Earnings Call: Q2 2021

Jul 20, 2021

Welcome to the Old National Bancorp Second Quarter 2021 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC's Regulation FD. Corresponding presentation slides can be found on the Investor Relations page at oldnational.com and will be archived there for 12 months. Management would like to remind everyone that certain statements on today's call may be forward looking in nature and are subject to certain risks, uncertainties and other factors that could cause actual results to differ from those discussed. The company's risk factors are fully disclosed and discussed within its SEC filings. In addition, certain slides contain non GAAP measures, which management believes provide more appropriate comparisons. These non GAAP measures are intended to assist investors' understanding of performance trends. Reconciliations for these numbers are contained within the appendix of the presentation. I'd now like to turn the call over to Jim Ryan for opening remarks. Mr. Ryan? Thank you, and good morning. Starting on Slide 5, we are pleased to share our 2nd quarter results and an update on our recently announced partnership with First Midwest Bank. I would characterize this quarter's results as right on plan. Adjusted earnings per share were $0.41 when adjusted for Specific merger charges, O and B Way cost and debt securities gains. During the quarter, commercial loans excluding PPP loans grew nicely at 11%. Our net interest margin was stable, capital markets and wealth management revenue were stronger and mortgage revenue was down, consistent with our expectations with a lower pipeline valuation and a smaller gain on sale margin. Expenses were well managed and Slightly higher, primarily due to merit increases and higher incentive accruals. Credit quality metrics remained benign. Adjusted return on average tangible common equity was a strong 14.6% and the adjusted efficiency ratio was just under 58%. During the quarter, we worked hard with our clients in the SBA forgiveness process. 83 percent of round 2 loans through the forgiveness process. Most of our reported credit quality metrics improved during the quarter. We have reduced reserves consistent with our modeling as a result of the better than better expected economic forecast and the massive stimulus programs. We still have approximately 30% of our reserves supported by qualitative adjustments given the higher than average level of economic uncertainty that exist today. The further we move beyond the pandemic's economic shock, the more confidence we will have in taking our reserve closer to day 1, CECL. A quick update on hiring. We continue to add significant talent during the quarter. The cost of the increased investment in talent will start impacting our expenses slightly in the back half of the year. Our talent pipeline remains strong. We have a fantastic story to tell and we have strong interest from new team members wanting to join. Moving to Slide 6, which contains a quick refresher on some of the more significant details of our merger with First Midwest. I will not bother reading the slide, But I will share that I reminded each time that I'm with our First Midwest colleagues how much our cultures are aligned and how strong our strategic fit truly is. Additionally, conversations with investors and sell side analysts confirm they understand and agree with our strategic rationale. Moving to Slide 7, both companies have a tremendous integration history and experience and our work is off to a good start. We have made the appropriate SEC filings and regulatory applications. Kendra Banzo and Jeff Newcomb have been appointed to lead the merger integration efforts and we have assembled a group of over 350 team members from both companies to help with the integration. We have met with client facing and support team members from both companies and they're all excited and engaged. Additionally, the management team An outside advisor deeply involved in making technology selections, which we hope to finalize this summer. We also expect A special meeting of shareholders to be held in the Q3 for each company. And lastly, despite the ongoing distraction from the pandemic And now our transformational merger, we have remained focused on serving our clients and communities, and I think our results illustrate the success of those efforts. I will now turn the call over to Brendan. Thank you, Jim. Turning to Slide 8. Our GAAP earnings per share is $0.38 while our adjusted earnings per share is $0.41 Adjusted earnings exclude $6,500,000 in early merger related charges, $700,000 in debt securities gains and the last of our OMB Way related charges of $400,000 Slide 9 shows the trend in commercial loans and the related commercial pipeline and production trends, all excluding the impact of PPP loans. Q2 represents our 4th consecutive quarter of organic loan growth and over that year commercial outstandings have grown more than $1,000,000,000 Q2 commercial production of $1,100,000,000 was the 2nd highest on record, resulting in a $250,000,000 increase in outstanding over prior quarter. Commercial activity continues to be strong throughout the footprint and we are heading into Q3 with a very healthy $2,600,000,000 pipeline. Turning briefly to pricing. Absolute coupons of new business continues to be impacted by the low rate environment and the high percentage of floating rate versus fixed rate production. However, spreads and risk adjusted returns are strong and have remained consistent throughout this rate cycle. The investment portfolio increased slightly in quarter as deposit growth once again outpaced total loan growth. We are taking a disciplined approach of putting excess liquidity to work in our investment portfolio with new money yields of 1.53 percent and a portfolio duration well within 5 years. Moving to Slide 10, average deposits increased 11 While the growth in period end balances has moderated, total cost of deposits for the quarter was a low 6 basis points, a 1 basis point improvement over Q1. Next on Slide 11, you will see details of our net interest income and margin. Net interest income increased $1,800,000 quarter over quarter, largely due to our strong commercial loan growth. Excluding the impact of PPP, interest income increased $2,400,000 which was slightly better than expectations as the impact of earning asset growth more than offset the decline in asset yields. Net interest margin declined 3 basis points to 2.91% from prior quarter, primarily due to the low rate environment's impact on asset yields. Core margin excluding accretion and PPP declined just 2 basis points to 2.72%. Slide 12 shows trends in adjusted non interest income. Adjusted non interest income of $51,000,000 in Q2, $4,000,000 lower than the $55,000,000 we recorded in the Q1. The decline was primarily driven by lower mortgage banking revenue that was partially offset by quarter over quarter improvements in all of our other major fee categories. The decline in mortgage revenues macro headwinds impacting the industry today. While mortgage production was largely flat from Q1, a decline in both the size End value of the secondary pipeline resulted in a $5,600,000 decrease in revenue. I would also remind you that Q1 was positively impacted by a $1,200,000 recapture of prior year's MSR impairment charge. Next Slide 13 shows the trend in adjusted non interest expenses. Adjusting for merger charges, O and B related charges and tax credit amortization, non interest expense was $121,000,000 These results were consistent with our expectations and our Q1 guidance. Turning to PPP loans on Slide 14, you will see a roll forward of those balances, which stood at $721,000,000 at quarter end. We continue to assist PPP clients with forgiveness with approximately 83 With that, I will turn it over to Daryl to discuss credit. Thank you, Brendan. As we've presented in the past, this quarter's Slide 15 reflects the performance of our loan portfolio both on a current quarter and historical trend basis. Total 30 day delinquencies continued their improving trend for a 4th consecutive quarter falling to 9 basis points at the most recent quarter's end. As our commercial delinquencies have historically been on the low side, the improvement we have seen over the past several quarters has been concentrated in retail portfolio with lower than historic delinquency rates in the 1 to 4 family residential mortgage, indirect auto and HELOC portfolios. Government payments and higher levels of savings due to reduced spending during the pandemic have almost certainly been a contributing factor to the lower retail delinquency numbers. While the effect of these payments will diminish over time, many of our borrowers will benefit from the child tax credit payments, which began last week and will continue at minimum at least through With all that being said, these extremely low levels of delinquencies are, in my opinion, unsustainable in the long run. Net charge offs continued well contained with the $300,000 recovery posted in the quarter. While total recoveries were slightly lower than last quarter At the lowest level posted over the last 6 quarters, gross charge offs were less than $1,000,000 which led to the net recovery for the period. Non performing loans fell for the 2nd consecutive quarter mainly on the reduction of non accrual loans in the period. As you can see, the gap between Old National and its Peers in this particular metric has favorably narrowed over the last several quarters. We continue to perform well in net charge offs to non performing measurement category With net charge offs as a percent of non performing loans being well south of 5% over the last 6 years. This, as you can see, is significantly lower than peer levels over the time As a closing comment, I would say that the challenges our borrowers are currently facing are much different than what we might have imagined 15 months ago. On the C and I side, the most significant challenges many of our clients seem to be facing are supply shortages and the lack of dependable adequately trained labor. Additionally, we may see impacts on margins going forward with borrowers who are unwilling or unable at the present time to pass along higher input costs to customers. On the commercial real estate portfolio front, we think all banks continue to watch to see what long term impacts the pandemic might have on the retail and office portfolio segments. With those comments, I'll turn the call back over to Brendan. Thank you, Daryl. On Slide 16, you will see the details of our 2nd quarter allowance, which support a modestly lower reserve level. That said, we recognize that not all sectors of our economy have recovered and the threat of future COVID related disruption persists. As a result, we believe it is prudent to maintain a larger than normal qualitative reserve until we have greater clarity on the economic outlook. I would also like to remind you that we continue to carry $41,000,000 in unamortized marks from our acquired portfolios. While these marks will not directly offset charge offs, Any remaining marks will accrete through margin upon resolution. As I wrap up my comments, here are some key takeaways. We are very pleased with the fundamental results of the quarter. Double digit commercial loan growth led to higher core net interest income despite interest rate headwinds. Mortgage revenues were down due to pipeline valuation and normalizing margins, While all our other fee businesses posted quarter over quarter improvements, expenses remained well controlled and our strong credit quality continued to keep credit costs low. Slide 17 includes thoughts in our outlook for 2021. We ended the quarter with a healthy $2,600,000,000 commercial pipeline, which supports our favorable outlook on loan growth. This historically low interest rate environment will continue to put pressure on net interest income, which should be mitigated through continued earning asset growth. The PPP loan forgiveness process continues for our round 1 and round 2 clients and we expect runoff of round 2 balances to occur in the latter half of twenty twenty one and and the recognition of most of the related $26,000,000 in unamortized fees to occur at that time. We expect our fee businesses We are encouraged by the momentum in our wealth business and the strong commercial activity should help maintain a high level of performance in our capital markets business. While mortgage revenue will continue to follow industry trends, current production levels and gain on sale margins should support quarterly revenue consistent with Q2 throughout the remainder of the year. Our other fee lines are expected to be stable in the near term. Our outlook on expenses is consistent with our prior guidance. We expect a modest increase in the back half of the year as our efforts to attract top revenue talent picks up momentum. Lastly, a brief update on taxes. We continue to expect a reduction in the volatility caused by our tax credits as we work through the last of the remaining 1 year historical tax credit commitments. In total, we are expecting approximately $5,000,000 in tax credit amortization for the year with a corresponding full year effective tax rate of approximately 21%. Our first question comes from Ben Gurlinger with Hovde Group. Your line is open. Good morning, Ben. Good Good morning. I was going to start off with just loan growth in general. You guys seem to have pretty consistently beat both Midwest and National peer growth trends over the past, let's call it, 4 quarters or so. I know you guys have done a great job getting out in the markets. I was wondering if you could shed a little light on to kind of the secret sauce, if you will, of what Old National is doing to not only Exceed peers, but also have pretty sustainable growth really for the past 4 quarters. Yes, Ben. This is Jim Sandgren. I don't know if there's any secret sauce. Obviously, we're a strong relationship bank. We've been Out calling on customer lift for the last 12 months, while many other banks obviously were working from home. And so that provided us an opportunity to serve our clients. We brought in a lot of new prospects. I think we were pretty opportunistic as other banks might have changed kind of their credit stances. So I just think it's kind of blocking and tackling, being out, helping our customers when they need us. And so that mentality has carried through Throughout the year and it certainly helped us as we've started the first half of this year. Obviously, pipelines look good for the back half of the year. And so again, I think I don't know if there's any secret sauce. I think the fact that we restructured through the ONB way and aligned skill sets of our relationship managers with the Managers with the client needs, I think that's played a major role as well. But I just think it's the fact that we are out Building strong relationships and being there for our clients and being opportunistic for those new relationships as well. Ben, I would just add, it's all hands on deck. I'm going to spend the next 2 days in Northern Indiana out calling on clients. So It's all hands on deck. We're all locked arms and we continue to believe we're doing building quality relationships For the long term health and success of our company and it's a primary focus of our entire leadership team. Okay, great. That was a bit of a softball question. So the harder one would be, your new production yields are A little lower than your net interest margin today. And then even though you have a great deposit base and it's very low Cost. I was wondering how you weigh continued growth against the net interest margin. Every loan you put on should be A little dilutive today. I guess that they're floating. So I was wondering how you manage balance sheet growth relative to maintaining that NIM? Yes, Ben. This is Brendan. Yes, we look very closely at the pricing. We have very strict risk adjusted return hurdles all of our loans. And as I said in my comments earlier, our spreads have held in throughout this rate cycle. They've been strong. So you think about that floating rate production today relative to LIBOR, that's 200 plus basis points over LIBOR for that floating rate production. I think so we'll continue to put on loans at that rate and feel really good about it. Okay, great. I will step back and get in the queue. Thanks, Ben. Our next question comes from Scott Siefers with Piper Sandler. Your line is open. Good morning, Scott. Good morning, guys. How are you doing? Good. Maybe you didn't get up as early as some others this morning, but good to hear from you anyways. Oh, man. You just couldn't let it pass, couldn't you? Sorry, Scott. No worries. I'll get up earlier next time. Honestly, there are so many going. I'm just thankful that I dialed the right phone number. Let's see, but thanks for taking the question. Just wanted to sort of follow-up on the environment for commercial lending. I feel like last year you guys Capitalized so well on some of your larger competitors in particular kind of shutting down for the year. To what degree have you noticed that there, especially the larger guys, are they sort of back in the market in a bigger way, Number 1. And then number 2, how, if at all, is that impacting the competitive dynamic as you see it? Yes, Scott. This Jim saying, there's no question that really everyone's back in the market now. So competitive pressures are certainly heating up. Again, we're staying very disciplined as we think about credit structure, but we're still getting a lot of it back. Our pipeline, I think, remains robust as we Pointed out. So still feel good about the back half and there'll be deals that we're going to walk away from because there's certainly some structures out there that are getting stretched and that's Okay. But overall, I think clients feel really good about their opportunities to be successful in the back half of the year and into 2022. It's always going to be competitive out there and I think we like our chances given our relationship banking model. Okay, perfect. Thank you. And then I guess just a question on the merger. So President Biden had put out that executive order a couple of weeks ago. Have you guys seen any impact in discussions with regulators on the approval process? I mean, the order kind of left a lot to the imagination. So just I'm curious how the conversations are going and if there's any change visavis what you might have thought prior to seeing the order? No changes, no additional feedback from any of our regulators. Obviously, we're curious, we're not Sure. If it applies to us or maybe our biggest brother out there. So time will only tell as we go through the regulatory approval process, but really no indications of any Any different, just full steam ahead. Okay, perfect. All right. Thank you guys very much. I appreciate it. Thanks, Scott. Thanks, Scott. Our next question comes from Chris McGratty with KBW. Your line is open. Good morning, Chris. Hey, Jim. How are you doing? I wanted to ask about the bond portfolio, given the back down the move down in rates lately. Yes, obviously, I'm growing it too dramatically, but interested if you're a bit more cautious about growing that near term And maybe what reinvestment rates are today versus the $153,000,000 that you gave in the quarter? Thanks. Yes. So we'll continue to grow that investment fully to the extent we have excess liquidity that we can't put to work in the loan portfolio. New business rates are probably down a little bit marginally from average for the quarter, but not dramatically so at this So we'll continue to be disciplined and our hope is that we'll continue to grow loans at the pace that we're growing. And as we talked about the end of peer deposits have That growth has moderated a bit. So hope is that we can continue to drive a better earning asset mix through the back half of the year. Okay. And on the loan growth, historically, the origination has been quite granular. I'm interested if any of the growth this quarter was a deviation from that or if it continued? No, it's still pretty granular, Chris. I mean average loan new production still continues to grow over time. And I think we're still just a little bit over I think $1,000,000 So that again, that's grown over the last few quarters, but still fairly granular. Okay. Maybe just one last one for Daryl. I mean, I'm looking at your slide on the reserve. I'm trying to I think we're all trying to figure out where reserves bottom With the improvement, appreciating that you think around 30% of your reserve is still qualitative. Do we get to do we breach CECL Day 1 this year if the economy continues to improve at the pace it is? Hey, Chris, this is Brendan. I'll take that one. Look, what I'll tell you is the is this credit portfolio is actually a better quality than it was Pre pandemic at day 1 CECL. That said, we are going to be very, very judicious in bringing that reserve down until we get some clarity Around the economic outlook. But as we look forward, it's a possibility and we'll measure our portfolio on our CECL reserve based on the model when the time Great. Thank you very much. Our next Question comes from Terry McEvoy with Stephens. Your line is open. Good morning, Terry. Hi, good morning, everyone. Maybe the first question, your outlook for expenses, you talk about the investment in new revenue generating talent positions. I'm just wondering if you could expand on certain markets where you're hiring talent and what areas of the bank? Yes, Terry. This is Jim Sandgren. We're really focusing in really on primarily on wealth and commercial. And we've added some really good talent in both those areas and up in the Minnesota region. We've added some talent in our loan production office They're in St. Louis as well. Recently added some great talent in Louisville. So it's really across the footprint. We're being, again, opportunistic. We can find great talent. We're adding them to the team, and we're going to continue to do that. I would also add, we actually put a couple Key hires in our IT and data areas here recently too, which it's a function of us getting bigger, Us folks are getting better at some of those technology needs. And so, while it's a much smaller part of the total, we are investing in some key support Thanks. And then maybe Jim, Ryan, a question for you. What's been the feedback from your customers in say Michigan, Indiana In the Twin Cities where there's just no overlap with First Midwest. I'm just curious from their perspective, is there any reason For them to expect or worry about change at all or are they maybe excited about the merger given what it could bring to the table? Yes. I think by and large, I would characterize as the team members and our clients are excited about the prospects of just being bigger, being able to bring more product To the table, more services to the table. I think everybody's kind of generally excited. And obviously, we don't know if There'll be any impact to those individual clients, but I think generally everybody is really excited about the prospects of just being having a bigger balance sheet as well. Great. Thank you. Thanks, Terry. Our next question comes from Jon Arfstrom with RBC Capital Markets. Your line is open. Good morning, John. Hey, good morning. Good morning. A couple of follow ups. Terry's question on some of the new hires and you're flagging that as maybe some a bit of an expense headwind later in the year. How material do You expect the hiring to be in terms of the expense impact? Yes, not material. I'm thinking of the $1,000,000 to $2,000,000 range per quarter. Pretty consistent with what we said as we were heading into the year about building that pipeline of talent $1,000,000 to $2,000,000 approximately. Okay. Brandon, question for you on the or maybe Jim, on the deposit growth slowing a bit. So a little bit different than peers, kind of like your loan growth is a little bit different than peers. But why do you think that is for you? And does that Potentially make you a little more optimistic on the ability to hold the NIM later in the year if this continues? Yes, we'll see. I think the excess Liquidity has been sort of certainly outside of our control and largely driven by stimulus. I know Jim and the team are still after their gathering deposits still a focus of ours. But I think the stimulus generates excess Liquidity seems to be not moderating at least in our footprint in our portfolio today. And as I talked about earlier, I do think it will be helpful to margin as we are able to put Back to work in the loan portfolio rather than the invest portfolio. Okay. And is it too simple to say that maybe some of your commercial clients are using Some of their deposits and you're seeing some of this maybe pull through in terms of loan growth or is it just the stimulus slowdown? Yes. Like I said, so core deposits still did grow quarter over quarter, just not at the rapid pace that they grew before. And actually our business deposits actually grew more than Our retail deposits this last quarter. PPP funds are starting to get drawn down a bit, but we're still holding a lot of PPP money still on deposit Okay. And then Daryl, one for you. You touched on commercial real estate retail and office. Just Any changes in terms of your thinking there? Any new concerns? Or any information you can share? John, I don't think they are. I think That has to play out as leases expire, right? So you've got people in those in the office buildings today and in the retail structures that are still paying lease payments. The real decision making comes when those leases expire and what they do. Do they vacate those buildings? Do they renegotiate much lower rates? So We're all concerned about it or watching it, but I think we've still got probably 12, 24 months before that all kind of plays out and we see the trends. All right. Thanks for the questions or the answers. I appreciate it. Thanks, Our next question comes from David Long with Raymond James. Your line is open. Good morning, David. Good morning, everyone. First question is related to credit and maybe this is more for Daryl. But as You were going through the process, the due diligence process with First Midwest. I'm sure you got to look at a lot of their loan book. Are you having constant discussions with them pre Closing about the loan makeup and how they're thinking about their ratings? Or is that something that won't really happen until after the deal closes? Yes, David, it's Darryl. We're not having extensive conversations only because as the two banks put their books together, there is Very, very little difference in the way we approach loans and the way we look at risk. And so, the transition with the 2 banks is Probably as easy as any merger we've done or partnership we've been up to this point in time. So we're getting policies together. We're looking at those. We're tweaking those. We're communicating a lot. But There's not a lot of kind of arm wrestling about you're doing this right, you're doing this wrong. It's just pretty much the same. Got it. Thank you, Darryl. Appreciate that. And then, as far as IT spending goes, in the near term prior to the close of the deal, Do you guys adjust how you're spending or how you're thinking about spending? And then any changes in your longer term spending strategies once the deal does close? Hey, David, this is Brendan. No, I think as we talk about in the call, I think both banks And really robust IT roadmaps. We're going to continue to sort of complete those roadmaps and make incremental investments where it makes sense as the time goes, but no Material change in the run rate of our IT spend has been contemplated, but we think we have plenty of room to invest in some technology Investments that will be meaningful to the combined organization going forward. David, I would just add, the war for talent will continue on our side. We're going to continue to At all of our markets and especially doubling down in Chicago and Milwaukee and places like that. So I would just add that we're going to continue to invest. I'm convinced that's the key to our success and our story Resonates really well right now and we're going to take advantage of that and make sure we invest in a lot of great talent. Got it. Thank you, guys. Appreciate it. There are no further questions at this time. Well, great. Again, we appreciate all your support. And as always, we are here to answer any questions This concludes Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old Dominion's website, Old National's website, oldnational.com. A replay of the call will also be available by dialing 855 859-two thousand and fifty six, conference ID code 7,447,647. This replay will be available through August 3rd. If anyone has additional questions, please contact Lonnel Walton at 812 464-1366. Thank you for your participation in today's conference call.