Old National Bancorp

Welcome to the Old National Bancorp second quarter 2022 earnings conference call. This call is being recorded and has been made accessible to the public in accordance with the SEC's regulation SD. Corresponding presentation slides can be found on the investor relations page at oldnational.com and will be archived there for 12 months. Management would like to remind everyone that certain statements on today's call may be forward-looking in nature and are subject to certain risks, uncertainties, and other factors that could cause actual results or outcomes to differ from those discussed. The company refers you to its forward-looking statement legend in the earnings release and presentation slides. The company's risk factors are fully disclosed and discussed within its SEC filings. In addition, certain slides contain non-GAAP measures, which management believes provide more appropriate comparisons. These non-GAAP measures are intended to assist investors' understanding of performance trends. Reconciliations for these numbers are contained within the appendix of the presentation. I'd now like to turn the call over to Jim Ryan for opening remarks. Mr. Ryan, please proceed.

Good morning. We're pleased to discuss our outstanding second quarter results and update you on our systems and branding changes from our transformational merger. Let's start on slide four. We recently completed our systems and brand conversion. It's been a busy couple of weeks. The data and systems conversion went very well overall, and our commercial clients have quickly and successfully adapted to the new systems. As expected, our branches and contact centers have experienced elevated activity levels but have started to normalize. I want to thank all of our team members for their hard work and dedication to serving our clients and communities. Completing the data and systems convergence should accelerate our ability to achieve our model synergies. Brendan will fill you in on our progress later in the presentation. I'm gratified to share that despite the merger activities, our teams achieved outstanding loan growth results and continue to build robust pipelines. I can't imagine better results, especially given the distractions. Lastly, we started branding campaigns in Chicagoland and some of our metropolitan markets and are receiving good feedback from those efforts. Moving to slide five, we reported gap earnings for the second quarter of $0.38 per share. The second quarter included pre-tax charges of $36.6 million in merger expenses. Excluding these charges from the current quarter, adjusted EPS was $0.46 per common share, or $135 million. Our adjusted average tangible common equity in assets was a strong 20% and 1.21% respectively. Our adjusted efficiency ratio was approximately 54%. Our focused execution on our merger and growing our commercial business drove these robust results and leading returns. We saw higher balances in nearly every portfolio and market across our commercial and community banking business. Total loan growth was 19%, and the commercial business grew 18% on an annualized basis. The higher loan growth paired with the benefit of higher interest rates primarily contributed to a 45 basis point margin expansion. Credit quality remains excellent, but we remain diligent with new credit requests. Our pipeline ended at a record $5.9 billion. Overall, clients in our markets have strong balance sheets and continue to grow and expand as evidenced by our record pipeline. We were pleased to hold deposits quarter over quarter while maintaining our deposit pricing discipline. Much of the government and municipal clients' stimulus funds are yet to be invested. Therefore, balances remained high and grew during the quarter. A quick update on hiring. We successfully welcomed 17 new client-facing commercial and wealth management relationship managers during the quarter. Our talent pipeline remains robust, and we will continue to make more new investments throughout the year. While 2022 continues to bring its own set of unique challenges, our businesses are performing very well. Business and consumer sentiment are worsening slightly, but we remain optimistic that our balance sheet will continue to grow. We are well-positioned to withstand any new challenges. Thank you. I will now turn the call over to Brendan for further details.

Thanks, Jim. Turning to the quarter's results on slide six, we reported GAAP net income applicable to common shares of $111 million, or 38 cents per share. Reported earnings were impacted by $37 million in merger-related charges. Excluding these charges, as well as debt securities gains, our adjusted earnings per share was 46 cents. Slide seven shows the trend in total loan growth on a historical combined basis, excluding PPP loans. Q2 represents our eighth consecutive quarter of organic loan growth, with total loans increasing 19% on an annualized basis, driven by robust commercial growth of 18%, and consumer growth of 22%. Growth within consumer loans was driven by residential mortgage, which reflects lower saleable production, and is net of the transactional book runoff of $58 million. The balance of the transactional book at quarter end was approximately $1.7 billion. The investment portfolio decreased modestly by approximately $200 million quarter over quarter, with the overall mix remaining largely unchanged. And I note we have deployed a significant portion of the cash outstanding at the end of last quarter in support of loan growth. Investment portfolio yields improved significantly to 2.37%, with new money yields of 3.68%. Effective duration was stable despite the dramatic shift in the yield curve, with new money purchases focused on the shorter end. In addition, we transferred another $1 billion of securities into our HDM portfolio to help mitigate future OCI impacts. Slide 8 provides further details of our commercial loans and pipeline. The strong second quarter growth was well distributed with 20% annualized growth in T&I and 16% annualized growth in CRE. We were also pleased that despite the strong second quarter production, our pipeline ended the quarter at a record $5.9 billion, which is a 9% increase over Q1. Turning briefly to pricing, new money yields on T&I increased 80 basis points from Q1 to 4.2%. with new CRE production yields up 53 basis points to 3.67%. Slide 9 shows details of our Q2 commercial production by product and market. The $2.2 billion of production was well balanced across all product lines and major markets. The Chicago market continued its strong momentum with nearly $1 billion of production, but all of our legacy and expansion markets had strong quarters as well. In addition, all of our product lines posted quarter-over-quarter loan growth, a clear reflection of the strong loan demand throughout our footprint. Moving to slide 10, end of period deposits were stable quarter of a quarter, although we did see some deployment of deposits in our commercial and retail clients that was largely offset by seasonal increases in municipal and government funds. Total cost of deposits continues to be low at six basis points, up just one basis point from the prior quarter. We are prepared to defend deposits through rate actions if necessary, but we have ample funding sources and asset liquidity to support future commercial loan growth. Next, on slide 11, you will see details of our net interest income and margin. Both improved meaningfully due to strong loan growth, improved earning asset mix, and higher interest rates. NIM expanded 45 basis points quarter over quarter to 3.33%. Core margin, excluding accretion and PPP income, increased 34 basis points to 2.98%. Slide 12 provides additional details on our asset liability position and projected margin range. Margin is expected to continue to expand meaningfully over the next two quarters, albeit at a slower pace. The assumptions in our outlook include a Fed funds target rate of 3.5% at year-end, a static balance sheet, and deposit betas that increase from 3% today to a December recycled-to-date beta in the range of 20% to 25%. We believe we have opportunities to outperform this outlook through continued strong loan growth, remixing of earning assets, and a longer deposit pricing lag. Also, while we remain well positioned for rising rates, we have been proactively hedging the balance sheet over the last several quarters to protect our margin from the possibility of a hard economic landing and quick reversal in Fed policy. We currently have over $1 billion of down rate protection, including floors and collars, which we will continue to build over the remainder of the year. Slide 13 shows trends in adjusted non-interest income, which was $89 million for the quarter, slightly better than expected due to $4 million of discrete items related to equity investment returns and the recovery from fully charged off acquired loans that we don't expect to recur. Mortgage production was higher than anticipated. However, normalizing gain on sale margins and a higher percentage of portfolio production did negatively impact VREV. Next, slide 14 shows the trend in adjusted non-interest expenses. Adjusting for merger charges and tax credit amortization, non-interest expense was $239 million, and our adjusted efficiency ratio was 53.9%. Expenses were slightly higher than anticipated due to a year-to-date screw-up with incentive accruals to reflect better than planned performance. We continue to run slightly ahead of our planned cost synergies, but expect the bulk of the savings to begin late third quarter. Merger charges are also tracking in line with our diligence estimates, with approximately $65 million remaining. Slide 15 provides further details on our path to achieving the cost savings of $109 million. With the systems conversion now behind us, we have completed the last major milestone required, prior to realizing the remaining cost dates. Expectations on timing are unchanged with 85% of the cost synergies on an annualized basis realized in the fourth quarter and the remainder to come early in 2023. Note our four-Q run rate was updated to include higher incentive related expenses resulting from better than planned performance. Slide 16 shows our credit trends of both historical Old National and First Midwest. Credit conditions continue to be benign and our commercial and consumer portfolios continue to perform exceptionally well. We ended Q2 with positive trends and better than fear results in all key credit metrics. Net charge-offs were a modest two basis points. On slide 17, you will see the details of our first quarter allowance, which stands at $288 million, up from $281 million at the end of Q1. Reserve build was driven by strong loan growth and a more pessimistic economic forecast, partly offset by lower specific reserves and improved asset quality in our commercial book. The financial health of our clients remains strong, and while we are not seeing any signs of credit deterioration in our portfolios today, we believe it is prudent to maintain elevated levels of qualitative reserves until the cloud of economic uncertainty lifts. In addition to the $288 million in total reserves, we also carry $131 million in credit marks. Slide 18 provides details on our capital position at quarter end. As you can see, it remains strong with a CET1 ratio of 9.9%. The modest 14 basis point quarterly decrease reflects robust loan growth, which more than offset our strong retained earnings. We continue to monitor our balance sheet for economic stress and feel very comfortable with our capital levels. As I wrap up my comments, here are some key takeaways. We couldn't have scripted a better result in the first full quarter following the closing of our partnership. Client and RM retention has been exceptional, leading to another quarter of broad-based quality loan growth led by our Chicago market, Rating increases brought welcome margin expansion that was meaningfully higher than our peers. We recently completed the major systems conversion on schedule, credit conditions remain benign, and we are tracking ahead of our planned cost synergies. Slide 19 includes thoughts on our outlook for the remainder of 2022. We ended the quarter with a record commercial pipeline, which supports our favorable outlook on loan growth, albeit at a potentially slower pace than Q2, given waning consumer and business sentiment. Net interest income and margin should benefit from continued loan growth and Fed rate increases, consistent with the margin guidance we outlined earlier. We expect our fee businesses to continue to perform well despite headwinds. We expect solid organic growth in our wealth business, but AUM will continue to be under pressure for market fluctuations in both equities and fixed income. Mortgage is following industry patterns with fee revenue under pressure from normalizing gain on sale margins, as well as a higher percentage of portfolio production. Commercial activities should support continued strong capital markets revenues. And lastly, we anticipate pressure on deposit service charges consistent with industry trends. We are targeting adjusted Q4 expenses of $227 million.