Old National Bancorp (ONB) Q3 2021 Earnings Call Transcript

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Old National Bancorp (ONB 0.06%)
Q3 2021 Earnings Call
Oct 19, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

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. Reconciliations 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.

James C. Ryan III -- Chairman and Chief Executive Officer

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 categorize this quarter's result 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 one-time 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 reserve 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 railroads [Phonetic] issues, we may develop more confidence in moving our reserve closer to Day 1 CECL levels.

A quick update on hiring. We continue to add significant talent during the quarter, especially on our wealth management team. This was highlighted by three 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 in institutional services. They opened Scottsdale, Arizona wealth management office to better serve the growing number of clients in that area. We also hired two new commercial relationship managers in St. Louis to build upon our recent success in that market. Our talent pipeline remains 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 decision 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 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 the Federal Reserve remains pending with the Board in Washington, DC along with the merger applications on 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 non-profit advocacy organization with a history of filing lawsuits, alleging lending discrimination. We strongly and categorically denied the claims in this lawsuit regarding certain of our lending practices. Old National was committed to engaging a 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'm 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.

Brendon B. Falconer -- Chief Financial Officer

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 to 11%. Our strong commercial production of $1 billion was once again led by our Louisville and Minnesota markets with all other 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 pricings. 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 five 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 non-interest 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 owning NII stable through earning asset growth. Net interest margin increased 1 basis point 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 non-interest income. Adjusted non-interest 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 continue to normalize.

Next, Slide 11 shows the trend in adjusted non-interest expenses. Adjusting for merger charges and tax credit amortization, non-interest expense was $118 million. The quarter-over-quarter improvement was driven by an accrual adjustment to incentives as well as the 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 for 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 a previously written down senior living credit. The non-performing 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 crumble credits early and our patient approach to work out results in better outcomes for our clients and ultimately lower cost 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 it made the decision to maintain our higher level of qualitative reserves, which stood at $35 million at quarter-end. As a reminder, we also continue 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 of 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 and 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 to run off 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 the 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 non-interest expenses in the fourth quarter, given the non-recurring 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 worked through the last of the remaining one-year historical tax credit commitments. In total, we are expecting approximately $6 million in tax credit and amortization for the year, the corresponding full year effective tax rate of approximately 22%.

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Ben Gerlinger with Hovde Group. Your line is open.

Ben Gerlinger -- Hovde Group -- Analyst

Hey, good morning guys.

James C. Ryan III -- Chairman and Chief Executive Officer

Good morning, Ben.

Brendon B. Falconer -- Chief Financial Officer

Good morning.

Ben Gerlinger -- Hovde Group -- Analyst

I just wanted to take a moment. Let's assume that the deal closes in the fourth quarter, would you probably will. So there's going to be a lot of noise integration over the next, let's call it six months. So are there any areas in what you feel like there is 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 in that playbook post those two deals a couple of years ago seem to be chugging right along. So 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 that two-year to three-year goal, either footprintwide or Chicago itself?

James A. Sandgren -- President and Chief Operating Officer

Yeah, Ben. This is Jim Sandgren. Yeah, 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 has seen some nice growth. And then obviously with our partnership with First Midwest, I mean we see big upside when we get together with them in the Chicago area, a bigger balance sheet. So looking forward to really growing throughout the footprint.

James C. Ryan III -- Chairman and Chief Executive Officer

Yeah. I think, Ben, one thing 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. It 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.

Ben Gerlinger -- Hovde Group -- Analyst

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

James C. Ryan III -- Chairman and Chief Executive Officer

Well, long term, we continue to believe wealth management as 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 three areas that we continue to believe. Mortgage will just be cyclical and we will [Phonetic] just drive along with everybody else's mortgage business, but those three 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 cost for those new hires and it's not only the three 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.

Ben Gerlinger -- Hovde Group -- Analyst

Got you. Okay. That's helpful color. I will step back in the queue and congrats on a solid quarter.

James C. Ryan III -- Chairman and Chief Executive Officer

Thanks. Good to see you got first again.

Ben Gerlinger -- Hovde Group -- Analyst

Thanks.

Operator

Thank you. Our next question comes from the line of Scott Siefers with Piper Sandler. Your line is open.

James C. Ryan III -- Chairman and Chief Executive Officer

Sorry, Scott.

Scott Siefers -- Piper Sandler -- Analyst

Jim, I'll just add the list of ways I have disappointed people. So apologies. Well, no, I appreciate you're taking the question. Just as we sort of look at this the strong loan growth you guys have been generating, just curious if you could maybe make a comment or two about what your commercial lenders are seeing in terms of things like pricing and structure? And how you guys are responding to that?

James C. Ryan III -- Chairman and Chief Executive Officer

Sure.

James A. Sandgren -- President and Chief Operating Officer

Yes, Scott. This is Jim again. It's really competitive out there. But -- and the good news is we've talked on 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 we've been out calling throughout the pandemic and as we came through it, I feel like that help kind of support the growth. And I think we're set up in the fourth quarter with a really nice pipeline in a nice accepted portion of that pipeline as well, so pretty encouraged.

James C. Ryan III -- Chairman and Chief Executive Officer

And Scott you know this well. I mean we're glad to 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 to make sure we stayed true to our history and roots.

Scott Siefers -- Piper Sandler -- Analyst

Perfect. Okay. Thank you. 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, Jim, if you can maybe add some comments about, so 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?

James C. Ryan III -- Chairman and Chief Executive Officer

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. 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 paid today. So, but -- what 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, 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.

Scott Siefers -- Piper Sandler -- Analyst

Perfect. All right. Thank you guys very much. I appreciate it.

James C. Ryan III -- Chairman and Chief Executive Officer

Thanks, Scott.

Operator

Thank you. Our next question comes from the line of Terry McEvoy with Stephens. Your line is open.

James C. Ryan III -- Chairman and Chief Executive Officer

Morning, Terry.

Terry McEvoy -- Stephens -- Analyst

Hi. Good morning, everyone. 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?

James A. Sandgren -- President and Chief Operating Officer

It's really hard to tell, Terry. There is no outstanding questions we have with any regulatory agencies, in particular with 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 I 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 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, will close shortly thereafter.

Terry McEvoy -- Stephens -- Analyst

I appreciate that. And then as a follow-up, you used to provide the 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 a upmarket for larger deals that's contributing to some of the -- at least the dollar growth that we're seeing in the commercial portfolio?

James C. Ryan III -- Chairman and Chief Executive Officer

Yeah. I'll give some high level commentary and let Jim get 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?

James A. Sandgren -- President and Chief Operating Officer

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

Terry McEvoy -- Stephens -- Analyst

Great. Thank you, guys.

James C. Ryan III -- Chairman and Chief Executive Officer

Thanks, Terry.

Operator

Thank you. Our next question comes from the line of Chris McGratty with KBW. Your line is open.

James C. Ryan III -- Chairman and Chief Executive Officer

Good morning, Chris.

Chris McGratty -- Keefe Bruyette & Woods -- Analyst

Good morning, everybody. 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?

James C. Ryan III -- Chairman and Chief Executive Officer

Yeah. I think both organizations going [Indecipherable]. Go out, talk with its clients, service 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 that we have today, right. So, well, we haven't given any specific guidance. I think what you see is what we should continue to produce. We do think there -- again there is upside relative to the total balance sheet and our whole 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.

Chris McGratty -- Keefe Bruyette & Woods -- Analyst

Okay. And then on the deposit growth, you and some of your peers, I think have spoken about just the surprise factor of the deposit same [Phonetic] on balance sheet and to 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. Just trying to see an outlook for that. Thanks.

Brendon B. Falconer -- Chief Financial Officer

Yeah, Chris. We continue to put the excess cash to work. We're actually sitting 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 us.

Chris McGratty -- Keefe Bruyette & Woods -- Analyst

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

Brendon B. Falconer -- Chief Financial Officer

Yeah. 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.

Chris McGratty -- Keefe Bruyette & Woods -- Analyst

Great. Thank you.

Operator

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

James C. Ryan III -- Chairman and Chief Executive Officer

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.

Operator

Ladies and gentlemen, 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 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. That's 812-464-1366. [Operator Closing Remarks]

Duration: 26 minutes

Call participants:

James C. Ryan III -- Chairman and Chief Executive Officer

Brendon B. Falconer -- Chief Financial Officer

James A. Sandgren -- President and Chief Operating Officer

Ben Gerlinger -- Hovde Group -- Analyst

Scott Siefers -- Piper Sandler -- Analyst

Terry McEvoy -- Stephens -- Analyst

Chris McGratty -- Keefe Bruyette & Woods -- Analyst

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