Old National Bancorp

Welcome to the Old National Bancorp Second Quarter 2023 Earnings Conference Call. This call is being recorded and has been accessible to the public in accordance with the SEC's Regulation FD. 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 for 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 the 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 those numbers are contained within the appendix of the presentation. I'd now like to turn the call over to Old National CEO Jim Ryan. Mr. Ryan, please go ahead.

Good morning. We are pleased to be with you today to share details about our strong second quarter performance. Simply put, the quarter was business as usual for Old National with growth in deposits, solid liquidity and credit quality, disciplined loan growth, and well-managed expenses. The strength of our franchise remains evident in the results outlined on slide four. We reported EPS of 52 cents for the quarter, adjusted EPS was 54 cents per common share, with adjusted ROA and ROATCE of 133 and 22% respectively. Our adjusted efficiency ratio was a low 49%. Tangible book value, excluding AOCI, also increased 15% year-over-year. Deposit balances were up 4% during the quarter, with growth in core deposits of 2% as we continued to compete for new banking relationships effectively. Our total cost of deposits was 115 basis points, and we maintained our deposit pricing discipline with a low 23% total deposit beta cycle to date. Our credit quality remains stable with six basis points of non-PCD related charge-offs. We remain watchful and consistent with other banks are focused on potential pockets of softness. Like our deposit portfolio, our loan portfolio is granular and relationship driven, which should continue to serve us well. We remain confident in our client selection and underwriting. And as you know, Old National has taken a proactive approach to managing credit. This approach has served us well in the past and you see evidence of that stance this quarter as we work to address any credit deterioration aggressively. On the client side, engagement rained high in the quarter. We expect full relationships with our borrowing clients, and to the extent that new or existing clients lack that potential, we will manage accordingly. We do, however, continue to expect disciplined loan portfolio growth in 2023. In other areas, it's more of the same. Our below peer deposit costs should drive a funding advantage. We expect to see organic growth of our wealth management client base, and we continue to focus on discipline expense management while building tangible book value. We also continue to invest in top revenue generating talent and expand into dynamic new markets within our footprint. We recently celebrated the opening of our first Metro Detroit area commercial banking office with a terrific new team, and we announced two prominent commercial relationship managers have joined our Nashville wealth management team. Before I turn things over to Brendan, I also want to take a moment to share that our old national family continues to recover and heal from the Louisville tragedy on April 10th that claimed the lives of five of our team members and impacted so many others. More than three months later, our O&B family continues to do our best to love, care for, and support one another. Additionally, in June, Our downtown Louisville team began serving clients at a new location in the heart of downtown Louisville. Once again, I want to thank countless individuals and organizations who have cared for and supported our family during this challenging time. I also want to acknowledge and thank our team members for their resiliency and their commitment to supporting one another. With that, I will now turn the call over to Brendan to cover the quarterly results in more detail.

Thanks, Jim. Turning to our quarter end balance sheet on slide five, we continue to effectively navigate the challenging operating environment, achieving a more efficient balance sheet. We improved our earning asset mix with cash flows from our investment portfolio reinvested in loans, while their funding mix improved through higher deposit balances and lower borrowings. As a result, our loan to deposit ratio improved by 100 basis points, while strong earnings bolstered our capital levels and contributed to tangible book value growth, despite facing AOCI headwinds. On slide six, we present the trend in total loan growth and portfolio yields. Total loans grew by 2%, in line with our expectations. We sold approximately $300 million of non-relationship C&I loans at par during the quarter, as we look to manage liquidity while prioritizing lending to our clients with full banking relationships. The investment portfolio decreased by 2%, mainly due to portfolio cash flows and declines in fair values. Despite rate shifts, the duration remains steady at 4.4 years and is not expected to extend further. Cash flows from the portfolio are expected to be $1.2 billion over the next 12 months. Moving to slide seven, we show our trend in total deposits, which increased $1.3 billion, or 4%, quarter over quarter. Core deposits grew approximately $800 million, including $490 million of normal seasonal public inflows. The trend in average deposits reflects the continued mixed shift away from noninterest-bearing accounts into money markets and CDs. Market conditions continue to put upward pressure on deposit rates, with interest-bearing deposit costs increasing 57 basis points to 1.66%, resulting in a cycle-to-date interest-bearing deposit beta of 33%. Total deposit costs were relatively low at 1.15%, which equates to a cycle-to-date total deposit beta of 23%. While it's challenging to estimate the terminal beta, we have a strong track record of managing deposit rates and are confident we can maintain our funding cost advantage throughout the remainder of the rate cycle. Our disciplined approach to exception pricing has allowed us to successfully defend deposit balances, and our targeted promotions have resulted in above-peer deposit growth. Slide 8 provides our quarter-end income statement. where we reported gap net income applicable to common shares of $151 million or 52 cents per share. Reported earnings include $6 million in pre-tax merger related and other charges. Excluding these items, our adjusted earnings per share was 54 cents. Our profitability continues to be strong with an adjusted return on average tangible common equity of 22.1% and adjusted return on average assets of 1.33%. Moving on to slide nine, we present details of our net interest income and margin. Both metrics surpassed our expectations as we reported a linked quarter increase in net interest income and experienced lower than anticipated margin compression. Our strong performance was bolstered by the quarter point rate hike by the Fed in May and are better than expected deposit growth. Furthermore, we continue to make progress towards achieving our targeted neutral rate risk position by the end of the rate cycle while prudently adding protection against any sudden reversal in Fed rate policy. Slide 10 shows trends in adjusted non-interest income, which was $82 million for the quarter. Our primary fee businesses remained stable, but we did benefit from a $4 million increase in other income that we would not anticipate in a run rate next quarter. The items driving that increase were company-owned life insurance revenues, a recovery from a prior charged-off asset, and positive derivative valuations associated with the transition from LIBOR to SOFR. Continuing to slide 11, we show the trend in adjusted non-interest expenses. Adjusted expenses were $241 million, and our adjusted efficiency ratio was a low 49.4%. Our expenses were well-controlled and consistent with the previous quarter, excluding a $5 million increase in incentive accruals related to our strong year-to-date performance. This would equate to a Q3 run rate of $237.5 million. On slide 12, we present our credit trends, which remain stable, reflecting the strong performance of both our commercial and consumer portfolios. Delinquencies have decreased, and net charge-offs have remained steady at a modest six basis points, excluding the seven basis point impact from PCD loans. The rise in non-performing loans primarily stems from the anticipated migration of PCD credits, as we maintain an aggressive approach to resolving these loans. While charge-offs from this portfolio are expected to remain elevated in the short term, we expect minimal impact on provision expense, given that we currently carry a $39 million, or approximately 4%, reserve against this book. Our second quarter allowance, including reserve for unfunded commitments, stands at $338 million, or 104 basis points of total loans. The modest reserve increase was largely driven by loan growth, partially offset by adjustments in our economic forecast. We continue to rely on a 100% weighted Moody's S3 scenario that projects peak unemployment of 7.2% and negative GDP growth of 3.1%. Barring any significant deterioration beyond these economic assumptions, we expect provision expense to remain limited to portfolio performance and loan growth. Shifting to key areas of focus on slide 14, you will see further details on our loan portfolio. Our commercial loan book, which constitutes approximately 70% of our total loans, is granular and well diversified. Our non-owner occupied CRE is also well diversified across various asset classes and geographies. Regarding non-owner occupied office properties, the majority of the portfolio is comprised of suburban or medical offices with a significant portion of credit tenant leases. Only a negligible percentage, less than 1% of total loans, is attributed to properties located within central business districts that are geographically dispersed across 11 Midwestern cities in our footprint. On slide 15, we provide highlights from a recent examination of fixed rate CRE maturities over the next 18 months. Less than 1% of total loans that are non-owner occupied CRE mature within 18 months and carry a note rate of less than 4%. Our approach to underwriting CRE includes a 300 basis point margin over the current rates at the time of origination. While these maturing credits have surpassed the original underwriting stress coupon, we have observed improved net operating income from higher rents. This improvement has been sufficient to uphold debt service ratios in line with our underwriting guidelines, and we believe the refinance risk in this portfolio to be minimal. Slide 16 details our Q2 commercial production. The $1.9 billion of production was well balanced across all product lines and major markets. As discussed on last quarter's call, we have tightened our pricing standards, enhanced our credit structure, and reinforced with our RMs the importance of acquiring a full banking relationship for new loan requests. As a result of these actions and strong Q2 production, our pipeline has decreased to $3.1 billion and is consistent with low to mid single-digit loan growth we expect in the back half of the year. On slide 17, we present further insights into our deposit base. Our average core deposit balance is meaningfully lower than peers. Eighty-one percent of our accounts have less than $25,000 on deposit and carry an average balance of just $4,500. It's important to highlight that we maintain strong, enduring relationships with our deposit customers, 50% of which have been with the bank for over 15 years. Our top 20 deposit clients represent only 5% of total deposits and have a weighted average tenure of greater than 30 years. Lastly, our broker deposits were 3.5% of total deposits at the end of the quarter, which we expect to be well below peer average. On slide 18, we provide a comprehensive overview of our capital position at the end of the quarter. We observed improvements in all regulatory capital ratios and maintained stability in our TCE ratio, despite facing the negative impact of increasing AOCI. Our above peer return on tangible common equity, coupled with our peer average dividend payout ratio, should result in us accreting capital at a faster rate than most. Additionally, we anticipate 30% of our outstanding AOCI to accrete to capital by the end of 2024. We did not repurchase any shares in the quarter and do not intend to do so in the near term as we focus on capital growth. In summary, our strong second quarter performance marked the successful conclusion of the first half of 2023, with results slightly exceeding our expectations. We have improved the efficiency ratio of our balance sheet through a better earning asset mix, strong core deposit growth led to a better funding mix, and we grew tangible book value per share by 15%, excluding OCI impact. Despite the challenging rate environment, our net interest income grew quarter over quarter, largely due to the strong execution of our deposit strategy. We have demonstrated an ability to both expand our customer base while maintaining peer-leading deposit costs. Our credit portfolio remains stable, and our disciplined approach to managing expenses is evident in our quarterly adjusted efficiency ratio of 49.4%. Slide 20 includes thoughts on our outlook for the remainder of 2023. We believe our current pipeline should support second half 2023 loan growth in the low to mid single-digit range with full-year growth in the mid to high single-digit range. We continue to target at or above industry deposit growth, and we are reconfirming our guide on 9% to 12% year-over-year net interest income increase with a stronger conviction towards the higher end of this range. The key assumptions in this guidance include one more rate hike, and a through the cycle interest bearing deposit beta of 43 to 53% by year end, and non-interest bearing deposits falling to 28%. We expect fee businesses to be stable in the back half of 2023 with the exception of the $4 million in non-run rate items we noted earlier. Our expense outlook is adjusted to approximately $949 million for full year 2023, excluding merger related charges and property optimization related expenses. This reflects our prior guidance of $939 million, adjusted upward by $10 million for higher incentive accruals. $5 million of this has already been accrued at quarter end. Provision expense should continue to be limited to loan growth, portfolio changes, and non-PCD charge-offs, as we believe we have adequate reserves against the PCD book. Turning to taxes, we expect approximately $8 million in tax credit amortization for the remainder of 2023, with a corresponding full-year effective tax rate of 25% on a core FTE basis and 23% on a GAAP basis. With those comments, I'd like to open up the call for your questions. We do have the full team available, including Mark Sander, Jim Sangren, and John Moran.