Old National Bancorp Q3 2023 Earnings Call Transcript

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October 24, 2023

There are 11 speakers on the call.

Operator

Welcome to the Old National Bancorp Third Quarter 2023 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC's regulations 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 certain risks, uncertainties and other factors that could cause actual results or outcomes to differ from those discussed. The company refers you to its forward looking statements legend in the earnings release and presentation slides.

Operator

The company's risk factors are fully disclosed and discussed in the SEC filings. The company's financial statements to provide appropriate comparisons. These non GAAP measures are intended to assist investors' understanding of performance trends. Reconciliation of these numbers are contained within and the appendix of the presentation. And now to turn the call over to National CEO, Jim Ryan for opening remarks.

Speaker 1

Good morning. We're pleased to be with you today to share details about our strong third quarter performance. The strength of our franchise remains evident in the results outlined on slide 4. This quarter was like our last. Business as usual for Old National with growth in deposits, well controlled funding cost, ample liquidity and stable credit quality.

Speaker 1

We also saw slightly positive loan growth the impact of the company's earnings release. We've reported an EPS of $0.49 for the quarter. Adjusted EPS was $0.51 per common share with adjusted ROA and ROATCE of 1.26% and 21% respectively. Importantly, we achieved significant year over year tangible book value growth. Our adjusted efficiency ratio remained under 50%.

Speaker 1

Total and core deposit balances were up 3% during the quarter as we compete effectively for new deposits. Our total cost of deposits was 161 basis points and we maintained our deposit pricing discipline with a low 30% total deposit beta cycle to date. As a result, we beat our own margin expectations. Our credit quality remains stable. Net charge offs were 24 basis points, 15 of which related to a single charge off the SEC that we don't believe indicates a broader weakness in the portfolio.

Speaker 1

We remain diligent in managing the portfolio consistent with our past strong credit management practices. On the new business side, while our loan pipeline has declined, we continue to actively seek and win new loan business where we can develop full relationships, meet hurdle rate returns and have a strong credit profile. Broadly, some competitors have seen significant appetite change creating new opportunities for us. As a result, we expect the loan portfolio to grow modestly for the remainder of the year. We also continue to hire top revenue generating talent selectively, albeit slower than previous quarters.

Speaker 1

With that, I will now turn the call over to Brendan to cover the quarter results in more detail.

Operator

Thanks, Jim. Turning to

Speaker 2

our quarter end balance sheet on Slide 5. We continue to effectively navigate this challenging operating environment. Our focus on deposit acquisitions resulted in 3% growth this quarter and has led to a better funding mix, stronger than expected net interest income and will allow us to take advantage of new lending opportunities while many of our peers are pulling back. Our strong earnings improved all regulatory capital ratios and our tangible book value per share increased 3%, excluding the AOCI impact. On Slide 6, we present the trend in total loan growth and portfolio yields.

Speaker 2

Total loans grew in line with our expectations. We sold $389,000,000 of non relationship C and I loans at par during the quarter as we look to manage liquidity while prioritizing lending to our clients with full banking relationships. Excluding these loan sales, total loans increased 1.7%. The investment portfolio declined in line with our expectations and the duration remained steady at 4.3. Cash flows from portfolio are expected to be $1,400,000,000 over the next 12 months.

Speaker 2

Moving to slide 7, we show our trend in total deposits, which increased $1,000,000,000 including approximately $300,000,000 of normal seasonal public fund inflows. All three of our lines of business posted solid growth and client acquisition. Growth came mostly from the money market and time deposit categories, offset by declines in non interest bearing deposits, which continue to experience migration to higher yielding products. Non interest bearing deposits as a percentage of total deposits was 28% at quarter end, and we anticipate this downward trend to continue in the near term, albeit at a slower pace. Market conditions continue to put upward pressure on deposit rates with interest bearing deposit costs up 56 basis points to 2.22%.

Speaker 2

Total deposit costs were 1.61 percent for the quarter, which equates to a cycle to date total deposit beta of a very low 30%. While it's challenging to estimate the terminal beta, we have a strong history of managing deposit rates and are confident we can maintain our cost advantage through the remainder of the rate cycle. Our deposit promotions have been highly successful at bringing in new clients and we are actively working to deepen and expand those relationships. Slide 8 provides our quarter end income statement. We reported GAAP net income applicable to common shares of $144,000,000 or $0.49 per share.

Speaker 2

Reported earnings include $6,000,000 in pre tax merger related charges. Excluding these items, our adjusted earnings per share was $0.51 our profitability continues to be strong with an adjusted return on average tangible common equity of 20.9% and adjusted return on average assets of 1.26%. Moving on to slide 9, we present details of our net interest income and margin. As expected, deposit pricing led to modest declines in both NII C and NIM. We anticipate approximately $3,400,000,000 in fixed rate loans to be repriced over the next 12 months reinvestment rates approximately 260 basis points better than runoff yields.

Speaker 2

This should provide a considerable offset to late cycle deposit repricing. Slide 10 shows trends in adjusted non interest income, which was $81,000,000 for the quarter. All of our primary fee businesses performed as expected with a slight seasonal uptick in mortgage revenue. Continuing to Slide 11, we show the trend in adjusted non interest expenses. Adjusted expenses were $239,000,000 and our adjusted efficiency ratio was a low 49.7%.

Speaker 2

These results were generally in line with our Q2 guidance. On Slide 12, we present our credit trends, which remain stable, reflecting the quality of both our commercial and consumer portfolios. Delinquencies and non performing loan trends were both within our normalized range. Net charge offs were 24 basis points with 15 basis points related to a single long term C and I client that suffered operational challenges following a generational management succession. Our 3rd quarter allowance including reserve for unfunded commitments stands at $337,000,000 or 103 basis points of total loans and was largely unchanged from the prior quarter.

Speaker 2

Our reserve model assumptions already reflect a material slowdown in the economy consistent with the Moody's S3 scenario, portfolio. We have no material change in our office portfolio with less than 1% of total outstandings located in the central business districts. Our shared national credit portfolio of 7% of our total portfolio has above average credit quality and continues to perform well. We did have some limited exposure to mandated regulatory downgrades this quarter, which accounted for half of our credit migration. That said, as part of our ongoing portfolio management, we were able to exit one of these credits at par shortly following the forced downgrade announcement.

Speaker 2

On Slide 15, we provide highlights from our recent examination of fixed rate CRE maturities over the next 18 months. We continue to believe given the small exposure and current performance that the refinance risk in this portfolio will be minimal. Slide 16 details our Q3 commercial production. Our slightly lower production and pipeline this quarter reflect moderating client demand and are focused on obtaining full banking relationships with new loan requests. On Slide 17, we present further insights into our franchise leading deposit base, which is exceptionally granular and long tenured.

Speaker 2

Please note we reduced our broker deposit exposure this quarter, which stands at only 3.2 percent of total deposits compared to the industry average of 10.6% last quarter. On Slide 18, we provide a comprehensive overview of our capital position at the end of the quarter. We observed improvements in all regulatory capital ratios and a modest decline in our TCE ratio, which was driven by rate related increases in AOCI. Our above peer return on tangible common equity coupled with our peer average dividend payout ratio should result in OMB accreting capital at a faster rate than most. Additionally, we anticipate 30% of our outstanding AOCI to accrete to capital by the end of 2024.

Speaker 2

In summary, our strong third quarter performance exceeded our expectations. We have improved the efficiency of our balance sheet with strong core deposit growth, which has led to a better funding mix and better than expected net interest income. We continue to demonstrate our ability to expand our customer base while maintaining peer leading deposit costs. Our strong liquidity also positions us well to take advantage of new lending opportunities. Our credit portfolio remains stable and our disciplined approach to managing expenses is evident in our quarterly adjusted efficiency ratio of 49.7%.

Speaker 2

Slide 20 includes thoughts on our outlook for the remainder of 2023. We believe our current pipeline should support 4th quarter growth in the low single digit range. We anticipate continued success in our execution of our deposit strategy and expect to meet or exceed the industry growth in the 4th quarter. We're expecting a 3% to 4% decline in NII in Q4, which equates to a 13% year over year increase, a slight upward revision from our Q2 guide that anticipated 12% year over year growth. This updated guidance assumes no additional Fed actions, a through the cycle interest bearing deposit beta of 46% by year end and non interest bearing deposits falling to 26%.

Speaker 2

We expect fee businesses to be stable with typical seasonal patterns. Longer term, we remain bullish on both TM and Wealth as our investments in these areas build momentum. Our expense outlook for the Q4 should be consistent with Q3, excluding merger related charges with some potential variability related to incentive accruals. Provision expense should continue to be limited to loan growth, portfolio change and non PCD charge offs as we believe we have adequate reserves against the PCD book. Turning to taxes, we expect approximately $5,000,000 in tax credit amortization for the remainder of 2023 with a corresponding full year effective tax rate the impact of 25% on a core FTE basis and 23% on a GAAP basis.

Speaker 2

With those comments, I'd like to open the call for your questions. We do have the full team available, including Mark Sander, Jim Sandgren, and John Moran.

Speaker 1

That prepared or concluded our prepared remarks. So with any questions, please go ahead and ask.

Speaker 3

Your first question comes from the line of Scott Siefers of Piper Sandler. Your line is open.

Speaker 4

Good morning, everybody. Good morning.

Speaker 5

Thanks for taking the question.

Speaker 1

Good morning, Scott. Sorry for the delay and I'm glad you're back on top.

Speaker 5

No problem. Me too. Thank you.

Speaker 6

Let's see.

Speaker 5

I was hoping to start on the deposit side, maybe just some expanded thoughts on the way You were sort of thinking about the balance between growth and rate or cost on the deposit side. So you accelerated total deposit growth, which was great, but in some higher cost areas. So just maybe kind of philosophically how you were thinking about things through the Q3?

Speaker 7

Yes. We think there's opportunities to continue to lend and building some dry powder through deposit growth makes a lot of sense to us at the rates we're able to do it. You think about growing deposits at a low 4 handle and be able to lend that out in mid to high 7s, I think gives you marginal margin that is a quality risk as a return. So that's the thought process. So as long as we can continue to raise deposits at those levels and have lending opportunities in those high sevens.

Speaker 7

We'll continue to do that.

Speaker 4

And as we raise a lot of deposits, Scott, through money markets. A good chunk of that is new clients to the bank. And so we think there's opportunities to expand those relationships over time. So I think it's And we've got room to do that, to raise some market competitive deposits right now.

Speaker 5

Okay. Perfect. And then, I know you talked about the 3 nearly $3,500,000,000 in fixed rate loans that would So reprice over or recast over the next 12 months. Do you think that will be allow or will be enough to allow the margin to trough in the next quarter or 2 if the Fed finishes its tightening cycle?

Speaker 7

Scott, I think it's still too early to tell. I can tell you that it does provide a a lot of offset to late cycle deposit repricing. If it's going to be enough, hard to say, but it's a meaningful amount. And couple that with the $1,400,000,000 of cash flows from the vest portfolio. That's a meaningful offset.

Speaker 7

Okay.

Operator

All right.

Speaker 5

Perfect. Thank you.

Speaker 1

Thanks, Scott.

Speaker 3

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

Speaker 6

Hi, good morning everyone.

Speaker 1

Good morning, Terry.

Speaker 6

Maybe start a question on capital CET1 up to 10 for TCE62. So can you discuss any near term capital targets given what you call market conditions here in the presentation and essentially what would you need to see to begin repurchasing stock again?

Speaker 7

No, Terry, the spread and no capital targets now. Not thinking about turning on our share repurchase and no dividend actions considered at this time. We'll continue to kind of run the play and grow capital.

Speaker 6

Thanks. And a question for Jim. Could you just expand on the 2024 growth strategy that's right in the beginning of the press release, maybe best markets to build share, opportunistic hiring? And then how does that play into your expense management for next year?

Speaker 1

Yes, I mean, great question. I think it's more business as usual than not. We continue to find great opportunities to hire folks selectively. That pace has slowed down a little bit. We're not really considering any kind of new markets in terms of hiring, relate commercial relationship talent or wealth management talent.

Speaker 1

They may come along and we certainly see a fair number of those opportunities. But I think it's more business as usual for us and continue to really execute on the teams and the folks who've already hired. And then I think there's still opportunities within our existing footprint to continue to add selectively in our key markets. So I would say it's more business as usual. We're sensitive to obviously the demand on the expense base and we'll continue to look ways to be judicious in how we manage our expenses going forward, hopefully to offset any incremental costs from those new hires.

Speaker 6

I'll squeeze 1 in. Brendan, any thoughts on expense growth for next year? Any targets in mind?

Speaker 7

No specific targets. I'll just state here that we have a good track record of making sure our expense base does not grow much beyond sort of a typical merit increase and we have some levers there to pull. But as Jim said, it's not going to stop us from investing in ourselves, but we got to find ways to pay for that.

Speaker 6

Thanks for taking my questions.

Speaker 1

Thanks, Terry.

Speaker 3

Your next question comes from the line of Jon Strom of RBC Capital Markets. Your line is open.

Speaker 8

Hey, thanks. Good morning.

Speaker 1

Good morning, John. Good to hear from you.

Speaker 8

Hey, thank you. Brennan, just one for you back on Scott's question. Your NII guide suggests a pretty big step down in the Q4 in the margin. Can you just help us understand a little bit more some of the puts and takes there in terms of what's going on?

Speaker 7

Yes, largely that kind of 3% to 4 percent decline in Q4 is almost entirely deposit cost related. Again, we're not getting a lot of help on the asset beta the at this point other than the fixed rate repricing. But the question on the NII side is can we continue to kind of grow through that and help bolster NII. And that's the game

Speaker 8

plan. Okay. All right. And then I guess on Slide 17, you talk about the exception pricing on deposits. How is that trending?

Speaker 8

Is that intensifying or easing off at all?

Speaker 7

Not intensifying. We're still less than 30% of our book is exception priced or promotional related. And again those are in the very low 4% handle. So we feel really good about that marginal funding opportunity that we have.

Speaker 8

Okay, good. The loan sale, I think I understand it, but was that the SNC that you talked about?

Speaker 7

One of them was a shared net script and the rest out of the capital markets book. You're talking it was out

Speaker 4

of our capital markets book, which was a transactional book that we had used to soak up excess liquidity over time. And so all of the loan sales of the $400,000,000 came out of that book.

Speaker 8

Okay. More to come on that or not?

Speaker 4

At a lesser pace. If there is additional, it will be at a lesser pace than that in the next couple of quarters, I would say.

Speaker 8

Okay. Okay, good. And then you kind of touched on it, Jim, with Terry's question. But the pipeline change, it It feels like maybe the market is slowing down, but you're seeing better opportunities. But can you just maybe touch on some of the elements of the pipeline change?

Speaker 8

Thank you.

Speaker 4

I think the pipeline change is reflective of what's going on in the economy more broadly as well as our selectivity that Jim alluded to. Yes. There's certainly less CRE activity overall in the marketplace clearly. And even C and I is a little bit We're projecting a little slower growth over the next couple of quarters than we saw the quarters before as an industry. We think we're still well positioned to outgrow the industry.

Speaker 4

We think industry growth is going to be a little more muted going forward.

Speaker 1

Yes. I do think we've seen a significant appetite change out of some of our regional competitors and that is creating new opportunities. We were with a client last night, that fall would fall into that camp and I think that's going to create nice opportunities for us, both on our ability to get the right credit profile picture, a full relationships and full pricing. So Those are expectations. We are definitely open for business.

Speaker 1

We're still on the offense and still believe we've got room to continue to grow here.

Speaker 8

Okay. All right. Thank you very much.

Speaker 1

Thanks, John.

Speaker 3

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

Operator

Hey, good morning.

Speaker 1

Good morning, Chris.

Speaker 9

Jim or Mark, the comment about the forced downgrades of the certain relationships. Maybe a little bit more color there. I presume that's the Shared National Credit book, but just a little bit of color on the regulatory guidelines you talked about.

Speaker 4

As Brendan alluded to, about half of our downgrades this quarter came from the SNC review. All credits which we feel good about. And as Brendan alluded to, we already sold 1. Frankly, I think we'll sell another one this quarter at par. So we feel good about all those credits and yet a little downgrade as a result of the exam.

Speaker 4

Other than that, you saw a little bit of risk migration, but no concentrations, no nothing to point to, just kind of reflective of what's going on in the broader economy.

Speaker 9

Okay. And then maybe just Brandon on the balance sheet, you obviously have the ability to bring down borrowings, not a lot on the books, but anything you're considering in terms of retooling the balance sheet into next year with the securities portfolio or plans to kind of reduce that you talked about the $1,400,000,000 that's 12 months cash flows?

Speaker 7

Yes, no major restructuring the U. S. Portfolio, but we'll continue to manage our portfolio appropriately and take appropriate action there, but no major

Operator

restructuring plan.

Speaker 9

Okay, great. And then maybe the last one, a lot of questions this quarter for the industry about the trough in revenues, net interest income. How are you thinking without providing 2024 full year, how are you thinking about just the cadence of the NII for the next several quarters?

Speaker 7

Yes, as we talked about, so I think there's the 3% to 4% step down. And then largely, I think this becomes sort of the fight for flat that we've kind of been talking about. I think that's how we're going to be thinking about 2024. And if we get some rate cuts in the back half, the forecast actually plays out, I think that's where you start to see some upside.

Speaker 10

All right. That's helpful. Thank you.

Speaker 1

Thanks, Chris.

Speaker 3

Your next question comes from the line of Brody Preston with UBS. Your line is open.

Speaker 10

Hey, good morning, everyone.

Speaker 1

Good morning, Brody.

Speaker 10

Hey, I just wanted to ask a question. It's a little bit in the weeds. But just the $3,400,000,000 of the fixed rate loan repricing over the next 12 months, it doesn't quite put to like the call report bucket, I guess, like as I would have expected maybe in the 3 to 12 months. So I guess I wanted to ask kind of what's driving that difference? And then also is there any kind of the lumpiness to that 3.4 or is it fairly evenly distributed?

Speaker 7

Fairly evenly distributed. This is coming right out of our asset liability management system, which would obviously include some prepaid speed assumptions in there, which is probably the biggest piece of what you from a regulatory report versus what we're sharing.

Speaker 10

Okay, great. That's helpful. And I appreciated the additional SNC disclosure on Slide 14. I did want to ask If you could give us any color, I know it's a small book for you, but was there anything specific that drove the downgrades you know that you know from the SNC review like was it debt service coverage related like just looking for a little bit of color there?

Speaker 4

It was principally debt service coverage Related, it was a half dozen credits across with no concentration in industry, Rohde. So And again, looked at off of 'twenty two numbers. So I think there's more to come as 'twenty three plays out.

Speaker 10

Got it. Got it. No, that's extremely helpful. I also wanted to ask, I saw the tidbit on the maturing CRE loans, and it said loans underwritten at 300 basis the current market rate. And so I just wanted to clarify, I think on your previous slides, you said you originate and stuff in the 7% to the $7.70 range or something like that.

Speaker 10

Does that mean that you underwrote those loans that are coming due at the ability to form at a 10% interest rate. Am I understanding that correctly?

Speaker 7

Yes. So Brody, that note means 300 basis points above the rate at the time of origination. So if you have the forehand

Operator

at the

Speaker 7

time of origination, those are underwritten at 7%, which again helps give us confidence given current market rates. Most of those will have the ability to cash flow.

Speaker 10

Got it. That's very helpful. And then the excuse me, on the deposit slide, You noted that 25% of total deposits are exception and special pricing with a weighted average rate of 4.17. How would you expect those deposits, the beta on those deposits to be if rate cuts did happen in the back half of twenty twenty four.

Speaker 7

Yes, we have the opportunity to reprice a lot of those in a hurry. Some of them are fully indexed. Many of them are related to teaser rates that will reset early back end and middle of next year. So with the opportunity to bring those down in a hurry if we get rate cuts.

Speaker 10

Got it. Thank you for that. And then just one follow-up on the SNC review. And I guess it's not as familiar with the process. That's for each individual bank, right?

Speaker 10

So different banks go through that at different points in the year. Is that accurate?

Speaker 4

No. So it's done across universally reviewed at the agent bank and then the other participants in those credit facilities have to adjust the rates at the time that it's issued to the agent bank, but it's all done at once.

Speaker 10

Got it. Thank you very much. I appreciate it.

Speaker 1

Thanks, Brody.

Speaker 3

There are no further questions at this time. I'd like to turn the call back to Mr. Jim Ryan for closing remarks.

Speaker 1

Well, thank you all for coming on this morning. We apologize for the technical difficulties we had this Hopefully, you're able to get all your information and get all your questions answered. But as always, Lonnel and Brendan and John and the whole team will be here to answer any questions you might have. We hope you have a great day. Thank you.

Speaker 3

This concludes the Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old National's website, oldnational.com. A replay of the call will also be available by dialing 800 7,702,030, access code 5,258,325. This replay will be available through November 8. If anyone has additional questions, please contact Lonnel Dierkols at 812 4,641,366.

Speaker 3

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

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