UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------------------------------
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 1-15817
------------------------------
OLD NATIONAL BANCORP
(Exact name of Registrant as specified in its charter)
INDIANA 35-1539838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
420 Main Street 47708
Evansville, Indiana (Zip Code)
(Address of principal executive offices)
----------------
(812) 464-1434
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to the filing requirements for
at least the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock. The Registrant has one class of common stock (no par value) with
66,357,000 shares outstanding at April 30, 2004.
OLD NATIONAL BANCORP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page No.
--------
Consolidated Balance Sheet
March 31, 2004 and 2003, and December 31, 2003 3
Consolidated Statement of Income
Three months ended March 31, 2004 and 2003 4
Consolidated Statement of Changes in Shareholders' Equity
Three months ended March 31, 2004 and 2003 5
Consolidated Statement of Cash Flows
Three months ended March 31, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 26
Item 4. Controls and Procedures 29
PART II OTHER INFORMATION 30
SIGNATURES 32
2
OLD NATIONAL BANCORP
CONSOLIDATED BALANCE SHEET
- ------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
(unaudited)
(dollars and shares in thousands) 2004 2003 2003
- ------------------------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 176,022 $ 210,980 $ 222,385
Money market investments 15,733 5,916 14,504
- ------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 191,755 216,896 236,889
Investment securities-available-for-sale, at fair value
U.S. Treasury 13,117 5,316 26,057
U.S. Government agencies and corporations 552,228 635,434 580,820
Mortgage-backed securities 1,298,932 1,633,788 1,298,881
States and political subdivisions 664,264 683,726 655,068
Other securities 140,579 119,647 145,514
- ------------------------------------------------------------------------------------------------------------------------
Investment securities - available-for-sale 2,669,120 3,077,911 2,706,340
Investment securities - held-to-maturity, at amortized cost
(fair value $205,812, $236,825 and $209,316 respectively) 204,406 236,825 210,905
Residential loans held for sale 17,895 52,999 16,338
Loans:
Commercial 1,614,516 1,690,403 1,618,095
Commercial real estate 1,830,532 1,871,861 1,849,275
Residential real estate 939,156 974,329 939,422
Consumer credit, net of unearned income 1,175,450 1,050,317 1,163,325
- ------------------------------------------------------------------------------------------------------------------------
Total loans 5,559,654 5,586,910 5,570,117
Allowance for loan losses (108,600) (83,993) (104,571)
- ------------------------------------------------------------------------------------------------------------------------
Net loans 5,451,054 5,502,917 5,465,546
- ------------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 194,262 143,433 181,398
Goodwill 129,251 110,648 129,251
Other intangible assets 41,113 27,044 41,912
Mortgage servicing rights 12,319 10,464 14,659
Accrued interest receivable and other assets 348,159 346,039 350,658
- ------------------------------------------------------------------------------------------------------------------------
Total assets $ 9,259,334 $ 9,725,176 $ 9,353,896
========================================================================================================================
Liabilities
Deposits:
Noninterest-bearing demand $ 794,502 $ 727,077 $ 823,146
Interest-bearing:
NOW 1,587,353 1,397,363 1,612,145
Savings 467,575 514,758 441,427
Money market 593,222 594,104 608,177
Time 2,942,451 3,087,641 3,008,197
- ------------------------------------------------------------------------------------------------------------------------
Total deposits 6,385,103 6,320,943 6,493,092
Short-term borrowings 471,403 974,835 414,588
Other borrowings 1,533,202 1,364,946 1,624,092
Guaranteed preferred beneficial interests in subordinated debentures -- 165,042 --
Accrued expenses and other liabilities 128,765 156,373 106,634
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 8,518,473 8,982,139 8,638,406
- ------------------------------------------------------------------------------------------------------------------------
Shareholders' Equity
Preferred stock, 2,000 shares authorized, no shares issued or outstanding -- -- --
Common stock, $1 stated value, 150,000 shares authorized,
66,449, 63,593 and 66,575 shares issued and outstanding, respectively 66,449 63,593 66,575
Capital surplus 578,650 522,404 581,224
Retained earnings 59,987 110,795 53,107
Accumulated other comprehensive income, net of tax 35,775 46,245 14,584
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 740,861 743,037 715,490
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 9,259,334 $ 9,725,176 $ 9,353,896
========================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of this statement.
3
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF INCOME
- ------------------------------------------------------------------------------------
Three Months Ended
March 31,
(dollars and shares in thousands,
except per share data) (unaudited) 2004 2003
- ------------------------------------------------------------------------------------
Interest Income
Loans including fees:
Taxable $ 74,382 $ 84,955
Nontaxable 4,367 4,264
Investment securities, available-for-sale:
Taxable 19,893 25,982
Nontaxable 7,362 8,029
Investment securities, held-to-maturity, taxable 2,097 277
Money market investments 20 71
- ------------------------------------------------------------------------------------
Total interest income 108,121 123,578
- ------------------------------------------------------------------------------------
Interest Expense
Deposits 29,365 38,079
Short-term borrowings 990 2,574
Other borrowings 12,655 13,122
- ------------------------------------------------------------------------------------
Total interest expense 43,010 53,775
- ------------------------------------------------------------------------------------
Net interest income 65,111 69,803
Provision for loan losses 7,500 9,000
- ------------------------------------------------------------------------------------
Net interest income after provision for loan losses 57,611 60,803
- ------------------------------------------------------------------------------------
Noninterest Income
Trust and asset management fees 7,500 7,360
Service charges on deposit accounts 10,765 10,778
ATM fees 1,965 1,867
Mortgage banking revenue (320) 4,403
Insurance premiums and commissions 14,509 8,247
Investment product fees 3,185 2,678
Bank-owned life insurance 2,053 1,685
Net securities gains 1,985 2,730
Other income 3,986 3,172
- ------------------------------------------------------------------------------------
Total noninterest income 45,628 42,920
- ------------------------------------------------------------------------------------
Noninterest Expense
Salaries and employee benefits 49,269 41,660
Occupancy 4,851 4,521
Equipment 3,562 3,698
Marketing 2,358 2,427
Outside processing 4,970 4,192
Communication and transportation 2,969 3,119
Professional fees 3,088 2,416
Loan expense 1,467 1,379
Supplies 1,059 1,262
Other real estate owned expense 1,656 547
Other expense 5,204 4,944
- ------------------------------------------------------------------------------------
Total noninterest expense 80,453 70,165
- ------------------------------------------------------------------------------------
Income before income taxes 22,786 33,558
Income tax expense 3,277 7,298
- ------------------------------------------------------------------------------------
Net income $ 19,509 $ 26,260
====================================================================================
Net Income Per Common Share
Basic $ 0.29 $ 0.39
Diluted 0.29 0.39
- ------------------------------------------------------------------------------------
Weighted Average Number Of Common Shares Outstanding
Basic 66,359 66,889
Diluted 66,460 66,945
- ------------------------------------------------------------------------------------
Dividends Per Common Share $ 0.19 $ 0.18
The accompanying notes to consolidated financial statements are an integral part
of this statement.
4
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
(dollars and shares Common Stock Capital Retained Comprehensive Shareholders'
in thousands) (unaudited) Shares Amount Surplus Earnings Income Equity
- --------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 63,856 $ 63,856 $ 528,379 $ 96,652 $ 51,823 $ 740,710
Net income -- -- -- 26,260 -- 26,260
Unrealized net securities losses,
net of $(2,659) tax -- -- -- -- (3,849) (3,849)
Reclassification adjustment for
gains included in net income,
net of $(1,116) tax -- -- -- -- (1,614) (1,614)
Net unrealized derivative losses
on cash flow hedges,
net of $(102) tax -- -- -- -- (159) (159)
Reclassification adjustment on
cash flow hedges,
net of $28 tax -- -- -- -- 44 44
Cash dividends -- -- -- (12,117) -- (12,117)
Stock repurchased (560) (560) (12,011) -- -- (12,571)
Stock reissued under stock
option and stock purchase plans 297 297 6,036 -- -- 6,333
- --------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2003 63,593 $ 63,593 $ 522,404 $ 110,795 $ 46,245 $ 743,037
====================================================================================================================
Balance, December 31, 2003 66,575 $ 66,575 $ 581,224 $ 53,107 $ 14,584 $ 715,490
Net income -- -- -- 19,509 -- 19,509
Unrealized net securities gains,
net of $15,922 tax -- -- -- -- 21,929 21,929
Reclassification adjustment for
gains included in net income,
net of $(835) tax -- -- -- -- (1,150) (1,150)
Net unrealized derivative gains
on cash flow hedges,
net of $235 tax -- -- -- -- 365 365
Reclassification adjustment on
cash flow hedges,
net of $31 tax -- -- -- -- 47 47
Cash dividends -- -- -- (12,629) -- (12,629)
Stock repurchased (468) (468) (9,613) -- -- (10,081)
Stock reissued under stock
option and stock purchase plans 342 342 7,039 -- -- 7,381
- --------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2004 66,449 $ 66,449 $ 578,650 $ 59,987 $ 35,775 $ 740,861
====================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of this statement.
5
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------
Three Months Ended
March 31,
(dollars in thousands) (unaudited) 2004 2003
- --------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 19,509 $ 26,260
- --------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation 3,229 3,197
Amortization of other intangible assets 799 524
Net premium amortization on investment securities 2,175 2,773
Provision for loan losses 7,500 9,000
Net securities gains (1,985) (2,730)
Gains on sale of other assets (1,362) (3,737)
Residential real estate loans originated for sale (83,911) (261,559)
Proceeds from sale of residential real estate loans 82,857 264,499
(Increase) decrease in other assets 16,864 (11,428)
Increase in accrued expenses and other liabilities 6,778 43,862
- --------------------------------------------------------------------------------------------------------
Total adjustments 32,944 44,401
- --------------------------------------------------------------------------------------------------------
Net cash flows provided by operating activities 52,453 70,661
- --------------------------------------------------------------------------------------------------------
Cash Flows From Investing Activities
Purchases of investment securities available-for-sale (389,151) (580,903)
Proceeds from maturities, prepayments and calls
of investment securities available-for-sale 254,910 293,445
Proceeds from sales of investment securities available-for-sale 207,394 278,085
Purchases of investment securities held-to-maturity -- (236,846)
Proceeds from maturities, prepayments and calls
of investment securities held-to-maturity 6,242 --
Net principal collected from customers 6,992 116,977
Proceeds from sale of premises and equipment 806 249
Purchases of premises and equipment (16,261) (12,083)
- --------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) investing activities 70,932 (141,076)
- --------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities
Net increase (decrease) in deposits and short-term borrowings:
Noninterest-bearing demand deposits (28,644) (51,352)
Savings, NOW and money market deposits (13,599) 76,359
Time deposits (65,746) (143,344)
Short-term borrowings 56,815 56,486
Payments for maturities on other borrowings (156,559) (70,309)
Proceeds from issuance of other borrowings 54,543 201,600
Cash dividends paid (12,629) (12,117)
Common stock repurchased (10,081) (12,571)
Common stock reissued under stock option and stock purchase plans 7,381 6,333
- --------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities (168,519) 51,085
- --------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (45,134) (19,330)
Cash and cash equivalents at beginning of period 236,889 236,226
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 191,755 $ 216,896
========================================================================================================
Total interest paid $ 42,051 $ 55,490
Total taxes paid $ -- $ 1,735
The accompanying notes to consolidated financial statements are an integral part
of this statement.
OLD NATIONAL BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of Old National Bancorp and its wholly-owned affiliates ("Old
National") and have been prepared in conformity with generally accepted
accounting principles and prevailing practices within the banking industry. Such
principles require management to make estimates and assumptions that affect the
reported amounts of assets, liabilities and the disclosures of contingent assets
and liabilities at the date of the financial statements and amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates. All significant intercompany transactions and balances have been
eliminated. Certain prior year amounts have been reclassified to conform with
the 2004 presentation. Such reclassifications had no effect on net income. In
the opinion of management, the consolidated financial statements contain all the
normal and recurring adjustments necessary for a fair statement of the financial
position of Old National as of March 31, 2004 and 2003, and December 31, 2003,
and the results of its operations for the three months ended March 31, 2004 and
2003. Interim results do not necessarily represent annual results.
NOTE 2 - IMPACT OF ACCOUNTING CHANGES
In December 2003, the Financial Accounting Standards Board ("FASB") revised SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." This statement requires annual disclosures in addition to those in
the original SFAS No. 132, which provides additional information regarding
assets, obligations, cash flows and net periodic benefit costs of defined
benefit pension plans. In addition, interim disclosure of the components of net
periodic benefit costs is required. The revised SFAS No. 132 is effective for
financial statements with fiscal years ending after December 15, 2003. Old
National adopted this statement as of December 31, 2003, and has included all
such required disclosures in Note 9.
In December 2003, the FASB revised FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," which was initially released in
January 2003. FIN 46 provides guidance with respect to variable interest
entities and when the assets, liabilities, noncontrolling interest and results
of operations of a variable interest entity need to be included in a company's
consolidated financial statements. FIN 46 was effective for companies with
"special-purpose entities" as of December 31, 2003. Old National does not have
special-purpose entities. However, under this new guidance, Old National was
required to deconsolidate ONB Capital Trust I and ONB Capital Trust II as these
trusts no longer meet the definition of a related subsidiary under the terms of
FIN 46. This change also resulted in the remaining debt being disclosed in
"other borrowings" beginning with the period ending December 31, 2003, compared
to the separate disclosure on the balance sheet prior to that date. The effect
of this deconsolidation was an increase of $4.6 million to both assets and
liabilities with no impact to the results of operations. The effective date for
consolidation of all other entities was after March 15, 2004. Old National
consolidated various low income housing partnerships on March 31, 2004, for
which the impact on the results of operations and financial position was
immaterial.
Old National applies APB Opinion No. 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation costs have
been recognized. In accordance with SFAS No. 148, "Accounting for Stock-based
Compensation - Transition and Disclosure" and SFAS No. 123, "Accounting for
Stock-Based Compensation," Old National has presented in the table below net
income and net income per share adjusted to proforma amounts had compensation
cost for Old National's stock option plan been recorded based on the fair value
at the grant dates for awards under the plan. All per share data has been
adjusted for stock dividends, including a 5% stock dividend distributed to
shareholders on January 27, 2004.
7
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
(dollars in thousands, except per share data) 2004 2003
- --------------------------------------------------------------------------------
Net income as reported $19,509 $26,260
Deduct total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1,663) (1,099)
- --------------------------------------------------------------------------------
Proforma net income $17,846 $25,161
================================================================================
Basic net income per share:
As reported $ 0.29 $ 0.39
Proforma 0.27 0.37
Diluted net income per share:
As reported $ 0.29 $ 0.39
Proforma 0.27 0.37
- --------------------------------------------------------------------------------
NOTE 3 - NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding during each year, adjusted
to reflect all stock dividends. Diluted net income per share is computed as
above and assumes the conversion of outstanding stock options. The following
table reconciles basic and diluted net income per share for the three months
ended March 31:
- ------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
(dollars and shares ----------------------------- -----------------------------
in thousands,
except per share data) Income Shares Amount Income Shares Amount
- ------------------------------------------------------------------------------------------------
Basic Net Income Per Share
Income from operations $19,509 66,359 $0.29 $26,260 66,889 $0.39
======= =======
Effect Of Dilutive Securities
Stock options -- 101 -- 56
- --------------------------------------------------- -----------------
Diluted Net Income Per Share
Income from operations
and assumed conversions $19,509 66,460 $0.29 $26,260 66,945 $0.39
================================================================================================
NOTE 4 - INVESTMENT SECURITIES
The market value and amortized cost of investment securities as of March 31 are
set forth below:
- ----------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
(dollars in thousands) Cost Gains Losses Value
- ----------------------------------------------------------------------------
2004
Available-for-sale $2,609,506 $68,873 $(9,259) $2,669,120
Held-to-maturity 204,406 1,406 - 205,812
- ----------------------------------------------------------------------------
2003
Available-for-sale $3,000,957 $80,157 $(3,203) $3,077,911
Held-to-maturity 236,825 - - 236,825
- ----------------------------------------------------------------------------
8
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
- ------------------------------------------------------------------------
(dollars in thousands) 2004 2003
- ------------------------------------------------------------------------
Balance, January 1 $ 104,571 $ 87,742
Additions:
Provision charged to expense 7,500 9,000
Deductions:
Loans charged-off 5,652 14,378
Recoveries (2,181) (1,629)
- ------------------------------------------------------------------------
Net charge-offs 3,471 12,749
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
Balance, March 31 $ 108,600 $ 83,993
========================================================================
The following is a summary of information pertaining to impaired loans at March
31:
- ------------------------------------------------------------------------
(dollars in thousands) 2004 2003
- ------------------------------------------------------------------------
Impaired loans without a valuation allowance $ 22,137 $ 45,624
Impaired loans with a valuation allowance 71,913 225,780
- ------------------------------------------------------------------------
Total impaired loans $ 94,050 $ 271,404
========================================================================
Valuation allowance related to impaired loans $ 27,475 $ 62,003
- ------------------------------------------------------------------------
A loan is considered impaired under SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan, an amendment of FASB Statement No. 5 and 15" when based on
current information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. An impaired loan does not include larger groups of smaller-balance
homogeneous loans that are collectively evaluated for impairment, loans that are
measured at fair value or at the lower of cost or fair value, leases and debt
securities.
For the three months ended March 31, 2004, the average balance of impaired loans
was $92.8 million for which $0.1 million of interest was recorded. For the three
months ended March 31, 2003, the average balance of impaired loans was $287.3
million for which $10.7 million of interest was recorded. During the third
quarter of 2003, Old National revised its interpretation of impaired loans to
strictly follow SFAS No. 114. Previous to this change, Old National's
interpretation of impaired loans more conservatively included all problem
credits with a potential collateral deficiency in the event of default and
nonaccrual loans in larger groups of smaller-balance homogeneous loans. Had Old
National applied this interpretation in the prior year, impaired loans would
have totaled $96.7 million with a valuation allowance of $18.9 million rather
than $271.4 million with a valuation allowance of $62.0 million as reported at
March 31, 2003. No additional funds are committed to be advanced in connection
with impaired loans. Loans deemed impaired are evaluated primarily using the
fair value of the underlying collateral.
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS
At March 31, 2004 and 2003, Old National had goodwill in the amount of $129.3
million and $110.6 million, respectively. During 2003, Old National performed
its annual goodwill impairment testing resulting in no impairment. At March 31,
2004, the community banking segment and the non-bank services segment had
goodwill of $70.9 million and $58.3 million, respectively. There was no change
in the carrying amount of goodwill by segment for the three month period ended
March 31, 2004.
Old National continues to amortize definite-lived intangible assets over the
estimated remaining life of each respective asset. At March 31, 2004, Old
National had $41.1 million in unamortized intangible assets compared with $27.0
million in unamortized identifiable intangible assets at March 31, 2003.
Indefinite-lived assets of $2.8 million were included in each year.
9
The following table shows the gross carrying amounts and accumulated
amortization for intangible assets as of March 31:
- --------------------------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
(dollars in thousands) Amount Amortization Amount
- --------------------------------------------------------------------------------
2004
Amortized intangible assets:
Core deposit $ 5,574 $(3,198) $ 2,376
Customer business relationships 36,676 (2,544) 34,132
Non-compete agreements 1,100 (96) 1,004
Technology 1,300 (499) 801
- -------------------------------------------------------------------------------
Total amortized intangible assets 44,650 (6,337) 38,313
Unamortized intangible assets:
Trade name 2,800 -- 2,800
- -------------------------------------------------------------------------------
Total intangible assets $47,450 $(6,337) $41,113
===============================================================================
2003
Amortized intangible assets:
Core deposit $ 5,574 $(2,556) $ 3,018
Customer business relationships 19,720 (638) 19,082
Non-compete agreements 1,100 (42) 1,058
Technology 1,300 (214) 1,086
- -------------------------------------------------------------------------------
Total amortized intangible assets 27,694 (3,450) 24,244
Unamortized intangible assets:
Trade name 2,800 -- 2,800
- -------------------------------------------------------------------------------
Total intangible assets $30,494 $(3,450) $27,044
===============================================================================
Total amortization expense associated with intangible assets for the three
months ended was $799 thousand in 2004 and $524 thousand in 2003. The following
is the estimated amortization expense for the future years:
-------------------------------------------
Estimated
(dollars in thousands) Amortization
For the years ended: Expense
-------------------------------------------
2004 remaining $2,376
2005 3,065
2006 2,849
2007 2,386
2008 2,213
2009 2,122
Thereafter 23,302
-------------------------------------------
Total $38,313
===========================================
NOTE 7 - MORTGAGE SERVICING RIGHTS
Mortgage servicing rights derived from loans sold with servicing retained were
$12.3 million and $10.5 million at March 31, 2004 and 2003, respectively. Loans
serviced for others are not included in the consolidated balance sheet of Old
National. The unpaid principal balance of mortgage loans serviced for others at
March 31 was $1.737 billion in 2004 and $1.627 billion in 2003. At March 31,
2004 and 2003, the fair value of capitalized mortgage servicing rights, net of
valuation allowance, was $12.4 million and $10.5 million, respectively. Old
National's key economic assumptions used in determining the fair value of
mortgage servicing rights were a weighted average prepayment rate of 436 PSA and
a discount rate of 8.50% at March 31, 2004 and a weighted average prepayment
rate of 558 PSA and a discount rate of 8.50% at March 31, 2003.
10
The following summarizes the activities related to mortgage servicing rights and
the related valuation allowance at March 31:
- ----------------------------------------------------------------------
(dollars in thousands) 2004 2003
- ----------------------------------------------------------------------
Balance before valuation allowance, January 1 $ 15,790 $ 13,423
Rights capitalized 830 2,290
Amortization (1,725) (932)
- ----------------------------------------------------------------------
Balance before valuation allowance, March 31 14,895 14,781
- ----------------------------------------------------------------------
Valuation allowance:
Balance, January 1 (1,131) (2,056)
Additions to valuation allowance (1,940) (2,261)
Reductions to valuation allowance 495 --
- ----------------------------------------------------------------------
Balance, March 31 (2,576) (4,317)
- ----------------------------------------------------------------------
Mortgage servicing rights, net $ 12,319 $ 10,464
======================================================================
NOTE 8 - FINANCING ACTIVITIES
The following table summarizes Old National's other borrowings at March 31:
- --------------------------------------------------------------------------------
(dollars in thousands) 2004 2003
- --------------------------------------------------------------------------------
Old National Bancorp:
Medium-term notes, Series 1997 (fixed rates
3.50% to 7.03%) maturities July 2004 to
June 2008 $ 113,200 $ 43,200
Junior subordinated debentures (fixed rates
8.00% to 9.50%) maturities March 2030
to April 2032 150,000 --
SFAS 133 hedge and other basis adjustments 11,416 208
Old National Bank:
Securities sold under agreements to repurchase
(variable rates 1.12% to 2.69%) maturities
March 2006 to December 2008 298,000 183,000
Federal Home Loan Bank advances (fixed rates
3.59% to 8.34% and variable rates 1.92% to
2.12%) maturities April 2004 to October 2022 608,788 814,848
Senior unsecured bank notes (fixed rate 3.95%
and variable rates 1.32% to 2.12%) maturities
June 2004 to February 2008 190,000 160,000
Subordinated bank notes (fixed rate 6.75%)
maturing October 2011 150,000 150,000
Capital lease obligation 4,543 --
SFAS 133 hedge and other basis adjustments 7,255 13,690
- --------------------------------------------------------------------------------
Total other borrowings $1,533,202 $1,364,946
================================================================================
11
Contractual maturities of other borrowings at March 31, 2004, were as follows:
------------------------------------------------------------
(dollars in thousands)
------------------------------------------------------------
Due in 2004 $ 101,721
Due in 2005 195,082
Due in 2006 252,402
Due in 2007 160,034
Due in 2008 343,037
Thereafter 462,255
SFAS 133 hedge and other basis adjustments 18,671
------------------------------------------------------------
Total $1,533,202
============================================================
FEDERAL HOME LOAN BANK
Federal Home Loan Bank advances had weighted-average rates of 5.24% and 5.42% at
March 31, 2004, and 2003, respectively. These borrowings are secured by
investment securities and residential real estate loans up to 150% of
outstanding debt.
SUBORDINATED BANK NOTES
Subordinated bank notes qualify as Tier 2 Capital for regulatory purposes and
are in accordance with the senior and subordinated global bank note program in
which Old National Bank may issue and sell up to a maximum of $1 billion. Notes
issued by Old National Bank under the global note program are not obligations
of, or guaranteed by, Old National Bancorp.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S SUBORDINATED DEBENTURES
ONB Capital Trust II issued $100 million in preferred securities in April 2002.
The preferred securities have a liquidation amount of $25 per share with a
cumulative annual distribution rate of 8.0% or $2.00 per share payable quarterly
and maturing on April 15, 2032. Proceeds from the issuance of these securities
were used to purchase junior subordinated debentures with the same financial
terms as the securities issued by ONB Capital Trust II. Old National guarantees
the payment of distributions on the preferred securities issued by ONB Capital
Trust II.
ONB Capital Trust I issued $50 million in preferred securities in March 2000.
The preferred securities have a liquidation amount of $25 per share with a
cumulative annual distribution rate of 9.5% or $2.375 per share payable
quarterly and maturing on March 15, 2030. Proceeds from the issuance of these
securities were used to purchase junior subordinated debentures with the same
financial terms as the securities issued by ONB Capital Trust I. Old National
guarantees the payment of distributions on the preferred securities issued by
ONB Capital Trust I.
Old National may redeem the junior subordinated debentures and thereby cause a
redemption of the trust preferred securities in whole (or in part from time to
time) on or after March 15, 2005 (for debentures owned by ONB Capital Trust I)
and on or after April 12, 2007 (for debentures owned by ONB Capital Trust II),
and in whole (but not in part) following the occurrence and continuance of
certain adverse federal income tax or capital treatment events. These securities
qualify as Tier 1 capital for regulatory purposes and the SEC registration
related to these securities has remaining funding capacity of $50 million.
In accordance with FIN 46, the outstanding junior subordinated debentures
related to these trust preferred securities were reclassified to "other
borrowings" at December 31, 2003, from the separate disclosure on the balance
sheet prior to that date.
12
CAPITAL LEASE OBLIGATION
On January 1, 2004, Old National entered into a long-term capital lease
obligation for a new branch office building in Owensboro, Kentucky, which
extends for 25 years with one renewal option for 10 years. The economic
substance of this lease is that Old National is financing the acquisition of the
building through the lease and accordingly, the building is recorded as an asset
and the lease is recorded as a liability. The fair value of the capital lease
obligation was estimated using a discounted cash flow analysis based on Old
National's current incremental borrowings rate for similar types of borrowing
arrangements. At March 31, 2004, the future minimum lease payments under the
capital lease were as follows:
------------------------------------------------------------
(dollars in thousands) Minimum
Lease
For the year ending: Payments
------------------------------------------------------------
2004 remaining $ 278
2005 371
2006 371
2007 371
2008 371
Thereafter 13,265
------------------------------------------------------------
Total minimum lease payments 15,027
Less amounts representing interest 10,484
------------------------------------------------------------
Present value of net minimum lease payments $4,543
============================================================
NOTE 9 - EMPLOYEE BENEFIT PLANS
RETIREMENT PLAN
The following table sets forth the components of the net periodic benefit cost
for Old National's noncontributory defined benefit retirement plan for the three
months ended March 31:
--------------------------------------------------------------------
Three Months Ended
March 31,
(dollars in thousands) 2004 2003
--------------------------------------------------------------------
Service cost $ 537 $ 486
Interest cost 975 846
Expected return on plan assets (851) (504)
Amortization of prior service cost 8 8
Amortization of transitional asset (108) (108)
Recognized actuarial loss 397 249
--------------------------------------------------------------------
Net periodic benefit cost $ 958 $ 977
====================================================================
STOCK OPTIONS
On February 2, 2004, Old National granted 0.3 million stock options to key
employees at an option price of $21.45, the closing price of Old National's
stock on that date. The options vest 100% on December 31, 2004, and expire in
ten years. On January 31, 2003, Old National granted 2.6 million stock options
to key employees at an option price of $21.71, the closing price of Old
National's stock on that date. The options vest 25% per year over a four-year
period and expire in ten years. If certain financial targets are achieved,
vesting is accelerated. Old National was authorized to grant up to 7.3 million
shares of common stock under the 1999 Equity Incentive Plan. At March 31, 2004,
Old National had 6.3 million of stock options outstanding.
Old National applies APB Opinion No. 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation costs have
been recognized. See Note 2 for proforma net income and net income per share
data.
13
NOTE 10 - DERIVATIVE FINANCIAL INSTRUMENTS
The following table summarizes the derivative financial instruments utilized by
Old National at March 31:
- ---------------------------------------------------------------------------------------------------------------------------------
2004 2003
----------------------------------------- -----------------------------------------
Estimated Fair Value Estimated Fair Value
Notional -------------------------- Notional --------------------------
(dollars in thousands) Amount Gain Loss Amount Gain Loss
- ---------------------------------------------------------------------------------------------------------------------------------
Fair Value Hedges
Received fixed interest rate swaps $1,068,096 $ 22,118 $ (5,877) $ 753,000 $ 26,957 $ (1,277)
Interest rate lock commitments 65,535 129 -- 130,813 1,446 --
Forward mortgage loan contracts 72,428 -- (81) 133,050 -- (698)
Options on contracts purchased 4,000 -- -- -- -- --
Loans held for sale warehouse 17,895 33 -- 52,999 718 --
Mortgage rate lock derivative 65,535 101 -- 130,813 197 --
Cash Flow Hedges
HELOC cash flow 100,000 2,073 -- 100,000 791 (61)
Pay fixed interest rate swaps 150,000 109 (468) -- -- --
Customer interest rate swaps 44,523 1,097 (69) 2,916 54 --
Customer interest rate swaps
with counterparty 44,523 69 (1,097) 2,916 -- (54)
Customer interest rate cap 15,300 -- (53) -- -- --
Customer interest rate cap
with counterparty 15,300 53 -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Total $1,663,135 $ 25,782 $ (7,645) $1,306,507 $ 30,163 $ (2,090)
=================================================================================================================================
For further information regarding derivative financial instruments, see Note 16
of the notes to the consolidated financial statements of the 2003 annual report.
NOTE 11 - INCOME TAXES
The following is a summary of the major items comprising the differences in
taxes computed at the federal statutory rate and as recorded in the consolidated
statement of income for the three months ended March 31:
--------------------------------------------------
2004 2003
--------------------------------------------------
Provision at statutory rate 35.0 % 35.0 %
Tax-exempt income (21.1) (13.1)
Other, net 0.5 (0.2)
--------------------------------------------------
Effective tax rate 14.4 % 21.7 %
==================================================
For the three months ended March 31, 2004, the effective tax rate was
significantly lower than for the same period of last year. The decrease in the
effective tax rate resulted from a higher percentage of tax-exempt income to
total income for the quarter ended March 31, 2004, compared to the quarter ended
March 31, 2003.
14
NOTE 12 - COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------------------------
Three Months Ended
March 31,
(dollars in thousands) 2004 2003
- --------------------------------------------------------------------------------------------------
Net income: $19,509 $26,260
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period, net of tax 21,929 (3,849)
Less: reclassification adjustment for securities gains realized in net
income, net of tax (1,150) (1,614)
Cash flow hedges:
Net unrealized derivative gains (losses) on cash flow hedges, net of tax 365 (159)
Less: reclassification adjustment on cash flow hedges, net of tax 47 44
- --------------------------------------------------------------------------------------------------
Net unrealized gains (losses) 21,191 (5,578)
- --------------------------------------------------------------------------------------------------
Comprehensive income $40,700 $20,682
==================================================================================================
NOTE 13 - COMMITMENTS AND CONTINGENCIES
LITIGATION
In the normal course of business, various legal actions and proceedings, which
are being vigorously defended, are pending against Old National and its
affiliates.
Among these are several lawsuits relating to activities during 1995 of First
National Bank & Trust Company, Carbondale, Illinois, ("First National"), which
was purchased by Old National in 1999. These lawsuits include one class action
brought by alleged third-party creditors of structured settlement trusts. The
lawsuits are pending against Old National Bank, as successor to First National,
and allege actual damages totaling approximately $31 million, as well as
unspecified punitive damages, and other damages and attorneys' fees. The cases
are pending against Old National Bank in the City of St. Louis, Missouri; St.
Clair County, Madison County and Cook County, Illinois; and U.S. Federal
District Court in Southern Illinois.
During the fourth quarter of 2003, Old National advanced steps to settle certain
litigation arising out of these claims and established a reserve of $10 million
for settlement. During the quarter ended March 31, 2004, Old National paid $8
million of this reserve to settle $10 million of the exposure. $16 million of
the estimated $31 million exposure has been ruled in favor of Old National at
the trial court level and is currently on appeal. The $2 million remaining in
the reserve for litigation settlement is deemed to be adequate to cover the
remaining $5 million of exposure. It is not expected that any future losses will
have a material impact on Old National's results of operations.
BUILDING COMMITMENT
On October 11, 2002, Old National entered into a $52 million contract awarded to
a company controlled by a director for the construction of its Evansville-based
main banking center and bank headquarters. Construction began on June 27, 2002,
and is expected to be complete in the third quarter of 2004.
CREDIT-RELATED FINANCIAL INSTRUMENTS
In the normal course of business, Old National's banking affiliates have entered
into various agreements to extend credit, including loan commitments of $1.520
billion, commercial letters of credit of $19.5 million and standby letters of
credit of $96.1 million at March 31, 2004. At March 31, 2003, loan commitments
were $1.362 billion, commercial letters of credit were $73.8 million and standby
letters of credit were $56.1 million. These commitments are not reflected in the
consolidated financial statements. No material losses are expected to result
from these transactions.
At March 31, 2004 and 2003, Old National had credit extensions of $72.4 million
and $49.1 million, respectively, with various unaffiliated banks related to
letter of credit commitments issued on behalf of Old National's customers. At
March 31, 2004 and 2003, Old National provided collateral to the unaffiliated
banks to secure credit extensions totaling $41.0 million and $12.5 million,
respectively. Old National did not provide collateral for the remaining credit
extensions.
15
NOTE 14 - FINANCIAL GUARANTEES
Old National holds instruments, in the normal course of business with customers,
that are considered financial guarantees in accordance with FIN 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." Standby letters of credit guarantees are
issued in connection with agreements made by customers to counterparties.
Standby letters of credit are contingent upon failure of the customer to perform
the terms of the underlying contract. Credit risk associated with standby
letters of credit is essentially the same as that associated with extending
loans to customers and is subject to normal credit policies. The term of these
standby letters of credit is typically one year or less. At March 31, 2004, the
notional amount of standby letters of credit was $96.1 million, which represents
the maximum amount of future funding requirements, and the carrying value was
$0.4 million.
Old National also enters into forward contracts for the future delivery of
conforming residential real estate loans at a specified interest rate to reduce
interest rate risk associated with loans held for sale. These forward contracts
are considered derivative instruments accounted for under SFAS No. 133. See
additional information in Note 10.
NOTE 15 - SEGMENT INFORMATION
Old National operates in three reportable segments: community banking, non-bank
services and treasury. The community banking segment serves customers in both
urban and rural markets providing a wide range of financial services including
commercial, real estate and consumer loans; lease financing; checking, savings,
time deposits and other depository accounts; cash management services; and debit
cards and other electronically accessed banking services and Internet banking.
The non-bank services segment combines the management and operations of trust,
asset management, insurance, brokerage and investment and annuity sales.
Treasury manages investments, wholesale funding, interest rate risk, liquidity
and leverage for Old National. Additionally, treasury provides other
miscellaneous capital markets products for its corporate banking customers.
In order to measure performance for each segment, Old National allocates
capital, corporate overhead and income tax provision to each segment. Capital
and corporate overhead are allocated to each segment using various
methodologies, which are subject to periodic changes by management. Income taxes
are allocated using the effective tax rate. Tax-exempt income is primarily
within the treasury segment, creating a tax benefit for this segment.
Intersegment sales and transfers are not significant.
Old National uses a funds transfer pricing ("FTP") system to eliminate the
effect of interest rate risk from the community banking and non-bank services
segments net interest income. The FTP system is used to credit or charge each
segment for the funds the segments create or use. The net FTP credit or charge
is reflected in segment net interest income.
The financial information for each operating segment is reported on the basis
used internally by Old National's management to evaluate performance and is not
necessarily comparable with similar information for any other financial
institution.
16
Summarized financial information concerning segments is shown in the following
table for the three months ended March 31:
- ---------------------------------------------------------------------------------------------------------
Community Non-bank
(dollars in thousands) Banking Services Treasury Other Total
- ---------------------------------------------------------------------------------------------------------
2004
Net interest income $ 70,191 $ 142 $ (1,909) $ (3,313) $ 65,111
Provision for loan losses 7,442 -- 58 -- 7,500
Noninterest income 15,030 23,963 4,099 2,536 45,628
Noninterest expense 59,470 21,161 599 (777) 80,453
Income tax expense (benefit) 4,401 955 (2,079) -- 3,277
Segment profit 13,908 1,989 3,612 -- 19,509
Total assets 5,731,111 121,665 3,276,565 129,993 9,259,334
- ---------------------------------------------------------------------------------------------------------
2003
Net interest income $ 70,212 $ 54 $ (1,460) $ 997 $ 69,803
Provision for loan losses 9,000 -- -- -- 9,000
Noninterest income 20,394 16,953 4,468 1,105 42,920
Noninterest expense 52,464 15,358 241 2,102 70,165
Income tax expense (benefit) 8,516 565 (1,783) -- 7,298
Segment profit 20,626 1,084 4,550 -- 26,260
Total assets 5,908,926 88,330 3,624,637 103,283 9,725,176
- ---------------------------------------------------------------------------------------------------------
NOTE 16 - SUBSEQUENT EVENTS
Subsequent to March 31, 2004, Old National entered into a Commitment Letter to
execute a Whole Loan Sale and Servicing Agreement to sell approximately $427
million of residential real estate loans with servicing retained. This
transaction is expected to be completed by the quarter ended June 30, 2004 and
is not expected to have a material impact on Old National's results of
operations.
17
PART I. FINANCIAL INFORMATION
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
EXECUTIVE SUMMARY
Net income for the quarter ended March 31, 2004, decreased significantly
compared to the quarter ended March 31, 2003, driven primarily by declining
interest rates and slow loan demand that resulted in significant decreases in
both the net interest income and mortgage banking revenue. In addition,
noninterest expense included charges for severance payments to three senior
executives who left the company during the quarter ended March 31, 2004 and an
increase in incentive expense compared to the quarter ended March 31, 2003.
As a result of management's balance sheet strategies, Old National's financial
condition showed a decrease in assets and liabilities at March 31, 2004,
compared to March 31, 2003 and December 31, 2003, reflecting heavy refinancing
of residential real estate loans during 2003, a reduction in the investment
portfolio, and a reduction of certificates of deposits and borrowed funds.
Management uses various indicators such as return on assets, return on equity
and asset quality ratios in order to evaluate the performance of the business.
These are discussed throughout this "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
FINANCIAL BASIS AND FORWARD-LOOKING STATEMENTS
This discussion analyzes Old National's results of operations for the three
months ended March 31, 2004 and 2003, and financial condition as of March 31,
2004, compared to March 31, 2003, and December 31, 2003.
This management's discussion and analysis contains certain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements include expressions such as "expects,"
"intends," "believes," "anticipates," and "should," which are statements of
belief as to the expected outcomes of future events. Internal and external
factors that might cause such a difference include, but are not limited to,
market, economic, operational, liquidity, credit and interest rate risks
associated with Old National's business, competition, government legislation and
policies, ability of Old National to execute its business plan and implement the
"Ascend" project initiatives (see "Results of Operations" for further
information on the "Ascend" project), credit quality trends and the ability to
generate loans, and other matters discussed in this management's discussion and
analysis. These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements. Actual results could materially differ from those presented. Old
National undertakes no obligation to release revisions to these forward-looking
statements or reflect events or conditions after the date on which the forward
looking statement is made or to reflect the occurrence of unanticipated events.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The "Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as disclosures found elsewhere in this report, are based
upon Old National's consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires Old National
to make estimates and judgements that affect the reported amounts of assets,
liabilities, revenues and expenses. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination
of the allowance for loan losses, the valuation of the mortgage servicing rights
and the valuation of goodwill and intangibles. Actual results could differ from
those estimates.
o Allowance for Loan Losses. The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses inherent in
the consolidated loan portfolio. Management's evaluation of the adequacy of
the allowance is an estimate based on reviews of individual loans,
assessments of the impact of current and anticipated economic conditions on
the portfolio and historical loss experience. The allowance represents
management's best estimate, but significant downturns in circumstances
relating to loan quality and economic conditions could result in a
requirement for additional allowance in the near future. Likewise, an
upturn in loan quality and improved economic conditions may allow a
reduction in the required reserve. In either instance, unanticipated
changes could have a significant impact on results of operations.
18
The allowance is increased through a provision charged to operating
expense. Uncollectible loans are charged-off through the allowance.
Recoveries of loans previously charged-off are added to the allowance. A
loan is considered impaired when it is probable that contractual interest
and principal payments will not be collected either for the amounts or by
the dates as scheduled in the loan agreement. Old National's policy for
recognizing income on impaired loans is to accrue interest unless a loan is
placed on nonaccrual status.
o Mortgage Servicing Rights. Mortgage servicing rights are recognized as
separate assets when loans are sold with servicing retained. The total
price of loans sold is allocated between the loans sold and the mortgage
servicing rights retained based on the relative fair values of each. The
fair value of capitalized mortgage servicing rights is estimated by
calculating the present value of estimated future net servicing income
derived from related cash flows. Amortization of capitalized mortgage
servicing rights is determined in proportion to and over the period of
estimated net servicing income of the underlying financial assets.
Impairment of mortgage servicing rights exists if the book value of the
mortgage servicing rights exceed its estimated fair value. In determining
impairment, mortgage servicing rights are stratified by interest rates.
Critical assumptions used in determining fair value include expected
mortgage loan prepayment rates, discount rates and other economic factors,
which are determined based on current market conditions. The expected rates
of mortgage loan prepayments are the most significant factors driving the
value of mortgage servicing rights. Increases in expected mortgage loan
prepayments reduce estimated future net servicing cash flows because the
life of the underlying loan is reduced. Fair values, using estimated
mortgage loan prepayment rates, are derived from a third-party statistical
model. Negative adjustments to the value, if any, are recognized through a
valuation allowance by charges against mortgage servicing income. The use
of a valuation allowance enables the recovery of this value as market
conditions become more favorable.
o Goodwill and Intangibles. For purchase acquisitions, Old National is
required to record the assets acquired, including identified intangible
assets, and the liabilities assumed at their fair value, which in many
instances involves estimates based on third party valuations, such as
appraisals, or internal valuations based on discounted cash flow analyses
or other valuation techniques that may include estimates of attrition,
inflation, asset growth rates or other relevant factors. In addition, the
determination of the useful lives for which an intangible asset will be
amortized is subjective.
Under Statement of Financial Accounting Standards ("SFAS") No. 142
"Goodwill and Other Intangible Assets," goodwill and indefinite-lived
assets recorded must be reviewed for impairment on an annual basis, as well
as on an interim basis if events or changes indicate that the asset might
be impaired. An impairment loss must be recognized for any excess of
carrying value over fair value of the goodwill or the indefinite-lived
intangible with subsequent reversal of the impairment loss being
prohibited. The tests for impairment fair values are based on internal
valuations using management's assumptions of future growth rates, future
attrition, discount rates, multiples of earnings or other relevant factors.
Changes is these factors, as well as downturns in economic or business
conditions, could have a significant adverse impact on the carrying values
of goodwill or intangibles and could result in impairment losses affecting
the financials of the company as a whole and the individual lines of
business in which the goodwill or intangibles reside.
Management believes the accounting estimates related to the allowance for loan
losses; the capitalization, amortization and valuations of mortgage servicing
rights; and the valuation of goodwill and intangibles are "critical accounting
estimates" because: (1) the estimates are highly susceptible to change from
period to period because they require company management to make assumptions
concerning, among other factors, the changes in the types and volumes of the
portfolios, rates of future prepayments, valuation assumptions and anticipated
economic conditions, and (2) the impact of recognizing an impairment or loan
loss could have a material effect on Old National's assets reported on the
balance sheet as well as net income. Management has discussed the development
and selection of these critical accounting estimates with the Audit Committee of
the Board of Directors and the Audit Committee has reviewed the company's
disclosure relating to it in this Management's Discussion and Analysis.
19
RESULTS OF OPERATIONS
Earnings Summary
Old National reported net income of $19.5 million for the three months ended
March 31, 2004, a reduction of 25.7% from the $26.3 million recorded for the
three months ended March 31, 2003. On a diluted per share basis, net income was
$0.29 for the quarter ended March 31, 2004, compared to $0.39 for the quarter
ended March 31, 2003. Old National's return on average assets for the three
months ended March 31, 2004, was 0.84% and return on shareholders' equity was
10.68%, compared to the three months ended March 31, 2003, ratios of 1.11% and
14.03%, respectively.
Earnings for the three months ended March 31, 2004, were impacted primarily by
significant decreases in net interest income resulting from continued weak
commercial loan demand and declining interest rates, decreases in mortgage
banking revenue related to declines in values of mortgage servicing rights as
well as reduced new loan originations, increases to salary expense relating
primarily to severance payments to three senior executives who left Old National
during the quarter and an increase in incentive accruals over the quarter ended
March 31, 2003.
A company-wide program, "Ascend," was announced in late 2003 and, at March 31,
2004, was nearing the implementation phase. The project was conducted with the
assistance of EHS Partners and designed to be an intense evaluation of every
aspect of operations for expense reductions and revenue growth ideas. All
initiatives arising from the project are scheduled to be fully implemented over
the next 18 months and Old National is expecting to realize approximately
$55-$60 million in annualized pre-tax earnings, excluding one-time
implementation charges which will be recognized in the second quarter of 2004.
Approximately 65%-70% of the annualized benefit is expected to come from
efficiency improvement/cost reduction initiatives, including position
eliminations, with the remainder from revenue enhancement initiatives.
Net Interest Income
Net interest income is the difference between interest income earned on
interest-earning assets, such as loans and investments, and interest expense
incurred on interest-bearing liabilities, such as deposits and borrowed funds.
Net interest income and margin are influenced by many factors, primarily the
volume and mix of earning assets, funding sources and interest rate
fluctuations. Other factors include accelerated prepayments of mortgage-related
assets and the composition and maturity of earning assets and interest-bearing
liabilities. Net interest income and net interest margin in the following
discussion is presented on a fully taxable equivalent basis, which adjusts
tax-exempt or nontaxable interest income to an amount that would be comparable
to interest subject to income taxes using the federal statutory tax rate in
effect of 35% for all periods. Net income is unaffected by these taxable
equivalent adjustments as the offsetting increase of the same amount is made in
the income tax section. Net interest income included taxable equivalent
adjustments of $6.1 million and $6.4 million for the three months ended March
31, 2004 and 2003, respectively.
Taxable equivalent net interest income was $71.2 million for the three months
ended March 31, 2004, a 6.5% decrease from the $76.2 million reported for the
same period of 2003. The net interest margin was 3.37% for the three months
ended March 31, 2004, compared to 3.46% reported for the three months ended
March 31, 2003. The reduction in both net interest income and net interest
margin reflects a smaller portfolio of average earning assets and lower levels
of interest rates when compared to the three months ended March 31, 2003.
Average earning assets were $8.461 billion for the three months ended March 31,
2004, compared to $8.796 billion for the same period of 2003, a decrease of 3.8%
or $334.5 million. This decrease resulted primarily from reductions in
investment portfolio assets and residential mortgages.
The overall decrease in interest rates during 2003 and continuing into 2004 had
a significant impact on the mix and yield of earning assets. Driven by lower
rates, many of the company's residential real estate loans were refinanced in
2003, with the new loan production being sold into the secondary loan market,
shrinking the residential loan portfolio. Additionally, commercial and
commercial real estate loans did not grow appreciably during 2003 and the lack
of growth continued into the three months ended March 31, 2004, a result of both
continued weak loan demand in Old National's markets and more stringent loan
underwriting standards. In a continuation of a strategy begun during 2003, the
company reduced its investment portfolio assets in recognition of the narrow
spreads available on those assets in the current rate environment.
20
Provision for Loan Losses
The provision for loan losses is the charge to earnings that management
determines necessary to provide an adequate allowance for losses in the loan
portfolio. The provision for loan losses was $7.5 million for the three months
ended March 31, 2004, compared to $9.0 million for the three months ended March
31, 2003, a result of lower charge-offs during the quarter ended March 31, 2004.
Refer to "Allowance for Loan Losses and Asset Quality" section for further
discussion of non-performing loans, charge-offs and additional items impacting
the provision.
Noninterest Income
Old National generates revenues in the form of noninterest income through fees
and sales commissions from its core banking franchise and other related
businesses, such as trust and asset management, investment products and
insurance. This source of revenue has grown as a percentage of total revenue to
41.2% in the three months ended March 31, 2004, compared to 38.1% in the three
months ended March 31, 2003. Old National will continue to focus on noninterest
income revenue growth while carefully managing balance sheet risk positions to
ensure that Old National is well-positioned for the anticipated turnaround in
market conditions.
Noninterest income for the three months ended March 31, 2004, was $45.6 million,
an increase of $2.7 million, or 6.3% over the $42.9 million reported for the
three months ended March 31, 2003. Total fee and service charge income,
excluding gains on sales of securities, for the quarter ended March 31, 2004,
was $43.6 million compared to $40.2 million for the quarter ended March 31,
2003. Insurance premiums and commissions, the largest component of this category
of revenue, increased to $14.5 million for the three months ended March 31,
2004, compared to $8.2 million for the three months ended March 31, 2003.
Acquisitions of various insurance agencies beginning in the second quarter of
2003, accounted for $4.9 million of the increase. These increases were offset by
a decrease in mortgage banking revenue totaling $4.7 million. This decrease was
mostly attributable to a reduced level of originations for the quarter ended
March 31, 2004 compared to the quarter ended March 31, 2003, due to a lower
level of loan refinancing. Residential real estate loan originations for the
three months ended March 31, 2004, were $145.6 million resulting from 1,493
loans closed compared to $296.5 million resulting from 3,062 loans closed for
the three months ended March 31, 2003. Also during the quarter ended March 31,
2004, a net impairment charge was recognized on the mortgage servicing rights
asset of $1.4 million. This charge in addition to the reduced level of loan
originations resulted in negative mortgage banking revenue for the quarter ended
March 31, 2004.
Noninterest Expense
Noninterest expense for the three months ended March 31, 2004, totaled $80.5
million, an increase of $10.3 million, or 14.7% over the $70.2 million recorded
for the same period of 2003. Salaries and benefits, the largest component of
noninterest expense, totaled $49.3 million for the three months ended March 31,
2004, compared to $41.7 million for the three months ended March 31, 2003, an
increase of $7.6 million. This increase in 2004 resulted from $2.9 million in
severance expense related to three senior executives, including the chief
executive officer, who left the company during the quarter ended March 31, 2004,
$3.0 million directly attributed to acquisitions of insurance agencies that
occurred after the first quarter of 2003 and an increase of incentive expenses
of $2.0 million over the three months ended March 31, 2003.
All other components of noninterest expense totaled $31.2 million for the three
months ended March 31, 2004, compared to the $28.5 million for the three months
ended March 31, 2003, an increase of $2.7 million or 9.4%. Of this increase,
$1.0 million was directly related to the acquisitions of insurance agencies
during 2003 and $1.4 million resulted from write-downs of foreclosed real estate
during the quarter ended March 31, 2004.
As a part of "Ascend," Old National anticipates improvements in noninterest
expense at the program's completion by the end of 2005, however it is expected
that a significant charge for the initial phase of the implementation will occur
in the quarter ending June 30, 2004.
Provision for Income Taxes
Old National records a provision for income taxes currently payable and for
income taxes payable in the future, which arise due to timing differences in the
recognition of certain items for financial statement and income tax purposes.
The major difference between the effective tax rate applied to Old National's
financial statement income and the federal statutory tax rate is caused by
interest on tax-exempt securities and loans. The provision for income taxes, as
a percentage of pre-tax income, was 14.4% for the three months ended March 31,
2004, compared to 21.7% in the three months ended March 31, 2003. The decreased
effective tax rate in 2004 resulted from a higher percentage of tax-exempt
income to total income.
21
FINANCIAL CONDITION
Overview
Old National initiated balance sheet strategies beginning in the second half of
2003 to reduce the assets and liabilities of the company, including a reduction
in the investment portfolio and a reduction in certificates of deposits and
borrowed funds. Old National's assets at March 31, 2004, were $9.259 billion, a
4.8% decrease compared to March 31, 2003, and a 4.0% decrease compared to
December 31, 2003. Investments and loans decreased $441.2 million and $27.3
million, respectively, since March 31, 2003, and decreased $43.7 million and
$10.5 million, respectively, since December 31, 2003. Total liabilities declined
$463.7 million compared to March 31, 2003, and $119.9 million since December 31,
2003. Total shareholders' equity decreased $2.2 million from March 31, 2003, but
showed an increase over December 31, 2003, of $25.4 million due to changes in
the unrealized gains on investment securities.
Earning Assets
Old National's earning assets are comprised of loans and loans held for sale,
investment securities and money market investments. Earning assets were $8.467
billion at March 31, 2004, a decrease of 5.5% from March 31, 2003, and a
decrease of 2.4% since December 31, 2003. The reduction in earning assets is due
to a continuation of balance sheet strategies initiated by management during the
second half of 2003. Old National reduced its investment portfolio in light of
fewer attractive investment opportunities and the company's desire to reduce its
sensitivity to rising interest rates. Total loans decreased only slightly, which
can be attributed to continued weakness in commercial lending, partially offset
by growth in consumer loans. In addition, the decrease in total loans from March
31, 2004, compared to March 31, 2003, was also affected by the sales of $62.7
million of nonaccrual commercial and residential real estate loans during the
second and third quarters of 2003. Money market investments at March 31, 2004,
increased by $9.8 million from March 31, 2003, primarily attributable to
acquisitions that occurred after the first quarter of 2003.
Investment Securities
Old National has classified all investment securities as available-for-sale or
held-to-maturity on the date of purchase. The majority of Old National's
investment securities are classified as available-for-sale, which gives
management the flexibility to sell the securities prior to maturity, if needed,
based on fluctuating interest rates or changes in the company's funding
requirements.
At March 31, 2004, the investment securities portfolio was $2.874 billion
compared to $3.315 billion at March 31, 2003, a decrease of $441.2 million or
13.3%. Investment securities decreased $43.7 million at March 31, 2004, compared
to December 31, 2003, a decrease of 6.0%. Investment securities represented
33.9% of earning assets at March 31, 2004, compared to 37.0% at March 31, 2003,
and 34.2% at December 31, 2003. During the first half of 2003, Old National
increased the investment portfolio as a short-term alternative source of earning
assets to offset declining residential real estate and minimal commercial and
consumer loan growth. During the second half of 2003 and continuing into 2004,
Old National decreased the size of the investment portfolio and used the cash
flows generated by the declining investment portfolio to reduce borrowed funds.
Stronger economic activity and stronger commercial loan demand would likely
result in increased investments in loans and a reduction in the investment
securities portfolio.
The investment securities available-for-sale portfolio had net unrealized gains
of $59.6 million at March 31, 2004, compared to $77.0 million at March 31, 2003.
The decrease of $17.4 million was the result of higher market interest rates and
a smaller portfolio of securities available-for-sale at March 31, 2004.
Unrealized gains increased by $35.9 million due to somewhat reduced market
interest rates resulting in a higher unrealized gain at March 31, 2004, compared
to December 31, 2003.
The investment portfolio had an average life of 4.30 years at March 31, 2004,
compared to 3.59 years at March 31, 2003 and 4.86 years at December 31, 2003.
The average yields on investment securities, on a taxable equivalent basis, were
4.62% for the quarter ended March 31, 2004, compared to 4.99% for the quarter
ended March 31, 2003 and 4.70% for the quarter ended December 31, 2003. This
decrease was primarily due to prepayments of mortgage-backed securities and
calls of higher coupon agency securities that left lower coupon securities in
the portfolio.
22
Residential Loans Held for Sale
Residential loans held for sale were $17.9 million at March 31, 2004, compared
to $53.0 million at March 31, 2003, a decrease of 66.2%, and compared to $16.3
million at December 31, 2003. Residential loans held for sale are loans that are
closed, but not yet sold on the secondary market. The amount of residential
loans held for sale on the balance sheet varies depending on the timing of
movement of originations and loan sales to the secondary market. At March 31,
2004, residential real estate loan origination activity was down as compared to
March 31, 2003, primarily due to a reduced level of loan refinancing.
Commercial and Consumer Loans
Commercial and consumer loans are the largest classification within the earning
assets of Old National representing 54.6% of earning assets at March 31, 2004,
an increase from 51.5% at March 1, 2003, and 54.4% at December 31, 2003. At
March 31, 2004, commercial and commercial real estate loans were $3.445 billion,
a slight decrease of $117.2 million since March 31, 2003, and a decrease of
$22.3 million since December 31, 2003. During the third quarter of 2003, Old
National sold $48.2 million of non-performing commercial loans. Weak loan demand
in Old National's non-urban markets impacted commercial loan growth in 2003 and
continues into 2004.
At March 31, 2004, consumer loans, including automobile loans, personal and home
equity loans and lines of credit, and student loans, increased $125.1 million or
11.9% compared to March 31, 2003, and increased $12.1 million or 4.2% since
December 31, 2003, primarily due to enhancements to marketing and customer
contact programs.
Residential Real Estate Loans
Residential real estate loans, primarily 1-4 family properties, have decreased
in significance to the loan portfolio over the past five years due to higher
levels of loan sales into the secondary market, primarily to Federal Home Loan
Mortgage Corporation and Federal National Mortgage Association. Old National
sells the majority of residential real estate loans it originates as a strategy
to better manage interest rate risk and liquidity. These loans are sold with
loan servicing retained in order to maintain customer relationships and generate
noninterest income and fees. By using this strategy, Old National is able to
recognize an immediate gain in noninterest income versus a small net interest
income spread over a longer period of time. Old National sells the majority of
the residential real estate loans without recourse, currently having less than
1% of loans sold with recourse.
At March 31, 2004, residential real estate loans were $939.2 million, a decrease
of $35.2 million or 3.6% from March 31, 2003. Residential real estate loans
liquidated at high levels during 2003 due to the low interest rate environment
and the related boom in refinancing. Residential real estate loans were
virtually unchanged from December 31, 2003, to March 31, 2004, as new loans
originated and held on the balance sheet replaced the maturities and prepayments
of existing loans. Old National's residential real estate loan portfolio was
also affected by the sales of delinquent loans in the second and third quarters
of 2003. These sales were to improve credit quality and reduce the level of
non-performing loans and are not a part of Old National's ongoing strategy.
Delinquent residential real estate loans of $14.5 million were sold to
independent investors resulting in write-downs of $3.4 million recorded against
the allowance for loan losses. During 2003, Old National developed additional
mortgage products that fit within the company's interest rate risk profile that
will be retained by the bank. As a result of this strategy, Old National has
begun to see increased stabilization of residential real estate loans on the
consolidated balance sheet.
Allowance for Loan Losses and Asset Quality Administration
Old National monitors the quality of its loan portfolio on an on-going basis and
uses a combination of detailed credit assessments by relationship managers and
credit officers, historic loss trends, and economic and business environment
factors in determining its allowance for loan losses. Old National records
provisions for loan losses based on current and projected loans outstanding,
grade changes, mix of loans and expected losses. A detailed loan loss evaluation
on an individual loan basis for the company's highest risk loans is performed
quarterly.
Each month, problem loan reports are prepared and reviewed, which include
borrowers that show indications of being unable to meet debt obligations in the
normal course of business, and loans which have other characteristics deemed by
bank management to warrant special attention or have been criticized by
regulators in the examination process. Classified loans include non-performing
loans, past due 90 days and other problem loans while criticized loans, also
known as special mention loans, are loans that have potential weaknesses that
deserve management's close attention and require specific quarterly reviews by
the bank.
23
Assets determined by the various evaluation processes to be under-performing
receive special attention by Old National management. Under-performing assets
consist of: 1) nonaccrual loans where the ultimate collectibility of interest or
principal is uncertain; 2) loans renegotiated in some manner, primarily to
provide for a reduction or deferral of interest or principal payments because
the borrower's financial condition deteriorated; 3) loans with principal or
interest past due ninety (90) days or more; and 4) foreclosed properties.
A loan is generally placed on nonaccrual status when principal or interest
become 90 days past due unless it is well secured and in the process of
collection, or earlier when concern exists as to the ultimate collectibility of
principal or interest. When loans are classified as nonaccrual, interest accrued
during the year is reversed against earnings; interest accrued in the prior
year, if any, is charged to the allowance for loan losses. Cash received while a
loan is classified as nonaccrual is recorded to principal.
Old National analyzes on a quarterly basis the composition of the loan portfolio
to determine if there is any concentration of loans in any single industry
exceeding 10% of its portfolio, and has determined that no such concentration
exists as of March 31, 2004, as measured by Old National. In addition, Old
National has no exposure to foreign borrowers or lesser-developed countries.
Allowance for Loan Losses and Asset Quality
At March 31, 2004, the allowance for loan losses was $108.6 million, an increase
of $24.6 million compared to $84.0 million at March 31, 2003, and an increase of
$4.0 million compared to $104.6 million at December 31, 2003. As a percentage of
total loans held for investment, the allowance increased to 1.95% at March 31,
2004, from 1.50% at March 31, 2003, and 1.88% from December 31, 2003. The
significantly higher allowance for loan losses at March 31, 2004, compared to
March 31, 2003, was due to Old National's increased provision during 2003,
reflecting higher than normal losses in 2003. Loan collateral values in the
markets served by Old National have deteriorated and recent experience has
elevated the rate of expected future losses compared to earlier periods in 2003.
For the three months ended March 31, 2004, the provision for loan losses
amounted to $7.5 million, a decrease of $1.5 million from the three months ended
March 31, 2003.
Charge-offs, net of recoveries, totaled $3.5 million for the three months ended
March 31, 2004, the lowest level since the second quarter of 2002, and a
decrease of $9.3 million from the three months ended March 31, 2003. Net
charge-offs to average loans were 0.2% for the three months ended March 31,
2004, as compared to 0.9% for the three months ended March 31, 2003. The net
charge-offs were higher for the quarter ended March 31, 2003, primarily due to
the charge-off of a single commercial credit of $8.5 million.
Under-performing assets totaled $114.8 million at March 31, 2004, remaining
relatively unchanged from December 31, 2003, and significantly lower than the
$139.7 million at March 31, 2003. As a percent of total loans and foreclosed
properties, under-performing assets at March 31, 2004, were 2.06%, a reduction
from the December 31, 2003 ratio of 2.12% and the March 31, 2003 ratio of 2.47%.
Nonaccrual loans were $107.1 million at March 31, 2004, compared to $104.6
million at December 31, 2003, and $116.5 million at March 31, 2003. Management
believes that it has appropriately identified and reserved for loan losses
related to nonaccrual loans at March 31, 2004. Approximately $47.2 million of
nonaccrual loans less than thirty days delinquent were contractually performing
at March 31, 2004. Management will continue its efforts to reduce the level of
non-performing loans and may consider the possibility of additional sales of
troubled and non-performing loans, which could result in additional write-downs
to the allowance for loan losses.
While the level of nonaccrual loans has remained relatively unchanged over the
last three quarters, the total portfolio of loans identified by Old National as
problem credits continues to decline. Total classified and criticized loans were
$526.4 million at March 31, 2004, a decrease of $33.2 million from December 31,
2003 and a decrease of $126.0 million from March 31, 2003. While the absolute
level of classified and criticized loans at March 31, 2004, decreased,
management believes it has taken a prudent approach to the evaluation of
under-performing credits and the loan portfolio in general, both in
acknowledging the portfolio's general condition and in establishing the
allowance for loan losses.
24
Old National has been affected by weakness in the economy of its non-urban
markets, which has resulted in minimal growth of commercial loans and tighter
credit underwriting standards. Management expects that trends in nonaccrual
loans will be influenced by the degree to which the economy strengthens. The
longer the significant softness in manufacturing continues, the more stress it
puts on Old National's borrowers, increasing the potential for additional
nonaccrual loans.
The table below shows the various components of under-performing assets:
- ------------------------------------------------------------------------------------------
March 31, December 31,
(dollars in thousands) 2004 2003 2003
- ------------------------------------------------------------------------------------------
Nonaccrual loans $107,122 $116,547 $104,627
Renegotiated loans -- -- --
Past due loans (90 days or more) 2,334 14,112 5,120
Foreclosed properties 5,304 8,999 8,763
- ------------------------------------------------------------------------------------------
Total under-performing assets $114,760 $139,658 $118,510
==========================================================================================
Classified loans (includes non-performing loans,
past due 90 days and other problem loans) $321,328 $445,151 $343,943
Criticized loans 205,101 207,293 215,700
- ------------------------------------------------------------------------------------------
Total criticized and classified loans $526,429 $652,444 $559,643
==========================================================================================
Asset Quality Ratios: (1)
Non-performing loans/total loans (1) (2) 1.92 % 2.07 % 1.87 %
Under-performing assets/total loans and
foreclosed properties (1) 2.06 2.47 2.12
Under-performing assets/total assets 1.24 1.44 1.27
Allowance for loan losses/under-performing assets 94.63 60.14 88.24
- ------------------------------------------------------------------------------------------
(1) Items referring to loans are net of unearned income and include residential
loans held for sale.
(2) Non-performing loans include nonaccrual and renegotiated loans.
Premises and Equipment
Premises and equipment was $194.3 million at March 31, 2004, an increase of
$50.8 million or 35.4% since March 31, 2003, and an increase of $12.9 million or
28.4% since December 31, 2003. The increase is primarily due to the
construction-in-progress of Old National's Evansville-based corporate
headquarters and main banking center. The building is expected to be complete in
the third quarter of 2004 at which time depreciation will begin.
Goodwill and Other Intangible
The non-bank services segment acquired various financial services companies in
the second and third quarters of 2003, increasing goodwill to $129.3 million at
March 31, 2004, from $110.6 million at March 31, 2003. Also as a result of these
acquisitions, other intangible assets related to customer business relationships
increased to $41.1 million at March 31, 2004, from $27.0 million at March 31,
2003. Old National performs impairment testing of goodwill and other intangibles
on an annual basis. As of March 31, 2004 and 2003, there was no impairment.
Funding
Total funding, comprised of deposits and wholesale borrowings, was $8.390
billion at March 31, 2004, a decrease of 4.9% from $8.826 billion at March 31,
2003, and a decrease of 6.7% from $8.532 billion at December 31, 2003. Total
deposits were $6.385 billion at March 31, 2004, an increase of 1.0% compared to
March 31, 2003, and a decrease of 6.7% compared to December 31, 2003. Old
National experienced growth in demand deposits and other low cost transaction
accounts when comparing March 31, 2004 to March 31, 2003, due to the lower rate
environment and customer preference for transaction accounts. When comparing
March 31, 2004 to December 31, 2003, Old National's transaction accounts were
lower due to seasonal deposit declines. Old National experienced a reduction in
time accounts from March 31, 2004, compared to March 31, 2003 and December 31,
2003, due to the maturity of a group of higher interest rate certificates of
deposits during the first quarter of 2004.
Old National uses wholesale funding to augment deposit funding and to help
maintain its desired interest rate risk position. At March 31, 2004, wholesale
borrowings, including short-term borrowings and other borrowings, decreased
20.0% and 6.7% from March 31, 2003, and December 31, 2003, respectively.
Wholesale funding was increased during the first half of 2003 to finance
investment portfolio growth, offset a reduction in certificates of deposits, and
take advantages of favorable interest rates. During the second half of 2003 and
continuing into 2004,
25
wholesale borrowings decreased as the investment portfolio growth slowed.
Wholesale borrowings as a percentage of total funding was 23.9% at March 31,
2004 compared to 28.4% at March 31, 2003 and 23.9% at December 31, 2003. The
lower level of earning assets and stable levels of total core deposits during
the first quarter of 2004 reduced the company's reliance on wholesale funding.
Capital Resources and Regulatory Guidelines
Shareholders' equity totaled $740.9 million at March 31, 2004, essentially
unchanged from March 31, 2003, and an increase of 14.2% compared to December 31,
2003. A higher unrealized gain on investment securities was the primary
contributor to the increase in shareholders' equity from December 31, 2003 to
March 31, 2004.
Old National paid cash dividends of $0.19 per share for the three months ended
March 31, 2004, which decreased equity by $12.6 million, compared to cash
dividends of $0.18 per share for the three months ended March 31, 2003,
(restated for the 5% stock dividend distributed on January 27, 2004), which
decreased equity by $12.1 million. Old National purchased shares of its stock in
the open market under an ongoing repurchase program, reducing shareholders'
equity by $10.1 million during the first quarter of 2004 and $12.6 million
during the first quarter of 2003. Shares reissued for stock options and stock
purchase plans increased shareholders' equity by $7.4 million during the first
quarter of 2004 compared to $6.3 million during the first quarter of 2003.
Old National and the banking industry are subject to various regulatory capital
requirements administered by the federal banking agencies. Old National's
consolidated capital position remains strong as evidenced by the following
comparisons of key industry ratios.
- -------------------------------------------------------------------------------------------------------
Regulatory
Guidelines March 31, December 31,
Minimum 2004 2003 2003
- -------------------------------------------------------------------------------------------------------
Risk-based capital:
Tier 1 capital to total avg assets (leverage ratio) 4.00 % 7.53 % 7.56 % 7.35 %
Tier 1 capital to risk-adjusted total assets 4.00 11.08 11.31 10.96
Total capital to risk-adjusted total assets 8.00 14.76 14.95 14.65
Shareholders' equity to assets N/A 8.00 7.64 7.65
- -------------------------------------------------------------------------------------------------------
ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK MANAGEMENT
Inherent in Old National's balance sheet is market risk, defined as the
sensitivity of income, fair market values and capital to changes in interest
rates, foreign currency exchange rates, commodity prices and other relevant
market rates or prices. The primary market risk to which Old National has
exposure is interest rate risk. Interest rate risk arises because assets and
liabilities may reprice, mature or prepay at different times or based upon
different indices as market interest rates change. Changes in the slope of the
yield curve and the pace of changes in interest rates may also impact net
interest income and the fair value of the balance sheet.
Old National manages interest rate risk within an overall asset and liability
management framework that includes attention to credit risk, liquidity risk and
capitalization. A principal objective of asset/liability management is to manage
the sensitivity of net interest income to changing interest rates. Asset and
liability management activity is governed by a policy reviewed and approved
annually by the Board of Directors. The Board of Directors has delegated the
oversight of the administration of this policy to the Funds Management
Committee, a committee of the Board of Directors, which meets quarterly. In
addition, a second oversight committee, the Balance Sheet Management Committee
comprised of senior executive managers, provides guidance for the execution of
the activities.
Old National uses two modeling techniques to quantify the impact of changing
interest rates on the company, Net Interest Income at Risk and Economic Value of
Equity. Net Interest Income at Risk is used by management and the Board of
Directors to evaluate the impact of changing rates over a two-year horizon while
Economic Value of Equity is more useful for long-term interest rate risk. These
models simulate the likely behavior of the company's net interest income and the
likely change in the company's market value due to changes in interest rates
under various possible interest rate scenarios. Because the models are driven by
expected behavior in various interest rate
26
scenarios and many factors besides market interest rates impact the company's
net interest income and value, Old National recognizes that model outputs are
not guarantees of actual results. For this reason, Old National models many
different combinations of interest rates and balance sheet assumptions to best
understand its overall sensitivity to market interest rate changes.
Old National's Board of Directors, through its Funds Management Committee,
monitors the company's interest rate risk. The Funds Management Committee
establishes policy guidelines for the allowable change in cumulative net
interest income over a two-year period and the change in Economic Value of
Equity in an up or down 200 basis point instantaneous parallel change to the
yield curve (+/- 200 basis point yield curve shock). The current guideline for
Net Interest Income at Risk is +/- 5% of net interest income over a two-year
period in a 200 basis point shock to the yield curve. The current guideline for
the allowable fluctuation in Economic Value of Equity is +/- 12% in a 200 basis
point shock to the yield curve. In addition, Old National has included the
output of its rate risk model in up and down 50 and 100 basis point yield curve
shocks to provide a better understanding of Old National's sensitivity to market
interest rate changes.
At March 31, 2004 and 2003, Old National was slightly outside its policy of
Economic Value of Equity in a -200 basis point interest rate shock. Management
and the Funds Management Committee have determined that this is an acceptable
variance given the unusually low interest rates. The following table shows Old
National's market risk in various interest rate scenarios.
Interest Rate Risk /Static Balance Sheet Model
- ---------------------------------------------------------------------------------------
Estimated 24- Month Estimated Change
Interest Rate Cumulative Impact On in Economic
Change Net Interest Income Value of Equity
---------------------------------- ------------------------------
(basis points) Policy Actual Policy Actual
- ---------------------------------------------------------------------------------------
2004
+200 +/- 5.00 % -4.55 % +/- 12.00 % -8.43 %
+100 -2.01 -2.94
+50 -0.80 -1.61
-50 0.34 % -1.51 %
-100 -0.45 -3.21
-200 +/- 5.00 % -3.87 +/- 12.00 % -13.85
- ---------------------------------------------------------------------------------------
2003
+200 +/- 5.00 % -0.78 % +/- 12.00 % -2.15 %
+100 0.39 0.57
+50 0.42 0.44
-50 0.01 % -2.49 %
-100 -0.73 -5.04
-200 +/- 5.00 % -3.49 +/- 12.00 % -13.36
- ---------------------------------------------------------------------------------------
The company's rate risk model output depicted in the preceding table is based on
a static, or unchanged future balance sheet. Based on management's expected
balance sheet, which includes expected changes in the company's asset and
funding mix, Old National expects net interest income to be impacted positively
by the market's current expectation of gradually increasing interest rates
during 2004 and 2005.
Old National uses derivatives to manage interest rate risk in the ordinary
course of business. See Note 10 to the consolidated financial statements for a
discussion of derivative financial instruments. These transactions serve to
better balance the repricing of assets and liabilities in various rate change
scenarios and protect the company from changes in interest rates.
27
LIQUIDITY MANAGEMENT
The Funds Management Committee of the Board of Directors and the Balance Sheet
Management Committee establish liquidity risk guidelines and monitor liquidity
risk. The objective of liquidity management is to ensure Old National has the
ability to fund balance sheet growth and meet deposit and debt obligations in a
timely and cost-effective manner. Management monitors liquidity through a
regular review of asset and liability maturities, funding sources, and loan and
deposit forecasts to minimize funding risk. The company maintains strategic and
contingency liquidity plans to ensure sufficient available funding to satisfy
requirements for balance sheet growth, properly manage capital markets' funding
sources and to address unexpected liquidity requirements.
Old National's ability to raise funding at competitive prices is influenced by
rating agencies' views of the company's credit quality, liquidity, capital and
earnings. The senior debt ratings of Old National Bancorp and Old National Bank
at March 31, 2004, are shown in the following table.
SENIOR DEBT RATINGS
- ------------------------------------------------------------------------------------------------------------------
Standard and Poor's Moody's Investor Services Fitch, Inc.
---------------------------- ----------------------------- -------------------------
Long-term Short-term Long-term Short-term Long-term Short-term
- ------------------------------------------------------------------------------------------------------------------
Old National Bancorp BBB N/A Baa1 N/A BBB F2
Old National Bank BBB+ A2 A3 P-2 BBB F2
- ------------------------------------------------------------------------------------------------------------------
N/A = not applicable
On January 30, 2004, Fitch, Inc. lowered its ratings on Old National Bancorp and
Old National Bank to BBB and changed its outlook on Old National from "negative"
to "stable."
As of March 31, 2004 Old National Bank had the capacity to borrow $1.037 billion
from the Federal Reserve Bank's discount window. Old National Bank is also a
member of the Federal Home Loan Bank ("FHLB") of Indianapolis, which provides a
source of funding through FHLB advances. Old National also maintains
relationships in capital markets with brokers and dealers to issue certificates
of deposits and short-term and medium-term bank notes. In addition, at March 31,
2004, Old National had $660 million available for issuance under a $1 billion
global bank note program for senior and subordinated debt.
Old National Bancorp, the parent company, has routine funding requirements
consisting primarily of operating expenses, dividends to shareholders, debt
service, net derivative cash flows and funds used for acquisitions. Old National
Bancorp obtains funding to meet its obligations from dividends and management
fees collected from its subsidiaries and the issuance of debt securities. At
March 31, 2004 the parent company's other borrowings outstanding was $274.6
million, compared with $43.4 million at March 31, 2003. This increase in other
borrowings was driven by the issuance of $100 million of fixed-rate medium-term
notes and the reclassification of $161.9 million related to guaranteed preferred
beneficial interests in subordinated debentures, which was partially offset by
medium-term note maturities of $30 million. See Note 8 to the consolidated
financial statements for a discussion of the reclassification. Old National
Bancorp's debt scheduled to mature in the next 12-months is $3.2 million. These
debt obligations are expected to be met through current cash balances and
dividends from subsidiaries. Federal banking laws regulate the amount of
dividends that may be paid by banking subsidiaries without prior approval. For
further information regarding dividend restrictions, see Note 19 of the notes to
the consolidated financial statements of the 2003 annual report. At March 31,
2004, Old National had an SEC shelf registration in place for the issuance of
$200 million preferred securities by a series of Trusts. Old National has issued
$150 million of these securities, called trust preferred securities, and has the
capacity to issue an additional $50 million.
28
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Old National's principal
executive officer and principal financial officer have concluded that Old
National's disclosure controls and procedures (as defined in Exchange Act Rule
13a-14(c) under the Securities Exchange Act of 1934, as amended), based on their
evaluation of these controls and procedures as of the end of the period covered
by this Form 10-Q, are effective at the reasonable assurance level as discussed
below to ensure that information required to be disclosed by Old National in the
reports it files under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission and that such
information is accumulated and communicated to Old National's management,
including its principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding required disclosure.
Limitations on the Effectiveness of Controls. Management, including the
principal executive officer and principal financial officer, does not expect
that Old National's disclosure controls and internal controls will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within the company have
been detected. These inherent limitations include the realities that judgements
in decision-making can be faulty, and that breakdowns can occur because of
simple error or mistake. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more people or by
management override of the controls.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be only
reasonable assurance that any design will succeed in achieving its stated goals
under all potential future conditions, over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
29
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE
ITEM 2. CHANGES IN SECURITIES
ISSUER PURCHASES OF EQUITY SECURITIES
- ----------------------------------------------------------------------------------------------------
Total Number Maximum Number (or
of Shares Approximate Dollar
Total Average Purchased as Value) of Shares
Number Price Part of Publically that May Yet Be
of Shares Paid Per Announced Plans Purchased Under
Period Purchased Share or Programs the Plans or Programs
- ----------------------------------------------------------------------------------------------------
01/01/04 - 01/31/04 346,139 $21.31 346,139 2,965,183
02/01/04 - 02/29/04 94,100 21.28 94,100 2,867,307
03/01/04 - 03/31/04 27,500 22.36 27,500 2,854,710
- ----------------------------------------------------------------------------------------------------
Year-to-date 3/31/04 467,739 $21.55 467,739 2,854,710
====================================================================================================
NOTE: Old National announced on December 4, 2003, that the board of directors
approved the continuation of the company's stock repurchase program up to 5% of
the company's outstanding stock for 2004.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits filed as part of this report and exhibits incorporated herein
by reference to other documents are as follows:
Exhibit
Number
3 (i) Articles of Incorporation of Old National (incorporated by
reference to Exhibit 3(i) of Old National's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002).
3 (ii) By-Laws of Old National, amended and restated effective April 22,
2004, are filed herewith.
4 Instruments defining rights of security holders, including
indentures.
Form of Indenture between Old National and Bank One Trust Company,
NA, as trustee (incorporated by reference to Exhibit 4.1 to Old
National's Registration Statement on Form S-3, Registration No.
333-87573, filed with the Securities and Exchange Commission on
September 22, 1999).
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10 Material contracts
(a) Form of Severance Agreement for Thomas F. Clayton, Michael R.
Hinton, Daryl D. Moore and John S. Poelker, as amended, is filed
herewith.*
(b) Form of Change of Control Agreement for Thomas F. Clayton,
Michael R. Hinton, Daryl D. Moore and John S. Poelker, as
amended, is filed herewith.*
(c) Severance Agreement, between Old National and James A. Risinger,
is filed herewith.*
(d) Old National Bancorp 1999 Equity Incentive Plan (incorporated by
reference to Old National's Form S-8 filed on July 20, 2001).*
(e) Construction Manager Contract, dated as of May 30, 2002, between
Old National Bancorp and Industrial Contractors, Inc.
(incorporated by reference to Old National's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002).
(f) Owner-Contractor Agreement, dated as of October 11, 2002, between
Old National Bancorp and Industrial Contractors, Inc.
(incorporated by reference to Old National's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002).
(g) Summary of Old National Bancorp's Outside Director Compensation
Program (incorporated by reference to Old National's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).*
31.1 Certification of Principal Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Principal Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
--------------
* Management contract or compensatory plan or arrangement
(b) Reports on Form 8-K filed during the quarter ended March 31, 2004.
Old National filed a current report on Form 8-K dated February 18, 2004.
The purpose of this Form 8-K was to report the retirement of Old National's
Chairman and Chief Executive Officer, James A. Risinger.
Old National filed a current report on Form 8-K dated January 23, 2004. The
purpose of this Form 8-K was to report the transcript of the conference
call held by Old National for the fourth quarter 2003.
Old National filed a current report on Form 8-K dated January 22, 2004. The
purpose of this Form 8-K was to report Old National's results for the
fourth quarter 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OLD NATIONAL BANCORP
--------------------
(Registrant)
By: /s/ John S. Poelker
--------------------------------
John S. Poelker
Executive Vice President and Chief Financial Officer
Duly Authorized Officer and Principal Financial Officer
Date: May 10, 2004
32