UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2003
Commission File Number 1-15817
OLD NATIONAL BANCORP
(Exact name of the Registrant as specified in its charter)
INDIANA 35-1539838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
420 Main Street
Evansville, Indiana 47708
(Address of principal executive offices) (Zip Code)
(812) 464-1434
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act
Title of Each Class Name of each exchange on which registered
Common Stock, No Par Value New York Stock Exchange
Preferred Stock Purchase Rights
Securities registered pursuant to Section 12(g) of the Act:
None
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 (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the Registrant's voting common stock held by
non-affiliates on June 30, 2003, was $1,460,687,361 (based on the closing price
on that date of $21.90, as quoted on the New York Stock Exchange). In
calculating the market value of securities by non-affiliates of the Registrant,
the Registrant has treated as securities held by affiliates as of June 30, 2003,
voting stock owned of record by its directors and principal executive officers,
and voting stock held by the Registrant's trust department in a fiduciary
capacity.
The number of shares outstanding of the Registrant's classes of common stock, as
of January 31, 2004, was 66,226,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be
held April 29, 2004, is incorporated by reference into Part III of this Form
10-K.
OLD NATIONAL BANCORP
2003 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I PAGE
Item 1. Business 3
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Item 2. Properties 10
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Item 3. Legal Proceedings 10
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Item 4. Submission of Matters to a Vote of Security Holders 10
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PART II
Item 5. Market for The Registrant's Common Equity and Related Stockholder Matters 10
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Item 6. Selected Financial Data 11
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk 29
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Item 8. Financial Statements and Supplementary Data 32
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 64
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Item 9A. Controls and Procedures 64
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PART III
Item 10. Directors and Executive Officers of the Registrant 65
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Item 11. Executive Compensation 65
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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
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Matters 66
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Item 13. Certain Relationships and Related Transactions 66
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Item 14. Principal Accountant Fees and Services 66
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PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 67
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SIGNATURES 69
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2
OLD NATIONAL BANCORP
2003 ANNUAL REPORT ON FORM 10-K
PART I
ITEM 1. BUSINESS
GENERAL
Old National Bancorp ("Old National") is a financial holding company
incorporated in the State of Indiana and maintains its principal executive
office in Evansville, Indiana. Old National, through its wholly-owned banking
subsidiary, provides a wide range of services, including commercial and consumer
banking, depository services, lease financing and other traditional banking
services. Through its non-bank affiliates, Old National provides services to
supplement the banking business including fiduciary and trust services,
investment and brokerage services, asset management, insurance and other
financial services. As of December 31, 2003, Old National employed 3,019
full-time equivalent employees.
COMPANY PROFILE
Old National Bank, Old National Bancorp's wholly-owned banking subsidiary, was
founded in 1834 and is the oldest company in Evansville, Indiana. In 1982, Old
National Bancorp was formed and in 2001 became a financial holding company. Also
in 2001, Old National completed the consolidation of 21 bank charters enabling
Old National to operate under a common name with consistent product offerings
throughout the banking locations, improving back-office efficiency and allowing
Old National to provide more convenient service to customers. Over the past
several years, Old National has grown to include financial services operations
in Indiana, Illinois, Ohio, Kentucky, Tennessee and Missouri.
In 2002, Old National identified four components of growth essential to the
achievement of the company's long-term earnings and financial performance
objectives:
o In Old National's traditional banking markets, growth strategies will be
focused on adding products and services. Old National's operations in these
communities continue to account for a high percentage of the company's
revenue and the growth of revenue from these slower growth markets will
come primarily from providing additional services to current customers.
o Old National Signature Group is responsible for fee-based services such as
insurance, investment, trust, asset management, financial planning and
similar non-traditional banking services. It is anticipated that these
units will generate revenue growth at rates exceeding Old National's
traditional banking products.
o Mortgage lending is a traditional offering at Old National banking centers.
By aligning these mortgage initiatives more closely and focusing a
management team on them, Old National has improved efficiencies, added new
products and increased revenue. In addition, Old National plans to use
stand-alone mortgage offices to help gain entry into new markets.
o Old National is continuing to add to its presence in Indianapolis,
Louisville and St. Louis, where it anticipates opportunities to attract
high-value clients to Old National's strong service emphasis.
During the third quarter of 2003, Old National determined that it must intensify
its efforts to improve lending administration and overall operating efficiency
in order to improve its overall financial performance. Old National has
identified the following initiatives as having very high priority:
o Improving credit quality approval processes and disciplines and the
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reduction of non-performing loans in the portfolio
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Lending operations have been reorganized to realign the traditional
relationship management and credit analysis functions. Local lending and
customer relationship officers will still have primary responsibility for
business development and loan approval, but credit analysts independent of
local bank management will work with lenders on credit approvals. This
formalized process will ensure consistency in underwriting criteria across
the organization, while maintaining a strong commitment to being responsive
to customer needs. In addition to these efforts aimed at improving the
quality of new loans, additional staff and resources have been assigned to
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manage the problem loan portfolio. These efforts include intensified
work-out and restructuring efforts with borrowers, negotiations with
borrowers to move the credit relationship to other lenders, and the
consideration of the sale of pools of problem loans.
o Improving efficiencies and optimizing profit in all aspects of the
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operation through an intense company-wide review of revenue and expense
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opportunities
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Old National retained the services of EHS Partners, LLC to assist in this
project. EHS has worked with a wide range of financial institutions similar
to Old National that have experienced growth through acquisitions and
product expansion and had a desire to conduct a similar company-wide
operations review. The project, referred to as "Ascend," involves two
phases. The first phase is an intensive idea generation and evaluation
process which is expected to be completed in early April 2004. The
implementation of profit improvement strategies is expected to begin during
the second quarter of 2004 and to be fully implemented by the end of 2005.
ACQUISITION STRATEGY
Since the formation of Old National Bancorp in 1982, Old National has acquired
more than 40 financial institutions and financial services companies. As a part
of Old National's four component strategy as previously described, Old National
has acquired several financial services companies primarily to grow the non-bank
services segment and to achieve a presence in various targeted metro markets:
o Insurance and Risk Management based in Fort Wayne, Indiana, acquired in
August 2003, is an insurance agency that offers products including
commercial and personal property and casualty insurance, employee benefits
insurance and third party administrator services.
o Graham and Peat Insurance Agency based in St. Louis, Missouri, acquired in
June 2003, is an insurance agency that offers property and casualty and
life insurance.
o James L. Will Insurance Agency, Inc., based in Evansville, Indiana,
acquired in May 2003, is an insurance agency focused on commercial property
and casualty as well as personal lines of insurance.
o Terrill Group, Inc., based in St. Louis, Missouri, acquired in December
2002, is an insurance agency that offers property and casualty, health,
life, disability and accident insurance.
o Fund Evaluation Group, Inc., acquired July 2002, is an investment and
consulting firm based in Cincinnati, Ohio, that provides investment
consulting and performance management services to a wide range of
institutional clients.
In the future, Old National will continue to pursue opportunities to acquire
both financial institutions and financial services companies, focusing on the
following primary objectives:
o Acquire financial institutions in the Midwestern and South-central regions
of the United States, generally with assets in the range of $200 million to
$3 billion.
o Acquire financial services companies located in, but not limited to, the
same geographic markets that provide products and services consistent with
and complementary to those products and services offered by Old National
Signature Group.
As with previous acquisitions, the consideration paid by Old National will be in
the form of cash, debt or Old National Bancorp stock. The amount and structure
of such consideration is based on reasonable growth and cost savings assumptions
and a thorough analysis of the impact on both long and short term financial
results.
OPERATING SEGMENTS
Old National has been divided into three operating segments: community banking,
non-bank services and treasury. A description of each segment is described
below.
Community Banking Segment
The community banking segment, operating under the name of Old National Bank,
has traditionally been the most significant contributor to Old National,
historically representing approximately 80% of consolidated net income. The
primary goal of the community banking segment is to provide products and
services that address the client's needs and help clients reach their financial
goals by providing quality services at prices that are fair. Old National's
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banking centers focus on convenience factors such as location, adequate space
for private consultations, quick client access to routine transactions and good
parking.
As of December 31, 2003, Old National's affiliate bank operated over 120 banking
centers in Indiana, Illinois, Kentucky, Tennessee and a limited area in Ohio.
The community banking segment primarily consists of lending and depository
activities, but also includes services such as merchant services, cash
management services, payroll services, Internet banking and services relating to
the general banking business. In addition, the community banking segment
includes the Indiana Old National Insurance Company ("IONIC") and Central Life
Insurance Company, which reinsure credit life insurance. IONIC also provides
captive property and casualty insurance for Old National and reinsures most of
the coverage with non-affiliated carriers.
Lending Activities
Old National earns interest income on loans as well as fee income from the
origination of loans. Lending activities include loans to individuals, which
primarily consist of home equity lines of credit, residential real estate loans
and consumer loans, and loans to small business and commercial customers, which
include commercial loans, commercial real estate, letters of credit and lease
financing. Typically, fixed-rate residential real estate loans are sold to
secondary investors with servicing rights retained by Old National, with gains
or losses from the sales being recognized, while adjustable-rate loans are held
in the portfolio.
Depository Activities
Old National strives to provide depository services to individuals and
commercial customers that fit their needs at competitive rates. Old National
pays interest on the interest-bearing deposits and receives service fee revenue
on various accounts. The transaction accounts include products such as
noninterest-bearing demand, NOW, savings and money market, and time deposits.
Debit and ATM cards provide access to the customer's accounts 24 hours a day at
any ATM location. Old National also provides 24-hour telephone access as well as
other electronic banking services.
Non-bank Services Segment
The non-bank services segment provides a variety of financial services including
investment advisory and trust services, investment and brokerage services, asset
management consulting services and insurance agency services. Old National has
identified the non-bank services segment as an important growth opportunity.
This accelerates Old National's transition to a financial services company with
broader client relationships and less dependence on interest rate conditions.
The non-bank services, especially those geared toward high net worth clients,
help open new markets for Old National. Old National's non-bank services segment
operates in the same geographical markets as the community banking segment and
through acquisitions has broadened its scope to include Missouri and expanded
its area in Ohio.
Investment Advisory and Trust Services
Fiduciary and trust services are offered through an affiliate trust company
under the business name of Old National Trust Company. Signal Capital
Management, Inc., an affiliate of Old National Trust Company, provides fee-based
asset management and manages and sells mutual funds.
Investment and Brokerage Services
ONB Investments Services, Inc., a registered broker-dealer, operates as a
subsidiary of Old National Bank in order to provide bank customers with
convenient and professional investment services and a variety of brokerage
products. ONB Investment Services, Inc. offers a full-array of investment
options and investment advice to bank customers and members of the general
public.
Asset Management Consulting Services
Fund Evaluation Group, Inc. specializes in portfolio structure, investment
management research and performance reporting, providing asset management
consulting services to its investment customers.
Insurance Agency Services
Through its insurance agency subsidiaries, Old National offers full service
insurance brokerage services including commercial property and casualty, surety
loss control services, employee benefits consulting and administration, and
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personal insurance. These subsidiaries are insurance agencies that offer
products that are issued and underwritten by various insurance companies not
affiliated with Old National.
Treasury Segment
Treasury manages investments, wholesale funding, interest rate risk, liquidity
and leverage for Old National. Additionally, treasury provides other
miscellaneous capital markets products for Old National's corporate banking
customers.
Additional information about Old National's business segments is included in
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 21 to the consolidated financial statements.
MARKET AREA
Old National operates primarily in the state of Indiana, with limited presence
in the northern part of the state. Old National is also located in the eastern
and southeastern regions of Illinois and central and western regions of Kentucky
and has a strong presence in Clarksville, Tennessee. These markets include a
number of densely populated areas as well as rural areas in which Old National
has achieved the first or second ranking in deposit share. The income classes
include some high-income areas as well as many middle-income and some
low-to-moderate income areas. In addition, through acquisitions, the market area
has expanded to include insurance agency operations based in St. Louis,
Missouri, and asset management consulting based in Cincinnati, Ohio. Old
National continues to add to its metropolitan strategy in order to increase its
presence within targeted cities including Indianapolis, Indiana; Louisville,
Kentucky; and St. Louis, Missouri. Old National is considering expansion into
additional larger metropolitan markets within a 250-mile radius of Old
National's Evansville, Indiana, headquarters.
Indiana, Old National's primary state of operations, has faced several long-term
challenges to its future growth and has been among the national leaders in job
losses over the past few years. According to a report issued by the U.S.
Conference of Mayors in coordination with the Indiana Association of Cities and
Towns, Indiana is the most highly industrialized state in the nation. Indiana
relies on manufacturing for 20.2% of jobs and 27.2% of Gross State Product as of
May 2003. This almost doubles the U.S. average dependence on manufacturing for
jobs and Gross State Product. The manufacturing industry has been one of the
most affected by the economic downturn experienced by the nation.
The following table reflects Old National's market share for significant markets
with most recent data available.
Old National Deposit Market Share and Number of Branch Locations
Deposits as of June 30, 2003
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Number of Deposit Market
Market Location Branches Share Rank
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Evansville, Indiana 15 1st
Clarksville, Tennessee 4 1st
Muncie, Indiana 8 2nd
Bloomington, Indiana 5 3rd
Terre Haute, Indiana 8 2nd
Danville, Illinois 4 1st
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Source: SNL Financial
COMPETITION
The banking industry and related financial service providers operate in a highly
competitive market. Within its six-state geography, Old National competes with
financial services providers such as local, regional and national banking
institutions, savings and loan associations, credit unions, thrifts, finance
companies and mortgage banking companies. In addition, Old National's non-bank
services segment faces competition with investment brokers, asset managers and
advisory services, money market and mutual fund companies and insurance
agencies.
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SUPERVISION AND REGULATION
Old National is registered as a bank holding company and has elected to be a
financial holding company. It is subject to the supervision of, and regulation
by, the Board of Governors of the Federal Reserve System ("Federal Reserve")
under the Bank Holding Company Act of 1956, as amended ("BHC Act"). The Federal
Reserve has issued regulations under the BHC Act requiring a bank holding
company to serve as a source of financial and managerial strength to its
subsidiary banks. It is the policy of the Federal Reserve that, pursuant to this
requirement, a bank holding company should stand ready to use its resources to
provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity.
The BHC Act requires the prior approval of the Federal Reserve to acquire more
than a 5% voting interest of any bank or bank holding company. Additionally, the
BHC Act restricts Old National's non-banking activities to those which are
determined by the Federal Reserve to be closely related to banking and a proper
incident thereto.
On July 30, 2002, the Senate and the House of Representatives of the United
States (Congress) enacted the Sarbanes-Oxley Act of 2002, a law that addresses,
among other issues, corporate governance, auditing and accounting, executive
compensation, and enhanced and timely disclosures of corporate information. The
New York Stock Exchange has also proposed corporate governance rules that were
presented to the Securities and Exchange Commission for review and approval. The
proposed changes are intended to allow stockholders to more easily and
efficiently monitor the performance of companies and directors.
Effective August 29, 2002, as directed by Section 302(a) of the Sarbanes-Oxley
Act, Old National's principal executive officer and principal financial officer
are required to certify that Old National's quarterly and annual reports do not
contain any untrue statements of a material fact. The rules also require that
these officers certify that they are responsible for establishing, maintaining
and regularly evaluating the effectiveness of Old National's internal controls;
they have made certain disclosures to auditors and the Audit Committee of the
Board of Directors about internal controls; and they have included information
in Old National's quarterly and annual reports about their evaluation and
whether there have been significant changes in Old National's internal controls
or in other factors that could significantly affect internal controls subject to
the evaluation.
On January 23, 2003, the Board of Directors of Old National Bancorp approved
various corporate governance matters to strengthen and improve its already
strong corporate governance practices. The Board adopted a Corporate Governance
and Nominating Committee Charter, amended the Audit Committee Charter and
adopted a Compensation Committee Charter. In addition, the Board of Directors
approved Corporate Governance Guidelines, a Code of Business Conduct and Ethics
which applies to all officers and employees as well as Directors of the
Corporation, and a Senior Financial and Executive Officer Code of Ethics. These
documents are available for review under the Corporate Governance link on Old
National's website at www.oldnational.com.
On October 26, 2001, the USA Patriot Act of 2001 was signed into law. Enacted in
response to the terrorist attacks in New York, Pennsylvania, and Washington,
D.C. on September 11, 2001, the Patriot Act is intended to strengthen U.S. law
enforcement's and the intelligence community's ability to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the Patriot Act
on financial institutions of all kinds is significant and wide-ranging. The
Patriot Act contains sweeping anti-money laundering and financial transparency
laws and requires various regulations, including: (a) due diligence requirements
for financial institutions that administer, maintain, or manage private banks
accounts or correspondent accounts for non-U.S. persons; (b) standards for
verifying customer identification at account opening; (c) rules to promote
cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering; (d) reports by non-financial trades and business filed with the
Treasury Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000; and (e) filing of suspicious activities reports by brokers
and dealers if they believe a customer may be violating U.S. laws and
regulations.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), a bank holding company is required to guarantee the compliance of
any insured depository institution subsidiary that may become "undercapitalized"
(as defined in FDICIA) with the terms of any capital restoration plan filed by
such subsidiary with its appropriate federal bank regulatory agency.
Bank holding companies are required to comply with the Federal Reserve's
risk-based capital guidelines. The Federal Deposit Insurance Corporation
("FDIC") and the Office of the Comptroller of the Currency ("OCC") have adopted
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risk-based capital ratio guidelines to which depository institutions under their
respective supervision are subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk-weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk. Old
National's affiliate bank met all risk-based capital requirements of the FDIC
and OCC as of December 31, 2003. For Old National's regulatory capital ratios
and regulatory requirements as of December 31, 2003, see Note 19 to the
consolidated financial statements.
Old National's affiliate bank is subject to the provisions of the National Bank
Act, is supervised, regulated and examined by the OCC, and is subject to the
rules and regulations of the OCC, Federal Reserve and the FDIC.
A substantial portion of Old National's cash revenue is derived from dividends
paid to it by its affiliate bank. These dividends are subject to various legal
and regulatory restrictions as summarized in Note 19 to the consolidated
financial statements.
Both federal and state law extensively regulates various aspects of the banking
business, such as reserve requirements, truth-in-lending and truth-in-savings
disclosures, equal credit opportunity, fair credit reporting, trading in
securities and other aspects of banking operations.
Branching by Old National's affiliate bank is subject to the jurisdiction and
requires notice to or the prior approval of the OCC.
Old National and its affiliate bank are subject to the Federal Reserve Act,
which restricts financial transactions between banks and affiliated companies.
The statute limits credit transactions between banks, affiliated companies and
its executive officers and its affiliates. The statute prescribes terms and
conditions for bank affiliate transactions deemed to be consistent with safe and
sound banking practices, and restricts the types of collateral security
permitted in connection with a bank's extension of credit to an affiliate.
Additionally, all transactions with an affiliate must be on terms substantially
the same or at least as favorable to the institution as those prevailing at the
time for comparable transactions with nonaffiliated parties.
FDICIA accomplished a number of sweeping changes in the regulation of depository
institutions, including Old National's affiliate bank. FDICIA requires, among
other things, federal bank regulatory authorities to take "prompt corrective
action" with respect to banks which do not meet minimum capital requirements.
FDICIA further directs that each federal banking agency prescribe standards for
depository institutions and depository institution holding companies relating to
internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
management compensation, a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb losses, a minimum ratio of market value to
book value of publicity traded shares and such other standards as the agency
deems appropriate.
The deposits of Old National's affiliate bank are insured up to $100,000 per
insured account by the Bank Insurance Fund ("BIF"), which is administered by the
FDIC, except for deposits acquired in connection with affiliations with savings
associations, which deposits are insured by the Savings Association Insurance
Fund ("SAIF"). Accordingly, Old National's affiliated bank pays deposit
insurance premiums to both BIF and SAIF.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allows
for interstate banking and interstate branching without regard to whether such
activity is permissible under state law. Bank holding companies may now acquire
banks anywhere in the United States subject to certain state restrictions.
The Gramm-Leach-Bliley Act ("GLBA") permits bank holding companies which have
elected to become financial holding companies to engage in a substantially
broader range of non-banking activities, including securities, investment advice
and insurance activities, than is permissible for bank holding companies that
have not elected to become financial holding companies. Old National has elected
to be a financial holding company. As a result, Old National may underwrite and
sell securities and insurance. It may acquire, or be acquired by, brokerage
firms and insurance underwriters. GLBA established new requirements for
financial institutions to provide enhanced privacy protections to customers. In
June of 2000, the Federal banking agencies jointly adopted a final regulation
providing for the implementation of these protections. Financial institutions
are required to provide notice to consumers which
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details its privacy policies and practices, describes under what conditions a
financial institution may disclose nonpublic personal information about
consumers to nonaffiliated third parties and provides an "opt-out" method which
enables consumers to prevent the financial institution from disclosing customer
information to nonaffiliated third parties. Financial institutions were required
to be in compliance with the final regulation by July 1, 2001, and Old National
was in compliance at such date and continues to be in compliance.
In addition to the matters discussed above, Old National's affiliate bank is
subject to additional regulation of its activities, including a variety of
consumer protection regulations affecting its lending, deposit and collection
activities and regulations affecting secondary mortgage market activities. The
earnings of financial institutions are also affected by general economic
conditions and prevailing interest rates, both domestic and foreign and by the
monetary and fiscal policies of the United States government and its various
agencies, particularly the Federal Reserve.
Additional legislative and administrative actions affecting the banking industry
may be considered by the United States Congress, state legislatures and various
regulatory agencies, including those referred to above. It cannot be predicted
with certainty whether such legislative or administrative action will be enacted
or the extent to which the banking industry in general or Old National and its
affiliate bank in particular would be affected.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The following is a cautionary note about forward-looking statements. In its oral
and written communication, Old National from time to time includes
forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward looking statements can include
statements about estimated cost savings, plans and objectives for future
operations, and expectations about performance as well as economic and market
conditions and trends. They often can be identified by the use of words like
"expect," "may," "could," "intend," "project," "estimate," "believe" or
"anticipate." Old National may include forward-looking statements in filings
with the Securities and Exchange Commission, such as this Form 10-K, in other
written materials, and in oral statements made by senior management to analysts,
investors, representatives of the media and others. It is intended that these
forward-looking statements speak only as of the date they are made, and Old
National undertakes no obligation to update any forward-looking statement to
reflect events or circumstances after the date on which the forward looking
statement is made or to reflect the occurrence of unanticipated events. By their
nature, forward-looking statements are based on assumptions and are subject to
risks, uncertainties and other factors. Actual results may differ materially
from those contained in the forward-looking statement. Uncertainties which could
affect Old National's future performance include, but are not limited to: (1)
economic, market, operational, liquidity, credit and interest rate risks
associated with Old National's business; (2) economic conditions generally and
in the financial services industry; (3) increased competition in the financial
services industry either nationally or regionally, resulting in, among other
things, credit quality deterioration; (4) volatility and direction of market
interest rates; (5) governmental legislation and regulation (see the discussion
under the heading "Supervision and Regulation" above), including changes in
accounting regulation or standards; (6) ability of Old National to execute its
business plan; (7) a weakening of the economy which could materially impact
credit quality trends and the ability to generate loans; (8) changes in the
securities markets; and (9) changes in fiscal, monetary and tax policies.
Investors should consider these risks, uncertainties and other factors in
addition to those mentioned by Old National in its other filings from time to
time when considering any forward-looking statement.
AVAILABLE INFORMATION
All reports filed electronically by Old National Bancorp with the Securities and
Exchange Commission ("SEC"), including the annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and
information statements, other information and amendments to those reports filed
(if applicable), are accessible at no cost on Old National's web site at
www.oldnational.com. These filings are also accessible on the SEC's web site at
www.sec.gov. The public may read and copy any materials filed by Old National
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330.
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ITEM 2. PROPERTIES
The principal executive offices of Old National and its community banking,
non-banking services and treasury segments are currently located in leased space
in the multi-story Old National Bank building located at 420 Main Street,
Evansville, Indiana. The building is owned by a non-affiliated third party. Old
National began construction of a new headquarters building at One Main Street in
Evansville, Indiana, on June 27, 2002, with completion in 2004, at which time
this location will become the principal executive offices. On October 11, 2002,
Old National entered into a $52 million construction contract for the new
building with a company controlled by a director.
Old National's affiliate bank and subsidiaries conduct business primarily from
facilities Old National Bank owns. Of the over 120 banking and financial
services centers operated by Old National Bank in Indiana, Illinois, Kentucky,
Tennessee and Ohio, 47 are leased from non-affiliated third parties and the
remainder are owned by Old National Bank and are free from mortgages and major
encumbrances.
ITEM 3. LEGAL PROCEEDINGS
Old National has no material pending legal proceedings required to be disclosed
under Item 3. See Note 17 to the consolidated financial statements for further
discussion of Old National's legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of Old National during
the fourth quarter of 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Old National's stock is traded on the New York Stock Exchange ("NYSE") under the
ticker symbol ONB. Old National's shares began trading on the NYSE on February
15, 2002. The following table lists the NASDAQ price quotes, share volume and
dividend data from January 1, 2002 to February 14, 2002. The NYSE price quotes,
share volume and dividend data are used from February 15, 2002 to December 31,
2003.
---------------------------------------------------------------
Price Per Share
----------------------- Share Dividend
High Low Volume Declared
---------------------------------------------------------------
2003
First Quarter $22.71 $20.18 3,742,305 $0.18
Second Quarter 22.67 20.52 4,263,000 0.18
Third Quarter 22.82 21.29 3,785,250 0.18
Fourth Quarter 22.14 20.61 3,862,846 0.18
---------------------------------------------------------------
2002
First Quarter $22.36 $21.30 2,685,139 $0.15
Second Quarter 23.56 21.81 2,742,910 0.15
Third Quarter 24.04 20.69 3,352,703 0.18
Fourth Quarter 23.04 20.85 3,555,783 0.18
-----------------------------------------------------------------
Data adjusted for all stock dividends, including a 5% stock dividend to
shareholders of record on January 6, 2004, distributed on January 27,
2004.
In December 2003, a 5% stock dividend was declared to shareholders of record on
January 6, 2004. There were 25,459 shareholders of record as of December 31,
2003. Also, Old National declared $0.72 per share in dividends during the year
ended December 31, 2003, and $0.66 per share in dividends for the year ended
December 31, 2002. Old National's ability to pay cash dividends primarily
depends on cash dividends received from Old National Bank. Dividend payments
from Old National Bank are subject to various regulatory restrictions. See Note
19 to the consolidated financial statements for additional information.
10
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
- -------------------------------------------------------------------------------------------------------------------------------
Five-Year
(dollars in thousands, Growth
except per share data) 2003 2002 2001 2000 1999 1998 Rate
- -------------------------------------------------------------------------------------------------------------------------------
Results of Operations
Net interest income (1) $ 297,130 $ 314,606 $ 312,620 $ 289,510 $ 299,165 $ 277,892 1.3 %
Fee and service charge income 168,593 129,580 108,197 101,832 80,513 71,808 18.6
Net securities gains (losses) 23,556 12,444 4,770 (119) 2,637 1,090 N/M
Gain on branch divestitures -- 12,473 -- -- -- -- N/M
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue (1) 489,279 469,103 425,587 391,223 382,315 350,790 6.9
- -------------------------------------------------------------------------------------------------------------------------------
Provision for loan losses 85,000 33,500 28,700 29,803 14,798 14,987 41.5
Salaries and
other operating expenses 299,716 257,845 245,109 228,034 223,897 199,088 8.5
Merger and restructuring costs -- -- 9,703 37,503 -- -- N/M
Income taxes (1) 34,150 59,826 49,031 34,187 50,363 51,272 (7.8)
- -------------------------------------------------------------------------------------------------------------------------------
Income from
continuing operations 70,413 117,932 93,044 61,696 93,257 85,443 (3.8)
Discontinued operations (after-tax) -- -- -- -- 4,101 (9,854) N/M
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 70,413 $ 117,932 $ 93,044 $ 61,696 $ 97,358 $ 75,589 (1.4)%
===============================================================================================================================
Per Share Data (2)
Net income (diluted) $ 1.05 $ 1.75 $ 1.36 $ 0.90 $ 1.36 $ 1.06 (0.1)%
Cash dividends paid 0.72 0.66 0.59 0.56 0.51 0.46 9.5
Book value at year-end 10.75 11.05 9.48 8.98 8.51 8.76 4.2
Stock price at year-end 21.76 22.04 21.81 24.63 25.42 27.73 (4.7)
Balance Sheet Data
(at December 31)
Total assets $9,353,896 $9,612,556 $9,080,473 $8,767,748 $8,086,012 $7,334,271 5.0 %
Loans (3) 5,586,455 5,769,635 6,132,854 6,348,313 5,714,688 5,058,460 2.0
Deposits 6,493,092 6,439,280 6,616,440 6,583,906 5,962,069 5,436,381 3.6
Other borrowings 1,624,092 1,234,014 1,083,046 863,165 768,055 675,745 19.2
Shareholders' equity 715,490 740,710 639,235 626,341 584,995 605,849 3.4
Performance Ratios
Return on average assets 0.74 % 1.27 % 1.05 % 0.73 % 1.25 % 1.08 %
Return on average
shareholders' equity 9.48 17.05 14.45 10.55 15.82 12.65
Dividend payout 68.69 37.25 43.13 62.84 36.52 40.38
Average equity to average assets 7.78 7.47 7.27 6.92 7.90 8.57
Net interest margin (1) 3.37 3.65 3.77 3.65 4.09 4.26
Efficiency ratio
(noninterest expense/revenue) (1) 61.26 54.97 59.87 67.87 58.56 56.75
Net charge-offs
to average loans (3) 1.21 0.34 0.45 0.39 0.17 0.24
Allowance for loan losses to
ending loans (3) 1.87 1.52 1.21 1.16 1.15 1.17
Other Data
Number of full-time
equivalent employees 3,019 2,941
Number of shareholders 25,459 25,718
Number of shares traded
(in thousands) (2) 15,653 12,337
- -------------------------------------------------------------------------------------------------------------------------------
(1) Includes the effect of taxable equivalent adjustments of $25.1 million for
2003, $25.2 million for 2002, $21.3 million for 2001, $19.6 million for
2000, $17.9 million for 1999, and $15.9 million for 1998 using the federal
statutory tax rate in effect of 35% for all periods.
(2) All share and per share data have been adjusted for stock dividends and
stock splits, including a 5% stock dividend to shareholders of record on
January 6, 2004, distributed on January 27, 2004. Diluted data assumes the
conversion of stock options and subordinated debentures.
(3) Includes residential loans held for sale.
N/M = Not meaningful
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
EXECUTIVE SUMMARY
The 2003 net income of Old National decreased significantly compared to previous
years. Old National was negatively affected by considerable credit quality
issues during 2003, resulting in substantially increased provisions for loan
losses. In addition, a reserve for the settlement of pending litigation resulted
in $10.0 million of additional expenses for the year. Weak loan demand in the
markets served by Old National as well as low interest rates negatively affected
the net interest margin.
As a result of management's balance sheet strategies, Old National's financial
condition showed a decrease in assets and liabilities at December 31, 2003,
reflecting heavy refinancing of residential real estate loans during the year, a
reduction in the investment portfolio, and a reduction of certificates of
deposits and borrowed funds. Management uses various indicators such as return
on assets, return on equity and asset quality ratios in order to evaluate the
performance of the business. These are discussed throughout this "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
FINANCIAL BASIS
The following discussion is an analysis of Old National's results of operations
for the years ended December 31, 2001 through 2003, and financial condition as
of December 31, 2003 and 2002. This discussion and analysis should be read in
conjunction with Old National's consolidated financial statements and related
notes. This discussion contains forward-looking statements concerning Old
National's business that are based on estimates and involves certain risks and
uncertainties. Therefore, future results could differ significantly from
management's current expectations and the related forward-looking statements.
See Item 1, "Business" for further information regarding forward-looking
statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The "Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as disclosures found elsewhere in the annual report, are
based upon Old National's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
Old National to make estimates and judgements that affect the reported amounts
of assets, liabilities, revenues and expenses. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the valuation of the mortgage
servicing rights and the valuation of goodwill and intangibles. Actual results
could differ from those estimates.
o Allowance for Loan Losses. The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses inherent in
the consolidated loan portfolio. Management's evaluation of the adequacy of
the allowance is an estimate based on reviews of individual loans,
assessments of the impact of current and anticipated economic conditions on
the portfolio and historical loss experience. The allowance represents
management's best estimate, but significant downturns in circumstances
relating to loan quality and economic conditions could result in a
requirement for additional allowance in the near future. Likewise, an
upturn in loan quality and improved economic conditions may allow a
reduction in the required reserve. In either instance, unanticipated
changes could have a significant impact on results of operations.
The allowance is increased through a provision charged to operating
expense. Uncollectible loans are charged-off through the allowance.
Recoveries of loans previously charged-off are added to the allowance. A
loan is considered impaired when it is probable that contractual interest
and principal payments will not be collected either for the amounts or by
the dates as scheduled in the loan agreement. Old National's policy for
recognizing income on impaired loans is to accrue interest unless a loan is
placed on nonaccrual status.
o Mortgage Servicing Rights. Mortgage servicing rights are recognized as
separate assets when loans are sold with servicing retained. The total
price of loans sold is allocated between the loans sold and the mortgage
servicing rights retained based on the relative fair values of each. The
fair value of capitalized mortgage servicing rights is estimated by
calculating the present value of estimated future net servicing income
derived from related cash flows. Amortization of capitalized mortgage
servicing rights is determined in proportion to and over the period of
estimated net servicing income of the underlying financial assets.
Impairment of
12
mortgage servicing rights exists if the book value of the mortgage
servicing rights exceed its estimated fair value. In determining
impairment, mortgage servicing rights are stratified by interest rates.
Critical assumptions used in determining fair value include expected
mortgage loan prepayment rates, discount rates and other economic factors,
which are determined based on current market conditions. The expected rates
of mortgage loan prepayments are the most significant factors driving the
value of mortgage servicing rights. Increases in expected mortgage loan
prepayments reduce estimated future net servicing cash flows because the
life of the underlying loan is reduced. Fair values, using estimated
mortgage loan prepayment rates, are derived from a third-party statistical
model. Negative adjustments to the value, if any, are recognized through a
valuation allowance by charges against mortgage servicing income. The use
of a valuation allowance enables the recovery of this value as market
conditions become more favorable.
o Goodwill and Intangibles. Effective January 1, 2002, Old National adopted
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets".
SFAS No. 141 requires the use of the purchase method of accounting for all
business combinations initiated after June 30, 2001. SFAS No. 142
discontinued amortization of goodwill and indefinite-lived assets.
Intangible assets with a determinable useful life continue to be amortized
over that period. For purchase acquisitions, Old National is required to
record the assets acquired, including identified intangible assets, and the
liabilities assumed at their fair value, which in many instances involves
estimates based on third party valuations, such as appraisals, or internal
valuations based on discounted cash flow analyses or other valuation
techniques that may include estimates of attrition, inflation, asset growth
rates or other relevant factors. In addition, the determination of the
useful lives for which an intangible asset will be amortized is subjective.
Under SFAS No. 142, goodwill and indefinite-lived assets recorded must be
reviewed for impairment on an annual basis, as well as on an interim basis
if events or changes indicate that the asset might be impaired. An
impairment loss must be recognized for any excess of carrying value over
fair value of the goodwill or the indefinite-lived intangible with
subsequent reversal of the impairment loss being prohibited. The tests for
impairment fair values are based on internal valuations using management's
assumptions of future growth rates, future attrition, discount rates,
multiples of earnings or other relevant factors. The resulting estimated
fair values could have a significant impact on the carrying values of
goodwill or intangibles and could result in impairment losses affecting the
financials of the company as a whole and the individual lines of business
in which the goodwill or intangibles reside.
Management believes the accounting estimates related to the allowance for loan
losses; the capitalization, amortization and valuations of mortgage servicing
rights; and the valuation of goodwill and intangibles are "critical accounting
estimates" because: (1) the estimates are highly susceptible to change from
period to period because they require company management to make assumptions
concerning, among other factors, the changes in the types and volumes of the
portfolios, rates of future prepayments, valuation assumptions and anticipated
economic conditions, and (2) the impact of recognizing an impairment or loan
loss could have a material effect on Old National's assets reported on the
balance sheet as well as net income. Management has discussed the development
and selection of these critical accounting estimates with the Audit Committee of
the Board of Directors and the Audit Committee has reviewed the company's
disclosure relating to it in this Management's Discussion and Analysis.
NON-GAAP FINANCIAL MEASURES
In January 2003, the United States Securities and Exchange Commission ("SEC")
issued Regulation G, "Conditions for Use of Non-GAAP Financial Measures." A
non-GAAP financial measure is a numerical measure of a company's historical or
future performance, financial position or cash flow that excludes or includes
amounts or adjustments that are not in accordance with generally accepted
accounting principles ("GAAP"). Regulation G requires companies that present
non-GAAP financial measures to disclose a numerical reconciliation to the most
directly comparable measurement using GAAP as well as the reason why the
non-GAAP measure is an important measure. Management does not believe it has
used any non-GAAP financial measures in this annual report on Form 10-K.
ACQUISITION, CONSOLIDATION AND DIVESTITURE ACTIVITY
During 2003 and 2002, Old National acquired various financial services
companies. These acquisitions were accounted for as purchases in accordance with
SFAS No. 141, "Business Combinations." These key acquisitions in the asset
management consulting and insurance agency operations enhanced the growth of the
non-bank services
13
segment, also referred to as the Old National Signature Group, and expanded Old
National into its targeted metropolitan markets. See Note 2 to the consolidated
financial statements for more details regarding the various acquisitions.
During the third quarter of 2002, Old National finalized branch sales in markets
no longer considered consistent with the company's strategy resulting in a
pre-tax gain of $12.5 million and an after-tax gain of $8.3 million. The branch
sales resulted in a decrease in total loans of $107.3 million and total deposits
of $202.9 million. During 2001, Old National completed its One Bank
consolidation project that started in 1999 with the merger of its remaining
banking charters into one bank. The goals of One Bank included a single brand
image, common products offered throughout the banking locations and improved
back-office efficiency. In the second quarter of 2001, Old National further
streamlined its regional banking administrative structure and incurred after-tax
expenses of $5.9 million in the consolidation of acquisitions made in 2000.
RESULTS OF OPERATIONS
Earnings Summary
In 2003, Old National generated $70.4 million of net income and $1.05 net income
per share compared to $117.9 million and $1.75, respectively in 2002. The 2002
earnings included an $8.3 million, or $0.12 per share, after-tax gain on branch
sales. Old National's return on average assets was 0.74% and return on average
shareholders' equity was 9.48% for the year, which decreased significantly from
2002 ratios of 1.27% and 17.05%, respectively.
The most significant impact on net income in 2003 was the provision for loan
losses of $85.0 million, an increase of $51.5 million over the $33.5 million
recorded in 2002, resulting from significant deterioration in credit quality.
Other significant factors negatively affecting net income included weak
commercial loan demand, deterioration of the net interest margin from declining
interest rates, and a charge of $10.0 million pre-tax, or $6.7 million
after-tax, to establish a reserve related to litigation settlements. During
2003, Old National recognized $23.6 million of gains on the sales of investment
securities compared to $12.4 million recognized in 2002. In addition, record
origination volumes in mortgage operations and acquisitions in the non-bank
services segment had a positive impact on 2003 earnings results.
Business Line Results
Old National is managed in three primary business segments. Table 1 summarizes
Old National's business line results for the years ended December 31.
BUSINESS LINE RESULTS (TABLE 1)
-------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------
Community banking $58,759 $93,260 $78,671
Non-bank services 4,472 2,402 2,200
Treasury 13,916 13,988 18,093
Other (6,734) 8,282 (5,920)
-------------------------------------------------------------------
Consolidated net income $70,413 $117,932 $93,044
===================================================================
The 2003 community banking segment profit decreased $34.5 million from 2002.
Increases in noninterest income of $13.3 million over 2002, were offset by the
increased provision for loan losses of $51.5 million and decreases in net
interest income of $6.8 million. Net interest income suffered from the
refinancing of residential real estate loans, with many of the new loans being
sold into the secondary market, and weak commercial and commercial real estate
loan demand in the regions served by Old National. Noninterest income for 2003
increased primarily due to the increased mortgage banking activity during the
current year. Noninterest expense increased $8.3 million, or 3.4% primarily due
to outside processing expenses related to the third-party subcontracting of the
servicing functions of Old National's mortgage banking activities.
The 2003 non-bank services segment profit increased $2.1 million from 2002
primarily due to acquisitions of several insurance agencies and an asset
management company over the past year and a half. These acquisitions increased
noninterest income by $29.4 million and noninterest expense by $24.8 million
over 2002.
14
The treasury segment showed very little change in 2003 as compared to 2002, as
the net securities gains increase of $11.1 million in 2003 compared to 2002, was
offset by an $11.6 million decrease in net interest income for this segment.
Treasury's net interest income included income derived from the company's
interest rate risk position that was negatively impacted by declining interest
rates during most of 2003.
The "Other" segment profit included gains or charges which management chose not
to allocate to the various segments. "Other" for 2003 included expenses to
record the litigation reserve of $10.0 million and 2002 included the gain of
$12.5 million related to the sales of branches.
Net Interest Income
Net interest income, the difference between interest income earned on
interest-earning assets, such as loans and investments, and interest expense
incurred on interest-bearing liabilities, such as deposits and borrowed funds,
was the most significant component of Old National's earnings, comprising over
58% of Old National's 2003 revenues. Net interest income and net interest margin
in the following discussion is presented on a fully taxable equivalent basis,
which adjusts tax-exempt or nontaxable interest income to an amount that would
be comparable to interest subject to income taxes using the federal statutory
tax rate in effect of 35% for all periods. Net income is unaffected by these
taxable equivalent adjustments. Net interest income included taxable equivalent
adjustments of $25.1 million for 2003 and $25.2 million for 2002.
Net interest income and margin are influenced by many factors, primarily the
volume and mix of earning assets and funding sources and the interest rate
fluctuations. Other factors include accelerated prepayments of mortgage-related
assets and the composition and maturity of earning assets and interest-bearing
liabilities. Loans typically generate more interest income than investment
securities with similar maturities. Funding from customer deposits generally
cost less than wholesale funding sources. Factors, such as general economic
activity, Federal Reserve Board monetary policy and price volatility of
competing alternative investments, can also exert significant influence on Old
National's ability to optimize its mix of assets and funding and its net
interest income and margin.
Taxable equivalent net interest income was $297.1 million in 2003, a 5.6%
decrease from the $314.6 million reported in 2002. The net interest margin was
3.37% for 2003, compared to 3.65% reported for 2002. Average earning assets grew
$191.2 million, which primarily consisted of increased investment securities of
$417.6 million net of decreased loans of $226.8 million, while the yield on
average earning assets declined 103 basis points from 6.65% to 5.62%. Much of
the asset growth was funded by interest-bearing liabilities that increased
$172.5 million or 2.2%, and the cost of interest-bearing liabilities declined
only 83 basis points from 3.32% to 2.49%. Noninterest-bearing deposits provided
an additional $40.5 million in funding and other liabilities and equity
increased $75.1 million.
The decline in interest rates was the primary factor contributing to lower net
interest income and net interest margin in 2003. The target Federal funds rate,
the rate that dictates national prime rate and determines many other short-term
loan and liability rates, declined in June 2003 to 1.00% and was unchanged
through the remainder of the year. Market-driven interest rates, as evidenced by
the five-year United States Treasury Note yield, decreased during 2003 before
rebounding by the end of 2003. The five-year Treasury note yield fell from 2.93%
in January 2003 to 2.29% in May 2003 before increasing to 3.25% by December
2003.
The decrease in interest rates during 2003 had a significant impact on the mix
and yield of earning assets. Driven by lower rates, many of the company's
residential real estate loans were refinanced in 2003, with the new loan
production being sold into the secondary loan market, shrinking the residential
loan portfolio. Additionally, commercial and commercial real estate loans did
not grow appreciably during the year, a result of both continued weak loan
demand in our markets and more stringent loan underwriting standards. The
decline in loans shifted much of the company's asset growth to investment
securities, a lower yielding asset class compared to loans. In addition, many of
the company's investment securities matured, prepaid or were sold in 2003
because of lower rates and were replaced by lower yielding securities.
Table 2 presents a three-year average balance sheet and for each major asset and
liability category, its related interest income and yield or its expense and
rate for the years ended December 31. Table 3 shows fluctuations in net interest
income attributable to the impact of changes in the average balances of assets
and liabilities and the yields earned or rates paid for the years ended December
31.
15
THREE-YEAR AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS (TABLE 2)
- -----------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- ------------------------------
(tax equivalent basis, Average Interest Yield/ Average Interest Yield/ Average Interest Yield/
dollars in thousands) Balance & Fees Rate Balance & Fees Rate Balance & Fees Rate
- -----------------------------------------------------------------------------------------------------------------------------
Earning Assets
Money market investments $ 26,284 $ 314 1.19 % $ 25,841 $ 383 1.48 % $ 21,683 $ 805 3.71 %
Investment securities:
U.S. Treasury and
Government agencies (1) 2,338,860 94,475 4.04 1,934,693 100,076 5.17 1,254,893 79,644 6.35
States and political
subdivisions (4) 667,498 46,856 7.02 656,085 46,777 7.13 581,725 41,125 7.07
Other securities 122,507 5,956 4.86 120,467 7,135 5.92 159,501 10,155 6.37
- -----------------------------------------------------------------------------------------------------------------------------
Total investment securities 3,128,865 147,287 4.71 2,711,245 153,988 5.68 1,996,119 130,924 6.56
- -----------------------------------------------------------------------------------------------------------------------------
Loans: (2)
Commercial (4) 1,686,664 94,706 5.61 1,690,377 111,201 6.58 1,691,817 138,433 8.18
Commercial real estate 1,866,105 109,475 5.87 1,844,492 127,877 6.93 1,855,338 152,575 8.22
Residential real estate (3) 1,003,098 63,947 6.37 1,286,664 94,135 7.32 1,682,167 130,664 7.77
Consumer, net of
unearned income 1,095,567 79,142 7.22 1,056,730 84,976 8.04 1,051,673 97,627 9.28
- -----------------------------------------------------------------------------------------------------------------------------
Total loans (3) 5,651,434 347,270 6.14 5,878,263 418,189 7.11 6,280,995 519,299 8.27
- -----------------------------------------------------------------------------------------------------------------------------
Total earning assets 8,806,583 $494,871 5.62 % 8,615,349 $572,560 6.65 % 8,298,797 $651,028 7.84 %
=============== =============== ===============
Less: Allowance for
loan losses (93,154) (81,365) (74,491)
Non-Earning Assets
Cash and due from banks 178,189 186,534 180,227
Other assets 660,360 543,421 459,941
- ------------------------------------------- ---------- ----------
Total assets $9,551,978 $9,263,939 $8,864,474
=========================================== ========== ==========
Interest-Bearing Liabilities
NOW deposits $1,504,662 $ 13,550 0.90 % $1,215,858 $ 15,033 1.24 % $ 930,120 $ 14,712 1.58 %
Savings deposits 479,328 3,511 0.73 462,633 5,454 1.18 409,220 7,839 1.92
Money market deposits 612,044 5,729 0.94 644,037 10,003 1.55 778,366 25,864 3.32
Time deposits 3,061,922 115,881 3.78 3,468,623 156,070 4.50 3,706,416 205,199 5.54
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
deposits 5,657,956 138,671 2.45 5,791,151 186,560 3.22 5,824,122 253,614 4.35
Short-term borrowings 687,588 7,258 1.06 688,958 10,971 1.59 583,035 21,862 3.75
Other borrowings 1,590,262 51,812 3.26 1,283,225 60,423 4.71 1,062,377 62,932 5.92
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 7,935,806 $197,741 2.49 % 7,763,334 $257,954 3.32 % 7,469,534 $338,408 4.53 %
=============== =============== ===============
Noninterest-Bearing
Liabilities
Demand deposits 752,788 712,308 664,347
Other liabilities 120,300 96,601 86,499
Shareholders' equity 743,084 691,696 644,094
- ------------------------------------------- ---------- ----------
Total liabilities and
shareholders' equity $9,551,978 $9,263,939 $8,864,474
=========================================== ========== ==========
Interest Margin Recap
Interest income/average
earning assets $494,871 5.62 % $572,560 6.65 % $651,028 7.84 %
Interest expense/average
earning assets 197,741 2.25 257,954 3.00 338,408 4.07
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income
and margin $297,130 3.37 % $314,606 3.65 % $312,620 3.77 %
=============================================================================================================================
(1) Includes Government agency mortgage-backed securities.
(2) Includes principal balances of nonaccrual loans. Interest income relating
to nonaccrual loans is included only if received. Includes loan fees of
$8.9 million in 2003, $12.2 million in 2002 and $12.0 million in 2001.
(3) Includes residential loans held for sale.
(4) Interest on states and political subdivision investment securities and
commercial loans includes the effect of taxable equivalent adjustments of
$15.9 million and $9.2 million, respectively, in 2003; $16.0 million and
$9.2 million, respectively, in 2002; and $13.4 million and $7.9 million,
respectively, in 2001; using the federal statutory tax rate in effect of
35% for all periods.
16
NET INTEREST INCOME - RATE/VOLUME ANALYSIS (TABLE 3)
- -------------------------------------------------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001
------------------------------------ ------------------------------------
Attributed to Attributed to
(tax equivalent basis, Total ----------------------- Total -----------------------
dollars in thousands) Change Volume Rate Change Volume Rate
- -------------------------------------------------------------------------------------------------------
Interest Income
Money market investments $ (69) $ 6 $ (75) $ (422) $ 108 $ (530)
Investment securities (1) (6,701) 21,689 (28,390) 23,064 43,761 (20,697)
Loans (1) (70,919) (15,038) (55,881) (101,110) (30,974) (70,136)
- -------------------------------------------------------------------------------------------------------
Total interest income (77,689) 6,657 (84,346) (78,468) 12,895 (91,363)
- -------------------------------------------------------------------------------------------------------
Interest Expense
NOW deposits (1,483) 3,086 (4,569) 321 4,026 (3,705)
Savings deposits (1,943) 160 (2,103) (2,385) 827 (3,212)
Money market deposits (4,274) (398) (3,876) (15,861) (3,275) (12,586)
Time deposits (40,189) (16,846) (23,343) (49,129) (11,932) (37,197)
Short-term borrowings (3,713) (18) (3,695) (10,891) 2,829 (13,720)
Other borrowings (8,611) 12,231 (20,842) (2,509) 11,741 (14,250)
- -------------------------------------------------------------------------------------------------------
Total interest expense (60,213) (1,785) (58,428) (80,454) 4,216 (84,670)
- -------------------------------------------------------------------------------------------------------
Net interest income $ (17,476) $ 8,442 $ (25,918) $ 1,986 $ 8,679 $ (6,693)
=======================================================================================================
The variance not solely due to rate or volume is allocated equally between the
rate and volume variances.
(1) Interest on investment securities and loans includes the effect of taxable
equivalent adjustments of $15.9 million and $9.2 million, respectively, in
2003; $16.0 million and $9.2 million, respectively, in 2002; and $13.4
million and $7.9 million, respectively, in 2001; using the federal
statutory tax rate in effect of 35% for all periods.
Provision for Loan Losses
The provision for loan losses is the charge to earnings that management
determines necessary to provide an adequate allowance for losses in the loan
portfolio. The provision for loan losses was $85.0 million for 2003, a
significant increase from the $33.5 million recorded in 2002. Refer to
"Allowance for Loan Losses and Asset Quality " section for further discussion of
non-performing loans, charge-offs and additional items impacting the provision.
Noninterest Income
Old National generates revenues in the form of noninterest income through fees
and sales commissions from its core banking franchise and other related
businesses, such as trust and asset management, investment products and
insurance. This source of revenue has grown as a percentage of total revenue to
39.3% in 2003 compared to 32.9% in 2002, which has been beneficial during this
downward turn in net interest income. Old National will continue to focus on
noninterest income revenue streams while carefully managing balance sheet risk
positions to ensure that Old National is well-positioned for the anticipated
turnaround in market conditions.
Noninterest income for 2003 was $192.1 million, an increase of $37.7 million, or
24.4% over the $154.5 million reported for 2002. In 2003, Old National realized
$23.6 million of gains on the sales of investment securities in comparison to
$12.4 million for the same period of 2002. Investment securities transactions
are considered as part of the continuing management of the balance sheet to
address interest rate and yield curve shifts.
Total fee and service charge income in 2003 increased 30.1% from 2002. Mortgage
banking revenue, a major component of this increase, totaled $19.1 million for
2003 compared to $14.5 million for 2002, an increase of $4.6 million, or 32.1%.
Residential real estate loan originations reached record levels in 2003 with
dollars of loans closed of $1.316 billion compared to $1.100 billion for 2002
and number of closed loans of 13,249 in 2003 compared to 11,537 in 2002. Trust
and asset management, insurance brokerage and investment product revenues
totaled $80.3 million during 2003 compared to $50.1 million during 2002. During
2003 and in the second half of 2002, Old National acquired various insurance
agencies and an asset management consulting company, which provided Old National
with additional sources of noninterest income. The acquisition of these
companies increased noninterest trust and asset management fees by $5.0 million,
insurance brokerage fees by $22.6 million and investment product revenue by $0.5
million over 2002 results. Deposit-related fees and service charges were $44.9
million in 2003 compared to $42.0 million for 2002, an increase of $2.9 million,
or 6.8%. This increase came from growth in transaction accounts, collection
initiatives and an increase in service charge rates.
17
Table 4 presents changes in the components of noninterest income for the years
ended December 31.
NONINTEREST INCOME (TABLE 4)
- -------------------------------------------------------------------------------------------
% Change From
Prior Year
----------------
(dollars in thousands) 2003 2002 2001 2003 2002
- -------------------------------------------------------------------------------------------
Trust and asset management fees $ 30,470 $ 24,387 $ 20,681 24.9 % 17.9 %
Service charges on deposit accounts 44,855 41,988 40,478 6.8 3.7
ATM fees 7,474 6,876 5,604 8.7 22.7
Mortgage banking revenue 19,144 14,496 9,737 32.1 48.9
Insurance premiums and commissions 39,225 16,686 13,296 135.1 25.5
Investment product fees 10,567 8,983 6,819 17.6 31.7
Bank-owned life insurance 6,922 7,944 5,349 (12.9) 48.5
Other income 9,936 8,220 6,233 20.9 31.9
- -------------------------------------------------------------------------------------------
Total fee and service charge income 168,593 129,580 108,197 30.1 19.8
Net securities gains 23,556 12,444 4,770 N/M N/M
Gain on branch divestitures -- 12,473 -- N/M N/M
- -------------------------------------------------------------------------------------------
Total noninterest income $192,149 $154,497 $112,967 24.4 % 36.8 %
===========================================================================================
Noninterest income to total revenue (1) 39.3 % 32.9 % 26.5 %
- --------------------------------------------------------------------------
(1) Total revenue includes the effect of a taxable equivalent adjustment of
$25.1 million in 2003, $25.2 million in 2002 and $21.3 million in 2001.
N/M = Not meaningful
Noninterest Expense
Old National strives to improve its efficiency through cost control efforts and
technology advancements while still providing quality customer service. In the
banking industry, the efficiency ratio, which is calculated by dividing
noninterest expense by the sum of taxable equivalent net interest income and
noninterest income, is often used to measure expense levels. The efficiency
ratio decreases when revenue is greater in relation to expenses and increases
when revenue is lesser in relation to expenses. A decreasing efficiency ratio
represents positive trends and improved efficiency. The efficiency ratio
increased to 61.26% in 2003 from 54.97% in 2002, representing a negative trend.
A company-wide program, "Ascend," has been initiated as discussed in Item 1,
"Business," which is designed to be an intense evaluation of every aspect of
operations for expense reductions and revenue growth ideas. As a result of this
program, Old National expects to have significant improvements in efficiency by
the end of the implementation phase in 2005.
Noninterest expense for 2003 totaled $299.7 million, an increase of $41.9
million, or 16.2% over the $257.8 million recorded in 2002. Salaries and
benefits, the largest component of noninterest expense, totaled $169.0 million
in 2003 compared to $148.5 million in 2002, an increase of $20.6 million, of
which $18.1 million directly related to acquisitions. Outside processing
expenses totaled $19.1 million for 2003 compared to $13.6 million recorded in
2002. This increase in 2003 primarily resulted from a full year of expense
related to the mortgage third-party servicing subcontractor compared to one-half
year in 2002. Other losses of $14.7 million in 2003 compared to $5.4 million in
2002, included a $10.0 million charge in 2003 to establish a reserve in
connection with litigation, which was partially settled during the fourth
quarter. For additional information, see Note 17 to the consolidated financial
statements. Overall, the remaining components of noninterest expense totaled
$96.9 million for 2003 compared to $90.3 million for 2002, an increase of 7.3%
or $6.6 million, with $6.1 million directly related to acquisitions.
Old National will complete construction of its principal executive offices in
2004. It is expected that the net increase to occupancy, equipment and other
noninterest expense components will have an annualized impact to net income per
share of $0.02. However, the impact does not take into account that the lease of
Old National's current headquarters would have increased substantially beginning
in 2005, decreasing the impact below $0.02.
Table 5 presents changes in the components of noninterest expense for the years
ended December 31.
18
NONINTEREST EXPENSE (TABLE 5)
- -------------------------------------------------------------------------------------------
% Change From
Prior Year
----------------
(dollars in thousands) 2003 2002 2001 2003 2002
- -------------------------------------------------------------------------------------------
Salaries and employee benefits $169,025 $148,450 $138,210 13.9 % 7.4 %
Occupancy 18,166 16,154 15,599 12.5 3.6
Equipment 14,296 15,153 16,206 (5.7) (6.5)
Marketing 11,085 11,026 8,109 0.5 36.0
FDIC insurance premiums 1,007 1,132 1,222 (11.0) (7.4)
Outside processing 19,078 13,640 10,757 39.9 26.8
Communications and transportation 11,595 11,738 10,907 (1.2) 7.6
Professional fees 9,111 8,959 7,415 1.7 20.8
Loan expense 7,041 6,496 6,416 8.4 1.2
Supplies 4,829 5,048 5,529 (4.3) (8.7)
Other losses 14,676 5,445 6,177 169.5 (11.9)
Goodwill amortization -- -- 5,909 -- (100.0)
Other intangible amortization 2,612 1,174 865 122.5 35.7
Other expense 17,195 13,430 11,788 28.0 13.9
- -------------------------------------------------------------------------------------------
Salaries and other operating expenses 299,716 257,845 245,109 16.2 5.2
Merger and restructuring costs -- -- 9,703 N/M N/M
- -------------------------------------------------------------------------------------------
Total noninterest expense $299,716 $257,845 $254,812 16.2 % 1.2 %
===========================================================================================
N/M = Not meaningful
Provision for Income Taxes
Old National records a provision for income taxes currently payable and for
income taxes payable in the future, which arise due to timing differences in the
recognition of certain items for financial statement and income tax purposes.
The major difference between the effective tax rate applied to Old National's
financial statement income and the federal statutory tax rate is caused by
interest on tax-exempt securities and loans. Old National's effective tax rate
was 11.4% in 2003 and 22.7% in 2002. The decreased tax rate in 2003 resulted
from a higher percentage of tax-exempt income to total income. The reduction in
2003 total income is discussed in the earnings summary above. See Note 11 to the
consolidated financial statements for additional details on Old National's
income tax provision.
Interim Financial Data
Table 6 provides a detailed summary of quarterly results of operations for the
years ended December 31. These results contain all normal and recurring
adjustments necessary for a fair and consistent presentation.
INTERIM FINANCIAL DATA (TABLE 6)
- -------------------------------------------------------------------------------------------------------------------------------
Quarters Ended 2003 Quarters Ended 2002
(unaudited, dollars ----------------------------------------------- ---------------------------------------------
and shares in thousands, December September June March December September June March
except per share data) 31 30 30 31 31 30 30 31
- -------------------------------------------------------------------------------------------------------------------------------
Interest income $ 111,176 $ 114,761 $ 120,233 $ 123,578 $ 131,052 $ 136,277 $ 139,704 $ 140,350
Interest expense 44,909 47,289 51,768 53,775 61,001 64,710 66,350 65,893
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income 66,267 67,472 68,465 69,803 70,051 71,567 73,354 74,457
Provision for loan losses 26,000 27,500 22,500 9,000 7,500 11,000 7,500 7,500
Noninterest income 40,543 45,773 62,913 42,920 40,354 52,512 31,124 30,507
Noninterest expense 80,126 75,465 73,960 70,165 69,307 66,729 60,545 61,264
- -------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 684 10,280 34,918 33,558 33,598 46,350 36,433 36,200
Income tax expense (benefit) (4,592) (1,530) 7,851 7,298 6,869 11,521 7,920 8,339
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 5,276 $ 11,810 $ 27,067 $ 26,260 $ 26,729 $ 34,829 $ 28,513 $ 27,861
===============================================================================================================================
Net income per share (1)
Basic $ 0.08 $ 0.17 $ 0.41 $ 0.39 $ 0.40 $ 0.52 $ 0.42 $ 0.41
Diluted 0.08 0.17 0.41 0.39 0.40 0.52 0.42 0.41
- -------------------------------------------------------------------------------------------------------------------------------
Weighted average shares (1)
Basic 66,678 66,904 66,646 66,889 66,794 67,096 67,433 67,393
Diluted 66,728 67,071 66,699 66,945 66,863 67,279 67,603 67,495
- -------------------------------------------------------------------------------------------------------------------------------
(1) All share and per share data have been adjusted for stock dividends,
including a 5% stock dividend to shareholders of record on January 6, 2004,
distributed on January 27, 2004. Diluted data assumes the conversion of
stock options.
19
FINANCIAL CONDITION
Overview
Old National's assets at December 31, 2003, were $9.354 billion, a 2.7% decrease
compared to $9.613 billion recorded at December 31, 2002. Investments and loans
decreased $160.6 million and $106.9 million, respectively, and total liabilities
declined $233.4 million compared to December 31, 2002. Total shareholders'
equity decreased $25.2 million from year-end 2002.
Earning Assets
Old National's earning assets are comprised of loans and loans held for sale,
investment securities and money market investments. Earning assets were $8.518
billion at December 31, 2003, a decrease of 3.9% from December 31, 2002. During
the first half of 2003, investment securities increased as a temporary source of
earning assets. During the second half of 2003, Old National reduced its
investment portfolio due to fewer attractive investment opportunities and the
company's need to reduce its sensitivity to rising interest rates. Despite the
continued weakness in commercial lending and the specific sales of $62.7 million
of nonaccrual commercial and residential real estate loans, total loans
decreased only slightly as these factors were partially offset by consumer loan
growth.
Investment Securities
Old National classifies investment securities primarily as available-for-sale to
give management the flexibility to sell the securities prior to maturity if
needed, based on fluctuating interest rates or changes in the company's funding
requirements. However, Old National added 15- and 20-year fixed-rate mortgage
pass-through securities to its held-to-maturity investment portfolio during
2003.
At December 31, 2003, the investment securities portfolio was $2.917 billion
compared to $3.078 billion at December 31, 2002, a decrease of 5.2%. Investment
securities represented 34.2% of earning assets at December 31, 2003, compared to
34.7% at December 31, 2002. During 2002 and the first half of 2003, Old National
increased the investment portfolio as a short-term alternative source of earning
assets to offset declining residential real estate and minimal commercial and
consumer loan growth. During the second half of 2003, Old National began
decreasing the size of the investment portfolio and used the cash flows
generated by the declining investment portfolio to reduce borrowed funds.
Stronger economic activity and stronger commercial loan demand would likely
result in increased investments in loans and the investment portfolio would
stabilize or decrease. Continued weak commercial loan demand, however, may cause
Old National to use cash flows to reinvest in securities.
Investment securities available-for-sale portfolio had net unrealized gains of
$23.7 million at December 31, 2003, compared to $86.2 million at December 31,
2002. The decrease was a result of higher market interest rates and a smaller
portfolio of securities available-for-sale at December 31, 2003, compared to
December 31, 2002. Also, Old National realized pre-tax gains on sales of
securities from this portfolio of $23.6 million during 2003.
The investment portfolio had an average life of 4.86 years at December 31, 2003,
compared to 3.10 years at December 31, 2002. The average yields on
available-for-sale investment securities, on a taxable equivalent basis, were
4.90% in 2003 and 5.43% in 2002. The average yield on the held-to-maturity
portfolio was 4.29% in 2003.
At December 31, 2003, Old National had a concentration of investment securities
issued by certain states and their political subdivisions with the following
aggregate market values: $149.0 million by Indiana, which represented 20.8% of
shareholders' equity, and $119.4 million by Illinois, which represented 16.7% of
shareholders' equity. At December 31, 2002, the aggregate market values of the
concentration of certain states and their political subdivisions were $156.8
million by Indiana, which represents 21.2% of shareholders' equity, and $122.8
million by Illinois, which represents 16.6% of shareholders' equity. There were
no other concentrations of investment securities issued by an individual state
and its political subdivisions that were greater than 10% of shareholders'
equity.
Residential Loans Held for Sale
Residential loans held for sale were $16.3 million at December 31, 2003,
compared to $92.6 million at December 31, 2002. Residential loans held for sale
are loans that are closed, but not yet sold on the secondary market. The amount
of residential loans held for sale on the balance sheet varies depending on the
timing of movement of originations and loan sales to the secondary market. At
December 31, 2003, loan originations were down compared to December 31, 2002,
primarily due to an upturn in interest rates at the end of 2003.
20
Lending and Loan Administration
Old National's credit culture has historically featured decision-making near the
customer with corporate oversight. In 2003, due to continued credit quality
concerns, Old National implemented certain credit approval disciplines in order
to continue to focus on the reduction of problem and non-performing loans in the
portfolio, including a restructuring of the manner in which commercial loans are
analyzed and approved. Community-based loan personnel, which now include
independent underwriting and analytic support staff, continue to have the
authority to extend credit under guidelines established and administered by Old
National's Credit Policy Committee. This committee, which meets quarterly,
includes members from both the holding company and the bank. The committee
monitors credit quality through its review of information such as delinquencies,
problem loans and charge-offs and regularly reviews the loan policy to assure it
remains appropriate for the current lending environment.
Old National lends primarily to small- and medium-sized commercial and
commercial real estate customers in various industries including manufacturing,
agribusiness, transportation, mining, wholesaling and retailing. As measured by
Old National, the company had no concentration of loans in any single industry
exceeding 10% of its portfolio and has no exposure to foreign borrowers or
lesser-developed countries. Old National's policy is to concentrate its lending
activity in the geographic market areas it serves, primarily Indiana, Illinois,
Kentucky and Tennessee, with a focus on increasing its presence in the
metropolitan markets, including Indianapolis, Louisville and St. Louis. Old
National has been affected by weakness in the economy of its principal markets,
particularly in its home state of Indiana, which has resulted in minimal growth
of commercial and consumer loans and tighter credit underwriting standards. Old
National anticipates that when the economy in Old National's principal markets
begins to improve, commercial and consumer loans will begin to show higher
levels of growth.
In the past four years, commercial loans average growth rate was 4.9% per year
while commercial real estate grew 9.1% per year. Residential real estate loans
declined 18.7% per year while consumer loans rose 5.9% annually over the same
period. Table 7 presents the composition of the loan portfolio at December 31.
LOAN PORTFOLIO AT YEAR-END (TABLE 7)
- -----------------------------------------------------------------------------------------------------------------------------
Four-Year
(dollars in thousands) 2003 2002 2001 2000 1999 Growth Rate
- -----------------------------------------------------------------------------------------------------------------------------
Commercial $1,618,095 $1,696,347 $1,742,937 $1,606,509 $1,338,255 4.9 %
Commercial real estate 1,849,275 1,883,303 1,848,945 1,810,805 1,306,312 9.1
Consumer credit 1,163,337 1,053,620 1,064,109 1,042,629 926,345 5.9
- -----------------------------------------------------------------------------------------------------------------------------
Total loans excluding residential real estate 4,630,707 4,633,270 4,655,991 4,459,943 3,570,912 6.7
Residential real estate 939,422 1,043,816 1,449,080 1,890,872 2,148,974 (18.7)
- -----------------------------------------------------------------------------------------------------------------------------
Subtotal 5,570,129 5,677,086 6,105,071 6,350,815 5,719,886 (0.7)%
=========
Less: Unearned income 12 49 317 2,502 5,198
- -----------------------------------------------------------------------------------------------------------------------------
Total loans 5,570,117 5,677,037 6,104,754 6,348,313 5,714,688
Less: Allowance for loan losses 104,571 87,742 74,241 73,833 65,685
- -----------------------------------------------------------------------------------------------------------------------------
Net loans $5,465,546 $5,589,295 $6,030,513 $6,274,480 $5,649,003
=================================================================================================================
Commercial and Consumer Loans
Commercial and consumer loans are the largest classification within the earning
assets of Old National representing 54.4% of earning assets at December 31,
2003, a slight increase from 52.3% at December 31, 2002. At December 31, 2003,
commercial and commercial real estate loans decreased $78.3 million and $34.0
million, respectively, from December 31, 2002. During 2003, Old National sold
$48.2 million of non-performing commercial loans, which contributed to the
change in commercial and commercial real estate loans. A write-down of $11.3
million was recorded against the allowance for loan losses related to these
sales. Consumer loans, including automobile loans, personal and home equity
loans and lines of credit, and student loans, increased $109.8 million or 10.4%
at December 31, 2003, compared to December 31, 2002, primarily due to a renewed
focus on consumer lending.
Table 8 presents the maturity distribution and rate sensitivity of commercial
loans and an analysis of these loans that have predetermined and floating
interest rates. A significant percentage of commercial loans are due within one
year, reflecting the short-term nature of a large portion of these loans.
21
DISTRIBUTION OF COMMERCIAL LOAN MATURITIES AT DECEMBER 31, 2003
(TABLE 8)
--------------------------------------------------------------------
Within 1 - 5 Beyond
(dollars in thousands) 1 Year Years 5 Years Total
--------------------------------------------------------------------
Interest rates:
Predetermined $216,322 $383,597 $210,477 $ 810,396
Floating 531,657 224,078 51,964 807,699
--------------------------------------------------------------------
Total $747,979 $607,675 $262,441 $1,618,095
====================================================================
Residential Real Estate Loans
Residential real estate loans, primarily 1-4 family properties, have decreased
in significance to the loan portfolio over the past five years due to higher
levels of loan sales on the secondary market, primarily to Federal Home Loan
Mortgage Corporation or Federal National Mortgage Association. Old National
sells the majority of residential real estate loans originated as a strategy to
better manage interest rate risk and liquidity. These loans are sold with loan
servicing retained in order to maintain customer relationships and generate
noninterest income and fees. By using this strategy, Old National is able to
recognize an immediate gain in noninterest income versus a small net interest
income spread over a longer period of time. Old National sells the majority of
the residential real estate loans without recourse, currently having less than
1% of loans sold with recourse.
During 2003, residential real estate loans continued to liquidate at
extraordinary levels in the low interest rate environment and the related boom
in refinancing. As of December 31, 2003, residential real estate loans were
$939.4 million, a decrease of $104.4 million or 10.0% from December 31, 2002.
Old National's residential real estate loan portfolio was also affected by the
sales of delinquent loans in 2003. These sales were to improve credit quality
and reduce the level of non-performing loans and are not a part of Old
National's ongoing strategy. Delinquent residential real estate loans of $14.5
million were sold to independent investors resulting in write-downs of $3.4
million recorded against the allowance for loan losses. During 2003, Old
National developed additional mortgage products that fit within the company's
interest rate risk profile that will be retained by the bank. As a result of
this strategy, Old National would expect to see a stabilization of residential
real estate loans on the consolidated balance sheet.
Allowance for Loan Losses and Asset Quality Administration
Old National monitors the quality of its loan portfolio on an on-going basis and
uses a combination of detailed credit assessments by relationship managers and
credit officers, historic loss trends, and economic and business environment
factors in determining its allowance for loan losses. Old National records
provisions for loan losses based on current and projected loans outstanding,
grade changes, mix of loans and expected losses. A detailed loan loss evaluation
on an individual loan basis for the company's highest risk loans is performed
quarterly. Management follows the progress of the economy and how the continuing
slow recovery might affect Old National's borrowers in both the near and the
intermediate term. Old National has a formalized and disciplined independent
loan review program. Its loan review system evaluates loan administration,
credit quality and compliance with corporate loan standards. This program
includes periodic reviews conducted at the community bank locations as well as
regular reviews of problem loan reports, delinquencies and charge-offs.
Each month, problem loan reports are prepared and reviewed, which include
borrowers that show indications of being unable to meet debt obligations in the
normal course of business, and loans which have other characteristics deemed by
bank management to warrant special attention or have been criticized by
regulators in the examination process. Classified loans include non-performing
loans, past due 90 days and other problem loans while criticized loans, also
known as special mention loans, are loans that have potential weaknesses that
deserve management's close attention and require specific quarterly reviews by
the bank.
Assets determined by the various evaluation processes to be under-performing
receive special attention by Old National management. Under-performing assets
consist of: 1) nonaccrual loans where the ultimate collectibility of interest or
principal is uncertain; 2) loans renegotiated in some manner, primarily to
provide for a reduction or deferral of interest or principal payments because
the borrower's financial condition deteriorated; 3) loans with principal or
interest past due ninety (90) days or more; and 4) foreclosed properties.
A loan is generally placed on nonaccrual status when principal or interest
become 90 days past due unless it is well secured and in the process of
collection, or earlier when concern exists as to the ultimate collectibility of
principal or
22
interest. When loans are classified as nonaccrual, interest accrued during the
year is reversed against earnings; interest accrued in the prior year, if any,
is charged to the allowance for loan losses. Cash received while a loan is
classified as nonaccrual is recorded to principal.
Adjustments to the allowance for loan losses are made as deemed necessary for
probable losses inherent in the portfolio. While an estimate of future losses
is, by its very nature, difficult to precisely predict, management of Old
National believes that the methodology that it uses in determining an
appropriate reserve for future losses is reasonable.
Loan officers grade the larger commercial and commercial real estate loans in
the portfolio periodically as determined by loan policy requirements or
determined by specific guidelines based on loan characteristics as set by
management and banking regulation. Periodically, these loan grades are reviewed
independently by the loan review department. For impaired loans, an assessment
is conducted as to whether there is likely loss in the event of default. If such
a loss is determined to be likely, the loss is quantified and a specific reserve
is assigned to the loan. For the balance of the commercial and commercial real
estate loan portfolio, loan grade migration projections coupled with historic
loss experience within the respective grades is used to develop reserve
requirement ranges based on expected future losses.
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. During the third quarter of 2003, Old National revised its
interpretation of impaired loans to strictly follow SFAS No. 114. Previous to
this change, Old National's interpretation of impaired loans more conservatively
included all problem credits with a potential collateral deficiency in the event
of default and nonaccrual loans in larger groups of smaller-balance homogeneous
loans. Had Old National made this in the prior year, impaired loans would have
totaled $80.4 million rather than $303.2 million as reported at December 31,
2002. At December 31, 2003, the total impaired loans were $91.6 million of which
$60.6 million had an allocated reserve of $20.6 million and $31.0 million had no
specific reserve recorded.
Historic loss ratios adjusted for future expectations of economic conditions are
used in determining the appropriate level of reserves for consumer and
residential real estate loans. The methodology used by Old National to predict
losses on loans that are not impaired uses a system of allocating losses back to
the original time the respective loans were booked and then moving those losses
through the different loan grades as the loans migrate to higher risk
classifications.
Allowance for Loan Losses and Asset Quality
At December 31, 2003, the allowance for loan losses was $104.6 million, an
increase of $16.8 million compared to $87.7 million at December 31, 2002. As a
percentage of total loans held for investment, the allowance increased to 1.88%
at December 31, 2003, from 1.55% at December 31, 2002. During 2003, the
provision for loan losses amounted to $85.0 million, an increase of $51.5
million over 2002. Various factors led to Old National's higher provision in
2003. First, the amount necessary to cover the higher than normal losses in 2003
was significant. Second, loan collateral values in the markets served by Old
National deteriorated which led to the need for higher reserves in the event of
liquidation. Third, recent experience elevated the rate of expected future
losses.
The increase in the allowance for loan losses for commercial and commercial real
estate loans accounted for virtually all of the increase in the total reserve
from December 31, 2002, to December 31, 2003. For commercial and commercial real
estate loans, the reserve as a percentage of that portfolio increased to 2.64%
at December 31, 2003, from 2.22% at December 31, 2002. While the absolute level
of classified and criticized loans at December 31, 2003, decreased 21.5% from
December 31, 2002, bank management believed this level was appropriate given
continued economic weakness and stresses in the Midwestern region on commercial
borrowers. As a result, the reserve for commercial and commercial real estate
loans increased by $12.3 million.
The reserve for residential real estate loans as a percentage of that portfolio
increased to 0.5% at December 31, 2003, from 0.1% at December 31, 2002. This
increase reflected an increase in historical loss rates due to higher
residential real estate loan charge-offs during 2003, including the losses
resulting from the sales of non-performing
23
residential real estate loans. The reserve for consumer loans increased only
slightly and the reserve as a percentage of loans in this portfolio was
unchanged from December 31, 2002, to December 31, 2003 at 0.7% of the portfolio.
This was reflective of little or no change in the performance and loss
experience on the consumer loan portfolio. Table 9 details the allowance for
loan losses by loan category and the percent of loans in each category compared
to total loans at December 31.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY CATEGORY OF LOANS
AND THE PERCENTAGE OF LOANS BY CATEGORY TO TOTAL LOANS (TABLE 9)
- -------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------ ---------------- ---------------- ---------------- ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
to Total to Total to Total to Total to Total
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- -------------------------------------------------------------------------------------------------------------------------
Commercial and
commercial real estate $ 91,671 62.2 % $ 79,412 63.1 % $ 65,669 58.9 % $ 61,450 53.8 % $ 53,460 46.3 %
Residential real estate 4,400 16.9 1,200 18.4 1,422 23.7 1,500 29.8 1,400 37.6
Consumer credit 8,500 20.9 7,130 18.5 7,150 17.4 10,883 16.4 10,825 16.1
- -------------------------------------------------------------------------------------------------------------------------
Total $104,571 100.0 % $ 87,742 100.0 % $ 74,241 100.0 % $ 73,833 100.0 % $ 65,685 100.0 %
=========================================================================================================================
Charge-offs, net of recoveries, totaled $53.4 million in 2003 and $20.0 million
in 2002. Additionally in 2003, write-downs of $14.7 million from loans
transferred to held for sale related to loan sales were recognized. The 2003
charge-offs included significant items including one loan relationship
write-down of $10.3 million and a $6.5 million single commercial credit
charge-off resulting from fraud in the customer's operation. Although net
charge-offs have been concentrated primarily in commercial loans reflecting
slowdown of the economy, no single industry segment represented a significant
share of total net charge-offs. The allowance to average loans, which ranged
from 1.18% to 1.85% for the last five years, was 1.85% at December 31, 2003.
Table 10 summarizes activity in the allowance for loan losses for the years
ended December 31, along with related statistics for the allowance and net
charge-offs.
ALLOWANCE FOR LOAN LOSSES (TABLE 10)
- ---------------------------------------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------
Balance, January 1 $ 87,742 $ 74,241 $ 73,833 $ 65,685 $ 59,371
Loans charged-off:
Commercial and commercial real estate 50,173 16,429 25,292 19,561 6,977
Residential real estate 1,358 1,211 1,399 1,500 1,524
Consumer credit 10,123 9,936 9,461 8,284 8,358
- ---------------------------------------------------------------------------------------------------------
Total charge-offs 61,654 27,576 36,152 29,345 16,859
- ---------------------------------------------------------------------------------------------------------
Recoveries on charged-off loans:
Commercial and commercial real estate 5,622 3,989 5,013 2,402 2,975
Residential real estate 82 913 165 510 443
Consumer credit 2,523 2,675 2,682 2,546 3,957
- ---------------------------------------------------------------------------------------------------------
Total recoveries 8,227 7,577 7,860 5,458 7,375
- ---------------------------------------------------------------------------------------------------------
Net charge-offs 53,427 19,999 28,292 23,887 9,484
Write-downs on loans transferred
to held for sale 14,744 -- -- -- --
Provision charged to expense 85,000 33,500 28,700 29,803 14,798
Acquired by acquisition -- -- -- 2,232 1,000
- ---------------------------------------------------------------------------------------------------------
Balance, December 31 $ 104,571 $ 87,742 $ 74,241 $ 73,833 $ 65,685
==========================================================================================================
Average loans for the year (1) $5,651,434 $5,878,263 $6,280,995 $6,087,869 $5,425,148
Asset Quality Ratios: (1)
Allowance/year-end loans 1.87 % 1.52 % 1.21 % 1.16 % 1.15 %
Allowance/average loans 1.85 1.49 1.18 1.21 1.21
Net charge-offs/average loans (2) 1.21 0.34 0.45 0.39 0.17
- ---------------------------------------------------------------------------------------------------------
(1) Loans include residential loans held for sale.
(2) Net charge-offs include write-downs on loans transferred to held for sale.
24
Under-performing assets at year-end totaled $118.5 million in 2003 and $117.7
million in 2002. As a percent of total loans and foreclosed properties,
under-performing assets at December 31 were 2.12% for 2003 and 2.04% for 2002.
In 2003, the nonaccrual category of under-performing loans was $104.6 million,
an increase of $4.3 million since December 31, 2002. This increase and the lower
net loan balance at December 31, 2003, were significant contributors to the
higher ratio of under-performing assets to total loans and foreclosed
properties. In a review of industry standards during 2003 and in discussions
with regulators, the company strengthened its internal policies in regards to
nonaccrual loans. Also, in order to reduce the negative impact on earnings from
high levels of nonaccrual loans, Old National sold $62.7 million of
non-performing loans. At December 31, 2003, the allowance for loan losses to
under-performing assets ratio stood at 88.24% compared to 74.54% at December 31,
2002.
Management believes that it has appropriately identified and reserved for loan
losses related to nonaccrual loans at December 31, 2003. A loan is generally
placed on nonaccrual status when principal or interest becomes 90 days past due
unless it is well secured and in the process of collection, or earlier when
concern exists as to the ultimate collection of principal or interest.
Approximately $42.4 million of nonaccrual loans less than thirty days delinquent
were still contractually performing at December 31, 2003. Management will
continue its efforts to reduce the level of non-performing loans and may
consider the possibility of additional sales of troubled and non-performing
loans, which could result in additional write-downs to the allowance for loan
losses.
Management expects that trends in nonaccrual loans will be influenced by the
degree to which the economy strengthens. Old National operates in the Midwest,
primarily in the state of Indiana, which has been particularly negatively
impacted by the weakness in the manufacturing segment of the economy. The longer
the significant softness in manufacturing continues, the more stress it puts on
Old National's borrowers, increasing the potential for additional nonaccrual
loans.
Interest income of approximately $16.7 million in 2003 and $14.2 million in 2002
would have been recorded on nonaccrual and renegotiated loans if such loans had
been accruing interest throughout the year in accordance with their original
terms. The amount of interest income actually recorded on nonaccrual and
restructured loans was $8.2 million in 2003 and $3.8 million in 2002. Old
National had no renegotiated loans at December 31, 2003 and 2002, however, in
2001, Old National had renegotiated loans of $25.9 million from two borrowers
whose loan payment schedules were modified to reduce their cash flow
requirements while obtaining additional collateral and/or guarantees and
shortening the loan term.
Classified loans were $343.9 million at December 31, 2003, a decrease of $111.8
million from $455.7 million at December 31, 2002. Of this total, other problem
loans, which are loans reviewed for the borrowers' ability to comply with
present repayment terms, totaled $234.2 million at December 31, 2003, compared
to $345.9 million at December 31, 2002. Criticized loans, or special mention
loans, were $215.7 million at December 31, 2003, a decrease of $41.4 million
from $257.1 million at December 31, 2002. Management believes it has taken a
prudent approach to the evaluation of under-performing credits and the loan
portfolio in general, both in acknowledging the portfolio's general condition
and in establishing the allowance for loan losses.
25
Table 11 presents the components of under-performing assets for the years ended
December 31.
UNDER-PERFORMING ASSETS (TABLE 11)
- --------------------------------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001 2000 1999
- --------------------------------------------------------------------------------------------------
Nonaccrual loans $104,627 $100,287 $ 37,894 $ 22,690 $ 19,286
Renegotiated loans -- -- 25,871 227 450
Past due loans (90 days or more):
Commercial and commercial real estate 4,127 8,567 8,024 2,269 1,797
Residential real estate 67 322 2,946 2,795 2,462
Consumer 926 627 1,610 1,524 947
- --------------------------------------------------------------------------------------------------
Total past due loans 5,120 9,516 12,580 6,588 5,206
Foreclosed properties 8,763 7,916 9,204 3,616 3,700
- --------------------------------------------------------------------------------------------------
Total under-performing assets $118,510 $117,719 $ 85,549 $ 33,121 $ 28,642
==================================================================================================
Classified loans (includes nonaccrual,
renegotiated, past due 90 days
and other problem loans) $343,943 $455,723 $359,847 $211,108 $122,466
Criticized loans 215,700 257,059 340,007 198,064 133,666
- --------------------------------------------------------------------------------------------------
Total criticized and classified loans $559,643 $712,782 $699,854 $409,172 $256,132
==================================================================================================
Asset Quality Ratios:
Non-performing loans/total loans (1) (2) 1.87 % 1.74 % 1.04 % 0.36 % 0.35 %
Under-performing assets/total loans and
foreclosed properties (1) 2.12 2.04 1.39 0.52 0.50
Under-performing assets/total assets 1.27 1.22 0.94 0.38 0.35
Allowance for loan losses/
under-performing assets 88.24 74.54 86.78 222.92 229.33
- --------------------------------------------------------------------------------------------------
(1) Loans include residential loans held for sale.
(2) Non-performing loans include nonaccrual and renegotiated loans.
Goodwill and Other Intangibles
The non-bank services segment acquired various financial services companies in
2003, which increased goodwill to $129.3 million at December 31, 2003 from
$110.6 million at December 31, 2002. Also as a result of these acquisitions,
other intangible assets, primarily related to customer business relationships,
increased to $41.9 million at December 31, 2003, from $27.0 million at December
31, 2002. Old National performs impairment testing of goodwill and other
intangibles on an annual basis. As of December 31, 2003 and 2002, there was no
impairment.
Funding
Total average funding, comprised of deposits and wholesale borrowings, was
$8.689 billion at December 31, 2003, an increase of 2.5% from $8.476 billion at
December 31, 2002. Average deposits decreased 1.4% in 2003 compared to an
increase of 0.2% in 2002. Old National experienced growth in demand deposits and
other low cost transaction accounts due to the lower rate environment and
customer preference for transaction accounts.
Old National uses wholesale funding to augment deposit funding and to help
maintain its desired interest rate risk position. Average wholesale borrowings,
including short-term borrowings and other borrowings, increased 15.5% in 2003
compared to 19.9% in 2002. Increases during the first half of 2003 financed
investment portfolio growth, offset a reduction in certificates of deposits and
was designed to take advantages of favorable interest rates. During the second
half of 2003, wholesale borrowings decreased as investment portfolio growth
slowed. See Notes 9 and 10 to the consolidated financial statements for
additional details on Old National's financing activities. Table 12 presents
changes in the average balances of all funding sources for the years ended
December 31.
26
FUNDING SOURCES - AVERAGE BALANCES (TABLE 12)
- --------------------------------------------------------------------------------
% Change From
Prior Year
(dollars in thousands) 2003 2002 2001 2003 2002
- --------------------------------------------------------------------------------
Demand deposits $ 752,788 $ 712,308 $ 664,347 5.7 % 7.2 %
NOW deposits 1,504,662 1,215,858 930,120 23.8 30.7
Savings deposits 479,328 462,633 409,220 3.6 13.1
Money market deposits 612,044 644,037 778,366 (5.0) (17.3)
Time deposits 3,061,922 3,468,623 3,706,416 (11.7) (6.4)
- --------------------------------------------------------------------------------
Total deposits 6,410,744 6,503,459 6,488,469 (1.4) 0.2
Short-term borrowings 687,588 688,958 583,035 (0.2) 18.2
Other borrowings 1,590,262 1,283,225 1,062,377 23.9 20.8
- --------------------------------------------------------------------------------
Total funding sources $8,688,594 $8,475,642 $8,133,881 2.5 % 4.2 %
===============================================================================
Table 13 presents a maturity distribution for certificates of deposit with
denominations of $100,000 or more at December 31.
CERTIFICATES OF DEPOSIT, $100,000 AND OVER (TABLE 13)
- -----------------------------------------------------------------------------
Maturity Distribution
-----------------------------------------
Year-End 1-90 91-180 181-365 Beyond
(dollars in thousands) Balance Days Days Days 1 Year
- -----------------------------------------------------------------------------
2003 $760,278 $477,835 $ 79,753 $41,435 $161,255
2002 887,366 507,218 115,535 53,242 211,371
2001 984,632 443,084 256,004 78,771 206,773
- -----------------------------------------------------------------------------
Capital Resources and Regulatory Guidelines
Shareholders' equity totaled $715.5 million or 7.6% of total assets at December
31, 2003, and $740.7 million or 7.7% of total assets at December 31, 2002. The
reduction in shareholders' equity during 2003 was primarily attributed to the
change in the unrealized gains on investment securities, reflecting the change
in the interest rate environment during 2003 and the fact that securities with
gains of $23.6 million were sold during the year, with the gains recognized in
income.
Old National paid cash dividends of $0.72 per share in 2003 (restated for the 5%
stock dividend distributed on January 27, 2004), which decreased equity by $48.4
million. Also in 2003, Old National purchased shares of its stock in the open
market under an ongoing repurchase program, reducing shareholders' equity by
$37.8 million. Shares reissued for stock options and stock purchase plans, and
stock issued for purchase merger transactions increased shareholders' equity by
$6.7 million and $21.1 million, respectively, in 2003.
Old National and the banking industry are subject to various regulatory capital
requirements administered by the federal banking agencies. For additional
information on capital adequacy see Note 19 to the consolidated financial
statements.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES AND OFF-BALANCE
SHEET ARRANGEMENTS
Table 14 presents Old National's significant fixed and determinable contractual
obligations and significant commitments at December 31, 2003. Further discussion
of each obligation or commitment is included in the referenced note to the
consolidated financial statements.
27
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES
AND OFF-BALANCE SHEET ARRANGEMENTS (TABLE 14)
- -------------------------------------------------------------------------------------------------------------------------
Payments Due In
----------------------------------------------------
Note One Year One to Three to Over
(dollars in thousands) Reference or Less Three Years Five Years Five Years Total
- -------------------------------------------------------------------------------------------------------------------------
Deposits without stated maturity $3,484,895 $ -- $ -- $ -- $3,484,895
Consumer and brokered certificates of deposit 1,399,163 1,001,453 128,953 478,628 3,008,197
Short-term borrowings 9 414,588 -- -- -- 414,588
Other borrowings 10 256,700 447,461 454,470 465,461 1,624,092
Operating leases 17 8,740 12,567 6,864 12,085 40,256
- -------------------------------------------------------------------------------------------------------------------------
Commitments, Contingent Liabilities and Off-Balance Sheet Arrangements
Commitments to extend credit 17 1,577,124 -- -- -- 1,577,124
Commercial letters of credit 17 19,297 -- -- -- 19,297
Standby letters of credit 17 85,381 -- -- -- 85,381
- -------------------------------------------------------------------------------------------------------------------------
Old National is party to various derivative contracts as a means to manage the
balance sheet, as a means to manage exposure to changes in interest rates in its
residential real estate loan origination and sale activity, and to provide
derivative contracts with its customers. Since the derivative liabilities
recorded on the balance sheet change frequently and do not represent the amounts
that may ultimately be paid under these contracts, these liabilities are not
included in the table of contractual obligations presented above. Further
discussion of derivative instruments is included in Note 16 to the consolidated
financial statements.
Old National has entered into a $52 million contract for the construction of its
Evansville, Indiana, bank headquarters and banking center. The contract is
expected to be complete in 2004.
In the normal course of business, various legal actions and proceedings are
pending against Old National and its affiliates which are incidental to the
business in which they are engaged. Further discussion of contingent liabilities
is included in Note 17 to the consolidated financial statements.
COMPARISON OF 2002 WITH 2001
Net income in 2002 was $117.9 million and diluted net income per share was $1.75
compared to $93.0 million and $1.36, respectively, in 2001. The increases in net
income and net income per share were primarily due to increases in noninterest
income resulting from securities gains of $12.4 million and a $12.5 million
pre-tax gain on branch divestitures in 2002. These gains along with strong
growth in mortgage banking revenue more than offset increases in the provision
for loan losses related to deteriorating economic conditions in the company's
geographic markets. In addition, 2001 net income included merger and
restructuring costs as a result of the completion of the One Bank consolidation
project resulting in additional pre-tax expense of $9.7 million.
Return on average assets was 1.27% and return on shareholders' equity was 17.05%
in 2002 compared with 1.05% and 14.45%, respectively, in 2001.
Net interest income on a taxable equivalent basis was $314.6 million and net
interest margin was 3.65% in 2002 compared to $312.6 million and 3.77%,
respectively, in 2001. The decrease in net interest margin was due primarily to
declining interest rates during 2002, and a change in the asset and funding mix.
Net interest income includes taxable equivalent adjustments of $25.2 million for
2002 and $21.3 million for 2001.
The increase in the provision for loan losses to $33.5 million in 2002 from
$28.7 million in 2001 resulted from a slowdown in the pace of the current
economic recovery in the geographic areas served by Old National and significant
increases in the level of non-performing loans.
Noninterest income was $154.5 million in 2002, compared to $113.0 million in
2001. The 2002 results included a gain on branch divestitures of $12.5 million
and realized net securities gains of $12.4 million. A major contributor to the
remaining amount of increase was mortgage banking revenue. With the decrease in
interest rates during 2002,
28
loan origination volumes reached $1.100 billion compared to $929.2 million in
2001, increasing mortgage banking revenue to $14.5 million from $9.7 million in
2001, or 48.9%. In addition, trust and asset management fees, insurance premiums
and commissions, and investment product fees increased 22.7% in 2002. These
increases were a result of acquisitions of an asset management consulting firm,
which contributed an additional $5.0 million of fee income for 2002 and an
insurance agency, which added $1.6 million fee income for 2002. Investment and
brokerage business fees increased 31.7% in 2002, primarily from strong annuity
sales.
Old National's efficiency ratio was 54.97% in 2002 compared to 59.87% in 2001.
Increases in total revenue, primarily from noninterest income, exceeded
increases in noninterest expense resulting in an improved efficiency ratio.
Noninterest expense was $257.8 million in 2002, an increase of 1.2% over the
$254.8 million recorded in 2001. The primary reason for the increase in expense
was acquisitions in the non-bank services segment during the second half of
2002, resulting in an additional $5.7 million of noninterest expense. Salaries
and benefits, which comprised approximately 58% of total noninterest expense,
grew $10.2 million or 7.4%, including $4.0 million from acquisitions. Marketing
expense increased 36.0% related to a new marketing campaign used to better
describe the broadening scope of financial services and markets being served by
Old National. Outside processing expense increased 26.8% reflecting costs
associated with subcontracting the servicing functions of Old National's
mortgage banking activities to an outside company. Goodwill amortization ceased
in January 2002 in accordance with generally accepted accounting principles
contributing a decrease of $5.9 million from 2001. In addition, noninterest
expense decreased $9.7 million from 2001 related to merger and restructuring
charges incurred when Old National further streamlined its regional banking
administrative structure and incurred expenses in the consolidation of
acquisitions made in 2000.
Provision for income taxes was $34.6 million in 2002 compared to $27.7 million
in 2001. Old National's effective tax rate was 22.7% in 2002 compared to 22.9%
in 2001.
In regard to segment reporting, the community banking segment profit was $93.3
million in 2002 compared to $78.7 million in 2001, as revenues grew with very
little growth in expenses. The non-bank services segment profit was $2.4 million
in 2002 compared to $2.2 million in 2001 with acquisitions in the second half of
2002 accounting for the majority of the changes in noninterest income and
noninterest expenses. The treasury segment profit showed a decrease from $18.1
million in 2001 to $14.0 million in 2002, with increased income from investment
portfolio growth and decreased borrowing costs from a declining interest rate
environment more than offseting the decline in profits generated from the
corporate balance sheet position and associated interest rate risk profile. The
remaining profit includes $8.3 million after-tax gain related to the sales of
branches in 2002 and after-tax loss of $5.9 million related to the restructuring
of the regional banking administrative structure in 2001. Management chose not
to allocate these charges to the various segments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK MANAGEMENT
Inherent in Old National's balance sheet is market risk, defined as the
sensitivity of income, fair market values and capital to changes in interest
rates, foreign currency exchange rates, commodity prices and other relevant
market rates or prices. The primary market risk to which Old National has
exposure is interest rate risk. Interest rate risk arises because assets and
liabilities may reprice, mature or prepay at different times or based upon
different indices as market interest rates change. Changes in the slope of the
yield curve and the pace of changes in interest rates may also impact net
interest income and the fair value of the balance sheet.
Old National manages interest rate risk within an overall asset and liability
management framework that includes attention to credit risk, liquidity risk and
capitalization. A principal objective of asset/liability management is to manage
the sensitivity of net interest income to changing interest rates. Asset and
liability management activity is governed by a policy reviewed and approved
annually by the Board of Directors. The Board of Directors has delegated the
oversight of the administration of this policy to the Funds Management
Committee, a committee of the Board of Directors, which meets quarterly. In
addition, a second oversight committee, the Balance Sheet Management Committee
comprised of senior executive managers, provides guidance for the execution of
the activities.
29
Old National uses two modeling techniques to quantify the impact of changing
interest rates on the company, Net Interest Income at Risk and Market Value of
Equity. Net Interest Income at Risk is used by management and the Board of
Directors to evaluate the impact of changing rates over a two-year horizon while
Market Value of Equity is more useful for long-term interest rate risk. These
models simulate the likely behavior of the company's net interest income and the
likely change in the company's market value due to changes in interest rates
under possible interest rate scenarios. Because the models are driven by
expected behavior in various interest rate scenarios and many factors besides
market interest rates impact the company's net interest income and value, Old
National recognizes that model outputs are not guarantees for actual results.
For this reason, Old National models many different combinations of interest
rates and balance sheet assumptions to best understand its overall sensitivity
to market interest rate changes.
Old National's Board of Directors, through its Funds Management Committee,
monitors the company's interest rate risk. The Funds Management Committee
establishes policy guidelines for the allowable change in cumulative net
interest income over a two-year period and the change in Market Value of Equity
in an up or down 200 basis point instantaneous parallel change to the yield
curve (+/- 200 basis point yield curve shock). The current guidelines for Net
Interest Income at Risk is +/- 5% of net interest income over a two-year period
in a 200 basis point shock to the yield curve. As of December 31, 2003, Old
National projects that in a -200 basis point shock to interest rates, net
interest income would be down 2.19% cumulative over the next two years. In a
+200 basis point shock to interest rates, Old National projects net interest
income would be down 5.59% cumulative over the next two years. The current
guidelines for the allowable fluctuation in Market Value of Equity are +/- 12%
in a 200 basis point shock to the yield curve. As of December 31, 2003, Old
National projects Market Value of Equity to decrease by 7.39% in a -200 basis
point shock to interest rates and to decrease by 8.07% in a +200 basis point
shock.
At December 31, 2003, Old National was slightly outside its policy of Net
Interest Income at Risk in a +200 basis point interest rate shock. The
significant steepening of the yield curve during the second half of 2003 and its
impact on the duration of the company's investment portfolio and the growth of
money market and interest bearing checking accounts during the year contributed
to the change in the company's interest rate risk profile from December 2002.
Old National continues to lengthen the repricing of its deposits and wholesale
funding, and shorten the repricing of its asset portfolios to bring the interest
rate risk position back within the policy guideline.
- ----------------------------------------------------------------------------------------
Estimated 24-Month Estimated Change
Cumulative Impact On in Market
Net Interest Income at Risk Value of Equity
Interest Rate Change
(basis points) Policy Actual Policy Actual
- ----------------------------------------------------------------------------------------
2003
+200 +/- 5.00 % -5.59 % +/- 12.00 % -8.07 %
-200 +/- 5.00 -2.19 +/- 12.00 -7.39
- ----------------------------------------------------------------------------------------
2002
+200 +/- 5.00 % 2.12 % +/- 12.00 % -1.32 %
-200 +/- 5.00 -6.64 +/- 12.00 -14.16
- ----------------------------------------------------------------------------------------
At December 31, 2003, Old National's most likely interest rate scenario was one
in which interest rates gradually increase during the next 24 months. Many
factors can impact the interest rate outlook and it is possible that the
company's interest rate outlook could change. The Net Interest Income model
scenario that most closely matches the company's current outlook was a 25 basis
point upward shift in the yield curve quarterly for four quarters, then flat
rates for the following four quarters (+100 basis point ramp). The estimated
24-month cumulative impact on net interest income was down 1.57% in this
scenario. Given that balance sheet assumptions and interest rate forecasts in
the model are inherently uncertain, the company views the rate risk position as
virtually neutral in this scenario.
Old National uses derivatives to manage interest rate risk in the ordinary
course of business. See Note 16 to the consolidated financial statements for a
discussion of derivative financial instruments. These transactions serve to
better balance the repricing of assets and liabilities in various rate change
scenarios and protect the company from changes in interest rates.
30
LIQUIDITY MANAGEMENT
The Funds Management Committee of the Board of Directors and the Balance Sheet
Management Committee establish liquidity risk guidelines and monitor liquidity
risk. The objective of liquidity management is to ensure Old National has the
ability to fund balance sheet growth and meet deposit and debt obligations in a
timely and cost-effective manner. Management monitors liquidity through a
regular review of asset and liability maturities, funding sources, and loan and
deposit forecasts to minimize funding risk. The company maintains strategic and
contingency liquidity plans to ensure sufficient available funding to satisfy
requirements for balance sheet growth, properly manage capital markets' funding
sources and to address unexpected liquidity requirements.
Old National's ability to raise funding at competitive prices is influenced by
rating agencies' views of the company's credit quality, liquidity, capital and
earnings. The senior debt ratings of Old National Bancorp and Old National Bank
at December 31, 2003, are shown in the following table.
SENIOR DEBT RATINGS
- -------------------------------------------------------------------------------------------------
Standard and Poor's Moody's Investor Services Fitch, Inc.
--------------------- ------------------------- ----------------------
Long-term Short-term Long-term Short-term Long-term Short-term
- -------------------------------------------------------------------------------------------------
Old National Bancorp BBB N/A Baa1 N/A BBB F2
Old National Bank BBB+ A2 A3 P-2 BBB F2
- -------------------------------------------------------------------------------------------------
N/A = not applicable
Standard & Poor's Rating Services lowered its long-term ratings on Old National
Bancorp and Old National Bank from BBB+ to BBB and A- to BBB+, respectively,
during 2003. The outlook was revised to stable. Moody's Investor Services
affirmed its stable outlook on Old National Bancorp and Old National Bank's
long-term ratings at Baa1 and A3, respectively, during 2003. Fitch, Inc.
affirmed its ratings and changed its outlook on Old National Bancorp and Old
National Bank from "stable" to "negative" during 2003. Subsequent to year-end,
on January 30, 2004, Fitch, Inc. lowered its ratings on Old National Bancorp and
Old National Bank to BBB, however, changed its outlook on Old National from
"negative" to "stable."
As of December 31, 2003, Old National Bank had the capacity to borrow $766
million from the Federal Reserve Bank's discount window. Old National Bank is
also a member of the Federal Home Loan Bank ("FHLB") of Indianapolis, which
provides a source of funding through FHLB advances. Old National also maintains
relationships in capital markets with brokers and dealers to issue certificates
of deposits and short-term and medium-term bank notes. In addition, at December
31, 2003, Old National had $660 million available for issuance under a $1
billion global bank note program for senior and subordinated debt.
Old National Bancorp, the parent company, has routine funding requirements
consisting primarily of operating expenses, dividends to shareholders, debt
service, net derivative cash flows and funds used for acquisitions. Old National
Bancorp obtains funding to meet its obligations from dividends and management
fees collected from its subsidiaries and the issuance of debt securities. At
December 31, 2003, the parent company's other borrowings outstanding was $270.5
million, compared with $58.3 million at December 31, 2002. The increase in other
borrowings in 2003 was driven by the issuance of $100 million of fixed-rate
medium-term notes and the reclassification of $160.2 million related to
guaranteed preferred beneficial interests in subordinated debentures, which was
partially offset by medium-term note maturities of $45 million. See Note 10 to
the consolidated financial statements for a discussion of the reclassification.
Old National Bancorp's debt scheduled to mature in the next 12-months is $3.2
million. These debt obligations are expected to be met through current cash
balances and dividends from subsidiaries. Federal banking laws regulate the
amount of dividends that may be paid by banking subsidiaries without prior
approval. For further information regarding dividend restrictions, see Note 19
to the consolidated financial statements. At December 31, 2003, Old National had
an SEC shelf registration in place for the issuance of $200 million preferred
securities by a series of Trusts. Old National has issued $150 million of these
securities, called trust preferred securities, and has the capacity to issue an
additional $50 million.
31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
MANAGEMENT'S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS
Management is responsible for the preparation of the financial statements and
related financial information appearing in this annual report on Form 10-K. The
financial statements and notes have been prepared in conformity with generally
accepted accounting principles and include some amounts which are estimates
based upon currently available information and management's judgement of current
conditions and circumstances. Financial information throughout this annual
report on Form 10-K is consistent with that in the financial statements.
SYSTEM OF INTERNAL ACCOUNTING CONTROLS
Management maintains a system of internal accounting controls which is believed
to provide, in all material respects, reasonable assurance that assets are
safeguarded against loss from unauthorized use or disposition, transactions are
properly authorized and recorded, and the financial records are reliable for
preparing financial statements and maintaining accountability for assets. In
addition, Old National has a Code of Business Conduct and Ethics, a Senior
Financial and Executive Officer Code of Ethics and Corporate Governance
Guidelines that outline high levels of ethical business standards. All systems
of internal accounting controls are based on management's judgement that the
cost of controls should not exceed the benefits to be achieved and that no
system can provide absolute assurance that control objectives are achieved.
Management believes Old National's system provides the appropriate balance
between costs of controls and the related benefits.
In order to monitor compliance with this system of controls, Old National
maintains an extensive internal audit program. Internal audit reports are issued
to appropriate officers and significant audit exceptions, if any, are reviewed
with management and the Audit Committee of the Board of Directors.
AUDIT COMMITTEE OF THE BOARD
The Board of Directors, through an Audit Committee comprised solely of outside
directors, oversees management's discharge of its financial reporting
responsibilities. The Audit Committee meets regularly with Old National's
independent public accountants, PricewaterhouseCoopers LLP, and the managers of
internal auditing and loan review. During these meetings, the committee has the
opportunity to meet privately with the independent public accountants as well as
with internal audit and loan review personnel to review accounting, auditing,
loan, and financial reporting matters. The appointment of the independent public
accountants is made by the Audit Committee of the Board of Directors.
INDEPENDENT ACCOUNTANTS
The financial statements in this annual report on Form 10-K have been audited by
PricewaterhouseCoopers LLP, for the purpose of determining that the financial
statements are presented fairly in all material respects. PricewaterhouseCoopers
LLP's report on the financial statements follows. Their audit included a
consideration of Old National's system of internal accounting controls for the
purpose of setting the scope and timing of their auditing procedures.
32
[LETTERHEAD OF PRICEWATERHOUSECOOPERS LLP]
Report of Independent Auditors
To the Shareholders and
Board of Directors of
Old National Bancorp:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Old National Bancorp and affiliates (the "Company") at December 31, 2003 and
2002, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 1, the Company adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets, on January 1, 2002.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Chicago, Illinois
February 23, 2004
33
OLD NATIONAL BANCORP
CONSOLIDATED BALANCE SHEET
- ------------------------------------------------------------------------------------------------------
December 31,
(dollars and shares in thousands) 2003 2002
- ------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 222,385 $ 223,007
Money market investments 14,504 13,219
- ------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 236,889 236,226
Investment securities - available-for-sale, at fair value 2,706,340 3,077,798
Investment securities - held-to-maturity, at amortized cost
(fair value $209,316) 210,905 --
Residential loans held for sale 16,338 92,598
Loans, net of unearned income 5,570,117 5,677,037
Allowance for loan losses (104,571) (87,742)
- ------------------------------------------------------------------------------------------------------
Net loans 5,465,546 5,589,295
- ------------------------------------------------------------------------------------------------------
Premises and equipment, net 181,398 134,914
Accrued interest receivable 55,800 59,101
Goodwill 129,251 110,648
Other intangible assets 41,912 27,042
Mortgage servicing rights 14,659 11,367
Other assets 294,858 273,567
- ------------------------------------------------------------------------------------------------------
Total assets $ 9,353,896 $ 9,612,556
======================================================================================================
Liabilities
Deposits:
Noninterest-bearing demand $ 823,146 $ 778,429
Interest-bearing:
NOW 1,612,145 1,365,821
Savings 441,427 475,434
Money market 608,177 588,611
Time 3,008,197 3,230,985
- ------------------------------------------------------------------------------------------------------
Total deposits 6,493,092 6,439,280
- ------------------------------------------------------------------------------------------------------
Short-term borrowings 414,588 918,349
Other borrowings 1,624,092 1,234,014
Guaranteed preferred beneficial interests in subordinated debentures -- 163,843
Accrued expenses and other liabilities 106,634 116,360
- ------------------------------------------------------------------------------------------------------
Total liabilities 8,638,406 8,871,846
- ------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 17)
Shareholders' Equity
Preferred stock, 2,000 shares authorized, no shares issued or outstanding -- --
Common stock, $1 stated value, 150,000 shares authorized,
66,575 and 63,856 shares issued and outstanding, respectively 66,575 63,856
Capital surplus 581,224 528,379
Retained earnings 53,107 96,652
Accumulated other comprehensive income, net of tax 14,584 51,823
- ------------------------------------------------------------------------------------------------------
Total shareholders' equity 715,490 740,710
- ------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 9,353,896 $ 9,612,556
======================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of this statement.
34
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF INCOME
- ------------------------------------------------------------------------------------------
Years Ended December 31,
(dollars and shares in thousands, except per share data) 2003 2002 2001
- ------------------------------------------------------------------------------------------
Interest Income
Loans including fees:
Taxable $320,859 $391,412 $495,138
Nontaxable 17,240 17,578 16,231
Investment securities, available-for-sale:
Taxable 93,564 107,268 89,867
Nontaxable 30,828 30,742 27,666
Investment securities, held-to-maturity, taxable 6,943 -- --
Money market investments 314 383 805
- ------------------------------------------------------------------------------------------
Total interest income 469,748 547,383 629,707
- ------------------------------------------------------------------------------------------
Interest Expense
Deposits 138,671 186,560 253,614
Short-term borrowings 7,258 10,971 21,862
Other borrowings 51,812 60,423 62,932
- ------------------------------------------------------------------------------------------
Total interest expense 197,741 257,954 338,408
- ------------------------------------------------------------------------------------------
Net interest income 272,007 289,429 291,299
Provision for loan losses 85,000 33,500 28,700
- ------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 187,007 255,929 262,599
- ------------------------------------------------------------------------------------------
Noninterest Income
Trust and asset management fees 30,470 24,387 20,681
Service charges on deposit accounts 44,855 41,988 40,478
ATM fees 7,474 6,876 5,604
Mortgage banking revenue 19,144 14,496 9,737
Insurance premiums and commissions 39,225 16,686 13,296
Investment product fees 10,567 8,983 6,819
Bank-owned life insurance 6,922 7,944 5,349
Net securities gains 23,556 12,444 4,770
Gain on branch divestitures -- 12,473 --
Other income 9,936 8,220 6,233
- ------------------------------------------------------------------------------------------
Total noninterest income 192,149 154,497 112,967
- ------------------------------------------------------------------------------------------
Noninterest Expense
Salaries and employee benefits 169,025 148,450 138,210
Occupancy 18,166 16,154 15,599
Equipment 14,296 15,153 16,206
Marketing 11,085 11,026 8,109
FDIC insurance premiums 1,007 1,132 1,222
Outside processing 19,078 13,640 10,757
Communication and transportation 11,595 11,738 10,907
Professional fees 9,111 8,959 7,415
Loan expense 7,041 6,496 6,416
Supplies 4,829 5,048 5,529
Other losses 14,676 5,445 6,177
Goodwill amortization -- -- 5,909
Other intangible amortization 2,612 1,174 865
Other expense 17,195 13,430 11,788
Merger and restructuring costs -- -- 9,703
- ------------------------------------------------------------------------------------------
Total noninterest expense 299,716 257,845 254,812
- ------------------------------------------------------------------------------------------
Income before income taxes 79,440 152,581 120,754
Income tax expense 9,027 34,649 27,710
- ------------------------------------------------------------------------------------------
Net income $ 70,413 $117,932 $ 93,044
==========================================================================================
Net Income Per Common Share
Basic $ 1.05 $ 1.75 $ 1.36
Diluted 1.05 1.75 1.36
- ------------------------------------------------------------------------------------------
Weighted Average Number Of Common Shares Outstanding
Basic 66,779 67,177 68,506
Diluted 66,832 67,308 68,608
- ------------------------------------------------------------------------------------------
The accompanying notes to consolidated financial statements are an integral part
of this statement.
35
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
(dollars and shares Common Stock Capital Retained Comprehensive Shareholders' Comprehensive
in thousands) Shares Amount Surplus Earnings Income Equity Income
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 60,311 $ 60,311 $ 457,267 $ 106,809 $ 1,954 $ 626,341
Net income -- -- -- 93,044 -- 93,044 $ 93,044
Unrealized net securities gains,
net of $10,573 tax -- -- -- -- 17,241 17,241 17,241
Reclassification adjustment for
gains included in net income,
net of $(1,813) tax -- -- -- -- (2,957) (2,957) (2,957)
Net unrealized derivative losses
on cash flow hedges,
net of $(1,069) tax -- -- -- -- (1,706) (1,706) (1,706)
Cash dividends -- -- -- (40,131) -- (40,131)
5% stock dividend 2,913 2,913 65,747 (68,660) -- --
Stock repurchased (2,131) (2,131) (52,592) -- -- (54,723)
Stock reissued under dividend
reinvestment, stock options,
and stock purchase plans 81 81 2,045 -- -- 2,126
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 61,174 61,174 472,467 91,062 14,532 639,235 $ 105,622
=========
Net income -- -- -- 117,932 -- 117,932 $ 117,932
Unrealized net securities gains,
net of $28,458 tax -- -- -- -- 44,075 44,075 44,075
Reclassification adjustment for
gains included in net income,
net of $(4,882) tax -- -- -- -- (7,562) (7,562) (7,562)
Net unrealized derivative gain on
on cash flow hedge,
net of $389 tax -- -- -- -- 603 603 603
Reclassification adjustment on
cash flow hedges, net of $113 tax -- -- -- -- 175 175 175
Stock issued for acquisition 656 656 14,717 -- -- 15,373
Cash dividends -- -- -- (43,926) -- (43,926)
5% stock dividend 3,040 3,040 65,376 (68,416) -- --
Stock repurchased (1,302) (1,302) (30,250) -- -- (31,552)
Stock reissued under stock
option and stock purchase plans 288 288 6,069 -- -- 6,357
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 63,856 63,856 528,379 96,652 51,823 740,710 $ 155,223
=========
Net income -- -- -- 70,413 -- 70,413 $ 70,413
Unrealized net securities losses,
net of $(15,566) tax -- -- -- -- (23,321) (23,321) (23,321)
Reclassification adjustment for
gains included in net income,
net of $(9,429) tax -- -- -- -- (14,127) (14,127) (14,127)
Net unrealized derivative gain
on cash flow hedge,
net of $23 tax -- -- -- -- 35 35 35
Reclassification adjustment on
cash flow hedges,
net of $113 tax -- -- -- -- 174 174 174
Stock issued for acquisitions 918 918 20,156 -- -- 21,074
Cash dividends -- -- -- (48,366) -- (48,366)
5% stock dividend 3,170 3,170 62,422 (65,592) -- --
Stock repurchased (1,681) (1,681) (36,149) -- -- (37,830)
Stock reissued under stock
option and stock purchase plans 312 312 6,416 -- -- 6,728
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 66,575 $ 66,575 $ 581,224 $ 53,107 $ 14,584 $ 715,490 $ 33,174
=============================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of this statement.
36
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
(dollars in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 70,413 $ 117,932 $ 93,044
- -------------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation 13,018 12,401 13,513
Amortization of goodwill -- -- 5,909
Amortization of other intangible assets 2,612 1,174 865
Net premium amortization on investment securities 12,472 7,074 1,242
Provision for loan losses 85,000 33,500 28,700
Net securities gains (23,556) (12,444) (4,770)
Gain on branch divestitures -- (12,473) --
(Gains) losses on sale of other assets (11,369) (5,977) 432
Residential real estate loans originated for sale (844,902) (913,794) (779,264)
Proceeds from sale of residential real estate loans 930,999 853,755 752,193
(Increase) decrease in interest receivable 3,301 (5,740) (6,785)
Increase in other assets (39,404) (35,856) (16,851)
Increase (decrease) in accrued expenses and other liabilities 5,408 (10,167) (2,741)
- -------------------------------------------------------------------------------------------------------------------------
Total adjustments 133,579 (88,547) (7,557)
- -------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by operating activities 203,992 29,385 85,487
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows From Investing Activities
Purchases of investment securities available-for-sale (2,155,166) (2,339,004) (1,558,133)
Proceeds from maturities, prepayments and calls
of investment securities available-for-sale 1,413,262 812,993 819,282
Proceeds from sales of investment securities available-for-sale 1,062,875 762,066 328,601
Purchases of investment securities held-to-maturity (237,190) -- --
Proceeds from maturities, prepayments and calls
of investment securities held-to-maturity 25,417 -- --
Purchases of subsidiaries, net of cash acquired (12,838) (30,115) --
Payments related to branch divestitures -- (82,160) --
Proceeds from sale of loans 47,934 -- --
Net principal collected from (loans made to) customers (9,185) 303,969 214,199
Proceeds from sale of premises and equipment 1,434 2,305 1,448
Purchases of premises and equipment (57,246) (32,223) (4,968)
- -------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) investing activities 79,297 (602,169) (199,571)
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities
Net increase (decrease) in deposits and short-term borrowings:
Noninterest-bearing demand deposits 44,717 58,740 22,401
Savings, NOW and money market deposits 231,883 292,520 124,647
Time deposits (222,788) (326,207) (115,004)
Short-term borrowings (503,761) 316,037 42,489
Proceeds from guaranteed preferred beneficial interests in
subordinated debentures -- 100,000 --
Payments for maturities on other borrowings (184,809) (135,008) (202,867)
Proceeds from issuance of other borrowings 431,600 275,683 415,363
Cash dividends paid (48,366) (43,926) (40,131)
Common stock repurchased (37,830) (31,552) (54,723)
Common stock reissued under stock option and stock purchase plans 6,728 6,357 2,126
- -------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities (282,626) 512,644 194,301
- -------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 663 (60,140) 80,217
Cash and cash equivalents at beginning of period 236,226 296,366 216,149
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 236,889 $ 236,226 $ 296,366
=========================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of this statement.
37
OLD NATIONAL BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of Old
National Bancorp and its wholly-owned affiliates ("Old National") and have been
prepared in conformity with generally accepted accounting principles 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. A
summary of the more significant accounting and reporting policies used in
preparing the statements is presented below.
NATURE OF OPERATIONS
Old National, a financial holding company headquartered in Evansville, Indiana,
operates in Indiana, Illinois, Kentucky, Tennessee, Ohio and Missouri. Through
its bank and non-bank affiliates, Old National provides to its customers an
array of financial services including loan, deposit, trust and asset management,
investment and insurance products.
INVESTMENT SECURITIES
Old National classifies investment securities as available-for-sale or held-to
maturity on the date of purchase. Securities classified as available-for-sale
are recorded at fair value with the unrealized gains and losses, net of tax
effect, recorded as a separate component of shareholders' equity. Realized gains
and losses affect income and the prior fair value adjustments are reclassified
within shareholders' equity. Securities classified as held-to-maturity, which
management has the intent and ability to hold to maturity, are reported at
amortized cost.
Premiums and discounts are recognized in interest income using the interest
method over the period to maturity. Gains and losses on the sale of
available-for-sale securities are determined using the specific-identification
method.
RESIDENTIAL LOANS HELD FOR SALE
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
Statement of Financial Accounting Standard ("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.
LOANS
Loans are stated at the principal amount outstanding. Interest income is accrued
on the principal balances of loans outstanding, except on discounted loans,
which are recognized using other methods that generally approximate the interest
method. A loan is generally placed on nonaccrual status when principal or
interest becomes 90 days past due unless it is well secured and in the process
of collection, or earlier when concern exists as to the ultimate collection of
principal or interest. Interest accrued during the current year on such loans is
reversed against earnings. Interest accrued in the prior year, if any, is
charged to the allowance for loan losses. The interest on these loans is
accounted for on the cash-basis or cost-recovery method, until qualifying for
return to accrual. Loans are returned to accrual status when all the principal
and interest amounts contractually due are brought current, remain current for
six months and future payments are reasonably assured.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the consolidated loan
portfolio. Management's evaluation of the adequacy of the allowance is an
estimate based on reviews of individual loans, assessments of the impact of
current and anticipated economic conditions on the portfolio, and historical
loss experience. The allowance is increased through a provision charged to
operating expense. Loans deemed to be uncollectible are charged to the
allowance. Recoveries of loans previously charged-off are added to the
allowance.
38
A loan is considered impaired when it is probable that contractual interest and
principal payments will not be collected either for the amounts or by the dates
as scheduled in the loan agreement. Old National's policy for recognizing income
on impaired loans is to accrue interest unless a loan is placed on nonaccrual
status.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is charged to operating expense over the useful lives of the
assets, principally on the straight-line method. Maintenance and repairs are
expensed as incurred while major additions and improvements are capitalized.
Interest costs on construction of qualifying assets are capitalized.
GOODWILL AND OTHER INTANGIBLE ASSETS
The excess of the cost of acquired entities over the fair value of identifiable
assets acquired less liabilities assumed is recorded as goodwill. Amortization
on goodwill and indefinite-lived assets are no longer recorded as a result of
Old National's adoption of SFAS No. 142 as described further in this footnote.
However, the recoverability of goodwill and other intangible assets are annually
tested for impairment. Other intangible assets are amortized, on an accelerated
cash flow basis over the period benefited, ranging from 4 to 40 years.
MORTGAGE SERVICING RIGHTS
Mortgage servicing rights are recognized as separate assets when loans are sold
with servicing retained. The total price of loans sold is allocated between the
loans sold and the mortgage servicing rights retained based on the relative fair
values of each. The fair value of capitalized mortgage servicing rights is
estimated by calculating the present value of estimated future net servicing
income derived from related cash flows. Amortization of capitalized mortgage
servicing rights is determined in proportion to and over the period of estimated
net servicing income of the underlying financial assets. Impairment of mortgage
servicing rights exists if the book value of the mortgage servicing rights
exceed its estimated fair value. In determining impairment, mortgage servicing
rights are stratified by interest rates. Critical assumptions used in
determining fair value include expected mortgage loan prepayment rates, discount
rates and other economic factors, which are determined based on current market
conditions. The expected rates of mortgage loan prepayments are the most
significant factors driving the value of mortgage servicing rights. Increases in
expected mortgage loan prepayments reduce estimated future net servicing cash
flows because the life of the underlying loan is reduced. Fair values, using
estimated mortgage loan prepayment rates, are derived from a third-party
statistical model. Negative adjustments to the value, if any, are recognized
through a valuation allowance by charges against mortgage servicing income. The
use of a valuation allowance enables the recovery of this value as market
conditions become more favorable.
DERIVATIVE FINANCIAL INSTRUMENTS
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." Old National uses interest rate contracts such as
interest rate swaps to manage its interest rate risk. These contracts are
designated as hedges of specific assets and liabilities. For a derivative
designated as a fair value hedge, the derivative is recorded at fair value on
the consolidated balance sheet. Fair value is defined as the amount at which the
instrument could be exchanged in a current transaction between willing parties.
The change in fair value of the derivative and hedged item (related to the
hedged risk) along with any ineffectiveness of the hedge is recorded in current
earnings. For a derivative designated as a cash flow hedge, the effective
portion of the derivative's gain or loss is initially reported as a component of
accumulated other comprehensive income (loss) and subsequently reclassified into
earnings when the hedged exposure affects earnings. Any ineffective portion of
the gain or loss is reported in earnings immediately. The net interest
receivable or payable on swaps is accrued and recognized as an adjustment to the
interest income or expense of the hedged asset or liability. Old National
assesses the effectiveness of each hedging relationship by comparing the changes
in fair value or cash flows of the derivative hedging instrument with the
changes in fair value or cash flows of the designated hedged item or
transaction.
CREDIT-RELATED FINANCIAL INSTRUMENTS
In the ordinary course of business, Old National's affiliate bank has entered
into credit-related financial instruments consisting of commitments to extend
credit, commercial letters of credit and standby letters of credit. These
commitments are not reflected in the consolidated financial statements until
they are funded.
39
FORECLOSED REAL ESTATE
Other assets include real estate properties acquired as a result of foreclosure
and are valued at the lower of the recorded investment in the related loan or
fair value of the property less estimated cost to sell. The recorded investment
is the sum of the outstanding principal loan balance, any accrued interest which
has not been received and acquisition cost associated with the loan. Any excess
recorded investment over the fair value of the property received is charged to
the allowance for loan losses. Any subsequent write-downs are charged to
expense, as are the costs of operating the properties. Such costs are not
material to Old National's results of operation.
NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding during each year, adjusted
to reflect all stock dividends. Diluted net income per share is computed as
above and assumes the conversion of outstanding stock options. The following
table reconciles basic and diluted net income per share for the years ended
December 31:
NET INCOME PER SHARE RECONCILIATION
- ------------------------------------------------------------------------------------------------------------------
2003 2002 2001
--------------------------- ---------------------------- ---------------------------
(dollars and shares in thousands,
except per share data) Income Shares Amount Income Shares Amount Income Shares Amount
- ------------------------------------------------------------------------------------------------------------------
Basic Net Income Per Share
Income from operations $70,413 66,779 $1.05 $117,932 67,177 $1.75 $93,044 68,506 $1.36
======== ======== =========
Effect Of Dilutive Securities
Stock options - 53 - 131 - 102
- ------------------------------------------------- -------------------- ------------------
Diluted Net Income Per Share
Income from operations
and assumed conversions $70,413 66,832 $1.05 $117,932 67,308 $1.75 $93,044 68,608 $1.36
==================================================================================================================
INCOME TAXES
Deferred income tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and laws.
Recognition of deferred tax assets is based on management's belief that it is
more likely than not that the tax benefit associated with certain temporary
differences, tax operating loss carryforwards and tax credits will be realized.
STATEMENT OF CASH FLOWS DATA
For the purpose of presentation in the accompanying consolidated statement of
cash flows, cash and cash equivalents are defined as cash, due from banks and
money market investments, which have maturities less than 90 days. Cash paid
during 2003, 2002 and 2001 for interest was $201.8 million (net of capitalized
interest of $1.2 million), $261.2 million, (net of capitalized interest of $0.3
million) and $353.0 million, respectively. Cash paid for income tax during 2003,
2002 and 2001 were $26.0 million, $33.0 million and $34.7 million, respectively.
Other noncash transactions include stock issued in acquisitions of subsidiaries
of $21.1 million in 2003 and $15.4 million in 2002 and loans transferred to
loans held for sale of $62.7 million in 2003.
IMPACT OF ACCOUNTING CHANGES
In December 2003, the Financial Accounting Standards Board ("FASB") revised SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." This statement requires disclosures in addition to those in the
original SFAS No. 132, which provides additional information regarding assets,
obligations, cash flows and net periodic benefit costs of defined benefit
pension plans. The revised SFAS No. 132 is effective for financial statements
with fiscal years ending after December 15, 2003. Old National adopted this
statement as of December 31, 2003, and has included all such required
disclosures in Note 12.
In December 2003, the FASB revised FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," which was initially released in
January 2003. FIN 46 provides guidance with respect to variable interest
entities and when the assets, liabilities, noncontrolling interest and results
of operations of a variable interest entity need to be included in a company's
consolidated financial statements. FIN 46 is effective for companies with
40
"special-purpose entities" as of December 31, 2003. Old National does not have
special-purpose entities. However, under this new guidance, Old National was
required to deconsolidate ONB Capital Trust I and ONB Capital Trust II as these
trusts no longer meet the definition of a related subsidiary under the terms of
FIN 46. This change also resulted in the remaining debt being disclosed in
"other borrowings" for the year ended December 31, 2003, compared to the
separate disclosure on the balance sheet at December 31, 2002. The effect of
this deconsolidation was an increase of $4.6 million to both assets and
liabilities with no impact to the results of operations. The effective date for
consolidation of all other entities is after March 15, 2004, at which time Old
National will be required to consolidate various low income housing
partnerships. Old National does not expect the consolidation of low income
housing partnerships to have a material impact on the results of operations or
financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for classification and measurement in the statement of
financial position of certain financial instruments with characteristics of both
liabilities and equity. Old National has determined that it has no such
instruments.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement clarifies
reporting of contracts as either derivatives or hybrid instruments. Old National
has determined that all derivatives or hybrid instruments covered under this
statement have been properly reported under SFAS No. 149.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-based
Compensation - Transition and Disclosure," which provides guidance on how to
transition from the intrinsic value method of accounting for stock-based
compensation under Accounting Principles Board ("APB") Opinion No. 25 to SFAS
No. 123's fair value method of accounting, if a company so elects. Old National
applies APB Opinion No. 25 and related Interpretations in accounting for the
stock option plan. Accordingly, no compensation costs have been recognized. Had
compensation cost for Old National's stock option plan been recorded based on
the fair value at the grant dates for awards under the plan consistent with the
method prescribed by SFAS No. 123, net income would have been adjusted to a
proforma amount as indicated for the years ended December 31. All per share data
has been adjusted for stock dividends, including a 5% stock dividend distributed
to shareholders on January 27, 2004.
- ------------------------------------------------------------------------------------
(dollars in thousands, except per share data) 2003 2002 2001
- ------------------------------------------------------------------------------------
Net income as reported $70,413 $117,932 $93,044
Deduct total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (6,002) (2,992) (3,090)
- ------------------------------------------------------------------------------------
Proforma net income $64,411 $114,940 $89,954
====================================================================================
Basic net income per share:
As reported $1.05 $1.75 $1.36
Proforma 0.96 1.71 1.31
Diluted net income per share:
As reported $1.05 $1.75 $1.36
Proforma 0.96 1.71 1.31
- ------------------------------------------------------------------------------------
In November 2002, FIN 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others" was
issued. FIN 45 elaborates on the disclosures to be made by a guarantor in its
financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. Certain guarantee contracts that are
excluded from both the disclosure and recognition requirements of FIN 45,
including, among others, residual value guarantees under capital lease
arrangements, commercial letters of credit and loan commitments. The disclosure
requirements of FIN 45 were effective as of December 31, 2002. The recognition
requirements of FIN 45 are to be applied prospectively to guarantees issued or
modified after December 31, 2002. The impact of FIN 45 at December 31, 2003,
resulted in additional liabilities of $0.3 million and reduced noninterest
income by the same amount.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." The
Statement addresses financial accounting and reporting for business combinations
and supersedes APB Opinion No. 16, "Business Combinations."
41
It requires all business combinations within the scope of the Statement to be
accounted for using one method, the purchase method. It establishes criteria for
the initial recognition of intangible assets acquired in a business combination.
The provisions of the Statement apply to all business combinations initiated
after June 30, 2001.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," addressing financial accounting and reporting for acquired goodwill and
other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets."
Under this Statement, goodwill and other intangible assets that have indefinite
useful lives will not be subject to amortization. The Statement is effective for
fiscal years beginning after December 15, 2001.
Old National adopted SFAS No. 141 and SFAS No. 142 effective January 1, 2002. As
of the date of adoption, Old National had unamortized goodwill in the amount of
$82.8 million and unamortized identifiable intangible assets in the amount of
$4.4 million, all of which were subject to the transition provisions of SFAS No.
141 and 142. As part of the adoption, Old National performed a transitional
impairment test on its goodwill assets, which indicated no impairment charge was
required. As of the date of transition, Old National had no indefinite-lived
intangible assets recorded on its consolidated balance sheet. In addition, no
material reclassifications or adjustments to the useful lives of definite-lived
intangible assets were made as a result of adopting the new guidance. The
following table is a reconciliation of net income and net income per share had
goodwill amortization been excluded for the year ended December 31, 2001. All
per share data has been adjusted for stock dividends, including a 5% stock
dividend distributed to shareholders on January 27, 2004. Refer to Note 7 for
additional information regarding goodwill and intangible assets.
IMPACT OF ACCOUNTING CHANGE FOR GOODWILL
- -------------------------------------------------------------------------
2001
Net Net Income
(dollars in thousands, except per share data) Income Per Share
- -------------------------------------------------------------------------
Basic earnings per common share computation:
Reported net income $93,044 $1.36
Add back goodwill amortization 5,417 0.08
- -------------------------------------------------------------------------
Adjusted net income/Net income per share $98,461 $1.44
=========================================================================
Diluted earnings per common share computation:
Reported net income $93,044 $1.36
Add back goodwill amortization 5,417 0.08
- -------------------------------------------------------------------------
Adjusted net income/Net income per share $98,461 $1.44
=========================================================================
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the 2003
presentation. Such reclassifications had no effect on net income.
NOTE 2 - ACQUISITION AND DIVESTITURE ACTIVITY
COMPLETED MERGERS
Old National acquired several companies in the non-bank services segment during
2003 and 2002. All acquisitions were accounted for as purchases in accordance
with SFAS No. 141.
- -----------------------------------------------------------------------------------------------------------------
Purchase Price
------------------------------------------
(dollars in thousands) Shares Stock Cash Other
Entity Acquired Date Issued Value Paid Total Goodwill Intangibles
- -----------------------------------------------------------------------------------------------------------------
Insurance and Risk Management 8/1/03 590,411 $13,739 $16,206 $29,945 $14,213 $12,376
Graham and Peat Insurance Agency 6/1/03 131,992 3,029 72 3,101 2,058 1,797
James L. Will Insurance Agency 5/1/03 195,427 4,306 92 4,398 2,634 2,667
Terrill Group, Inc. 12/1/02 656,180 15,373 4,951 20,324 15,383 11,229
Fund Evaluation Group, Inc. 7/1/02 - - 26,838 26,838 12,668 11,800 (1)
- -----------------------------------------------------------------------------------------------------------------
(1) Includes an indefinite-lived intangible asset of $2.8 million.
42
Intangible assets related to customer business relationships from these
purchases are being amortized over 4 to 40 years. Of the $47.0 million of
goodwill recorded from these transactions $26.9 million is expected to be
deductible for tax purposes. Unaudited financial statements of aggregate
companies acquired during 2003 showed assets of $12.2 million on the acquisition
dates and revenues from the beginning of the year to acquisition dates of $10.9
million with net income of $1.5 million. Unaudited financial statements of
aggregate companies acquired during 2002 showed assets of $12.5 million on the
acquisition dates and revenues from the beginning of the year to acquisition
dates of $19.8 million with net income of $0.6 million. Contingent payments are
often made as a result of these acquisitions. These payments, which are not
deemed to be material, result in a change to the purchase price and goodwill
when paid.
DIVESTITURES
During 2003, Old National sold its Fort Wayne, Indiana, trust operations
resulting in a pre-tax gain totaling $0.3 million. Old National finalized the
sales of branches in the normal course of business resulting in a pre-tax gain
totaling $12.5 million during 2002.
NOTE 3 - INVESTMENT SECURITIES
The following tables summarize the amortized cost and fair value of the
available-for-sale and held-to-maturity investment securities portfolio at
December 31 and the corresponding amounts of unrealized gains and losses
therein:
- ----------------------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
(dollars in thousands) Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
2003
Available-for-Sale
U.S. Treasury $ 25,972 $ 115 $ (30) $ 26,057
U.S. Government agencies and corporations 590,941 1,863 (11,984) 580,820
Mortgage-backed securities 1,306,293 12,629 (20,041) 1,298,881
States and political subdivisions 617,703 37,543 (178) 655,068
Other securities 141,682 3,862 (30) 145,514
- ----------------------------------------------------------------------------------------------
Total available-for-sale securities $2,682,591 $ 56,012 $ (32,263) $2,706,340
==============================================================================================
Held-to-Maturity
Mortgage-backed securities $ 210,905 $ 170 $ (1,759) $ 209,316
==============================================================================================
2002
Available-for-Sale
U.S. Treasury $ 5,113 $ 251 $ -- $ 5,364
U.S. Government agencies and corporations 765,230 11,978 -- 777,208
Mortgage-backed securities 1,442,486 39,000 (100) 1,481,386
States and political subdivisions 676,071 32,734 (608) 708,197
Other securities 102,706 3,022 (85) 105,643
- ----------------------------------------------------------------------------------------------
Total available-for-sale securities $2,991,606 $ 86,985 $ (793) $3,077,798
==============================================================================================
Proceeds from sales of investment securities available-for-sale were $1.063
billion in 2003, $762.1 million in 2002 and $328.6 million in 2001. In 2003,
realized gains were $24.3 million and losses were $0.7 million. In 2002,
realized gains were $12.7 million and losses were $0.3 million. In 2001,
realized gains were $4.8 million. At December 31, investment securities were
pledged to secure public and other funds with a carrying value of $1.743 billion
in 2003 and $1.489 billion in 2002.
The amortized cost and fair value of the investment securities portfolio are
shown by expected maturity. Expected maturities may differ from contractual
maturities if borrowers have the right to call or prepay obligations with or
without call or prepayment penalties.
43
- ------------------------------------------------------------------------------------------------------------
2003 2002
------------------------------- Weighted --------------------------- Weighted
(dollars in thousands) Amortized Fair Average Amortized Fair Average
Maturity Cost Value Yield Cost Value Yield
- ------------------------------------------------------------------------------------------------------------
Available-for-Sale
Within one year $ 148,498 $ 149,591 4.31 % $ 730,555 $ 741,579 4.92 %
One to five years 1,394,858 1,402,042 4.46 1,599,632 1,647,012 5.02
Five to ten years 704,216 698,180 4.60 251,045 262,762 6.34
Beyond ten years 435,019 456,527 7.01 410,374 426,445 7.36
- ------------------------------------------------------------------------------------------------------------
Total $2,682,591 $2,706,340 4.90 % $2,991,606 $3,077,798 5.43 %
============================================================================================================
Held-to-Maturity
One to five years $210,905 $209,316 4.29 % $ - $ - - %
============================================================================================================
Weighted average yield is based on amortized cost (taxable equivalent basis).
The following table summarizes the available-for-sale and held-to-maturity
investment securities with unrealized losses at December 31, 2003, by aggregated
major security type and length of time in a continuous unrealized loss
position:
- -------------------------------------------------------------------------------------------------------------------------
Less than 12 months 12 months or longer Total
------------------------ ----------------------- -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(dollars in thousands) Value Losses Value Losses Value Losses
- -------------------------------------------------------------------------------------------------------------------------
Available-for-Sale
U.S. Treasury $ 7,939 $ (30) $ -- $ -- $ 7,939 $ (30)
U.S. Government agencies and corporations 399,248 (11,984) -- -- 399,248 (11,984)
Mortgage-backed securities 837,218 (20,041) -- -- 837,218 (20,041)
States and political subdivisions 17,243 (167) 444 (11) 17,687 (178)
Other securities 688 (30) -- -- 688 (30)
- -------------------------------------------------------------------------------------------------------------------------
Total available-for-sale $1,262,336 $ (32,252) $ 444 $ (11) $1,262,780 $ (32,263)
=========================================================================================================================
Held-to-Maturity
Mortgage-backed securities $ 162,808 $ (1,759) $ -- $ -- $ 162,808 $ (1,759)
=========================================================================================================================
The investment shown in the 12 months or longer column is an AAA rated, 100%
insured municipal bond, and thus has been determined to have no permanent
impairment.
NOTE 4 - LOANS HELD FOR SALE
At December 31, 2003 and 2002, Old National had residential loans held for sale
of $16.3 million and $92.6 million, respectively. During 2003, residential real
estate loans of $14.5 million and commercial loans of $48.2 million were
transferred to loans held for sale. As a result of these transfers, write-downs
of $3.4 million and $11.3 million, respectively, were recorded against the
allowance for loan losses. These loans, which were classified as nonaccrual,
were sold for $11.1 million and $36.9 million, respectively, net of expenses
incurred with the sale.
NOTE 5 - LOANS
The composition of loans at December 31 by lending classification was as
follows:
----------------------------------------------------------------
(dollars in thousands) 2003 2002
----------------------------------------------------------------
Commercial $1,618,095 $1,696,347
Commercial real estate 1,849,275 1,883,303
Residential real estate 939,422 1,043,816
Consumer credit, net of unearned 1,163,325 1,053,571
----------------------------------------------------------------
Total loans $5,570,117 $5,677,037
================================================================
44
Through its affiliates, Old National makes loans to customers in various
industries including manufacturing, agribusiness, transportation, mining,
wholesaling and retailing. Old National predominately operates in the geographic
market areas of Indiana, Illinois, Kentucky and Tennessee. Old National has no
concentration of loans in any single industry exceeding 10% of its portfolio.
Executive officers and directors of Old National and significant subsidiaries
and their related interests are loan customers of Old National's affiliate bank
in the normal course of business. These loans are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the same
time for comparable transactions with unrelated parties and involve no unusual
risk of collectibility. An analysis of the current year activity of these loans
is as follows:
--------------------------------------------------
(dollars in thousands) 2003
--------------------------------------------------
Balance, January 1 $ 67,209
New loans 102,070
Repayments (143,053)
Officer and director changes (5,127)
--------------------------------------------------
Balance, December 31 $ 21,099
==================================================
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
- -----------------------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------------------
Balance, January 1 $ 87,742 $74,241 $73,833
Additions:
Provision charged to expense 85,000 33,500 28,700
Deductions:
Write-downs on loans transferred to held for sale 14,744 - -
Loans charged-off 61,654 27,576 36,152
Recoveries (8,227) (7,577) (7,860)
- -----------------------------------------------------------------------------------------
Net charge-offs and other charges 68,171 19,999 28,292
- -----------------------------------------------------------------------------------------
Balance, December 31 $104,571 $87,742 $74,241
=========================================================================================
The following is a summary of loans deemed by management to be impaired in
accordance with accounting requirements as of December 31:
- ----------------------------------------------------------------------------
(dollars in thousands) 2003 2002
- ----------------------------------------------------------------------------
Impaired loans without a valuation allowance $31,027 $47,772
Impaired loans with a valuation allowance 60,562 255,407
- ----------------------------------------------------------------------------
Total impaired loans $91,589 $303,179
============================================================================
Valuation allowance related to impaired loans $20,588 $66,932
- ----------------------------------------------------------------------------
For the year ended December 31, 2003, the average balance of impaired loans was
$182.6 million for which no interest was recorded. For the year ended December
31, 2002, the average balance of impaired loans was $261.8 million for which
$14.0 million of interest was recorded. During 2003, Old National revised its
interpretation of impaired loans to strictly follow SFAS No. 114. Previous to
this change, Old National's interpretation of impaired loans more conservatively
included all problem credits with a potential collateral deficiency in the event
of default and nonaccrual loans in larger groups of smaller-balance homogeneous
loans. Had Old National made this interpretation in the prior year, impaired
loans would have totaled $80.4 million with a valuation allowance of $22.5
million rather than $303.2 million with a valuation allowance of $66.9 million
as reported at December 31, 2002. No additional funds are committed to be
advanced in connection with impaired loans. Loans deemed impaired are evaluated
using the fair value of the underlying collateral.
45
NOTE 7 - GOODWILL AND OTHER INTANGIBLE ASSETS
At December 31, 2003 and 2002, Old National had goodwill in the amount of $129.3
million and $110.6 million, respectively. Old National performed its annual
impairment testing resulting in no impairment for 2003 and 2002. The change in
the carrying amount of goodwill by segment for the year ended December 31, 2003,
was as follows:
- ----------------------------------------------------------------------------------------------
Community Non-bank
(dollars in thousands) Banking Services Total
- ----------------------------------------------------------------------------------------------
Balance, January 1 $70,944 $39,704 $110,648
Goodwill acquired during the year - 18,905 18,905
Adjustments to goodwill acquired in prior year - (74) (74)
Goodwill related to divestitures - (228) (228)
- ----------------------------------------------------------------------------------------------
Balance, December 31 $70,944 $58,307 $129,251
==============================================================================================
Old National continues to amortize definite-lived intangible assets over the
estimated remaining life of each respective asset. At December 31, 2003, Old
National had $41.9 million in unamortized intangible assets compared with $27.0
million in unamortized identifiable intangible assets at December 31, 2002.
Indefinite-lived assets of $2.8 million were included in each year.
The following table shows the gross carrying amounts and accumulated
amortization for intangible assets as of December 31:
- ----------------------------------------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
(dollars in thousands) Amount Amortization Amount
- ----------------------------------------------------------------------------------------------
2003
Amortized intangible assets:
Core deposit $ 5,574 $(3,044) $ 2,530
Customer business relationships 36,676 (1,984) 34,692
Non-compete agreements 1,100 (82) 1,018
Technology 1,300 (428) 872
- ----------------------------------------------------------------------------------------------
Total amortizing intangible assets 44,650 (5,538) 39,112
Unamortized intangible assets:
Trade name 2,800 - 2,800
- ----------------------------------------------------------------------------------------------
Total intangible assets $47,450 $(5,538) $41,912
==============================================================================================
2002
Amortized intangible assets:
Core deposit $5,574 $(2,385) $3,189
Customer business relationships 19,193 (371) 18,822
Non-compete agreements 1,100 (27) 1,073
Technology 1,300 (142) 1,158
- ----------------------------------------------------------------------------------------------
Total amortizing intangible assets 27,167 (2,925) 24,242
Unamortized intangible assets:
Trade name 2,800 - 2,800
- ----------------------------------------------------------------------------------------------
Total intangible assets $29,967 $(2,925) $27,042
==============================================================================================
46
Total amortization expense associated with intangible assets was $2.6 million in
2003, $1.2 million in 2002, $0.9 million in 2001. The following is the estimated
amortization expense for the future years:
-----------------------------------------------------
Estimated
Amortization
(dollars in thousands) Expense
-----------------------------------------------------
2004 $3,175
2005 3,065
2006 2,849
2007 2,386
2008 2,213
Thereafter 25,424
-----------------------------------------------------
Total $39,112
=====================================================
NOTE 8 - MORTGAGE SERVICING RIGHTS
Mortgage servicing rights derived from loans sold with servicing retained were
$14.7 million and $11.4 million at December 31, 2003 and 2002, respectively.
Loans serviced for others are not included in the accompanying consolidated
balance sheet. The unpaid principal balance of mortgage loans serviced for
others at December 31 was $1.738 billion in 2003, $1.523 billion in 2002 and
$1.148 billion in 2001.
The following summarizes the activities related to mortgage servicing rights and
the related valuation allowance:
- --------------------------------------------------------------------------
(dollars in thousands) 2003 2002
- --------------------------------------------------------------------------
Balance before valuation allowance, January 1 $13,423 $ 8,820
Rights capitalized 8,655 8,245
Amortization (6,288) (3,033)
Impairment - (609)
- --------------------------------------------------------------------------
Balance before valuation allowance, December 31 15,790 13,423
- --------------------------------------------------------------------------
Valuation allowance:
Balance, January 1 (2,056) -
Additions to valuation allowance (6,433) (2,056)
Reductions to valuation allowance 7,358 -
- --------------------------------------------------------------------------
Balance, December 31 (1,131) (2,056)
- --------------------------------------------------------------------------
Mortgage servicing rights, net $14,659 $11,367
==========================================================================
The following summarizes the fair market value of mortgage servicing rights as
of December 31 and the key economic assumptions used in determining this value
as well as a sensitivity analysis:
- ----------------------------------------------------------------------------
(dollars in thousands) 2003 2002
- ----------------------------------------------------------------------------
Fair market value $15,039 $11,367
Expected weighted-average life (in years) 5.2 3.1
Weighted-average prepayment speed assumptions 335 473
Discount rate 8.50 % 8.50 %
Prepayment speed assumptions:
Decrease in fair value from 10% adverse change $ (743)
Decrease in fair value from 20% adverse change (1,423)
Discount rate:
Decrease in fair value from 10% adverse change (376)
Decrease in fair value from 20% adverse change (735)
- ----------------------------------------------------------------------------
47
The key economic assumptions used in determining the fair value of mortgage
servicing rights capitalized during the year was as follows:
---------------------------------------------------------------
Weighted-average prepayment speed assumptions 397
Weighted-average life (in years) 4.4
Weighted-average discount rate 9.43 %
---------------------------------------------------------------
NOTE 9 - SHORT-TERM BORROWINGS
The following table presents the distribution of Old National's short-term
borrowings and related weighted-average interest rates for each of the years
ended December 31:
- --------------------------------------------------------------------------------------------------
Other
Federal Funds Repurchase Short-term
(dollars in thousands) Purchased Agreements Borrowings Total
- --------------------------------------------------------------------------------------------------
2003
Outstanding at year-end $123,582 $276,471 $14,535 $ 414,588
Average amount outstanding 340,124 327,101 20,363 687,588
Maximum amount outstanding at
any month-end 592,880 429,425 73,397
Weighted-average interest rate:
During year 1.18 % 0.91 % 1.42 % 1.06 %
End of year 0.92 0.94 0.77 0.93
- --------------------------------------------------------------------------------------------------
2002
Outstanding at year-end $500,180 $334,418 $83,751 $918,349
Average amount outstanding 299,846 323,386 65,726 688,958
Maximum amount outstanding at
any month-end 500,180 352,687 281,889
Weighted-average interest rate:
During year 1.67 % 1.49 % 1.76 % 1.59 %
End of year 1.21 1.09 1.42 1.18
- --------------------------------------------------------------------------------------------------
2001
Outstanding at year-end $119,700 $351,086 $131,526 $602,312
Average amount outstanding 226,561 286,267 70,207 583,035
Maximum amount outstanding at
any month-end 468,799 351,086 184,453
Weighted-average interest rate:
During year 4.21 % 3.25 % 4.30 % 3.75 %
End of year 1.64 1.44 1.40 1.47
- --------------------------------------------------------------------------------------------------
LINES OF CREDIT
During 2003, Old National cancelled an unused, unsecured line of credit with an
unaffiliated bank. At December 31, 2002, Old National had $25 million available
borrowing capacity under this line of credit, however there were no borrowings
under the line of credit during 2002. During 2001, the average interest rate on
the lines of credit was 5.61%.
48
NOTE 10 - FINANCING ACTIVITIES
The following table summarizes Old National's other borrowings at December 31:
- ---------------------------------------------------------------------------
(dollars in thousands) 2003 2002
- ---------------------------------------------------------------------------
Old National Bancorp:
Medium-term notes, Series A $ -- $ 5,000
Medium-term notes, Series 1997 (fixed rates
3.50% to 7.03%) maturities July 2004 to
June 2008 113,200 53,200
Junior subordinated debentures (fixed rates
8.00% to 9.50%) maturities March 2030
to April 2032 150,000 --
SFAS 133 hedge and other basis adjustments 7,336 144
Old National Bank:
Securities sold under agreements to repurchase
(variable rates 0.64% to 2.36%) maturities
March 2006 to December 2008 248,000 83,000
Federal Home Loan Bank advances (fixed rates
3.59% to 8.34% and variable rates 1.96% to
2.17%) maturities January 2004 to October
2022 765,347 868,556
Senior unsecured bank notes (fixed rate 3.95%
and variable rates 1.17% to 1.48%) maturities
June 2004 to February 2008 190,000 60,000
Subordinated bank notes (fixed rate 6.75%)
maturing October 2011 150,000 150,000
SFAS 133 hedge and other basis adjustments 209 14,114
- ---------------------------------------------------------------------------
Total other borrowings $1,624,092 $1,234,014
===========================================================================
FEDERAL HOME LOAN BANK
Federal Home Loan Bank advances had weighted-average rates of 5.48% and 5.44% at
December 31, 2003, and 2002, respectively. These borrowings are secured by
investment securities and residential real estate loans up to 150% of
outstanding debt.
SUBORDINATED BANK NOTES
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.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S SUBORDINATED DEBENTURES
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 guarantees
the payment of distributions on the preferred securities issued by ONB Capital
Trust II.
ONB Capital Trust I issued $50 million in preferred securities in March 2000.
The preferred securities have a liquidation amount of $25 per share with a
cumulative annual distribution rate of 9.5% or $2.375 per share payable
quarterly and maturing on March 15, 2030. 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. Old National
guarantees the payment of distributions on the preferred securities issued by
ONB Capital Trust I.
49
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 March 15, 2005 (for debentures owned by ONB Capital Trust I)
and on or after April 12, 2007 (for debentures owned by ONB Capital Trust II),
and in whole (but not in part) following the occurrence and continuance of
certain adverse federal income tax or capital treatment events. These securities
qualify as Tier 1 capital for regulatory purposes and the SEC registration
related to these securities has remaining funding capacity of $50 million.
Costs associated with the issuance of the trust preferred securities totaling
$3.3 million in 2002 and $1.8 million in 2000, 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 accordance with FIN 46, the remaining junior subordinated debentures related
to these trust preferred securities were reclassed to "other borrowings" at
December 31, 2003, from the separate disclosure on the balance sheet at December
31, 2002.
Contractual maturities of long-term debt at December 31, 2003, were as follows:
-------------------------------------------------------------
(dollars in thousands)
-------------------------------------------------------------
Due in 2004 $ 256,700
Due in 2005 195,053
Due in 2006 252,408
Due in 2007 110,000
Due in 2008 344,470
Thereafter 457,916
SFAS 133 hedge and other basis adjustments 7,545
-------------------------------------------------------------
Total $1,624,092
=============================================================
NOTE 11 - TAXES
Following is a summary of the major items comprising the differences in taxes
computed at the federal statutory tax rate and as recorded in the consolidated
statement of income for the years ended December 31:
- ---------------------------------------------------------------------------
2003 2002 2001
- ---------------------------------------------------------------------------
Provision at statutory tax rate 35.0 % 35.0 % 35.0 %
Tax-exempt income (24.0) (12.5) (12.8)
State income taxes (0.7) 0.9 0.2
Other, net 1.1 (0.7) 0.5
- ---------------------------------------------------------------------------
Effective tax rate 11.4 % 22.7 % 22.9 %
===========================================================================
The effective tax rate was significantly lower in 2003 as compared to 2002 and
2001. The main factor for the significant decrease in the effective tax rate was
that tax-exempt income comprised a larger percentage of total income compared to
prior years.
The provision for income taxes consisted of the following components for the
years ended December 31:
- ------------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------
Income taxes currently payable
Federal $16,715 $31,829 $32,375
State (914) 2,114 (9)
Deferred income taxes related to:
Provision for loan losses (6,505) (5,642) (758)
Other, net (269) 6,348 (3,898)
- ------------------------------------------------------------------------------
Deferred income tax expense (benefit) (6,774) 706 (4,656)
- ------------------------------------------------------------------------------
Provision for income taxes $9,027 $34,649 $27,710
==============================================================================
50
Significant components of net deferred tax assets (liabilities) were as follows
at December 31:
- -------------------------------------------------------------------------
(dollars in thousands) 2003 2002
- -------------------------------------------------------------------------
Deferred Tax Assets
Allowance for loan losses,
net of recapture $ 40,372 $ 33,867
Benefit plan accruals 3,706 8,922
AMT credit 8,389 8,480
Net operating loss 8,523 -
Other, net 1,416 -
- -------------------------------------------------------------------------
Total deferred tax assets 62,406 51,269
- -------------------------------------------------------------------------
Deferred Tax Liabilities
Premises and equipment (3,580) (1,257)
Accretion on investment securities (47) (417)
Unrealized gains on available-
for-sale investment securities (8,933) (33,553)
Lease receivable, net (12,713) (12,041)
Mortgage servicing rights (5,717) (4,433)
Purchase accounting (7,047) (3,440)
Other, net - (1,499)
- -------------------------------------------------------------------------
Total deferred tax liabilities (38,037) (56,640)
- -------------------------------------------------------------------------
Net deferred tax assets (liabilities) $ 24,369 $ (5,371)
=========================================================================
No valuation allowance was recorded at December 31, 2003 and 2002.
NOTE 12 - EMPLOYEE BENEFIT PLANS
RETIREMENT PLAN
Old National has a noncontributory defined benefit retirement plan. During 2001,
Old National amended this plan 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.
This curtailment resulted in $7.6 million reduction in the benefit obligation as
of year-end 2001 and a $0.2 million reduction in pension expense in 2001. In
addition, the amendment discontinued new enrollments under the plan after
December 31, 2001.
Retirement benefits are based on years of service and compensation during the
highest paid five years of employment. Old National's policy is to contribute at
least the minimum funding requirement determined by the plan's actuary. Old
National uses a December 31 measurement date for its pension plans.
51
The following table sets forth the plan's benefit obligation and funded status
at December 31:
- -------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
- -------------------------------------------------------------------------
Change in Benefit Obligation
Balance at January 1 $ 54,267 $ 51,912 $ 43,833
Service cost 1,866 1,816 3,600
Interest cost 3,846 3,720 3,344
Benefits paid (4,605) (6,422) (6,426)
Actuarial loss 8,145 3,241 15,178
Curtailment adjustment - - (7,617)
- -------------------------------------------------------------------------
Balance at December 31 63,519 54,267 51,912
- -------------------------------------------------------------------------
Change in Plan Assets
Fair value at January 1 27,409 32,253 39,947
Actual return on plan assets 3,405 (2,549) (1,170)
Employer contributions 18,726 4,127 217
Benefits paid (4,605) (6,422) (6,426)
Administrative expenses - - (315)
- -------------------------------------------------------------------------
Fair value at December 31 44,935 27,409 32,253
- -------------------------------------------------------------------------
Funded status (18,584) (26,858) (19,659)
Unrecognized:
Net actuarial loss 23,298 17,436 9,398
Transition asset (431) (862) (1,293)
Prior service cost 233 267 300
- -------------------------------------------------------------------------
Net amount recognized $4,516 $(10,017) $(11,254)
=========================================================================
The accumulated benefit obligation for the defined benefit pension plan was
$45.6 million, $39.1 million and $37.6 million at December 31, 2003, 2002 and
2001, respectively.
The net periodic benefit cost and its components were as follows for the years
ended December 31:
- -------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
- -------------------------------------------------------------------------
Service cost $ 1,866 $ 1,816 $ 3,600
Interest cost 3,846 3,720 3,344
Expected return on plan assets (2,411) (2,622) (3,162)
Amortization of prior service cost 33 33 (42)
Amortization of transitional asset (431) (431) (431)
Recognized actuarial loss 1,291 373 140
Curtailment gain - - (227)
- -------------------------------------------------------------------------
Net periodic benefit cost $ 4,194 $ 2,889 $ 3,222
=========================================================================
The weighted-average assumptions used to determine benefit obligations at
December 31 were as follows:
- ------------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------
Discount rate 6.25 % 6.75 % 7.25 %
Rate of compensation increase 5.00 5.00 5.00
- ------------------------------------------------------------------------------
The weighted-average assumptions used to determine net periodic benefit costs
for the years ended December 31 were as follows:
- ------------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------
Discount rate 6.75 % 7.25 % 7.75 %
Expected return on plan assets 8.00 8.00 8.00
Rate of compensation increase 5.00 5.00 5.00
- ------------------------------------------------------------------------------
52
Old National's pension plan weighted-average asset allocations at December 31 by
asset category were as follows:
- ------------------------------------------------------------------------------
2004 Target
Asset Category Allocation 2003 2002 2001
- ------------------------------------------------------------------------------
Equity securities 40 - 70% 50 % 53 % 60 %
Debt securities 30 - 60% 27 39 37
Cash equivalents 0 - 15% 23 8 3
- ------------------------------------------------------------------------------
Total 100 % 100 % 100 %
==============================================================================
The expected long-term rate of return on assets, based on 10-year compounded
trailing returns on equity and fixed income indices weighted by the typical
asset allocation for the plan, exceeds the assumed long-term rate of return of
8%. This assumption is monitored on an on-going basis.
The plan's assets are invested in the plan trust within the ranges specified
above. Fixed income and cash equivalents must meet minimum rating standards.
Exposure to any particular company or industry are also limited. The investment
policy is reviewed annually. Equity securities included common stock of Old
National in the amount of $3.3 million (7% of total plan assets), $3.4 million
(12% of total plan assets) and $3.3 million (10% of total plan assets), at
December 31, 2003, 2002 and 2001 respectively.
At December 31, 2003, asset category allocations were outside the target range
due to a December employer contribution included in cash equivalents. On January
31, 2004, subsequent to investing this contribution, allocations were 60% equity
securities, 31% debt securities and 9% cash equivalents.
Old National expects to contribute $0.2 million to the pension plan in 2004. In
addition, the following benefit payments, which reflect expected future service,
are expected to be paid:
-----------------------------------------------------
(dollars in thousands)
-----------------------------------------------------
2004 $ 1,362
2005 1,603
2006 1,881
2007 2,257
2008 2,656
Years 2009 - 2013 20,571
-----------------------------------------------------
EMPLOYEE STOCK OWNERSHIP PLAN
Old National has an employee stock ownership plan (previously known as the
Employee's Savings and Profit Sharing Plan) covering all employees who have
completed an eligibility period of at least 12 months of employment and 1,000
hours of service, as defined under the plan. Contributions, in cash or Old
National Bancorp stock, made to the plan are a percentage match, based on years
of service, of each eligible participant's contributions to the Old National
Bancorp Employees' Savings Plan (401K). In addition, Old National may contribute
an amount designated at the sole discretion of the Board of Directors.
Contribution expense under the plan was $7.4 million in 2003, $7.7 million in
2002 and $7.6 million in 2001.
RESTRICTED STOCK PLAN
Old National has a restricted stock plan, which covers certain officers. Shares
were earned each year based on the achievement of net income targets and are
currently fully vested.
STOCK OPTIONS
On January 31, 2003, Old National granted 2.6 million stock options to key
employees at an option price of $21.71, the closing price of Old National's
stock on that date. On January 22, 2002, Old National granted 2.0 million of
stock options to key employees at an exercise price of $21.62, the closing price
of Old National's stock on that date. On June 27, 2001, Old National granted 1.6
million of stock options to key employees at an exercise price of $22.79, the
closing price of Old National's stock on that date. The options vest 25% per
year over a four-year period and expire in ten years. If certain financial
targets are achieved, vesting is accelerated. Old National was authorized to
grant up to 7.3 million shares of common stock under the 1999 Equity Incentive
Plan. Under this plan, active
53
employees with unvested restricted stock shares could exchange those shares for
stock options by August 27, 2001. On that date, 76,858 unvested restricted stock
shares were converted to 0.5 million of stock options.
Old National applies APB Opinion No. 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation costs have
been recognized. See Note 1 for proforma net income and net income per share
data.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model using the following weighted-average
assumptions: dividend yield of 3.1% in 2003, 3.0% in 2002 and 2.7% in 2001;
expected volatility of 18.0% in 2003, 18.0% in 2002, 18.2% in 2001; and a
risk-free rate of 4.5% in 2003, 5.4% in 2002 and 5.3% in 2001. All per share
data and exercise price data have been adjusted for a 5% stock dividend that was
declared to shareholders of record on January 6, 2004, and distributed on
January 27, 2004.
- --------------------------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------- ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(shares in thousands) Shares Price Shares Price Shares Price
- --------------------------------------------------------------------------------------------------------------------
Outstanding, January 1 4,054 $21.87 2,246 $21.79 233 $11.47
Granted 2,608 21.71 1,980 21.62 1,965 22.79
Exercised (21) 9.67 (57) 9.37 (49) 13.49
Forfeited (175) 22.06 (115) 22.21 (10) 22.79
- --------------------------------------------------------------------------------------------------------------------
Outstanding, December 31 6,466 $21.84 4,054 $21.87 2,139 $21.79
====================================================================================================================
Options exercisable at end of year 2,202 $21.96 975 $21.25 613 $19.29
Weighted-average fair value of options
granted during the year 4.39 5.13 5.87
- --------------------------------------------------------------------------------------------------------------------
Information pertaining to options outstanding was as follows at December 31,
2003:
- ---------------------------------------------------------------------------------------------------
(shares in Options Outstanding Options Exercisable
thousands ------------------------------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Price Outstanding Contractual Life Price Exercisable Price
- ------------------------------------------------------------------- ----------------------------
$ 5.33 - 7.76 9 0.4 Years $7.44 9 $7.44
9.67 - 11.67 62 3.4 10.83 62 10.83
12.50 - 15.08 31 4.5 14.06 31 14.06
16.61 - 18.02 14 4.1 17.27 14 17.27
21.62 - 22.79 6,350 8.3 22.01 2,086 22.51
- ---------------------------------------------------------------------------------------------------
Total 6,466 8.2 $21.84 2,202 $21.96
===================================================================================================
NOTE 13 - OUTSIDE DIRECTOR STOCK COMPENSATION PROGRAM
During 2003, Old National implemented a director stock compensation program
covering all outside directors. Compensation shares are earned semi-annually. A
maximum of 157,500 shares of common stock is available for issuance under this
program. As of December 31, 2003, Old National had issued 6,221 shares under
this program.
NOTE 14 - SHAREHOLDERS' EQUITY
STOCK DIVIDEND
A 5% stock dividend was declared on December 4, 2003, and distributed on January
27, 2004, to the shareholders of record on January 6, 2004. All share and per
share amounts have been retroactively adjusted to reflect this stock dividend.
54
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
Old National has a dividend reinvestment and stock purchase plan under which
common shares issued may be either repurchased shares or authorized and
previously unissued shares. As of December 31, 2003, 500,000 authorized and
unissued common shares were reserved for issuance under the plan.
SHAREHOLDER RIGHTS PLAN
Old National has adopted a Shareholder Rights Plan whereby one right was
distributed for each outstanding share of Old National's common stock. The
rights become exercisable on the tenth day following a public announcement that
a person has acquired or intends to acquire beneficial ownership of 20% or more
of Old National's outstanding common stock. Upon exercising the rights, the
holder is entitled to buy 1/100 of a share of Junior Preferred Stock at $60,
subject to adjustment, for every right held. Upon the occurrence of certain
events, the rights may be redeemed by Old National at a price of $0.01 per
right.
In the event an acquiring party becomes the beneficial owner of 20% or more of
Old National's outstanding shares, rights holders (other than the acquiring
person) may purchase two shares of Old National common stock for the price of
one share at the then market price. If Old National is acquired and is not the
surviving corporation, or if Old National survives a merger but has all or part
of its common stock exchanged, each rights holder will be entitled to acquire
shares of the acquiring company with a value of two times the then exercise
price of the rights for each right held.
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of certain financial instruments, both assets and liabilities
recognized and not recognized in the consolidated balance sheet, are required to
be disclosed when it is practicable to estimate fair value. The following
methods and assumptions were used to estimate the fair value of each type of
financial instrument.
CASH, DUE FROM BANKS AND MONEY MARKET INVESTMENTS For these instruments, the
carrying amounts approximate fair values.
INVESTMENT SECURITIES
For investment securities, fair values are based on quoted market prices, if
available. For securities where quoted prices are not available, fair values are
estimated based on market prices of similar securities.
RESIDENTIAL LOANS HELD FOR SALE
Residential loans held for sale have been hedged using fair value hedge
accounting in accordance with SFAS No. 133. The loans' carrying basis reflects
the effects of the SFAS No. 133 adjustments, thus their carrying amount is a
reasonable estimate of their fair value.
LOANS
The fair value of loans is estimated by discounting future cash flows using
current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
MORTGAGE SERVICING RIGHTS
Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions.
DERIVATIVE FINANCIAL INSTRUMENTS
The fair values of derivative financial instruments are determined based on
dealer quotes and are recorded in "Other assets" or "Accrued expenses and other
liabilities".
DEPOSITS
The fair value of noninterest-bearing demand deposits and savings, NOW and money
market deposits is the amount payable as of the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated using rates currently
offered for deposits with similar remaining maturities.
55
SHORT-TERM BORROWINGS
Federal funds purchased and securities sold under agreements to repurchase
generally have an original term to maturity of 30 days or less and, therefore,
their carrying amount is a reasonable estimate of fair value.
OTHER BORROWINGS
The fair values of other borrowings are estimated using rates currently
available to Old National for obligations with similar terms and remaining
maturities.
STANDBY LETTERS OF CREDIT
Fair values for standby letters of credit are based on fees currently charged to
enter into similar agreements. In 2003, the fair value for standby letters of
credit was recorded in "Accrued expenses and other liabilities" on the
consolidated balance sheet in accordance with FIN 45.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Fair values for off-balance sheet credit-related financial instruments are based
on fees currently charged to enter into similar agreements, and for fixed-rate
commitments, also considered the difference between current levels of interest
rates and committed rates. For further information regarding the notional
amounts of these financial instruments, see Note 17.
The estimated carrying and fair values of Old National's financial instruments
as of December 31 are as follows:
- ------------------------------------------------------------------------------
Carrying Fair
(dollars in thousands) Value Value
- ------------------------------------------------------------------------------
2003
Financial Assets
Cash, due from banks and money market investments $ 236,889 $ 236,889
Investment securities available-for-sale 2,706,340 2,706,340
Investment securities held-to-maturity 210,905 209,316
Residential loans held for sale 16,338 16,338
Loans, net 5,465,546 5,460,630
Mortgage servicing rights 14,659 15,039
Derivative assets 15,317 15,317
Financial Liabilities
Deposits $6,493,092 $6,542,898
Short-term borrowings 414,588 414,588
Other borrowings 1,624,092 1,692,186
Derivative liabilities 13,024 13,024
Standby letters of credit 326 326
Off-Balance Sheet Financial Instruments
Commitments to extend credit $ - $2,590
Commercial letters of credit - 69
- ------------------------------------------------------------------------------
56
- ------------------------------------------------------------------------------
Carrying Fair
(dollars in thousands) Value Value
- ------------------------------------------------------------------------------
2002
Financial Assets
Cash, due from banks and money market investments $ 236,226 $ 236,226
Investment securities available-for-sale 3,077,798 3,077,798
Residential loans held for sale 92,598 92,598
Loans, net 5,589,295 5,614,204
Mortgage servicing rights 11,367 11,367
Derivative assets 34,920 34,920
Financial Liabilities
Deposits $6,439,280 $6,522,471
Short-term borrowings 918,349 918,349
Other borrowings 1,397,857 1,429,949
Derivative liabilities 574 574
Off-Balance Sheet Financial Instruments
Commitments to extend credit $ - $2,544
Commercial letters of credit - 234
Standby letters of credit - 282
- ------------------------------------------------------------------------------
NOTE 16 - DERIVATIVE FINANCIAL INSTRUMENTS
The following table summarizes the derivative financial instruments utilized by
Old National at December 31:
- ------------------------------------------------------------------------------------------------------------------
2003 2002
-------------------------------------- -------------------------------------
Estimated Fair Value Estimated Fair Value
Notional ----------------------- Notional ----------------------
(dollars in thousands) Amount Gain Loss Amount Gain Loss
- ------------------------------------------------------------------------------------------------------------------
Fair Value Hedges
Received fixed interest rate swaps $ 714,696 $12,878 $(11,784) $ 824,000 $32,804 $ (1)
Interest rate lock commitments 26,152 239 - 89,694 989 -
Forward mortgage loan contracts 36,832 - (266) 133,076 - (573)
Options on contracts purchased 3,000 - (3) - - -
Loans held for sale warehouse 16,338 73 - - - -
Mortgage rate lock derivative 26,152 41 - 89,694 135 -
Cash Flow Hedges
HELOC cash flow 100,000 1,127 - 50,000 992 -
Pay fixed interest rate swaps 30,000 - (12) - - -
Customer interest rate swaps 43,756 618 (293) - - -
Customer interest rate swaps
with counterparty 43,756 293 (618) - - -
Customer interest rate cap 13,000 - (48) - - -
Customer interest rate cap
with counterparty 13,000 48 - - - -
- ------------------------------------------------------------------------------------------------------------------
Total $1,066,682 $15,317 $(13,024) $1,186,464 $34,920 $(574)
==================================================================================================================
Old National has interest rate contracts that are an exchange of interest
payments with no effect on the principal amounts of the underlying hedged
liabilities. For the fair value hedges, Old National pays the counterparty a
variable rate based on LIBOR and receives fixed rates ranging from 2.00% to
9.50%. The contracts terminate on or prior to April 15, 2032. Old National has
cash flow hedges that pay the counterparty a variable rate based on prime and
receives a fixed rate ranging from 2.12% to 6.15%.
During 2001, Old National entered into an interest rate swap with a notional
value of $75 million for a forecasted issuance of debt. The transaction was
designated as a cash flow hedge with the effective portion of the derivative's
loss initially reported as a component of accumulated other comprehensive income
(loss). Upon termination of the
57
derivative, the loss on the interest rate swap of approximately $1.5 million is
being reclassified into earnings as a yield adjustment over the 10-year term of
the $150 million 6.75% fixed-rate subordinated bank notes issued on October 5,
2001.
In accordance with SFAS No. 149 adopted in 2003, loan commitments that relate to
the origination of residential real estate loan commitments with customers that
will be held for sale are accounted for as derivative instruments at fair value.
Accordingly, Old National marks these derivatives to market through earnings.
Old National uses derivatives, primarily mortgage-backed whole loan cash forward
sale agreements, to hedge exposure to changes in interest rates in its
residential real estate loan origination and sale activity. In addition,
beginning in February 2003, Old National began fair value hedge accounting for
the closed loans held for sale warehouse. As of December 31, 2003, no
ineffectiveness was recognized, therefore no income statement impact was
recorded as a result of these mortgage banking derivatives.
In 2003, Old National began entering into various derivative contracts with its
customers, which include interest rate swaps and caps. Old National hedges the
exposure of these derivatives by entering into an offsetting third-party
contract with reputable counterparties with matching terms. These derivative
contracts are not linked to specific assets and liabilities in the balance sheet
or to a forecasted transaction in an accounting hedge relationship, therefore,
do not qualify for hedge accounting. Contracts are carried at fair value with
changes recorded as a component of other noninterest income.
Old National is exposed to losses if a counterparty fails to make its payments
under a contract in which Old National is in the net receiving position. Old
National anticipates that the counterparties will be able to fully satisfy their
obligations under the agreements. In addition, Old National obtains collateral
up to certain thresholds of the fair value of its hedges for each counterparty
based upon their credit standing.
NOTE 17 - COMMITMENTS AND CONTINGENCIES
LITIGATION
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 during 1995 of First
National Bank & Trust Company, Carbondale, Illinois, ("First National"), which
was purchased by Old National in 1999. These lawsuits include one class action
brought by alleged third-party creditors of structured settlement trusts. The
lawsuits are pending against Old National Bank, as successor to First National,
and allege actual damages totaling approximately $31 million, as well as
unspecified punitive damages, and other damages and attorneys' fees. The cases
are pending against Old National Bank in the City of St. Louis, Missouri; St.
Clair County, Madison County and Cook County, Illinois; and U.S. Federal
District Court in Southern Illinois.
During the fourth quarter of 2003, Old National advanced steps to settle certain
litigation arising out of these claims and has established a reserve of $10
million for the settlement and other related litigation still pending. $16
million of the estimated $31 million exposure has been ruled in favor of Old
National at the trial court level and is currently on appeal, with the remaining
$15 million of the exposure to be covered by the reserve. It is not expected
that any future losses will have a material impact on Old National's results of
operations.
BUILDING COMMITMENT
On October 11, 2002, Old National entered into a $52 million contract awarded to
a company controlled by a director for the construction of its Evansville-based
main banking center and bank headquarters. Construction began on June 27, 2002,
and is expected to be complete in 2004.
58
LEASES
Old National rents certain premises and equipment under operating leases, which
expire at various dates. Many of these leases require the payment of property
taxes, insurance premiums, maintenance and other costs. In some cases, rentals
are subject to increase in relation to a cost-of-living index. Total rental
expense was $6.8 million in 2003, $5.7 million in 2002 and $5.2 million in 2001.
The following is a summary of future minimum lease commitments as of December
31, 2003:
-----------------------------------
(dollars in thousands)
-----------------------------------
2004 $ 8,740
2005 7,254
2006 5,313
2007 3,365
2008 3,499
Thereafter 12,085
-----------------------------------
CREDIT-RELATED FINANCIAL INSTRUMENTS
In the normal course of business, Old National's banking affiliates have entered
into various agreements to extend credit, including loan commitments of $1.577
billion, commercial letters of credit of $19.3 million and standby letters of
credit of $85.4 million at December 31, 2003. At December 31, 2002, loan
commitments were $1.178 billion, commercial letters of credit were $62.4 million
and standby letters of credit were $70.0 million. These commitments are not
reflected in the consolidated financial statements. No material losses are
expected to result from these transactions.
At December 31, 2003, Old National had credit extensions of $70.2 million with
various unaffiliated banks related to letter of credit commitments issued on
behalf of Old National's customers. At December 31, 2003, the unsecured portion
was $31.6 million and the secured portion was $38.6 million.
NOTE 18 - FINANCIAL GUARANTEES
Old National holds instruments, in the normal course of business with customers,
that are considered financial guarantees in accordance with FIN 45. Standby
letters of credit guarantees are issued in connection with agreements made by
customers to counterparties. Standby letters of credit are contingent upon
failure of the customer 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 customers and is subject to normal credit
policies. The term of these standby letters of credit is typically one year or
less. At December 31, 2003, the notional amount of standby letters of credit was
$85.4 million, which represents the maximum amount of future funding
requirements, and the carrying value was $0.3 million.
Old National also enters into forward contracts for the future delivery of
conforming residential real estate loans at a specified interest rate to reduce
interest rate risk associated with loans held for sale. These forward contracts
are considered derivative instruments accounted for under SFAS No. 133. See
additional information in Note 16.
NOTE 19 - REGULATORY RESTRICTIONS
RESTRICTIONS ON CASH AND DUE FROM BANKS
Old National's affiliate bank is required to maintain reserve balances on hand
and with the Federal Reserve Bank which are noninterest bearing and unavailable
for investment purposes. The reserve balances at December 31 were $58.5 million
in 2003 and $52.2 million in 2002.
RESTRICTIONS ON TRANSFERS FROM AFFILIATE BANK
Regulations limit the amount of dividends an affiliate bank can declare in any
year without obtaining prior regulatory approval. At December 31, 2003, prior
regulatory approval was not required for Old National's affiliate bank.
59
CAPITAL ADEQUACY
Old National and its bank subsidiary are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can elicit certain mandatory actions by regulators
that, if undertaken, could have a direct material effect on Old National's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, Old National and its bank subsidiary
must meet specific capital guidelines that involve quantitative measures of
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The capital amounts and classifications are
also subject to qualitative judgements by the regulators about components, risk
weightings and other factors. Prompt corrective action provisions are not
applicable to bank holding companies. Quantitative measures established by
regulation to ensure capital adequacy require Old National and its bank
subsidiary to maintain minimum amounts and ratios as set forth in the following
table.
At December 31, 2003, Old National and its bank subsidiary exceeded the
regulatory minimums and met the regulatory definition of well-capitalized. To be
categorized as well-capitalized, the bank subsidiary must maintain minimum total
risk-based, Tier 1 risked-based and Tier 1 leverage ratios. The following table
summarizes capital ratios for Old National and its significant bank subsidiary
as of December 31:
- ------------------------------------------------------------------------------------------------------
For Capital For Well
Actual Adequacy Purposes Capitalized Purposes
----------------------- ---------------------- -----------------------
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------
December 31, 2003
Total capital to
risk-weighted assets
Old National Bancorp $905,941 14.65 % $494,882 8.00 % $ N/A N/A %
Old National Bank 861,986 14.23 484,706 8.00 605,883 10.00
Tier 1 capital to
risk-weighted assets
Old National Bancorp 678,279 10.96 247,441 4.00 N/A N/A
Old National Bank 635,898 10.50 242,353 4.00 363,530 6.00
Tier 1 capital to
average assets
Old National Bancorp 678,279 7.35 369,195 4.00 N/A N/A
Old National Bank 635,898 6.97 273,526 3.00 455,876 5.00
- ------------------------------------------------------------------------------------------------------
December 31, 2002
Total capital to
risk-weighted assets
Old National Bancorp $928,848 14.75 % $503,650 8.00 % $ N/A N/A %
Old National Bank 845,743 13.68 494,721 8.00 618,401 10.00
Tier 1 capital to
risk-weighted assets
Old National Bancorp 700,061 11.12 251,825 4.00 N/A N/A
Old National Bank 618,365 10.00 247,360 4.00 371,040 6.00
Tier 1 capital to
average assets
Old National Bancorp 700,061 7.53 371,888 4.00 N/A N/A
Old National Bank 618,365 6.71 276,515 3.00 460,859 5.00
- ------------------------------------------------------------------------------------------------------
The capital treatment of trust securities is currently under review by the
Federal Reserve Board ("FRB") due to the issuing trust companies being
deconsolidated under FIN 46. See Note 1 for additional information on this
deconsolidation. Depending on the capital treatment resolution, trust securities
may no longer qualify for Tier 1 Capital treatment, but instead would qualify
for Tier 2 Capital. On July 2, 2003, the FRB issued a Supervision and Regulation
Letter requiring that bank holding companies continue to follow the current
instructions for reporting trust securities in its regulatory reports.
Accordingly, Old National will continue to report trust securities in Tier 1
Capital until further notice from the FRB.
60
NOTE 20 - PARENT COMPANY FINANCIAL STATEMENTS
The following are the condensed parent company only financial statements of Old
National Bancorp:
OLD NATIONAL BANCORP (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEET
- -------------------------------------------------------------------------
December 31,
(dollars in thousands) 2003 2002
- -------------------------------------------------------------------------
Assets
Deposits in affiliate bank $ 174 $ 127
Deposits in banks 8 8
Investments at fair value 1,181 999
Investment in affiliates:
Bank, including purchase accounting goodwill
of $5,102 in 2003 and 2002 731,978 751,052
Non-banks 112,411 75,280
Advances to affiliates 81,611 77,807
Other assets 84,418 73,475
- -------------------------------------------------------------------------
Total assets $1,011,781 $ 978,748
=========================================================================
Liabilities and Shareholders' Equity
Other liabilities $ 25,755 $ 15,851
Other borrowings 270,536 58,344
Guaranteed preferred beneficial interests in
subordinated debentures -- 163,843
Shareholders' equity 715,490 740,710
- -------------------------------------------------------------------------
Total liabilities and shareholders' equity $1,011,781 $ 978,748
=========================================================================
OLD NATIONAL BANCORP (PARENT COMPANY ONLY)
CONDENSED STATEMENT OF INCOME
- -----------------------------------------------------------------------------
Years Ended December 31,
(dollars in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------
Income
Dividends from affiliates $56,000 $71,550 $145,500
Other income 2,089 2,263 1,171
Other income from affiliates 24,306 22,311 28,108
- -----------------------------------------------------------------------------
Total income 82,395 96,124 174,779
- -----------------------------------------------------------------------------
Expense
Interest on borrowings 8,141 9,726 10,758
Amortization of goodwill - - 559
Other expenses 34,557 19,709 28,740
- -----------------------------------------------------------------------------
Total expense 42,698 29,435 40,057
- -----------------------------------------------------------------------------
Income before income taxes and equity
in undistributed earnings of affiliates 39,697 66,689 134,722
Income tax benefit (8,042) (3,417) (4,768)
- -----------------------------------------------------------------------------
Income before equity in undistributed
earnings of affiliates 47,739 70,106 139,490
Equity in undistributed earnings of affiliates 22,674 47,826 (46,446)
- -----------------------------------------------------------------------------
Net income $70,413 $117,932 $93,044
=============================================================================
61
OLD NATIONAL BANCORP (PARENT COMPANY ONLY)
CONDENSED STATEMENT OF CASH FLOWS
- -------------------------------------------------------------------------------------------
Years Ended December 31,
(dollars in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 70,413 $117,932 $ 93,044
- -------------------------------------------------------------------------------------------
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation 491 483 668
Amortization of goodwill - - 559
(Increase) decrease in other assets (13,108) (26,891) 1,464
Increase in other liabilities 9,904 3,850 1,460
Equity in undistributed earnings of affiliates (22,674) (47,826) 46,446
- -------------------------------------------------------------------------------------------
Total adjustments (25,387) (70,384) 50,597
- -------------------------------------------------------------------------------------------
Net cash flows provided by operating activities 45,026 47,548 143,641
- -------------------------------------------------------------------------------------------
Cash Flows From Investing Activities
Purchases of subsidiaries (16,295) (31,863) -
Purchases (sales) of investment securities available-for-sale - 16,608 (17,584)
Net advances to affiliates (3,804) (38,344) (31,403)
Purchases of premises and equipment (412) (670) (451)
- -------------------------------------------------------------------------------------------
Net cash flows used in investing activities (20,511) (54,269) (49,438)
- -------------------------------------------------------------------------------------------
Cash Flows From Financing Activities
Payments for maturities on other borrowings (45,000) (24,100) (1,500)
Proceeds from issuance of other borrowings 100,000 - -
Proceeds from guaranteed preferred beneficial
interest in subordinated debentures - 100,000 -
Cash dividends paid (48,366) (43,926) (40,131)
Common stock repurchased (37,830) (31,552) (54,723)
Common stock reissued under stock option
and stock purchase plans 6,728 6,357 2,126
- -------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities (24,468) 6,779 (94,228)
- -------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 47 58 (25)
Cash and cash equivalents at beginning of period 135 77 102
- -------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 182 $ 135 $ 77
===========================================================================================
NOTE 21 - SEGMENT INFORMATION
Old National operates in three reportable segments: community banking, non-bank
services 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.
The non-bank services segment combines the management and operations of trust,
asset management, insurance brokerage and investment and annuity sales. 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 customers. The accounting
policies of the segments are the same as those described in Note 1.
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 management changes. Income taxes
are allocated using the effective tax rate. Also, to provide a basis for
employee incentives, revenues and expenses related to the non-bank services
segment are allocated to the community banking segment and reflected in both the
community banking segment and the non-bank services segment. This allocation of
revenue and expense is eliminated in the "Other" column. The "Other" column for
2003 includes noninterest expense of $10.0 million and segment loss of $6.7
million after-tax related to litigation as discussed in Note 17. The "Other"
column for 2002 also includes noninterest income of $12.5 million and segment
profit of $8.3 million after-tax related to the branch divestitures as discussed
in Note 2. In
62
2001, the "Other" column includes segment noninterest expense of $9.7 million
and segment loss of $5.9 million after-tax related to merger and restructuring
costs as discussed in Note 22. 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 the community banking and non-bank services
segments net interest income. 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 years ended December 31:
- ----------------------------------------------------------------------------------------------------
Community Non-bank
(dollars in thousands) Banking Services Treasury Other Total
- ----------------------------------------------------------------------------------------------------
2003
Net interest income $ 292,643 $ 272 $ (24,882) $ 3,974 $ 272,007
Provision for loan losses 85,000 -- -- -- 85,000
Noninterest income 124,796 75,055 30,647 (38,349) 192,149
Noninterest expense 254,353 68,686 1,052 (24,375) 299,716
Income tax expense (benefit) 19,327 2,169 (9,203) (3,266) 9,027
Segment profit (loss) 58,759 4,472 13,916 (6,734) 70,413
Total assets 5,794,286 137,927 3,286,544 135,139 9,353,896
- ----------------------------------------------------------------------------------------------------
2002
Net interest income $ 299,429 $ 1,565 $ (13,242) $ 1,677 $ 289,429
Provision for loan losses 33,500 -- -- -- 33,500
Noninterest income 111,477 50,464 20,706 (28,150) 154,497
Noninterest expense 246,030 48,405 2,355 (38,945) 257,845
Income tax expense (benefit) 38,116 1,222 (8,879) 4,190 34,649
Segment profit 93,260 2,402 13,988 8,282 117,932
Total assets 6,066,210 97,051 3,359,363 89,932 9,612,556
- ----------------------------------------------------------------------------------------------------
2001
Net interest income $ 282,412 $ 779 $ 5,940 $ 2,168 $ 291,299
Provision for loan losses 28,700 -- -- -- 28,700
Noninterest income 100,713 35,335 9,864 (32,945) 112,967
Noninterest expense 241,697 32,742 1,447 (21,074) 254,812
Income tax expense (benefit) 34,057 1,172 (3,736) (3,783) 27,710
Segment profit (loss) 78,671 2,200 18,093 (5,920) 93,044
Total assets 6,505,072 28,101 2,454,630 92,670 9,080,473
- ----------------------------------------------------------------------------------------------------
63
NOTE 22 - MERGER AND RESTRUCTURING COSTS
During the second quarter of 2001, Old National announced that it would further
restructure its regional banking administrative structure and incur additional
expenses in the consolidation of ANB Corporation, which it acquired in the first
quarter of 2000. The restructuring of the banking operations involved
consolidating the administrative structure of the banking franchise from six
regions into three regions and the closure or sale of up to 10 branches.
Approximately 100 positions were eliminated and the charges associated with
severance, facilities and equipment write-offs were $7.7 million. The operations
and management integration plan was finalized for the ANB acquisition and
additional charges of $2.0 million for personnel costs and costs of
consolidating the operation function of the Trust business were recorded. The
components of the charges were as follows:
--------------------------------------------------------
(dollars in thousands)
--------------------------------------------------------
Professional fees $ 428
Severance and related costs 6,477
Fixed asset write-downs 2,047
Other 751
--------------------------------------------------------
Total merger and restructuring costs $9,703
========================================================
The changes to the remaining restructuring charge accrual were as follows for
the years ended December 31:
--------------------------------------------------------
(dollars in thousands) 2003 2002
--------------------------------------------------------
Balance, January 1 $1,039 $ 4,124
Payments:
Professional fees - (126)
Severance and related costs (630) (2,000)
Fixed asset write-downs (53) (457)
Other - (502)
--------------------------------------------------------
Balance, December 31 $ 356 $ 1,039
========================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Old National's principal
executive officer and principal financial officer have concluded that Old
National's disclosure controls and procedures (as defined in Exchange Act Rule
13a-14(c) under the Securities Exchange Act of 1934, as amended), based on their
evaluation of these controls and procedures as of the end of the period covered
by this annual report on Form 10-K, are effective at the reasonable assurance
level as discussed below to ensure that information required to be disclosed by
Old National in the reports it files under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the Securities and Exchange
Commission and that such information is accumulated and communicated to Old
National's management, including its principal executive officer and principal
financial officer, as appropriate to allow timely decisions regarding required
disclosure.
Limitations on the Effectiveness of Controls. Management, including the
principal executive officer and principal financial officer, does not expect
that Old National's disclosure controls and internal controls will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within the company have
been detected. These inherent limitations include the realities that judgements
in decision-making can be faulty, and that breakdowns can occur because of
simple error or mistake. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more people or by
management override of the controls.
64
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be only
reasonable assurance that any design will succeed in achieving its stated goals
under all potential future conditions, over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Significant changes were made during 2003 to upgrade and improve the systems and
controls used by management in the determination of an appropriate allowance for
loan losses at December 31, 2003. These new controls continue to be tested and
refined and management used a variety of additional information and analytical
techniques to supplement the data provided by the new methodology in arriving at
the appropriate allowance at year-end 2003.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information is omitted from this report pursuant to General Instruction
G.(3) of Form 10-K as Old National will file with the Commission its definitive
Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, not later than 120 days after December 31, 2003.
Old National has adopted a code of ethics that applies to Old National's
principal executive officer, principal financial officer and principal
accounting officer. The text of the code of ethics is available on Old
National's Internet website at www.oldnational.com.
ITEM 11. EXECUTIVE COMPENSATION
This information is omitted from this report pursuant to General Instruction
G.(3) of Form 10-K as Old National will file with the Commission its definitive
Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, not later than 120 days after December 31, 2003.
65
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
This information is omitted from this report, with the exception of the equity
compensation plan information, pursuant to General Instruction G.(3) of Form
10-K as Old National will file with the Commission its definitive Proxy
Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended, not later than 120 days after December 31, 2003.
EQUITY COMPENSATION PLAN INFORMATION
The following table contains information concerning the 1999 Equity Incentive
Plan approved by security holders in 1999 as of the fiscal year ended December
31, 2003.
- ----------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plan
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- ----------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 6,350,433 $22.01 924,372
Equity compensation plans not
approved by security holders - - -
- ----------------------------------------------------------------------------------------------------------
Total 6,350,433 $22.01 924,372
==========================================================================================================
NOTE: Old National has assumed a number of stock options through various
mergers. The number of stock options outstanding related to acquisitions at
December 31, 2003, was 115,834 with a weighted-average exercise price of $12.17.
The stock options outstanding and the exercise price have been adjusted for a 5%
stock dividend to shareholders of record on January 6, 2004, and distributed on
January 27, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is omitted from this report pursuant to General Instruction
G.(3) of Form 10-K as Old National will file with the Commission its definitive
Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, not later than 120 days after December 31, 2003.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
This information is omitted from this report pursuant to General Instruction
G.(3) of Form 10-K as Old National will file with the Commission its definitive
Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, not later than 120 days after December 31, 2003.
66
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
The following consolidated financial statements of the registrant and its
subsidiaries are filed as part of this document under "Item 8. Financial
Statements and Supplementary Data."
Report of Independent Accountants
Consolidated Balance Sheet--December 31, 2003 and 2002
Consolidated Statement of Income--Years Ended December 31, 2003, 2002
and 2001
Consolidated Statement of Changes in Shareholders' Equity--Years Ended
December 31, 2003, 2002 and 2001
Consolidated Statement of Cash Flows--Years Ended December 31, 2003,
2002 and 2001
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
The schedules for Old National and its subsidiaries are omitted because
absence of conditions under which they are required, or because the
information is set forth in the consolidated financial statements or the
notes thereto.
3. Exhibits
The exhibits filed as part of this report and exhibits incorporated herein
by reference to other documents are as follows:
Exhibit
Number
3 (i) Articles of Incorporation of Old National (incorporated by
reference to Exhibit 3(i) of Old National's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002).
3 (ii) By-Laws of Old National (incorporated by reference to Exhibit
3(ii) of Old National's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).
4 Instruments defining rights of security holders, including
indentures
Form of Indenture between Old National and Bank One Trust Company,
NA, as trustee (incorporated by reference to Exhibit 4.1 to Old
National's Registration Statement on Form S-3, Registration No.
333-87573, filed with the Securities and Exchange Commission on
September 22, 1999).
10 Material contracts
(a) Old National Bancorp Employees' Retirement Plan (incorporated by
reference to Old National's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997).*
(b) Employees' Savings and Profit Sharing Plan of Old National Bancorp
(incorporated by reference to Old National's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997).*
(c) Form of Severance Agreement for James A. Risinger, Thomas F.
Clayton, Michael R. Hinton, Daryl D. Moore and John S. Poelker,
as amended (incorporated by reference to Old National's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998).*
(d) Old National Bancorp 1999 Equity Incentive Plan (incorporated by
reference to Old National's Form S-8 filed on July 20, 2001).*
67
(e) Stock Purchase and Dividend Reinvestment Plan (incorporated by
reference to Old National's Post-Effective Amendment of the
Registration Statement on Form S-3, Registration No. 333-20083,
filed with the Securities and Exchange Commission on August 14,
2000).
(f) Construction Manager Contract, dated as of May 30, 2002, between Old
National Bancorp and Industrial Contractors, Inc. (incorporated by
reference to Old National's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).
(g) Owner-Contractor Agreement, dated as of October 11, 2002, between
Old National Bancorp and Industrial Contractors, Inc. (incorporated
by reference to Old National's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).
(h) Summary of Old National Bancorp's Outside Director Compensation
Program (incorporated by reference to Old National's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).*
21 Subsidiaries of Old National
23 Consent of PricewaterhouseCoopers LLP
31.1 Certification of Principal Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Principal Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
--------------
* Management contract or compensatory plan or arrangement
With the exception of the information herein expressly incorporated by
reference, the 2003 Proxy Statement is not to be deemed filed as part of
this annual report on Form 10-K.
(b) Reports on Form 8-K filed during the quarter ended December 31, 2003.
Old National filed a current report on Form 8-K dated October 24, 2003. The
purpose of this Form 8-K was to report the comments of the conference call
held by Old National for the third quarter 2003.
Old National filed a current report on Form 8-K dated October 23, 2003. The
purpose of this Form 8-K was to report Old National's results for the third
quarter 2003.
68
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, Old National has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
OLD NATIONAL BANCORP
By: /s/ James A. Risinger Date: March 15, 2004
----------------------- -------------
James A. Risinger,
Chairman of the Board of Directors,
Chief Executive Officer (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on March 15, 2004, by the following persons on behalf of
Old National and in the capacities indicated.
By: /s/ Alan W. Braun By: /s/ James A. Risinger
----------------------------- ------------------------
Alan W. Braun, Director James A. Risinger,
Chairman of the Board of Directors and
By: /s/ Larry E. Dunigan Chief Executive Officer (Principal
----------------------------- Executive Officer)
Larry E. Dunigan, Director
By: /s/ Marjorie Z. Soyugenc
By: /s/ David E. Eckerle ---------------------------
----------------------------- Marjorie Z. Soyugenc, Director
David E. Eckerle, Director
By: /s/ Kelly N. Stanley
By: /s/ Niel C. Ellerbrook ---------------------------
----------------------------- Kelly N. Stanley, Director
Niel C. Ellerbrook, Director
By: /s/ Charles D. Storms
By: /s/ Douglas D. French ---------------------------
----------------------------- Charles D. Storms, Director
Douglas D. French, Director
By: /s/ John S. Poelker
By: /s/ Andrew E. Goebel ----------------------------
----------------------------- John S. Poelker,
Andrew E. Goebel, Director Executive Vice President and Chief
Financial Officer (Principal Financial
By: /s/ Phelps L. Lambert Officer)
-----------------------------
Phelps L. Lambert, Director By: /s/ Candice J. Jenkins
----------------------------
By: /s/ Lucien H. Meis Candice J. Jenkins,
----------------------------- Vice President and Corporate Controller
Lucien H. Meis, Director (Principal Accounting Officer)
By: /s/ Louis L. Mervis
-----------------------------
Louis L. Mervis, Director
69