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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

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 68,648,000 shares outstanding at July 31, 2005.

 2 

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

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

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

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

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. All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform with the 2005 presentation. Such reclassifications had no effect on net income. In the opinion of management, the consolidated financial statements contain all the normal and recurring adjustments necessary for a fair statement of the financial position of Old National as of June 30, 2005 and 2004, and December 31, 2004, and the results of its operations for the three and six months ended June 30, 2005 and 2004. 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, 2004.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” that requires companies to expense the value of employee stock options and similar awards. Subsequently, the Securities and Exchange Commission (“SEC”) delayed the effective date of SFAS No. 123R to annual periods beginning after June 15, 2005. Given this delay, Old National expects to adopt SFAS No. 123R in the first quarter of 2006 using the modified prospective method applied to all outstanding and unvested share-based payment awards at the adoption date. Under this method, Old National expects to expense approximately $1.4 million in 2006 and $0.1 million in 2007. At June 30, 2005, and until the effective date of SFAS No. 123R, Old National will apply Accounting Principles Board (“APB”) Opinion No. 25 and related Interpretations in accounting for stock-based compensation plans. Under APB Opinion No. 25, no compensation cost has been recognized for any of the years presented, except with respect to restricted stock plans as disclosed in the accompanying table. Old National has presented in the following table net income and net income per share adjusted to proforma amounts had compensation costs for Old National’s stock-based compensation plans been recorded based on fair values at grant dates.

On May 1, 2005, Old National acquired J. W. F. Insurance Companies, an Indianapolis, Indiana-based insurance agency that did business as J.W. Flynn Company and J.W.F. Specialty Company, Inc., for $19.0 million, including acquisition costs. Common shares of 970,912 were issued as part of the transaction with a stock value of $18.5 million. Goodwill of $12.0 million was recorded of which $3.5 million is expected to be deductible for tax purposes. In addition, intangible assets totaling $8.4 million related to customer business relationships were recorded and are being amortized over 12 to 22 years. Beginning with the quarter ended June 30, 2005, these acquisitions will be included with the non-bank service companies in the “other” column of Note 17 — Segment Information. In accordance with the purchase agreement, future contingent payments may be paid in relation to this acquisition. These payments, which are not expected to be material, would result in a change to the purchase price and goodwill when paid. On the date of acquisition, unaudited financial statements of the companies showed assets of $5.0 million with year-to-date revenues of $4.7 million and net loss of $0.2 million.

Restricted stock shares were antidilutive at June 30, 2005, for purposes of calculating diluted net income per share. The following table reconciles basic and diluted net income per share for the three and six months ended June 30:

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

At June 30, 2005, 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. 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 June 30, 2005 and 2004, Old National had residential loans held for sale of $53.3 million and $26.8 million, respectively. As of June 30, 2005 and 2004, ineffectiveness related to the hedge of a portion of the residential loans held for sale was immaterial.

During the second quarter of 2005, commercial loans held for investment of $26.7 million were reclassified to loans held for sale and sold for $21.4 million resulting in a write-down on loans transferred to held for sale of $5.3 million, which was recorded as a reduction to the allowance for loan losses. During the second quarter of 2004, residential real estate loans held for investment of $405.6 million were reclassified to loans held for sale and sold for $404.4 million resulting in a write-down on loans transferred to held for sale of $1.2 million, which was recorded as a reduction to the allowance for loan losses. Also in connection with this transaction, mortgage servicing rights of $2.7 million were capitalized, and a net gain of $2.7 million was recognized.

Activity in the allowance for loan losses was as follows:

During 2004, Old National reclassified the allowance for loan losses related to unfunded loan commitments to other liabilities.

The following is a summary of information pertaining to impaired loans at June 30:

A loan is considered impaired under SFAS No. 114, “Accounting by Creditors for Impairment of a Loan, an amendment of FASB Statement No. 5 and 15” when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. An impaired loan does not include larger groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value or at the lower of cost or fair value, leases and debt securities.

For the six months ended June 30, 2005, the average balance of impaired loans was $42.4 million for which no interest was recorded. For the six months ended June 30, 2004, the average balance of impaired loans was $90.1 million for which $0.4 million of interest 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.

At June 30, 2005 and 2004, Old National had goodwill in the amount of $113.1 million and $129.3 million, respectively. During the six months ended June 30, 2005, Old National reclassified the assets and liabilities of specific non-strategic companies as held for sale, including $26.1 million of goodwill. Concurrent with this classification, these discontinued operations were evaluated for impairment using estimated fair values in the current market, resulting in goodwill impairment of $2.9 million.

The change in the carrying amount of goodwill by segment for the six months ended June 30 was as follows:

At June 30, 2005 and 2004, Old National had $24.3 million and $40.3 million, respectively, in unamortized intangible assets. During the six months ended June 30, 2005, Old National reclassified definite-lived intangible assets of $18.9 million and indefinite-lived assets of $2.8 million to assets held for sale and discontinued the related amortization. Old National continues to amortize definite-lived intangible assets in continuing operations over the estimated remaining life of each respective asset.

The following table shows the gross carrying amounts and accumulated amortization for other intangible assets as of June 30:

Total amortization expense associated with other intangible assets for the three months ended June 30 was $0.6 million in 2005 and $0.5 million in 2004. Year-to-date amortization expense as of June 30, 2005 and 2004, was $1.2 million and $0.9 million, respectively.

The following is the estimated amortization expense for the future years ending:

Mortgage servicing rights derived from loans sold with servicing retained were $14.6 million and $17.6 million at June 30, 2005 and 2004, respectively. Loans serviced for others are not included in the consolidated balance sheet of Old National. The unpaid principal balance of mortgage loans serviced for others at June 30 was $1.937 billion in 2005 and $2.134 billion in 2004. At June 30, 2005 and 2004, the fair value of capitalized mortgage servicing rights was $16.9 million and $21.5 million, respectively. Old National’s key economic assumptions used in determining the fair value of mortgage servicing rights at June 30, 2005 and 2004, respectively, were a weighted average prepayment rate of 305 PSA together with a weighted average discount rate of 9.10% and a weighted average prepayment rate of 223 PSA together with a weighted average discount rate of 9.2%.

The following summarizes the activities related to mortgage servicing rights and the related valuation allowance at June 30:

The following table summarizes Old National’s other borrowings at June 30:

Contractual maturities of other borrowings at June 30, 2005, were as follows:

Federal Home Loan Bank advances had weighted-average rates of 5.50% and 5.32% at June 30, 2005 and 2004, 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 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.

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, and in whole (but not in part) following the occurrence and continuance of certain adverse federal income tax or capital treatment events. 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.

In March 2000, ONB Capital Trust I issued $50 million in preferred securities guaranteed by Old National. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by ONB Capital Trust I. In May 2005, Old National redeemed the $50 million of junior subordinated debentures issued in March 2000, thereby causing a redemption of all of the ONB Capital Trust, 9.5% trust preferred securities. In connection with the redemption, Old National expensed the remaining $1.7 million of unamortized debt issuance costs related to this debt.

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

At June 30, 2005, the future minimum lease payments under the capital lease were as follows:

The following table sets forth the components of the net periodic benefit cost for Old National’s noncontributory defined benefit retirement plan for the six months ended June 30:

Under the 1999 Equity Incentive Plan, Old National is authorized to grant up to 7.6 million shares of common stock. At June 30, 2005, 6.5 million shares were outstanding under the plan, including 6.0 million stock options and 0.5 million shares of restricted stock as described below, and 1.1 million shares were available for issuance. In addition, Old National assumed 0.1 million stock options outstanding through various mergers. Old National accounts for its stock-based compensation plans in accordance with APB Opinion No. 25 and related Interpretations, under which no compensation cost has been recognized, except with respect to restricted stock plans. See Note 2 for proforma net income and net income per share data.

On February 2, 2004, Old National granted 0.3 million stock options to key associates at an option price of $20.43, the closing price of Old National’s stock on that date. The options vested 100% on December 31, 2004, and expire in ten years. Also during 2004, Old National granted 26.3 thousand shares to a key associate at an option price of $23.99, the closing price of Old National’s stock on that date. These options vest 100% on September 7, 2005, and expire in ten years. At June 30, 2005, Old National had 6.0 million of stock options outstanding.

On January 27, 2005, Old National’s Board of Directors approved a restricted stock award to grant 0.2 million shares to certain key officers with shares vesting at the end of a thirty-eight month period based on the achievement of certain targets. On July 22, 2004, Old National’s Board of Directors approved a restricted stock award to grant 0.3 million shares to certain key officers with shares vesting at the end of a thirty-two month period based on the achievement of certain targets. Compensation expense is recognized on a straight-line basis over the performance period. Shares are subject to certain restrictions and risk of forfeiture by the participants.

At June 30, 2005, the shares issued have an estimated value of $10.0 million based on the stock price on that date. The expense recognized during the six months ended June 30, 2005, related to the vesting of these awards was $1.4 million. The remaining $7.5 million of deferred compensation is included as a component of capital surplus.

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 months and six months ended June 30:

For the three months and six months ended June 30, 2005, the effective tax rate was higher than for the three and six months ended June 30, 2004. The increased effective tax rate resulted from a lower percentage of tax-exempt income to total income compared to the three and six months ended June 30, 2004.

Old National designates its derivatives based upon criteria established by SFAS No. 133, as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment to FASB Statement No. 133,” and SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” The following table summarizes the derivative financial instruments utilized by Old National at June 30:

In the normal course of business, various legal actions and proceedings, which are being vigorously defended, are pending against Old National and its affiliates.

Among these are several lawsuits relating to activities in 1995 of First National Bank & Trust Company, Carbondale, Illinois, (“First National”), which Old National acquired in 1999. These lawsuits were brought against Old National Bank, as successor to First National, and were filed by alleged third-party creditors of certain structured settlement trusts. The lawsuits filed by the third-party creditors allege actual damages totaling approximately $31.0 million, as well as unspecified punitive damages and other damages and attorneys’ fees. In addition, certain of the corporate defendants in these lawsuits have filed lawsuits asserting contribution and indemnity against Old National Bank. The cases were brought in the City of St. Louis and St. Louis County in Missouri; St. Clair County, Madison County and Cook County in Illinois; and the U.S. Federal District Court in southern Illinois. During the quarter ended March 31, 2005, Old National received summary judgement in its favor in the U.S. Federal District Court case in southern Illinois.

During the fourth quarter of 2003, Old National established a reserve of $10.0 million for settlement of certain of the lawsuits pending in the City of St. Louis and St. Louis County in Missouri and St. Clair County and Madison County in Illinois. As of March 31, 2004, Old National had paid $9.1 million of this reserve to settle a number of lawsuits representing approximately $12.0 million in alleged damages. As of June 30, 2005, the approximate $0.9 million remaining in the reserve for litigation settlement is deemed to be adequate to cover the remaining exposure for these cases of approximately $3.0 million.

Old National has obtained a summary judgement in its favor at the trial court level on lawsuits representing approximately $16.0 million of the estimated $31.0 million in exposure. The Court of Appeals for the First District affirmed the decision of the trial court for these cases filed in Cook County, Illinois. The plaintiffs petitioned the Illinois Supreme Court to review the Court of Appeal’s decision. As of June 30, 2005, the Illinois Supreme Court has not yet determined whether or not it will review the Court of Appeals’ decision. It is uncertain at this time whether any future judgements or settlements in the Cook County matters will have a material impact on Old National’s results of operations.

In the normal course of business, Old National’s banking affiliates have entered into various agreements to extend credit, including loan commitments of $1.279 billion, commercial letters of credit of $4.2 million and standby letters of credit of $138.2 million at June 30, 2005. At June 30, 2004, loan commitments were $1.345 billion, commercial letters of credit were $16.3 million and standby letters of credit were $101.9 million. These commitments are not reflected in the consolidated financial statements. No material losses are expected to result from these transactions.

At June 30, 2005 and 2004, Old National had credit extensions of $94.7 million and $72.1 million, respectively, with various unaffiliated banks related to letter of credit commitments issued on behalf of Old National’s clients. At June 30, 2005 and 2004, Old National provided collateral to the unaffiliated banks to secure credit extensions totaling $62.7 million and $41.3 million, respectively. Old National did not provide collateral for the remaining credit extensions.

Old National holds instruments, in the normal course of business with clients that are considered financial guarantees in accordance with FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Standby letters of credit guarantees are issued in connection with agreements made by clients to counterparties. Standby letters of credit are contingent upon failure of the client to perform the terms of the underlying contract. Credit risk associated with standby letters of credit is essentially the same as that associated with extending loans to clients and is subject to normal credit policies. The term of these standby letters of credit is typically one year or less. At June 30, 2005, the notional amount of standby letters of credit was $138.2 million, which represents the maximum amount of future funding requirements, and the carrying value was $0.5 million.

Old National operates in two reportable segments: community banking and treasury. The community banking segment serves customers in both urban and rural markets providing a wide range of financial services including commercial, real estate and consumer loans; lease financing; checking, savings, time deposits and other depository accounts; cash management services; and debit cards and other electronically accessed banking services and Internet banking. Treasury manages investments, wholesale funding, interest rate risk, liquidity and leverage for Old National. Additionally, treasury provides other miscellaneous capital markets products for its corporate banking clients. Beginning January 1, 2005, Old National disaggregated internal reporting for its non-bank operations, including wealth management, investment consulting, insurance, brokerage and investment and annuity sales. These lines of business are now included in the “other” column for all periods reported.

In order to measure performance for each segment, Old National allocates capital, corporate overhead and income tax provision to each segment. Capital and corporate overhead are allocated to each segment using various methodologies, which are subject to periodic changes by management. Income taxes are allocated using the effective tax rate. Tax-exempt income is primarily within the treasury segment, creating a tax benefit for this segment. Intersegment sales and transfers are not significant.

Old National uses a funds transfer pricing (“FTP”) system to eliminate the effect of interest rate risk from net interest income in the community banking segment and from companies included in the other column. The FTP system is used to credit or charge each segment for the funds the segments create or use. The net FTP credit or charge is reflected in segment net interest income.

The financial information for each operating segment is reported on the basis used internally by Old National’s management to evaluate performance and is not necessarily comparable with similar information for any other financial institution. Summarized financial information concerning segments is shown in the following table for the three months and six months ended June 30: