Old National Bank - 10-Q quarterly report FY

 

 

(Exact name of Registrant as specified in its charter)

 

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to the filing requirements for at least the past 90 days. Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Act.

Large accelerated filer þ      Accelerated filer o      Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock. The Registrant has one class of common stock (no par value) with 66,202,000 shares outstanding at October 31, 2007.

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying notes to consolidated financial statements are an integral part of these statements.

Comprehensive income for the quarters ended September 30, 2007 and 2006 was $36.3 million and $45.3 million, respectively.
The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying unaudited consolidated financial statements include the accounts of Old National Bancorp and its wholly-owned affiliates (“Old National”) and have been prepared in conformity with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. Such principles require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses, goodwill and intangibles, derivative financial instruments and income taxes are particularly subject to change. In the opinion of management, the consolidated financial statements contain all the normal and recurring adjustments necessary for a fair statement of the financial position of Old National as of September 30, 2007 and 2006, and December 31, 2006, and the results of its operations for the three and nine months ended September 30, 2007 and 2006. Interim results do not necessarily represent annual results. These financial statements should be read in conjunction with Old National’s Annual Report for the year ended December 31, 2006.

All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform with the 2007 presentation. Such reclassifications had no effect on net income.

FASB Interpretation No. 48 – In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 became effective for the Company on January 1, 2007. The impact of adopting FIN 48 is discussed in Note 14 to the consolidated financial statements.

SFAS No. 157 – In September 2006, the FASB issued Statement No. 157 – Fair Value Measurements. The standard defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The standard establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The new standard is effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 157 on the consolidated financial statements.

SFAS No. 159 – In February 2007, the FASB issued Statement No. 159 – The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard is effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 on the consolidated financial statements.

EITF 06-5 – In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5,Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance). This Issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the Issue discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. EITF 06-5 became effective for the Company on January 1, 2007 and resulted in a $0.1 million reduction to retained earnings.

On February 1, 2007, Old National acquired St. Joseph Capital Corporation (''St. Joseph’’), a banking franchise headquartered in Mishawaka, Indiana, for $78.1 million, including acquisition costs. Pursuant to the merger agreement, the shareholders of St. Joseph received $40.00 in cash for each share of St. Joseph stock in an all-cash transaction. Goodwill of $45.8 million was recorded, of which none is deductible for tax purposes. In addition, intangible assets totaling $14.5 million related to core deposits and customer relationships were recorded and are being amortized over 10 to 11 years. See Note 9 to the consolidated financial statements for additional information. On the date of acquisition, unaudited financial statements of St. Joseph showed assets of $452.9 million, which included $336.6 million of loans and $78.6 million of securities, $357.3 million of deposits and year-to-date net interest income and other income of $0.8 million and net loss of $3.3 million.

During the first quarter of 2006, Old National sold its financial center located in O’Fallon, Illinois, selling approximately $27.9 million in loans and assigning $22.2 million in deposits. The financial center was in a market no longer considered consistent with the Company’s strategy. The sale resulted in a pre-tax gain of $3.0 million which was included in income from continuing operations during the first quarter of 2006.

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during each period. Diluted net income per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. At September 30, 2007 and 2006, stock options to purchase approximately 5.8 million and 5.9 million shares, respectively, and restricted stock of 0.4 million shares were excluded from the computation of diluted net income per share because their inclusion would have been anti-dilutive.

The following table reconciles basic and diluted net income per share for the three months ended September 30:

The following table reconciles basic and diluted net income per share for the nine months ended September 30:

The following table summarizes the amortized cost and fair value of the available-for-sale and held-to-maturity investment securities portfolio at September 30, 2007 and December 31, 2006 and the corresponding amounts of unrealized gains and losses therein:

Year-to-date proceeds from the sales of investment securities available-for-sale were $180.3 million in 2007 and $298.7 million in 2006. For the nine months ended September 30, 2007, realized gains were $0.9 million and losses were $4.1 million. For the nine months ended September 30, 2006, realized gains were $4.4 million and losses were $3.7 million.

At September 30, 2007, Old National does not believe any individual unrealized loss represents other-than-temporary impairment. The unrealized losses are primarily attributable to changes in interest rates. Factors considered in evaluating the securities included whether the securities were backed by U.S. Government-sponsored agencies and credit quality concerns surrounding the recovery of the full principal balance. Old National has both the intent and ability to hold securities with any individual unrealized loss for a time necessary to recover the amortized cost.

Residential loans held for sale are recorded at lower of cost or market value determined as of the balance sheet date. A portion of Old National’s residential loans held for sale have been hedged using fair value hedge accounting in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The loans’ carrying basis reflects the effects of the SFAS No. 133 adjustments. At September 30, 2007 and December 31, 2006, Old National had residential loans held for sale of $13.3 million and $16.6 million, respectively. As of September 30, 2007 and December 31, 2006, ineffectiveness related to the hedge of a portion of the residential loans held for sale was immaterial.

During the first nine months of 2007, commercial real estate loans held for investment of $10.2 million and commercial loans of $4.0 million were transferred to loans held for sale at the lower of cost or market, resulting in a $2.5 million reduction to the allowance for loan losses.

Activity in the allowance for loan losses was as follows:

Individually impaired loans were as follows:

For the nine months ended September 30, 2007 and 2006, the average balance of impaired loans was $43.3 million and $38.9 million, respectively, for which no interest income was recorded. No additional funds are committed to be advanced in connection with impaired loans. Loans deemed impaired are evaluated primarily using the fair value of the underlying collateral.

Nonperforming loans were as follows:

Nonperforming loans includes both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. Nonaccrual loans related to the St. Joseph acquisition amounted to $13.1 million.

The following table shows the changes in the carrying amount of goodwill by segment for the nine months ended September 30, 2007 and 2006:

Goodwill is reviewed annually for impairment. Old National completed its most recent annual goodwill impairment test as of August 31, 2007 and determined that no impairment existed as of this date. Old National recorded $45.8 million of goodwill in 2007 associated with the acquisition of St. Joseph Capital Corporation.

The gross carrying amount and accumulated amortization of other intangible assets at September 30, 2007 and December 31, 2006 was as follows:

Other intangible assets consist primarily of core deposit intangibles and customer relationship intangibles and are being amortized on a straight-line or accelerated basis over their estimated useful lives, generally over a period of 10 to 25 years. Old National reviews intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. Old National recorded $14.5 million of other intangibles associated with the acquisition of St. Joseph Capital Corporation in 2007. Total amortization expense associated with other intangible assets for the nine months ended September 30 was $2.6 million in 2007 and $1.8 million in 2006.

Estimated amortization expense for the future years is as follows:

In March 2007, Old National committed to sell certain bank branch properties. A letter of intent was executed in May 2007 to sell eighty-five properties to an unrelated party for approximately $205 million and to lease them back pursuant to individual ten, fifteen, and twenty-four year triple-net leases. The properties are to be sold in a series of transactions.

The first transaction closed September 19, 2007, and included 25 banking and one insurance property. Old National received cash proceeds of $98.2 million, net of selling costs. The properties sold had a carrying value of $41.9 million, resulting in a gain of $56.3 million. The majority of the gain will be deferred and amortized over the term of the leases; $0.6 million is included in current earnings.

Old National has agreed to lease each of these 26 properties back from the buyers for terms expiring September 30, 2031. Under each of the lease agreements, Old National has the right at its option to extend the term of the lease for four additional successive terms of five years each, upon specified terms and conditions. Old National is obligated to pay base rents for the properties in an aggregate annual amount of $9.0 million through September 30, 2027; no rent is payable for the final four years of the initial 24-year term. For financial reporting purposes, the rents will be expensed ratably over the 24-year term at an annual rate of $7.5 million.

The carrying amounts of the remaining assets included as held for sale were as follows at September 30, 2007:

The second transaction closed October 19, 2007, subsequent to the quarter ended September 30, 2007. This transaction included 40 banking properties. Old National received cash proceeds of $67.0 million, net of selling costs. The properties sold had a carrying value of $19.8 million, resulting in a gain of $47.2 million. The majority of the gain will be deferred and amortized over the term of the leases; $3.8 million will be recognized during the fourth quarter.

Old National has agreed to lease each of these 40 properties back from the buyers for terms expiring either October 31, 2017 or October 31, 2022. Under each of the lease agreements, Old National has the right at its option to extend the term of the lease for four additional successive terms of five years each, upon specified terms and conditions. Old National is obligated to pay base rents for the properties in an aggregate amount of $5.5 million during the first year.

The Company continues to market the remaining assets classified as held for sale and anticipates that the majority will be sold during the next 60 to 90 days.

The following table summarizes Old National’s other borrowings at September 30, 2007, and December 31, 2006:

Contractual maturities of other borrowings at September 30, 2007, were as follows:

Federal Home Loan Bank advances had weighted-average rates of 5.19% and 5.37% at September 30, 2007, and December 31, 2006, respectively. These borrowings are collateralized by investment securities and residential real estate loans up to 150% of outstanding debt.

Subordinated bank notes qualify as Tier 2 Capital for regulatory purposes, subject to certain limitations, and are in accordance with the senior and subordinated global bank note program in which Old National Bank may issue and sell up to a maximum of $1 billion. Notes issued by Old National Bank under the global note program are not obligations of, or guaranteed by, Old National Bancorp.

Junior subordinated debentures related to trust preferred securities are classified in “other borrowings”. These securities qualify as Tier 1 capital for regulatory purposes, subject to certain limitations.

Old National guarantees the payment of distributions on the trust preferred securities issued by ONB Capital Trust II. ONB Capital Trust II issued $100 million in preferred securities in April 2002. The preferred securities have a liquidation amount of $25 per share with a cumulative annual distribution rate of 8.0% or $2.00 per share payable quarterly and maturing on April 15, 2032. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by ONB Capital Trust II. Old National may redeem the junior subordinated debentures and thereby cause a redemption of the trust preferred securities in whole (or in part from time to time) on or after April 12, 2007. Costs associated with the issuance of these trust preferred securities totaling $3.3 million in 2002 were capitalized and are being amortized through the maturity dates of the securities. The unamortized balance is included in other assets in the consolidated balance sheet.

During February 2007, Old National acquired St. Joseph Capital Trust I and St. Joseph Capital Trust II in conjunction with its acquisition of St. Joseph Capital Corporation. Old National guarantees the payment of distributions on the trust preferred securities issued by St. Joseph Capital Trust I and St. Joseph Capital Trust II. St. Joseph Capital Trust I issued $3.0 million in preferred securities in July 2003. The preferred securities carry a variable rate of interest priced at the three-month LIBOR plus 305 basis points, payable quarterly and maturing on July 11, 2033. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by St. Joseph Capital Trust I. St. Joseph Capital Trust II issued $5.0 million in preferred securities in March 2005. The preferred securities have a cumulative annual distribution rate of 6.27% until March 2010 when it will carry a variable rate of interest priced at the three-month LIBOR plus 175 basis points, payable quarterly and maturing on March 17, 2035. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by St. Joseph Capital Trust II. Old National may redeem the junior subordinated debentures and thereby cause a redemption of the trust preferred securities in whole (or in part from time to time) on or after September 30, 2008 (for debentures owned by St. Joseph Capital Trust I) and on or after March 31, 2010 (for debentures owned by St. Joseph Capital Trust II), and in whole (but not in part) following the occurrence and continuance of certain adverse federal income tax or capital treatment events.

On January 1, 2004, Old National entered into a long-term capital lease obligation for a new branch office building in Owensboro, Kentucky, which extends for 25 years with one renewal option for 10 years. The economic substance of this lease is that Old National is financing the acquisition of the building through the lease and accordingly, the building is recorded as an asset and the lease is recorded as a liability. The fair value of the capital lease obligation was estimated using a discounted cash flow analysis based on Old National’s current incremental borrowing rate for similar types of borrowing arrangements.

At September 30, 2007, the future minimum lease payments under the capital lease were as follows:

Old National maintains a funded noncontributory defined benefit plan (the “Retirement Plan”) that was frozen as of December 31, 2005. Retirement benefits are based on years of service and compensation during the highest paid five years of employment. The freezing of the plan provides that future salary increases will not be considered. Old National’s policy is to contribute at least the minimum funding requirement determined by the plan’s actuary.

Old National also maintains an unfunded pension restoration plan (the “Restoration Plan”) which provides benefits for eligible employees that are in excess of the limits under Section 415 of the Internal Revenue Code of 1986, as amended, that apply to the Retirement Plan. The Restoration Plan is designed to comply with the requirements of ERISA. The entire cost of the plan, which was also frozen as of December 31, 2005, is supported by contributions from the Company.

Old National contributed $0.8 million to cover benefit payments from the Restoration Plan during the first nine months of 2007. Old National expects to contribute an additional $0.2 million to cover benefit payments from the Restoration Plan during the remainder of 2007.

The net periodic benefit cost and its components were as follows for the three and nine months ended September 30:

Under the 1999 Equity Incentive Plan, Old National is authorized to grant up to 7.6 million shares of common stock. At September 30, 2007, 6.4 million shares were outstanding under the plan, including 5.8 million stock options and 0.6 million shares of restricted stock, 0.5 million shares have been exercised or released, and 0.7 million shares were available for issuance.

Old National recorded $0.1 million of stock based compensation expense, net of tax, during the first nine months of 2007 as compared to $0.4 million for the first nine months of 2006. The 2006 expense includes costs related to the modification of certain options in addition to the pro-rata vesting of options during the year.

The Company granted 218,100 stock options during 2007 and substituted 47,604 Old National stock options for St. Joseph stock options in connection with its acquisition of St. Joseph. Using the Black-Scholes option pricing model, the Company estimated the fair value of the stock options granted during 2007 to be $0.5 million. The Company will expense this amount ratably over the three-year vesting period. The assumptions used in the option pricing model and the determination of stock option expense were an expected volatility of 15.3%; a risk free interest rate of 4.85%; an expected option term of six years; a 4.23% dividend yield; and a forfeiture rate of 7%. These options expire in ten years.

Old National recorded expense of $0.5 million, net of tax benefit, during the first nine months of 2007, compared to income of $0.3 million during the first nine months of 2006 related to the vesting of restricted share awards. Included in the first nine months of 2007 and 2006 is the reversal of $1.4 million and $2.4 million of expense, respectively, associated with certain performance-based restricted stock grants.

The Company granted 123,000 shares of performance based restricted stock awards to certain key officers during 2007, with shares vesting at the end of a thirty-six month period based on the achievement of certain targets. In addition, the Company granted 56,000 time-based restricted stock awards to certain key officers during 2007, with shares vesting at the end of a thirty-six month period. Compensation expense is recognized on a straight-line basis over the vesting period. Shares are subject to certain restrictions and risk of forfeiture by the participants. As of September 30, 2007, unrecognized compensation expense was estimated to be $5.2 million for unvested restricted share awards.

The Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), on January 1, 2007 and, as the cumulative effect of applying its provisions, recognized a $3.4 million reduction to the balance of retained earnings on that date with a corresponding decrease in deferred tax assets which are reported as other assets on the balance sheet. The amount of unrecognized tax benefits as of January 1, 2007 totaled $10.3 million, all of which, if recognized, would affect the effective tax rate. Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

It is the Company’s policy to recognize interest and penalties accrued relative to unrecognized tax benefits in their respective federal or state income tax accounts. As of January 1, 2007, $2.7 million in interest, and no penalties, had been accrued on the Company’s balance sheet.

The Company and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various state returns. On August 21, 2007, the Company received a notice from the Internal Revenue Service (“IRS”) that the Joint Committee on Taxation had concluded their review of the audit for the years 2002, 2003 and 2004 and had taken no exceptions to the conclusions reached by the IRS. The IRS has informed the Company of its intent to audit tax year 2005. The Company incurred net operating losses in 2003 and 2004 that were utilized in 2005. The IRS could adjust the net operating loss carryover used on the 2005 tax return during the 2005 audit. Therefore, the 2003 and 2004 years have not been fully effectively settled. The federal statute of limitations on the 2002 year has been extended to December 31, 2007; however the Company determined that the conclusion of the 2003 and 2004 audit, as evidenced by the IRS notice, effectively settled the year 2002 as well as several items from 2003 and 2004 that the IRS notice indicated were effectively settled. As a result of the conclusion of the audit, the Company released a total of $1.8 million from its unrecognized tax benefit liability. The balance of the Company’s unrecognized tax benefits remaining at September 30, 2007 is $9.0 million.

The following is a summary of the major items comprising the differences in taxes from continuing operations computed at the federal statutory rate and as recorded in the consolidated statement of income for the three and nine months ended September 30: