Old National Bank - 10-Q quarterly report FY

 

(Exact name of Registrant as specified in its charter)

(812) 464-1294
(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 filerþ          Accelerated filero          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 oNo 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 66,406,000 shares outstanding at October 31, 2006.

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.

Comprehensive income for the three months ended September 30, 2006 and 2005 was $45.3 million and $0.3 million, respectively.

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 2006 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 September 30, 2006 and 2005, and December 31, 2005, and the results of its operations for the three and nine months ended September 30, 2006 and 2005. 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, 2005.

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 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of adopting FIN 48 on the consolidated financial statements.

SFAS No. 157 – In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement 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 fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting SFAS No. 157 on the consolidated financial statements.

SFAS No. 158 – In September 2006, the FASB issued Statement No. 158 – Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R). This Statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability, with any unrecognized prior service costs, transition obligations or actuarial gains/losses reported as component of other comprehensive in shareholders’ equity. The new standard is effective for fiscal years ending after December 15, 2006.

Based on the Company’s funded status of plan obligations disclosed in Note 14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, the estimated impact of adopting SFAS 158 would have been a reduction to December 31, 2005 comprehensive income of approximately $9.6 million, with no impact to the Company’s consolidated statements of income or cash flows. As the actual impact of adopting SFAS 158 will be dependent upon the fair value of plan assets and the amount of projected benefit obligations measured as of December 31, 2006, the above estimated amount may not be reflective of the actual impact of the adoption at December 31, 2006.

SAB 108 – In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement

misstatements as material if they are material according to either the income statement or balance sheet approach. This statement is effective as of the end of the fiscal year ending after December 15, 2006. The Company is currently evaluating the impact of adopting SAB 108 on the consolidated financial statements.

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. These acquisitions are included in the “other” column of Note 19 – 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.

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.

In February, 2005, Old National committed to a plan to sell J.W. Terrill Insurance Agency (“Terrill”) in St. Louis, Missouri, and the Fund Evaluation Group (“FEG”) in Cincinnati, Ohio, to better align its operations with its market and product focus. The operating activities of these companies were reclassified to discontinued operations for all periods in the consolidated statement of income. During the quarter ended June 30, 2005, Old National recorded an impairment charge of $1.1 million, net of tax, related to J.W. Terrill Insurance Agency. This impairment charge was included in income (loss) from discontinued operations. During the third quarter of 2005, Old National completed the sale of both Terrill and FEG. Old National sold Terrill for $22.2 million of cash. Terrill had been acquired in a tax-free reorganization under Internal Revenue Code section 368, and as a result of the taxable sale, Old National recorded a loss of $8.7 million, including $8.6 million of tax expense. Old National completed the sale of FEG for $15.1 million of cash and a $0.5 million note receivable. The sale resulted in an after tax loss of $5.9 million.

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during each period, adjusted to reflect all stock dividends. Diluted net income per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Restricted stock shares were excluded from the denominator in the computation of diluted net income per share for the nine months ended September 30, 2005 because their inclusion would have been anti-dilutive.

The following table reconciles basic and diluted net income per share for the three and 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, 2006 and December 31, 2005 and the corresponding amounts of unrealized gains and losses therein:

During the third quarter of 2006, proceeds from the sales of investment securities available-for-sale were $273.9 million, resulting in a gain of $0.8 million. Year-to-date proceeds from sales of investment securities available-for-sale were $298.7 million in 2006 and $609.5 million in 2005. For the nine months ended September 30, 2006, realized gains were $4.4 million and losses were $3.7 million. For the nine months ended September 30, 2005, realized gains were $8.3 million and losses were $7.1 million.

At September 30, 2006, 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, 2006 and December 31, 2005, Old National had residential loans held for sale of $15.9 million and $43.8 million, respectively. As of September 30, 2006 and December 31, 2005, ineffectiveness related to the hedge of a portion of the residential loans held for sale was immaterial.

During the third quarter of 2006, commercial real estate loans held for investment of $27.4 million and commercial loans of $1.4 million were reclassified to loans held for sale and sold for $26.1 million resulting in a write-down on loans transferred to held for sale of $2.8 million, which was recorded as a reduction to the allowance for loan losses.

The following summarizes the changes in the allowance for loan losses:

The following presents information regarding the period-end balances of impaired loans:

For the nine months ended September 30, 2006 and 2005, the average balance of impaired loans was $38.9 million and $43.1 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.

SFAS No. 142, Goodwill and Other Intangible Assets, issued in June 2001, discontinued the practice of amortizing goodwill and initiated an annual review for impairment. Impairment is to be examined more frequently if certain indicators are encountered. Old National completed its most recent annual goodwill impairment test required by this Statement as of August 31, 2006 and determined that no impairment existed as of this date.

The changes in the carrying amount of goodwill by segment for the nine months ended September 30, 2006 and 2005, were as follows:

Intangibles, including core deposits and customer business relationships, are 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.

The following table shows the gross carrying amounts and accumulated amortization for other intangible assets as of September 30, 2006 and December 31, 2005:

Total amortization expense associated with other intangible assets for the three months ended September 30 was $0.6 million in 2006 and $0.6 million in 2005. Amortization expense for the nine months ended September 30, 2006 and 2005, was $1.8 million and $1.9 million, respectively.

Estimated amortization expense for the future years is as follows:

During the third quarter of 2005, Old National sold its mortgage servicing rights relating to $1.917 billion of mortgage loans serviced for other investors for a total sales price of $17.7 million. The sale resulted in a pre-tax net gain of $0.4 million which was included in Other Income during the third quarter of 2005.

The activity for mortgage servicing rights and the related valuation allowance for the period ended September 30, 2005 is summarized below:

In September, 2006, Old National committed to a plan to sell and lease back its three main buildings in downtown Evansville, Indiana. A letter of intent was executed in September and the transaction is expected to close during the fourth quarter of 2006. These assets are reported as held for sale at historical cost as the sales price less costs to sell is expected to exceed the carrying value. These assets are reported in the “other” column for segment reporting.

The carrying amounts of the classes of assets included as held for sale were as follows at September 30, 2006:

The following table summarizes Old National’s other borrowings at September 30, 2006, and December 31, 2005:

Contractual maturities of other borrowings at September 30, 2006, were as follows:

Federal Home Loan Bank advances had weighted-average rates of 5.37% and 5.22% at September 30, 2006, and December 31, 2005, respectively. These borrowings are collateralized by investment securities and residential real estate loans up to 145% 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, 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, 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.

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, 2006, 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 nine months ended September 30:

Old National has qualified and nonqualified noncontributory defined benefit pension plans. During 2001, Old National amended the plans freezing the benefits accrued for all participants except active participants who had completed at least 20 years of service or who had attained age 50 with at least five years of vesting service. In addition, the amendment discontinued new enrollments under the plans after December 31, 2001. During 2005, Old National amended the plan by redefining the pay definition, resulting in a reduction to the Projected Benefit Obligation of $2.8 million. During the third quarter of 2005, Old National further amended the plan to grant two years additional benefits to plan participants age 55 or older with 15 years of benefit service resulting in an increase in the Projected Benefit Obligation of $0.8 million and to freeze benefit accruals for all remaining participants effective December 31, 2005. The curtailment resulted in a $10.1 million reduction in Projected Benefit Obligation and a one-time curtailment gain of $1.5 million. Lump sum cash payments of $5.2 million paid to participants during 2005 reduced the Projected Benefit Obligation by the same amount. The Company presently anticipates contributing an additional $0.6 million to fund its pension plans in 2006.

Under the 1999 Equity Incentive Plan, Old National is authorized to grant up to 7.6 million shares of common stock. At September 30, 2006, 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, and 0.7 million shares were available for issuance. In addition, Old National assumed 0.1 million stock options outstanding through various mergers. Effective January 1, 2006, the Company began recording compensation expense associated with the stock options in accordance with SFAS No. 123-R, Share-Based Payment. Prior to January 1, 2006, the Company accounted for its stock-based compensation plans in accordance with APB Opinion No. 25 and related Interpretations, under which no compensation cost had been recognized, except with respect to the restricted stock plans. Old National adopted the fair value recognition provisions of SFAS No. 123-R using the modified prospective transition method, and, consequently, has not retroactively adjusted results from prior periods.

The following table reflects the effect on net income and net income per share as if the fair value based method had been applied to all outstanding and unvested stock options during the three and nine months ended September 30, 2005.

Old National recorded $0.4 million of stock based compensation expense, net of tax, during the first nine months of 2006. This cost is primarily related to the modification of certain options during the second quarter and the pro-rata vesting of options during the year.

The Company granted 141,700 stock options during 2006. Using the Black-Scholes option pricing model, the Company estimated the fair value of the stock options granted during 2006 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 19.5%; a risk free interest rate of 4.7%; an expected option term of six years; a 3.6% dividend yield; and a forfeiture rate of 0%. These options expire in ten years. No options were granted in 2005.

Old National recorded income of $0.3 million, net of tax benefit, during the first nine months of 2006, related to the reversal of expense associated with certain performance-based restricted stock grants. This reversal of expense was partially offset by the pro-rata vesting of restricted stock awards during the year.

The Company granted 132 thousand shares of performance based restricted stock awards to certain key officers during 2006, with shares vesting at the end of a thirty-six month period based on the achievement of certain targets. In addition, the Company granted 60 thousand time-based restricted stock awards to certain key officers during 2006, with vesting periods ranging from 12 to 36 months. 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. 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. As of September 30, 2006, unrecorded compensation expense was estimated to be $3.9 million for unvested restricted stock awards.

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:

For the three months and nine months ended September 30, 2006, the effective tax rate on income from continuing operations was higher than for the three months and nine months ended September 30, 2005. The increased effective tax rate in the three months and nine months ended September 30, 2006 resulted from a lower percentage of tax-exempt income to total income compared to the three months and nine months ended September 30, 2005.

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:

Old National enters into certain matched customer hedges to accommodate the business needs of its customers. Upon the origination of a customer hedge, Old National simultaneously enters into an offsetting contract with a third party to mitigate its exposure.

In the normal course of business, various legal actions and proceedings, which are being vigorously defended, are pending against Old National and its affiliates. Management does not believe any of these claims 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 $1.326 billion, commercial letters of credit of $92 thousand and standby letters of credit of $130.7 million at September 30, 2006. At December 31, 2005, loan commitments were $1.317 billion, commercial letters of credit were $55 thousand and standby letters of credit were $141.6 million. These commitments are not reflected in the consolidated financial statements. Management believes the reserve for unfunded commitments is adequate as of September 30, 2006.

At September 30, 2006 and December 31, 2005, Old National had credit extensions of $77.7 million and $88.1 million, respectively, with various unaffiliated banks related to letter of credit commitments issued on behalf of Old National’s clients. At September 30, 2006 and December 31, 2005, Old National provided collateral to the unaffiliated banks to secure credit extensions totaling $54.5 million and $55.2 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, which requires the Company to record the instruments at fair value. 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 September 30, 2006, the notional amount of standby letters of credit was $130.7 million, which represents the maximum amount of future funding requirements, and the carrying value was $0.5 million.