactly right. Minnesota continues to be a bright spot and we see that as opportunity to grow in the future. Louisville, Kentucky continues to be really good for us; Indianapolis; and some of those markets. I know Jim talked a little bit about St. Louis, which is a newer market for us which have seen some nice growth. And then obviously with our partners from First Midwest, I mean, we'd see big upside when we get together with them in the Chicago area, bigger balance sheet. So looking forward to really growing throughout the footprint.

Yes. I think, Ben, one of the things that attract us from First Midwest is they have spent more time and they're ahead of the game in terms of building out some niche verticals. I think those niche verticals help us. We can export those across our footprint and maybe give us new opportunities that we weren't looking at today. And I think we can continue to use that bigger balance sheet across the entire footprint to create new opportunities for us.

Got you. That's helpful. And then in terms of the noninterest income, it seems like everything was moving in the right direction, if you look at it from a momentum perspective. Mortgage rebounded. Wealth continues to be strong. I'm just curious. Is there any areas in which you're kind of doubling down in reinvestment? I know that there are some recent hires in wealth management. Capital markets continues to perform well. Is there any areas in which it's potentially punching above its weight and we could see some reversion to the mean? Or is everything kind of operating as is and we should expect similar results for the next year or so?

Long term, we continue to believe wealth management is a source for us, as well as the treasury management business coupled with a strong commercial business, which means capital markets as well. I think those are the 3 areas that we continue to believe -- mortgage will just be cyclical, [in a way]. And it will just [thrive] along with everybody else's mortgage business, but those 3 areas in particular -- and we really haven't seen the benefits of our new hires in that wealth management business yet. We're carrying the costs for those new hires. And it's not only the 3 new hires we just talked about, but we've been pretty consistently hiring in that area. And so long term, we believe we're going to drive "higher than our trend line" kind of growth in those areas.

Our next question comes from the line of Scott Siefers with Piper Sandler.

Sorry, Scott.

Jim, I'll just (inaudible) list of ways I've disappointed people, so apologies -- no. Just as we sort of look at this, the strong loan growth you guys have been generating, I'm just curious if you could maybe make a comment or 2 about what your commercial lenders are seeing in terms of things like pricing and structure and how you guys are responding to that.

Sure.

Yes. Scott, this is Jim again. It's really competitive out there, but -- and the good news that we've talked in a number of the last few quarterly calls is that we've been out calling and working with our customers and prospects and building really strong relationships. So I will tell you credit structure is getting a little crazy, so we continue to stay disciplined there. Pricing, I think we're doing a good job meeting our pricing hurdles quarter-over-quarter. So it's tough right now. There's no doubt about it, but again I think, because of the strong relationships we've had and the fact that we've been out calling throughout the pandemic and as we came through it, I feel like that's helped kind of support the growth. And I think we're set up in the fourth quarter with a really nice pipeline and a nice and accepted portion of that pipeline as well, so pretty encouraged.

And Scott, you know [us well]. I mean we'd gladly give up a few points of growth to stick to our discipline around pricing and structure. So we're going to play a long game here, make sure we stay true to our history and roots.

Perfect, okay. And then just switching gears a little: hiring talent away from some of your competitors. That's been a big part of the story over the last couple of years. Just was curious if you can maybe add some comments about sort of what you're seeing in terms of costs to attract new talent and if you could speak to sort of the notion of wage inflation overall within the bank.

Yes. It's a good question. We're certainly not immune to wage inflation at all levels. And we intentionally raised our minimums a year ago, and so a lot of that cost is built into our current run rates. And clearly, going out and attracting high-caliber talent away is more expensive than kind of the average price we pay today, so -- but we think again these are long-term investments that we believe are going to pay high dividends. And so we're willing to make those investments and just be really thoughtful and deliberate about it. And we have got a great story to tell. And that story resonates so well with so many people today, where they can see themselves being successful in our organization and being able to take care of the clients and really do their best work. And so if we keep telling that story, the price that we have to pay is not unreasonable. And we think it's good for the long-term health of our company.

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

Jim, maybe start with a question for you. You've been involved in a lot of M&A transactions with your time at Old National Bank. Could you just talk about the -- just the level of discussions with regulators? How in-depth are they as it relates to getting First Midwest closed just given the size and the structure? And essentially what I'm getting at is maybe a soft way of asking what is the risk that the MOE gets postponed given changes in the regulatory landscape.

It's really hard to tell, Terry. There's no outstanding questions we have with any regulatory agencies and in particular the Fed. Obviously we have OCC approval. And I think, like many other bank holding companies, we're in the queue and we're just waiting for that approval process. We think we've answered any questions they have for us and really don't have any other feedback. And they're not waiting on any new information from us, so we're just going to continue to be patient and thoughtful. I think the most important point, though, is we continue to work on the integration efforts, which are really scheduled to happen in the second quarter. So none of that work stops. We continue to build relationships with each other. We continue to do strategic planning with each other, so none of that really stops. We'll just keep moving forward. And we'll wait for -- be patient and wait for the final regulatory approval, and then as soon as we get that, we'll close shortly thereafter.

Appreciate that. And then as a follow-up: You used to provide average loan size within the commercial portfolio. I'm just wondering. Has that changed following the ONB Way and industry verticals? And are you competing now kind of upmarket for larger deals that's contributing to some of the -- at least the dollar growth that we're seeing in the commercial portfolio?

Yes, I'll give some high-level commentary and let Jim get into the details, but it's certainly on average higher. Just as we entered larger metropolitan markets, most notably when we entered Wisconsin and Minneapolis specifically, I think we've just seen that trend to move higher. Even having said that, I still think it's pretty granular on average. And today, Jim, we're running -- what was the average recently here?

So for C&I, we're at about $300,000 from a portfolio perspective, and commercial real estate about -- a little over $900,000, so to your point, still very granular.

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

Jim, I think I want to start with loan growth. Typically when MOEs get announced, there's a little bit of market apprehension about pro forma growth rate. You guys had solid growth. First Midwest had a little bit of growth this quarter. How are you thinking about the pro forma profile of the company, especially with the economy recovered?

I think both organizations are [growing every day], go out, talk to its clients, serve its communities, right? And loan growth will be somewhat dependent on kind of the status of the economy, right, but I think the loan growth that we've been putting up and producing is the kind of loan growth we ought to be able to put up and produce in a normal kind of economy or even slightly warm economy than we have today, right? So while we haven't given any specific guidance, I think what you see is what we should continue to produce. We do think, again, there's upside relative to the total balance sheet. And our hold limits will potentially increase in the future, plus leveraging those industry verticals, so I think there's great opportunities for us to continue to grow the loan portfolio.

Okay. And then on the deposit growth, you and some of your peers, I think, have spoken about just the surprise factor of the deposits [staying on] balance sheet and continuing to come in. With that confidence, can you speak to kind of the pace of investments -- securities investments you might make? You've grown the bond book a little bit in the last couple of quarters. I'm just trying to see an outlook for that.

Sure.

Yes, Chris. We continue to put the excess cash to work. We're actually sitting on a little more cash this quarter than last quarter. And we'll be thoughtful as we put that to work given the outlook on rates, but our bias is to put more money to work than not.

Great. And then maybe if I could sneak one in on once you close the deal. You guys have a ton of capital. Maybe updated thoughts on returning capital through buybacks?

Yes. Our capital priorities will remain the same. Look, at the current valuation, we think there's a great opportunity to return money to investors via share repurchase. We have an authorization outstanding today that will take us through the end of the year and we'll be looking for an opportunity to make use of that.

Thank you. I'm showing no further questions in the queue.

Well, thank you all for your support. As usual, Lynell and Brendon and the whole team is available to take any follow-up questions.

Thanks again and have a great day.

Ladies and gentlemen, this conclude 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 the Old National's website, oldnational.com. A replay of the call will also be available by dialing (855) 859-2056. Conference ID code is 4242648. This replay will be available through November 2. If anyone has additional questions, please contact Lynell Walton at (812) 464-1366.

Thank you for your participation in today's conference call. You may now disconnect.