SECURITIES & 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 June 30, 1998 [ ] 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 0-10888 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, Evansville, Indiana 47708 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code, (812) 464-1200 Former name, former address and former fiscal year, if changed since last reports. 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 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 approximately 27.6 million shares outstanding at June 30, 1998. OLD NATIONAL BANCORP FORM 10-Q INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Page No. Consolidated Balance Sheet June 30, 1998 and 1997, and December 31, 1997. . . 3 Consolidated Statement of Income Three and six months ended June 30, 1998 and 1997. 4 Consolidated Statement of Cash Flows Six months ended June 30, 1998 and 1997. . . . . . 5 Notes to Consolidated Financial Statements . . . . 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . 10 PART II OTHER INFORMATION . . . . . . . . . . . . . . . . 14 SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . 15 INDEX OF EXHIBITS . . . . . . . . . . . . . . . . . . . . 16 2 <TABLE> <CAPTION> OLD NATIONAL BANCORP CONSOLIDATED BALANCE SHEET June 30, June 30, December 31, ($ in thousands) (unaudited) 1998 1997 1997 Assets <S> <C> <C> <C> Cash and due from banks. . . . . . . . . . $175,111 $147,208 $159,241 Money market investments . . . . . . . . . 2,530 1,968 7,868 Investment Securities: U.S. Treasury . . . . . . . . . . . . . . 102,255 136,187 117,188 U.S. Government agencies and corporations. . . . . . . . . . . . 974,201 966,627 951,444 Obligations of states and political subdivisions. . . . . . . . . . . . . . 468,912 452,773 452,933 Other . . . . . . . . . . . . . . . . . . 51,407 42,447 45,411 --------- --------- ---------- Total Investment Securities . . . . . . 1,596,775 1,598,034 1,566,976 --------- --------- ---------- Loans Commercial. . . . . . . . . . . . . . . . 969,164 848,305 878,690 Commercial real estate. . . . . . . . . . 800,568 698,014 762,505 Residential real estate . . . . . . . . . 1,454,220 1,340,959 1,416,963 Consumer credit, net of unearned income . 660,446 675,595 672,043 Financial . . . . . . . . . . . . . . . . 20,000 1,800 -- --------- --------- ---------- Total Loans . . . . . . . . . . . . . . 3,904,398 3,564,673 3,730,201 Allowance for loan losses . . . . . . . (48,875) (44,358) (46,233) --------- --------- ---------- Net Loans . . . . . . . . . . . . . . . 3,855,523 3,520,315 3,683,968 Other assets . . . . . . . . . . . . . . . 349,590 267,413 270,162 --------- --------- ---------- Total Assets. . . . . . . . . . . . . . $5,979,529 $5,534,938 $5,688,215 ========= ========= ========= Liabilities Deposits Noninterest bearing demand. . . . . . . . $485,879 $463,723 $502,276 Interest bearing: NOW accounts. . . . . . . . . . . . . . 439,283 442,740 450,381 Savings accounts. . . . . . . . . . . . 466,982 484,410 469,589 Money market accounts . . . . . . . . . 651,171 645,765 660,240 Certificates of deposit $100,000 and over . . . . . . . . . . . 363,841 318,544 359,695 Other time. . . . . . . . . . . . . . . 1,996,359 1,877,979 1,856,549 --------- --------- ---------- Total Deposits. . . . . . . . . . . . . 4,403,515 4,233,161 4,298,730 --------- --------- ---------- Short-term borrowings. . . . . . . . . . . 488,435 479,130 442,686 Other borrowings . . . . . . . . . . . . . 520,212 289,744 388,832 Accrued expenses and other liabilities . . 81,973 67,155 80,764 --------- --------- ---------- Total Liabilities . . . . . . . . . . . . 5,494,135 5,069,190 5,211,012 Shareholders' Equity Common stock. . . . . . . . . . . . . . . 27,639 26,401 27,457 Capital surplus . . . . . . . . . . . . . 296,942 252,354 299,988 Retained earnings . . . . . . . . . . . . 145,165 178,377 133,218 Accumulated other comprehensive income, net of tax . . . . . . . . . . 15,648 8,616 16,540 --------- --------- ---------- Total Shareholders' Equity. . . . . . . . 485,394 465,748 477,203 --------- --------- ---------- Total Liabilities and Shareholders' Equity. . . . . . . . . . . . . . . . . $5,979,529 $5,534,938 $5,688,215 ========= ========= ========= The accompanying notes are an integral part of this statement. </TABLE> 3 <TABLE> <CAPTION> OLD NATIONAL BANCORP CONSOLIDATED STATEMENT OF INCOME Three Months Ended Six Months Ended ($ in thousands except share June 30, June 30, and per share data) (Unaudited) 1998 1997 1998 1997 <S> <C> <C> <C> <C> Interest income Loans including fees: Taxable . . . . . . . . . . . . . . . $83,069 $77,494 $163,839 $152,325 Non-taxable . . . . . . . . . . . . . 1,398 1,073 2,642 2,040 Investment securities: Taxable . . . . . . . . . . . . . . . 17,839 18,900 36,288 36,802 Non-taxable . . . . . . . . . . . . . 5,828 5,931 11,489 11,927 Money market investments . . . . . . . 228 222 689 398 ------- ------- ------- ------- Total Interest Income . . . . . . . . 108,362 103,620 214,947 203,492 ------- ------- ------- ------- Interest Expense Savings, NOW and money market accounts . . . . . . . . 10,725 11,279 21,541 22,423 Certificates of deposit of $100,000 and over . . . . . . . . . . 5,573 4,031 10,922 7,807 Other time deposits. . . . . . . . . . 27,251 26,274 53,212 51,481 Short-term borrowings. . . . . . . . . 5,235 5,605 10,421 10,479 Other borrowings . . . . . . . . . . . 6,327 3,954 12,255 7,614 ------- ------- ------- ------- Total Interest Expense. . . . . . . . 55,111 51,143 108,351 99,804 ------- ------- ------- ------- Net Interest Income . . . . . . . . . 53,251 52,477 106,596 103,688 Provision for loan losses. . . . . . . 3,097 2,811 6,100 5,630 ------- ------- ------- ------- Net Interest Income After Provision For Loan Losses . . . . . . . . . . . 50,154 49,666 100,496 98,058 ------- ------- ------- ------- Noninterest Income Trust fees . . . . . . . . . . . . . . 3,071 2,752 6,244 5,553 Service charges on deposit accounts. . 4,071 3,968 7,921 7,802 Loan servicing fees. . . . . . . . . . 1,528 1,391 2,952 2,796 Securities gains (losses), net . . . . 32 (4) 51 (10) Other income . . . . . . . . . . . . . 4,865 3,096 9,008 6,406 ------- ------- ------- ------- Total Noninterest Income. . . . . . . 13,567 11,203 26,176 22,547 ------- ------- ------- ------- Noninterest Expense Salaries and employee benefits . . . . 22,242 21,930 44,624 43,590 Occupancy expense. . . . . . . . . . . 2,254 2,253 4,492 4,595 Equipment expense. . . . . . . . . . . 3,146 3,149 6,225 6,164 Marketing expense. . . . . . . . . . . 1,522 1,413 2,839 2,703 FDIC insurance expense . . . . . . . . 168 178 347 328 Data processing expense. . . . . . . . 1,308 1,305 2,551 2,574 Supplies expense . . . . . . . . . . . 970 1,047 1,955 2,115 Communication and transportation expense 1,644 1,619 3,446 3,326 Other expenses . . . . . . . . . . . . 5,617 5,289 10,811 10,187 ------- ------- ------- ------- Total Noninterest Expense . . . . . . 38,871 38,183 77,290 75,582 ------- ------- ------- ------- Income from continuing operations before income taxes. . . . . . . . . 24,850 22,686 49,382 45,023 Provision for income taxes . . . . . . 7,495 6,807 14,912 13,539 ------- ------- ------- ------- Income from continuing operations. . . 17,355 15,879 34,470 31,484 Income (loss) from discontinued operations . . . . . . . . . . . . . (9,193) 393 (9,854) 846 ------- ------- ------- ------- Net Income . . . . . . . . . . . . . . $8,162 $16,272 $24,616 $32,330 ======= ======= ======= ======= Income from continuing operations per common share Basic . . . . . . . . . . . . . . . . $ 0.62 $ 0.57 $1.25 $1.13 ======= ======= ======= ======= Diluted . . . . . . . . . . . . . . . $ 0.61 $ 0.56 $1.21 $1.10 ======= ======= ======= ======= Weighted average common shares outstanding: Basic . . . . . . . . . . . . . . 27,724,321 27,784,456 27,583,960 27,890,074 ========== ========== ========== ========== Diluted . . . . . . . . . . . . . 28,895,185 29,380,412 28,958,427 29,485,098 ========== ========== ========== ========== The accompanying notes are an integral part of this statement. </TABLE> 4 <TABLE> <CAPTION> OLD NATIONAL BANCORP CONSOLIDATED STATEMENT OF CASH FLOWS Six Months Ended June 30, ($ in thousands) (unaudited) 1998 1997 Cash flows from operating activities: <S> <C> <C> Net income . . . . . . . . . . . . . . . . . . . . . . $ 24,616 $ 32,330 -------- -------- Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation. . . . . . . . . . . . . . . . . . . . . 4,828 4,667 Amortization of intangible assets . . . . . . . . . . 684 642 Net premium amortization on investment securities . . 1,371 780 Provision for loan losses . . . . . . . . . . . . . . 6,100 5,630 Loss (gain) on sale of investment securities. . . . . (51) 10 Gain on sale of assets. . . . . . . . . . . . . . . . (391) (126) (Increase)decrease in interest receivable . . . . . . 523 (914) Increase in other assets. . . . . . . . . . . . . . . (81,285) (27,433) Increase in accrued expenses and other liabilities. . . . . . . . . . . . . . . . . 1,815 1,790 -------- -------- Total adjustments . . . . . . . . . . . . . . . . . (66,406) (14,954) -------- -------- Net cash flows provided by (used in) operating activities . . . . . . . . . . . . . . . (41,790) 17,376 -------- -------- Cash flows from investing activities: Purchase of investment securities available-for-sale . (305,534) (243,057) Proceeds from maturities and paydowns of investment securities available-for-sale . . . . . . . . . . . . 213,323 139,396 Proceeds from sales of investment securities available- for-sale. . . . . . . . . . . . . . . . . . . . . . . 59,594 20,711 Net principal collected from (loans made to) customers: Commercial and financial . . . . . . . . . . . . . . (111,164) (53,488) Mortgage . . . . . . . . . . . . . . . . . . . . . . (123,038) (78,194) Consumer . . . . . . . . . . . . . . . . . . . . . . 8,952 20,183 Proceeds from sale of mortgage loans . . . . . . . . . 47,967 11,112 Proceeds from sale of premises and equipment . . . . . 410 45 Purchase of premises and equipment . . . . . . . . . . (4,658) (5,137) -------- -------- Net cash flows used in investing activities . . . . . (214,148) (188,429) -------- -------- Cash flows from financing activities: Net increase (decrease) in deposits and short-term borrowings: Noninterest bearing demand. . . . . . . . . . . . . . (16,397) (48,558) NOW Accounts. . . . . . . . . . . . . . . . . . . . . (11,098) (6,746) Savings accounts. . . . . . . . . . . . . . . . . . . (2,607) (4,361) Money market accounts . . . . . . . . . . . . . . . . (9,069) (60,028) Certificates of deposit $100,000 and over . . . . . . 4,146 60,556 Other time deposits . . . . . . . . . . . . . . . . . 139,810 24,274 Short-term borrowings . . . . . . . . . . . . . . . . 45,749 143,145 Other borrowings. . . . . . . . . . . . . . . . . . . 139,794 51,589 Cash dividends paid. . . . . . . . . . . . . . . . . . (12,671) (11,924) Common stock repurchased . . . . . . . . . . . . . . . (20,648) (18,223) Common stock reissued, net of shares used to convert subordinated debentures. . . . . . . . . . . . . . . 9,461 4,213 -------- -------- Net cash flows provided by financing activities . . . 266,470 133,937 -------- -------- Net increase (decrease) in cash and cash equivalents . 10,532 (37,116) Cash and cash equivalents at beginning of period . . . 167,109 186,292 -------- -------- Cash and cash equivalents at end of period . . . . . . $177,641 $149,176 ======== ======== Total interest paid. . . . . . . . . . . . . . . . . . $106,437 $ 98,034 ======== ======== Total taxes paid . . . . . . . . . . . . . . . . . . . . $ 13,484 $ 14,061 ======== ======== The accompanying notes are an integral part of this statement. </TABLE> 5 Old National Bancorp Notes to Consolidated Financial Statements 1. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Old National Bancorp and its affiliate entities (ONB). All significant intercompany transactions and balances have been eliminated. In the opinion of management, the consolidated financial statements contain all the normal and recurring adjustments necessary to present fairly the financial position of ONB as of June 30, 1998 and 1997 and December 31, 1997, and the results of its operations for the three and six months ended June 30, 1998 and 1997 and its cash flows for the six months ended June 30, 1998 and 1997. All prior period information has been restated for the effects of business combinations accounted for as pooling-of-interests. 2. Net Income Per Share Net income per common share computations are based on the weighted average number of common shares outstanding during the periods presented. A 5% stock dividend was paid January 29, 1998 to shareholders of record on January 8, 1998. All share and per share data presented herein have been restated for the effects of this stock dividend. Net income on a diluted basis is computed as above and assumes the conversion of ONB's 8% convertible subordinated debentures (Note 5). For the diluted computation, net income is adjusted for the assumed reduction in interest expense, net of income tax effect, and an additional 1.1 million for the quarter and 1.3 million year-to-date common shares are assumed to be issued in connection with the conversion of the remaining outstanding debentures. <TABLE> <CAPTION> Earnings Per Share Reconciliation ($ and shares in thousands except per share data): For the three For the three months ended months ended June 30, 1998 June 30, 1997 ---------------------------- ---------------------------- Per-Share Per-Share Income Shares Amount Income Shares Amount Basic EPS <S> <C> <C> <C> <C> <C> <C> Income from continuing operations available to common stockholders $17,355 27,724 $0.62 $15,879 27,784 $0.57 ===== ===== Effect of Dilutive securities: Stock options 88 96 8% convertible debentures 264 1,083 368 1,500 ------- ------ ------- ------ Diluted EPS Income from continuing operations available to common stockholders + assumed conversions $17,619 28,895 $0.61 $16,247 29,380 $0.56 ======= ====== ===== ======= ====== ===== 6 For the six For the six months ended months ended June 30, 1998 June 30, 1997 --------------------------- ---------------------------- Per-Share Per-Share Income Shares Amount Income Shares Amount Basic EPS Income from continuing operations available to common stockholders $34,470 27,584 $1.25 $31,484 27,890 $1.13 ===== ===== Effect of Dilutive securities: Stock options 88 95 8% convertible debentures 611 1,286 736 1,500 ------- ------ ------- ------ Diluted EPS Income from continuing operations available to common stockholders + assumed conversions $35,081 28,958 $1.21 $32,220 29,485 $1.10 ======= ====== ===== ======= ====== ===== </TABLE> 3. Merger and Divestiture Activity Pending Mergers On May 27, 1998, ONB and Southern Bancshares LTD (Southern) of Carbondale, Illinois, executed a definitive merger agreement. ONB will issue common shares in exchange for all of the outstanding common shares of Southern. The transaction will be accounted for as a pooling-of-interests. The merger is subject to the approvals of Southern's shareholders and regulatory authorities. As of June 30, 1998, Southern's financial statements reflected $248.1 million in total assets, net loans of $186.0 million, total deposits of $220.2 million and net income for the six months then ended of $1,670 thousand. This merger is expected to be consummated in the first quarter of 1999. Discontinued Operations In April 1998, ONB announced it would look at exit strategies from its sub- prime lending affiliate, Consumer Acceptance Corporation (CAC). During June 1998, ONB finalized the sale of CAC's sub-prime auto loans, which closed in July 1998, and has included the loss in the second quarter results. ONB has accounted for this entity as discontinued operations on the consolidated financial statements. Net assets of the entity which were included in other assets were $71.1 million at June 30, 1998, $71.6 million at June 30, 1997 and $79.2 Million at December 31, 1997. Income(loss) from discontinued operations for the three and six months ended June 30, 1998 and 1997 were as follows ($ in thousands): Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 Income (loss) before taxes ------- ----- ------- ------ from operations of discontinued operations $(6,833) $654 $(7,943) $1,411 Income tax expense (benefit) (2,734) 261 (3,183) 565 ------- ----- ------- ------ Income (loss) from operations of discontinued operations (4,099) 393 (4,760) 846 ------- ----- ------- ------ Loss before taxes from disposal of discontinued operations (8,489) 0 (8,489) 0 Income tax expense (benefit) (3,395) 0 (3,395) 0 ------- ----- ------- ------ Loss from disposal of discontinued operations (5,094) 0 (5,094) 0 ------- ----- ------- ------ Income (loss) from discontinued operations $(9,193) $393 $(9,854) $846 ======= ===== ======= ====== Income (loss) from discontinued operations per common share Basic $(0.33) $0.01 $(0.36) $0.03 ======= ===== ======= ===== Diluted $(0.32) $0.01 $(0.34) $0.03 ======= ===== ======= ===== 4. Investments The market value and amortized cost of investment securities as of June 30, 1998 are set forth below ($ in thousands): Market Value Amortized Cost Available for Sale, at market value $1,596,775 $1,570,710 ========== ========== 5. Borrowings ONB has outstanding $22.0 million of 8% convertible subordinated debentures which are due September 15, 2012, unless previously converted or redeemed. The debentures are convertible at any time prior to maturity into shares of common stock of ONB at a conversion rate of 49.218 shares for each one thousand dollars principal amount of debentures. Interest on the debentures is payable on March 15 and September 15 of each year. The debentures are redeemable in whole or in part at the option of ONB at a premium to par value. Beginning September 15, 1998, debenture holders are entitled to an annual sinking fund of $2.5 million principal amount of debentures annually less conversions and redemptions. The debentures are subordinated in right of payment to all senior indebtedness of ONB. As of June 30, 1998, 1.1 million authorized and unissued common shares were reserved for conversion of the debentures. ONB has registered Series A Medium Term Notes in the principal amount of $50 million. The series has been fully issued. As of June 30, 1998, a total of $32 million of the notes were outstanding, with maturities ranging from one to five years and fixed interest rates of 6.1% to 7.0%. At June 30, 1997, ONB had outstanding $44 million of medium term notes. ONB also has registered Medium Term Notes in the principal amount of $150 million. These notes may be issued with maturities of nine months or more and rates may either be fixed or variable. As of June 30, 1998, a total of $64.3 million of the notes were outstanding, with maturities ranging from four to nine years and fixed interest rates from 6.4% to 7.0%. No notes were issued under this program as of June 30, 1997. As of June 30, 1998, ONB has $80 million in unsecured lines of credit with unaffiliated banks. These lines of credit include various informal arrangements to maintain compensating balances. The compensating balances are maintained for the benefit of the parent company by affiliate banks which normally maintain correspondent balances with unaffiliated banks. As of June 30, 1998, $13.4 million was outstanding under these lines bearing interest rates that averaged 6.33%. As of June 30, 1997, $67.8 million was outstanding. 8 6. Interest Rate Contracts ONB uses interest rate contracts such as interest swaps and caps to manage its interest rate risk. These contracts are designated as hedges of specific assets and liabilities. The net interest receivable or payable on swaps is accrued and recognized as an adjustment to the interest income or expense of the hedged asset or liability. The premium paid for an interest rate cap is included in the basis of the hedged item and is amortized as an adjustment to the interest income or expense on the related asset or liability. At June 30, 1998, ONB has an interest rate swap with a notional value of $20 million. The contract is an exchange of interest payments with no affect on the principle amounts of the underlying hedged liability. The fair value of the swap contract was $0.1 million as of June 30, 1998. ONB pays the counterparty a variable rate based on three-month LIBOR and receives a fixed rate of 6.50%. The contract terminates on or prior to March 13, 2008. At June 30, 1998, ONB has interest rate cap agreements (caps) with notional amounts of $11 million with a fair value of $0.1 million. These caps are indexed to LIBOR with a strike price of 5.00% and mature in 1999. The carrying value at June 30, 1998 was $0.1 million. ONB is exposed to losses if a counterparty fails to make its payments under a contract in which ONB is in the receiving position. Although collateral or other security is not obtained, ONB minimizes its credit risk by monitoring the credit standing of the counterparties and anticipates that the counterparties will be able to fully satisfy their obligation under the agreements. 7. Impact of Accounting Changes Effective January 1, 1998, ONB adopted Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income" which establishes standards for reporting and display of comprehensive income and its components. The new rule requires reporting of comprehensive income, which includes net income and all other nonowner changes in equity during the period. <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, June 30, June 30, 1998 1997 1998 1997 ($ in Thousands) <S> <C> <C> <C> <C> Net income $ 8,162 $ 16,272 $ 24,616 $ 32,330 Unrealized gains(losses)on securities: Unrealized holding gains(losses) arising during period, net of tax (1,764) 7,519 (861) 730 Less: reclassification adjustment for (gains) losses realized in net income, net of tax (19) 2 (31) 6 ------- -------- -------- -------- Net unrealized gains (losses) (1,783) 7,521 (892) 736 ------- -------- -------- -------- Comprehensive income $ 6,379 $ 23,793 $ 23,724 $ 33,066 ======= ======== ======== ======== </TABLE> ONB also adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for reporting information on operating segments. Segment data will be disclosed starting December 31, 1998, including interim periods. The adoption of the above statement did not have a material impact on ONB's disclosures. 9 PART I. FINANCIAL INFORMATION ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following management's discussion and analysis is presented to provide information concerning the financial condition of ONB as of June 30, 1998, as compared to June 30, 1997 and December 31, 1997, and the results of operations from continuing operations for the three and six months ended June 30, 1998 and 1997. Financial Condition ONB's assets at June 30, 1998 were $5.980 billion, a 8.0% increase since June 1997 and a 5.1% increase since December 1997. Earning assets, which consist primarily of money market investments, investment securities and loans, grew 6.6% over the prior year. During the past year, the mix of earning assets reflected loan growth of 9.5% while money market investments and investment securities remained steady. Since December 1997, earning assets increased 3.7% with loans growing 4.7% and investment securities and money market investments increasing 1.6%. At June 30, 1998, total risk assets (defined as loans 90 days or more past due, nonaccrual and restructured loans and foreclosed properties) increased slightly to $19.0 million from $18.8 million as of December 31, 1997. As of these dates, risk assets in total were 0.49% and 0.50%, respectively, of total loans and foreclosed properties. June 30, December 31, 1998 1997 Nonaccrual loans $12,499 $11,233 Restructured loans 231 248 Foreclosed properties 2,315 2,881 ------ ------ Total Non-Performing Assets 15,045 14,362 Past due 90 days or more 3,962 4,405 ------ ------ Total Risk Assets $19,007 $18,767 ====== ====== Risk assets as a % of total loans and foreclosed properties 0.49% 0.50% ==== ==== As of June 30, 1998, the recorded investment in loans for which impairment has been recognized in accordance with SFAS No. 114 and 118 was $5.8 million with no related allowance and $42.5 million with $9.7 million of related allowance. ONB's policy for recognizing income on impaired loans is to accrue earnings unless a loan becomes nonaccrual. When loans are classified as nonaccrual, interest accrued during the current 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 nonaccrual is recorded to principal. For the six months ended June 30, 1998, the average balance of impaired loans was $49.6 million and $1.6 million of interest was recorded. ONB's consolidated loan portfolio is well diversified and contains no concentrations of credit in any particular industry exceeding 10% of its portfolio. ONB has minimal exposure to construction lending or leveraged buyouts and no exposure in credits to foreign or lesser-developed countries. Total deposits at June 30, 1998, increased $170.4 million or 4.0% compared to June 1997. Brokered CD's, included in other time, increased $172.9 million 10 since June 1997. Since December 1997, total deposits increased $104.8 million or 2.4% with Brokered CD's increasing $150.6 million in this same period. Other categories had minimal fluctuations. Short-term borrowings, comprised of Federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings, increased $9.3 million since June 1997. Since December 1997, ONB's short-term borrowings increased $45.8 million. Capital Total shareholders' equity increased $19.6 million since June 1997 and has increased $8.2 million since December 1997. Since June 1997, accumulated other comprehensive income, primarily net unrealized gain on investment securities, increased $7.0 million. During the first six months of 1998, accumulated other comprehensive income decreased $0.9 million and $8.3 million of subordinated debentures converted to common stock. ONB's consolidated capital position remains strong as evidenced by the following comparisons of key industry ratios: <TABLE> <CAPTION> Regulatory Guidelines June 30, June 30, December 31, ------------------------ Minimum Well-Capitalized 1998 1997 1997 ------- ---------------- ---- ---- ---- Risk-based capital: <S> <C> <C> <C> <C> <C> Tier 1 capital to total avg assets (leverage ratio). . . . 4.00% 5.00% 7.83% 8.18% 7.95% Tier 1 capital to risk-adjusted total assets . . . . . . . . 4.00 6.00 11.82 12.46 12.16 Total capital to risk-adjusted total assets . . . . . . . . 8.00 10.00 13.64 14.56 14.24 Shareholders' equity to total assets N/A N/A 8.12 8.41 8.39 Each of ONB's affiliate banks have capital ratios which exceed regulatory minimum and well-capitalized guidelines. </TABLE> Liquidity and Asset/Liability Management ONB continually monitors its liquidity and actively manages its asset/liability position. The purpose of liquidity management is to match the sources of funds with anticipated customer borrowings and withdrawals and other obligations. The primary purpose of asset/liability management is to minimize the effect on net income of changes in interest rates and to maintain a prudent match within specified time periods of rate-sensitive assets and rate-sensitive liabilities. ONB also uses net interest income simulation modeling to better quantify the impact of potential interest rate fluctuations on net interest income. With this understanding, management can best determine possible balance sheet changes, pricing strategies, and appropriate levels of capital and liquidity which allows ONB to generate strong net interest income while controlling and monitoring interest rate risk. ONB simulates a gradual change in rates of 200 basis points up or down over 12 months and sustained for an additional 12 months. The policy limit for the maximum negative impact on net interest income over 12 months is 10%. At June 30, 1998 the model's fluctuation has not materially changed from December 31, 1997. Using static gap, ONB's rate-sensitive assets at June 30, 1998 were 78% of rate-sensitive liabilities in the 1-180 day maturity category and 83% in the 181-365 day category. These figures compared to 79% and 89% on December 31, 1997 and 79% and 89% on June 30, 1997. ONB's funds management committee meets bi-monthly to closely monitor and effect changes as needed in the consolidated rate-sensitivity position. Year 2000 With the new millennium drawing near, some computers and software throughout the world may be unable to properly handle dates after December 31, 1999. ONB has developed a plan to address its risk, and has identified and assessed its 11 critical software and hardware. ONB is following a four step approach which includes assessment, renovation, validation and implementation, with awareness being a top priority within and throughout each phase. This approach allows ONB to systematically identify and evaluate all areas of our corporation in a timely and effective manner. All mission critical items have completed the assessment phase and are on schedule to complete the renovation and validation phases by 12/31/98. Updates are reported to executive management of the holding company and the status of the project are reviewed periodically by the corporate and affiliate board of directors. At this time the estimated cost of Year 2000 compliance is not expected to be material to ONB. Results of Operations Income from Continuing Operations Income from continuing operations for the six months ended June 30, 1998 was $34.5 million, a 9.5% increase from the same period 1997. Income from continuing operations for the second quarter of 1998 was up 9.3% over 1997. Basic net income from continuing operations per common share for the second quarter of 1998 and for the six months ended June 30, 1998 were $0.62 and $1.25, respectively. The company's return on average assets (ROA) for the second quarter of 1998 was 1.19% compared to 1.17% for 1997. Year-to-date ROA percentages were 1.19% in 1998 and 1.17% for 1997. Return on average equity (ROE) for the quarter and the first six months of 1998 were 14.61% and 14.68%, respectively, excluding unrealized security gains(losses). These compare favorably to 1997 ROE results of 14.02% and 13.94% for similar periods. Growth in net interest income and other income generated the net income improvements. Net Interest Income/Net Interest Margin (taxable equivalent basis) Year-to-date net interest income for 1998 was $113,521 a 2.7% increase over 1997. Net interest income for the second quarter of 1998 was $56,785 compared to $55,908 in 1997, a 1.6% increase over the prior year. The net interest margin for the second quarter was 4.19% and 4.39% for 1998 and 1997, respectively. The year-to-date net interest margin percentage in 1998 was 4.22% compared to 4.38% in 1997. The lower net interest margin resulted from the lower and flatter yield curve and our investment in bank owned life insurance discussed in noninterest income. Increases in earning assets offset the declining yields to contribute to an improved net interest income. Provision and Allowance for Loan Losses The provision for loan losses was $3.1 million in the second quarter of 1998 compared to $2.8 million in the second quarter of 1997. Year-to-date, the provision for loan losses of $6.1 million compares to $5.6 million in 1997. ONB's net charge-offs were 0.21% of average loans for the current quarter, compared to 0.17% in the second quarter of 1997. For the first six months, net charge-offs were 0.18% in 1998 compared to 0.16% in 1997. The provision and net charge-off levels in the first half of 1997 were low. Levels in 1998 are comparable with the second half of 1997. The allowance for loan losses is continually monitored and evaluated both within each affiliate bank and at the holding company level to provide adequate coverage for potential losses. ONB maintains a comprehensive loan review program to provide independent evaluations of loan administration, credit quality, loan documentation, and adequacy of the allowance for loan losses. The allowance for loan losses to end-of-period loans of 1.25% at June 30, 1998 compares to 1.24% in 1997. The allowance for loan losses covers all under-performing loans by 2.6 times at June 30, 1998 compared to 2.5 times at December 31, 1997. 12 Noninterest Income Excluding securities gains (losses), noninterest income increased 20.8% in the three months ended June 30, 1998 as compared to the same period in 1997. For the first six months, this increase was 15.8%. Both increases were fueled by several factors. Trust fees were up 11.6% for the second quarter and 12.4% for the first six months and income from bank owned life insurance (BOLI) policies, purchased in March 1998 and included in other income, which generated $1.2 million income in the second quarter, $1.3 million year-to-date. There was no BOLI income in 1997. Brokerage income rose over 1997 in excess of 40% for both periods and reached $0.9 million for the quarter and $1.8 million for the first six months. Insurance commission income increased over 17% for these periods and added income of $1.3 million for the quarter and $2.5 million for the first six months. Most other categories of noninterest income were comparable to last year's results. Noninterest Expense Noninterest expense increased 1.8% in the second quarter of 1998 compared to 1997. For the first six months noninterest expense increased 2.3% from 1997. Salaries and benefits, together the largest individual component of noninterest expense, increased 1.4% in the second quarter of 1998 compared to 1997. For the first six months, this percentage increased 2.4%. Other expense increased 6.2% over the second quarter of 1997 and 6.1% over 1997 year-to-date. These increases were mainly related to new outsourcing charges, which would have replaced previous salaries and benefit expense, professional fees, and loan related expenses. Most other categories of noninterest expense experienced relatively small changes between the years. Provision for Income Taxes The provision for income taxes, as a percentage of pre-tax income, remained relatively unchanged in the second quarter at 30.1% compared to 30.0% in 1997. For the first six months, this percentage was 30.2% for 1998 and 30.1% in 1997. 13 PART II OTHER INFORMATION ITEM 1. Legal Proceedings NONE ITEM 2. Changes in Securities NONE ITEM 3. Defaults Upon Senior Securities NONE ITEM 4. Submission of Matters to a Vote of Security Holders None ITEM 5. Other Information If a shareholder proposal is introduced at the 1999 Annual Meeting of Shareholders without any discussion of the proposal in the proxy statement, and if the proponent does not notify the Company on or before March 1, 1999, as required by SEC Rule 14a-4(c)(1), of the intent to raise such proposal at the Annual Meeting of Shareholders, then proxies received by the Company for the 1999 Annual Meeting will be voted by the persons named as proxies in their discretion with respect to such proposal. Notice of such proposals is to be given to the Secretary of the Company in writing at its principal executive office, 420 Main Street, P.O. Box 718, Evansville, Indiana 47705. ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits as required by Item 601 of Regulation S-K. (10.1) Severance Agreement, as amended (10.2) Employment Agreement (27) Financial Data Schedule (b) ONB did not file a current report on Form 8-K during the quarter ended June 30, 1998. 14 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/s Ronald W. Seib Ronald W. Seib Vice President Corporate Controller Date: August 14, 1998 15 INDEX OF EXHIBITS Regulation S-K Reference (Item 601) 10.1 Severance Agreement, as amended 10.2 Employment Agreement 27 Financial Data Schedule