Old National Bancorp

Welcome to the Old National Bancorp third 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.

Thank you, Form. Good morning. We are pleased to discuss our outstanding third quarter results and update you on our transformational merger. We completed our systems conversion and branding changes during the quarter. Internally, we have branded our merger as better together, and these last two quarters of strong results demonstrate how we are truly better together to all stakeholders. I also want to take this opportunity to acknowledge and thank our team members for their hard work and dedication in serving our clients, communities, and supporting one another throughout this process. Let's start on slide four. We reported gap earnings for the third quarter of 47 cents per share. The third quarter included pre-tax charges of 23 million in merger expenses. Excluding these charges from the quarter, adjusted EPS was 51 cents per common share. This quarter's adjusted EPS was almost 11% higher than the second quarter. Our adjusted return on average tangible common equity and assets were a strong 23% and 1.35% respectively. And our adjusted efficiency ratio was at low 51%, which is the best efficiency ratio I can remember in my 20-year-plus career at Old National. Our focused execution in our merger, strong deposit franchise, and growing commercial business drove these robust results and leading returns. We saw higher balances in every portfolio and most markets across our commercial business. Total loan growth was 14%, and the commercial business grew 17% on an annualized basis. The higher loan growth paired with the benefit of a strong deposit franchise contributed to a 38 basis point margin expansion. Our commercial pipeline ended at a strong $5.4 billion. Overall, credit quality remains strong and we continue to be diligent given the increasing economic uncertainties. However, corporate balance sheets remain solid and personal clients retain higher saving rates than we saw in previous cycles. We were pleased to grow deposits slightly quarter over quarter while maintaining our deposit pricing discipline with just a 5% deposit data. A quick update on hiring. We successfully welcomed 25 new client-facing commercial and wealth management relationship managers during the quarter. Our talent pipeline remains robust and we will continue to make these strategic investments. We recently expanded our wealth presence with a new office in Nashville, Tennessee hiring seven wealth management professionals. The experienced team will be led by Steve Cook, who will also serve as our market president, and the office will operate under our new 1834 high net worth wealth management brand. This was a fantastic opportunity, and we are already adding new clients to the bank. Over time, we will look to expand and offer other banking services to this high growth dynamic market. This further expansion builds upon last year's strategic investment in a high net worth team in Scottsdale, Arizona. We were also pleased to announce the hiring of Brent Tischler as our community banking CEO. Brent is responsible for all consumer and retail banking segments. I'm excited about his extensive knowledge and experience in leading consumer and small business segments, as well as the optimism and enthusiasm he brings to our organization. In early December, we will implement several enhancements to our overdraft protection programs to provide clients with more flexibility. The changes will include eliminating the NSF fee, and we believe our program will be consistent with current best practices. In closing, we will continue to demonstrate the strength of our expanded franchise with commercial loan growth for the third quarter of nearly 17%, significant improvement to our net interest margin because of our deposit franchise, and continued strong credit, capital, and efficiency metrics. As we look forward, we expect the loan portfolios to continue to grow, margins to continue to expand driven by our below pure deposit costs, organic growth of our wealth management client base, disciplined expense management, and continued savings from our merger synergies and strong relative credit metrics. I believe we are well-positioned to withstand any of your challenges that lie ahead. Thank you. I will now turn the call over to Brendan.

Thanks, Jim. Turning to the quarter's results on slide five, we reported GAAP net income applicable to common shares of $136 million, or 47 cents per share. Reported earnings were impacted by $23 million in merger-related charges. Excluding these charges, as well as debt securities losses, our adjusted earnings per share was 51 cents, up 19% year-over-year. Slide 6 shows the trend in total loan growth on a historical combined basis, excluding PPP loans. Q3 represents our ninth consecutive quarter of organic loan growth, with total loans increasing 14% on an annualized basis. Commercial loans grew an annualized 17%, while consumer loans grew an annualized 7%, driven by residential mortgage. The invest portfolio decreased 6% quarter over quarter due to rate-related fair value adjustments and reinvestment of portfolio cash flows in support of loan growth. We expect investment cash flows of $850 million over the next 12 months. Slide 7 provides further details of our commercial loans and pipeline. The strong second quarter growth was well distributed with 17% annualized growth in CNI and 15% in CRE. Q3 production put some pressure on the pipeline, but loan demand remained strong, and we did see a marked increase in the accepted category, which was up $400 million over prior quarter. Turning briefly to pricing, new money yields on CNI increased 109 basis points from Q2 to 5.29%, with new CRE production yields up 88 basis points to 4.55%. Slide 8 shows details of our Q3 commercial production. The $2.4 billion in production was well balanced across all product lines and major markets, and as always, was consistent with our disciplined approach to credit. In addition, all of our product segments posted quarter-over-quarter balance sheets for retaining lenders and clients in Chicago, our successful entrances into new expansion markets, and the quality of our commercial team throughout our footprint. Moving to slide nine, end-of-period deposits were up 1.5% quarter-over-quarter, driven by increases in municipal deposits. We are pleased with the stability of our commercial and retail deposit balances, particularly our non-interest-bearing accounts. Our low loan-to-deposit ratio coupled with asset liquidity in the form of our investment and indirect book provides flexibility heading into this competitive deposit market. That said, we are actively defending deposit balances through competitive rack rates and pricing exceptions. We are also playing offense to various deposit specials and select geographies where we have limited market share. These actions put upward pressure on rates in Q3, with average total deposit costs up six basis points quarter over quarter to a still very low 12 basis points. Interest-faring deposit costs were up nine basis points to 18 basis points resulting in a cycle-to-date beta of just 5%. Our granular, low-cost deposit base should continue to give us a beta advantage relative to peers throughout this rate cycle, but pricing is expected to increase in Q4. As a reference point, we ended the quarter with a spot rate on interest-free deposits of 33 basis points on September 30th. Next, on slide 10, you will see details of our net interest income and margin. Both improved more than expected due to better loan growth, higher interest rates, and better than expected deposit pricing lies. Net interest margin expanded 38 basis points quarter over quarter to 3.71%. Core margin, excluding accretion and PPP income, increased 48 basis points to 3.46%. Slide 11 provides additional details on our asset liability position and projected margin range. Core margin is expected to continue to expand meaningfully over the next quarter, albeit at a slower pace. The assumption in our outlook includes a Fed funds target rate of 4.5% at year end and a 4% yield on 10-year treasuries. Our outlook assumes deposit beta is increasing from 5% today to a cycle-to-date beta by year end of 15%. This equates to a marginal 4Q beta of 30%. We believe the current forward curve should allow us to expand margin beyond 2022. Margin expansion is expected to slow, but we believe we can manage margin deposit betas at or below our asset betas into 2023. 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 added $600 million in hedge protection this quarter, with an average floor strike of 3%. Slide 12 shows trends in adjusted non-interest income, which was $81 million for the quarter. This is generally in line with our expectations as market conditions continue to put pressure on mortgage and wealth revenues. The linked quarter decrease was also impacted by $4 million in discrete Q2 items we discussed last quarter. Next, slide 13 shows the trend in adjusted non-interest expenses. Adjusting for merger charges and tax credit amortization, non-interest expense was $241 million and our adjusted efficiency ratio was historically low 50.7%. Expenses were higher than anticipated due to $4 million in provision for unfunded commitments related to Q3 loan growth, a $3 million incentive accrual increase, and a $4 million conversion-related reduction in deferred loan origination costs. The total $7 million impact of incentives and deferred costs are not expected to recur. Despite the moving parking Q3, we continue to run ahead of our planned cost synergies and are on track for the promised merger synergies in the fourth quarter. Q4 expenses are now expected to be $225 million, a $2 million improvement from our prior quarter estimate, which equates to approximately 90% of cost synergies achieved by year end. Slide 14 shows our credit friends. Credit conditions are stable and our commercial and consumer portfolios continue to perform exceptionally well. Net charge-offs were in modest two basis points, excluding eight basis points of net charge-offs on PCD loans that had an allowance established through acquisition accounting. Our special assets team is continuing to work toward PCD loans, and we would expect charge-offs from this portfolio to remain elevated. The provision expense impact from this effort is expected to be minimal, as we carry $61 million, or approximately 5% reserve against this book. On slide 15, you will see details of our third quarter allowance, which stands at $302 million, up from $288 million at the end of Q2. Reserve build was driven primarily by strong loan growth with relatively small increases due to portfolio mix and a marginally worse economic forecast. The financial health of our clients remains strong, and while credit metrics are stable, we believe it is prudent to maintain elevated qualitative reserves given the uncertainty in our base case economic outlook. In addition to the $302 million of total reserves, we also carry $112 million in credit marks. Slide 16 provides details on our capital position at quarter end. Our CET1 ratio remains strong at 9.9%. Our TCE ratio declined 38 basis points quarter over quarter due to increases in unrealized losses in our investment book. Total OCI is now impacting TCE by 160 basis points. 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 grew adjusted earnings per share 11%. Profitability ratios continue to be strong with an adjusted return on tangible common equity of 22.6% and a return on average assets of 1.35%. We posted another strong quarter of loan growth and better than peer merit margin expansion, aided by an industry-leading deposit data. Expenses also continue to be well managed with a record low efficiency ratio of 50.7% with meaningful savings yet to come. Slide 17 includes thoughts on our outlook for the remainder of 2022. We ended the quarter with a strong commercial pipeline which supports our favorable outlook on loan growth, albeit at a slower pace than Q3. Deposits are expected to be stable, excluding the impact of the HSA sale. Income and margins 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, with wealth management and mortgage following industry patterns. Commercial activity should support continued strong capital markets revenues, albeit at a lower level than Q3. We have also finalized plans to implement changes to our NSF OD policies in December that are largely consistent with industry best practice. We estimate this impact to be minimal in Q4 and approximately $5 million for the full year of 2023. Turning to taxes, we expect approximately $4 million in tax credit and amortization for the remainder of the year with a corresponding full year effective tax rate of approximately 24% on a core FTE basis and 20% on a GAAP basis. Lastly, our sale of the HSA deposits is expected to close in mid-November. Real estate repositioning, as well as other strategic investments, are expected to partially offset the gain from that sale. With those comments, I'd like to open the call for your questions. We do have a full team available, including Mark Sander, Tim Sandren, and John Moran.